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MISCELLANEOUS  REVENUE  ISSUES 


Y  4.  W  36: 103-64 

ffiscellaneous  Revenue  Issues>   Seria... 

HEARINGS 

BEFORE  THE 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

OF  THE 

COMMITTEE  ON  WAYS  AND  MEANS 
HOUSE  OF  REPRESENTATIVES 

ONE  HUNDRED  THIRD  CONGRESS 

FIRST  SESSION 


JUNE  17,  22,  24;  JULY  13,  1993;  AND  SEPTEMBER  8,  21,  23,  1993 


PART  2  OF  3 

SEPTEMBER  8,  21,  AND  23,  1993 


Serial  103-64 


Printed  for  the  use  of  the  Committee  on  Ways  and  Means 


oppoftrmov 


JUL2  0t99* 
BOSTONeobaGUttHAF 


MISCEIiANEOUS  REVENUE  ISSUES 


HEARINGS 

BEFORE  THE 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 


OF  THE 


COMMITTEE  ON  WAYS  AND  MEANS 
HOUSE  OP  REPRESENTATIVES 

ONE  HUNDRED  THIRD  CONGRESS 

FIRST  SESSION 


JUNE  17,  22,  24;  JULY  13,  1993;  AND  SEPTEMBER  8,  21,  23,  1993 


PART  2  OF  3 

SEPTEMBER  8,  21,  AND  23,  1993 


Serial  103-64 


Printed  for  the  use  of  the  Committee  on  Ways  and  Means 


U.S.  GOVERNMENT  PRINTING  OFFICE 
WASHINGTON   :  1994 


For  sale  by  the  U.S.  Government  Printing  Office 
Superintendent  of  Documents,  Congressional  Sales  Office,  Washington,  DC  20402 
ISBN  0-16-04A369-5 


COMMITTEE  ON  WAYS  AND  MEANS 
DAN  ROSTENKOWSKI,  IllinoiB.  Chairman 


SAM  M.  GIBBONS,  Florida 
JJ.  PICKLE,  Texas 
CHARLES  B.  RANGEL,  New  York 
FORTNEY  PETE  STARK,  California 
ANDY  JACOBS,  Jk.,  Indiana 
HAROLD  E.  FORD,  Tennessee 
ROBERT  T.  MATSUI.  California 
BARBARA  B.  KENNELLY,  Connecticut 
WILLIAM  J.  COYNE,  Pennsylvania 
MICHAEL  A.  ANDREWS.  Texas 
SANDER  M.  LEVIN,  Michigan 
BENJAMIN  L.  CARDIN,  Maryland 
JIM  MCDERMOTT,  Washington 
GERALD  D.  KLECZKA,  Wisconsin 
JOHN  LEWIS,  Georgia 
L.F.  PAYNE,  Virginia 
RICHARD  E.  NEAL,  Massachusetts 
PETER  HOAGLAND,  Nebraska 
MICHAEL  R.  MCNULTY,  New  York 
MIKE  KOPETSKI,  Oregon 
WILLIAM  J.  JEFFERSON,  Louisiana 
BILL  K.  BREWSTER,  Oklahoma 
MEL  REYNOLDS,  Illinois 


BILL  ARCHER,  Texas 
PHILIP  M.  CRANE,  Illinois 
BILL  THOMAS,  California 
E.  CLAY  SHAW,  JR.,  Florida 
DON  SUNDQUIST,  Tennessee 
NANCY  L.  JOHNSON,  Connecticut 
JIM  BUNNING,  Kentucky 
FRED  GRANDY,  Iowa 
AMO  HOUGHTON,  New  York 
WALLY  HERGER,  California 
JIM  McCRERY,  Louisiana 
MEL  HANCOCK,  Missouri 
RICK  SANTORUM,  Pennsylvania 
DAVE  CAMP,  Michigan 


Janice  Mays,  Chief  Counsel  and  Staff  Director 
ChaRL£S  M.  Brain,  Assistant  Staff  Director 
PHILUP  D.  Moseley,  Minority  Chief  of  Staff 


Subcommittee  on  Select  Revenue  Measures 


CHARLES  B.  RANGEL,  New  York,  Chairman 

L.F.  PAYNE,  Virginia  MEL  HANCOCK,  Missouri 

RICHARD  E.  NEAL,  Massachusetts  DON  SUNDQUIST, 

PETER  HOAGLAND,  Nebraska  JIM  McCRERY,  Louisiana 

MICHAEL  R.  McNULTY,  New  York  DAVE  CAMP,  Michigan 
MIKE  KOPETSKI,  Oregon 
ANDY  JACOBS.  Jr..  Indiana 


(ID 


CONTENTS 


Page 

Part  1  (June  17,  22,  24;  and  July  13,  1993)  1 

Part  2  (September  8,  21,  and  23,  1993)  1055 

Part  3  (Submissions  for  the  Record — Revenue  losers  and  revenue 

raisers) 1787 

Press  releases  announcing  the  hearings  2 

WITNESSES 

U.S.  Department  of  the  Treasury,  Hon.  Leslie  B.  Samuels,  Assistant 
Secretary  for  Tax  Policy: 

June  22,  1993 299 

September  21,  1993  1397 

U.S.  Department  of  Commerce,  Diana  H.  Josephson,  Deputy  Under  Secretary 
for  Oceans  and  Atmosphere,  National  Oceanic  and  Atmospheric  Adminis- 
tration    353 

U.S.  (General  Accounting  Office,  Natwar  M.  Gandhi,  Associate  Director,  Tax 
Policy  and  Administration  Issues,  General  Government  Division,  Tom 
Short,  Assignment  Manager,  and  David  Pasquarello,  Evaluator,  Philadel- 
phia GAO  1421 

Abrahamson,  (Jen.  James  A.,  Oracle  Corp.,  and  FSC  Software  Coalition  638 

Actors'  Equity  Association,  Ron  Silver  and  Mark  J.  Weinstein  1121 

Ad  Hoc  Group  to  Preserve  Deduction  for  Advertising,  Mark  McConaghy 1171 

Advanced  Micro  Devices,  Cliff  Jemigan  265 

Advertising  Tax  Coalition 

Timothy  White  1179 

Dewitt  F.  Helm,  Jr  1184 

Aerospace  Industries  Association,  Douglas  C.  McPherson 668 

Aerospace  States  Association  (see  listing  for  Hon.  C.  Michael  Callihan) 

Air  Transport  Association  of  America,  Edward  A.  Merlis  1303 

Alfers,  Stephen  D.,  Mineral  Resources  Alliance 1265 

Alliance  for  Collaborative  Research,  Larry  W.  Sumney  371 

Alliance  for  Responsible  CFC  Policy,  Kevin  J.  Fay  1709 

Alliance  of  American  Insurers,  Robert  Jarratt 1488 

Alliance  to  Save  Energy,  Mary  Beth  Zimmerman  699 

Allis,  John  E.,  Houston,  Tex  1536 

American  Agriculture  Movement,  Inc.,  Harvey  Joe  Sanner  1740 

American  Bankers  Association,  Taxation  Committee,  Lynda  A.  Kern 192 

American  Bar  Association,  Section  of  Taxation,  Committee  on  S  Corporations, 

Jordan  P.  Rose 434 

American  Express  Travel  Related  Services,  Co.,  Richard  P.  Romeo  1153 

American  Farmland  Trust,  Edward  Thompson,  Jr 801 

American  Federation  of  Television  &  Radio  Artists,  Ron  Silver  and  Mark 

Weinstein  1121 

American  Financial  Services  Association,  Richard  P.  Romeo  1153 

American  Football  Coaches  Association,  Charles  McClendon  91 

American  Institute  of  Certified  Public  Accountants: 

Gerald  W.  Padwe  466 

Pamela  J.  Pecarich  1454 

American  Insurance  Association,  Robert  Rahn  1500 

(III) 


IV 

Page 

American  Iron  Ore  Association,  John  L.  Kelly 1275 

American  Land  Title  Association,  Irving  Morgenroth  1037 

American  Nuclear  Insurers,  Robert  Rahn  1500 

American  Public  Power  Association,  Stephen  F.  Johnson  770 

American  Society  of  Association  Executives,  Susan  Bitter  Smith 1335 

American  Vintners  Association,  Herbert  Schmidt  141 

American  Wind  Energy  Association,  Michael  L.  Marvin  756 

AmSouth  Bank  N.A.,  Lynda  A.  Kern 192 

Aponte,  Angelo  J.,  National  Council  of  State  Housing  Agencies,  and  New 

York  State  Division  of  Housing  and  Community  Renewal 876 

Arizona  Cable  Television  Association,  Susan  Bitter  Smith  1335 

Amdt,   Aurel   M.,   National   League   of  Cities,   et   al;   and   Lehigh  County 

Authority 979 

Associated  Builders  &  Contractors,  Inc.: 

Robert  Permison  and  Bernard  Leibtag 427 

Don  Owen 1547 

Associated  General  Contractors  of  America,  Robert  J.  Desjardins 

July  13,  1993  1030 

September  21,  1993  1553 

Association  of  American  Railroads,  Edwin  L.  Harner  514 

Association  of  Christian  Schools  International,  Jonn  C.  Holmes  1082 

Association  of  Independent  Colleges  of  Art  and  Design,  Fred  Lazarus  IV  1103 

Association  of  Local  Housing  Finance  Agencies,  Stephen  G.  Leeper  887 

Association  of  National  Advertisers,  Inc.,  Dewitt  F.  Helm,  Jr  1184 

Bacchus,  Hon.  Jim,  a  Representative  in  Congress  from  the  State  of  Florida  ....  989 

Baptist  Foundation  of  Oklahoma,  James  H.  Lockhart  1768 

Barlow,  Hon.  Thomas  J.  Ill,  a  Representative  in  Congress  from  the  State 

of  Kentucky 1598 

Bartsch,  Charles,  Northeast  Midwest  Institute  840 

Battle  Fowler  Uw  Offices,  Richard  L.  OToole  227 

Beard,  E.  Lee,  Business  Women's  GolPLink,  and  First  Federal  Savings  1325 

Bechtel  Construction  Co.,  Michael  E.  Martello  1043 

Berman,  Hon.  Howard  L.,  a  Representative  in  Congress  from  the  State  of 

California  100 

Bloch,  Robert  A.,  Gordonsville,  Va  794 

Borton,    Pamela    K.,    Council    for   Rural    Housing   and    Development,    and 

Southwind  Management  Company 902 

Bouldin,  Kenneth  A.,  CDLA  Computer  Leasing  &  Remarketing  Association  ....  272 
Bretagne  Corp.,  Virginia  Lazenby: 

June  24,  1993  691 

September  8,  1993  1242 

Bristol  Savings  Bank  of  Connecticut,  Edward  P.  Lorenson  562 

Brooklyn  Union  Gas  Co.,  Fred  J.  Gentile  1632 

Bryn  Awel  Corp.,  Gerald  J.  Herr 1558 

Buford,  Shamia  "Tab,"  City  National  Bank  of  Newark  233 

Building  Owners  &  Managers  Association  International: 

James  C.  Dinegar  1738 

Thomas  B.  McChesney  254 

Bunning,  Hon.  Jim,  a  Representative  in  Congress  from  the  State  of  Kentucky  1595 

Business  Women's  GolPLink,  E.  Lee  Beard  1325 

Cahan,  Cora,  New  42nd  Street,  Inc  361 

California  Association  of  Winegrape  Growers,  Robert  P.  Hartzell  1648 

California  Carrot  Board,  John  Guerard 1662 

California  League  of  Savings  Institutions,  Henry  W.  Schmidt,  Jr 1309 

California  Pistachio  Commission,  Joseph  C.  Macllvarne  1655 

California  Water  Service  Co.,  Donald  L.  Houck 132 

Callihan,  Hon.  C.  Michael,  Lieutenant  Governor  of  Colorado;  and  Aerospace 
States  Association,  as  presented  by  Hon.  Joel  Hefley,  a  Representative 

in  Congress  from  Colorado  865 

Campbell,  Robert  H.,  Independent  Refiners  Coalition,  and  Sun  Co.,  Inc  1229 

Capon,  Ross,  Nationsd  Association  of  Railroad  Passengers  518 

Carbonic  Industries  Corp.,  J.  Vernon  Hinely  1760 

CDLA  Computer  Leasing  &  Remarketing  Association,  Kenneth  A.  Bouldin  272 

Central  State  Life  Insurance  Co.,  Virginia  Kirkland  Shehee  158 

Chemical  Manufacturers  Association,  Thomas  G.  Singley 1472 

Chicago  Title  &  Trust  Co.,  B.  Wyckliffe  Pattishall  1673 

Chicago,  City  of,  Hon.  Richard  M.  Daley,  Mayor 830 


V 

Page 

Cianbro  Corp.,  Robert  J.  Desjardins: 

July  13,  1993  1030 

September  21,  1993  1553 

City  National  Bank  of  Newark,  Shamia  'Tab"  Buford  233 

Cleveland-Cliffs,  Inc.,  John  L.  Kelly  1275 

Coalition  for  Asset  Backed  Securities,  Donald  B.  Susswein  214 

Coalition  for  the  Fair  Treatment  of  Environmental  Cleanup  Costs,  Wajrne 

Robinson 1626 

Coalition  on  Energy  Taxes,  R.  David  Damron  1254 

Coalition  to   Elinunate   Tax   Barriers   to  Environmental   Cleanup,   Fred  J. 

Gentile 1632 

Coalition  to  Preserve  the  Current  Deductibility  of  Environmental  Remedi- 
ation Costs,  Roy  E.  Hock  1604 

Cohber  Press,  Inc.,  Howard  C.  Webber,  Jr 1209 

Cohen,  Sheldon  S.,  Leadership  Council  on  Advertising  Issues 1192 

Colorado,  State  of  (see  listing  for  Hon.  C.  Michael  Callihan) 

Commercial  Finance  Association,  Louis  Eliasberg,  Jr 201 

Conmiittee  for  Competition  Through  Advertising,  Gerald  Z.  Gibian  1164 

Community  Bankers  Association  of  Illinois,  David  E.  Manning  208 

Computer     &     Business     Equipment     Manufacturers     Association,     Robert 

Mattson  645 

Conference  of  Chief  Justices,  and  Conference  of  State  Court  Administrators, 

Hon.  Thomas  R.  Phillips,  Chief  Justice 71 

Construction  Financial  Management  Association,  Gerald  J.  Herr 1558 

Contos,   Larry,  National  Grocers  Association,  and  Pay  Less  Supermarkets, 

Inc 523 

Coopers  &  Lybrand,  Ronald  T.  Maheu  1754 

Comeel,  Frederic  G.,  Sullivan  &  Worcester  479 

Costello,  Hon.  Jerry  F.,  a  Representative  in   Congress  from  the  State  of 

Illinois  64 

Council  for  Rural  Housing  and  Development,  Pamela  K.  Borton  902 

Cox,  Dale,  Independent  Bakers  Association  1094 

Crispin,  Robert  W.,  Travelers  Corp 180 

Crop  Protection  Coalition,  Richard  Douglas 1745 

Dakin,  William  G.,  National  Association  of  Manufacturers,  and  Mobil  Corp  ....  1431 

Daley,  Hon.  Richard  M.,  Mayor,  City  of  Chicago  830 

Damron,  R.  David,  Petrochemical  Energy  Group,  Coalition  on  Energy  Taxes, 

and  Hoechst  Celanese  Corp 1254 

DeFazio,  Hon.  Peter  A.,  a  Representative  in  Congress   from  the  State  of 

Oregon  59 

Desjardins,    Robert   J.,    Associated    General    Contractors    of  America,    and 

Cianbro  Corp.: 

July  13,  1993  1030 

September  21,  1993  1553 

Destec  Energy,  Inc.,  Tom  Remar 677 

Dinegar,  James  C,  Building  Owners  &  Managers  Association  International  ...  1738 

Disabled  American  Veterans,  John  F.  Heilman  120 

Douglas,  Richard,  Crop  Protection  Coalition,  and  Sun-Diamond  Growers  of 

California  1745 

Dyer,  Randy  (see  listing  for  National  Structured  Settlement  Trade  Associa- 
tion) 

Education  Finance  Council,  Lawrence  W.  OToole  1136 

Ege,  Karl  J.,  Frank  Russell  Co.  and  Frank  Russell  Investment  Management 

Co 593 

Electronic  Industries  Association,  Peter  F.  McCloskey: 

July  13,  1993  622 

September  21,  1993  1464 

Eliasberg,  Louis,  Jr.,  Commercial  Finance  Association,  and  Finance  Company 

of  America 201 

Elliott,  Gary,  National  Wood  Energy  Association  751 

Emergency  Committee  for  American  Trade,  Raymond  J.  Wiacek 1528 

Emil  Buehler  Perpetual  Trust,  Ira  J.  Kaltman 420 

Erlandson,  Dawn,  Friends  of  the  Earth 1294 

Estee  Lauder  Co.,  Gerald  Z.  Gibian  1164 

Farren,  Michael  J.,  Xerox  Corp  631 

Fay,  Kevin  J.,  Alliance  for  Responsible  CFC  Policy  1709 

Feeney,  David  L.,  National  Retail  Federation,  and  R.H.  Macy  &  Co.,  Inc  1203 


VI 

Page 
Feulner,  Edwin  J.,  Jr.  {see  listing  for  Heritage  Foundation) 

Finance  Company  of  America,  Louis  Eliasberg,  Jr 201 

Fink,  Matthew  P.,  Investment  Company  Institute 572 

Firemen's  Association  of  the  State  of  New  York,  Kenneth  E.  Newton  ..!!".***...il  105 

First  Colony  Life  Insurance  Co.,  Andrew  Larsen 174 

First  Federal  Savings,  E.  Lee  Beard 1325 

Florida  Clinical  Practice  Association,  Inc.,  Stanley  W.  Rosenkranz  ................."  1106 

Florida  Farm  Bureau  Casualty  Insurance  Co.,  Robert  Jarratt 1488 

Florida  Farm  Bureau  General  Insurance  Co.,  Robert  Jarratt  .....".  1488 

Forest  Industries  Council  on  Taxation,  Bartow  S.  Shaw,  Jr 682 

Frank  Russell  Co.,  and  Frank  Russell  Investment  Management  Co.,  Karl 

J.  Ege,  and  Warren  Thompson 593 

Friends  of  the  Earth,  Dawn  Erlandson  1284 

FSC  Software  Coalition,  Gen.  James  A.  Abrahamson 638 

Gackenbach,  Julie  Leigh,  U.S.  Chamber  of  Commerce  I444 

GenCorp,  Wayne  Robinson  1626 

General  Dynamics  Corp.,  Douglas  C.  McPherson  668 

General  Motors  Corp.,  G.  Mustafa  Mohatarem 262 

Gentile,  Fred  J.,  Coalition  to  Eliminate  Tax  Barriers  to  Environmental  Clean- 
up, and  Brooklyn  Union  Gas  Co  1632 

Gentile,  Peter  A.,  North  American  Reinsurance  Corp  1480 

Geothermal  Resources  Association,  Thomas  C.  Hinnchs  766 

Gibian,  Gerald  Z.,  Estee  Lauder  Co.,  and  Committee  for  Competition  Through 

Advertising 1164 

Gill,  Charles  B.,  National  Rural  Utilities  Cooperative  Finance  Corp  1346 

Girard,  William  C.  "Chris,"  National  Association  of  Convenience  Stores,  and 

Plaid  Pantries  538 

Glunt,  Roger  C,  (see  listing  for  National  Association  of  Home  Builders) 

Golden  State  Mutual  Life  Insurance  Co.,  Laricin  Teasley  187 

Graphic  Arts  Legislative  Council,  Howard  C.  Webber,  Jr  1209 

Great  Western  Financial   Corp.,  Michael  Palko  (see  listing  for  Savings  & 
Community  Bankers  of  America) 

Green,  Robert  H.,  National  Foreign  Trade  Council,  Inc 1507 

Gregg.  Robert  S.,  Sequent  Computer  Systems,  Inc  389 

GrilTm,  James  T.,  John  D.  and  Catherine  T.  MacArthur  Foundation  402 

Grubb  &  Ellis  Co.,  Thomas  B.  McChesney 254 

Guerard,  John,  California  Carrot  Board,  and  Wm.  Bolthouse  Farms,  Inc  1662 

Hamrick,  Stephen  H.,  Investment  Program  Association,  and  PaineWebber 

Inc 496 

Harman,  Hon.  Jane,  a  Representative  in  Congress  from  the  State  of  Califor- 
nia    1073 

Harper,  Edwin  L.,  Association  of  American  Railroads  514 

Hartzell,  Robert  P.,  California  Association  of  Winegrape  Growers  1648 

Hecht,  Marjorie  Mazel,  21st  Century  Science  &  Technology  1730 

Hefley,  Hon.  Joel,  a  Representative  in  Congress  from  the  State  of  Colorado 
(see  listing  for  Hon.  C.  Michael  Callihan) 

Heilman,  John  F.,  Disabled  American  Veterans 120 

Helm,  Dewitt  F.,  Jr.,  Advertising  Tax  Coalition,  and  Association  of  National 

Advertisers,  Inc  1184' 

Henderson,  Robert  E.,  South  Carolina  Research  Authority 973 

Heritage  Foundation,  William  J.  Lehrfeld  (on  behalf  of  Edwin  J.  FauLaer, 

Jr.)  1331 

Herr,  Gerald  J.,  Construction  Financial  Management  Association,  and  Bryn 

Awel  Corp  1558 

Hinely,  J.  Vernon,  Carbonic  Industries  Corp  1760 

Hinrichs,  Thomais  C,  Geothermal  Resources  Association,  and  Magma  Power 

Co 766 

Hock,  Rov  E.,  Coalition  to  Preserve  Deductibility  of  Environmental  Remedi- 
ation Costs,  and  Technitrol,  Inc  1604 

Hoechst  Celanese  Corp.,  R.  David  Damron 1254 

Holmes,  John  C,  Association  of  Christian  Schools  International  1082 

Home  Health  Services  and  Stafiing  Association,  James  C.  Pyles  1574 

Hood,  John  A.,  National  Assisted  Management  Association,  and  Volunteers 

of  America  940 

Horn,  Hon.  Stephen,  a  Representative  in  Congress  from  the  State  of  Califor- 
nia    1074 

Houck,  Donedd  L.,  National  Association  of  Water  Cos.,  and  California  Water 

Service  Co  132 


VII 

Page 

Housing,  Urban  Redevelopment  Authority  of  Pittsburgh,  Stephen  G.  Leeper  ...  887 

Hughes,  Vester  T.,  Jr.,  Hughes  &  Luce  126 

Hyman,  Morton  P.,  International  Shipholding  Corp.;  Overseas  Shipholding 

Group,  Inc.;  and  OMI  Corp  660 

IBM  Corp.,  Robert  Mattson  645 

Independent  Bakers  Association,  Dale  Cox  1094 

Independent  Petroleum  Association  of  America,  Vii^nia  Lazenby: 

June  24,  1993  691 

September  8,  1993  1242 

Independent  Refiners  Coalition,  Robert  H.  Campbell  1229 

International  Shipholding  Corp.,  Morton  P.  Hyman  660 

Investment  Company  Institute,  Matthew  P.  Fink  572 

Investment  Program  Association,  Stephen  H.  Hamrick,  and  Bruce  H.  Vincent  496 

IRECO  IncTDyno  Nobel  Inc.,  David  G.  Millett  527 

Itel  Corp.,  James  E.  Knox  585 

Izaak  Walton  League  of  America,  Maitland  Sharpe  798 

Jarratt,  Robert,  National  Association  of  Independent  Insurers,  Alliance  of 

American  Insurers,  National  Association  of  Mutual  Insurance  Companies, 

Florida  Farm  Bureau  Casualty  Insurance  Co.,  and  Florida  Farm  Bureau 

General  Insurance  Co  1488 

Jefferson,  Hon.   William  J.,   a  Representative  in  Congress  from  the  State 

of  Louisiana  58 

Jemigan,   ClifF,   Semiconductor  Industry  Association,    and  Advanced  Micro 

Devices  265 

John  D.  and  Catherine  T.  MacArthur  Foundation,  James  T.  Griffin  402 

Johnson,  Hon.  Nancy  L.,  a  Representative  in  Congress  from  the  State  of 

Connecticut  41 

Johnson,  Stephen  F.,  American  Public  Power  Association,  and  Washington 

Public  Utility  Districts' Association  770 

Joseph,  Rachel  A.,  National  Congress  of  American  Indians  557 

Jung,  Paul,  Student  Loan  Interest  Deduction  Restoration  Coalition 1016 

Kabsh,  Mark,  National  Association  of  Home  Builders  1436 

Kaltman,  Ira  J.,  Emil  Buehler  Perpetual  Trust 420 

Kaman  Corp.,  Glenn  M.  Messemer  277 

Kelly,  John  L.,  American  Iron  Ore  Association  and  Cleveland-ClifTs,  Inc  1275 

Kern,   Lynda  A.,  American  Bankers  Association,  Taxation  Committee;  and 

AmSouth  Bank  N.A  192 

Kies,  Kenneth  J.,  North  American  Reinsurance  Corp  1480 

Kilpatrick  Life  Insurance  Co.,  Virginia  Kilpatrick  Shehee  158 

Kleczka,  Hon.  Gerald  D.,  a  Representative  in  Congress  from  the  State  of 

Wisconsin  1372 

Kmart  Corp.,  James  P.  Sheridan  258 

Knox,  James  E.,  Itel  Corp  585 

Land  Insurance  Title  Co.,  Irving  Morgenroth  1037 

Lange,  Robert  T.,  Malvern,  Pa  811 

Larsen,  Andrew,  National  Structured  Settlement  Trade  Association,  and  First 

Colony  Life  Insurance  Co  174 

Lazarus,  Fred,  FV,  Association  of  Independent  Colleges  of  Art  and  Design  1103 

Lazenbv,  Virginia: 

Independent  Petroleum  Association  of  America,  and  Bretagne  Corp  691 

Independent   Petroleum   Association   of  America,    Bretagne   Corp.,    and 

National  Stripper  Well  Association  1242 

Leadership  Council  on  Advertising  Issues,  Sheldon  S.  Cohen 1192 

Lee,  John  W.,  College  of  William  and  Mary,  Marshall-Wythe  School  of  Law  ....  1687 
Leeper,  Stephen   G.,  Association  of  Local   Housing  Finance  Agencies;  and 

Housing,  Urban  Redevelopment  Authority  of  Pittsburgh 887 

Lehigh  County  Authority,  Aurel  M.  Amdt  979 

Lehman  Brothers,  Inc.,  K.  Fenn  Putnam  954 

Lehrfeld,  William  J.,  Heritage  Foundation  1331 

Leibtag,  Bernard,  Associated  Builders  &  Contractors,  Inc  427 

Levin,  Hon.  Sander  M.,  a  Representative  in  Congress  from  the  State  of 

Michigan  30 

Levine,  Howard  J.,  Roberts  &.  Holland  1680 

Lewis,  Terry,  National  Association  of  Housing  Cooperatives  947 

Lockhart,  James  H.,  Baptist  Foundation  of  Oklahoma  1768 

Longsworth,  Nellie  L.,  Preservation  Action  929 

Lorenson,  Edward  P.,  Savings  &  Community  Bankers  of  America,  and  Bristol 

Savings  Bank  of  Connecticut  562 


VIII 

Page 

Louisiana  Insurers'  Conference,  Virginia  Kilpatrick  Shehee  158 

Lovain,  Timothy,  Trade  Taxes  Group  507 

Macllvaine,  Joseph  C,  Western  Growers  Association,  Western  Pistachio  Asso- 
ciation, California  Pistachio  Commission,  and  Paramount  Farming  Co  1655 

MAERP  Reinsurance  Association,  Robert  Rahn  1500 

Magill,  James  N.,  Veterans  of  Foreign  Wars  of  the  United  States  123 

Magma  Power  Co.,  Thomas  C.  Hinrichs  766 

Maheu,  Ronald  T.,  Coopers  &  Lybrand 1754 

Mangis,  Jon  A.,  Oregon  Department  of  Veterans'  Affairs  , 990 

Manning,  David  E.,  Community  Bankers  Association  of  Illinois  208 

Martell,  James  G.,  Prime  Group,  Inc  838 

Martello,  Michael  E.,  National  Constructors  Association,  and  Bechtel  Con- 
struction Co  1043 

Marvin,  Michael  L.,  American  Wind  Energy  Association  756 

Mattson,  Robert,  Computer  &  Business  Equipment  Manufacturers  Associa- 
tion, and  IBM  Cons  645 

Mayer,  Matthew,  Times  Square  Center  Associates,  and  Park  Tower  Realty 

Corp  362 

McChesney,  Thomas  B.,   Building  Owners  &  Managers  Association  Inter- 
national, and  Grubb  &  Ellis  Co  254 

McClendon,  Charles,  American  Football  Coaches  Association  91 

McCloskey,  Peter  F.,  Electronic  Industries  Association: 

June  24,  1993  622 

September  21,  1993  1464 

McConaghy,  Mark,  Ad  Hoc  Group  to  Preserve  Deduction  for  Advertising 1171 

McPherson,    Douglas    C,    Aerospace    Industries    Association,    and    General 

Dynamics  Corp  668 

Merlis,  Edward,  Air  Transport  Association  of  America 1303 

Merrill  Lynch  &  Co.,  Inc.,  LaBrenda  Garrett  Stodghill  580 

Merrill,  Peter,  U.S.  Multinational  Corporation  Tax  Policy  Coalition  1516 

Messemer,  Glenn  M.,  Kaman  Corp  277 

Metzger,  Philip  C,  New  York  State  Office  of  Federal  Affairs  788 

Michigan  State  Hospital  Finance  Authority,  and  Michigan  Higher  Education 

Facilities  Authority,  Roy  A.  Pentilla  966 

Millett,  David  G.,  IRECO  Inc/Dyno  Nobel  Inc  527 

Mineral  Resources  Alliance,  Stephen  D.  Alfers 1265 

Mobil  Corp.,  William  G.  Dakin  1431 

Mohatarem,  G.  Mustafa,  General  Motors  Corp 262 

Montgomery,  Hon.  G.V.  (Sonny),  Chairman,  Committee  on  Veterans'  Affairs, 

anda  Representative  in  Congress  from  the  State  of  Mississippi  46 

Morgenroth,  Irving,  American  Land  Title  Association,  and  Land  Insurance 

Title  Co  1037 

Mutual  Atomic  Energy  Liability  Underwriters,  Robert  Rahn  

National  Assisted  Management  Association,  John  A.  Hood  940 

National    Association    of    Computer    Consultant    Businesses,    Harvey    J. 

Shulman  110 

National  Association  of  Convenience  Stores,  William  C.  "Chris"  Girard 538 

National  Association  of  Home  Builders: 

J.  Leon  Peace,  Jr.  (on  behalf  of  Roger  C.  Glunt) 893 

Mark  Kalish  (on  behalf  of  Thomas  N.  Thompson) 1436 

National  Association  of  Housing  Cooperatives,  Terry  Lewis  947 

National  Association  of  Independent  Insurers,  Robert  Jarratt  1488 

National  Association  of  Manufacturers,  William  G.  Dakin 1431 

National  Association  of  Mutual  Insurance  Cos.,  Robert  Jarratt  1488 

National  Association  of  Railroad  Passengers,  Ross  Capon  518 

National  Association  of  Water  Cos.,  Donald  L.  Houck 132 

National  Congress  of  American  Indians,  Rachel  A.  Joseph  557 

National  Constructors  Association,  Michael  E.  Martello  1043 

National  Council  of  Health  Facilities  Finance  Authorities,  Roy  A.  Pentilla  966 

National  Council  of  State  Housing  Agencies,  Angelo  J.  Aponte  876 

National  Foreign  Trade  Council,  Inc.,  Robert  H.  Green 1507 

National  Grocers  Association,  Larry  Contos  523 

National  Insurance  Association,  Laricin  Teasley  187 

National  League  of  Cities,  et  al,  Aurel  M.  Amdt 979 

National  ResXtv  Committee: 

Stefan  F.  Tucker 1668 

William  C.  Rudin  247 


IX 

Page 

National  Retail  Federation: 

David  L.  Feeney 1203 

James  P.  Sheridan  258 

National  Rural  Utilities  Cooperative  Finance  Corp.,  Charles  B.  Gill  1346 

National  Staff  Network,  Marvin  R.  Selter 100 

National  Stripper  Well  Association,  Virginia  Lsizenby 1242 

National  Structured  Settlement  Trade  Association  (Andrew  Larsen  on  behalf 

of  Randy  Dyer)  174 

National  Trust  for  Historic  Preservation,  Hany  K.  Schwartz 918 

National  Volunteer  Fire  Council,  Kenneth  E.  Newton 105 

National  Wood  Energy  Association,  Gary  Elliott 751 

Native  American  Affairs,  Subcommittee  on,  Committee  on  Natural  Resources, 
Hon.  Bill  Richardson,  Chairman,  and  a  Representative  in  Congress  from 

the  State  of  New  Mexico 292 

Navajo  Nation,  Faith  R.  Roessel  549 

New  42nd  Street,  Inc.,  Cora  Cahan 361 

New  England  Education  Loan  Marketing  Corp.,  Lawrence  W.  OToole  1136 

New  York  State  Division  of  Housing  and  Community  Renewal,  Angelo  J. 

Aponte  876 

New  York  State  oflice  of  Federal  Affairs,  Philip  C.  Metzger  788 

Newspaper  Association  of  America,  Timothy  White  1179 

Newton,  Kenneth  E.,  Firemen's  Association  of  the  State  of  New  York,  and 

National  Volunteer  Fire  Council  105 

North  American  Reinsurance  Corp.,  Peter  A.  Gentile  and  Kenneth  J.  Kies  1480 

Northeast  Midwest  Institute,  Charles  Bartsch  840 

NPES  The  Association  for  Suppliers  of  Printing  &  Publishing  Technologies, 

Mark  J.  Nuzzaco  1215 

Nurse  Brokers  and  Contractors  of  America,  Sally  Sumner  1566 

Nuzzaco,  Mark  J.,  NPES  The  Association  for  Suppliers  of  Printing  &  Publish- 
ing Technologies  1215 

O'Connor,  Edward  A.,  Jr.,  Spaceport  Florida  Authority  998 

O'Connor,  James  E.,  Savings  ana  Community  Bankers  of  America  1316 

OToole,  Lawrence  W.,  New  England  Education  Loan  Marketing  Corp.,  and 

Education  Finance  Council  1136 

OToole,  Richard  L.,  Battle  Fowler  Law  Offices  227 

OMI  Corp.,  Morton  P.  Hyman  660 

Ono,  Rutn  M.,  Queen  Emma  Foundation  414 

Oracle  Corp.,  Gen.  James  A.  Abrahamson  638 

Oregon  Department  of  Veterans'  Affairs,  Jon  A.  Mangis  990 

Overseas  Shipholding  Group,  Inc.,  Morton  P.  Hyman  660 

Owen,  Don  Associated  Builders  &  Contractors,  Inc.,  and  P&P  Contractors  1547 

P&P  Contractors,  Don  Owen  1547 

Padwe,  Gerald  W.,  American  Institute  of  Certified  Public  Accountants  466 

PaineWebber  Inc.,  Stephen  H.  Hamrick  496 

Palko,  Michael,  Great  Western  Financial  Corp.  (see  listing  for  Savings  & 
Community  Bankers  of  America) 

Paramount  Farming  Co.,  Joseph  C.  Macllvaine  1655 

Park  Tower  Realty  Corp.,  Matthew  Mayer  362 

Pattishall,  B.  Wyckliffe,  Chicaeo  Title  &  Trust  Co  1673 

Pay  Less  Supermarkets,  Inc.,  Larry  Contos  523 

Peace,  J.  Leon,  Jr.,  National  Association  of  Home  Builders  (see  listing  for 
Roger  C.  Glunt) 

Pecarich,  Pamela  J.,  American  Institute  of  Certified  Public  Accountants 1454 

Pennell,  Jeffrey  N.,  Emory  University  School  of  Law  1776 

Pentilla,  Roy  A.,  National  Council  of  Health  Facilities  Finance  Authorities, 
Michigan  State  Hospital  Finance  Authority,  and  Michigan  Higher  Edu- 
cation Facilities  Authority 966 

Permison,  Robert,  Associated  Builders  &  Contractors,  Inc  427 

Petrochemical  Energy  Group,  R.  David  Damron  1254 

PHH  Corp.,  Samuel  H.  Wright  1089 

Phillips,  Hon.  Thomas  R.,  Chief  Justice,  Supreme  Court  of  Texas;  Joint  Task 
Force  on  Judicial  Pension  Plans;  Conference  of  Chief  Justices;  and  Con- 
ference of  State  Court  Administrators  71 

Plaid  Pantries,  WilUam  C.  "Chris"  Girard  538 

PPG  Industries,  Inc.,  Donna  Lee  Walker  154 

Preservation  Action,  Nellie  L.  Longsworth  929 

Prime  Group,  Inc.,  James  G.  Martell  838 

Printing  Industries  of  America,  Howard  C.  Webber,  Jr  1209 


X 

Page 

Public  Securities  Association,  R.  Fenn  Putman,  and  Lehman  Brothers,  Inc  954 

Pyles,  James  C,  Home  Health  Services  and  Stafllng  Association  1574 

Queen  Enama  Foundation,  Ruth  M.  Ono  414 

R.H.  Macy  &  Co.,  Inc.,  David  L.  Feeney 1203 

R.R.  Donnelley  &  Sons  Co.,  Frank  Uvena  1148 

Rahn,  Robert,  American  Nuclear  Insurers,  American  Insurance  Association, 
Mutual  Atomic  Energy  Liability  Underwriters,  and  MAERP  Reinsurance 

Association  1500 

Ray,  Cecil  A.,  Jr.,  State  Bar  of  Texas,  Section  of  Taxation  814 

Remar,  Tom,  WMX  Technology  &  Services;  Teco  Energy,  Inc.,  and  Destec 

Energy,  Inc  677 

Renewable  Fuels  Association,  Eric  Vaughn  741 

Reynolds,  Hon.  Mel,  a  Representative  in  Congress  from  the  State  of  Dlinois  ....  857 
Richardson,  Hon.  Bill,  Chairman,  Subcommittee  on  Native  American  Affairs, 
Committee  on  Natural  Resources,  and  a  Representative  in  Congress  from 

the  State  of  New  Mexico  292 

Robert  Mondavi  Winery,  Herbert  Schmidt  141 

Robinson,  Wayne,  CoaUtion  for  the  Fair  Treatment  of  Environmental  Cleanup 

Costs 1626 

Roessel,  Faith  R.,  Navajo  Nation  549 

Romeo,  Richard  P.,  American  Financial  Services  Association,  and  American 

Express  Travel  Related  Services  Co  1153 

Rose,  Jordan  P.,  American  Bar  Association,  Section  of  Tjixation,  Committee 

on  S  Corporations 434 

Rosenkranz,  Stanley  W.,  Florida  Clinical  Practice  Association,  UniversiW  of 
Florida  Agency  Funds,  and  University  of  South  Florida  College  of  Medi- 
cine's Faculty  Practice  Plan  1106 

Roybal-AUard,  Hon.   Lucille,  a  Representative  in  Congress  from  the  State 

of  California  1072 

Rudin,  William  C,  National  Realty  Committee,  and  Rudin  Management  Co  ...  247 

Sanner,  Harvey  Joe,  American  Agriculture  Movement,  Inc  1740 

Savings  &  Community  Bankers  of  America: 

Edward  P.  Lorenson  562 

James  E.  O'Connor  (on  behalf  of  Michael  Palko) 1316 

Schmidt,  Henry  W.,  Jr.  California  League  of  Savings  Institutions  1309 

Schmidt,    Herbert,    American   Vintners    Association,    and   Robert   Mondavi 

Winery 141 

Schumer,  Hon.   Charles  E.,   a  Representative  in  Congress   from  the  State 

of  New  York  859 

Schwartz,  Harry  K.,  National  Trust  for  Historic  Preservation 918 

Screen  Actors  Guild,  Ron  Silver,  and  Mark  Weinstein  1121 

Selter,  Marvin  R.,  National  Staff  Network 100 

Semiconductor  Industry  Association,  Cliff  Jemigan 265 

Semiconductor  Research  Corp.,  Larry  W.  Sumney  371 

Sequent  Computer  Systems,  Inc.,  Robert  S.  Greg^  389 

Sharpe,  Maitland,  Izaak  Walton  League  of  America 798 

Shaw,  Bartow  S.,  Forest  Industries  Council  on  Taxation  682 

Shaw,  Hon.  E.  Clay,  Jr.,  a  Representative  in  Congress  from  the  State  of 

Florida 35 

Shehee,  Virginia  Kilpatrick,  Louisiana  Insurers'  Conference,  Kilpatrick  Life 

Insurance,  and  Central  State  Life  Insurance  Co 158 

SheU  Oil  Co.,  Thomas  G.  Singley  1472 

Sheridan,  James  P.,  National  Retail  Federation,  and  Kmart  Corp 258 

Shulman,     Harvey     J.,     National     Association     of    Computer     Consultant 

Businesses 110 

Silver,  Ron,  Actors'  Equity  Association,  and  Screen  Actors  Guild,  and  Amer- 
ican Federation  of  Television  &  Radio  Artists 1121 

Singley,  Thomas  G.,  Chemical  Manufacturers  Association  and  Shell  Oil  Co  1472 

Sklar,  Scott,  Solar  Energy  Industries  Association  706 

Smith,  Anthony  L.,  Southern  California  Edison  Co.,  et  al  733 

Smith,  Donald  David,  Western  Commercial  Space  Center  1005 

Smith,  Hon.  Nick,  a  Representative  in  Congress  from  the  State  of  Michigan  ...  82 
Smith,  Susan  Bitter,  Arizona  Cable  Television  Association,  and  American 

Society  of  Association  Executives  1335 

Solar  Energy  Industries  Association,  Scott  Sklar  706 

Solomon,  Michael  F.,  Irvins,  Phillips  &  Barker  1614 

South  Carolina  Research  Authority,  Robert  E.  Henderson 973 

Southern  California  Edison  Co.,  et  al,  Anthony  L.  Smith 733 


XI 

Page 

Southwind  Management  Company,  Pamela  K.  Borton  902 

Spaceport  Florida  Authority,  Edward  A.  O'Connor,  Jr  998 

Stodffhill,  LaBrenda  Garrett,  Merrill  Lynch  &  Co.,  Inc  580 

Strickland,  Hon.  Ted,  a  Representative  in  Congress  from  the  State  of  Ohio  871 

Studds,  Hon.   Gerry  E.,   a  Representative   in   Congress   from  the  State  of 

Massachusetts  49 

Student  Loan  Interest  Deduction  Restoration  Coalition,  Paul  Jung 1016 

Sullivan  &  Worcester,  Frederic  G.  Comeel  479 

Sumner,  Sally,  Nurse  Brokers  and  Contractors  of  America  1566 

Sunmey,  Larry  W.,  Alliance  for  Collaborative  Research,  and  Semiconductor 

Research  Corp  371 

Sun  Co.,  Inc.,  Robert  H.  Campbell  1129 

Sun-Diamond  Growers  of  California,  Richard  Doiiglas  1745 

Susswein,  Donald  B.,  Coalition  for  Asset  Backed  &curitie8  214 

Swift  Energy  Co.,  Bruce  H.  Vincent 496 

Teasley,  Larkin,  National  Insurance  Association,  and  Golden  State  Mutual 

Life  Insurance  Co  187 

Technitrol,  Inc.,  Roy  E.  Hock  1604 

Teco  Energy,  Inc.,  Tom  Remar  677 

Texas,  State  Bar  of.  Section  of  Taxation,  Cecil  A.  Ray,  Jr 814 

Texas,  Supreme  Court  of,  Hon.  Thomas  R.  Phillips,  Chief  Justice  71 

Thompson,  Edward,  Jr.,  American  Farmland  Trust 801 

Thompson,  Thomas  N.  (see  listing  for  National  Association  of  Home  Builders) 
Thompson,  Warren,  Frank  Russell  Co.,  and  Frank  Russell  Investment  Man- 
agement Co  593 

Times  Square  Center  Associates,  Matthew  Mayer  and  Dale  W.  Wickham  362 

Times  Union,  Timothy  White  1179 

Torricelli,  Hon.  Robert  G.,  a  Representative  in  Congress  from  the  State  of 

New  Jersey  52 

Trade  Taxes  Group,  Timothy  Lovain  507 

Travelers  Corp.,  Robert  W.  Crispin  180 

Tucker,  Hon.  Walter  R.  Ill,  a  Representative  in  Congress  from  the  State 

of  California  1057 

Tucker,  Stefan  F.,  National  Realty  Committee  1668 

Twenty-First  (21st)  Century  Science  &  Technology,  Marjorie  Mazel  Hecht  1730 

U.S.  Chamber  of  Commerce,  Julie  Leigh  Gackenbach  1444 

U.S.  Multinational  Corporation  Tax  Policy  Coalition,  Peter  Merrill  1516 

Uvena,  Frank,  R.R.  Donnelley  &  Sons  Co  1148 

Vaughn,  Eric,  Renewable  Fuels  Association  741 

Veterans  of  Foreign  Wars  of  the  United  States,  James  N.  Magill  123 

Veterans'  AfTaris,  Committee,  Hon.  G.V.  (Sonny)  Montgomery,  and  a  Rep- 
resentative in  Congress  from  the  State  of  Mississippi  46 

Vincent,  Bruce  H.,  Investment  Program  Association,  and  Swift  Enei^  Co  496 

Volunteers  of  America,  John  A.  Hood  940 

Walker,  Donna  Lee,  PPG  Industries,  Inc  154 

Washington  Public  Utility  Districts'  Association,  Stephen  F.  Johnson 770 

Waters,  Hon.  Maxine,  a  Representative  in  Congress  from  the  State  of  Califor- 
nia    1075 

Webber,  Howard  C,  Jr.,  Printing  Industries  of  America,  Graphic  Arts  Legisla- 
tive Council,  and  Cohber  Press,  Inc  1209 

Weinstein,  Mark  J.,  Screen  Actors  Guild,  American  Federation  of  Television 

and  Radio  Artists,  Actors'  Equity  Association  1121 

Western  Commercial  Space  Center,  Donald  David  Smith  1005 

Western  Growers  Association,  Joseph  C.  MacFlvaine  1655 

Western  Pistachio  Association,  Joseph  C.  Macllvaine 1655 

Wheat,  Hon.  Alan,  a  Representative  in  Congress  from  the  State  of  Missouri  ...  1384 
White,  Timothy,  Times  Union,  Advertising  Tax  Coalition,  and  Newspaper 

Association  of  America 1179 

Wiacek,  Raymond  J.,  Emergency  Committee  for  American  Trade  1528 

Wickham,  Dale  W.,  Times  Square  Center  Associates 362 

Wm.  Bolthouse  Farms,  Inc.,  John  Guerard  1662 

WMX  Technology  &  Services,  Tom  Remar  677 

Wright,  Samuel  H.,  PHH  Corp  1089 

Xerox  Corp.,  Michael  J.  Farren  631 

Zimmerman,  Mary  Beth,  Alliance  to  Save  Energy  699 


SUBMISSIONS  FOR  THE  RECORD 
Listing  by  Subject— Revenue  Losers 

tax  accounting 

National  Association  of  Regulatory  Utility  Commissioners,  Linda  Bisson  Ste- 
vens, letter  and  attachments 1787 

FINANCIAL  INSTITUTIONS 

Associated  Bank,  NA,  Neenah,  Wis.,  Michael  B.  Mahlik,  letter 1792 

Bank  Securities  Association,  statement 1793 

Bank  South,  N.A.,  Atlanta,  Ga.,  J.  Blake  Young,  Jr.,  letter  1796 

Bamett  Banks  Trust  Co.,  N.A.,  Jacksonville,  Fla.,  Michael  C.  Baker,  letter 1797 

Commerce  Bancshares,  Inc.,  Kansas  City,  Mo.,  John  S.  Archer,  letter  1798 

First  Fidelity  Bank,  NA.,  Newark,  New  Jersey,  John  J.  Phillips,  letter  1799 

First  National  Bank  of  Chicago,  Michael  P.  Traba,  statement 1801 

First  Source  Bank,  South  Bend,  Ind.,  James  P.  Coleman,  letter  1804 

First  Trust  National  Association,  St.  Paul,  Minn.,  John  M.  Murphy,  Jr., 

letter 1805 

Hawaiian  Trust  Co.,  Ltd.,  Honolulu,  Hawaii,  Douglas  Philpotts,  letter 1807 

Independent  Bankers  Association  of  America,  James  R.  LaufTer,  statement 1809 

Investment  Co.  Institute,  statement  (see  listing  under  Multiple  Issues  head- 
ing) 

KPMG  Peat  Marwick,  New  York,  N.Y.,  Kathy  L.  Anderson,  letter  1811 

Magna  Trust  Co.,  Belleville,  111.,  Peter  C.  Merzian,  letter  1812 

Meridian  Asset  Management,  Inc.,  Valley  Forge,  Pa.,  Robert  C.  Williams, 

letter 1813 

Midlantic  National  Bank,  Edison,  NJ.,  AJ.  DiMatties,  letter 1814 

Northern  Trust  Co.,  Chicago,  111.,  Bany  G.  Hastings,  letter  1815 

Old  Kent  Bank  and  Trust  Co.,  Grand  Rapids,  Mich.,  E.  Philip  Farley,  letter  ...  1816 
Savings  Bank  Life  Insurance  Co.,  Wobum,  Mass.,  Robert  K.  Sheridan,  state- 
ment    1820 

Securities  Industry  Association,  Marc  E.  Lackritz,  statement  1823 

Security  Trust  Co.,  NA.,  Baltimore,  Md.,  Timothy  J.  Hynes  III,  letter  1817 

Texas  Commerce  Investment  Co.,  Houston,  Tex.: 

H.  Mitchell  Harper,  letter 1818 

William  0.  Leszinske,  letter  1819 

INSURANCE 

Association  of  Financial  Guaranty  Insurers,  William  A.  Geoghegan,  statement 
and  attachments 1837 

Canadian   Life   and  Health  Insurance  Association,  Raymond   L.   Britt,  Jr., 

and  Mary  V.  Harcar,  statement  1826 

Colonial  Life  &  Accident  Insurance  Co.,  Inc.,  Columbia,  S.C,  statement  and 

attachment 1844 

Mutual  of  America,  Daniel  W.  Coyne,  letter  1836 

PASS-THROUGH  ENTITIES 

Alcoma  Association,  Inc.,  Lake  Wales,  Fla.,  Lawrence  C.  Updike,  statement  ....  1858 

Arkansas  Electric  Cooperative  Corp.,  Carl  S.  Whillock,  letter  1870 

Florida  Bar,  Tax  Section,  Jerald  David  August,  statement  1849 

Griflin  Industries,  Inc.,  Cold  Spring,  Ky.,  Dennis  B.  GrifTm,  statement  1864 

(XII) 


XIII 

Page 

Investment  Co.  Institute,  statement  (see  listing  under  Multiple  Issues  head- 
ing) 

National  Rural  Electric  Cooperative  Association,  Bob  Bergland,  statement 1871 

Schnitzer  Investment  Corp.,  Portland,  Ore.,  Kenneth  M.  Novack,  statement  ...  1866 

Solo  Cup  Co.,  statement  1859 

Wells  Manufacturing  Co.,  statement  1862 

COST  RECOVERY 

American  Automobile  Manufacturers  Association,  statement  1883 

D'Agostino  Supermarkets,  Inc.,   Larchmont,  N.Y.,  Nicholas  D'Agostino,  Jr., 

letter 1885 

Delta  Queen  Steamboat  Co.,  New  Orleans,  La.,  statement  1876 

Kennelly,  Hon.  Barbara  B.,  a  Representative  in  Congress  from  the  State 

of  Connecticut,  statement  (see  listing  under  Multiple  Issues  heading) 
National  Association   for  the  Self-Employed,   Bennie   L.  Thayer,  letter  (see 

listing  under  Multiple  Issues  heading) 

New  York  Cruise  Lines,  Inc.,  August  J.  Ceradini,  Jr.,  letter 1879 

Passenger  Vessel  Association,  Eric  G.  Scharf,  letter  1880 

Sayville  Ferry,  Sayville,  N.Y.,  Ken  Stein,  Jr.,  letter  1882 

EMPLOYEE  BENEFITS 

AlliedSignal  Inc.,  Ronald  A.  Sinaikin,  statement  1908 

American  Legion,  Steve  A.  Robertson,  statement  1887 

Bedford  Countv  (Va.)  Circuit  Court,  Hon.  William  W.  Sweeney,  letter  (for- 
warded by  the  Hon.  L.F.  Payne,  a  Representative  in  Congress  from  the 

State  of  Virginia)  1896 

Chrysler  Corp.,  Robert  G.  Liberatore,  statement  and  attachment  1902 

Committee  oi  Annuity  Insurers,  statement  and  attachment  1898 

CrisaUi,  Donna  M.,  Washington,  D.C.,  statement 1889 

ESOP  Association: 

Statement  1901 

J.  Michael  Keeling,  statement  1906 

Illinois  Supreme  Court,  Hon.  Benjamin  K.  Miller,  Chief  Justice,  letter  and 

attachment 1893 

Investment  Co.  Institute,  statement  (see  listing  under  Multiple  Issues  head- 
ing) 

Kansas  City  Royals  Baseball,  Michael  E.  Herman,  statement  1385 

Kennelly,  Hon.   Barbara  B.,   a  Representative  in  Congress  from  the  State 

of  Connecticut,  statement  (see  listing  under  Multiple  Issues  heading) 
Non  Commissioned  Officers  Association  of  the  United  States  of  America, 

Larry  D.  Rhea  and  Michael  Ouelette,  statement  1913 

PPG  Industries,  Inc.,  Raymond  W.  LeBoeuf,  statement  1911 

Rahall,  Hon.  Nick  J.,  II,  a  Representative  in  Congress  from  the  State  of 

West  Virginia,  statement 1890 

Stump,  Hon.  Bob,  a  Representative  in  Congress  from  the  State  of  Arizona, 
letter  and  attachment  1892 

iNDivrouAL 

American  Dental  Association,  statement  and  attachment  1926 

American  Society  for  Payroll  Management,  Robert  D.  Williamson,  statement  ..  1917 

Associated  Builders  and  Contractors,  Inc.,  Charles  E.  Hawkins  III,  letter 1919 

Building  and  Construction  Trades  Department,  AFL-CIO,  Robert  A.  Georgine, 

statement  1921 

Construction  Financial  Management  Association,  Joseph  J.   Lozano,  state- 
ment    1924 

Johnson,  Hon.  Nancy  L.,  a  Representative  in  Congress  from  the  State  of 

Connecticut,  statement  851 

MUitary  Coalition,  Paul  W.  Arcari  and  Michael  Ouellette,  letter  1929 

ESTATE  AND  GIFT 

American  Farm  Bureau  Federation,  statement  1957 

Appalachian  Mountain  Club,  Boston,  Mass.,  Jennifer  Melville,  statement 1942 

Appalachian  Trail  Conference,  Harpers  Ferry,  W.Va.,  John  Stokes  and  David 

N.  Startzell,  statement  1943 

Baptist  Foundation  of  Oklahoma,  James  H.  Lockhart,  statement  1931 


XIV 

Page 

Brandywine  Conservancy,  Chadda  Ford,  Pa.,  George  A.  Weymouth,  state- 
ment    1945 

Brennan,  Edward  V.,  Gray,  Caiy,  Ames  &  Frye,  La  Jolla,  Calif.,  statement 

and  attachments 1934 

Brewster,  Hon.  Bill,  a  Representative  in  Congress  from  the  State  of  Okla- 
homa, statement 1932 

Chesapeake  Bay  Foundation,  Annapolis,  Md.,  William  C.  Baker,  letter  1946 

Dutchess  Land  Conservancy,  Stanfordville,  N.Y.,  Ira  Stem,  statement 1947 

Johnson,  Hon.  Nancy  L.,  a  Representative  in  Congress  from  the  State  of 

Connecticut,  statement  609 

Land  Trust  Alliance,  Jean  W.  Hocker,  statement 1948 

Oregon  Trout,  Inc.,  Portland,  Ore.,  GeofF  Pampush,  letter  1950 

Piatt,  Ronald  L.,  and  Gregory  F.  Jenner,  McDermott,  Will  &  Emery,  Washing- 
ton, D.C.,  statement  1958 

Save  the  Bay,  Providence,  R.I.,  Curt  Spalding,  letter  1951 

South  Carolina  Coastal  Conservation  League,  Charleston,  S.C.,  Dana  Beach, 

statement  1952 

Ward  L.  Quaal  Co.,  Ward  L.  Quaal,  statement 1954 

Worthy,  K.  Martin,  Hopkins  &  Sutter,  Washington,  D.C.,  statement  611 

FOREIGN  TAX  PROVISIONS 

American  Petroleum  Institute,  statement  1961 

Bell  Atlantic  Corp.,  statement  and  attachment  1965 

Beneficial  Corp.,  Gary  J.  Perkinson,  statement 2012 

BirdsaU,  Inc.,  Riviera  Beach,  Fla.,  John  H.  Birdsall  HI,  letter  and  attach- 
ments    1997 

Cargill,  Inc.,  Minneapolis,  Minn.,  Bruce  H.  Bamett,  statement  and  attach- 
ments    2028 

Caribbean  Latin  American  Action,  Peter  Johnson,  letter  2009 

Chevron  Corp.: 

Statement 1985 

Statement  2016 

Chubb  Corp.,  Warren,  NJ.,  Dean  R.  OUare,  statement  1970 

Committee  on  State  Taxation,  Mark  Cahoon,  statement 2026 

Emergency  Committee  for  American  Trade,  Robert  L.  McNeill,  letter 1975 

Evans  Economics,  Inc.,  Washington,  D.C.,  Michael  K.  Evans,  letter 2006 

Federal-Mogul  Corp.,  Detroit,  Mich.,  Robert  C.  Rozycki,  statement  2019 

Federation  of  American  Controlled  Shipping,  Philip  J.  Loree,  statement  1987 

General  Motors  Corp.,  statement  2014 

Information  Tecnology  Association  of  America,  Luanne  James,  statement  1984 

Matsui,  Hon.  Robert  T.,  a  Representative  in  Congress  from  the  State  of 

California,  statement  674 

McClure,  Trotter  &  Mentz,  Chtd.,  Washington,  D.C.,  William  P.  McClure, 

statement  2023 

National  Foreign  Trade  Council,  Inc.,  statement 1976 

Shaw,  Hon.  E.  Clay,  Jr.,  a  Representative  in  Congress  from  the  State  of 

Florida,  statement 1996 

Tax  Executives  Institute,  Inc.,  Robert  H.  Perlman,  letter  1981 

NATURAL  RESOURCES 

American  Gas  Association,  statement 2062 

American  Methanol  Institute,  Raymond  A.  Lewis,  statement 2069 

American  Public  Power  Association,  Larry  Hobart;  National  Rural  Electric 
Cooperative  Association,  Bob  Bergland;  and  National  Association  of  Regu- 
latory Utility  Commissioners,  Thomas  Choman,  joint  letter  2095 

City  Utilities  of  Springfield,  Mo.,  Robert  E.  Roundtree,  letter  (forwarded 
by  the  Hon.  Mel  Hancock,  a  Representative  in  Congress  from  the  State 

of  Missouri)  2074 

Columbia  Gas  Development  Corp.,  Houston,  Tex.,  Robert  C.  Williams,  Jr., 

statement  2050 

Delson  Lumber  Co.,  Hardel  Mutual  Plywood  Corp.,  Manke  Lumber  Co.,  and 

Conifer  Pacific,  joint  statement 2034 

Destec  Energy,  Inc.,  Houston,  Tex.,  Charles  F.  Goff,  statement  2040 

Electric  Transportation  Coalition,  Kateri  A.  Callahan,  letter  2075 

Independent  Oil  and  Gas  Association  of  West  Virginia,  Rich  HefTelfinger, 

statement  2044 


XV 

Page 

Independent  Petroleum  Association  of  America,  Roy  W.  Willis,  letter  2080 

Kenetech/U.S.  Windpower,  Robert  T.  Boyd,  statement  2088 

Large  Public  Power  Council,  and  Salt  River  Project  of  Hioenix,  Ariz.,  Mai^ 

BonsaU,  statement  2085 

Los  Angeles,  Calif.,  City  of,  statement 2083 

Louisiana  Land  &  Exploration  Co.,  New  Orleans,   La.,   Leigjiton  Steward, 

statement  2054 

Matsui,  Hon.  Robert  T.,  a  Representative  in  Congress  from  the  State  of 

California,  statement  730 

MDU  Resources  Group,  Inc.,  Bismarii,  N.Dak.,  Robert  E.  Wood,  statement  2057 

Mitchell  Energy  &  Development  Corp.,  The  Woodlands,  Tex.,  Craig  G.  Good- 
man, letter  and  attachment  2059 

National  Rural  Electric  Cooperative  Association,  Bob  Bergland,  statement 718 

Natural  Resources  Defense  Council,  Marika  Tatsutani,  statement  2084 

Northeast  Public  Power  Association,  Westborough,  Mass.,  statement  {see  list- 
ing under  Multiple  Issues  heading) 
Nortnwest  Independent  Forest  Manufacturers,  Tacoma,  Wash.,  MJ.  "Gus" 

Kuehne,  statement  and  attachment  2036 

Sacramento,  Calif.,  Municipal  Utility  District,  statement  2096 

Southern  California  Public  Power  Authority,  Pasadena,  CaUf.,  statement  2086 

Tampa  (Fla.)  Electric  Co.,  statement  2042 

USX  Corp.,  statement  2091 

Washington  Citizens  for  World  Trade,  Olympia,  Wash.,  Nicholas  J.  Kirkmire, 

statement  2093 

Wise,  Hon.  Bob,  a  Representative  in  Congress  from  the  State  of  West  Vir- 
ginia, letter  and  attachments  2045 

HOUSING 

Ford,  Hon.  Harold  E.,  a  Representative  in  Congress  from  the  State  of 
Tennesses,  statement  and  attachment  849 

J&B  Management  Co.,  Fort  Lee,  N.J.,  Bernard  Rodin,  statement 2110 

Lowey,  Hon.  Nita  M.,  a  Representative  in  Congress  from  the  State  of  New 
York,  statement  2109 

National  Cooperative  Business  Center,  Russell  C.  Notar,  statement  2102 

New  York,  Citv  of,  Hon.  David  N.  Dinkins,  Mayor,  statement  (see  listing 
under  Multiple  Issues  heading) 

PacifiCorp  Financial  Services,  Portland,  Ore.,  William  E.  Peressini,  state- 
ment      2098 

Salem,  Irving,  and  Carol  A.  Quinn,  Latham  &  Watkins,  New  York,  N.Y., 
statement  2104 

TAX-EXEMPT  BONDS 

Alaska  Aerospace  Development  Corp.,  Anchorage,  Alaska,  H.P.  "Pat"  Ladner, 

statement  2114 

Alaska  Housing  Finance  Corp.,  statement  2117 

American  Association  of  Port  Authorities,  Jean  C.  Godwin,  letter  2146 

American  Public  Power  Association,  Larry  Hobart,  statement  2133 

Barca,  Hon.  Peter  W.,  a  Representative  in  Congress  from  the  State  of  Wiscon- 
sin, statement  2129 

Belz  Investment  Co.,  Inc.,  Memphis,  Tenn.,  Jack  A.  Belz,  statement  (see 
listing  under  Multiple  Issues  heading) 

Connecticut,  State  of,  Hon.  Joseph  M.  Suggs,  Jr.,  statement  2127 

Council  of  Envelopment  Finance  Agencies,  statement  2120 

Edison  Electric  Institute,  statement  2136 

Kennelly,  a  Representative  in  Congress  from  the  State  of  Connecticut,  Hon. 

Barbara  B.  statement  (see  listing  under  Multiple  Issues  heading) 
Kleczka,  Hon.  Gerald  D.,  a  Representative  in  Congress  from  the  State  of 

Wisconsin,  statement  2131 

Massachusetts  Municipal  Wholesale  Electric  Co.,  statement  2140 

Matsui,  Hon.  Robert  T.,  a  Representative  in  Congress  from  the  State  of 
California: 

Statement 853 

Statement 855 

National  Association  of  Bond  Lawyers,  statement  2141 


XVI 

Page 

National  Association  of  Independent  Colleges  and  Universities;  American 
Council  on  Education;  Association  of  American  Universities,  and  National 
Association  of  State  Universities  and  Land  Grant  Colleges,  Richard  F. 

Rosser,  joint  letter 2124 

New  Mexico,  State  of,  Hon.  Casey  Luna,  Lt.  Governor,  statement 2115 

New  York,  City  of,  Hon.  David  N.  Dinkins,  Mayor,  statement  (see  listing 

under  Multiple  Issues  heading) 
Northeast  FHiblic  Power  Association,  Westborough,  Mass.,  statement  (see  list- 
ing under  Multiple  Issues  heading) 

Stanford  University,  Stanford,  Calif.,  Peter  Van  Etten,  statement  2122 

Texas  Veterans  Land  Board,  Austin,  Tex.,  Garry  Mauro,  statement  2118 

Wisconsin  Department  of  Veterans  Affairs,  Daniel  D.  Stier,  letter  2119 

COMPLIANCE 

Brewster,  Hon.  Bill  K.,  a  Representative  in  Congress  from  the  State  of  Okla- 
homa, statement 1037 

MISCELLANEOUS  ISSUES 

Allegheny  Electric  Cooperative,  Inc.,  Harrisburg,  Pa.,  Ed  Uravic,  letter  2178 

American  Bakers  Association,  Paul  C.  Abenante,  letter  2191 

American  College  of  Trust  and  Estate  Counsel,  James  M.  Trapp,  letter  2198 

American  Vintners  Association,  statement  2167 

Arctic  Slope  Regional  Corp.,  (joldbelt  Corp.,  and  Sealaska  Corp.,  joint  state- 
ment     2151 

Art  Institute  of  Southern  California,  Laguna  Beach,  Calif.,  John  W.  Lottes, 

letter 2159 

Association  of  American  Medical  Colleges,  Robert  G.  Petersdorf,  M.D.,  letter  ..    2193 
Basin  Electric  Power  Cooperative,  Bismark,  N.Dak.,  Robert  L.  McPhaU,  state- 
ment      2180 

Belz  Investment  Co.,   Inc.,  Memphis,  Tenn.,  Jack  A,  Belz,  statement  (see 

listing  under  Multiple  Issues  heading) 
D'Amato,  Hon.  Alfonse  M.,  a  United  States  Senator  from  the  State  of  New 

York,  statement  2174 

Dairymen,  Inc.,  Boyd  M.  Cook,  statement 2163 

Harrington,  Carol  A.,  Kathryn  G.  Henkel,  Carlyn  S.  McCaffrey,  Lloyd  Leva 
Plaine,  and  Pam  H.  Schneider,  American  Bar  Association,  Real  Property, 

Probate  &  Trust  Section,  joint  letter 2201 

Harsch  Investment  Corp.,  Portland  Ore.,  Harold  and  Arlene  Schnitzer,  state- 
ment     2160 

Kanjorski,  Hon.  Paul  E.,  a  Representative  in  Congress  from  the  State  of 

Pennsylvania,  statement  2169 

Koncor  Forest  Products  Co.,  Anchorage,  Alaska,  John  Sturgeon,  statement  2155 

Maryville  University,  St.  Louis,  Mo.,  Keith  Lovin,  letter  2206 

Moakley,  Hon.  John  Joseph,  a  Representative  in  Congress  from  the  State 

of  Massachusetts,  statement  2196 

Myers,  Robert  J.,  Silver  Spring,  Md.,  statement  2195 

National  Association  for  the  Self-Employed,  Bennie  L.  Thayer,  letter  (see 

listing  under  Multiple  Isssues  heading) 
NationS  Presto  Industries,  Inc.,  Eau  Claire,  Wis.,  Joseph  H.  Bemey,  state- 
ment      2183 

National  Staff  Leasing  Association,  Rob  Lederer,  letter  2186 

Neal,  Hon.  Richard  E.,  a  Representative  in  Congress  from  the  State  of  Massa- 
chusetts, statement  2197 

New  York,  State  of,  Vincent  Tese,  statement 2176 

Shoshone  and  Arapaho  Tribes'  Joint  Business  Council,  Fort  Washakie,  Wyo., 

Richard  L.  Ortiz,  letter  and  attachment  2148 

Sierra  Semiconductor  Corp.,  James  V.  Diller,  statement  and  attachments  2187 

Southland  Corp.,  Dallas,  Tex.,  Ronald  L.  Piatt,  statement 2171 

University  of  Arkansas,  Fayetteville,  Ark.,  A.H.  Edwards,  letter 2208 

Western  Farmers  Electric  Cooperative,  Anadarko,  Okla.,  James  D. 
Pendergrass,  statement 2165 

MULTIPLE  ISSUES 

Belz  Investment  Co.,  Inc.,  Memphis,  Tenn.,  Jack  A.  Belz,  statement  2209 

Investment  Co.  Institute,  statement  2211 


XVII 

Page 

Kennelly,  Hon.  Barbara  B.,  a  Representative  in  Congress  from  the  State 

of  Connecticut,  statement  2219 

National  Association  for  the  Self -Employed,  Bennie  L.  Thayer,  letter  2221 

New  York,  City  of,  Hon.  David  N.  Dinkins,  Mayor,  statement 2223 

Northeast  Public  Power  Association,  Westborough,  Mass.,  statement  2230 

Combined  Listing  by  Name  and  Organization  (Losers) 

Abenante,  Paul  C,  American  Bakers  Association,  letter  2191 

Alaska  Aerospace  Development  Corp.,  Anchorage,  Alaska,  H.P.  "Pat"  Ladner, 

statement  2114 

Alaska  Housing  Finance  Corp.,  statement  2117 

Alcoma  Association,  Inc.,  Lake  Wales,  Fla.,  Lawrence  C.  Updike,  statement  ....  1858 

Allegheny  Electric  Cooperative,  Inc.,  Harrisburg,  Pa.,  Ed  Uravic,  letter  2178 

AlliedSignal  Inc.,  Ronald  A.  Sinaikin,  statement  1908 

American  Association  of  Port  Authorities,  Jean  C.  Gfodwin,  letter  2146 

American  Automobile  Manufacturers  Association,  statement  1883 

American  Bakers  Association,  Paul  C.  Abenante,  letter  2191 

American  College  of  Trust  and  Estate  Counsel,  James  M.  Trapp,  letter  2198 

American  Council  on  Education,  Richard  F.  Rosser,  joint  letter  {see  listing 
for  National  Association  of  Independent  Colleges  and  Universities 

American  Dental  Association,  statement  and  attachment  1926 

American  Farm  Bureau  Federation,  statement  1957 

American  Gas  Association,  statement 2062 

American  Legion,  Steve  A.  Robertson,  statement 1887 

American  Methanol  Institute,  Rajrmond  A.  Lewis,  statement 2069 

American  Petroleum  Institute,  statement  1961 

American  Public  Power  Association,  Larry  Hobart,  statement  2133 

American  Public  Power  Association,  Larry  Hobart;  National  Rural  Electric 
Cooperative  Association,  Bob  Bergland;  and  National  Association  of  Regu- 
latory Utility  Commissioners,  Thomas  Choman,  joint  letter  2095 

American  Society  for  Payroll  Management,  Robert  D.  Williamson,  statement  ..  1917 

American  Vintners  Association,  statement  2167 

Anderson,  Kathy  L.,  KPMG  Peat  Marwick,  New  York,  N.Y.,  letter  1811 

Appalachian  Mountain  Club,  Boston,  Mass.,  Jennifer  Melville,  statement 1942 

Appalachian  Trail  Conference,  Harpers  Ferry,  W.Va.,  John  Stokes  and  David 

N.  Startzell,  statement  1943 

Arcari,  Paul  W.,  Military  Coalition,  letter 1929 

Archer,  John  S.,  Commerce  Bancshares,  Inc.,  Kansas  City,  Mo.,  letter  1798 

Arctic  Slope  Regional  Corp.,  Goldbelt  Corp.,  and  Sealaska  Corp.,  joint  state- 
ment    2151 

Arkansas  Electric  Cooperative  Corp.,  Carl  S.  Whillock,  letter  1870 

Art  Institute  of  Southern  California,  Laguna  Beach,  Calif.,  John  W.  Lottes, 

letter 2159 

Associated  Bank,  NA,  Neenah,  Wis.,  Michael  B.  Mahlik,  letter 1792 

Associated  Builders  and  Contractors,  Inc.,  Charles  E.  Hawkins  III,  letter 1919 

Association  of  American  Medical  Colleges,  Robert  G.  Petersdorf,  M.D.,  letter  ..  2193 
Association  of  American   Universities  (see  listing  for  National  Association 

of  Independent  Colleges  and  Universities) 
Association  of  Financial  Guaranty  Insurers,  William  A.  Geoghegan,  statement 

and  attachments 1837 

August,  Jerald  David,  Florida  Bar,  Tax  Section,  statement  1849 

Baker,  Michael  C,  Bamett  Banks  Trust  Co.,  NA.,  Jacksonville,  Fla.,  letter  ....  1797 

Baker,  William  C,  Chesapeake  Bay  Foundation,  Annapolis,  Md.,  letter  1946 

Bank  Securities  Association,  statement 1793 

Bank  South,  NA.,  Atlanta,  Ga.,  J.  Blake  Young,  Jr.,  letter  1796 

Baptist  Foundation  of  Oklahoma,  James  H.  Lockhart,  statement  1931 

Barca,  Hon.  Peter  W.,  a  Representative  in  Congress  from  the  State  of  Wiscon- 
sin, statement  2129 

Bamett  Banks  Trust  Co.,  N.A.,  Jacksonville,  Fla.,  Michael  C.  Baker,  letter 1797 

Bamett,  Bruce  H.,  Cargill,  Inc.,  Minneapolis,  Minn.,  statement  and  attach- 
ments    2028 

Basin  Electric  Power  Cooperative,  Bismark,  N.Dak.,  Robert  L.  McPhail,  state- 
ment    2180 

Beach,  Dana,  South  Carolina  Coastal  Conservation  League,  Charleston,  S.C, 

statement  1952 


XVIII 

Page 
Bedford  County  (Va.)  Circuit  Court,  Hon.  William  W.  Sweeney,  letter  (for- 
warded  by  the  Hon.  L.F.  Payne,  a  Representative  in  Congress  from  the 

State  of  Virginia) 1896 

Bell  Atlantic  Corp.,  statement  and  attachment  1965 

Belz  Investment  Co.,  Inc.,  Memphis,  Tenn.,  Jack  A.  Belz,  statement  2209 

Beneficial  Corp.,  Gary  J.  Perkinson,  statement  2012 

Bergland,  Bob,  National  Rural  Electric  Cooperative  Association: 

Statement  718 

Statement  1871 

Joint  letter  (see  listing  for  American  Public  Power  Association) 
Bemey,  Joseph  H.,  National  Presto  Industries,  Inc.,  Eau  Claire,  Wis.,  state- 
ment      2183 

Birdsall,  Inc.,  Riviera  Beach,  Fla.,  John  H.  BLrdsall  III,  letter  and  attach- 
ments      1997 

Bonsall,  Mark,  Large  Public  Power  Council,  and  Salt  River  Project  of  Phoenix, 

Ariz.,  statement  2085 

Boyd,  Robert  T.,  Kenetech/U.S.  Windpower,  statement  2088 

Brandywine  Conservancy,  Chadds  Ford,  Pa.,  George  A.  Weymouth,  state- 
ment      1945 

Brennan,  Edward  V.,  Gray,  Gary,  Ames  &  Frye,  La  JoUa,  Calif.,  statement 

and  attachments 1934 

Brewster,  Hon.  Bill,  a  Representative  in  Congress  from  the  State  of  Okla- 
homa: 

Statement  1932 

Statement  1037 

Britt,  Raymond  L.,  Jr.,  Canadian  Life  and  Health  Insurance  Association, 

statement  1826 

Building  and  Construction  Trades  Department,  AFL-CIO,  Robert  A.  Georgine, 

statement  1921 

Cahoon,  Mark,  Committee  on  State  Taxation,  statement  2026 

Callahan,  Kateri  A.,  Electric  Transportation  Coalition,  letter  2075 

Canadian   Life   and  Health   Insurance  Association,   Raymond   L.   Britt,  Jr., 

and  Mary  V.  Harcar,  statement 1826 

Cargill,  Inc.,  Minneapolis,  Minn.,  Bruce  H.  Bamett,  statement  and  attach- 
ments      2028 

Caribbean  Latin  American  Action,  Peter  Johnson,  letter  2009 

Ceradini,  Jr.,  August  J.,  New  York  Cruise  Lines,  Inc.,  letter 1879 

Chesapeake  Bay  Foundation,  Annapolis,  Md.,  William  C.  Baker,  letter  1946 

Chevron  Corp.: 

Statement  1985 

Statement  2016 

Choman,  Thomas,  National  Association  of  Regulatory  Utililty  Commissioners, 
joint  letter  (see  listing  for  American  FHiblic  Power  Association) 

Chrysler  Corp.,  Robert  G.  Liberatore,  statement  and  attachment  1902 

Chubb  Corp.,  Warren,  N.J.,  Dean  R.  CHare,  statement  1970 

City  Utilities  of  Springfield,  Mo.,  Robert  E.  Roundtree,  letter  (forwarded 
by  the  Hon.  Mel  Hancock,  a  Representative  in  Congress  from  the  State 

of  Missouri)  2074 

Coleman,  James  P.,  First  Source  Bank,  South  Bend,  Ind.,  letter  1804 

Colonial  Life  &  Accident  Insurance  Co.,  Inc.,  Columbia,  S.C.,  statement  and 

attachment  1844 

Columbia  Gas  Development  Corp.,  Houston,  Tex.,  Robert  C.  Williams,  Jr., 

statement  2050 

Commerce  Bancshares,  Inc.,  Kansas  City,  Mo.,  John  S.  Archer,  letter  1798 

Committee  of  Annuity  Insurers,  statement  and  attachment  1898 

Committee  on  State  Taxation,  Mark  Cahoon,  statement 2026 

Conifer  Pacific,  joint  statement  (see  listing  for  Delson  Lumber  Co.) 

Connecticut,  State  of,  Hon.  Joseph  M.  Suggs,  Jr.,  statement  2127 

Construction  Financial  Management  Association,  Joseph  J.   Lozano,   state- 
ment      1924 

Cook,  Boyd  M.,  Dairymen,  Inc.,  statement 2163 

Council  of  Development  Finance  Agencies,  statement  2120 

Coyne,  Daniel  W.,  Mutual  of  America,  letter  1836 

Cnsalli,  Donna  M.,  Washington,  D.C.,  statement 1889 

D'Agostino  Supermarkets,  Inc.,  Larchmont,  N.Y.,  Nicholas  D'Agostino,  Jr., 

letter 1885 

D'Amato,  Hon.  Alfonse  M.,  a  United  States  Senator  from  the  State  of  New 
York,  statement  2174 


XIX 

Page 

Dairymen,  Inc.,  Boyd  M.  Cook,  statement 2163 

Delson  Lumber  Co.,  Hardel  Mutual  Plywood  Corp.,  Manke  Lumber  Co.,  and 

Conifer  Pacific,  joint  statement 2034 

Delta  Queen  Steamboat  Co.,  New  Orleans,  La.,  statement  1876 

Destec  Energy,  Inc.,  Houston,  Tex.,  Charles  F.  Goff,  statement  2040 

DiUer,  James  V.,  Sierra  Semiconductor  Corp.,  statement  and  attachments  2187 

DiMatties,  AJ.,  Midlantic  National  Bank,  Edison,  NJ.,  letter 1814 

Dinkins,  Hon.  David  N.,  Mayor,  City  of  New  York,  statement 2223 

Dutchess  Land  Conservancy,  StanfordviUe,  N.Y.,  Ira  Stem,  statement 1947 

Edison  Electric  Institute,  statement  2136 

Edwards,  A.H.,  University  of  Arkansas,  Fayetteville,  Ark.,  letter  2208 

Electric  Transportation  Coalition,  Kateri  A.  Callahan,  letter  2075 

Emereency  Committee  for  American  Trade,  Robert  L.  McNeiU,  letter 1975 

ESOP  Associ ation : 

Statement  1901 

J.  Michael  Keeling,  statement  1906 

Evans  Economics,  Inc.,  Washington,  D.C.,  Michael  K.  Evans,  letter 2006 

Farley,  E.  Philip,  Old  Kent  Bank  and  Trust  Co.,  Grand  Rapids,  Mich.,  letter  ..  1816 

Federal-Mogul  Corp.,  Detroit,  Mich.,  Robert  C.  Rozycki,  statement  2019 

Federation  of  American  Controlled  Shipping,  Philip  J.  Loree,  statement  1987 

First  FideUty  Bank,  NA.,  New  Jersey,  John  J.  Phillips,  letter 1799 

First  National  Bank  of  Chicago,  Michael  P.  Traba,  statement 1801 

Fu^t  Source  Bank,  South  Bend,  Ind.,  James  P.  Coleman,  letter  1804 

First  Trust  National  Association,  St.  Paul,  Minn.,  John  M.  Murphy,  Jr., 

letter 1805 

Florida  Btir,  Tax  Section,  Jerald  David  August,  statement  1849 

Ford,   Hon.   Harold  E.,   a   Representative   in   Congress   from   the  State   of 

Tennesses,  statement  and  attachment  849 

General  Motors  Corp.,  statement  2014 

Geoghegan,  William  A.,  Association  of  Financial  Guaranty  Insurers,  state- 
ment and  attachments  1837 

Georgine,  Robert  A.,  Building  and  Construction  Trades  Department,  AFL- 

CIO,  statement  1921 

Godwin,  Jean  C,  American  Association  of  Port  Authorities,  letter  2146 

Goff,  Charles  F.,  Destec  Energy,  Inc.,  Houston,  Tex.,  statement  2040 

Goldbelt  Corp.,  joint  statement  {see  listing  for  Arctic  Slope  Regional  Corp.) 
Goodman,  Craig  G.,  Mitchell  Energy  &  Development  Corp.,  The  Woodlands, 

Tex.,  letter  and  attachment 2059 

GrifTm  Industries,  Inc.,  Cold  Spring,  Kv.,  Dennis  B.  Grifiin,  statement  1864 

Harcar,  Mary  V.,  Canadian  Life  and.  Health  Insurance  Association,  state- 
ment    1826 

Hardel  Mutual  Plywood  Corp.,  joint  statement  (see  listing  for  Delson  Lumber 

Co.) 

Harper,  H.  Mitchell,  Texas  Commerce  Investment  Co.,  Houston,  Tex.,  letter  ...  1818 
Harrington,  Carol  A.,  Kathryn  G.  Henkel,  Carlyn  S.  McCaffrey,  Llovd  Leva 
Plaine,  and  Pam  H.  Schneider,  American  Bar  Association,  Real  Property, 

Probate  &  Trust  Section,  joint  letter 2201 

Harsch  Investment  Corp.,  Portland  Ore.,  Harold  and  Arlene  Schnitzer,  state- 
ment    2160 

Hastings,  Barry  G.,  Northern  Trust  Co.,  Chicago,  111.,  letter  1815 

Hawaiian  Trust  Co.,  Ltd.,  Honolulu,  Hawaii,  Douglas  Philpotts,  letter 1807 

Hawkins,  Charles  E.,  Ill,  Associated  Builders  and  Contractors,  Inc.,  letter 1919 

Heffelfinger,  Rich,  Independent  Oil  and  Gas  Association  of  West  Virginia, 

statement  2044 

Henkel,  Kathryn  G.,  American  Bar  Association,  Real  Property,  Probate  & 
Trust  Section,  ioint  letter  (see  listing  for  Carol  A.  Harrington) 

Herman,  Michael  E.,  Kansas  City  Royals  Baseball,  statement  1385 

Hobart,  Larry,  American  Public  Power  Association;  National  Rural  Electric 
Cooperative  Association,  Bob  Bergland;  and  National  Association  of  Regu- 
latory Utility  Commissioners,  Thomas  Choman,  joint  letter  2095 

Hobart,  Larry,  American  Public  Power  Association,  statement  2133 

Hocker,  Jean  W.,  Land  Trust  Alliance,  statement 1948 

Hynes,  Timothy  J.,  Ill,  Security  Trust  Co.,  NA.,  Baltimore,  Md.,  letter  1817 

Illinois  Supreme  Court,  Hon.  Benjamin  K.  Miller,  Chief  Justice,  letter  and 

attachment 1893 

Independent  Bankers  Association  of  America,  James  R.  LaufTer,  statement 1809 

Independent  Oil  and  Gas  Association  of  West  Virginia,  Rich  Hefielfinger, 

statement  2044 


XX 

Page 

Independent  Petroleum  Association  of  America,  Roy  W.  Willis,  letter  2080 

Information  Tecnology  Association  of  America,  Luanne  James,  statement  1984 

Investment  Co.  Institute,  statement  2211 

J&B  Management  Co.,  Fort  Lee,  N.J.,  Bernard  Rodin,  statement 2110 

James,  Luanne,  Information  Tecnology  Association  of  America,  statement  1984 

Jenner,  Gregory  F.,  and  Ronald  L.  Piatt,  McDermott,  Will  &  Emery,  Washing- 
ton, D.C.,  statement  1958 

Johnson,  Hon.  Nancy  L.,  a  Representative  in  Congress  from  the  State  of 
Connecticut: 

Statement  609 

Statement  851 

Johnson,  Peter,  Caribbean  Latin  American  Action,  letter  2009 

Kanjorski,  Hon.  Paul  E.,  a  Representative  in  Congress  from  the  State  of 

Pennsylvania,  statement  2162 

Kansas  City  Royals  Baseball,  Michael  E.  Herman,  statement  1385 

Keeling,  J.  Michael,  ESOP  Association,  statement 1906 

KenetechAJ.S.  Windpower,  Robert  T.  Boyd,  statement  2088 

Kennelly,  Hon.  Barbara  B.,   a  Representative  in  Congress  from  the  State 

of  Connecticut,  statement  2219 

Kirkmire,  Nicholas  J.,  Washington  Citizens  for  World  Trade,  Olympia,  Wash., 

statement  2093 

Kleczka,  Gerald  D.,  a  Representative  in  Congress  from  the  State  of  Wisconsin, 

statement  2131 

Koncor  Forest  Products  Co.,  Anchorage,  Alaska,  John  Sturgeon,  statement  2155 

KPMG  Peat  Marwick,  New  York,  N.Y.,  Kathy  L.  Anderson,  letter  1811 

Kuehne,  M.J.  "Gus",  Northwest  Independent  Forest  Manufacturers,  Tacoma, 

Wash.,  statement  and  attachment 2036 

Lackritz,  Marc  E.,  Securities  Industry  Association,  statement  1823 

Ladner,  H.P.  'Tat",  Alaska  Aerospace  Development  Corp.,  Anchorage,  Alaska, 

statement  2114 

Land  Trust  Alliance,  Jean  W.  Hocker,  statement 1948 

Large  Public  Power  Council,  Phoenix,  Ariz.,  Mark  Bonsall,  statement 2085 

Lauffer,  James  R.,  Independent  Bankers  Association  of  America,  statement  ....  1809 

LeBoeuf,  Raymond  W.,  PPG  Industries,  Inc.,  statement  1911 

Lederer,  Rob,  National  Staff  Leasing  Association,  letter  2186 

Leszinske,  William  O.,  Texas  Commerce  Investment  Co.,  Houston,  Tex.,  let- 
ter    1819 

Lewis,  Raymond  A.,  American  Methanol  Institute,  statement 2069 

Liberatore,  Robert  G.,  Chrysler  Corp.,  statement  and  attachment  1902 

Lockhart,  James  H.,  Baptist  Foundation  of  Oklahoma,  statement  1931 

Loree,  Philip  J.,  Federation  of  American  Controlled  Shipping,  statement  1987 

Los  Angeles,  Calif.,  City  of,  statement 2083 

Lottes,  John  W.,  Art  Institute  of  Southern  California,  Laguna  Beach,  Calif., 

letter 2159 

Louisiana  Land  &  Exploration  Co.,  New  Orleans,   La.,  Lei^ton  Steward, 

statement  2054 

Lovin,  Keith,  Maryville  University,  St.  Louis,  Mo.,  letter  2206 

Lowey,  Hon.  Nita  M.,  a  Representative  in  Congress  from  the  State  of  New 

York,  statement  2109 

Lozano,  Joseph  J.,  Construction  Financial  Management  Association,  state- 
ment    1924 

Luna,  Hon.  Casey,  Lt.  Governor,  State  of  New  Mexico,  statement  2115 

Magna  Trust  Co.,  Belleville,  111.,  Peter  C.  Merzian,  letter  1812 

Mahlik,  Michael  B.,  Associated  Bank,  N.A,  Neenah,  Wis.,  letter 1792 

Manke  Lumber  Co.,  joint  statement  {.see  listing  for  Delson  Lumber  Co.)  2034 

Maryville  University,  St.  Louis,  Mo.,  Keith  Lovin,  letter  2206 

Massachusetts  Municipal  Wholesale  Electric  Co.,  statement  2140 

Matsui,  Hon.  Robert  T.,  a  Representative  in  Congress  from  the  State  of 
California: 

Statement  674 

Statement  730 

Statement  853 

Statement  855 

Mauro,  Garry,  Texas  Veterans  Land  Board,  Austin,  Tex.,  statement  2118 

McCaffrey,  Caryln  S.,  American  Bar  Association,  Real  Property,  Probate  & 

Trust  Section,  joint  letter  {see  listing  for  Carol  A.  Harrington) 
McClure,  Trotter  &  Mentz,  Chtd.,  Washington,  D.C.,  William  P.  McClure, 

statement  2023 


XXI 

Page 

McNeill,  Robert  L.,  Emergency  Committee  for  American  Trade,  letter 1975 

McPhaU,  Robert   L.,   Basin  Electric  Power  Cooperative,   Bismark,  N.Dak., 

statement  2180 

MDU  Resources  Group,  Inc.,  Bismaric,  N.Dak.,  Robert  E.  Wood,  statement  2057 

Melville,  Jennifer,  Appalachian  Mountain  Club,  Boston,  Mass.,  statement 1942 

Meridian  Asset  Management,  Inc.,  Valley  Forge,  Pa.,  Robert  C.  Williams, 

letter 1813 

Merzian,  Peter  C,  Magna  Trust  Co.,  Belleville,  DL,  letter 1812 

Midlantic  National  Bank,  Edison,  NJ.,  AJ.  DiMatties,  letter 1814 

Military  Coalition,  Michael  Ouelette  and  Paul  W.  Arcari,  letter  1929 

MUler,  Hon.  Benjamin  K.,  Chief  Justice,  Dlinois  Supreme  Court,  letter  and 

attachment 1893 

Mitchell  Energy  &  Development  Corp.,  The  Woodlands,  Tex.,  Craig  G.  Good- 
man, letter  and  attachment  2059 

Moakley,  Hon.  John  Joseph,  a  Representative  in  Congress  from  the  State 

of  Massachusetts,  statement  2196 

Murphy,  John  M.,  Jr.,  First  Trust  National  Association,  St.  Paul,  Minn., 

letter 1805 

Mutual  of  America,  Daniel  W.  Coyne,  letter  1836 

Myers,  Robert  J.,  Silver  Spring,  Md.,  statement  2195 

National  Association  for  the  Self-Employed,  Bennie  L.  Thayer,  letter  2221 

National  Association  of  Bond  Lawyers,  statement  2141 

National  Association  of  Independent  Colleges  and  Universities;  American 
Council  on  Education;  and  National  Association  of  State  Universities  and 

Land  Grant  Colleges,  Richard  F.  Rosser,  joint  letter 2124 

National  Association  of  Regulatory  Utililty  Commissioners: 

Thomas  Choman,  joint  letter  (see  listing  for  American  Public  Power  Asso- 
ciation) 

Linda  Bisson  Stevens,  letter  and  attachments  1787 

National  Association  of  State  Universities  and  Land  Grant  Colleges,  Richard 
F.  Rosser,  joint  letter  (see  listing  for  National  Association  of  Independent 
Colleges  and  Universities) 

National  Cooperative  Business  Center,  Russell  C.  Notar,  statement  2102 

National  Foreign  Trade  Council,  Inc.,  statement 1976 

National  Presto  Industries,  Inc.,  Eau  Claire,  Wis.,  Joseph  H.  Bemey,  state- 
ment      2183 

National  Rural  Electric  Cooperative  Association,  Bob  Bergland: 
Joint  letter  (see  listing  for  American  Public  Power  Association) 

Statement  718 

Statement  1871 

National  Staff  Leasing  Association,  Rob  Lederer,  letter  2186 

Natural  Resources  Defense  Council,  Marika  Tatsutani,  statement  2084 

Neal,  Hon.  Richard  E.,  a  Representative  in  Congress  from  the  State  of  Massa- 
chusetts, statement  2197 

New  Mexico,  State  of,  Hon.  Casey  Luna,  Lt.  Governor,  statement  2115 

New  York,  City  of,  Hon.  David  N.  Dinkins,  Mayor,  statement 2223 

New  York  Cruise  Lines,  Inc.,  August  J.  Ceradini,  Jr.,  letter 1879 

New  York,  State  of,  Vincent  Tese,  statement 2176 

Non   Commissioned  Officers  Association  of  the  United  States  of  America, 

Larry  D.  Rhea  and  Michael  F.  Ouelette,  statement 1913 

Northeast  Public  Power  Association,  Westborough,  Mass.,  statement  2230 

Northern  Trust  Co.,  Chicago,  HI,  Barry  G.  Hastings,  letter  1815 

Northwest  Independent  Forest  Manufacturers,  Tacoma,  Wash.,  M.J.  "Gus" 

Kuehne,  statement  and  attachment  2036 

Notar,  Russell  C,  National  Cooperative  Business  Center,  statement  2102 

Novack,  Kenneth  M.,  Schnitzer  Investment  Corp.,  Portland,  Ore.,  statement  ..    1866 

©"Hare,  Dean  R.,  Chubb  Corp.,  Warren,  NJ.,  statement  1970 

Old  Kent  Bank  and  Trust  Co.,  Grand  Rapids,  Mich.,  E.  Philip  Farley,  letter  ...    1816 

Oregon  Trout,  Inc.,  Portland,  Ore.,  Geoff  Pampush,  letter  1950 

Ortiz,  Richard  L.,  Shoshone  and  Arapaho  Tribes'  Joint  Business  Council, 

Fort  Washakie,  Wyo.,  letter  and  attachment 2148 

Ouelette,  Michael: 

Militaiy  Coalition,  letter  1929 

Non  Commissioned  Officers  Association  of  the  United  States  of  America, 

statement  1913 

PacifiCorp  Financial  Services,  Portland,  Ore.,  William  E.  Peressini,  state- 
ment      2098 

Pampush,  Geoff,  Oregon  Trout,  Inc.,  Portland,  Ore.,  letter  1950 


XXII 

Page 

Passenger  Vessel  Association,  Eric  G.  Scharf,  letter  1880 

Pendei^ass,  James  D.,  Western  Farmers  Electric  Cooperative,  Anadarko, 

Okla.,  statement  2165 

Peressini,  William  E.,  PacifiCorp  Financial  Services,  Portland,  Ore.,  state- 
ment    2098 

Perkinson,  Gary  J.,  Beneficial  Corp.,  statement  2012 

Perlman,  Robert  H.,  Tax  Executives  Institute,  Inc.,  letter 1981 

Petersdorf,  M.D.,  Robert  G.,  Association  of  American  Medical  Colleges,  letter  .  2193 

Phillips,  John  J.,  First  Fidelity  Bank,  NA.,  New  Jersey,  letter 1799 

Philpotts,  Douglas,  Hawaiian  Trust  Co.,  Ltd.,  Honolulu,  Hawaii,  letter  1807 

Plaine,   Lloyd   Leva,  American  Bar  Association,   Real  Property,  Probate   & 

Trust  Section,  joint  letter  (see  listing  for  Carol  A.  Harrington) 
Piatt,  Ronald  L.,  and  Gregory  F.  Jenner,  McDermott,  Will  &  Emery,  Washing- 
ton, D.C.,  statement  1958 

Piatt,  Ronald  L.,  Southland  Corp.,  Dallas,  Tex.,  statement 2171 

PPG  Industries,  Inc.,  Raymond  W.  LeBoeuf,  statement  1911 

Quaal,  Ward  L.,  Ward  L.  Quaal  Co..  statement 1954 

Quinn,  Carol  A.,  and  Irving  Salem,  Latham  &  Watkins,  New  York,  N.Y., 

statement  2104 

Rahall,  Hon.  Nick  J.,  II,  a  Representative  in  Congress  from  the  State  of 

West  Virginia,  statement 1890 

Rhea,  Larry  D.,  Non  Commissioned  Officers  Association  of  the  United  States 

of  America,  statement  1913 

Robertson,  Steve  A.,  American  Legion,  statement  1887 

Rodin,  Bernard,  J&B  Management  Co.,  Fort  Lee,  NJ.,  statement 2110 

Rosser,  Richard  F.,  National  Association  of  Independent  Colleges  and  Univer- 
sities; American  Council  on  Education;  and  National  Association  of  State 

Universities  and  Land  Grant  Colleges,ioint  letter  2124 

Roundtree,  Robert  E.,  City  Utilities  of  Springfield,  Mo.,  letter  (forwarded 
by  the  Hon.  Mel  Hancock,  a  Representative  in  Congress  from  the  State 

of  Missouri)  2074 

Rozycki,  Robert  C,  Federal-Mogul  Corp.,  Detroit,  Mich.,  statement  2019 

Sacramento,  Calif.,  Municipal  Utility  District,  statement  2096 

Salem,  Irving,  and  Carol  A.  Quinn,  Latham  &  Watkins,  New  York,  N.Y., 

statement  2104 

Salt  River  Project  of  Phoenix,  Ariz.,  Mark  Bonsall,  statement  2085 

Save  the  Bay,  Providence,  R.L,  Curt  Spalding,  letter  1951 

Savings  Bank  Life  Insurance  Co.,  Wobum,  Mass.,  Robert  K.  Sheridan,  state- 
ment    1820 

Savville  Ferry,  Sayville,  N.Y.,  Ken  Stein,  Jr.,  letter  1882 

Scharf,  Eric  G.,  Passenger  Vessel  Association,  letter  1880 

Schneider,  Pam  H.,  American  Bar  Association,  Real  Property,  Probate   & 

Trust  Section,  joint  letter  (see  listing  for  Carol  A.  Harrington) 
Schnitzer,  Harold  and  Arlene,  Harsch  Investment  Corp.,  Portland  Ore.,  state- 
ment    2160 

Schnitzer  Investment  Corp.,  Portland,  Ore.,  Kenneth  M.  Novack,  statement  ...  1866 
Sealaska  Corp.,  joint  statement  (see  listing  for  Arctic  Slope  Regional  Corp.) 

Securities  Industry  Association,  Marc  E.  Lackritz,  statement  1823 

Security  Trust  Co.,  N.A.,  Baltimore,  Md.,  Timothy  J.  Hynes  III,  letter  1817 

Shaw,  Hon.  E.  Clay,  Jr.,  a  Representative  in  Congress  from  the  State  of 

Florida,  statement  1996 

Sheridan,  Robert  K.,  Savings  Bank  Life  Insurance  Co.,  Wobum,  Mass.,  state- 
ment    1820 

Shoshone  and  Arapaho  Tribes'  Joint  Business  Council,  Fort  Washakie,  Wyo., 

Richard  L.  Ortiz,  letter  and  attachment  2148 

Sierra  Semiconductor  Corp.,  James  V.  Diller,  statement  and  attachments  2187 

Sinaikin,  Ronald  A.,  AlliedSignal  Inc.,  statement  1908 

Solo  Cup  Co.,  statement  1859 

South  Carolina  Coastal  Conservation  League,  Charleston,  S.C,  Dana  Beach, 

statement  1952 

Southern  California  Public  Power  Authority,  Pasadena,  Calif.,  statement  2086 

Southland  Corp.,  Dallas,  Tex.,  Ronald  L.  Piatt,  statement 2171 

Spalding,  Curt,  Save  the  Bay,  Providence,  R.I.,  letter  1951 

Stanford  University,  Stanford,  Calif.,  Peter  Van  Etten,  statement  2122 

Startzell,  David  N.,  Appalachian  Trail  Conference,  Harpers  Ferry,  W.Va., 

statement  1943 

Stein,  Ken,  Jr.,  Sayville  Ferry,  Sayville,  N.Y.,  letter  1882 

Stem,  Ira,  Dutchess  Land  Conservancy,  Stanfordville,  N.Y.,  statement 1947 


XXIII 

Page 

Stevens,  Linda  Bisson,  National  Association  of  Regulatory  Utility  Commis- 
sioners, letter  and  attachments  1787 

Steward,  Leighton,  Louisiana  Land  &  Exploration  Co.,  New  Orleans,  La., 

statement  2054 

Stier,  Daniel  D.,  Wisconsin  Department  of  Veterans  Affairs,  letter  2119 

Stokes,  John,  Appalachian  Trail  Conference,  Harpers  Ferry,  W.Va.,  state- 
ment    1943 

Stump,  Hon.  Bob,  a  Representative  in  Congress  from  the  State  of  Arizona, 

letter  and  attachment  1892 

Sturgeon,  John,  Konoor  Forest  Products  Co.,  Anchorage,  Alaska,  statement  ....  2155 

Suggs,  Hon.  Joseph  M.,  Jr.,  Connecticut,  State  of,  statement  2127 

Sweeney,  Hon.  William  W.,  Bedford  County  (Va.)  Circuit  Court,  letter  (for- 
warded by  the  Hon.  L.F.  Payne,  a  Representative  in  Congress  from  the 

State  of  Virginia) 1896 

Tampa  (Fla.)  Electric  Co.,  statement  2042 

Tatsutani,  Marika,  Natural  Resources  Defense  Council,  statement  2084 

Tax  Executives  Institute,  Inc.,  Robert  H.  Perlman,  letter  1981 

Tese,  Vincent,  State  of  New  York,  statement 2176 

Texas  Commerce  Investment  Co.,  Houston,  Tex.: 

H.  Mitchell  Harper,  letter 1818 

William  O.  Leszinske,  letter  1819 

Texas  Veterans  Land  Board,  Austin,  Tex.,  Garry  Mauro,  statement  2118 

Thayer,  Bennie  L.,  National  Association  for  the  Self-Employed,  letter  2221 

Traba,  Michael  P.,  First  National  Bank  of  Chicago,  statement 1801 

Trapp,  James  M.,  American  College  of  Trust  andEstate  Counsel,  letter  2198 

University  of  Arkansas,  Fayetteville,  Ark.,  A.H.  Edwards,  letter  2208 

Updike,  Lawrence  C,  Alcoma  Association,  Inc.,  Lake  Wales,  Fla.,  statement  ...  1858 

Uravic,  Ed,  Allegheny  Electric  Cooperative,  Inc.,  Harrisburg,  Pa.,  letter  2178 

USX  Corp.,  statement  2091 

Van  Etten,  Peter,  Stanford  University,  Stanford,  Calif.,  statement  2122 

Ward  L.  Quaal  Co.,  Ward  L.  Quaal,  statement 1954 

Washington  Citizens  for  World  Trade,  Olympia,  Wash.,  Nicholas  J.  Kiricmire, 

statement  2093 

Wells  Manufacturing  Co.,  statement  1862 

Western     Farmers     Electric     Cooperative,     Anadarko,     Okla.,     James     D. 

Pendergrass,  statement  2165 

Weymouth,  George  A.,  Brandywine  Conservancy,  Chadds  Ford,  Pa.,  state- 
ment    1945 

Whillock,  Carl  S.,  Arkansas  Electric  Cooperative  Corp.,  letter  1870 

Williams,  Robert  C,  Jr.,  Columbia  Gas  Development  Corp.,  Houston,  Tex., 

statement  2050 

Williams,  Robert  C,  Meridian  Asset  Management,  Inc.,  Valley  Forge,  Pa., 

letter 1813 

Williamson,  Robert  D.,  American  Society  for  Payroll  Management,  statement  .  1917 

Willis,  Roy  W.,  Independent  Petroleum  Association  of  America,  letter  2080 

Wisconsin  Department  of  Veterans  Affairs,  Daniel  D.  Stier,  letter  2119 

Wise,  Hon.  Bob,  a  Representative  in  Congress  from  the  State  of  West  Vir- 
ginia, letter  and  attachments 2045 

Wood,  Robert  E.,  MDU  Resources  Group,  Inc.,  Bismark,  N.Dak.,  statement  ....  2057 

Worthy,  K.  Martin,  Hopkins  &  Sutter,  Washington,  D.C.,  statement  611 

Young,  J.  Blake,  Jr.,  Bank  South,  NA.,  Atlanta,  Ga.,  letter  1796 

Listing  by  Subject— Revenue  Raisers 


Business  Roundtable,  statement  2233 

National  Society  of  Public  Accountants,  Leroy  A.  Strubberg,  and  Jeffrey  A. 
Lear,  statement  2235 

alternative  minimum  tax 

American  Forest  and  Paper  Association,  statement  (see  listing  under  Multiple 
Issues  heading) 

Coal  Tax  Committee,  statement  2240 

National  Coal  Association,  Richard  L.  Lawson,  statement  2237 


XXIV 

Page 

ACCOUNTING 

American  Bankers  Association,  statement  {see  listing  under  Multiple  Issues 

heading) 
American  Electronics  Association,  statement  (see  listing  under  Multiple  Issues 

heading) 
American  Forest  and  Paper  Association,  statement  (see  listing  under  Multiple 

Issues  heading) 
American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 

Issues  heading) 

Barth,  James  P.,  North  Bend,  Ohio,  letter  2243 

Black  Entertainment  Television,  Robert  L.  Johnson,  letter  2244 

Burt,  R.L.,  Southampton,  Mass.,  letter  (see  listing  under  Multiple  Issues 

heading) 

Center  for  the  Study  of  Commercialism,  Michael  F.  Jacobson,  letter 2245 

Centex  Corp.,  Dallas,  Tex.,  Richard  C.  Harvey,  letter  (see  listing  under  Mul- 
tiple Issues  heading) 
Danaher  Corp.,  Washington,  D.C.,  James  H.  DitkofF,  letter  and  attachment  ....    2249 

Edwin  L.  Cox  Co.,  Dallas,  Tex.,  J.  Oliver  McGonigle,  letter 2251 

Fisher,  John  J.,  Barrington,  111.,  letter  2252 

Food  Marketing  Institute,  and  International  Mass  Retail  Association,  joint 

statement  2253 

Larsen,  Bryant  &  Porter,  CPA'S,  P.C.,  Lincoln,  Neb.,  Brent  L.  Stehlik,  letter 

(see  listing  under  Multiple  Issues  heading) 

Mattel,  Inc.,  statement  2255 

Miles  Inc.,  Pittsburgh,  Pa.,  Helge  H.  Wehmeier,  letter 2257 

National  Association  of  Enrolled  Agents,  James  E.  Forrester,  statement  (see 

listing  under  Multiple  Issues  heading) 
National  Association  of  Realtors,  statement  (see  listing  under  Multiple  Issues 

heading) 

Ralston  Purina  Co.,  Ronald  B.  Weinel,  statement  and  attachments  2258 

Retail  Tax  Committee  of  Common  Interest,  statement  2263 

Sundquist,  Hon.  Don,  a  Representative  in  Congress  from  the  State  of  Ten- 
nessee, statement  2266 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  statement  (see  listing  under 

Multiple  Issues  heading) 
True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 

heading) 
United  States  Telephone  Association,  John  Sodolski,  statement  (see  listing 

under  Multiple  Issues  heading) 

FINANCIAL  INSTITUTIONS 

American  Bankers  Association,  statement  (see  listing  under  Multiple  Issues 
heading) 

Centex  Corp.,  Dallas,  Tex.,  Richard  C.  Harvey,  letter  (see  listing  under  Mul- 
tiple Issues  heading) 

Fidelty  Federal  Bank,  Glendale,  Calif.,  Kathleen  A.  Christianson,  letter 2267 

KPMG  Peat  Marwick,  statement  2268 

COST  RECOVERY 

Kieffer-Nolde,  Chicago,  LI.,  Neil  J.  Schecter,  letter 2278 

Laser  Graphics,  Inc.,  Hillside,  111.,  Steve  Giusti,  letter  2279 

National  Association  of  Water  Companies,  James  L.  (Jood,  statement  2274 

Sundquist,  Hon.  Don,  a  Representative  in  Congress  from  the  State  of  Ten- 
nessee, statement  2280 

Techtron  Imaging  Centre,  Chicago,  111.,  Walter  C.  Pabst,  letter  2281 


XXV 

Page 
INDIVIDUAL  INCOME  TAX 

American  Greyhound  Track  Operators  Association,  Henry  C.  Cashen  and 

John  C.  Dill,  statement  (see  listing  under  Multiple  Issues  heading) 
American  Horse  Council,  Inc.,  statement  (see  listing  under  Multiple  Issues 

heading) 
Americsm  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 

Issues  heading) 
Bilbray,  Hon.  James  H.,  a  Representative  in  Congress  from  the  State  of 

Nevada,  statement  (see  listing  under  Multiple  Issues  heading) 
Bryan,  Hon.  Richard,  a  United  States  Senator  from  the  State  of  Nevada, 

statement  (see  listing  under  Multiple  Issues  heading) 
Burt,  R.L.,  Southampton,  Mass.,  letter  (see  listing  under  Multiple  Issues 

heading) 

Coopers  &  Lybrand,  Washington,  D.C.,  statement  2284 

Customs  Science  Services,  Inc.,  Kensington,  Md.,  Roger  J.  Crain,  letter 2283 

Larsen,  Bryant  &  Porter,  CPA's,  P.C,  Lincoln,  Neb.,  Brent  L.  StehUk,  letter 

(see  listing  under  Multiple  Issues  heading) 
National  Association  for  the  Self-Employed,  Bennie   L.  Thayer,  letter  (see 

listing  under  Multiple  Issues  heading) 
National  Association  of  Enrolled  Agents,  James  E.  Forrester,  statement  (see 

listing  under  Multiple  Issues  heading) 
National  Association  of  Realtors,  statement  (see  listing  under  Multiple  Issues 

heading) 
National  Conference  of  State  Social  Security  Administrators,  Daryl  Dunagan, 

letter  (see  listing  under  Multiple  Issues  heading) 

Nevada  Resort  Association,  David  Belding,  statement  2287 

Reid,  Hon.  Harry,  a  United  States  Senator  from  the  State  of  Nevada,  state- 
ment (see  listing  under  Multiple  Issues  heading) 

SeaWest,  San  Diego,  Calif.,  Thomas  G.  Famham,  letter  2290 

Swavelle/Mill  Creek  Fabrics,  New  York,  N.Y.,  Jeffrey  B.  Kraut,  letter 2282 

True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 

heading) 
United  States  Telephone  Association,  John  Sodolski,  statement  (see  listing 

under  Multiple  Issues  heading) 
Vucanovich,  Hon.  Barbara  F.,  a  Representative  in  Congress  from  the  State 

of  Nevada,  statement  (see  listing  under  Multiple  Issues  heading) 

NATURAL  RESOURCES 

American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 

Issues  heading) 
Center  for  International  Environmental  Law,  Robert  F.  Housman,  statement  .   2294 

National  Petroleum  Refiners  Association,  Urvan  R.  Stemfels,  letter  2298 

Reid,  Hon.  Harry,  a  United  States  Senator  from  the  State  of  Nevada,  state- 
ment      2291 

True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 
heading) 

FOREIGN  TAX  PROVISIONS 

American  Bankers  Association,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Electronics  Association,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Federation  of  Labor  and  Congress  of  Industrial  Organizations,  Rob- 
ert E.  Lucore,  statement 2325 

American  Forest  and  Paper  Association,  statement  (see  listing  under  Multiple 
Issues  heading) 

American  Petroleum  Institute,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 
Issues  heading) 

Arthur  Andersen  &  Co.,  Andre  P.  Fogarasi  and  Richard  A.  Gordon,  state- 
ment      2329 

Association  of  British  Insurers,  statement  2339 

Attorneys'  Liability  Assurance  Society,  Inc.,  John  E.  Chapoton  and  Thomas 
A.  Stout,  Jr.,  letter 2345 


XXVI 

Page 

Danaher  Corp.,  Washington,  D.C.,  James  H.  DitkofT,  letter 2337 

Export  Source  Coalition,  Paul  W.  Oosterhuis  and  Roseann  M.  Cutrone,  state- 
ment and  attachments  2299 

International  Tax  Policy  Forum,  Joel  Slemrod,  statement  and  attachment  2309 

Kennelly,  Hon.  Barbara  B.,  a  Representative  in  Congress  from  the  State 

of  Connecticut,  letter  and  attachments  2350 

National  Association  of  Insurance  Brokers,  Michael  J.  Hass,  letter 2364 

Organization  for  International  Investment  Inc.,  Alexander  Spitzer,  statement 
and  attachments  (see  listing  under  Multiple  Issues  heading) 

Public  Securities  Association,  statement  2318 

Reinsurance  Association  of  America,  statement  2366 

Risk  and  Insurance  Management  Society,  Inc.,  Paul  S.  Brown,  letter  2374 

Securities  Industry  Association,  Marc  E.  Lackritz,  statement  2320 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  statement  (see  listing  under 

Multiple  Issues  heading) 
United  States  Council  for  International  Business: 

Statement  2312 

Statement  2324 

United  States  Telephone  Association,  John  Sodolskl,  statement  (see  listing 

under  Multiple  Issues  heading) 
United  Technologies,  William  F.  Paul,  letter  2316 

EXCISE  TAXES 

American  Forest  and  Paper  Association,  statement  and  attachment  2399 

American  Horse  Council,  Inc.,  statement  (see  listing  under  Multiple  Issues 

heading) 
American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 

Issues  heading) 
Asociacion  de  Exportadores  De  Chile  (Chilean  Exporter's  Association),  Ronald 

S.  Bown  F.,  letter  and  attachment  2402 

Association  of  Home  Appliance  Manufacturers,  statement 2407 

Bilbray,  Hon.  James  H.,  a  Representative  in  Congress  from  the  State  of 

Nevada,  statement  (see  listing  under  Multiple  Issues  heading) 
Bryan,  Hon.  Richard,  a  United  States  Senator  from  the  State  of  Nevada, 
statement  (see  listing  under  Multiple  Issues  heading) 

Carrier  Corp.,  Syracuse,  N.Y.,  Edward  A.  Baily,  letter 2409 

Cetylite  Industries,  Inc.,  Pennsauken,  NJ.,  Stanley  L.  Wachman,  statement  ..    2410 

Mack  Trucks,  Inc.,  Mark  Cherry,  statement  and  attachments   2388 

National  Cable  Television  Association,  Decker  Anstrom,  statement  2381 

National  Truck  Equipment  Association,  Michael  E.  Kastner,  letter  and  at- 
tachment      2396 

Nevada  Resort  Association,  David  Belding,  statement  2378 

Newspaper  Association  of  America,  statement  2382 

Organization  for  International  Investment  Inc.,  Alexander  Spitzer,  statement 

and  attachments(sce  listing  under  Multiple  Issues  heading) 
Polyisocyanurate  Insulation  manufacturers  Association,  Jared  O.  Blum,  state- 
ment      2412 

Reid,  Hon.  Harry,  a  United  States  Senator  from  the  State  of  Nevada,  state- 
ment (see  listing  under  Multiple  Issues  heading) 

Renewable  Fuels  Association,  Eric  Vaughn,  statement  2383 

Society  of  the  Plastics  Industry,  Inc.,  Maureen  A.  Healey,  letters  and  attach- 
ments      2416 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  statement  (see  listing  under 
Multiple  Issues  heading) 

Truck  Trailer  Manufacturers  Association,  Richard  P.  Bowling,  letter 2398 

True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 

heading) 
United  States  Telephone  Association,  John  Sodolski,  statement  (see  listing 

under  Multiple  Issues  heading) 
Vucanovich,  Hon.  Barbara  F.,  a  Representative  in  Congress  from  the  State 

of  Nevada,  statement  (see  listing  under  Multiple  Issues  heading) 
Whirlpool  Corp.,  Michael  C.  Thompson,  statement  2421 

TAX-EXEMPT  ENTITIES 

Alliance  for  Justice,  Nan  Aron  and  Carol  Siefert,  letter  and  attachment  2431 

American  Association  of  Museums,  Edward  H.  Able,  Jr.,  letter  2436 


XXVII 

Page 

AmericEin  Gas  Association,  statement  (see  listing  under  Multiple  Issues  head- 
ing) 

American  Petroleum  Institute,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 
Issues  heading) 

Center  for  Non -Profit  Corporations,  Princeton,  NJ.,  Linda  M.  Czipo,  letter  2438 

Independent  Bankers  Association  of  America,  statement  (see  listing  under 
Multiple  Issues  heading) 

National  Association  of  Convenience  Stores,  statement  (see  listing  under  Mul- 
tiple Issues  heading) 

National  Association  of  Realtors,  statement  (see  listing  under  Multiple  Issues 
heading) 

National  Club  Association,  statement 2423 

National  Panhellenic  Conference,  Harriett  B.  Macht;  National  Pan -Hellenic 
Council,  Inc.,  Daisy  Wood;  and  National  Interfratemity  Conference,  Robert 
D.  Lynd,  joint  statement  and  attachment 2426 

National  Venture  Capital  Association,  Dean  C.  (Jordanier,  Jr.,  letter  2440 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  statement  (see  listing  under 
Multiple  Issues  heading) 

True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 
heading) 

United  States  Telephone  Association,  John  Sodolski,  statement  (see  listing 
under  Multiple  Issues  heading) 

COMPLIANCE 

American  Bankers  Association,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Electronics  Association,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Forest  and  Paper  Association,  statement  (see  listing  under  Multiple 
Issues  heading) 

American  Gas  Association,  statement  (see  listing  under  Multiple  Issues  head- 
ing) 

American  Greyhound  Track  Operators  Association,  Henry  C.  Cashen  and 
John  C.  Dill,  statement  (see  listing  under  Multiple  Issues  heading) 

American  Horse  Council,  Inc.,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Land  Title  Association,  Ann  vom  Eigen,  statement  2447 

American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 
Issues  heading) 

Bilbray,  Hon.  James  H.,  a  Representative  in  Congress  from  the  State  of 
Nevada,  statement  (see  listing  under  Multiple  Issues  heading) 

Bryan,  Hon.  Richard,  a  United  States  Senator  from  the  State  of  Nevada, 
statement  (see  listing  under  Multiple  Issues  heading) 

Burt,  R.L.,  Southampton,  Mass.,  letter  (see  listing  under  Multiple  Issues 
heading) 

Coalition  on  Interest  Disallowance,  statement  2455 

Federation  of  Tax  Administrators,  Harley  T.  Duncan,  statement  and  attach- 
ment      2449 

CJomola,  Gary  R.,  Coughlin  &  Gomola,  Middletown,  Conn.,  letter 2453 

Independent  Bankers  Association  of  America,  statement  (see  listing  under 
Multiple  Issues  heading) 

Larsen,  Bryant  &  Porter,  CPA's,  P.C,  Lincoln,  Neb.,  Brent  L.  Stehlik,  letter 
(see  listing  under  Multiple  Issues  heading) 

Levenson,  Daniel  D.,  Lourie  &  Cutler,  P.C,  Boston,  Mass.,  statement 2461 

National  Association  for  the  Self-Em  ployed,  Bennie  L.  Thayer,  letter  (see 
listing  under  Multiple  Issues  heading) 

National  Association  of  Convenience  Stores,  statement  (see  listing  under  Mul- 
tiple Issues  heading) 

National  Association  of  Enrolled  Agents,  James  E.  Forrester,  statement  (see 
listing  under  Multiple  Issues  heading) 

National  Conference  of  State  Social  Security  Administrators,  Daryl  Dunagan, 
letter  (see  listing  under  Multiple  Issues  heading) 

Nevada  Resort  Association,  David  Belding,  statement  2458 


XXVIII 

Page 

Reid,  Hon.  Harry,  a  United  States  Senator  from  the  State  of  Nevada,  state- 
ment (see  listing  under  Multiple  Issues  heading) 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  statement  (see  listing  under 
Multiple  Issues  heading) 

True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 
heading) 

United  States  Telephone  Association,  John  Sodolski,  statement  (see  listing 
under  Multiple  Issues  heading) 

Vucanovich,  Hon.  Barbara  F.,  a  Representative  in  Congress  from  the  State 
of  Nevada,  statement  (see  listing  under  Multiple  Issues  heading) 

MISCELLANEOUS  ISSUES 

Alliance  Exchange  Group,  Inc.,  Santa  Ana,  Calif.,  Deanna  F.  Burton,  letter  ....    2498 
American  Electronics  Association,  statement  (see  listing  under  Multiple  Issues 
heading) 

American  Equity  Exchange,  Inc.,  Dillon,  Mont.,  Max  A.  Hansen,  letter  2499 

American  Forest  and  Paper  Association,  statement  (see  listing  under  Multiple 

Issues  heading) 
American  Gas  Association,  statement  (see  listing  under  Multiple  Issues  head- 
ing) 

American  Land  Title  Association,  Ann  vom  Eigen,  statement  2500 

American  Petroleum  Institute,  statement  (see  listing  under  Multiple  Issues 

heading) 
American  Trucking  Associations,  Inc.,  statement  (see  listing  under  Multiple 
Issues  heading) 

Bishop,  Barbara,  Pasedena,  Calif.,  letter  2502 

Building  and  Construction  Trades  Department,  AFL-CIO,  Robert  A.  Georgine, 

statement  2463 

Coalition  for  Independent  Contractors,  Edward  N.  Delaney  and  Russell  A. 

Hollrah,  statement  2469 

Environcol,  James  C.  (}odbout,  Diane  Herndon,  and  Mary  Frances  Pearson, 

statement  2513 

Equitv  Advantage,  Inc.,  Salem,  Ore.,  Lonnie  C.  Nielson,  Thomas  N.  Moore, 

and  David  S.  Moore,  letter  2503 

Equity  Reserve,  Inc.,  Newport  Beach,  Calif.,  Frank  C.  Huntsman,  letter 2504 

Federation  of  Exchange  Accommodators,  Newport  Beach,  Calif.,  Andrew  G. 

Potter,  letter  2505 

Hulen,  Myron,  Colorado  State  University;  William  Kinny,  Portland  State 
University;  Jack  Robison,  California  Polytechnic  State  University;  and  Mi- 
chael Vaughan,  Colorado  State  University,  joint  statement  2474 

Independent  Fuel  Terminal  Operators  Association,  statement  and  attach- 
ment      2518 

International  Council  of  Shopping  Centers,  Steven  J.  Guttman,  statement  2507 

Lantos,  Hon.  Tom,  a  Representative  in  Congress  from  the  State  of  California, 

statement  1379 

National  Association   for  the  Self-Employed,  Bennie   L.  Thayer,  letter  (see 

listing  under  Multiple  Issues  heading) 
Nationsd  Association  of  Convenience  Stores,  statement  (see  listing  under  Mul- 
tiple Issues  heading) 
National  Association  of  Realtors,  statement  (see  listing  under  Multiple  Issues 
heading) 

National  Federation  of  Independent  Business,  statement  2482 

New  York  Gas  Group,  Donald  F.  Straetz,  statement  2523 

Real  Estate  Exchange,  Inc.,  Portland,  Ore.,  James  C.  Casterline,  letter  2510 

Security  Trust  Co.,  San  Diego,  Calif.,  J.  Paul  Spring,  letter  2512 

Shays,  Hon.  Christopher,  a  Representative  in  Congress  from  the  State  of 

Connecticut,  statement  1382 

Stratford  Technologies,  Inc.,  Somerdale,  NJ.,  William  R.  Patterson,  letter  2490 

Studds,  Hon.   Gerry  E.,  a  Representatives  in  Congress  from  the  State  of 

Massachusetts,  statement  2497 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  rtatement  (see  listing  under 

Multiple  Issues  heading) 
True  Companies,  Casper,  Wyo.,  statement  (see  listing  under  Multiple  Issues 

heading) 
United  Brotherhood  of  Carpenters  and  Joiners  of  America,  AFL-CIO,  state- 
ment      2492 


XXIX 

Page 

United  States  Telephone  Association,  John  Sodolski,  statement  (see  listing 
under  Multiple  Issues  heading) 

MULTIPLE  ISSUES 

American  Bankers  Association,  statement  2525 

American  Electronics  Association,  statement  2529 

American  Forest  and  Paper  Association,  statement  2533 

American  Gas  Association,  statement 2535 

American  Greyhound  Track  Operators  Association,  Heniy  C.  Cashen  and 

John  C.  Dill,  statement 2544 

American  Horse  Council,  Inc.,  statement  2546 

American  Petroleum  Institute,  statement  2551 

American  Trucking  Associations,  Inc.,  statement 2560 

Bilbray,  Hon.  James  H.,  a  Representative  in  Congress  from  the  State  of 

Nevada,  statement  2563 

Bryan,  Hon.  Richard,  a  United  States  Senator  from  the  State  of  Nevada, 

statement  2564 

Burt,  R.L.,  Southampton,  Mass.,  letter 2566 

Centex  Corp.,  Dallas,  Tex.,  Richard  C.  Harvey,  letter  2567 

Independent  Bankers  Association  of  America,  statement  2568 

Larsen,  Bryant  &  Porter,  CPA's,  P.C.,  Lincoln,  Neb.,  Brent  L.  Stehlik,  letter  ..  2570 

National  Association  for  the  Self-Employed,  Bennie  L.  Thayer,  letter  2573 

National  Association  of  Convenience  Stores,  statement 2576 

National  Association  of  Enrolled  Agents,  James  E.  Forrester,  statement 2580 

National  Association  of  Realtors,  statement  2583 

National  Conference  of  State  Social  Security  Administrators,  Daryl  Dunagan, 

letter 2587 

Organization  for  International  Investment  Inc.,  Alexander  Spitzer,  statement 

and  attachments 2589 

Reid,  Hon.  Harry,  a  United  States  Senator  from  the  State  of  Nevada,  state- 
ment    2597 

Tax  Executives,  Inc.,  Ralph  J.  Weiland,  statement  2599 

True  Companies,  Casper,  Wyo.,  statement  2609 

United  States  Telephone  Association,  John  Sodolski,  statement  2618 

Vucanovich,  Hon.  Barbara  F.,  a  Representative  in  Congress  from  the  State 

of  Nevada,  statement  2623 

Combined  Listing  by  Name  and  Organizations  (Raisers) 

Able,  Edward  H.,  Jr.,  American  Association  of  Museums,  letter  2436 

Alliance  Exchange  Group,  Inc.,  Santa  Ana,  Calif.,  Deanna  F.  Burton,  letter  ....  2498 

Alliance  for  Justice,  Nan  Aron  and  Carol  Siefert,  letter  and  attachment  2431 

American  Association  of  Museums,  Edward  H.  Able,  Jr.,  letter  2436 

American  Bankers  Association,  statement  2525 

American  Electronics  Association,  statement  2529 

American  Equity  Exchange,  Inc.,  Dillon,  Mont.,  Max  A.  Hansen,  letter  2499 

American  Federation  of  Labor  and  Congress  of  Industrial  Organizations,  Rob- 
ert E.  Lucore,  statement  2325 

American  Forest  and  Paper  Association: 

Statement  and  attacnment  2399 

Statement  2533 

American  Gas  Association,  statement 2535 

American  Greyhound  Track  Operators  Association,  Henry  C.   Cashen  and 

John  C.  DiU,  statement 2544 

American  Horse  Council,  Inc.,  statement  2546 

American  Land  Title  Association,  Ann  vom  Eigen: 

Statement  2447 

Statement  2500 

American  Petroleum  Institute,  statement  2551 

American  Trucking  Associations,  Inc.,  statement 2560 

Anstrom,  Decker,  National  Cable  Television  Association,  statement  2381 

Aron,  Nan,  Alliance  for  Justice,  letter  and  attachment  2431 

Arthur  Andersen  &  Co.,  Andre  P.  Fogarasi  and  Richard  A.  Gordon,  state- 
ment    2329 

Asociacion  de  Exportadores  De  Chile  (Chilean  Exporter's  Association),  Ronald 

S.  Bown  F.,  letter  and  attachment  2402 

Association  of  British  Insurers,  statement 2339 


XXX 

Page 

Association  of  Home  Appliance  Manufacturers,  statement 2407 

Attorneys'  Liability  Assurance  Society,  Inc.,  John  E.  Chapoton  and  Thomas 

A.  Stout,  Jr.,  letter  2345 

Baily,  Edward  A.,  Carrier  Corp.,  Syracuse,  N.Y,,  letter 2409 

Barth,  James  P.,  North  Bend,  Ohio,  letter  2243 

Belding,  David,  Nevada  Resort  Association: 

Statement  2287 

Statement  2378 

Statement  2458 

BUbray,  Hon.  James  H.,  a  Representative  in  Congress  from  the  State  of 

Nevada,  statement  2563 

Bishop,  Barbara,  Pasedena,  Calif.,  letter  2502 

Black  Entertainment  Television,  Robert  L.  Johnson,  letter  2244 

Blum,    Jared    O.,    Polyisocyanurate    Insulation   Manufacturers   Association, 

statement  2412 

Bowling,  Richard  P.,  Truck  Trailer  Manufacturers  Association,  letter 2398 

Bown  F.,  Ronald  S.,  Asociacion  de  Exportadores  De  Chile  (Chilean  Exporter's 

Association),  letter  and  attachment 2402 

Brown,  Paul  S.,  Risk  and  Insurance  Management  Society,  Inc.,  letter  2374 

Bryan,  Hon.  Richard,  a  United  States  Senator  from  the  State  of  Nevada, 

statement  2564 

Building  and  Construction  Trades  Department,  AFL-CIO,  Robert  A.  Georgine, 

statement  2463 

Burt,  R.L.,  Southampton,  Mass.,  letter 2566 

Burton,  Deanna  F.,  Alliance  Exchange  Group,  Inc.,  Santa  Ana,  Calif.,  letter  ...  2498 

Business  Roundtable,  statement  2233 

Carrier  Corp.,  Syracuse,  N.Y.,  Edward  A.  Baily,  letter 2409 

Cashen,  Henry  C,  American  Greyhound  Track  Operators  Association,  state- 
ment    2544 

Casterline,  James  C,  Real  Estate  Exchange,  Inc.,  Portland,  Ore.,  letter  2510 

Center  for  International  Environmental  Law,  Robert  F.  Housman,  statement  .  2294 

Center  for  Non-Profit  Corporations,  Princeton,  N.J.,  Linda  M.  Czipo,  letter  2438 

Center  for  the  Study  of  Commercialism,  Michael  F.  Jacobson,  letter 2245 

Centex  Corp.,  Dallas,  Tex.,  Richard  C.  Harvey,  letter  2567 

Cetylite  Inaustries,  Inc.,  Pennsauken,  N.J.,  Stanley  L.  Wachman,  statement  ..  2410 

Chapoton,  John  E.,  Attorneys'  Liability  Assurance  Society,  Inc.,  letter  2345 

Cherry,  Mark,  Mack  Trucks,  Inc.,  statement  and  attachments  2388 

Christianson,  Kathleen  A.,  Fidelty  Federal  Bank,  Glendale,  Calif.,  letter  2267 

Coal  Tax  Committee,  statement  2240 

Coalition  for  Independent  Contractors,  Edward  N.  Delaney  and  Russell  A. 

Holb-ah,  statement  2469 

Coalition  on  Interest  Disallowance,  statement  2455 

Coopers  &  Lybrand,  Washington,  D.C.,  statement  2284 

Customs  Science  Services,  Inc.,  Kensington,  Md.,  Robert  J.  Grain,  letter  2283 

Cutrone,  Roseann  M.,  Export  Source  Coalition,  statement  and  attachments  ....  2299 

Czipo,  Linda  M.,  Center  for  Non-Profit  Corporations,  Princeton,  N.J.,  letter  ....  2438 
Danaher  Corp.,  Washington,  D.C.,  James  H.  Ditkoff: 

Letter 2249 

Letter 2337 

Delaney,  Edward  N.,  Coalition  for  Independent  Contractors,  statement  2469 

Dill,  John  C,  American  Greyhound  Track  Operators  Association,  statement  ...  2544 
Ditkoff,  James  H.,  Danaher  Corp.,  Washington,  D.C.: 

Letter  2249 

Letter  2337 

Dunagan,  Daryl,  National  Conference  of  State  Social  Security  Administrators, 

letter 2587 

Duncan,  Harley  T.,  Federation  of  Tax  Administrators,  statement  and  attach- 
ment    2449 

Edwin  L.  Cox  Co.,  Dallas,  Tex.,  J.  Oliver  McGonigle,  letter 2251 

Environcol,  James  C.  Godbout,  Diane  Hemdon,  and  Mary  Frances  Pearson, 

statement  2513 

Equity  Advantage,  Inc.,  Salem,  Ore.,  Lonnie  C.  Nielson,  Thomas  N.  Moore, 

and  David  S.  Moore,  letter  2503 

Equity  Reserve,  Inc.,  Newport  Beach,  Calif.,  Frank  C.  Huntsman,  letter 2504 

Export  Source  Coalition,  Paul  W.  Oosterhuis  and  Roseann  M.  Cutrone,  state- 
ment and  attachments  2299 

Famham,  Thomas  G.,  SeaWest,  San  Diego,  Calif.,  letter  2290 


XXXI 

Page 

Federation  of  Exchange  Accommodators,  Newport  Beach,  Calif.,  Andrew  G. 

Potter,  letter  2505 

Federation  of  Tax  Administrators,  Harley  T.  Duncan,  statement  and  attach- 
ment    2449 

Fidelty  Federal  Bank,  Glendale,  Calif.,  Kathleen  A.  Christiansen,  letter 2267 

Fisher,  John  J.,  Barrineton,  111.,  letter  2252 

Fogarasi,  Andre  P.,  Artnur  Andersen  &  Co.,  statement  2329 

Food  Marketing  Institute,  and  International  Mass  Retail  Association,  joint 

statement  2253 

Forrester,  James  E.,  National  Association  of  Enrolled  Agents,  statement  2580 

Georgine,  Robert  A.,  Building  and  Construction  Traifes  Department,  AFL- 

CIO,  statement  2463 

Giusti,  Steve,  Laser  Graphics,  Inc.,  Hillside,  111.,  letter  2279 

Godbout,  James  C,  Environcol,  statement 2513 

Gomola,  Gary  R.,  Coughlin  &  Gomola,  Middletown,  Conn.,  letter 2453 

Good,  James  L.,  National  Association  of  Water  Companies,  statement  2274 

Gordanier,  Dean  C,  Jr.,  National  Venture  Capital  Association,  letter  2440 

Gordon,  Richard  A.,  Arthur  Andersen  &  Co.,  statement  2329 

Guttman,  Steven  J.,  International  Council  of  Shopping  Centers,  statement  2507 

Hansen,  Max  A.,  American  Equity  Exchange,  Inc.,  Dillon,  Mont.,  letter  2499 

Harvey,  Richard  C,  Centex  Corp.,  Dallas,  Tex.,  letter  2567 

Hass,  Michael  J.,  National  Association  of  Insurance  Brokers,  letter  2364 

Healey,  Maureen  A.,  Society  of  the  Plastics  Industry,  Inc.,  letters  and  attach- 
ments    2416 

Hemdon,  Diane,  Environcol,  statement 2513 

HoUrah,  Russell  A.,  Coalition  for  Independent  Contractors,  statement  2469 

Housman,  Robert  F.,  Center  for  International  Environmental  Law,  statement  2294 
Hulen,  MjTX)n,   Colorado  State  University;  William  Kinny,  Portland  State 
University;  Jack  Robison,  California  Polytechnic  State  University;  and  Mi- 
chael Vaughan,  Colorado  State  University,  joint  statement  2474 

Huntsman,  Frank  C,  Equity  Reserve,  Inc.,  Newport  Beach,  Calif.,  letter 2504 

Independent  Bankers  Association  of  America,  statement  2568 

Independent  Fuel  Terminal  Operators  Association,   statement  and  attach- 
ment    2518 

International  Council  of  Shopping  Centers,  Steven  J.  Guttman,  statement  2507 

International  Mass  Retail  Association,  and  Food  Marketing  Institute,  joint 

statement  2253 

International  Tax  Policy  Forum,  Joel  Slemrod,  statement  and  attachment  2309 

Jacobson,  Michael  F.,  Center  for  the  Study  of  Commercialism,  letter 2245 

Johnson,  Robert  L.,  Black  Entertainment  Television,  letter  2244 

Kastner,  Michael  E.,  National  Truck  Equipment  Association,  letter  and  at- 
tachment    2396 

Kennelly,  Hon.  Barbara  B.,  a  Representative  in  Congress  from  the  State 

of  Connecticut,  letter  and  attachments  2350 

Kiefler-Nolde,  Chicago,  Bl.,  Neil  J.  Schecter,  letter 2278 

Kinny,  William,  Portland  State  University,  joint  statement  (see  listing  for 
Myron  Hulen) 

KPMG  Peat  Marwick,  statement  2268 

Kraut,  Jeffrey  B.,  Swavelle/Mill  Creek  Fabrics,  New  York,  N.Y.,  letter 2282 

Lackritz,  Marc  E.,  Securities  Industry  Association,  statement  2320 

Lantos,  Hon.  Tom,  a  Representative  in  Congress  from  the  State  of  California, 

statement  1379 

Larsen,  Bryant  &  Porter,  CPA's,  P.C,  Lincoln,  Neb.,  Brent  L.  Stehlik,  letter  ..  2570 

Laser  Graphics,  Inc.,  Hillside,  Bl.,  Steve  Giusti,  letter  2279 

Lawson,  Richard  L.,  National  Coal  Association,  statement  2237 

Lear,  Jeffrey  A.,  National  Society  of  Public  Accountants,  statement 2235 

Levenson,  Daniel  D.,  Lourie  &  Cutler,  P.C,  Boston,  Mass.,  statement 2461 

Lucore,  ELobert  E.,  American  Federation  of  Labor  and  Congress  of  Industrial 

Organizations,  statement  2325 

Lynd,  Robert  D.,  National  Interfratemitv  Conference,  joint  statement  and 

attachment  (see  listing  for  National  Panhellenic  Conference) 
Macht,  Harriett  B.,  National  Panhellenic  Conference,  joint  statement  and 

attachment 2426 

Mack  Trucks,  Inc.,  Mark  Cherry,  statement  and  attachments  2388 

Mattel,  Inc.,  statement  2255 

McGonigle,  J.  Oliver,  Edwin  L.  Cox  Co.,  Dallas,  Tex.,  letter 2251 

Miles  Inc.,  Pittsburgh,  Pa.,  Helge  H.  Wehmeier,  letter 2257 

Moore,  David  S.,  Equity  Advantage,  Inc.,  Salem,  Ore.,  letter 2503 


XXXII 

Page 

Moore,  Thomas  N.,  Eguity  Advantage,  Inc.,  Salem,  Ore.,  letter  2503 

National  Association  for  the  Self-Employed,  Bennie  L.  Thayer,  letter  2573 

National  Association  of  Convenience  Stores,  statement 2576 

National  Association  of  Enrolled  Agents,  James  E.  Forrester,  statement  2580 

National  Association  of  Insurance  Brokers,  Michael  J.  Hass,  letter  2364 

National  Association  of  Realtors,  statement  2583 

National  Association  of  Water  Companies,  James  L.  Good,  statement  2274 

National  Cable  Television  Association,  Decker  Anstrom,  statement  2381 

National  Club  Association,  statement 2423 

National  Coal  Association,  Richard  L.  Lawson,  statement  2237 

National  Conference  of  State  Social  Security  Administrators,  Daryl  Dunagan, 

letter 2587 

National  Federation  of  Independent  Business,  statement  2482 

National  Panhellenic  Conference,  Harriett  B.  Macht;  National  Pan-Hellenic 
Council,  Inc.,  Daisy  Wood;  and  National  Interfratemity  Conference,  Robert 

D.  Lynd,  joint  statement  and  attachment  2426 

National  Petroleum  Refiners  Association,  Urvan  R.  Stemfels,  letter 2298 

National  Society  of  Public  Accountants,  Leroy  A.  Strubberg,  and  Jeffrey  A. 

Lear,  statement  2235 

National  Truck  Equipment  Association,  Michael  E.  Kastner,  letter  and  at- 
tachment    2396 

National  Venture  Capital  Association,  Dean  C.  Gordanier,  Jr.,  letter  2440 

Nevada  Resort  Association,  David  Belding: 

Statement  2287 

Statement  2378 

Statement  2458 

New  York  Gas  Group,  Donald  F.  Straetz,  statement  2523 

Newspaper  Association  of  America,  statement  2382 

Nielson,  Lonnie  C,  Equity  Advantage,  Inc.,  Salem,  Ore.,  letter  2503 

Oosterhuis,  Paul  W.,  Export  Source  Coalition,  statement  and  attachments 2299 

Organization  for  International  Investment  Inc.,  Alexander  Spitzer,  statement 

and  attachments 2589 

Pabst,  Walter  C,  Techtron  Imaging  Centre,  Chicago,  HI.,  letter  2281 

Patterson,  William  R.,  Stratford  Technologies,  Inc.,  Somerdale,  N.J.,  letter  2490 

Paul,  William  F.,  United  Technologies,  letter  2316 

Pearson,  Mary  Frances,  Environcol,  statement  2513 

Polyisocyanurate  Insulation  Manufacturers  Association,  Jared  O.  Blum,  state- 
ment    2412 

Potter,  Andrew  G.,  Federation  of  Exchange  Accommodators,  Newport  Beach, 

Calif.,  letter 2505 

Public  Securities  Association,  statement  2318 

Ralston  Purina  Co.,  Ronald  B.  Weinel,  statement  and  attachments  2258 

Real  Estate  Exchange,  Inc.,  Portland,  Ore.,  James  C.  Casterline,  letter  2510 

Reid,  Hon.  Harry,  a  United  States  Senator  from  the  State  of  Nevada: 

Statement  2291 

Statement  2597 

Reinsurance  Association  of  America,  statement  2366 

Renewable  Fuels  Association,  Eric  Vaughn,  statement  2383 

Retail  Tax  Committee  of  Common  Interest,  statement 2263 

Risk  and  Insurance  Management  Society,  Inc.,  Paul  S.  Brown,  letter  2374 

Robison,  Jack,  California  Polytechnic  State  University,  joint  statement  (see 
listing  for  Myron  Hulen) 

Schecter,  Neil  J.,  Kieffer-Nolde,  Chicago,  111.,  letter 2278 

SeaWest,  San  Diego,  Calif.,  Thomas  G.  Famham,  letter  2290 

Securities  Industry  Association,  Marc  E.  Lackritz,  statement  2320 

Security  Trust  Co.,  San  Diego,  Calif.,  J.  Paul  Spring,  letter  2512 

Shays,  Hon.  Christopher,  a  Representative  in  Congress  from  the  State  of 

Connecticut,  statement  1382 

Siefert,  Carol,  Alliance  for  Justice,  letter  and  attachment  2431 

Slemrod,  Joel,  International  Tax  Policy  Forum,  statement  and  attachment  2309 

Society  of  the  Plastics  Industry,  Inc.,  Maureen  A.  Healey,  letters  and  attach- 
ments    2416 

Sodolski,  John,  United  States  Telephone  Association,  statement  2618 

Spitzer,  Alexander,  Organization  for  International  Investment  Inc.,  statement 

and  attachments 2589 

Spring,  J.  Paul,  Security  Trust  Co.,  San  Diego,  Calif.,  letter  2512 

Stehl&,  Brent  L.,  Ursen,  Bryant  &.  Porter,  CPA's,  P.C,  Lincoln,  Neb.,  letter  .  2570 

Stemfels,  Urvan  R.,  National  Petroleum  Refiners  Association,  letter  2298 


XXXIII 

Page 

Stout,  Thomaa  A.,  Jr.,  Attorneys'  Liability  Assurance  Society,  Inc.,  letter  2345 

Straetz,  Donald  F.,  New  York  Gas  Group,  statement  2523 

Stratford  Technologies,  Inc.,  Somerdale,  NJ.,  William  R.  Patterson,  letter  2490 

Strubberc,  Leroy  A.,  National  Society  of  Public  Accountants,  statement 2235 

Studds,  Hon.  Gerry  E.,  a  Representative  in  Congress  from  the  State  of  Massa- 
chusetts, statement  2497 

Sundquist,   Hon.   Don,    a   Represeiitative   in   Congress   from  the   State   of 
Tennessee: 

Statement  2266 

Statement  2280 

Swavelle/Mill  Creek  Fabrics,  New  York,  N.Y.,  Jeffrey  B.  Kraut,  letter 2282 

Tax  Executives  Institute,  Inc.,  Ralph  J.  Weiland,  statement  2599 

Techtron  Ima^ng  Centre,  Chicago,  111.,  Walter  C.  Pabst,  letter  2281 

Thayer,  Bennie  L.,  National  Association  for  the  Self-Employed,  letter  2573 

Thompson,  Michael  C,  Whirlpool  Corp.,  statement  2421 

Truck  Trailer  Manufacturers  Association,  Richard  P.  Bowling,  letter 2398 

True  Companies,  Casper,  Wyo.,  statement  2609 

United  Brotherhood  of  Carpenters  and  Joiners  of  America,  AFL#-CIO,  state- 
ment    2492 

United  States  Council  for  International  Business: 

Statement  2312 

Statement  2324 

United  States  Telephone  Association,  John  Sodolski,  statement  2618 

United  Technologies,  William  F.  Paul,  letter  2316 

Vaughan,  Michael,  Colorado  State  University,  joint  statement  (see  listing 
for  Myron  Hulen) 

Vaughn,  Eric,  Renewable  Fuels  Association,  statement  2383 

vom  Eigen,  Ann,  American  Land  Title  Association,  statement  2500 

Vucanovich,  Hon.  Barbara  F.,  a  Representative  in  Congress  from  the  State 

of  Nevada,  statement  2623 

Wachman,  Stanley  L.,  Cetylite  Industries,  Inc.,  Pennsauken,  NJ.,  statement  .  2410 

Wehmeier,  Helge  H.,  Miles  Inc.,  Pittsburgh,  Pa.,  letter 2257 

Weiland,  Ralph  J.,  Tax  Executives  Institute,  Inc.,  statement  2599 

Weinel,  Ronald  B.,  Ralston  Purina  Co.,  statement  and  attachments  2258 

Whirlpool  Corp.,  Michael  C.  Thompson,  statement  2421 

Wood,  Daisy,  National  Pan-Hellenic  Council,  Inc.,  joint  statement  and  attach- 
ment (see  listing  for  National  Panhellenic  Conference) 


77-130  0 -94 -2 


MISCELLANEOUS  REVENUE  ISSUES 


WEDNESDAY,  SEPTEMBER  8,  1993 

House  of  Representatives, 
Committee  on  Ways  and  Means, 
Subcommittee  on  Select  Revenue  Measures, 

Washington,  D.C. 

The  subcommittee  met,  pursuant  to  call,  at  10:05  a.m.,  in  room 
1100,  Longworth  House  Office  Building,  Hon.  Charles  B.  Rangel 
(chairman  of  the  subcommittee)  presiding. 

Chairman  Rangel.  Good  morning. 

The  Subcommittee  on  Select  Revenue  Measures  will  resume  its 
series  of  hearings  on  miscellaneous  revenue  issues.  Earlier  this 
year,  we  conducted  four  hearings  focused  on  these  matters.  All  of 
those  were  the  revenue-losing  issues.  We  will  consider  additional 
testimony  today  on  other  miscellaneous  items.  This  time  we  will 
concentrate  on  those  issues  that  raise  revenue. 

As  those  of  you  who  are  familiar  with  the  committee  are  aware, 
Chairman  Rostenkowski  and  our  committee  have  a  strong  commit- 
ment to  deficit  reduction  and  responsible  fiscal  policv.  In  keeping 
with  long  tradition,  any  miscellaneous  issue  that  the  committee 
brings  up,  the  member  must  offset  it  by  an  appropriate  revenue- 
raising  item.  So  we  have  to  do  both,  raise  the  issue  and  find  out 
how  we  are  going  to  pay  for  it.  Those  suggested  revenue  raisers 
will  be  the  subject  of  today's  hearing  and  again  on  September  21 
we  will  review  or  return  to  this  issue. 

We  will  hear  from  public  witnesses  in  the  following  areas:  the  al- 
ternative minimum  tax,  accounting,  financial  institution  costs,  re- 
covery pass-through  entities,  individual  taxes,  natural  resources 
issue,  and  tax-exempt  entities.  On  the  second  day  of  the  hearings, 
Treasury  is  expected  to  testify  on  these  issues,  which  will  be  Sep- 
tember 21. 

At  this  point,  I  would  like  to  recognize  the  ranking  member  of 
the  subcommittee,  Mel  Hancock  for  whatever  opening  remarks  he 
has  to  make. 

Mr.  Hancock.  Thank  you,  Mr.  Chairman. 

Today  we  will  hear  testimony  from  a  wide  variety  of  witnesses 
on  a  number  of  revenue-raising  proposals  before  this  subcommittee. 
As  you  remember,  the  committee  spent  several  weeks  this  summer 
considering  the  revenue-losing  provisions  which  constituted  the 
easv  part  of  the  miscellaneous  tax  bill's  journey  through  the  Ways 
and  Means  Committee. 

Many  items  discussed  in  the  previous  hearings  made  good  sense 
and  many  should  be  enacted  into  law,  but  when  you  look  at  the  list 
of  revenue  raisers  we  have  before  us  today,  and  the  additional 

(1055) 


1056 

items  we  will  discuss  later  this  month,  one  has  to  ask:  Do  the  bene- 
fits derived  fi-om  this  process  outweigh  the  burdens  placed  on  indi- 
viduals and  businesses  through  the  so-called  revenue-raising  off- 
sets? 

One  merely  has  to  look  at  this  list  of  offsets  to  see  that  the  bur- 
den on  individuals  and  business  will  be  great,  in  my  opinion  much 
greater  than  any  benefits  provided  through  this  process.  What  is 
worse,  these  new  tax  proposals  come  1  month  after  the  President 
signed  into  law  a  new  massive  tax  plan,  which  will  affect  nearly 
every  individual  and  business  in  this  country. 

The  effects  of  this  process  appear  to  be  just  as  grave.  Not  only 
will  these  numerous  provisions  increase  direct  costs  to  individuals 
and  businesses,  the  cost  of  complying  with  these  complicated  pro- 
posals could  be  astoundingly  high.  Limiting  deductions,  lengthen- 
ing recovery  periods,  and  stretching  out  amortization  schedules  are 
the  methods  of  choice  in  raising  this  revenue. 

Few  of  these  proposals  contain  the  characteristics  of  sound  tax 
policy,  and  several  make  no  sense  at  all.  Many  were  conceived  with 
no  concern  for  their  effect  on  those  who  will  be  impacted,  but  mere- 
ly as  a  means  to  finance  other  provisions  of  the  bill.  In  these  times 
of  slow  economic  growth  and  on  the  heels  of  the  largest  tax  in- 
crease in  history,  we  should  not  seriously  be  considering  the  items 
before  us  today. 

While  at  first  glance  the  items  we  will  explore  today  may  seem 
minor,  let  me  assure  you,  Mr.  Chairman,  they  are  very  important 
to  those  who  will  be  affected  and  could  hold  disastrous  economic 
consequences.  I  think  it  is  some  sort  of  dichotomy  that  yesterday 
the  Vice  President  released  an  administration  proposal  to  reinvent 
Government  through  consolidation  and  simplification.  Now  here  we 
are  today. 

I  encourage  my  colleagues  on  this  panel  to  listen  carefully  to  the 
witnesses  who  will  testify  before  us,  many  of  whom  have  already 
sacrificed  under  the  President's  tax  bill.  At  the  end  of  this  long  day, 
it  should  be  clear  to  all  that  the  burdens  mandated  through  this 
process  outweigh  any  benefits  which  may  exist. 

Mr.  Chairman,  this  is  the  first  day  back  from  a  vacation  and  I 
wish  we  had  held  this  up  for  a  few  more  days  because  this  is  not 
something  I  want  to  address  this  quickly  after  a  pleasant  30  days 
away  from  here.  I  know  it  has  to  be  done,  but  let's  seriously  con- 
sider what  we  are  doing  and  consider  the  impact  that  this  is  going 
to  have  on  the  people  who  are  going  to  end  up  paying  these  addi- 
tional taxes. 

Chairman  Rangel.  If  your  district  had  the  problems  that  my  dis- 
trict had,  you  would  recognize  the  vacation  starts  today  for  me.  I 
am  glad  to  be  back  here. 

Does  anyone  seek  recognition? 

We  have  a  panel  before  us  led  by  Hon.  Walter  Tucker  concerning 
a  project  that  the  committee  is  anxious  to  hear  about  in  the  sov- 
ereign State  of  California.  We  welcome  all  members  of  the  delega- 
tion. 

Ms.  Allard  is  here.  Mr.  Horn  is  here.  Ms.  Waters  is  expected,  and 
Congress  woman  Harman  is  here.  As  others  arrive,  they  will  be 
recognized. 


1057 

STATEMENT  OF  HON.  WALTER  R.  TUCKER  HI,  A  REPRESENTA- 
TIVE IN  CONGRESS  FROM  THE  STATE  OF  CALIFORNIA 

Mr.  Tucker.  Thank  you,  Mr.  Chairman  and  distinguished  mem- 
bers of  the  committee. 

Again  thank  you  for  hearing  us  today  and  recognizing  this  dele- 
gation that  is  concerned  about  alternative  financing  for  a  project 
called  the  Alameda  Corridor.  Before  I  give  background  on  the  Ala- 
meda Corridor,  I  would  like  to  have  entered  into  the  record  a  for- 
mal statement  which  I  will  extrapolate  from. 

Chairman  Rangel.  Without  objection. 

Mr.  Tucker.  Thank  you,  Mr.  Chairman. 

I  believe  members  of  the  committee  do  have  a  packet  and  com- 
prised within  the  packet  is  also  a  map,  which  may  be  of  use  to 
them  in  following  some  of  my  commentary  about  the  overall  make- 
up of  what  is  called  the  Alameda  Corridor  Project.  This  project  was 
initiated  by  the  Alameda  Corridor  Transportation  Authority  com- 
prised of  local  communities  stretching  from  downtown  L.A.  to  the 
port  of  Los  Angeles  and  the  port  of  Long  Beach,  a  20-mile  stretch. 

Those  two  ports  combined  comprise  the  largest  port  facility  in 
the  country  and  the  third  largest  in  the  world.  They  generate  100 
million  tons  annuallv  and  they  are  obviously  a  very  great  source 
of  exportation  over  tne  Pacific  Rim  which,  as  we  heard  during  the 
campaign,  is  the  most  prodigious  source  of  exports  for  this  country. 

This  particular  project  came  about  as  a  result  of  a  concern  to 
consolidate  and  a  concern  to  become  more  efficient.  There  are  cur- 
rently three  separate  railroads  using  four  different  routes  to  move 
cargo  between  downtown  L.A.  and  the  ports,  resulting  in  inefficien- 
cies and  environmental  problems. 

The  additional  cost  to  shippers,  who  must  put  up  with  delays  in 
transportation  and  transshipment  of  cargo  destined  for  the  East 
Coast  and  other  points,  is  becoming  difficult  to  justify.  Even  as  we 
speak,  there  are  reports  about  a  possible  construction  of  a  port  in 
Mexico  in  the  Baja  Peninsula,  which  would  create  some  kind  of 
competition  for  the  ports  of  Los  Angeles  and  Long  Beach. 

In  light  of  a  lot  of  impending  discussions  and  negotiations  on 
NAFTA,  this  may  or  may  not  bring  such  competition  to  fruition. 
We  are  trying  to  come  up  with  alternative  financing  to  better  the 
facilities  at  the  ports  of  Los  Angeles  and  Long  Beach;  in  other 
words,  the  Alameda  Corridor.  The  issue  is  a  question  of  how  we 
can  possibly  come  up  with  tax-exempt  bond  financing. 

In  IRS  Code  section  142(c),  there  is  language  as  to  the  ability  to 
have  tax-exempt  bond  financing  for  ports  and  docks  and  wharves 
including  airports.  Our  submission  to  this  distinguished  committee 
is  that  that  particular  code  section  be  amended  to  include  transpor- 
tation and  port-related  facilities,  such  as  the  Alameda  Corridor  not 
exclusive  to  the  Alameda  Corridor,  but  certainly  exemplary  of  the 
Alameda  Corridor. 

We  believe  that  this  is  a  natural  extension,  physical,  legal  and 
practical  of  the  port  and  thereby  not  in  any  way  thwarting  or  un- 
dermining the  intent  of  the  law,  the  intent  of  the  code  as  written. 
For  that  reason,  we  believe  that  such  an  amendment  should  be 
made. 

Mind  you,  even  as  the  chairman  indicated  about  the  economic 
problems  all  over  the  country,  we  understand  that  in  New  York,  in 


1058 

New  Jersey,  and  other  parts  of  the  country,  port  facilities  are  also 
undergoing  expansion  and  progress,  whether  they  are  on  our  time- 
table or  not.  Such  amendment  we  believe  would  be  advantageous 
and  beneficial  to  such  projects  throughout  the  whole  country,  not 
exclusive  just  to  California.  But  as  it  relates  to  statistics  as  to  Cali- 
fornia, we  can  share  with  you  at  this  point  that  the  projection  is 
that  700,000  more  jobs  would  be  created  in  California  by  the  year 
2020.  ^^^^^^ 

Of  course,  some  people  have  said-as  California  goes,  so  goes  the 
country.  But  the  importance  of  this  particular  project  is  that  it  has 
national  implications  inasmuch  as  we  are  talking  about  the  better- 
ment and  enhancement  of  trade  on  a  national  basis.  Once  again, 
the  project  will  consolidate  rail  traffic  and  the  total  project  would 
be  estimated  to  cost  $1.8  billion.  We  have  looked  at  and  you  will 
see  in  our  written  statement,  we  have  looked  at  the  possibility  of 
highway  funds. 

We  have  looked  at  the  possibility  of  funds  by  the  different  ports; 
in  fact,  the  ports  have  already  put  up  hundreds  of  millions  of  dol- 
lars for  the  betterment  of  this  project,  $400  million  contribution  to 
be  specific.  Eight  million  dollars  is  expected  from  other  local,  State 
and  Federal  sources.  There  remains  a  $600  million  shortfall  and 
this  is  why  we  are  coming  to  this  committee  to  look  at  it  these  al- 
ternative sources. 

The  language  of  the  proposed  agreement  to  the  Internal  Revenue 
Code  would  permit  the  issuance  of  tax-exempt  bonds  by  the  Ala- 
meda Corridor  Transportation  Authority  for  the  purpose  of  upgrad- 
ing the  20-mile  consolidated  rail  and  highway  corridor  that  we  say 
is  an  extension  of  the  physical  port  itself  Once  again,  this  Alameda 
Corridor  Transportation  Authority,  that  we  call  ACTA,  is  a  public 
entity  and  therefore  a  public  entity  will  in  fact  own  the  corridor  au- 
thority and  in  fact  then  come  within  the  governmental  guidelines, 
if  you  will,  of  the  IRS  142(c)  language. 

The  language  of  the  amendment  is  entirely  consistent  with  the 
public  policy  underlying  the  ability  to  issue  tax-exempt  bonds  to  fi- 
nance ports  because  it  covers  only  facilities  that  are  integral  to  op- 
erations of  the  ports  and  dedicated  to  those  operations. 

I  might  also  add  that  this  project  has  received  national  support 
from  the  American  Association  of  Port  Authorities.  This  project  has 
also  received  bipartisan  support  from  Republicans  and  Democrats 
alike.  I  might  cite  a  dear  colleague  letter  that  is  included  in  the 
packet  that  has  just  about  every  signature  of  the  members  of  the 
California  delegation,  crossing  all  party  lines. 

In  summary,  Mr.  Chairman  and  members  of  the  committee,  we 
would  ask  that  you  look  very  closely  at  this.  We  understand  that 
there  have  been  numbers  projected  that  this  might  cost  $115  mil- 
lion over  5  years,  but  that  our  share  would  be  measurably  less 
than  that. 

I  am  sure  that  one  of  the  first  questions  that  you  will  raise  is 
how  will  we  pay  for  this.  I  am  sure  your  committee  is  in  the  busi- 
ness of  working  out  those  kinds  of  details.  But  we  are  here  today 
to  get  the  ball  rolling  initially  to  say  that  this  is  a  project  of  na- 
tional and  international  import  and  hopefully  export  too,  and  that 
we  believe  that  it  is  important  to  get  this  going  now  to  look  at  al- 


1059 

temative  financial  and  financing  sources  and  we  believe  the  tax- 
exempt  bond  financing  would  be  one  of  the  best  ways  to  do  it. 

Let  me  add,  I  am  joined  by  another  distinguished  member  of  the 
California  delegation,  Ms.  Waters.  We  want  to  welcome  her  as  part 
of  this  delegation. 

At  this  time,  I  would  like  to  turn  it  over  to  Congresswoman 
Lucille  Roybal-Allard. 

[The  prepared  statement  and  attachments  follow:] 


1060 
(CoxiQxt^i  of  tfje  Winitth  ^tatt^ 

J^oviie  of  iRcpregcntatibeff 
3Ba£f)tng:ton.  BC  20515 

Written  Testimony  of 

The  Honorable  Walter  R.  Tucker  III 

The  Honorable  Steve  Horn 

The  Honorable  Lucille  Roybal-Allard 

The  Honorable  Maxine  Waters 

The  Honorable  Jane  Harman 

The  Honorable  Xavier  Becerra 

Before  the  Subconunittee  on  Select  Revenue  Measures 
Conunittee  on  Ways  and  Means 
September  8,  1993 

Good  morning,  Mr.  Chairman,  and  Members  of  the  Committee.  We  are 
here  today  in  support  of  a  proposed  amendment  to  Section  142(c)  of 
the  Internal  Revenue  Code  to  allow  exempt  facility  bonds  to  be 
issued  for  certain  transportation  facilities  (including  trackage 
and  rail  facilities)  used  for  the  transport  of  cargo  or  passengers 
mainly  to  or  from  airports,  docks,  or  wharves,  regardless  of 
whether  the  facilities  meet  the  governmental  ownership  requirement 
of  Code  section  142(b)(1). 

While  the  proposed  amendment  could  potentially  affect  projects 
around  the  Country,  we  would  like  to  address  its  significance  to  a 
specific  project  with  which  we  are  very  familiar  --  the  Alameda 
Transportation  Corridor.  This  20  mile  corridor  passes  through  our 
districts  as  it  runs  from  downtown  Los  Angeles  to  the  San  Pedro 
Bay  Ports,  the  largest  port  complex  in  the  United  States. 

We  have  attached  for  the  record  a  report  that  outlines  the  full 
scope  of  this  project.  However,  we  would  like  to  tell  you  just 
enough  about  it  to  demonstrate  why  the  amendment  has  national 
significance  even  if  it  were  to  apply  to  this  project  alone. 

The  Alameda  Corridor  Project 

The  Alameda  Corridor  Project  was  initiated  by  the  Alameda  Corridor 
Transportation  Authority  and  an  EIR  funded  by  the  Authority  was 
certified  January  14  of  this  year.  The  objective  of  the  project 
is  to  consolidate  rail  traffic  along  the  Alameda  Street  route  that 
extends  from  the  main  rail  yards  in  downtown  Los  Angeles  to  the 
two  ports  of  Los  Angeles  and  Long  Beach.  Currently,  three 
separate  railroads  use  four  different  routes  to  move  their  cargo 
between  downtown  and  the  ports.  The  inefficiencies  and 
environmental  problems  associated  with  the  current  practice  is 
unacceptable  not  only  to  the  people  who  live  and  work  in  this  area 
but  to  the  competitive  position  of  the  United  States  in  World 
markets.  The  additional  cost  to  shippers  who  must  put  up  with 
delays  in  the  transhipment  of  cargo  destined  for  the  East  Coast 
and  other  points  is  becoming  increasingly  difficult  to  justify  and 
there  are  already  reports  that  Mexico  is  hoping  to  attract  foreign 


1061 


capital  to  the  Baja  Peninsula  for  the  purpose  of  constructing  a 
port  to  compete  with  the  San  Pedro  Bay  Ports. 

Currently,  cargo  volumes  through  the  port  complex  amount  to 
roughly  100  million  tons  annually,  and  in  a  study  completed  by  the 
U.S.  Army  Corps  of  Engineers  on  behalf  of  the  two  ports,  these 
totals  are  projected  to  double  by  the  year  2020.  Indeed  a  new 
coal  shipping  agreement  signed  just  recently  opens  the  way  to 
dramatically  increase  the  flow  of  U.S.  coal  through  the  ports  to 
Japan  in  the  short  term. 

Mr.  Chairman,  we  must  make  the  surface  transportation  systems 
serving  our  ports  competitive  if  we  are  to  protect  our  foreign 
trade  status  in  the  World  economy.  At  the  same  time  we  have  to  be 
mindful  of  the  impact  these  systems  have  on  the  local  communities 
and  work  to  make  them  compatible  with  their  surrounding 
communities.  In  the  case  of  the  consolidation  of  the  three 
railroads  on  the  Alameda  corridor,  90  miles  of  tracks  crossing  198 
roads  at  grade  level  and  having  a  direct  impact  on  71,000  people 
whose  residences  are  within  500  feet  of  the  rail  line  would  be 
reduced  to  20  miles  of  track,  with  zero  grade  crossings  and 
directly  affecting  only  7,900  people  whose  residences  are  within 
500  feet  of  the  line.  These  are  dramatic  improvements  that  will 
significantly  improve  the  efficiency  of  the  ports  and  the  quality 
of  life  for  the  people  who  live,  work  and  travel  the  Alameda 
Corridor.  As  a  demonstration  of  the  broad  support  for  the  Alameda 
Corridor  Project,  we  have  attached  a  letter  signed  by  46  Members 
of  the  California  Congressional  Delegation  supporting  a  request 
for  federal  funding. 

Tax-Exempt  Bond  Eligibility 

Under  current  law  (section  142  of  the  Code)  dock  and  wharf 
facilities  are  eligible  for  tax-exempt  financing.  Though  the 
facilities  generally  must  be  included  in  the  public  port's 
jurisdiction,  they  are  not  limited  solely  to  the  actual  dock  or 
wharf  facilities  but  include  facilities  which  are  functionally 
related  and  subordinate  to  the  dock  or  wharf.  Nevertheless,  the 
Authority  has  been  advised  by  legal  counsel  that  rail  facilities 
to  transport  cargo  into  and  out  of  a  port,  even  though  dedicated 
to  handling  public  port  cargo,  are  not  a  dock  or  wharf  or 
functionally  related  and  subordinate  to  it.  Therefore,  a  rail  and 
highway  corridor  project  such  as  the  Alameda  Corridor  Project  does 
not  appear  to  be  eligible  for  tax-exempt  financing  at  this  time. 

Our  legal  counsel  has  further  determined  that  the  language  of  the 
proposed  amendment  to  the  Internal  Revenue  Code  would  permit  the 
issuance  of  tax-exempt  bonds  by  the  Alameda  Corridor 
Transportation  Authority  for  the  purpose  of  upgrading  the  20  mile 
consolidated  rail  and  highway  corridor.  We  feel  that  the  language 
of  the  amendment  is  entirely  consistent  with  the  public  policy 
underlying  the  ability  to  issue  tax-exempt  bonds  to  finance  ports 
because  it  covers  only  facilities  that  are  integral  to  the 
operations  of  the  ports  and  dedicated  to  those  operations;  under 
the  amendment  80  percent  of  the  utilization  of  the  project  must  be 
directly  connected  to  port  activity.   Consequently,  we  are  asking 


1062 


that  your  Committee,  Mr.  Chairman,  adopt  the  proposed  sunendment 
thereby  setting  in  motion  one  of  the  most  significant  intermodal 
transportation  projects  in  the  Country. 

Project  Funding  Plan 

Mr.  Chairman,  the  total  cost  of  the  Corridor  consolidation  and 
upgrading  has  been  set  at  $1.8  billion.  Already  the  San  Pedro  Bay 
Ports  have  committed  $400  million  toward  the  right-of-way 
acquisition  and  project  construction.  The  Metropolitan 
Transportation  Authority  has  just  recently  committed  $8  million  in 
local  sales  tax  dollars  for  engineering.  In  addition  to  these 
local  commitments,  four  of  the  grade  crossings  on  the  corridor 
were  authorized  for  partial  federal  funding  under  the  Intermodal 
Surface  Transportation  and  Efficiency  Act  (ISTEA). 

Local,  state  and  federal  highway  funds  will  be  used  to  fund  $800 
million  in  highway  improvements  and  grade  crossings  along  the 
corridor.  While  not  all  such  funding  can  be  identified  in  the 
current  five  year  local  funding  cycle  or  ISTEA  authorization,  we 
are  confident  that  subsequent  extensions  of  ISTEA  authorization 
will  provide  the  federal  funding  that  we  feel  is  appropriate  for 
this  project.  Indeed  there  is  a  very  good  chance  that  the  highway 
segment  of  the  Alameda  Corridor  Project  will  be  included  in  the 
National  Highway  System  when  Congress  completes  its  review  in 
1995.  Once  included  we  are  relatively  assured  that  the  project 
can  be  completed  by  our  target  date  of  the  year  2000. 

Nevertheless,  even  with  the  Ports'  $400  million  contribution  and 
the  $800  million  expected  from  other  local.  State  and  federal 
sources,  there  remains  a  $600  million  shortfall.  The  State  of 
California  has  given  the  Alameda  Corridor  Transportation  Authority 
the  ability  to  issue  bonds  for  the  purpose  of  improving  the  rail 
and  highway  corridor.  The  Authority  is  prepared  to  take  such 
action,  but  Mr.  Chairman,  it  desperately  needs  authority  to  issue 
tax-exempt  bonds. 

Consequently,  we  have  come  before  this  Committee  to  support  an 
amendment  that  would  give  the  Authority  the  ability  to  issue  these 
bonds,  which  would  be  repaid  from  port  and  corridor  user  charges 
and  fees. 

Mr.  Chairman,  you  have  be^n  most  generous  in  taking  our  proposal 
under  consideration,  and  in  your  deliberations  on  this  tax  bill  we 
think  you  will  find  that  the  merits  of  our  position  are 
compelling.  Indeed,  we  feel  that  this  project  can  become  a 
national  model  that  demonstrates  the  willingness  of  all  levels  of 
government  to  work  in  concert  toward  a  mutual  goal  with  truly 
global  economic  significance. 


1063 


llameda  Corridor  Update 


On  Januaiy  14,  1993,  the  Goveniing  Board  of  the  Alameda  Coiridor  Transportation  Authority 
(ACTA)  certified  the  I^nal  Environmental  Impact  Repoit  and  foimally  adopted  the  Alameda 
Corridor  project  Hie  action,  which  was  unanimous,  signifies  a  strong  regional  consensus  that  Ae 
Alameda  Coiridor  should  be  built.  Approximatdy  20  miles  in  length,  the  project  is  designed  to 
facilitate  rail  and  highway  access  to  the  ports  of  Los  Angeles  and  Long  Beach,  while  mitigating 
potentially  adverse  impacts  of  the  ports'  growth,  including  highway  traffic  congestion,  air  pollution, 
vehicle  delays  at  grade  crossings,  and  noise  in  residential  areas. 


Railroad  Component 


The  goal  of  the  railroad  component  of  the  Alameda  Corridor  is  to  consolidate  the  movements  of  the 
Union  Pacific,  Sanu  Fe,  and  Southern  Pacific  Railroads  onto  an  unproved  right-of-way  parallel  to 
Alameda  Street  South  of  Route  9 1  the  railroad  impro  vanents  will  be  at-grade  with  east-west  grade 
separations.  Between  Route  9 1  and  25th  Street  the  raUway  will  be  depressed,  with  the  tracks  in  a 
trench,  33  feet  deep  and  47  feet  wide.  East-west  streets  will  bndge  straight  across  this  trench. 


Highway  Component 


South  of  Route  91: 

The  Ports  Access  Demonstrauon  Project  (PADP),  the  first  phase  of  the  Alameda  Corridor,  will 
widen  Heniy  Ford  Avenue  and  Alameda  Street  from  four  to  six  lanes  between  the  Tenninal  Island 
Freeway  and  Route  9 1 .  The  PADP  also  includes  east-west  grade  separations  at  Camsn  Street  and 
DelAjHoBoukvanL 

The  PADP  has  been  funded  with  federal  giants  in  1982, 1987,  and  1 99 1 .  The  Intenooodal  Surface 
Transportation  Efficiency  Act  (ISTEA)  includes  additional  funds  for  grade  separations  at  Pacific 
Coast  Highway,  Squitveda  Boulevard,  Anaheim  Street,  and  Alameda  Street  near  Laurel  Park  Road. 
Funding  for  a  freeway  interchange  at  the  intersection  of  the  Terminal  Island  Freeway  and  Ocean 
Boulevard  is  also  included  in  the  legislation. 


1064 


Qiameda  Corridor  Update 


North  of  Route  91: 

Alameda  Street,  from  the  Artesia  Freeway  (SR  91)  to  the  Santa  Monica  Freeway  (I-IO),  will  be 
reconstructed  with  the  existing  number  of  through  lanes,  thus  maintaining  little  Alameda  Street  on 
the  east  side  of  the  railroad  tracks  and  main  Alameda  Street  on  die  west  side  of  the  tracks.  This 
would  include  alternative  traffic  engineering  solutions,  such  as  left  turn  pockets  alongmain  Alameda 
Street  and  new  signahzation  at  all  existing  crossings.  No  light-of-way  would  be  taken  along  the  cast 
or  west  side  of  Alameda  Street  that  would  result  in  acquisition  of  buildings  or  create  a  non- 
conforming use. 


The  project  will  cost  about  $1.8  billion  in  inflated  dollars. 


Railroad  Agreements 


On  August  18,  1993  the  Port  of  Los  Angeles  terminated  the  agreement  with  Southern  Pacific  to 
purchase  the  property  needed  for  the  Alameda  Corridor.  The  Port  of  Long  Beach  withdrew  from 
the  agreement  on  Septanber  1,  1993.  The  ports  have  reaffirmed  their  suppon  for  the  project,  but 
have  stated  that  more  time  is  needed  to  resolve  issues  of  title  and  clean-up  of  hazardous  materials 
along  the  corridor.  An  operating  agreement  with  all  three  railroad  companies  has  also  not  been 
completed.  All  parties  are  woiking  diligently  to  resolve  tte  remaining  issues. 


Financing 


To  date,  approximately  S535  million  has  been  committed  for  the  project  from  federal,  state,  local 
and  port  sources.  Remaining  funds  will  come  from  future  government  grants,  revenue  bonds 
supported  by  the  users  of  Ae  coiridor,  and  other  sources.  Depending  on  the  availabQity  of  funds, 
the  project  may  be  constructed  in  phases.  The  goal,  however,  is  to  complete  the  project  by  the  year 
2000. 


m 


1065 


liameda  Corridor  Update 


Benefits  of  the  Project 


Increased  Economic  Activity 

■  The  Alameda  Coihdor  will  allow  the  poits  of  Los  Angeles  and  Long  Beach  to 
expand.  Port  growth  is  expected  to  generate  700,000  more  jobs  throughout  Southem 
California  by  the  year  2020. 

■  Because  of  improved  access  along  the  Comdor,  redevelopment  opportunities  will 
be  enhanced. 

■  The  Alameda  Corridor  project  itself  will  generate  about  10,000  construction-related 
jobs  in  the  central  Los  Angeles  area. 

■  The  corridor  traverses  several  communities  that  were  hit  hard  by  the  recent  civil 
unrest.  The  project  is  an  important  element  in  the  effort  to  rebuild  Los  Angeles. 

Aedoced  Freeway  Congestion/Improved  Freeway  Safety 

■  The  Alameda  Comdor  will  facilitate  the  development  of  near-dock  and  on-dock  rail 
systems,  reducmg  truck  traffic  on  firccways  and  improving  roadway  safety. 

■  The  Alameda  Corridor  will  divert  truck  traffic  to  Alameda  Street,  which  will  further 
reduce  truck  traffic  on  the  freeways. 

Reduced  Noise  and  Traffic  Delays 

■  The  project  will  result  in  an  estimated  90  percent  reduction  m  tram-related  noise  in 
residential  areas. 

■  The  Alameda  Comdor  will  lead  to  a  90  percem  reduction  in  train-related  traffic 
delays,  eliminating  some  14,000  vehicle  hours  of  delay  by  the  year  2020,  due  to  the 
rerouting  of  trains  and  elimination  of  grade  crossmgs. 


.Q 


1066 


llameda  Corridor  Update 


Improved  Railroad  Operations 

a  The  project  wiU  result  in  an  esdmaied  30  p»canreductuHi  in  train  operating  hours, 
and  a  75  percent  reliction  in  the  number  of  times  trains  have  to  stop  for  other  trains 
to  pass.  (Stopped  trains  cause  severe  traffic  tie-ups  on  streets) 

■  Train  speeds  will  increase  from  10-20  miles  per  hour  to  30-40  miles  per  hour. 
Improved  Air  Quality 

■  Smoother  flowing  freeways  and  a  reduction  in  truck  traffic  will  reduce  vehicular 


The  reducti<»  in  traffic  delays  at  grade  crossings  will  fijother  reduce  emissions. 
Railroad  emissions  (mostly  NOx)  will  be  reduced  by  28%. 


The  project  increases  the  feasibility  for  eleccification  of  the  rail  lines,  which  will 
also  reduce  *^rp^yvoT|.s. 


For  addicional  information,  please  call  or  wnce 

Gill  Hicks.  General  Manager 

Alameda  Corridor  Transpornacion  Auchorlcy 

6550  Miles  Avenue,  Room  I  I  3 

Huntington  Park.  CA  90255 

(213)583-3080 


.a 


1067 


The  Alameda  Corridor 


1068 


WALTER  R.  TUCKER.  IM 


PUBLIC  WORKS  *H0  thanspobtahom 

COMMITTU  ON  SMALL  BUSINtSS 

(EongreHS  of  ttie  United  ^otes 

KouBc  of  SepreHentatiuea 

9aBt}{nglan.  BCH  20315 

May  28,  1993 

Honorable  Bob  Can- 
Chairman,  House  Appropriations 
Subcommittee  on  Transportation 

Dear  Mr. 


We  are  writing  to  request  a  $10  million  appropriation  from  your  subcommittee  for  FY 
1994  for  the  Alameda  Corridor.  These  funds,  in  combination  with  $16  million  in  local  and 
state  funding,  would  be  committed  to  preliminary  engineering,  program  management,  and 
final  design  woric  for  the  Corridor.  The  Alameda  Corridor  Transportation  Authority  has 
completed  work  on  the  subcommittee's  funding  criteria. 

The  Alameda  Corridor  concept  will  be  a  new,  state-of-the-art,  and  world-class  truck  and 
rail  seaport  access  transportation  line,  stretching  some  20  miles  from  the  Los  Angeles/Long 
Beach  port  complex  to  rail  yards  in  East  Los  Angeles.  As  you  know,  the  combined  port 
complex  of  Los  Angeles  and  Long  Beach  is  the  largest  in  the  nation  and  the  third  largest 
in  the  world.  Its  Customs  District  is  the  largest  customs  contributor  in  the  nation,  with 
annual  revenue  exceeding  $4  billion.  An  estimated  363,000  Jobs  depend  on  the  Ports' 
activity. 

As  you  know,  both  ports  are  now  engaged  hi  ambitious  expansion  activities  hi  order  to 
fuUill  the  identified  capacity  needs  of  tiie  21st  Century.  Yet,  the  Ports  must  have  a  i 
to  move  cargo  efficiently  in  and  out  of  the  port  complex  if  the  benefits  of  the  ( 
activities  are  to  be  realhed.   Simply  put,  the  largest  port  complex  in  the  nation  i 
on  the  successful  construction  and  operation  of  the  Alameda  Corridor  if  they 
continue  to  fuUiQ  their  role  of  economic  engines  for  the  region  and  for  the  nation. 

The  Alameda  Corridor  has  the  bacUng  of  Governor  Pete  Wilson,  Senator  Dianne 
Feinstein,  Senator  Barbara  Boxer,  The  California  Transportation  Commission,  the  Ports 
of  Los  Angeles  and  L<»g  Beach,  the  Southern  California  Association  of  Govemmoits,  the 
Los  Angeles  County  Transportation  Commission,  and  numerous  tocal  and  state  oRIdals. 

Federal  investments  in  the  Alameda  Corridor  will  have  substantial  returns.  Esthnated 
annual  customs  revenue  after  completion  of  the  port  expansion  projects  Is  esthnated  to  be 
$12  billion  by  the  year  2020.  WhOe  the  Ports  and  tiie  State  of  California  are  both 
committed  to  providing  substantial  funds  for  the  Corridor,  federal  help  is  necessary  to 
bring  tiliis  project  to  fruition.  We  can  thmk  of  few  other  projects  which  wOl  nilflll  the 
faitermodal  visioa  of  the  Inteimodal  Surface  Transportation  EfBdency  Act  of  1991.  We 
hope  your  subcommittee  can  support  the  Alameda  Corridor.  Fhially,  we  would  like  to 
extend  an  invitatioa  to  you  to  come  and  visit  the  Corridor  personally  so  that  you  can  see 
the  need  for,  and  potemHal  of,  this  critical  transportation  line. 


1069 

We  thank  you  for  your  time  and  consideration  of  tliis  request. 


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1072 

STATEMENT  OF  HON.  LUCILLE  ROYBAL-ALLARD,  A 
REPRESENTATIVE  IN  CONGRESS  FROM  THE  STATE  OF 
CALIFORNIA 

Ms.  Roybal-Allard.  Thank  you,  Mr.  Chairman,  for  the  oppor- 
tunity to  appear  before  you  today  in  support  of  granting  tax-exempt 
bond  status  to  the  Alameda  Corridor  Project.  This  project  will  have 
significant  economic  benefits  for  both  the  country  and  the  southern 
California  region.  I  recently  had  the  opportunity  to  fly  over  the 
project  site  with  Secretary  Pena.  Viewing  the  project  from  that 
vantage  point  clearly  illustrated  how  the  project  will  link  the  two 
ports  of  Los  Angeles  and  Long  Beach,  improve  their  transportation 
infrastructure  and  create  the  Nation's  largest  seaport  complex. 

National  economic  benefits  will  be  delivered  to  the  Congress  that 
can  be  scored  by  the  CBO.  Accordingly,  the  national  importance  of 
this  project  must  be  underscored.  The  two  ports  currently  handle 
about  100  million  metric  tons  of  goods  annually  for  shipment 
throughout  the  Nation.  The  expansion  in  port  capacity  generated 
by  the  project  will  significantly  improve  both  port  access  and  cargo 
transportation. 

This  is  not  simply  a  regional  project.  It  represents  an  effort  to 
maintain  our  Nation's  trade  competitiveness  in  the  face  of  in- 
creased competition  from  Mexico  and  other  international  ports.  The 
project's  surface  transportation  system  improvements  are  needed  to 
keep  our  ports  competitive  in  the  world  economy. 

The  economic  development  benefits  from  this  project  on  a  local 
level  are  considerable  as  well.  Cargo  volume  for  the  ports  is  pro- 
jected to  reach  210  million  tons  by  the  year  2020.  This  growth  will 
generate  700,000  jobs  throughout  southern  California  and  over  2 
million  nationally.  The  project  will  also  generate  approximately 
10,000  construction  jobs  in  the  Los  Angeles  area  and  help  to  revi- 
talize the  local  economy. 

California  has  always  served  as  a  weather  vane  for  the  rest  of 
the  country.  The  entire  Nation  will  benefit  through  the  improved 
economy  of  California.  The  project  will  also  have  important  envi- 
ronmental benefits  by  reducing  traffic  congestion  and  air  pollution. 
Presently  three  railroad  companies  use  four  different  tracks  cross- 
ing at  grade  level,  thereby  directly  impacting  thousands  of  resi- 
dents living  within  500  feet  of  those  lines. 

The  Alameda  Corridor  Project  will  reduce  the  number  of  tracks 
to  a  single  major  line  with  zero  grade  crossings  and  dramatically 
mitigate  their  impact  upon  local  residents.  The  project  will  reduce 
train-related  noise  in  residential  areas  by  90  percent  and  signifi- 
cantly reduce  truck  traffic  on  local  freeways.  The  rail  transpor- 
tation system  will  be  streamlined  and  made  more  cost-effective 
through  a  large  reduction  in  train  operating  hours. 

The  Alameda  Corridor  Project  will  promote  local,  regional  and 
national  economic  development  in  transportation  planning.  Tax- 
exempt  bond  status  is  critical  to  the  continued  construction  of  the 
project.  We  must  not  lose  this  opportunity  to  improve  our  transpor- 
tation infrastructure  and  trade  competitiveness. 

Thank  you. 

Mr.  Tucker.  Thank  you,  Mr.  Chairman. 

Any  questions  for  Ms.  Allard? 


1073 

Chairman  Rangel.  We  would  like  to  hear  from  the  entire  panel, 
and  if  there  are  questions,  anyone  can  decide  who  would  respond. 
Mr.  Tucker.  Thank  you,  Mr.  Chairman. 
At  this  time  I  will  turn  it  over  to  Congresswoman  Harman. 

STATEMENT  OF  HON.  JANE  HARMAN,  A  REPRESENTATIVE  IN 
CONGRESS  FROM  THE  STATE  OF  CALIFORNIA 

Ms.  Harman.  Thank  you,  Mr.  Chairman  and  thank  you,  Mr. 
Hancock,  for  permitting  us  all  to  testify  on  a  bipartisan  basis. 

I  am  the  designated  lawyer  on  this  committee  who  will  address 
in  a  little  more  detail  the  tax-exempt  financing  questions.  I  hope 
if  you  have  questions  for  me,  you  will  refer  them  to  my  colleagues 
first. 

Let  me  underscore  several  points  which  have  already  been  made. 
First  of  all,  the  Alameda  Corridor  will  be  publicly  owned  by  the 
Corridor  Authority. 

Second,  80  percent  or  more  of  the  use  of  the  corridor  will  be  for 
the  port.  We  want  to  make  sure  the  committee  understands  this  in 
connection  with  our  request  for  tax-exempt  financing.  We  have 
been  advised  by  legal  counsel  that  rail  facilities  to  transport  cargo 
into  and  out  of  a  port,  even  though  dedicated  to  handling  public 
port  cargo,  are  not  a  dock  or  wharf  or  functionally  related  and  sub- 
ordinate to  it.  It  is  for  this  reason  that  we  are  seeking  the  amend- 
ment, because  we  believe  that  what  we  have  is  not  eligible  for  tax- 
exempt  financing  at  this  time.  Should  that  opinion  be  different,  we 
would  be  very  happy,  but  we  believe  it  cannot  be  different. 

The  language  of  the  proposed  amendment  to  the  Internal  Reve- 
nue Code  would  permit  the  issuance  of  tax-exempt  bonds  by  the  Al- 
ameda Corridor  Transportation  Authority,  ACTA,  a  public  author- 
ity for  the  purpose  of  upgrading  the  20-mile  consolidated  rail  and 
highway  corridor. 

Under  the  amendment,  80  percent  of  the  utilization  of  the  project 
must  be  directly  connected  to  port  activities.  Let  me  point  out  tnat 
this  is  not  a  California  amendment.  This  is  a  generic  amendment 
and  it  could  potentially  affect  projects  around  the  country.  It  is 
supported  by  the  American  Association  of  Port  Authorities  for  this 
reason  and  we  understand  that  they  will  be  submitting  a  statement 
in  support  for  the  record. 

Points  have  already  been  made  about  the  national  significance  of 
this.  This  is  the  largest  port  complex  in  the  United  States  even  as 
it  stands  today.  There  is  no  real  alternative  on  the  West  Coast  for 
entry  and  exit  of  goods  and  the  real  alternative  on  the  West  Coast, 
if  we  don't  permit  upgrading  in  some  reasonable  way  in  the  short 
term,  will  be  Mexico.  Then  we  will  be  building  Mexican  jobs  rather 
than  American  jobs,  not  just  in  California,  but  as  these  goods  come 
in  and  out  all  across  the  United  States  and  specifically  benefiting 
many  of  our  East  Coast  ports. 

I  am  looking  at  you,  Mr,  Chairman,  thinking  about  the  ports  of 
New  York  and  New  Jersey,  which  can  logically  be  an  entry  and  exit 
point  for  the  same  goods  we  are  talking  about  entering  and  exiting 
this  new  expanded  facility.  Tax-exempt  financing  will  permit  reve- 
nue-raising of  a  piece  of  the  $1.8  billion  that  we  need  for  this  ex- 
pansion. It  will  build  jobs  across  the  United  States  and  enable  us 
effectively  to  compete  with  what  we  expect  will  be  an  expanded  and 


1074 

very,  very  dangerous  competitor  to  our  south  in  Mexico  in  terms  of 
denying  U.S.  jobs  and  building  jobs  in  another  country. 

Thank  you. 

Let  me  add  one  thing.  Mr.  Hancock  asked:  "Do  the  benefits  de- 
rived outweigh  the  burdens?"  I  want  to  answer  that  with  a  re- 
sounding yes. 

Mr.  Tucker.  Thank  you. 

Also  let  me  add,  Mr.  Chairman,  onto  that  aspect  of  her  presen- 
tation, that  $224  million  in  savings  would  occur  with  tax-exempt 
financing  as  opposed  with  taxable  bonds  over  30  years  on  this 
project. 

I  would  like  to  turn  it  over  now  to  Congressman  Steve  Horn. 

STATEMENT  OF  HON.  STEPHEN  HORN,  A  REPRESENTATIVE  IN 
CONGRESS  FROM  THE  STATE  OF  CALIFORNIA 

Mr.  Horn.  Thank  you  very  much. 

As  has  been  noted  by  several  witnesses,  this  is  a  national  project. 
It  is  generic  for  other  future  projects.  I  think  the  committee  should 
know  that  right  now  the  ports  of  Los  Angeles  and  Long  Beach  gen- 
erate $1  billion  in  terms  of  revenue  in  terms  of  customs  and  by  the 
year  2020,  which  is  the  end  of  the  overall  port  plan  for  both  ports, 
there  will  be  roughly  $5  billion  in  revenue  coming  into  the  Federal 
Treasury. 

This  is  the  major  access  point  for  trade  from  and  to  Asia,  and 
this  is  also  going  to  do  a  lot  to  improve  the  lives  of  thousands  of 
citizens  along  these  train  tracks.  It  brings  together  three  railroads 
in  one  corridor  that  go  transcontinental  and  cover  every  one  of  the 
States  now  represented  on  this  committee  so  that  they  can  go  right 
up  to  take  the  containers  off  the  ships  and  eliminate  most  of  the 
truck  traffic  except  for  regional  southern  California. 

In  terms  of  the  total  financing  of  the  project,  the  total  cost  is  esti- 
mated at  $1.8  billion.  The  two  ports,  the  port  of  Long  Beach  and 
the  port  of  Los  Angeles,  the  so-called  San  Pedro  Bay  ports,  have 
committed  $400  million  toward  right-of-way  acquisition  and  project 
construction.  The  Metropolitan  Transportation  Authority  of  the  re- 
gion, Los  Angeles  County  primarily,  has  committed  $8  million  in 
local  sales  tax  dollars  for  engineering.  Four  of  the  35  grade  cross- 
ings on  the  corridor  have  already  been  authorized  in  the  Inter- 
modal  Surface  Transportation  and  Efficiency  Act,  which  the  Con- 
gress approved  last  year.  The  local,  State  and  Federal  highway 
funds  will  be  used  to  fund  $800  million  in  highway  improvements 
and  grade  crossings  along  the  corridor,  and  that  will  improve  the 
lives  of  roughly  60,000  to  70,000  citizens  where  the  traffic  disrupts 
their  lives. 

Although  not  all  the  funding  has  been  identified  yet  in  the  high- 
way sector  because  some  might  be  in  future  bills  passed  by  the 
Congress,  there  is  a  very  good  chance  that  the  highway  segment 
will  be  included  in  the  national  highway  system  when  Congress 
completes  that  review  in  1995. 

Even  with  the  $400  million  contribution  of  the  ports,  the  $800 
million  and  more  expected  from  local.  State  and  Federal  sources, 
there  remains  that  $600  million  shortfall.  That  is  why  the  delega- 
tion— and  you  have  in  the  official  filing  of  our  testimony  a  letter 
I  believe  signed  by  48  of  the  52  members  of  the  delegation — is  ask- 


1075 

ing  for  this  generic  authority  with  which  we  could  issue  tax-exempt 
bonds  which  would  be  retired  based  on  the  fees  collected  by  the 
board  from  the  rail  and  the  truck  traffic  that  will  be  going  in  and 
out  of  the  port. 

So  we  hope  that  you  will  grant  that  to  the  authority,  the  ability 
to  issue  tax-exempt  bonds  that  would  be  repaid  over  the  next  sev- 
eral decades. 

I  would  now  like  to  ask  my  colleague  Maxine  Waters  to  wrap  up 
the  discussion. 

STATEMENT  OF  HON.  MAXINE  WATERS,  A  REPRESENTATIVE 
IN  CONGRESS  FROM  THE  STATE  OF  CALIFORNIA 

Ms.  Waters.  Thank  you  very  much. 

I  am  extremely  pleased  to  join  my  southern  California  colleagues 
at  this  hearing  to  speak  on  behalf  of  the  Alameda  Corridor  Project. 
The  Alameda  Corridor  Project,  if  fully  funded  and  constructed, 
promises  to  be  an  efficient,  productive,  and  resourceful  addition  to 
the  entire  southern  California  economy. 

While  the  benefits  of  this  program  would  be  regional  indeed,  na- 
tional in  scope,  they  would  be  a  direct  link  to  my  own  congressional 
district,  the  35th  Congressional  District.  The  project  would  run 
through  my  congressional  district  at  two  points,  following  Alameda 
Street  between  Jefferson  Boulevard  and  Slawson  Boulevard  and 
again  on  Alameda  between  79th  and  91st  Streets. 

In  these  areas  the  Alameda  Corridor  would  substantially  im- 
prove the  living  conditions  of  many  of  my  constituents,  who  cur- 
rently live  within  500  feet  of  the  3  operating  rail  lines.  This  would 
be  true  all  along  the  corridor  and  would  affect  literally  thousands 
of  southern  California  residents. 

In  my  brief  presentation,  I  would  like  to  focus  on  the  economic 
impact  of  the  project  in  southern  California.  By  way  of  background, 
it  is  important  to  talk  about  the  state  of  the  southern  California 
economy  overall.  The  State  of  California  is  mired  in  a  3-year  reces- 
sion which  has  already  cost  800,000  jobs.  Military  downsizing  and 
other  global  economic  factors  have  taken  a  disproportionate  toll  in 
California  and  in  our  region  in  particular.  The  overall  unemploy- 
ment in  the  State  still  is  over  10  percent  and  worse  along  the  cor- 
ridor, leaving  1.4  million  people  out  of  work.  In  many  parts  of 
southern  California  that  would  be  touched  by  the  Alameda  Cor- 
ridor, unemployment  rates  are  indeed  much,  much  higher. 

Since  1989,  Los  Angeles  County  has  lost  40,000  high-tech  manu- 
facturing jobs  due  to  military  downsizing.  This  translates  into  $1.5 
billion  in  lost  wages  in  the  county. 

It  is  against  this  backdrop  that  we  approach  the  huge  economic 
and  competitive  potential  of  the  Alameda  Corridor  Project.  First, 
construction  of  the  Alameda  Corridor  alone  will  generate  an  esti- 
mated 10,000  jobs  in  the  central  Los  Angeles  area.  The  improved 
efficiency  of  the  new  corridor  will  dramatically  expand  import  op- 
portunities by  the  entire  region,  a  region  that  is  threatened  by 
tough  economic  competition  from  Mexico.  This  could  lead  to  hun- 
dreds of  thousands  of  new  jobs,  up  to  700,000  by  the  year  2020,  ac- 
cording to  some  estimates. 


1076 

The  benefits  fi'om  the  increased  use  of  the  Long  Beach  and  Los 
Angeles  ports  would  lead  to  expanded  development  opportunities  as 
weU. 

Finally,  the  area  is  trying  desperately  to  rebuild.  We  stand  to 
gain  enormously  from  the  Alameda  Corridor  Project,  as  it  would 
cut  through  some  of  the  most  economically  deprived  sections  of  L.A. 
County. 

In  conclusion,  Mr.  Chairman  and  members,  the  proposed  Ala- 
meda Corridor  Project  can  work.  All  we  need  is  a  simple  change  in 
the  tax  law  to  get  the  program  off  the  ground.  I  hope  you  and  this 
committee  will  help  us  realize  the  enormous  economic  potential  of 
this  very  worthwhile  program. 

Thank  you  very  much,  Mr.  Chairman. 

Mr.  Tucker.  I  believe  that  concludes  our  presentation,  Mr. 
Chairman. 

Chairman  Rangel.  Thank  you. 

Where  is  this  project?  Is  this  a  State-operated  project?  Will  the 
State  be  in  charge?  This  is  a  subdivision  of  the  State  government 
that  is  going  to  operate  the 

Mr.  Tucker.  It  is  operated  by  the  Alameda  Corridor  Transpor- 
tation Authority,  which  is  a  body  that  has  been  given  jurisdiction 
on  a  local  basis,  but  it  derives  from  the  State,  yes. 

Chairman  Rangel.  So  they  are  private  sector  people  who  are  on 
the  board? 

Mr.  Tucker.  The  corridor  is  comprised  of  the  local  communities; 
if  you  look  at  the  map,  communities  like  Compton  and  Lynwood. 

Chairman  Rangel.  Who  would  issue  the  bonds? 

Mr.  Tucker.  I  believe  that  the  corridor,  the  Transportation  Au- 
thority would  do  it. 

Chairman  Rangel.  How  much  has  been  invested  in  this  project 
approximately? 

Mr.  Tucker.  How  much  has  been  invested  already? 

Chairman  Rangel.  Already. 

Mr.  Tucker.  Let  me  find  out  how  many  hundreds  of  millions 
have  been  invested.  Over  $100  million  has  been  invested  already 
in  demonstration  projects  such  as  overpasses  and  underpasses. 

Chairman  Rangel.  Was  the  investment  made  with  the  hope  that 
tax-exempt  bonds  would  be  made  available? 

Mr.  Tucker.  The  investment  was  made  at  the  time  with  highway 
funds  and  they  anticipated,  I  believe,  that  they  would  have  enougn 
to  complete  the  project,  but  I  think  that  they  did  anticipate  at  the 
same  time  that  tax-exempt  bonds  would  have  to  come  in  to  assist 
at  some  point  in  time. 

Chairman  Rangel.  But  they  are  private  investment  funds  in  the 
project?  It  is  all  not  publicly  funded,  is  it? 

Mr.  Tucker.  Yes,  there  are  private  investment  funds  in  the 
project  by  way  of  the  railroad,  Southern  Pacific  and  others. 

Chairman  Rangel.  Why  did  they  choose  to  make  this  generic 
and  not  a  specific  exemption  for  this  particular  project? 

Mr.  Tucker.  I  believe,  Mr.  Chairman,  that  even  though  we  could 
maybe  lay  claim  to  the  fact  that  we  have  special  interests  here, 
that  we  believe  that  in  the  long  run  or  in  the  aggregate  picture, 
as  we  indicated  earlier,  there  may  be  other  port  facilities  that 
might  benefit  from  that  language  generically.  I  can  defer  as  to  that. 


1077 

Ms.  Harman.  I  wanted  to  add  that  we  understand  that  other 
ports  are  learning  from  this  whole  concept  of  a  transportation  cor- 
ridor and  we  would  think  it  unwise  for  the  committee  to  limit  this 
possibility  just  to  this  very  important  West  Coast  port.  If,  for  exam- 

f>le,  the  ports  of  New  York  and  New  Jersey  wanted  to  build  a  simi- 
ar  transportation  corridor  and  have  part  of  the  financing  come 
from  tax-exempt  bonds,  we  would  think  it  logical  given  the  need  in 
California  for  a  similar  facility  to  be  able  to  be  put  together  on  the 
East  Coast. 

Chairman  Rangel.  The  budget  people  have  an  illogical  way  in 
which  they  score  this.  This  would  be  considered  a  revenue  loss  even 
though  no  revenue  would  be  generated  if  the  bonds  didn't  issue;  so 
therefore  it  would  be  more  diflficult  to  determine  how  much  this 
would  cost  if  it  is  generic. 

Mr.  Horn.  Could  I  comment  that  this  is  a  natural  extension  of 
the  docks  and  wharves  provision,  as  I  am  sure  you  know,  and  we 
wouldn't  be  opposed  to  a  particular  designation  for  it,  but  I  think 
it  makes  sense  that  some  of  the  major  ports  in  the  United  States 
might  wish  to  access  such  authority  to  do  a  similar  thing,  combine 
transportation  corridors  so  you  would  get  more  rapid  service,  much 
more  efficient  lower  cost  domestically  across  all  your  States  than 
the  now  system  of  both  ship,  truck  to  connector  rail  lines. 

Chairman  Rangel.  Since  this  is  a  national,  or  indeed  has  inter- 
national implications,  how  far  up  in  the  administration  do  you  have 
support  for  this? 

Mr.  Tucker.  Well,  we  have  support  for  this,  Mr.  Chairman,  from 
the  Secretary  of  Transportation.  We  have  support  from  the  Sec- 
retary of  Commerce.  I  have  spoken  with  the  President  about  it.  So 
we  have  an  extreme  amount  of  support  for  it. 

Mr.  Horn.  I  might  add  on  that  point  that  when  Secretary  Pefia 
visited  there,  he  said  the  corridor  is  not  only  a  California  issue,  it 
is  a  national  priority. 

Chairman  Rangel.  I  would  think  that  is  a  bit  more  than  persua- 
sive. 

Does  any  member  seek  recognition? 

Mr.  Camp. 

Mr.  Camp.  Thank  you,  Mr.  Chairman. 

Ms.  Harman,  this  doesn't  change  the  bond  volume  cap,  does  it? 

Ms.  Harman.  It  doesn't  change  the  cap.  My  understanding  is 
that  as  defined  this  way,  this  would  not  be  part  of  that  cap.  This 
would  just  be  an  extension  to  an  existing  exemption  for  docks  and 
wharves  and  it  would  make  it  apply  to  tnis  logical  transportation, 
20-mile  transportation  corridor  that  comes  directly  off  the  dock. 

Mr.  Camp.  Has  Joint  Tax  issued  a  revenue  estimate  on  this 
project? 

Ms.  Harman.  That  is  the  one  we  have  been  talking  about,  the 
$115  million  figure.  As  we  have  been  discussing  with  the  chairman, 
it  is  for  all  the  projects,  not  just  the  Alameda  Corridor  Project.  We 
believe  our  portion  of  that  is  $35  million. 

As  the  chairman  discussed,  he  wants  to  know  what  the  rest  of 
it  is.  We  have  felt  that  making  this  a  generic  amendment  would 
be  more  logical  in  public  policy  terms.  As  Mr.  Horn  said,  we  would 
not  resist  the  committee  deciding  it  should  just  apply  to  this 
project,  but  we  think  it  makes  more  sense  to  apply  it  generically. 


1078 

Mr.  Camp.  Was  there  a  policy  reason  behind  saying  that  a  rail- 
road that  goes  to  a  port  is  not  functionally  related  to  the  port?  Was 
it  because  private  interests  were  involved  in  the  railroad?  I  am  con- 
fused as  to  why  the  ruling  came  down  the  way  it  did,  making  this 
legislation  necessary, 

Ms.  Harman.  I  would  assume  we  could  make  the  ruling  available 
to  the  committee.  There  is  no  specific — this  is  the  IRS  position,  and 
I  think  it  is  derived  from  a  kind  of  common  sense  concept  of  what 
a  port  is,  that  20-mile  extension  of  some  kind  of  a  transportation 
corridor  is  not  a  port.  We  think  it  is  in  terms  of  conceptually  under- 
standing what  is  the  purpose  of  the  port  as  an  entry  and  exit  point 
for  goods. 

Obviously,  the  consolidation  of  the  rail  and  other  systems  into 
this  port  will  make  this  an  efficient  port  and  able  to  compete  with 
Mexico.  Similarly  other  important  U.S.  ports  could  do  the  same 
thing,  those  that  are  impacted  by  traffic  and  noise,  et  cetera. 

We  feel  therefore  that  the  United  States  would  be  in  a  much  bet- 
ter position  in  terms  of  international  trade,  and  this  is  in  every- 
one's interest,  for  a  very,  very  modest  cost. 

Mr.  Camp.  Thank  you. 

Your  comments  have  been  very  helpful  and  I  look  forward  to 
working  with  you  on  this. 

Chairman  Rangel.  Mr.  Payne. 

Mr.  Payne.  I  think  that  what  you  are  proposing  has  important 
and  positive  public  policy  implications.  I  was  on  the  Public  Works 
Committee  last  year  as  we  wrote  the  Intermodal  Surface  Transpor- 
tation and  Efficiency  Act.  You  are  proposing  putting  into  practice 
what  we  were  attempting  to  look  at  in  that  bill  in  terms  of  a  blue- 
print for  the  Nation  of  intermodality  and  how  various  modes  of 
transportation  could  best  work  together  in  order  to  produce  the 
most  efficient  system  and  one  that  would  help  us  compete  with 
other  nations  aroimd  the  world. 

So  I  think  this  is  a  very  important  proposal  that  you  are  making 
and  one  that  deserves  very  serious  consideration. 

Thank  you. 

Chairman  Rangel.  Mr.  Kopetski. 

Mr.  Kopetski.  I  think  this  is  creative  financing.  My  question  has 
to  do  with  profits  and  whether  the  railroads  are  saying  that  this 
is  the  only  way  that  they  can  make  this  go  is  for  Government  to 
subsidize  this  corridor,  that  they  wouldn't  make  money  off  of  it  un- 
less Government  stepped  in  and  financed  this  capital  project. 

Mr.  Horn.  Could  I  comment?  This  is  not  about  profits  for  rail- 
roads. I  grew  up  in  the  Hiram  Johnson  tradition  of  being  against 
big  railroads  in  California.  This  is  about  congestion  in  the  south- 
land of  L.A.  County  and  Orange  County  and  clogging  up  the  free- 
ways and  not  being  able  to  readily  deliver  products  given  the  unbe- 
lievable expansion  that  is  going  to  take  place  in  the  next  three  dec- 
ades at  these  port  facilities. 

The  idea  is  to — ^that  won't  decrease  traffic  very  much.  We  would 
like  it  to  stay  where  it  is  because  trucks  will  still  need  the  regional 
southern  California  delivery.  But  if  you  are  going  to  move  produce 
through  that  port  by  containers  or  into  the  Midwest,  into  the 
Northwest,  into  the  South,  even  into  Mexico,  then  we  need  to  get 
moving  from  the  dock  side.  It  goes  straight  from  the  ship  into  the 


1079 

train  and  away  by  train.  It  solves  a  lot  of  pollution  and  a  lot  of  peo- 
ple problems  and  would  be  a  more  efficient  operation  simply  on 
congestion. 

Mr.  KoPETSKi.  So  the  railroads  are  not  going  to  make  any  money 
on  this? 

Mr.  Horn.  We  are  trying  to  buy  out  the  railroads.  The  ports  are 
doing  this.  The  two  ports  have  agreed  to  do  that.  There  are  now 
three  separate  lines  going  into  the  port,  Santa  Fe,  Union  Pacific, 
and  Southern  Pacific.  The  best  corridor  for  getting  the  traffic  into 
where  it  is  assembled  to  move  east  and  north  and  south  is  to  take 
this  Alameda  Corridor,  22  miles  long,  which  is  owned  by  Southern 
Pacific  Railroad.  The  ports  are  going  to  buy  them  out,  and  it  is  just 
a  matter  of  agreeing  on  the  price,  and  the  railroads  will  pay  a  fee 
to  use  this  corridor.  It  is  not  a  freebie  for  them.  It  brings  them 
dockside  in  the  port  of  Los  Angeles,  the  port  of  Long  Beach,  and 
all  three  will  be  using  this  one  corridor. 

Mr.  KOPETSKI.  Thank  you,  Mr.  Chairman. 

Chairman  Rangel.  It  certainly  sounds  like  an  exciting  project 
and  it  would  have  impact  on  our  trade  policy.  I  would  think  the 
administration  might  even  be  able  to  identify  similar  projects  that 
could  work  in  an  overall  national  trade  policy,  and  as  all  of  you 
know,  if  this  came  as  a  part  of  an  administration  package  to  us, 
they  would  be  able  to  find  it  much  easier  to  pay  for  it  since  we 
have  to  hurt  people,  industries,  and  other  projects  in  order  to  bring 
about  this  balance. 

In  any  event,  I  would  encourage  you  to  work  with  the  adminis- 
tration and  to  get  as  much  support  as  they  can  give  it  since  this 
committee  tries  not  only  to  write  good  tax  policy,  but  also  to  try 
to  avoid  conflict  with  the  administration  as  well  when  that  is  pos- 
sible. So  it  sounds  like  a  national  project  with  international  impli- 
cations, and  I  think  it  should  be  raised  to  that  level  since  it  has 
definitely  regional  support. 

I  thank  you  for  the  time  that  you  have  spent  with  us  today. 

Mr.  Tucker.  Thank  you  very  much,  Mr.  Chairman.  We  look  for- 
ward to  giving  you  and  your  subcommittee  more  information  and 
even  letters  of  support  from  the  administration  on  the  project. 
Thank  you,  again. 

Chairman  Rangel.  Thank  you. 

[The  information  follows:] 


STEPHEN  HORN 


1080 


€onqxtii  o!  tte  iHniteb  S^tatti 

J^ovat  of  iElepretfentatibeii 

nadijington.  SC  20515 

September  28,  1993 


The  Honorable  Charles  B.  Rangel 

Chainnan 

Select  Revenue  Measures  Subcommittee 

Committee  On  Ways  and  Means 

1105  Longworth 

Washington,  D.C.,     20515 

Dear  Mr.  Chairman: 

Thank  you  for  the  opportunity  to  testify  before  your  subcommittee  Wednesday, 
September  8. 

I  hope  we  were  able  to  effectively  communicate  the  importance  of  the  Alameda 
Corridor  not  only  to  the  Southern  California  region,  but  also  to  the  nation.   The  critical 
bottleneck  to  the  growth  of  the  Long  Beach  -  Los  Angeles  port  complex  is  land-side  access. 
If  cargo  cannot  move  efficiently  in  and  out  of  the  ports  through  the  tremendous  congestion 
of  the  Los  Angeles  region,  then  all  expansion  activities  will  be  for  naught.   The  answer  to 
this  problem  is  the  Alameda  Corridor. 

In  response  to  your  question  regarding  Administration  support  for  the  Corridor,  I 
have  attached  an  article  from  the  September  2,  1993  Journal  of  Commerce  entitled,  "Pena 
Pledges  Federal  Help  For  Alameda  Corridor. "    I  would  also  like  to  correct  a  figure  I  gave 
with  regard  to  the  amount  of  Customs  revenue  the  combined  Ports  generate.    I  was  mistaken 
when  I  stated  at  the  hearing  that  the  current  annual  revenue  is  approximately  $1  billion.   In 
fact,  current  combined  Customs  revenue  is  more  than  $3  billion  per  year.   With  the  2020 
expansion  plans,  Customs  receipts  are  expected  to  grow  to  $8  billion  per  year.    Clearly,  the 
federal  stake  in  this  investment  is  more  than  substantial.   Tax-exempt  bond  authority  would 
seem  a  small  down  payment  in  view  of  the  returns. 

Again,  thank  you  for  the  opportunity  to  appear  before  your  subcommittee.   If  I  may 
answer  any  ibrther  questions  you  have  on  the  Alameda  Corridor,  please  do  not  hesitate  to 


With  kindest  regards. 


Sincerely  yours, 


]u 


STEPHEN  HORN 
Member  of  Congress 


1081 


THE  JOURNAL  OF  COMMERCE  —  THURSDAY.  SEPTEMBER  2.  1993 


Pena  Pledges  Federal  Help 
For  Alam^a  Corridor 


By  KEVIN  a  HALL 

Jeonul  M  Canmicm  Su«t 

LOS  ANGELES  -  Touring 
Southern  CaUlomU  port*.  Tranapor- 
tatioo  Secretary  Kederico  Pena  hai 
pledged  the  federal  govenuneflc  will 
play  a  greater  role  in  th*  develop- 
menc  at  the  nation's  largest  iocer- 
modal  infrastructure  proJecL 

Mr.  Pena  toured  the  ports  of  Los 
Aogeles  and 
Long  Beach  this 
week  to  get  a 
belter  under- 
standing of  bow 
tntemaodal  imio- 
vatioas  have 
made  the  twin 
waierfroat  fnclH- 
ties  t&e  nation's 
largest  contaLn- 
erpoR  cocnpiex. 

The  secretary 
alao    flew    over  p^NA 

the  pro- .. ^ 

posed  Alameda  Corridor,  a  planned 
S1.8  Rulllon  consolidated  truck  and 
rail  corridor  from  the  ports  to  rail- 
yards  in  t&e  ea^t  part  of  sprawling 
Los  Angeles. 

The  corridor  b  being  planned  in 
an  effort  to  relieve  expected  mas- 
sive congestion  a.^sodaf/ai  with  th« 
predicted  doubling  of  cargo  moving 
through  the  bustling  ports  by  Uw 
year  2020.  ,.,,.,  ..-.o^.  ■■'.  i.'^  .-■• 
•  Project  backers  like  Geraldine 
Knatz.  planning  director  at  tj»  Port 
.of  Long.  Beach,  used  the  helicopter 
flight  and  visit  with  the  secretary  to 
sell  the  benefits  the  project  will 
yield  to  the  federal  govemtnenL  - 
'  Among  the  benefits,  she  said.  Is 
that  the  project  wtU  allow  for  In- 
creased freight  movements  worth 
billjoas  amiually  to  the  VS.  Customs 
Service..,  :.,.;  _;;  ...  ;  ^^... ;;:,;.■.  .\.. 

"They're  (Customs  receipts)  going 
to  grow  by  another  JS.2  bluioo,*  said 
Ms.  Rnata,  noting  receipts  are  ex- 
pected to  grow  from  $3  billion  amiu- ' 
ally  to  w  bilUon.  •.'.-;"■•:,?  ^■/r^'" 
The  growth  In  Customs  receipts 
will  eclipse  Che  $1.2  bllUon  funding 
shortfall  that  now  e^dsts  for  the 


project,  a  shortfall  that  represents! 
only  23%  of  the  expected  receipts.  ■ 
Although  the  plan  was  dealt  a 
major  setback  last  month  when  the 
Port  of  Los  Angeles  backed  out  oi 
its  share  of  a  $260  million  purchase 
of  trackage  needed  for  the  project, 
the  Idea  remains  viable  and  the  sec- 
retary said  he  came  to  g«  a  first- 
hand look  at  the  project. 

Two  of  Mr.  Pena's  predecessors 
«;ere  also  familiar  with  the  massive 
incermodal  project  but  did  little  to 
rally  federal  funding,  which  to  date 
remains  at  roughly  W  tnillioo  of  ' 
tlte  iHi  million  in  secured  commit<  ' 
mants. 

'  Saying  he  hoped  to  "to  be  the  ' 
last"  transportation  secretary  to  - 
deal  with  the  Intermodal  project. 
Mi-.  Pena  said  once  the  ports  have  ' 
concluded  their  track-purchase 
agreement  with  Southern  PacUlc  ', 
Lines,  the  federal  government  will  ■ 
step  up  its  role.  '. 

'We'll  have  a  definitive  state-  ' 
ment  about  the  need  from  the  feder- : 
al  government  in  terms  of  oor 
contribution,"  the  secretary  said  '. 
dudng  an  Interview  on  the  docio  of  ' 
American  Pre*ldent  Lines'  terminal  . 
in  Los  Angeles.  "Once  we  have  that 
(hen  we  go  to  work  and  begin  to 
decide  where  we  can  get  those  dol-  •" 
laxa  to  make  the  Alameda  Corridor 
a  reality.'      '  .. 

Added  Richard  Mlnti,  Mr.  Pena's  ,' 
spokesman.  "I  think  you're  going  to  ' 
see  additiooa!  federal  commitments  " 
down  the  road."  '  -~  ■-'^  •-,••.--?  ~'  -■:.;" 
-  Separately,'  Mr,  Pena  banded  " 
over  a  $49.6  million  check  to  expand 
the  city's  Metro  Red  Line  subway.  -: 
saying  the  project  will  help  rebuild  ; 
California's  struggling  economy.  :',';,' 
The  mone^  will  be  used  to  contin-  ' 
ue  construction  q{  the  WUshire  Cor-  ' 
ridor  segment,  which  follows'' 
Wilshire  Boulevard  from  the  West-." 
lake  area  to  Hollywood.  .'-'..  ^i  ''•.:'■■ 
■  The  J1.6  billion  subway,  already  ■ 
In  operation  downtown,  is  scheduled  • 
for  completion  In  IMS.  -..\s:j.-r, ."•.>„' 
•  -T;hi3  Is  the  largest  federal  In-  ^ 
vestment  in  any  transit  agency  In.* 
this  nation^'Mr.  Pena  said.   <.V.i;/n--'- 


1082 

Chairman  Rangel.  The  next  panel  consists  of  the  Association  of 
Christian  Schools  International,  John  Holmes,  director  of  govern- 
ment affairs;  the  PHH  Corp.  in  Maryland,  Samuel  Wright,  vice 
president  and  general  counsel;  the  Independent  Bakers  Association, 
Dale  Cox,  from  San  Raphael,  Calif,  accompanied  by  the  chairman 
of  the  Independents  Contractors  Committee,  Robert  Fanelli;  Fred 
Lazarus,  vice  president  of  the  Association  of  Independent  Colleges 
of  Art  and  Design,  from  Florida;  and  the  University  of  Florida 
Health  Science  Center,  Stanley  Rosenkranz,  general  counsel. 

Because  of  the  severe  limitations  on  time  that  we  have  and  the 
large  number  of  witnesses,  the  Chair  would  ask  that  the  witnesses 
restrict  their  oral  testimony  to  5  minutes  with  the  understanding, 
if  there  is  no  objection  from  the  committee,  that  your  full  written 
statements  will  be  entered  into  the  record. 

The  Chair,  hearing  no  objections,  will  proceed  with  Dr.  Holmes. 

STATEMENT  OF  JOHN  C.  HOLMES,  ED.D.,  DIRECTOR,  GOVERN- 
MENT AFFAIRS,  ASSOCIATION  OF  CHRISTIAN  SCHOOLS 
INTERNATIONAL 

Mr.  Holmes.  Good  morning,  Mr.  Chairman,  and  members  of  the 
committee.  Thank  you  for  this  opportunity  to  speak  concerning  rev- 
enue issue  No.  8,  which  would  restore  fair  treatment  of  lay-board 
religious  schools  under  the  Federal  Unemployment  Tax  Act. 

With  me  today  is  Dr.  Pauline  Washington,  who  is  an  adminis- 
trator and  founder  of  the  Washington-McLaughlin  Christian  School 
in  Takoma  Park,  Md.  She  is  right  over  the  Washington  line.  She 
is  right  behind  me.  Also  with  me  is  Rabbi  Abba  Cohen,  who  is  with 
Agudath  Israel  of  America,  and  also  Curran  Tiffany,  attorney  with 
the  National  Association  of  Evangelicals. 

ACSI  serves  over  3,000  schools.  ACSI  schools  follow  a  policy  of 
racial  nondiscrimination,  reaffirming  this  policy  annually.  I  come  to 
address  the  problem  of  unfair  treatment  and  inequity  within  the 
Tax  Code  concerning  about  15  percent  of  our  Christian  schools,  and 
all  of  the  Jewish  day  schools  represented  by  Agudath  Israel  of 
America.  About  20  percent  of  all  religious  schools  in  America  are 
not  owned  or  affiliated  directly  with  the  church.  The  schools  we 
seek  to  exempt  from  mandatory  participation  in  the  Federal  Unem- 
ployment Tax  Act  are  as  religious  as  church  or  synagogue-affiliated 
schools. 

Thev  are  denied  equal  treatment  without  anyone  even  suggesting 
that  they  are  not  religious,  but  they  are  under  the  governance  of 
boards  of  religious  laymen  rather  than  clergy.  Dr.  Washington, 
with  me  today,  is  an  administrator  of  such  a  school.  Because  of  this 
distinction  without  difference,  this  small  portion  of  religious  schools 
in  America  has  been  forced  to  participate  in  FUTA.  The  50  States 
could  mandate  participation  in  State  unemployment  laws,  but  the 
majority  of  the  States,  46,  I  believe,  choose  to  mirror  the  Federal 
statute  which  exempts  church-related  schools. 

Issue  8,  which  is  identical  to  Congressman  Crane's  H.R.  828, 
would  offer  the  same  choice  of  participation  in  FUTA  to  lay-board 
religious  schools  and  alleviate  the  inequity  faced  by  these  schools 
because  of  the  technicality  of  control.  For  religious  schools,  their 
faith  is  far  more  important  than  their  organizational  structure 
whether  or  not  they  are  affiliated  with  another  religious  body. 


1083 

Allow  me  to  give  a  personal  example  of  the  double  standard  now 
faced  by  religious  schools  not  owned  or  affiliated  with  a  church  or 
synagogue.  I  served  as  a  superintendent  of  four  Christian  schools 
in  Southern  California  in  the  same  area  that  they  were  talking 
about  this  morning.  The  schools  were  operated  by  a  church  in  Los 
Angeles  County.  The  school  board  discussed  how  the  secondary 
schools  could  serve  a  wider  constituency  of  evangelical  Christian 
community  if  the  junior  highs  and  the  high  schools  were  not 
viewed  by  the  parents  as  a  ministry  of  a  particular  church  because 
of  doctrinal  distinctions.  A  change  of  status  seemed  logical  to  the 
board  members  and  the  sponsoring  church  officials  shared  this  con- 
cern and  approved  the  legal  separation  of  the  two  secondary 
schools. 

A  board  of  laymen  was  formed  and  began  to  function  as  an  inde- 
pendent religious  educational  institution.  The  teachers  were  the 
same,  the  chapel  services  were  the  same,  the  curriculum  was  the 
same,  the  Bible  classes  were  the  same,  everything  except  the  rela- 
tionship with  the  church  remained  the  same,  but  the  schools,  con- 
sidered too  religious  to  be  eligible  for  participation  in  various  Fed- 
eral and  State  funding  sources,  were  no  longer  exempt  from  man- 
datory participation  in  FUTA.  This  was  a  triumph  of  form  over 
substance.  Issue  8  asks  no  more  or  less  than  what  church  schools 
now  have  by  virtue  of  section  3309(b)(1)  of  the  Internal  Revenue 
Code  of  1986,  which  relates  to  exemption.  When  the  exemption  sec- 
tion was  enacted.  Congress  exempted  employees  who  worked  in 
churches  and  religious  organizations  operated  by  churches.  Then  in 
1981  in  St.  Martin  Evangelical  Lutheran  Church  v.  the  State  of 
South  Dakota,  the  U.S.  Supreme  Court  ruled  that  the  exemption 
extended  to  elementary  and  secondary  schools  that  churches  oper- 
ate. 

Any  religious  school  that  receives  exemption  as  a  result  of  this 
measure  has  established  the  fact  with  the  Internal  Revenue  Service 
that  it  operates  primarily  for  religious  purposes  described  in  sec- 
tion 501(c)(3)  and  is  exempt  from  tax  under  the  501(a). 

We  believe  that  Congress  inadvertently  failed  to  exempt  lay- 
board  controlled  religious  schools  from  FUTA  because  these  schools 
are  not  numerous  and  Congress  was  simply  unaware  of  the  dif- 
ference and  the  technicalities  of  affiliation  from  other  religious 
schools. 

Back  in  1988  an  identical  amendment  to  Issue  No.  8  was  spon- 
sored by  Senator  Strom  Thurmond  and  it  was  unanimously  adopt- 
ed by  tne  Senate  during  consideration  of  the  tax  technical  correc- 
tions bill.  Unfortunately,  the  amendment  was  dropped  in  con- 
ference. This  amendment  was  viewed  by  the  Joint  Committee  on 
Taxation  as  revenue  neutral.  The  committee  said  that  the  net 
budget  effect  of  this  bill  would  actually  gain  the  Federal  Govern- 
ment less  than  $5  million  in  the  fiscal  year  and  negligible  effect 
each  year  thereafter.  Therefore  they  viewed  it  as  revenue  neutral. 
Thus  there  is  no  fiscal  burden  to  the  Government  to  provide  tax 
equity  and  simple  justice. 


1084 


We  urge  this  subcommittee  to  carefully  consider  this  remedial 
measure.  Its  passage  would  help  lay-board  religious  schools,  Catho- 
lic, Jewish,  and  Protestant,  which  are  helping  American  children 
succeed  morally,  spiritually,  and  academically.  Thank  you  for  lis- 
tening to  our  concerns. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


1085 


Testimony  of 

Dr.  John  C.  Holmes,  Director  for  Government  Affairs 
Association  of  Christian  Schools  International 

Concerning 

MISCELLANEOUS  REVENUE  ISSUE  #8 

Before 

Subcommittee  on  Select  Revenue  Measures, 
Committee  on  Ways  and  Means, 
U.  S.  House  of  Representatives 

The  Honorable  Charles  B.  Rangel,  Chairman 
Septembers,  1993 


Mr.  Chairman  and  Members  of  the  Subcommittee  on 
Select  Revenue  Measures: 

Thank  you  for  this  opportunity  to  address  you  today 
conceming  Miscellaneous  Revenue  Issue  #8,  which  would 
restore  fair  treatment  of  lay-board  religious  schools  which  come 
under  the  Federal  Unemployment  Tax  Act.  My  name  is  Dr. 
John  Holmes  and  I  serve  here  in  Washington,  DC  as  the 
Association  of  Christian  Schools  Intemational's  Director  for 
Government  Affairs.  With  me  today  is  Dr.  Pauline  Washington 
who  is  the  administrator  and  founder  of  the  Washington- 
McLaughlin  Christian  School  in  Takoma  Park,  Maryland. 

The  Association  of  Christian  Schools  Intemational  is  the 
largest  association  of  evangelical  Christian  schools  in  the  nation 
with  over  three  thousand  schools  and  colleges.  We  now  serve 
nearly  570,000  students.  All  ACSI  schools  follow  a  policy  of 
racial  non-discrimination,  re-affirming  this  policy  on  an  annual 
basis  when  they  renew  their  membership.  I  come  here  today  to 
address  a  problem  of  unfair  treatment  and  inequity  within  the 
tax  code  concerning  about  three  out  of  every  twenty  of  our 
member  Christian  schools  and  nearly  all  of  the  Jewish  Day 
Schools  that  are  represented  by  Agudath  Israel  of  America. 

Approximately  one  out  of  every  five  religious  schools  in 
America  is  dqI  owned  or  affiliated  with  a  particular  church  or 
synagogue.  The  elementary  and  secondary  schools  we  seek  to 
exempt  from  mandatory  participation  in  the  Federal  Unemploy- 
ment Tax  Act  are  as  pervasively  religious  as  a  church  or  syna- 
gogue owned  or  affiliated  schools  would  be.  They  are  denied 


77-130  0-94 -3 


1086 


equal  treatment,  without  anyone  even  suggesting  that  they  are 
not  religious,  because  they  lack  formal  church  affiliation  and  are 
governed  by  boards  of  religious  laymen.  Dr.  Washington  is  the 
administrator  of  such  a  school. 

Because  of  this  distinction,  without  difference,  this  small 
portion  of  religious  schools  in  America  has  been  forced  to  par- 
ticipate in  FUTA.  On  their  own,  the  fifty  states  could  make  par- 
ticipation in  state  unemployment  laws  mandatory.  However,  an 
ovenwhelming  majority  of  states  choose  to  mirror  the  federal 
statute,  which  exempts  church  related  or  affiliated  elementary 
and  secondary  religious  schools.  Miscellaneous  Revenue 
Issue  #8,  which  I  understand  is  identical  to  Congressman  Phil 
Crane's  H.  R.  828,  would  offer  the  same  choice  of  participation 
in  FUTA  to  lay-board  religious  schools  and  alleviate  the  inequity 
faced  by  these  schools  because  of  the  technicality  of  control. 
For  religious  schools,  their  faith  is  far  more  important  than  their 
organizational  structure,  whether  or  not  they  are  affiliated  with 
another  religious  body. 

Allow  me  to  give  a  personal  example  of  the  double  stan- 
dard now  faced  by  religious  schools  which  are  not  owned  or 
affiliated  with  a  church  or  synagogue.  Before  coming  to  Wash- 
ington, DC,  I  served  as  a  superintendent  of  four  evangelical 
Christian  schools  in  southem  California.  All  of  the  schools  were 
operated  under  the  umbrella  of  a  church  in  Los  Angeles 
County.  Much  discussion  by  the  evangelical  school  board 
revolved  around  how  our  secondary  schools  could  more  ade- 
quately sen/e  a  wider  constituency  of  the  evangelical  Christian 
community  if  the  junior  and  senior  high  schools  were  not  viewed 
by  parents  as  a  ministry  of  a  particular  church,  because  of 
doctrinal  distinctives.  Since  the  secondary  schools  sought  to 
meet  the  needs  of  the  greater  evangelical  community  and  not 
stress  particular  doctrinal  distinctives,  a  change  of  status 
seemed  logical  to  a  majority  of  the  board  members  and  church 
officers. 

The  sponsoring  church  officials  shared  this  concern  and 
approved  the  legal  separation  of  the  secondary  schools.  A 
board  of  laymen  was  formed  and  began  to  function  as  an  inde- 
pendent religious  educational  institution.  The  teachers  were  the 
same,  the  chapel  services  were  the  same,  the  curriculum  was 
the  same,  the  Bible  classes  were  the  same-everything  except 
the  relationship  with  the  church  remained  the  same.  But  the 
schools,  which  were  considered  too  religious  to  be  eligible  for 
participation  in  various  federal  and  state  funding  sources,  were 
no  longer  exempt  from  mandatory  participation  in  federal 
unemployment  tax.  This  is  a  triumph  of  form  over  substance. 


1087 


Each  of  the  states  has  slightly  different  ways  of  handling 
unemployment  tax,  but  approximately  46  states  largely  mirror 
the  federal  code.  The  wording  proposed  in  Miscellaneous  Rev- 
enue Issue  #8  asks  no  more  or  less  than  what  private  religious 
schools  that  are  operated  or  affiliated  with  a  church  or  syna- 
gogue now  have  by  virtue  of  Section  3309  (b)(1)  of  the  Internal 
Revenue  Code  of  1986,  which  relates  to  exemption.  Back 
when  the  exemption  section  was  enacted.  Congress  exempted 
employees  who  worked  for  churches  and  religious  organiza- 
tions operated  by  churches.  Subsequently,  in  1981  in  St.  Martin 
Evangelical  Lutheran  Church  v.  South  Dakota,  the  U.  S. 
Supreme  Court  ruled  that  the  exemption  extended  to  elemen- 
tary and  secondary  schools  that  churches  operate. 

Any  religious  elementary  or  secondary  school  that  would 
receive  exemption  as  a  result  of  this  measure  would  have 
already  established  the  fact  with  the  Intemal  Revenue  Service 
that  it  "operated  primarily  for  religious  purposes,  which  is 
described  in  section  501(c)(3),  and  which  is  exempt  from  tax 
under  section  501  (a)." 

Lay-board  religious  schools  provide  excellent  education 
and  moral  training  for  American  young  people  with  a  caring 
environment  where  students  can  achieve  academically.  My 
own  doctoral  research  in  Los  Angeles  on  why  black,  Hispanic 
and  white  parents  chose  to  send  their  children  to  evangelical 
Christian  schools  attests  to  this  fact.  Parents  of  all  ethnic  back- 
grounds chose  to  re-enroll  their  children  because  of  the  caring 
environment  that  they  found  in  evangelical  Christian  schools. 

We  believe  that  Congress  failed  to  exempt  lay-board  con- 
trolled religious  schools  from  FUTA  because  these  schools  are 
not  numerous,  and  Congress  was  simply  unaware  of  the  differ- 
ence in  the  technicalities  of  affiliation  from  other  religious 
schools.  This  oversight  was  not  intentional  discrimination  on 
Congress'  part,  merely  inadvertent.  Back  in  1988,  an  identical 
amendment  to  Miscellaneous  Revenue  Issue  #8  was  spon- 
sored by  Senator  Strom  Thunnond.  The  amendment  was 
unanimously  adopted  by  the  Senate  during  consideration  of  the 
tax  technical  corrections  bill.  Unfortunately,  the  amendment 
was  dropped  in  conference.  We  do  not  know  why.  Amendment 
No.  3443  (in  the  100th  Congress)  was  viewed  by  the  Joint 
Committee  on  Taxation  as  revenue  neutral.  The  Joint  Commit- 
tee on  Taxation  said  the  "net  budget  effect  of  this  bill  would  be 
a  gain  of  less  than  $5  million  in  the  fiscal  year. .  .and  a  negligi- 
ble effect  each  year  thereafter."  (Congressional  Record,  100th 
Congress,  S14861-2)  Thus,  there  is  no  fiscal  burden  to  the 
government  to  provide  tax  equity  and  simple  justice. 


1088 


Groups  that  are  supportive  of  Miscellaneous  Revenue 
Issue  #8  include  Agudath  Israel  of  America,  the  American 
Association  of  Christian  Schools,  Coalitions  for  America,  Con- 
cemed  Women  for  America,  the  f^arian  [Catholic]  Secondary 
Schools  Association  and  the  National  Association  of  Evangeli- 
cals. We  urge  this  Sut>committee  to  carefully  consider  this 
remedial  measure.  Its  passage  would  help  lay-board  religious 
schools  which  are  helping  American  children  succeed  morally, 
spiritually  and  academically. 

Again,  thank  you  for  listening  to  our  concerns. 


1089 
Chairman  Rangel.  Mr.  Wright. 

STATEMENT  OF  SAMUEL  H.  WRIGHT,  VICE  PRESIDENT  AND 
GENERAL  COUNSEL;  PHH  CORP.,  HUNT  VALLEY,  MD. 

Mr.  Wright.  Thank  you,  Mr.  Chairman.  I  am  vice  president  and 
general  counsel  of  PHH  Corp.  I  am  testifying  on  behalf  of  PHH  and 
the  American  Automotive  Leasing  Association,  of  which  PHH  is  a 
member.  Our  company  leases  and  provides  management  services 
for  approximately  400,000  vehicles  throughout  North  America. 

AALA  members  lease  and  manage  the  majority  of  sales  and  serv- 
ice vehicles  used  by  businesses  throughout  our  country,  a  market 
that  exceeds  3V2  million  vehicles.  We  strongly  support  the  proposal 
to  modify  the  computation  of  depreciation  under  the  alternative 
minimum  tax  by  increasing  the  acceleration  method  from  150  per- 
cent of  declining  balance  to  200  percent.  This  proposal  would  go  a 
long  way  toward  redressing  unfair  treatment  accorded  to  these  as- 
sets under  our  tax  system. 

Passenger  cars  and  trucks  are  allowed  inadequate  depreciation 
deductions  under  both  alternative  and  regular  income  tax.  These 
assets  receive  worse  depreciation  treatment  than  other  business  as- 
sets. This  discrimination  artificially  increases  the  actual  cost  of 
these  business  assets,  distorting  business  investment  decisions,  re- 
ducing the  number  of  passenger  vehicles  purchased.  Prior  to  1986 
automobiles  were  depreciated  over  3  years  using  a  200  percent  de- 
clining balance  method.  This  provided  a  modest  amount  of  incen- 
tive depreciation,  consistent  with  the  regular  tax  depreciation. 

Unfortunately,  in  1986  Congress  lengthened  the  writeoff  period 
to  5  years.  This  change  removed  all  tax  incentive  for  passenger 
cars  and  light  trucks  from  regular  tax  depreciation.  The  1986  legis- 
lation also  included  a  corporate  alternative  minimum  tax.  Under 
the  AMT,  depreciation  deductions  were  intended  to  approximate 
economic  depreciation  in  the  value  of  business  assets.  For  business- 
use  passenger  vehicles,  this  period  was  set  at  the  same  5-year  pe- 
riod provided  under  the  regular  tax,  but  using  a  150  percent  declin- 
ing balance  method. 

In  1989  Congress  directed  the  Treasury  Department  to  conduct 
a  study  of  the  proper  class  life  of  cars  and  light  trucks.  In  1981  the 
Treasury  Department  issued  a  report,  which  recommended  a  class 
life  of  3.5  years  for  business-use  cars  generally.  They  also  con- 
cluded that  the  actual  useful  life  of  cars  in  business  fleets,  the  type 
of  vehicles  I  am  talking  about  today,  is  2.8  years.  The  1991  report 
is  just  the  latest  in  a  long  line  of  Treasury  determinations  going 
back  over  50  years,  concluding  that  cars  should  be  depreciated  over 
a  3-year  period.  Shortening  the  regular  tax  recovery  period  for  pas- 
senger vehicles  to  3  years  to  reflect  the  Treasury  Department's  re- 
port would  simply  reinstate  an  incentive  comparable  to  that  ac- 
corded other  business  assets. 

As  I  mentioned  earlier,  the  Treasury  Department's  1991  study 
concludes  that  the  appropriate  class  life  for  business-use  cars 
should  be  3.5  years,  2.8  years  for  fleet  cars.  Thus,  in  order  to  re- 
flect real  world  depreciation,  the  cost  recovery  period  under  AMT 
for  cars  should  be  no  more  than  3.5  years.  The  economic  effect  of 
the  proposal  to  increase  the  acceleration  method  for  business-use 
passenger  vehicles  from  150  to  200  percent  is  equivalent  to  short- 


1090 

ening  the  AMT  recovery  period  from  5  to  4  years.  Increasing  the 
acceleration  method  from  150  to  200  percent  would  therefore  mere- 
ly allow  us  to  deduct  amounts  which  reflect  the  actual  decline  in 
the  value  of  our  business  assets,  nothing  more. 

I  should  mention  that  the  recent  repeal  of  the  ACE  a(Jjustment 
for  depreciation  under  AMT  was  a  substantial  simplification.  How- 
ever, repealing  ACE  did  not  provide  business-use  vehicles  with  eco- 
nomic depreciation  and  did  not  remove  the  discrimination  against 
these  assets  as  compared  with  other  business  assets. 

In  closing,  I  would  like  to  emphasize  the  importance  of  this 
change  to  the  entire  economy.  More  than  95  percent  of  business- 
use  cars  are  products  of  domestic  manufacturers.  Over  125,000 
businesses  have  fleets  of  10  or  more  automobiles.  Business-use  cars 
also  account  for  over  one-third  of  all  automobiles  sold  by  domestic 
manufacturers,  over  3.5  million  cars  annually.  Merely  providing 
these  vehicles  with  depreciation  rules,  which  reflect  economic  re- 
ality, will  increase  sales  and  result  in  more  economic  growth  and 
more  jobs  not  only  in  the  automobile  manufacturing  industry,  but 
also  in  industries  such  as  steel,  glass,  rubber,  textiles,  and  semi- 
conductors that  supply  the  automobile  manufacturers.  Thank  you, 
Mr.  Chairman,  and  the  committee  for  your  attention. 

Chairman  Rangel.  Thank  you,  Mr.  Wright. 

[The  prepared  statement  follows:] 


1091 


Statement  of 
Samuel  H.  Wright 
American  Automotive  Leasing 

Before 

The  Subcommittee  on  Select  Revenue  Measures 

Committee  on  Ways  and  Means 

United  States  House  of  Representatives 

September  8,  1993 

Mr.  Chairman: 

My  name  is  Samuel  H.  Wright.  I  am  the  vice  president  and  general  counsel  of 
PHH  Corporation  which  is  located  in  Hunt  Valley,  Maryland.  I  am  testifying  on  behalf  of  PHH 
Corporation  and  the  American  Automotive  Leasing  Association  of  which  PHH  is  a  member. 

PHH  Corporation  is  a  $4  billion  company  whose  stock  is  traded  on  the  New  York 
Stock  Exchange.  Through  its  subsidiary,  PHH  FleetAmerica,  PHH  Corporation  leases  and 
provides  management  services  for  approximately  400,000  vehicles  throughout  North  America. 
AALA  is  composed  of  companies  who  lease  and  manage  the  majority  of  sales  and  service 
vehicles  used  by  businesses  throughout  our  country,  a  market  exceeding  three  and  a  half  million 
vehicles. 

We  want  to  thank  you  for  giving  us  the  opportunity  to  present  our  views  of  the 
proposal  to  modify  the  computation  of  depreciation  under  the  alternative  minimum  tax  by 
increasing  the  acceleration  method  from  the  150  percent  declining  balance  method  applicable 
under  present  law  to  a  200  percent  declining  balance  method.  This  proposal  would  go  a  long 
way  toward  redressing  unfair  treatment  accorded  to  these  assets  under  our  tax  system. 

The  problem  we  have  under  present  law  is  simply  that  passenger  cars  and  light 
trucks  are  allowed  inadequate  depreciation  deductions  under  both  the  alternative  minimum  tax 
and  the  regular  income  tax.  These  assets  receive  worse  depreciation  treatment  than  other 
business  assets.  This  discrimination  artificially  increases  the  actual  cost  of  these  business  assets, 
distorting  business  investment  decisions  and  reducing  the  number  of  passenger  vehicles 
purchased. 

I  am  sure  that  it  is  difficult  to  understand  how  such  an  important  part  of  our 
economy  such  as  the  automobile  industry  and  passenger  vehicles  used  in  business  has  come  to 
be  treated  so  unfairly  by  our  tax  system.  It  may  be  helpful  if  I  summarized  some  historical 
background  on  this  issue. 


Background 

Automobiles  have  traditionally  been  depreciated  over  three  years  using  a  200 
percent  declining  balance  method  under  the  regular  tax.  This  provided  a  modest  amount  of 
incentive  depreciation  consistent  with  the  intent  of  regular  tax  depreciation.  Unfortunately,  in 
1986,  Congress  lengthened  the  write-off  period  to  five  years,  evidently  based  on  a 
misapprehension  of  the  useful  life  of  these  vehicles.  This  removed  all  incentive  from  regular  tax 
depreciation. 

The  1986  Tax  Reform  Act  also  included  a  corporate  alternative  minimum  tax. 
Under  the  AMT,  depreciation  deductions  were  intended  to  approximate  economic  depreciation 
in  the  value  of  business  assets,  rather  than  to  provide  any  incentive  similar  to  that  intended  to 
be  provided  for  regular  tax  depreciation.  As  a  result,  most  assets  were  to  be  depreciated  over 
a  somewhat  longer  period  using  a  ISO  percent  declining  balance  method.  For  business-use 
passenger  vehicles,  this  period  was  set  at  the  same  five-year  period  provided  under  the  regular 
tax,  reflecting  that  the  regular  tax  cost  recovery  period  was  longer  than  i4>pn^riate. 


1092 


Treasury  Department  Study 


Since  1986,  it  has  been  made  absolutely  clear  that  business-use  passenger  vehicles 
receive  inadequate  cost  recovery  treatment. 

The  Omnibus  Budget  Reconciliation  Act  of  1989  directed  the  Treasury  Department 
to  conduct  a  study  of  the  proper  class  life  of  cars  and  light  trucks.  The  Treasury  Department 
issued  a  report  in  April,  1991,  which  recommended  a  class  life  of  3.S  years  for  business-use 
cars,  and,  in  fact,  concluded  that  the  actual  adjusted  economic  life  for  cars  used  in  business  fleets 
is  2.8  years. 

The  1991  Treasury  Dqjartment  rqx>rt  is  just  the  latest  in  a  long  line  of  Treasury 
determinations  that  cars  should  be  depreciated  over  a  3-year  period.  The  earliest  determination 
was  made  in  Bulletin  F,  an  I.R.S.  list  of  guideline  lives  for  depreciable  assets  promulgated  in 
1942.  In  1962,  the  Treasury  Department  issued  new  depreciation  guidelines  in  Revenue 
Procedure  62-21  and  once  again  provided  for  a  3-year  class  life  for  automobiles.  Finally,  in 
1971 ,  the  Treasury  Department  issued  new  "asset  depreciation  range"  ("ADR")  guidelines  which 
were  based  on  the  1962  guidelines,  but  allowed  taxpayers  to  select  a  class  life  within  a  20 
percent  range  around  the  mid-point  life.   Cars  were  assigned  a  mid-point  class  life  of  3  years. 

Absent  legislation  to  the  contrary,  an  asset  with  a  3.S  year  class  life  would  be 
treated  as  three-year  property  for  tax  purposes.  However,  the  1986  Act  specified  that  passenger 
cars  placed  in  service  after  December  31,  1986,  and  before  January  1,  1992,  were  to  be 
classified  as  five-year  property.  After  that  period,  the  Treasury  Department  was  given  the 
authority  to  reclassify  cars  and  light  trucks  as  i^ropriate. 


Congressional  Intent 

It  is  important  to  highlight  this  point.  When  the  cost  recovery  period  for  cars  was 
lengthened  to  five  years.  Congress  intended  that  the  five-year  write-off  period  was  to  be  required 
only  through  1991,  presumably  to  balance  revenues  to  the  Treasury  over  that  period.  After 
1991,  the  Treasury  Department  was  given  authority  to  reclassify  cars  as  three-year  property  if 
it  deemed  the  shorter  period  to  be  appropriate  based  on  economic  useful  life  of  the  asset. 

Unfortunately,  in  1988,  Congress  enacted  legislation  that  removed  the  Treasury 
Department's  authority  to  reclassify  assets  as  appropriate.  While  that  change  was  intended  to 
keep  Treasury  from  lengthening  cost  recovery  periods  for  certain  assets  without  clear 
Congressional  direction,  it  had  the  effect  of  locking  cars  into  an  inappropriately  long  recovery 
period. 

Shortening  the  cost  recovery  period  for  passenger  vehicles  would  not  be  an 
incentive  of  some  arbitrary  amount,  but  would,  rather,  simply  provide  these  assets  with  a  cost 
recovery  period  that  accurately  reflects  their  usefulness  in  business.  Nevertheless,  shortening  the 
cost  recovery  period  to  three  years  for  business-use  cars  would  also  be  one  of  the  most  effective 
and  targeted  tax  incentives  that  the  GovCTnment  could  provide. 


AMT  Pgprggiation 

The  1991  Treasury  Dqurtment  report  also  makes  absolutely  clear  that  a  five-year 
cost  recovery  period  using  the  150  percent  declining  balance  method  provides  less  than  economic 
depreciation.  Nevertheless,  under  present  law,  taxpayers  are  forced  to  use  this  five-year  period 
for  automobiles  used  in  their  business.  This  is  absolutely  contrary  to  the  intent  of  the  AMT  to 
tax  no  more  than  economic  income.  Simple  fairness  would  require  that  AMT  depreciation  be 
improved  to  reflect  economic  depreciation. 


1093 


As  I  mentioned  earlier,  the  Treasury  Department's  1991  study  concludes  that  an 
appropriate  class  life  for  business-use  cars  would  be  3.5  years.  Thus,  the  cost  recovery  period 
for  cars  under  the  AMT  should  be  no  more  than  3.5  years  to  reflect  economic  depreciation,  not 
the  5-year  period  provided  under  present  law. 

The  economic  effect  of  increasing  the  acceleration  method  for  business-use 
passenger  vehicles  from  150  percent  to  200  percent  declining  balance  is  equivalent  to  shortening 
the  AMT  cost  recovery  period  for  these  assets  from  5  years  to  4  years.  This  would  provide  tax 
depreciation  no  greater  than  an  approximation  of  the  economic  depreciation  in  the  value  of  the 
assets. 

I  would  like  to  thank  the  members  of  this  committee  for  their  efforts  in  repealing 
the  ACE  adjustment  for  depreciation  under  the  AMT.  That  change  was  a  substantial 
simplification.  However,  it  is  not  an  alternative  to  changing  the  acceleration  method  to  200 
percent  of  the  declining  balance.  Repealing  the  ACE  adjustment  did  not  provide  business-use 
vehicles  with  economic  depreciation  and  did  not  remove  the  discrimination  against  these  assets 
as  compared  with  other  business  assets. 

We  hope  that,  when  you  review  requests  for  depreciation  relief  under  the  AMT, 
you  will  ask  whether  relief  requested  would  provide  simply  economic  depreciation  or  whether 
the  requested  relief  would  provide  incentive  depreciation.  All  we  are  asking  is  that  we  be 
allowed  to  deduct  amounts  which  reflect  the  actual  decline  in  the  value  of  business  assets. 
Increasing  the  acceleration  method  from  150  percent  to  200  percent  would  accomplish  this. 


Economic  Impact 

In  closing,  I  would  like  to  emphasize  the  importance  of  this  change  to  our 
country's  economic  well-being.  More  than  95  percent  of  business-use  cars  are  products  of 
domestic  manufacturers.  Over  125,000  businesses  have  fleets  of  ten  or  more  automobiles. 
Business-use  cars  also  account  for  over  one-third  of  all  automobiles  sold  by  domestic 
manufacturers  -  over  3.5  million  cars  per  year. 

Improving  tax  depreciation  deductions  directly  reduces  the  cost  of  a  vehicle.  It 
is  generally  agreed  in  the  industry  that  a  reduction  in  price  will  result  in  an  increase  in  sales  of 
an  equal  percentage.  In  the  business  context,  the  increase  in  sales  will  occur  both  because 
businesses  will  operate  more  automobiles  and  because  they  will  replace  their  fleets  more  often. 


Thus,  merely  providing  these  vehicles  with  the  depreciation  rules  which  reflect 
economic  reality  will  increase  sales  and  result  in  more  economic  growth  and  more  jobs,  not  only 
in  automobile  manufacturing  directly,  but  also  in  industries  such  as  steel,  glass,  rubber,  textiles, 
and  semiconductors  that  supply  the  automobile  manufacturers. 

For  this  reason  we  strongly  urge  that  you  adopt  the  proposal  to  provide  for  the  use 
of  200  percent  declining  balance  depreciation  for  passenger  vehicles  for  alternative  minimum  tax 
purposes.  We  believe  that  the  cost  recovery  period  for  these  assets  under  the  regular  tax  should 
also  be  reduced  from  five  to  three  years,  reflecting  the  results  of  the  1991  Treasury  Department 
study.  However,  if  revenue  constraints  require  deferral  of  this  proposal,  you  can  be  certain  that 
the  proposed  change  in  AMT  depreciation  will  have  a  real  and  important  impact. 


1094 

Chairman  Rangel,  Independent  Bakers,  Dale  Cox. 

STATEMENT  OF  DALE  COX,  INDEPENDENT  CONTRACTOR,  SAN 
RAPHAEL,  CALIF.,  ON  BEHALF  OF  THE  INDEPENDENT 
BAKERS  ASSOCIATION;  ACCOMPANIED  BY  ROBERT  FANELLI, 
CHAIRMAN,  INDEPENDENT  CONTRACTORS  COMMITTEE 

Mr.  Cox.  Thank  you,  Mr.  Chairman.  I  am  here  today  in  support 
of  the  proposal  bv  the  baking  industry  for  relief  from  the  statutory 
employee  rule.  The  statutory  employee  rule  could  place  special  and 
troublesome  burdens  on  distributors  of  bakery  products  that  essen- 
tially are  not  imposed  on  any  other  industry  in  America. 

A  recerif  change  of  interpretation  of  the  statutory  employee  rule 
by  the  IRS  threatens  to  destroy  an  opportunity  that  was  available 
to  me. 

I  would  like  to  tell  you  a  little  bit  about  myself  and  what  the  op- 
portunity to  be  an  independent  businessman  has  meant  to  me. 

I  was  bom  and  raised  in  California.  I  don't  have  a  college  degree, 
and  with  only  a  high  school  diploma  spent  the  first  decade  of  my 
adult  life  working  as  an  employee  in  a  job  which  offered  little  fu- 
ture beyond  a  weekly  paycheck.  In  1968,  at  the  age  of  31,  I  was 
fortunate  enough  to  come  across  the  opportunity  to  purchase  a 
Pepperidge  Farm  Cookie  territory  in  northern  California  for  $5,000. 

I  was  married  and  in  those  days  $5,000  was  an  enormous 
amount  of  money.  Even  so,  my  young  wife  and  I  were  determined 
to  build  a  better  life  for  our  children  and  so,  frightened  to  death, 
we  bought  the  territory. 

I  thrived  as  a  bakery  distributor  entrepreneur.  For  the  first  time 
in  my  life  I  was  excited  about  my  work,  and  while  I  routinely  had 
to  work  60  or  more  hours  a  week,  those  were  happy  times.  The 
business  was  small  and  my  resources  smaller.  My  garage  was  my 
warehouse  and  at  busy  times  of  the  year  cartons  of  cookie  inven- 
tory could  be  found  in  every  nook  and  cranny  of  our  home,  where 
the  kids  quickly  discoverea  that  they  could  be  stacked  to  make 
great  play  forts.  Needless  to  say,  all  of  the  kids  in  the  neighborhood 
wanted  to  play  at  our  house. 

The  years  of  hard  work  and  sacrifice  paid  off  and  my  business 
grew  and  grew.  Today  I  have  19  employees  and  my  $5,000  original 
investment  is  worth  well  in  excess  of  $1  million.  It  is  a  wonderful 
thing  to  have  that  kind  of  financial  security,  but  the  greatest  joy 
for  my  wife  and  me  has  come  from  what  it  has  enabled  us  to  do 
for  our  family. 

Our  son,  Kussell,  now  33,  is  active  with  me  in  the  business  and 
we  work  closely  together  on  a  daily  basis.  That  is  a  joy  every  father 
should  get  to  experience.  Our  daughter,  Suzanne,  who  is  28,  has 
graduated  from  Oregon  State  University  and  Dominican  College 
with  a  teaching  degree  and  is  happily  married  to  a  good  and  able 
husband.  We  have  four  grandchildren  so  far  and  look  forward  to 
watching  them  grow  and  to  being  able  to  help  them  if  they  are  ever 
in  need. 

It  is  doubtful  that  I  could  ever  have  had  all  these  blessings  un- 
less that  bakery  distributorship  had  come  into  my  life.  The  ability 
to  act  as  my  own  boss,  to  market  my  products  as  I  saw  fit,  and  to 
have  a  financial  reward  for  my  hard  work  was  a  tremendous  incen- 
tive. That  incentive  would  have  been  lost  if  I  were  an  employee. 


1095 

which  is  the  Hkely  result  of  applying  the  statutory  employee  rule 
in  the  manner  recently  put  forth  by  the  IRS.  In  terms  of  my  suc- 
cess, that  would  have  been  tragic. 

I  understand  that  the  matter  of  tax  compliance  generally  is  an 
ongoing  concern  of  Congress.  I  appreciate  that  concern.  I  can  tell 
you  that  in  my  years  as  a  bakery  distributor  I  have  been  careful 
to  discharge  my  responsibilities  as  a  taxpayer  under  the  law.  I 
want  to  assure  the  members  of  this  subcommittee  that  if  this  pro- 
posal is  adopted,  I  and  the  baking  industry  stand  ready  to  assist 
the  subcommittee  to  ensure  compliance  with  the  law. 

I  have  attached  to  this  written  statement  a  copv  of  the  statement 
submitted  on  behalf  of  the  Independent  Bakers  Association.  I  com- 
pletely endorse  the  IBA  statement  and  ask  that  it  be  included  in 
the  record  as  part  of  my  statement. 

Thank  you  for  the  opportunity  to  appear  here  today  and  present 
these  remarks. 

[The  prepared  statement  and  attachment  follow:] 


1096 

STATEMENT  ON  BEHALF  OF  THE 

INDEPENDENT  BAKERS  ASSOCIATION  AND  THE  BAKERY  INDUSTRY 

IN  SUPPORT  OF  THE  PROPOSAL  TO  CLARIFY  THE  EMPLOYMENT 

TAX  STATUS  OF  DISTRIBUTORS  OF  BAKERY  PRODUCTS 


Hearings  on  Miscellaneous  Revenue  Issues 

Subcoimnittee  on  Select  Revenue  Measures 

House  Ways  and  Means  Committee 

September  8,  1993 

Chairman  Rangel  and  Members  of  the  Subcommittee: 

The  Independent  Bakers  Association  appreciates  the 
opportunity  to  present  its  views  and  the  views  of  the  bakery 
industry  on  the  proposal  by  Congressman  Sundquist  to  amend  IRC 
§  3121(d) (3) (A)  relating  to  the  employment  tax  status  of  bakery 
distributors.   We  would  like  to  thank  Mr.  Sundquist  for  his 
strong  support  for  this  proposal. 

Description  of  the  Issue 

The  issue  before  the  Subcommittee  is  whether  bakery 
distributors  should  be  classified  by  statute  as  employees  for 
employment  tax  purposes  even  though  they  may  be  treated  as 
independent  contractors  for  income  tax  purposes.   Our  proposal 
(which  is  attached  to  this  statement  as  Exhibit  1)  would  delete 
the  phrase  "bakery  products,"  from  section  3121(d)(3)(A)  of  the 
Code.   Section  3121(d)(3)(A)  presently  provides  that  certain 
distributors,  including  bakery  distributors,  will  under  certain 
circumstances  be  treated  as  employees  for  employment  tax 
purposes. - 

We  believe  it  is  important  to  clarify  for  the 
Subcommittee  what  this  proposal  will  and  will  not  do.   The 
proposal  under  consideration  today  does  not  seek  to  classify 


-'section  3121(d)(3)(A)  provides: 

(d)  EMPLOYEE. — For  purposes  of  this  chapter,  the  term 
"employee"  means — 

(1)  ...;  or 

(2)  ...;  or 

(3)  any  individual  (other  than  an  individual  who  is  an 
employee  under  paragraph  (1)  or  (2))  who  performs  services 
for  remuneration  for  any  person — 

(A)  as  an  agent-driver  or  commission-driver  engaged 
in  distributing  meat  products,  vegetable  products, 
bakery  products,  beverages  (other  than  milk) ,  or 
laundry  or  dry-cleaning  services,  for  his  principal; 

(B)  . 

(C)  . 

(D)  . 

if  the  contract  of  service  contemplates  that  substantially 
all  of  such  services  are  to  be  performed  personally  by  such 
individual;  except  that  an  individual  shall  not  be  included 
in  the  term  "employee"  under  the  provisions  of  this 
paragraph  if  such  individual  has  a  substantial  investment  in 
facilities  used  in  connection  with  the  performance  of  such 
services  (other  than  in  facilities  for  transportation) ,  or 
if  the  services  are  in  the  nature  of  a  single  transaction 
not  part  of  a  continuing  relationship  with  the  person  for 
whom  the  services  are  performed;  or 

(4)  .... 


1097 


bakery  distributors  as  independent  contractors.-   Neither  does 
it  seek  to  change  in  any  way  the  common  law  test  by  which 
individuals  are  classified  as  either  employees  or  independent 
contractors.   The  proposal  would  simply  eliminate  the 
irrebuttable  presumption  that  bakery  distributors  are  employees 
for  employment  tax  purposes  and  would  place  them  on  the  same 
footing  with  other  individuals  by  making  distributors  subject  to 
the  same  common  law  test  for  employment  status  as  everyone  else. 

Section  3121(d) (3) (A)  overrides  the  normal,  common  law 
test  for  employment  status;  thus,  even  though  a  bakery 
distributor  would  be  treated  as  an  independent  contractor  for 
income  tax  purposes,  if  that  person  falls  under  section 
3121(d)(3)(A),  he  or  she  will  nevertheless  be  considered  an 
employee  for  employment  tax  purpose.-   We  contend  that  this 
treatment  as  statutory  employees  is  completely  inappropriate  in 
light  of  the  way  in  which  the  bakery  industry  is  organized. 
Classifying  bakery  distributors  as  statutory  employees  is 
disruptive  of  sound  business  arrangements,  is  technically 
unworkable,  and  serves  no  identifiable  tax  or  retirement  policy 
goal.   Current  law  discriminates  against  distributors  by  creating 
an  irrebuttable  presumption  that  they  are  employees  for 
employment  tax  purposes  even  though  they  may  be  independent 
contractors  for  income  tax  purposes. 

History  of  the  Statutory  Emplovee  Provision 

Section  3121(d) (3) (A)  was  enacted  in  1950,  at  a  time 
when  the  combined  FICA  tax  rate  for  employees  was  higher  than  the 
tax  on  self-employed  individuals.-   Section  3121(d)(3)(A)  was 
enacted  as  remedial  legislation.   Congress  concluded  that  "the 
usual  common-law  rules  for  determining  the  employer-employee 
relationship  [fell]  short  of  covering  certain  individuals  who 
should  be  taxed  at  the  employee  rate  under  the  old-age, 
survivors,  and  disability  insurance  program."-'   Congress 
apparently  concluded  that  it  was  important  to  secure  for 
distributors  the  higher  Social  Security  benefits  that  would 
accrue  to  them  as  a  result  of  the  higher  tax  rates. 

While  originally  drafted  to  apply  to  house-to-house 
sales  persons,  the  language  eventually  enacted  referred  to 
individuals  distributing  certain  goods  and  services,  such  as 
bakery,  meat,  vegetable  and  beverage  products,  and  laundry  and 
dry  cleaning  services.-   The  statute  excepted  from  its  coverage 
individuals  who  had  a  substantial  investment  in  facilities  used 


-The  announcement  for  today's  hearing  described  the  proposal  as 
one  to  "eliminate  the  rule  treating  distributors  of  bakery 
products  as  statutory  employees  for  purposes  of  Social  Security 
payroll  taxation  and  coverage,  and  to  treat  such  persons  as 
independent  contractors."   This  is  technically  not  correct. 
While  the  proposal  does  eliminate  the  rule  classifying  bakery 
distributors  as  statutory  employees,  it  does  not  classify  them  as 
independent  contractors.   It  merely  leaves  these  individuals 
subject  to  the  normal,  common  law  test  for  employment  status. 

-'section  3121(d)(3)(A)  classifies  certain  driver-distributors  as 
employees  for  employment  tax  purposes.   It  was  made  applicable  to 
the  unemployment  tax  in  1972.   See  IRC  §  3306(i).   It  has  no 
application  or  effect  on  their  classification  for  income  tax 
purposes. 

-'in  1950,  the  combined  FICA  tax  rate  for  employees  was  4%  while 
the  tax  on  self-employed  individuals  was  2.25%.   The  "combined" 
FICA  tax  rate  for  employees  is  the  sum  of  the  equal  taxes  paid  by 
employers  and  employees  on  wages  paid  to  the  employee. 

-'see  Senate  Report  1669,  81st  Cong.,  2d  Sess.  144  (1950). 

-  Indeed,  the  legislative  history  of  the  statute  is  replete  with 
references  to  house-to-house  sales. 


1098 


in  connection  with  the  performance  of  such  services  (other  than 
in  facilities  for  transportation) .- 

It  is  apparent  that  the  world  has  changed  dramatically 
from  the  time  the  statute  was  enacted  in  1950.   Door-to-door 
deliveries  of  bread,  milk  and  cakes  have  long  since  gone  the  way 
of  the  dinosaur.-   Today,  local  bakeries  have  disappeared, 
having  been  consolidated  into  regional  and  national  concerns. 
Bakery  products  are  no  longer  sold  door-to-door.   Instead,  these 
products  are  often  distributed  by  individuals  owning  their  own 
territories,  who  purchase  their  products  directly  from  the 
bakeries,  and  who  distribute  the  products  to  commercial  customers 
(such  as  grocery  stores  and  restaurants)  for  resale. 

More  important  still  is  the  change  in  the  respective 
tax  rates  for  employees  and  self-employed  individuals.   As 
previously  discussed,  the  combined  FICA  tax  rate  for  employees  in 
1950  was  4  percent  while  the  tax  rate  on  self-employed 
individuals  was  2.25  percent.   In  1984,  these  tax  rates  were 
equalized.-   Today,  both  the  self-employed  tax  rate  and  the 
combined  FICA  tax  rate  stand  at  15.3  percent.   Therefore,  the 
primary  reason  for  the  enactment  of  the  statutory  employee  rule 
—  the  higher  tax  rate  for  employees  and  the  higher  benefits 
derived  from  that  higher  tax  rate  —  no  longer  exists.   Section 
3121(d) (3) (A)  is  an  anachronism  in  today's  world. 

Why  Is  The  statutory  Emplovee  Issue  Important  Today? 

Some  members  of  the  Subcommittee  may  wonder  why  this 
issue  is  so  critical  in  1993  when  the  statute  has  been  in  effect 
since  1950.   The  answer  is  simple.   For  many  years  the  bakery 
industry  considered  section  3121(d)(3)(A)  inapplicable  to  most 
distributors.   It  was  not  until  1991,  when  the  Internal  Revenue 
Service  issued  GCM  39853,  that  the  industry's  long-held  view  was 
called  into  question. 

As  previously  discussed,  the  statute  provides  an 
exception  where  the  individual  has  a  "substantial  investment  in 
facilities."  Throughout  the  years,  many  bakery  distributors  have 
purchased  their  territories  from  the  bakeries  or  from  the 
previous  owners  of  the  territories.   The  distributor's  ownership 
of  the  territory  has  been  consistently  interpreted  as  a 
substantial  investment  in  facilities,  thus  exempting  the 
distributor  from  the  statutory  employee  provision.— 

This  interpretation  of  the  substantial  facilities 
exception  was  never,  to  anyone's  knowledge,  challenged  by  the 
Internal  Revenue  Service  on  audit.   Indeed,  in  1985,  the  Internal 


-  The  statute  also  provides  an  additional  exception  in  cases 
where  the  contract  contemplates  that  substantially  all  of  such 
services  shall  be  performed  personally  by  such  individual. 

-Throughout  the  1940s  and  1950s,  bakeries  were  essentially  local 
operations.   Bread  and  layer  cakes  were  baked  daily  and  delivered 
to  the  homes  of  customers.   These  products  were  typically  sold  by 
individuals  who  used  delivery  vehicles  to  cover  certain 
neighborhoods  or  routes.   The  vehicles  used  may  or  may  not  have 
been  owned  by  the  individuals.   Similarly,  meat  and  vegetable 
products  were  sold  off  of  vehicles  making  house-to-house 
deliveries.   Milk  was  also  delivered  house-to-house,  although 
dairy  products  were  excepted  from  the  final  version  of  the  bill 
without  explanation.   Finally,  laundry  services  were  typically 
provided  on  a  house-to-house  basis. 

-'see  Social  Security  Amendments  of  1983,  P.L.  98-21,  section 
123. 

^It  Should  be  noted  that  many  distributors  have  substantial 
investments  in  equipment  in  addition  to  their  investment  in  their 
territories. 


1099 


Revenue  Service  concluded  in  a  technical  advice  memorandum  that 
investment  ^n  a  territory  constituted  a  substantial  investment  in 
facilities.—   It  was  not  until  that  technical  advice 
memorandum  was  withdrawn  in  1988  and  the  IRS,  in  1991,  released 
General  Counsel  Memorandum  39853  that  the  issue  became  one  of 
concern  to  the  bakery  industry. 

GCM  39853  takes  the  position  that  the  term  "facilities" 
in  section  3121(d)(3)(A)  does  not  include  distribution  rights, 
such  as  a  territory.   Ironically,  the  Internal  Revenue  Service 
has  never  sought  to  enforce  the  position  taken  in  the  GCM  by 
means  of  an  audit  or  through  litigation.   The  GCM  stands  as  the 
sole  pronouncement  of  the  IRS  position  on  this  issue. 

There  is  serious  doubt  that  the  GCM  is  correct.   Its 
reasoning  is  questionable,  its  logic  weak  and  its  timing  (41 
years  after  the  statute  was  passed)  is  suspect.—   It  is  the 
undisputed  opinion  of  tax  advisors  to  the  bakery  industry  that 
the  position  taken  in  the  GCM  would  not  prevail  in  court  if  the 
issue  were  litigated.   Nevertheless,  the  uncertainty  that  the  GCM 
has  created  among  members  of  the  industry  makes  legislative 
action  to  clarify  the  issue  imperative. 

Effect  on  the  Bakery  Industry 

1.    Technical  Problems 

Application  of  the  statutory  employee  rules  to  bakery 
distributors  would  create  numerous  technical  difficulties. 
First,  the  distributor  would  be  required  to  compute  his  or  her 
income  two  different  ways  —  once  as  an  employee  and  once  as  a 
self-employed  individual  —  since  certain  expenses  are  deductible 
for  self-employed  individuals  but  not  for  employees.   The 
absurdity  of  requiring  two  sets  of  books  for  the  same  person, 
especially  a  small  business  person,  is  self-evident. 

Second,  if  the  bakery  is  required  to  treat  the 
distributor  as  an  employee,  what  amount  does  the  bakery  report  to 
the  distributor  and  to  the  IRS  as  wages  paid?   Bakeries  sell 
their  products  to  distributors.   The  distributor  then  resells  the 
product  to  the  market  or  other  establishment.   The  distributors 
income  is  the  profit  made  from  this  resale.   The  bakery  has  no 
information  about  the  profit  the  distributor  has  made.   If  the 
bakery  were  to  report  the  price  paid  by  the  distributor  for  the 
product,  that  would  grossly  overstate  the  amount  of  income 
actually  earned  by  the  distributor.   It  would  totally  fail  to 
take  into  account  the  purchase  cost  of  the  products  and  any  of 
the  distributor's  expenses  (such  as  fuel,  marketing  costs,  wages 
paid  to  the  distributor's  employees,  etc.),  as  well  as  any 
discounts  or  allowances  given  to  the  distributor's  customers 
directly  by  the  distributor. 

The  distributor  system,  as  it  has  evolved  through  the 
years,  bears  no  resemblance  whatsoever  to  a  wage-based 
compensation  system.   The  industry  would  be  forced  to  completely 
restructure  itself  in  order  to  comply  in  any  meaningful  way  with 
the  statutory  employee  rule.   The  costs  of  this  restructuring 
would  be  wholly  disproportionate  to  the  benefit  (if  any)  derived. 

Finally,  classification  of  distributors  as  statutory 
employees  is  particularly  confusing  in  light  of  the  fact  that 


'see  TAM  8607001. 


—  For  example,  the  GCM  argues  that  distribution  rights  (such  as  a 
delivery  territory)  are  more  akin  to  education,  training  and 
experience  because  all  are  intangible.   Unlike  education, 
training  and  experience,  however,  distribution  rights  are  assets 
that  are  readily  transferable  and  that  have  a  value  in  the  market 
place  that  is  affected  by  the  skill  and  industry  of  the 
distributor. 


1100 


many  distributors  have  their  own  employees  and  operate  in 
corporate  form.   In  particular,  distributors  with  large,  heavily 
populated  or  prosperous  territories  may  have  several  employees  of 
their  own. 

Many  questions  arise  as  to  how  the  employees  of  the 
distributor  are  to  be  treated.   A  few  of  those  questions  include: 
(1)  Will  they  be  considered  employees  of  the  distributor  or  the 
bakery?   (2)  If  the  latter,  how  will  that  affect  their  treatment 
by  the  bakery  for  income  tax  purposes.   (3)  Are  these  employees 
of  the  distributor  eligible  for  benefit  plans  maintained  by  the 
bakery?   (4)  If  they  are  not  treated  as  employees  of  the  bakery, 
are  their  wages  deductible  for  purposes  of  computing  the  FICA  tax 
on  the  distributor's  income. 

This  last  question  points  out  the  strange  consequences 
of  applying  the  statutory  employee  rule  to  bakery  distributors. 
If  the  distributor  is  treated  as  an  independent  contractor,  wages 
paid  to  the  distributor's  employees  are  deductible  in  computing 
the  distributor's  self -employment  tax.   However,  these  wages  are 
not  be  deductible  by  the  distributor  if  he  or  she  is  treated  as 
an  employee.   The  result  is  that  the  wages  paid  to  the 
distributor's  employees  is  subject  to  double  FICA  tax:  once  by 
the  bakery  and  the  distributor  (because  these  wages  are  not 
deductible  in  computing  the  distributor's  wages)  and  once  by  the 
distributor  and  his  or  her  employee,   without  question,  this  is 
the  wrong  outcome.   Yet  it  would  be  required  if  the  statutory 
employee  rule  applies. 

The  result  is  even  more  egregious  under  the  recently- 
passed  Omnibus  Budget  Reconciliation  Act  of  1993.   Before  passage 
of  the  Act,  there  was  a  cap  on  the  wages  or  self -employment 
income  subject  to  FICA  or  self-employment  tax.—   Section  13207 
of  the  Act  repealed  the  cap  on  amounts  subject  to  the  hospital 
insurance  portion  of  the  employment  tax  (now  equal  to  2.9 
percent)  beginning  in  1994.   Thus,  where  the  damage  done  by  the 
statutory  employee  rule  was  once  mitigated  by  the  wage  cap,  that 
cap  as  now  been  removed,  at  least  for  purposes  of  the  HI  tax. 

It  is  not  difficult  to  see  that  application  of  the 
statutory  employee  rule  to  bakery  distributors  creates  bizarre 
results.   Without  any  policy  rationale  remaining  to  support  its 
existence,  this  potential  for  bizarre  results  is  a  compelling 
reason  to  eliminate  the  rule. 

2.    Effect  on  Entrepreneurship 

The  eventual  outcome  of  applying  the  statutory  employee 
rule  to  the  bakery  industry  is  likely  to  be  a  complete 
restructuring  of  the  industry.   A  part  of  that  restructuring  will 
no  doubt  be  a  severe  cutback  on  the  use  of  independent  bakery 
distributors.   Such  a  result  would  be  truly  unfortunate  in  view 
of  the  benefits  that  the  industry  (both  the  bakeries  and  the 
distributors  themselves)  has  gained  from  their  use. 

Application  of  the  statutory  employee  rule  would  deny 
an  entrepreneurial  opportunity  to  those  individuals  desiring  to 
operate  a  wholesale  distributorship  business.   Independent 
wholesalers  have  significant  opportunities  to  develop  a 
successful  distributorship  and  earn  profits  substantially  greater 
than  the  salaries  that  would  be  paid  to  employees.   In  addition, 
if  the  distributor  owns  his  or  her  distribution  rights,  the 
distributor  has  the  opportunity  to  build  the  value  of  the 
distributorship  that  he  or  she  may  eventually  sell  for  a  greater 
profit.   All  these  incentives  are  lost,  however,  if  the 
distributor  cannot  be  an  independent  wholesaler. 

Moreover,  application  of  the  statutory  employee  rule  to 
existing  ownership  arrangements  would  substantially  undermine  the 


and  135,000  for  the  HI  portion  of  the  tax. 


For  1993,  the  caps  were  57,600  for  the  OASDI  portion  of  the  tax 


1101 


value  of  the  distributorships  already  in  place.   The  value  of 
these  existing  arrangements  was  premised  on  an  assumption  of 
independent  contractor  status.   Application  of  the  statutory 
employee  rule  would  severely  lower  those  values  to  the  detriment 
of  the  distributors  owning  distribution  rights. 

Conqjusion 

It  is  understandable  that  Congress  would  seek  to 
prevent  abuses  in  the  employment  tax  system  that  can  occur  from 
classification  of  an  individual  as  an  independent  contractor 
rather  than  an  employee.   However,  the  bakery  distributor  system 
is  not  riddled  with  those  abuses.   Even  if  the  system  were, 
however,  application  of  the  statutory  employee  rule  is  clearly 
the  wrong  answer  to  the  problem.   Indeed,  its  application  would 
create  far  more  problems  than  it  would  solve.   For  all  the 
reasons  stated  above,  we  urge  the  Subcommittee  to  endorse  the 
proposal  of  the  Independent  Bakers  Association  to  repeal  the  rule 
with  respect  to  bakery  distributors. 

Thank  you  very  much,  Mr.  Chairman. 


1102 


EXHIBIT    1 

SEC.  XXX.  CLARIFICATION  OF  SELF-EMPLOYMENT  STATUS  OF  CERTAIN 
BAKERY  DISTRIBUTORS. 

(a)  In  General.— Subparagraph  (A)  of  section  3121(d)(3) 
(relating  to  the  definition  of  employee  for  employment  tax 
purposes)  is  amended  by  stri)cing  "bakery  products,". 

(b)  Effective  Date.— The  amendment  made  by  this  section  shall 
take  effect  on  the  date  of  enactment  of  this  Act. 


1103 

Chairman  Rangel.  Thank  you. 

Next  is  Fred  Lazarus,  the  Association  of  Independent  Colleges  of 
Art  and  Design. 

STATEMENT  OF  FRED  LAZARUS  IV,  VICE  PRESIDENT,  ASSO- 
CIATION OF  INDEPENDENT  COLLEGES  OF  ART  AND  DESIGN 

Mr.  Lazarus.  Mr.  Chairman,  members  of  the  committee,  thank 
you  for  allowing  me  to  testify  today.  I  am  here  representing  the  As- 
sociation of  Independent  Colleg:es  of  Art  and  Design.  These  30  col- 
leges are  major  sources  of  designers  throughout  this  country  and 
employ  thousands  of  designers  and  artists  on  their  faculties.  They 
include  institutions  that  range  on  the  West  Coast  from  the  Arts 
Center  in  Pasadena  to  Parsons  School  of  Design  and  the  School  of 
Visual  Arts  in  New  York  City.  All  of  these  are  leaders  in  their  field 
producing  the  leading  industrial  designers  in  the  automobile  indus- 
try, fashion  designers,  and  graphic  designers.  There  are  dozens  of 
these  institutions  throughout  this  country. 

We  are  here  today  asking  your  committee  to  correct  what  we  be- 
lieve was  an  oversight  of  the  1986  Tax  Reform  Act.  That  bill  under 
section  170(e)(4)  provided  companies  who  contributed  equipment  to 
colleges  and  universities  a  greater  level  of  deductibility  for  gifts 
made  for  the  purposes  of  the  physical  and  biological  sciences.  This 
section  encouraged  many  gifts,  enhanced  research  at  these  colleges 
and  universities,  and  is  helping  this  Nation  enhance  its  competi- 
tiveness through  the  work  being  done  by  these  colleges  and  univer- 
sities. 

The  section  does  not  allow  the  same  level  of  deductibility  for  con- 
tributions of  equipment  used  in  the  fields  of  design.  It  is  particu- 
larly discriminatory  to  colleges  that  do  not  have  physical  or  biologi- 
cal sciences.  Colleges  such  as  ours,  which  do  not  nave  these  depart- 
ments, are  excluded  firom  these  gifts  and  are  not  able  to  receive  the 
benefits  that  our  colleagues  in  other  colleges  and  universities  have. 
However,  the  contribution  that  these  colleges  are  making  to  the 
fields  of  design  and  to  the  competitiveness  of  this  country  are  more 
substantial  than  all  these  other  institutions.  The  financial  impact 
of  this  modification  in  the  bill  would  be  negligible,  and  the  impact 
would  be  very  significant.  It  would  enhance  research  and  develop- 
ment in  the  field  of  design,  and  we  hope  we  would  have  your  sup- 
port for  this  change  in  section  170(e)(4)  of  the  bill.  Thank  you  very 
much. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:! 


1104 


TESTIMONY  FOR  THE  MODIFICATION  OF  THE 
INTERNAL  REVENOE  CODE  OP  1986 


September  8,  1993 


Submitted  by  Fred  Lazarus,  President,  Maryland  Institute, 
College  of  Art,  on  behalf  of  the  Association  of  Independent 
Colleges  of  Art  and  Design 


Mr.  Chairman  and  Members  of  the  Committee.  Thank  you  for 
inviting  the  Association  of  Independent  Colleges  of  Art  and  Design 
to  testify  before  you  today. 

The  Association  of  Independent  Colleges  of  Art  and  Design  is 
an  organization  representing  virtually  every  art  and  design  college 
in  the  country.  These  colleges  employ  thousands  of  artists  and 
designers  and  include  among  their  alumni  the  finest  artists  and 
designers  in  this  country. 

We  come  before  you  to  request  your  help  in  correcting  an 
oversight  in  the  1986  Internal  Revenue  Code  which  we  believe,  if 
changed,  will  help  enhance  the  competitiveness  of  American 
industry. 

The  1986  Internal  Revenue  Code,  under  Section  170(e)(4), 
provides  for  a  greater  level  of  deductibility  for  contributions  of 
scientific  property  used  in  research  activities  by  educational 
institutions.  However,  for  the  gift  to  qualify,  the  property 
donated  must  be  scientific  equipment  used  for  research  or 
experimentation  or  for  research  training  in  the  physical  or 
biological  sciences. 

This  provision  in  the  tax  code  has  resulted  in  millions  of 
dollars  worth  of  critical  equipment  being  donated  to  colleges  and 
universities  which  offer  degrees  in  the  physical  or  biological 
sciences  and  do  research  in  these  fields.  The  rationale  for  this 
tax  provision  has  been  that  this  research  has  a  direct  impact  on 
the  United  State's  economic  competitiveness.  The  Ways  and  Means 
Committee  Report  stated,  as  part  of  its  rationale,  that  studies 
indicate  that  in  equipment-intensive  research  areas,  such  as 
physics,  chemistry,  and  electrical  engineering,  the  continuing 
growth  of  university  expenditures  has  not  kept  pace  with  the  rising 
costs  of  scientific  instrumentation.  The  budget  impact  of  this 
change  was  estimated  to  be  $5  million. 

The  same  rationale  that  caused  the  Congress  to  recognize  the 
importance  of  providing  a  greater  level  of  deductibility  for 
contributions  of  equipment  for  the  biological  and  physical  sciences 
can  and  should  be  applied  to  design  and  design  theory.  America's 
competitiveness  not  only  depends  upon  scientific  research  but  also 
on  the  quality  of  design  of  our  products.  The  design  process  15  to 
20  years  ago  required  a  minimum  of  equipment.  Today,  that  has 
changed.  Design  today  has  become  an  equipment-intensive  area  of 
research  and  study. 

The  design  colleges  and  university  design  departments  are  the 
country's  major  source  of  talent  and  know-how  in  the  automotive 
and  product  design  fields,  and  fashion  and  in  film.  However,  there 
is  a  growing  list  of  other  product  areas  that  draw  upon  the  design 
work  of  these  colleges  and  universities.  These  fields  include: 
computer  graphics;  computer  animation;  image  processing;  scientific 
and  aga^^al  visualization;  object,  product,  process  simulation  and 
dimensional  modeling;  image  modification  and  storage;  interactive 
digital  television;  typography  and  letter  design  and  image  and 
photo  screening. 


1105 


Most  of  these  applications  are  parts  of  the  film,  print  and 
graphics,  and  electronic  imagery  industries.  These  are  huge 
industries  where  our  competitiveness  is  being  threatened.  However, 
even  more  important  to  our  economy  is  the  impact  these  industries 
and  processes  have  on  other  product  areas  and  manufacturing. 

colleges  and  universities,  particularly  the  specialized 
colleges  of  art  and  design  yhich  produce  most  of  our  leading 
designers,  do  not  have  the  resources  to  provide  their  faculty  and 
students  with  the  equipment  that  is  now  available.  Much  of  the 
research  that  is  needed  to  determine  how  to  use  and  apply  this 
equipment  to  the  needs  of  the  design  fields  is  not  being  developed 
because  of  the  lack  of  monetary  resources  in  the  colleges  and 
universities. 

The  current  language  In  the  tax  code  precludes  equipment 
manufacturers  from  contributing  equipment  to  colleges  where  the 
intent  of  the  donee  is  to  use  the  equipment  to  advance  design 
theory  or  develop  new  concepts  and  uses  of  design.  This  impediment 
has  reduced  the  rate  of  progress  in  design  research  at  the  college 
and  university  level  and  caused  design  training  to  lag  behind. 

This  is  a  request  made  on  behalf  of  the  members  of  the 
Association  of  Independent  Colleges  of  Art  and  Design  to  modify  the 
current  IRS  code  to  include  Design  and  Design  Theory  within  the 
definition  of  allowable  research,  experimentation,  and  research 
training  in  Section  170(e)(4). 


1106 

Chairman  Rangel.  Mr.  Rosenkranz,  counsel,  University  of  Flor- 
ida Health  Center. 

STATEMENT  OF  STANLEY  W.  ROSENKRANZ,  GENERAL  COUN- 
SEL, FLORroA  CLINICAL  PRACTICE  ASSOCIATION,  INC.;  AND 
SPECIAL  COUNSEL,  UNIVERSITY  OF  FLORIDA  AGENCY,  AND 
UNIVERSITY  OF  SOUTH  FLORIDA  COLLEGE  OF  MEDICINE'S 
FACULTY  PRACTICE  PLAN 

Mr.  Rosenkranz.  Good  morning,  Mr.  Chairman,  and  members  of 
the  subcommittee.  Our  law  firm  is  general  counsel  to  the  Florida 
Clinical  Practice  Association,  a  section  501(c)(3)  Florida  not-for- 
profit  corporation,  and  special  counsel  both  to  the  University  of 
South  Florida  College  of  Medicine  practice  plan  and  the  University 
of  Florida  agency  funds. 

The  Florida  Clinical  Practice  Association  I  will  refer  to  as  the 
FCPA  and  the  agency  funds  as  the  University  Fund.  I  appear  today 
on  behalf  of  our  clients  to  support  the  enactment  of  a  proposed 
amendment  to  section  125(a)  of  Public  Law  98-21,  which  I  will 
refer  to  as  section  125. 

While  our  firm  does  not  represent  the  board  of  regents  of  the 
State  of  Florida,  I  have  been  authorized  to  say  the  proposed 
amendment  has  the  full  and  enthusiastic  support  of  the  board's 
chancellor.  Section  3121(s)  of  the  code  speaks  to  FICA  responsibil- 
ity when  two  or  more  related  corporations  concurrently  employ  the 
same  individual.  Section  125  under  certain  circumstances  treats  as 
related  corporations  for  purposes  of  section  3121(s)  a  State  univer- 
sity, which  employs  health  professionals  at  a  medical  school,  and 
a  faculty  practice  plan,  which  employs  faculty  members  of  such 
medical  school. 

Section  125,  however,  requires  employment  by  the  practice  plan. 
To  do  so  in  Florida,  which  has  broadly  retained  the  doctrine  of  sov- 
ereign immunity,  would  expose  faculty  members  at  the  Health 
Science  Center  and  the  respective  practice  plans  to  severe  liabilitv 
for  medical  malpractice  claims.  For  multiple  reasons,  some  of  whicn 
will  be  discussed  later,  including  accommodating  the  instant  situa- 
tion, moneys  are  transferred  to  tne  University  Fund.  From  the  Uni- 
versity Fund  from  time  to  time,  a  check  is  drawn  in  part  payment 
of  the  compensation  agreed  to  in  the  sole  contract  of  employment. 

As  currently  required  by  the  Internal  Revenue  Service  and  cur- 
rently the  subject  of  controversy  between  the  college  and  the  Inter- 
nal Revenue  Service,  the  University  Fund  pays  FICA  as  if  it  were 
the  sole  employer.  The  result,  a  single  contract  of  employment,  two 
checks  in  payment  of  the  compensation  required  by  the  single  con- 
tract of  employment,  double  employer  share  of  FICA  with  no  auto- 
matic refund  mechanism,  double  employee  share  of  FICA  with  an 
automatic  refund  provision,  two  form  W-2s  and  two  form  941s. 

Our  written  statement  cites  both  letter  and  published  rulings  in- 
dicating that  the  existence  of  two  taxpaying  entities  having  two 
taxpayer  identification  numbers  and  each  filing  separate  W-9s  and 
Form  941s  is  not  unknown  to  the  Internal  Revenue  Service. 

In  short,  the  Internal  Revenue  Service  is  familiar  with  dual 
payer  situations  such  as  that  for  which  we  contend.  Moreover,  in 
the  world  of  computers  it  should  be  a  situation  of  no  moment.  The 
proposed  legislation  will  merely  allow  the  intended  result  provided 


1107 

by  section  125  a  provision  not  practically  available  to  the  various 
health  professional  colleges  at  the  University  of  Florida  Health 
Science  Center  or  the  University  of  South  Florida.  The  proposed 
amendment  postulates  a  position  that  is  supported  by  an  American 
Association  of  Medical  College  letter  that  will  be  submitted  for  the 
record. 

It  is  also  supported,  Mr.  Chairman,  by  a  letter  to  you  signed  by 
all  members  of  the  Florida  Delegation,  Democrat  and  Republican. 
Based  on  our  informal  survey  of  other  medical  schools  in  this  situa- 
tion, it  would  appear  that  the  revenue  impact  should  be  limited  to 
the  employer's  share  of  FICA  that  would  otherwise  be  paid  by  the 
agency  funds  at  the  University  of  Florida  and  the  University  of 
South  Florida.  Thus,  we  estimate  that  the  impact  would  not  exceed 
$3  million  a  year.  These  dollars  would,  of  course,  otherwise  be 
available  to  support  academic  and  research  activities  and  the  provi- 
sion of  health  care  services  to  both  categorically  and  medically  indi- 
gent patients. 

The  essence  of  the  matter  before  this  subcommittee  is  the  pay- 
ment of  double  FICA  by  respective  agency  accounts  at  the  univer- 
sities in  Florida.  The  situation  is  caused  by,  one,  the  inability  of 
the  agency  funds  to  utilize  section  125  because  neither  is  a  practice 
plan  and  an  employer  and,  two,  the  inability  of  our  clients  to  con- 
vince the  Comptroller  of  the  State  of  Florida,  a  constitutional  offi- 
cer of  the  State  of  Florida,  to  agree  to  effect  payment  of  faculty 
compensation  in  a  manner  that  would  obviate  the  need  for  legisla- 
tion. 

At  a  meeting  with  a  member  of  the  staff  of  the  House  Ways  and 
Means  Committee's  Subcommittee  on  Social  Security,  amplification 
of  this  point  was  requested.  As  we  attempted  to  prevent  the  double 
FICA  situation,  an  obvious  solution  suggested  itself.  In  lieu  of  mul- 
tiple payments  due  under  a  faculty  member's  single  contract  of  em- 
ployment, such  payment  would  be  effected  solely  through  the  Office 
of  Comptroller  of  the  State  of  Florida. 

In  an  attempt  to  effect  such  an  arrangement,  negotiations  over 
a  protracted  period  of  time  were  carried  on  with  top  officials  of  the 
Comptroller's  office.  In  addition  to  members  of  the  staff  of  one  of 
the  universities,  as  well  as  assorted  legal  counsel,  the  meetings 
were  attended  by  either  the  chancellor  of  the  Florida  system  or  one 
of  the  vice  chancellors.  Three  major  concerns  evolved. 

One,  when  would  the  money  become  State  funds  if  transferred  to 
the  Comptroller  and  what  would  be  the  legal  ramifications  if  the 
funds  were  deemed  to  be  State  funds.  The  thought  was  that  a 
marked  actuarial  adjustment  under  the  Florida  retirement  system 
would  be  required.  Having  then  just  recently  suffered  the  economic 
consequences  of  such  a  readjustment,  $6  to  $7  million,  the  Univer- 
sity of  Florida  College  of  Medicine  was  less  than  enthusiastic  con- 
cerning such  a  possibility. 

The  second  problem  was  nonacademic  intrusion  into  the  aca- 
demic decisionmaking  process.  This  question  is  particularly  perti- 
nent in  the  State  of  Florida,  a  State  where  the  university  system 
has  been  historically  subject  to  the  micromanagement  proclivities 
of  both  the  legislative  and  executive  branches  of  the  State  govern- 
ment. 


1108 

At  the  University  of  Florida,  practice  plans  contribute  52  percent 
of  the  College  of  Medicine's  budget,  and  at  the  University  of  South 
Florida  55  percent  of  the  College  of  Medicine's  budget.  Given  such 
facts,  the  chancellor,  along  with  the  academic  leadership,  felt  it 
most  important  to  ensure  academic  control  and  oversight  by  man- 
dating that  these  funds  be  retained  in  a  university  agency  account, 
thereby  assuring  continued  university  oversight. 

The  final  problem  was  loss  of  flexibility  in  connection  with  fixing 
the  compensation  of  the  clinical  faculty.  At  a  time  when  the  health 
care  system  is  imdergoing  tremendous  change,  particularly  as  re- 
gards physician  compensation,  the  prospect  of  such  loss  of  flexibil- 
ity was  of  grave  concern.  It  was  felt  that  the  health  care  delivery 
system  environment  mandated  afforded  each  college  of  medicine 
flexibility  as  to  the  compensation  to  be  paid  to  members  of  the  clin- 
ical faculty  staff",  neither  party  being  able  to  assuage  the  other's 
concerns  at  the  termination  of  the  negotiations.  The  chancellor  con- 
cluded that  it  was  not  possible  to  fi'ame  a  solution  that  adequately 
addressed  the  concerns  of  each  of  the  involved  parties. 

Thank  you,  Mr.  Chairman, 

[The  prepared  statement  follows:] 


1109 


WRITTEN  STATSIENT  OF  STANLEY  M.  ROSENKRANZ  OF 
SHEAR,  NEWMAN,  HAHN  ft  ROSENKRANZ,  P. A., 
GENERAL  COUNSEL  TO  FLORIDA  CLINICAL  PRACTICE 
ASSOCIATION,  INC.,  A  FLORIDA  NOT  FOR  PROFIT 
a}RPORATI(»«  AND  SPECIAL  COUNSEL  TO  THE 
UNIVERSITY  OF  FLORIDA  AGENCY  FUNDS  AND  THE 
UNIVERSITY  OF  SOUTH  FLORIDA  COLLEGE  OF 
MEDICINE'S  FACULTY  PRACTICE  PLAN  SUBMITTED  IN 
SUPPORT  OF  A  PROPOSED  AMENDMENT  TO  SECTION 
12S(a)  OF  P.L.  98-21  (THE  "PROPOSED 
LEGISLATION") 

PRQPQgED  LEGISLATIOr^ 

Section  3121 (s)  of  the  Internal  Revenue  Code  of  1986,  as 
amended  (the  "Code")  speaks  to  "FICA  responsibility"  when  two  or 
more  related  corporations  concurrently  employ  the  same  individual 
compensated  through  a  common  paymaster  which  is  one  of  such 
corporations.   Section  125(a)  of  Public  Law  98-21  (the  "Special 
Act"),  under  certain  circumstances,  treats  as  related 
corporations  for  purposes  of  that  Code  section,  a  state 
university  which  employs  health  professionals  at  a  medical  school 
and  a  faculty  practice  plan  which  employs  faculty  members  of  such 
medical  school. 

The  Proposed  Legislation  would  amend  the  Special  Act  as 
follows : 

"Sec.     125(a)    of  P.L.    98-21,    TREATMENT  OF  CERTAIN 
FACULTY  PRACTICE  PLANS  OR   UNIVERSITY  ACCOUNTS. 

"(a)      General  Rule   —  For  purposes  of  subsection    (s)  of 
Section  3121   of  the  Internal  Revenue  Code  of   1954    (relating  to 
concurrent  employment  by  2  or  more  employers)   — 

"(1)      the  following  entities  shall  be  deemed  to  be 
related  corporations   that  concurrently  employ   the  same 
individual  : 

"(A)      a  State  university  which  employs  health 
professionals  as  faculty  members  at  a  Health  Science  Center  that 
includes  a  College  of  Medicine,    and  one  or  more  of  the  following: 
a  College  of  Dentistry,    a  College  of  Public  Health,    a  College  of 
Nursing,    a  College  of  Veterinary  Medicine,    a  College  of  Health 
Related  Professions,    or  a  College  of  Pharmacy,    and  either 

"(B)      a  faculty  practice  plan  described  in  section 
501 (c) (3)   of  such  Code  and  exempt  from   tax  under  section  501(a) 
of  such  Code  -- 

"(i)      which  employs  faculty  members  of  such 
medical  school,    and 

"(ii)      30  percent  or  more  of  the  employees  of 
which  are  concurrently  employed  by  such  medical   school;   or 

"(C)      an  agency  account  of  a  State  university 
which  is  described  in    (a)(1)(A)   of  this  section  and  from  which 
there  is  distributed  to  faculty  members  of  any  of  the  colleges 
described  in   (a)(1)(A)  of  this  section,   payments  forming   a  part 
of  the  compensation   the  State,    or  such  State  university,    as  the 
case  may  be,    agreed  to  cause   to  be  paid  any  such  faculty  member, 
and 

"(2)     remuneration  which  is  disbursed  by  either: 

(A)     such  faculty  practice  plan   to  a  health 
professional  employed  by  both  of  the  respective  entities  referred 
to  in  paragraph   1(A)  and  (B)  of  this  section;  or 


1110 


(B)      such  agency  account   to  a  faculty  member  of 
any  of  the  Colleges  described  in    (a)(1)(A)   of  this  section 

shall  be  deemed  to  have  been  actually  disbursed  by  the  State,  or 
such  State  university,  as  the  case  may  be,  as  a  common  paymaster 
and  not  to  have  been  actually  disbursed  by  such  faculty  practice 
plan  or  agency  account,    as   the  case  may  be. 

"(b)     Effective  Date  —" 


The  need  for  the  Proposed  Legislation  emanates  from  the  unique 
manner  in  which  compensation  is  paid  certain  members  of  the 
respective  faculties  at  the  University  of  Florida  (the 
"University")  Health  Science  Center  in  Gainesville,  Florida  and 
at  the  University  of  South  Florida  in  Teunpa,  Florida  ("USF"). 

Based  on  our  informal  survey  of  medical  schools,  it  would 
appear  that  the  revenue  impact  of  the  Proposed  Legislation  would 
be  limited  in  scope.   More  particularly,  the  revenue  impact 
should  be  limited  to  the  employer's  share  of  FICA  that  would 
otherwise  be  paid  by  the  agency  funds  at  the  University  of 
Florida  and  the  University  of  South  Florida.   Assuming  (1)  a 
constant  FICA  tax  rate  and  (ii)  no  dramatic  increase  in  faculty 
compensation,  it  is  estimated  the  annual  revenue  impact  would  be 
less  than  $3  million.   These  dollars  would  otherwise  be  available 
to  support  (1)  the  respective  medical  colleges'  academic  and 
research  activities  and  (11)  the  delivery  of  health  care  services 
to  indigent  and  underfunded  patients. 

FACTUAL  BACKGROUND 

As  an  integral  part  of  their  respective  University  teaching 
or  research  activities,  or  both,  members  of  the  respective 
faculties  of  the  University's  College  of  Medicine,  College  of 
Dentistry  and  College  of  Health  Related  Professions  (singularly, 
a  "College"  and  collectively,  the  "Colleges")  generate  patient 
fees  (collectively,  the  "Fees").   The  same  would  hold  true  for 
faculty  members  of  USF's  College  of  Medicine. 

Pursuant  to  rules  of  the  Board  of  Regents  of  the  State  of 
Florida  (the  "Board"),  each  such  faculty  member,  as  a  condition 
of  employment  by  the  respective  colleges,  agreed  that  all  Fees 
generated  by  his/her  faculty  activities  will  belong  to  and  be 
deposited  into  the  practice  plan  created  by  his/her  respective 
College.  There  Is  no  employment  relationship  between  any  faculty 
member  and  any  practice  plan. 

The  Florida  Clinical  Practice  Association,  Inc.,  a  Florida 
Not  for  Profit  Corporation,  which  Is  exempt  under  section 
501(c)(3)  of  the  Code  (the  "FCPA"),  is  the  repository  of  all 
patient  fees  generated  by  clinical  activities  of  any  member  of 
the  faculty  of  the  University's  College  of  Medicine.   From  time 
to  time,  subsequent  to  collection  of  the  Fees  by  the  FCPA  or  any 
other  practice  plan,  a  substantial  portion  of  such  plan's  monies 
are  deposited  into  an  identifiable  account  within  the  University 
of  Florida  agency  funds  (the  "University  Fund").   The  latter, 
Itself,  is  merely  a  statutorily  authorized  bank  account  outside 
of  the  State  Treasury.  The  FCPA  also  collects  a  portion  of  the 
patient  fees  generated  by  the  activities  of  faculty  members  of 
the  University's  College  of  Health  Related  Professions,  all  of 
which  fees  it  deposits  in  the  University  Fund.   The  University's 
College  of  Dentistry  effects  a  direct  collection  of  fees 
generated  by  its  faculty  members.   All  of  such  fees  are  deposited 
into  the  University  Fund. 

The  monies  in  the  respective  practice  plans  are  used  to 
support  (1)  the  educational  and  research  activities  of  the 


1111 


respective  Colleges  and  (ii)  the  delivery  of  health  care  services 
to  indigent  and  to  underfunded  patients.   Indeed,  the  FCPA,   the 
University's  College  of  Medicine's  practice  plan,  provides 
approximately  fifty-two  percent  of  that  College's  entire  budget. 

Additionally,  on  a  continuing  basis,  the  assets  of  a 
particular  practice  plan  are  the  means  by  which  a  significant 
capital  project  can  be  undertaken  by  the  University.   As  an 
example,  the  FCPA's  gross  revenues  are  the  main  source  of 
security  for  the  bonds  from  the  sale  of  which  emanated  the 
capital  to  build  and  equip  an  academic  research  building  at  the 
University's  Health  Science  Center. 

Each  faculty  member  is  employed  by  his/her  respective 
College  pursuant  to  a  single  contract  of  employment.   Pursuant  to 
pertinent  rules  of  the  Board,  the  compensation  provided  for  in 
such  contract  is  approved  annually  by  (i)  the  Dean  of  the 
respective  College,  (ii)  the  University's  Vice  President  for 
Health  Affairs,  and  (iii)  the  President  of  the  University. 
Pursuant  to  the  single  contract  of  employment,  each  faculty 
member  is  compensated  for  services  rendered  in  his/her  role  as  a 
teacher  for  both  his/her  teaching  duties  and  for  health  care 
services  provided  individuals  concomitant  to  those  teaching 
responsibilities.   For  a  substantial  portion  of  the  pertinent 
faculty  members,  payment  of  total  compensation  is  effected  in  the 
form  of  two  documents:   a  warrant  from  the  State  Treasury  and  a 
check  from  the  University  Fund.   The  pertinent  compensation 
payments  from  the  University  Fund  represent  a  procedure  of 
paying  such  faculty  member's  compensation  with  both  State  and 
University  Fund  provided  monies. 

As  noted,  a  faculty  member  is  employed  by  the  University 
pursuant  to  a  single  contract  of  employment.   For  this  reason, 
the  Special  Act,  which  contemplates  a  duality  of  employers,  is  of 
no  benefit  in  this  situation.   Accordingly,  by  reason  of  such 
compensation  payments,  the  State  and  the  University  Fund,  for  its 
respective  component  of  such  member's  compensation,  each  issues  a 
Form  W-2  to  each  faculty  member  whose  total  compensation  is  fixed 
and  paid  as  indicated  in  the  first  and  last  sentences  of  the 
prior  paragraph,  respectively.   The  State  and  the  University  Fund 
have  separate  federal  taxpayer  identification  numbers.   Utilizing 
its  own  respective  taxpayer  identification  number,  the  State  and 
the  University  Fund  each  also  files  a  Form  941 . 

The  State,  by  reason  of  its  "Section  218  Agreement",  pays 
employer  FICA  taxes  and  withholds  employee  FICA  taxes  on  that 
portion  of  the  wages  paid  directly  by  the  State  to  each  affected 
faculty  member.   In  effecting  compensation  payments  on  behalf  of 
each  of  the  Colleges,  the  University  Fund,  as  required  by  the 
Internal  Revenue  Service,  also  pays  employer  FICA  taxes  and 
withholds  employee  FICA  taxes  as  if  it  were  an  employer  and  as  if 
the  State  had  not  caused  FICA  payments  to  be  made.   (This 
situation  is  presently  the  subject  of  a  controversy  between  the 
University  Fund  and  the  Internal  Revenue  Service.)   Such  is  the 
case  despite  the  fact  neither  the  State,  the  University,  any  of 
the  Colleges  nor  the  University  Fund  deem  the  University  Fund,  a 
mere  bank  account,  a  separate  employer.   Indeed,  an  appellate 
court  in  Florida  has  held  that  such  a  fund  is  not  an  employer. 
See.  Bryant  v.  Duval  County  Hospital  Authority,  et  al.  459  So.  2d 
1154  (Fla.  Dist.  Ct.  of  App,  1984). 

The  essence  of  the  matter  before  the  House  Ways  and  Means 
Coimnittee's  Subconunittee  on  Select  Revenues  is  the  payment  of 
"Double  FICA"  by  respective  agency  accounts  at  the  University  of 
Florida  (Gainesville,  Florida)  and  the  University  of  South 
Florida  (Tampa,  Florida).   The  situation  is  caused  by  the 
inability  (i)  of  the  agency  funds  to  utilize  Section  125(a)  of 
Public  Law  98-21  because  neither  is  a  practice  plan  and  an 
employer  and  (ii)  of  the  Comptroller  of  the  State  of  Florida  (a 
constitutional  officer)  to  agree  to  effect  payment  of  faculty 


1112 


compensation  in  a  manner  that  would  obviate  the  need  for 
legislation.   At  a  meeting  with  a  member  of  the  staff  of  the 
House  Ways  and  Means  Committee's  Subcommittee  on  Social  Security, 
amplification  of  point  (ii)  was  requested. 

As  the  agency  accounts,  particularly  the  University  of 
Florida  Agency  Fund,  attempted  to  prevent  the  "double  FICA" 
situation,  an  obvious  solution  presented  itself.   In  lieu  of 
multiple  sources  effecting  payment  of  the  compensation  due  under 
a  faculty  member's  single  contract  of  employment,  such  payment 
would  be  effected  solely  through  the  Office  of  the  Comptroller  of 
the  State  of  Florida  (the  "Comptroller"). 

In  an  attempt  to  effect  such  an  arrangement,  negotiations 
over  a  protracted  period  of  time  were  carried  on  with  top 
officials  of  the  Comptroller's  Office.   In  addition  to  members  of 
the  staff  of  one  of  the  involved  universities,  as  well  as 
assorted  legal  counsel,  the  meetings  were  attended  by  either  the 
Chancellor  of  Florida's  State  University  System  (the 
"Chancellor")  or  one  of  the  Vice  Chancellors. 

No  mutually  satisfactory  agreement  could  be  reached  with  the 
Comptroller.   Among  the  many  concerns  expressed  and  vigorously 
discussed  were  the  following: 

1 .  When,  if  at  all,  would  the  money  transferred  to  the 
Comptroller  by  the  respective  Agency  Fund  become  "state 
funds"?   What  legal  ramifications  would  result? 

If  the  funds  were  to  be  deemed  "state  funds",  the 
thought  was  that  a  marked  actuarial  adjustment 
under  the  Florida  Retirement  System  would  be 
required.   Having  just  recently  suffered  the 
economic  consequences  ($6  to  $7  million)  of  such  a 
re-adjustment,  the  University  of  Florida  College 
of  Medicine  was  less  than  enthusiastic  concerning 
such  a  possibility. 

2.  Non-academic  intrusion  into  the  academic  decision 
making  process. 

The  question  is  particularly  pertinent  in  the 
State  of  Florida.   Historically,  the  State's 
university  system  has  been  subjected  to  the  micro 
management  proclivities  of  both  the  legislative 
and  executive  branches  of  State  government.   At 
the  University  of  Florida,  faculty  practice  plan 
funds  represent  approximately  fifty-two  percent 
(52%)  of  its  College  of  Medicine's  budget,  while 
at  the  University  of  South  Florida,  fifty-five  per 
cent  (55%)  of  its  College  of  Medicine's  budget. 
Given  such  facts,  the  Chancellor,  along  with  the 
Academic  leadership,  felt  it  most  important  to 
ensure  academic  control  and  oversight  by  mandating 
funds  be  placed  in  an  agency  account,  thereby,  in 
turn,  assuring  continued  University  oversight. 

3.  Loss  of  flexibility  in  connection  with  fixing  the 
compensation  of  clinical  faculty.   At  a  time  when  the 
health  care  system  is  undergoing  tremendous  change, 
particularly  as  regards  physician  compensation,  the 
prospect  of  such  loss  of  flexibility  was  of  grave 
concern.   The  health  care  delivery  system  environment 
mandated,  it  was  felt,  affording  a  College  of  Medicine 
increased  flexibility  as  to  the  compensation  to  be  paid 
to  members  of  its  clinical  faculty  staff.   It  was 
thought  that  this  important  flexibility  element  would 
be  markedly  compromised  if  funds  were  deposited  with 
the  Comptroller. 


1113 


At  the  termination  of  these  negotiations,  the  Chancellor 
concluded  that  it  was  not  possible  to  frame  a  solution  that 
adequately  addressed  the  concerns  of  each  of  the  involved 
parties.   Accordingly,  it  was  impossible  to  arrange  for 
compensation  to  be  paid  from  one  source. 

AUTHORITIES 

In  other  situations,  such  duality  of  the  source  of 
compensation  has  not  prevented  a  result  similar  to  the  result 
that  the  Proposed  Legislation  would  provide.   For  example,  the 
Regulations  promulgated  under  Section  218  of  the  Social  Security 
Act  indicate  that 

"(W)here  an  individual  in  any  calendar  year  performs 
covered  services  as  an  employee  of  a  State  and  as  an 
employee  of  one  or  more  political  subdivisions  of  the 
State,  or  as  an  employee  of  more  than  one  political 
subdivision;  and  the  State  provides  all  the  funds  for 
the  payment  of  the  amounts  which  are  the  equivalent  to 
the  taxes  imposed  on  the  employer  under  FICA  on  the 
individual's  remuneration  for  services;  and  no 
political  subdivision  reimburses  the  State  for  paying 
those  amounts;  the  State's  agreement  or  modification  of 
an  agreement  may  provide  that  the  State's  liability  for 
the  contributions  on  that  individual's  remuneration 
shall  be  computed  as  though  the  individual  had 
performed  services  for  only  one  political  subdivision. 
The  State  may  then  total  the  individual's  covered  wages 
from  all  these  governmental  employers  and  compute 
contributions  based  on  that  total,  subject  to  the  wage 
limitations  in  Section  404.1047."   See  Regulation 
Section  404.1256. 


The  University  Fund,  of  course,  being  a  mere  bank  account,  cannot 
be  considered  a  political  subdivision  for  purposes  of  the 
foregoing. 

Acceptance  of  the  dual  source  of  funds  concept  is  also 
suggested  by  Code  Section  31 21 (u) (2) (D)  which  specifically  states 
that  all  agencies  and  instrumentalities  of  a  single  state  shall 
be  treated  as  a  single  employer.   This  language  manifests 
recognition  that  where  an  employee  of  a  state  performs  services 
for  more  than  one  agency  or  instrumentality  of  that  state  then 
such  service  will  be  viewed  as  services  for  a  single  employer. 
This  section  recognizes  the  singularity  of  the  employment 
relationship  and  limits  the  state's  liability  to  a  single  wage 
base  for  each  of  its  employees  for  all  agencies  and 
instrumentalities . 

A  similar  view  that  dual  sources  of  funds,  by  themselves, 
should  not  prevent  the  existence  of  a  single  employer  is  also 
suggested  by  the  legislative  intent  indicated  in  the  Senate  Bill 
Report  for  the  Special  Act.   That  law  amended  Code  section 
3121(b)  and  (s)  to  include  a  provision  applicable  when  a  state 
university  employs  health  care  professionals  at  a  medical  school 
and  a  tax-exempt  faculty  practice  plan  employs  a  significant 
percentage  of  those  same  physicians.   Given  such  a  situation,  the 
Special  Act  mandates  that  the  disbursements  by  the  faculty 
practice  plan  are  to  be  deemed  to  be  actually  disbursed  by  the 
university.   Thus,  the  singularity  of  the  employment  relationship 
is  clearly  recognized  amd  is  deemed  to  require  a  single 
calculation  of  the  wage  base.   In  short,  the  Special  Act  provides 
that  remuneration  disbursed  by  the  faculty  practice  plan  to  a 
health  professional  employed  both  by  the  plan  and  the  university, 
will  be  deemed  "to  have  been  actually  disbursed  by  such 
university  as  a  common  paymaster  and  not  to  have  been  actually 
disbursed  by  such  faculty  practice  plan."   Result:   one  FICA  tax 
payment,  in  a  situation  in  which  there  is  clearly  two  separate 


1114 


employers.   This  is  to  be  distinguished  from  the  University's 
situation  which  involves  one  employer  hiring  each  of  its  faculty 
members  pursuant  to  a  single  contract  of  employment  and 
compensating  such  faculty  members  from  two  sources. 

That  the  existence  of  two  paying  entities  could  give  rise  to 
a  situation  involving  two  taxpayer  identification  numbers  should 
be  of  no  significance.   A  review  of  Private  Letter  Rulings  makes 
it  at  once  apparent  that  such  a  situation  is  not  unknown  to  the 
Internal  Revenue  Service.   Private  Letter  Ruling  66091 64800A  (the 
"Letter  Ruling"),  for  instance,  contemplated  a  situation 
involving   two  separate  corporations,  A  and  B,  each  having  its 
own  taxpayer  (employer)  identification  number,  which  operated 
under  a  joint  contract.   Under  the  contract,  all  employees 
performed  duties  for  both  corporations.   Only  Corporation  A, 
however,  filed  employment  tax  returns. 

Addressing  the  question  as  to  which  corporation  had  the 
responsibility  for  filing  such  returns,  the  IRS  determined  that 
the  two  entities  were  truly  distinct  employers  and  therefore, 
each  should  file  Forms  941  and  940.   However,  for  those  years 
which  corporation  B,  had  failed  to  collect,  report  and  pay  FICA 
employee  tax,  it  was  relieved  of  doing  so,  since  corporation  A 
had  already  reported  and  paid  the  requisite  amounts.   In  order  to 
satisfy  the  IRS,  corporation  B  simply  attached  a  supporting 
statement  to  its  employment  tax  returns,  setting  forth  the  entire 
factual  situation,  that  is,  that  FICA  taxes  had  previously  been 
paid  by  corporation  A. 

Rev.  Rul.  57-22,  1957-1  C.B.  569  (the  "Revenue  Ruling")  also 
suggests  Internal  Revenue  Service  familiarity  with  dual  payor 
situations.   Factually,  the  Revenue  Ruling  was  concerned  with  a 
cooperative  agreement  between  a  federal  agency  and  a  state  for 
the  investigation  of  the  water  resources  of  the  state. 

Under  the  terms  of  the  agreement,  each  party  paid  a  certain 
amount  of  the  expenses  of  the  project.   The  agreement  also 
provided  that  tne  field  and  office  work  pertaining  to  the 
investigation  was  to  be  under  the  direction  of  the  federal 
agency.   The  state,  however,  agreed  to  carry  the  individuals  on 
its  payroll  and  to  make  payment  to  them  for  their  services. 

The  individuals  involved  in  the  project,  worked  for,  took 
orders  from  and  were  under  the  control  and  direction  of  the 
federal  agency.   The  state  payroll  claim,  however,  was  made  up  by 
the  federal  agency  and  approved  by  an  officer  of  the  state. 
Moreover,  the  state  did  not  select,  or  have  any  voice  in  the 
selection  of,  the  individuals  performing  the  services.   For  FICA 
purposes,  the  Revenue  Ruling  held  that,  based  upon  the  applicable 
common  law  rules  for  determining  an  employer-employee 
relationship,  the  individuals  were  employees  of  the  federal 
agency. 

SUMMARY: 

As  a  result  of  effecting  their  respective  contractually 
obligated  teaching  or  research  activities  concomitant  with 
patient  care  activities,  or  both,  members  of  the  respective 
faculties  of  the  Colleges  generate  Fees.   The  Fees  belong  to  and 
are  deposited  into  the  practice  plan  created  by  a  particular 
faculty  member's  respective  College.   From  time  to  time,  a 
particular  practice  plan  pays  a  substantial  portion  of  the  Fees 
to  the  University  Fund,  a  statutorily  authorized  bank  account 
outside  of  the  State  Treasury. 

For  services  rendered  in  his/her  role  as  a  teacher  and  in 
the  health  care  services  provided  as  incident  to  those  teaching 
responsibilities,  each  faculty  member  is  compensated  pursuant  to 
a  single  contract  of  employment.   Generally,  payment  of  such 


1115 


compensation  is  effected  in  the  form  of  two  documents:   a  warrant 
from  the  State  Treasury  and  a  check  from  the  University  Fund. 

An  obvious  solution  to  the  "double  FICA"  situation  --  i.e., 
all  payments  to  be  effected  solely  through  the  Comptroller  --  was 
not  available,  because  no  mutual  satisfactory  agreement  could  be 
reached  with  the  Comptroller.   His  office's  concerns  revolved 
around  questions  such  as  (i)  when,  if  at  all,  would  the  money 
transferred  to  the  Comptroller  by  each  of  the  agency  funds, 
become  "state  funds"  and  (ii)  what  would  be  the  legal 
ramifications  of  such  monies  becoming  state  funds,  such  as 
requiring  unacceptable  levels  of  actuarial  adjustments  in  Florida 
State  Retirement  System  contributions.   For  their  part,  the 
respective  agency  funds  were  concerned  about  ( i )  non-academic 
intrusion  into  the  academic  decision  making  process  and  (ii)  loss 
of  flexibility  in  connection  with  fixing  faculty  compensation. 

The  State  and  the  University  Fund  each  possesses  a  taxpayer 
identification  nximber.   Each  withholds  the  maximum  FICA  on  the 
compensation  paid  by  it;  albeit,  neither  deems  the  University 
Fund  either  an  employer  for  purposes  of  FICA  or  an  entity 
required  to  withhold  and  pay  over  FICA  taxes.   Rather,  given  the 
existence  of  separate  taxpayer  identification  numbers,  the  dual 
paying  over  and  withholding  was  utilized  solely  to  insure  the 
Treasury  Department  that  each  faculty  member's  total  compensation 
had  been  properly  recognized  for  FICA  purposes. 

The  Employment  Tax  Regulations  list  a  number  of  factors  to 
be  looked  to  in  determining  whether  an  "employer-employee" 
relationship  exists.   Treas.  Regs.  §31 .3401 (c)-1 (b) .   None  are 
present  in  the  instant  situation.   Manifestly,  there  is  but  one 
employer  --  the  State  of  Florida. 

The  concept  of  multiple  sources  of  payment  and  one  employer 
is  not  unique.   See  Regulation  Section  404.1256,  Code  section 
3121 (u) (2) (D),  Senate  Bill  Report  for  Section  125(a)  of  Public 
Law  98-21,  April  20,  1983,  PLR  6609164800A,  and  Rev.  Rul.  57-22, 
1957-1  C.B.  569.   There  being  one  employer,  the  University  Fund 
should  be  exempted  from  FICA  responsibility  to  the  extent  the 
State  has  carried  out  such  responsibility. 


1116 

Chairman  Rangel.  Mr.  Rosenkranz,  wliere  is  the  negotiation 
now?  Are  you  still  working  this  out  with  IRS? 

Mr.  Rosenkranz.  We  have  a  claim  for  refund  at  the  IRS.  It  is 
being  considered  by  the  IRS  at  the  agent  level. 

Chairman  Rangel.  Are  you  still  talking  with  them  or  is  the  opin- 
ion just  pending? 

Mr.  Rosenkranz.  My  30  years  of  practice  tell  me  the  opinion  is 
just  pending.  We  can't  break — frankly,  Mr.  Chairman,  I  can't  break 
through  the  agent  and  get  to  the  district  counsel's  office  to  speak 
lawyer-to-lawyer,  and  so  I  have  every  reason  to  believe  that  what 
we  are  going  to  get  is  a  denial  of  a  claim  for  refund  and  we  will 
have  to  follow  the  judicial  path. 

Chairman  Rangel.  Congressman  Ben  Cardin,  a  hard-working 
member  of  this  committee,  wanted  badly  to  be  here  to  introduce 
Mr.  Wright,  as  well  as  Mr.  Lazarus,  and  he  asked  me  through  staff 
to  extend  his  deepest  apologies,  as  well  as  indicating  that  he  will 
be  leaving  some  questions  for  Mr.  Wright  for  a  response  in  the 
record. 

Now,  as  I  understand  it,  Mr.  Holmes,  you  are  looking  for  an  ex- 
emption based  on  the  status  of  your  organization  that  would  relieve 
you  of  paying  taxes  for  the  employees? 

Mr.  Holmes.  We  represent  3,000  evangelical  Christian  schools. 
There  are  approximately  10,000  private  religious  schools  in  Amer- 
ica and  about  20  percent  of  them,  Jewish,  Catholic,  and  Protestant 
are  not  exempt  from  Federal  unemployment  tax.  Eighty  percent  of 
the  schools  that  are  members  of  our  association  are  owned  by  a 
church  or  they  are  affiliated  with  a  church. 

Chairman  Rangel.  I  understood  that  in  your  testimony.  Natu- 
rally, you  know,  we  try  to  protect  employees  in  case  of  job  losses 
and  unemployment,  and  what  you  are  saying  is  that  some  entities 
don't  have  to  provide  that  protection,  and  you  would  like  that  same 
type  of  exemption  from  taking  care  of  the  employees  in  case  of  job 
loss? 

Mr.  Holmes.  Well,  I  am  aware  of  religious  schools,  church 
schools  that  choose  to  cooperate  and  be  part  of  mandator — they 
are — if  you  are  in  a  church  situation.  It  is  not  mandatory,  but  you 
may  participate.  If  you  are  an  independent  board,  then  it  is  manda- 
tory. We  would  like  to  give  the  schools  the  option  to  choose  which 
way  they  elect  to  do,  just  as  church  schools  do. 

In  other  words,  they  would  not  have  to  participate  should  they 
not  want  to  or  they  could  if  they  chose  to. 

Chairman  Rangel.  I  assume  that  you  are  hired  to  make  certain 
it  is  not  mandatory  and  that  the  employee,  you  know,  would  not 
be  receiving  unemployment  benefits.  I  mean,  you  don't  have  any- 
thing to  say  about  the  merits  of  participating?  I  know  no  one  likes 
anything  to  be  done  mandatorily,  but  since  it  is  such  a  spiritual 
and  religious  institution,  you  know,  taking  care  of  employees  that 
are  out  of  work 

Mr.  Holmes.  We  have  asked  our  schools  to  very  carefully  look  to 
ways  that  they  can  provide  for  the  needs  of  their  teachers  and 
staff,  and  each  one  of  them  does  it  a  different  way,  but  we 
have 

Chairman  Rangel.  What  ways  do  you  do  that?  What  are  those 
ways  that  you  take  care  of  your  employees? 


1117 

Mr.  Holmes.  We  do  not  control  what  the  schools  choose  to  do, 
but  we  have  encouraged  them  to  provide  benefits.  As  a  matter  of 
fact,  we  do  annual  surveys  of  what  benefits  are  provided  to  encour- 
age them  to  have  more  benefits,  including  retirement  and  ways  of 
providing  for  the  needs  for  their  family. 

Chairman  Rangel.  But  you  don't  know  of  any  method  that 
they — they  haven't  told  you  how  they  would  like  to  do  that, 
though? 

Mr.  Holmes.  Well,  having  served  as  a  superintendent  of  schools 
in  California,  where  there  was  a  situation  of  having  attached  to 
FUTA  health  care  benefits  in  case  a  person  was  hurt  off  the  job, 
we  provided  that  through  a  private  agency. 

Chairman  Rangel.  Why  do  you  think  the  religious  institutions 
are  exempt  from  mandatory  coverage? 

Mr.  Holmes.  Congress  chose  to  exempt  churches  and  church-af- 
filiated entities  from  this  law,  and  we  feel  that 

Chairman  Rangel.  Why? 

Mr.  Holmes.  Because  they  are  a  religious  institution  and  this  is 
a  form  of  taxation. 

Chairman  Rangel.  It  is  a  form  of  protecting  the  employees,  isn't 
it?  I  don't  see  any  more  reason  why  there  should  be  any  exemp- 
tions, personally,  and  so  if  you  protect  the  employees  iust  because 
your  boss  is  spiritual,  that  doesn't  mean  that  the  employee  should 
not  be  protected,  in  my  opinion.  In  any  event,  there  is  no  moral 
basis  for  it.  You  just  believe  that  in  a  sense  similar  type  institu- 
tions get  the  exemption  from  mandatory  coverage  for  employees, 
that  just  because  your  structure  is  different  and  you  also  are  spir- 
itually motivated  to  take  care  of  the  helpless,  that  you,  too,  should 
not  have  to  do  it  mandatorily,  but  from  the  deep  spirit  in  which 
you  feel  when  you  want  to  do  it.  OK 

Mr.  Holmes.  Yes,  sir. 

Chairman  Rangel.  Mr.  Wright,  you,  I  gather,  as  relates  to  de- 
preciation and  the  alternative  minimum  tax,  believe  that  you  are 
better  off  under  the  new  law,  but  not — the  past  legislation,  but  it 
is  not  as  liberal  as  you  would  like  to  see  it. 

Mr.  Wright.  The  new  law  deals  with  basically  simplification  is- 
sues, which  are  very  significant  and  very  useful,  but  it  does  not  ad- 
dress the  issues  concerning  what  we  think  was  an  incorrect  change 
included  in  the  1986  law  concerning  the  lengthening  of  the  depre- 
ciation period  for  automobiles  and  light  trucks.  Based  upon  the 
1991  Treasury  Department  study  mandated  by  Congress,  the  de- 
preciation period  for  automobiles  and  light  trucks  is  much  longer 
than  it  should  be. 

Chairman  Rangel.  The  bakers'  problem  is  one  of  the  distributors 
being  considered  as  employees? 

Mr.  Fanelll  Mr.  Chairman,  if  I  may  take  that  question,  the 
bakers  in  the  baking  industry  and  the  distributors  in  the  baking 
industry  are  not  looking  for  classification  as  independent  contrac- 
tors. We  have  no  reason  to  claim  special  treatment  in  that  area, 
and  we  think  whether  or  not  these  individuals  are  independent 
contractors  or  employees  should  be  judged  by  the  same  20-step  test 
that  the  IRS  and  the  courts  have  imposed  on  everybody  in  the  in- 
dustrv. 


77-130  0 -94 -4 


1118 

The  problem  here  is  a  statute  adopted  in  1950  which  said  essen- 
tially that  even  if  you  were  an  independent  businessman  for  pur- 
poses of  FICA  tax,  you  would  be  treated  as  a  statutory  employee 
under  certain  limited  circumstances.  At  the  time  that  law  was 
passed,  the  difference  between  FICA  and  SECA  rates  was  signifi- 
cant. The  intent  of  Congress  to  make  sure  that  bakery  drivers  had 
the  benefit  of  the  higher  FICA  contribution  rate  and  therefore 
higher  benefit  payment  at  their  retirement  was  primarily  the  moti- 
vation for  the  statute.  That  is  no  longer  the  case.  The  rates  are 
substantially  identical  for  both  FICA  and  SECA,  so  there  is  no 
positive  benefit  to  this  statute  anymore,  and  it  significantly  threat- 
ens the  ability  of  the  industry  to  establish  independent  contractor 
relationships,  which  have  worked  very  effectively  and  efficiently  in 
this  industry,  to  create  the  kind  of  success  stories  that  Mr.  Cox  re- 
lated to  the  committee  this  morning. 

Chairman  Rangel.  Is  there  any  controversy  as  relates  to  the 
unions  involved  in  the  relief  that  you  are  seeking? 

Mr.  Fanelli.  I  am  not  aware  of  any,  Mr.  Chairman.  The  indus- 
try has  functioned  substantially  identically  to  the  way  it  functions 
today  since  1950,  and  this  issue  becomes  important  todav  only  be- 
cause the  IRS  has  recently  changed  its  interpretation  of  the  statute 
and  taken  the  position  that  the  money  that  these  people  invest  in 
purchasing  these  distributorships,  which  can  be  very  substantial 
amounts  of  money,  does  not  constitute  an  investment  in  facilities 
under  the  statute. 

Early  in  the  1950s  they  took  the  position  that  it  did  constitute 
an  investment,  and  they  continued  to  take  that  position  on  an  un- 
broken basis  for  40  years,  and  it  is  only  in  the  last  2  years  that 
they  have  reversed  themselves  on  that. 

Chairman  Rangel.  Mr.  Lazarus,  did  you  include  in  your  testi- 
mony what  benefits  institutions  such  as  yours  intend  to  receive 
from  charitable  donations  if  the  legislation  is  changed? 

Mr.  Lazarus.  The  major  benefit  would  be  primarily  electronic, 
computer-related  equipment  that  could  be  used  by  faculties  of  our 
institutions  in  developing  research  on  the  applications  of  design. 
This  is  now  not  being  supported  through  contributions  of  equip- 
ment because  of  the  way  the  Teix  Code  is  written. 

Chairman  Rangel.  And  what  type  of  art  and  design  would  that 
be? 

Mr.  Lazarus.  It  is  related  primarily  to  the  design  field,  and  those 
would  include  all  applied  design  from  industrial  design,  automotive 
design,  fashion  design,  textile  design  to  the  graphic  arts,  and  pack- 
aging design  as  well. 

Chairman  Rangel.  Is  there  a  group  of  educators  in  this  field 
that  support  this?  This  is  not  just  your  institute. 

Mr.  Lazarus.  No,  I  am  here  representing  the  Association  of  Inde- 
pendent Colleges  of  Art,  which  includes  all  of  the  independent  col- 
leges. Most  of  the  comprehensive  universities  in  this  country  have 
been  able  to  receive  this  equipment  because  they  offer  degrees  in 
the  biological  and  physical  sciences.  Because  we  are  independent 
colleges,  we  are  excluded  from  those  gifts  because  we  don't  have 
those  degree  programs. 

Chairman  Rangel.  But  the  independent  colleges,  they  are  formal 
associations? 


1119 

Mr.  Lazarus.  Yes. 

Chairman  Rangel.  Mr.  Hancock. 

Mr.  Hancock.  Thank  you,  Mr.  Chairman. 

Mr.  Wright. 

Mr.  Wright.  Yes,  sir. 

Mr.  Hancock.  OK  I  have  two  or  three  questions  that  I  would 
like  to  ask  you.  I  think  what  we  are  talking  about  is  decreasing  the 
length  of  time  required  for  depreciation  of  leased  vehicles,  primary 
vehicles.  What  do  you  estimate  the  life  to  be  for  a  vehicle  used  in 
business?  What  would  be  the  proper  number? 

Mr.  Wright.  In  our  fleet,  which  I  think  is  representative  of  the 
industry  and  business-use  fleets  generally,  it  is  between  27  and  29 
months.  You  need  to  keep  in  mind  that  vehicles  in  that  category 
are  generally  averaging  in  excess  of  2,000  miles  per  month,  so  that 
level  of  use  is  a  major  factor  of  the  length  of  the  vehicle's  term. 

Mr.  Hancock.  The  lease  cars  that  they  are  using  now  on  the 
daily  rentals,  the  companies  don't  keep  them  in  service  for  any- 
thing close  to  that  length  of  time? 

Mr.  Wright.  No,  sir. 

Mr.  Hancock.  If,  in  fact,  we  did  reduce  the  time  for  depreciation, 
do  you  have  an  estimate  of  how  this  could  affect  the  economy? 

Mr.  Wright.  Well,  I  think  it  is  important  to  recognize,  as  I  said 
in  my  testimony,  that  well  over  95  percent  of  our  industry  is  buy- 
ing vehicles  manufactured  by  domestic  manufacturers.  In  PHH's 
case  the  average  is  about  97  percent.  The  ripple  effect  of  the  auto- 
mobile industry  in  glass  and  steel  and  plastic  and  the  rubber  in- 
dustry would  have  a  dramatic  stimulus,  I  believe,  to  the  economy, 
particularly  at  this  point  in  time  when  the  automotive  industry 
seems  to  be  coming  out  of  the  doldrums.  It  is  not  the  time  to  be 
sending  a  message  on  reducing  tax  benefits  on  these  business-use 
assets. 

Mr.  Hancock.  Well,  if  we  were  going  to  make  the  depreciation 
deductions  equal  the  loss  of  the  value  of  the  car,  what  would  the 
tax  law  have  to  say?  Would  it  be  straight  line  depreciation?  I  think 
we  are  using  straight  line  depreciation  in  my  company. 

Mr.  Wright.  Obviously,  you  can  come  up  with  numbers  using  a 
combination  of  changing  both  the  depreciation  period  as  well  as  the 
methodology  of  declining  balance.  The  Treasury,  when  they  devel- 
oped their  study  which  concluded  that  2.8  years  was  the  correct 
number  for  business  fleet  vehicles,  that  was  based  upon  a  straight 
line  determination,  but,  again,  that  rate  of  depreciation — straight 
line — and  depreciable  life  of  2.8  years  is  only  equal  to  economic  de- 
preciation without  any  incentive  at  all.  We  think  that  4  years  at 
150  percent  or  5  years  at  a  200  percent  declining  balance  also 
would  reach  economic  depreciation.  Again,  these  combinations  of 
rates  and  lines  do  not  produce  any  tax  incentive,  as  other  assets 
have,  but  would  basically  reach  only  economic  depreciation. 

Mr.  Hancock.  Well,  isn't  there  a  cap  on  vehicles  now,  the  maxi- 
mum amount  that  you  can  depreciate  on  a  business  car? 

Mr.  Wright.  It  is,  for  the  so-called  luxury  cars,  the  types  of  vehi- 
cles that  we  are  talking  about  in  the  business  fleets  generally 
range  from  $12,000  to  $15,000  and  are  below  that  maximum  cap. 

Mr.  Hancock.  Thank  you. 


1120 

Chairman  Rangel.  Mr.  Cardin  has  arrived,  but  before  I  recog- 
nize him,  are  there  any  other  members  who  are  seeking  recogni- 
tion? 

Mr.  Shaw. 

Mr.  Shaw.  Thank  you,  Mr.  Chairman.  I  will  be  very  brief.  I  ap- 
preciate being  allowed  to  sit  with  this  subcommittee  of  the  commit- 
tee that  we  all  belong  to,  the  Ways  and  Means  Committee,  and  I 
am  here  because  of  Mr.  Rosenkranz'  testimony  and  what  he  has 
put  forth  for  the  University  of  Florida.  I  very  much  side  with  his 
testimony  as  to  what  needs  to  be  done.  I  think  it  is  very  clear  here, 
and,  Mr.  Chairman,  I  think  you  voiced  a  sensitivity  to  his  testi- 
mony. What  they  are  seeking  is  more  of  a  technical  change  or  a 
technical  correction,  I  should  say,  rather  than  a  substantive  change 
in  the  code. 

When  we  get  into  a  situation,  as  we  are  today,  where  we  are  try- 
ing to  bring  the  cost  of  health  care  down,  admittedly,  this  is  a  very 
small  speck  on  the  total  question  of  health  care.  However,  it  is  a 
substantial  amount  of  money  to  the  State  university  system,  which 
I  think  should  certainly  be  recouped  by  them.  I  would  hope  that 
this  would  be  put  into  law,  if  Mr.  Rosenkranz  is  not  successfiil  with 
bringing  the  Internal  Revenue  Service  around  without  the  neces- 
sity of  legislation.  I  think  that  this  should  certainly  appear  as  a 
substantive  change  to  the  law  should  the  IRS  not  side  with  or  not 
fully  understand  the  point  that  he  is  making. 

It  is  clearly  double-dipping.  It  is  clearly  taxpayers'  money  from 
the  residents  of  the  State  of  Florida  that  is  being  double  taxed  on 
the  same  employee,  and  I  think  that  the  merits  are  clearly  on  his 
side  and  the  side  of  the  university  system  of  the  State  of  Florida. 
I  would  just  like  to  add  my  comments  to  the  record  in  that  regard. 

Thank  you,  Mr.  Chairman. 

Chairman  Rangel.  Thank  you,  Mr.  Shaw. 

Mr.  Kopetski  passes,  and  the  Chair  recognizes  the  distinguished 
Representative  from  Baltimore,  Md. 

Mr.  Cardin.  Thank  you,  Mr.  Chairman.  I  want  to  thank  you  for 
including  on  this  panel  two  representatives  from  Maryland,  Mr. 
Wright,  who  is  from  PHH,  who  has  done  yeoman's  service  in  our 
community.  I  just  really  want  to  thank  him  for  appearing  here 
today  and  welcome  him  to  the  Ways  and  Means  Committee. 

He  brings  an  issue  to  our  committee  which  I  think  is  extremely 
important,  and  that  is  to  try  to  bring  a  little  bit  more  economic  re- 
ality to  the  depreciation  schedules  used  on  leased  vehicles.  I  hope 
that  we  will  be  able  to  look  into  this  matter  and  to  try  to  adjust 
the  tax  treatment  to  the  realities  of  the  real  world  as  to  the  useful 
life  of  the  automobiles  involved. 

Also,  I  would  like  to  welcome  Fred  Lazarus  to  the  Ways  and 
Means  Committee.  Fred  has  brought  to  our  attention  a  matter  that 
is  extremely  important  to  many  of  the  private  institutions.  Fred 
has  done  a  great  service  to  our  community  at  the  Maryland  Insti- 
tute College  of  Art,  and  it  is  a  pleasure  to  have  him  here. 

I  would  like  to  ask  a  question,  if  I  might,  to  Mr.  Lazarus  as  to 
the  Treasury's  view  on  the  legislation  that  is  pending.  Treasury 
has  basically  indicated  that  they  are  not  sure  that  this  legislation 
is  needed,  because  private  gifts  to  your  types  of  institutions  have 
been  keeping  pace  with  need.  I  am  wondering  whether  you  could 


1121 

comment  as  to  whether  the  private  gifts  have  kept  pace  with  the 
needs  of  your  colleges  as  the  Treasury  release  would  have  this  com- 
mittee believe. 

Mr.  Lazarus.  I  can  speak  both  personally  and  on  behalf  of  oth- 
ers. I  have  had  corporations  that  are  in  the  business  of  developing 
equipment  in  the  fields  of  design,  particularly  computer  equipment, 
that  have  indicated  to  me  that  they  would  not  provide  that  equip- 
ment to  my  institution  because  we  do  not  qualify  under  this  section 
of  the  bill,  and  have  proceeded  to  support  university  programs  that 
have  biological  and  physical  science  programs  with  these  gifts.  So 
there  is  no  question  that  I  and  other  institutions  have  been  person- 
ally experiencing  the  fact  that  we  do  not  receive  gifts  that  would 
make  a  tremendous  difference  to  us. 

There  is  no  question  that  some  of  the  large  universities  have 
been  able  to  secure  these  gifts  because  thev  do  have  the  qualifica- 
tions of  providing  degrees  in  the  biological  and  physical  sciences. 

Mr.  Cardin.  So  a  company  can  make  a  gift  to  one  college  but  not 
to  another  because  of  the  quirk  in  the  current  structure? 

Mr.  Lazarus.  In  your  district,  in  the  Baltimore  area,  an  institu- 
tion like  the  University  of  Maryland,  Baltimore  County  can  receive 
a  gift,  and  we  cannot.  That  is  correct. 

Mr.  Cardesi.  I  certainly  want  UMBC  to  receive  a  gift,  but  would 
also  like  to  see  you  qualified  to  receive  a  gift.  Thank  you,  Mr. 
Chairman. 

Chairman  Rangel.  On  behalf  of  the  full  committee,  I  thank  this 
panel  for  the  changes  in  laws  recommended.  Staff  may  be  getting 
in  touch  with  you  if  there  are  any  other  questions  that  members 
have  and  they  have  not  had  a  chance  to  ask.  Thank  you  very  much. 

The  next  panel,  representing  the  Screen  Actors  Guild,  the  Amer- 
ican Federation  of  Television  &  Radio  Artists,  and  the  Actors'  Eq- 
uity Association,  is  a  person  well  known  in  the  arts  from  the  city 
of  New  York,  Ron  Silver.  Also  on  this  panel  we  have  Mark  J. 
Weinstein,  counsel  from  Squadron,  EUenoff,  Plesent,  Sheinfeld  and 
Sorkin  from  New  York. 

We  also  will  be  listening  to  Lawrence  O'Toole,  president  and 
CEO  of  Braintree,  Mass.,  representing  the  New  England  Education 
Loan  Marketing  Corp.  and  the  Education  Finance  Council.  Rep- 
resenting R.R.  Donnelly  &  Sons  Co.  from  Chicago,  Frank  Uvena, 
senior  vice  president.  Representing  the  American  Financial  Serv- 
ices Association,  Richard  Romeo,  chairman  of  the  tax  committee. 
That  concludes  this  panel. 

Mr.  Silver,  it  is  good  to  see  you  once  again.  We  all  admire  the 
excellent  performances  that  you  give  and  those  of  us  from  New 
York  are  proud  to  have  you  be  included  in  our  number.  The  com- 
mittee is  anxious  to  hear  your  thoughts  on  the  tax  provision  as  to 
deductibility  for  unreimbursed  business  expenses. 

STATEMENT  OF  RON  SILVER,  PRESmENT,  ACTORS'  EQUITY 
ASSOCIATION;  ALSO  ON  BEHALF  OF  SCREEN  ACTORS  GUILD, 
AND  AMERICAN  FEDERATION  OF  TELEVISION  &  RADIO  ART- 
ISTS; ACCOMPANIED  BY  MARK  J.  WEINSTEIN,  COUNSEL 

Mr.  Silver.  Thank  you  very  much,  Mr.  Chairman.  Before  I  begin 
I  would  like  to  introduce  counsel  here,  Mark  Weinstein. 


1122 

Mr.  Weinstein.  Good  morning,  Mr.  Chairman,  members  of  the 
committee.  Thank  you  for  allowing  me  to  speak  today.  I  am  Mark 
Weinstein.  I  am  a  partner  in  Squadron,  Ellenoff,  Plesent,  Sheinfeld 
and  Sorkin. 

We  are  tax  counsel  to  several  performing  artists  unions,  which 
include  the  Screen  Actors  Guild,  the  American  Federation  of  Tele- 
vision &  Radio  Artists,  Actors'  Equity  Association,  and  the  Writers 
Guild.  As  you  know,  seated  to  my  left  is  Mr,  Silver,  a  distinguished 
performer  who  is  currently  the  president  of  Actors'  Equity  Associa- 
tion. Mr.  Silver  will  speak  on  behalf  of  the  performing  artists 
unions  in  support  of  a  proposal  to  increase  the  adjusted  gpross  in- 
come ceiling  of  section  62(a)(2)  of  the  Internal  Revenue  Code  from 
$16,000  to  $32,000. 

We  encourage  Congress  to  further  promote  a  policy  of  tax  fair- 
ness to  the  lesser  known  struggling  actors,  musicians,  and  writers. 
These  persons  were  the  intended  beneficiaries  of  legislation  that 
was  enacted  in  1986.  In  a  nutshell,  Mr.  Chairman,  the  1986  tax 
provision,  although  enacted  with  good  intention,  simply  does  not 
work.  We  are  asking  you  to  correct  this  result. 

Mr.  Silver. 

Mr.  Silver.  Thank  you.  Mr.  Chairman,  my  children  went  back 
to  school  today.  It  was  their  first  day  in  school.  You  are  back  at 
work.  I  am  going  back  to  New  York  after  this  testimony.  I  wish  us 
all  well  this  year. 

On  a  personal  note  to  you,  sir,  being  a  distinguished  alumnus  of 
DeWitt  Clinton  High  School,  I  will  have  you  know  that  I  went  to 
Stuyvesant  High  Soiool  and  for  the  last  46  years  you  have  defeated 
us  in  football.  We  have  never  been  victorious  over  you,  so  I  trust 
that  you  will  show  us  some  kindness  today  in  our  presentation. 

Chairman  Rangel.  You  have  always  exceeded  in  the  arts  and 
sciences,  so  I  yield  to  you  in  that  field. 

Mr.  Silver.  Thank  you,  sir.  I  don't  have  to  tell  you,  you  know 
it  better  than  I  do,  that  when  legislation  is  enacted  sometimes  the 
original  legislative  intent  might  not  be  effected  and  revisiting  the 
original  legislation  and  amending  it  might  be  required  to  achieve 
the  bill's  original  intentions.  Justice  Scalia  notwithstanding,  I  be- 
lieve you  still  believe  that. 

I  am  not  here  on  behalf  of  Steven  Spielberg  or  Madonna,  Arnold 
Schwarzenegger,  Sylvester  Stallone,  Jack  Nicholson,  et  cetera. 
Congress  has  already  provided  all  the  protection  successful  people 
in  mj^  business  already  need.  They  can  form  personal  service  cor- 
porations and  they  can  incorporate  themselves  and  deduct  all  their 
business  expenses  above  the  line. 

I  am  here  on  behalf  of  the  vast  majority  of  the  members  of  the 
Actors'  Equity  Association,  the  Screen  Actors  Guild,  and  the  Amer- 
ican Federation  of  Television  &  Radio  Artists,  the  vast  majority 
who  are  not  able  to  deduct  their  legitimate  business  expenses.  And 
while  we  asked  for  this  change  in  1986,  we  are  partially  at  fault 
for  not  understanding  some  of  the  consequences,  and  it  has  had  a 
devastating  impact,  not  only  on  the  struggling  actors  and  musi- 
cians and  performing  artists,  but  on  the  mid-level  professionals. 

People  outside  of  our  business  tend  to  see  it  as  black  and  white. 
There  are  young  kids  struggling  to  get  into  the  business,  and  then 
there  are  very  successful  people  who  work  in  movies  and  on  stage 


1123 

and  in  TV.  The  reality  of  our  business  is  that  most  people  are  mid- 
level  professionals  that  are  eking  out  a  living  or  earning  a  basic 
subsistence,  married  and  with  children,  and  it  is  those  people  who 
I  am  speaking  on  behalf 

The  current  law,  section  62(a)(2),  which  amended  the  code  in 
1986,  was  part  of  that  Tax  Reform  Act.  The  reason  for  the  change 
then  was  to  allow  the  lesser  known  struggling  performers  and  mu- 
sicians to  deduct  their  job  search  and  other  business  expenses  such 
as  agent  and  other  representational  fees,  which  generally  run  10 
percent  or  more  and  costs  for  a  video  or  audiotapes. 

Now,  the  law  actually  stipulated  that  a  qualified  performing  art- 
ist was  permitted  to  deduct  their  allowable  section  162  expenses 
above  the  line.  To  qualify  for  a  QPA,  a  qualified  performing  artist, 
you  had  to  meet  three  criteria.  You  had  to  have  more  than  one  em- 
ployer in  the  performing  arts,  you  had  to  incur  allowable  section 
162  expenses  as  an  employee  in  connection  with  such  services  in 
the  performing  arts  at  an  amount  exceeding  10  percent  of  gross  in- 
come from  those  services,  and  you  did  not  have  an  adjusted  gross 
income  as  determined  before  deducting  the  expenses  in  excess  of 
$16,000. 

Now,  what  was  wrong  with  this  was  the  law  did  not  provide  the 
relief  to  the  intended  beneficiaries;  that  is,  the  lesser  known  strug- 
gling artists  and  the  mid-level  professionals.  The  facts  are  these: 
Based  on  1992  earnings,  less  than  5  percent  of  performing  artists 
fell  under  the  $16,000  adjusted  gross  ceiling. 

Now,  that  sounds  pretty  good.  That  means  95  percent  of  them 
earned  more  than  that,  so  what  am  I  here  complaining  about  and 
asking  you  here  to  do?  Unfortunately  about  92  percent  of  perform- 
ing artists  earn  less  than  $15,000  from  their  craft.  Now,  in  order 
to  earn  a  living  wage,  most  of  the  people  I  know  in  this  business 
have  to  supplement  their  income  by  doing  something  else.  They  are 
waiters,  they  are  lawyers,  they  are  carpenters,  they  are  doing  work 
that  will  allow  them  to  pursue  their  crafl  while  also  enabling  them 
to  earn  a  living  wage  to  support  themselves  and  their  families. 

Also  in  1987  unemployment  insurance  became  taxable,  so  if  you 
earned  $15,000  and  collected  $2,000  UIB  that  would  knock  you  out 
of  the  box  and  put  you  over  the  limit  as  well.  What  I  have  here, 
and  I  would  like  to  submit  for  the  record  in  addition  to  the  written 
record,  are  two  tax  forms.  One  is  computed  under  the  1985  rules 
and  one  is  computed  under  the  current  rules,  and  if  you  assume 
that  the  taxpayer  is  a  performer  working  in  a  regional  theater, 
housing  is  usually  provided  for  them,  but  other  expenses,  including 
meals  are  paid  out  of  the  performer's  take-home  pay. 

If  the  performer's  weekly  salary  is  $425,  which  is  a  minimum  in 
a  regional  theater,  and  she  is  employed  for  40  weeks,  she  has 
earned  $17,000.  If  the  performer  spends  $15  a  day  on  food,  which 
is  not  terribly  generous  and  all  the  other  expenses  for  laundry, 
whatever,  total  $50 — that  is  about  a  $4,250  deduction.  If  she  has 
received  $2,000  in  unemployment  compensation,  under  the  reform 
act  intended  to  benefit  these  people,  the  performer  would  have  had 
a  Federal  tax  liabihty  of  $1,234.  She  was  entitled  to  deduct  all  her 
travel  expenses,  even  though  she  didn't  file  a  schedule  A  at  that 
point.  She  was  also  entitled  to  the  standard  deduction. 


1124 

Now,  under  the  current  postreform  rules,  the  performer's  tax  li- 
ability is  $1,969,  a  difference  of  $735  or  a  percentage  increase  of 
over  59  percent.  This  did  not  have  the  consequences  that  we  antici- 
pated. Now,  why  change  the  law  to  accomplish  what  was  originally 
intended?  Performing  artists  as  employees  continue  to  incur  costs 
associated  with  employment  that  strongly  resemble  costs  that  are 
incurred  by  independent  contractors,  not  employees,  and  I  can  give 
you  a  pretty  good  example  of  this  from  my  own  career  and  when 
I  started  out. 

If  I  earned  $1,000,  I  had  to  pay  $100,  10  percent  commission,  to 
an  agent.  You  have  no  choice.  Every  actor,  every  performer  has  an 
agent  in  the  business.  They  are  essentially  an  employment  agency. 
Now,  most  employers  pick  up  the  employment  agency  fee.  Actors 
who  are  currently  looking  for  work  over  and  over  and  over  again 
consistently  pay  this  employment  fee  of  10  percent.  In  order  to  con- 
tinue working  as  an  actor  where  I  earned  $1,000,  I  had  to  get  pho- 
tographs of  myself,  I  had  to  get  audiotapes,  videotapes,  I  had  to — 
in  addition  to  obvious  expenses  of  keeping  myself  fit  and  this  and 
that,  but  that  is  really  secondary.  There  were  necessary  expenses 
that  exceeded  30,  40  percent  of  my  income. 

Now,  why  we  are  asking  for  some  correction  of  that  1986  bill  is 
that  absent  a  change,  the  tax  burden  is  not  allocated  equally  to 
persons  of  the  same  dollar  gross  income.  If  you  are  a  ditchdigger 
and  you  earn  $16,000  and  most  of  your  expenses  are  paid  by  your 
employer,  you  have  an  aftertax  cash  income  of  $14,481.  Whereas 
a  performing  artist  earning  that  same  $16,000  and  incurring  typi- 
cal employee  expenses  of  20,  25  percent  of  earnings  or  $4,000  has 
an  aftertax  income  of  $10,000. 

In  1986  there  was  an  interesting  colloquy  on  the  floor  of  the  Sen- 
ate when  then  Senator  Wilson  spoke  very  eloquently  for  the  unique 
situation  of  artists  and  why  they  should  be  treated  perhaps  spe- 
cially in  this  area,  and  he  stated,  and  I  am  not  quoting  him  ver- 
batim now,  but  I  am  paraphrasing  him,  that  levying  a  tax  on  in- 
come, not  on  gross  receipts  is  a  concept  recognized  in  the  tax  treat- 
ments of  businesses,  corporate  or  not,  by  allowing  deductions  for 
ordinary  and  necessary  expenses  that  help  generate  income. 

If  an  employer  covered  such  expenses,  they  would  be  deductible 
to  the  employer  for  income  tax  purposes.  The  denial  of  deductions 
for  expenses  that  truly  serve  to  generate  income  is  not  simply  bad 
tax  policy,  it  is  not  fair:  Deductions  are  not  a  loophole.  Deductibil- 
ity of  legitimate  employee  expenses  ensures  that  our  Federal  in- 
come tax  does  not  become  a  gross  receipts  tax.  So  respectfully,  our 
proposal  would  be  that  if  you  could  see  your  way  clear  to  increase 
the  earnings  ceiling  to  $36,000,  indexed  for  inflation,  only  income 
earned  from  the  performing  artist  craft  be  counted  in  the  earning 
ceiling  and  the  earning  ceiling  should  be  tested  individually  for 
married  taxpayers.  If  two  people  are  married  and  they  are  both  ac- 
tors or  musicians  or  performing  artists  of  any  kind,  we  really  need 
an  individually  tested  ceiling  for  both. 

I  would  be  happy  to  answer  any  questions.  I  don't  want  to  take 
more  of  the  committee's  time. 

[The  prepared  statement  and  attachments  follow:] 


1125 


MEMORANDUM 


August  31,   1993 


PROPOSAL  ON  BEHALF  OF  PERFORMING  ARTISTS 
FOR  U.S.  TAX  LEGISLATION 


Films,  television  and  radio  shows,  theatrical  performances,  musical 
concerts  and  videos  are  among  the  nation's  most  valuable  trade  assets.  The 
works  created  by  United  States  filmmakers,  performers,  musicians  and 
technicians  are  dominant  in  virtually  every  market  on  every  continent  around  the 
world. 

American  films,  shows  and  concerts  are  the  best  in  the  world  because  of 
the  expertise  that  resides  in  America.  These  fine  artists  are  hardworking 
persons  who,  unfortunately,  currently  bear  a  disproportionately  greater  tax 
burden  than  workers  in  other  crafts.  Current  United  States  tax  policy 
inappropriately  penalizes  the  performing  artist  who,  of  necessity,  must  contend 
with  irregular  employment  patterns.  The  criteria  of  equity  and  fairness  in  the 
implementation  of  a  tax  structure  "demands  that  the  income-tax  burden  should  as 
far  as  possible  apply  equally  to  persons  of  the  same  dollar  income."' 

Performing  artists^  contribute  to  one  of  the  nation's  largest  export 
commodities  -  entertainment;  an  industry  that  returns  to  this  country  some  $4 
billion  in  surplus  balance  of  trade.  Most  other  industries  do  not  yield  such 
favorable  trade  balances  and  do  not  contribute  as  much  to  the  Gross  Domestic 
Product;  yet  employees  in  these  industries  do  not  suffer  the  tax  burdens  borne 
by  the  performing  artist  under  the  Internal  Revenue  Code. 

ACCORDINGLY.  THE  SCREEN  ACTORS  GUILD  ("SAG").  THE  AMERICAN  FEDERATION  OF 
TELEVISION  &  RADIO  ARTISTS  ("AFTRA')  AND  ACTORS'  EQUITY  ASSOCIATION  ("AEA"),  FOR 
THEMSELVES  AND  ON  BEHALF  OF  OTHER  UNIONS  REPRESENTING  PERFORMING  ARTISTS. 
RESPECTFULLY  REQUEST  THAT  CONGRESS  ENACT  LEGISLATION  TO  EXPAND  THE  APPLICATION 
OF  INTERNAL  REVENUE  CODE  SECTION  62(a)(2)  TO  MAINTAIN  PARITY  IN  TAX  TREATMENT 
BETWEEN  PERFORMING  ARTISTS  AND  OTHER  EMPLOYEES. 


CURRENT  LAW 

The  Tax  Reform  Act  of  1986  (Public  Law  99-514)  amended  the  Internal 
Revenue  Code  (the  "Code")  to  provide  an  actor  or  other  individual  who  performs 
service  in  the  performing  arts  (a  "performing  artist")  an  above-the-line 
deduction  for  his  or  her  employee  business  expenses  (allowable  under  section  162 
of  the  Code)  during  a  year  if  the  performing  artist  for  that  year  (1)  had  more 
than  one  employer  (excluding  any  nominal  employer)  in  the  performing  arts,  (2) 
incurred  allowable  Section  162  expenses  as  an  employee  in  connection  with  such 
services  in  the  performing  arts  in  an  amount  exceeding  10  percent  of  the 
individual's  gross  income  from  such  services,  and  (3)  did  not  have  adjusted 
gross  income,  as  determined  before  deducting  such  expenses,  exceeding  $16,000. 

In  the  six  plus  years  this  amendment  has  been  effective,  the  statute  has 
not,  in  practice,  accomplished  its  objective  of  providing  performing  artists 
parity  of  tax  treatment  with  that  accorded  to  other  laborers.^ 

The  $16,000  adjusted  gross  income  ceiling  of  Section  62(b)  has  virtually 
eliminated  the  intended  tax  benefit.  Based  on  1992  earnings  and  tax  information 


'  Surrey,  The  Congress  and  the  Tax  Lobbyist  -  How  Special  Tax  Provisions  Get 
Enacted,   70  Harv.L.Rev  1145  (1957). 

^    This  term  includes  both  persons  "in  front  of"  and  "behind"  the  camera. 

^  See  the  colloquy  among  former  Senator  Wilson  and  Senators  Packwood  and 
Bradley,  attached  hereto  as  Exhibit  A,  for  a  discussion  of  the  reasons  for  the 
amendment. 


1126 


for  SAG,  AFTRA  and  AEA  members,  less  than  5%  of  performing  artists  fell  under 
the  adjusted  gross  income  ceiling.  More  than  95%  of  the  performing  artists  had 
adjusted  gross  incomes  in  excess  of  the  $16,000  ceiling,  yet  their  earnings  from 
the  performing  arts  was  far  below  the  ceiling.*  Thus,  in  order  to  earn  a 
living  wage  performing  artists  must  supplement  their  performing  arts  income  with 
outside  earnings.  The  $16,000  income  ceiling  penalizes  the  performing  artist 
whose  earnings  from  all  sources  puts  him  or  her  above  the  ceiling.  This  is  an 
inappropriate  result  and  demonstrates  the  need  for  an  amendment  to  Section 
62(a)(2). 

BACKGROUND 

The  performing  artist,  while  generally  treated  as  an  employee  under  the 
income  tax  law,  incurs  costs  associated  with  his  or  her  employment  that  strongly 
resemble  costs  typically  incurred  by  an  independent  contractor.  This  situation 
arises  because  of  the  inherently  short-term  nature  of  any  particular  employment 
opportunity.  While  the  average  American  worker  will  stay  at  one  job  for  several 
or  more  years,  a  performing  artist's  term  of  employment  at  any  particular  job 
will  rarely  exceed  a  month  or  even  a  day.  Due  to  the  short-term  nature  of  his 
or  her  employment,  the  performing  artist  incurs  job  search  expenses  of  a  type, 
frequency  and  amount  that  are  not  generally  incurred  by  workers  in  other 
industries.  For  example,  an  actor  will  incur  expenses  for  travel  to  and  from 
various  audition  sites,  resumes,  video  or  audio  tapes,  photographic  portfolios, 
and  gratuities  to  theater  doormen. 

Perhaps  the  most  significant  and  unique  costs  incurred  by  a  performing 
artist  are  agent  and  other  representational  fees,  which  usually  are  10%  or  more 
of  the  artist's  gross  income.  No  other  class  of  employee  is  burdened  with  such 
a  fee.  In  other  industries  the  employer  pays  any  employment  agency  fee  and  gets 
the  benefit  of  a  tax  deduction  without  limitation. 

Additionally,  performing  artists  incur  other  out-of-pocket  expenses  that 
further  reduce  their  true  employment  income.  These  include  costs  of 
photographs,  musical  instruments,  costumes,  publicists  and  practice  facilities, 
as  well  as  costs  for  maintaining  physical  condition  and  personal  appearance. 
It  is  the  rare  instance  in  other  lines  of  employment  that  such  expenses  directly 
effect  a  person's  employment  opportunities  and  success. 

PROPOSAL 

To  fairly  allocate  the  income  tax  burden  to  performing  artists,  we 
respectfully  request  that  Congress  adopt  the  following  proposal: 

The  language  of  Section  62(b)(1)(C)  of  the  Code  be  amended  to  read  in  its 
entirety  as  follows: 

the  adjusted  gross  income  earned  by  such  individual  in 
the  performing  arts  for  the  taxable  year  (determined 
without  regard  to  subsection  (a)(2)(B))  does  not  exceed 
$36,000^  (increased  by  an  amount  equal  to  $36,000, 
multiplied  by  the  cost-of-living  adjustment  determined 
under  Section  1(f)(3)  for  the  calendar  year  in  which 
the  taxable  year  begins  (but  substituting  "calendar 
year  1992"  for  "calendar  year  1989"  in  subparagraph  (B) 
thereof));" 

Such  amendment  would  properly  reflect  the  intent  of  the  1986  changes  by 
establishing  a  clearer  relationship  between  the  earnings  of  a  performing  artist 
in  the  performing  arts  and  the  tax  burden  that  should  be  levied  on  such 
earnings.  A  performing  artist  should  not  suffer  a  tax  penalty  because  he  or  she 
must  supplement  his  or  her  income  with  income  from  odd  jobs  and  unemployment 


*  This  information  was  obtained  from  the  1992  federal  income  tax  returns  of 
a  representative  sample  of  performing  artists  and  from  earnings  reports 
maintained  by  SAG,  AFTRA  and  AEA.  Attached  hereto  as  Exhibits  B  through  D  are 
charts  which  show  an  analysis  of  1992  earnings  by  performing  artists. 

'  This  amounts  represents  the  median  earnings  of  families  in  the  United 
States  for  1992  as  provided  by  the  Bureau  of  Labor  Statistics. 


1127 


insurance  benefits  in  order  to  support  self  and  family.  Earnings  from  outside 
the  performing  arts  bear  no  relationship  to  the  performing  artist's  expenses 
incurred  in  the  performing  arts.  Such  outside  earnings  should  not  restrict  a 
performing  artist's  ability  to  deduct  allowable  business  expenses. 

The  proposed  amendment  establishes  a  ceiling  amount  which  would  provide 
a  living  wage  from  the  performing  arts  for  the  "lesser  known,  struggling  actors 
and  musicians,"*  which  was  the  intention  of  the  1986  legislation.  Such  a 
ceiling  would  not  benefit  any  of  the  "better  known"  performing  artists. 

CONCLUSION 

The  proposal  set  forth  herein  should  be  adopted  in  order  to  provide  equity 
and  fairness  to  performing  artists  who  necessarily  incur  business  expenses  of 
a  type,  frequency  and  amount  not  incurred  by  other  employees.  Otherwise  the 
performing  artist  will  continue  to  bear  a  higher  income  tax  burden  on  his  or  her 
true  economic  income. 


*     132  Cong.  Rec.  S  8132  (June  23,  1986).  See  Exhibit  A  for  the  complete 
text  of  former  Senator  Wilson's  statement. 


1128 

EXHIBIT  A 

132  Cong  Rec  5  8132  Monday,  June  23,  1986 

The  PRESIDING  OFFICER.  The  pending  business  is  the  committee 
substitute. 

Mr.  WILSON  addressed  the  Chair. 

The  PRESIDING  OFFICER.  The  Senator  from  California  has  the  floor. 

AMENDMENT  NO.  2157 

(Purpose:  To  allow  for  deduction  of  certain  expenses  related  to  an 
individual's  trade  or  business) 

Mr.  WILSON.  Mr.  President,  as  the  votes  on  the  Senate  floor  have  made 
clear,  there  is  broad  support  for  the  tax  reform  bill  as  it  was  reported  by  the 
Finance  Committee.  It  is  a  bill  that  I  enthusiastically  support,  and  it  is  a 
bill  that  I  hope  to  see  enacted  --  enacted  in  a  form  very  close  to  that  of  the 
bill  now  before  us. 

But  one  issue  I  believe  is  dealt  with  better  in  the  House  bill  is  the 
treatment  of  miscellaneous  business  expenses. 

Mr.  President,  while  there  are  many  commendable  reforms  to  be  undertaken 
as  part  of  tax  reform,  we  must  remember  that  we  are  levying  a  tax  on  income,  not 
gross  receipts. 

This  concept  is  well  recognized  by  the  tax  treatment  of  businesses,  be 
they  in  corporate  form  or  not,  by  allowing  deductions  for  ordinary  and  necessary 
expenses  that  help  generate  income.  A  broad  array  of  deductions  are  allowed, 
from  advertising  expenses,  association  dues,  and  costs  of  equipment  to  hand 
tools  and  typewriter  ribbons. 

Yet,  deductions  for  these  same  expenses  would  be  denied  by  the  Senate's 
tax  bill.  No  longer  would  carpenters  be  able  to  deduct  the  cost  of  tools  or  a 
police  officer  deduct  the  cost  of  uniforms.  Furthermore,  if  an  individual  loses 
his  or  her  job  and  incurs  significant  expenses  to  find  a  new  ons,  none  of  these 
expenses  would  be  deductible.  I  find  this  last  change  particularly  objectionable 
when  considering  all  of  the  money  we  spend  through  direct  Federal  payment  for 
unemployment  coverage  or  trade  adjustment  assistance  in  order  to  help  the 
unemployed. 

It  should  also  be  noted  that  if  an  employer  covered  such  expenses,  they 
would  be  deductible  by  the  employer  for  income  tax  purposes  --  and  they  would 
not  be  imputed  as  income  to  the  employees. 

Mr.  President,  denial  of  deductions  for  expenses  that  truly  serve  to 
generate  income  is  not  simply  bad  tax  policy,  it  is  not  fair. 

In  this  regard,  I  believe  that  the  House  took  the  proper  route  by  allowing 
for  the  continued  deductibility  of  these  employee  expenses,  while  imposing  a  1- 
percent  floor.  The  1-percent  floor  is  a  reasonable  threshold  that  allows  us  to 
lower  rates  while  imposing  a  relatively  small  burden  on  individual  taxpayers. 
Furthermore,  it  removes  a  significant  auditing  problem  for  minor  expenses  that 
may  be  only  tangentially  related  to  the  taxpayer's  employment,  thereby  reducing 
compliance  costs.  Unfortunately,  the  Senate  bill,  while  also  imposing  a 
1-percent  floor,  eliminates  the  deductibility  of  most  types  of  employee 
expenses.  Mr.  President,  elimination  of  the  employee  expense  deduction  is  not 
supportable  as  a  means  of  lowering  tax  rates,  for  the  deduction  is  not  a 
loophole,  nor  is  it  an  incentive  that  furthers  some  governmental  policy  that  we 
can  no  longer  afford  if  we  are  to  have  lower  tax  rates.  Rather,  deductibility 
of  legitimate  employee  expenses  ensures  that  our  Federal  income  tax  does  not 
become  a  gross  receipts  tax. 

Mr.  President,  in  order  to  show  the  impact  that  the  Senate  bill's 
treatment  of  employee  expenses  would  have,  I  want  to  highlight  one  type  of 
deduction  that  will  no  longer  be  allowed  and  its  effect  on  one  group  of 
employees  performing  artists. 

The  one  aspect  of  the  bill  that  I  am  referring  to  is  the  repeal  of  the 
deduction  for  expenses  incurred  to  search  for  new  employment.  This  change  will 


1129 


place  an  additional  burden  on  someone  looking  to  change  jobs,  and  will  be 
particularly  severe  for  anyone  who  is  unemployed. 

Within  the  group  of  unemployed,  the  change  envisioned  by  the  Senate  tax 
bill  could  have  a  devastating  impact  on  people  in  the  motion  picture,  music,  and 
television  industries,  as  well  as  those  who  ply  their  trade  on  the  stage  or  as 
models,  for  by  the  very  nature  of  their  profession,  their  costs  for  finding  new 
employment  recur  over  and  over  again  in  a  continual  fashion. 

That  is  why  I  have  prepared  an  amendment  to  the  tax  bill  in  order  to 
restore  the  deductibility  of  agency  fees  and  related  expenses  that  are  incurred 
for  the  purpose  of  finding  new  employment  of  limited  duration. 

Mr.  President,  what  makes  the  impact  disproportionately  severe  on  actors, 
producers,  directors,  musicians,  and  others  in  the  entertainment  industry  is 
that  such  individuals  are  constantly  looking  for  new  work,  with  the  assistance 
of  agents  and  others,  no  matter  how  talented  they  may  be.  Employment  is  always 
temporary,  for  regardless  of  how  successful  a  movie  or  television  show  you 
appear  on,  regardless  of  how  good  a  musician  you  are,  and  regardless  of  how 
successful  a  show  you  may  be  acting  in,  it  is  highly  unusual  that  the  length  of 
employment  will  extend  as  long  as  1  year.  Indeed,  the  employment  more  often  that 
not  lasts  only  a  few  months,  a  few  weeks,  or  even  1  day. 

Now,  the  bill  does  not  affect  all  similarly  situated  people  in  the  same 
fashion.  It  hurts  only  those  in  the  entertainment  industry  who  are  at  the  bottom 
of  the  ladder.  Those  at  the  top  are  unaffected  by  this  one  particular  change. 

The  reason  for  the  disparate  treatment  is  that  the  big-name  actors, 
musicians,  and  others,  have  most  often  formed  personal  service  corporations. 
And,  like  other  corporations,  the  cost  of  finding  new  business  is  an  ordinary 
and  necessary  business  expense  deductible  by  them.  Or  such  people  may  perform 
their  work  as  independent  contractors.  And  like  other  independent  contractors, 
the  cost  of  acquiring  new  work  is  deductible  to  them  as  independent  contractors. 

The  lesser  known,  struggling  actors  and  musicians  will,  when  they  can 
find  work,  be  hired  as  employees  --  and  their  agent  and  other  representational 
fees,  which  run  10  percent  or  more,  will  not  be  deductible.  Also  nondeductible 
will  be  the  costs  of  their  resumes,  which,  because  they  often  include  video  or 
audio  tapes  as  well  as  photographic  portfolios,  can  cost  hundreds  of  dollars. 

Unfortunately,  this  group  of  lesser  knowns  constitute  the  vast  majority 
in  the  entertainment  business.  According  to  the  New  York  Times,  of  the  50 
percent  of  the  members  of  Actors  Equity  that  work  during  the  year,  half  earn 
less  than  $4,500.  And  at  the  Screen  Actors  Guild,  70  percent  earn  less  than 
$2,000  per  year  at  their  craft.  At  the  American  Federation  of  Television  and 
Radio  Artists,  the  picture  is  somewhat  brighter,  but  even  there  the  median  pay 
is  $11,000. 

I  do  not  know  what  the  revenue  impact  would  be  of  a  remedial  change  to  the 
tax  bill  that  would  fix  this  problem.  But  I  do  know  that  leaving  the  bill  in 
its  present  state  would  unfairly  penalize  those  struggling  for  success  as 
entertainers,  for,  by  denying  them  deductions  for  legitimate  job-search  costs, 
the  kind  that  they  continually  must  incur,  it  would  make  it  even  more  difficult 
for  them  to  find  employment. 

I  ask  unanimous  consent  that  a  copy  of  this  amendment  No.  2157  be 
printed  in  the  Record. 

There  being  no  objection,  the  amendment  was  ordered  to  be  printed 
In  the  Record,  as  follows: 

On  page  1413  of  the  amendment,  strike  out  line  24  and  insert  in  lieu 
thereof  the  following: 

employer,  and 

"(4)  Expenses  for  obtaining  employment  of  limited  duration.  --  The 
deductions  allowed  by  part  VI  (sec.  161  and  following)  which  consist  of  agency 
fees  and  other  related  expenses  directly  related  to  the  seeking  of  employment 
of  limited  duration  in  the  taxpayer's  present  trade  or  business,  under 
regulations  to  be  prescribed  by  the  Secretary." 


1130 


Mr.  WILSON.  Mr.  President,  I  have  a  concern  as  I  have  stated  and  I 
know  that  that  concern  is  deeply  shared  by  my  colleague,  the  senior  Senator  from 
New  Jersey,  and  I  would  be  pleased  to  inquire  of  him  at  this  time  his  thoughts 
on  this  issue. 

Mr.  BRADLEY.  Mr.  President,  let  me  commend  the  distinguished  Senator 
from  California  for  raising  what  I  consider  to  be  a  short  coming  in  the  Finance 
Committee  bill.  Existing  law  allows  employees  to  deduct  ordinary  and  necessary 
expenses  incurred  in  performing  their  jobs. 

The  Finance  Committee  bill,  recognizing  this  provision  has  been 
abused  and  has  also  imposed  burdensome  recordkeeping  requirements,  made  some 
changes  I  believe  that  went  too  far.  I  believe  the  bill  went  too  far  in  making 
draconian  changes  in  this  area. 

I  say  to  the  distinguished  Senator  from  California  who  I  know  is  extremely 
sensitive  to  the  area  that  the  amendment  relates  to,  which  is  the  performing 
arts,  that  the  issue  is  even  broader  than  he  has  defined  it.  It  is  true  that 
performing  artists  will  be  particularly  hard  hit  by  disallowances  of  deductions 
of  employee  business  expenses  but  it  is  not  just  agency  fees,  and  I  think  the 
Senator's  statement  laid  that  out. 

It  is  not  just  agency  fees  that  we  are  talking  about  here  but  legitimate 
out-of-pocket  expenses  for  things  like  photographs,  musical  instruments, 
costumes,  publicists,  and  so  on,  that  are  legitimate  expenses  incurred  in 
producing  income  and  therefore  ought  to  be  deducted. 

I  would  say  to  the  Senator  that  although  performing  artists  are  an 
important  example  of  this,  a  very  important  example  of  this,  as  he  also 
correctly  pointed  out,  there  are  many  other  professions  that  would  be  affected 
by  a  draconian  provision  in  the  final  bill. 

Take,  for  example,  trades  people  like  carpenters  or  bricklayers,  or 
whatever.  They  have  to  furnish  their  own  tools  and  those  should  be  deductible. 
Expenses  of  those  employees  who  have  to  buy  their  own  uniforms  in  order  to  get 
a  job  ought  to  be  deductible.  All  these  expenditures  are  legitimate  business 
costs.  If  they  exceed  1  percent  of  the  floor  they  should  be  deductible. 

Let  me  say  to  the  distinguished  Senator  from  California  that  I  share  his 
concern  and  I  support  what  he  is  trying  to  do,  and  I  hope  that  the  conference 
will  restore  the  deduction  for  all  employees. 

Mr.  WILSON.  Mr.  President,  I  thank  the  Senator  from  New  Jersey  for  his 
comment.  I  know  that  he  has  been  very  much  concerned  with  the  same  problem,  and 
I  know  that  it  is  his  purpose  to  work  for  the  elimination  of  this  problem  in  a 
way  that  is  fair  and  equitable  and  that  will  allow  those  employees,  who  have  the 
myriad  of  expenses  of  the  wide  range  that  he  has  described  and  that  I  have 
touched  on  in  my  own  statement,  to  find  some  relief. 

I  wonder  if  I  might  inquire  of  the  chairman  of  the  Finance  Committee,  whom 
I  know  has  been  eager  to  keep  the  bill  in  its  present  form  and  as  free  of 
amendments  as  possible,  whether  or  not  his  views  are  compatible  with  those 
expressed  by  the  Senator  from  New  Jersey  and  the  Senator  from  California.  I  know 
that  he,  too,  is  aware  of  the  problem. 

Mr.  PACKWOOD.  I  am.  I  talked  to  the  Senator  from  New  Jersey,  and  the 
Senator  from  California  was  good  enough  to  talk  to  me  before  he  started  his 
comments  tonight. 

I  am  sympathetic  to  the  problem.  I  think  it  is  one  that  should  be 
addressed  on  a  broader  scale  than  one  or  two  occupations  or  professions.  That 
is  obviously  an  issue  in  conference  that  we  will  consider. 

Mr.  WILSON.  I  thank  the  distinguished  chairman  of  the  Finance  Committee. 

Mr.  President,  based  on  the  colloquy  that  we  have  had,  it  is  not  my 
purpose  to  pursue  the  amendment  at  this  time.  I  am  reassured  by  the  expressions 
here  on  the  floor  of  a  recognition  that  this  problem  Is  one  that  needs  to  be 
dealt  with.  I  will  look  forward  to  the  action  of  the  conferees  to  bring  equity 
to  it. 


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1134 

Chairman  Rangel.  I  know  you  have  to  leave  and  you  will  be  ex- 
cused. We  will  present  whatever  questions  to  you — first  of  all,  you 
know  the  committee  and  the  Congress  are  very  supportive  of  strug- 
gling people.  We  know  how  difficult  it  is  to  break  through.  It  is 
equally  as  difficult  for  us  to  determine  who  is  serious  about  being 
in  the  business  and  who  is  serious  about  whatever  they  do. 

We  are  going  to  have  to  work  to  attempt  to  fine  tune  this,  and 
if  you  don't  have  the  answer  today  you  can  think  about  it,  because 
nobody  in  the  business  would  want  someone  getting  deductions 
that  they  don't  really  deserve  merely  because  they  declare  them- 
selves as  wanting  to  be  considered  a  performer. 

I  can  understand  your  audio  tapes  and  your  agent  fees  and 
things  like  that.  You  weren't  implying  that  meals  should  be  de- 
ducted in  that,  were  you? 

Mr.  Silver.  Yes.  I  was  kind  of  explicit  about  it  in  my  example. 
Perhaps  I  shouldn't  have  been.  But  when  you  are  on  the  road  for 
40  weeks,  you  often  don't  have  facilities  where  you  can  cook  for 
yourself  or  do  that.  We  have  just  got  even  the  provision  where 
housing  has  been  provided.  Often  not  all  your  travel  expenses  to 
get  to  the  job,  $15  a  day. 

Chairman  Rangel.  As  long  as  you  agree  that  this  has  to  be 
shown,  that  is  in  connection  with  working  in  the  arts. 

Mr.  Silver.  Absolutely.  It  should  be  connected  to  how  much 
money  is  actually  spent. 

Chairman  Rangel.  You  see  the  problem  that  can  be  presented. 

Mr.  Weinstein.  Yes.  I  have  two  comments  to  make,  one  with  re- 
spect to  your  concern  about  those  who  are  not  really  in  the  busi- 
ness. I  believe  the  hobby  loss  rules  currently  in  the  Internal  Reve- 
nue Code  take  care  of  that  problem. 

Two,  with  respect  to  meals  and  travel,  the  provision  would  only 
govern  those  expenses  that  are  allowable  deductions  under  section 
162,  meaning  if  the  artist  is  away  from  home  for  less  than  a  year 
doing  a  road  show  and  the  expenses  are  otherwise  allowable  under 
section  162,  those  would  be  within  the  coverage  of  this  provision 
currently  and  hopefully  as  extended. 

Chairman  Rangel.  Besides  the  items  already  mentioned,  what 
other  deductions  do  you  think  would  be  equitable  in  this  area? 

Mr.  Silver.  Any  expenses  incurred  to  allow  them  to  generate  in- 
come, pursue  their  crafts  and  continually  look  for  new  work,  be- 
cause employment  in  my  field  is  always  temporary.  When  you  fin- 
ish a  job,  you  don't  know  when  the  next  job  is  coming,  or  if  there 
will  be  one.  If  somebody  is  earning  $30,000  or  $35,000  in  their  cho- 
sen profession,  something  that  they  allegedly  love  to  do,  it  is  very 
unlikely  that  they  will  be  doing  another  job  to  generate  more  in- 
come. If  people  are  lucky  enough  to  earn — $36,000  is  the  median 
for  a  family  of  four — if  they  are  lucky  enough  to  earn  that,  very  few 
of  them  are  pursuing  other  work  to  supplement  their  income  unless 
they  want  to  live  a  certain  way  which  we  would  not  have  it  be  al- 
lowable. That  is  why  we  are  asking  for  that  figure  at  that  point. 

Chairman  Rangel.  Mr.  Hancock. 

Mr.  Hancock.  When  you  say  "in  the  business,"  can  that  be  meas- 
ured fairly  easily  by  the  amount  of  income? 

Mr.  Weinstein.  That  is  correct,  sir. 


1135 

Mr.  Hancock.  If  you  are  really  in  the  business,  you  will  have 
some  income  from  it.  I  don't  understand  what  you  mean  by 

Mr.  Weinstein.  The  hobby  loss  rules  deny  deductions  for  ex- 
penses incurred  for  someone  who  is  not  really  in  the  business,  but 
instead  is  pursuing  a  hobby.  If  you  are  committed  to  being  a  per- 
forming artist,  there  is  always  an  opportunity  of  earning  $1,000, 
$10,000.  Given  the  commitment  of  time  and  effort  and  expenses 
that  the  performing  artist  incurs,  that  would  be  good  evidence  of 
whether  he  or  she  is  really  in  the  business. 

Mr.  Hancock.  Are  you  talking  about  being  able  to  deduct  ex- 
penses beyond  the  amount  of  income  from  other  sources?  That  is 
what  I  don't  understand.  You  can't  deduct  expenses  from  nothing, 
can  you? 

Mr.  Weinstein.  If  you  are  not  subject  to  the  hobby  loss  rule,  that 
means  all  expenses  are  allowable.  If  your  expenses  exceed  income 
and  your  total  income  threshold  is  under  $16,000,  under  current 
law  you  would  get  full  benefit  for  the  deductibility  of  your  allow- 
able expenses. 

Mr.  Hancock.  Thank  you. 

Chairman  Rangel.  Do  other  members  have  questions?  Mr. 
Kopetski. 

Mr.  Kopetski.  It  is  not  clear  if  nonperforming  art  income  is  in- 
cluded in  that  $16,000  ceiling  or  not. 

Mr.  Weinstein.  The  current  law  does  not  differentiate  between 
income  from  the  performing  arts  and  income  from  outside  the  per- 
forming arts. 

Mr.  Kopetski.  I  assume  that  new  performing  artists  are  not  tak- 
ing advantage  by  either  organizing  as  a  corporation,  a  personal  cor- 
poration, because  it  is  just  not  worth  filing  the  papers  and  spend- 
ing the  money  to  become  incorporated,  is  that  the  case? 

Mr.  Silver.  I  think  most  business  managers  would  tell  you  that 
that  only  pays  to  do  at  a  certain  income  level.  People  earning  so 
few  dollars,  it  probably  doesn't  pay  for  them  to  do  that. 

Mr.  Kopetski.  The  Tax  Code  requires  that  they  be  employees 
rather  than  declare  themselves  an  independent  contractor,  Thev 
would  not  meet  the  test  of  an  independent  contractor  even  thougn 
they  are  working  a  day  here,  maybe  a  week  there? 

Mr.  Silver.  One  of  the  mistakes  we  made  is  that  when  we  said 
"had  more  than  one  employer,"  we  didn't  take  into  account  where 
somebody  works  at  a  theater  in  Los  Angeles  or  Chicago  and  are 
employed  for  the  season,  and  are  lucky  to  be  so  employed,  and  they 
work  for  40  weeks,  don't  work  the  other  12  weeks,  and  they  have 
only  had  one  employer.  There  were  a  couple  of  things  that  we  were 
remiss  in  not  bringing  to  your  attention  in  1986. 

Mr.  Kopetski.  The  one  employer  would  be  stricken  from  the 
code — ^you  are  going  to  keep  the  one  employer  exemption? 

Mr.  Silver.  It  is  three-pronged.  To  qualify  as  a  performing  artist 
you  had  to  have  more  than  one  employer  in  the  performing  arts  be- 
cause we  assume  that  is  the  nature  of  the  business  everybody  does. 
But  we  didn't  take  into  account  some  people  who  are  employed  on 
a  long-term  basis  only  having  one  employer. 

Mr.  Kopetski.  Do  you  think  we  should  address  that  by  a  26- 
weeks-of-the-year  type?  Is  that  something  that  is  common,  in  other 
words,  in  the  theater? 


1136 

Mr.  Silver.  Yes.  We  have  a  lot  of  actors  who  are  employed  by 
one  theater  for  the  season  and  don't  find  employment  for  the  other 
20  weeks  they  are  not  working. 

Mr.  KOPETSKI.  Perhaps  we  should  try  to  address  that  issue  as 
well,  Mr.  Chairman. 

Oregon  has  a  growing  film  industry,  and  also  we  have  a  lot  of 
writers  living  there  because  of  our  great  quality  of  life  there.  I  won- 
der if  that  is  iust  my  impression,  or  is  it  true  that  with  airplanes 
and  faxes  and  modems  today  that  people  aren't  necessarily  living 
just  in  New  York  or  California  and  involved  in  the  performing  arts 
industry,  and  that  there  may  be  different  kinds  of  deductions  today 
if  they  are  a  screenwriter  or  playwrite,  et  cetera? 

Mr.  Silver.  That  is  correct.  Most  of  the  people  I  know,  if  they 
had  the  option,  would  probably  live  in  Oregon. 

Mr.  KOPETSKI.  New  York  is  a  nice  place  to  visit. 

Mr.  Silver.  I  like  it. 

Mr.  KOPETSKI.  Thank  you,  Mr.  Chairman. 

Chairman  Rangel.  You  are  welcome  to  stay,  but  recognizing  that 
you  have  a  pressing  schedule  in  New  York  we  thank  you  for  your 
testimony. 

The  committee  is  anxious  to  work  with  you  to  make  certain  that 
where  applicable  as  relates  to  aspiring  artists  that  at  the  same 
time  we  can  distinguish  between  them  and  others  that  are  just 
doing  it  for  a  hobby.  Thank  you  very  much. 

Mr.  Silver.  Thank  you  very  much,  Mr.  Chairman. 

Mr.  Weinstein.  Thank  you  very  much. 

Chairman  Rangel.  We  will  next  hear  from  Lawrence  CToole, 
president  and  CEO,  representing  the  New  England  Education  Loan 
Marketing  Corp. 

STATEMENT  OF  LAWRENCE  W.  OTOOLE,  PRESIDENT  AND 
CHIEF  EXECUTIVE  OFFICER,  NEW  ENGLAND  EDUCATION 
LOAN  MARKETING  CORP.,  AND  EDUCATION  FINANCE 
COUNCIL 

Mr.  O'Toole.  Thank  you  for  the  opportunity  to  appear  before  you 
today  in  support  of  H.R.  2603,  the  bill  introduced  by  Congressman 
Richard  Neal,  a  member  of  your  subcommittee,  and  Congressman 
Joseph  Moakley. 

My  name  is  Lawrence  O'Toole  and  I  am  the  president  and  chief 
executive  officer  of  Nellie  Mae.  I  am  before  you  on  behalf  of  Nellie 
Mae  and  on  behalf  of  the  Education  Finance  Council,  which  is  a 
trade  association  including  23  States  and  nonprofit  secondary  mar- 
kets involved  in  the  Federal  student  loan  programs,  thereby  rep- 
resenting virtually  all  of  the  nonprofit  student  loan  providers  and 
all  of  the  organizations  that  might  be  affected  by  this  bill,  if  en- 
acted. 

As  you  know,  the  recently  passed  Budget  Reconciliation  Act  in- 
cluded the  Student  Loan  Reform  Act  of  1993,  which  substantially 
altered  Federal  policy  in  this  area  and  the  28-year-old  public-pri- 
vate partnership  that  has  provided  student  loan  capital  for  genera- 
tions of  students. 

Under  this  legislation,  a  new  direct  Federal  loan  program  will  be 
phased  in  over  the  next  4  years,  increasing  to  a  level  of  60  percent 
of  total  national  student  loan  volume  in  1997-98.  Conversely,  the 


1137 

current  Federal  programs  are  expected  to  gradually  reduce  their 
volume  to  40  percent  of  new  loan  volume  by  that  time.  This  grad- 
ual and  halfway  solution  represents  a  compromise  between  the 
Clinton  administration's  desire  to  convert  fully  to  a  direct  loan  pro- 
gram and  those  in  Congress  who  were  concerned  that  abandoning 
the  current  system  without  first  testing  it  presented  too  great  a 
risk  to  the  delivery  of  funding  for  college  students. 

I  am  before  you  today  to  recommend  your  consideration  and  ap- 
proval of  Tax  Code  changes  which  we  believe  complement  these 
changes  in  Federal  education  policy,  but  which  fall  under  the  juris- 
diction of  the  Ways  and  Means  Committee  rather  than  the  Edu- 
cation Committees.  In  many  respects  these  complementary,  hand- 
in-glove  changes  mirror  the  policy  actions  taken  by  Congress  in 
1976  which  substantially  expanded  the  guaranteed  student  loan 
program  to  provide  access  to  student  loans  for  all  American  stu- 
dents and  concurrently  made  Tax  Code  changes  which  authorized 
the  creation  of  scholarship  funding  corporations,  organizations  such 
as  our  own. 

As  background,  there  are  21  scholarship  funding  corporations,  as 
defined  in  Tax  Code  section  150(d),  across  the  country  which  pro- 
vide secondary  market  support  and  services  in  the  Federal  student 
loan  programs.  Nellie  Mae  is  the  largest  of  these  and  the  fourth 
largest  student  loan  holder  in  the  country.  All  other  funding  schol- 
arship corporations  rank  among  the  100  largest  providers  of  stu- 
dent loan  capital  in  the  Federal  programs. 

We  have  been  and  can  continue  to  be  effective  stewards  of  Fed- 
eral policy,  providing  innovation  and  superior  administration  of 
these  programs.  Our  local  and  regional  focus  and  familiarity  with 
students,  colleges  and  lending  institutions  in  our  areas  contribute 
to  our  strong  performance.  As  an  example,  the  Department  of  Edu- 
cation recently  released  cohort  default  rates  by  a  lender,  and  in 
those  statistics  Nellie  Mae's  default  rate  was  less  than  half  of  that 
of  the  Student  Loan  Marketing  Association,  a  Gk)vemment-spon- 
sored  enterprise. 

Section  150(d)  of  the  code  defines  scholarship  funding  corpora- 
tions as  private  nonprofit  corporations  which  are  designated  by 
State  or  local  governments  and  the  activities  of  which  are  dedicated 
exclusively  to  the  Federal  student  loan  programs.  Since  1976  the 
code  has  permitted  these  private  nonprofit  organizations  to  issue 
tax-exempt  debt  to  fulfill  the  education  policy  objectives  of  the  Fed- 
eral Government. 

We  believe  that  the  Tax  Code  changes  that  we  seek  in  section 
2603  will  again  better  permit  our  organizations  to  contribute  to  the 
attainment  of  Federal  policy  obiectives  by,  one,  allowing  us  to  in- 
crease the  level  of  funding  which  we  can  efficiently  and  effectively 
provide  to  students  to  make  up  for  any  reduction  or  withdrawal  of 
commercial  lending  institutions  during  this  phase-down  period; 
two,  by  removing  the  restriction  that  our  nonprofit  activities  be  ex- 
clusively related  to  the  diminishing  Federal  loan  programs,  thus  al- 
lowing us  to  participate  in  activities  permissible  for  section 
501(c)(3)  organizations  generally;  and  three,  in  the  longer  term  pro- 
viding an  effective  transition  for  these  organizations  to  the  tax  pay- 
ing sector  of  our  economy  in  order  to  preserve  the  experience  and 
expertise  that  has  been  developed  over  the  past  17  years. 


1138 

We  have  been  in  close  communication  with  the  staff  of  the  Joint 
Committee  on  Taxation,  the  staff  of  the  Treasury  Department,  and, 
as  a  result,  we  believe  that  amendments  to  the  original  2603  can 
be  developed  to  effectively  meet  the  transition  objectives  of  our  or- 
ganizations to  satisfy  the  legitimate  Federal  tax  policy  questions 
concerning  nonprofit  corporations  and  tax-exempt  organizations 
and  can,  over  time,  result  in  a  conversion  to  the  taxable  sector 
which  will  generate  significant  Federal  tax  revenues  over  a  5-year 
period. 

In  brief,  the  amendments  to  2603  would  allow  the  transfer,  at 
fair  market  value,  of  a  scholarship  funding  corporation's  student 
loan  assets  and  of  its  outstanding  debt,  both  taxable  and  tax-ex- 
empt, to  a  successor  taxable  corporation. 

Further,  the  scholarship  funding  corporation  would  be  permitted 
to  invest  any  of  its  net  assets  into  the  equity  stock  of  a  successor 
taxable  corporation,  but  providing  that  equity  interest  was  senior 
and  superior  to  any  subsequent  or  additional  equity  interest,  as  is- 
sued by  the  taxable  corporation. 

The  amendments  recognize  the  need  for  a  transition  provision  in 
this  area  providing  a  limited  exception  to  the  so-called  "excess  busi- 
ness holding"  ruling  that  is  applied  to  tax-exempt  private  founda- 
tions. This  exception  is  limited  in  both  time,  10  years,  and  scope 
of  business  activity  requiring  that  the  successor  corporation  con- 
tinue to  engage  to  at  least  50  percent  of  its  business  activities  in 
the  Federal  student  loan  programs. 

While  the  amendments  allow  the  transfer  of  outstanding  tfix-ex- 
empt  debt  to  a  taxable  corporation,  they  do  not  create  a  new  pri- 
vate use  as  prohibited  by  the  code.  The  use  of  tax-exempt  debt  to 
support  student  loans  has  been  part  of  the  code  since  1976.  Simi- 
larly, no  changes  to  the  statutory  or  regulatory  treatment  of  the 
tax-exempt  bonds  are  proposed  nor  are  there  changes  suggested 
that  would  change  the  private  activity  bond  caps  by  State.  In  this 
area,  consistent  with  the  tradition  of  transition  amendments,  both 
the  tax-exempt  corporation  and  the  successor  taxable  corporation 
would  waive  or  forgo  their  ability  to  issue  any  tax-exempt  debt  in 
the  future.  So  we  would  be  talking  about  just  the  currently  out- 
standing tax-exempt  debt  which  would  itself  pay  down  over  the 
stated  maturity  of  those  debts. 

In  closing,  I  want  to  thank  Mr.  Neal  and  Mr.  Moakley  for  their 
sponsorship  of  2603  and  thank  the  subcommittee  members  and 
staff  for  their  interest.  We  believe  that  we  have  achieved  that  most 
elusive  of  targets,  a  proposal  endorsed  by  virtually  the  entire  af- 
fected population  which  helps  to  attain  Federal  education  policy  ob- 
jectives and  which  contributes  to  Federal  tsix  revenues. 

I  would  be  pleased  to  answer  any  questions  at  the  conclusion  of 
the  panel. 

Mr.  KOPETSKI  [presiding].  Thank  you  for  your  testimony. 

[The  prepared  statement  and  attachment  follow:] 


1139 

statement  Of 

LAWRENCE  W.  O'TOOLE 

President  and  CEO 

NEW  ENGLAND  EDUCATION  LOAN  MARKETING  CORPORATION 

On  Behalf  Of 

NELLIE  MAE 

AND 

THE  EDUCATION  FINANCE  COUNCIL 

Submitted}  To 

THE  SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

United  States  House  of  Representatives 

September  IS,  1993 

I. 
Introduction 


My  name  is  Lawrence  W.  O'Toole.  I  am  President  and  Chief 
Executive  Officer  of  The  New  England  Education  Loan  Marketing 
Corporation,  also  known  as  "Nellie  Mae".  I  appreciate  this 
opportunity  to  follow  up  my  appearance  before  the  Subcommittee  on 
Select  Revenue  Measures  by  submitting  this  statement  on  behalf  of 
Nellie  Mae,  and  on  behalf  of  the  Education  Finance  Council,  whose 
membership  contains  sister  organizations  from  across  the 
country.!' 

We  hope  to  serve  as  constructive  participants  in  the 
development  of  federal  policy  relating  to  student  loan 
programs.  The  contours  of  the  federal  policy  in  the  student  loan 
area  have  changed  over  time  to  reflect  the  changing  needs  of  our 
nation's  students.  In  this  connection,  we  urge  the  Subcommittee 
to  support  tax  amendments  that  would  permit  scholarship  funding 
corporations  to  evolve,  as  the  federal  student  loan  programs 
evolve,  so  that  we  can  continue  to  accomplish  our  mission  to 
support  these  programs.  The  amendments  contained  in  H.R.  2603, 
introduced  by  Congressmen  Neal  and  Moakley,  represent  a  practical 
and  efficient  means  of  assuring  continued  private  sector  support 
for  the  programs  without  market  dislocation.  We  hope  the 
Subcommittee  will  support  an  amendment  of  this  type,  as  we  do. 

Scholarship  funding  corporations,  which  are  described  in 
Internal  Revenue  Code  section  150(d),  are  private,  nonprofit 
corporations  which  are  devoted  exclusively  to  providing  capital 
and  services  to  support  student  loans  made  under  the  Federal 
Family  Education  Loan  Programs.  We  serve  principally  as 
secondary  markets  for  these  loans.  Altogether  there  are 
approximately  21  nonprofit  scholarship  funding  corporations 
servicing  this  nation's  students  and  their  educational  lenders. 

We  believe  that  passage  of  an  amendment  reflecting  the 
concept  embodied  in  H.R.  2603  is  vital  to  accomplishing  our 
mission  of  assuring  that  college  students  receive  the  financial 


1/    Attached  as  an  appendix  hereto  is  a  brief  description  of 
the  membership  of  the  Education  Finance  Council. 


1140 


assistance  they  need.  This  financial  assistance  amounts  to  $15 
billion  in  new  student  loans  each  year,  which  will  be  funded 
through  the  current  Federal  Family  Education  Loan  Programs  and 
through  the  recently  enacted  Federal  Direct  Loan  Program. 

II. 

The  Role  of  Secondary  Markets  for  Student  Loans 

A.    Secondary  Markets  within  the  Framework  of  the  Privately 
Funded  Student  Loan  Programs. 

Since  the  enactment  of  the  Higher  Education  Act  of  1965, 
Congress  has  championed  affordable  financing  for  college 
education.  Until  the  enactment  of  the  Omnibus  Budget 
Reconciliation  Act  of  1993,  which  provides  for  a  graduated  phase- 
in  of  student  loans  funded  by  .  the  federal  government,  the 
hallmark  of  our  nation's  higher  education  policy  has  been  to 
encourage  private  lenders  to  provide  affordable  student  loans 
under  the  federal  guaranteed  student  loan  programs.  These 
programs  rely  on  the  voluntary  participation  of  private  sector 
organizations  to  provide  capital  to  originate  student  loans,  to 
provide  secondary  markets  offering  liquidity  to  lenders  and  to 
service  these  loans. 

To  further  its  policy  of  encouraging  low-cost  educational 
financing.  Congress  has  long  permitted  state  and  local 
governments  and  organizations  formed  on  their  behalf  to  issue 
tax-exempt  bonds  to  raise  capital  to  acquire  or  finance  student 
loan  notes.  However,  because  some  states  and  local  governments 
were  not  permitted  to  form  organizations  that  could  issue  tax- 
exempt  financing  for  student  loans,  under  a  special  provision 
enacted  by  Congress  in  1976  private,  nonprofit  corporations 
formed  under  state  law  and  whose  income  is  devoted  to  acquiring 
student  loans  are  permitted  to  issue  tax-exempt  bonds  to  finance 
the  purchase  of  those  loans. 

For  this  reason,  it  is  fair  to  say  that  nonprofit 
scholarship  funding  corporations  are  literally  creatures  of  the 
federal  student  loan  programs  and  the  tax  code.  In  order  for  the 
interest  paid  on  outstanding  tax-exempt  bonds  to  remain  exempt 
from  federal  income  tax,  we  are  required  to  operate  exclusively 
for  the  purpose  of  acquiring  student  loan  notes  made  under  the 
Higher  Education  Act  of  1965.  However,  because  of  the  many 
statutory  limitations  and  restrictions  on  the  use  of  tax-exempt 
financing,  scholarship  funding  corporations  often  use  both 
taxable  and  tax-exempt  sources  of  debt  to  finance  the  acquisition 
of  student  loan  portfolios.  As  nonprofit  corporations,  we  are 
prohibited  from  raising  capital  to  support  student  loan  programs 
through  the  equity  markets. 

Nonprofit  scholarship  funding  corporations  serve  an 
important  function  in  the  student  loan  financing  process,  by 
assuring  a  reliable  source  of  replacement  capital  for  originating 
lenders.  By  providing  liquidity  to  lenders,  the  lenders  are  able 
to  make  more  loans  to  student  borrowers.  The  importance  of  our 
role  is  recognized  by  Congress  and  the  Department  of  Education, 
which  treat  nonprofit  scholarship  funding  corporations  as 
"eligible  lenders"  under  the  federal  student  loan  programs. 

But  our  efforts  go  far  beyond  merely  acquiring  and  holding 
student  loans.  Although  our  primary  purpose  has  been  to  serve  as 
a  secondary  market  for  originating  lenders,  in  fact  we  provide  a 
broad  array  of  services  to  the  federal  student  loan  programs  and 
participants  in  those  programs.  These  include  originating 
student  loans  themselves,  consulting  with  and  advising  lenders 
and  loan  guarantors  regarding  underwriting,  servicing  and  default 
controls,  and  assisting  borrowers  with  repayment  matters.  We 
also  have  devised  sophisticated,  financial  systems  which  account 
for  and  monitor  outstanding  loans.  Our  workforce  is  experienced, 
well-trained  and  efficient. 


1141 


In  sum,  scholarship  funding  corporations  have  brought  much 
innovation  and  efficiency  to  the  federal  student  loan  programs. 
This  has  reduced  the  burdens  of  students,  lenders,  guarantors  and 
the  federal  government,  while  facilitating  the  delivery  of  $15 
billion  in  new  loans  to  almost  four  million  students  annually. 
Our  local  and  regional  activities  often  place  us  closest  to  the 
student  borrower  and  make  us  better  able  to  secure  repayment  of 
troubled  loans,  which  reduces  federal  costs.  As  a  consequence  of 
our  local  nature  and  our  systems  and  procedures,  we  are  able  to 
minimize  the  default  rate  on  the  student  loans  we  hold. 

The  Student  Loan  Reform  Act  of  1993,  adopted  as  part  of  the 
recently  enacted  Omnibus  Budget  Reconciliation  Act  of  1993, 
represents  a  substantial  shift  in  federal  policy  and  will, 
beginning  in  as  little  as  10  months,  create  a  new  federal  direct 
student  loan  program  to  compete  with  the  current  federal  student 
loan  programs. 

Our  foremost  concern  —  and  I  am  sure  the  concern  of 
Congress  as  well  —  is  that  all  eligible  students  have  access  to 
the  loan  capital  which  they  need  to  complete  their  educations. 
Our  organizations  have  played  and  can  continue  to  play 
substantial  roles  in  assuring  that  this  goal  is  accomplished. 

For  reasons  outlined  below,  there  will  continue  to  be  a 
great  need  for  private  capital  during  the  four  year  phase-in 
period  of  the  direct  loan  program.  The  concepts  of  H.R.  2603 
effectively  will  allow  scholarship  funding  corporations  to  have 
access  to  equity  capital  that  can  be  leveraged  for  the  benefit  of 
the  student  loan  programs  during  this  period.  Just  as  important, 
these  concepts  will  provide  scholarship  funding  corporations  the 
opportunity  to  remain  "going  concerns"  having  the  flexibility  to 
preserve  and  best  utilize  our  expertise  and  operational 
capabilities  to  support  the  new  federal  policy  and  the 
administration  of  the  federal  student  loan  programs  after  1997. 

B.    Anticipated  Consequences  of  Federal  Student  Loan  Program 
Changes . 

Under  the  recently  passed  Budget  Reconciliation  Act,  signed 
into  law  by  President  Clinton  on  August  10,  1993,  the  federal 
government  will  begin  making  direct  student  loans  in  the  1994-95 
academic  year.  Direct  loans  will  account  for  a  maximum  of  5 
percent  of  loan  volume  in  that  year,  increasing  to  maximums  of  40 
percent,  50  percent  and  60  percent  in  the  1995-96,  1996-97  and 
1997-98  academic  years,  respectively.-'  The  direct  loan  program 
adopted  by  Congress  will  rely  to  a  large  extent  on  colleges, 
universities  and  other  institutions  of  higher  education  to 
originate  loans  with  students.  In  addition,  however,  the  federal 
government  will  contract  with  third  parties  for  loan  origination, 
servicing  and  collection  activities.  Thus,  under  the  direct  loan 
program,  significant  private  sector  participation  will  be 
required  to  implement  and  administer  the  program.  As  noted 
above,  these  functions  are  many  of  the  same  now  successfully 
performed  by  nonprofit  scholarship  funding  corporations,  and  we 
believe  that  students  will  benefit  if  the  federal  government  has 
a  large  pool  of  competitors  for  these  service  contracts. 

With  the  introduction  of  the  direct  loan  program  and  the 
many  financial  cuts  made  in  the  current  programs,  it  is  expected 
that  a  number  of  lending  institutions  will  terminate  their 
participation  in  the  federal  programs."  This  will  occur  for 
several  reasons.  First,  with  the  advent  of  a  direct  loan 
program,  many  lenders  will  decide  to  devo'te  their  resource  to 


2/    It  is  not  clear  at  this  juncture  what  changes  to  the  mix  of 
privately  and  publicly  funded  student  loans  will  occur 
after  academic  year  1997-98. 


1142 


investments  other  than  the  guaranteed  student  loan  programs. 1/ 
Lenders  will  find  it  difficult  to  justify  increasing  their 
investment  in  a  program  that  may  be  phased  out  and  ultimately 
eliminated.  Moreover,  the  impetus  for  lenders  to  terminate 
participation  during  the  transition  period  will  increase  because 
of  the  significant  reduction  in  financial  incentives  for 
participation,  such  as  the  required  one-half  percent  origination 
fee  charged  lenders  and  required  default  risk-sharing  under  the 
new  policy.  Second,  there  will  be  increased  concern  among 
lenders  that  state  guaranty  agencies  will  experience  financial 
difficulty  because  of  the  potential  impact  of  reduced  loan 
volumes  on  the  revenues  and  solvency  levels  of  those  guarantors 
and  due  to  their  own  risk-sharing.  Third,  capital  markets  may  be 
more  reluctant  to  invest  in  the  bonds  and  notes  of  nonprofit 
scholarship  funding  corporations  during  the  transition 
period.l'  As  a  consequence  of  these  scenarios,  one  can  expect 
that  the  availability  of  private. sector  capital  could  decline 
significantly  during  the  comparison  period. 

In  summary,  the  phase-in  of  the  direct  loan  program, 
especially  when  coupled  with  reduced  financial  incentives  for 
private  lenders  and  state  guaranty  agencies,  virtually  assures 
that  only  focused,  high  volume  lenders  will  remain  to  provide 
private  loans  to  students.  The  overall  loss  of  private  capital 
to  sustain  student  loans  issued  by  the  private  sector  during  the 
transition  period  will  result  in  a  substantial  need  for  capital 
from  other  sources,  a  need  which  can  be  met  effectively  by 
scholarship  funding  corporations  aided  by  the  proposed 
amendments. 

C.     Impediments  Preventing  Scholarship  Funding  Corporations 
from  Raising  Needed  Capital. 

Many  nonprofit  scholarship  funding  corporations  are  ready 
and  willing  to  meet  the  additional  private  sector  capital  needs 
during  the  transition  phase.  Unfortunately,  however,  we  face 
both  legal  and  practical  constraints  affecting  our  ability  to 
raise  additional  capital  to  support  the  transition.  From  a  legal 
standpoint,  as  nonprofit  organizations  described  in  section 
501(c)(3)  of  the  Internal  Revenue  Code,  we  are  unable  to  raise 
equity  capital  from  private  investors.  All  of  our  equity  capital 
must  be  internally  generated  through  retained  earnings.  Because 
our  earnings-generated  equity  capital  builds  slowly,  it  cannot 
itself  be  expected  to  provide  sufficient  additional  capital  to 
meet  funding  needs. 

The  prohibition  against  equity  investment  also  serves  to 
limit  the  amount  of  debt  financing  which  may  be  accomplished  as  a 
result  of  the  insistence  of  the  financial  markets  on  reasonable 
debt-to-equity  ratios.  For  example,  Nellie  Mae's  own  ratio  of 
debt-to-equity  is  approximately  20:1;  thus,  increasing  debt 
levels  substantially  to  accommodate  large  new  loan  volumes  may  be 
difficult. 

Further,  the  default  risk-sharing  and  reduction  in  loan 
yield  provisions  of  the  Budget  Reconciliation  Act  will  make  debt 
financings  more  difficult  without  added  cushions  of  equity 
protection  for  bond  and  note  holders. 


3/    For  example,  already  one  of  the  nation's  largest  banks  has 
solicited  proposals  to  sell  its  student  loan  portfolio 
worth  approximately  $250  million. 

4/  As  a  consequence,  to  the  extent  they  do  in  fact  invest, 
investors  likely  will  require  higher  interest  rates  to 
account  for  this  perceived  greater  risk. 


1143 


Lastly,  potential  investors  will  look  to  the  single  purpose 
restriction  of  section  150(d)  with  concern  and  ask  the  question, 
"How  will  the  experience  and  expertise  of  these  organizations  be 
utilized  if  up  to  60  percent  of  the  student  loans  made  under 
federal  programs  are  converted  to  direct  federal  loans?".  The 
transition  relief  provided  by  H.R.  2603  effectively  responds  to 
that  question  by  providing  long  term  opportunities  to  utilize 
that  expertise,  while  facilitating  the  delivery  of  needed  private 
capital  during  the  transition  period. 

We  believe  our  nation's  students  will  continue  to  derive 
substantial  benefits  by  having  regional  organizations,  such  as 
ourselves,  compete  with  Sallie  Mae  for  secondary  market  purchases 
of  loan  portfolios  and  for  services  to  be  provided  to  the 
Department  of  Education  with  respect  to  direct  student  loans.  It 
is  virtually  impossible  to  believe  that  the  private  sector 
capital  required  during  the  transition  phase  could  be  raised  by 
start-up  corporations  nor  used  efficiently  by  such  corporations 
during  the  transition.  The  time  frame  is  simply  too  short  and 
the  investment  in  systems  and  personnel  too  great.  The  solution 
to  the  anticipated  capital  vacuum  must  address  the  need  to  avoid 
operational  redundancies  and  to  preserve  operational 
efficiencies.  Nonprofit  scholarship  funding  corporation  stand 
ready  to  assist  in  solving  the  dilemma  caused  by  this  anticipated 
capital  drain. 

III. 

The  Efficient  Transition  Solution  of  H.R.  2603 

The  basic  concept  of  H.R.  2603  offers  a  simple  yet 
efficient  blueprint  for  strengthening  the  ability  of  the  private 
sector  to  provide  capital  during  the  transition  phase  and,  at  the 
same  time,  contributing  to  an  increase  in  federal  tax  revenues. 

In  brief,  H.R.  2603  provides  three  substantive  elements  of 
transition  relief.  The  first  is  the  deletion  of  the  restriction 
that  the  nonprofit  organization  electing  the  transition  be 
engaged  exclusively  in  providing  a  secondary  market  for  the 
federal  student  loan  programs.  This  amendment  would  allow  the 
nonprofit  to  engage  in  activities  permitted  Internal  Revenue  Code 
section  501(c)(3)  organizations  generally.  Although  it  would 
retain  an  economic  investment  in  a  corporation  taking  over  its 
student  loan  secondary  market  role,  the  nonprofit  must  remain 
devoted  to  charitable,  educational  or  other  exempt  activities.-' 

The  second  element  would  permit  the  transfer  of  the 
scholarship  funding  corporation's  assets,  and  the  assumption  of 
its  outstanding  debt  (both  taxable  and  tax-exempt),  by  a 
successor  taxable  corporation  in  exchange  for  an  economic 
investment  in  the  successor.  This  element  would  permit  the 
scholarship  funding  corporation  to  make  a  transitional  investment 
of   its   net  assets   in  the  equity  stock  of  the  successor 


5/    Nellie  Mae,  through  its  sister  organization  Nellie  Mae, 
Inc.,  itself  a  section  501(c)(3)  organization,  already 
undertakes  traditional  charitable  activities.   It  has 
established  the  Nellie  Mae  Fund  for  Education  which,  over 
the  last  three  years,  has  provided  more  than  $2  million  in 
funding  for  over  76  educational  projects.   These  grants 
have  included  projects  designed  to  encourage  at-risk 
students  to  stay  in  school,  establish  goals,  and  build 
aspirations  that  provide  the  impetus  to  pursue  post- 
secondary  education.   In  addition,  Nellie  Mae,  Inc.  engages 
in  programs  designed  to  expand  access  to  higher  education 
financing  for  students  and  families  no  longer  eligible  for 
federal  programs  or  whose  financial  needs  exceed  the  limits 
of  federal  student  aid. 


1144 


corporation.  The  successor  would  be  able  to  increase  its  equity 
capital  by  the  issuance  of  further  equity  stock  interests,  as 
necessary  to  provide  acceptable  ratios  for  further  debt  issuance 
to  meet  student  loan  needs.  This  solution  will  solidify  the 
secondary  market  for  student  loan  notes  during  the  transition 
period,  provide  additional  capital  for  loan  origination,  and 
preserve  the  student  loan  origination  and  servicing  expertise 
that  will  aid  the  federal  student  loan  programs  after  the 
transition  is  complete.  Most  significantly,  these  goals  will  be 
accomplished  as  efficiently  as  possible,  without  the  inevitably 
wasted  lag  time  or  market  dislocation  that  would  occur  if 
scholarship  funding  corporations  were  forced  to  wind  down. 

Finally,  the  third  element  of  relief  is  the  ability  to 
structure  the  nonprofit's  economic  investment  in  the  successor  to 
contain  voting  rights,  without  causing  the  immediate  imposition 
of  the  tax  on  the  "excess  business  holdings"  applicable  to 
certain  nonprofits.  This  relief  will  afford  the  nonprofits  the 
ability  to  protect  their  investment. 

Specifically,  H.R.  2603  would  amend  section  150(d)  of  the 
Internal  Revenue  Code  to  permit  a  nonprofit  scholarship  funding 
corporation  to  elect  to  transfer  all  of  its  student  loan  notes  to 
a  for-profit  successor  corporation,  and  for  the  successor 
corporation  to  assume  (or  otherwise  arrange  to  repay)  the 
outstanding  tax-exempt  debt  of  the  nonprofit.  Under  the  bill, 
this  transaction,  in  and  of  itself,  would  not  adversely  affect 
the  income  tax  exemption  for  interest  paid  with  respect  to  the 
tax-exempt  debt.  No  new  "private  use"  exemption  for  tax-exempt 
bonds  would  be  created  by  this  transfer:  the  bonds  still  would  be 
devoted  to  the  acquisition  of  student  loan  notes  under  federal 
programs,  which  is  the  intent  underlying  Internal  Revenue  Code 
section  150(d);  moreover,  the  nonprofit  sector  would  retain  the 
benefit  of  the  value  of  the  net  assets  transferred  through  its 
economic  interest  in  the  successor  corporation. 

In  essence,  the  bill  would  allow  a  scholarship  funding 
corporation  to  convert  to  a  for-profit  corporation  and  maintain 
its  operational  efficiency  by  transferring  all  of  its  functions 
as  a  "going  concern."  By  allowing  a  full  and  complete  "going 
concern"  transition,  H.R.  2603  provides  scholarship  funding 
corporations  the  ability  to  immediately  seek  additional  capital 
to  support  the  direct  loan  phase-in  period  and  to  preserve  their 
capabilities  as  independent  service  contractors  to  the  Department 
of  Education  with  respect  to  direct  loans.-' 

To  meet  the  requirement  of  the  election,  the  nonprofit  must 
remain  an  organization  described  in  section  501(c)(3)  of  the 
Internal  Revenue  Code  after  the  transfer.  Thus,  the  nonprofit 
would  not  continue  to  be  limited  to  investing  only  in  student 
loan  notes  issued  under  the  Higher  Education  Act  of  1965,  but 
would  be  able  to  undertake  the  broader  activities  of  an 
organization  described  in  section  501(c)(3),  such  as  charitable 
or  other  educational  activities.  The  economic  return  received  by 
the  nonprofits  from  its  investment  in  the  successor  would  be  a 
primary  funding  source  for  the  nonprofit's  exempt  activities. 

We  recognize  that  an  important  aspect  of  this  proposal  is 
ensuring  that  the  investment  made  by  the  nonprofits  in  the 
successor  corporation  is  protected,  both  from  an  economic  and 


6/    The  concern  has  been  raised  that,  after  the  transition,  th 
scholarship  funding  corporations  may  not  remain  as 
participants  in  the  federal  student  loan  programs. 
Although  we  believe  this  concern  is  unwarranted,  we  would 
not  object  to  reasonable  statutory  rules  that  require  the 
successor  corporations  to  serve  the  federal  student  loan 
programs;  after  all,  this  is  our  mission. 


1145 


corporate  governance  standpoint.  We  continue  to  discuss  these 
aspects  with  the  staff  of  the  Subcommittee,  representatives  of 
the  Treasury  Department  and  the  staff  of  the  Joint  Committee  on 
Taxation.  We  believe  the  outcome  of  these  discussions  will  be  an 
appropriate  resolution  of  these  concerns  that  does  not  place 
unnecessary  burdens  on  the  successor  corporation's  ability  to 
raise  additional  capital  to  support  private  financing  of  student 
loans.!/ 

Solely  as  a  result  of  the  transfer  of  assets  and 
liabilities  to  the  for-profit  corporation  in  exchange  for  the 
economic  interest  in  that  corporation,  it  is  likely  that  the 
nonprofit  would  become  subject  to  one  of  the  excise  taxes  imposed 
on  section  501(c)(3)  organizations  that  are  classified  as  private 
foundations  (i.e.,  those  section  501(c)(3)  organizations  that  do 
not  meet  certain  thresholds  of  financial  support  from  the 
public).  Under  section  4943  of.  the  Internal  Revenue  Code, 
private  foundations  that  have  "excess  business  holdings"  are 
subject  to  an  initial  tax  equal  to  5  percent  of  the  value  of  such 
holdings  and  an  extremely  onerous  additional  tax  if  the  situation 
persists. 

In  view  of  the  close  relationship  between  the  secondary 
market  activities  of  the  successor  corporation  after  the  transfer 
and  the  secondary  market  activities  of  the  nonprofit  scholarship 
funding  corporation  prior  to  the  transfer,  H.R.  2603  provides 
limited  relief  from  the  tax  on  excess  business  holdings 
attributable  to  the  nonprofit's  investment  in  the  successor 
corporation.  Under  the  bill,  the  excise  tax  under  Code  section 
4943  for  the  "excess  business  holdings"  of  a  private  foundation 
will  not  apply  with  respect  to  the  nonprofit's  stockholdings  in 
the  successor  corporation,  but  only  so  long  as  more  than  50 
percent  of  the  gross  income  of  the  successor  corporation  is 
derived  from,  or  more  than  50  percent  of  the  value  of  the  assets 
of  the  successor  corporation  consists  of,  student  loan  notes. 

This  transition  relief  is  narrowly  crafted.  It  would  apply 
only  when  the  successor  corporation  is  primarily  servicing  the 
same  function  after  the  transfer  as  the  nonprofit  served  prior  to 
the  transfer.  Significantly,  it  avoids  unwanted  competition 
between  the  nonprofit  and  the  successor  for  equity  investors  in 
the  successor  corporation's  stock  during  the  transition,  which 
would  potentially  drain  capital  from  support  of  the  federal 
student  loan  programs.   This  is  an  important  consideration. 

This  limited  exception  to  the  excess  business  holdings  rule 
of  section  4943  is  appropriate  for  two  reasons.  First,  we 
believe  that,  from  a  corporate  governance  standpoint,  it  is 
necessary  for  a  nonprofit  which  is  making  a  substantial 
investment  in  the  successor  to  have  a  voice  in  the  direction  of 
that  corporation  so  it  may  protect  its  investment.  Although  the 
nonprofit  should  not  be  involved  in  the  everyday  business 
decisions  of  the  successor,  it  should  be  able  to  express  its 
approval  or  disapproval  of  major  corporate  transactions  or  other 
significant  corporate  matters  commensurate  with  its  interest  in 
the  successor.  Second,  the  exception  is  necessitated  by  a  change 
in  federal  policy  as  it  affects  an  organization  devoted  to 
serving  the  prior  federal  policy.  In  contrast  with  many  other 
statutory  exceptions,  this  exception  in  fact  would  facilitate  the 
implementation  of  the  new  federal  policy. 


7/    For  example,  these  objectives  perhaps  could  be  accomplished 
by  structuring  the  investment  in  the  successor  corporation 
as  the  most  senior  equity  interest  in  the  successor 
corporation,  with  features  that  would  permit  the  investment 
to  participate  in  the  appreciation  in  value  of  the 
corporation  yet  protect  the  investment  from  downside 
potential. 


1146 


Once  a  nonprofit  scholarship  funding  corporation  makes  the 
election,  we  believe  that  neither  the  nonprofit  nor  the  successor 
corporation  should  be  allowed  to  issue  additional  tax-exempt 
debt.  The  proceeds  of  tax-exempt  debt  outstanding  on  the  date  of 
the  transfer,  in  the  hands  of  the  successor  corporation,  will 
continue  to  support  the  student  loan  programs  until  that  debt  is 
retired.  Moreover,  any  earnings  benefit  derived  by  the  successor 
corporation  from  the  tax-exempt  debt  will  be  fully  subject  to 
federal  income  tax. 

IV. 

Conclusion 

We  urge  the  Subcommittee  to  support  the  concept  contained 
in  H.R.  2603.  This  proposal  offers  a  cost-effective  means  of 
bolstering  the  capital  base  of  the,  secondary  student  loan  market 
during  the  transition  period  and  of  assuring  that  the  expertise 
and  workforce  of  the  scholarship  funding  corporations  are 
maintained  to  provide  services  in  furtherance  of  the  federal 
student  loan  programs.  In  short,  the  proposal  would  permit 
scholarship  funding  corporations  to  evolve  with  the  federal 
student  policy,  serve  the  recognized  needs  for  capital  and 
services  provided  by  the  private  sector  and,  in  this  connection, 
compete  with  Sallie  Mae  to  the  benefit  of  the  federal  government 
and  our  nation's  students. 

The  adoption  of  an  amendment  of  this  type  will,  we  believe, 
also  have  the  effect  of  increasing  federal  tax  revenues  by 
transferring  this  student  loan  activity  from  the  tax-exempt  to 
the  taxable  sector.  We  look  forward  to  working  with  the 
Subcommittee  to  refine  this  proposal  so  that  these  goals  can  be 
accomplished. 


1147 


The  Edncation  Finance  Coundi.  Inc. 

The  Education  Finance  Council  ("EFC")  is  a  noi-for-profit  association  organized  to 
promote  ttie  conunon  interests  of  tax-exempt  education  loan  secondary  market  organizanons 
whose  mission  is  to  maimain  and  expand  student  access  to  higher  education  oppominities  by 
ensunng  the  availability  of  tax-exempt  funding  for  education  loans  and  fulfilling  the  resource 
needs  of  students  and  families  pursuing  post-secondary  education.   EFC.  while  only  formed 
in  December.  1992.  cunemly  represents  the  23  nonprofit  state-based  secondary  markets 
which  are  listed  below. 

As  of  December  31.  1992,  nonprofit  state  secondary  markets  held  at  least  SI2  billion. 
or  approximately  20%.  of  all  outstanding  FFEL  Program  Loans. 

Arkansas  Studem  Loan  Authority 

California  Higher  Education  Loan  Authority.  Inc. 

Central  Texas  Higher  Education  Authority.  Inc. 

CitiState  Advisors  on  behalf  of  LA  Public  Facilities  Authority 

Colorado  Student  Obligation  Bond  Authority 

Greater  East  Texas  Higher  Education  Authority 

Illinois  Student  Assistance  Commission/IDAPP 

Iowa  Student  Loan  Liquidity  Corporation 

Maine  EdtuMtional  Loan  Marketing  Corporation 

Michigan  Higher  Education  Student  Loan  Authority 

Mississippi  Higher  Education  Assistarxe  Corporation 

Missouri  Higher  Ediuxuion  Loan  Authority 

Montana  Higher  Education  Student  Assistance  Corporation 

Nebraska  Higher  Education  Loan  Program.  Inc. 

North  Texas  Higher  Education  Authority.  Inc. 

New  Jersey  Higher  Education  Assistance  Authority 

Panhandle  Plains  Higher  Education  Authority 

Pennsylvania  Higher  Education  Assistance  Agency 

Southwest  Texas  Higher  Education  Authority,  Inc. 

The  Studem  Loan  Funding  Corporation 

Utah  Higher  Education  Assistance  Authority 

Vermont  Student  Assistance  Corporation 
Volunteer  State  Student  Funding  Corporation 


1148 

Mr.  KOPETSKI.  I  want  to  remind  the  panelists  that  we  have  seven 
panels  today.  I  know  some  of  you  probably  have  airplanes  at  5 
o'clock  that  you  would  want  to  catch  after  your  testimony.  If  we 
could  adhere  as  closely  as  possible  to  the  5-minute  rule,  we  will  all 
make  our  airplanes  and  other  places  that  we  have  to  be  later  this 
afternoon. 

With  that,  we  have  Mr.  Uvena.  Welcome. 

STATEMENT  OF  FRANK  UVENA,  SENIOR  VICE  PRESIDENT, 
LAW  AND  CORPORATE  STAFFS,  R.R.  DONNELLEY  &  SONS 
CO.,  CfflCAGO,  ILL. 

Mr.  Uvena.  I  am  Frank  Uvena,  senior  vice  president,  law  and 
corporate  staffs  of  R.R.  Donnelley  &  Sons  Co.  As  such,  I  have  held 
responsibility  for  employee  benefits,  and  for  human  resources.  I  am 
not  a  tax  expert. 

R.R.  Donnelley  is  a  leader  in  managing,  reproducing  and  distrib- 
uting print  and  digital  information  services,  worldwide.  We  are  129 
years  old.  Our  total  current  employment  is  32,000,  mostly  in  the 
United  States.  More  than  11,500  of  our  employees  have  been  with 
us  for  more  than  10  years. 

I  appreciate  the  opportunity  to  appear  before  you  today  to  offer 
my  company's  view  on  an  issue  of  importance  to  us.  I  would  also 
like  to  thank  Congressman  Reynolds  for  helping  us  bring  this  mat- 
ter before  you. 

I  am  here  to  propose  that  the  committee  consider  the  reinstate- 
ment of  a  tax  credit  that  was  in  effect  until  1987.  That  provision 
allowed  employers  a  tax  credit  of  three-quarters  of  1  percent  of  the 
compensation  due  to  employees  provided  that  the  entire  amount 
was  contributed  to  an  employee  stock  ownership  plan  to  purchase 
stock  to  be  distributed  only  to  employees.  This  particular  variety 
was  known  as  a  PAYSOP.  The  tax  credit  was  initiated  by  Congress 
to  encourage  widespread  stock  ownership  by  employees  of  Amer- 
ican companies.  Our  company  adopted  this  plan  in  1981.  Our  plan 
was  designed  for  the  broadest  possible  employee  participation.  We 
made  it  available  to  everyone  with  at  least  1  year's  full  service,  and 
we  paid  all  costs  of  administration  to  ensure  that  the  entire  credit 
would  be  used  only  to  acquire  stock.  The  plan  was  so  popular  that 
by  1987  75  percent  of  our  full-time  employees  in  the  United  States 
were  participating  and  held  over  1,750,000  shares  they  had  re- 
ceived through  the  PAYSOP. 

It  is  clear  the  PAYSOP  tax  credit,  as  it  existed  in  1986,  was  an 
important  contribution  to  employee  morale,  an  effective  way  of  en- 
hancing commitment,  of  encouraging  employees  to  feel  a  relation- 
ship beyond  employee-employer,  to  feel  a  real  sense  of  ownership 
in  the  company. 

I  believe  this  was  Congress'  intent  in  enacting  the  program  in 
the  first  place.  It  clearly  worked  at  Donnelley.  It  worked  because 
it  was  available  to  all  employees.  It  worked  because  it  was  simple 
in  operation.  It  worked  because  it  was  easy  to  understand,  and, 
most  important,  it  worked  because  it  benefited  employees  directly. 
I  know  our  employees  were  surprised  and  disappointed  by  the  Gov- 
ernment's decision  to  drop  the  program  after  1986.  We  discon- 
tinued further  funding  of  the  program  in  1987  when  tax  credits 
were  no  longer  available.  This  decision  underscores  a  fundamental 


1149 

point  which  I  would  hke  to  emphasize.  We  have  never  considered 
the  PAYSOP  plans  as  in  way  a  substitute  for  retirement  benefits 
or  for  other  employee  benefits  generally. 

If  the  Congress  sees  fit  to  reinstate  the  program,  we  will  partici- 
pate enthusiastically,  but  we  have  no  intention  of  using  it  to  re- 
place any  employee  benefits  now  in  place.  The  change  will  benefit 
our  employees  only.  It  will  not  add  a  penny  to  Donnelley's  earn- 
ings. 

Let  me  now  address  the  PAYSOP  issue  in  a  somewhat  broader 
context.  All  of  us  know  that  American  businesses  are  participants 
in  a  highly  competitive  global  economy.  It  is  essential  all  employees 
be  empowered  to  think  and  act  much  like  business  owners.  We  feel 
strongly  stock  ownership  can  help  to  foster  such  an  attitude  and 
reward  such  work  and  sacrifice. 

We  all  know  in  an  effort  to  remain  competitive  and  productive 
in  a  global  marketplace,  American  businesses  have  sharply  reduced 
the  number  of  middle  managers  and,  indeed,  the  number  of  core 
employees  generally.  This  makes  it  all  the  more  important  all  em- 
ployees see  themselves  as  partners  in  the  business. 

Let  me  summarize.  The  overall  goal  of  our  proposal  is  to  put 
stock  into  the  hands  of  all  employees.  This  will  help  foster  an  atti- 
tude of  ownership,  a  long-term  view  of  employment  and  its  bene- 
fits, and  therefore,  ultimately,  higher  productivity. 

Past  experience  demonstrates  that  the  PAYSOP  was  an  effective 
mechanism  for  sharply  increasing  stock  ownership  by  all  employ- 
ees. It  was  easy  to  understand,  simple  to  administer,  and  all  its 
benefits  flowed  directly  to  the  employees. 

We  ask  for  reinstatement  of  the  PAYSOP  tax  credit  which  ex- 
isted prior  to  the  Tax  Reform  Act  of  1986.  Your  staff  will  shortly 
provide  an  estimate  of  the  revenue  impact  of  this  proposal.  Al- 
though clearly  preferring  and  strongly  recommending  reinstate- 
ment of  the  credit  as  it  existed  in  1986,  we  do  suggest  several  other 
options  the  committee  may  want  to  consider.  They  are  set  forth  in 
my  written  statement. 

In  conclusion,  what  we  advance  here  today  will  allow  our  Gov- 
ernment to  reinstate  a  simple,  proven  and  effective  mechanism  for 
substantially  increasing  stock  ownership  among  the  working  people 
of  America.  This  in  turn  will  make  a  major  contribution  to  Ameri- 
ca's economic  prospects  for  the  future. 

Thank  you  for  your  time  and  attention. 

Mr,  KOPETSKI.  Thank  you  very  much  for  your  testimony. 

[The  prepared  statement  follows:] 


77-130  0 -94 -5 


1150 


TESTIMONY  OF  FRANK  J.  UVENA 
R.R.  DONNELLEY  &  SONS  CO. 

Good  Morning  Mr.  Chairman,  Members  of  the  Committee  - 

My  name  is  Frank  Uvena.   1  eua  Senior  Vice  President,  Law  and 
Corporate  Staffs,  of  RR  Donnelley  &  Sons  Company.   As  such,  I 
have  held  responsibility  for  employee  benefits,  for  human 
resources  and  for  corporate  staff  functions  which  emphasize  high 
employee  involvement  and  quality  management. 

RR  Donnelley  is  a  leader  in  managing,  reproducing  and 
distributing  print  and  digital  information  services  world  wide. 
As  the  world's  largest  commercial  printer,  we  produce  catalogs, 
newspaper  advertising  inserts,  magazines,  books,  directories, 
financial  printing  and  computer  documentation.   Our  total  current 
employment  is  about  32,000,  with  most  of  our  employees  in  the 
United  States. 

I  very  much  appreciate  the  opportunity  to  appear  before  you 
today  to  offer  my  company's  view  on  an  issue  of  importance  to  us. 

I  am  here  to  propose  that  the  Committee  consider  the 
reinstatement  of  a  tax  credit  that  was  in  effect  until  1987. 
That  provision  allowed  employers  a  tax  credit  of  0.75%  of  the 
compensation  due  to  employees,  provided  that  the  entire  amount 
was  contributed  to  an  Employee  Stock  Ownership  Plan,  to  purchase 
stock  to  be  distributed  only  to  employees.   This  particular 
variety  was  known  as  a  PAYSOP.   The  tax  credit  was  initiated  in 
1981  to  encourage  wide-spread  stock  ownership  by  the  employees  of 
all  types  of  American  companies. 

My  company  adopted  such  a  plan  in  1981.   From  the  beginning, 
our  plan  was  designed  for  the  broadest  possible  employee 
participation.   We  made  it  available  to  everyone  with  at  least 
one  full  year  of  service,  and  we  paid  all  costs  of  administration 
to  ensure  that  the  entire  credit  would  be  used  only  to  acquire 
stock.   The  plan  was  so  popular  that  by  1987  some  75%  of  all  of 
our  full  time  employees  in  the  United  States  were  participating. 
At  that  time  our  employees  held  1,752,220  shares  they  had 
received  through  the  PAYSOP. 

Our  employees  understood  and  appreciated  the  stock  ownership 
rights  obtained  under  the  program.   For  generations  at  Donnelley, 
members  of  senior  management  have  met  with  all  employees 
regularly  to  discuss  the  state  of  the  company  and  to  receive 
employee  questions,  comments  and  criticisms.   As  one  of  the 
Donnelley  executives  regularly  involved  in  these  meetings,  I  know 
that  employees  frequently  asked  questions  about  their  benefits 
and  rights  under  the  PAYSOP  plan.   I  know  it  gave  them  an 
important  feeling  of  ownership,  of  partnership  in  their  company. 
I  can  also  testify  they  were  sujrprised,  dismayed  and  disappointed 
when  this  benefit  was  no  longer  available  after  1986.   They 
simply  never  understood  why  it  was  discontinued  by  the 
government . 

Based  on  our  objective  statistics  on  employee  participation, 
and  the  personal  experience  which  I  have  just  described,  which 
was  shared  by  my  colleagues  in  the  senior  management  of  the 
company,  it  was  clear  the  PAYSOP  tax  credit  as  it  existed  in  1986 
was  an  important  contribution  to  employee  morale  and  an  effective 
way  of  enhancing  commitment,  of  encouraging  employees  to  feel  a 
relationship  beyond  employee-employer,  to  feel  a  real  sense  of 
ownership  in  their  company.   I  believe  this  was  Congress's  intent 
in  enacting  the  program  in  the  first  place.   It  clearly  worked  at 
Donnelley.   It  worked  because  it  was  available  to  all  employees, 
simple  in  operation,  easy  to  understand  and,  most  important, 
benefitted  employees  directly. 

We  discontinued  further  funding  of  the  program  in  1987  when 
tax  credits  were  no  longer  available.   As  I  mentioned,  at  that 
time  approximately  75%  of  our  employees  in  the  United  States  were 
participants  in  the  plan  and  thereby  Donnelley  stock  holders. 

One  might  well  ask  why  Donnelley  withdrew  from  the  program 
entirely  at  that  time,  when,  as  you  know,  a  number  of  provisions 
permitting  Employee  Stock  Ownership  Plans  remained  in  the  law, 
and  are  indeed  still  there  today?  This  is  a  fair  question.   In 
our  view,  the  remaining  provisions  governing  ESOPs  are  intended 
to  serve  purposes  quite  different  from  that  of  the  plan  in  which 
we  participated.   Some  such  provisions  were  intended  to  apply 
primarily  to  closely  held  corporations  and  their  stockholders. 
Other  provisions  allowing  for  an  effective  deduction  of  ESOP  loan 


1151 


payments  helped  facilitate  stock  buyouts  on  a  highly  leveraged 
basis.   Finally,  some  companies  used  ESOP  incentives  to  radically 
change  their  benefit  structure  for  employees,  so  as  to  feature  an 
ESOP  as  the  predominant  benefit  available. 

In  short,  as  the  law  currently  stands,  the  ESOP  tax 
incentives  are  designed  to  further  the  business  purposes  of 
certain  corporate  entities  and  their  stockholders  by  providing 
favorable  means  of  transferring  shares,  obtaining  less  costly 
financing  or  a  less  expensive  package  of  benefits. 

We  of  course  have  examined  and  carefully  considered  these 
possibilities.   The  first  two  clearly  did  not  apply  to  us.   with 
respect  to  benefit  packages,  we  already  had  what  we  regarded  as 
an  extraordinarily  attractive  benefit  package,  that  was 
understood  by  and  effective  for,  our  employees  generally.   We  saw 
no  reason  to  change  it. 

This  decision  underscored  a  fundamental  point  which  I  should 
like  to  emphasize.   We  never  considered  the  PAYSOP  plans  as  in 
any  way  a  substitute  for  retirement  benefits  or  for  other 
employees  benefits  generally,  and  we  do  not  do  so  now.   If  the 
Congress  sees  fit  to  reinstate  the  program,  we  will  participate 
enthusiastically,  but  we  have  no  intention  of  using  it  to  replace 
any  employee  benefits  now  in  place.   The  change  will  benefit  our 
employees  only;  it  will  not  add  a  penny  to  Donnelley's  earnings. 

I  should  now  like  to  take  a  moment  to  place  the  PAYSOP  issue 
in  a  somewhat  broader  context.   All  of  us  know  that  we  are 
participants  in  a  highly  competitive  global  economy.   If 
individual  American  companies  and  American  industry  generally  are 
to  remain  competitive  in  the  world  marketplace,  we  must 
anticipate  customers'  needs,  respond  to  those  needs  more  quickly, 
deliver  the  quality  the  customers  demand,  and  do  all  of  this  at  a 
very  competitive  price.   We  feel  that  this  sort  of  response,  with 
the  needed  level  of  innovation  and  quality  control,  is 
impossible,  unless  we  empower  our  hourly  employees  to  participate 
fully  in  the  operation  of  the  company.   This  revolutionary  new 
corporate  culture  often  requires  our  employees  to  think  and  act 
and  make  sacrifices  much  like  those  of  a  small  business  owner. 
We  feel  strongly  that  to  foster  such  an  attitude  and  to  reward 
such  work  and  sacrifice,  all  employees  should  actually  be  owners, 
and  participate  in  the  long-term  benefits  of  stock  ownership. 

You  gentlemen  all  know  that  in  an  effort  to  remain 
competitive  and  productive  in  a  global  marketplace,  American 
business  has  sharply  reduced  the  number  of  middle  managers  and, 
indeed,  the  number  of  core  employees  generally.   The  wide-spread 
anxiety  and  pain  resulting  from  this  unavoidable  process  make  it 
all  the  more  important  that  our  employees  generally  see 
themselves  as  partners  in  the  business,  feel  that  they  have  a 
real  stake  beyond,  although  certainly  not  instead  of,  the  regular 
pay  check.   At  this  point  you  might  ask:  This  is  very  persuasive. 
It  sounds  like  an  excellent  program.   So,  why  don't  you  just  go 
ahead  and  do  it?  Why  are  you  here  talking  to  us?  To  answer  that 
question,  I  must  again  emphasize  the  rigorous  competitiveness  of 
the  environment  in  which  we  operate.   Our  wage  levels  rank  near 
the  top  of  our  industry  and  compare  very  favorably  to  industry 
generally.   Our  employee  benefits,  such  as  insurance,  healthcare, 
and  a  fully  funded  retirement  plan,  are,  we  think,  generous.   In 
view  of  the  very  narrow  profit  margins  under  which  we  must 
operate  in  these  difficult  days,  we  cannot  afford  to  do  more. 

Most  companies  have  gone  through  or  are  going  through 
dramatic  and  difficult  changes  to  reduce  their  costs  and  remain 
competitive.   Adding  additional  costs  is  simply  not  an  option  for 
such  companies  in  today's  economic  environment. 

Many  employees  are  struggling  to  maintain  their  standard  of 
living.   They  could  not  easily  accept  a  conversion  of  their 
current  cash  compensation  to  mostly  cash  with  some  employers' 
stock.   It  follows  that  in  the  current  environment,  broadened 
employee  stock  ownership  will  not  occur  without  significant 
support  by  the  United  States  government. 

Let  me  summarize. 
The  purpose; 

The  overall  goal  is  to  put  stock  into  the  hands  of  all 
employees.   This  will  help  to  foster  an  attitude  of  ownership,  a 


1152 


long  term  view  of  employment  and  its  benefits,  and  therefore, 
ultimately,  higher  productivity. 

Past  experience  demonstrates  that  the  PAYSOP  was  an 
effective  mechanism  for  sharply  increasing  stock  ownership  by 
rank  and  file  employees.   It  was  easy  to  understand,  simple  to 
administer,  and  all  its  benefits  flowed  directly  to  the 
employees. 

ESOP  provisions  in  the  current  Internal  Revenue  Code  focus 
on  more  narrow,  targeted  groups,  such  as  closely  held 
corporations,  LBO's  and  corporations  needing  to  restructure  their 
benefits  plans.   As  a  result,  ESOP,  as  it  appears  in  the  current 
law,  is  really  oriented  to  favor  the  corporate  entity  or 
investment  community.   This  is  not  our  purpose. 
Our  Proposal 
We  ask  for  reinstatement  of  the  0.75%  PAYSOP  tax  credit 
which  existed  prior  to  the  TAx  Reform  Act  of  1986.   It  was 
formerly  codified  as  Sec.  44G  of  the  Internal  Revenue  Code  of 
1954. 

Some  revenue  impact  from  such  a  program  is  inescapable.   It 
is  our  understanding  that  the  staff  of  this  Committee  hopes  to 
have  available  an  estimate  of  the  amount  of  this  impact  on  or 
about  September  14th,  so  it  is  pointless  for  me  to  speculate  at 
this  juncture  as  to  what  those  numbers  might  be.   However,  in 
order  to  limit  the  revenue  impact  of  this  proposal  RR  Donnelley, 
although  clearly  preferring  and  strongly  recommending 
reinstatement  of  the  credit  as  it  existed  in  1986,  is  suggesting 
several  options  the  Committee  may  want  to  consider.   All  of  them 
will  achieve  the  primary  goal,  the  increase  of  stock  ownership  by 
lower  compensated  employees. 

Option  One  -  Limit  the  contribution  and  tax  credit  to 
$450  per  employee.   This  figure  is  derived  by  limiting 
the  contribution  to  0.75%  of  compensation  up  to  a 
maximum  of  $60,000. 

Option  Two  -  Limit  the  credit  to  the  compensation  only 
of  "non-highly  compensated"  employees.   The  definition 
of  such  employees  would  be  that  presently  set  out  in 
the  Internal  Revenue  Code. 

Option  Three  -  Provide  the  0.75%  tax  credit,  but 
require  a  distribution  of  stock  from  the  plan  to  each 
employee  within  four  years  of  the  contribution  by  the 
employer.   This  would  trigger  taxation  to  the  employee 
on  the  value  of  the  stock  as  of  the  date  of 
distribution,  and  therefore  reduce  the  tax  loss  to  the 
government . 

Option  Four  -  Reduce  the  tax  credit  to  0.5%  of 
compensation,  the  provision  which  was  in  effect  for  the 
tax  years  1983  and  1984.   To  limit  the  revenue  impact 
further.  Option  Four  could  be  combined  with  Option  One 
or  Two  and  Three. 
We  believe  that  Options  One  and  Two  are  essentially  inter- 
changeable and  are  clearly  preferable  to  Options  Three  and  Four. 
They  provide  different  ways  to  approach  the  same  issue.   The 
third  option  is  least  preferred  because  it  would  have  the  effect 
of  reducing  the  amount  of  stock  held  by  employees  in  the  long 
term. 

Conclusion 
The  proposals  advanced  here  will  allow  our  government  to 
reinstate  a  simple,  proven  and  effective  mechanism  for 
substantially  increasing  stock  ownership  among  the  working  people 
of  America.   When  combined  with  sweeping  internal  corporate 
changes,  variously  termed  high  employee  involvement  or  employee 
empowerment,  the  proposal  will  significantly  improve 
productivity.   This,  in  turn,  will  make  a  major  contribution  to 
America's  economic  prospects  for  the  future. 


1153 

Mr.  KOPETSKI.  Mr.  Romeo. 

STATEMENT  OF  RICHARD  P.  ROMEO,  CHAIRMAN,  TAX  COM- 
MITTEE, AMERICAN  FINANCIAL  SERVICES  ASSOCIATION, 
AND  VICE  PRESIDENT  AND  GENERAL  TAX  COUNSEL, 
AMERICAN  EXPRESS  TRAVEL  RELATED  SERVICES  CO.,  INC., 
NEW  YORK,  N.Y. 

Mr.  Romeo.  Thank  you,  Mr.  Chairman  and  members  of  the  sub- 
committee. I  am  Richard  P.  Romeo,  vice  president,  general  tax 
counsel  of  American  Express  Travel  Related  Services  Co.,  Inc.,  in 
New  York. 

Today,  I  am  testifying  on  behalf  of  the  American  Financial  Serv- 
ices Association  (AFSA),  which  is  the  Nation's  largest  trade  asso- 
ciation representing  nonbank  providers  of  consumer  financial  serv- 
ices. 

We  have  a  more  detailed  written  statement  that  we  would  like 
to  submit  for  the  record. 

Today,  we  appreciate  the  opportunity  to  testify  in  support  of  a 
proposal  to  clarify  when  a  debt  will  be  considered  worthless  for  tax 
purposes  so  that  a  deduction  may  be  obtained.  AFSA  urges  your 
support  for  this  proposal  since  it  would  achieve  substantial  sim- 
plification of  current  law,  would  assure  that  taxpayers  in  similar 
businesses  will  be  treated  similarly  for  tax  purposes,  and  would 
have  little  or  no  adverse  revenue  impact. 

Under  current  law,  deductions  for  bad  debts  are  allowed  only  in 
the  year  in  which  the  debts  become  worthless.  For  companies  like 
AFSA  members,  which  typically  have  a  high  volume  of  relatively 
small  loans  and  receivables,  proving  worthlessness  on  a  loan-by- 
loan  basis  is  a  cumbersome  and  time  consuming,  if  not  impossible, 
task. 

For  regulated  financial  institutions  such  as  banks  and  thrifts, 
Treasury  regulations  now  afford  a  conclusive  presumption  allowing 
conformity  of  financial  accounting  and  tax  treatment  for  worthless 
debts.  No  such  standard  applies  to  unregulated  creditors  such  as 
AFSA  members,  even  though  they  compete  with  regulated  lenders 
and  hold  similar  loans  and  receivables. 

In  connection  with  the  repeal  of  the  reserve  method  by  the  Tax 
Reform  Act  of  1986,  Congress  directed  the  Treasury  Department  to 
study  and  issue  a  report  on  bad  debt  deductions.  In  its  report, 
Treasury  acknowledged  the  fundamental  similarities  between 
banks  and  nonbank  financial  services  companies,  and  the  problems 
that  nonbanks  face  without  a  similar  bad  debt  standard. 

One  approach  considered  by  Treasury  for  nonbank  creditors 
would  be  to  determine  worthlessness  for  tax  purposes  by  reference 
to  the  standards  set  by  bank  regulatory  authorities.  Treasury's 
evaluation  of  this  approach  was  largely  favorable,  and  it  was  deter- 
mined to  involve  an  insignificant  revenue  effect.  However,  Treasury 
concluded  that  extending  a  book- tax  conformity  rule  to  creditors 
other  than  regulated  lenders  should  be  introduced  with  congres- 
sional approval  rather  than  by  unilateral  regulatory  action. 

It  is  important  to  note  that  the  proposed  rule  would  not  impose 
a  book-tax  conformity  rule  for  all  bad  debt  deductions.  Rather,  it 
would  apply  only  with  respect  to  those  types  of  debts  for  which 
bank  regulators  prescribe  specific,  objective  rules  that  can  be  read- 


1154 

ily  applied  by  taxpayers  and  the  Internal  Revenue  Service.  This 
would  have  the  effect  of  limiting  the  presumption  to  those  low  bal- 
ance, high  volume  loans  and  receivables  for  which  the  administra- 
tive burdens  of  proving  worthlessness  on  a  loan-by-loan  basis  are 
most  readily  apparent. 

The  Treasury  Department  has  raised  concerns  about  this  pro- 
posal for  reasons  that  appear  to  give  insufficient  weight  to  the 
basic  principle  of  competitive  equality  that  underlies  AFSA's  sup- 
port. We  are  confident  that  Treasures  concerns  may  be  satisfied. 

First,  the  current  book-tax  conformity  rule  for  banks  and  other 
regulated  institutions  was  found  by  Treasury  in  its  report  on  bad 
debts  to  be  supported  by  general  tax  principles  and  not  by  any  spe- 
cial status  of  regulated  entities. 

Second,  the  use  of  specific,  objective  criteria  for  worthlessness, 
such  as  the  length  of  delinquency,  in  the  case  of  consumer  install- 
ment loans  and  credit  card  debt,  would  help  assure  that  chargeoff 
standards  will  be  uniform  for  all  creditors  with  similar  types  of 
loans  and  be  relatively  easy  to  administer  for  both  taxpayers  and 
the  IRS. 

Third,  the  oversight  and  expertise  regulators  bring  to  this  issue 
is  embodied  almost  entirely  in  establishing  the  objective  chargeoff 
criteria  and  not  in  performing  detailed  audits,  thus  making  moot 
the  absence  of  regulatory  oversight  of  other  taxpayers  that  seek  to 
apply  those  same  rules. 

Finally,  AFSA  maintains  that  unregulated  creditors  would  be  no 
more  prone  to  take  advantage  of  a  book-tax  conformity  rule  to  ac- 
celerate tax  deductions  than  would  their  regulated  competitors.  In 
any  event,  the  ability  to  accelerate  chargeoffs  would  be  precluded 
since  bad  debt  deductions  would  be  allowable  no  earlier  than  the 
time  specified  in  the  appropriate  regulatory  guidelines. 

In  conclusion,  I  would  like  to  thank  the  chairman  and  the  mem- 
bers of  the  subcommittee  for  their  attention  this  morning.  My  own 
company  as  well  as  other  members  of  AFSA  are  interested  in  this 
and  other  pending  tax  legislative  proposals  that  raise  a  similar 
issue  regarding  comparable  tax  treatment  for  competitors  in  the  fi- 
nancial services  industry. 

We  appreciate  the  opportunity  we  have  had  to  meet  with  con- 
gressional and  Treasury  staff  to  discuss  this  issue,  to  provide  infor- 
mation regarding  our  industry  and  to  attempt  to  develop  a  work- 
able rule  that  reflects  sound  tax  policy.  We  look  forward  to  continu- 
ing to  work  with  you  and  the  staff  on  these  issues  as  the  legislative 
process  progresses. 

Mr.  KOPETSKI.  Thank  you  for  your  testimony. 

[The  prepared  statement  follows:] 


1155 


AMERICAN  FINANCIAL  SERVICES  ASSOCIATION 

TESTIMONY  REGARDING  BAD  DEBT  DEDUCTIONS  OP  NON-BANK  CREDITORS 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES  OF  THE 
HOUSE  WAYS  AND  MEANS  COMMITTEE 

SEPTEMBER  8.  1993 

Introduction 

Good  morning,  Mr.  Chairman  and  members  of  the  Subcommittee.  My 
name  is  Richard  P.  Romeo,  Vice  President  -  General  Tax  Counsel  of  American 
"Express  Travel  Related  Services  Company,  Inc. 

Today,  I  am  testifying  on  behalf  of  the  American  Financial  Services 
Association  (AFSA).  AFSA  is  the  nation's  largest  trade  association  representing 
non-bank  providers  of  consumer  financial  services.  Organized  in  1916,  AFSA 
represents  367  companies  operating  10,910  offices  engaged  in  extending  over 
$200  billion  of  consumer  credit  throughout  the  United  States.  These  companies 
range  from  independently-owned  consumer  finance  offices  to  the  nation's 
largest  financial  services,  retail,  and  automobile  companies.  Retail  and 
automobile  credit  is  extended  through  thousands  of  stores  and  dealers. 
Consumer  finance  companies  hold  over  $150  billion  of  consumer  credit 
outstanding  and  $67  billion  in  second  mortgage  credit,  representing  one 
quarter  of  all  consumer  credit  outstanding  in  the  United  States. 

We  appreciate  this  opportunity  to  testify  in  support  of  a  proposal  to  clarify 
when  a  debt  will  be  considered  worthless  for  tax  purposes  so  that  a  deduction 
may  be  obtained.  In  general,  the  proposal  would  allow  creditors  with  a  high 
volume  of  low  balance,  homogeneous  loans  to  establish  worthlessness  by 
reference  to  the  standards  that  have  been  provided  for  banks  and  other 
regulated  institutions.  AFSA's  support  for  this  proposal  is  based  upon  the  belief 
that  it  would  achieve  substantial  simplification  of  current  law,  would  assure  that 
taxpayers  in  similar  businesses  will  be  treated  similarly  for  tax  purposes,  and 
would  have  little  or  no  adverse  revenue  impact. 

WhY  New  Lgglslqtten  gn  Pqd  Pgbt  Pgductions  Is  NgcessqrY 

The  need  for  new  legislation  in  this  area  stems  from  the  repeal  of  the 
reserve  method  for  bad  debts  by  the  Tax  Reform  Act  of  1986.  Under  the  reserve 
method,  deductions  had  been  allowed  for  oddifions  to  a  reserve  for  bad  debts 
for  charge-offs  that  were  expected  to  occur  in  the  future. 

Since  the  repeal  of  the  reserve  method,  deductions  for  bad  debts  have 
been  allowed  only  in  the  year  in  which  the  debts  become  worthless  (or 
worthless  in  port)  and  charged  off.  For  companies  like  AFSA  members,  which 
typically  have  a  high  volume  of  relatively  small  loans  and  receivables,  proving 
worthlessness  on  a  loan-by-loan  basis  is  a  cumbersome  and  time  consuming,  if 
not  impossible  task.  In  addition  to  the  resources  required  on  the  port  of  both 
taxpayers  and  the  Internal  Revenue  Service  in  audits  of  bad  debt  deductions, 
taxpayers  face  the  risk  that  the  IRS  would  propose  disallowances  of  claimed 
deductions  that  may  not  be  easily  disproven  on  a  loan-by-loan  basis. 


1156 


For  regulated  financial  institutions  such  as  banks  and  thrifts.  Treasury 
regulations  now  afford  a  conclusive  presumption  allowing  conformity  of 
financial  accounting  and  tax  treatment  for  worthless  debts.  There  is  no  such 
standard  that  applies  to  unregulated  creditors  such  as  AFSA  members,  even 
though  they  compete  with  regulated  lenders  and  hold  similar  loans  and 
receivables.  In  our  view,  this  disparity  in  treatment  of  similarly  situated  taxpayers 
is  unnecessary  and  unfair,  and  this  legislative  proposal  is  on  appropriate 
response  to  the  problem. 


Thg  Trggsmry  Pgpqrtmgnt  Rgpcrt  tg  thg  Conqrg??  on  Pod  Pebt? 

In  connection  v^th  the  repeal  of  the  reserve  method  for  bad  debts  in 
1986,  Congress  directed  the  Treasury  Department  to  study  and  issue  a  report  on 
"appropriate  criteria  to  be  used  to  determine  if  a  debt  is  worthless'  for  tax 
purposes,  and  to  "consider  under  what  circumstances  a  conclusive  or 
rebuttable  presumption  of  the  worthlessness  of  an  indebtedness  is  appropriate" 
(H.  R.  Conf.  Rep.  No.  841 ,  99th  Cong.  2d  Sess.  II  -316  (1986)). 

While  AFSA  closely  monitored  the  progress  of  the  Treasury  Department 
study  and  was  even  afforded  the  opportunity  to  provide  input  concerning  the 
business  of  its  members,  the  conclusions  and  recommendations  that  resuited 
from  the  studf  essentially  left  our  industry  in  limbo. 

In  its  report  ("Report  to  the  Congress  on  the  Tax  Treatment  of  Bod  Debts 
by  Financial  Institutions",  Department  of  the  Treasury,  September  17, 1991) 
(hereinafter  "Treasury  Report"),  Treasury  defended  the  book-tax  conformity  rule 
that  applies  to  regulated  lenders  on  the  ground  that  "the  regulatory  and  tax 
definitions  of  assets  that  should  be  charged  off  are  quite  similar  in  that  they  are 
both  based  on  apparent  uncollectibility,  notwithstanding  the  p>ossibility  of  partial 
recovery  at  some  time  in  the  future"  (Treasury  Report,  page  22). 

While  noting  that  the  book-tax  conformity  approach  was  available  only 
to  regulated  lenders.  Treasury  did  acknowledge  the  fundamental  similarities 
between  the  lending  activities  of  non-bank  financial  sery/ices  companies  and 
banks,  and  the  problems  that  non-banks  face  without  a  similar  bod  debt 
standard: 

"These  nondepository  institutions  resemble  regulated  lenders  in  a 
number  of  ways.  They  typically  hold  large  portfolios  of 
homogeneous  loan  receivables.  Like  large  banks,  they  ore  not 
permitted  to  use  the  reserve  method  in  computing  the  deduction 
for  bad  debts.  As  a  consequence,  they  face  similar  difficulties  in 
evaluating  the  quality  of  assets  in  their  portfolios  on  a  loan-by-loan 
basis  for  purposes  of  determining  their  bod  debt  deductions.  But 
because  they  are  not  subject  to  the  regime  of  state  and  federal 
regulation  that  governs  depository  institutions,  the  conclusive 
presumption  allowing  conformity  of  tax  and  book  treatment  of 
worthless  debts  is  not  available  to  them.  Therefore,  in  the  absence 
of  the  reserve  method,  these  taxpayers  must  use  the  specific 
charge-off  method  for  deducting  worthless  debts  and  support  such 
deductions  with  'all  F>ertinent  evidence'  if  challenged  by  the 
Internal  Revenue  Service. 

In  view  of  many  similarities  between  these  unregulated 
lenders  and  depository  institutions  and  the  burdens  imposed  by  the 
ioan-by-loan  analysis  required  under  the  specific  charge-off 
method,  it  is  worthwhile  to  consider  whether  such  lenders  should 


1157 


have  some  sort  of  book/tax  conformity  rule  now  availoble  to  bonks 
and  thrifts."  (Treasury  Report,  page  29) 

Treasury  expressed  the  view  that  because  of  the  absence  of  regulatory 
oversight,  a  book-tax  conformity  rule  for  such  creditors  should  be  qualified  by 
some  additional  standard  to  deter  overly  aggressive  charge-off  policies  to 
obtain  tax  advantages.  Among  the  various  approaches  that  could  be  used  in 
'developing  a  proxy  for  regulatory  oversight"  is  the  so-called  "identical 
standards"  approach,  which  most  closely  approximates  the  proposal  under 
consideration.  Under  this  approach,  the  determination  of  worthlessness  for  tax 
purposes  of  particular  types  of  debts  held  by  any  creditor,  whether  or  not 
regulated,  would  be  determined  by  reference  to  the  standards  sefby  bank 
regulatory  authorities.  Treasury's  evaluation  of  this  method  was  largely 
favorable: 

The  identical  standards  approach  is  appealing  in  that  it  adopts 
identifiable  objective  standards  for  determining  worthlessness  and 
seeks  to  create  parity  between  the  treatment  of  regulated  and 
unregulated  lenders  with  respect  to  similar  types  of  loans .... 
(W)e  believe  the  substance  of  this  proposal  may  provide  a 
promising  basis  for  the  development  of  a  workable  conformity  rule 
and  would  have  on  insignificant  revenue  effect."  Creasury  Report, 
page  31) 

Treasury  concluded  that  extending  a  book-tax  conformity  rule  to  creditors 
other  than  regulated  lenders  would  be  a  departure  from  settled  policy  and 
practice  that  should  be  introduced  with  Congressional  approval  rather  than  by 
unilateral  regulatory  action.  This  is  what  prompted  the  introduction  of  the 
legislative  proposal  now  under  consideration. 


How  the  Proposed  Rule  Would  Operate 

tt  is  important  to  note  that  the  proposal  would  not  impose  a  book-tax 
conformity  rule  foroU  bad  debt  deductions.  Rather,  a  conclusive  presumption 
of  worthlessness  would  be  provided  only  with  respect  to  those  types  of  debts  for 
which  bank  regulatory  authorities  hove  prescribed  specific,  objective  rules  that 
can  be  readily  applied  by  taxpayers  and  the  Internal  Revenue  Service.  To  the 
extent  that  regulatory  authorities  require  an  examination  of  all  facts  and 
circumstances  relating  to  a  particular  loan,  rather  than  such  objective  criteria, 
there  would  be  no  presumption  of  worthlessness  based  upon  book-tax 
conformity.  This  would  have  the  effect  of  limiting  the  presumption  to  those  low 
balance,  high  volume  loans  and  receivables  for  which  the  administrative 
burdens  of  proving  worthlessness  on  a  loan-by-loan  basis  are  most  readily 
apparent. 

Thus,  the  Treasury  Report  notes  that  the  Comptroller  of  the  Currency's 
Handbook  for  National  Bank  Examiners  adopts  mechanical,  automatic  charge- 
off  procedures  for  high-volume  loans  (such  as  consumer  installment  loans,  credit 
card  plans,  and  check  credit  plans)  that  look  solely  to  the  time  the  debt  has 
been  delinquent.  Similar  rules  regarding  "consumer  credit"  have  been 
promulgated  by  the  Office  of  Thrift  Supervision  (12  C.F.R.  §  561).  Instead  of 
performing  a  loan-by-loan  review,  a  bank  examiner  confirms  that  the  proper 
automatic  charge-off  procedures  have  been  adopted  and  followed.  Use  of  a 
similar  approach  by  IRS  auditors  examining  nondepository  financial  services 
companies  would  significantly  diminish  audit  burdens  for  both  taxpayers  and 
the  IRS  and  bring  much-needed  certainty  to  the  issue  of  deductions  for 
worthless  debts.  In  addition,  it  is  important  to  note  Treasury's  conclusion  that 


1158 


basing  a  book-tax  conformity  rule  for  nondepository  providers  of  consumer 
financial  services  on  an  "identical  standards"  approach  "would  have  an 
insignificant  revenue  effect." 

The  approach  of  bank  regulators  in  determining  worthlessness  on  the 
basis  of  a  single  fact,  ler>gth  of  delinquency,  may  appear  to  depart  from  tax 
precedents  calling  for  consideration  of  "all  p>ertinent  evidence."  However, 
Treasury  noted  that  the  unsecured  nature  of  most  consumer  debt  "may  cause 
that  single  fact  to  be  an  adequate  measure  of  worthlessness  for  tax  purposes. 
In  any  event,  the  high  volume  of  such  loans  and  their  comparatively  low  face 
value  would  moke  an  in-depth  inquiry  into  all  relevant  facts  and  circumstances 
a  very  burdensome  task  for  the  lending  institution"  G'reasury  Reportrpage  23). 


Response  to  Treasury  Department  Concerns  About  the  Proposal 

The  principle  that  underlies  AFSA's  support  for  this  proposal  is  that  there 
should  not  be  a  disparity  in  the  tax  rules  for  bad  debt  deductions  applicable  to 
competitors  in  the  financial  services  industry  based  solely  upon  whether  or  not  a 
taxpayer  is  regulated  for  norv-tax  purposes.  In  this  regard,  we  note  that  the 
Treasury  Department  has  submitted  testimony  in  opposition  to  the  proposal  for 
reasons  that  appear  to  conflict  v^flth  this  basic  principle  of  competitive  equality. 
We  are  confident  that  Treasury's  concerns  may  be  satisfied,  and  we  would  like 
to  address  those  concerre  for  the  record  at  this  time. 

The  written  comments  on  this  issue  submitted  to  this  Subcommittee  on 
June  22, 1993  by  Assistant  Secretary  of  the  Treasury  (Tax  Policy)  Leslie  B.  Samuels 
provided  as  follows: 

"The  rules  concerning  bad  debts  of  federally  regulated  financial 
institutions  recognize  their  special  status  which  is  not  shared  by  non- 
federally  regulated  institutions.  There  are  no  assurances  in  the  case 
of  unregulated  lenders  that  the  debts  will  be  worthless  under 
general  tax  principles  when  charged  off  for  book  purposes,  or  that 
uniform  charge-off  standards  will  be  applied.  In  addition,  the 
absence  of  federal  regulatory  oversight  provides  unacceptable 
opportunities  for  distortions,  particularly  in  the  form  of  accelerated 
charge-offs." 

The  concerns  expressed  by  Assistant  Secretaiy  Samuels  were  in  large  part 
addressed  in  the  Treasury  Department's  own  report  to  the  Congress  on  bad 
debt  deductions  cited  earlier  in  this  statement.  Thus,  the  special  book-tax 
conformity  rule  that  now  applies  with  respect  to  the  bad  debt  deductions  of 
banks  and  other  regulated  institutions  is  not  based  merely  upon  their  "special 
status"  as  regulated  entities.  Rather,  Treasury  viewed  that  rule  as  jusfified  by  the 
fact  that  "the  regulatory  and  tax  definitions  of  assets  that  should  be  charged  off 
are  quite  similar  in  that  they  are  both  based  upon  apparent  uncollectibility, 
notwithstanding  the  F>ossibility  of  partial  recovery  at  some  time  in  the  future" 
(Treasury  Report,  page  22).    Even  where  a  single  fact,  the  length  of 
delinquency,  determines  worfhiessness  for  regulatory  purposes  of  consumer 
installment  and  credit  card  debt,  Treasury  was  satisfied  that  "it  is  appropriate  to 
permit  the  regulatory  loss  classification  to  determine  the  worthlessness  of  such 
debts  for  tax  purposes"  (Treasury  Report,  page  23). 

In  short,  even  though  regulators  might  be  expected  to  have  a  more 
conservative  approach  to  bad  debt  charge-offs  than  tax  auditors.  Treasury 
concluded  that  the  regulatory  criteria  were  in  fact  consistent  with  the  "general 
tax  principles"  referred  to  by  Assistant  Secretary  Samuels.  We  submit  that  this 


1159 


should  be  true  whether  or  not  the  particular  taxpayer  whose  debts  the  criteria 
are  applied  to  is  regulated. 

We  believe  that  the  concern  that  the  charge-off  standards  to  be  applied 
should  be  "uniform'  would  be  satisfied  by  the  relatively  limited  scope  and  terms 
of  the  proposed  rule.  As  stated  earlier,  the  rule  should  apply  only  to  those 
sp>ecific  types  of  debts  characterized  by  their  relatively  high  volume  and  low 
balances  for  which  regulators  prescribe  specific,  objective  criteria  for 
worthlessness  (such  as  the  length  of  delinquency,  in  the  case  of  consumer 
installment  loans  and  credit  card  debt).  In  the  cose  of  other  types  of  loans  for 
which  a  more  subjective,  "facts  and  circumstances"  analysis  is  made  by 
regulators,  there  would  be  no  book-tax  conformity  presumption.  Relying  solely 
up>on  objective  criteria  should  alleviate  any  concern  regarding  uniformrty. 

The  concern  that  the  absence  of  federal  regulation  presents 
unacceptable  opportunrties  for  tax  avoidance  overstates  the  role  regulators 
perform  with  respect  to  the  types  of  loans  in  question.  Instead  of  a  loan-by-loan 
review,  an  on-site  examination  of  a  bank  by  a  regulator  is  limited  to  "confirming 
that  the  proper  automatic  charge-off  procedures  have  been  adopted  for 
installment  and  credit  card  loons"  (Treasury  Report,  page  16).  Thus,  the 
oversight  and  expertise  regulators  bring  to  this  issue  is  embodied  almost  entirely 
in  establishing  the  objective  charge-off  criteria  that  may  be  applied  to  loans 
held  by  any  creditor,  whether  regulated  or  unregulated.  The  absence  of 
detailed  regulatory  audits  with  respect  to  such  loans  tends  to  make  moot  the 
absence  of  regulatory  oversight  of  other  taxpayers  that  seek  to  apply  those 
same  rules.  Further,  the  relatively  streamlined  audit  inquiry  into  whether  an 
institution's  charge-off  procedures  comply  with  objective  regulatory  standards 
confirms  the  administrative  advantages  of  this  approach  and  responds  to  the 
administrative  concerns  Assistant  Secretary  Samuels  cited  in  his  oral  testimony. 

AFSA  maintains  that  unregulated  creditors  would  be  no  more  prone  to 
take  advantage  of  a  book-tax  conformity  rule  to  accelerate  tax  deductions 
than  would  their  regulated  competitors.  Unregulated  finance  companies,  like 
banks,  need  to  report  strong  earnings  to  maintain  their  good  standing  wrth  debt 
rating  agencies,  creditors  and  shareholders.  In  any  event,  since  bad  debt 
deductions  would  be  allowable  no  earlier  than  the  time  specified  in  the 
appropriate  regulatory  guidelines,  the  ability  to  accelerate  charge-offs  to 
obtain  earlier  tax  deductions  for  bad  debts  would  be  precluded. 

Assistant  Secretary  Samuels  also  stated  that  smaller,  privately-held  lenders 
would  be  disadvantaged  if  the  proposal  would  apply  only  to  their  publicly-held 
competitors.  AFSA  agrees  with  this  concern.  A  tax  standard  for  bad  debt 
deductions  that  is  based  upon  objective  criteria  set  forth  by  bank  regulators 
should  be  available  to  all  taxpayers,  regardless  of  whether  they  are  public  or 
private,  regulated  or  unregulated. 


I  would  like  to  thank  the  Chairman  and  the  members  of  the 
Subcommittee  for  their  attention  this  morning.  My  own  company  as  well  as 
other  members  of  AFSA  are  interested  in  this  and  other  pending  tax  legislative 
proposals  that  raise  a  similar  issue  regarding  comparable  tax  treatment  for 
competitors  in  the  financial  services  industry.  We  appreciate  the  opportunity 
we  have  had  to  meet  with  Congressional  and  Treasury  staff  to  discuss  this  issue, 
to  provide  information  regarding  our  industry  and  to  attempt  to  develop  a 
workable  rule  that  reflects  sound  tax  policy.  We  look  forward  to  continuing  to 
work  with  you  and  the  staff  on  these  issues  as  the  legislative  process  progresses. 


1160 

Mr.  KOPETSKI.  I  want  to  begin  questioning  with  Mr.  OToole. 

Organizations  such  as  Nellie  Mae  have  been  subsidized  gener- 
ously by  Federal  tax  benefits  in  the  past.  Now  you  feel  that  you 
could  better  serve  the  needs  of  student  borrowers  by  converting  to 
for  profit  status.  Why  the  change  in  philosophy? 

Mr.  OToole.  Thank  you,  Mr.  Chairman. 

Organizations  such  as  ours  have  been  nonprofit  organizations 
from  the  start  as  required  by  the  code.  All  of  the  earnings  or  the 
accumulation  of  net  assets  that  have  been  created  over  that  period 
of  time,  since  the  beginning  of  those  organizations'  existence,  would 
stay  within  those  organizations  and  be  dedicated  to  nonprofit  pur- 
poses, broader  nonprofit  purposes,  than  just  the  Federal  student 
loan  programs  but  still  purposes  associated  with  fostering  edu- 
cational opportunity  in  a  nonprofit  sense. 

Our  suggestion  is  that  in  order  to  meet  the  student  loan  funding 
needs  during  the  4-year  transition  period  that  we  be  permitted  to 
establish  a  successor  corporation  under  the  rules  and  restrictions 
set  out  in  H.R.  2603.  We  are  expecting  that  under  the  current  law 
private  lending  will  be  phased  down  from  the  current  program  vol- 
ume, but  that  demand  will  not  change.  We  are  expecting  that  orga- 
nizations such  as  ours,  that  are  among  the  largest  providers  of  stu- 
dent loan  capital  in  the  country  which  support  Federal  programs, 
will  be  called  upon  to  provide  still  greater  levels  of  student  loan 
funding  in  response  to  phase  down  of  private  funding.  With  the 
changes  to  the  current  program  enacted  by  the  Congress  and  devel- 
oped by  the  education  committees,  there  will  be  greater  difficulty 
during  the  transition  in  raising  funds  sufficient  to  meet  the  student 
loan  capital  needs  because  of  the  reductions  in  yields  and  the 
greater  risk  sharing  associated  with  student  loans.  Thus,  we  are 
looking  for  an  opportunity  to  be  able  to  strengthen  the  balance 
sheet  of  our  organizations  by  injections  of  equity  investment  that 
would  allow  us  to  then  leverage  that  equity  investment  to  greater 
levels  of  debt  financing  to  meet  those  student  loan  capital  needs  in 
support  of  the  student  loan  program  during  the  transition. 

Mr.  KOPETSKI.  Mr.  Hoagland,  do  you  have  any  questions  of  Mr. 
OToole? 

Mr.  Hoagland.  Not  of  Mr.  OToole. 

Mr.  KOPETSKI.  Mr.  Uvena,  under  your  proposal  there  would  be 
a  great  expansion  of  ESOPs  as  a  means  of  providing  employee  re- 
tirement benefits.  Prior  laws  which  provided  tax  favored  treatment 
for  ESOPs  resulted  in  providing  greater  tax  benefits  to  employers 
and  others  engaged  in  ESOP  transactions  without  ensuring  in- 
creased rights  of  ownership  for  participating  employees.  Can  we  ex- 
pect to  see  a  recurrence  of  similar  concerns  under  your  proposal? 

Mr.  UvENA.  I  would  hope  not.  There  are  other  laws  governing 
ESOPs  which  remain  and  serve  legitimate  purposes.  What  we  sug- 
gest, it  be  reinstated  is  a  very  narrow  one  directed  just  to  provide 
stock  to  employees.  In  our  company  we  have  a  fully  funded  defined 
benefit  retirement  plan  which  will  not  change,  which  did  not 
change  during  this  period  of  time.  In  fact,  it  was  very  clear  that 
this  was  a  tax  funded  benefit  and  that  was  clearly  communicated 
to  our  employees.  It  was  never  a  substitute  for  compensation,  for 
retirement  or  any  other  benefits. 

Mr.  KoPETSKL  I  see. 


1161 

Mr,  Romeo,  are  members  of  your  association  prepared  to  accept 
other  tax  rules  applicable  to  your  competitors  in  the  financial  serv- 
ices area?  For  example,  the  recently  passed  budget  reconciliation 
bill  contains  a  provision  that  would  require  banks  and  thrifts  to  re- 
port to  the  IRS  wnth  respect  to  discharges  of  indebtedness  in  excess 
of  $600.  Would  you  object  if  this  reporting  requirement  were  ex- 
tended to  all  companies  engaged  in  the  business  of  making  loans? 

Mr.  Romeo.  We  are  very  much  aware  of  that  provision.  It  was 
added  in  the  recently  enacted  bill,  and  it  only  applies  to  regulated 
institutions.  While  we  believe  that  there  is  an  insignificant  revenue 
effect  with  regard  to  the  bad  debt  proposal,  we  think  extending  the 
reporting  requirement  would  be  consistent  with  the  idea  of  com- 
petitive equality  and  parity  so  that  the  same  rule  should  apply. 

In  fact,  many  of  us  have  regulated  institutions  within  our  con- 
solidated groups  and  do  in  fact  have  to  comply  with  that  rule  as 
to  those  entities  anyway.  We  think  an  extension  of  the  rule  would 
be  consistent  with  the  principle  that  underlies  our  support  for  the 
bad  debt  rule.  So,  yes,  Mr.  Chairman,  we  have  seen  it  linked. 
There  is  not  necessarily  a  quid  pro  quo  between  the  bad  debt  and 
information  reporting  proposals,  but  they  certainly  stem  from  the 
same  principle  of  treating  all  competitors  in  the  financial  services 
industry  on  a  level  playing  field. 

Mr.  KOPETSKI.  I  appreciate  your  openness.  Mr.  Hoagland. 

Mr.  Hoagland.  Let  me  say,  Mr.  Romeo,  that  I  am  pleased  that 
you  specifically  addressed  Treasury's  concerns  in  your  testimony. 

Mr.  Samuels  indicated  reservations  earlier,  and  you  have  ad- 
dressed those  reservations  and  I  concur  with  your  analysis. 

Let  me  indicate  that  my  staff  is  currently  working  with  Amer- 
ican Express  and  other  members  of  the  association  together  with 
Joint  Tax  to  gather  the  information  necessary  to  develop  legislation 
that  will  satisfy  Treasury  and  at  the  same  time  provide  a  method 
that  will  permit  nonbank  lenders  to  establish  the  worthlessness  of 
low  balance,  homogeneous  loans  by  reference  to  standards  similar 
to  those  that  have  been  provided  for  banks  and  thrifts.  I  think  we 
ought  to  be  able  to  do  it,  don't  you? 

Mr.  Romeo.  Yes,  sir.  I  thank  you  for  your  interest  in  this  issue 
and  your  efforts  in  getting  it  into  the  legislative  arena  and  under 
discussion  at  this  time. 

Mr.  Hoagland.  We  have  a  rule  for  regulated  institutions,  banks 
and  thrifts  that  works  well,  and  I  think  there  is  no  reason  we  can't 
extend  that  to  nonbank  institutions. 

Mr.  Romeo.  In  that  regard  I  wish  to  emphasize  that  we  are  not 
talking  about  a  blanket,  across-the-board  parity  rule  under  which 
whatever  is  deductible  for  book  purposes  should  be  deductible  for 
tax  purposes.  We  are  talking  about  a  more  limited  class  of  loan,  the 
relatively  low  balance,  high  volume  situation.  Some  of  our  compa- 
nies, like  banks,  have  millions  of  these  types  of  accounts,  such  as 
consumer  installment  loans,  credit  card  debt,  et  cetera.  The  ability 
to  be  able  to  look  at  those  on  a  loan-by-loan  basis  is  simply  an  im- 
possible task. 

Those  are  the  type  of  loans  for  which  regulators  have  specified 
some  fairly  workable  rules  that  can  be  applied  by  anybody  who  has 
that  type  of  loan.  That  is  essentially  the  standard  we  are  seeking 
to  adopt  here  and  have  available  for  tax  purposes. 


1162 

Mr.  HOAGLAND.  It  would  simplify  the  process  for  IRS  and  all 
companies  involved? 

Mr.  Romeo.  Yes,  sir.  We  think  it  is  very  much  a  step  toward  ad- 
ministrative simplification.  Having  a  bright  line  test,  while  it  may 
be  rough  in  some  regard,  certainly  would  be  easier  to  administer, 
minimize  audit  burdens,  and  minimize  the  time  and  resources  and 
effort  that  has  to  be  expended  by  both  taxpayers  and  IRS  in  audit- 
ing this  type  of  issue. 

Mr.  HOAGLAND.  I  don't  think  it  is  in  the  interest  of  IRS  or  the 
industry  to  be  required  to  determine  the  worthlessness  to  these 
loans  on  a  loan-by-loan  basis  and  we  can  and  should  move  to  a 
more  efficient  system. 

Mr.  Romeo.  We  agree  and  appreciate  your  support  for  that  effort. 
We  certainly  do  think  it  is  very  much  an  open  issue.  There  are 
some  details  that  we  need  to  work  out  with  congressional  and 
Treasury  staff  and  we  certainly  are  very  eager  to  continue  with 
that  process. 

Mr.  HOAGLAND.  Let's  hope  we  can  get  it  done.  Thank  you,  Mr. 
Chairman. 

Mr.  KOPETSKI.  I  thank  the  panelists  and  thank  vou  for  your  ex- 
pert advice  and  opinion  and  written  testimony  and  brevity. 

We  will  now  move  to  the  next  panel,  panel  three  out  of  seven 
panels  today.  We  will  move  to  the  advertising  arena  with  the  Com- 
mittee for  Competition  Through  Advertising,  Gerald  Gibian,  Cor- 
porate Vice  President,  Tax  and  Real  Estate,  Estee  Lauder  Co., 
N.Y.;  the  Ad  Hoc  Group  to  Preserve  Deduction  for  Advertising, 
Mark  McConaghy,  former  chief  of  staff  of  the  Joint  Committee  on 
Taxation;  and  the  Advertising  Tax  Coalition,  Timothy  White,  pub- 
lisher. Times  Union,  Albany,  N.Y.  With  him  is  DeWitt  Helm,  presi- 
dent. Association  of  National  Advertisers  of  New  York.  Welcome, 
gentlemen. 

Before  I  begin  the  testimony,  I  want  to  have  a  statement  of  my 
own  entered  into  the  record.  I  have  an  advertising  public  relations 
background.  I  will  let  my  bias  be  known  immediately. 

I  believe  firmly  that  advertising  goes  into  a  product  iust  as  much 
as  the  research  and  development  to  develop  the  product  and  the 
raw  materials  to  make  the  product.  We  recognize  that  in  our  legal 
system,  stressing  the  importance  of  our  copyright  laws. 

If  you  look  at  all  the  trade  negotiations,  one  of  the  centerpieces 
of  dispute  is  enforcement  of  the  intellectual  property  rights  because 
they  get  abused.  One  of  the  reasons  why  American  products  are  so 
valuable  is  the  amount  of  money  and  creativity  that  goes  into  the 
advertising  of  that  product. 

With  that  prejudgment  on  my  part,  I  will  now  turn  to  Mr.  Gibian 
from  Estee  Lauder  Co.  We  are  under  I  hope  a  5-minute  rule. 

[Mr.  Kopetski  submitted  the  following:] 


1163 


SUGGESTED  STATEMENT 
MR.  KOPETSKI 

Mr.  Chairman,  I  would  like  to  voice  my  opposition  to  the  proposal  to  limit  the 
deduction  for  advertising  expenses  -  this  proposal  is  tantamount  to  a  tax  on 
advertising.  Such  a  tax  could  seriously  disrupt  the  economy,  reduce  competition 
among  businesses  and  products  and  discriminate  against  small  businesses  as  well 
as  minority  and  small  media  outlets.  It  also  would  levy  higher  taxes  on  companies 
solely  because  they  have  large  advertising  budgets,  and  reduce  the  pubUc's  access  to 
news,  information  and  entertainment. 

The  tax  treatment  of  advertising  costs  is  governed  by  the  same  general 
principles  applicable  to  all  other  business  expenses.  The  recurring  nature  of  an 
expenditure  in  roughly  the  same  amoimts  each  year  suggests  that  the  benefits  of 
the  expenditure  do  not  last  beyond  the  year.  This  feature  is  characteristic  of 
virtually  all  advertising  expenses.  Moreover,  no  element  of  advertising  costs  is 
viewed  by  Congress  or  Treasury  as  a  tax  expenditure. 

Advertising  is  the  most  economically  e£5cient  means  of  marketing  a  product 
to  a  mass  society.  Advertising  allows  producers  to  deliver  goods  and  services  more 
efficiently  and  it  permits  consumers  to  significantly  improve  their  standards  of 
living  because  it  enhances  their  knowledge  of  and  their  access  to  better  quahty, 
lower  priced  products. 

Any  change  in  the  tax  law  that  makes  advertising  more  expensive  also  is 
likely  to  discourage  some  companies  from  introducing  new  products.  If  new 
entrants  cannot  advertise  as  effectively  and  efficiently  they  will  have  a  lower 
probabiUty  of  success. 

At  a  time  when  Treasury  and  the  Congress  are  looking  at  ways  to  simphfy 
the  tax  code,  a  law  which  defers  a  deduction  for  "advertising"  expenses  would  add 
complexity  and  be  too  imprecise  to  be  workable.  The  Treasury  would  be  forced  to 
attempt  to  draw  lines  which  would  rule  one  type  of  marketing  expense  "advertising" 
and  another  not.  Is  a  free  copy  of  a  newspaper  an  advertising  or  a  production 
expense?  Is  the  salary  of  the  marketing  director  to  be  divided  by  some  formula 
between  advertising  and  non-advertising?  Unworkable  concepts  create  complexity, 
high  compliance  costs,  and  disrespect  for  the  tax  system.  When  the  tax  law  makes 
distinctions  that  are  not  economically  real,  confusion  follows. 


1164 

STATEMENT  OF  GERALD  Z.  GIBIAN,  CORPORATE  VICE  PRESI- 
DENT, TAX  AND  REAL  ESTATE,  ESTEE  LAUDER  CO., 
MELVDLE,  N.Y.,  ON  BEHALF  OF  COMMITTEE  FOR  COMPETI- 
TION  THROUGH  ADVERTISING 

Mr.  GiBlAN.  Thank  you  very  much.  I  am  Gerald  Gibian,  corporate 
vice  president,  tax  and  real  estate,  of  the  Estee  Lauder  Cos.  Estee 
Lauder  is  a  member  of  the  Committee  for  Competition  Through  Ad- 
vertising. 

On  behalf  of  the  committee,  I  appreciate  the  opportunity  to  tes- 
tify before  you  today  in  opposition  to  a  proposal  to  capitalize  adver- 
tising costs  and  amortize  them  over  a  period  of  years. 

The  Committee  for  Competition  Through  Advertising  is  made  up 
of  companies  in  various  industries  associated  with  advertising,  in- 
cluding the  companies  that  must  advertise  their  products  in  order 
to  compete  in  the  domestic  and  international  marketplaces,  the 
companies  that  assist  them  in  communicating  their  message,  and 
the  companies  that  provide  the  media  for  carrying  that  message. 

Raising  consumer  awareness  of  our  products  and  providing  infor- 
mation about  the  prices  and  features  of  our  products  are  an  inte- 
gral part  of  our  efforts  to  compete  in  the  global  marketplace  and 
to  continue  to  make  certain  that  U.S.  companies  remain  pre- 
eminent. 

It  is  obviously  not  in  the  interest  of  businesses  that  must  adver- 
tise to  establish  and  expand  the  markets  for  their  products  and 
services  to  be  subject  to  a  tax  penalty  for  costs  related  to  selling 
their  products  and  services.  Nor  is  it  in  the  interest  of  these  busi- 
nesses that  provide  the  media  for  advertising,  including  television 
and  radio  stations,  newspapers,  magazines,  publishers  of  yellow 
pages  and  sports  franchisers.  It  is  also  not  in  the  interest  of  firms 
that  provide  support  services  for  advertising.  However,  what  we 
wish  to  focus  on  today  are  the  numerous  reasons  that  it  is  not  in 
the  interest  of  the  general  public  to  impose  this  new  tax  burden. 

The  increased  cost  of  advertising  as  a  result  of  this  proposal 
would  present  a  barrier  to  market  expansion  for  producers  of  goods 
and  services.  Companies  that  will  be  hardest  hit  by  the  increased 
cost  will  be  both  startup  ventures  and  established  businesses  that 
must  continually  introduce  new  products.  In  both  cases,  more  ad- 
vertising is  needed  to  make  the  products'  existence  and  attributes 
known  to  potential  customers. 

Creating  barriers  for  new  products  entering  the  marketplace  will 
also  result  in  less  product  innovation,  causing  the  United  States  to 
lose  global  competitiveness.  In  addition,  U.S.  producers  of  goods 
and  services  will  be  at  a  competitive  disadvantage  vis-a-vis  goods 
and  services  produced  by  foreign-owned  companies,  because  vir- 
tually all  of  our  trading  partners  permit  a  tax  deduction  for  adver- 
tising. 

Finally,  this  proposal  will  have  a  particularly  devastating  effect 
on  small  businesses  which  rely  heavily  on  advertising  for  short- 
term  business  growth. 

In  summary,  the  proposal  to  require  the  amortization  of  advertis- 
ing expenses  does  not  have  a  sound  policy  basis.  It  is  bad  tax  pol- 
icy. It  is  bad  economic  policy.  It  does  not  make  business  sense.  To 
make  this  clear,  there  are  some  points  I  would  like  to  highlight: 


1165 

First  is  the  mismatching  of  income  and  expense.  Under  current 
law,  advertising  costs  are  subject  to  the  same  principles  as  other 
business  expenses  for  determining  whether  they  should  be  de- 
ducted in  the  year  incurred.  The  Tax  Code  does  not  provide  special 
treatment  of  advertising.  Recurring  expenditures  are  generally 
found  to  be  currently  deductible  because  the  need  to  renew  the 
benefits  through  additional  expenditures  each  year  suggests  a  use- 
ful life  of  less  than  a  year. 

The  reasoning  behind  the  argument  for  requiring  amortization  of 
advertising  is  abstract.  A  conceptual  argument  is  made  that  adver- 
tising is  like  capital  spending  on  equipment  and  structures.  There 
is  little  evidence  to  substantiate  such  a  claim.  If  anything,  eco- 
nomic studies  show  that  the  value  of  most  advertising  is  entirely 
eliminated  within  1  year. 

However,  I  can  tell  you  for  more  than  20  years  in  the  consumer 
products  industry,  which  is  heavily  reliant  on  advertising,  that  a 
large  proportion  of  all  advertising  refers  to  offers  of  short  duration. 

For  example,  in  the  cosmetic  industry  much  of  our  advertising  is 
seasonal,  focused  on  holidays.  Similarly,  retail  advertising  is  di- 
rected at  the  sale  of  goods  directly  to  consumers  within  a  short  pe- 
riod of  time.  Also,  weekly  newspaper  ads  by  a  local  supermarket 
announcing  the  price  of  lettuce  have  little  value  next  month,  much 
less  next  year. 

Classified  advertising  is  similar.  In  addition,  promotion  advertis- 
ing is  designed  to  provide  an  incentive  for  immediate  sales,  and  in 
point  of  fact  most  coupons  have  an  expiring  date  of  less  than  1 
year. 

Direct  marketing  through  mail  or  telephone  sales  is  also  de- 
signed to  generate  immediate  sales.  Industries  suffering  from  fi- 
nancial problems  advertise  for  quick  sales. 

Finally,  advertising  affects  decay  quickly.  Even  well-known 
brands  that  stop  advertising  experience  a  rapid  decline  in  sales. 

Nevertheless,  a  proposal  requiring  amortization  of  advertising 
expenses  would  not  allow  a  complete  writeoff  of  expenditures  until 
years  after  such  expenditures  rendered  any  value  to  the  business. 
This  is  pure  mismeasurement  of  income,  and  a  pure  tax  penalty. 

In  addition,  complexity  would  be  increased.  There  would  be  re- 
duced competition.  There  would  be  a  distortion  of  business  prac- 
tices, and  revenue  would  not  be  significantly  enhanced. 

In  conclusion,  there  is  no  policy  justification  for  further  limiting 
the  deductibility  of  advertising  beyond  the  limitations  set  by 
present  law.  Enactment  of  any  proposal  would  create  a  barrier  to 
expansion  of  markets  for  goods  and  services,  thereby  impeding  eco- 
nomic growth  at  a  point  in  time  when  economic  growth  is  des- 
perately needed. 

In  addition,  such  a  proposal  would  reduce  competition  by  restrict- 
ing information  flow  and  impeding  the  ability  of  new  entrants  to 
challenge  established  firms.  It  would  also  add  substantial  complex- 
ity to  current  tax  rules. 

Thank  you  for  affording  me  the  opportunity  to  testify. 

Mr.  KOPETSKI.  Thank  you  very  much,  Mr.  Gibian. 

[The  prepared  statement  follows:] 


1166 


STATEMENT 

on 

CAPITALIZATION  OF  ADVERTISING  EXPENSES 

scheduled  for  hearings  on 

September  8, 1993 

before  the 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

of  the 

HOUSE  COMMITTEE  ON  WAYS  AND  MEANS 

as  part  of  their  hearings  on 

MISCELLANEOUS  REVENUE  ISSUES 

on  behalf  of  the 

Committee  for  Competition  Through  Advertising 

by 

Gerald  Z.  Gibian,  Estee  Lauder  Companies 


I  am  Gerald  Z.  Gibian,  Corporate  Vice  President  Tax  and  Real  Estate,  Estee  Lauder  Companies. 
Estee  Lauder  is  a  member  of  the  Committee  for  Competition  through  Advertising,  which 
represents  a  coalition  of  companies  in  various  industries  associated  with  advertising,  including  the 
companies  that  must  advertise  their  products  in  order  to  compete  in  the  domestic  and 
international  marketplaces,  the  companies  that  assist  them  in  communicating  their  message,  and 
the  companies  that  provide  the  media  for  carrying  that  message.  Raising  consumer  awareness  of 
our  products  and  providing  information  about  the  prices  and  features  of  our  products  are  an 
integral  part  of  our  efforts  to  compete  in  the  global  marketplace  and  continue  to  make  certain  that 
U.S.  companies  remain  pre-eminent 

On  behalf  of  the  Committee  for  Competition  through  Advertising,  which  includes  Estee  Lauder 
Companies;  J.  Walter  Thompson;  Ogilvy  and  Mather,  the  Omnicom  Group,  which  includes  the 
BBDO,  DDB  Needham,  and  TWBA  advertising  networks;  Hachette  Filipacchi  Magazines,  Inc., 
the  publishers  of  American  Photo,  Audio,  Boating,  Car  and  Driver,  Cycle  World,  Flying, 
''opular  Photography,  Road  and  Track,  Showboats  International,  Stereo  Review,  Woman's  Day, 
Elle,  Elle  Decor,  Home  Magazine,  Best  Selling  Home  Plans,  Metropolitan  Home;and  Euro 
RSCG  Holdings,  Inc,  Messner  Vetere  Berger  McNamee  Schmetterer,  Tatham,  Stranger  & 
Associates,  Creamer  Dickon  Basford,  Lally  McFarland  &  Pantello,  Robert  A.  Becker,  I  would 
like  to  thank  you  for  the  opportunity  to  express  our  views  on  a  proposal  that  would  replace 
immediate  write-offs  of  advertising  expenses  with  amortization  of  these  expenses  over  a  fixed 
number  of  years. 

It  is  obviously  not  in  the  interest  of  businesses  that  must  advertise  to  establish  and  expand  the 
markets  for  their  products  and  services  to  be  subject  to  a  tax  penalty  ~  which  is  what  this 
proposal  amounts  to  -  for  costs  related  to  selling  their  products  and  services.  Nor  is  it  in  the 
interests  of  those  businesses  which  provide  the  media  for  advertising,  including  television  stations, 
radio  stations,  newspapers,  magazines,  publishers  of  "yellow  pages,"  and  sports  franchises.  It  is 
also  not  in  the  interest  of  firms  that  provide  the  support  services  for  advertising  firms.  However, 
what  we  wish  to  focus  on  today  are  the  numerous  reasons  that  it  is  not  in  the  interest  of  the 
general  public  to  impose  this  new  tax  burden. 

The  increased  cost  of  advertising  as  a  result  of  this  proposal  would  present  a  barrier  to  market 
expansion  for  producers  of  goods  and  services,  which  could  result  in  lower  overall  economic 
growth.  Companies  that  will  be  hardest  hit  by  the  increased  cost  will  be  both  start-up  ventures, 
already  strapped  for  cash,  and  established  businesses  that  must  continually  introduce  new 
products.  In  both  cases,  more  advertising  is  needed  to  make  the  products  existence  and  attributes 
known  to  potential  customers.  Creating  barriers  for  new  products  entering  the  marketplace  will 
also  result  in  less  product  innovation,  causing  the  U.S.  to  lose  global  competitiveness.  In 
addition,  U.S.-owned  producers  of  goods  and  services  will  be  at  a  competitive  disadvantage  vis-^- 
vis  goods  and  services  produced  by  foreign-owned  companies  because  virtually  all  of  our  trading 
partners  permit  a  deduction  for  advertising.  Finally,  this  proposal  will  have  a  particularly 


1167 


devastating  effect  on  small  businesses,  which  rely  heavily  on  advertising  for  short-term  business 
growth. 

Increasing  the  cost  of  advertising  would  also  affect  publishers  and  broadcasters  and  the  wide 
public  access  to  news  and  information,  as  well  as  commercial  television  and  radio  programming, 
that  they  currently  can  provide  to  tiie  public  at  litde  or  no  charge  because  they  are  supported  by 
advertising.  Increased  costs  of  advertising  will  result  in  less  advertising  revenue  for  the  media  and 
likely  will  be  felt  more  in  smaller  communities.  Publishers  and  broadcasters  that  are  suffering 
financially  may  not  be  able  to  withstand  the  drop  in  advertising  revenue. 

In  summary,  the  proposal  to  require  the  amortization  of  advertising  expenses  does  not  have  a 
sound  policy  basis.  It  is  bad  tax  policy.  It  is  bad  economic  policy.  It  does  not  make  business 
sense.  To  make  this  clear,  there  are  five  additional  points  I  would  like  to  highlight: 

1 .  In  general,  the  anticipated  effect  of  advertising  is  to  increase  sales  in  the  immediate  future. 
Thus,  capitalizing  a  portion  of  advertising  expenses  would  create  a  mismatching  of  income 
and  expense  that  penalizes  companies  that  advertise  to  increase  sales  of  their  products. 

2.  Devising  and  implementing  a  definition  of  "advertising"  for  tax  purposes  would  be 
extremely  difficult  and  would  add  a  great  deal  of  complexity  to  the  tax  law. 

3.  Increases  in  the  after-tax  cost  of  advertising  reduce  competition. 

4.  Requiring  amortization  of  advertising  expenses  would  result  in  the  needless  distortion  of 
business  practices. 

5.  Behavioral  responses  to  a  requirement  to  capitalize  advertising  would  eliminate  a 
significant  portion  of  the  anticipated  revenue  gain. 

Mismatching  Inwmc  and  Expense 

Under  current  law,  advertising  costs  are  subject  to  the  same  principles  as  other  business  expenses 
for  determining  whether  they  should  be  deducted  in  the  year  incurred,  as  so-called  "period  costs," 
or  whether  tiiey  should  be  capitalized  and  amortized  over  a  period  of  years.  The  tax  code  does 
not  provide  special  treatment  of  advertising.  Reciuring  expenditures  are  generally  found  to  be 
cuirentiy  deductible  because  the  need  to  renew  the  benefits  through  additional  expenditures  each 
year  suggests  a  useful  life  of  less  than  a  year.  Colorado  Springs  National  Bank  v.  U.S..505  F.2d 
1 185,  1 192(1 0th  Cir.  1974).  The  reason  for  currently  deducting  most  normal  recurring 
advertising  has  been  stated  as  follows: 

"The  reason  advertising  expenses  are  (currently  expensed)  is  tiiat  these  expenses 
are  generally  of  a  yearly  recurring  nature  resulting  from  a  regular  activity  of  a 
taxpayer  which  produces  new  business  on  a  relatively  consistent  basis  each  year." 
ManhaMn  Cq,  Qf  Virginia.  Ing.,  50  T.C.  at  86  (1968). 

The  reasoning  behind  the  argument  for  requiring  amortization  of  advertising  is  abstract:  a 
conceptual  argument  is  made  that  advertising  is  like  capital  spending  on  equipment  and  structures. 
However,  although  this  is  a  theoretically  intriguing  argument,  there  is  litde  evidence  to 
substantiate  such  a  claim.  If  anything,  economic  studies  show  that  the  value  of  most  advertising  is 
entirely  eliminated  within  one  year.  A  recent  study '  partially  co-autiiored  by  two  Nobel 
Laureates  in  economics.  Dr.  Kenneth  J.  Arrow  and  Dr.  George  G.  Stigler,  concludes: 

[A]lthough  there  are  a  number  of  economic  studies  that  suggest  that 
advertising  is  long-lived,  tiiey  are  generally  so  fraught  witii  errors  that  one  caruiot 
rely  on  their  findings.  When  we  correct  for  some  statistical  problems,  we  find  that 


'      Kenneth  J.  Arrow,  George  G.  Stigler,  Elisabeth  M.  Landes,  and  Andrew  M.  Rosenfeld, 
Economic  Analvsis  of  Proposed  Changes  in  Tax  Treatment  of  Advertising  Expenditures. 
Lexicon,  Inc.,  Chicago,  April  1990. 


1168 


the  estimated  duration  intervals  are  much  shorter  than  originally  thought 
Moreover,  there  are  a  number  of  studies  (particularly  more  recent  ones)  that 
suggest  that  advertising  depreciates  so  rapidly  that  virtually  all  of  its  effects  are 
gone  within  a  year.  In  short,  the  economic  evidence  does  not  support  the  view 
that  advertising  is  long-lived. ^ 

For  those  that  do  not  trust  economists-even  those  with  Nobel  prizes-it  is  important  to  check 
their  claims  against  a  little  common  sense.  Obviously,  a  large  proportion  of  all  advertising  refers 
to  offers  of  short  duration.  Retail  advertising  is  directed  at  the  sale  of  goods  direcUy  to 
consumers  within  a  short  period  of  time.  For  example,  weekly  newspaper  ads  by  a  local 
supermarket  announcing  the  price  of  lettuce  have  littie  value  next  month,  much  less  next  year. 
Classified  advertising  is  similar.  In  addition,  promotion  advertising  (e.g.  where  cents-off,  refunds, 
premiums,  or  coupons  are  offered)  is  designed  to  provide  an  incentive  for  immediate  sales  and,  in 
point  of  fact,  most  coupons  have  an  expiration  date  of  less  than  one  year.  Direct  marketing, 
through  mail  or  telephone  sales,  is  also  designed  to  generate  immediate  sales.  Industries  suffering 
from  financial  problems  advertise  for  quick  sales.  Seasonal  products  are  advertised  for  short 
periods  during  the  year  with  the  objective  of  selling  as  much  as  possible  during  that  time.  In 
addition,  a  large  portion  of  new  product  advertising  clearly  has  little  value  after  one  year  because 
the  products  themselves  often  do  not  exist  after  one  year.  Furthermore,  the  Federal  Trade 
Commission  regulates  the  length  of  time  that  certain  advertisements  can  run.  An  advertiser 
cannot  describe  a  product  as  "new"  for  a  period  of  time  longer  than  six  months.  SfiS  Advisory 
Opinion  Digest,  No.  120,  April  15, 1967;  Advisory  Opinion  Digest,  No.  146,  October  24,  1967. 
Finally,  advertising's  effects  "decay"  quickly  -  even  well-known  brands  that  stop  advertising 
experience  a  rapid  decline  in  sales.  Nevertheless,  a  proposal  requiring  amortization  of  advertising 
expenses  would  not  allow  a  complete  write-off  of  expenditures  until  years  after  such  expenditures 
rendered  any  value  to  the  business.  This  is  pure  mismeasurement  of  income,  and  a  pure  tax 
penalty  to  businesses  simply  trying  to  promote  their  products. 

Of  course,  we  can  all  imagine  instances  when  advertising  does  have  a  useful  life  in  excess  of  one 
year.  However,  there  is  no  need  to  change  the  law  to  achieve  the  proper  tax  treatment  in  these 
cases.  Under  present  law,  there  are  already  established  criteria  for  determining  whether 
advertising,  like  any  other  business  expense,  should  be  capitalized  and  amortized  over  a  number  of 
years.3 

CQmplgyitY 

Any  proposals  that  require  amortization  of  expenses  would  add  a  new  layer  of  mind-numbing 
complexity  to  the  tax  law.  A  description  of  legislation  to  implement  this  proposal  could  be 
deceptively  simple,  but  the  Treasury  regulations  interpreting  this  rule  will  be  extremely 
complicated  and  will  be  followed  by  years  of  controversies  between  taxpayers  and  the  IRS  over 
which  costs  are  non-deductible  advertising  expenses  and  which  may  be  considered  to  be  some 
other  deductible  business  expense. 

The  term  "advertising"  is  just  one  component  of  general  marketing  expenses  incurred  by  business. 
Advertising,  promotion,  and  marketing  expense  can  take  many  forms.  Product  demonstrations, 
trade  shows,  free  samples,  price  discounts,  phone  solicitations,  mail  solicitations  (including  mail 
order  catalogs),  on-site  solicitation,  public  relations,  and  community  service  are  all  methods  that 
businesses  use  to  promote  themselves  and  their  products.  It  is  unclear  which  of  these  are 
"advertising"  under  the  proposal  and  which  are  not. 


2ld.  at  39-40. 

3§£s,  e.g.,  Welch  v.  Helvering.  290  U.S.  1 1  (1933)  (payments  to  promote  development  of 
business  and  to  establish  goodwill  of  prospective  customers);  Cleveland  Electric  Illuminating  Co. 
V.  U.S..  7  CI.  Ct  220  (1985)  (advertising  expenditures  intended  to  lessen  public  fears  about  a 
nuclear  power  plant);  Best  Lock  Corp.  v.  Comm'r..  31  T.C.  1217,  1234-5  (1959)  (expenditures  to 
produce  trade  catalogues);  Rev.  Proc.  89-16,  1989-1  C.B.  822  (package  design  costs);  Rev.  Rul. 
68-283, 1968-2  C.B.  63  (advertising  to  promote  products  at  state  fair  operated  over  two  tax 
•years). 


1169 


The  end  result  would  be  tremendous  uncertainty  for  taxpayers  that  are  acting  in  good  faith  and 
trying  to  comply  with  the  law.  It  is  important  to  remember  that  advertising  expenditures  are 
undertaken  by  hundreds  of  thousands  of  corporations,  partnerships,  and  sole  proprietorships  of  all 
sizes.  Their  uncertainty  would  not  be  reduced  after  the  publication  of  dozens  of  pages  of 
regulations  (probably  three  to  five  years  after  passage  of  the  initial  statute).  Even  scarier  is  the 
specter  of  hundreds  and  perhaps  thousands  of  accountants  and  attorneys  who  would  be  hired  by 
private  business  to  defend  us  against  the  onslaught  of  controversy  with  IRS.  On  the  government 
side,  a  legion  of  IRS  agents  would  have  to  be  trained  in  the  intricacies  of  this  new  law.  Steep 
compliance  costs  for  business  as  well  as  large  administrative  costs  for  the  Federal  government 
need  to  included  in  your  consideration  of  any  proposal  to  require  amortization  of  advertising. 
Although  they  do  not  appear  in  any  official  revenue  estimate,  these  costs  are  very  real. 

Rgtfwccd  Compctitign 

As  any  economist  will  tell  you-whether  it  is  the  stock  market  or  the  supermarket-it  is 
mformation  that  makes  markets  function  efficienUy.  Advertising  provides  essential  information  to 
consumers  and  businesses  and  thereby  promotes  competition.^  When  a  business  advertises  price 
and  quality,  it  forces  competitors  to  lower  prices  and  increase  quality. 

Furthermore,  the  consiuner  benefits  from  advertising  are  not  only  information  about  the  specific 
product  of  the  company  sponsoring  the  advertising  but  are  often  also  general  information  about 
that  product  which  may  be  sold  by  a  number  of  companies.  This  "spillover"  benefit  of  advertising 
is  especially  large  for  new  products  and  more  complex  products.  In  such  cases,  there  is  concern 
that  there  is  too  little  advertising  and  the  last  thing  that  should  be  done  is  penalize  such 
advertising.  For  example,  consider  the  introduction  of  a  new  type  of  low-fat  shortening  used  in  a 
wide  variety  of  food  products.  It  certainly  may  be  a  benefit  for  society  as  a  whole  to  be  better 
informed  about  a  product  that  can  improve  public  health,  but  it  does  not  pay  for  any  one  firm  to 
do  tiiis  advertising.  Therefore,  less  advertising  is  undertaken  tiian  is  socially  optimal. 

Finally,  advertising  is  the  great  equalizer.  By  means  of  advertising,  new  entrants  with  lower-cost 
or  higher-quality  products  can  enter  into  a  market  and  may  take  on  existing  dominant  firms.  By 
breaking  down  "barriers  to  entry,"  advertising  greatiy  increases  the  competition  within  an  industry 
and  the  overall  competitiveness  of  the  economy.  Increasing  the  cost  of  advertising  will 
disproportionately  hurt  start-up  businesses  and  businesses  with  new  products  that  are  more 
dependent  on  advertising.  In  addition,  tiie  increased  cost  will  be  particularly  hannful  to  marginal 
businesses  that  depend  on  advertising  to  create  a  quick  boost  in  sales.  Small  business,  in 
particular,  will  be  hurt  by  this  proposal  because  they  are  very  dependent  on  advertising  for  short- 
term  sales  to  create  the  cash  to  build  their  business. 

Not  only  would  the  capitalization  of  advertising  result  in  reduced  competition  in  the  marketplace, 
but  also  it  would  put  U.S.  producers  of  goods  and  services  at  a  competitive  disadvantage  vis-k-vis 
foreign-owned  companies  selling  goods  in  tiie  United  States.  Virtually  all  of  our  trading  partners 
provide  a  deduction  for  advertising.  Therefore,  for  U.S.-owned  firms  the  cost  of  advertising  their 
products  will  be  higher  than  it  is  for  foreign-owned  firms. 

Pistgrtion  of  Pusiness  Practices 

If,  as  proposed,  the  current  deductibility  of  advertising  were  limited,  businesses  likely  would  shift 
their  marketing  activities  from  tiiose  falling  under  the  new  tax  definition  of  "advertising"  to  other 
similar  activities.  For  example,  in  response  to  this  new  tax  penalty,  a  business  might  reduce 
spending  on  "conventional"  advertising  and  instead  increase  the  size  of  its  sales  force  or  increase 
its  direct  mail  solicitation  even  though  these  methods  may  not  be  the  most  effective  means  of 
promoting  its  product  Thus,  purely  in  response  to  a  change  in  the  tax  law,  resources  would  be 
diverted  from  their  most  efficient  uses. 


4  See,  for  example,  Benham,  "The  Effect  of  Advertising  on  the  Price  Of  Eyeglass, "  Journal  of 
l.awanHFxonomics.  Vol..  15  (1972),  p.337. 


1170 


Those  businesses  that  rely  heavily  on  tax-disadvantaged  advertising  would  be  at  a  competitive 
disadvantage.  For  example,  a  clothing  retailer  that  relies  on  conventional  print  advertising  would 
be  put  at  a  competitive  disadvantage  with  a  clothing  mail-order  cataloger  who  relies  entirely  upon 
mailing  to  market  its  product. 

Similarly,  those  businesses  that  rely  heavily  on  providing  tax-disadvantaged  advertising  would  be 
at  competitive  disadvantage.  For  example,  television  stations  and  newspapers  would  suffer  at  the 
expenses  of  firms  that  perform  promotions  and  phone  solicitation. 

Revenue 

This  Subcommittee  is  currently  considering  a  proposal  to  capitalize  and  amortize  a  portion  of 
advertising  expenses  in  order  to  raise  revenue.  However,  behavioral  responses  to  the  proposal 
will  eliminate  a  significant  portion  of  the  anticipated  revenue  gain  as  businesses  seek  other  means 
to  market  their  goods  and  services.  However,  even  if  a  relatively  small  amount  of  revenue  were 
collected,  the  overall  burden  on  the  users  and  providers  of  advertising  would  still  be  large. 

Conclusion 

ThCTe  is  no  policy  justification  for  further  limiting  the  deductibility  of  advertising  beyond  the 
limitations  set  by  present  law.  Enactment  of  any  such  proposal  would  create  a  barrier  to 
expansion  of  markets  for  goods  and  services,  thereby  impeding  economic  growth  at  a  point  in 
time  when  economic  growth  is  desperately  needed.  In  addition,  such  a  proposal  would  reduce 
competition  by  restricting  information  flow  and  impeding  the  ability  of  new  entrants  to  challenge 
established  firms.  It  would  also  add  substantial  complexity  to  current  tax  rules. 


1171 

Mr.  KoPETSKi.  Our  next  witness  is  Mark  McConaghy,  former 
Chief  of  Staff  of  the  Joint  Committee  on  Taxation,  presently  the 
Managing  Partner  of  the  Washington  National  Tax  Services,  Price 
Waterhouse  Corp.  here  in  Washington,  D.C.  Welcome  back  to  this 
committee. 

STATEMENT  OF  MARK  MCCONAGHY,  MANAGING  PARTNER, 
WASHINGTON  NATIONAL  TAX  SERVICES,  PRICE 
WATERHOUSE,  WASHINGTON,  D.C,  ON  BEHALF  OF  AD  HOC 
GROUP  TO  PRESERVE  DEDUCTION  FOR  ADVERTISING 

Mr.  McCoNAGHY.  Thank  you,  Mr.  Chairman.  I  appreciate  the  op- 
portunity to  appear  before  the  subcommittee  today  to  discuss  the 
tax  policy  issues  relating  to  advertising  expenses.  I  am  testifying 
today  on  behalf  of  a  coalition  of  companies  with  a  common  goal  of 
retaining  the  current  tax  treatment  of  advertising  expenses. 

As  you  know,  before  the  subcommittee  is  a  proposal  to  limit  the 
current  business  deduction  for  advertising  expenses  as  a  part  of  a 
number  of  revenue-raising  proposals.  Such  proposals  are  not  new. 
They  have  been  considered  in  the  past  by  the  Ways  and  Means 
Committee  and  the  Senate  Finance  Committee.  For  a  number  of 
good  reasons.  Congress  has  declined  to  make  changes  in  this  area 
of  the  tax  law. 

I  would  like  to  focus  today  on  several  issues  relating  to  the  tax 
treatment  of  advertising  expenses  that  demonstrate  why  Congress 
should  continue  to  permit  the  current  deduction.  These  issues  are 
the  status  of  the  law  and  policy  issues  relating  to  the  treatment  of 
current  versus  capital  expenditures,  the  financial  statement  treat- 
ment of  advertising  expenses,  and,  finally,  the  administrative  com- 
plexity that  would  be  added  to  the  tax  law  if  such  proposals  were 
enacted. 

Advertising  is  an  ordinary  necessary  business  expense  permitted 
as  a  deduction  imder  section  162  of  the  Internal  Revenue  Code. 

The  allowance  of  that  deduction  reflects  the  net  income  concept 
underlying  the  U.S.  income  tax  system.  Under  a  net  income  con- 
cept, all  expenditures  that  are  not  contrary  to  public  policy  should 
be  recognized  either  as  a  current  deduction  or  a  future  deduction 
through  depreciation  or  amortization.  To  determine  when  the  ex- 
penditure is  recognized,  one  must  satisfy  two  concerns;  that  the  ex- 
penditure be  recognized  at  approximately  the  same  time  as  the  rev- 
enue to  which  it  relates  is  recognized  and  that  the  items  only  be 
recognized  when  they  can  be  measured  with  reasonable  certainty. 
Generally  an  expenditure  should  be  allowed  as  a  deduction  unless 
it  creates  some  measurable  future  benefit. 

The  fact  is  that  most  advertising  expenses  are  associated  with 
current  income.  For  example,  advertising  is  used  to  notify  consum- 
ers of  current  prices,  provide  information  about  new  models,  pro- 
vide industrial  customers  with  product  specifications,  and  direct 
consumers  to  retailers  who  stock  the  product.  To  limit  the  current 
deduction  of  the  cost  of  a  real  estate  listing  or  a  supermarket  ad- 
vertisement in  today's  newspaper  on  the  grounds  that  some  portion 
of  the  advertising  may  be  related  to  a  future  year's  income  is  just 
not  fair. 

To  go  down  the  road  suggested  by  the  proposal  before  the  sub- 
committee today  would  suggest  that  a  portion  of  all  of  our  salaries 


1172 

should  be  capitalized  to  reflect  the  fact  that  every  working  experi- 
ence we  encounter  in  our  jobs  will  train  us  for  future  workplace  ex- 
periences. Similarly,  such  an  argument  might  require  capitalization 
for  expenditures  relating  to  the  preparation  of  a  corporation's  fi- 
nancial statement,  a  portion  of  a  marketing  director's  salary  or  the 
costs  associated  with  a  corporate  strategic  planning  department 
since  these  expenditures  may  produce  some  future  benefit  to  the 
corporation. 

To  single  out  advertising  costs  from  other  period  costs  that  are 
currently  deductible  does  not  represent  sound  tax  policy.  Moreover, 
any  lines  that  are  drawn  between  advertising  costs  and  other  cor- 
porate expenditures  will  give  an  advantage  to  certain  approaches 
to  marketing  as  compared  to  others.  It  is  for  these  reasons  that  the 
financial  accounting  principles  have  required  that  advertising  be 
deducted  currently  and  have  allowed  the  capitalization  of  advertis- 
ing expenses  only  in  very  limited  circumstances. 

This  position  has  recently  been  reviewed  and  affirmed  by  the  fi- 
nancial accountants  in  the  AICPA  and  accepted  and  cleared  for 
final  issuance  by  the  Financial  Standards  Accounting  Board. 

The  AICPA  concluded  that  capitalizing  advertising  expenses  gen- 
erally should  not  be  permitted  due  to  tne  difficulty  in  identifying 
and  isolating  future  benefits  that  arise  from  those  expenditures. 
While  the  tax  and  financial  statement  treatment  of  an  expense  do 
not  necessarily  have  to  be  the  same,  in  the  case  of  advertising  a 
common  issue  drives  both  tax  and  accounting  treatment.  It  is  sim- 
plv  too  difficult  to  identify  and  measure  the  asset  that  is  produced 
when  expenditures  are  made  on  advertising. 

Current  tax  law  already  addresses  instances  where  the  future 
benefit  of  advertising  expenses  extend  significantly  beyond  the  pe- 
riod in  which  the  expenditures  are  incurred.  In  such  cases,  adver- 
tising expenses  are  capitalized. 

Finally,  distinguishing  those  advertising  expenses  for  which  a  de- 
duction would  not  currently  be  allowed  would  create  administrative 
nightmares  for  both  the  IRS  and  taxpayers.  Even  if  Congress  were 
to  limit  the  current  deductibility  to  an  arbitrary  percentage,  the 
IRS  and  taxpayers  would  still  be  thrown  into  endless  controversies 
over  resolving  which  marketing  and  other  expenditures  would  con- 
tinue to  be  deducted  currently. 

What  would  be  the  treatment,  for  example,  of  product  inventory 
discounts,  or  giveaway  promotions  that  are  utilized  to  launch  a 
product?  What  about  the  sponsorship  of  public  events,  the  prepara- 
tion of  point  of  sale  materials  such  as  brochures,  or  something  as 
simple  and  basic  as  printing  business  cards?  The  list  goes  on  and 
on  and  the  definitional  issues  would  be  tremendous. 

Any  limitation  on  the  deductibility  of  advertising  expenses  would 
require  that  rules  and  tests  be  established  for  all  these  activities 
and  expenditures  which  are  generally  deductible  under  present 
law.  It  would  be  extremely  difficult  for  the  IRS  to  write  and  admin- 
ister any  rules  that  distinguish  between  these  costs. 

In  summary,  I  would  like  to  thank  the  subcommittee  for  permit- 
ting me  the  opportunity  to  testify  on  this  issue  today.  Furthermore, 
I  would  like  to  urge  the  subcommittee  to  continue  to  heed  the  prin- 
ciples of  tax  reform  and  simplification  as  it  considers  revenue-rais- 
ing proposals.  Proposals  requiring  a  portion  of  advertising  costs  to 


1173 

be  capitalized  run  counter  to  those  principles  by  needlessly  com- 
plicating the  tax  law  and  wasting  precious  Government  and  tax- 
payer resources  on  litigation  and  record  keeping. 

Mr.  Chairman,  I  would  like  permission  to  submit  a  written  state- 
ment for  the  hearing  record  and  would  be  pleased  to  answer  ques- 
tions. 

Mr.  Payne  [presiding].  Without  objection,  so  ordered,  and  thank 
you  for  your  testimony. 

[The  prepared  statement  follows:] 


1174 


STATEMENT  OF  MARK  McCONAGHY 
AD  HOC  GROUP  TO  PRESERVE  THE  DEDUCTION  FOR  ADVERTISING 

I.    SUMMARY 

My  name  is  Mark  McConaghy  and  I  am  the  managing  partner  of  Price  Waterhouse's 
Washington  National  Tax  Services  office.   I  appreciate  the  opportunity  to  appear  before  the 
subcommittee  today  to  discuss  the  tax  and  financial  accounting  issues  relating  to  advertising 


I  am  testifying  today  on  behalf  of  a  coalition  of  companies  and  trade  associations  with  the 
common  goal  of  retaining  the  current  tax  treatment  of  advertising  expenses.  A  list  of  the 
members  of  the  coalition  is  included  at  the  end  of  this  testimony. 

As  you  know,  before  the  subcommittee  is  a  proposal  to  limit  the  current  business  deduction 
for  advertising  expenses  as  one  of  a  number  of  miscellaneous  revenue-raising  proposals. 
Such  proposals  are  not  new;  they  have  been  considered  in  the  past  by  both  the  House  Ways 
and  Means  Committee  and  the  Senate  Finance  Committee. 

For  a  number  of  sound  reasons,  Congress  has  declined  to  make  changes  in  this  area  of  the 
tax  law.   I  would  like  to  focus  today  on  several  issues  relating  to  the  tax  treatment  of 
advertising  expoises  that  demonstrate  why  Congress  should  continue  to  permit  the  current 
deduction.  These  are  as  follows: 

•  The  policy  issues  relating  to  the  treatment  of  current  versus  cs^ital  expenditures. 

•  The  &iancial  accounting  treatment  of  advertising  expoises. 

•  The  administrative  complexity  that  would  be  added  to  the  tax  law  if  such  proposals 
were  enacted. 


n.  BACKGROUND  AND  TAX  POUCY  ISSUES 

Matching  and  Measurability 

Advertising  is  an  ordinary  and  necessary  business  expense  permitted  as  a  deduction  under 
Internal  Revenue  Code  Section  162(a).  The  allowance  of  the  deduction  reflects  the  net 
income  concq)t  underlying  the  U.S.  income  tax  system. 

Under  a  net  income  concq>t,  all  ordinary  and  necessary  business  expenditures  (not  contrary 
to  public  policy)  should  be  recognized  either  as  a  current  deduction  or  as  a  future  deduction, 
through  depreciation  or  amortization.   To  determine  when  the  expenditure  is  recognized,  one 
must  satisfy  two  tax  policy  concerns  that  permeate  our  income  tax  system  -  the  need  to 
match  deductions  and  income,  and  the  practical  requirement  that  items  of  income  and 
expense  be  recognized  when  they  can  be  accurately  measured. 

The  matching  of  income  and  expenditures  results  in  a  more  accurate  calculation  of  net 
income.  Thus,  expenditures  generally  are  required  to  be  c^italized  -  and  amortized  and 
deducted  over  a  period  -  if  they  produce  significant  income  over  a  period  that  is  longer  than 
one  year.  The  accurate  calculation  of  net  income  also  requires  that  items  be  recognized 
when  they  can  accurately  be  measured.   Requiring  an  expenditure  to  be  capitalized  where  the 
future  benefit  to  be  derived  from  the  expenditure  is  merely  speculative  does  not  accurately 
measure  income.   Generally,  an  expenditure  is  and  should  be  allowed  as  a  current  deduction 
unless  it  creates  a  measurable  future  benefit. 

The  fact  is  that  advertising  expenses  are  associated  with  current  income.   For  example, 
advertisements  are  used  to  notify  consumers  of  current  prices,  provide  information  about  new 
models,  provide  industrial  customers  with  product  specification,  and  direct  consumers  to 
retailers  who  stock  the  product.   To  limit  the  current  deduction  of  the  cost  of  a  real  estate 
listing  or  a  supermarket's  advertisement  in  today's  newspiq>er  on  grounds  that  some  portion 
of  the  advertising  may  be  related  to  a  future  year's  income  is  clearly  unfoir.    It  is  extremely 


1175 


difficult  to  identify  the  benefits  of  advertising  that  stretch  beyond  a  relatively  short  period  of 
time.   If  it  is  possible  that  some  future  benefit  may  be  derived  from  advertising,  that  future 
benefit  is  neither  demonstrable  nor  suscq)tible  to  measurement. 

It  is  also  important  to  recognize  that  advertising  expenses  generally  represait  a  risky 
investment.   No  one  knows  whether  a  new  ad  campaign  will  be  successful  or  how  long  the 
effects  of  advertising  will  last. 

Large  corporations  that  undertake  so-called  goodwill  or  institutional  advertising  to,  among 
other  things,  improve  consumer  recognition  of  the  company  and  its  products  generally  do  so 
on  a  regular  basis.   There  is  little  or  no  expectation  that  the  benefits  of  this  advertising  will 
last  for  a  significant  period  of  time.  It  is  extremely  unlikely  that  a  corporation  could 
measure  whether  institutional  advertising  produced  any  increase  in  sales  over  the  long  run. 
There  is  no  method  that  exists  for  identifying  and  measuring  those  lasting  benefits,  if  such 
benefits  do  in  fact  exist. 

In  many  respects,  advertising  expenditures  that  are  longer  lasting  are  similar  to  outlays  for 
research  and  developm«it.   They  may  produce  income  in  future  years,  but  the  amount  and 
duration  of  those  returns  are  very  uncertain.   Congress  has  continued  to  reaffirm  the  current 
deductibility  of  research  and  developmental  expenditures.    Congress  has  done  so  not  only  as 
an  incentive  but  also  in  recognition  of  the  fact  that  requiring  the  capitalization  of  such 
expenditures  would  create  difficult  administrative  problems  and  would  not  necessarily 
produce  a  better  measure  of  net  income. 

The  proposal  before  the  committee  to  limit  the  current  deduction  for  a  portion  of  advertising 
expenditures  supposes  the  use  of  an  arbitrary  capitalization  rule  that  is  not  designed  to 
accurately  measure  net  income.   For  example,  if  it  were  assumed  that  virtually  all 
companies'  advertising  provides  no  future  benefit,  any  average  capitalization  rate  would 
mismeasure  the  net  income  of  those  companies.     The  average  capitalization  rate  would  also 
not  be  correct  for  the  very  small  percentage  of  companies  whose  advertising  was  presumed  to 
provide  a  future  benefit.  Thus,  such  an  approach  can  never  adequately  or  accurately  match 
income  and  deductions.   It  would  be  inaccurate  for  virtually  all  taxpayers. 

Copparison  with  othgr  pgriod  costs 

Treating  a  portion  of  advertising  costs  as  a  capitalizable  item  would  set  a  very  disturbing 
precedent.   It  would  suggest  that  a  portion  of  any  ordinary  and  necessary  business 
expenditure  could  be  capitalized  if  it  includes  a  component  that  produces  a  speculative  future 
benefit. 

In  performing  our  jobs,  each  of  us  learns  how  to  perform  the  job  better.   Every  working 
experience  we  encounter  in  our  jobs  trains  us  to  handle  future  work  place  experiences.   Yet 
few  would  suggest  that  an  arbitrary  portion  of  each  of  our  wages  should  be  capitalized  in 
order  to  reflect  that  potential  future  benefit  to  our  employers. 

Similarly,  it  could  be  argued  that  expenditures  relating  to  the  preparation  of  a  corporation's 
financial  statement  or  the  costs  associated  with  a  corporate  strategic  planning  department  will 
produce  some  future  benefit  to  the  corporation,  and  thus  should  be  c^italized.   There  is  also 
a  future  benefit  in  making  expaiditures  to  ensure  that  a  company  is  complying  with  federal 
and  state  regulations.  Yet,  in  none  of  these  cases  is  capitalization  appropriate  or  desirable 
because  the  future  benefit  is  speculative  and  uncertain. 

To  single  out  advertising  costs  from  other  period  costs  that  are  currently  deductible  simply 
does  not  represent  sound  tax  policy.    Moreover,  any  lines  that  are  drawn  between 
advertising  costs  and  other  corporate  expenses  will  give  an  advantage  to  certain  ^proaches 
to  marketing  as  compared  to  others.   For  example,  retailers  that  must  advertise  on  a  regu'ir, 
weekly  basis  in  order  to  bring  consumers  into  their  stores  would  be  disadvantaged  by  the 
proposal. 


1176 


Current  Tax  Law  Adequately  Addresses  Future  Benefits 

Current  tax  law  already  addresses  instances  where  the  future  benefit  of  advertising 
expenditures  extends  significantly  beyond  the  period  in  which  the  expenditures  are  incurred. 
In  such  cases,  advertising  expenditures  are  capitalized. 

For  example,  where  advertising  expenditures  are  incurred  in  connection  with  placing 
depreciable  property  in  service,  the  advertising  costs  must  be  capitalized  into  the  cost  of  the 
property.   Thus,  in  Cleveland  Electric  Dluminating  Co.  v.  U.S..  7  CI.  Ct.  220  (1985), 
advertising  expenditures  made  by  a  utility  to  ease  the  public's  fear  of  nuclear  power  related 
to  the  construction  of  a  nuclear  power  plant  were  required  to  be  recovered  as  the  plant  was 
depreciated. 

Advertising  expenditures  that  result  in  identifiable  tangible  assets  with  useful  lives,  such  as 
the  purchase  of  a  blimp,  are  currently  required  to  be  capitalized  for  Federal  income  tax 
purposes.   Expenditures  that  result  in  identifiable  intangible  assets  that  will  be  used 
repeatedly  in  future  advertising  campaigns  must  also  be  capitalized. 

There  are  other  examples  where  the  law  clearly  provides  for  the  capitalization  of  large,  one- 
time expenditures  associated  with  the  creation  of  a  tangible  or  intangible  asset  with  a  life  that 
extends  beyond  one  year.   In  each  of  these  situations  an  asset  that  could  be  exploited  for 
future  benefit  had  clearly  been  brought  into  existence.   On  the  other  hand,  the  more  common 
types  of  advertising  do  not  generate  such  an  asset.   In  the  absence  of  the  generation  of  an 
asset  that  will  demonstrably  contribute  to  a  future  income  stream,  a  current  deduction  is 
appropriate. 


in.      FINANCIAL  ACCOUNTING  ISSUES 

The  inability  to  establish  and  measure  the  future  economic  benefit  of  advertising  is  the 
primary  reason  that  financial  accounting  principles  have  required  almost  all  advertising  to  be 
expensed  currently,  and  has  allowed  capitalization  in  only  very  limited  circumstances. 

The  American  Institute  of  Certified  Public  Accountants  recently  J^jproved  a  Statement  of 
Position  (SOP)  entitled,  "Reporting  on  Advertising  Costs"  that  was  prepared  by  its 
Accounting  Standards  Executive  Committee  (AcSEC).  The  SOP  was  approved  and  cleared 
for  final  issuance  by  the  Financial  Accounting  Standards  Board  (FASB)  on  June  10,  1993. 
Accordingly,  the  SOP  may  be  considered  an  explanation  of  the  application  of  generally 
accepted  accounting  principles. 

The  SOP  requires  that  the  costs  of  advertising  be  expensed  on  a  company's  financial 
statements  either  as  incurred  or  as  of  the  first  time  the  advertising  takes  place,  unless  the 
advertising  is  direct-response  advertising  that  results  in  probable  future  economic  benefits  or 
results  in  the  acquisition  or  creation  of  a  tangible  asset  with  use  beyond  the  current 
advertising  campaign  (such  as  the  above-noted  blimp). 

In  preparing  the  SOP,  the  AcSEC  rejected  the  notion  that  advertising  costs  that  are  not 
related  to  tangible  assets  ~  other  than  direct-response  advertising  expenditures  -  be 
c^italized  because  "future  benefits  beyond  the  first  time  the  advertising  takes  place  are  too 
uncertain  and  are  not  demonstrable  or  measurable  with  the  degree  of  precision  required  to 
recognize  an  asset." 

The  AcSEC  concluded  that  the  ability  to  identify  and  isolate  future  benefits  has  improved 
because  of  greater  sophistication  of  data-gathering  and  analysis,  based  on  econometiic  models 
and  scanner  studies.   However,  the  AcSEC  maintained  that  most  advertising  should  be 
expensed  and  that  capitalization  of  most  advertising  should  be  prohibited  because  the  benefits 
are  not  measurable  "with  the  degree  of  precision  required  to  report  an  item  in  the  financial 
statements." 


1177 


The  financial  accounting  and  tax  treatment  of  particular  business  expenditures  do  not 
necessarily  have  to  be  the  same.   In  fact,  the  financial  accounting  treatment  of  advertising 
costs  should  be  only  one  factor  taken  into  account  in  determining  the  tax  accounting 
treatment  of  such  costs.   However,  the  theory  behind  capitalization  for  both  financial  and  tax 
accounting  principles  is  the  same  --  that  the  period  in  which  expenses  are  deducted  should 
match  the  period  in  which  the  income  generating  those  expenses  was  earned.   In  general,  for 
both  tax  and  financial  accounting  purposes,  advertising  costs  match  income  earned  in  the 
current  year. 

Direct  Response  Advertising 

The  AcSEC  determined  that  the  only  exception  to  the  concept  that  advertising  be  expensed 
for  financial  accounting  purposes  should  be  in  the  case  of  direct-response  advertising. 
Direct-response  advertising  is  advertising  that  is  expected  to  result  in  a  decision  to  buy  an 
entity's  products  or  sovices  by  customers  who  can  be  shown  to  have  responded  specifically 
to  the  advertising.   In  order  to  sustain  such  a  showing,  documentation  demonstrating  the 
customer  has  responded  to  a  specific  advertisement  is  required.   Where  capitalization  of 
direct-response  advertising  is  allowed  by  the  SOP,  it  is  expected  that  the  period  over  which 
the  benefits  of  direct-response  advertising  are  amortized  would  usually  be  short. 


IV.       ISSUES  OF  ADMINISTERABILITY  AND  COMPLEXITY 

Distinguishing  those  advertising  expenditures  for  which  a  deduction  would  not  be  currently 
allowed  would  create  administrative  nightmares  for  both  the  IRS  and  taxpayers.   Even  if 
Congress  were  to  limit  the  current  deductibility  to  an  arbitrary  percentage,  the  IRS  and 
taxpayers  would  still  be  thrown  into  endless  controversies  over  resolving  which  marketing 
and  other  expenditures  would  continue  to  be  deductible  currently. 

Direct  payments  to  the  media  for  placing  advertisements  may  more  easily  fall  within  a 
simplified  definition  of  advertising.   However,  the  line  between  direct  advertising 
expenditures  and  other  product  marketing  costs  is  very  difficult  to  draw.     What  would  be  the 
treatment,  for  example  of  product  introductory  discounts,  or  even  giveaway  promotions  that 
are  utilized  to  launch  a  product?   What  about  the  sponsorship  of  public  events,  the 
preparation  of  point-of-sale  materials,  such  as  brochures,  or  something  as  simple  and  basic  as 
printing  business  cards?  The  list  goes  on  and  on. 

Such  a  proposal  would  require  additional  recordkeeping  to  c^ture  costs  for  a  category  of 
business  expense  arbitrarily  carved  out  from  other  ordinary  and  necessary  business  costs. 
Taxpayers  probably  would  be  required  to  maintain  records  of  their  advertising  and  other 
marketing  expenses  for  lengthy  periods.   Moreover,  the  discrq)ancy  between  financial  and 
tax  accounting  that  would  be  created  under  the  proposal  would  require  taxpayers  to  create 
new  reconciliations  of  these  differences  to  be  accounted  for  on  Form  1 120.    While 
businesses  identify  "advertising  costs"  on  their  tax  returns  now,  most  businesses  do  not 
undertake  the  recordkeqring  necessary  to  distinguish  advertising  from  promotional  costs,  or 
to  allocate  payroll  to  reflect  time  an  employee  may  spend  in  reviewing  an  advertising 
campaign,  for  example. 

Any  limitation  on  the  deductibility  of  advertising  expenditures  would  require  that  rules  and 
tests  be  established  for  all  these  activities,  the  expenditures  for  which  generally  are  deductible 
under  current  law.   It  would  be  extremely  difficult  for  the  IRS  to  write  and  administer  any 
rules  that  distinguish  between  these  costs. 


V.        REVENUE  CONSIDERATIONS 

A  principal  reason  for  proposals  to  limit  the  current  deduction  for  advertising  have 
traditionally  been  the  revenue  that  such  proposals  would  generate.   It  is  not  sound  tax  policy 
to  adopt  rules  that  result  in  the  mismeasurement  of  net  income  solely  to  raise  revenue. 


1178 


It  should  also  be  noted  that  a  proposal  to  require  capitalization  and  amortization  of  some  or 
all  advertising  expenditures  is  a  timing  issue,  not  an  issue  of  reducing  total  deductions 
permitted  to  the  taxpayer.   Deferral  of  advertising  deductions  could  increase  revenue  initially 
through  a  substantial  one-time  effect,  but  would  otherwise  raise  only  modest  additional 
revenue  in  later  years.   Thus,  any  five-year  revenue  estimate  would  greatly  overstate  the 
long-run  revenue  effect  of  such  proposals. 


VI.      CONCLUSION 

Congress  in  general,  and  this  subcommittee  in  particular,  should  reject  any  proposal  to 
capitalize  a  portion  of  advertising  expenses.   Such  a  proposal  would  result  in  less  accurate 
measurement  of  net  income,  would  deviate  firom  well-established  principles  of  financial 
accounting,  and  would  create  new  and  unnecessary  compliance  burdens  for  taxpayers  as  well 
as  increase  the  administrative  burden  on  the  IRS.  While  such  a  proposal  would  raise  some 
"one-time"  revenue,  it  would  do  so  at  the  cost  of  permanent  inaccuracies  in  the  measurement 
of  net  income  and  permanent  inefficiencies  in  the  administration  of  the  tax  system. 


Ad  Hoc  Group  to  Preserve  the  Deduction  for  Advertising 

Borden,  Inc. 

Campbell  Soup  Company 

E.I.  Du  Pont  De  Nemours  and  Company 

Eastman  Kodak  Company 

General  Mills,  Inc. 

General  Motors  Corporation 

Goodyear  Tire  &  Rubber  Company 

Hallmark  Cards,  Inc. 

Hasbro,  Inc. 

Hewlett-Packard  Company 

Kellogg  Company 

Merck  &  Co.,  Inc. 

NATIONAL  ASSOCL^TION  OF  REALTORS* 

NKE,  Inc. 

NYNEX  Corporation 

Owens-Coming 

PepsiCo,  Inc. 

Pillsbury 

Sara  Lee  Corporation 


1179 

Mr,  Payne.  Our  last  witness  of  this  panel  represents  the  Adver- 
tising Tax  Coalition,  Timothy  White,  who  is  a  publisher  of  Times 
Union,  Albany,  N.Y.;  and  my  good  friend  DeWitt  Helm,  the  presi- 
dent of  the  Association  of  National  Advertisers,  New  York,  N.Y. 
DeWitt  and  I  were  business  colleagues  in  Virginia.  We  never 
thought  at  that  time  we  would  be  seeing  each  other  in  this  setting. 
Welcome  to  the  Ways  and  Means  Committee. 

STATEMENT  OF  TIMOTHY  WHITE,  PUBLISHER,  TIMES  UNION, 
ALBANY,  N.Y^  ON  BEHALF  OF  THE  ADVERTISING  TAX  COALI- 
TION AND  THE  NEWSPAPER  ASSOCIATION  OF  AMERICA 

Mr,  White.  Thank  you  for  the  introduction.  In  addition  to  being 
publisher  of  the  Times  Union,  a  daily  newspaper  with  a  circulation 
of  103,000  dailv  and  a  Sunday  edition  of  160,000,  additionally  I  ap- 
pear on  behalf  of  the  Newspaper  Association  of  America  and  the 
Advertising  Tax  Coalition. 

The  Newspaper  Association  of  America  represents  approximately 
1,250  newspapers  in  the  United  States  and  Canada.  The  majority 
are  newspapers  that  account  for  more  than  80  percent  of  the  total 
dailv  circulation  in  the  United  States. 

The  Advertising  Tax  Coalition  consists  of  10  national  trade  asso- 
ciations of  which  the  newspaper  association  is  one  member. 

As  our  country  struggles  to  emerge  from  this  recession,  the  last 
thing  we  need  or  anyone  needs  is  a  reason  not  to  advertise.  Public 
policy  should  be  encouraging  manufacturers,  retailers  and  service 
providers  to  reach  out  to  new  customers  through  advertising  in  an 
effort  to  break  this  recession  and  to  get  the  economy  growing  again. 
A  tax  on  advertising  would  have  the  opposite  effect. 

The  present  law  treatment  of  advertising  costs  represents  sound 
tax  policy.  It  reflects  the  reality  that  the  cost  of  advertising  is  just 
as  essential  to  the  operation  of  a  business  as  the  salaries  of  its  em- 
ployees, the  rent  for  its  space  or  the  gasoline  for  the  cars  used  by 
the  sales  staff. 

It  is  impossible  to  distinguish  between  advertising  and  all  other 
marketing  expenses  or  promotion  and  sales  expenses.  Limiting  ad- 
vertising expense  deductibility  would  mean  that  sales  staff  meet- 
ings to  discuss  new  sales  techniques  would  be  fully  deductible,  but 
not  meetings  to  review  the  latest  ad  campaign. 

Another  reason  to  currently  deduct  the  cost  of  advertising  is  that 
it  is  an  expense  that  must  be  repeated  or  even  increased  from  year 
to  year,  reflecting  the  fact  that  advertising  does  not  stay  around  to 
create  ongoing  sales.  Buying  advertising  does  not  buy  an  asset  for 
a  company.  The  overwhelming  volume  of  newspaper  advertising  is 
designed  to  alert  the  reader  to  the  availability  of  a  certain  product 
or  service  at  a  certain  price  under  certain  conditions  and  most 
often  at  a  specific  time  and  location. 

Take  a  look  at  this  copy  of  last  Sunday's  edition  of  the  Times 
Union.  We  have  some  advertising  on  the  back  page  of  the  A  section 
by  Olender  Furniture  and  Sleep  Shop,  a  local  enterprise  promoting 
a  12-hour  Labor  Day  sale.  Just  inside  we  have  a  Filene's  Labor 
Day  clearance  sale,  and  on  page  2  an  optician  promoting  free  eye 
exams  to  returning  students. 

Where  is  the  residual  asset  value  for  the  retailers  whose  lifeblood 
is  promoting  tomorrow's  special  offer  on  a  gallon  of  milk,  a  Mercury 


1180 

Marquis  or  back  to  school  overalls?  Most  consumer  businesses,  es- 
pecially retailers,  have  two  things  in  common.  First,  they  already 
operate  on  razor  thin  profit  margins  and,  second,  advertising  ex- 
pense represents  a  significant  portion  of  their  total  operating  costs. 

Reduce  the  deductibility  of  those  advertising  expenses  and  you 
unfairly  pressure  an  already  stressed  sector  of  our  private  econ- 
omy. Two  Nobel  laureates  in  economics,  the  late  George  Stigler  and 
Dr.  Kenneth  Arrow,  wrote  a  paper  for  the  Advertising  Tax  Coali- 
tion stating  that  "Advertising  is  a  powerful  tool  of  competition.  It 
provides  valuable  information  about  products  and  services  in  an  ef- 
ficient and  cost-effective  manner.  In  this  way  advertising  helps  the 
economy  to  function  smoothly,  it  keeps  prices  low  and  facilitates 
the  entry  of  new  products  and  new  firms  into  the  marketplace." 

The  ads  in  this  edition  of  the  Times  Union  offer  our  readers  a 
potpourri  of  choices  between  vegetables  and  cuts  of  meat  at  com- 
peting grocery  stores,  new  automobiles  at  various  Albany  dealer- 
ships, or  new  jobs  with  employers  competing  for  a  variety  of  em- 
ployee skills.  Without  advertising,  consumers  would  have  to  search 
on  their  own  for  information  about  the  existence  and  identity  of 
sellers  and  the  prices  they  charge. 

Certainly  no  one  has  to  explain  to  a  newspaper  publisher  how 
dramatically  advertising  fosters  competition.  During  the  past  30 
years  our  country  has  witnessed  a  virtual  explosion  of  alternative 
information  sources  in  every  community  in  the  United  States.  In 
the  14-county  Albany  area  alone,  for  instance,  there  are  11  other 
dailv  newspapers,  four  local  network  affiliated  TV  stations,  20  net- 
work affiliated  radio  stations,  16  independent  radio  stations,  a 
cable  advertising  network  with  three  franchises  reaching  142,000 
homes,  6  outdoor  billboard  advertising  companies,  and  more  than 
48  weekly  community  newspapers  and  shoppers.  These  100+  media 
companies  together  with  direct  mail  and  yellow  pages  advertising 
compete  for  the  annual  $330  million  spent  in  this  relatively  small 
marketplace  alone. 

Since  more  than  80  percent  of  the  ad  dollars  spent  in  this  mar- 
ketplace are  spent  with  competitors  of  the  Times  Union,  I  am  re- 
minded daily  of  the  role  advertising  plays  in  stimulating  diversity 
and  competition  in  American  media. 

In  conclusion,  I  cannot  conceive  of  a  tax  proposal  that  more  vio- 
lates our  American  concept  of  fair  play  or  a  level  playing  field  than 
does  the  proposal  to  limit  the  current  deduction  for  advertising  ex- 
penses, nor  can  I  think  of  a  tax  proposal  that  is  more  counter- 
productive at  a  time  when  we  are  attempting  to  stimulate  our  na- 
tional and  local  economies. 

Mr.  Chairman,  this  subcommittee  has  a  challenging  task  to  meet 
the  revenue  needs  of  this  country,  and  I  appreciate  the  difficulty 
of  your  job.  Nevertheless,  we  believe  that  the  proposal  to  limit  the 
deductions  for  advertising  costs  would  be  unfair  and  anticompeti- 
tive and  would  only  contribute  to  slow  growth  or  no  growth  in  our 
economy.  We  strongly  urge  you  to  reject  this  proposal.  Thank  you. 

[The  prepared  statement  follows:] 


1181 


Statement  By  Tim  White 

On  BEHALF  Of 

THE  NEWSPAPER  ASSOCIATION  OF  AMERICA 

AND 

THE  ADVERTISING  TAX  COALITION 

BEFORE  THE 

SuBCOMMirrEE  ON  Select  Revenue  Measures 

COMMITTEE  on  WAYS  AND  MEANS 

u.s.  house  of  representatives 
Washington,  D.  C. 

September  8, 1993 


Mr.  Chairman,  and  Members  of  the  Subcommittee,  my  nsime  is  Tim  White, 
and  I  am  publisher  of  the  Times  Union  of  Albany,  New  York,  a  daily  newspaper 
with  a  circulation  of  106,000,  and  a  Sunday  edition  circulation  of  160,000.  I  am 
appearing  today  on  behalf  of  the  Newspaper  Association  of  America  (NAA)  and  the 
Advertising  Tax  Coalition,  of  which  NAA  is  a  member. 

The  Newspaper  Association  of  America  is  a  non-profit  trade  association 
representing  approximately  1,250  newspapers.  NAA  members  account  for  more 
than  80  percent  of  U.S.  daily  and  Sunday  newspaper  circulation.  Many  non-daily 
newspapers  also  are  members  of  NAA. 

The  Advertising  Tax  Coalition  consists  often  national  trade  associations, 
including  NAA.  The  other  members  of  the  Advertising  Tax  Coalition  include: 
American  Advertising  Federation,  the  American  Association  of  Advertising 
Agencies,  the  Association  of  National  Advertisers,  the  Direct  Marketing  Associatio 
the  Grocery  Manufacturers  of  America,  the  Magazine  Publishers  of  America,  the 
National  Association  of  Broadcasters,  the  National  Newspaper  Association,  and  thi 
Yellow  Pages  Publisher's  Association. 

As  our  country  struggles  to  emerge  from  this  recession,  the  last  thing  we 
need,  or  anyone  needs,  is  a  reason  not  to  advertise.  Public  policy  should  be 
encoxu-aging  manufacturers,  retailers,  and  service  providers  to  reach  out  to  new 
customers  through  advertising,  in  an  effort  to  break  this  recession,  and  to  get  the 
economy  growing  again.  A  tax  on  advertising  would  have  the  opposite  effect: 

First,  the  present  law  treatment  of  advertising  costs  represents  soxmd  tax 
pohcy.  It  reflects  the  reality  that  the  cost  of  advertising  is  indistinguishable  from 
£my  other  marketing  cost,  whether  for  direct  promotion,  point  of  sales  promotion, 
discoimt  promotions,  or  the  salaries  of  sales  personnel.  The  cost  of  advertising  is 
just  as  essential  to  the  operation  of  a  business  as  the  salaries  of  its  employees,  the 
rent  for  its  space,  or  the  gasoline  for  the  sales  staffs  cars. 

Second,  it  is  impossible  to  distinguish  between  advertising  and  all  other 
marketing  expenses,  or  promotion  and  sales  expenses.  Sales  staff  meetings  to 
discuss  new  sales  techniques  would  be  fully  deductible,  but  not  meetings  to  review 
the  latest  ad  campaign. 

Third,  another  reason  to  ciurently  deduct  the  cost  of  advertising  is  that  it 
represents  a  period  cost  —  the  amount  spent  on  it  must  be  repeated  or  increased 
from  year  to  year,  which  reflects  the  fact  that  advertising  does  not  stay  aroxmd  to 
create  ongoing  sales.  Buying  advertising  does  not  buy  an  asset  for  a  company.  Th< 
overwhelming  volume  of  newspaper  advertising  is  designed  to  alert  the  reader  to 
the  availability  of  a  certain  product  or  service,  at  a  certain  price,  vmder  certain 
conditions,  and  often  at  a  specific  location.  It  would  not  take  a  Times  Union  reade 
long  to  reach  that  conclusion  without  the  benefit  of  economic  research.  Just  take  a 
look  at  this  copy  of  last  Sunday's  edition  of  the  Times  Union  --  we  have  advertising 
for  Olender  Furniture  and  Sleep  Shop  ("91  Years  of  Good  Family  Business"), 
promoting  a  12-hour  Labor  Day  Sale.  We  have  Filene's  Labor  Day  Clearamce  Sale, 
and  on  Page  A2  we  have  an  ad  for  a  local  optician  offering  returning  students  free 
eye  exams. 


77-130  0 -94 -6 


1182 


Where  is  the  residual  asset  value  for  the  thoussuids  (no,  millions)  of  retailers 
whose  life-blood  is  promoting  tomorrow's  special  offer  on  a  gallon  of  milk,  a  Mercur 
Marquis,  or  back-to-school  overalls?  Most  consumer  businesses  -  and  especially 
retailers  --  have  two  things  in  common:  (1)  They  already  operate  on  razor- thin 
profit  margins,  and  (2)  Advertising  expense  represents  a  significant  portion  of  thei 
total  operating  costs.  Reduce  the  deductibihty  of  those  advertising  expenses  and 
you  unfairly  pressure  an  already-stressed  sector  of  our  private  economy. 

Two  Nobel  Laureates  in  economics,  the  late  Dr.  George  Stigler  auid  Dr. 
Kenneth  Arrow,  wrote  a  paper  for  the  Advertising  Tax  Coalition  which  states  that 
"advertising  is  a  powerful  tool  of  competition  ...  It  provides  valuable  information 
about  products  and  services  in  an  e£5cient  and  cost  effective  mainner.  In  this  way, 
advertising  helps  the  economy  to  function  smoothly  -  it  keeps  prices  low,  and 
facilitates  the  entry  of  new  products  emd  new  firms  into  the  market."  The  ads  in 
this  edition  of  the  Times  Union  offer  our  readers  a  potpourri  of  choices  between 
vegetables  and  cuts  of  meat  at  competing  grocery  stores,  new  automobiles  at  varioi 
Albany  dealerships,  or  new  jobs  with  employers  competing  for  a  vsuiety  of  employe 
skills.  Without  advertising,  consumers  woidd  have  to  search  on  their  own  for 
information  about  the  existence  and  identity  of  sellers,  and  the  prices  they  charge. 

As  any  daily  newspaper,  magazine,  broadcast  station,  or  other  advertising- 
supported  form  of  media  will  demonstrate,  advertising  makes  it  possible  for  reader 
and  viewers  to  have  access  to  a  range  of  information  and  entertainment  at  little  or 
no  cost,  which  makes  the  marketing  and  entertainment  segments  of  our  economy 
the  model  for  the  world. 

No  one  has  to  explain  to  a  newspaper  publisher  how  dramatically  advertisin 
fosters  competition.  During  the  past  30  years  our  country  has  witnessed  an 
explosion  of  alternative  information  sources  in  every  community  in  the  United 
States.  Recently,  my  local  phone  company  suggested  that  the  Times  Union  was  a 
non-competitive  monopoly  in  the  Albany  market. 

Let  me  describe  how  absurd  it  feels  to  be  described  by  my  NYNEX  colleague 
as  monopoUstic.  Markets  are  defined  today  by  the  television  industry  -  they  are 
called  Areas  of  Dominant  Influence  (ADI's).  In  the  14-County  Albany  ADI  there  ai 
11  other  daily  newspapers,  four  local  network-affiliated  TV  stations,  20  network- 
affiliated  radio  stations,  16  independent  radio  stations,  a  cable  advertising  networl 
representing  three  franchises  and  142,000  homes,  six  outdoor  billboard  advertising 
companies,  and  more  than  48  weekly  community  newspapers  and  shoppers. 

These  lOO-plus  media  compemies,  together  with  direct  mail  and  Yellow  Page 
advertising,  compete  for  the  annual  $330  miUion  spent  in  this  marketplace.  Over 
80  percent  of  the  ad  dollars  spent  in  this  marketplace  are  spent  with  competitors  o 
the  Times  Union.  In  fact,  three  out  of  five  newspaper  readers  read  something  othe 
than  the  Times  Union  each  weekday,  and  one-third  of  those  who  do  read  our  paper 
also  read  something  other  than  the  Times  Union  on  an  average  weekday. 

Advertising  also  is  indispensable  to  a  fi-ee  and  independent  press.  In  a 
statement  last  yeaur  on  the  floor  of  the  House  of  Representatives,  Ilep.  Michael  A. 
Andrews  described  advertising  as  ".  .  .  the  economic  engine  that  provides  the 
resources  necess£iry  for  the  media  to  supply  the  information  the  pubUc  needs  and 
wants.  Without  advertising,  media  would  become  a  State-run  enterprise  with  all 
the  constraints  and  burdens  that  entails." 

Washington  Post  columnist  Richard  Harwood  wrote  earUer  this  year  that 
"advertisers  and  the  media  need  each  other."  Companies  "advertise  out  of  necessit 
the  necessity  to  move  goods  in  a  competitive  international  economy  in  which  even 
the  biggest  players  .  .  .  are  insecure  and  struggling  to  survive,"  Harwood  observed. 
He  went  on  to  comment  that  advertising  ensured,  in  the  last  century,  the  economic 
independence  of  the  American  press  from  the  control  of  government  and  political 
parties. 

Advertising  provides  approximately  80  percent  of  the  gross  revenues  of 
newspapers,  with  the  remsdnder  derived  fi-om  subscription  income.  Most  of  the 
advertising  revenue  comes  fi-om  retail  and  service  industries,  which  are 
predominantly  local  businesses.  Thus,  it  is  the  advertising  that  maikes  it  possible 


1183 


for  newspapers,  radio,  television  and  magazines  to  present  a  diverse  offering  of 
news,  sports,  weather,  business,  lifestyle,  and  entertainment  information  at  a 
nominal  cost  to  the  consimier.  It  is  axiomatic  that  if  advertising  is  taxed,  and 
therefore  more  expensive,  advertisers  will  buy  less  of  it  and  there  will  be  less 
information  and  entertainment  in  the  media. 

Mr.  Chairman,  in  conclusion,  I  cannot  conceive  of  a  tax  proposal  that  more 
violates  our  American  concept  of  fair  play  or  a  level  playing  field  than  does  the 
proposal  to  limit  the  current  deduction  for  advertising  expenses.  Nor  can  I  think  o 
a  tax  proposal  that  is  more  counterproductive  at  a  time  when  we  are  attempting  to 
stimulate  our  national  and  local  economies.  A  limit  on  the  deduction  for  advertisir 
costs  would  depress  economic  activity  at  a  time  when  it  is  important  to  achieve 
productivity  and  efficiency  in  our  economy.  The  effect  would  be  to  increase  prices 
and  reduce  competition.  At  a  time  when  Americans  are  benefiting  more  and  more 
from  broader  sources  of  information  and  entertainment,  at  Uttle  or  no  cost  because 
of  its  advertising  support,  it  would  tend  to  shrink  the  number  of  these  multiple 
media  outlets.  And,  at  a  time  (in  1991)  when  daily  newspapers  have  experienced 
the  worst  advertising  revenues  since  World  War  II,  it  would  impose  a  further 
penalty  cost  on  our  advertising-dependent  industry. 

Mr.  Chairman,  this  Committee  has  a  challenging  task  to  meet  the  revenue 
needs  of  this  country,  and  we  appreciate  the  difficulty  of  your  job.  Nevertheless,  w 
believe  that  the  proposal  to  limit  the  deduction  for  advertising  costs  would  be 
unfair,  and  sinti-competitive,  and  would  only  contribute  to  slow  growth,  or  no 
growth  in  our  economy. 

We,  therefore,  strongly  urge  you  to  reject  this  proposal. 


1184 

Mr.  Payne.  Thank  you,  Mr.  White. 
Mr.  Helm. 

STATEMENT  OF  DEWITT  F.  HELM,  JR.,  PRESmENT,  ASSOCIA- 
TION OF  NATIONAL  ADVERTISERS,  INC.,  AND  ALSO  ON 
BEHALF  OF  THE  ADVERTISING  TAX  COALITION 

Mr.  Helm.  Thank  you,  Mr.  Chairman,  for  those  warm  words  of 
welcome. 

For  the  benefit  of  the  full  subcommittee,  my  name  is  DeWitt 
Helm,  and  before  becoming  president  of  the  Association  of  National 
Advertisers,  10  years  ago,  I  was  an  advertising  and  marketing  pro- 
fessional for  25  years  with  three  well-known  consumer  product 
companies.  I  appear  today  on  behalf  of  ANA  and  the  Advertising 
Tax  Coalition  in  strong  opposition  to  the  proposal  that  would  im- 
pose a  tax  on  advertising. 

ANA  represents  virtually  every  manufacturing  and  service  seg- 
ment of  industry.  Our  members  account  for  approximately  80  per- 
cent of  national  and  regional  advertising  expenditures,  and  the 
ATC  represents  10  national  trade  associations  whose  members  play 
a  dominant  role  in  advertising. 

All  of  the  members  of  our  coalition  strongly  urge  Congress  to  re- 
tain the  full  and  current  deductibility  of  advertising  expenses.  A 
tax  on  advertising^  would  severely  weaken  a  powerful  economic  en- 
gine that  creates  jobs,  produces  sales,  and  generates  profits. 

The  proposal  under  consideration  is  bad  public  policy  and  bad 
tax  policy.  It  would  damage  the  business  community,  throttle  the 
media,  and  stifle  the  efforts  to  invigorate  our  economy.  Any  limita- 
tion on  the  deductibility  of  advertising  would  make  advertising 
more  expensive  and,  like  the  Red  Queen  in  Alice  In  Wonderland, 
companies  would  have  to  run  faster  by  spending  more  on  advertis- 
ing each  year  merely  to  remain  in  the  same  place. 

A  decrease  in  advertising  will  translate  into  reduced  sales  and 
resonate  throughout  the  economy.  This  tax  would  not  only  damage 
the  country's  largest  advertisers  but  also  hundreds  of  thousands  of 
small  businesses  that  advertise;  every  drug  store,  grocery  store, 
general  store,  and  hardware  store  in  this  country  would  feel  the 
impact  directly. 

Proponents  of  limiting  the  advertising  tax  deduction  argue  that 
since  some  advertising  may  provide  benefits  for  longer  than  1  year, 
all  advertising  costs  should  not  be  taken  fully  in  the  year  incurred, 
but  most  advertising  is  directed  to  the  sale  of  a  particular  product 
or  service  in  a  veiy  limited  time  frame.  Advertising  for  super- 
market specials,  holiday  and  seasonal  promotions,  and  classified 
advertising  for  houses  and  job  openings  fill  the  spaces  of  our  na- 
tional and  local  media. 

In  1989  the  ATC  asked  the  late  Dr.  George  Stigler  of  the  Univer- 
sity of  Chicago  and  Dr.  Kenneth  Arrow  of  Stanford  University,  both 
winners  of  the  Nobel  Prize  in  economics,  to  carefully  examine  pro- 
posals to  change  the  tax  treatment  of  advertising,  and  after  com- 
prehensive analysis  they  concluded,  "We  do  not  believe  that  exist- 
ing economic  evidence  supports  proposed  changes  in  the  tax  treat- 
ment of  advertising." 

Now,  changing  the  tax  treatment  of  advertising  would  also  create 
an  enormous  administrative  burden  for  both  Government  and  busi- 


1185 

ness.  Advertising  simply  is  not  a  term  of  art.  It  does  not  have  any 
fixed  meaning.  Will  direct  mail  or  signs  in  retail  stores  be  consia- 
ered  advertismg?  Should  brand  or  company  logos  on  trucks  or  T- 
shirts  be  defined  as  advertising? 

Developing  working  definitions  will  be  complex,  time  consuming, 
and  impose  high  compliance  costs.  There  is  simply  no  business,  tax 
or  public  policy  purpose  served  by  singling  out  and  discriminating 
against  advertising  through  the  Tax  Code.  At  best,  our  Nation's 
economy  is  in  a  veiy  sensitive  phase,  and  it  would  take  very  little 
to  throw  it  into  a  tailspin. 

The  incentive  for  American  business  simply  should  and  must  be 
to  produce  more  profits,  profits  that  will  put  people  back  to  work. 
Let  advertising  do  its  job  by  driving  the  economic  engine  that  cre- 
ates sales,  profit,  and  employment. 

In  conclusion,  one  Member  of  Congress  recently  told  a  group  of 
advertising  and  media  executives  that  trying  to  sell  a  product  or 
service  without  advertising  would  be  like  a  bird  trying  to  fly  with- 
out wings,  and  that  metaphor  captures  better  than  most  the  mes- 
sage I  hope  to  leave  with  this  subcommittee  today. 

Advertising  permits  the  consumer  to  make  an  informed  choice 
from  a  range  of  options.  I  urge  you  not  to  clip  its  wings  but  to  let 
advertising  carry  its  message  without  an  additional  burden  that 
would  impede  it  from  realizing  its  goal. 

Thank  you  very  much. 

[The  prepared  statement  follows:] 


1186 


Statement  By 

DeWittF.  Helm,  JR. 

On  Behalf  Of 

The  association  of  National  advertisers 

And 

The  Advertising  Tax  Coalition 

Before  The 

Subcommittee  On  Select  Revenue  Measures 

Committee  On  Ways  And  Means 

U.S.  House  of  representatives 

Washington,  D.C. 

September  8, 1993 


Mr.  Chairman,  and  members  of  the  Subcommittee:  Good  morning.  My 
name  is  DeWitt  F.  Hehn,  Jr.  Before  becoming  President  of  the  Association  of 
National  Advertisers,  Inc.  (A.N.A.)  ten  years  ago,  I  was  President  of  the  Miller- 
Morton  Company,  then  the  consumer  products  subsidiary  of  a  prominent 
multinational  diversified  pharmaceutical  company.  Previously,  I  also  served  as  an 
advertising  and  marketing  executive  at  Richardson- Vicks  (now  a  part  of  Procter 
and  Gamble)  and  Pfizer,  Inc. 

I  am  appearing  today  on  behalf  of  A.N  A  and  the  Advertising  Tax  Coalition 
in  strong  opposition  to  a  proposal  that  would  impose  a  tax  burden  on  advertising. 
This  proposal  is  both  bad  public  poUcy  and  bad  tax  poUcy  because  it  would  damage 
the  business  conmmnity;  severely  harm  the  media;  and  adversely  impact  efforts  to 
invigorate  the  economy. 

A.N.A.  represents  virtually  every  segment  of  the  business  commimity.  Our 
broad  corporate  membership  includes,  within  its  entities,  over  2,000  8ubsi(fiaries, 
divisions,  and  operating  units  located  throughout  the  United  States.  Our 
members  market  a  vast  range  of  products  and  services  smd  employ  advertising  as 
an  important  element  of  their  selling  and  pubUc  relations  programs.  A.N.A.'s 
members  collectively  account  for  approximately  80%  of  all  national  and  regional 
advertising  expenditures  in  the  United  States.  Although  A.N.A.'8  membership 
includes  most  of  the  nation's  largest  advertisers,  it  also  includes  many  smaller 
companies.  A  nimiber  of  oiir  members,  for  example,  spend  under  5  miiUion  dollars 
annually  for  advertising. 

The  ATC  includes,  in  addition  to  our  association,  the  American  Advertising 
Federation,  the  American  Association  of  Advertising  Agencies,  the  Direct 
Marketing  Association,  the  Grocery  Manufacturers  of  America,  the  Magazine 
Publishers  of  America,  the  National  Association  of  Broadcasters,  the  National 
Newspaper  Association,  the  Newspaper  Association  of  America,  and  the  Yellow 
Pages  Publisher's  Association.  Together,  the  members  of  these  organizations  play 
a  dominant  role  in  preparing  and  pubUshing  or  broadcasting  the  advertising 
produced  in  this  coimtry. 

All  the  members  of  our  Coalition  strongly  urge  that  Congress  retjun  the  full 
and  current  deductibility  of  advertising  expenses.  The  full  tax  deductibihty  of 
advertising  expenses  provides  enormous  benefits  to  our  nation's  economy. 
Advertising  generates  the  sales  that  lead  to  corporate  profitability  ~  it  is  the  most 
efficient  means  of  selling  ever  devised.  A  tax  burden  on  advertising  would 
severely  weaken  an  important  economic  engine  that  helps  to  create  jobs,  produce 
sales,  and  generate  corporate  profits. 

From  the  vantage  point  of  a  former  company  president,  and  an  advertising 
and  marketing  professional  with  over  thirty-five  years  of  real  world  experience,  I 
offer,  for  your  consideration,  my  perspective  of  the  likely  impact  of  the  advertising 
tax  proposal  on  the  advertising  and  business  communities.  A  business  only  has  a 
certain  portion  of  its  operating  budget  to  allocate  to  advertising  in  the  course  of  a 
year,  and  any  business  will  attempt  to  maximize  the  impact  of  its  advertising.  If  a 
limitation  were  to  be  imposed  on  tiie  deductibility  of  advertising  costs,  it  would 
make  the  same  amount  of  advertising  more  expensive.  Like  the  Red  Queen  in 


1187 


Alice  in  Wonderland,  companies  would  have  to  run  faster  (or  in  this  case,  make 
larger  expenditures)  merely  to  remain  in  the  same  place. 

If  the  tax  deductibility  of  advertising  is  limited,  companies  would  be  forced 
to  consider  one  or  more  of  the  following  options: 

1.  Decrease  their  expenditures  for  advertising; 

2.  Reduce  their  work  force  or  mandate  other  expense  reductions  in  an 
effort  to  increase  productivity  so  that  they  can  apply  "savings"  to  the 
increased  cost  of  advertising  in  order  to  maintain  the  same 
communication  levels. 

3.  Shift  expenditures,  where  possible,  from  advertising  to  promotional 
or        other  communication  vehicles  that  will  continue  to  be  fully  tax 

deductible. 

Before  I  expand  on  these  three  points,  permit  me  to  imderscore  the  effect 
the  recession  already  has  had  on  business  in  general.  As  the  Subcommittee 
knows,  many  of  this  coimtrys  most  respected  business  entities  have  found  it 
necesseiry  to  lay  off  tens-of-thousands  of  workers  and  to  close  major  installations 
throughout  this  country  in  an  effort  to  maintain  economic  viability  and 
competitiveness.  These  companies,  like  all  others,  soon  will  be  facing  higher 
corporate  taxes.  A  Umitation  on  the  tax  deductibility  of  advertising  will  further 
increase  their  teix  burden. 

While  companies  can  elect  to  decrease  advertising  budgets  to  compensate 
for  the  reduced  deductibihty  of  advertising,  less  advertising  will  translate  into  a 
reduction  in  sales  for  companies'  goods  and  services.  Reduced  advertising  will 
resonate  throughout  the  economy.  There  will  be  less  revenue  for  the  advertising 
agencies  that  develop  advertising  and  the  media  which  carry  advertising 
messages,  including  newspapers,  television  and  radio  stations,  magazines,  and 
other  specialty  publications.  Reduced  advertising  also  will  mean  less  revenue  for 
all  those  businesses  that  support  and  supply  the  advertising  commimity. 

Another  option  for  companies  will  be  to  reduce  their  workforce,  or  to  make 
other  expense  reductions.  Theoretically,  the  "savings"  from  these  cutbacks  could 
be  applied  to  a  company's  advertising  budget  in  order  to  maintain  cvirrent  levels  of 
advertising.  Some  people  have  suggested  that  companies  instead  could  pass  these 
higher  costs  on  to  the  public.  But,  even  a  cxirsory  reading  of  the  business  pages 
demonstrates  that  in  this  economy,  it  is  virtuedly  impossible  for  companies  to  raise 
prices.  Companies  that  do  risk  a  downturn  in  sales,  and  lower  sales  mean  fewer 
jobs  in  the  long  run.  Most  companies,  as  already  noted,  face  higher  costs  and  are 
aggressively  trimming  budgets,  and  many  now  are  la3ring  off  people  in  response  to 
growing  economic  pressure  and  increasing  competition. 

Faced  with  higher  advertising  costs,  ainother  strategy  for  companies  will  be 
to  shifl  advertising  expenditures  to  promotion,  or  other  communication  vehicles 
that  continue  to  be  fully  tax  deductible.  While  it  is  well  established  that 
advertising  is  the  most  efficient  method  of  sellins  to  mass  markets,  less  efficient 
methods  will  become  more  attractive  if  advertisijig  is  made  more  expensive 
because  it  is  less  than  fully  deductible.  If  advertising  becomes  more  expensive, 
companies  may  shift  to  other  communication  vehicles,  and  if  these  vehicles  are 
defined  as  advertising,  companies  may  then  resort  to  other  options,  including 
reductions  in  levels  of  communication. 

This  scenario  highlights  the  difficulty  of  defining  what  constitutes 
advertising  as  compeinies  concentrate  on  increasing  public  awareness  of  their 
products  and  services.  The  word  "advertising"  is  not  a  term  of  art  -  it  does  not 
have  any  fixed  or  agreed  upon  definition.  Even  the  most  experienced  practitioners 
in  the  field  often  disagree  as  to  what  should  be  considered  advertising  and  what 
should  be  excluded.  Nevertheless,  the  proposal  to  limit  the  deduction  for 
adverting  costs  will  require  the  DepEutment  of  the  Treasury  to  make  such  a 
determination. 


1188 


How  will  this  determination  be  made  to  insure  a  fair  tax  policy?  Will  direct 
mail  or  signs  in  retail  stores  be  considered  advertising?  What  about  decorated 
shipping  containers  which  protect  the  product  and  are  also  used  for  display 
purposes?  Should  bramd  or  company  logos  on  trucks,  tee-shirts,  or  other  wearing 
apparel  be  defined  as  advertising?  Should  advertising  be  separated  from  other 
related  communication  vehicles  such  as  "^ubUc  relations"  and  "promotion?"  These 
examples,  of  course,  could  be  multiplied  many  times  over.  Developing  working 
concepts  will  be  complex,  time  consuming,  and  impose  high  compliance  costs.  But, 
all  this  highly  technical  effort  and  burdensome  bxireaucratic  expense 
notwithstanding,  these  efforts  still  cannot  avoid  significantly  hampering  the 
selling  process. 

The  members  of  A.N.A.  are  among  the  country's  largest  employers  and  most 
sophisticated  advertisers.  The  three  options  I  have  outlined  are  the  ones  with 
which  they  will  be  faced  if  advertising  becomes  less  than  fiilly  tax  deductible  as  a 
business  expense.  But  there  are  also  hundreds-of-thousands  of  smzdl  businesses 
throughout  the  United  States  that  will  face  the  same  difficult  choices.  These  £ire 
not  just  small  manufacturers  or  service  based  businesses,  but  grocery  stores,  drug 
stores,  apparel  stores,  and  hardware  stores  that  make  manufactiu-ers'  products 
available  to  consumers.  At  every  step  in  the  distribution  process,  advertising  is 
the  most  effective  and  most  efBdent  way  to  reach  consumers  -  but  taxing 
advertising  expenses  will  greatly  reduce  its  efficiency. 

When  Wharton  Econometrics  Forecasting  Associates,  Inc.  specifically 
analyzed  the  issue  of  limiting  advertising  deductions  as  it  impacts  small  business, 
it  concluded:  "The  impact  of  limiting  the  deductibility  of  advertising  expenses 
should  have  a  larger  negative  impact  on  small  business  than  on  large  business  .  .  . 
many  new  small  business  firms  enter  existing  markets  with  the  help  of 
advertising  --  it  will  make  it  more  expensive  for  new  small  businesses  to  obtain  a 
sufficient  market  share.  These  higher  costs  of  entering  markets  will  discotirage 
the  creation  of  new  business  and  inhibit  competition." 

In  fact,  the  advertising  tax  deductibility  limitations  proposal  will  impact 
particularly  heavily  on  companies  ~  whatever  their  size  -  that  are  attempting  to 
introduce  new  products  or  break  into  new  markets.  These  companies, 
furthermore,  wiU  find  themselves  competing  against  companies  that  developed 
market  share  at  a  time  when  they  could  immediately  deduct  100%  of  their 
advertising  expenses.  Placing  a  burden  on  advertising,  a  key  tool  of  economic 
competition,  is  clearly  coimterproductive. 

Advertising  is  merely  an  integral  part  of  the  total  marketing  mix.  Any 
"ordinary  and  necessary  business  expense"  is  geared  to  maximizing  the  sale  of 
goods  and  services.  A  business  expense  in  job  training,  reseeirch  and  development, 
public  relations  and  advertising  aU  lead  business  to  the  same  goal.  In  light  of  that 
fact,  is  there  any  business,  tax,  or  public  policy  purpose  to  be  served  by  singling 
out  and  discriminating  {igainst  advertising  throu^  the  tax  code?  I  strongly  urge 
Congress  not  to  head  down  the  road  of  micro-managing  the  btisiness  process 
through  differential  tax  treatment  of  the  various  segments  of  product  development 
and  the  selUng  process.  Furthermore,  I  believe  that  once  we  begin  to  head  down 
this  road  it  w5l  be  extremely  difficult  to  turn  back. 

Proponents  of  limiting  the  advertising  tax  deduction  have  argued  that  since 
some  advertising  provides  benefits  for  longer  than  one  year,  advertising  costs 
should  not  be  permitted  to  be  taken  fully  in  the  year  incurred.  Unfortunately, 
while  this  argument  initially  may  sotmd  attractive,  closer  examination 
demonstrates  such  an  approach  will  be  administratively  unworkable  and 
economically  damaging. 

Most  advertising  is  directed  to  the  sale  of  a  particular  product  or  service  in 
a  very  limited  time  fi-ame.  For  example,  supermarket  advertising  in  newspapers 
for  food  specials,  national  TV  seasonal  and  holiday  promotions,  buyer  incentive 
programs,  classified  advertising  for  real  estate,  job  openings,  and  a  multitude  of 
other  goods  and  services  all  serve  to  fill  the  advertising  space  of  our  national  and 
local  media.  To  allow  a  small  number  of  advertisements,  that  theoretically  may 
have  an  impact  in  more  than  one  year,  to  create  a  precedent  for  all  other 
advertising  is  clearly  unfair  and  inappropriate. 


1189 


Furthermore,  no  one  knows  whether  a  new  advertising  campaign  will  be 
successful,  or  how  long  the  efifects  of  the  advertising  will  last.  Yet  this  proposal 
totally  ignores  the  fact  that  most  new  product  introductions,  and  their  advertising, 
fail  in  the  marketplace.  How  should  we  capitalize,  for  tax  purposes,  the  famous 
campaign  for  the  Edsel  automobile?  In  fact,  the  number  of  new  products  being 
brought  into  the  market  has  expanded  drastically  in  the  last  few  years,  but  the 
success  rate  has  gone  down.  From  1980  to  1985,  some  28,196  new  items  were 
brought  onto  the  market,  but  only  12%  succeeded.  From  1985  to  1990,  amother 
54,080  products  were  brought  onto  the  market,  but  only  10%  succeeded. 
Advertising  is  not  magic.  Nothing  kills  a  bad  product  faster  than  good 
advertising.  Without  effective  advertising,  however,  the  odds  of  getting  lost  in  the 
clamor  of  the  competitive  marketplace  has  increased  exponentially. 

In  1989,  the  Advertising  Tax  Coalition  asked  two  winners  of  the  Nobel  Prize 
in  Economics,  the  late  Dr.  George  Stigler  of  the  University  of  Chicago,  and  Dr. 
Kenneth  Arrow  of  Stanford  University,  to  carry  out  a  comprehensive  and 
systematic  examination  of  proposals  to  change  the  tax  treatment  of  advertising. 
Their  findings  were  published  in  August  of  1990.  "Advertising  is  a  powerful  tool  of 
competition,"  they  wrote.  "It  provides  vaduable  information  about  products  and 
services  in  an  efficient  and  cost  effective  manner.  In  this  way,  advertising  helps 
the  economy  to  fimction  smoothly  --  it  keeps  prices  low  and  facilitates  the  entry  of 
new  products  and  new  firms  into  the  market." 

Economists  have  long  recognized  the  role  of  advertising  in  providing 
information.  The  basic  economic  model  of  perfect  competition  assimies  that 
consumers  have  perfect  information.  In  a  groundbreaking  study,  for  which  he  won 
the  Nobel  prize,  however,  Stigler  showed  that  constmiers  rarely  have  such 
information  --  hence  the  need  for  advertising. 

Stigler  and  Arrow  also  noted,  "Since  the  information  conveyed  by 
advertising  is  valuable,  one  must  be  particularly  cautious  about  taxes  that  would 
raise  the  cost,  and  hence  lower  the  quantity  of  advertising.  Such  taxes  would 
reduce  the  overall  flow  of  economic  information  available  to  consumers.  As  a 
result,  we  expect  that  prices  would  rise,  the  dispersion  in  prices  for  particular 
products  woiild  increase,  and  consimiers  would  be  less  able  to  find  goods  that 
satisfy  their  preferences." 

When  commenting  on  the  durability  of  advertising  these  two  distinguished 
scholars  wrote,  "Our  works  points  out  how  very  difficvJt  it  is  to  obtain  any  general 
measure  of  the  durability  of  advertising.  In  part,  this  is  probably  due  to  the  fact 
that  advertising  is  an  extremely  heterogeneous  product  and  thus  not  easily 
measured;  and  in  part,  it  is  probably  due  to  the  fact  that  economists  do  not  yet 
have  a  good  testable  model  of  the  way  in  which  advertising  affects  sales.  In  either 
event,  we  do  not  beUeve  that  existing  economic  evidence  supports  proposed 
chamges  in  the  tax  treatment  of  advertising." 

Stigler  and  Arrow  concluded,  "Although  there  are  a  number  of  economic 
studies  that  suggest  that  advertising  is  long-lived,  they  are  generally  so  fi-aught 
with  errors  that  one  cannot  rely  on  their  findings.  When  we  correct  for  some  of 
the  statistical  problems,  we  find  that  estimated  duration  intervals  are  much 
shorter  than  originally  thought.  Moreover,  there  are  a  nimiber  of  studies 
(partictdarly  more  recent  ones)  that  suggest  that  advertising  depreciates  so 
rapidly  that  virtually  all  of  its  effects  are  gone  within  a  year." 

Critics  of  advertising  also  have  suggested  that  advertising  should  be  singled 
out  for  adverse  tax  treatment  because  other  business  expenses,  in  their  view,  such 
as  research  and  development,  are  somehow  more  vital  to  the  nation's  economy.  It 
is  suggested  that  advertising  is  frivolous  in  comparison  to  these  supposedly  more 
important  functions.  But  this  view  totedly  ignores  the  role  advertising  plays  in  our 
economy.  It  often  has  been  claimed,  that  "if  you  build  a  better  mouse  trap  the 
world  will  beat  a  path  to  yovu-  door."  However,  many  companies  have  found  that 
the  improvements  their  research  and  development  programs  yield  often  are 
completely  nullified  if  they  do  not  effectively  bring  this  information  to  the 
attention  of  the  public  through  advertising. 


1190 


In  summary,  the  proposed  limitation  on  the  deductibility  of  advertising 
expenses  is  bad  tax  policy  auid  bad  public  policy.  There  is  no  evidence  that  tWs  tax 
would  be  absorbed  automatically  by  corporate  America  without  adversely  affecting 
corporate  profits.  If  corporate  profits  sire  reduced,  the  tax  base  itself  would  be 
reduced  so  that  this  form  of  taxation  could  prove  to  be  counter-productive.  The 
administrative  burden  on  govenmient  Eind  business  would  be  laborious  aind 
inefficient  as  government  assumed  the  responsibiUty  for  manipulating  and  micro- 
managing  American  business. 

At  best,  our  nation's  economy  is  in  a  very  sensitive  phase  -  it  would  take 
very  little  to  throw  it  into  a  tail  spin.  Corporate  tax  rates  already  have  been 
increased  significantly  in  the  largest  tax  increase  in  our  history.  Even  so,  I  believe 
it  is  far  preferable,  more  efficient,  and  much  soimder  tax  and  public  policy  to  tax 
business  profits,  as  Congress  recently  has  done,  rather  than  to  interfere  with  the 
business  process  by  taxing  advertising. 

The  incentives  for  American  business  now  should  be,  and  must  be,  to 
produce  more  profits  ~  profits  that  will  put  people  back  to  work.  Let  advertising 
do  its  job  by  driving  the  economic  engine  that  creates  sales,  corporate  profits,  and 
employment.  I  urge  you  to  reject  disincentives  that  will  be  counterproductive, 
ftnstrate  business,  stifle  corporate  profits,  and  increase  unemployment. 

One  member  of  Congress  recently  told  a  group  of  advertising  and  media 
executives  that,  "Trying  to  sell  a  product  or  service  without  advertising,  would  be 
hke  a  bird  trying  to  fly  without  wings."  That  metaphor  captures  better  than  most 
the  message  I  hope  to  leave  with  this  Subcommittee  today.  Advertising  to  the 
consimier,  permits  the  consumer  to  make  an  informed  choice  fi-om  a  range  of 
options.  I  urge  you  not  to  clip  its  wings  but  to  let  advertising  carry  its  message 
without  an  additional  burden  that  would  impede  it  in  realizing  its  goal. 


1191 

Mr.  Payne.  Thank  you  very  much,  Mr.  Helm. 

I  feel  like  my  colleague  Mike  Kopetski  before  me;  I  should  an- 
nounce my  biases.  I  am  strongly  opposed  to  changing  the  tax  treat- 
ment of  advertising  based  on  my  own  business  background  and  the 
reliance  of  my  business  on  consumer  advertising,  and  second, 
because  my  wife  is  the  owner  of  an  advertising  agency  in  central 
Virginia,  and  I  feel  like  I  may  have  heard  this  testimony  before 
somewhere. 

I  do  have  several  questions,  though,  that  I  would  like  to  pose  to 
this  panel  before  we  conclude.  The  first  has  to  do,  Mr.  McConaghy, 
with  something  you  brought  up.  You  mentioned  the  AICPA  had 
looked  into  this  issue  of  advertising  giving  rise  to  benefits  that  ex- 
tend beyond  the  current  accounting  period,  and  if  that  is  true, 
should  they  be  capitalized  and  amortized  for  an  additional  period. 
You  mentioned  that  they  had  reached  some  conclusion.  Could  you 
just  comment  once  again  on  the  findings  of  the  AICPA  on  this 
issue. 

Mr.  McConaghy.  Sure.  First,  Mr.  Chairman,  the  pressure  obvi- 
ously for  financial  saving  purposes  is  to  allow  amortization,  be- 
cause that,  of  course,  spreads  the  deduction  and  therefore  adds 
larger  earnings  per  share.  Nevertheless,  with  that  pressure  the  fi- 
nancial accountants  in  the  AICPA  concluded  that  there  really  is  no 
measurable  future  benefit.  And  therefore  generally,  except  for  one 
or  two  isolated  cases,  advertising  has  to  be  deducted  currently  for 
financial  statement  purposes  and  not  capitalized. 

Mr.  Payne.  Mr.  Helm,  it  seems  to  me  companies  or  corporations 
or  entities  that  are  selling  goods  and  services  have  options  among 
different  media.  They  could  advertise  their  products  through  a 
broadcast  medium,  the  newspaper,  public  relations  efforts  or  any 
number  of  ways.  Could  you  comment  on  what  kinds  of  changes 
would  occur  within  the  advertising  business  if  this  particular  pro- 
posal became  law? 

Mr.  Helm.  Well,  very  simply,  faced  with  this  kind  of  a  proposal 
becoming  law,  companies  would  have  two  or  three  options.  One 
would  be  to  simply  reduce  their  expenditures  in  order  to  com- 
pensate for  the  effect  of  the  tax.  That  is  going  to  result  in  less  com- 
munication, it  will  result  in  lower  sales,  it  will  result  in  lower  cor- 
porate profits,  in  my  judgment,  and  therefore  less  tax  revenue,  and 
so  it  will  be  counterproductive. 

Another  option  is  to  try  to  reduce  expenditures  in  other  areas,  be 
it  R&D,  be  it  in  selling  expenses  in  order  to  effect  quote  savings 
that  can  be  applied  to  advertising.  Frankly,  I  see  this  as  placing 
the  Government  in  a  position  of  micromanaging  American  busi- 
ness, and  I  feel  it  would  be  much,  much  preferable  to  have  the 
Congress  continue  to  generate  revenue  through  corporate  profit 
taxes,  through  increases  in  the  corporate  profit  tax.  I  am  not  advo- 
cating still  another  one  on  top  of  the  recent  one,  but  my  plea  is  to 
tax  profit,  not  interfere  with  process. 

Mr.  Payne.  Would  anyone  like  to  comment  then  on  how  this  pro- 
posal would  afiFect  industries?  Are  there  certain  vvinners  and  losers 
that  might  come  about  as  a  result  of  a  proposal  like  this? 

Mr.  White. 

Mr.  White.  Yes,  I  would  be  happy  to.  Clearly  in  the  spectrum  of 
American  business  there  are  industries  and  individual  companies 


1192 

that  rely  significantly  more  heavily,  because  of  the  inherent  nature 
of  their  business,  on  advertising  as  the  mix  of  their  total  expenses 
as  opposed  to,  for  instance,  a  more  industrial-oriented  company 
which  places  a  lot  of  its  investment  in  the  R&D  area  and  in  direct 
contact  with  its  customers,  a  much  more  Hmited  customer  base.  So 
the  very  nature  of  the  proposal  is  inherently  discriminatory  against 
those  types  of  businesses  that  must  of  necessity  rely  more  heavily 
on  advertising  than  those  who  don't. 

Mr.  Payne.  Mr.  Gibian. 

Mr.  Gibian.  I  would  like  to  add  a  point  as  a  tax  lawyer,  and  what 
would  happen  is  that  there  would  be  a  tremendous  incentive  for 
tax  lawyers  to  find,  in  the  complexity  area,  the  areas  that  did  not 
get  disqualified  as  being  current  deductions,  so  you  would  have  a 
whole  new  profession  built  up  of  tax  professionals  who  would  be 
trying  to  find  ways  and  the  means,  no  pun  intended,  to  find  those 
expenditures  which  would  be  deductible,  and  that  in  turn  would 
create  enormous  complexity,  as  one  of  the  other  copanelists  has 
commented  on. 

Mr.  Payne.  Mr.  White. 

Mr.  White.  I  think  in  addition  to  the  straight  complexity,  it 
would  have  the  very  real  likelihood  of  pushing  advertising  market- 
ing and  promotional  efforts  in  many  directions  that  most  of  us  con- 
sider less  desirable,  more  intrusive  forms — telemarketing  the  direct 
sales  calls,  and  so  forth.  Advertising  is  a  more  passive  and  hence, 
we  believe,  more  benign  approach  to  communication. 

Mr.  Payne.  I  want  to  thank  you  all  very  much  for  your  testi- 
mony. It  will  be  very  useful  to  us  as  we  continue  to  consider  this 
and  other  revenue  issues.  Thank  you  very  much. 

Mr.  Payne.  Our  fourth  panel  will  continue  testimony  on  the 
issue  of  the  amortization  of  advertising  expenses,  and  testimony  on 
the  depreciation  of  assets  in  the  printing  industry. 

Would  those  who  are  carrying  on  conversations  please  take  them 
outside  the  hearing  room  so  that  we  can  continue  with  our  next 
panel. 

Our  first  witness  in  this  panel  is  with  the  Leadership  Council  on 
Advertising  Issues,  Sheldon  S.  Cohen,  counsel  with  Morgan,  Lewis 
and  Bockius  here  in  Washington,  D.C. 

Mr.  Cohen,  if  you  would  proceed  on  the  5-minute  rule  please, 
thank  you. 

STATEMENT  OF  SHELDON  S.  COHEN,  COUNSEL,  LEADERSHIP 
COUNCm  ON  ADVERTISING  ISSUES 

Mr.  Cohen.  Mr.  Chairman,  I  certainly  will.  And  I  will  summa- 
rize my  testimony,  I  will  not  read  it  all.  You  have  heard  a  lot  today 
and  you  have  got  a  lot  more  to  hear. 

Mr.  Payne.  Thank  you,  Mr.  Cohen. 

Mr.  Cohen.  I  would  like  to  discuss  with  you  briefly  a  summary 
of  my  submission,  why  it  is  unsound  economic  and  tax  policy  to 
capitalize  advertising  costs  and  to  amortize  them  over  a  number  of 
years. 

It  is  elementary  that  advertising  is  an  important  element  in  our 
national  economy.  It  increases  demand  for  products  which  reduces 
their  costs  and  results  in  the  wonderful  vibrant  economy  that  is  the 


1193 

envy  of  the  world.  Any  change  in  the  tax  treatment  will  have  seri- 
ous economic  ramifications. 

Advertising  costs  have  been  treated  as  deductible  items  back  to 
the  beginning  of  the  modem  income  tax,  and  indeed  I  was  studying 
George  Boutwell's  manual  to  the  1862  income  tax,  and  advertising 
costs  were  deductible  in  those  days.  There  really  isn't  any  future 
benefit,  that  has  been  discussed  here. 

The  two  or  three  instances  where  advertising  results  in  capital 
goods,  that  is  signs  or  other  materials  that  last  for  1  year  or  more 
than  1  year,  or  advertising  campaigns  that  are  directed  toward  fu- 
ture sales,  that  is  a  product  that  isn't  on  the  market  yet.  Those 
costs  right  now  have  to  be  capitalized  and  amortized  over  the  pe- 
riod of  your  usefulness  or  those  costs  which  relate  to  the  creation 
of  a  capital  good  have  to  be  amortized.  So  we  do  have  a  dichotomy 
now,  some  are  deductible — most  are  deductible,  a  very  limited  clas- 
sification are  capitalized  and  amortized  now,  and  I  think  the  con- 
cept that  is  thrown  up  here  is  misconceived. 

An  important  element  here,  as  has  been  discussed  with  you,  is 
the  GAAP  role  and  the  AICPA  statement.  There  the  accountants 
are  working  against  their  clients'  interest,  you  see.  The  accountants 
are  saying  that  we  don't  want  to  let  you  amortize  those  costs  be- 
cause that  will  increase  your  earnings  per  share,  and  that  might 
be  misstated,  and  therefore  we  want  vou  to  reflect  a  more  conserv- 
ative income  to  the  current  owners  of  your  stock.  That  is  a  careful, 
well-thought  through,  well-conceived  idea,  and  it  goes  to  all  of  the 
SEC  full  disclosure  rules  and  the  fact  that  one  shouldn't  puff  one's 
income,  one  shouldn't  puff  it  for  tax  purposes,  either. 

The  complications  are  myriad.  Presently  there  are  a  number  of 
accounting  treatments  that  are  different  for  tax  and  for  book- 
keeping purposes.  We  should  not  multiply  those  because  each  one 
creates  another  justification  for  another  one,  and  each  of  those  cre- 
ates complications.  They  have  to  be  accounted  for  separately,  they 
have  to  be  reconciled  to  books.  There  are  adjustments  on  the  tax 
return;  the  schedule  M  on  the  tax  return  has  to  justify  those  items. 
Those  are  each  complications  both  for  the  taxpayer  and  for  the 
Government,  just  equally  for  the  Government. 

I  might  remind  the  chairman  that  the  chairman  of  the  whole 
committee,  Mr.  Rostenkowski,  said  in  discussing  this  just  last  year 
that  the  amortization,  the  rule  that  was  put  in  for  intangibles 
would  not  be  used  as  a  justification  for  capitalizing  advertising 
costs  and  amortizing  them  over  a  period  of  time. 

So,  in  summary,  I  would  say  that  the  committee  has  been  search- 
ing for  a  number  of  years  now  for  ways  to  simplify  the  Internal 
Revenue  Code.  One  of  the  most  important  ways  to  simplify  the  In- 
ternal Revenue  Code  is  not  to  add  complications.  Certainly  this 
kind  of  concept  would  add  further  complications. 

Thank  you,  sir. 

[The  prepared  statement  and  attachments  follow:] 


1194 


STATEMENT  OF  SHELDON  S.  COHEN 
LEADERSHIP  COUNCIL  ON  ADVERTISING  ISSUES 

TAX  POLICY  AMD  ECONOMIC  ISSDEfl  RELATED  TO 
DEPyCTIBT^^ITY  O?  ApVEBTISiyq  DMpEy  fEDgRM.  TAX  LAW 

I.  Introduction 

I  am  Sheldon  S.  Cohen,  a  partner  in  the  law  firm  of  Morgan, 
Lewis  &  Bockius.   I  appear  as  a  representative  of  the  Advertising 
Leadership  Council,  a  coalition  of  major  advertisers,  advertising 
agencies,  and  media  companies."  The  Advertising  Leadership 
Council  asked  me  to  discuss  why  it  is  unsound,  from  a  tax  policy 
and  economic  perspective,  to  require  that  advertising  costs  be 
capitalized  and  amortized  over  a  period  established  by  statute. 

Advertising  expenses  are  a  major  component  of  the  national 
economy.   Advertising  encourages  both  competition  and  growth  of 
business.   Advertising  takes  many  forms,  from  commercials  on 
radio  and  television,  to  print  advertisements  in  newspapers  and 
magazines,  to  billboards,  blimps,  and  the  sponsorship  of  sporting 
events.   It  is  used  to  introduce  new  products  and  services,  or  to 
convey  information  about  prices  and  availability.   Advertising 
reminds  consumers  of  their  favorable  experiences  with  particular 
products  or  services.   Advertising  does  not  motivate  people  to 
purchase  products  with  which  they  had  an  unfavorable  experience 
or  which  have  not  lived  up  to  their  expectations. 

Any  change  in  the  present  treatment  of  advertising  costs 
will  have  serious  economic  repercussions.   Advertising  costs  are 
deductible  under  present  law  because  they  are  generally  incurred 
to  produce  current  revenues.   The  amortization  of  advertising 
costs  over  a  period  of  years  would  distort  the  matching  of  these 
expenses  with  related  revenues  and  would  greatly  complicate  the 
filing  of  tax  returns. 

II.  Federal  Tax  Treatment  of  Advertising  Expenses 

Section  162  of  the  Internal  Revenue  Code  allows  a  current 
deduction  for  ordinary  and  necessary  business  expenses.^ 
Section  263  prohibits  deductions  for  any  amount  paid  to  acquire 
an  asset  or  to  increase  the  value  of  any  asset.   The  primary 
effect  of  characterizing  a  business  expenditure  as  either  a 
business  expense  or  a  capital  expenditure  concerns  the  timing  of 
the  taxpayer's  cost  recovery.   A  business  expense  is  currently 
deductible,  whereas  a  capital  expenditure  is  usually  amortized 
over  the  life  of  the  relevant  asset. 

Through  sections  such  as  162  and  263,  the  Code  endeavors  to 
match  deductions  with  benefits  over  the  period  during  which  the 
benefits  are  enjoyed.   The  matching  of  deductions  and  income 
results  in  a  more  accurate  calculation  of  net  income  for  tax 
purposes.   Generally,  if  an  expenditure  produces  significant 
benefits  that  extend  beyond  the  year  in  which  the  expenditure  is 
made,  that  expenditure  is  capitalized.   An  example  would  be  legal 
and  accounting  fees  incurred  in  connection  with  a  corporate 
merger  or  acquisition.-'  Moreover,  if  an  expenditure  contributes 
to  the  creation  or  enhancement  of  a  separate,  identifiable  asset, 
that  expenditure  is  generally  capitalized  and  amortized.-'  An 
example  would  be  costs  incurred  to  develop  a  patent  or  trademark. 


1/   A  list  of  the  members  of  the  Advertising  Leadership  Council 
is  attached  as  an  appendix  hereto. 

2/   All  references  to  "sections"  are  to  sections  of  the  Internal 
Revenue  Code  of  1986,  as  amended.   The  rule  enunciated  in 
section  162  has  been  consistently  applied  since  the  advent 
of  the  modern  income  tax  early  in  this  century. 

3/    Indopco.  Inc.  v.  Commissioner.  112  S.Ct.  1039  (1992). 

4/   Commissioner  v.  Lincoln  Savings  &  Loan  Ass'n.  403  U.S.  345 
(1971). 


1195 


Advertising  expenses  have  long  been  recognized  as  ordinary 
and  necessary  business  expenses.   All  advertising  expenses  that 
are  reasonably  related  to  the  taxpayer's  trade  or  business  are 
currently  deductible,  including  amounts  spent  on  goodwill  or 
institutional  advertising.-'  The  law  in  this  area  is  so 
established  that  the  IRS  and  the  courts  have  rarely  questioned 
the  deductibility  of  advertising  expenses. 

Proponents  of  capitalization  of  advertising  expenses  have 
argued  that  such  expenses  produce  benefits  lasting  beyond  one 
year,  either  in  the  form  of  future  income  or  in  the  form  of  a 
separate  intangible  asset  like  goodwill  or  product/brand-name 
loyalty.^  They  generally  have  been  seeking  this  change  as  a 
revenue-raising  measure  to  offset  changes  which  would  cost 
revenue.   Advocates  of  this  position  erroneously  state  that 
advertising  produces  benefits  or  revenues  extending  beyond  the 
current  tax  year. 

Advertising  costs  do  not  produce  significant  benefits 
extending  beyond  the  current  tax  year.   Product  advertising  — 
such  as  a  retail  electronic  store's  advertisements  for  a  holiday 
sale  —  does  not  generate  revenues  beyond  the  period  that  the 
advertisement  is  published  or  broadcast.   Another  example 
familiar  to  most  Washingtonians  is  the  weekly  advertising 
supplement  for  Giant  Food.   This  advertisement  prominently 
features  the  food  and  drug  items  on  sale  and  the  prices  for  such 
items.   The  "product"  being  sold  is  the  particular  item  at  the 
advertised  price  and  this  advertisement  produces  benefits  for 
Giant  Food  only  so  long  as  the  company  offers  that  product  at 
that  price. 

Institutional  or  goodwill  advertising,  such  as  a  general 
advertisement  by  a  corporation  to  keep  the  corporation's  name  in 
the  minds  of  the  public,  generally  does  not  generate  revenues 
beyond  the  current  year.   Institutional  or  goodwill  advertising 
is  typically  done  by  large  companies,  and  usually  on  a  regular 
basis.   There  may  be  incidental  future  benefits  from 
institutional  or  goodwill  advertising,  but  they  are  insignificant 
and  impossible  to  quantify.   These  benefits  depend  on  each 
individual  consumer's  recollection  of  an  advertisement  in  a 
future  year.   For  example,  if  a  consumer  purchases  a  Toyota  in 
1994,  is  it  due  to  the  commercial  he  saw  in  1992  or  1993,  the 
commercial  he  saw  the  night  before  he  bought  the  car,  or  the 
cumulative  effect  of  seeing  advertisements  for  a  Toyota  from  1992 
through  1994? 

Under  present  law,  advertising  expenses  have  been 
capitalized  in  two  instances.   The  first  instance  is  when  the 
expenses  relate  to  a  tangible  asset,  such  as  a  sign  or  a 
billboard,  or  an  intangible  asset,  such  as  the  rights  to  package 
designs.   In  this  first  instance,  it  is  appropriate  to  amortize 
the  billboard  or  the  package  design  over  its  useful  life.   The 
second  instance  in  which  advertising  expenses  have  been 
capitalized  is  when  the  terms  of  the  advertisement  explicitly 
extend  beyond  the  current  tax  year,  such  as  an  advertisement  for 
a  product  that  will  be  unavailable  until  the  following  year. 

III.  Matching  Principle  and  Book/Tax  Parity 

As  I  have  stated,  the  tax  law  attempts  to  match  expenses 
with  the  revenues  generated  by  such  expenses  to  accurately 
measure  net  income  for  tax  purposes.   Generally  accepted 
accounting  principles  ("GAAP")  have  the  same  goal.   While  the  tax 


See,  e.g. .  Congressional  Budget  Office,  Selected  Spending 
and  Revenue  Options,  134,  June  1991  (hereinafter  "CBO 
Papers") . 


1196 


accounting  treatment  of  an  item  is  not  necessarily  dictated  by 
book  accounting  principles,-'  those  principles  are  often  helpful 
in  deciding  whether  an  expense  should  be  deducted  or  capitalized. 

There  is  currently  no  GAAP  governing  the  treatment  of 
advertising  costs.   Some  businesses  deduct  advertising  costs  when 
paid  or  incurred  whereas  some  businesses  capitalize  advertising 
costs  and  amortize  them  over  a  period  of  years.   However,  an 
AICPA  subcommittee  has  promulgated  a  proposed  Statement  of 
Position  ("SOP")  which  would  treat  advertising  costs  as 
deductible  when  paid  or  incurred  unless  (a)  the  advertising  is 
"direct-response  advertising"  or  (b)  the  costs  are  for  billboards 
or  blimps  which  are  used  for  several  advertising  campaigns.   I 
understand  that  this  proposed  SOP  has  been  approved  by  the  FASB 
and  is  set  to  be  released  this  quarter. 

If  costs  are  for  direct-response  advertising,  such  costs 
would  be  reported  as  "assets"  and  written  off  over  the  estimated 
period  of  the  benefits.   The  proposed  SOP  defines  direct-response 
advertising  as  advertising  intended  to  persuade  a  customer  to 
purchase  a  company's  products  or  services  by  responding 
specifically  to  the  advertisement  (i.e. .  by  means  of  a  coded 
order  form  included  with  an  advertisement,  a  coded  coupon  turned 
in  by  a  customer,  etc.).   This  proposed  rule  is  similar  to  the 
rule  for  tax  purposes,  which  requires  capitalization  of 
advertising  costs  when  it  is  certain  that  the  benefits  extend  to 
future  periods.^' 

The  proposed  GAAP  exception  for  billboards  and  blimps  is 
identical  to  the  rule  for  tax  purposes.   For  example,  a 
corporation  that  uses  signs  or  billboards  to  advertise  its 
products  must  capitalize  the  cost  of  the  sign  or  billboard  and 
amortize  it  over  the  respective  asset's  useful  life  for  federal 
tax  purposes.-' 

Neither  product  advertising  nor  institutional  and  goodwill 
advertising  generate  significant  benefits  or  revenues  beyond  the 
current  tax  year.   Thus,  it  would  be  violative  of  the  matching 
principle  to  require  that  advertising  costs  be  capitalized  and 
amortized  over  an  arbitrarily  determined  period.   Absent  policy 
justifications  for  departing  from  the  matching  principle,  the  tax 
law  should  be  consistent  with  book  accounting  principles. 
Otherwise,  you  will  add  new  complications  to  schedules  required 
to  reconcile  such  differences. 

IV.   Capitalisation  ot   Advertising  Costs  Would  Conflict  With 
Long-Standjng  Case  Law  and  IRS  Rulings 

A.   Advertising  costs  do  not  create  or  enhance  a 
sepjirate  intangible  asset 

The  Supreme  Court  held  in  Lincoln  Savings  that  premiums  paid 
by  a  savings  and  loan  to  the  FSLIC  for  a  secondary  reserve  fund 
should  be  capitalized  because  the  premiums  created  or  enhanced  a 


7/   I.R.C.  S  446(a);  see  Thor  Power  Tool  Co  v.  Commissioner, 

439  U.S.  522  (1979);  see  also  American  Auto.  Ass'n  v.  United 
States.  367  U.S.  687  (1961). 

8/   See  Rev.  Rul.  68-283,  1968-1  C.B.  63  (amounts  paid  to  a 
corporation  for  advertising  and  promoting  the  taxpayer's 
products  at  a  fair  resulted  in  benefits  extending  beyond  one 
year  because  the  fair  operated  for  six  months  in  each  of  two 
years) . 

9/   See  Alabama  Coca-Cola  Bottling  Co.  v.  Commissioner.  28 

T.C.M.  (CCH)  635  (1969)  (cost  of  "Coke"  signs  placed  by  a 
bottler  into  retailers'  stores  had  to  be  capitalized  and 
amortized  over  the  useful  lives  of  the  signs) . 


1197 


separate  and  distinct  additional  asset  (i.e. ,  the  reserve 
fund) .—   As  clarified  by  the  recent  Indopco  decision,  the 
creation  or  enhancement  of  a  separate  asset,  while  not  a 
prerequisite  to  capitalization,  will  certainly  suggest  that 
capitalization  is  appropriate. 

Proponents  of  the  capitalization  of  advertising  costs 
erroneously  believe  that  advertising  is  a  substantial  contributor 
to  the  creation  of  a  separate  intangible  asset.—   Their 
argument  is  that  a  company's  sales  receipts  would  decline 
dramatically  if  advertising  were  curtailed  or  eliminated.   Thus, 
advocates  of  this  view  reason  that  advertising  creates  an 
assurance  that  customers  will  make  purchases  next  week,  next 
month,  and  next  year.   They  assert  that  this  assurance  of 
continued  customer  purchases  is  itself  an  intangible  asset,  much 
like  purchased  goodwill.   Whether  this  intangible  is  denoted 
"goodwill,"  "brand  loyalty,"  or  something  else,  its  effects  are 
said  to  be  long-lived.   On  this  basis,  it  is  stated  that  such 
expenses  are  capital  in  nature  and  should  be  fully  or  partially 
capitalized  rather  than  deductible  in  the  year  incurred. - 

The  fundamental  flaw  in  this  analysis  is  a  misunderstanding 
of  the  functions  performed  by  advertising.   A  decline  in 
advertising  would  certainly  reduce  a  company's  sales  over  time, 
but  this  would  be  the  result  of  a  reduced  amount  of  information 
provided  to  consumers.   It  is  simply  untrue  that  long-term 
customer  loyalties  —  namely,  the  assurance  that  current 
customers  will  buy  a  company's  goods  in  future  years  —  are 
created  by  this  year's  advertising  costs. 

Although  advertising  is  a  valuable  activity  to  advertisers 
and  consumers  alike,  advertising  itself  does  not  create  something 
of  value.   In  fact,  to  serve  its  business  purpose  of  conveying 
information,  advertising  must  be  repeated  over  and  over  as  it 
does  not  have  long-term  staying  power.   Consider  three  categories 
of  advertising:   (a)  advertising  of  new,  improved,  or  expanded 
products  or  services,  (b)  advertising  of  products  that  are 
available  for  a  limited  time  or  are  on  sale,  and 
(c)  institutional  or  goodwill  advertising. 

First,  for  a  new,  improved,  or  expanded  product  or  service, 
advertising  is  critically  important.  New  product  advertising  is 
intended  to  generate  immediate  interest,  attention,  and  sales. 

Second,  for  time-sensitive  information  about  a  product  or 
service,  such  as  a  sale  price  or  limited  availability, 
advertising  is  the  most  effective  means  of  informing  potential 
customers  about  the  product  or  service  being  offered.   Grocery 
stores  and  general  merchandise  retailers  make  extensive  use  of 
such  advertising  on  a  daily  or  weekly  basis.   Automobile 
dealerships  and  airlines  and  other  businesses  utilize  such 
advertising  when  they  offer  discount  fares  or  other  limited-time 
features  to  consumers. 

Long-term  sales  are  not  the  purpose  of  either  of  these  two 
forms  of  advertising.   Indeed,  the  information  presented  in  such 
advertising  is  usually  out-of-date  within  a  few  days  or  weeks. 


10/   Commissioner  v.  Lincoln  Savings  &  Loan  Ass'n.  403  U.S.  345 
(1971). 

11/   "A  Little  Too  Creative,  "Forbes.  July  1990;  James  Dezart, 
"New  Turns  in  the  Slugfest  on  Amortizable  Intangibles," 
Mergers  &  Acquisitions.  March/April  1991;  "Time  Is  Right  for 
Washington  to  extend  Tax  Deductibility  to  Purchased 
Goodwill,"  American  Banker.  March  20,  1991. 

12/   See  CBO  Papers  at  134. 


1198 


Such  advertisements  would  be  worthless  or  even  counterproductive 
if  continued  for  an  extended  period. 

The  third  general  category  of  advertising,  which  appears  to 
have  given  rise  to  the  amortization  proposals,  is  institutional 
or  goodwill  advertising.   This  is  advertising  intended  to  remind 
customers  of  the  company's  name  or  to  convey  general  information 
rather  than  new  product  or  time-sensitive  information.   Some  have 
argued  that  this  category  of  advertising  is  an  effort  to  develop 
an  intangible  such  as  goodwill  or  brand  loyalty  that  will  bring 
the  customer  back  for  additional  purchases  in  future  years.   For 
this  reason,  such  advertising  is  thought  to  be  a  capital 
expenditure  rather  than  a  deductible  expense. 

Granted,  customers  develop  loyalties  to  a  product  or  a 
service.   However,  such  loyalty  is  due  to  favorable  experiences 
in  the  past.   Quality  and  reliability  create  repeat  sales,  as 
well  as  encourage  sales  of  a  new  product  produced  by  a  trusted 
company.   Many  factors  contribute  to  quality  and  reliability, 
such  as  research  and  development,  experienced  and  well-trained 
employees,  good  technology  and  equipment,  high  quality-control 
standards  and  so  on.   These  are  the  expenses  that  produce  the 
intangible  value.   Advertising  reminds  the  customer  of  his  or  her 
satisfaction  with  that  quality,  but  it  does  not  create  that 
quality.   Thus,  advertising  creates  a  short-hand  summary  for  the 
customer  of  the  quality  associated  with  the  company  or  particular 
product  or  brand  name.   The  summary  may  come  in  the  form  of 
specific  information  in  an  advertisement.   Or,  the  mere  mention 
of  a  company  name  or  brand  name  may  trigger  the  customer's  mental 
summary . 

Accordingly,  while  advertising  performs  critically  important 
informational  functions,  it  does  not  create  or  enhance  an 
intangible  asset  with  a  useful  life  that  extends  beyond  the 
taxable  year.   The  only  intangible  is  the  one  created  by  the 
quality  of  the  customer's  past  experience  with  the  product  or 
service. 

B.   Advertising  costs  do  not  create  significant 

benefits  that  extend  beyond  the  current  tax  year 

Some  proponents  of  capitalization  argue  that  advertising 
produces  benefits  that  extend  beyond  the  year  in  which  the 
advertising  occurred.   This  conclusion  is  unsupported  by  any 
empirical  evidence,  principally  because  it  is  nearly  impossible 
to  gather  and  measure  any  data  to  substantiate  such  a  claim. 

The  Supreme  Court's  recent  decision  in  Indopco  does  not 
require  the  capitalization  of  advertising  costs.   In  Indopco.  the 
Supreme  Court  found  that  merger  expenses  had  to  be  capitalized 
even  though  they  did  not  create  or  enhance  a  separate  asset.   The 
expenses  at  issue  in  Indopco  related  to  a  specific  corporate 
transaction.   The  Court  relied  on  established  precedent,  which 
held  that  expenses  incurred  in  connection  with  a  change  in 
corporate  structure  are  capital  expenditures.   Moreover,  the 
transaction  created  unmistakable  benefits  extending  beyond  the 
current  year. 

In  the  case  of  advertising,  there  is  no  corporate 
transaction  involved  or  other  identifiable  capital  event.   Thus, 
there  is  simply  no  way  to  measure  the  duration  or  fact  of  any 
future  benefit  generated  by  advertising.   Of  the  three  general 
categories  of  advertising  already  discussed,  only  institutional 
or  goodwill  advertising  could  be  said  to  have  long-term 
effectiveness.   However,  numerous  factors  may  combine  to 
influence  the  duration  of  an  advertising  campaign's  success. - 


13/   Kenneth  J.  Arrow,  Economic  Analysis  of  Proposed  Changes  in 
the  Tax  Treatment  of  Advertising  Expenditures.  1990  p.  22. 


1199 


The  consumer's  interest  in  the  subject  and  ability  to  remember 
must  be  considered.-   These  factors  are  so  individualized  as  to 
be  virtually  impossible  to  quantify.   Additionally,  the  success 
and  duration  of  every  advertising  campaign  is  necessarily 
affected  by  the  intensity  of  the  competition's  advertising.— 

Even  advertising  that  is  meant  to  have  long-term  results  may 
fail  to  do  so.   One  of  the  most  notoriously  unsuccessful 
advertising  campaigns  was  that  for  the  Edsel  in  the  1950s.   The 
advertisers  of  the  Edsel  hoped  to  present  the  public  with  a 
product  it  would  remember  and  enjoy  for  years,  but  the 
advertising  failed  to  do  so. i^  A  more  recent  example  of  failed 
advertising  was  the  advertising  blitz  for  "New  Coke,"  which  not 
only  initially  hurt  Coca-Cola's  business,  but  wound  up  helping 
the  company's  sales  in  an  area  unintended  by  the  "New  Coke" 
campaign,  by  ultimately  increasing  sales  of  "Classic  Coke." 

Advertising  may  also  establish  a  company's  name  or  product 
in  the  mind  of  the  consumer  without  increasing  sales.—   Economic 
studies  which  have  attempted  to  measure  the  lifespan  of 
advertising  generally  have  been  problematic,  but  most  results 
show  that  advertising  depreciates  rapidly  with  effects  rarely 
surviving  as  long  as  a  year.- 

It  makes  little  sense  then  to  capitalize  an  expenditure  that 
does  not  contribute  to  a  significant  benefit  lasting  beyond  the 
year  in  which  the  expenditure  is  made,  particularly  an 
expenditure  that  is  otherwise  an  "ordinary  and  necessary" 
business  expense.   The  current  federal  tax  treatment  of 
advertising  wisely  reflects  this  reality.   The  Service  has  taken 
the  position  in  a  1992  revenue  ruling  that  the  Indopco  analysis 
is  inapplicable  to  advertising  expenses.   According  to  the 
Service,  advertising  expenses  "are  generally  deductible 
under  .  .  .  section  [162]  even  though  advertising  may  have  some 
future  effect  on  business  activities,  as  in  the  case  of 
institutional  or  goodwill  advertising."^'  Advertising  expenses 
are  to  be  amortized  only  "in  the  unusual  circumstance  where  [the] 
advertising  is  directed  towards  obtaining  future  benefits 
significantly  beyond  those  traditionally  associated  with  ordinary 
product  advertising  or  with  institutional  or  goodwill 
advertising.  "23' 

Finally,  capitalization  of  advertising  costs  on  the  basis 
that  such  costs  create  benefits  extending  beyond  one  year  would 
call  into  cjuestion  the  treatment  of  certain  other  ordinary  and 
necessary  business  expenses  that  arguably  have  a  future  benefit 
component.   For  instance,  reasonable  compensation  paid  to  an 
officer  is  generally  deductible  under  section  162  even  though  it 
is  reasonable  to  assume  that  the  officer  being  paid  currently  is 
engaged  in  long-term  planning  that  extends  beyond  the  current 
year.   Currently,  the  IRS  and  the  courts  require  compensation  to 
be  capitalized  only  when  the  recipient  is  performing  services  in 
connection  with  a  capital  transaction.   Otherwise,  they  do  not 
get  involved  in  a  case-by-case  determination  of  whether  the 
recipient's  services  produce  benefits  beyond  one  year.   This  is  a 


14/  Id. 

15/  Id. 

16/  Id. 

12/  Id. 

18/  Id. 

19/  See  Rev.  Rul.  92-80,  1992-2  C.B.  57. 

20/  Id. 


1200 


complication  which  the  Government  and  taxpayers  can  live  better 
without. 

V.  There  is  No  Justifiable  Policy  Reason  for  Setting  an 
Arbitrary  Write-off  Period  for  Advertising  Costs 

As  the  previous  discussion  demonstrates,  it  is  virtually 
impossible  to  quantify  the  long-term  benefits  of  institutional  or 
goodwill  advertising.   It  has  been  recognized  that,  "because  the 
useful  life  of  advertising  depends  on  its  unknown  effect  on 
customers,  any  amortization  rate  would  be  arbitrary."— 
Imposition  of  an  arbitrary  write-off  period  with  absolutely  no 
basis  in  economic  reality  is  unjustified,  particularly  given  the 
heavy  administrative  burdens  that  this  proposal  would  inflict  on 
both  taxpayers  and  the  Government. 

The  proposal  would  require  taxpayers  to  maintain  annual 
accounts  of  their  advertising  expenses  for  years  to  come  and 
would  increase  the  Government's  administrative  costs  of  policing 
this  change  in  the  law.   If  the  tax  law  is  changed  to  require 
that  advertising  costs  be  capitalized,  there  would  be  different 
treatment  of  advertising  costs  for  tax  and  book  accounting 
purposes.   Every  new  distinction  between  GAAP  and  tax  accounting 
creates  new  reconciliations  to  be  accounted  for  as  Schedule  M-1 
adjustments  on  Form  1120.   This  is  a  complicating  factor  for  both 
taxpayers  and  the  Government. 

In  exchange  for  these  heavy  administrative  costs,  the 
proposal  would  merely  defer  a  portion  of  current  costs  to  the 
future.   As  such,  the  proposal  would  generate  additional  revenue 
only  in  the  first  several  years  following  enactment.   To 
illustrate  this  point,  assume  that  a  corporation  spends  annually 
$100  on  advertising  and  thus  under  current  law  deducts  $100  each 
year  on  its  Form  1120  for  advertising  expenses.   If,  for  the  sake 
of  argument.  Congress  enacts  a  provision  requiring  amortization 
of  advertising  expenses  over  a  three-year  period,  the 
corporation's  $100  annual  deduction  would  be  limited  only  for  the 
first  two  years  following  enactment  of  the  write-off  provision. 

In  year  one,  the  corporation  would  be  entitled  to  deduct 
only  one-third  of  the  $100  expense  for  year  one,  or  $33,  and,  in 
year  two,  the  corporation  would  be  entitled  to  deduct  only  one- 
third  of  the  $100  expense  for  year  two  and  one-third  of  the  $100 
expense  from  year  one,  or  a  total  of  $66.   Beginning  in  year 
three,  however,  the  corporation  would  be  entitled  to  a  $100 
annual  deduction,  computed  in  year  three  as  the  sum  of  one-third 
of  the  $100  expense  for  year  three,  one-third  of  the  $100  expense 
from  year  two,  and  one-third  of  the  $100  expense  from  year  one, 
for  a  total  of  $100. 

VI.  Congress  Has  Reoeatedlv  Chosen  to  Uphold  the 
Deductibility  of  Advertising  Expenses 

Like  the  IRS,  Congress  has  also  had  a  recent  opportunity  to 
consider  the  deductibility  of  advertising  expenses.   As  part  of 
the  Revenue  Reconciliation  Act  of  1993,  Congress  adopted  new  Code 
Section  197,  which  permits  goodwill  and  other  intangible  assets 
to  be  written  off  over  15  years  in  certain  circumstances.   In 
considering  the  breadth  of  this  provision,  Chairman  Rostenkowski 
reaffirmed  the  continued  vitality  of  the  deductibility  of 
advertising  expenses:   "Some  persons  have  questioned  whether  this 
bill  [section  197  on  amortization  of  intangibles]  was  intended  to 


21/  See  CBO  Papers  at  134 


1201 


open  the  door  for  reconsidering  tax  deductions  for  advertising 
expenses.   Let  me  be  clear.   The  answer  is,  no."— 

VII.  Conclusion 

The  historical  treatment  of  advertising  as  a  deductible 
business  expense  is  sound  and  reasonable  and  should  be  upheld. 
Current  deductibility  of  advertising  costs  comports  with  proposed 
GAAP  reporting  requirements  and  is  consistent  with  the  tax  law's 
matching  principle. 

Advertising  does  not  create  goodwill,  brand  loyalty,  or 
similar  intangibles.   Customers'  past  experiences  with  a 
product's  or  service's  reliability  and  quality  determine  future 
purchase  decisions.   Many  expenditures  contribute  to  the  creation 
of  such  quality,  including  research  and  development,  employee 
training,  customer  service,  and  the  like.   These  are  the 
expenditures  that  create  intangible  value,  not  advertising  costs. 

Further,  it  is  nearly  impossible  to  establish  that 
advertising  has  any  measurable  effects  on  business  that  extend 
beyond  the  year  in  which  the  advertising  occurred.   Thus, 
establishment  of  an  arbitrary  write-off  period  with  no  basis  in 
economic  reality  would  be  unjustified. 


22/   See  Unofficial  Transcript  of  Oct.  2  Ways  &  Means  Comm. 
Hearing  on  Amortization  of  Intangibles,  91  TNT  208-26 
(Statement  of  Chairman  Rostenkowski) ,  quoted  in  John  W.  Lee, 
Doping  Out  The  Capitalization  Rules  After  Indopco.  57  Tax 
Notes  669,  683  n.l26  (Nov.  2,  1992). 


1202 

Advertiainq  Leadership  Council 

American  Express  Company 

Backer  Spielvogel  Bates  Worldwide,  Inc. 

Black  Entertainment  Television 

D'Arcy,  Masius,  Benton  &  Bowles 

Frito-Lay,  Inc. 

H.  J.  Heinz  Company 

Hublein 

Interactive  Telemedia 

The  Interpublic  Group  of  Companies,  Inc. 

Kraft  General  Foods 

Leo  Burnett  Company 

Mars,  Incorporated 

Mattel,  Inc. 

Nestle  U.S.A. 

Nynex  Corporation 

Ogilvy  &  Mather  Worldwide 

Philip  Morris  Companies  Inc. 

Joseph  E.  Seagrams  &  Sons,  Inc. 

Tatham/RSCG 

Time-Warner  Inc. 

Unilever  United  States,  Inc. 

Univision 

The  Washington  Post  Company 

Young  &  Rubicam 


1203 

Mr.  Payne.  Thank  you,  Mr.  Cohen. 

The  next  paneHst  is  representing  the  National  Retail  Federation, 
David  Feeney,  senior  vice  president  in  the  corporate  tax  depart- 
ment of  R.H.  Macy  Co.  in  New  York. 

Mr.  Feeney. 

STATEMENT  OF  DAVID  L.  FEENEY,  SENIOR  VICE  PRESIDENT, 
CORPORATE  TAXES,  RJI.  MACY  AND  CO^  INC.,  ON  BEHALF 
OF  THE  NATIONAL  RETAIL  FEDERATION 

Mr.  Feeney.  Thank  you.  Mr.  Chairman,  members  of  the  commit- 
tee, my  name  is  David  Feeney.  I  am  senior  vice  president,  cor- 
porate taxes,  as  you  just  pointed  out,  for  R.H.  Macy.  I  am  pleased 
to  appear  today  on  behalf  of  the  National  Retail  Federation  to  ex- 
press our  opposition  to  a  proposal  to  capitalize  advertising  costs 
and  amortize  them  over  a  period  of  years. 

By  way  of  background,  the  National  Retail  Federation  is  the  Na- 
tion's largest  trade  group  that  speaks  for  the  retail  industry.  The 
organization  represents  the  entire  spectrum  of  retailing,  including 
the  Nation's  leading  department,  chain,  discount,  specialty,  and 
independent  stores,  several  dozen  national  retail  associations,  and 
all  50  State  retail  associations.  The  federation's  membership  rep- 
resents an  industry  that  encompasses  over  1.3  million  U.S.  retail 
establishments,  employs  nearly  20  million  people  and  registered 
sales  in  excess  of  $1.9  trillion  in  1992. 

The  retail  industry  would  be  severely  harmed  by  a  proposal  to 
capitalize  advertising.  Our  industry  relies  on  advertising  to  bring 
customers  into  our  stores  on  a  day-by-day  basis.  This  is  an  ordi- 
nary and  necessary  cost  of  doing  business  for  retailers.  There  is  no 
good  tax  policy  basis  for  denying  taxpayers  the  ability  to  deduct 
these  costs  as  incurred.  It  is  also  bad  economic  policy  to  increase 
our  cost  of  advertising,  which  directly  affects  sales.  The  ripple  ef- 
fect on  the  economy  will  be  to  reduce  production  and  lower  eco- 
nomic growth. 

Advertising  fosters  competition.  When  a  business  advertises 
prices  and  quality,  it  forces  competitors  to  lower  prices  and  in- 
crease quality.  Advertising  is  also  the  means  by  which  new  prod- 
ucts can  enter  into  a  market.  Increasing  the  cost  of  advertising  will 
disproportionately  hurt  businesses  that  are  trying  to  market  new 
products.  The  results  will  be  less  innovation  and  a  drag  on  U.S. 
global  competitiveness. 

Advertising  also  provides  customers  with  an  important  source  of 
information  about  products,  including  price  and  quality.  It  provides 
competition  within  the  marketplace,  and  it  also  helps  to  bolster 
consumer  confidence.  With  consumer  confidence  at  its  current  low 
point,  our  Government  cannot  afford  to  adopt  a  policy  that  would 
be  a  further  detriment  to  consumer  confidence.  Rather,  stronger 
consumer  confidence  is  needed  to  help  generate  an  economic  recov- 
ery. 

In  addition,  increased  advertising  costs  will  have  a  particularly 
harsh  impact  on  financially  troubled  retailers,  some  of  which  al- 
ready may  be  in  bankruptcy.  Businesses  that  are  strapped  for  cash, 
and  in  particular  financially  troubled  retailers,  use  advertising  as 
a  means  of  producing  a  quick  boost  in  sales  and  to  increase  their 
cash  flow.  It  would  be  diflficult  for  these  businesses  to  bear  the  in- 


1204 

creased  costs  of  this  advertising.  It  may  affect  their  abihty  to  sur- 
vive, and  it  could  result  in  a  loss  of  jobs  for  manv  Americans. 

Under  current  law,  advertising  costs  generally  are  deducted  in 
the  year  incurred  as  a  cost  of  doing  business.  This  is  the  same  tax 
treatment  that  is  given  to  a  myriad  of  other  business  expenses  that 
are  generally  considered  period  costs.  Tax  law  also  provides  that 
recurring  expenditures  are  currently  deductible  because  of  the  need 
to  renew  the  benefits  through  additional  expenditures  each  year, 
suggesting  a  useful  life  of  less  than  a  year.  Advertising  generally 
is  considered  a  recurring  expenditure  because  taxpayers  must  regu- 
larly engage  in  advertising  activities  in  order  to  produce  new  busi- 
ness on  a  relatively  consistent  basis  in  each  year. 

There  is  no  tax  incentive  for  engaging  in  advertising  activities, 
nor  is  there  any  other  special  "tax  break"  for  advertising.  Retailers 
engage  in  advertising  on  a  day-to-day  basis  in  order  to  inform  cus- 
tomers about  current  products,  prices,  and  to  bring  customers  into 
our  store.  Hopefully,  this  translates  into  immediate  sales.  The  costs 
of  the  business  activity  of  generating  sales  are  deducted  from  in- 
come in  the  year  incurred  in  order  to  properly  match  the  revenues 
with  expenses  of  generating  the  revenues. 

Other  than  serving  as  a  revenue  raiser,  the  tax  policy  basis  that 
has  been  suggested  for  requiring  the  capitalization  of  a  portion  of 
advertising  expenses  is  that  the  revenue  stream  or  benefit  ven- 
erated from  advertising  extends  to  future  years.  From  a  retailer's 
perspective,  I  can  state  emphatically  that  this  is  not  the  case.  Re- 
tail advertising  is  directed  at  the  sale  of  goods  directly  to  consum- 
ers within  a  short  period  of  time.  The  advertisement  may  announce 
a  sale  of  a  product,  a  special  promotion  associated  with  the  product 
or  the  availability  of  the  product  at  a  particular  store.  In  all  of 
these  cases,  the  goal  is  to  bring  the  customer  into  the  store  during 
the  time  the  sale  or  promotion  is  taking  place.  Again,  the  purpose 
is  to  generate  immediate  sales.  For  example,  a  newspaper  ad  an- 
nouncing the  price  of  chicken  for  the  coming  week  is  designed  to 
bring  customers  into  the  store  during  that  week  to  purchase  chick- 
en. The  advertisement  will  have  no  value  after  that  week. 

Seasonal  advertising  is  similar.  Advertisement  directed  at 
Christmas  sales  clearly  are  directed  at  short-term  results,  as  are 
sales  of  ski  equipment,  bathing  suits,  and  other  items  of  use  only 
during  certain  times  of  the  year.  In  such  cases,  products  that  are 
advertised  for  sale  in  a  particular  store  this  month  may  not  even 
be  offered  for  sale  in  that  store  in  future  years. 

Proposals  to  require  capitalization  of  advertising  expenses  will 
also  add  a  great  deal  of  complexity  to  the  Tax  Code.  The  primary 
reason  for  the  complexity  will  result  from  trying  to  make  deter- 
minations as  to  what  activities  actually  constitute  advertising.  For 
example,  if  an  advertising  agency  is  hired,  are  all  fees  paid  to  the 
agency  considered  to  be  advertising,  or  are  research  and  other  con- 
sulting services  not  advertising?  Are  salaries  paid  to  store  employ- 
ees, who  deal  with  ad  agencies  and  do  other  advertising  and  mar- 
keting activities,  considered  to  be  advertising  costs? 

If  tne  store  puts  its  label  in  a  coat  that  it  sells,  is  that  advertis- 
ing? Is  the  store's  name  on  the  bill  that  it  sends  to  its  credit  card 
customers  advertising?  Are  product  demonstrations  in  the  store  ad- 
vertising? Are  telephone  and  mail  solicitations  advertising? 


1205 

If  advertising  is  broadly  defined,  capitalization  will  be  difficult 
for  the  Internal  Revenue  Service  to  administer.  However,  if  a  nar- 
rower definition  of  advertising  is  used,  then  sellers  of  goods  and 
services  will  be  encouraged  to  switch  to  a  form  of  marketing  that 
is  deductible.  Thus,  the  tax  law  will  influence  sellers  to  use  a  less 
efficient  means  of  marketing. 

In  either  case,  the  issue  of  what  constitutes  "advertising"  will 
lead  to  innumerable  controversies  between  taxpayers  and  the  In- 
ternal Revenue  Service,  leading  to  years  of  litigation.  This  is  ex- 
actly the  opposite  of  the  goals  set  by  this  committee  to  simplify  our 
overly  complex  tax  system. 

In  summary,  the  National  Retail  Federation  opposes  any  pro- 
posal to  restrict  the  deduction  for  advertising  costs.  Retailers  rely 
on  advertising  to  bring  customers  into  our  stores  and  make  sales, 
which  leads  to  stronger  economic  growth.  There  is  no  tax  policy  jus- 
tification for  limiting  a  retailer's  deduction  for  this  cost  of  doing 
business.  This  would  distort  the  basic  premise  of  matching  reve- 
nues and  expenses.  In  addition,  advertising  contributes  to  the  sale 
of  new  and  innovative  products,  which  are  needed  to  keep  our  Na- 
tion competitive.  Finally,  modifying  the  tax  rules  relating  to  adver- 
tising would  add  a  great  deal  of  complexity  to  the  Tax  Code  and 
result  in  innumerable  controversies  between  taxpayers  and  the  IRS 
over  the  definition  of  advertising. 

Mr.  Chairman  and  members  of  the  committee,  I  thank  you  for 
your  time  and  kind  attention. 

[The  prepared  statement  follows:] 


1206 


STATEMENT  OF  DAVID  L.  FEENEY 
NATIONAL  RETAIL  FEDERATION 

Mr  Chairman,  members  of  the  Committee,  my  name  is  David  L  Feeney,  Senior  Vice  President  - 
Corporate  Taxes,  of  the  R  H.  Macy  &  Co.,  Inc    I  am  pleased  to  appear  today  on  behalf  of  the 
National  Retail  Federation  to  express  our  opposition  to  a  proposal  to  capitalize  advertising  costs 
and  amortize  them  over  a  period  of  years. 

By  way  of  background,  the  National  Retail  Federation  is  the  nation's  largest  trade  group  that 
speaks  for  the  retail  industry    The  organization  represents  the  entire  spectrum  of  retailing, 
including  the  nation's  leading  department,  chain,  discount,  specialty  and  independent  stores, 
several  dozen  national  retail  associations  and  all  50  state  retail  associations.  The  Federation's 
membership  represents  an  industry  that  encompasses  over  1.3  million  U.S.  retail  establishments, 
employs  nearly  20  million  people  and  registered  sales  in  excess  of  $1.9  trillion  in  1992. 

The  retail  industry  would  be  severely  harmed  by  a  proposal  to  capitalize  advertising.  Our  industry 
relies  on  advertising  to  bring  customers  into  our  stores  on  a  day-to-day  basis.  This  is  an  ordinary 
and  necessary  cost  of  doing  business  for  retailers.  There  is  no  good  tax  policy  basis  for  denying 
taxpayers  the  ability  to  deduct  these  costs  as  incurred.  It  is  also  bad  economic  policy  to  increase 
our  cost  of  advertising,  which  directly  affects  sales.  The  ripple  effect  on  the  economy  will  be  to 
reduce  production  and  lower  economic  growth 

Advertising  fosters  competition.  When  a  business  advertises  prices  and  quality,  it  forces 
competitors  to  lower  prices  and  increase  quality.  Advertising  is  also  the  means  by  which  new 
products  can  enter  into  a  market.  Increasing  the  cost  of  advertising  will  disproportionately  hurt 
businesses  that  are  trying  to  market  new  products.  The  results  will  be  less  innovation  and  a  drag 
on  U.S.  global  competitiveness. 

Advertising  also  provides  customers  with  an  important  source  of  information  about  products, 
including  price  and  quality.   It  provides  competition  within  the  marketplace,  and  it  also  helps  to 
bolster  consumer  confidence.  With  consumer  confidence  at  its  current  low  point,  our  government 
cannot  afford  to  adopt  a  policy  that  would  be  a  further  detriment  to  consumer  confidence. 
Rather,  stronger  consumer  confidence  is  needed  to  help  generate  an  economic  recovery. 

Increased  advertising  costs  will  have  a  particulariy  harsh  impact  on  financially  troubled  retailers, 
some  of  which  already  may  be  in  bankruptcy.  Businesses  that  are  strapped  for  cash,  and  in 
particular  financially  troubled  retailers,  use  advertising  as  a  means  of  producing  a  quick  boost  in 
sales  to  increase  their  cash  flow.  It  will  be  diflficult  for  these  businesses  to  bear  the  increased  cost 
of  this  advertising. 

Similarly,  increased  advertising  costs  will  be  harmful  to  small  businesses,  and  especially  small 
retailers,  that  rely  on  increased  sales  as  a  result  of  advertising  to  provide  the  basis  for  building 
their  businesses. 

Advertising  Increases  Short-Term  Sales 

Under  current  law,  advertising  costs  generally  are  deducted  in  the  year  incurred  as  a  cost  of 
doing  business.  This  is  the  same  tax  treatment  that  is  given  to  a  myriad  of  other  business  expenses 
that  are  generally  considered  period  costs.  Tax  law  also  provides  that  recurring  expenditures  are 
currently  deductible  because  of  the  need  to  renew  the  benefits  through  additional  expenditures 
each  year,  suggesting  a  useful  life  of  less  than  a  year.  Advertising  generally  is  considered  a 
recurring  expenditure  because  taxpayers  must  regularly  engage  in  advertising  activities  in  order  to 
produce  new  business  on  a  relatively  consistent  basis  in  each  year 


1207 


There  is  no  tax  incentive  for  engaging  in  advertising  activities,  nor  is  there  any  other  special  "tax 
break"  for  advertising.  Retailers  engage  in  advertising  on  a  day-to-day  basis  in  order  to  inform 
customers  about  current  products  and  prices  and  bring  customers  into  our  stores.  Hopefully,  this 
translates  into  immediate  sales.  The  costs  of  the  business  activity  of  generating  sales  are  deducted 
from  income  in  the  year  incurred  in  order  to  match  revenue  with  the  expenses  of  generating  the 
revenue. 

Other  than  serving  as  a  revenue  raiser,  the  tax  policy  basis  that  has  been  suggested  for  requiring 
the  capitalization  of  a  portion  of  advertising  expenses  is  that  the  revenue  stream  or  benefit 
generated  from  advertising  extends  to  future  years.  From  a  retailer's  perspective,  I  can  state 
emphatically  that  is  not  the  case.  Retail  advertising  is  directed  at  the  sale  of  goods  directly  to 
consumers  within  a  short  period  of  time.  The  advertisement  may  announce  a  sale  of  a  product,  a 
special  promotion  associated  with  the  product,  or  the  availability  of  the  product  at  a  particular 
store.  In  all  of  these  cases,  the  goal  is  to  bring  the  customer  into  the  store  during  the  time  that  the 
sale  or  promotion  is  taking  place.  Again  -  the  purpose  is  to  generate  immediate  sales.  For 
example,  a  newspaper  ad  announcing  the  price  of  chicken  for  the  coming  week  is  designed  to 
bring  customers  into  the  store  during  thai  week  to  purchase  chicken  —  the  advertisement  will  have 
no  value  after  that  week.   Seasonal  advertising  is  similar    Advertisements  directed  at  Christmas 
sales  clearly  are  directed  at  short  term  results,  as  are  sales  of  ski  equipment,  bathing  suits,  and 
other  items  of  use  only  during  certain  times  of  the  year    In  some  cases,  products  that  are 
advertised  for  sale  in  a  particular  store  this  month  may  not  even  be  ofiFered  for  sale  in  that  store  in 
future  years. 

Economic  studies  confirm  that  the  value  of  most  advertising  is  eliminated  within  one  year.  A 
recent  study  co-authored  by  two  Nobel  Laureates  in  economics.  Dr.  Kenneth  J.  Arrow  and  Dr. 
George  G  Stigler,  concludes 

[AJlthough  there  are  a  number  of  economic  studies  that  suggest  that  advertising  is  long- 
lived,  they  are  generally  so  fraught  with  errors  that  one  cannot  rely  on  their  findings. 
When  we  correct  for  some  statistical  problems,  we  find  that  the  estimated  duration 
intervals  are  much  shorter  than  originally  thought.  Moreover,  there  are  a  number  of 
studies  (particularly  more  recent  ones)  that  suggest  that  advertising  depreciates  so  rapidly 
that  virtually  all  of  its  effects  are  gone  within  a  year.  In  short,  the  economic  evidence  does 
not  support  the  view  that  advertising  is  long-lived.' 

Requiring  Caoitalization  Will  Greatly  Increase  the  Comnlexitv  of  the  Tax  Code 

Proposals  to  require  capitahzation  of  advertising  expenses  will  add  a  great  deal  of  complexity  to 
the  tax  code.  The  primary  reason  for  the  complexity  will  result  from  trying  to  make 
determinations  as  to  what  activities  constitute  advertising  and  what  activities  do  not.  For 
example,  if  an  advertising  agency  is  hired,  are  all  fees  paid  to  the  agency  considered  to  be  for 
advertising,  or  are  research  and  other  consulting  services  not  advertising?  Are  salaries  paid  to 
store  employees  who  deal  with  ad  agencies  and  do  other  advertising  and  marketing  activities 
considered  to  be  advertising  costs?  If  a  store  puts  its  label  in  a  coat  that  it  sells,  is  that 
advertising?  Is  the  store's  name  on  the  bills  it  sends  to  its  credit  card  customers  advertising?  Are 
product  demonstrations  in  the  store  advertising''  Are  telephone  and  mail  solicitations  advertising? 

If  advertising  is  defined  broadly,  capitalization  will  be  difficult  for  the  Internal  Revenue  Service  to 
administer    However,  if  a  narrower  definition  of  advertising  is  used,  then  sellers  of  goods  and 
services  will  be  encouraged  to  switch  to  a  form  of  marketing  that  is  deductible.  Thus,  the  tax  law 
will  influence  sellers  to  use  a  less  efiBcient  means  of  marketing. 

In  either  case,  the  issue  of  what  constitutes  "advertising"  will  lead  to  innumerable  controversies 
between  taxpayers  and  the  Internal  Revenue  Service  —  leading  to  years  of  litigation.  This  is 
exactly  the  opposite  of  the  goals  set  by  this  Committee  to  simplify  our  overiy  complex  tax  system. 


'Kenneth  J.  Arrow,  George  G.  Stigler,  Elisabeth  M.  Landes.  and  Andrew  M  Rosenfield,  Economic  Analysis  of 
Proposed  Changes  in  Tax  Treatment  of  Advertisine  Expenditures.  Lexicon,  Inc.,  Chicago,  April  1990  at  39-40. 


1208 


Conclusion 


In  summary,  the  National  Retail  Federation  opposes  any  proposal  to  restrict  the  deduction  for 
advertising  costs    Retailers  rely  on  advertising  to  bring  customers  into  our  stores  and  make  sales, 
which  leads  to  stronger  economic  growth    There  is  nc  tax  policy  justification  for  limiting  a 
retailer's  deduction  for  this  cost  of  doing  business  This  would  distort  the  basic  premise  of 
matching  revenues  and  expenses  In  addition,  advertising  contributes  to  the  sale  of  new  and 
innovative  products,  which  are  needed  to  keep  our  nation  competitive.  Finally,  modifying  the  tax 
rules  relating  to  advertising  would  add  a  great  deal  of  complexity  to  the  tax  code  and  result  in 
innumerable  controversies  between  taxpayers  and  the  Internal  Revenue  Service  over  the  definition 
of  advertising. 


1209 

Mr.  Payne.  Thank  you  very  much,  Mr.  Feeney. 

Our  next  two  witnesses  will  be  testifying  concerning  the  depre- 
ciation of  assets  in  the  printing  and  publishing  industry.  We  will 
first  hear  fi-om  Mr.  Webber. 

STATEMENT  OF  HOWARD  C.  WEBBER,  JR^  CHAIRMAN, 
COHBER  PRESS,  INC.,  ROCHESTER,  N.Y.,  ON  BEHALF  OF  THE 
PRINTING  INDUSTRIES  OF  AMERICA,  AND  GRAPHIC  ARTS 
LEGISLATIVE  COUNCIL 

Mr.  Webber.  Thank  you.  Mr.  Chairman,  members  of  the  sub- 
committee, mv  name  is  Howard  C.  Webber,  Jr.  I  am  the  chairman 
and  CEO  of  Uohber  Press,  Inc.,  a  58-employee  commercial  printing 
firm  located  in  Rochester,  N.Y.  I  am  a  former  chairman  of  the 
board  of  the  Printing  Industries  of  America,  the  largest  printing 
and  graphic  arts  trade  association  in  the  United  States,  with  over 
14,000  member  companies. 

I  am  appearing  before  you  today  on  behalf  of  the  Graphic  Arts 
Legislative  Council,  a  group  of  national  graphic  arts  associations 
formed  in  1988  to  provide  a  forum  for  addressing  legislative  and 
regulatory  proposals  before  Federal  and  State  government.  The 
council  consists  of  14  associations  representing  every  aspect  of  the 
printing  and  graphic  arts  industry. 

Mr.  Chairman,  it  is  important  to  understand  the  printing  and 
publishing  industry  is  comprised  of  several  key  segments.  Publish- 
ers are  those  companies  which  publish  periodicals,  books,  and  other 
items  but  who  do  not  own  printing  equipment.  Newspaper  publish- 
ers are  those  who  both  publish  and  print  newspapers.  The  remain- 
der of  printing  and  publishing,  or  roughly  half  the  total  of  the  en- 
tire industry,  is  commercial  printing  and  activities  related  to  com- 
mercial printing.  While  these  companies  print  books  and  maga- 
zines, they  also  print  many  newspaper  inserts,  newsletters,  adver- 
tising materials,  labels,  forms,  wedding  invitations,  and  virtually 
every  other  item  where  an  image  is  created  on  some  type  of  sur- 
face. 

Let  me  just  spend  a  moment  describing  today's  commercial  print- 
ing industry.  Commercial  printing  is  the  largest  manufacturing  in- 
dustry in  tne  Nation  in  terms  of  number  of  establishments.  Over 
42,000  firms  generating  $79  billion  in  sales  employ  more  than 
820,000  individuals.  Unlike  many  U.S.  manufacturers  we  have  wit- 
nessed steady  increases  in  productivity  while  watching  employment 
and  average  wages  increase  as  well.  We  also  are  a  net  exporter, 
having  enjoyed  a  favorable  balance  of  trade  for  many  years. 

Mr.  Chairman,  my  comments  today  are  directed  toward  item  No. 
2  under  the  cost  recovery  section  of  the  August  17  press  release 
which  was  a  proposal  to  extend  the  recovery  period  applicable  to 
certain  assets  used  in  printing  and  publishing  to  10  years.  As  I  un- 
derstand the  proposal,  it  would  shift  equipment  which  is  today  on 
a  7-year  depreciation  schedule,  including  press  equipment,  bindery 
equipment  and  certain  prepress  equipment  such  as  electronic  scan- 
ners, to  a  10-year  schedule. 

I  must  tell  you,  in  all  honesty,  that  this  proposal  has  been  met 
with  shock,  disbelief  and  genuine  outrage  by  an  industry  that  is 
still  climbing  back  to  health  after  the  recent  recession.  Because  our 
industry  is  comprised  of  a  high  number  of  small  family-owned  en- 


1210 

terprises,  the  most  successful  of  which  have  already  taken  a  hit 
this  year  from  the  recent  reconciliation  bill  which  increased  the 
rates  of  subchapter  S  corporations,  we  are  already  concerned  about 
generating  the  capital  necessary  to  keep  our  plants  up  to  date  and 
competitive. 

Printing  is  a  capital-intensive  industry  that  has  been  revolution- 
ized in  recent  years  by  rapid  changes  in  technology.  Even  the  cur- 
rent 7-vear  depreciation  schedule  is  often  inadequate  to  allow  for 
the  full  recovery  of  equipment  investments.  Stretching  the  depre- 
ciation schedule  out  to  10  years  not  only  fails  to  take  into  account 
the  reality  of  today's  printing  environment  but  it  unfairly  singles 
out  our  industry  relative  to  other  American  manufacturers. 

It  used  to  be  we  kept  a  printing  press  for  8  to  10  years  and  only 
replaced  it  because  it  wore  out.  Today,  however,  we  replace  our 
equipment  in  5  to  7  years,  primarily  because  new  technologies  are 
constantly  evolving.  Investing  in  this  new  technology  can  give  a 
printer  a  competitive  edge  in  a  particular  market  segment. 

In  view  of  the  rapid  changes  in  technology,  any  changes  in  the 
depreciation  schedule  for  our  industry  should  be  geared  toward  re- 
ducing the  term  such  as  a  5-year  schedule  used  in  Grermany  rather 
than  increasing  the  schedule  far  beyond  the  useful  life  of  a  product. 
However,  we  do  not  come  to  Congress  to  propose  a  shorter  depre- 
ciation schedule.  In  fact,  the  commercial  printing  industry  has 
never  approached  this  committee  for  a  tax  break  or  a  special  pro- 
gram. 

Instead,  someone  in  Congress  took  it  upon  themselves  to  suggest 
a  change  in  our  depreciation  solely  based  upon  the  need  for  in- 
creased Federal  revenue  rather  than  out  of  any  interest  to  adjust 
the  schedules  to  economic  reality.  If  the  proposal  were  part  of  a 
broad  review  of  depreciation  schedules  for  all  industry,  we  would 
be  happy  to  make  our  case  for  retaining  the  present  schedules,  but 
on  this  issue  printing  has  been  singled  out  as  the  only  industry  to 
take  a  direct  hit,  and  the  proposed  changes  have  nothing  to  do  with 
the  actual  use  of  equipment  in  our  plants  today. 

Contrary  to  the  predictions  of  many,  the  market  for  printed  prod- 
ucts is  larger  than  ever  and  shows  every  indication  of  continuing 
steady  growth  well  into  the  future.  Remember  the  paperless  office? 
If  your  office  is  anything  like  mine,  it  has  more  paper  in  it  today 
than  ever  before.  Yes,  much  of  it  is  photocopied,  but  even  with  the 
tremendous  growth  in  photocopying,  demand  for  printing  has  con- 
tinued to  grow.  Many  predicted  that  the  advent  of  the  personal 
computer  would  mark  the  end  of  traditional  printing,  yet  imagine 
a  book  store  today  without  computer  magazines  and  books  and 
imagine  your  PC  without  volumes  of  software  manuals  and  instruc- 
tion material,  all  of  it  printed  by  our  industry.  The  advent  of  the 
computer  age  has  resulted  in  more  printing,  not  less. 

The  greatest  impact  of  these  new  technologies  on  printing  has 
been  the  way  the  technologies  themselves  have  been  utilized  in  the 
printing  process.  The  computer  chip  is  now  an  integral  part  of  al- 
most every  new  piece  of  equipment  in  the  industry.  As  new  mar- 
kets for  printed  material  develop,  competition  for  the  latest  press 
technology  to  enable  a  printer  to  maintain  a  competitive  edge 
grows  sharper. 


1211 

At  a  time  when  this  industry  is  growing  at  a  rate  faster  than  the 
gross  national  product  and  when  we  are  enjoying  a  favorable  trade 
balance,  this  committee  should  be  taking  steps  to  urge  us  to  ex- 
pand, not  contract.  In  the  name  of  the  42,000  small  firms  making 
up  this  industry,  we  urge  you  not  to  ask  the  printing  industry  to 
slow  its  growth  solely  for  additional  revenue. 

Mr.  Chairman,  I  have  attached  a  chart  on  the  next  page  which 
you  have,  I  believe,  which  demonstrates  the  effect  of  the  proposed 
change  on  printers  of  varying  size. 

I  want  to  thank  you  for  this  opportunity  to  appear  before  you 
today.  Thank  you. 

[The  statement  and  attachment  follow:] 


1212 


STATEMENT  OF  HOWARD  C.  WEBBER,  JR.,  ON  BEHALF  OF  PRINTING 
INDUSTRIES  OF  AMERICA,  AND  GRAPHIC  ARTS  LEGISLATIVE  COUNCIL 

Mr.  ChaiiTOan,  memben  of  the  Subcommittee,  my  name  is  Howard  C.  Webber,  and  I  am  the 
chainnan  and  chief  executive  ofRca  of  Cohbo-  Press,  Inc.,  a  58  employee  commercial  printing 
firm  located  in  Rochester,  New  York.  I  am  a  foimer  Chainnan  of  the  Board  of  Printing 
Industries  of  Amoica,  the  largest  printing  and  graphic  arts  trade  association  in  the  United  States 
with  ova- 14,000  member  companies. 

I  am  appearing  before  you  today  on  behalf  of  the  Graphic  Aits  Legislative  Council  (GALQ,  a 
group  of  national  graphic  aits  associations  formed  in  1988  to  provide  a  forum  for  addressing 
legislative  and  regulatory  proposals  before  federal  and  state  government.  The  Council  consists 
of  14  associations  representing  every  aspect  of  the  printing  and  gr^hic  aits  industry. 

Mr.  Chairman,  it  is  important  to  understand  that  the  "printing  and  publishing  industry"  is 
comprised  of  several  key  segments.  Publishers  are  those  companies  which  publish  periodicals, 
books,  and  otha  items  but  who  do  not  own  printing  equipment.  Newspaper  publishers  are  those 
who  both  publish  and  print  newspapers.  The  remainder  of  "printing  and  publishing,"  or  roughly 
half  the  total  of  the  entiie  industry,  is  commercial  printing  and  activities  related  to  commaxnal 
printing.  While  these  companies  print  books  and  magazines,  they  also  print  many  newspaper 
insots,  newsletters,  advertising  materials,  labels,  forms,  wedding  invitations,  and  virtually  every 
other  item  where  an  image  is  created  on  some  type  of  surface. 

L^  me  spend  a  moment  describing  today's  commercial  printing  industry.  Commercial  printing 
is  the  largest  manufacturing  industry  in  the  nation  in  terms  of  numbers  of  establishments.  Over 
42,000  firms  generating  $79  billion  in  sales  employ  more  than  820,000  individuals.  Unlike  many 
U.S.  manufacturers,  we  have  witnessed  steady  increases  in  productivity  while  watching 
anployment  and  average  wages  increase  as  weU.  We  are  also  a  net  exporter,  having  enjoyed  a 
favorable  balance  of  trade  for  many  years. 

Mr.  Chairman,  my  comments  today  are  directed  toward  item  number  2  under  the  cost  recovery 
section  of  the  August  17  press  release  which  was  "a  proposal  to  extend  the  recovery  period 
q>plicable  to  certain  assets  used  in  printing  and  publishing  to  10  years."  As  I  understand  this 
proposal,  it  would  shift  equipment  which  is  today  on  a  7  year  deineciation  schedule,  including 
press  equipment,  bindery  equipment  and  certain  prepress  equipment  such  as  electronic  scanners 
to  a  10  year  schedule. 

I  must  tell  you  in  all  honesty,  that  this  proposal  has  been  met  with  shock,  disbelief,  and  genuine 
outrage  by  an  industry  that  is  still  climbing  back  to  health  after  the  recent  recession.  Because 
our  industry  is  comprised  of  a  high  number  of  small  family-owned  enterprises,  the  most 
successful  of  which  have  already  taken  a  hit  this  year  from  the  recent  reconciliation  bill  which 
increased  the  rates  on  Subch^>ter  S  corporations.  We  are  aheady  concerned  about  generating 
the  capital  necessary  to  ke^  our  plants  up  to  date  and  competitive. 

Printing  is  a  cental  intensive  industry  that  has  been  revolutionized  in  recent  yeais  by  rapid 
changes  in  technology.  Evea  the  current  7-year  depreciation  schedule  is  often  inadequate  to 
allow  for  the  fuU  recovoy  of  equipmoit  investments.  Stretching  the  depreciation  period  out  to 
10  years  not  only  fails  to  take  into  account  the  reality  of  today's  printing  environment,  but  it 
unfairly  singles  out  our  industry  relative  to  other  American  manufactures. 

It  used  to  be  that  we  kept  a  printing  press  for  8-10  years  and  only  replaced  it  because  it  wore  out 
Today,  however,  we  replace  our  equipment  in  5-7  years  primarily  because  new  technologies  are 
constantly  evolving.  Investing  in  this  new  technology  can  give  a  printer  a  competitive  edge  in 
a  particular  market  segment  In  view  of  the  rapid  changes  in  technology,  any  changes  in  the 
dqjreciation  schedule  for  our  industry  should  be  geared  toward  reducing  the  term,  such  as  the 
five  year  schedule  used  in  Germany,  rather  than  increasing  the  schedule  far  beyond  the  useful 
life  of  a  product 

However,  we  did  not  come  to  Congress  to  propose  a  shorter  depreciation  schedule.  In  fact,  the 
corrmiercial  printing  industry  has  never  ^jproached  this  conmiittee  for  a  tax  break  or  special 
program.  Instead  someone  in  Congress  took  it  upon  themselves  to  suggest  a  change  in  our 
depreciation  solely  based  on  the  need  for  increased  federal  revenue  rather  than  out  of  any  interest 
to  adjust  the  schedules  to  economic  reality.    If  the  proposal  were  part  of  a  broad  review  of 


1213 


depreciation  schedules  for  all  industry,  we  would  be  happy  to  make  our  case  for  retaining  the 
present  schedules.  But  on  this  issue,  printing  has  been  singled  out  as  the  only  industry  to  take 
a  direct  hit  and  the  proposed  changes  have  nothing  to  do  with  the  actual  use  of  equipment  in  our 
plants  today. 

Contraiy  to  the  predictions  of  many,  the  market  for  printed  products  is  largo-  than  ever,  and 
shows  every  indication  of  continuing  steady  growth  well  into  the  future.  Remembe-  the 
"pEqierless  office?"  If  your  office  is  anything  like  mine,  it  has  more  papa  in  it  today  than  ever 
before.  Yes,  much  of  it  is  photocopied.  But  even  with  the  tremendous  growth  in  photocopying, 
demand  for  printing  has  continued  to  grow.  Many  predicted  that  the  advent  of  the  personal 
computer  would  mark  the  end  of  traditional  printing.  Yet  imagine  a  bookstore  today  without 
computer  related  magazines  and  books  and  imagine  your  PC  without  volumes  of  software 
manuals  and  instructional  material,  all  of  it  printed  by  our  industry.  The  advent  of  the  computer 
age  has  resulted  in  more  printing,  not  less. 

The  greatest  impact  of  these  new  technologies  on  printing  has  been  the  way  the  technologies 
themselves  have  been  utilized  in  the  printing  process.  The  computer  chip  is  now  an  integral  part 
of  almost  evoy  new  piece  of  equipment  in  the  industry.  As  new  markets  for  printed  material 
develop,  competition  for  the  latest  press  technology  to  enable  a  printer  to  maintain  a  competitive 
edge  grows  sharper. 

At  a  time  when  this  iiufaistry  is  growing  at  a  rate  faster  than  the  Gross  National  Product  and 
when  we  are  enjoying  a  favorable  trade  balance,  this  committee  should  be  taking  st^M  to  urge 
us  to  expand,  not  contract.  In  the  name  of  the  42,000  small  firms  making  up  this  industry,  we 
urge  you  not  to  ask  the  printing  industry  to  slow  its  growth  solely  for  additional  revenue. 

Mr.  Chairman,  I  have  attached  a  chart  on  the  next  page  which  demonstrates  the  effiect  of  the 
proposed  change  on  printers  of  varying  size.  I  want  to  thank  you  for  this  opportunity  to  ^>pear 
before  you  today. 


Members  of  the  Graphic  Arts  Legislative  Council  include:  Book  Manufacturers '  Institute,  bic. 
Envelope  Manufacturers  Association  of  America,  Flexographic  Technical  Association,  Inc.,  Foil 
Stamping  and  Embossing  Association,  bttemational  Association  ofDiecutting  and  Diemaking, 
baemational  Prepress  Association,  bttemational  Reprographic  Association,  National  Association 
of  Printers  and  Lithographers,  National  Association  of  Printing  bik  Manufacturers,  bic..  National 
Association  of  Quick  Printers,  bic..  North  American  Graphic  Arts  Suppliers  Association,  Printing 
Industries  of  America,  bu:..  Research  and  Engineering  Coundl  of^  Graphic  Arts  bidustry,  bic 
and  Typographers  bttemational  Association. 


Mr.  Howard  C  Webber,  Jr.  Graphics  Arts  Legislative  Council 

Cohber  Press,  bK.  c/o  Printing  Industries  of  America 

1000  John  Street  100  Daingerfield  Road 

P.O.  Box  93100  Alexandria,  VA  22314 

Rochester,  NY  14692  Contact:  Benjamin  Y.  Cooper 

(716)  475-9100  (703)  519-8158 


77-130  0-94 -7 


1214 


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1215 

Mr.  Payne.  Thank  you,  Mr.  Webber. 

Our  last  witness,  representing  the  Association  for  Supphers  of 
Printing  and  Publishing  Technologies,  is  Mark  Nuzzaco,  director  of 
government  affairs. 

STATEMENT  OF  MARK  J.  NUZZACO,  DIRECTOR  OF  GOVERN- 
MENT AFFAIRS,  NPES,  THE  ASSOCIATION  FOR  SUPPLIERS 
OF  PRINTING  AND  PUBLISHING  TECHNOLOGIES 

Mr.  Nuzzaco.  Thank  you.  Good  afternoon.  My  name  is  Mark 
Nuzzaco.  I  am  director  of  government  affairs  for  NPES,  the  Asso- 
ciation for  Suppliers  of  Printing  and  Publishing  Technologies. 

We  thank  tne  chairman  and  subcommittee  tor  the  opportunity  of 
appearing  before  the  subcommittee  to  comment  on  a  proposed 
change  in  the  tax  law  extending  to  10  years  the  recovery  period  for 
certain  assets  used  in  printing  and  publishing.  We  feel  that  such 
a  change  would  be  very  detrimental  to  the  economic  recovery  and 
long-term  vitality  of  our  industry  and  our  customers. 

My  full  statement,  which  has  been  submitted  for  the  record, 
elaborates  on  our  opposition  to  this  proposal.  For  purposes  of  to- 
day's hearing,  I  will  summarize  our  concerns. 

Before  beginning  my  comments,  I  would  like  to  acknowledge  that 
I  am  pleased  to  share  the  witness  table  today  with  Mr.  Webber, 
chairman  of  Cohber  Press,  Rochester,  N.Y.,  representing  our  sister 
association,  Printing  Industries  of  America,  which  is  comprised  of 
thousands  of  our  members'  customers,  and  the  Graphics  Arts  Leg- 
islative Council.  In  light  of  the  subcommittee's  full  agenda,  my  re- 
marks are  intended  to  complement  Mr.  Webber's  testimony. 

NPES  represents  approximately  300  companies  which  account 
for  about  90  percent  of  domestic  production  of  printing  and  publish- 
ing technology.  Nearly  60  percent  of  NPES's  members  are  small 
businesses  with  gross  sales  of  $5  million  or  less. 

The  printing  and  publishing  technologies  industry  provides  an 
enormous  variety  of  products  and  supplies  to  meet  the  needs  of  the 
printing  and  publishing  industry  and  its  many  segments.  It  is  an 
arena  in  which  societal  trends,  fast-moving  technology  and  intense 
competition  are  all  helping  to  shape  the  future. 

The  most  obvious  of  the  assets  used  in  this  industry,  printing 
presses,  represent  just  one  stage  in  the  long  and  technically  com- 
plex task  of  transforming  ideas  into  printed  materials.  However, 
many  other  technologically  sophisticated  products  are  also  em- 
ployed in  the  industry. 

The  total  market  for  printing  equipment  in  1992  approached  $2.1 
billion  in  orders  and  was  slightly  over  $2.1  billion  in  product  ship- 
ments. The  relatively  modest  size  of  the  printing  and  publishing 
technologies  industry  belies  its  critical  role  in  supporting  the  much 
larger,  crucially  important  graphics  communication  industry  that 
has  been  described  by  Mr.  Webber. 

Until  just  a  few  years  ago,  most  information  was  disseminated 
by  publications  that  were  printed  by  one  of  four  major  printing 
processes.  Today,  however,  we  are  witnessing  a  broad  expansion  of 
communicational  alternatives,  largely  based  on  rapidly  changing 
technologies. 

The  proposal  to  extend  to  10  years  the  recovery  period  for  certain 
assets  used  in  printing  and  publishing  is  detrimental  to  the  graphic 


1216 

communication  industry's  need  for  improved  quality  and  productiv- 
ity. Currently,  assets  used  in  printing  and  publishing  are  defined 
to  have  an  11-year  class  life  and  are  in  the  7-year  modified  acceler- 
ated cost  recovery  system  class  for  depreciation.  These  assets  would 
include  printing  presses  and  machinery  used  in  the  bindery. 

In  light  of  the  new  technological  changes  to  this  traditional 
equipment,  even  the  current  7-year  depreciation  period  exceeds  the 
commercial  life  of  much  of  this  machinery.  Extending  the  capital 
cost  recovery  period  by  nearly  another  50  percent  to  10  years  would 
clearly  be  the  wrong  policy  to  adopt  at  a  critical  point  in  the  indus- 
try's recovery  from  the  economic  downturn  we  have  just  endured. 

Historically,  the  industry  has  had  an  electromechanical  orienta- 
tion. However,  in  1979  the  technological  revolution  began  in  the 
graphics  arts  industry  with  introduction  of  the  color  electronic 
prepress  system.  With  this  product  computers  were  introduced  to 
the  printing  process,  and  that  change  more  than  any  other  caused 
a  fundamental  change  in  the  printing  and  publishing  industry.  Be- 
fore this  era  in  the  mid  1970s,  printing  press  speeds  were  just  one- 
third  of  today's  top  speeds  of  over  3,000  feet  per  minute.  It  took  10 
years  to  increase  from  1,000  to  1,500  feet  per  minute.  But  speeds 
have  doubled  to  over  3,000  feet  per  minute  in  just  the  last  7  years. 

Clearly,  the  rate  of  change  is  increasing  dramatically.  At  such 
speeds,  computerized  controls  were  required. 

At  the  same  time,  the  1980s  witnessed  the  color  revolution  in  the 
printing  and  publishing  industry.  Advertisers  demanded  more  and 
higher  quality  color.  This  color  revolution  fueled  rapid  growth  in 
the  printing  market  and  demanded  new  and  more  sophisticated 
technology. 

As  rapidly  as  press  technolo^  is  changing,  innovation  in  the 
prepress  area  is  occurring  even  faster.  The  conversion  from  analog 
to  digital  data  use  is  an  underlying  cause  of  the  change.  This  tran- 
sition is  forcing  vendors  to  focus  on  the  development  and  sale  of 
discreet  products  that  can  be  indiscriminately  interchanged  by  the 
user. 

This  situation  is  similar  to  what  has  already  happened  in  the 
electronic  office  environment.  As  we  have  continued  to  see  in  the 
"plug  and  play"  environment  of  the  electronic  office,  standards- 
based  prepress  products  will  also  require  more  frequent  revision 
and/or  replacement,  thus  requiring  routine  upgrade  to  stay  com- 
petitive. 

As  long  as  printers  have  been  putting  ink  to  paper,  the  quest  for 
greater  output  and  better  quality  witn  fewer  man  hours  and  re- 
duced waste  has  been  the  driving  force  for  every  press  manufac- 
turer. Today's  technologies  have  taken  this  quest  to  even  a  new 
level.  Today's  increasingly  rapid,  technological  advances  are  yield- 
ing faster  production  speeds,  quicker  make-readies,  reduced  run- 
ning and  make-ready  waste,  better  flexibility  and  quality  over  a 
range  of  jobs,  less  downtime  and,  more  importantly,  the  ability  to 
compete  better  with  other  communications  vehicles. 

New  orders  for  printing  equipment  are  expected  to  rise  12  per- 
cent this  year  and  6  percent  in  1994.  Shipments  of  imaging  and 
prepress  equipment  systems,  in  essence,  computers  and  the  soft- 
ware needed  to  run  them,  are  expected  to  rise  about  10  percent 
this  year  and  8  percent  in  1994.  While  these  are  respectable  gains. 


1217 

they  lag  far  behind  the  15  to  20  percent  growth  rates  of  the  com- 
puter industry  generally.  This  is  because  the  technological  revolu- 
tion is  incompletely  implemented  in  the  printing  industry  because 
of  a  lack  of  cash  flow  and  ability  to  borrow,  especially  by  smaller 
printing  companies. 

Capital  spending,  after  getting  off  to  a  good  start  in  the  first 
quarter,  abruptly  reversed  course  when  the  Clinton  administration 
announced  it  would  not  reinstate  the  investment  tax  credit  after 
all.  Although  the  provision  of  the  Omnibus  Budget  Reconciliation 
Act  of  1993  increasing  the  expenses  deduction  for  small  businesses 
from  $10,000  to  $17,500  is  helpful,  its  incentive  for  investment  will 
be  severely  eroded  by  the  extension  of  the  depreciation  period  to  10 
years  as  called  for  in  this  proposal. 

Rather  than  impeding  investment,  especially  productivity-im- 
proving capital  expenditures  by  small  businesses,  Congress  should 
be  looking  for  ways  to  encourage  capital  formation  and  investment 
in  new  technologies  necessary  for  a  revitalized  industrial  infra- 
structure. 

Mr.  Chairman,  we  respectfully  urge  you  to  adopt  such  a  course, 
and  reject  the  current  proposal.  We  thank  you  for  the  opportunity 
to  present  these  comments.  I  would  be  pleased  to  answer  any  ques- 
tions or  submit  additional  information  for  the  record. 

Thank  you. 

[The  prepared  statement  follows:] 


1218 

STATEMENT  BY 

MARK  J.  NUZZACO 

DIRECTOR  OF  GOVERNMENT  AFFAIRS 

NPES  THE  ASSOCIATION  FOR  SUPPLIERS  OF  PRINTING  AND  PUBLISHING 
TECHNOLOGIES 

BEFORE  THE 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

OF  THE 

COMMITTEE  ON  WAYS  AND  MEANS 

UNITED  STATES  HOUSE  OF  REPRESENTATIVES 

SEPTEMBER  8,  1993 


I.         INTRODUCTION 

Good  Morning.   My  name  is  Mark  J.  Nuzzaco.   I  am  Director  of  Government  Affairs 
for  NPES  The  Association  for  Suppliers  of  Printing  and  Publishing  Technologies.    I  am  here 
today  representing  the  thousands  of  women  and  men  who  comprise  a  basic  industry  that  is 
part  of  our  nation's  industrial  backbone.    On  their  behalf  I  thank  you  Mr.  Chairman  for  the 
opportunity  of  appearing  before  the  Subcommittee  on  Select  Revenue  Measures  to  comment 
on  a  proposed  change  in  the  tax  law  extending  to  ten  years  the  recovery  period  for  certain 
assets  used  in  printing  and  publishing.   We  feel  that  such  a  change  would  be  very  detrimental 
to  the  economic  recovery  and  long-term  vitality  of  our  industry.    My  full  statement,  which 
has  been  submitted  for  the  record,  elaborates  on  our  opposition  to  this  proposal.    For  the 
purpose  of  today's  hearing  I  will  summarize  our  concerns. 

Before  beginning  my  comments,  I  would  also  like  to  acknowledge  that  I  am  pleased 
to  share  the  witness  table  today  with  Mr.  Howard  C.  Webber,  Jr.,  President,  Cohber  Press, 
Rochester,  N.Y.,  representing  our  sister  association  Printing  Industries  of  America,  which  is 
comprised  of  thousands  of  our  members'  customers,  and  the  Graphic  Arts  Legislative 
Council.   In  light  of  the  Subcommittee's  full  agenda,  my  remarks  are  intended  to  compliment 
Mr.  Webber's  testimony. 

A.  NPES  The  Association  for  Suppliers  of  Printing  and  Publishing  Technologies 

NPES  The  Association  for  Suppliers  of  Printing  and  Publishing  Technologies  is  a 
national  trade  association  whose  member  companies  are  engaged,  within  the  United  States,  in 
building,  manufacturing,  repairing,  selling,  importing  for  sale,  or  distributing  printing  and 
publishing  technologies  used  in  the  graphic  communications  industries.    NPES  membership 
currently  stands  at  approximately  300  companies  which  account  for  about  90%  of  domestic 
production  of  printing  and  publishing  technologies.    Nearly  60%  of  NPES  members  are  small 
businesses  with  gross  sales  of  $5  million  or  less  annually. 

B.  The  Printing  and  Publishing  Technologies  Industry 

America's  graphic  communications  industry  requires  an  enormous  variety  of  products 
to  do  its  work.   The  printing  and  publishing  technologies  industry  provides  the  products  and 
supplies  that  meet  the  needs  of  the  printing  and  publishing  industry  and  its  many  segments. 
These  segments  include  commercial  printing,  corporate  publishing,  magazines  and 
periodicals,  newspapers,  book  printing  and  publishing,  business  forms,  packaging,  specialty 
printing,  trade  services,  graphic  design  houses,  advertising  agencies  and  desktop  publishers 
using  lithographic,  letterpress,  flexographic,  gravure,  screen,  and  non-impact  processes.   It  is 


1219 


an  arena  in  which  societal  trends,  fast-moving  technology,  and  intense  competition  are  all 
helping  to  shape  the  future. 

The  most  obvious  of  the  assets  used  in  this  industry,  printing  presses,  represent  just 
one  stage  in  the  long  and  technically  complex  task  of  transforming  ideas  into  printed 
materials.    Every  printing  job,  from  the  simplest  to  the  most  elaborate,  goes  through  the 
same  basic  processes:  prepress,  press,  and  bindery. 

The  products  employed  in  the  printing  industry  include  typesetting  systems,  page 
composition  systems,  negative  and  plate-making  equipment,  presses  of  all  types,  press 
accessories  and  binding  and  finishing  apparatus.    Printing  supplies  include  papers,  films, 
plates,  and  chemicals  for  photo  typesetting  and  other  prepress  functions. 

Printing  Trades  Machinery  (SIC  3555)  is  identifiable  as  a  discrete  category  within  the 
more  general  classification  of  Special  Industry  Machinery  of  the  Department  of  Commerce's 
Standard  Industrial  Classifications  System  (SIC).  The  total  market  for  printing  equipment  in 
1992  approached  $2.1  billion  in  orders  and  was  over  $2.1  billion  in  product  shipments. 

The  graphics  arts  supplies  portion  of  the  industry  is  less  readily  identified,  as  these 
products  typically  are  not  aggregated  as  a  separate  group,  but  are  spread  across  several 
broader  industry  categories,  such  as  chemicals  and  photographic  supplies. 

C.        America's  Graphic  Communications  Industry 

The  relatively  modest  size  of  the  printing  and  publishing  technologies  industry  belies 
its  critical  role  in  supporting  the  much  larger,  crucially  important  graphic  communications 
industry.    With  establishments  in  virtually  every  town  and  county,  products  of  the  U.S. 
printing  and  publishing  industry  serve  the  country's  diverse  communication  needs. 
According  to  the  1992  Census  of  Manufacturers,  of  the  20  major  manufacturing  groups 
included  in  the  SIC,  printing  and  publishing  ranks  third  in  the  number  of  establishments. 
There  are  more  than  60,000  printing  establishments  nationwide,  employing  some  1.55 
million  people. 

'      Until  just  a  few  years  ago  most  publications  were  printed  by  one  of  the  four  major 
printing  processes  (offset  lithography,  gravure,  flexography,  and  letterpress).    That  being  the 
case,  the  industry's  users,  vendors,  technologies  and  products  were  focused  on  the  printing 
process  and  meeting  its  requirements. 

Today,  however,  we  are  witnessing  a  significant  industry  refocus  from  printing  to 
publishing,  which  will  also  include  the  broad  world  of  communications  by  later  in  the 
decade.    As  a  result,  in  addition  to  printing,  many  of  the  same  publications  may  be:  1) 
reproduced  by  a  xerographic  electronic  publishing  system;  2)  provided  as  an  electronic 
database  (for  example:  airline  scheduling,  legal  records,  etc.);  and/or  3)  distributed  on 
magnetic  media  (for  example:  CD-ROM).   This  "non-traditional"  focus  represents  a 
substantial  shift  in  the  industry's  perspective,  made  possible  due  to  a  wide  range  of  factors. 
This  broad  expansion  of  communication  alternatives,  largely  based  on  rapidly  changing 
technologies,  offers  both  major  challenges  and  opportunities  for  traditional  printers  and  their 
suppliers. 


1220 


n.        THE  PROPOSAL  TO  EXTE^fD  TO  TEN  YEARS  THE  RECOVERY  PERIOD 
FOR  CERTAIN  ASSETS  USED  IN  PRINTING  AND  PUBLISHING  IS 
DETRIMENTAL  TO  THE  GRAPHIC  COMMUNICATION  INDUSTRY'S  NEED 
FOR  IMPROVED  QUALITY  AND  PRODUCTIVITY 

Currently,  assets  used  in  printing  and  publishing  are  defined  to  have  an  11  year  class 
life  and  are  in  the  7-year  MACRS  class  for  depreciation.   These  assets  would  include 
printing  presses,  and  machinery  used  in  the  bindery.    In  light  of  the  new  technological 
changes  to  this  traditional  equipment,  even  the  current  7-year  depreciation  period  exceeds  the 
commercial  life  of  most  of  this  machinery.   Extending  the  capital  cost  recovery  period  by 
nearly  another  50%  to  ten  years  would  clearly  be  the  wrong  policy  to  adopt  at  a  critical  point 
in  the  industry's  recovery  from  the  economic  downturn  we  have  just  endured.   To  help  put 
this  in  context,  let  me  tell  you  about  the  rapidly  changing  nature  of  the  technology  at  issue. 

A.  Printing  and  Publishing  and  the  Increasingly  Competitive  Communications 
Market 

There  are  a  number  of  trends  shaping  the  outlook  for  the  printing  and  publishing 
industry.  A  major  factor  is  the  impact  of  electronic  technologies  on  the  use  of  printing 
materials.    In  entertainment  we  have  interactive  video.   In  advertising  we  have  multi-media 
and  cable  TV.   In  the  business  marketplace  we  have  digital  technologies,  multi-media  and 
interactive  video.   The  same  products  impact  the  education  and  research  arena.    Not  long  ago 
print  was  the  sole  domain  of  communication.   Then  came  radio,  TV,  cable  and  today  we 
have  multi-media,  digital  data  bases,  CD  Rom  and  other  technologies  that  all  compete  with 
printing  and  publishing. 

B.  The  Eighties  -  A  Decade  of  Rapid  Technological  Change 

The  printing  and  publishing  industry  is  a  bit  of  a  paradox.    It  is  an  old,  mature 
industry  on  the  one  hand.    But  on  the  other  hand,  it's  an  industry  facing  rapid  technological 
change  mainly  due  to  the  adoption  of  computer  technology  to  a  craft-oriented  process. 

Historically,  the  industry  has  had  an  electromechanical  orientation.  Phototypesetting 
was  the  predominant  way  to  prepare  text  for  printing.   Graphic  arts  cameras  and,  to  a  certain 
degree,  analog  scanners  were  in  use  to  digitize  photographic  images  for  printing.   However 
in  1979  a  company  called  Scitex  launched  a  new  product,  the  color  electronic  prepress 
system  and  began  a  technological  revolution  in  the  graphic  arts  industry.   With  this  product, 
computers  were  introduced  to  the  printing  process  and  that  change,  more  than  any  other, 
caused  a  fundamental  change  in  the  printing  and  publishing  industry.   In  addition  to  the 
introduction  of  the  color  electronic  prepress  system,  a  number  of  other  major  innovations 
happened  in  the  1980's  that  had  a  dramatic  impact  on  the  industry. 

Before  this  era,  in  the  mid-1970's  printing  press  speeds  were  just  one-third  of  today's 
top  speeds  of  over  3,000  feet  per  minute.  It  took  ten  years  to  increase  from  1,000  to  1,500 
feet  per  minute.  But  speeds  have  doubled  to  over  3,000  feet  per  minute  in  just  the  last  seven 
years.  Cleariy,  the  rate  of  change  is  increasing  dramatically.  At  such  speeds,  computerized 
controls  were  required  so  that  register  was  maintained  throughout  the  run  length  and  that 
quality  could  be  insured  from  impression  #1  to  the  final  impression  on  the  job.  Automation 
of  press  equipment  was  the  means  that  allowed  these  increased  press  speeds.   Similarly, 


1221 


automation  in  the  bindery  improved  the  throughput,  so  that  the  entire  printing  process  from 
"cradle  to  grave"  was  much  faster,  efficient  and  reliable. 

Two  other  product  introductions  in  the  mid  1980's  continued  the  rapid  revolution  in 
the  printing  industry:  the  laser  printer  and  Postscript.   These  two  introductions  changed  the 
way  images  and  text  were  prepared  for  printing.   In  combination  with  a  software  program  by 
Aldus  Corporation  entitled  PageMaker,  these  low-end  (inexpensive)  systems  allowed  a  whole 
new  group  of  individuals  to  create  pages  and  become  involved  in  the  printing  and  publishing 
process.   This  phenomenon  was  called  desktop  publishing  by  Paul  Brainerd,  the  founder  of 
Aldus. 

At  the  same  time  the  80's  witnessed  a  color  revolution  in  the  printing  and  publishing 
industry.  Advertisers  demanded  more  and  higher  quality  color.  The  notion  that  color  sells 
became  the  dominant  theme  in  the  marketing  of  products.  In  order  to  compete  with  network 
TV,  cable  TV  and  other  media,  printers  had  to  produce  higher  quality  color  on  a  consistent 
basis.  In  addition,  the  launching  of  USA  Today  by  the  Gannett  Corporation  brought  color 
into  everyone's  home  or  office  on  a  daily  basis. 

This  color  revolution  fueled  rapid  growth  in  the  printing  market,  and  demanded  new 
and  more  sophisticated  technology.   One  and  two  color  presses  were  no  longer  the  norm. 
Four,  five,  six,  seven  and  in  some  cases  eight-color  printing  presses  were  purchased  by 
printers  all  over  the  country.    At  the  same  time  the  sophisticated  digital  prepress  equipment 
required  to  reproduce  these  quality  color  pages  was  purchased  by  color  trade  shops  and 
certain  printers  and  publishers.    So  the  1980's  began  an  era  of  tremendous  technological 
change  which  continues  today. 

The  fact  of  the  matter  is  that  the  printing  industry  is  evolving  from  a  craft  orientation 
to  a  technology  orientation  at  an  alarming  pace.    In  a  little  over  10  years,  the  industry  has 
gone  from  a  completely  photomechanical  and  electromechanical  orientation  to  one  where 
digital  technology  touches  all  aspects  of  the  process  from  design  through  printing  through 
binding  finishing  and  distribution. 

C.        The  Impact  of  Changing  Prepress  Technology 

As  rapidly  as  press  technology  is  changing,  innovation  in  the  prepress  area  is 
occurring  even  faster.    A  major  reason  for  this  is  the  expanding  role  that  prepress  is  having 
on  information  processing  and  dissemination  and  resulting  new  market  opportunities  that 
encompass  the  broader  worlds  of  publishing  and  communications. 

The  conversion  from  analog  to  digital  data  usage  is  an  underlying  cause  of  prepress 
change.    For  decades  photographic  materials  have  been  the  analog  prepress  standard.   They 
have  enabled  users  to  merge  discrete  elements,  from  virtually  any  origin,  into  a  final  page 
for  platemaking.    Generally  speaking,  digital  products  have  not  been  able  to  provide  this 
standard  environment  to  date. 

However,  with  the  development  of  industry  standards  and  the  evolution  of  products 
that  function  within  a  common  environment,  digital  standardization  will  occur  between  now 
and  the  year  2000,  and  be  adopted  by  the  major  prepress  service  suppliers.   The  adoption  of 
digital  standardization  is  also  a  basic  requirement  for  expanding  the  scope  of  the  prepress 


1222 


market  into  Computer-Based-Publishing  and  communications  market  applications. 

The  transition  to  a  digital  environment  will  result  in  manual  operations  being 
replaced.   The  transition  to  a  digital  standard  will  have  a  significant  effect  on  the  use  of 
certain  types  of  traditional  equipment  and  supplies.    Ultimately  the  analog-to  digital  transition 
will  result  in  new  hardware,  software,  supplies,  and  support  needs. 

Standardization  will  challenge  product  development.  First,  products  will  increasingly 
become  interchangeable.  The  transition  will  force  vendors  to  focus  on  the  development  and 
sale  of  discrete  products  that  can  be  indiscriminately  interchanged  by  the  user.   This  situation 

is  similar  to  what  has  happened  in  the  electronic  office  environment. 

Compounding  the  product  differentiation  challenge  is  the  issue  of  product  life  cycle. 
As  we  have  continued  to  see  in  the  "plug  and  play"  environment  of  the  electronic  office, 
standards-based  prepress  products  will  also  require  more  frequent  revision  and/or 
replacement,  thus  the  need  to  routinely  upgrade  to  stay  competitive. 

D.  The  Beneflts  of  Advanced  Technologies 

For  as  long  as  printers  have  been  putting  ink  to  paper,  the  quest  for  greater  output 
and  better  quality  with  fewer  man  hours  and  reduced  waste  has  been  the  driving  force  for 
every  press  manufacturer.   Today's  new  technologies  have  taken  this  quest  to  a  new  level. 

Take  for  example  one  manufacturer's  development  of  the  continuous  tubular  blanket 
sleeve  which  slides  onto  the  blanket  cylinder  through  the  side  frame  of  the  press,  thereby 
reducing  the  plate  cylinder  gap  to  a  mere  1/16  inch.   The  result  is  economic  and 
environmental  benefits  due  to  significant  paper  savings  as  a  result  of  the  elimination  of  the 
blanket  gap's  non-print  area.    This  and  other  increasingly  rapid  technological  advances  are 
yielding  faster  production  speeds,  quicker  makereadies,  reduced  running  and  makeready 
waste,  better  flexibility  and  quality  over  a  range  of  jobs,  less  downtime,  and  most 
importantly  -  the  ability  to  better  compete  with  other  communication  vehicles. 

E.  The  Challenge  to  Capital  Investment  in  Printing  and  Publishing 
Technologies 

The  NPES  Quarterly  Economic  Forecast,  prepared  by  NPES  consulting  economist, 
Michael  K.  Evans,  reviews  the  general  economic  outlook,  printing  and  publishing  equipment 
ordered  and  supplies  shipments.   The  forecast  is  derived  from  an  econometric  model 
developed  by  Evans  for  NPES.   Based  on  this  model,  new  orders  for  printing  equipment  are 
expected  to  rise  12%  this  year  and  6%  in  1994.    Most  of  the  growth  probably  occurred  in 
the  first  half  of  the  year,  when  prospects  for  economic  growth  seemed  brighter  and  many 
expected  the  investment  tax  credit  to  be  reinstated.    Although  interest  rates  will  remain  low, 
this  has  little  effect  on  capital  spending  during  a  period  when  capacity  utilization  rates  are 
low  and  many  smaller  firms  are  denied  access  to  credit  markets. 

Shipments  of  imaging  and  prepress  equipment  systems,  in  essence  computers  and  the 
software  needed  to  run  them,  are  expected  to  rise  about  10%  this  year  and  8%  in  1994. 
While  these  are  respectable  gains,  they  lag  far  behind  the  15%  to  20%  growth  rates  of  the 


1223 


computer  industry  generally.    The  technological  revolution  is  incompletely  implemented  in 
the  printing  industry  because  of  a  lack  of  cash  flow  and  ability  to  borrow,  especially  by 
smaller  printing  companies. 

Capital  spending,  after  getting  off  to  a  sparkling  start  in  the  first  quarter,  abruptly 
reversed  course  when  the  Clinton  Administration  announced  it  would  not  reinstate  the 
investment  tax  credit  after  all.   Thus  the  combination  of  insufficient  cash  flow  and  weak 
demand  for  customized  printing  will  keep  the  growth  in  shipments  of  imaging  and  prepress 
equipment  at  moderate  rates,  in  spite  of  the  continuing  computer  revolution. 

Although  the  provision  in  the  "Omnibus  Budget  Reconciliation  Act  of  1993" 
increasing  the  expensing  deduction  for  small  businesses  from  $10,000  to  $17,500  during  the 
year  that  the  property  is  purchased  is  helpful,  its  incentive  for  investment  will  be  severely 
eroded  by  the  extension  of  the  depreciation  period  to  ten  years  as  called  for  in  this  proposal. 
Clearly,  Congress  would  be  double-minded  to  adopt  such  a  policy. 

CONCLUSION 

Rather  than  impeding  investment,  especially  capital  expenditures  by  small  businesses, 
Congress  should  be  looking  for  ways  to  encourage  capital  formation  and  investment  in  new 
technologies  necessary  for  a  revitalized  industrial  infrastructure.    Mr.  Chairman,  we 
respectfully  urge  you  to  adopt  such  a  course,  and  thank  you  for  the  opportunity  to  present 
these  comments.    I  would  be  pleased  to  answer  any  questions  or  submit  additional 
information  for  the  record. 


1224 

Mr,  Payne,  Thank  you,  Mr.  Nuzzaco. 

Mr,  Hancock, 

Mr,  Hancock.  Thank  you,  Mr.  Chairman. 

Question  for  Mr.  Nuzzaco  or  Mr,  Webber.  We  have  two  situations 
here  we  are  talking  about.  One  is  a  change  in  the  depreciation 
schedule  on  printing  equipment.  Another  one  is  the  change  in  the 
deduction  for  advertising.  Which  one  of  those  two  will  impact  you 
the  most? 

One  of  them  is  likely  to  put  you  out  of  business.  What  will  the 
two  of  them  do  to  you? 

Mr.  Webber.  I  wouldn't  like  either  of  them,  but  I  am  certain  the 
change  in  advertising  would  be  extremely  harmful  to  the  printing 
industry,  too,  which  relies  heavily  on  the  advertising  industry. 

Mr.  Hancock.  Do  you  estimate  in  your  own  mind  that  requiring 
advertising  amortization  would  be  even  more  serious  to  the  print- 
ing industry  than  the  change  in  depreciation? 

Mr.  Webber.  Yes,  sir,  it  would  be. 

Mr.  Hancock.  Thank  you  very  much. 

Mr.  Webber.  But  they  both  would  be  harmful. 

Mr.  Hancock.  I  don't  know  if  you  are  aware  of  it  or  not,  but  a 
few  months  ago — in  fact,  you  might  want  to  look  it  up — I  think  it 
was  in  Reader's  Digest,  there  was  quite  an  article  about  who  the 
millionaires  really  are.  It  ended  up  saying  that  the  millionaires  are 
people  that  most  people  don't  know  are  millionaires;  they  are  peo- 
ple that  work  60,  70,  80  hours  a  week;  they  are  married;  they  are 
roughly  55  years  old,  been  married  one  time,  and  the  majority  of 
them  own  printing  plants.  I  thought  it  was  interesting. 

I  am  quite  familiar  with  the  printing  industry.  Let's  face  it,  you 
have  to  pump  so  much  money  back  in  for  equipment  in  the  printing 
industry  that  if  you  can  stay  in  it  and  compete,  you  will  end  up 
with  a  pretty  substantial  investment  in  equipment. 

Printing  equipment,  incidentally,  is  also  one  of  our  major  ex- 
ports. King  Press  down  in  my  district  recently  shipped  overseas 
some  web  press  equipment. 

[The  following  was  subsequently  received:] 


1225 


INPCSI 


The  Association  for  Suppliers  of 
Printing  and  Publishiing  Technologies 

0(y  Years  of  Service —1993 


September  14,  1993 


The  Honorable  Mel  D.  Hancock 
U.S.  House  of  Representatives 
Washington,  DC  20515 


Dear  Congressman  Hancock: 


I  am  writing  to  supplement  formal  testimony  given  by  me  on  behalf  of  NPES  The 
Association  for  Suppliers  of  Printing  and  Publishing  Technologies  before  the  House  Ways 
and  Means  Subcommittee  on  Select  Revenue  Measures  on  September  8,  1993.   I  was  a 
member  of  panel  number  four  that  day,  and  spoke  in  opposition  to  the  proposal  to  extend  to 
ten  years  the  recovery  period  for  certain  assets  used  in  printing  and  publishing.   A  copy  of 
my  full  statement  is  enclosed  with  this  letter. 

For  the  record  I  would  like  to  respond  to  a  question  you  posed  to  me  and  another 
witness  on  the  panel,  Mr.  Howard  C.  Webber,  Chairman,  Cohber  Press,  Rochester,  N.Y., 
representing  Printing  Industries  of  America  and  the  Graphic  Arts  Legislative  Council. 
Specifically,  you  asked  whether  in  general  printers  would  be  more  affected  by  the  proposed 
lengthening  of  the  period  for  depreciating  equipment  used  in  printing  and  publishing,  or  by  a 
proposal  to  require  that  a  portion  of  advertising  expenses  be  capitalized  and  amortized  over  a 
period  of  years  rather  than  treated  as  a  business  deduction  as  under  current  law. 

When  asked  to  assess  the  relative  affects  of  two  detrimental  proposals,  Mr.  Webber 
candidly,  and  I  think  accurately  from  the  point  of  viev/  of  most  printers,  responded  by  saying 
that  the  proposal  to  capitalize  advertising  expense  would  have  a  more  detrimental  affect  on 
printers'  businesses  than  the  lengthening  of  depreciation  from  seven  to  ten  years  on  printing 
equipment.   Although  I  did  not  respond  to  your  question  during  the  hearing,  I  would  like  to 
submit  the  following  comments,  with  the  request  that  they  be  inserted  at  the  appropriate 
place  in  the  hearing  record. 

As  you  wiU  note,  both  my  testimony  and  Mr.  Webber's  is  directed  solely  and 
specifically  to  the  proposal  to  extend  to  ten  years  the  capital  cost  recovery  period  for  assets 
used  in  printing  and  publishing.   As  manufacturers  and  consumers  of  this  equipment,  we  of 
course  have  a  particularly  keen  interest  in  this  narrowly  drawn  proposal  that  directly  targets 
our  businesses.    At  the  same  time,  however,  we  also  have  a  special  concern  about  the 
method  by  which  advertising  expenses  are  treated  for  tax  calculations,  due  to  the  fact  that 
significant  portions  of  many  printers'  incomes  are  derived  from  the  printing  of  advertising. 
While  in  aggregate  terms  the  proposed  change  in  the  treatment  of  advertising  expenses  would 
by  comparison  to  lengthening  depreciation  have  a  significantly  greater  impact  on  the 
economy  as  a  whole,  and  most  printers  in  particular,  neither  proposal  is  desirable  by  itself, 
and  if  combined  would  be  terribly  detrimental  to  the  economic  interests  of  printers  and  their 
suppliers. 

To  carry  the  analysis  further,  while  each  of  the  two  proposals  would  have  a  negative 
impact  on  printers  and  their  suppliers,  this  impact  would  affect  their  businesses  in  different 
ways.   For  example,  requiring  advertising  expenses  to  be  capitalized  and  amortized  would 
undoubtedly  have  a  chilling  effect  on  the  total  market  for  advertising,  as  the  cost  of  such 
activity  becomes  greater.   In  other  words,  the  economic  pie  of  advertising  revenue  would  be 
diminished  as  the  activity  becomes  relatively  more  expensive.   The  statements  of  many  other 
witnesses  in  opposition  to  this  proposal  is  testament  to  the  wide  spread  negative  effect  of 
such  a  proposal. 


1226 


On  the  other  hand,  the  lengthening  of  depreciation  has  more  to  do  with  printing  and 
publishing's  ability  to  compete  for  a  slice  of  the  advertising  revenue  pie.  In  a  market  that  is 
already  challenging  printers  to  stretch  to  remain  technologically  competitive,  the  additional 
competitive  disadvantage  of  lengthening  depreciation  would  make  it  even  more  difficult  for 
printing  and  publishing  to  compete  for  a  share  of  the  market  for  information  dissemination 
vis-a-vis  other  modes  of  communication. 

To  complete  my  response  to  your  question,  let  me  carry  the  analysis  one  final  step. 
Any  reduction  in  the  printing  and  publishing  industry's  ability  to  upgrade  its  technology  will 
have  a  negative  effect  on  the  printing  and  publishing  equipment  supply  industry,  regardless 
of  the  cause  of  that  reduction.    And  to  the  extent  that  these  suppliers'  businesses  decline,  the 
very  existence  of  those  at  the  margin  may  be  jeopardized  while  many  others  are  weakened, 
resulting  in  the  loss  of  good  paying  manufacturing  jobs. 

Moreover,  another  indirect  consequence  of  such  a  decline  which  may  not  immediately 
come  to  mind,  but  to  which  you  alluded  in  your  comments  during  the  hearing,  is  the  fact  that 
exports  of  printing  and  publishing  equipment  have  been  up  during  the  domestic  economic 
slowdown  we  have  been  enduring.   As  you  noted  at  the  time  of  the  hearing,  King  Press 
Corporation,  located  in  your  congressional  district  in  Missouri,  is  an  excellent  example  of  a 
capital  goods  manufacturer  that  has  excelled  in  exporting  to  the  extent  of  being  named 
Missouri  Exporter  of  the  Year.  For  example,  in  recent  times  over  65  percent  of  its  product 
has  been  exported.   Capital  goods  manufacturers  will  not  be  able  to  seize  such  opportunities 
unless  they  are  economically  viable  and  ready  to  compete  for  this  business.   Policies  that 
foster  such  commercial  readiness  are  in  the  economic  best  interest  of  the  country  and  should 
be  encouraged,  not  impeded  by  government  policy,  especially  policy  such  as  the  current 
proposal  to  extend  depreciation  for  assets  used  in  printing  and  publishing,  that  singles  out 
specific  industry  to  its  detriment. 

On  behalf  of  NPES  and  myself,  I  appreciated  the  opportunity  to  testify  before  you  and 
the  other  members  of  the  Subcommittee,  and  hope  that  this  letter  serves  to  further  explain 
our  opposition  to  the  lengthening  of  depreciation  on  assets  used  in  printing  and  publishing,  as 
well  as  the  proposal  to  capitalize  advertising  expenses. 

I  would  be  pleased  to  respond  fiirther  on  these  issues  if  necessary. 


Mark  J.  Nuzzaco 

Director  of  Government  Affairs 


Enclosure 


Subcommittee  on  Select  Revenue  Measures 
Committee  on  Ways  and  Means 
U.S.  House  of  Representatives 

Ben  Cooper 

Regis  J.  Delmontagne 

James  C.  Gould 

A.J.  HaU 

J.M.  Mike  Murray 

John  M.  Naimes 

Howard  C.  Webber,  Jr. 


1227 

Mr.  Cohen  and  Mr.  Feeney,  how  many  jobs  wall  be  affected  by 
this  change  in  the  advertising  deduction  in  your  judgment?  I  real- 
ize we  are  not  going  to  get  any  real  actuarial  or  GAO  accounting 
or  0MB  studies  or  anything  like  that. 

Mr.  Cohen.  Well,  it  is  very  difficult  to  judge.  The  costs  will  go 
up,  the  cost  of  advertising  will  go  up.  Therefore,  budgets  will  go 
down.  So  there  will  be  less  advertising,  there  will  be  less  printing, 
there  will  be  less  newspaper  ads  and  so  forth,  and  it  should — I 
mean,  if  logic  follows,  it  should  reduce  sales  because  people  adver- 
tise to  sell  things,  and  if  you  have  less  information,  there  will  be 
less  purchasers  right  there. 

So  it  is  going  to  have  a  dramatic  effect,  but  it  is  way  down  the 
pike.  It  takes  a  long  time  for  that  to  feed  through  the  system,  but 
it  is  deleterious  to  the  system  obviously. 

Mr.  Hancock.  This  idea  of  getting  rid  of  deductions  started  way 
back  many  years  ago  when  all  of  a  sudden  the  Government  de- 
cided, well,  it  can't  raise  rates  past  50  percent,  so  therefore  it  is 
going  to  start  getting  rid  of  deductions.  Well,  you  can't  fiilly  deduct 
the  cost  of  meals  and  entertainment  expenses. 

I  happen  to  be  a  small  businessman.  I  know  the  benefit  of  taking 
somebody  out  to  lunch  once  in  a  while.  In  fact,  I  probably  have 
closed  more  contracts  at  luncheon  meetings  than  any  other  time. 
So  they  cut  back  on  that  deduction. 

Now  they  are  going  to  reduce  it  to  50  percent.  Now  they  are  talk- 
ing about  cutting  back  the  advertising  deduction.  Here  again,  the 
business  lunch  is  a  little  bit  of  an  advertising. 

Now  my  question  is,  and  here  again  in  generalities,  are  we  head- 
ing toward  a  gross  receipts  tax  rather  than  an  income  tax?  You 
know,  just  taxing  gross  sales?  Is  that  where  we  are  going? 

Mr.  Feeney.  Hopefully  not. 

Mr.  Hancock.  Wouldn't  it  appear  that  this  is  the  route  we  are 
taking?  You  take  advertising.  You  say,  OK,  you  can't  deduct  20 
percent.  Now  3  years  from  now  we  will  say,  well,  you  can't  deduct 
50  percent.  If  we  keep  doing  this,  there  isn't  going  to  be  anybody 
left  to  tax. 

Mr.  Cohen.  The  problem  is  really  more  the  complications  in  ac- 
counting. That  is  as  you  add  one  more  job  for  the  internal  account- 
ant in  the  company  to  take  on,  and  his  external  accountant,  the 
CPA  to  take  on,  you  add  the  costs  there  and  of  course  you  add — 
when  these  proposals  are  suggested,  nobody  thinks  about  the  fact 
it  is  one  more  job  for  the  revenue  agent  to  do.  That  is,  the  revenue 
agent  now  takes  a  look  to  see  whether  the  advertising  costs  or 
other  costs  are  legitimate,  but  once  he  has  done  that,  that  is  the 
end  of  it.  But  there  would  be  a  new  purpose  now,  he  would  have 
to  list  those  which  are  going  to  be  subject  to  this  amortization, 
whatever  that  definition  might  be,  and  that  is  a  problem,  and  then 
he  has  to  subject  them  to  the  amortization  schedule,  and  then  he 
has  to  go  back  and  audit  last  year's  amortization  schedule  to  see 
that  you  are  carrying  forward  the  right  numbers,  so  you  have  add 
infinitely  more  complexity  out  of  this  one  little  change. 

Every  time  you  do  it,  as  you  indicated,  Mr.  Hancock,  every  time 
you  do  it,  you  add  that  much  more  complexity  on  top  of  an  already 
existing  complex  system. 


1228 

Mr,  Hancock.  I  am  having  trouble  finding  out  or  determining 
just  what  is  advertising.  Has  anybody  really  defined  it?  Are  we 
talking  about  radio  and  television?  We  talk  about  newspapers,  we 
talk  about  magazines.  Are  we  talking  about  Yellow  Pages  advertis- 
ing? Are  we  talking  about  handout  pieces?  Are  we  talking  about  a 
PR  employee,  a  guy  who  goes  out  to  solicit  business,  not  a  sales- 
man? Is  that  advertising?  What  is  advertising? 

Mr.  Cohen.  Your  committee  is  going  to  have  to  define  that.  If 
you  were  to  adopt  this  rule,  which  all  of  us  have  opposed,  if  you 
were  to  adopt  it,  you  will  have  to  adopt  a  definition  of  whether  the 
promotional  man  who  goes  out  and  calls  on  people,  is  he  advertis- 
ing? You  know,  are  the  people  who  prepare  materials  within  the 
company  to  supply  information  to  the  advertising  agency,  each  of 
those  would  require  definition.  And  whoever  is  going  to  draft  this, 
you  or  your  staff,  are  going  to  have  to  think  those  problems 
through,  because  otherwise  you  are  going  to  leave  it  to  a  regulation 
writer.  I  used  to  be  a  regulation  writer  once  in  the  Revenue  Service 
and  I  also  used  to  be  a  regulation  signer  once  in  the  Revenue  Serv- 
ice. Otherwise,  you  are  going  to  leave  those  problems  to  those  peo- 
ple and  they  don't  want  to  do  that  either.  They  would  rather  you 
define  them. 

Mr.  Hancock.  What  about  amortizing  election  campaign  adver- 
tising. That  makes  good  sense,  doesn't  it? 

Mr.  Cohen.  We  disallowed  that  many  years  ago,  sir. 

Mr.  Hancock.  Maybe  we  ought  to  look  into  that,  Mr.  Chairman, 
as  part  of  campaign  reform.  You  have  got  to  declare  your  contribu- 
tions as  income  and  then  amortize  the  advertising.  I  don't  know 
who  came  up  with  this,  but  I  know  this,  that  they  are  completely 
illogical.  It  absolutely  does  not  make  sense  to  do  this  to  a  business. 
As  a  small  businessman,  and  I  don't  spend  money  on  advertising 
just  for  the  fun  of  it  or  just  to  see  my  name,  because  my  company's 
name  is  not  my  name.  That  is  not  the  reason  we  advertise.  We  ad- 
vertise to  generate  profit,  therefore  to  expand,  therefore  to  employ 
more  people.  And  advertising  to  me  is  the  lifeblood  of  a  lot  of  small 
businesses,  especially  the  business  that  has  a  new  idea,  something 
that  the  public  wnl  buy  if  in  fact  they  hear  about  it.  Then  we  tell 
them  that  they  have  to  amortize  advertising  or  that  it  is  not  a  de- 
ductible business  expense.  Even  the  legal  profession  is  starting  to 
advertise  now.  They  are  finding  out  that  it  is  a  benefit  to  them. 

Anyway,  Mr.  Chairman,  I  strongly  recommend  that  this  commit- 
tee do  whatever  we  have  got  to  do  to  let  the  business  community 
advertise  their  products.  If  we  don't  advertise  American  products, 
I  will  bet  that  the  Japanese  and  the  Germans  and  others  are  going 
to  advertise  their  products,  and  then  what  happens?  There  is  noth- 
ing we  can  do  about  that. 

Thank  you,  Mr.  Chairman. 

Mr.  Payne.  Mr.  Hoagland  will  inquire. 

Mr.  Hoagland.  I  have  no  questions. 

Mr.  Payne.  Mr.  Camp. 

Mr.  Camp.  No  questions. 

Mr.  Payne.  I  had  just  a  question  for  Mr.  Webber.  Could  you  give 
us  a  description  of  the  kinds  of  equipment  that  are  being  consid- 
ered in  this  proposed  legislation  and  the  cost  of  that  equipment? 


1229 

Mr.  Webber.  Yes,  Mr.  Chairman.  On  the  prepress  area,  you  are 
probably  talking  scanners  and  equipment  that  you  can  start  buying 
for  $4,000,  could  probably  go  up  to  $150,000,  $200,000.  In  the  press 
area,  you  are  talking  probably  small  presses  starting  at  $6,000, 
$7,000,  $8,000,  going  up  to  your  larger  sheet-fed  presses  at  $1.8 
million,  then  into  your  web  presses  probably,  what,  $4  million  or 
on  up. 

In  the  bindery  area,  again  you  can  start  with  small  folders  at 
$5,000,  $6,000,  and  go  up  to  stitcher  trimmers  at  $200,000, 
$250,000,  all  the  way  up  to  $1  million.  For  example,  a  company 
like  ourselves,  a  $10  million  company,  our  presses  cost  anywhere 
in  the  realm  of  $40,000  up  to  $1.8  million.  And  we  sit  right  now, 
and  I  don't  want  to  elaborate,  but  with  a  bank  that  based  upon  a 
5-year  pay  back  to  the  bank,  and  I  don't  know  what  we  would  do 
if  we  went  to  10  years.  They  won't  even  let  us  go  to  7  years. 

Mr.  Payne.  How  long  do  these  assets  typically  last  in  the  print- 
ing industry? 

Mr.  Webber.  I  think  back  in  the  1970s  and  1980s,  they  used  to 
last  probably  10  years,  and  it  was  probably  an  active  thing.  Right 
now,  some  of  our  prepress  equipment  we  are  buying,  we  are  look- 
ing at  an  18-month  to  3-year  payback  because  by  then  it  is  going 
to  be  obsolete,  and  in  the  printing  press  area  we  are  probably  look- 
ing at  5  to  6  years  we  hope  to  replace  our  equipment,  again  be- 
cause of  obsolescence,  not  because  it  wears  out,  but  because  some- 
thing new  and  better  comes  on  the  market. 

Mr.  Payne.  With  your  scanner  equipment? 

Mr.  Webber.  Scanner  equipment.  For  example,  now  the  big  scan- 
ners that  were  bought  for  $200-,  $250,000,  are  being  replaced  by 
desk  top  scanners  costing  $45,000  that  are  no  bigger  than  that.  So 
probably,  I  would  say  scanners  probably  3  to  5  years  max. 

Mr.  Payne.  Thank  you  very  much. 

I  would  like  to  thank  this  panel  for  their  testimony  and  for  put- 
ting this  information  into  the  record.  It  will  be  very  useful  for  the 
subcommittee  and  for  the  full  committee. 

Mr.  Payne.  Our  next  panel  will  testify  concerning  the  increased 
tariff  on  imported  crude  oil  and  the  increased  tariff  on  refined  pe- 
troleum products,  and  we  will  also  have  a  witness  testifying  re- 
garding a  severance  tax  on  hard  rock  mineral. 

The  first  witness  represents  the  Independent  Refiners  Coalition, 
Robert  H.  Campbell,  president  and  chief  executive  officer  and 
chairman  of  the  Sun  Co.,  Inc.,  Philadelphia,  Pa. 

Mr.  Campbell,  if  you  would  proceed  under  the  5-minute  rule. 
Thank  you. 

STATEMENT  OF  ROBERT  H.  CAMPBELL,  PRESIDENT,  CHIEF 
EXECUTIVE  OFFICER  AND  CHAIRMAN,  SUN  CO.,  INC.,  ON  BE- 
HALF  OF  THE  INDEPENDENT  REFINERS  COALITION 

Mr.  Campbell.  Thank  you,  Mr.  Chairman  and  members  of  the 
committee.  As  you  indicated,  my  name  is  Robert  Campbell,  and  I 
am  chairman,  president,  and  chief  executive  officer  of  the  Sun  Co., 
which  as  you  probably  know  is  a  107-year-old  oil  company  that  is 
headquartered  in  Philadelphia.  Philadelphia  also  happens  to  be  the 
home  of  the  first-place  Philadelphia  Phillies,  and  the  expected  site, 
beginning  4  weeks  from  today,  of  the  National  League  baseball 


1230 

playoffs  which  will  determine  who  gets  to  compete  in  this  year's 
World  Series. 

I  am  here  today  to  address  a  world  series  of  another  kind.  This 
is  a  series  involving  our  Nation's  gasoline  production  industry, 
thousands  of  American  jobs,  our  commitment  to  the  environment, 
and  our  national  security. 

You  know,  when  the  Phillies  take  the  field  on  October  7  they  will 
do  so  knowing  that  their  opponents  will  face  the  same  rules  that 
they  do:  The  bases  are  going  to  be  90  feet  apart  for  both  teams  and 
the  pitcher's  mound  is  going  to  be  60  feet,  6  inches  from  home 
plate,  again  for  both  teams.  They  are  going  to  go  into  that  game 
confident  that  ability  will  determme  the  outcome.  Today,  I  am  here 
seeking  that  same  kind  of  competitive  fairness  for  this  country's 
independent  refiners. 

My  written  testimony  that  accompanies  these  remarks  spells  out 
the  background  information  that  I  think  you  will  find  useful.  It  will 
tell  you  that  the  Sun  Co.  is  a  member  of  the  Independent  Refiners 
Coalition,  and  those  are  U.S.  oil  companies  that  have  little  or  no 
crude  oil  production.  We  simply  purchase  crude  oil,  refine  it  into 
products,  and  supply  the  U.S.  economy. 

The  written  testimony  will  also  tell  you  that  70  independent  re- 
fining companies  operate  140  refineries  in  34  States.  We  employ 
200,000  people,  and  they  produce  nearly  40  percent  of  the  gasoline 
purchased  in  the  United  States  today. 

It  will  tell  you  that  independent  refiners  have  made  and  are  con- 
tinuing to  make  enormous  expenditures  to  fulfill  their  environ- 
mental obligations.  Those  expenditures  fall  into  two  categories.  The 
first  is  the  investment  in  new  processing  equipment  to  produce  the 
new,  cleaner  burning  fuels.  The  second  is  the  investment  in  our  re- 
fineries, pipelines  and  terminals  to  eliminate  air,  water,  and  soil 
contaminants. 

The  written  testimony  will  tell  you  that  foreign  manufacturers 
enjoy  a  significant  advantage  in  the  U.S.  marketplace  because  they 
are  not  required  to  meet  the  same  standards  that  we  do,  nor  incur 
the  investment  that  goes  along  with  such  conformance.  The  net  ef- 
fect of  this  is  that  we  are  systematically  shutting  down  refining  ca- 
pacity in  the  United  States  and  exporting  the  jobs  overseas.  This 
makes  absolutely  no  sense,  regardless  of  whether  you  are  a  busi- 
ness executive  like  myself  concerned  about  the  future  of  your  com- 
pany, a  union  leader  concerned  with  job  security  or  an  environ- 
mentalist who  realizes  that  closing  tne  plant  domestically  only 
transfers  the  pollution  overseas  which  still  fouls  the  worlds 
ecosystems. 

Incidentally,  I  might  mention  that  we  have  the  full  support  of 
the  president  of  our  major  union,  the  Oil,  Chemical  &  Atomic 
Workers  International  Union,  in  this  proposal  today. 

I  will  also  tell  you  that  shutting  down  our  refining  industry  in- 
creases our  dependence  on  a  few  foreign  product  manufacturers, 
and  that  creates  a  national  security  issue  of  the  first  magnitude. 

Our  written  testimony  on  behalf  of  the  Independent  Refiners  Co- 
alition will  clearly  urge  you,  as  I  do  now,  to  enact  an  environ- 
mental equalization  fee  on  imported  gasoline  and  blending  compo- 
nents. In  doing  this,  you  will  restore  some  sense  of  reason  to  the 
rule  book  and  curtail  the  further  erosion  of  an  industry  that  has 


1231 

seen  over  154  refineries  shut  down  in  the  United  States  in  the  past 
13  years. 

I  didn't  come  here  today  to  complain  about  the  bilHons  our  indus- 
try has  to  invest  to  comply  with  the  Clean  Air  Act  and  other  stand- 
ards. This  industry  has  heard  the  environmental  message.  We  have 
made,  are  making,  and  will  continue  to  make  the  necessary  invest- 
ments. 

The  company  I  work  for,  for  example,  is  the  first  and  onlv  For- 
tune 500  firm  to  endorse  the  CERES  environmental  principles.  In 
so  doing,  we  have  made  a  "no  doubt  about  it"  commitment  to  the 
environmental  improvement  and  increased  public  accountability.  I 
believe  our  environmental  conscience  and  credentials  are  in  order, 
and  I  know  that  the  air,  water,  and  soil  quality  in  this  country  are 
improving,  and  that  is  something  that  we  can  all  be  proud  of. 

What  we  seek  here  today  is  to  correct  the  consequences  of  a  one- 
sided contest  where  we  make  a  major  investment  in  the  environ- 
ment while  competing  with  foreign  manufacturers  who  get  a  free 
ride  in  our  markets.  Their  environmental  laws  are  5  to  20  years 
behind  ours,  and  it  gives  them  anywhere  from  a  5  to  10  cents  per 
gallon  advantage  as  a  head  start  in  the  U.S.  marketplace. 

You  should  make  no  mistake  about  it:  The  U.S.  refining  industry 
is  a  world-class  industry.  We  have  made  the  necessary  investments 
over  the  years  to  upgrade  our  plants  and  improve  our  productivity 
so  that  we  are  second  to  none  in  our  business.  However,  the  new 
environmental  regulations  have  changed  all  of  that.  It  just  makes 
no  sense  to  now  squander  our  hard-won  leadership  position. 

What  we  have  won  in  the  international  competitive  marketplace 
must  not  be  lost  by  legislative  inaction.  Without  an  environmental 
equalization  import  fee  on  gasoline,  additional  refineries  will  close 
and  additional  jobs  will  be  lost. 

Why  reward  foreign  manufacturers  for  their  inattention  to  the 
environment  while  penalizing  U.S.  firms  that  are  investing  billions 
of  dollars  to  improve  air  and  water  quality? 

Gentlemen,  by  the  decisiveness  of  your  actions,  steps  and  the 
speed  with  which  you  take  them,  you  can  send  a  message  of  fair- 
ness to  the  U.S.  refiners  and  a  message  of  reality  to  foreign  manu- 
facturers that  the  fi-ee  lunch  is  over. 

I  thank  you  very  much  for  your  invitation  to  visit  with  you  today. 

[The  prepared  statement  follows:] 


1232 


Testimony  pr?g^nt^d 

on  Beh93,f  Qf  the 

Independent  Refiners  Coalition 

$ept^pi]?gr  g.  199? 


Mr.  Chairman  and  Members  of  the  Committee,  my  name  is 
Robert  H.  Ceunpbell,  President,  CEO  &  Chairman  of  Sun  Company, 
Inc.  I  am  appearing  today  on  behalf  of  the  Independent 
Refiners  Coalition  of  which  my  company  is  a  member.  The 
Independent  Refiners  Coalition  is  composed  of  twelve  domestic 
independent  refining  companies  who  operate  27  refineries  which 
have  15%  of  U.S.  capacity.  The  members  are  Clark  Oil  & 
Refining  Corporation,  Louisiana  Land  &  Exploration,  The 
Coastal  Corporation,  Tosco  Corporation,  Crown  Central 
Petroleum  Corporation,  Valero  Energy  Corporation,  Ashland  Oil 
Incorporated,  United  Refining  Company,  Tesoro,  Kerr-McGee 
Corporation,  Indian  Refining,  and  Sun. 

Independent  refiners  process  more  than  38%  of  the 
gasoline  consumed  in  the  United  States  and  have  been  in 
business  for  more  than  65  years.  In  1992  there  were  more  than 
70  independent  refining  companies  operating  140  refineries  in 
34  states  employing  200,000  people.  Independent  refiners  are 
defined  as  those  who  buy  at  least  70%  of  their  crude  oil 
requirements  on  the  open  market  and  rely  largely  on  their 
refining  and  marketing  operations  to  meet  all  of  their  capital 
requirements  in  contrast  to  integrated  oil  companies  which 
have  revenue  streams  from  oil  and  gas  production.  In 
addition,  they  are  primarily  domestic  in  operations  and  not 
multinational . 

One  of  the  revenue  raising  proposals  being  considered  in 
this  hearing  is  to  increase  the  tariff  on  imported  crude  oil 
and  refined  petroleum  products.  The  Coalition  has  requested 
the  opportunity  to  be  heard  today  to  testify  in  favor  of  a  tax 
on  imported  gasoline  and  blending  components.  The  Coalition's 
support  for  such  a  tax  is  joined  by  other  refiners,  as  well. 
It  is  strongly  felt  by  the  Coalition  and  these  refiners  that 
a  tax  is  needed  on  imported  gasoline  and  blending  stocks  to 
offset  the  differential  in  the  substantial  embedded  costs  of 
environmental  compliance  in  this  country  compared  with 
relatively  minimal  environmental  compliance  costs  faced  by 
foreign  competitors.  This  differential  is  an  unfair  trade 
advantage  affecting  our  competitiveness  and  will  cause  a 
continued  loss  of  U.S.  refining  capacity.  The  result  is  a 
threat  to  the  national  security  of  the  United  States,  zmd  the 
global  environment. 

This  problem  of  a  significant  difference  in  protection  of 
the  environment  between  the  United  States  emd  other  countries 
creating  an  unfair  trade  advantage  has  been  recognized  by  the 
Administration  and  members  of  Congress.  For  example,  when 
the  President  was  czuapaigning  last  year  and  announced  his 
support  for  the  North  American  Free  Trade  Agreement  (NAFTA) , 
he  did  so  on  the  condition  that  the  environment  had  to  be 
protected  on  both  sides  of  the  border  or  it  would  lower 
Mexican  cost  of  production  which  would  be  unfair  to  American 


1233 


workers.^  Vice  President  Al  Gore  vnrote  in  his  book,  Earth  In 
The  Balance,  that  "...weeOc  and  ineffectual  enforcement  of 
pollution  control  measures  should  also  be  included  in  the 
definition  of  unfair  trading  practices."^  U.S.  Trade 
Representative  Mickey  Kantor  has  testified  on  several 
occasions  before  the  Congress  on  NAFTA  pointing  out  that  there 
would  be  a  trade  advantage  in  Mexico's  favor  if  it  failed  to 
enforce  environmental  laws^.  He  also  stated,  "I  think  we'll 
recognize  that  if  a  difference  is  maintained,  that  will 
probeibly  give  a  competitive  advantage  to  a  firm  operating,  say 
in  Mexico,  compared  to  that  same  firm  operating  in  the  United 
States."* 

The  Majority  Leader  of  the  U.S.  House  of  Representatives, 
Congressman  Richard  Gephardt,  has  spoken  of  the  need  of  other 
countries  to  have  environmental  laws  and  enforcement  of  them 
as  a  competitiveness  issue';  as  has  Senator  Max  Baucus, 
Chairman  of  the  Senate  Environment  and  Public  Works 
Committee."  In  addition.  Senator  David  Boren  has  introduced 
legislation  in  the  past  on  the  subject.'  One  scholar  has 
written  that  even  according  to  present  law,  the  lack  of 
environmental  controls  or  the  failure  to  enforce  them  should 
be  considered  a  subsidy  subject  to  a  countervailing  duty.' 
Therefore,  representatives  of  the  Executive  and  Legislative 
branches  of  our  government  have  recognized  that  the  lack  of 
environmental  protection  laws  and  regulations  or  enforcement 
of  them  is  a  competitiveness  problem  for  American  industries. 
This  has  been  recognized  by  environmentalists  as  well.' 


^Governor  Bill  Clinton  speaking  of  the  North  American 
Free  Trade  Agreement  at  a  presidential  campaign  rally  at  North 
Carolina  State  University,  Raleigh,  North  Carolina,  on  October 
4,  1992. 

^Senator  Al  Gore,  Earth  In  The  Balance.  (Houghton  Mifflin 
Co.:   Boston  1992)  p.  343. 

'Testimony  of  U.S.  Trade  Representative  Mickey  Kantor 
before  the  Senate  Finjmce  Committee,  May  20,  1993. 

*Testimony  of  U.S.  Trade  Representative  Mickey  Kantor 
before  the  Senate  Environment  and  Public  Works  Committee  on 
March  16,  1993. 

'bnA  Dailv  Report  for  Executives.  May  12,  1993. 

^Hearing  of  the  Senate  Environment  and  Public  Works 
Committee,  March  15,  1993. 

'international  Pollution  Deterrence  Act  of  1991,  S.984. 

"Thomas  K.  Plofchem,  Jr.,  "Recognizing  and  Countervailing 
Environmental  Subsidies",  The  International  Lawver.  Volume  26, 
Number  3  (Fall  1992),  p.  763. 

"Testimony  of  Robert  F.  Housman,  Center  for  International 
Environmental  Law,  before  the  Subcommittee  of  Foreign  Commerce 
and  Tourism,  Committee  on  Commerce,  Science  and 
Transportation,  U.S.  Senate,  May  18,  1993. 


1234 


The  cost  to  domestic  refining  for  pollution  etbatement  is 
substantial  and  is  higher  than  for  most  industries.^"  Based 
on  older  figures,  it  has  been  calculated  that  petroleum 
refining  could  account  for  a  disproportionate  17%  of  the 
national  environmental  expenditure  in  the  year  2000.^^  The 
domestic  petroleum  refining  industry  will,  according  to  a  very 
recent  study  done  for  the  Secretary  of  Energy,  invest  $37 
billion  from  1991  through  the  year  2000  and  $14  billion  more 
from  2001  to  2010  to  comply  with  government  environmental 
regulations.^  The  sums  spent  this  decade  will  actually 
exceed  the  total  1990  book  value  of  all  domestic  refineries 
(after  depreciation)  which  is  only  $31  billion."  Refineries 
spent  21%  of  their  capital  in  the  1980 's  on  pollution 
zQ^atement,  which  will  increase  to  42%  in  the  1990 's  and  47%  in 
the  first  decade  of  the  next  century.^*  The  significance  of 
this  massive  cost  is  that  the  cash  flow  of  all  of  these 
refineries  from  1991  through  1995  will  be  $25  billion  less 
than  the  required  environmental  expenditures.^'  These  new 
costs  of  environmental  compliance  will  increase  the  cost  of 
gasoline  by  approximately  5C  a  gallon  in  1994  and  will  rise  to 
approximately  13C  a  gallon  by  the  year  2000,*'  on  top  of  the 
historical  pollution  zQjatement  costs  for  1981  -  1991  of  20  a 
gallon." 

The  recent  National  Petroleum  Council  (NPC)  study  is  the 
only  one  of  which  we  are  aware  that  attempts  to  look  at 
foreign  refining  environmental  protection  requirements.  While 
we  think  this  study  in  general  has  been  very  helpful,  a  great 
deal  more  work  needs  to  be  done  in  actually  determining 
specific  information  on  foreign  environmental  protection. 
There  is,  in  our  opinion,  too  much  speculation  as  to  what 
environmental  standards  will  be  applied  when  and  where  as  well 
as  whether  or  not  they  will  be  enforced.  One  review  of  the 
study  has  noted  that  unlike  the  detailed  analysis  of  U.S. 
costs,  the  estimate  of  foreign  costs  "...is  more  arbitrary  and 
assumption-based  and  thus  subject  to  greater  uncertainty."*' 
The  NPC  study  is  aware  of  this  shortcoming  and  has  termed 
foreign   cost   estimates   as   subject   to   "significant 


Office  of  Technology  Assessment,  Congress  of  the  United 
States,  report  "Trade  and  Environment",  1992.  p.  98. 

**American  Petroleum  Institute  report,  "Costs  to  the 
Petroleum  Industry  of  Major  New  and  Future  Federal  Government 
Environmental  Requirements",  October  1991,  p.  21. 

"National  Petroleum  Council,  U.S.  Petroleum  Refining  . 
August  2,  1993  Draft,  p.  1.  I-l. 

"Uiifl. 

"ibid.,  p.  1.  1-2. 

"ibid. .  p.  1.  I-l. 

"ibid. .  raw  data  used  for  conclusions  in  Chapter  1. 

"Oept.  of  Commerce  report  MA-200. 

**Wright  Killen  &  Co.  report,  "A  Broader  Look  at  U.S. 
Refining  Industry  SurvivaJsility  and  International 
Competitiveness,"  June  8,  1993,  p.  2. 


1235 


uncertainty"."  Foreign  environment,  safety  and  health  costs 
present  and  projected  need  to  be  studied  in  much  more  detail 
and,  due  to  the  coi^>etitiveness  problem,  a  study  needs  to  be 
done  as  soon  as  possible. 

Even  with  these  caveats,  the  NPC  study  has  concluded 
that,  "...most  foreign  areas  lag  the  United  States  in  health, 
safety,  and  environmental  regulations  and,  consequently,  have 
lower  embedded  environmental  costs  them  the  United  States."" 
For  example,  the  U.S.  presently  spends  1.7%  of  its  GDP  on 
environmental  programs  while  the  European  Community's  average 
is  only  1.2%  or  a  third  less."  The  report  goes  on  to  note 
that  although  many  countries  have  adopted  some  environmental 
regulations,  it  is  "...far  less  common  for  these  regulations 
to  be  enforced"."  It  is  further  observed  that  oil  producing 
and  lesser  developed  countries  "...view  government  interests 
in  refining  as  vital  to  national  economic  health  -  a  belief 
that  can  supersede  environmental  agendas."^' 

The  NPC  report  concludes  that,  "Overall,  foreign  regions 
today  are  estimated  to  be  where  the  U.S.  was  roughly  5-20 
years  ago  in  terms  of  environmental  regulations."  Thus,  by 
the  best  information  available,  most  competing  refining  areas 
of  the  world  are  amy  where  from  5-20  years  behind  us  and  may 
or  may  not  adopt  similar  environmental  protection  as  required 
of  our  refiners.  If  they  are  adopted,  they  may  not  be 
enforced. 

Even  with  the  best  case  of  a  five  year  lag  time  for 
foreign  refiners  to  "catch  up"  with  U.S.  environmental 
standards  and  enforcement,  the  damage  to  domestic  refiners 
will  have  been  done,  and  in  all  probability,  will  be 
irreversible.  Over  the  critical  next  five  years,  imported 
gasoline  will  be  readily  availeUsle  to  replace  reduced  domestic 
production  which  will  prevent  U.S.  market  prices  from  rising 
to  allow  full  cost  recovery  of  increased  environment,  safety, 
and  health  costs."  Once  a  refinery  closes  for  these 
reasons,  it  will  not  likely  restart." 

The  NPC  report  concludes  that  if  foreic^n  environmental 
protections  do  not  materialize,  the  cost  of  foreign  produced 
gasoline  would  be  less  than  the  United  States.*'  This  would 


'"npc  Draft  report,  Executive  Summary,  p.  37. 

"ibifl..  Executive  Summary,  p.  11. 

*'eop  Group,  Inc. ,  "The  United  States  versus  European 
Community",  August  13,  1993,  p.  3. 

"ibid. .  Appendix  L,  Section  VII-9,  p.  5. 

"ibid.,  p.  14. 

**Ibid. .  Appendix  L,  Section  VII-10,  p.  1. 

**Wright  Killen  &  Co.,  June  8,  1993  report,  p.  3. 

"Ibid. 

"npC  Draft  report.  Executive  Summary,  p.  11. 


1236 


result  In  increased  Imports  of  gasoline  and  reduced  U.S. 
refinery  utilization." 

Today  management  teeuns  at  domestic  refining  headquarters 
aroxind  the  U.S.  face  a  most  difficult  quandary:  Whether  to 
commit  the  capital  investments  necessary  for  pollution 
eibatement  to  continue  operations  ]cnowing  that  lower  cost 
imported  product  will  make  it  unlikely  to  be  profiteible  or  not 
to  invest.   To  no  invest  means  to  close  the  refinery. 

A  very  important  fact  here  that  must  be  acknowledged  is 
that  although  the  NPC  report  concludes  there  is  a  similarity 
in  the  projected  foreign  refinery  investments  for  the  rest  of 
this  decade  to  American  refining  cost  increases,  those  in  the 
United  States  are  largely  attributed  to  the  environmental 
requirements  while  foreign  increases  included  a  more 
significant  capacity  expansion."  Increased  costs  for 
environmental  protection  neither  builds  additional  capacity  to 
produce  gasoline  nor  does  it  improve  efficiency  of  existing 
capacity  and  while  it  is  good  for  the  ecology,  it  is 
nonproductive  in  terms  of  production  of  additional  gasoline  or 
producing  it  cheaper.^"  Rather,  these  costs  add  another 
layer  of  costs  to  products  offered  in  competitive  markets. ^^ 
The  report  concludes  that  recovery  of  these  costs  are  going  to 
be  difficult  unless  dememd  is  increased  by  further  refinery 
capacity  shutdowns." 

Increasing  refinery  shutdowns  is  precisely  what  has  been 
happening  in  the  refining  industry.  In  the  1980' s,  the  number 
of  domestic  refineries  dropped  from  a  high  of  315  to  184.  131 
refineries  closed  for  a  42%  decrease  in  the  number  of 
refineries  and  the  refining  capacity  fell  from  18.62  million 
barrels  per  day  to  15.7  or  by  20%.  During  that  seune  time 
period,  imports  of  foreign  refined  gasoline  more  than  doubled 
from  140,000  barrels  a  day  to  366,000." 

The  shutdown  of  American  refineries  is  continuing. 
Wright  Killen  &  Co.  conducted  a  plant -by-plant  analysis  of  all 
refining  operations  in  the  U.S.  in  1992.  Their  report 
predicted  that  37  additional  U.S.  refineries  with  1.5  million 
barrels  a  day  of  capacity  or  another  10%  of  the  total  capacity 


"Ibid. 

"ibid. .  Executive  Summary,  p.  39. 

^°Ibid. .  p.  1.  II-2. 

"ibid. 

"Ibifl. 

"ibid.,  Executive  Summary,  p.  17;  Office  of  Industrial 
Resource  Administration,  U.S.  Department  of  Commerce,  The 
Effect  of  Crude  Oil  and  Refined  Petroleum  Product  imports  on 
the  National  Security,  zmd  Investigation  conducted  under 
Section  232  of  the  Trade  Expansion  Act  of  1962,  Table  III  -  3 
(Dec.  1,  1988). 

"ibid. .  Table  III-l. 


1237 


is  at  risk  in  closing  in  the  next  3-5  years.'*  They  have 
found  that  in  the  year  since  the  1992  study,  almost  a  third  of 
the  predicted  capacity  closure,  498,000  barrels  per  day,  has 
in  fact  closed.  At  least  one  more  refinery  has  closed  since 
that  June  8,  1993  update  with  a  loss  of  another  50,000  barrels 
per  day  capacity.'  That  report  is  corroborated  by  the  NPC 
study  which  predicts  that  there  is  going  to  be  a  substantial 
restructuring  in  the  coming  years  characterized  by  shutdowns 
of  refining  capacity.'*  Indeed,  the  NPC  study  concluded  that 
shutdowns  accelerated  in  1992  to  the  third  highest  level  in 
history.'*  A  third  recent  analysis  reporting  that  dropping 
refining  capacity  "  —  is  likely  to  continue  due  to  the  cost  of 
complying  with  environmental  regulations,  particularly 
amendments  to  the  Clean  Air  Act,  and  also  due  to  narrow  profit 
margins  for  most  refining  operations."*"  That  USEA  report 
predicts  increased  petroleum  product  imports  as  a  result 
accompanied  by  dropping  U.S.  employment.** 

Therefore,  we  have  seen  a  20%  decline  in  refining 
capacity  already  zmd  we  are  well  on  our  way  to  a  predicted 
additional  10%  for  a  total  of  a  30%  loss  of  domestic  refining 
capacity  in  just  over  a  decade.  While  additional  imports  will 
likely  occur  to  offset  the  reduced  domestic  production,  one 
should  not  focus  on  the  euaount  of  imports  as  the  sole 
determinant  of  the  problem.  Refining  and  marketing  price 
margins  are  just  as  important  if  not  more  so. 

The  way  the  gasoline  marketing  operates  in  the  United 
States  is  that  the  marginal  barrel  of  gasoline  coming  into  a 
market  sets  the  price.  The  price  is  set  at  the  margin.  Those 
last  barrels  of  gasoline  coming  into  the  market  are  imported 
because  we  are  not  producing  all  that  we  consume.  Because 
they  have  less  embedded  costs  for  environmental  protection  of 
at  least  70  a  gallon,  they  can  sell  their  gasoline  in  our 
markets  for  less  than  that  domestically  produced  even  taking 
into  consideration  the  difference  in  transportation  costs  of 
finished  products  and  that  of  crude  oil.  Their  marginal 
barrel  coming  in  sets  the  price  for  all  of  the  domestic 
gasoline.  If  domestic  gasoline  refiners  don't  lower  their 
prices  to  meet  imports,  then  more  imported  gasoline  will  come 
in  further  displacing  domestic  production  which  will  then  have 
no  market  since  it  costs  more  at  the  pump. 

Today  the  margin  of  profit  on  a  gallon  of  domestic 
produced  gasoline  is  a  penny  a  gallon  or  less.   Thus,  the  50 


"Wright  Killen  &  Co.  report,  "Btu  Energy  Tax  Study",  May 
1993,  p.  2. 

'^Wright  Killen  &  Co.  study,  June  8,  1993,  p.  1. 

"Marathon  Oil  Company  refinery  in  Indianapolis,  Indiana, 
The  American  Oil  &  Gas  Reporter.  August  1993,  p.  14. 

'*NPC  Draft  report,  p.  1.  VI-1. 

'"Ibid. 

*'*United  States  Energy  Association,  "U.S.  Energy  '93",  May 
1993,  p.  3. 

**iiLL<a. 


1238 


a  gallon  differential  now  enjoyed  by  imported  gasoline  which 
will  continue  to  increase  is  a  significant  factor  depressing 
costs  at  the  pump.  If  a  domestic  refiner  cannot  get  back  the 
capital  it  is  going  to  have  to  invest  in  the  future  for 
environmental  protection,  it  will  not  make  that  investment  and 
will  shut  down  the  refinery.  This  is  exactly  the  point  made 
in  the  NPC  study  in  comparing  the  total  pollution  costs  of  $37 
billion  over  the  rest  of  this  decade  substantially  exceeding 
the  cash  flow  of  the  refineries. 

Unless  there  is  some  tremendous  increase  in  demand  for 
gasoline,  which  is  not  predicted  by  anyone,  it  is  not  possible 
for  the  rate  of  return  to  justify  these  expenses.  Therefore, 
the  real  problem  is  not  so  much  whether  the  present  levels  of 
imported  gasoline  are  going  to  go  up  or  down,  but  rather  what 
is  the  marginal  rate  of  return  to  the  domestic  refiner.  As 
long  as  it  is  depressed  as  it  currently  is,  more  refineries 
will  shut  down  rather  than  invest  further.  If  the  embedded 
cost  differential  disappeared,  however,  the  margin  would 
increase  and  refineries  should  remain  on  streeun.  The 
environmental  playing  field  needs  to  be  leveled. 

There  are  several  results  to  a  continued  shut  down  of 
domestic  refineries.  The  first  is  the  economic  consequences 
to  the  United  States.  The  additional  10%  reduction  in 
refining  capacity,  according  to  the  conservative  scenario  of 
a  recent  economic  analysis,  would  increase  inflation  .7  of  a 
percent.*^  It  would  also  affect  interest  rates  by  raising  the 
short  and  long  term  rates  by  40  basis  points.  The  report 
calculates  that  the  dollar  would  rise  as  interest  rates  went 
up  which  in  turn  would  inhibit  the  competitiveness  of  U.S. 
produced  goods  in  international  markets.^*  The  decline  in 
refining  capacity  would  also  affect  U.S.  employment  by  a 
decline  of  nearly  200,000  jobs.*'  Lastly,  the  Gross  Domestic 
Product  would  see  a  decline  of  .3  of  a  percent  in  1994  and 
1995.** 

A  second  result  of  this  decline  in  domestic  refining 
capacity  is  the  effect  on  the  national  security  of  the  United 
States.  A  recent  report  noted  that  five  different  Presidents 
-  Eisenhower,  Kennedy,  Nixon,  Ford  and  Carter  -  imposed 
restrictions  on  imports  of  refined  petroleum  products  because 
they  recognized  that  maintaining  domestic  refining  capacity 
was  essential  to  national  security.*'  The  report  analyzes 
military  needs  in  several  scenarios  and  then  compares  those 
needs  to  our  domestic  refining  capacity.  There  is  a  gap  today 
between  what  we  produce  and  consume  of  1.8  million  barrels  a 


*^he  WEFA  Group,  "Macro  Economic  Impact  of  a  Ten  Percent 
Reduction  in  U.S.  Refining  Capacity,"  May  25,  1993,  p.  3. 

*^Ibid. .  p.  5. 

**Ibid.  .  p.  7. 

*'lbid. ,  p.  8. 

*''lbid. 

*'The  National  Defense  Council  Foundation,  "Refineries  in 
Crisis:  The  Threat  to  National  Security,"  July  23,  1993,  p. 
3. 


1239 


day  which  will  grow  in  1995  to  3.25  million  barrels  a  day  and 
by  the  year  2000  to  6.9  million  barrels  a  day.**  With  a 
military  conflict  arising,  the  gap  would  obviously  increase 
due  to  the  needs  of  the  military  and  military  industrial 
complex,  widening  the  gap  to  4.9  million  barrels  a  day  in  1995 
and  a  8.6  in  the  year  2000.*'  "Even  if  draconian 
conservation  and  rationing  measures  were  employed  during  a 
conflict  and  succeeded  in  achieving  a  reduction  in  civilian 
demand  of  as  much  as  20%,  a  severe  shortage  would  still 
develop."'"  Therefore,  the  report  concludes,  "There  can  be 
no  doubt  in  light  of  the  enormous  and  growing  gap  between 
domestic  refining  capacity  and  domestic  demand,  that  the  tests 
set  forth  in  the  Ford  Administration's  standard  for 
determining  the  point  at  which  refined  petroleum  product 
import  levels  could  constitute  a  national  security  threat  has 
been  met."" 

The  economic  impact  and  the  threat  to  our  national 
security  are  both  to  be  avoided  if  at  all  possible.  As  has 
been  concluded  by  the  United  States  Energy  Association,  "The 
decline  in  our  domestic  ...refining  capacity  cannot 
conceiveibly  be  in  our  national  interest."" 

In  our  opinion,  it  is  possible  to  avoid.  Congress  must 
take  action  to  prevent  further  decline  in  our  industry,  damage 
to  our  economy,  zuid  a  worsening  of  the  threat  to  our  national 
security.  We  propose  that  Congress  pass  a  tax  on  imported 
gasoline  approximately  equalling  the  embedded  costs 
differential  of  environmental  costs  starting  at  70  per  gallon 
on  January  1,  1994  and  increasing  IC  per  year  thereafter  until 
it  reaches  130  per  gallon  on  January  1,  2000.  In  our  opinion, 
this  tax  will  eliminate  the  differential  environmental  cost 
subsidy  enjoyed  by  foreign  refiners  that  will  in  turn  cause  an 
increase  in  the  domestic  refiners  margins  which  will  improve 
their  profiteJaility  preventing  further  shut  downs.  This  tax 
offers  several  advantages: 

1.  The  tax  would  eliminate  the  unfair  competitive 
advantage  held  by  foreign  refiners. 

2.  It  would  remove  a  further  increase  in  the  threat  to 
national  security  of  reduced  refining  capacity. 

3.  It  would  encourage  domestic  refiners  to  expend  the 
money  necessary  for  future  environmental  protection 
by  giving  them  an  opportunity  to  recover  their 
costs . 

4.  It  would  eliminate  the  incentive  for  foreign 
refiners  to  resist  imposition  of  environmental 


*'lbid..  p.  9'. 

*"'lbid. 

"ibid. 

'^Ibid. 

'United  States  Energy  Association,  "Energy  '93  Report" 
10. 


1240 


standards  or  their  enforcement  as  they  would  no 
longer  have  a  cost  advantage. 

5.    It  would  provide  additional  needed  revenues  to  the 
U.S.  Treasury." 

Either  Congress  through  legislation  or  the  President 
under  existing  legislation  could  impose  a  tax  on  imported 
gasoline  on  the  grounds  of  national  security.  Section  232  of 
the  Trade  Expansion  Act  of  1962  expressly  authorizes  the 
President  to  adjust  imports  by  quotas  or  import  fees  which 
threaten  to  impair  the  national  security.'*  This  legislation 
is  broad  and  does  not  define  what  constitutes  a  threat  to 
national  security  as  it  is  left  to  the  President's 
judgment."  Six  recent  Presidents  have  already  used  this 
authority  to  regulate  imports  of  petroleum  and  petroleum 
products.  President  Eisenhower  used  a  quota".  President 
Nixon  imposed  license  fees'',  and  President  Ford  increased 
the  import  fees". 

The  Congress  can  also  legislatively  find  a  threat  to 
national  security  and  impose  a  tax  on  imported  gasoline.  The 
fact  that  Congress  granted  to  the  President  powers  under  §  232 
of  the  Trade  Expansion  Act  of  1962  was  not  an  abdication  of 
its  constitutional  responsibilities.  Rather,  it  is  a  grant  of 
concurrent  power  to  the  Executive  Branch  which  gives  the 
President  the  limited  power  to  make  national  security  findings 
under  Congressionally  prescribed  circumstances,  while  Congress 
also  retains  its  power  to  make  a  national  security  finding.'* 

A  tax  on  imported  gasoline  passed  by  the  Congress  is  also 
consistent  with  U.S.  international  obligations.  It  does  not 
violate  the  General  Agreement  of  Tariffs  and  Trade.  Article 
XXI  of  GATT  provides  a  specific  exception  to  a  contracting 
party  imposing  trade  restrictions  for  reasons  of  national 
security.  That  Article  reads  in  part:  "Nothing  in  [GATT] 
shall  be  construed  ...to  prevent  any  contracting  party  from 
taking  any  action  which  it  considers  necessary  for  the 
protection  of  its  essential  security  interests..."  This 
Article  makes  no  requirement  eO^out  the  manner  in  which  a 
contracting  party  determines  when  it  does  have  a  national 
security  interest  sufficient  to  trigger  this  exception.  GATT 
practice  has  been  to  defer  to  the  decision  of  the  contracting 


'National  Defense  Council  Foundation  Report,  p.  11. 
'*19  U.S.C.  S  1862  (C)(1)(A). 

"ln<agpen<?gnt  gaspling  MarK^terg  cpyingjl  v,  Pungan,  492 

F.Supp.614(D.C.D.C.  1980). 

'^Proclamation  No.  3279,  March  10,  1959,  24  Fed.  Reg. 
1,781. 

"Proclamation  No.  4210,  April  18,  1973,  38  Fed.  Reg. 
9,645. 

'•proclamation  No.  4341,  January  23,  1975,  40  Fed.  Reg. 
3,965. 

"consumers  Union  of  U.S..  Inc.  v.  Kissinger.  506  F.2d  136 
(D.C.D.C.  1974). 


1241 


party  when  they  invoke  the  national  security  exception."  It 
should  also  be  noted  that  not  all  countries  that  export 
gasoline  to  the  United  States  are  contracting  parties  to  GATT. 

Such  a  tax  would  also  be  an  important  environmental 
policy.  If  American  businesses  are  expected  to  make 
significant  investments  to  protect  the  environment,  they  must 
be  reasonably  secure  in  believing  they  are  going  to  be  ahle  to 
get  their  money  back  from  the  operation  of  their  business  and 
not  be  rendered  less  competitive.  This  tax  would  show 
American  refiners  that  our  government  is  not  going  to  let  them 
lose  competitiveness  and  that  they  have  a  chance  in  the 
marketplace  to  get  their  investment  returned.  By  the  same 
token,  it  will  be  a  clear  message  to  countries  around  the 
world  that  have  not  implemented  environmental  protections  or 
are  not  enforcing  them,  that  there  will  be  no  profit  or  trade 
advantage  in  their  failing  to  do  so.  The  domestic  and 
international  environment  will  be  improved  as  a  result. 

A  final  result  of  this  tax  is  that  it  will  raise  revenue. 
Even  with  exempting  Canada  with  whom  we  have  a  free  trade 
agreement,  the  tax  beginning  at  7C  on  January  1,  1994  and 
increasing  IC  per  year  until  it  reaches  13C  per  year  on 
January  1,  2000  will  raise  approximately  $1.9  billion  over  the 
next  five  years.'*  Although  it  will  raise  a  substantial  sum 
of  money,  it  will  not  reflect  a  corresponding  increase  at  the 
pump.  One  report  has  estimated  that  the  average  U.S.  gasoline 
pump  prices  would  not  increase  by  more  than  IC  per  gallon  and 
in  some  cases  less  than  1/4C  per  gallon  as  a  result  of  the 
passage  of  this  t«uc." 

Therefore,  Mr.  Chairman  and  members  of  the  Committee  the 
Coalition  urgently  requests  that  you  pass  a  tax  on  imported 
gasoline  and  blending  components  in  a  miscellaneous  revenues 
bill  which  might  result  from  these  hearings  starting  at  7C  per 
gallon  on  Jemuary  1,  1994  and  increasing  by  IC  per  gallon  a 
year  until  it  reaches  13C  per  gallon  on  January  1,  2000  as 
necessary  to  protect  the  national  security  of  the  United 
States,  help  our  domestic  economy,  protect  the  domestic  and 
international  environment,  and  give  relief  to  the  domestic 
refining  industry  from  foreign  unfair  competition. 


^"Handbook  of  GATT  Disputes  Settlement.  Pierre  Pescatore, 
Transitional  Juris  Publications,  1992,  Part  1:  Introduction, 
p.  58;  GATT  Activities  1986,  pp.  58-59;  GATT  Activities  1987, 
pp.  69-70;  John  H.  Jackson  World  Trade  and  the  Law  of  the 
GATT f  1969 )  .  p.  749;  GATT  Activities  in  1982,  p.  72;  GATT 
Activities  1985,  p.  47. 

'^Energy  Information  Administration,  Petroleum  Supply 
Monthly  for  Imports  January  -  December,  1992  of  Finished  Motor 
Gasoline  and  Motor  Gasoline  Blending  Components  Totalled 
121,668,000  barrels;  divided  by  42  gallons  to  the  barrel 
equals  5,110,056,000  gallons  multiplied  times  7«  and  then  an 
additional  cent  for  each  year  through  IIC  in  the  fifth  year 
equal  $2,299,525,200  less  imports  from  Canada  that  year  which 
were  17%  of  the  total;  equal  $1.9  billion. 

^^right  Killen  &  Co.,  "The  Effects  of  National  Security 
Fee  on  U.S.  Gasoline  Prices",  June  14,  1993,  p.  1. 


1242 

Mr.  Payne.  Thank  you,  Mr.  Campbell. 

Our  next  witness,  representing  the  Independent  Petroleum  Asso- 
ciation of  America,  Virginia  Lazenby,  chairman  and  chief  executive 
officer  of  the  Bretagne  Corp.,  Nashville,  Tenn. 

Ms.  Lazenby. 

STATEMENT  OF  VIRGINIA  LAZENBY,  VICE  CHAIR,  CRUDE  OIL 
POLICY  COMMITTEE,  INDEPENDENT  PETROLEUM  ASSOCIA- 
TION OF  AMERICA,  AND  CHAIRMAN  AND  CHIEF  EXECUTIVE 
OFFICER,  BRETAGNE  CORP. 

Ms.  Lazenby.  Good  afternoon.  I  am  here  today  on  behalf  of  the 
Independent  Petroleum  Association  of  America,  its  44  cooperating 
State  and  regional  associations,  and  the  National  Stripper-Well  As- 
sociation where  I  serve  as  president.  These  organizations  whole- 
heartedly support  an  oil  import  fee  as  part  of  a  comprehensive  plan 
to  preserve  domestic  oil  production. 

Yesterday  oil  closed  at  $17.07  a  barrel,  down  66  cents,  the  lowest 
in  3  years.  Most  U.S.  producers  are  receiving  just  $14  to  $15  a  bar- 
rel. Marginal  production,  20  percent  of  our  U.S.  production,  2  mil- 
lion barrels  a  day,  is  operating  at  a  significant  loss — ^yes,  loss,  we 
are  losing  money. 

We  are  being  destroyed  by  cheap  oil,  which  does  not  pay  environ- 
mental costs.  And  our  Government's  response  is  to  finance  more 
cheap  imported  oil,  which  results  in  more  destruction  of  the  inde- 
pendent oil  producers  and  their  employees.  On  a  personal  note,  just 
before  I  came  over  here  today,  I  called  Kentucky  and  I  shut  in  a 
water  flood  a  well  that  has  been  producing  since  the  1950s. 

Mr.  Chairman,  there  has  been  a  rash  of  stories  in  the  press  late- 
ly about  the  U.S.  Government's  financial  assistance  to  encourage 
oil  production.  Let  me  read  from  the  September  3,  New  York  Times 
entitled  "Texaco  Gets  Aid  to  Invest  in  Russia." 

The  article  explains,  'The  oil  company  has  a  project  to  restore 
production  of  150  dormant  wells  in  Western  Siberia.  The  Overseas 
Private  Investment  Corp. — ^yes,  a  Federal  agency — will  provide  $28 
million  of  loan  guarantees  and  insurance  against  political  risk  for 
the  effort.  The  agency  is  prepared  to  provide  up  to  $2.5  billion  in 
new  loans,  loan  guarantees,  equity  and  insurance  in  the  next  year 
to  support  private  investment  in  Russia." 

I  come  here  representing  U.S.  independent  producers  to  ask  your 
assistance  to  develop  U.S.  resources.  It  is  not  just  the  big  multi- 
national oil  companies  operating  in  Russia  that  need  help  from  the 
U.S.  Government.  U.S.  producers  need  capital,  too,  and  rather  than 
the  $2.5  billion,  1-year  program  in  Russia,  we  are  asking  for  a  $1.5 
billion  program  spread  over  5  years. 

Keep  in  mind  we  may  need  this  even  more.  Since  we  are  told  by 
the  Grovernment  that  the  aim  of  producing  Russian  oil  is  to  sell  it 
on  the  world  market,  which  will  keep  oil  prices  low  and  which,  I 
might  add,  will  put  more  U.S.  independents  out  of  business  and  in- 
crease the  trade  deficit  by  something  like  $7  billion  and  put 
100,000  marginal  producers  out  of  business. 

The  experts  say  oil  prices  fell  yesterday  because  demand  is  down 
in  Russia.  Just  wait  until  the  Russian  production  which  our  Gov- 
ernment is  subsidizing  comes  on  line.  How  low  will  the  price  go 
then?  When  do  we  begin  to  think  about  American  jobs? 


1243 

An  oil  import  fee  is  justified  to  create  a  price  difference  that  bet- 
ter enables  U.S.  producers  to  compete,  to  offset  their  higher  operat- 
ing costs  that  result  to  a  large  degree  from  Government-mandated 
costs  principally  for  environmental  protection.  You  can  bet  that  the 
U.S.  subsidies  for  Russian  oil  development  do  not  come  with  the 
same  high-cost  environmental  requirements  that  U.S.  producers 
must  meet. 

Three  months  ago  I  appeared  before  this  subcommittee  to  discuss 
the  increasing  loss  of  marginal  oil  well  production  in  the  United 
States.  I  pointed  out  then  that  U.S.  oil  production  had  hit  its  low- 
est level  since  1960. 

Our  trade  deficit  is  dominated  by  oil  imports;  last  year  it  was 
$45  billion.  For  the  first  time  since  June,  the  United  States  has 
consistently  imported  more  oil  than  we  produce.  Thousands  of  bar- 
rels of  marginal  oil  production  have  been  shut  in  forever.  U.S.  com- 
panies have  gone  out  of  business. 

According  to  Energy  Secretary  Hazel  O'Leary,  "This  is  not  a  po- 
litical issue.  Everyone  agrees  there  is  a  problem.  The  question  is 
how  to  solve  it." 

Even  now,  her  department  is  finalizing  a  domestic  energy  initia- 
tive for  the  President.  As  part  of  that  initiative,  domestic  oil  and 
gas  producers  have  advocated  tax  policy  changes  that  will  stimu- 
late domestic  oil  and  natural  gas  production.  These  are  discussed 
in  detail  in  our  written  statement. 

Today  I  want  to  emphasize  that  these  tax  changes  can  be  funded 
by  a  small  increase  in  the  current  fee  on  imported  oil  and  petro- 
leum products. 

Mr.  Chairman,  it  costs  more  to  produce  oil  here  than  anywhere 
else.  A  big  part  of  these  costs  are  for  environmental  protection  and 
workplace  safety.  We  pay  for  it,  but  U.S.  oil  production  is  safer  and 
more  environmentally  sensitive  than  anywhere  in  the  world. 

In  all  the  world,  the  U.S.'s  463,000  U.S.  marginal  wells  are  the 
most  economically  vulnerable,  the  most  likely  to  oe  shut  in  if  world 
oil  prices  stay  at  their  currently  depressed  prices  or  fall  even  lower, 
a  very  real  prospect. 

If  the  United  States  adopts  an  energy  policy  that  says  simply 
"Back  oil  out  of  the  market  and  substitute  other  fuels"  like  domes- 
tically produced  natural  gas,  without  some  measure  to  preserve 
those  marginal  wells — it  will  be  oil  from  U.S.  stripper  wells  that 
will  be  backed  out  of  the  market,  not  imported  oil.  It  will  be  pro- 
ducers in  New  York,  Kansas,  Michigan,  Oklahoma  and  a  dozen 
other  States  that  will  be  forced  out  of  business,  not  the  sheiks  and 
princes  of  OPEC  countries. 

A  slight  import  fee  to  pay  for  a  production  credit  with  a  floor 
price,  which  I  understand  the  Clinton  administration  is  considering 
as  part  of  its  domestic  initiative,  will  give  our  country  a  much  bet- 
ter energy  policy,  a  policy  that  preserves  domestic  production  and 
creates  a  level  of  price  stability  that  will  encourage  investment. 

Thank  you,  Chairman  Payne.  That  concludes  my  testimony. 

[The  prepared  statement  and  attachment  follow:] 


1244 


Independent  Petroleum      {^UilJ  s       Association  of  America 


Statement  by 

Virginia  Lazenby 

on  behalf  of  the 

Independent  Petroleum  Association  of  America 

before  the 

Committee  on  Ways  and  Means 

Subcommittee  on  Select  Revenue  Measures 


United  States  House  of  Representatives 

September  8,  1993 


MR.  CHAIRMAN  AND  MEMBERS  OF  THE  COMMITTEE: 

I  am  Virginia  Lazenby.   I  am  from  Memphis,  Tennessee  and  Chairman  of 
Bretagne  Corporation,  an  oil  production  company  with  marginal  wells  operating 
principally  in  Kentucky.   I  appear  today  on  behalf  of  the  Independent  Petroleum 
Association  of  America,  where  I  serve  as  the  Vice  Chair  of  the  Crude  Oil  Policy 
Committee.   I  also  am  the  president  of  the  National  Stripper  Well  Association. 

I  am  pleased  to  provide  views  in  support  of  an  increase  in  fees  on  imported  oil 
and  refined  petroleum  products.   I  also  want  to  address  the  need  for  changes  in  tax 
policy  affecting  domestic  natural  gas  and  oil  production  and  to  restate  our  concerns 
about  other  tax  proposals  that  have  been  introduced  in  the  House  of  Representatives. 

BACKGROUND.   It  has  gone  unnoticed,  but  our  nation  had  an  anniversary  this  year. 
Twenty  years  ago  this  year,  the  Arab  oil  embargo  brought  America's  energy 
vulnerability  into  stark  focus  for  anyone  who  waited  in  a  gasoline  line.   The  1973 
embargo,  and  the  oil  price  rise  that  followed  it  and  the  1979  Iranian  Revolution, 
spawned  initiatives  to  improve  U.S.  energy  security  through  various  programs  focused 
on  conservation,  production  of  synthetic  fuels,  fuel  use  mandates,  and  alternative 
fuels,  but  with  little  to  stimulate  domestic  oil  production.   In  fact,  passage  of  the 
Windfall  Profits  Tax  drained  more  than  $78  billion  dollars  out  of  the  domestic  oil 
industry,  when  it  should  have  been  investing  those  resources  into  new  domestic  natural 
gas  and  oil  reserves. 


Representing  America's  Domestic  Petroleum  Explorer/Producers 
For  information  call  (202)  857-4722 


1245 


What  were  the  results  of  those  everything-but-produce  energy  policy  changes? 
Perhaps,  that  was  best  summed  up  by  the  Office  of  Technology  Assessment  (OTA)  in 
October,  1991,  which  concluded  that  the  United  States  was  more  vulnerable  than  ever 
to  an  oil  import  disruption.' 

The  OTA's  conclusion  was  supported  in  principle  by  an  earlier  Department  of 
Commerce  investigation  into  the  impact  of  oil  import  dependence  on  national  security. 
On  December  1,  1987  a  coalition  of  associations,  companies,  and  individuals 
petitioned^  the  Department  of  Commerce  to  investigate  the  impact  of  crude  oil  and 
petroleum  imports  on  national  security,  asserting  that  imports  had  weakened  the 
domestic  petroleum  industry  to  such  an  extent  it  that  would  not  be  able  to  support 
U.S.  security  needs  in  the  event  of  war. 

After  an  extensive  investigation  and  public  comment,  the  Department  found  that 
"petroleum  imports  threaten  to  impair  the  national  security."   The  Department  of 
Commerce  noted  that  there  had  been  substantial  improvements  in  U.S.  energy  security 
since  its  1979  investigation,  but  pointed  out  that  declining  domestic  oil  production, 
rising  oil  imports,  and  growing  Free  World  dependence  on  potentially  insecure 
sources  of  supply  raised  a  number  of  concerns,  including  vulnerability  to  a  major 
supply  disruption.   Regrettably,  the  report  did  not  result  in  direct  action  by  either  the 
executive  or  legislative  branches  of  the  Federal  government  to  decrease  oil  import 
vulnerability. 

A  substantial  portion  of  Congressional  energy  policy  action  in  the  late  1980s 
and  early  1990s  was  focused  on  repealing  or  greatly  modifying  the  command  and 
control  provisions  of  various  energy  laws,  even  though  the  level  of  the  nation's  oil 
import  dependence  had  begun  to  climb  once  again.   It  appears  that  the  strength  of 
political  will  needed  to  deal  with  our  nation's  dependence  on  imported  oil  had  waned 
with  the  collapse  oil  prices  in  1986.   Outside  of  oil-producing  states,  cheap  oil  was  not 
considered  a  problem.   However,  in  the  oil-producing  states  the  results  of  cheap  oil 
imports  were  devastating,  with  more  than  465,000  jobs  lost  in  less  than  a  decade. 

The  Bush  Administration  launched  its  National  Energy  Strategy  (NES)  in  1989, 
which  resulted  in  the  Energy  Policy  Act  of  1992.   At  the  outset,  the  NES  sought  to 
decrease  the  nation's  oil  import  vulnerability  by  opening  previously  restricted  Federal 
lands  to  oil  exploration  and  production,  providing  additional  incentives  for  the  use 
natural  gas  and  alternative  fuels,  streamlining  nuclear  plant  licensing,  and  encouraging 
greater  conservation  and  energy  efficiency.   Not  surprisingly,  all  elements  of  the 
proposed  NES  became  law,  except  those  proposals  to  open  Federal  lands  for 
exploration  and  development;  indeed,  the  Energy  Policy  Act  of  1992  placed  additional 
restrictions  on  offshore  development  and,  as  a  result  of  a  filibuster,  was  silent  on  the 
opening  of  a  small  portion  of  the  Arctic  National  Wildlife  Refuge  to  development. 


77-130  0 -94 -8 


1246 


The  U.S.  Congress  added  a  tax  title  to  Energy  Policy  Act  of  1992,  that 
substantially  removed  the  'tax  penalty'  on  domestic  drilling  and  production  imposed 
by  the  alternative  minimum  tax  (AMT).   While  these  AMT  changes  brought  the 
effective  tax  rates  of  oil  and  natural  gas  producers  closer  to  the  level  of  those  of  other 
businesses,  it  did  not  provide  new  incentives  for  production  and  drilling.   The  last 
significant  statutory  tax  incentive  for  domestic  exploration  and  production,  the  Non- 
conventional  Fuels  Tax  Credit,  expired  at  the  end  of  1992.   The  "Section  29  credit" 
led  to  the  development  of  extensive  natural  gas  resources  that  probably  would  not  have 
been  developed  at  that  time  without  the  credit. 

DOMESTIC  ENERGY  INITIATIVE. 

In  February  of  this  year.  Energy  Secretary  Hazel  O'Leary  announced  a 
"Domestic  Energy  Initiative"  that  would  seek  to  decrease  the  nation's  oil  import 
dependence,  increase  domestic  oil  and  natural  gas  production,  and  reconcile  energy 
and  environmental  goals.   This  month,  the  Department  of  Energy  is  expected  to 
submit  its  energy  policy  recommendations  to  President  Clinton.    The  IPAA  and 
numerous  other  domestic  energy  groups  have  advocated  an  oil  import  fee  as  part  of  a 
comprehensive  program  to  revitalize  the  domestic  oil  and  natural  gas  industry. 

OIL  IMPORT  FEE.  The  United  States  currently  collects  approximately 
$250,000,000  per  year  through  fees  on  imported  oil  and  refined  petroleum  products, 
as  follows: 

Item  Tariff  Rate 

(per  barren 


Crude  OU 

less  than  2S  gravity 

$0.0525 

more  than  25  gravity 

$0,105 

GasoUne 

$0,525 

Jet  Fuel 

$0,525 

Residual  Fuel  OU 

$0.0525 

No.  2  Fuel  Oil 

$0,105 

IPAA  SUPPORTS  AN  OIL  IMPORT  FEE.   As  the  recent  debate  over  the  BTU  tax 
demonstrated,  any  energy  tax  increase  will  be  controversial  and  raises  issues  ranging 
from  interfiiel  competition  to  disparate  economic  impacts  among  regions  of  the 
country,  and  consumer  costs.   However,  unlike  the  BTU  tax  and  most  other 
alternatives,  only  an  oil  import  fee  gets  to  the  core  issue  of  this  nation's  enerev  policy 
-  the  vulnerability  created  by  the  nation's  excessive  dependence  on  imported  oil  and 
petroleum.   Only  an  oil  import  fee  will  help  the  domestic  industry  survive  its  nearly 
seven-year  long  depression  and,  in  the  process,  create  jobs. 


1247 


EMPLOYMENT.  As  we  have  told  this  Committee  on  several  occasions  in  the  last 
two  yean,  the  U.S.  oil  and  gas  extraction  industry  has  lost  more  than  450,000  jobs 
since  its  peak  employment  in  1982,  more  jobs  than  were  lost  in  the  automobile, 
textile,  steel,  and  electronics  industries.   In  the  first  quarter  of  this  year,  employment 
fell  another  seven  percent  from  the  same  period  last  year.   The  domestic  oil  and 
natural  gas  industry  has  lost  more  jobs  than  it  has  retained  over  the  last  decade. 

RIG  COUNT.  The  rig  count,  the  basic  barometer  of  the  industry's  economic  health, 
fell  in  June,  1992  to  596.  the  lowest  level  ever  recorded  and  the  sixth  all-time  low  set 
in  1992,  which  had  the  lowest  annual  rig  count  ever.'  Rig  count  for  1993,  although 
improved  since  last  year,  is  still  at  less  than  half  the  average  level  over  the  last  twenty 
years. 

TRADE  DEFICIT.   Consumption  of  natural  gas  and  crude  oil  in  the  United  States, 
by  all  official  estimates,  will  continue  to  rise  well  into  the  future.   If  current  trends 
continue,  the  U.S.  could  be  importing  17  million  barrels  of  petroleum  each  day  by  the 
year  2010.   The  climb  in  oil  imports  is  readily  evident.   In  1991,  crude  oil  and 
petroleum  product  imports  accounted  for  more  than  50%  the  nation's  trade  deficit. 
Low  prices  kept  the  value  of  oil  imports  below  that  level  in  1992,  but  oil  imports 
were  46  percent  of  the  trade  deficit  and  remain,  as  in  years  passed,  the  largest  single 
component  of  the  trade  deficit.   This  year,  as  indicated  earlier,  more  than  50  percent 
of  the  crude  oil  and  petroleum  products  consumed  in  America  is  coming  fi-om  foreign 
suppliers. 

NATIONAL  SECURITY.   The  IPAA  was  so  concerned  about  this  trend  that  we 
wrote  President  Clinton  in  January,  and  again  in  June,  urging  him  to  investigate  the 
situation  and  to  take  action  by  imposing  an  oil  import  fee  under  the  authority  granted 
him  under  the  Trade  Expansion  Act.   We  have  not  heard  what  the  Clinton 
Administration  plans  to  do  on  our  request.   We  are  willing  to  examine  the  upcoming 
Domestic  Energy  Initiative  to  see  it  makes  substantial  recommendations  to  improve 
domestic  oil  production.   If  not,  the  IPAA,  other  industry  associations,  and  individual 
companies  may  file  a  petition  under  the  Trade  Expansion  Act.   We  believe  the  issue 
of  oil  import  dependence  must  be  addressed  directly. 

Domestic  natural  gas  and  oil  reserves  are  a  national  security  and  economic 
resource.  Every  barrel  of  oil  and  every  cubic  foot  of  natural  gas  produced  in  the 
United  States  creates  wealth,  jobs,  and  tax  revenues  at  every  level  of  government. 
Unfortunately,  our  nation  is  rapidly  losing  much  of  its  ability  to  domestically  produce 
the  country's  primary  sources  of  energy  ~  oil  and  natural  gas,  which  account  for 
nearly  65  percent  of  the  total  energy  consumption  in  the  United  States. 

THE  NEED  FOR  TAX  POUCY  CHANGES.  EarUer  this  year,  the  IPAA  testified 
before  this  subcommittee  on  H.R.  1024,  the  Energy  Independence,  Infrastructure,  and 


1248 


Investment  Act  of  1993,  that  proposes  tax  policy  changes  to  maintain  and  enhance 
existing  domestic  natural  gas  and  oil  production,  especially  from  economically 
marginal  wells,  and  to  encourage  investment  in  new  drilling.   Without  these  or  similar 
changes  in  tax  policy,  our  nation  will  grow  ever  more  dependent  on  imported  crude 
oil  as  more  domestic  wells  are  plugged  and  abandoned,  their  resources  effectively  lost 
forever. 

The  United  States  has  a  rich  endowment  of  potential  domestic  natural  gas  and 
oil  resources  that,  with  favorable  exploration  and  development  policies,  can 
significantly  reduce  future  oil  imports.   However,  these  resources  will  not  be 
discovered  and  produced  so  long  as  our  country  does  not  aggressively  counter  the 
efforts  of  other  governments  to  capture  the  capital  investment  needed  to  develop 
energy  resources.   The  United  States  cannot  sit  idly  by  while  every  other  nation  with 
energy  resource  potential  provides  inducemenU  to  oil  and  natural  gas  investments. 

Our  government  does  seem  to  understand  the  need  for  economic  inducements 
for  natural  gas  and  oil  development.   The  United  States  is  providing  more  than  $2.5 
billion  in  loans,  loan  guarantees,  and  other  economic  inducements  this  year  for  oil 
development  in  Russia,  through  the  Overseas  Private  Investment  Corporation,  a 
federal  agency.   Independent  producers,  who  account  for  about  60  percent  of  domestic 
natural  gas  production  and  about  40  perxxnt  of  domestic  crude  oil  production,  are 
eager  for  economic  conditions  which  would  allow  us  to  increase  domestic  natural  gas 
and  oil  production.   We  also  urge  Congress  to  create  incentives  for  maintaining  and 
expanding  production  from  the  nation's  marginal  wells. 

MARGINAL  WELLS.  The  United  States  operated  slighUy  more  than  875,000  oil 
and  natural  gas  wells  in  1992,  according  to  World  Oil.   About  two-thirds  of  those 
wells  are  oil  wells,  or  about  595,000  wells.   Nearly  78  percent  of  the  nation's  oil 
wells  are  stripper  wells,  with  an  average  per  well  output  of  about  2.2  barrels  per  day. 

Marginal  wells  -  defined  in  the  tax  code  as  those  wells  that  daily  produce  less 
than  15  barrels  of  oil  and  90  thousand  cubic  feet  of  gas  -  are  essential  to  our  domestic 
energy  supply.   They  provide  approximately  20  percent  of  domestic  oil  production  in 
the  lower  48  states.   These  high-cost  marginal  wells  collectively  produce  more  oil  than 
we  import  from  Saudi  Arabia.   Many  stripper  wells  are  already  uneconomic  to 
operate.   Producers  continue  to  operate  these  wells  in  hopes  of  higher  future  prices, 
but  too  often  are  economically  forced  to  abandon  the  producing  property  before  the 
mineral  deposit  has  been  exhausted.   Stripper  wells,  which  represent  over  15%  of 
domestic  proven  reserves,  have  been  abandoned  at  rate  of  over  17,000  wells  per  year 
for  each  of  the  past  10  years.  Once  these  wells  are  abandoned,  their  production  and 
proved  reserves  are  permanently  lost,  and  our  foreign  energy  dependency  grows. 


1249 


Let  me  point  out,  as  the  attached  map  clearly  shows,  that  the  greatest 
beneficiaries  of  changes  in  tax  policy  affecting  marginal  wells  are  states  not 
traditionally  viewed  as  "oil  producing  states." 

DOMESTIC  DRILLING.  Just  as  we  must  preserve  the  productive  capacity  of 
existing  wells,  the  nation  must  also  encourage  investment  in  drilling  for  new  wells. 
Last  year,  drilling  for  domestic  natural  gas  and  crude  oil  hit  the  lowest  level  since 
records  were  kept  beginning  in  the  1940s,  and  1993  looks  only  slightly  better. 

H.R.  1024  is  intended  to  spur  new  drilling,  as  well  as  improving  the  economic 
life  of  existing  production.   The  n>AA  supports  the  goals  of  this  proposal;  at  the  same 
time  we  have  continued  to  explore  alternative  approaches  to  achieve  the  goals  of  H.R. 
1024.   The  IPAA  Management  Committee  recently  approved  a  production-based  credit 
proposal  for  existing  marginal  wells  and  new  drilling,  based  on  the  approach  used 
under  the  Non-conventional  Fuels  Tax  Credit,  as  follows: 

ELEMENTS  OF  THE  PROPOSAL 

L   NEWLY  DRILLED  WELLS  would  be  eligible  for  a  tax  credit,  based  on 
production,  as  follows: 

a)  Newly  drilled  natural  gas  wells  would  receive  a  $0.50  per  Mcf  tax  credit  for 
the  first  2Q  Mcf  per  day.   Natural  gas  production  in  excess  of  90  Mcf  per  day 
will  receive  a  tax  credit  equal  to  $0.10  for  each  Mcf  of  such  additional 
production  per  day. 

b)  Oil  wells  drilled  in  producing  properties  which  produce  an  annual  per  well 
average  of  25  barrels  of  oil  per  day  or  less  would  receive  a  production  tax 
credit  of  $1 .55  for  each  of  the  first  2  barrels  of  oil  produced  per  well  per  day. 
The  annual  average  production  would  be  determined  after  considering  the 
production  from  the  newly  drilled  well. 

c)  Oil  wells  drilled  in  nonproducing  properties  which  produce  an  annual  per  well 
average  of  25  barrels  of  oil  per  day  or  less,  would  receive  a  production  tax 
credit  of  $1.55  for  each  of  the  first  15  barrels  of  oil  produced  per  well  per  day. 

n.   EXISTING  STRIPPER  WELLS.   Existing  oil  and/or  natural  gas  wells  which  on 
the  date  of  enactment  or  subsequently  qualify  as  a  Stripper  Well  property  would 
receive  a  production  tax  credit  in  the  following  amounts: 

a)  Oil:   $1 .55  for  each  barrel  of  daily  production  up  to  3  barrels  per  day. 

b)  Natural  Gas:  $0,268  per  mcf  of  daily  production  up  to  18  mcf  per  day 


1250 


in.   OTHER  CHARACTERISTICS 

•  Effective  for  production  after  June  1,  1994.  The  rate  of  the  tax  credit  would  be 
phased-in  by  one-third  each  year  between  1994  and  1996,  and  indexed  for 
inflation  thereafter. 

•  Available  to  carry  back  3  years  (but  not  to  a  year  which  precedes  the  enactment 
date)  and  carry  forward  15  years. 

•  Creditable  against  regular  tax  and  alternative  minimum  tax,  but  not  refundable. 

•  Available  to  working  interest  owners  only.  The  credit  would  not  be  allowable 
for  interests  held  by  nonworking  interest  royalty  owners,  or  royalty  interests 
held  by  nonprofit  organizations  such  as  governments,  universities  or  Indian 
tribes,  etc. 

•  Workovers/recompletions  earn  the  new  well  credit  on  incremental  production. 

•  Only  wells  operating  at  their  most  efficient  flow  rate  would  qualify  for  the  tax 
credit.   Otherwise  qualifying  stripper  wells  operating  at  reduced  production 
rates  in  accordance  with  state  regulation  will  not  be  disqualified. 

•  Stripper  wells  which  have  increased  their  efficient  production  through  work- 
over  expenditures  to  levels  in  excess  of  the  stripper  well  rate  will  be  allowed  to 
retain  eligibility  for  the  tax  credit  for  production  up  to  the  stripper  well  limits. 
(Qualification  would  continue  under  provisions  similar  to  the  newly  drilled  well 
limitations.) 

•  Existing  Section  29  wells  not  be  eligible  for  the  marginal  well  production  tax 
credit,  until  the  existing  Section  29  tax  credit  expires. 

•  Properties  producing  both  oil  and  natural  gas,  a  conversion  ratio  of  6  Mcf  per 
barrel  of  oil  would  be  used  to  calculate  equivalent  oil  production,  and  eligibility 
would  be  determined  by  adding  barrels  of  oil  produced  to  the  oil-equivalent  of 
gas  produced  from  each  well. 


NATURAL  GAS  DRILLING.  The  tax  proposal  outlined  above  will  attract  new 
capital  and  new  drilling  activity  to  all  geographic  regions  of  the  domestic  industry.   It 
is  needed.   For  the  first  time  in  several  years,  the  industry  needs  to  increase  natural 
gas  drilling  levels  to  meet  demand.   Government  agencies  and  private  analysts  have 
estimated  that  SOO-600  rigs  need  to  be  drilling  for  natural  gas  to  meet  projected 
consumption.   Only  298  gas  rigs  were  drilling  the  week  of  May  7,  1993. 


1251 


Equally  important,  the  production-based  credit  will  give  a  signal  to  domestic 
producers  that  their  industry's  contributions  are  viewed  as  necessary  to  achieve  the 
administration's  energy  independence  and  economic  recovery  goals.   It  will  also  signal 
that  the  health  of  the  domestic  oil  and  gas  industry  is  important  to  this  administration 
and  that  the  industry  is  not  being  singled  out  for  the  economic  penalties  which  are 
inherent  in  all  energy  taxes. 

REVENUE  OFFSET.   The  revenue  offset  proposed  by  H.R.  1024  to  pay  for 
production  and  drilling  tax  changes  could  be  used  for  the  proposal  outlined  above. 
H.R.  1024  proposes  an  increase  in  fees  on  imported  oil  and  petroleum  products. 
While  this  is  a  preferred  revenue  offset  from  IPAA's  perspective,  the  proposal  for 
increased  in  fees  on  imported  gasoline,  advocated  by  domestic  independent  refiners,  is 
also  acceptable  to  IPAA  if  used  to  provide  tax  policy  changes  for  domestic  production 
and  drilling. 

ADMINISTRATION'S  POSITION.   At  the  June  hearing  on  H.R.  1024,  the  Clinton 
Administration  opposed  making  the  proposed  changes  in  energy  tax  policy  as  outlined 
in  the  legislation.   The  IPAA  subsequently  met  with  Assistant  Secretary  of  the 
Treasury  Leslie  Samuels  and  others  in  the  Department  of  the  Treasury  to  discuss  our 
proposals.   We  have  urged  the  Clinton  Administration  to  recommend  tax  policy 
changes  as  part  of  its  Domestic  Energy  Initiative.    We  understand  that  the 
Administration  is  considering  several  tax  policy  options,  including  an  oil  import  fee 
and  a  floor  price  on  imported  oil. 

H.R.  2026,  Sections  305  and  306.   Finally,  Mr.  Chairman,  I  would  like  to  restate  the 
views  of  the  Independent  Petroleum  Association  of  America  in  opposition  to  two 
provisions  of  H.R.  2026,  Renewable  and  Energy  Efficiency  Incentives  Act  of  1993  - 
Section  305  and  Section  306.   These  two  sections  have  virtually  no  impact  on 
multinational  oil  companies;  their  detrimental  impact,  which  is  severe,  falls  squarely 
on  the  independent  section  of  the  domestic  oil  and  natural  gas  industry  and  most 
particularly  on  marginal  well  producers.    Section  305  would  eliminate  the  long- 
standing and  eminently  logical  distinction  in  tax  law  between  depreciating  assets 
(buildings,  vehicles,  machine  tools,  etc.)  and  depleting  assets  (oil  and  natural  gas 
reserves,  minerab,  etc.)  and  would  undermine  an  important  element  of  the  capital 
structure  which,  quite  frankly,  barely  sustains  the  domestic  independent  oil  and  natural 
gas  industry  today.   Section  306  repeals  the  exception  from  passive  loss  limitation  for 
working  interests  in  oil  and  natural  gas  properties.   This  provision  would  virtually 
eliminate  a  primary  source  of  investment  capital  for  domestic  oil  and  natural  gas 
exploration  and  development  ~  other  oil  and  natural  gas  producers!   Eliminating 
working  interest  investment  capital,  as  proposed  in  Section  306,  would  reduce 
substantially  the  already  anemic  capital  investment  in  drilling. 


1252 


1.  U.S.  Congress,  Office  of  Technology  Assessment,  U.S.   Oil 
Import  Vulnerability:   The  Technical  Replacement  Capability. 
OTA-E-605  (Washington,  DC:  U.S.  Government  Printing  Office, 
October,  1991) . 

2.  Petition  was  filed  under  Section  232  of  the  Trade  Expansion 
Act  of  1962,  as  amended,  (19  U.S.C.  1862). 

3.  The  1992  annual  rig  count  was  721. 


1253 


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Mr.  Payne.  Our  next  witness,  representing  the  Petrochemical 
Energy  Group  and  the  Coalition  on  Energy  Taxes,  is  David 
Damron,  manager  of  government  affairs,  Hoecnst  Celanese  Chemi- 
cal Corp.,  Dallas,  Tex. 

STATEMENT  OF  R.  DAVID  DAMRON,  MANAGER,  GOVERNMENT 
AFFAIRS,  HOECHST  CELANESE  CORP.,  INC.,  ON  BEHALF  OF 
THE  PETROCHEMICAL  ENERGY  GROUP  AND  COALITION  ON 
ENERGY  TAXES 

Mr.  Damron.  Thank  you,  Mr.  Chairman.  I  will  limit  my  verbal 
comments  today  to  three  concluding  statements  and  one  rec- 
ommendation. 

First,  an  oil  import  tax  is  a  poor  way  to  raise  revenues.  The  ulti- 
mate cost  in  jobs,  in  competitiveness,  in  Government  outlays,  far 
exceeds  the  other  benefits. 

Second,  the  failures  of  past  efforts  to  use  a  tax  on  imported  oil, 
that  is  ranging  from  regulation  of  domestic  oil,  windfall  profit 
taxes,  and  a  bureaucracv  allocating  competitive  advantages  and 
trying  to  achieve  regional  equity  in  prices  of  oil,  should  not  be  vis- 
ited again  on  the  American  people. 

Third,  an  oil  import  tax  will  not  address  the  problem  of  access 
to  new  sources  of  domestic  oil  and  will  induce  problems  with  for- 
eign sources,  particularly  if  there  is  selective  and  discriminatory 
application. 

The  recommendation  that  we  have  is  that  the  solution  is  to  re- 
frain from  imposing  any  tax  on  imported  oil  or  refined  petroleum 
products. 

Thank  you. 

Mr.  Payne.  Thank  you. 

[The  prepared  statement  follows:! 


1255 


BEFORE  THE  SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

COMMITTEE  ON  WAYS  AND  MEANS 

UNITED  STATES  HOUSE  OF  REPRESENTATIVES 

TESTIMONY  IN  OPPOSITION  TO  AN  OIL  IMPORT  TAX 

ON  BEHALF  OF 

THE  PETROCHEMICAL  ENERGY  GROUP  AND 

THE  COALITION  ON  ENERGY  TAXES 

September  8,  1993 


Thank  you  Mr.  Chainnan.   My  name  is  R.  David  Damron  and  I  appear 
today  on  behalf  of  the  Petrochemical  Energy  Group  ("PEG")  and  the  Coalition  on 
Energy  Taxes  ("COET')  at  the  hearing  of  September  8,  1993,  as  announced  by  Press 
Release  #9.   We  appreciate  the  opportunity  to  be  heard. 

The  companies  represented  are  independent  chemical  companies.'   That 
is,  we  are  not  vertically  integrated  with  major  oil  companies.    We  are  industrial 
consumers.   We  are  not  major  producers,  refiners,  transporters,  or  marketers  of  oil  or 
refined  petroleum  products.    But  we  are  major  manufacturers  who  must  consume  oil  and 
its  derivatives  in  order  to  make  goods  for  sale  in  the  domestic  and  foreign  markets. 

Petrochemical  manufacturers  have  the  additional  distinction  of  requiring 
oil  and  its  derivatives,  not  only  for  fuel,  but  also  for  raw  materials. 

A.         SUMMARY  STATEMENT:   THERE  SHOULD  BE  NO  FURTHER  TAX 
IMPOSED  ON  OIL  OR  REHNED  PETROLEUM  PRODUCTS 

One  of  the  proposals  under  consideration  at  this  hearing  is: 

"Natural  Resources" 

"2.  A  proposal  to  increase  the  tariff  on  imported  crude  oil 
by  15-cents-per-barrel  and  refined  petroleum  products  by  1- 
cent-per-gallon." 

We  respectfully  urge  that  there  be  no  new  tax  imposed  on  imported  crude 
oil  or  on  imported  refined  petroleum  products.   A  tariff  or  tax  on  imported  oil  and 
product  can  be  expected  to: 

(1)  decrease  domestic  jobs  and  productivity,  thus  lowering  tax  revenues 
and  increasing  social  costs; 

(2)  decrease  competitiveness  of  American-based  companies  in  both  the 
domestic  and  export  markets,  thus  lowering  tax  revenues  and  further  eroding  the  balance 
of  trade; 

(3)  increase  costs  to  all  consumers  of  oil,  just  as  the  BTU  tax  on  oil 
would  have  done,  had  the  Congress  decided  to  enact  one  in  connection  with  the  Budget 
Reconciliation  Act; 

(4)  result  in  the  revival  of  an  elaborate  bureaucracy  to  administer  the 
program  and  to  grant  exemptions,  subsidies,  and  entitlements  to  both  domestic  and 
foreign  oil,  and  to  resolve  claims  for  redistribution  of  taxes  and  costs  among  States  and 
Regions  of  the  country; 

(5)  result  in  a  revival  of  the  Windfall  Profit  Tax  on  domestic  oil; 


^Air  Products  &  Chemicals,  Inc.,  Dow  Chemical  Company,  Eastman  Chemical  Company, 
Goodyear  Tire  &  Rubber  Company,  Hoechst  Celanese  Corporation,  PPG  Industries,  Quantum  Chemical 
Corporation,  and  Union  Carbide  Corporation. 


1256 


(6)  be  ineffective  in  encouraging  exploration  and  production  of  new 
domestic  oil  reserves; 

(7)  be  ineffective  in  stemming  imports;  and 

(8)  be  inconsistent  with  respect  to  taxing  imports,  the  inconsistency 
being  based  upon  country  of  origin. 

The  reasons  for  these  expectations  are  set  forth  below  under  three 
groupings: 

B.  The  Effect  on  Jobs  and  Competitiveness  is  Too  Negative  to  Justify 
an  Oil  Import  Tax  as  a  Deficit  Reduction  Measure. 

C.  An  Oil  Import  Tax  Has  Been  Tried  In  The  Past  and  Was  a 


D.        A  Tax  or  Tariff  on  Foreign  Oil  Will  Not  Serve  To  Displace  Imports. 

In  connection  with  our  testimony,  we  do  not  intend  to  discuss  the  levels  of 
the  proposed  taxes  or  the  differential  between  the  tax  on  crude  oil  and  refined 
petroleum  products.   We  believe  that,  to  do  so,  would  detract  from  the  point:   no 
additional  tax,  at  any  level,  should  be  enacted.  Whatever  the  rate  in  the  initial 
legislation,  the  amount  could  be  changed  upward  at  any  time.  Therefore,  the  amount 
only  affects  the  degree  of  harm. 

B.        THE  EFFECT  ON  JOBS  AND  COMPETITIVENESS  IS  TOO  NEGATIVE 
TO  JUSTIFY  AN  OIL  IMPORT  TAX  AS  A  DEnCIT  REDUCTION 
MEASURE  aXEMS  A(l)  TO  A(3)). 

Such  a  tax  operates  to  drive  the  price  of  both  foreign  and  domestic  oil 
above  the  world  oil  price.   This  directiy  affects  the  abihty  of  domestic  enterprises  to 
compete  with  foreign  sources,  thereby  reducing  domestic  jobs  and  the  ability  of  domestic 
companies  to  compete  in  both  the  American  marketplace  and  the  world  marketplace. 

There  is  already  a  serious  problem  facing  this  country  with  respect  to  the 
balance  of  trade.   The  Washington  Post  of  June  16,  1993,  reported  that  the  United 
States  is  running  an  even  larger  deficit  in  the  trade  of  goods.   "Foreign  demand  for  U.S. 
products  continued  to  erode,  totalling  $112  billion  in  the  first  quarter,  down  from  $114 
billion  the  previous  quarter.   But  U.S.  imports  of  goods  increased  a  fraction,  to  $140 
billion."   A  headline  in  the  August  20,  1993,  issue  of  The  Washington  Post  reads  "U.S. 
Trade  Deficit  Hit  Six- Year  High  in  June;  White  House  Voices  Fear  Over  Yen's 
Strength". 

A  basic  policy  question  to  ask  is  whether  it  is  prudent  to  affect  adversely 
the  ability  of  American  industry  to  produce  goods  and  to  provide  jobs  in  the  country  by 
adding  still  another  tax  in  the  form  of  an  oil  import  fee? 

I  appear  today  as  a  representative  of  one  segment  of  American  industry,  a 
segment  that  can  be  called  "chemical"  companies.   Chemicals  have  been  more  exported 
than  imported  into  this  country.  This  has  been  a  bright  spot  in  the  balance  of  trade, 
contributing  a  positive  $16.3  biUion  in  1992  and  providing  employment  for  some  1.1 
million  employees.   (Bureau  of  Labor  Statistics,  U.S.  Department  of  Labor, 
"Employment  and  Earnings"  (June  1993).) 

Unfortunately,  the  trend  is  not  good,  due  to  global  competition.    In  1991, 
the  positive  balance  of  trade  was  $18.8  billion.   (U.S.  Bureau  of  Census,  U.S. 
Department  of  Commerce,  "U.S.  Merchandise  Trade,  Jan  1991-  Dec  1992  Final 
Report".)   We  need  no  further  handicaps  to  our  competitiveness. 


1257 


Just  to  nail  down  the  point,  the  Department  of  Commerce  has  noted  that 
"small  price  differentials  of  its  commodity  products  can  determine  whether  it  is  better  to 
produce  or  import  primary  petrochemicals."   (International  Trade  Administration,  U.S. 
Department  of  Commerce,  U.S.  Industrial  Outlook  1993.  "Chemicals  and  Allied 
Products"  at  11-3  (1993).) 

The  Congress  recently  decided  to  raise  revenues  through  a  motor  fuels  tax 
and  not  through  a  BTU  tax.    (Omnibus  Budget  Reconciliation  Act,  Pub.L.  No.  103-66.) 
An  oil  import  tax  has  the  same  basic  effect  as  a  BTU  tax  on  oil  -  it  raises  the  cost  of 
petroleum-based  energy  and  feedstocks  to  residential,  commercial,  electric  utility, 
transportation,  and  industrial  consumers.   Hopefully,  the  issue  will  not  be  revisited. 

Since  we  must  withstand  the  allegations,  obviously  true,  of  being  personally 
interested  in  the  outcome,  we  respectfully  suggest  that  we  share  views  with  a  wide  variety 
of  expert  Government  agencies,  and  we  would  like  to  suggest  review  of  several  studies. 

It  is  appropriate  to  review  what  the  Congressional  Budget  Office  ("CBO") 
found  in  its  April,  1986  Study  entitled  "The  Budgetary  and  Economic  Effects  of  Oil 
Taxes."   Two  particular  passages  are  relevant  to  this  discussion.   First,  there  is 
recognition  that  the  tariff  receipts  as  well  as  the  higher  taxes  collected  from  domestic  oil 
producers  as  a  result  of  higher  prices  "would  be  offset  by  reduced  corporate  profits  and 
personal  incomes  elsewhere,  as  higher  energy  prices  raised  business  costs  and  reduced 
the  income  available  for  consumption  of  other  goods  and  services."   (Congressional 
Budget  Office,  "The  Budgetary  and  Economic  Effects  of  OU  Taxes",  at  17  (1986).^) 

Second,  the  CBO  in  the  same  study,  devoted  a  section  to  the  "Effects  on 
U.S.  Trade  and  Competitiveness"  at  39-42,  a  section  recommended  for  study.  Included 
at  39  is  this  statement: 

Whatever  the  net  effects  of  oil  taxes  on  the  balance  of  trade 
and  exchange  rates,  U.S.  comparative  advantage  in 
international  trade  would  be  likely  to  shift  away  from  those 
industries  that  are  relatively  oil  intensive  or  energy  intensive, 
since  their  foreign  competitors  would  not  be  paying  an  added 
tariff  on  their  energy  or  oil  inputs  [footnote  omitted].   This 
would  force  U.S.  firms  to  reduce  their  output  or  else  accept 
smaller  margins. 

The  CBO  identified  industries  which  it  found  to  be  vulnerable.   These 
included  paper,  particularly  in  New  England  and  the  Middle  Atlantic  States,  the 
chemical  industry  ("[t]he  U.S.  chemical  industry  also  has  substantial  exporte  that  could 
be  placed  at  risk  if  their  prices  rose  substantially",  id  at  41),  and  agricultural  exports. 

The  CBO  is  not  alone  in  reaching  these  conclusions.  The  "National 
Energy  Strategy:   Powerful  Ideas  for  America",  noted  that  measures  such  as  an  oil 
import  fee  would  have  an  adverse  affect.   ("National  Energy  Strategy:   Powerful  Ideas 
for  America"  at  5  (February  1991).)   "But  the  cost  would  be  very  high  -  in  higher  prices 
to  American  consumers,  lost  jobs,  and  less  competitive  U.S.  industries."   Id    (Accord 
U.S.  Department  of  Energy,  "Energy  Security:   A  Report  to  the  President  of  the  United 
States"  (March  1987).) 

The  Bureau  of  Economics  Staff  Report  to  the  Federal  Trade  Commission, 
puts  it  this  way:  "The  costs  of  using  a  tariff  on  oil  imports  to  raise  revenue  appear  to  be 
quite  high.  At  a  minimum,  the  figures  suggest  that  serious  consideration  should  be  given 
to  finding  a  less-costly  alternative  before  such  a  policy  is  adopted."   (Keith  B.  Anderson 


'For  the  sake  of  completeness,  the  CBO  Ubles  indicate  a  conchision  that  the  tariff  plus  the  corporate 
income  and  windfall  profit  taxes  collected  from  domestic  oil  consumers  as  a  result  of  the  tariff  would  be 
greater  than  the  loss  of  revenue  in  the  consuming  sector  and  residential  sector,  a  conclusion  noted  to  be 
inconsistent  with  that  of  DRI  in  the  Congressional  Research  Service's  report  entitled  "Oil  Import  Tax; 
Some  General  Economic  Effects",  CRS  Report  for  Congress  No.  87-259  E  (1987). 


1258 


&  Michael  R.  Metzger,  Bureau  of  Economics,  Federal  Trade  Commission,  "A  Critical 
Evaluation  of  Petroleum  Import  Tariffs:  Analytical  and  Historical  Perspectives",  at  52 
(April  1987).)   In  sum,  the  cost  to  consumers  and  the  cost  to  the  economy  are  found  to 
be  greater  than  the  tariff  revenue  raised. 

Please  also  consider  the  March  1987  report  of  the  Congressional  Research 
Service  of  the  Library  of  Congress  entitled  "Oil  Import  Tax:   Some  General  Economic 
Effects"  at  3  stating: 

An  oil  import  tax  would  reduce  the  Federal  Government 
budget  deficit  by  less  than  a  naive  calculation  would  indicate. 
Lx»wer  economic  activity  would  cut  Government  tax  revenues; 
and  higher  prices  would  increase  transfer  payments  with  cost- 
of-living  adjustments  and  Government  ouUays  for  suppUes. 
Higher  prices  would  also  raise  Government  receipts  —  by 
more  than  the  outlays  are  boosted,  but  not  enough  to  offset 
the  effect  of  lower  GNP. 

Further,  "[a]n  oil  import  tax  initially  would  tend  to  worsen  the  competitive 
position  of  certain  U.S.  industries.   Energy  costs  of  domestic  energy-intensive  indus- 
tries ~  such  as  petrochemicals,  paper,  and  primary  metals  -  would  tend  to  increase, 
while  relatively  lower  oil  prices  abroad  would  lower  production  costs  of  competing 
foreign  industries."   Id  at  7. 

Even  avid  proponents  of  an  oil  import  fee  concede  the  impact  on 
competitiveness.  The  Energy  and  Environmental  Policy  Center  at  Harvard  University, 
acknowledges  that  an  oil  import  fee  will  destroy  the  ability  of  domestic  petrochemical 
companies  to  compete  in  both  domestic  and  world  markets.   (William  W.  Hogan  & 
Bijan  Mossanar-Rahmani,  Harvard  International  Energy  Studies.  "Energy  Security 
Revisited",  (published  by  the  Energy  &  Environments  Policy  Center,  Harvard  University 
(1987).)  The  suggestion  is  either  that  we  simply  go  out  of  business  in  favor  of  foreign 
sources  or  that  we  seek  government  subsidies  in  order  to  remain  in  business.   Neither  is 
an  attractive  option  to  us.   We  hope  that  neither  driving  energy  intensive  manufacturers 
out  of  business  nor  subsidizing  them  is  an  attractive  option  to  the  Congress  either, 
particularly  for  those  industries  who  now  manage  to  compete  successfully  in  world 
markets  and  earn  a  favorable  balance  of  trade  for  this  nation. 

Therefore,  we  respectfully  suggest  that  the  costs  of  an  oil  import  tax  are 
too  high,  and  the  tax  on  imported  oil  and  refined  petroleum  products  should  not  be 
adopted. 

C.        AN  OIL  IMPORT  TAX  HAS  BEEN  TRIED  IN  THE  PAST  AND  WAS  A 
DISASTER  (ITEMS  A(4)  AND  (S)). 

The  concept  has  been  tried  in  the  past  and  abandoned.  Oil  import  quotas, 
fees,  tariffs  or  taxes  did  not  work.   The  disruptions  to  the  economy  were  both  real  and 
intense.  The  program,  in  any  form,  should  not  be  revived.   Once  should  be  enough. 

The  oil  import  quota,  fee,  or  tax  was  imposed  in  this  country  in  one  form 
or  another  from  1958  until  1981.    (Exec.  Order  No.  12,287,  3  C.F.R.  124  (1981),  reprinted 
in  46  Fed.  Reg.  9909.  (1981).)     Now,  even  twelve  years  later,  the  complexities  and  the 
litigation  arising  out  of  that  entire  scheme  have  still  not  been  resolved.   (Final  Filing 
Deadline  in  Special  Refund  Proceeding  Involving  Crude  Oil  Overcharge  Refunds,  58 
Fed.  Reg.  26,318-26,319  (1993).) 

In  brief  summary,  from  1958  until  the  early  1970's,  a  "quota"  system  was 
imposed  on  grounds  of  national  security.   This  was  called  the  "Mandatory  Oil  Import 
Program",  or  MOIP.   At  the  time,  the  U.S.  had  the  ability  to  supply  all  the  oil  that  this 
country  needed  as  well  as  to  meet  the  needs  of  foreign  countries  in  times  of  crisis.   The 
basic  thought  was  that  foreign  oil,  being  cheaper  following  World  War  II,  would  displace 
too  much  domestic  production  and,  thus,  had  to  be  limited. 


1259 


The  program  started  out  as  a  system  whereby  imports  of  foreign  oil  and 
foreign  refined  products  were  "licensed"  for  import,  sometimes  called  "tickets".   Since,  at 
the  time,  foreign  oil  was  perceived  to  be  "cheaper"  than  domestic  oil,  the  ability  to 
import  provided  a  profit  opportunity  represented  by  the  difference  between  the  price  of 
a  domestic  barrel  and  the  price  of  a  foreign  barrel.   Companies  who  had  "tickets" 
allocated  to  them  by  the  Federal  Govenmient  thus  gained  a  competitive  advantage  over 
those  who  did  not  get  an  allocation  of  "tickets"  from  the  Federal  Government. 

Needless  to  say,  before  a  decade  was  over,  legislative  and  administrative 
battles  were  fought  for  exemptions  from  the  quotas  for  certain  regions  and  the  "tickets" 
were  distributed  to  refiners  and  petrochemical  companies  in  ways  that  the  Government 
thought  achieved  economic  equity.   (See  Cabinet  Task  Force  on  Oil  Import  Control, 
"The  Oil  Import  Question:   A  Report  on  the  Relationship  of  Oil  Imports  to  the  National 
Security",  (February  1970).) 

The  Petrochemical  Energy  Group  came  into  existence  in  1972  for  the 
purpose  of  seeking  equity  between  independent  petrochemical  companies  and  the 
petrochemical  arms  of  major  refiners,  who  were  allocated  "tickets." 

The  second  phase  started  in  the  early  1970s,  not  uncoincidentally  about  the 
time  that  the  Texas  Railroad  Commission  and  the  other  producing  states  went  to  100% 
allowables,  or  the  equivalent  thereof,  for  their  programs  for  prorationing  the  production 
of  oil.   To  OPEC  or  elements  thereof,  this  was  the  signal  that  the  U.S.  had  not  only  lost 
its  ability  to  send  oil  to  Europe  in  times  of  crisis,  such  as  the  brief  war  over  the  Suez 
Canal,  but  that  the  U.S  was  no  longer  self  sufficient.   It  may  be  better  to  express  this 
point  in  the  exact  words  of  the  Congress  of  the  United  States  in  the  Emergency 
Petroleum  Allocation  Act  of  1973: 

Sec.2(a)  The  Congress  hereby  determines  that  - 

(1)  shortages  of  crude  oil,  residual  fuel  oil,  and  refined 
petroleum  products  caused  by  inadequate  domestic 
production,  environmental  constraints,  and  the  unavailability 
of  imports  sufficient  to  satisfy  domestic  demand,  now  exist  or 
are  imminent. 

The  rest,  as  they  say,  is  history.  The  quota  system  did  not  maintain  and 
protect  domestic  production  capability  so  that  the  U.S.  could  be  self-sufficient  in  oil. 
Imports  became  a  practical  necessity  over  twenty  years  ago. 

At  least  two  major  embargoes  of  exports  to  the  United  States  took  place  in 
the  1970s,  together  with  rapidly  escalating  oil  prices,  led  by  the  prices  from  abroad.  (See 
Daniel  Yergin,  The  Prize:   The  Epic  Ouest  for  Oil,  Money,  and  Power  (1992).) 

A  quota,  of  course,  became  obsolete,  and  the  "fee"  (another  word  for  tax 
or  tariff)  on  imported  oil  was  substituted.    Not  only  did  an  oil  import  fee  come  into 
existence,  but  the  regulatory  bureaucracy  needed  to  manage  the  MOIP  had  to  be 
expanded  in  order  to  take  over  the  allocation  and  pricing  of  domestic  oil  as  well  as  to 
allocate  subsidies  and  the  like.   A  new  feature  was  added:   a  Windfall  Profit  Tax  on 
domestic  oil.   These  two  features  will  be  discussed  immediately  below. 

First,  there  was  the  enlargement  of  an  even  more  elaborate  regulatory 
scheme,  far  eclipsing  that  under  the  quota  system.   This  included  agencies  for  allocating 
and  pricing  both  domestic  and  foreign  oil  and  refined  petroleum  products.   While  the 
degree  of  regulation  varied  over  the  next  decade,  at  its  zenith  the  effort  was  made  by  the 
federal  government  to  equalize  the  cost  of  all  domestic  oil  and  all  imports  as  well  as  to 
provide  subsidies  to  those  enterprises  thought  deserving  of  subsidy.    Rather  than 
"tickets",  these  were  called  "entitlements."   Entitlements  were  exchanged  for  cash.   The 
Department  of  Energy's  current  Secretary  --  the  Honorable  Hazel  O'Leary  ~  was,  in  her 


1260 


prior  Government  service,  in  charge  of  this  elaborate  bureaucracy.'  Such  a  bureaucracy 
lies  dormant  at  the  DOE,  with  ration  books  and  allocation  schedules  ready  to  go,  once 
the  Government  sets  a  differentia]  between  foreign  and  domestic  oil  and  the  scramble  is 
on  to  evade  the  tax,  to  profit  from  the  tax,  or  to  minimize  the  competitive  harm  in  the 
tax.   See  10  C.F.R.  §  211,  App.  A  (1993). 

Second,  there  was  a  Windfall  Profit  Tax.   (Crude  Oil  Windfall  Profit  Tax 
Act  of  1980,  Pub.L.  No.  96-223,  94  Stat  229  (April  2,  1980)(repealed  1988).)   In  essence, 
this  tax  sought  to  divert  to  the  Treasury  some  of  the  price  increases  for  domestic  oil  and 
product  which  were  made  possible  by  the  higher  foreign  prices  plus  the  oil  import  tax, 
acting  as  a  tariff  barrier.   (The  Btu  tax,  included  in  the  House-passed  version  of  the 
Omnibus  Budget  Reconciliation  Bill  of  1993,  had  the  same  basic  effect  as  a  Windfall 
Profit  Tax  in  that  it  was  applicable  both  to  domestic  and  to  foreign  oil.) 

In  net  effect,  the  two  phases  were  remarkably  similar,  as  stated  in  a  Report 
of  the  Department  of  Energy  entitled  "The  Effect  of  Legislative  and  Regulatory  Actions 
on  Competition  in  Petroleum  Markets."  The  following  statement  sums  it  up: 

Domestic  oil  prices,  now  regulated  by  formal  price  controls, 
were  previously  regulated  (in  effect)  through  state  pro- 
rationing  laws  and  oil  impori  quotas.  The  cost  equalizations 
among  refiners  made  possible  by  the  Entitlements  Program 
exhibited  similar  tendencies  under  the  quota  tickets  of  the 
Mandatory  Oil  Import  Program.  The  same  groups  which 
received  special  benefits  under  pre-Embargo  regulations  now 
receive  those  benefits  under  new  regulations;  small  refiners, 
importers  of  residual  fuel  oil  into  the  East  Coast,  and  PADD 
V  refiners  all  receive  special  consideration  under  the 
Entitlements  Program  similar  to  that  received  under  the 
MOIP.   The  only  change  in  the  focus  of  the  regulations 
appears  to  be  the  direction  of  price  controls.  Whereas 
before  the  Embargo,  domestic  oil  prices  were  supported  at  a 
higher  level  than  would  have  been  obtained  by  market  forces, 
the  current  regulations  maintain  them  at  a  lower  level  than 
the  "free"  market  price. 

("The  Effect  of  Legislative  and  Regulatory  Actions",  supra  note  3,  at  59.) 

The  last  sentence  in  the  above  quote  sums  up  the  basic  question:  is  the 
effect,  if  not  purpose,  of  the  tax  to  drive  domestic  prices  up  or  to  hold  them  down?   If 
there  is  a  differential  in  tax  between  foreign  and  domestic  oil  as  a  result  of  the  tariff, 
who  gets  the  benefit  of  the  differential?  Who  administers  it?   Will  all  or  some  of  the 
differential  be  taken  in  taxes  on  domestic  oil  or  not  -  e.g..  the  revival  of  the  Windfall 
Profit  Tax?   Are  there  those  who  should  be  sheltered  or  subsidized  by  means  of  the 
taxes?   Should  those  who  live  in  States  where  the  imports  arrive  pay  all  of  the  tariff  or 
should  some  method  be  devised  to  spread  the  tariff  to  other  regions?  Or  should  the 
States,  such  as  those  on  the  Eastern  Seaboard,  be  exempted  from  the  import  tax  and  the 
tax  rerouted  to  other  regions? 


'Some  recommended  sources  for  further  study  are  Reserves  and  Natural  Gas  Division  Office  of 
Oil  and  Gas,  U.S.  Department  of  Energy,  "A  Chronology  of  Major  Oil  and  Gas  Regulations  Issued 
Through  October  1985",  D0E/EIA-M016  (1986);  Energy  Information  Agency,  U.S.  Department  of 
Energy,  "The  Impact  of  the  Entitlements  Program  on  the  Market  for  Residual  Fuel  Oil  on  the  East  Coast" 
DOE/EIA  0184/29  (February  1980);  Energy  Information  Agency,  U.S.  Department  of  Energy,  "The  Effect 
of  Legislative  and  Regulatory  Actions  on  Competition  in  Petroleum  Markets",  DOE/ElA-0201/2  (October 
1979);  Energy  Information  Agency,  U.S.  Department  of  Energy,  "EffecU  of  Oil  Regulation  on  Prices  and 
Quantities:  A  Qualitative  Analysis",  DOE/EIA-0201/1  (October  1979);  Energy  Information  Agency,  U.S. 
Department  of  Energy,  "Effects  of  Oil  Regulation  on  Prices  and  Quantities:  A  QualiUtive  Analysis", 
DOE/EIA-0184/3  (May  1979);  Energy  Information  Agency,  U.S.  Department  of  Energy,  "The  Effect  of 
Legislative  and  Regulatory  Actions  on  Competition  in  Petroleum  Markets",  DOE/EIA-0 187/7  (April  1979); 
Energy  Information  Agency,  U.S.  Department  of  Energy,  "Proposed  Amendments  to  the  Entitlements 
Program  with  Respect  to  Imported  Residual  Fuel  Oil",  DOE/ElA-0102/30  (July  1978). 


1261 


These  are  some  of  the  issues  that  arise  whenever  an  oil  import  fee,  tax,  or 
quota  is  considered.   These  and  other  issues  are  thoroughly  explored  in  "A  Critical 
Evaluation  of  Petroleum  Import  Tariffs:  Analytical  and  Historical  Perspectives",  Bureau 
of  Economics  Staff  Report  to  the  Federal  Trade  Commission  (April  1987).   Particularly 
recommended  for  review  is  the  Conclusion  on  page  31,  wherein  the  inevitability  of 
appealing  to  the  political  process  for  "special  deals"  is  discussed,  since  "substantial 
economic  benefits  would  accrue  to  parties  who  obtained  exemptions  from  a  tariff  that 
allow  them  to  import  without  restrictions.   Such  special  deals  could  take  the  form  of 
exemptions  for  certain  products,  for  products  imported  from  certain  countries,  or  just  for 
imports  by  certain  firms."   Furthermore,  page  56  of  the  same  report  states: 

In  the  course  of  designing  and  implementing  a  tariff,  various 
parties  will  seek,  and  likely  obtain,  special  exemptions.  Such 
exemptions,  whether  for  certain  products,  firms,  or  countries 
exporting  to  the  United  States,  would  be  particularly  valuable 
to  the  favored  groups.   However,  tariff  revenues  would 
probably  be  reduced  as  a  result,  and  administrative  costs 
would  likely  be  increased.   Moreover,  many  of  these  special 
exemptions  would  encourage  inefficient  U.S.  production  of 
refined  petroleum  products  and  of  other  products.   As  a 
result,  the  U.S.  would  become  less  competitive  in  world 
markets.   All  of  the  above  points  suggest  that  the  social  costs 
of  a  tariff  would  be  greater  than  our  estimates.   Similar  costs 
are  likely  if  other  policies  are  used  to  aid  the  oil  industry. 

The  oil  import  fee,  or  tax,  or  tariff,  or  quota  died  a  natural  and  welcome 
death  over  a  decade  ago.  Please  let  it  rest  in  peace. 

If  it  is  to  be  revived,  please  then  provide  for  sufficient  exemptions  to 
maintain  parity  of  the  domestic  manufacturing  industry  with  foreign-based  manufacturing 
industry  and  please  maintain  parity  among  the  domestic  manufacturers  so  that  the 
Government  does  not  give  a  competitive  advantage  to  one  segment  over  another. 

Also,  please  set  standards  for  the  bureaucracy  which  will  be  needed  to 
administer  the  program.   Please  assure  that  all  who  ask  to  be  heard  on  the  question  of 
allocations  and  exemptions  -  and  their  adversaries  or  competitors  ~  be  given  a  fair  and 
expeditious  hearing.  The  federal  agency  which  will  be  given  responsibility  for 
administering  the  program  should  be  clearly  identified  fiom  the  start 

D.        A  TAX  OR  TARIFF  ON  FOREIGN  OIL  WILL  NOT  SERVE  TO 
DISPLACE  IMPORTS  GTEMS  A(6)  TO  A(8)). 

This  country,  years  ago,  elected  to  utilize  a  Strategic  Petroleum  Reserve 
("SPR")  as  the  primary  means  of  dealing  with  supply  disruptions.  The  SPR  deals  with 
the  situation  where  foreign  sources  choose  to  cut  off  exports  to  the  United  States.   The 
tax  or  tariff  deals  with  the  situation  where  imports  are  being  discouraged  and, 
presumably,  domestic  sources  gain  the  protection  of  a  tariff  barrier  and  can  raise  prices 
on  current  and  future  production.  The  question  is:  what  can  reasonably  be  expected  as 
a  result? 

For  purposes  of  this  section,  we  assume  the  following  scenario:  there  will 
only  be  a  tax  on  imported  oil  and  imported  refined  petroleum  products;  that  there  will 
be  no  price  controls  imposed  on  domestic  oil  or  product;  that  there  will  be  no  Windfall 
Profit  Tax  imposed  on  the  domestic  production;  that  the  tax  will  act  as  a  tariff  barrier 
allowing  all  domestic  prices  to  rise  at  least  to  the  level  of  the  tariff;  and  that  all  of  this 
differential  is  retained  by  the  producers  and  refiners  of  oil. 


1262 


The  first  expectation  that  should  be  considered  is  that  of  regional  fairness. 
It  probably  can  be  taken  as  a  given  that  consuming  States,  particularly  those  along  the 
Eastern  Seaboard,  would  bear  the  brunt  of  an  oil  import  tax.   The  expectation  might  be 
that  producing  states  would  be  the  beneficiaries  of  an  oil  import  fee,  but  this  expectation 
cannot  be  taken  as  a  given.   It  has  been  tested. 

If  there  is  any  State  in  the  Union  which  could  be  expected  to  benefit  from 
the  scenario  stated  above,  it  is  the  State  of  Texas,  a  State  near  and  dear  to  the  hearts,  as 
well  as  the  location  of  plants  of  many  petrochemical  companies.   However,  "an  oil 
import  fee  is  not  likely  to  have  a  significant  impact  on  the  state's  economy."   (Texas 
Economic  Outlook.  "How  Would  an  Oil  Import  Fee  Impact  the  Texas  Economy", 
published  by  the  Center  for  Business  and  Economic  Analysis,  Graduate  School  of 
Business,  Texas  A  &  M  University,  at  5  (February  1992).)  That  quotation  was 
summarizing  the  conclusion  of  the  study  "Impacts  of  Oil  Import  Fees  on  the  Texas 
Economy,"  conducted  at  the  same  institution,  by  Dr.  M.A.M.  Anari,  Research 
Economist,  and  Dr.  Jared  E.  Hazelton,  Director. 

If  there  will  not  be  a  significant  impact  on  the  economy  of  a  producing 
State  as  key  as  Texas,  where  and  how  will  there  be  an  effect?   The  next  expectation  is 
that  an  oil  import  fee  would  be  beneficial  to  the  domestic  oil  industry  and,  therefore,  to 
this  country  by  fostering  a  significant  increase  in  exploration  and  development  of  new  oil 
reserves.   The  objective  then,  of  an  oil  import  tax,  would  be  to  foster  a  significant 
increase  in  exploration  and  development  of  new  oil  reserves. 

PEG  will  yield  to  none  in  associating  with  the  view  that  it  is  extremely 
important  that  there  be  a  healthy  and  viable  domestic  oil  and  gas  industry  and  that 
encouragement  for  exploration  and  development  of  new  oil  reserves  is  indeed  important 
Therefore,  any  possible  "stimulus'  for  exploration  and  development  should  be  carefully 
considered. 

The  question  is,  is  a  tariff  on  imported  oil  an  effective  answer  to  the  need 
for  exploration  and  development  of  new  domestic  oil  and  gas  reserves? 

We  think  not.   The  problem  involving  exploration  and  production  of  new 
oil  reserves  is  not  going  to  be  solved  or  even  addressed  by  a  tariff  on  imported  oil  or  any 
indirect  subsidy  to  some  or  all  domestic  oil  production  and  refining.  What  is  needed  is 
access  to  promising  new  sources  of  domestic  supply  for  the  purpose  of  exploration  and 
production.   The  problem  is  caused  by  the  fact  that  it  is  the  national  policy  of  this 
country  to  deny  access  to  promising  new  sources  of  domestic  supply. 

Perhaps  the  best  way  to  demonstrate  this  last  point  is  to  quote  from  the 
Report  to  Stockholders  of  the  Chevron  Corporation  for  the  First  Quarter  of  1993.   The 
headline  on  page  five  and  the  first  two  paragraphs  are  quoted: 

CHEVRON  IS  SHIFTING  EXPLORATION  AND 
PRODUCTION  EFFORTS  OVERSEAS. 

Chevron  is  shifting  its  exploration  and  production  emphasis 
to  areas  with  the  strongest  potential  for  large  discoveries 
and  cost-effective  production.  Vice  Chairman  Dennis  Bonney 
told  stockholders. 

"Most  of  the  new  opportunities  lie  outside  the  United  States," 
he  explained.   This  is  partly  because  most  of  the  world's 
"truly  attractive  untapped  petroleum  reserves  are  overseas." 
Also,  "many  U.S.  Regions  with  high  potential  have  been 
placed  out  of  the  industry's  reach  by  government  actions." 


1263 


The  Office  of  Technology  Assessment  ("OTA"),  an  ann  of  the  Congress,  in 
its  October  1991  summary  "U.S.  Oil  Import  Vulnerability:  The  Technical  Replacement 
Capability"  at  17,  indicates  a  similar  conclusion: 

The  scarcity  of  new  opportunities  for  finding  large  new  oil 
fields  within  the  mature  oil  regions  of  the  lower  48  States  has 
created  pressure  for  the  Federal  Government  to  open  to 
exploratory  drilling  and  development  a  number  of  promising 
areas  currently  off-limits  to  such  activities,  such  as  the  Arctic 
National  Wildlife  Refuge  (ANWR),  offshore  California,  and 
other  frontier  areas. 

The  OTA  notes  on  that  same  page  that  DOI  has  estimated  that  ANWR 
has  a  46%  chance  of  recovering  3.6  billion  barrels  --  "a  potential  resource  equivalent  to 
the  third  largest  discovery  in  U.S.  territory  and  one  that,  for  a  few  decades,  could  deliver 
several  hundred  thousand  barrels  of  crude  oil  per  day  to  the  lower  48  States."   Id. 
(footnote  omitted). 

These  statements  by  a  major  oil  company  and  the  OTA,  we  fear,  reflect  all 
too  well  the  current  situation.   This  nation  cannot  expect  to  maintain  its  ability  to 
produce  and  to  refine  domestic  oil  even  at  current  levels  if  access  to  the  resource  bases 
are  denied  by  the  Federal  Government. 

We  recognize  that  this  is  an  unpopular  subject.   We  know  full  well  that  the 
National  Energy  Strategy  called  for  "environmentally  responsible  development  of 
promising  areas  like  ANWR  and  OCS."  (National  Energy  Strategy,  supra,  at  3.)   We  are 
aware  that  legislation  to  achieve  that  result  died  on  the  floor  of  the  Senate  and  did  not 
make  it  to  the  Energy  Policy  Act  of  1992.   (137  Cong.  Rec.  S15,754  (daily  ed.  Nov.  1, 
1991)(Rollcall  Vote  No.  242,  failure  to  invoke  cloture  on  motion  to  proceed  to 
consideration  of  S.  1220,  National  Energy  Security  Act  of  1991).)  To  us,  the  conclusion 
to  reach  is  that  the  Congress  is  not  presently  prepared  to  address  issues  related  to  access 
to  the  resource  base  for  new  domestic  oil  reserves.   Whether  that  is  good  or  bad  public 
policy  makes  no  difference  here.   It  is  the  fact. 

The  inescapable  corollary  is  that  higher  and  higher  percentages  of  oil 
imports  must  be  accepted.   Without  a  significant  increase  in  access  to  potential  reserves 
in  this  country  for  the  purposes  of  exploration  and  production,  imports  are  bound  to 
increase  in  volume,  and  the  question  is  not  whether,  but  where,  the  imports  come  from. 
Taxing  the  imports  only  adds  to  the  cost. 

As  Section  B  demonstrates,  an  oil  import  fee  is  a  poor  source  of  revenues. 
Section  B  assumes,  arguendo,  that  an  import  tax  will  be  collected  on  all  foreign  oil  and 
all  foreign  refined  petroleum  products.   This  assumption  is  extremely  unlikely  to  be 
achieved  in  practice,  thereby  both  reducing  anticipated  tax  revenues  and  increasing 
administrative  costs  to  the  Government  and  extraneous  costs  to  the  economy.   The 
expectation  would  be  that  some  countries'  exports  to  the  United  States  would  be 
exempted  from  the  tax. 

Where  the  imports  come  from  raises  this  thorny  issue  for  those  who  would 
impose  a  tax  on  imports:  would  any  foreign  source  be  exempt?   Canada,  for  example, 
under  the  Free  Trade  Agreement?   What  about  the  other  countries  who  now  provide  oil 
to  the  United  States?   According  to  the  EIA,  some  32  countries  other  than  Canada  have 
exported  to  the  United  States  continually  or  from  time  to  time  over  the  last  twenty 
years.    (Office  of  Energy  Markets  and  End  Use,  U.S.  Department  of  Energy,  Monthly 
Energy  Review.  Tables  3.3(a-h),  DOE/EIA-0035(93/07)(July  1993).)   Would  the 
Congress  exempt  any  foreign  source  from  an  import  tax?   Or  would  that  be  a  decision 
for  the  Administration  to  make? 


1264 


The  GAO,  in  its  1986  Report  entitled  "Petroleum  Products,  Effect  of 
Imports  on  U.S.  Oil  Refineries  and  U.S.  Energy  Security",  had  this  admonition: 

Possible  side  effects  should  also  be  considered  in  weighing 
the  desirability  of  tariffs  or  quotas.   One  such  side  effect  is 
the  potential  for  retaliatory  trade  measures  by  other  nations 
in  response  to  U.S.  tariffs  or  quotas.    For  example,  product- 
exporting  nations  could  establish  restrictions  on  purchases  of 
U.S.  products,  or  reduce  cooperation  with  the  United  States 
in  other  areas.    In  addition,  other  product-importing  nations, 
principally  members  of  the  European  Economic  Community 
and  Japan,  may  respond  to  U.S.  trade  restrictions  with 
restrictions  of  their  own.   As  we  noted  in  chapter  3,  Japanese 
government  officials  have  indicated  a  possible  relaxation  of 
its  ban  on  imports  of  gasoline  and  other  products,  and  the 
Conmiunity  presently  does  not  enforce  trade  restrictions 
against  Saudi  Arabia,  Kuwait,  and  other  major  product- 
exporting  nations.   Retaliatory  measures  by  these  countries  to 
restore  or  augment  trade  barriers  could  undermine  the 
effectiveness  of  the  U.S.  trade  restrictions. 

(General  Accounting  Office,  "Petroleum  Products,  Effect  of  Imports  on  U.S.  Oil 
Refineries  and  U.S.  Energy  Security",  GAO/RCED-86-85  at  63  (April  1986).) 

In  sum,  imposing  an  oil  import  tax  is  not  going  to  do  anything  to  increase 
access  to  the  most  promising  potential  new  reserves  of  oil.   If  the  State  of  Texas  is  a 
good  representative  of  a  producing  state,  an  oil  import  tax  will  not  do  much  regional 
good  while  harm  to  other  regions  is  manifest.   A  host  of  international  trade  and  other 
considerations  come  into  play  if  the  tax  is  imposed  on  some  countries  but  not  on  others. 
To  the  extent  that  country  of  origin  exemptions  are  given,  tax  revenues  are  reduced  and 
the  regulatory  mechanism  must  police  the  imports  to  be  sure  that  the  'country  of  origin" 
is  not  simply  a  paper  transfer  on  the  high  seas,  with  delivery  by  displacement. 

E.         CONCLUSION 

We  respectfully  suggest  that  we  have  demonstrated  that: 

•  An  oil  import  tax  is  a  poor  way  to  raise  revenues,  the  ultimate  cost 
in  jobs,  in  competitiveness,  in  other  government  outlays,  far  exceeding  any  benefit. 

•  The  failures  of  the  past  efforts  to  use  a  tax  on  imported  oil,  ranging 
from  regulation  of  domestic  oil.  Windfall  Profit  Taxes,  and  a  bureaucracy  allocating 
competitive  advantages  and  trying  to  achieve  regional  equity  in  prices  of  oil,  should  not 
again  be  visited  on  the  American  people. 

•  An  oil  import  tax  will  not  address  the  problem  of  access  to  new 
sources  of  domestic  oil  and  will  induce  problems  with  foreign  sources,  particularly  if 
there  is  selective  or  discriminatory  application. 

The  recommended  solution  is  to  refrain  from  imposing  any  tax  on 
imported  oil  or  refined  petroleum  products. 


1265 

Mr.  Payne.  Our  next  witnesses  will  testify  concerning  the  sever- 
ance tax  on  hard  rock  minerals.  Representing  the  Mineral  Re- 
sources Alliance  and  the  American  Iron  Ore  Association  are  Steve 
Alfers,  counsel,  and  John  Kelly,  tax  counsel  for  the  American  Iron 
Ore  Association. 

Please  proceed. 

STATEMENT  OF  STEPHEN  D.  ALFERS,  COUNSEL,  MINERAL 
RESOURCES  ALLIANCE 

Mr.  Alfers.  Thank  you,  Mr.  Chairman.  I  am  Steve  Alfers,  a 
partner  in  the  law  firm  of  Morrison  &  Foerster  from  Denver,  Colo. 
I  appreciate  the  opportunity  to  be  here  today  on  behalf  of  the  Min- 
eral Resources  Alliance,  an  association  of  more  than  1,000  mining 
companies,  vendors  and  their  supporters. 

I  nave  submitted  to  the  committee  a  written  statement  and  I 
would  refer  the  committee  to  that  statement.  My  comments  here 
today  will  be  brief. 

We  oppose  the  severance  tax  proposal.  We  think  it  has  four  very 
serious  problems.  First,  the  proposal  does  not  define  either  a  meth- 
od of  calculation  or  the  basis  of  the  severance  tax.  The  proposal 
calls  for  a  12  percent  tax  on  hard  rock  minerals,  but  does  not  speci- 
fy what  minerals  are  to  be  taxed,  the  basis  upon  which  the  tax 
would  be  calculated  or  whether  the  taxes  be  levied  on  minerals 
from  public  lands,  private  lands  or  both. 

We  can't  tell  whether  the  tax  would  be  limited  to  metals  or  also 
include  nonmetallic  minerals,  industrial  minerals  such  as  talc  and 
some  of  the  strategic  minerals,  the  rare  earths,  or  even  ferrous 
metals.  No  data  has  been  assembled  to  determine  the  revenue  im- 
pacts of  the  tax.  No  detailed  financial  or  economic  analysis  of  the 
proposed  tax  exists  from  which  an  accurate  projection  of  revenues 
could  be  determined.  Revenue  projections  would  be  guess  work. 

Congress  should  not  consider  this  new  tax  without  first  conduct- 
ing a  study  to  determine  the  revenue  impact  of  the  tax.  It  is  impos- 
sible to  predict  the  impact  of  the  proposed  severance  tax  without 
applying  that  tax  to  real  numbers  from  real  existing  hard-rock 
mining  projects.  Short-term  economic  analysis  is  especially  mis- 
leading in  the  mining  industry. 

Economic  projections  should  be  based  on  long-term  economic 
analysis  and  the  models  should  incorporate  actual  financial  and 
production  data  from  U.S.  mining  operations  covering  a  variety  of 
metallic  and  nonmetallic  mineral  deposits.  Producing  gold  is  not 
like  producing  lead  or  uranium  or  copper  or  zinc  or  beryllium  or 
other  industrial  minerals  or  almost  any  other  mineral,  and  it  is  a 
mistake  to  try  to  project  economic  impacts  based  on  anecdotal  in- 
formation about  a  single  metal  or  a  single  gold  mine. 

Finally,  based  on  economic  studies  of  the  U.S.  mining  industry, 
it  is  likely  that  the  net  Federal  impact  would  be  negative. 

A  recent  study  by  Coopers  &  Lybrand  and  Morrison  &  Foerster 
showed  that  a  Federal  royalty  on  hard  rock  minerals  had  a  nega- 
tive economic  impact  and  high  Federal  royalties  in  the  range  of  8 
to  12  percent  had  a  negative  impact  on  the  Federal  Treasury. 

Severance  tax  on  minerals  in  public  lands  would  have  a  similar 
impact  and  a  severance  tax  that  would  extend  to  minerals  on  pub- 
lic and  private  lands  would  have  a  greater  impact.  This  could  be 


1266 

translated  to  jobs.  Some  mines  would  close.  Other  mines  would 
downsize  and  contract  their  operations,  shorten  their  mine  lines, 
throw  off  employees. 

Perhaps  the  biggest  economic  impact  would  be  from  mine  con- 
struction projects  on  the  drawing  board  that  would  no  longer  go 
forward.  These  would  just  simply  drop  off.  That  would  mean  loss 
of  jobs  and  tax  revenues  and  loss  of  exports.  We  can  calculate  that. 
What  we  can't  calculate  is  the  fact  that  many  mines  would  never 
be  discovered,  because  the  exploration  dollars  would  migrate  over- 
seas at  the  bleak  economics  prospects  here. 

We  continue  to  need  the  gold  and  silver  and  copper  and  lead  and 
zinc  and  beryllium,  platinum,  chrome,  uranium,  and  many  other 
commodities,  some  of  which  we  haven't  even  discovered  yet.  That 
loss  is  incalculable.  Since  1989,  Congress  has  been  considering  re- 
form of  the  general  mining  law  governing  mining  on  public  lands 
in  the  United  States.  A  bill  reforming  me  mining  law  has  now 
passed  the  Senate  and  action  is  expected  in  the  House  this  year, 
perhaps  next  month.  Both  bills  substantially  reform  the  mining 
laws. 

New  mining  fees  and  royalty  on  production  are  part  of  both  bills. 
These  fees  and  royalties  portend  an  enormous  impact  on  mining. 
In  anticipation  of  these  bills,  industry  has  already  reduced  its  hold- 
ing of  mining  claims  in  the  United  States  by  one  half  Some 
sources  expect  a  decline  in  holding  of  mining  claims  by  up  to  80 
percent. 

U.S.  exploration  dollars,  a  clear  signal  of  whether  production  will 
come  in  the  future,  are  already  migrating  overseas.  This  is  not  the 
time  to  entertain  new  taxes  on  the  mining  industry.  A  wiser  course 
is  to  let  mining  law  reform  play  out  over  these  next  few  weeks. 
Then  Congress  can  watch  carefully  over  the  next  few  years  the  eco- 
nomic impact  of  mining  law  reforms  before  considering  new  taxes 
on  this  beleaguered  industry. 

Thank  you,  Mr.  Chairman. 

[The  prepared  statement  follows:] 


1267 


HEARING  ON  MINERAL  SEVERANCE  TAX  ISSXTES 

BEFORE  THE 

SX7BC0MMITTEE  ON  SELECT  REVENCTE  MEASURES 

COMMITTEE  ON  NAYS  AND  MEANS 

U.S.  HOUSE  OF  REPRESENTATIVES 

WRITTEN  STATEMENT 

OF 

STEPHEN  D.  ALFERS 

ON  BEHALF  OF 

THE  MINERAL  RESOURCES  ALLIANCE 

SEPTEMBER  8,  1993 


On  August  17,  1993,  the  Honoraibie  Charles  B.  Rangel 
announced  hearings  to  be  held  before  the  Subcommittee  on 
Select  Revenue  Measures  of  the  House  Ways  and  Means 
Committee  on  September  8th  and  September  14th.   I  appreciate 
the  opportunity  to  offer  testimony  on  September  8,  1993  on 
the  impact  of  a  12%  severance  tax  on  the  mining  industry. 
This  written  statement,  which  supplements  my  Preliminary 
Statement  offered  on  September  8,  contains  my  assessment  of 
this  proposed  severance  tax. 

INTRODUCTION 

Since  1989,  Congress  has  been  considering  reform  of 
the  General  Mining  Law  governing  mining  on  public  lands  in 
the  United  States.   A  bill  reforming  the  mining  law  has 
passed  the  Senate  (S.775)  and  action  is  expected  in  the 
House  this  month  or  next. 

Both  bills  substantially  reform  the  mining  laws. 
New  mining  fees  and  royalty  on  production  are  part  of  both 
bills.   These  fees  and  royalties  portend  an  enormous  impact 
on  mining.   In  anticipation  of  these  bills,  industry  has 
already  been  adversely  affected.   The  U.S.  mining  industry 
has  already  reduced  its  holdings  of  mining  claims  by  more 
than  one-half  --  some  sources  expect  close  to  60% -80% 
reductions  --   and  U.S.  exploration  expenditures,  a  clear 
signal  of  future  production,  are  already  migrating  overseas. 

This  is  not  the  time  to  entertain  new  taxes  on  the 
mining  industry.   The  wise  course  is  to  let  Mining  Law 
reform  play  out  over  these  next  few  weeks.   The  Congress 
should  watch  carefully  the  economic  impact  of  Mining  Law 
reform  before  considering  new  taxes  on  this  beleaguered 
industry. 


There  are  four  fundamental  problems  with  the 
proposed  severance  tax:   l)  The  proposal  does  not  define  the 
method  of  calculation  or  the  basis  of  the  severance  tax, 
2)  no  verifiable  data  has  been  assembled  to  determine  the 
revenue  impacts  of  the  tax,  3)  Congress  should  not  entertain 
such  a  proposal  without  conducting  a  study  to  determine  the 
revenue  impacts  of  the  tax,  and  4)  based  upon  previous 


1268 


studies,  it  is  likely  that  the  net  federal  revenue  impacts 
of  such  a  tax  would  be  negative.   I  will  address  each  of 
these  points  below. 

1.   The  ProDoaal  la  Vaoue 

The  proposed  severance  tax  calls  for  a  12%  tax  on 
"hard  rock"  minerals,  "such  as  gold,  silver  and  copper." 
The  proposal,  however,  describes  neither  the  minerals  to  be 
taxed,  the  basis  upon  which  the  tax  will  be  calculated,  nor 
whether  the  tax  will  be  levied  on  minerals  produced  from 
both  public  and  private  lands. 

Perhaps  the  proposal  would  impose  a  tax  only  on 
gold,  silver  and  copper,  or,  perhaps,  all  metallic  minerals 
(sweeping  in  lead,  zinc,  platinum,  chromium,  and  beryllium, 
to  name  just  a  few) .   Or  perhaps  the  proposal  is  to  reach 
"locatable  minerals."^ 

If  the  tax  is  to  be  applied  to  all  minerals,  it 
will  have  an  enormous  direct  impact  on  nearly  every  state  in 
the  country.   If  the  tax  is  to  be  levied  only  on  "locatable" 


1   The  list  of  locatable  minerals  could  include  the 
following  list  of  minerals:   gold,  silver,  cinnabar,  lead, 
tin,  copper,  building  stone,  salt  springs  and  other  deposits 
of  salt,  gilsonite,  elaterite  or  other  like  substances, 
kaolin,  kaolinite,  fuller's  earth,  china  clay  and  ball  clay, 
phosphate,  nitrate,  potash,  asphaltic  minerals,  sodium, 
borax,  sulphur,  agate,  albertite,  alkaline  substances,  alum, 
aluminum,  cyanite,  amber,  amphibole  schist,  amygdaloid 
bands,  asbestos,  asphalt,  barium,  bauxite,  bentonite, 
beryllium,  borates,  brine,  calc-spar,  cement,  auriferous 
cement,  chalk,  French  chalk,  clays,  colemanite,  kaolin, 
diainonds,  diatomaceous  earth,  fahlbands,  galena,  gilsonite, 
gravel,  sand,  granite,  graphite,  guano,  gypsum,  gypsum 
cement,  infusorial  earth,  iron,  chromate  of  iron,  oxide  of 
iron,  franklinite,  isinglass,  lead,  black  lead,  carbonate  of 
lead,  lepidolite,  limestone,  magnesia,  magnesite,  marble, 
texicalli  marble,  meteorites,  mica,  shale,  ochre,  oil  and 
gas,  oil  shale,  onyx,  opal,  ozocerite,  paint  rock,  paint 
stone,  platinum,  plumbago,  resin,  pumice,  salines, 
saltpeter,  sandstone,  silicate,  silicated  rock,  slate, 
natural  slate,  roofing  slate,  soda,  carbonate  of  soda, 
nitrate  of  soda,  sulphate  of  soda,  stone,  beds  of  stone, 
building  stone,  flint  stone,  free  stone,  iron  stone, 
limestone,  lithographic  stone,  lustral  stone,  stockwerke, 
sulphate,  tailings,  tin,  trap  rock,  tungsten,  umber, 
ulexite,  volcanic  ash  or  pumice,  mineral  white  quartz 
suitable  for  making  glass,  zeolites,  zinc,  carbonate, 
silicate  and  sulphide  of  zinc,  tungsten,  uranium,  vanadium 
and  zirconium.   See.  Ricketts,  American  Mining  Law.  4th  ed. 
1943,  Vol  I  §  11.   All  of  these  minerals  are  "locatable" 
under  the  1872  Mining  Law,  though  their  locatability  has 
been  constrained  by  a  number  of  subsequent  federal  statutes, 
including  the  Mineral  Leasing  Act  of  1920,  the  Materials  Act 
of  July  31,  1947,  as  amended  by  the  Common  Varieties  Act  on 
July  23,  1955,  and  the  Act  of  September  28,  1962.   In 
determining  what  minerals  would  be  taxed,  the  "locatable" 
label  complicates  rather  than  simplifies. 


1269 


minerals  or  metallic  minerals,  the  tauc  will  have  a 
disproportionately  large  direct  impact  on  the  western  states 
where  most  of  that  mineral  production  occurs.   But  the  tax 
would  also  have  a  tremendous  indirect  impact  on  those 
states  --  chiefly  in  the  midwest  and  the  mid-Atlantic  -- 
which  supply  the  machinery  and  supplies  used  in  metals 
mining. 

The  value  of  a  mineral  increases  as  it  progresses 
through  various  processing  stages,  reflecting  the  value  (and 
expense)  added  by  the  mine  operator.   A  severance  tax  levied 
on  the  value  of  the  mineral  immediately  upon  severance  from 
the  ground  will  yield  different  results  than  a  tax  levied  on 
the  value  of  the  mineral  as  a  finished  product.   Depending 
upon  the  stage  at  which  the  tax  is  levied  and  the  expense 
deductions  allowed  from  the  taixaJale  basis,  a  severance  tax 
may  result  in  higher  or  lower  payments,  and  correspondingly 
greater  or  lesser  financial  burdens  on  mineral  production. 

A  number  of  states  impose  a  severance  tax  on 
minerals  in  the  form  of  carefully  and  completely  defined 
statutes  which  set  forth  the  basis  for  those  taxes.   The 
federal  severance  tax  proposal  provides  no  detail  as  to  the 
method  of  calculation.   Without  that  detail,  even 
speculation  about  the  revenue  impact  of  the  proposal  is 
difficult. 

A  substantial  percentage  of  the  value  of  minerals 
mined  in  the  United  States  is  derived  from  mines  on  private 
lands.   A  severance  taix  on  minerals  extracted  from  public 
lands  only  would  fail  to  capture  a  significant  portion  of 
the  value  of  mineral  production  in  the  U.S.   The  rationale 
behind  a  severance  teix  only  on  mineral  production  from 
public  lands  is  difficult  to  fathom.   On  the  other  hand, 
mines  on  private  land  are  generally  already  subject  to 
private  royalties  and  state  severance  tauces .   The  imposition 
of  an  additional  tajc  on  those  operations  may  render  some  of 
them  unprof iteible,  thus  potentially  creating  a  net  negative 
treasury  impact.   In  addition,  a  tsoc  on  all  lands  would 
affect  all  states  in  which  there  is  mining,  rather  than  just 
the  western  states  in  which  hard  rock  minerals  from  public 
lands  are  produced. 2  The  potential  effect  of  such  a  tax  on 


2   Among  the  states  with  locateible  mineral  production  or 
development  targets  in  1990  were:   Alabama,  Alaska,  Arizona, 
Arkansas,  California,  Colorado,  Connecticut,  Florida, 
Georgia,  Idaho,  Illinois,  Indiana,  Iowa,  Kansas,  Maine, 
Michigan,  Minnesota,  Missouri,  Montana,  Nevada,  New  Mexico, 
New  York,  North  Carolina,  Oklahoma,  Oregon,  South  Carolina, 
South  Dakota,  Tennessee,  Texas,  Utah,  Vermont,  Virginia, 
Washington,  Wisconsin  and  Wyoming.   With  respect  to  mining 
employment  figures,  we  do  not  have  detailed  data  on  mining 
employment  broken  down  by  state.  We  do,  however,  have  data 
provided  by  the  U.S.  Department  of  Interior,  Bureau  of 
Mines,  that  in  1990,  the  total  employment  in  metal  mining 
was  179,100.   See  Mineral  Commodity  Summaries  1991,  U.S. 
Department  of  Interior,  Bureau  of  Mines,  p.  4.   The  same 
publication  estimates  1990  employment  in  non-metallic 
minerals  (except  fuels)  and  non-fuel  organic  minerals  at  a 
total  of  274,000.  IsL.   at  Table  1,  p.  5. 


1270 


states  like  Michigan  and  Minnesota,  which  have  significant 
iron  ore  production,  Missouri,  which  has  significant  lead 
production,  Tennessee,  which  has  significant  zinc 
production,  South  Carolina,  which  has  substantial  gold 
production,  Florida,  which  has  significant  phosphate 
production.  New  York,  which  has  lead  and  silver  production, 
and  Virginia  and  Vermont,  which  have  talc  production,  would 
be  substantial  and  would  likely  result  in  some  mine  closures 
and  job  losses  in  those  states. 

2.   Lack  of  Financial  and  Economic  Analvsia 

We  are  aware  of  no  detailed  financial  or  economic 
analysis  of  the  proposed  severance  tax.   In  light  of  the 
lack  of  detail  concerning  the  structure  of  the  severance  tax 
(as  discussed  above) ,  such  an  analysis  could  not  be 
performed  in  any  but  a  speculative  manner.   It  is  dangerous 
to  project  revenues  from,  a  mining  tax  without  economic 
analysis.   For  example,  one  might  try  to  estimate  tax 
revenues  from  historic  production  estimates.   That  approach 
assumes  that  production  levels  in  the  hard  rock  minerals 
industry  will  remain  constant  independent  of  external 
factors  other  than  the  imposition  of  a  severance  tax.   It 
also  assumes  that  levels  of  hard  rock  mineral  production 
would  remain  constant  despite  the  increased  production  costs 
that  would  be  associated  with  the  imposition  of  a  severance 
tax.   We  know  that  in  the  metals  mining  industry,  taxes, 
fees  and  royalties  cannot  be  absorbed  by  passing  on  the 
costs  of  the  severance  tax  to  consumers.   In  fact,  the 
demand  for  most  U.S . -produced  hard  rock  minerals,  for 
excimple,  gold,  is  almost  perfectly  elastic.   As  a  result, 
hard  rock  miners  in  most  cases  could  not  pass  the  additional 
costs  imposed  by  a  severance  tax  on  to  consumers,  and  would 
have  to  otherwise  cover  those  costs  by  reducing 
expenditures.   Especially  over  the  long-term,  this  would 
result  in  a  substantial  negative  economic  impact,  decrease 
in  production  levels,  and  erosion  of  the  severance  tax  base. 

In  the  short-term,  it  is  difficult  to  speculate  as 
to  whether  the  imposition  of  a  severance  tax  would  cause 
companies  to  close  existing  mines.   Over  the  long-term,  and 
in  light  of  the  fact  that  increased  costs  cannot  be  absorbed 
by  creating  higher  commodity  prices,  the  sheer  magnitude  of 
a  12%  severance  tax,  especially  if  based  on  gross  proceeds 
or  gross  revenues,  would  be  such  that  many  new  projects 
would  no  longer  be  economic  and  many  producing  mines  would 
not  be  replaced  once  they  were  exhausted.   It  is  this 
decrease  in  the  investment  activity  of  replacing  existing 
mines  that  would  cause  a  significant  reduction  in 
expenditures  by  the  industry  and  concomitant  negative 
economic  impacts.   Those  impacts  include  job  losses  as  well 
as  reductions  in  expenditures.   They  also  include  lost 
personal  and  corporate  income  taxes  which  are  likely 
ultimately  to  be  greater  than  the  increased  revenues  to  the 
federal  treasury  resulting  from  the  imposition  of  the  tax. 

Congress,  of  course,  has  already  learned  this 
lesson.   The  recent  experience  with  the  "luxury  tax"  is  a 
good  indicator  of  how  taxes  that  are  not  passed  along  to 
consumers  are  detrimental  to  the  industries  they  are  applied 
to  and,  because  of  the  resulting  negative  economic  impacts. 


1271 


are  not  revenue  producers .   In  a  more  recent  exeimple  that 
directly  affects  the  mining  industry,  the  Congressional 
Budget  Office  estimated  in  its  testimony  of  May  4,  1993 
before  the  Subcommittee  on  Mineral  Resources  Development 
that  60%  of  all  unpatented  mining  claims  on  public  lands 
would  be  abandoned  after  the  imposition  of  a  new  $lOO/per 
claim  holding  fee.   Jan  Paul  Acton  Testimony,  p.  14.   A 
recent  article  in  the  San  Francisco  Chronicle  estimates  that 
between  50%  and  80%  of  all  mining  claims  will  be  abandoned. 
September  1,  1993,  col.  A5 .   As  a  result  of  high  levels  of 
claim  abandonment,  the  revenue  impacts  of  the  $100  holding 
fee  are  likely  to  be  smaller  than  anticipated.   This  very 
recent  experience  with  mining  holding  fees  demonstrates  that 
the  mining  industry  cannot  simply  pass  on  the  costs. 
Accordingly,  Congress  should  be  skeptical  of  the  revenue- 
raising  potential  of  a  tax  resting  on  the  errant  assumption 
that  higher  costs  will  not  change  either  industry  behavior 
or  consumer  behavior. 

The  main  point  here  is  that  it  is  important  to 
define  the  purpose  of  the  severance  tcuc.   As  a  revenue 
raising  device,  the  tax  may  or  may  not  serve  its  purpose. 
Only  a  thorough  economic  analysis  will  demonstrate  its 
success  or  failure  on  that  score.   If  the  purpose  of  the  tax 
is  to  raise  money  to  deposit  in  a  fund  to  clean  up  abandoned 
mines  or  Superfund  sites  (two  very  different  problems) ,  the 
Committee  should  avoid  committing  funds  before  it  has 
defined  the  problem.   In  Burden  of  Gilt,  a  broadside 
published  by  the  Mineral  Policy  Center  ("MPC")  on  July  20, 
1993,  the  MPC  called  for  creation  of  a  federal  hardrock 
abandoned  mine  cleanup  fund.   The  MPC  report  was  an  advocacy 
piece  by  a  special  interest  group.   It  was  draimatic  and 
insistent.   It  was  also  misleading.   The  MPC  report  asserts 
that  the  mining  industry  is  practically  unregulated.   The 
report  asserts  that  vast  sums  (approximately  $71.5  billion) 
are  necessary  to  clean  up  the  mess  that  mining  has  made.   In 
his  excellent  September  9,  1993  critique  of  the  MPC  report, 
Steve  Barringer  of  Holland  &  Hart  pointed  out  that  MPC's 
cost  estimates  for  cleanup  of  abandoned  mine  sites  are  not 
only  undocumented,  but  erroneously  include  the  cost  of 
cleaning  up  Superfund  sites,  which  have  already  been  funded 
under  the  Superfund  laws.   As  Mr.  Barringer  points  out,  this 
double  counting  drastically  inflates  the  MPC's  estimated 
cost  of  abandoned  mine  cleanup  operations.   In  conclusion, 
the  Committee  is  considering  proposing  a  tax  whose  terms  are 
undefined,  and  the  purpose  of  which  is  murky,  at  best. 

The  problem  of  abandoned  mines  on  public  lands 
deserves  careful  study  and  deliberate  analysis.   We  must 
first  enlist  the  States  in  building  an  inventory  of  sites 
and  establishing  reclamation  goals  and  priorities.   Next,  we 
must  consider  private  side  cleanup  scenarios,  before  we 
saddle  the  public  with  a  reclamation  burden.   For  example, 
we  could  dramatically  reduce  the  public  burden  by 
encouraging  private  remining  of  old  abandoned  sites. 
Remining  could  generate  economic  activity  at  a  profit  and 
still  fund  reclamation. 

Abandoned  mine  reclaunation  is  a  complex  problem 
with  a  complex  solution.   It  is  a  terrible  mistake  to  create 
a  new  tax  to  fund  a  program  we  have  not  yet  defined. 


1272 


3 .   An  Bconomic  Analysis  Is  Critical  In  Estimating 
the  Mat  Revenue  Impact  of  the  Proposal 

It  is  impossible  to  predict  the  impact  of  the 
proposed  severance  tax  without  applying  that  tax  to  real 
numbers  from  existing  hard  rock  mineral  projects,  estimating 
changes  in  output  resulting  from  the  increased  costs 
associated  with  the  tax,  and  then  using  those  changes  in 
output  to  derive  the  input  to  the  Department  of  Commerce's 
Regional  Input-Output  Multiplier  system  ("RIMS") . 
Application  of  the  RIMS  multipliers  to  the  changes  in  output 
allows  for  an  estimate  of  the  economic  impact  of  such  a  tax. 

To  perform  such  an  analysis  on  the  proposed 
severance  tax,  one  would  have  to  calculate  the  impacts  of 
that  tax  on  a  representative  sample  of  hard  rock  mining 
projects  during  a  given  year,  extrapolate  those  numbers  up 
to  determine  state -wide  and  industry-wide  impacts,  and  then 
determine  the  economic  impacts  (in  terms  of  job  losses, 
declines  in  revenue  and  reduction  of  economic  output) 
through  application  of  the  RIMS  multipliers.   Such  an 
analysis  can  be  designed  to  avoid  risky  projections  about 
future  trends  and  production  performance.   It  can  instead  be 
constructed  using  a  model  reflecting  the  U.S.  mining 
industry  as  it  actually  existed  in  a  particular  year.   The 
analysis  would  then  look  at  the  financial  and  economic 
impacts  of  the  proposed  tax  on  the  mining  industry  as  it 
actually  existed  in  the  year  selected,  based  on  actual 
price,  cost,  and  production  data  collected  from  individual 
mining  companies.   From  that  "snapshot"  of  the  industry  one 
would  then  be  able  to  infer  what  the  industry  would  look 
like  going  forward.   That  method  will  allow  for  an  analysis 
of  the  impacts  of  the  proposed  tax  over  the  longer  term,  and 
also  for  a  determination  of  which  particular  projects  never 
would  have  begun  because  they  would  have  been  rendered 
uneconomic  by  the  new  tetx. 

In  performing  that  analysis,  all  of  the  guidelines 
listed  below  should  be  followed: 

•  The  analysis  should  use  long-term,  rather  than 
short-term,  estimates  in  deriving  the  impacts  of 
the  proposed  tax.   The  investments  in  the  hard  rock 
minerals  industry  are  relatively  long-term  in 
nature,  with  project  lives  averaging  from  5  to  30 
years.   As  a  result,  it  is  necessary  to  evaluate 
the  impact  of  the  proposed  tax  over  a  time  span 
that  corresponds  to  the  investment  horizon  of  the 
industry. 

•  The  analysis  should  utilize  actual  financial  and 
production  data  from  U.S.  mining  operations. 

•  .  The  analysis  should  account  for  the  regional 

differentiation  of  the  industry.   For  example, 
Colorado  does  not  produce  a  lot  of  hard  rock 
minerals  these  days,  but  the  presence  of  national 
and  regional  mining  company  headquarters  makes 
mining  important  to  Colorado.   Emphasizing  regional 
differentiation  recognizes  that  resource 
reallocation  between  states  or  regions  or  out  of 


1273 


the  mining  industry  into  other  industries  is 
unusual  at  best,  even  over  the  long  term.   That  is 
especially  true  with  capital  and  labor  resources. 
Barriers  to  resource  reallocation  will  be  even 
greater  in  this  case,  because  a  severance  tax 
affects  all  projects  in  all  states.   Workers 
displaced  in  Nevada  will  not  find  mining  jobs  in 
mines  in  California  because  miners  will  be 
displaced  everywhere. 

In  estimating  loss  of  output,  the  analysis  should 
consider  the  reductions  in  expenditures  and 
employment  beyond  the  impacts  on  operating  mining 
projects;  e.g.,  exploration,  development  and 
construction. 

The  analysis  should  consider  the  net  effect  on 
treasury  receipts,  including: 

Loss  of  personal  income  taxes  related  to  lost 

earnings , 

Loss  of  corporate  income  taxes  from  increased 

costs  and  non-viable  projects. 

Federal  administrative  costs  for  both 

administering  the  implementation  and 

collection  of  the  tax. 


4.   Ngq»tiv?  Tappet  Likgly 

As  shown  in  the  April  30,  1993  study  by  Coopers  & 
Lybrand  and  Morrison  &  Foerster,  entitled  "A  Comparative 
Analysis  of  Mining  Fees  and  Royalties"  {the  "1993  Study") ,  a 
poorly  designed  federal  royalty,  and  presumably  a  federal 
severance  tax,  can  have  dramatic  negative  effects  on  the 
federal  treasury.   As  shown  in  the  1993  Study,  the  8% 
royalty  on  gross  proceeds  plus  the  holding  fees  proposed  in 
the  1993  Bumpers  Bill  would  likely  result  in  a  $443  million 
net  loss  to  the  federal  treasury.   The  8%  royalty  plus  the 
holding  fees  proposed  in  the  1993  Rahall  Bill  would  result 
in  a  $422  million  net  loss  to  the  federal  treasury.   (See 
Table  2  of  the  1993  Study) .   In  performing  a  sensitivity 
analysis  on  the  1993  Bumpers  and  Rahall  Bill  royalties, 
assuming  the  holding  fee  remains  the  same,  the  study  team 
concluded  that  if  the  Bumpers  and  Rahall  royalties  were 
12.5%,  the  net  loss  to  the  federal  treasury  would  be  $527 
million  under  the  Bumpers  Bill  and  $472  million  under  the 
Rahall  Bill.   (See  Table  2  of  the  1993  Study).   The  1993 
Craig  Bill  proposed  a  2%  royalty  on  net  income  at  the  mouth 
of  the  mine.   Our  study  showed  that  at  a  12.5%  rate,  the 
Craig  royalty  plus  holding  fees  would  net  the  federal 
treasury  only  $22  million. 

Although  the  severance  tax  proposal  is  far  too 
vague  to  afford  any  guidance  on  the  question  of  net  treasury 
impacts,  a  comparison  of  the  net  treasury  impacts  of  the 
1993  Bumpers  and  Rahall  Bill  royalties  and  the  1993  Craig 
Bill  royalty  should  be  instructive.   A  federal  severance  tax 
in  the  form  of  Nevada's  net  proceeds  tax  is  likely  to  net 


1274 


the  treasury  more  than  a  severance  tax  on  gross  proceeds  or 
gross  income;  however,  either  form  of  severance  teuc  is 
likely  to  have  significant  negative  effects  on  the  mining 
industry. 

More  importantly,  our  1993  Study  only  analyzed  the 
impacts  of  a  gross  and  net  royalty  on  public  lands  in  12 
western  states.   A  federal  severance  tax  on  all  lands, 
public  and  private,  and  on  minerals  found  in  all  states 
would  be  likely  to  have  a  more  draunatically  negative  net 
treasury  impact.   A  severance  tax  applicable  to  public  lands 
only  may  insulate  all  but  the  western  states  from  direct 
negative  consequences  of  mine  closures.   A  severance  tax 
applicable  to  all  lands,  however,  would  affect  every  state 
with  an  active  mine.   Job  losses  and  mine  closures  in  every 
state  may  well  have  an  even  more  dramatic  negative  net 
treasury  impact  than  shown  in  our  1993  Study. 


1275 
Mr.  Payne.  Mr.  Kelly. 

STATEMENT  OF  JOHN  L.  KELLY,  VICE  PRESffiENT,  PUBLIC 
AFFAIRS,  CLEVELAND  CLIFFS,  INC.,  ON  BEHALF  OF  THE 
AMERICAN  IRON  ORE  ASSOCIATION 

Mr.  Kelly.  Mr.  Chairman  and  distinguished  members  of  the 
subcommittee,  I  appreciate  the  opportunity  to  appear  before  you.  I 
am  John  Kelly.  I  am  vice  president  of  public  affairs,  Cleveland- 
CliflFs,  Inc.  I  am  also  a  former  tax  committee  chairman  of  American 
Iron  Ore  Association  headquartered  in  Cleveland,  which  I  rep- 
resent here  today.  The  association  is  a  trade  organization  rep- 
resenting companies  that  mine  approximately  70  percent  of  the 
iron  ore  that  is  produced  in  the  United  States  and  Canada, 

I  am  here  to  convey  to  you  in  the  strongest  terms  possible  that 
iron  ore  producers  are  deeply  troubled  that  a  mineral  severance  tax 
has  been  proposed  and  moreover,  upset  that  it  would  apply  to  iron 
ore  mining.  We  fail  to  see  the  rationale  or  need  for  such  a  tax  and 
we  cannot  afford  this  new  tax  burden  at  any  percentage  level. 

My  remaining  testimony  will  focus  on  our  industry  profile  in  the 
hope  that  your  understanding  of  our  contribution  to  society  and  our 
economic  challenges  will  be  enhanced. 

Essentially  there  are  no  remaining  iron  ore  reserves  of  commer- 
cial grade  in  the  United  States,  but  huge  quantities  of  low  grade 
material  exist  in  northern  Michigan  and  Minnesota.  Presently 
there  are  nine  iron  ore  mining  operations  in  these  two  areas  that 
are  efficiently  producing  more  than  50  million  annual  tons  of  high 
quality  iron  ore  pellets  from  low  grade  deposits. 

These  operations  and  the  related  infrastructure  represent  several 
billion  dollars  of  fixed  investment.  Steel  mills  are  the  only  consum- 
ers of  iron  ore  pellets  and  the  iron  ore  industry  is  indispensable  to 
the  survival  of  our  basic  steel  industry. 

The  iron  content  of  low  grade  ore  is  36  percent  or  less.  These  de- 
posits are  not  suitable  for  any  commercial  use.  Pellets,  on  the  other 
hand,  contain  approximately  65  percent  iron.  To  the  extent  thev  re- 
main competitive  in  cost,  they  are  a  desirable  raw  material  for 
making  iron  and  steel  products  because  they  consistently  meet  de- 
manding physical  and  chemical  specifications.  Due  to  transpor- 
tation limitations  and  other  reasons,  our  pellets  generally  do  not 
enter  markets  outside  the  Great  Lakes  steel-producing  regions  of 
the  United  States  and  Canada. 

Global  conditions  in  the  iron  ore  and  steel  industries  over  the 
past  decade  have  kept  downward  pressure  on  prices  and  have  ne- 
cessitated intense  efforts  to  increase  quality  and  decrease  costs. 
Yet,  iron  ore  is  being  sold  below  cost  on  a  spot  market  basis;  and 
integrated  steel  producers  continue  to  report  losses  and  weak  earn- 
ings. Under  these  conditions,  a  severance  tax  on  U.S.  iron  ore  min- 
ing operations  cannot  be  passed  on  to  consumers  and  it  cannot  be 
absorbed  by  producers  without  substantial  negative  implications. 

The  northern  regions  of  Michigan  and  Minnesota  are  as  sparsely 
settled  and  are  noted  for  persistently  high  unemployment.  Iron  ore 
mining  represents  the  predominant  source  of  employment  for  a 
highly  skilled  and  highly  paid  work  force;  and  it  generates  consid- 
erable satellite  employment.  Negative  consequences  to  iron  ore  pel- 
let producers,  brought  about  by  a  severance  tax,  can  also  be  ex- 


1276 

pected  to  have  serious  implications  for  surrounding  communities  in 
these  two  States. 

Mining  is  uniquely  risky  business;  yet  over  the  past  two  decades, 
we  have  invested  billions  of  dollars  in  state-of-the-art  pelletizing 
plants  and  related  facilities.  These  investments  were  made  with 
the  expectation  that  a  reliable  and  stable  U.S.  tax  system  would 
continue  to  provide  essential  incentives  to  help  bring  an  adequate 
return  on  these  long-term  investments. 

Our  expectations  were  strengthened  by  enactment  of  the  Min- 
erals Policy  Acts  of  1970  and  1980,  both  of  which  support  minerals 
development  and  enhanced  minerals  availability  as  a  matter  of  na- 
tional policy.  Yet  our  tax  system  has  worsened  over  the  past  decade 
as  it  pertains  to  basic  industry,  and  costs  of  new  Government  man- 
dates have  not  helped  the  situation. 

To  now  be  confronted  with  another  proposed  tax  system  change 
in  the  form  of  a  national  severance  tax,  which  is  in  conflict  with 
national  minerals  policy,  is  beyond  our  ability  to  understand  or  rec- 
oncile. 

It  is  necessary  to  provide  tax  incentives  to  invest  in  domestic 
basic  industries  that  continue  to  be  ravaged  by  economic  depression 
and  threatened  by  foreign  dumping  and  subsidies. 

The  domestic  iron  ore  mining  and  steel  industries  compete  with 
foreign  suppliers  that  benefit  from  border  taxes  on  imported  prod- 
ucts and  tax  credits  on  their  own  exports.  Domestic  prices  of  iron 
ore  mining  and  steel  have  languished  for  more  than  a  decade  and 
higher  costs  cannot  be  absorbed. 

While  this  is  not  the  forum  in  which  to  discuss  wholesale  alter- 
ation of  the  U.S.  tax  system,  you  should  know  that  both  of  these 
industries  have  advocated  prompt  consideration  and  adoption  of  an 
equitable  GATT-legal  and  border-adjustable  tax  on  U.S.  business 
activities  as  a  substitute  for  the  present  tax  on  business  income. 

We  ask  you  to  reject  the  mineral  severance  tax  proposal  so  as  not 
to  exacerbate  the  major  shortcomings  of  our  Nation's  existing  busi- 
ness tax  system.  In  doing  so,  you  will  also  assist  the  President  in 
his  renewed  effort  to  stimulate  the  economy. 

Thank  you  for  your  attention. 

Mr.  Payne.  Thank  you  very  much. 

[The  prepared  statement  follows:] 


1277 


STATEMENT 

Of 

AMERICAN  IRON  ORE  ASSOCIATION 

before  the 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

COMMITTEE  ON  WAYS  AND  MEANS 


September  8,  1993 


PROPOSAL  TO  IMPOSE  A  SEVERANCE 
TAX  ON  HARD  ROCK  MINERALS 


Mr.  Chairman  and  other  distinguished  members  of  this 
Subcommittee,  I  appreciate  this  opportunity  to  appear  before  you. 
My  name  is  John  Kelley,  Vice  President-Public  Affairs,  Cleveland- 
Cliffs  Inc.  I  am  also  former  Tax  Committee  Chairman  of  American 
Iron  Ore  Association,  headquartered  in  Cleveland,  Ohio,  which  I  am 
representing  here  today.  The  Association  is  a  trade  organization 
representing  companies  that  mine  approximately  70%  of  the  iron  ore 
that  is  produced  in  the  United  States  and  Canada. 

My  purpose  in  requesting  to  be  heard  is  to  convey  to  you  in 
the  strongest  terms  possible  that  iron  ore  producers  are  deeply 
troubled  that  a  minerals  severance  tax  has  been  proposed  and, 
moreover,  upset  that  it  would  apply  to  iron  ore  mining.  We  fail  to 
see  the  rationale  or  need  for  such  a  tax;  and  we  cannot  afford  this 
new  tax  burden  at  any  percentage  level. 

Because  the  severance  tax  concept  is  not  complicated  and  our 
resistance  is  grounded  in  the  need  for  a  strong  and  world 
competitive  domestic  iron  ore  mining  industry,  my  remaining 
testimony  will  focus  on  our  industry  profile  in  the  hope  that  your 
understanding  of  our  contribution  to  society  and  our  economic 
challenges  will  be  enhanced. 

Essentially,  there  are  no  remaining  iron  ore  reserves  of 
commercial  grade  in  the  United  States,  but  huge  quantities  of  low 
grade  material  exist  in  northern  Michigan  and  Minnesota. 
Presently,  there  are  nine  iron  ore  mining  operations  in  these  two 
areas  that  are  efficiently  producing  more  than  50  million  armual 
tons  of  high  quality  iron  ore  pellets  from  low  grade  deposits. 
These  operations  and  related  infrastructure  represent  several 
billion  dollars  of  fixed  investment.  Steel  mills  are  the  only 
consumers  of  iron  ore  pellets,  and  the  iron  ore  industry  is 
indispensable  to  the  survival  of  the  basic  steel  industry. 

The  iron  content  of  low  grade  ore  ranges  from  less  than  30%  to 
approximately  36%.  These  deposits  are  not  suitable  for  steel 
industry  consumption  or  any  other  use.  Pellets,  on  the  other  hand, 
contain  approximately  65%  iron.  The  transformation  of  low  grade 
iron  ore  into  pellets  is  a  very  expensive  process  in  the  United 
States  because  of  high  energy,  labor  and  environmental  costs.  To 
the  extent  they  remain  competitive  in  cost,  they  are  a  desirable 
raw  material  for  making  iron  and  steel  products  because  they 
consistently  meet  demanding  physical  and  chemical  specifications. 
Due  to  transportation  limitations  and  various  other  reasons, 
however,  these  domestically  produced  pellets  generally  do  not  enter 
markets  outside  the  Great  Lakes  steel  producing  regions  of  the 
United  States  and  Canada,  except  for  minor  movements  to  steel 
producers  in  such  areas  as  Utah  and  Alabama.  In  contrast,  foreign 
competition  does  exist  for  the  U.S.  market,  notably  from  Brazil 
which  mines  a  very  high  grade  ore  requiring  no  expensive 
processing. 


TT  i'in  r\  —  QA 


1278 


Global  conditions  in  the  iron  ore  and  steel  industries  over 
the  past  decade  have  kept  downward  pressure  on  prices  and  have 
necessitated  intense  efforts  to  increase  quality  and  decrease 
costs.  Yet,  iron  ore  is  being  sold  below  cost  on  a  spot  market 
basis;  and  integrated  steel  producers  continue  to  report  losses  and 
weak  earnings.  Under  these  conditions,  a  severance  tax  on  U.S. 
iron  ore  mining  operations  cannot  be  passed  on  to  consumers;  and  it 
cannot  be  absorbed  by  producers  without  substantial  negative 
consequences. 

The  northern  regions  of  Michigan  and  Minnesota  are  sparsely 
settled  and  are  noted  for  persistently  high  unemployment.  Iron  ore 
mining,  which  has  been  forced  to  rationalize  its  operations 
considerably  in  recent  years,  represents  the  predominant  source  of 
employment  for  a  highly  skilled  and  highly  paid  work  force;  and  it 
generates  considerable  satellite  employment.  Negative  consequences 
to  iron  ore  pellet  producers,  brought  about  by  the  imposition  of  a 
severance  tax,  can  also  be  expected  to  have  serious  implications 
for  surrounding  communities  in  these  two  states,  because  of  reduced 
production  and  the  probability  that  some  operations  would  have  to 
close. 

It  is  generally  recognized  that  mining  is  an  extremely  risky 
business.  Yet,  over  the  past  two  decades  we  have  invested  billions 
of  dollars  in  state-of-the-art  pelletizing  plants,  related 
facilities,  modem  self -unloading  lake  vessels,  and  other 
infrastructure,  primarily  for  domestic  trade.  These  investments 
were  made  with  the  expectation  that  a  reliable  and  stzJsle  U.S.  tax 
system  would  continue  to  provide  essential  incentives  to  help  bring 
an  adequate  return  on  these  long-term  fixed  investments. 
Understandably,  our  expectations  were  strengthened  by  enactment  of 
the  Mining  and  Minerals  Policy  Act  of  1970  and  the  Materials  and 
Minerals  Policy  Act  of  1980,  both  of  which  are  in  support  of 
minerals  development  and  enhanced  minerals  availability  as  a  matter 
of  national  policy.  Yet,  our  tax  system  has  worsened  over  the  past 
decade  as  it  pertains  to  basic  industry,  and  costs  of  new 
government  mandates  have  not  helped  the  situation.  To  now  be 
confronted  with  another  proposed  tax  system  change  in  the  form  of 
a  national  severance  tax,  which  could  bring  eibout  results  that  are 
directly  in  conflict  with  existing  minerals  policy  as  enacted  by 
Congress,  is  beyond  our  ability  to  understand  or  reconcile. 

The  bottom  line  is,  our  industry  experienced  an  abrupt  and 
severe  business  contraction  over  the  past  decade,  and  our  present 
economic  condition  remains  bleak.  This  is  greatly  due  to  unfair 
trade  practices  by  offshore  competitors  and  competition  generally 
on  a  global  scale. 

To  carry  out  our  existing  national  policy,  it  is  urgently 
necessary  to  provide  through  our  tax  system  incentives  to  invest  in 
domestic  industries  that  continue  to  be  ravaged  by  economic 
depression  and  threatened  by  foreign  dumping  and  subsidies.  The 
question  today  is  not  growth  or  expansion;  it  is  tax  stability  and 
incentives  for  survival  of  vital  basic  industries  in  this  country. 

The  domestic  iron  ore  mining  and  steel  industries  compete 
directly  in  domestic  markets  and  elsewhere  with  foreign  suppliers 
that  benefit  from  border  taxes  on  imported  products  and  tax  credits 
on  their  own  exports.  Domestic  prices  of  iron  ore  and  steel  have 
languished  for  more  than  a  decade,  and  higher  tax  costs  cannot  be 
absorbed.  We  recognize  that  this  is  not  the  forum  in  which  to 
discuss  wholesale  alteration  of  the  U.S.  tax  system,  but  we  believe 
you  should  know  that  both  of  these  industries  have  advocated  prompt 
consideration  and  adoption  of  an  equitable,  GATT-legal,  and  border- 
adjustable  tax  on  U.S.  business  activities,  as  a  substitute  for  the 
present  tax  on  business  income. 

The  request  we  present  to  you  today  is  to  reject  the  minerals 
severance  tax  proposal,  so  as  not  to  exacerbate  the  major 
shortcomings  of  our  nations 's  existing  business  tax  system. 


1279 

Mr.  Payne.  We  have  been  called  to  vote  so  the  committee  will  be 
in  recess  until  2:30. 

[Brief  recess.] 

Mr.  Payne.  The  committee  will  come  to  order. 

We  had  concluded  with  the  testimony  of  our  fifth  panel  and  were 
preparing  to  ask  questions  of  the  witnesses. 

Mr.  Hancock  will  inquire. 

Mr.  Hancock.  Thank  you,  Mr.  Chairman.  I  have  several  ques- 
tions I  would  like  to  ask  just  generally. 

Is  there  a  specific  proposed  tax  on  mining?  If  there  is,  I  haven't 
seen  it.  Is  it  in  writing  any  place? 

Mr.  Alfers.  I  haven't  seen  one  either,  Mr.  Hancock. 

Mr.  Hancock.  It  will  be  difficult  to  evaluate  it  until  we  see  what 
it  is. 

Mr.  Alfers.  It  makes  it  difficult  to  speculate  what  the  revenue 
or  economic  impact  might  be.  It  is  terribly  important  to  nail  down 
what  this  proposal  is  to  give  it  any  kind  of  consideration. 

Mr.  Hancock.  We  are  talking  about  a  tax;  I  understand  that.  It 
seems  like  that  is  what  we  talk  about  here  most  of  the  time.  We 
don't  know  how  it  would  be  applied.  We  don't  know  for  sure  what 
would  be  subject  to  the  tax.  We  don't  know  how  it  would  be  col- 
lected. 

Mr.  Chairman,  we  might  be  premature  in  holding  a  hearing  on 
something  we  haven't  seen.  Has  there  been  a  tax  revenue  estimate 
prepared  and  if  so 

Mr.  Alfers.  I  have  seen  none. 

Mr.  Kelly.  I  don't  think  there  has.  I  would  think  it  would  be  ex- 
tremely difficult  for  anyone  to  make  a  reliable  estimate. 

Mr.  Hancock.  OK  I  understand  that  prices  of  metals  and  mate- 
rials are  determined  on  the  world  market.  It  seems  we  think  they 
aren't  at  times. 

Wouldn't  any  tvpe  of  a  tax  on  minerals  put  us  at  an  international 
competitive  disadvantage,  right  now  especially? 

Mr.  Alfers.  I  think  any  tax  becomes  a  cost  in  the  final  analysis 
and  some  taxes  become  a  bigger  cost  than  others.  A  tax  on  the 
gross  value  of  minerals,  for  example,  can  swallow  the  entire  mar- 
gin. Consider  the  idealized  example  of  the  production  of  an  ounce 
of  gold.  In  North  America,  the  average  cost  of  production  per  ounce 
of  gold  is  about  $330.  If  the  price  of  gold  is  $360,  we  are  looking 
at  a  $30  margin. 

If  one  calculates  the  tax  or  even  a  royalty  on  the  gross  value  of 
that  product,  it  more  than  swallows  all  the  margins,  about  140  per- 
cent of  the  operating  margin.  Something  like  that  is  obviously  un- 
tenable. The  reason  for  that  is  that  the  economics  of  mining,  the 
margins  are  very,  very  thin.  Often  a  mine  will  try  to  operate  some- 
times at  a  loss  for  awhile,  but  on  a  margin  of  80  or  90  percent.  So 
taxes  of  the  magnitude  that  we  are  looking  at  here  are  wholly  inap- 
propriate to  an  industry  like  this. 

Mr.  Hancock.  Well,  do  you  have  any  idea  of  what  the  total  num- 
ber is  of  how  many  different  companies  do  mining  and  oil  explo- 
ration? 

Mr.  Alfers.  In  mining,  there  must  be  several  thousand  compa- 
nies that  are  engaged  at  some  level  in  the  exploration  or 
prospecting,  development  of  mining. 


1280 


Mr  Hancock.  Do  you  have  any  idea  of  the  number  of  people  en- 
^^?f    ^A         mining  industry,  the  amount  of  employment"^ 

Mr  Alfers.  I  would  like  to  provide  you  a  memorandum  that 
would  lav  out  the  distribution  of  those  jobs.  I  don't  have  that  on 
the  tip  of  my  tongue. 

[The  information  follows:] 


1281 


SAN  FRANCISCO 
LOS  ANGELES 
SACRAMENTO 
ORANGE  COUNTY 
PALO  ALTO 
WALNUT  CREEK 
SEATTLE 


Morrison  &  Foerster 

ATTORNEYS  AT  LAW 

5200  REPUBLIC  PLAZA 

370  17TH  STREET 

DENVER,  COLORADO  80202-5638 

TELEPHONE  (303)  592-1500 

TELEFACSIMILE  (303)592-1510 


NEW  YORK 
WASHINGTON,  DC. 
LONDON 
BRUSSELS 
HONG  KONG 
TOKYO 


DIRECr  DL\L  NUMBER 


April    14,     1994 
VIA    FACSIMILE 


(303)  592-2265 


The  Honorable  Mel  Hancock 
Committee  on  Ways  and  Means 
U.S.  House  of  Representatives 
1102  Longworth  HOB 
Washington,  DC   20515-6348 

Re :   Employment  in  the  Mining  Industry 

Dear  Representative  Hancock: 

On  September  8,  1993,  I  testified  on  behalf  of  the 
Mineral  Resources  Alliance  at  hearings  held  by  the 
Subcommittee  on  Select  Revenue  Measures  of  the  House  Ways 
and  Means  Committee.   The  subject  of  those  hearings  was 
miscellaneous  revenue  measures,  among  which  was  a  proposed 
excise  tax  on  the  extraction  of  hard  rock  minerals.   At  the 
hearing,  you  asked  for  information  on  the  number  of  mining 
entities,  including  the  oil  and  gas  industry,  in  the  United 
States.   You  also  inquired  as  to  the  number  of  people 
employed  by  the  mining  industry. 

The  most  current  complete  set  of  government  figures 
on  employment  in  the  mining  industry  and  the  number  of 
enterprises  involved  in  the  mining  industry  come  from  1987.1 
The  total  number  of  entities  engaged  in  mining  activities 
("Establishments")  in  1987  was  33,617.   Broken  down,  that 
number  included  1,027  establishments  in  the  metal  mining 
industry;  5,775  establishments  in  the  nonmetallic  mining 


1    The  remainder  of  the  information  in  this  and  the 
following  paragraphs  comes  from  the  charts  attached  hereto 
as  Exhibits  A  and  B,  reprinted  from  the  U.S.  Department  of 
Commerce,  Bureau  of  the  Census,  Statistical  Abstract  of  the 
United  States  1993,  694  (1993)  (Exhibit  A),  and  the  U.S. 
Department  of  Labor,  Bureau  of  Labor  Statistics,  Employment 
and  Earnings  86  (January  1994)  (Exhibit  B) . 


1282 


industry;  3,905  establishments  in  the  coal  mining  industry; 
and  22,910  establishments  in  the  oil  and  gas  extraction 
industry. 

In  terms  of  employment,  in  1987  there  were  698,000 
people  directly  employed  by  the  mining  industry.   Of  those, 
the  metal  mining  industry  employed  44,000;  nonmetallic 
mining  employed  113,000;  the  coal  industry  employed  163,000; 
and  the  oil  and  gas  extraction  industry  employed  378,000. 
For  November  of  1993,  that  overall  employment  figure  dropped 
from  698,000  to  598,000.   In  November  of  1993,  the  metal 
mining  industry  employed  50,600  people;  nonmetallic  mining 
employed  101,400;  the  coal  industry  employed  94,600;  and  the 
oil  and  gas  extraction  industry  employed  351,200. 

During  the  six-year  period,  only  the  metal  mining 
industry  saw  an  increase  in  employment .   The  metal  mining 
industry,  which  includes  gold,  silver,  copper,  lead  and 
zinc,  is  the  industry  that  mines  most  of  the  minerals  that 
are  subject  to  appropriation  under  the  1872  Mining  Law  and 
which  would,  in  turn,  be  subject  to  the  proposed  excise  tax. 
In  addition,  some  of  the  minerals  included  in  the 
nonmetallic  minerals  category  are  subject  to  the  1872  Mining 
Law  and  would  be  subject  to  the  proposed  excise  tax  as  well. 

It  is  also  important  to  bear  in  mind  that  the 
mining  industry  is  extraordinarily  productive  in  creating 
indirect  jobs.   The  mining  industry  creates  service  and 
support  jobs  that  are  not  reflected  in  the  employment 
figures  reported  above.   Economists  often  use  the  Regional 
Input-Output  Modeling  System  ("RIMS")  developed  by  the 
Bureau  of  Economic  Analysis  to  determine  the  indirect  jobs 
created  by  a  particular  industry  in  a  particular  state.   For 
the  mining  industry  in  the  12  western  states  (where  the  vast 
majority  of  metal  mining  occurs) ,  that  multiplier  averages 
19.3073  (in  other  words,  a  total  of  19  jobs  are  created  for 
every  $1,000,000  of  output  from  the  mining  industry).   It  is 
both  the  direct  and  indirect  jobs  that  would  be  impacted  by 
the  imposition  of  an  excise  tax. 

By  way  of  illustration,  in  1993,  we,  along  with 
Coopers  &  Lybrand,  conducted  a  study  on  the  financial  and 
economic  impacts  of  various  royalty  proposals  on  the  hard 
rock  mining  industry. 2  The  results  of  that  study  highlight 


2    Alfers  &  Graff,  A  Comparative  Analysis  of  Mining  Fees 
and  Royalties  (1993) . 


1283 


both  this  job-creating  aspect  of  the  mining  industry  and, 
conversely,  the  job  loss  threatened  by  the  new  fees, 
royalties,  and  taxes  recently  imposed  on  or  now  proposed  for 
the  mining  industry.   Our  study  indicated  that  the  hard  rock 
mining  industry  would  employ  47,000  fewer  people  over  the 
long  term  as  a  result  of  the  imposition  of  an  8%  gross 
royalty  on  production.   It  is  the  possibility  of  impacts  of 
that  magnitude  that  demands  a  thorough  economic  analysis  of 
proposals  like  the  one  for  a  12%  excise  tax  that  was  the 
subject  of  the  hearing. 

If  we  can  be  of  any  assistance  to  the  Subcommittee 
in  performing  such  an  economic  analysis,  please  contact  me. 
Thank  you  again  for  the  opportunity  to  testify  before  the 
Subcommittee . 


Very  truly  yours, 


SDA :  j  e 
Enclosures 


1284 


EXHIBIT    A 

Mineral  Industries 


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1285 


EXHIBIT    B 


ESTABUSHMENT  DATA 

EMPLOYMENT 

NOT  SEASONALLY  ADJUSTED 

B-2.  EmptoyM*  on  norrtarm  payroll*  by  dotailed  Industry 


Pixxluetlon  wof1<ef»' 


343^ 

172.5 
165.2 


524.8 
26.5 
518.1 


1,101.8 
539.2 
27.3 
535.3 


351.2 
163.9 
181.9 


.09i0 
538.3 
27.3 


2,675.6 
604.9 
151.5 
502.0 


^»e4.6 

637.8 
166.2 
524.1 
443.5 
18Z0 
220.6 


676.9 
76.8 
176.6 
141.2 


22J 
27.3 
42.6 
59.5 
43.3 
80.8 

479.8 
27Z4 
121.8 
67.5 
20.6 
28.3 


249.6 
103.2 
69.2 
2Z9 


504.C 

2,934.9 
630.5 
178.3 
525.2 
434.2 
180.9 
218.1 


176.4 
140.5 
33.8 
249.5 
103.6 


3,523 
759.1 


2,142.1  : 
443.0 
1316 
387.8 


559.9 
64.6 
153.1 
122.2 
29.2 


731.3 
344.4 

iai 

374.8 


23Z0 
80.3 
147.5 


^360.6 
470.6 
157.7 
407.3 
382.2 
137.4 
179.2 


65.6 
153.7 
122.6 


229.6 
105.2 
73.8 


462.3 

149.3 
408.0 
372.4 


573.5 
63.5 

153.1 

121.9 
29.5 

200.3 
80.8 
55.6 


385.3 
230.6 
105.8 


SeefoOnotm 


1286 

Mr.  Hancock.  Would  you  say  the  severance  tax  would  force  some 
mines  to  close  or  do  you  think  that  the  marketplace  would  be  able 
to  absorb  the  severance  tax  they  are  talking  about? 

Mr,  Alfers.  Some  mines  would  close  and  others  would  change 
their  shape  in  a  way  that  would  be  similar  to  closing.  What  we 
have  not  done  though  is  looked  at  the  economics  of  a  tax  proposal, 
because  we  haven't  seen  that.  We  have,  however,  in  the  context  of 
the  reform  looked  pretty  hard  at  the  economics  of  mining  projects 
in  the  United  States,  and  we  have  looked  at  royalties  in  that  con- 
text. We  are  able  to  on  a  project-by-project  basis  look  at  the  way 
royalty  schemes  affect  the  operations,  and  some  mines  close. 

It  is  important  here  because  mining  is  one  of  those  industries 
where  there  is  a  tremendous  capital  investment  to  build  a  mine. 
Costs  can  be  sunk.  So  to  just  think  about  the  closure  of  a  mine  in 
the  short  run  grossly  understates  the  economic  impact. 

It  is  the  mines  over  a  longer  term,  those  mines  that  are  on  the 
table  if  you  will,  those  in  the  midst  of  feasibility  that  are  approach- 
ing a  construction  decision  where  the  capital  is  not  sunk,  those  will 
stop,  and  in  our  economic  analysis  that  is  where  we  saw  the  big 
jobs  impact. 

Mr.  Hancock.  On  August  6,  I  think  it  was,  we  passed  a  major 
tax  increase.  I  am  sure  you  are  associated  with  small  business  com- 
panies. What  kind  of  feedback  are  you  getting  from  them  now 
about  these  changes?  Are  you  getting  the  same  feedback  from  your 
members  as  I  am  getting  in  my  district  about  the  new  tax  law? 

Mr.  Campbell.  I  can't  comment  for  small  business,  but  as  a  large 
corporation,  our  tax  rate  has  gone  up  and  certainly  the  overall  fact, 
both  from  a  corporate  standpoint  as  well  as  personal,  there  is  a  tre- 
mendous outcry  at  least  to  the  people  I  am  in  contact  with  as  far 
as  the  new  tax  law  is  concerned. 

Mr.  Hancock.  But  you  do  business  with  a  lot  of  small  business 
people? 

Mr.  Campbell.  Absolutely,  yes. 

Mr.  Hancock.  What  are  those  people  telling  you? 

Mr.  Campbell.  Congressman,  I  haven't  found  any  support.  No- 
body is  pleased  with  it. 

Mr.  Hancock.  Thank  you  very  much. 

Mr.  Payne.  Mr.  Hoagland. 

Mr.  Hoagland.  No  questions. 

Mr.  Payne.  Mr.  McCrery. 

Mr.  McCrery.  Thank  you,  Mr.  Chairman. 

Mr.  Damron,  is  your  major  objection  to  an  import  fee  that  U.S. 
manufacturers  would  be  at  a  disadvantage  in  terms  of  energy 
costs?  Is  that  your  basic  objection? 

Mr.  Damron.  That  is  basically  it,  competitiveness  worldwide. 

Mr.  McCrery.  That  is  a  legitimate  point. 

Mr.  Campbell  and  Ms.  Lazenby,  how  do  you  answer  that  objec- 
tion? 

Ms.  Lazenby.  If  you  look  at  Japan  they  have  an  85  percent  cus- 
tom fee  for  imported  oil.  We  are  not  asking  for  a  very  large 
amount.  EC  imposes  a  customs  fee  so  I  don't  think  the  amount  is 
such  that  it  would  make  the  chemicals  noncompetitive.  We  are  ask- 
ing for  something  that  protects  American  jobs.  We  are  getting 


1287 

$14.50  for  our  oil  that  we  sell  and  it  costs  $12  a  barrel  to  operate 
that  oil.  We  have  to  pay  royalty. 

So  right  now,  we  are  losing  almost  $2  a  barrel  on  the  oil  that 
we  produce.  We  can't  survive,  and  you  are  going  to  lose  12  million 
barrels  of  oil,  certainly  at  least  a  million,  and  that  is  $7  bilHon 
more.  Surely  we  can  come  up  with  something  that  will  protect 
100,000  jobs. 

Mr.  McCrery.  Mr.  Campbell. 

Mr.  Campbell.  Congressman,  I  think  there  are  a  couple  of  over- 
riding issues.  First,  it  really  is  in  the  best  interest  of  this  country, 
I  think,  to  have  a  strong  exploration  and  production  industry  and 
refining  and  marketing  industry.  I  reallv  believe  that.  Second, 
there  is  a  difference  between  the  crude  oil  import  fee  and  the  re- 
fined product  fee  that  I  was  talking  about. 

In  the  case  of  the  crude  oil  fee,  the  world  is  awash  in  crude  oil. 
It  is  today  and  if  you  look  at  conservation,  alternative  fuels,  refor- 
mulated gasoline  and  oxygenates,  the  world  will  be  awash  in  crude 
oil  for  a  long  time. 

Any  import  fee  that  you  put  on  crude  oil  increases  the  cost  of  en- 
ergy in  this  country.  We  can  talk  about  the  amount,  but  that  is  the 
impact.  In  the  case  of  the  refined  product  fee,  there  is  a  big  dif- 
ference. When  the  Congress  passed  the  regulatory  laws  that  we  are 
living  with  today,  you  already  raised  the  cost  to  manufacture  a 
product  in  this  country. 

You  have  created  that  high  cost  product  island  versus  the  rest 
of  the  world.  We  are  talking  about  the  ability  of  foreign  manufac- 
turers to  undercut  that  because  they  aren't  playing  by  the  same 
rules.  So  the  higher  cost  product  has  already  been  created  by  the 
regulations  and  laws  recently  passed. 

Mr.  McCrery.  I  don't  disagree  with  that,  but  that  is  not  nec- 
essarily a  reason  to  exacerbate  the  problem.  I  mean,  I  share  Mr. 
Damron's  concern  and  I  am  from  Louisiana,  so  I  certainly  share 
the  concern  of  the  independent  producers. 

We  have  already  lost  somewhere  between  450,000  and  600,000 
jobs  depending  on  whose  estimates  you  believe,  so  another  100,000 
may  not  seem  too  critical.  But  certainly  those  of  us  in  the  energy 
producing  states  would  like  to  preserve  what  we  have  left  and  even 
create  more.  The  way  to  do  that  obviously  is  to  get  the  price  up. 

So  I  am  kind  of  stuck  between  the  concerns  of  our  manufacturing 
sector  and  the  concerns  of  the  producing  sector.  What  about  an  im- 
port fee  tied  to  a  peg  price,  put  on  a  sliding  scale,  so  that  if  the 
world  price  drops  below  the  peg  price,  the  import  fee  would  kick 
in?  Let's  say  we  establish  a  peg  price  of  $21  a  barrel.  If  the  world 
price  is  $17,  there  is  a  $4  import  fee.  Have  you  considered  that? 

It  seems  to  me  that  may  encourage  OPEC  and  other  producers 
to  limit  their  production  to  meet  our  peg  price,  giving  some  added 
incentive  to  get  the  price  up  to  our  peg  price.  What  do  you  think 
about  that? 

Mr.  Damron.  a  floor  price  still  gives  you  an  oil  import  fee  if  the 
world  oil  price  is  below  the  floor  price.  So  that  still  means  that  the 
chemical  industry  is  less  competitive  in  world  markets  under  that 
circumstance. 

Mr.  McCrery.  That  is  true.  If  the  world  price  were  below  the  peg 
price  and  we  had  an  import  fee,  you  are  right;  it  would  increase 


1288 

your  cost  vis-a-vis  your  competitors.  But  if  that  peg  price  gave  the 
rest  of  the  world's  producers  the  incentive  to  cut  production  to  meet 
our  peg  price,  then  you  wouldn't  be  at  a  disadvantage. 

Ms.  Lazenby.  My  comment  is  that  the  independent  producers 
would  welcome  such  an  initiative.  But  I  understand  the  concerns 
that  the  chemical  industry  and  I  am  sure  the  refining  industry 
might  have.  I  would  like  to  say  that  as  independent  producers  and 
U.S.  independent  producers  and  business  people  we,  like  the  refin- 
ers and  the  chemical  people,  are  paying  a  very  high  environmental 
cost  which  we  are  happy  to  pay. 

We  are  responsible  operators,  and  we  would  like  to  work  together 
with  this  committee  and  our  sister  industries  to  try  to  come  up 
with  some  method  that  keeps  our  refining,  our  chemical  and  our 
production  business  alive.  We  may  have  differences  in  nuances,  but 
we  ought  to  be  able  to  sit  down  and  work  something  out  and  do 
it  now  because  the  time  is  fleeting. 

Mr.  Campbell.  If  I  could  make  one  point.  I  indicated  to  you  that 
the  laws  are  increasing  the  cost  in  this  country  so  there  is  no  need 
to  exacerbate  that.  We  are  not  in  a  equilibrium  state.  We  have  just 
begun  to  make  the  investments  as  far  as  the  Clean  Air  Act  and 
other  regfulations  are  concerned,  so  it  is  not  a  state  of  equilibrium. 

An  important  point  is  that  rather  than  make  these  investments, 
in  many  cases,  we  are  shutting  down  plants.  I  just  shut  down  the 
fuel  section  of  our  Tulsa  refinery.  We  laid  off  the  people  in  that  re- 
finery that  has  been  around  for  almost  100  years;  because  you  can't 
invest  $150  million  in  that  refinery.  As  we  continue  to  move  for- 
ward with  reformulated  gasoline  one  in  1995,  reformulated  two  in 
1998,  there  will  be  more  and  more  of  those  plants  shut  down. 

As  long  as  you  can  take  the  industry  and  go  offshore  and  produce 
the  product  and  pollute  there  and  bring  it  back  in  under  today's 
costs  in  this  country,  you  have  to  recognize  that  you  are  going  to 
shut  down  the  refining  industry  in  this  country.  I  do  consider  that 
a  national  security  issue,  and  I  will  tell  you  the  reason  why.  When 
we  are  talking  about  importing  crude  oil,  you  are  talking  probably 
between  12  and  15  countries  out  there  and  the  threat  has  always 
been  the  formation  of  a  cartel  and  consequently  their  dictating 
prices  to  you. 

In  the  case  of  product,  you  have  very  few  foreign  manufacturers 
overseas.  You  don't  have  12  to  15.  Consequently,  once  we  shut 
down  refineries,  there  is  no  starting  them  back  up  again.  If  you  ex- 
port that  business,  you  will  become  dependent  upon  relatively  few 
foreign  manufacturers  to  put  that  product  into  this  country. 

By  the  way,  if  you  recall,  I  was  only  talking  about  gasoline  and 
blending  components,  not  distillate  and  heating  oils,  and  petro- 
chemicals and  residuals,  et  cetera.  You  primarily  hear  about  gaso- 
line and  gasoline  blending  components  only.  You  say  don't  exacer- 
bate the  problem.  But  as  each  year  goes  forward,  it  will  get  much 
worse. 

Mr.  McCrery.  I  was  referring  to  other  manufacturing  sectors  of 
the  economy,  not  yours. 

Mr.  Damron. 

Mr.  Damron.  Congressman,  let  me  make  a  few  comments  here. 
We  are  in  support  of  the  refining  industry.  We  are  dependent  on 


1289 

the  refining  industry,  so  we  would  like  to  see  the  domestic  refining 
industry  do  well  because  they  supply  our  raw  materials. 

Two,  the  concern  about  environmental  regulation  they  have  also 
applies  to  other  people  that  have  to  comply  with  environmental 
regulations  also  and  compete  with  foreign  competitors  that  do  not 
have  to  comply  with  those  same  type  of  regulations. 

Three,  if  you  want  a  differential  between  the  crude  price  and  the 
refined  petroleum  products,  the  only  way  I  can  see  you  can  main- 
tain the  differential  is  put  some  kind  of  a  ceiling  on  crude  oil.  We 
are  not  proposing  a  ceiling,  but  it  seems  that  would  be  necessary 
in  order  to  maintain  a  differential. 

Mr.  McCrery.  Thank  you  very  much. 

Thank  you,  Mr.  Chairman  for  your  indulgence.  This  country 
faces  a  problem  with  respect  to  its  energy  needs  and  its  domestic 
energy  producing  and  manufacturing  sectors,  and  it  is  something 
this  committee  ought  to  be  concerned  about. 

Thank  you  all  for  your  testimony. 

Mr.  Payne.  Mr.  Camp. 

Mr.  Camp.  Thank  you,  Mr.  Chairman.  I  will  direct  my  questions 
to  Mr.  Alfers  or  Mr.  Kelly,  whoever  can  answer  them. 

Regarding  the  severance  tax  on  hard  rock  minerals,  what  would 
that  include  and  can  you  tell  me  what  "hard  rock  minerals"  means? 

Mr.  Kelly.  Let  me  say  that  I  was  very  surprised  when  the  an- 
nouncement came  out  about  the  proposal  for  the  severance  tax  and 
the  first  persons  that  I  called,  because  I  didn't  think  there  was  a 
Tax  Code  definition,  was  our  geologist  and  R&D  people,  and  they 
weren't  sure,  and  had  a,  apparently  a  glossary  of  terms  used  in  the 
mining  industry,  and  the  response  was  that  any  mineral  that  has 
to  be  blasted  as  a  part  of  its  mining  extraction  process  is  a  hard 
rock  mineral,  and  consequently  iron  ore  is  about  as  hard  a  rock 
substance  as  you  can  get. 

And  it  was  at  that  point  that  I  concluded  that  we  had  to  take 
this  matter  seriously.  In  trying  to  find  out  more  about  the  genesis 
of  this  proposal,  we  ran  into,  you  might  say,  a  blind  alley.  We  could 
not  trace  it  back,  and  even  today,  we  were  attempting  to  try  to  find 
out  if  iron  ore  was,  let's  say,  originally  intended  to  be  part  of  this 
severance  tax,  and  we  have  not  been  able  to  get  a  conclusive  an- 
swer as  of  this  moment. 

Mr.  Camp.  Mr.  Chairman,  do  we  have  before  the  committee  any 
revenue  estimates  for  this  particular  proposal,  any  background  on 
how  this  information  or  calculation  might  be  made? 

Mr.  Payne.  We  do  not  have  any  such  revenue  estimate. 

Mr.  Camp.  Do  we  know  if  there  are  any  studies  that  have  been 
submitted  to  the  committee  on  this  proposal? 

Mr.  Payne.  Not  at  this  time. 

Mr.  Camp.  Thank  you  very  much.  Just  as  an  aside,  Mr.  Camp- 
bell, your  company  used  to  have  a  regional  headquarters  in  my 
hometown  and  it  was  a  very  welcome  corporate  citizen.  I  think  one 
of  the  reasons  it  is  not  there  anymore  is  outlined  in  your  testimony. 
It  was  good  to  have  you  here  and  I  appreciate  your  comments. 

Mr.  Campbell.  Thank  you  very  much. 

Mr.  Payne.  I  have  a  couple  of  questions  just  to  further  my  under- 
standing concerning,  first,  the  import  fee.  Ms.  Lazenby,  you  said 
that  right  now  you  are  losing  $2  a  barrel  at  the  world  price  so  that 


1290 

means  there  are  people  in  the  world  who  are  able  to  produce  oil 
for  $2  a  barrel  less  than  our  domestic  manufacturers  or  domestic 
producers  are  producing  oil  and  are  still,  I  assume,  making  a  prof- 
it? 

Ms.  Lazenby.  That  is  correct. 

Mr.  Payne.  In  order  to  sell  at  today's  world  price? 

Ms.  Lazenby.  That  is  correct. 

Mr.  Payne.  Then  the  increased  tariff  being  discussed  here  is  15 
cents  per  barrel? 

Ms.  Lazenby.  No,  85  cents  per  barrel. 

Mr.  Payne.  So  that,  at  least  in  today's  market,  it  doesn't  equate 
to  the  differential 

Ms.  Lazenby.  It  doesn't  completely  cover  our  problem,  but  what 
it  is  is  an  offset  for  some  tax  policies,  the  tax  policy  where  we  could 
get  a  production  credit,  where  we  could  raise  additional  funds  in 
order  to  keep  our  production  going. 

For  example,  if  you  have  production  and  it  is  a  declining  asset 
and  production  is  going  down,  if  you  can  take  some  cash  flow  that 
you  could  get  from  reduced  taxes.  Right  now  we  are  not  paying  a 
lot  of  tax  because  we  are  losing  money,  we  don't  have  a  positive 
cash  flow.  The  reason  for  this  proposed  import  fee,  there  are  two 
reasons.  One  is  to  pay  for  the  proposed  production  credit  that  Rep- 
resentative Mike  Ajidrews  proposed,  which  would  give  cash  flow  to 
producers  in  order  to  be  able  to  reinvest  that  and  keep  the  produc- 
tion from  falling. 

The  other  rationale  and  necessity  for  something,  and  it  has  come 
up  now  because  of  the  steep  drop  in  prices  and  it  doesn't  look  like 
it  is  going  to  turn  around  soon,  is  the  very  low  price  that  makes 
just  our  base  production  uneconomic.  So  there  are  two  problems. 

One  is  keeping  base  production  alive  with  a  price  that  is  a  floor 
price  that  keeps  us  at  least  at  a  positive  cash  flow  or  else  you  are 
looking  at  losing  a  million  barrels  a  day.  Yes,  there  are  countries 
and  companies  that  can  produce  oil  at  lesser  price  but  the  question 
is  are  we  going  to  let  that  cheaper  oil  come  in  and  lose  100,000  jobs 
and  increase  our  trade  deficit  by  $7  billion?  That  is  the  ultimate 
question. 

Mr.  Payne,  What  would  an  import  tax  of  85  cents  a  barrel  on 
crude  oil  ultimately  cost  the  consumer  per  gallon  of  gasoline? 

Ms.  Lazenby.  Less  than  2  cents. 

Mr.  Payne.  Mr.  Campbell,  won't  there  be  problems  associated 
with  an  import  fee  relative  to  our  GATT  agreement? 

Mr.  Campbell.  Mr.  Chairman,  the  short  answer  to  that  is  no. 
Both  U.S.  trade  laws  and  the  GATT  agreement  recognize  the  need 
for  unilateral  tariffs  in  the  event  that  a  country  such  as  the  United 
States  has  a  national  security  issue.  I  think  there  have  been  a 
number  of  studies,  the  most  recent  completed  in  July  of  this  year, 
indicating  the  trend  we  are  on  in  the  national  refining  industry  is 
creating  a  national  security  issue. 

That  is  at  least  part  of  an  answer  to  my  colleague  who  indicated 
that — the  issue  I  am  talking  about  applies  to  U.S.  manufacturing 
in  general  to  the  degree  that  products  can  be  produced  overseas  at 
less  cost  and  consequently  you  shut  it  down  here.  The  difference 
between  our  industry  and  the  rest  of  manufacturing  is  the  issue 


1291 

around  national  security,  so  it  does  not  conflict  with  the  GATT 
agreement. 

Mr.  Payne.  I  have  also  one  question  concerning  mineral  re- 
sources, and  Mr.  Alfers,  you  mentioned  as  you  began  your  testi- 
mony that  you  weren't  sure  whether  this  is  private  land  or  public 
land  and  I  am  not  sure  either.  I  understand  that  there  are  a  mil- 
lion-plus hard  rock  mining  claims  now  on  Federal  lands  based  on 
the  mining  laws  of  1872,  and  my  question  to  you  is:  Do  you  feel 
that  it  would  be  appropriate  on  Federal  lands  for  those  who  extract 
hard  rock  minerals  to  pay  something  in  terms  of  a  royalty  or  sever- 
ance tax  back  to  the  taxpayers  as  those  minerals  are  extracted? 

Mr.  Alfers.  This  issue  of  a  fair  return  to  the  public  has  been 
aired  now  since  1989,  and  the  industry  has  come  to  supporting  a 
bill  that  has  passed  the  Senate  that  includes  both  holding  fees  and 
a  royalty.  Those  holding  fees  have  been  introduced  as  part  of  the 
budget  process  for  the  past  couple  of  years  and  have  had  quite  an 
impact.  Just  as  of  September  1993,  we  are  now  able  to  see  how  the 
small  business  operators  in  the  mining  industry  have  so  quickly  re- 
sponded to  just  this  $100  holding  fee. 

Many  thought  it  would  be  very  small  and  very  little  impact,  and 
there  were  those  who  would  argue  that  taxes  on  an  industry  like 
this  can  simply  be  passed  on  somewhere.  We  have  learned  in  the 
past  couple  of  weeks  that  claims  are  dropping.  We  don't  know  ex- 
actly how  much.  A  newspaper  on  the  West  Coast  reported,  esti- 
mated between  60  and  80  percent  of  the  holdings  of  these  mining 
claims  will  be  dropped. 

That  is  important  for  all  of  us  trying  to  project  revenue  impacts 
and  economic  impacts,  because  a  $100  fee  on  a  claim  that  is 
dropped  yields  $0,  not  $100.  So  it  underscores  the  point  that  when 
we  impose  a  tax  on  mining  on  these  public  lands,  whether  it  is  a 
holding  fee  or  a  royalty,  we  are  dealing  with  an  industry  that  can- 
not pass  on  these  burdens.  They  deal  in  a  highly  competitive  mar- 
ket especially  in  the  case  of  metals.  The  response  will  be  to  drop 
their  land  holdings,  close  or  downsize  mines  or  cut  their  explo- 
ration projects  and  send  them  elsewhere.  We  are  seeing  evidence 
of  that  now. 

Mr.  Payne.  I  think  you  mentioned  that  the  average  margin  was 
8  or  9  percent.  Is  there  a  differential  between  the  private  land  and 
public  lands  profit  differential? 

Mr.  Alfers.  I  have  not  seen  one  that  has  shown  up  in  our  data. 
We  didn't  specifically  look  project  by  project  to  test  profit  margins. 
The  profit  margins  tended  to  be  more  of  a  variance  of  the  life  of 
the  mine,  the  commodity  and  the  current  prices  and  not  a  fact  that 
they  are  on  public  lands  or  private  lands. 

Mr.  Payne.  But  wouldn't  it  be  true  that  the  cost  of  goods  would 
be  higher  on  private  lands  where  more  payments  would  have  to  be 
made  than  on  public  lands? 

Mr.  Alfers.  In  some  cases  that  may  be  so,  where  there  may  be 
a  greater  burden  of,  say,  private  royalties.  The  fact  is  that  a  mining 
project  whether  a  public  lands  project  or  private  lands  project 
stands  many  royalties  because  in  the  mining  business,  the  royalty 
is  really  compensation  for  those  along  the  chain  of  title  in  a  project 
that  have  made  contributions  and  led  to  the  discovery  of  the  de- 
posit. 


1292 

That  is  so  on  private  lands  and  public  lands.  So  a  prospector  on 
public  land  who  discovers  a  project  and  turns  that  project  to  a 
major  mining  company  will  have  a  royalty  very  much  like  a  private 
royalty.  So  it  is  not  fair  to  see  this  as  an  unlevel  playing  field. 

On  the  private  side,  those  who  contribute  to  the  discovery  of  a 
project  are  often  rewarded  for  that,  and  that  is  also  so  for  those 
prospectors  and  explorers  on  public  lands.  I  wouldn't  expect  to  see 
a  big  differential  there. 

It  is  also  fair  to  say  that  a  high  tax  in  the  area  of,  say,  12  per- 
cent on  the  gross  or  high  royalties  would  no  doubt  disadvantage 
public  lands,  because  that  sort  of  burden  is  not  common  in  the  pri- 
vate sector.  Ordinarily,  one  does  not  have  to  negotiate  for  140  per- 
cent of  the  margins  to  obtain  a  project  in  the  private  sector.  So 
these  royalties  and  these  taxes  would  tend  to  drive  projects  some- 
where else,  overseas,  private  lands  if  we  have  them. 

In  this  country,  private  lands  is  no  refuge  for  the  mining  indus- 
try. Public  lands  occupy  nearly  a  third  of  the  land  area  of  the  Unit- 
ed States  and  in  the  areas  where  the  minerals  occur,  it  is  a  much 
higher  percentage  than  that — 90  percent  in  some  western  states, 
95  percent  in  Alaska.  These  are  all  public  lands,  and  if  we  effec- 
tively deny  access  to  these  public  lands,  there  is  no  place  for  that 
industry  to  go.  There  is  not  enough  private  land  with  minerals  on 
them  in  order  to  fill  that  gap.  We  are  seeing  now  the  exploration 
dollars  going  overseas  and  that  is  likely  where  it  will  go. 

Mr.  Payne.  You  said  that  your  industry  was  supporting  the  ac- 
tions of  the  Senate.  What  did  the  industry  decide  to  support? 

Mr.  Alfers.  The  industry  supports  Senator  Craig's  bill  which 
has  passed  the  Senate.  It  is  a  bill  that  has  among  other  things  a 
holding  fee  on  the  holding  of  mining  claims,  a  production  royalty 
on  the  production  of  minerals  off  of  mining  claims,  an  abandoned 
mine  land  fund,  some  reform  of  the  reclamation  bonding,  some  pro- 
visions to  assure  compliance  and  reclamation  of  all  permitted 
mines  on  public  lands.  But  the  main  distinction  between  the  ap- 
proaches in  the  Senate  and  the  approaches  in  the  House  are  really 
in  this  royalty. 

On  the  Senate  side,  it  is  a  royalty  that  is  based  on  the  net  profits 
from  the  mining.  It  is  not  exactly  a  net  profit  as  some  may  know 
it,  but  it  is  net  of  mining  costs  and  then  downstream  processing 
cost. 

On  the  Senate  side,  we  have  a  royalty  based  on  the  gross  pro- 
ceeds received  from  the  sale  of  a  finished  product.  There  is  some- 
thing unfair  about  that  gross  proceeds  approach.  A  gross  proceeds 
approach  has  no  analog  anywhere  that  I  know  of  It  is  not  like  Fed- 
eral royalties  on  coal;  it  is  not  like  Federal  royalties  on  gas.  Those 
royalties  are  paid  at  the  well  head  in  the  case  of  oil  and  gas,  and 
they  are  paid  at  mine  mouth  in  the  case  of  coal. 

The  royalty  in  the  House  bill  is  on  a  finished  product  of,  say, 
gold.  It  is  not  like  those  other  products.  In  the  case  of  metals  min- 
ing, which  we  spent  some  effort  to  analyze  these,  there  was  a  lot 
of  value  added  from  the  mouth  of  the  mine  to  market.  That  is  the 
problem.  That  is  why  we  see  this  arithmetic  that  says  an  8  percent 
royalty  can  swallow  80,  85  percent  of  the  profit  margin. 

The  Senate  bill  measures  the  royalty  at  the  mine  mouth.  That 
means  profitable  mines  pay  the  royalty,  less  profitable  mines  carry 


1293 

a  lesser  burden,  but  they  are  allowed  to  stay  open.  We  save  the 
jobs  and  we  continue  the  life  of  the  mines  somewhat  longer  and 
they  can  that  way  fund  the  reclamation  that  is  already  required  in 
the  permits. 

Mr.  Payne.  Thank  you. 

Mr.  Hoagland. 

Mr.  Hoagland.  Mr.  Alfers,  have  you  had  a  chance  to  review  the 
testimony  that  will  be  presented  in  the  next  panel  by  Friends  of 
the  Earth? 

Mr.  Alfers.  I  haven't  seen  it.  Before  I  walked  up  here,  I  just  saw 
a  couple  of  pages  of  that. 

Mr.  Hoagland.  Maybe  you  are  unable  to  respond  then  to  some 
of  the  statements  in  the  second  section  of  their  testimony,  impose 
a  severance  tax  on  hard  rock  minerals.  I  will  read  the  initial  para- 
graph. 

"Hard  rock  mining  has  come  under  increasing  scrutiny  for  its 
legacy  in  environmental  and  social  damage.  The  Mineral  Policy 
Center  recently  documented  the  vast  environmental  damage  caused 
by  more  than  a  half  million  abandoned  hard  rock  mines  in  its  re- 
port, "Burden  of  Guilt."  Left  behind  aft;er  mining  companies  pull 
out  of  mines  are  wastes  containing  highly  toxic  substances  such  as 
arsenic,  asbestos,  cyanide  and  mercury.  These  wastes  contaminate 
nearby  air,  land,  water  and  underground  aquifers."  And  then  it 
continues  to  study  data  collected  by  the  World  Resources  Institute. 
And  their  concern  sounds  like  the  huge  piles  of  tailings  that  are 
left  behind  untended.  And  that  it  would — ^to  clean  up  and  restore 
areas  surrounding  mines  requires  billions  of  dollars,  between  $32 
and  $71  billion  they  estimate  here. 

Mr.  Alfers.  I  will  try  to  respond  to  that.  I  haven't  had  a  chance 
to  review  it  carefully.  First,  it  is  important  to  draw  a  distinction 
between  the  reclamation  of  mines  from  the  past  and  the  reclama- 
tion of  mines  now.  I  thought  I  heard  you  using  the  present  tense 
there. 

Mines  permitted  today  require  reclamation,  so  it  is  a  mistake  to 
try  to  impose  too  harsh  a  burden  on  those  who  are  doing  the  envi- 
ronmental job  to  pay  for  something  in  the  past.  Mining  companies 
reclaim  today.  Did  they  always  reclaim?  No;  no  more  than  manu- 
facturers or  anybody  else  who  operated  before  the  word  environ- 
mental even  found  its  way  into  our  lexicon. 

We  have  a  problem  here  with  abandoned  mines  from  the  past 
and  there  are  lots  of  solutions.  I  rather  think  that  the  numbers 
that  we  see  from  the  Mineral  Policy  Center  are  a  little  overblown. 
But  whether  they  are  or  not,  what  is  important  is  not  to  get  the 
cart  before  the  horse. 

We  should  figure  out  what  the  problem  is  and  how  to  solve  it  be- 
fore we  try  to  fund  it.  A  number  of  ways  to  solve  these  abandoned 
mine  problems  is  to  encourage  the  remining  of  these  projects,  for 
example.  If  they  are  remined  and  permitted,  they  will  be  reclaimed, 
and  we  are  seeing  examples  of  that  now  around  the  West.  So  I 
think  we  should  all  take  a  look  at  this  problem. 

The  Senate  bill  which  industry  supports  provides  for  an  mind 
land  reclamation  fund,  an  abandoned  mine  fund,  and  we  would  like 
to  see  this  problem  solved,  but  we  should  get  our  arms  around  the 
magnitude  of  it  before  we  try  to  fund  it. 


1294 

Mr.  Kelly.  Could  I  have  a  quick  response  from  an  iron  ore  per- 
spective? I  would  say  that  the  lady  that  you  are  referring  to  from 
what  you  have  read  has  to  be  exaggerating.  It  sounds  like  there  is 
a  Love  Canal  in  every  county  in  the  United  States,  and  I  think  this 
has  to  be  an  exaggeration. 

I  also  want  to  say  that  iron  ore  happens  to  be,  and  that  is  what 
I  represent  here,  an  inert  waste  problem,  and  is  not  of  any  con- 
sequence whatsoever.  I  agree  with  Mr.  Alfers  on  the  reclamation 
requirements,  but  I  would  also  and  moreover  say  that  we  have  a 
Superfund  law  and  we  have  state  laws  such  as  in  Michigan — it  is 
the  307  sites — and  these  are  mines  that  have  previously  been 
closed. 

And  there  is  a  tremendous  effort  being  done  to  find  the  respon- 
sible parties,  and  through  the  Superfund  law,  they  are  being 
cleaned  up,  we  think  not  at  quite  the  rate  they  should  be,  but  1 
think  that  is  a  deficiency  in  the  Superfund  law,  which  is  of  course 
not  our  subject  here  today. 

Ms.  Lazenby.  May  I  make  one  more  comment?  I  would  like  to 
say  that  I  understand  the  administration  is  considering  a  floor 
price,  which  would  take  care  of  or  help  alleviate  this  up  and  down 
ride  on  crude  prices  and  that  the  small  import  fee  would  be  in  com- 
bination with  a  floor  price  and  the  small  import  fee  would  be  used 
to  offset  the  tax  policy  such  as  Congressman  Andrews  proposes  to 
stimulate  domestic  production.  We  need  a  combination,  but  we 
need  something  to  keep  the  bottom  from  falling  out  from  under- 
neath us. 

Mr.  Payne.  Thank  you.  I  thank  the  panel.  It  has  been  interesting 
for  the  subcommittee.  We  appreciate  your  time,  especially  waiting 
while  we  went  to  vote. 

Thank  you. 

Mr.  HOAGLAND.  Good  afternoon,  everyone.  We  now  have  before 
us  panel  6,  and  the  first  witness  that  we  are  to  hear  from  is  Dawn 
Erlandson  from  Friends  of  the  Earth.  Ms.  Erlandson. 

STATEMENT  OF  DAWN  ERLANDSON,  DIRECTOR  OF  TAX 
POLICY,  FRIENDS  OF  THE  EARTH 

Ms.  Erlandson.  Thank  you.  Mr.  Chairman  and  members  of  the 
committee,  good  afternoon.  I  am  Dawn  Erlandson,  director  of  tax 
policy  for  Friends  of  the  Earth.  Friends  of  the  Earth  is  a  global  en- 
vironmental advocacy  group  with  affiliates  in  50  other  countries. 
Thank  you  for  the  opportunity  to  appear  before  the  committee 
today  on  behalf  of  Friends  of  the  Earth  to  express  our  support  for 
three  of  the  miscellaneous  revenue  proposals  before  you. 

They  include  expansion  of  the  tax  on  ozone  depleting  chemicals, 
a  severance  tax  on  hard  rock  minerals,  and  disallowance  of  deduc- 
tions for  environmental  malfeasance.  These  proposals  represent  op- 
portunities not  only  to  raise  revenues  for  the  Federal  Treasury,  but 
also  to  further  environmental  protection.  The  tax  on  ozone  deplet- 
ing chemicals  is  one  of  the  most  powerful  tools  that  Congress  has 
created  to  protect  the  ozone  layer.  Unfortunately  all  chemicals  that 
deplete  the  ozone  layer  are  not  taxed. 

Accordingly,  we  urge  the  committee  to  cover  those  chemicals. 
They  include  methyl  bromide,  hydrochlorofluorocarbons  or  HCFCs, 
and  hydrobromofluorocarbons  or  HBFCs.  Methyl  bromide  is  a  wide- 


1295 

ly  used  fumigant  pesticide  that  not  only  depletes  the  ozone  layer, 
but  is  extremely  toxic.  Methyl  bromide  is  currently  responsible  for 
5  to  10  percent  of  ozone  depletion  and  if  emissions  continue  to  in- 
crease, it  will  be  responsible  for  15  percent  of  ozone  depletion  by 
2000. 

Industry  is  marketing  HCFCs  as  bridge  chemicals  between  CFCs 
and  ozone  safe  alternatives,  yet  some  HCFCs  are  as  damaging  as 
methyl  chloroform,  which  is  already  taxed.  Further  scientific  re- 
search conducted  by  NOAA  shows  that  HCFCs  are  more  damaging 
to  the  ozone  layer  than  previously  thought.  Industry  is  developing 
HBFCs  to  replace  firefighting  chemicals  known  as  halons,  yet 
ozone  safe  alternatives  to  nalons  exist. 

It  is  important  to  note  that  Congress  has  previously  taxed  all 
chemicals  controlled  by  the  Montreal  protocol.  In  addition,  all 
chemicals  categorized  as  class  one  substances  under  the  Clean  Air 
Act  are  taxed.  Since  the  committee  last  amended  this  tax,  the  par- 
ties to  the  Montreal  protocol  met  in  November  1992  in  Copenhagen 
and  listed  all  three  chemicals  as  controlled  substances. 

In  addition,  they  proposed  phasing  out  HBFCs  by  1996,  freezing 
consumption  of  methyl  bromide  at  1991  levels  in  1995,  and  requir- 
ing industrialized  countries  to  cap  HCFC  use  in  1996  and  phase  it 
out  by  2030.  In  February  EPA  proposed  listing  methyl  bromide  and 
HBFCs  as  class  one  substances  under  the  Clean  Air  Act  and  accel- 
erating the  HCFC  phase  out  schedule.  They  also  proposed  freezing 
production  of  methyl  bromide  at  1991  levels  by  1994  and  phasing 
it  out  by  2000,  as  well  as  phasing  HBFCs  out  by  1996. 

More  than  a  half  million  abandoned  hard  rock  mines  have  con- 
taminated the  air,  land  and  water  of  nearby  communities.  Hard 
rock  mining  produces  massive  quantities  of  waste  and  a  trail  of 
toxics,  including  arsenic,  cyanide,  asbestos  and  mercury.  Given  the 
legacy  of  environmental  degradation  associated  with  hard  rock 
mining,  we  urge  the  committee  to  adopt  a  broad-based  severance 
tax  on  hard  rock  minerals  as  both  a  means  to  compensate  tax- 
payers in  affected  communities  for  the  value  of  the  resource  ex- 
tracted and  for  the  waste  and  pollution  left  behind,  as  well  as  a 
funding  mechanism  for  cleanup  and  reclamation. 

Estimates  of  the  costs  of  reclamation  range  from  $20  to  $70  bil- 
lion. Of  course,  any  severance  tax  adopted  should  complement  cur- 
rent efforts  to  reform  the  1872  mining  law.  Yet  as  the  focus  of  min- 
ing reform  law  is  on  public  lands,  85  percent  of  hard  rock  mining 
occurs  on  non-Federal  lands.  Clearly  then  a  broad  severance  on  all 
extraction  rather  than  on  extraction  from  Federal  lands  only  would 
raise  the  most  revenue. 

Finally,  when  the  Exxon  Valdez  ran  aground  off  the  coast  of 
Alaska,  we  were  horrified  at  the  devastation  that  resulted.  Some- 
what relieved,  we  learned  that  Exxon  would  have  to  pay  over  $1 
billion  to  the  Government  for  the  disaster.  What  few  of  us  know  is 
that  that  $1  billion  was  tax  deductible  and  that  Exxon  was  able  to 
reduce  its  tax  bill  and  therefore  shift  $250  million  or  one-fourth  of 
the  settlement  cost  to  America's  other  taxpayers.  Outrageous  but 
perfectly  legal. 

Under  current  law,  companies  that  pollute  the  environment, 
whether  by  illegally  dumping  toxic  wastes  or  spilling  oil,  can  de- 
duct the  associated,  costs  as  ordinary  and  necessary  business  ex- 


1296 

penses.  What  are  not  ordinary  and  necessary  business  expenses 
under  current  law  include  illegal  bribes  and  kickbacks,  net  gam- 
bling losses  and  lavish  meal  or  beverage  expenses.  Even  this  com- 
mittee and  this  Congress  have  found  it  appropriate  to  limit  the  de- 
ductibility of  certain  business  expenses  associated  with  behavior 
that  is  clearly  less  deplorable  thsm  many  environmental  crimes.  In- 
deed, the  budget  bill  just  adopted  eliminated  business  deductions 
for  lobbying  and  for  executive  pay  over  $1  million. 

The  code  then  denies  business  deductions  for  normative  reasons 
in  order  to  engender  policies  of  less  than  critical  concern,  yet  there 
are  no  such  limitations  on  illegal  environmental  pollution  and  deg- 
radation. It  is  time  that  the  Federal  tax  law  reflect  the  fact  that 
polluting  this  Nation  is  not  an  ordinary  and  necessary  business  ex- 
pense. We  urge  you  to  adopt  legislation  proposed  by  Congressman 
Gerry  Studds,  H.R.  2441,  and  eliminate  the  ability  of  companies 
that  pollute  the  environment  to  pass  on  their  costs  to  other  tax- 
payers. Thank  you. 

Mr.  HOAGLAND.  Thank  you,  Ms.  Erlandson. 

[The  prepared  statement  follows:] 


1297 


Statement  of 

Dawn  Eriandson 
Director  of  Tax  Policy 
Friends  of  the  Earth 

On  Behalf  of 

Friends  of  the  Earth 

Hoarding 

Miscellaneous  Revenue-raising  Proposals 

Before  the 

Subcommittee  on  Select  Revenue  Measures 

Committee  on  Ways  and  Means 

United  States  House  of  Representatives 


September  8,  1993 


INTRODUCTION 

MR.  CHAIRMAN  AND  MEMBERS  OF  THE  COMMITTEE,  I  am  Dawn 
Eriandson,  Director  of  Tax  Policy  for  Friends  of  the  Earth  (FoE).  Friends  of  the  Earth  • 
is  a  global  environmental  advocacy  organization  with  affiliates  in  50  other  countries. 

Mr.  Chairman,  I  thank  you  for  the  opportuiuty  to  appear  before  the  Committee 
on  behalf  of  Friends  of  the  Earth  to  express  our  strong  support  for  three  of  the 
miscellaneous  revenue  proposals  before  you  today.  These  proposals  represent 
opportunities  not  only  to  raise  revenues  for  the  Federal  Treasury  but  also  to  further 
environmental  protection.   We  urge  the  Committee  to  embrace  these  environmentally 
sound  tax  proposals  as  it  has  similar  proposals  in  the  past  , 


STRENGTHEN  THE  TAX  ON  OZONE-DEPLETING  CHEMICALS 

The  tax  on  ozone-depleting  chemicals  is  one  of  the  most  powerful  tools  Congress 
has  created  to  protect  the  ozone  layer.  This  economic  instrument  has  successfully 
encouraged  industry  to  adopt  alternatives  to  CFCs  and  increase  CFC  recycling.   In  the 
short  period  since  the  tax  took  effea  in  1990,  U.S.  CFC  production  has  dropped 
significantly,  well  below  the  limit  allowed  by  the  Monueal  Protocol,  the  international 
ozone  protection  agreement. 

Unfortunately,  all  chemicals  that  deplete  the  ozone  layer  are  not  taxed. 
Accordingly,  we  urge  the  Committee  to  extend  the  current  tax  on  ozone-depleting 
chemical?,  to  three  additional  kinds  of  chemicals  that  harm  the  ozone  laver  and  threaten 
human  and  ecological  health.  These  chemicals  are  methyl  bromide, 
hydrochlorofluorocarbons  or  HCFCs,  and  hydrobromofluorocarbons  or  HBFCs. 


1298 


We  propose  that  the  Committee  tax  these  chemicals  using  the  same  approach  that  exists 
under  current  law:  the  tax  equals  the  base  tax  rate  multiplied  by  each  chemical's  ozone 
depletion  potential  (ODP).  The  base  rates  established  by  the  Energy  Policy  Act  of  1992 
should  be  used.  These  rates  per  pound  are:  $4.35  in  1994,  $535  in  1995,  $5.80  in  1996, 
$6.25  in  1997,  and  $6.70  in  1998. 


1.         Tax  Methyl  Bromide 

Methyl  bromide  is  a  widely  used  fumigant  pesticide.  It  not  only  depletes  the  ozone 
layer  but  is  extremely  toxic  and  can  be  lethal  if  mishandled.  The  bromine  in  methyl 
bromide  is  a  very  effective  ozone  depleter.  According  to  the  United  Nations  Environment 
Program's  (UNEP)  Methyl  Bromide  Interim  Scientific  Assessment  of  Jime  1992,  methyl 
bromide  is  currently  responsible  for  five  to  ten  percent  of  ozone  depletion,  and  if  emissions 
continue  to  increase  at  current  rates,  it  will  be  responsible  for  fifteen  percent  of  ozone 
depletion  by  2000. 

The  Parties  to  the  Montreal  Protocol  listed  methyl  bromide  as  a  controlled  substance 
in  Annex  E  of  the  November  1992  Copenhagen  amendment  to  the  protocol.  The 
amendment  freezes  industrialized  country  consumption  of  methyl  bromide  at  1991  levels  in 
1995.  The  Parties  resolved  to  decide  on  further  controls  and  a  possible  phaseout  date  by 
no  later  than  their  seventh  meeting  in  1995. 

On  February  16,  1993,  the  U.S.  Environmental  Protection  Agency  aimounced  a 
proposal  to  list  methyl  bromide  as  a  Class  I  Substance  under  Title  VI  of  the  Clean  Air  Act 
Amendments  of  1990.  The  Notice  of  Proposed  Rulemaking  proposes  to  freeze  methyl 
bromide  production  at  1991  levels  by  January  1,  1994  and  phase  out  production  by  January 

1,  2000. 

Congress  has  previously  taxed  all  chemicals  controlled  by  the  Montreal  Protocol.  The 
tax  initially  covered  CFCs  and  halons,  and  subsequently  Congress  expanded  the  tax  to 
include  methyl  chloroform  and  carbon  tetrachloride.  The  expansion  followed  the  June  1990 
London  amendment  to  the  protocol,  which  added  these  chemicals  to  the  list  of  controlled 
substances.  In  addition,  all  chemicals  categorized  as  a  Class  I  Substance  under  the  Clean 
Air  Act  are  subject  to  the  excise  tax. 

Annex  E  of  the  Copenhagen  amendment  to  the  Montreal  Protocol  lists  methyl 
bromide's  ozone  depletion  potential  (ODP)  at  0.7.  Based  on  an  estimated  1991  methyl 
bromide  production  level  of  50  million  pounds  per  year,  a  methyl  bromide  tax  would  yield 
$995.75  million  over  the  1994-1998  period.  This  revenue  estimate,  however,  does  not 
account  for  conservation  measures  which  the  tax  would  initiate  or  a  more  stringent  phaseout 
schedule. 

UNEP's  June  1992  methyl  bromide  assessment  indicates  that  significant  reductions 
in  methyl  bromide  can  be  achieved  during  the  1990s  by  replacing  the  chemical  with 
alternatives,  using  recovery  and  recycling  technology,  and  adopting  improved  practices. 

EPA's  policies  aimed  at  methyl  bromide  will  not  cut  methyl  bromide  consumption 
below  1991  levels  until  2000.  Worsening  ozone  depletion  requires  much  stronger  measures. 
Increasing  the  price  of  methyl  bromide  with  a  tax  will  create  an  incentive  for  industry  to 
immediately  reduce  consumption. 

2.  Tax  HCFCs 

Industry  is  marketing  HCFCs  as  "bridge"  chemicals  between  CFCs  and  ozone-friendly 
alternatives.  Nonetheless,  HCFCs  are  ozone-destroying  chemicals  and  should  not  be  exempt 
from  the  tax.  Indeed,  some  HCFCs  are  as  damaging  as  methyl  chloroform,  which  is  taxed. 
(According  to  the  ODPs  listed  in  the  Montreal  Protocol  and  the  Clean  Air  Act,  HCFC-141B 
and  methyl  chloroform  have  the  same  ODP  of  0.1.) 


1299 


Congress  recognized  the  environmental  impact  of  HCFCs  in  the  Qean  Air  Act 
Amendments  of  1990.  The  Act  requires  HCFC  recycling,  bans  certain  HCFC  applications, 
and  phases  out  HCFC  production  between  2015  and  2030. 

Parties  to  the  Montreal  Protocol  listed  HCFCs  as  controlled  substances  in  the  Annex 
C  of  the  November  1992  Copenhagen  Amendment  to  the  protocol.  The  Amendment 
requires  industrialized  countries  to  cap  HCFC  use  in  1996  and  then  reduce  HCFC 
consumption  by  35%  in  2004,  65%  in  2010,  90%  in  2015,  99.5%  in  2020,  and  100%  in  2030. 

On  February  16,  1993,  the  U.S.  EPA  annoimced  a  Notice  of  Proposed  Rulemaking 
that  proposes  accelerating  the  HCFC  phaseout  schedules  in  the  Qean  Air  Act  on  the  basis 
that  such  reductions  are  necessary  to  fwotect  human  health  and  the  environment  and  that 
they  are  technically  feasible.  The  agency  is  proposing  to  phaseout  HCFC-141B  in  2003, 
HCFC-22  and  HCFC-142B  in  2020.  and  aU  other  HCFCs  in  2030.  The  agency  beUeves 
these  reduction  will  meet  the  HCFC  requirement  of  the  Copenhagen  amendment  to  the 
Montreal  Protocol. 

Scientific  research  conducted  at  the  US  National  Oceanic  and  Atmospheric 
Administration  (NOAA)  shows  that  HCFCs  are  more  damaging  to  the  ozone  layer  than 
previously  thought.  While  their  long-term  ozone-depleting  potentials  (ODPs)  range  from 
2  to  10  percent  of  that  of  CFCs,  their  near-term  (5  to  10  years)  ODPs  are  much  higher.  For 
example,  HCFC-22  has  an  ODP  of  0.19  over  5  years  and  0.17  over  10  years  while  its  steady- 
state  ODP  is  only  0.05. 

Ozone-safe,  chemical-free  alternatives  and  less  harmful  chemicals  to  the  ozone  layer, 
such  as  HFCs,  have  been  developed.  While  HCFCs  and  HFCs  tend  to  contribute  to  cUmate 
change,  HFCs  tend  to  be  more  expensive  than  HCFCs.  Taxing  HCFCs  would  encourage 
industry  to  adopt  the  most  environmentally  sound  alternatives. 

Based  on  estimates  of  ODP-weighted  HCFC  production  in  the  United  States,  an 
HCFC  tax  would  yield  $753.02  million  over  the  1994-1998  period. 

3.         Tax  HBFCs 

HBFCs  are  chemicals  that  industry  is  developing  to  replace  fire-fighting  chemicals 
known  as  halons.  HBFCs  have  higher  ODPs  than  HCFCs.  For  example.  Fire  Master  100 
(HBFC-22B1),  developed  by  Great  Lakes  Chemical  to  replace  Halon-1301  and  Halon-1211, 
has  an  ODP  of  0.7.) 

Industry  has  developed  ozone-safe  alternatives  to  halons.  For  example,  Ansul  Fire 
Protection  is  manufacturing  a  halon  replacement  called  Inergen,  which  has  an  ODP  of  0. 

Parties  to  the  Montreal  Protocol  listed  HBFCs  as  controlled  substances  in  Armex  C 
of  the  Copenhagen  Amendment.  Due  to  then-  high  ODPs,  the  Parties  agreed  to  phase  out 
HBFCs  by  January  1,  1996,  on  the  same  schedule  as  CFCs. 

EPA's  Notice  of  Proposed  Rulemaking  proposes  listing  HBFCs  as  Class  I  Substances 
and  phasing  them  out  by  January  1,  1996. 


IMPOSE  A  SEVERANCE  TAX  ON  HARD  ROCK  MINERALS 

Hardrock  mining  has  come  imder  increasing  scrutiny  for  its  legacy  of  envirbnmeptal 
and  social  damage.  The  Mineral  Policy  Center  recently  documented  the  vast  environmental 
damage  caused  by  more  than  half  a  mUlion  abandoned  hardrock  mines  in  its  report,  Burden 
of  Guilt.  Left  behind  after  mining  companies  pull  out  of  mines  are  wastes  containing  highly 
toxic  substances  such  as  arsenic,  asbestos,  cadmium,  cyanide,  and  mercury.  These  wastes 
contaminate  nearby  air,  land,  water  and  underground  aquifers,  thus  threatening  human 
health  as  well  as  the  economic  vitality  of  neighboring  communities. 


1300 


In  addition  to  a  trail  of  toxics,  mining  operations  leave  behind  massive  quantities  of 
waste.  According  to  unpublished  data  from  the  World  Resources  Institute,  much  of  the 
excavated  material  from  mining  operations  is  waste.  For  both  metals  and  non-metallic 
minerals,  overburden  waste  accounts  for  29  percent  of  the  total  metric  tons  of  material 
mined.  For  metals  such  as  phosphorus  and  copper,  overburden  wastes  account  for  57 
percent  of  the  total  material  mined.  And  in  the  case  of  gold,  overburden  waste  accounts 
for  a  whopping  78  percent  of  the  total  material  excavated. 

Given  the  legacy  of  environmental  degradation  associated  with  hardrock  mining,  we 
urge  the  Committee  to  consider  adoption  of  a  broad-based  severance  tax  on  hardrock 
minerals  as  both  a  means  to  compensate  taxpayers  and  affected  communities  for  the  value 
of  the  resource  extracted  and  for  the  waste  and  pollution  left  behind  and  a  funding 
mechanism  for  cleanup  and  restoration.  Such  a  tax  would  be  levied  as  hardrock  minerals 
are  removed,  or  "severed,"  from  the  mine.  The  rate  of  tax  as  proposed  would  be  12  percent 
of  the  value  of  the  removal  price  of  the  mineral. 

To  clean  up  and  restore  areas  surrounding  mines  requires  billions  of  dollars.  The 
Mineral  Policy  Center  estimates  that  cleanup  costs  range  from  $32.7  to  $71.5  billion.  A 
severance  tax  such  as  the  one  under  consideration  by  the  Committee  could  provide  essential 
resources  to  undertake  the  desperately  needed  cleanup.  Precedence  for  such  a  dedicated 
fund  exists  in  the  form  of  the  Abandoned  Mine  Land  Fund  for  restoring  abandoned  coal 
mines.   Such  a  fund  could  be  financed  with  a  reclamation  fee  or  a  severance  tax. 

As  you  know,  the  Committee  on  Natural  Resources  is  in  the  process  of  reforming  the 
Mining  Law  of  1872  and  is  examining  the  issue  of  royalties.  The  environmental  community 
strongly  supports  reform  and  has  endorsed  reform  legislation,  H.R.  322.  We  urge  the  Ways 
and  Means  Committee  to  work  closely  with  the  Committee  on  Natural  Resources  to  adopt 
a  suitable  reform  plan  that  includes  severance  taxes. 

Much  of  the  focus  of  reform  of  the  1872  Mining  Law  is  on  the  management  of 
hardrock  mining  operations  on  public  lands.  However,  environmental  damage  caused  by 
hardrock  mining  does  not  occur  only  on  federal  lands.  In  fact,  an  estimated  85  percent  of 
hardrock  mining  actually  occurs  on  non-federal  lands.  These  lands  include  private,  state- 
owned  and  federal  lands  that  have  been  "patented"  by  private  companies  for  mining. 

Clearly,  the  greatest  revenue  to  be  raised  would  come  from  a  broad-based  severance 
tax  on  all  extraction  rather  than  on  extraction  from  federal  lands  only.  An  ancillary  benefit 
of  a  broad  severance  tax  would  allow  the  federal  government  to  collect  some  financial 
remuneration  from  companies  that  have  taken  title  to  public  land  through  patents.  Under 
current  law,  patenting  precludes  the  federal  government  from  collecting  royalties  from  the 
mining  companies.  Historically,  mining  companies  have  patented  lands  when  they  feared 
the  imposition  of  royalties  on  the  minerals  removed.  Recently,  the  Bureau  of  Land 
Management  has  been  deluged  with  patent  applications  by  miners  seeking  to  avoid  paying 
the  royalties  which  seem  imminent  in  the  proposed  reform  of  the  1872  Mining  Law. 

Many  states  have  some  form  of  severance  tax  on  hardrock  mining.  Generally,  these 
severance  taxes  apply  to  all  mining,  not  just  that  on  state-owned  lands.  Since  many  states 
already  impose  severance  taxes,  it  would  be  relatively  simple  to  follow  with  a  federal 
severance  tax.  Further,  the  existence  of  both  state  and  federal  levies  on  cigarettes  and 
gasoline  demonstrate  that  the  existence  of  a  tax  at  one  level  does  not  preclude  the  existence 
of  a  similar  tax  at  another  level. 

As  it  is  clear  that  taxpayers  have  an  interest  in  assuring  that  public  lands  not  be 
ravaged  by  profit-seeking  mining  operators  and  that  they  be  duly  compensated  for  the  value 
of  the  mineral  as  well  as  cleanup  costs  and  environmental  restoration  associated  with  the 
mining  wastes,  we  submit  that  a  federally-imposed  severance  tax  be  adopted  in  order  to 
further  the  public  interest. 


1301 


DISALLOW  DEDUCTIONS  FOR  ENVIRONMENTAL  MALFEASANCE 

In  1989,  the  Exxon  Valdez  ran  aground  off  the  coast  of  Alaska  and  spilled  nearly  11 
million  gallons  of  crude  oil  into  Prince  William  Sound.  In  1991,  Exxon  reached  a  settlement 
with  the  Federal  Government  and  the  State  of  Alaska  in  which  it  agreed  to  pay  $1,025 
billion  in  fines  and  damages  to  repair  the  vast  environmental  destruction  to  the  Alaskan 
shoreline.  Of  the  $1,025  billion,  only  $25  million  was  an  actual  fine  and,  under  current  law, 
not  tax  deductible.  The  remainder  of  the  settlement,  however,  was  characterized  as 
restitution  and  therefore  was  and  is  tax  deductible.  Indeed,  $1  billion  in  clean-up  costs, 
legal  fees,  damages,  and  even  the  11  million  gallons  of  oil  that  devastated  the  Soimd  were 
tax  deductible. 

The  effect  of  the  ability  of  Exxon  to  deduct  these  costs  from  its  tax  bill  were 
dramatic.  According  to  analyses  done  by  the  National  Wildlife  Federation  and  the  Alaska 
State  Legislature,  the  value  of  the  $1  billion  in  federal  and  state  tax  dedurtions  to  Exxon 
ranged  from  $279  to  298  million  dollars  in  reduced  tax  liability.  The  National  Wildlife 
Federation  estimated  that  Exxon  would  reduce  its  federal  tax  bill  by  $257  million  and  its 
Alaskan  tax  bill  by  $22  million.'  As  a  result,  Exxon  successfully  shifted  part  of  its 
responsibility  for  the  devastation  it  wrought  in  Alaska  to  America's  taxpayers,  some  of  whom 
lived  in  Alaska  and  suffered  direct  damage  from  the  spill. 

Last  Congress,  Congressman  Frank  Guarini  recognized  the  outrageousness  of 
requiring  American  taxpayers  to  assume  even  part  of  the  responsibility  for  a  company's 
negligent,  even  intentional,  pollution  of  the  environment.  He  introduced  legislation,  H.R. 
1726,  to  limit  tax  deductions  in  cases  of  environmental  malfeasance. 

This  Congress,  Chairman  Gerry  Studds  has  offered  comparable  legislation,  H.R.  2441. 
Chairman  Studds  bill  would  disallow  deductions  for  amounts  paid  pursuant  to  settlements 
and  for  compensatory  damages  under  certain  environmental  laws.  The  money  saved  by 
eliminating  this  tax  break  would  be  used  as  an  offset  for  tax  relief  for  people  who  pay  a 
disproportionately  high  percentage  of  their  income  for  sewer  and  water  services.  We  urge 
the  Committee  to  adopt  Chairman  Stucjds  legislation  ^nd  limit  thg  ability  pf  companies  that 
pollute  the  environment  to  pa.ss  on  their  costs  to  other  taxpayers. 

Under  current  tax  law,  companies  that  pollute  the  environment,  whether  by  spilling 
oil  or  dumping  toxic  wastes  illegally,  are  allowed  to  deduct  all  the  costs  associated  with  the 
pollution  as  ordinary  and  necessary  business  expenses,  even  though  the  companies  were 
found  to  have  broken  the  law. 

Some  would  argue  that  these  costs  should  continue  to  be  deductible  because  the 
purpose  of  the  Code  is  to  raise  revenues  and  that  businesses,  whether  good  or  evil,  are  taxed 
on  their  net  incomes.  Since  ill-gotten  gains  are  taxed,  some  aigae,  then  the  costs  of 
producing  such  gains  should  be  deductible.  However,  under  U.S.  tax  law,  all  tax  deductions 
were  once  subject  to  the  so-called  "public  policy  limitation,"  the  thrust  of  which  was  to 
disallow  a  deduction  in  any  instance  where  allowing  the  deduction  would  fi-ustrate  a  sharply 
defined  government  policy.  Tliis  "public  policy  limitation"  remains  in  effect  for  a  few 
business  deductions  that  are  deemed  to  violate  the  public  good  including  illegal  bribes  and 
kickbacks,  treble  damage  payments  under  the  antitrust  laws,  and  fines  and  penalties.^ 


^  Hearing  Record,  Task  Force  on  Urgent  Fiscal  Issues, 
Committee  on  the  Budget,  U.S.  House  of  Representatives,  "Budgetary 
Implications  of  the  Exxon  Valdez  Oil  Spill  Settlement,"  October  31, 
1991,  Washington,  DC. 

^  Asbjorn  Eriksson,  Robert  Hertzog,  John  Tiley,  David 
Williams,  Friedrich  von  Zezschwitz,  Taxation  for  Environmental 
Protection;  A  Multinational  Legal  Study,  ed.  Sanford  E.  Gaines  and 
Richard  A.  Westin  (Westport,  CT:  Quor\im  Books,  1991),  pp.  187  - 
189. 


1302 


Even  this  Committee  and  this  Congress  have  found  it  appropriate  to  limit  the 
deductibility  of  certain  business  expenses  associated  with  behavior  that  is  clearly  less 
deplorable  than  oil  spills  or  dumping  of  toxic  wastes.  Indeed,  the  budget  bill  that  the 
Congress  just  passed  eliminated  the  business  deductions  for  lobbying  expenses  and  executive 
pay  over  $1  million.  It  further  limited  the  deduction  for  business  meals  and  entertaimnent 
expenses  to  50  percent,  thereby  complementing  current  law  which  denies  all  deductions  for 
meal  or  beverage  expenses  that  are  lavish  or  extravagant. 

The  Code,  then,  denies  business  deductions  for  normative  reasons  in  order  to 
engender  policies  of  less  than  critical  concern,  yet  there  are  no  such  limitations  on  producers 
of  environmental  pollution  and  waste.  No  justifiable  reason  can  explain  why  we  deny 
business  deductions  for  high  executive  pay  and  lobbying  expenses  while  allowing  deductions 
for  expenses  related  to  illegal  environmental  devastation.  Failing  to  bar  taxpayers  from 
claiming  deductions  for  environmentally  destructive  business  behavior  amounts  to  a  tax 
subsidy  for  prima  facie  illegitimate  behavior.' 

The  Studds  bill  sends  the  right  messages  to  corporate  polluters.  Continuing  to  allow 
income  tax  deductions  for  violations  of  environmental  laws  seriously  undermines  the 
deterrent  effect  of  the  environmental  laws.  In  many  cases,  it  may  be  cheaper  for  a  company 
to  risk  a  violation  than  to  invest  in  prevention.  Thus,  denying  deductions  for  environmental 
cleanup  expenses  would  provide  a  significant  incentive  for  companies  to  comply  with  this 
nation's  environmental  laws,  and  to  safeguard  against  negligence.  Contrary  to  industry 
arguments,  denying  deductions  would  not  frustrate  expenditures  for  enviroimiental  cleanup 
because,  under  law,  the  companies  must  clean  up.  TTiere  is  no  need  to  provide  incentives 
to  obey  the  law.  It  is  time  the  federal  tax  code  reflected  the  fact  that  polluting  this  nation 
is  not  an  ordinary  and  necessary  business  expense. 

This  Committee  has  heard  in  the  past  about  the  perverse  effects  of  current  U.S.  tax 
policy  on  the  environment.  Allowing  a  tax  deduction  for  cleanups  associated  with 
environmental  crimes,  at  a  time  when  honest  taxpayers  cannot  afford  adequate  water  and 
sewage  service,  is  the  quintessential  example  of  this  perversity.  Currently,  we  give  tax  breaks 
to  polluters,  while  communities  cannot  pay  their  sewer  and  water  bills  because  of  the  high 
costs  of  dealing  with  water  pollution.  The  Studds  bill  addresses  this  incongruity.  Polluters 
must  pay  for  the  harms  that  they  cause,  only  then  will  they  recognize  the  true  costs  of  their 
actions.  The  American  taxpayer  must  no  longer  subsidize  behavior  that  is  environmentally 
irresponsible. 


'  Ibid. 


1303 

Mr.  HOAGLAND.  Mr.  Merlis. 

STATEMENT  OF  EDWARD  A.  MERLIS,  SENIOR  VICE  PRESI- 
DENT, EXTERNAL  AFFAIRS,  AIR  TRANSPORT  ASSOCIATION 
OF  AMERICA 

Mr.  Merlis,  Thank  you,  Mr.  Chairman.  I  appreciate  the  oppor- 
tunity to  appear  before  you  today  to  discuss  several  revenue  meas- 
ures which  will  have  a  substantial  impact  upon  the  financial  health 
of  the  U.S.  air  carriers.  I  am  Edward  Merlis,  senior  vice  president 
of  the  Air  Transport  Association  of  America.  ATA's  17-member  car- 
riers flv  96  percent  of  the  revenue  passenger  miles  and  97  percent 
of  the  freight  carried  by  U.S.  flag  carriers. 

The  airline  industry  is  currently  facing  desperate  financial  times. 
Having  suffered  unprecedented  losses  since  1990,  airlines  have 
parked  aircraft,  slashed  capital  orders  and  furloughed  workers. 

As  a  result,  earlier  this  year  the  Congress  established  a  National 
Airline  Commission  to  investigate,  study,  and  make  policy  rec- 
ommendations about  the  financial  health  and  future  competitive- 
ness of  the  U.S.  airlines  and  aerospace  industry.  The  commission 
has  now  completed  its  report  and  documented  industrywide  losses 
of  $10  billion  over  the  last  3  years. 

Among  the  negative  influences  on  airline  industry  health  cited  by 
the  commission  were,  "tax  policies  which  often  have  had  a  major 
and  adverse  effect  on  the  industry."  Although  the  commission  con- 
cluded that  "tax  changes  alone  will  not  restore  the  industry  to  prof- 
itability," it  did  observe  without  hesitation  that  "we  believe  there 
are  several  tax  provisions  that  impede  the  ability  of  the  industry 
to  return  to  financial  health."  Thus,  it  is  with  some  chagrin  that 
the  industry  finds  itself  once  again  in  the  position  of  needing  to  ad- 
dress proposed  changes  to  the  Tax  Code  which  would  adversely  af- 
fect the  environment  in  which  we  operate,  particularly  in  light  of 
the  commission  having  identified  Federal  taxes  totaling  more  than 
$1.5  billion  per  year  that  need  to  be  cut.  Measures  which  in  the 
commission's  words  "violate  reasonable  principles  of  common  sense 
and  good  public  policy." 

Instead  of  appearing  here  today  in  support  of  efforts  by  Congress 
to  implement  the  recommendations  of  your  commission,  we  are 
here  discussing  a  series  of  proposals  which  would  exacerbate  the  fi- 
nancial strains  on  the  industry  and  add  to  the  tally  of  jobs  lost  in 
the  airlines,  aircraft,  and  engine  manufacturers  and  in  the  travel 
and  tourism  industry. 

The  first  proposal  I  would  like  to  address  amends  the  Internal 
Revenue  Code  to  deny  a  business  deduction  for  that  portion  of  the 
cost  of  an  airline  ticket  in  excess  of  coach  fare.  While  the  proposal 
will  be  directed  at  the  business  traveler,  the  true  burden  will  fall 
upon  the  airline  industry  itself  To  the  extent  flyers  switch  to  coach 
as  a  result  of  the  enactment  of  this  proposal,  the  Government  does 
not  gain  any  revenue  and  the  airline  industry  loses  much  needed 
revenue.  Assuming  all  business  travelers,  who  would  otherwise 
travel  in  business  or  first  class  switched  to  coach  class  for  domestic 
tickets  only,  the  U.S.  airline  industry  would  lose  $220  million  per 
year  and  would  in  all  likelihood  lay  off  several  thousand  flight 
attendants. 


1304 

In  actual  practice  we  do  not  expect  all,  nor  do  we  know  which 
business  travelers  who  currently  travel  in  business  or  first  class 
would  switch  to  a  coach  seat.  Some  may,  in  fact,  choose  to  charter 
aircraft  at  greater  cost  to  the  Treasury  and  greater  injury  to  the 
airlines. 

This  proposal  is  particularly  objectionable  to  ATA  member  air- 
lines because  it  arbitrarily  singles  out,  one,  travel  fi^om  other  busi- 
ness expenses  and,  two,  air  travel  fi^om  other  business  travel.  The 
proposal  clearly  and  unfairly  targets  the  airline  industry.  Deduc- 
tions for  business  expenses  for  other  sectors  of  the  travel  industry, 
such  as  hotels,  cruise  lines,  trains  and  rental  cars,  are  not  im- 
pacted bv  this  proposal,  even  though  different  classes  of  service  can 
be  purchased  in  each  and  every  one  of  those  travel  industry 
services. 

Why  should  the  airline  industry,  which  has  been  hemorrhaging 
since  the  beginning  of  this  decade,  be  the  only  travel  industry  com- 
ponent that  must  bear  the  cost  of  this  proposed  change  in  deduc- 
tion policy?  Travel  in  business  or  first  class  is  not  undertaken  on 
a  lark  by  business  travelers.  Many  businesses  allow  their  employ- 
ees to  travel  in  first  or  business  class  because  the  seating  and  table 
space  are  more  conducive  to  work.  Oftentimes  corporate  policies 
limit  the  use  of  first  or  business  class  only  to  flights  of  greater  du- 
ration or  distance.  Such  travel  is  particularly  preferred  by  business 
travelers  on  international  flights.  In  general,  they  can  rest  more 
comfortably  and  be  better  equipped  to  handle  their  responsibilities 
at  their  international  destination. 

In  each  of  these  situations  the  business  travelers  made  a  legiti- 
mate business  decision  to  purchase  extra  space  in  which  to  work 
or  sleep.  The  proposed  change  in  the  deductibility  of  first  class 
fares  will  have  a  devastating  impact  upon  the  revenue  generated 
by  the  class  of  service.  A  far  higher  proportion  of  passengers  in  a 
first  class  cabin  has  paid  full  fare  for  their  seats  than  do  pas- 
sengers in  coach.  Moreover  the  average  yield  for  first  class  pas- 
sengers is  17.5  percent  higher  than  that  for  a  coach  class  pas- 
senger. Consequentlv,  driving  passengers  out  of  the  first  class 
cabin  will  appreciably  harm  airline  revenues  and  will  place  addi- 
tional pressure  on  airlines  to  cut  flights,  reduce  work  schedules, 
and  diminish  capital  expenditures,  particularly  aircraft  orders. 
There  does  not  appear  to  be  any  rationale  to  disallow  an  otherwise 
lawful  business  deduction  and  penalize  an  otherwise  commonly  ac- 
cepted business  practice. 

In  addition,  from  a  tax  policy  standpoint,  the  proposal  should  not 
be  adopted  because  of  its  clear  propensity  to  distort  competition  in 
the  marketplace.  Deductions  for  travel  on  charters,  corporate  air- 
craft or  airlines  which  offer  only  one  class  of  service  are  not  limited 
by  the  legislation.  Thus,  airlines  which  offer  multiple  classes  of 
service  and  thereby  respond  to  different  consumer  needs  would  be 
penalized  and  first-class-only  carriers  rewarded. 

From  an  administrative  perspective  the  proposal  would  be  an  ac- 
counting nightmare.  It  would  create  a  layer  of  complexity  both  for 
taxpayers  and  the  Internal  Revenue  Service. 

Business  travelers,  corporate  travel  departments  and  the  IRS 
will  be  forced  to  monitor  not  only  the  first  class  fare  paid  but  also 
the  coach  price  of  a  ticket  for  the  flight  taken  and  the  availability 


1305 

of  a  coach  seat.  Identification  of  the  cost  of  a  coach  ticket  is  not 
easy  in  the  competitive  air  travel  market.  The  price  of  a  coach  tick- 
et may  change  between  the  time  the  traveler  makes  his  reservation 
and  the  time  he  takes  his  flight.  By  the  time  a  company  is  audited, 
reliable  data  identifying  the  difference  between  the  coach  fare  and 
the  first  class  fare  is  unlikely  to  exist. 

Further  compounding  the  problem  would  be  the  situation  faced 
by  a  last-minute  traveler  whose  only  means  of  access  to  a  specific 
flight  is  to  purchase  a  first  class  fare.  Under  the  terms  of  the  pro- 
posal would  a  business  deduction  be  available  for  the  difference  be- 
tween first  and  coach  class?  Even  if  a  deduction  were  to  be  allowed 
in  such  a  circumstance,  record  keeping  requirements  would  be 
intolerable. 

The  Air  Transport  Association  stronglv  opposes  this  legislation 
and  recommends  that  the  proposal  not  be  adopted  because  of  its 
negative  impacts  upon  the  airline  industry,  the  traveling  public 
and  the  Federal  Government. 

Mr.  Chairman,  my  written  statement  covers  two  of  the  other  pro- 
posals which  others  far  more  qualified  than  I  have  already  ad- 
dressed earlier  today.  Thank  you  very  much  for  this  opportunity. 

Mr.  HOAGLAND.  Thank  you,  Mr.  Merlis. 

[The  prepared  statement  follows:] 


1306 


Statement  of  Edward  A.  Merlis 

Senior  Vice  President,  External  Affairs 

Air  Transport  Association  of  America 

Before  the  Subcommittee  on  Select  Revenue  Measures 

Committee  on  Ways  and  Means 

U.S.  House  of  Representatives 

Concerning  Miscellaneous  Revenue  Issues 

September  8,  1993 


I  am  Edward  Merlis,  Senior  Vice  President  of  the  Air  Transport  Associarion  of 
America.   I  appreciate  this  opportunity  to  appear  before  you  today  to  discuss  three  revenue 
measures  that  will  have  a  substantial  impact  upon  the  financial  health  of  the  17  U.S.  air 
carriers  who  arc  members  of  the  Air  Transpon  Association.  These  airlines  carry  over  96 
percent  of  the  revenue  passenger  miles  and  transport  over  97  percent  of  the  freight  carried  by 
U.S.  flag  airlines. 

The  airline  industry  is  currently  facing  desperate  financial  times.  Having  suffered 
unprecedented  losses  since  1990,  airlines  have  parked  aircraft,  slashed  capital  orders,  and 
furloughed  workers.  As  a  result,  earlier  this  year  the  Congress  established  a  National  Airline 
Commission  to  investigate,  study,  and  make  policy  recommendations  about  the  financial 
health  and  future  competitiveness  of  the  U.S.  airlines  and  aerospace  industry.   The 
Commission  has  now  completed  its  repon  and  documented  industry  -  wide  losses  of  $  10 
billion  over  the  last  Uiree  years. 

Among  the  negative  influences  on  airline  industry  health  cited  by  the  Commission 
were  "tax  policies  [which]  often  have  had  a  major  and  adverse  effect  on  the  industry". 
Although  the  Commission  concluded  that  "tax  changes  alone  will  not  restore  the  industry  to 
profitability,"  it  did  observe,  without  hesitation,  that  "we  believe  there  are  several  tax 
provisions  that  impede  the  ability  of  the  industry  to  return  to  financial  health." 

Thus  it  is  with  some  chagrin,  that  the  industry  finds  itself  once  again  in  the  position  of 
needing  to  address  proposed  changes  to  tiic  tax  code  which  would  adversely  affect  the 
environment  in  which  we  operate,  particularly  in  light  of  the  Commission  having  identified 
Federal  taxes  totaling  more  than  $  1.5  billion  per  year  that  need  to  be  cut  ~  measures  which, 
in  the  Commission's  words  "violate  reasonable  principles  of  common  sense  and  good  public 
policy." 

Instead  of  appearing  here  today  in  support  of  efforts  by  Congress  to  implement  the 
recommendations  of  your  Commission,  we  are  here  discussing  a  series  of  proposals  which 
would  exacerbate  the  financial  stimns  on  the  indusdy  and  add  to  the  tally  of  jobs  lost  in  the 
airlines,  aircraft  and  engine  manufacturers,  and  the  travel  and  tourism  industries. 


Deduction  limitations  for  airline  tickets. 

The  first  proposal  we  wish  to  address  amends  the  Internal  Revenue  Code  to  deny  a 
business  deduction  for  that  portion  of  the  cost  of  an  airline  ticket  in  excess  of  coach  fare. 
While  the  proposal  will  be  directed  at  the  business  traveler,  the  true  burden  will  fall  upon  the 
airline  industry  itself  To  the  extent  flyers  switch  to  coach,  as  a  result  of  the  enactment  of 
this  proposal,  the  government  does  not  gain  any  revenue  and  the  airline  industry  loses  much 
needed  revenue.  Assuming  all  business  travelers  who  would  otherwise  travel  in  business  or 
first  class  switch  to  coach  class,  the  U.S.  airline  industry  would  lose  $  220  million  per  year 
and  would  in  all  likelihood  lay  off  several  thousand  flight  attendants.  In  actual  practice,  we 
do  not  know,  however,  whether  those  business  travellers  who  would  currentiy  travel  in 
business  or  first  class  will  switch  to  a  coach  seat.  Some  may,  in  fact,  choose  to  charter 
aircraft  at  greater  cost  to  the  Treasury  and  injury  to  the  airlines. 

This  proposal  is  particularly  objectionable  to  ATA  member  airlines  because  it 
arbitrarily  singles  out  1)  travel  from  all  other  business  expenses  and  2)  air  travel  from  all 


other  travel.  The  proposal  clearly  and  unfairiy  targets  the  airline  industry.  Deductions  for 
business  expenses  for  other  sectors  of  the  travel  industry  such  as  hotels,  cruise  lines,  trains 
and  rental  cars  are  not  impacted  by  this  proposal  even  though  different  classes  of  service  can 
be  purchased  in  each  and  every  one  of  those  travel  industry  services.  Why  should  the  airline 
industry,  which  has  been  hemoniiaging  since  the  beginning  of  this  decade,  be  the  only  travel 
industry  component  that  must  bear  the  cost  of  this  proposed  change  in  deduction  policy? 

Mr.  Chairman,  travel  in  business  or  flrst  class  is  not  undertaken  on  a  laric  by  business 
travelers.   Many  businesses  allow  their  employees  to  travel  in  first  class  or  business  class  of 
an  airplane  because  die  seating  and  table  space  are  more  conducive  to  work.  Often  dmes 
corporate  policies  limit  the  use  of  first  or  business  class  only  to  flights  of  greater  duration  or 
distance.   Such  travel  is  particularly  preferred  by  business  travelers  on  international  flights. 
In  general  they  can  rest  more  comfortably  and  be  better  equipped  to  handle  their 
responsibilities  at  their  international  destination.   In  each  of  these  situations  the  business 
traveler  has  made  a  legitimate  business  decision  to  purchase  extra  space  in  which  to  work  or 
sleep  while  traveling. 

The  proposed  change  in  the  deductibility  of  first-class  fares  will  have  devastating 
effect  upon  the  revenue  generated  by  the  class  of  service.  A  far  higher  proportion  of 
passengers  in  a  first  class  cabin  have  paid  the  full  faire  for  their  seats  than  do  passengers  in 
coach.  Moreover,  the  average  yield  for  a  first  class  passenger  is  17.5%  higher  than  that  for  a 
coach  class  passenger.   ConsequenUy,  driving  passengers  out  of  the  first  class  cabin  will 
appreciably  harm  airline  revenues  and  will  place  additional  pressure  on  airlines  to  cut  flights, 
reduce  tiieir  work  forces,  and  diminish  capital  expenditures,  especially  aircraft  orders.  There 
does  not  appear  to  be  any  rationale  to  disallow  an  otherwise  lawful  business  expense 
deduction  and  penalize  an  otherwise  commonly  accepted  business  practice. 

In  addition.  Mr.  Chairman,  from  a  tax  policy  standpoint,  the  proposal  should  not  be 
adopted  because  of  its  clear  propensity  to  distort  competition  in  the  marketplace.   Deductions 
for  travel  on  charters,  corporate  aircraft,  or  airlines  which  offer  only  one  class  of  service  are 
not  limited  by  the  legislation.  Thus  airlines  which  offer  multiple  classes  of  service  and 
thereby  respond  to  different  consumer  needs,  would  be  penalized,  and.  first  class  only- 
cairiers,  rewarded. 

From  an  administrative  perspective  the  proposal  would  be  an  accounting  nightmare.  It 
would  create  a  layer  of  complexity  both  for  taxpayers  and  the  Internal  Revenue  Service. 
Business  travelers,  corporate  travel  departments  and  the  IRS  will  be  forced  to  monitor  not 
only  the  first-class  fare  paid  but  also  the  coach  price  of  a  ticket  for  the  flight  taken  and  the 
availability  of  a  coach  seat  Identification  of  the  cost  of  a  coach  ticket  is  not  easy  in  the 
competitive  air  travel  market  The  price  of  a  coach  ticket  may  change  numerous  times 
between  the  time  the  traveller  makes  his  reservation  and  the  time  he  takes  his  flight  By  the 
time  a  company  is  audited,  a  reliable  data  source  identifying  the  difference  between  the  coach 
fare  and  the  first  class  fare  is  unlikely  to  exist 

Further  compounding  the  problem  would  be  die  situation  faced  by  a  last  minute 
traveler  whose  only  means  of  access  to  a  specific  night  is  to  purchase  of  a  first  class  ticket 
Under  the  terms  of  the  legislation,  a  business  deduction  would  not  be  available  for  the 
difference  between  the  first  class  and  coach  class  ticket 

For  these  reasons  the  Air  Transport  Association  strongly  opposes  this  legislation  and 
recommends  diat  the  proposal  not  be  adopted  because  of  its  negative  impact  upon  the  airline 
industry,  die  travelling  public,  and  the  federal  government 


Increased  tariff  on  imported  crude  oil. 

The  proposal  to  increase  the  tariff  on  imported  crude  oil  by  15  cents  per  barrel  and 
refined  petroleum  products  by  1 -cents  per  gallon  is  unnecessarily  harsh  to  the  airline  industry 


1308 


which  must  share  the  burden  of  the  recently  enacted  transportation  fuels  tax  at  a  cost  to  the 
industry  of  $506  million  per  year  beginning  October  1,  1995.  The  increased  tariff  will  cost 
the  airline  industry  an  additional  $40  million  per  year.   It  is  akin  to  an  increase  in  the 
transportation  fuels  tax,  which  the  National  Airline  Commission  said  should  not  be  imposed 
on  the  airline  industry.   Accordingly,  the  Air  Transport  Association  recommends  that  the 
proposal  not  be  adopted. 


Amortization  of  advertising  expenses. 

The  proposal  to  require  a  portion  of  advertising  expenses  be  capitalized  and  amortized 
over  a  period  of  years  should  not  be  adopted.   Capitalization  is  generaUy  required  in  the  case 
of  assets  which  have  a  long  useful  life.  Advertising  campaigns  for  airline  travel  generally 
have  a  relatively  short  shelf  life.   They  are  run  for  a  short  period  of  time  to  capture  an 
audience  for  a  specific  travel  market  or  to  announce  new  discount  air  fares.    In  addition, 
these  ad  campaigns  serve  to  promote  travel  and  tourism,  which  benefits  the  economy  of  every 
state  in  the  U.S.  As  such,  the  expenses  associated  with  airline  advertising  campaigns  should 
remain  curtendy  deductible. 

Each  of  the  above  proposals  has  a  negative  impact  upon  the  financial  health  of  the 
airline  industry.  The  airline  industry  faces  many  hurdles  as  it  tries  to  return  to  profitability. 
It  does  not  need  to  face  additional  costs  resulting  from  new  tax  rules  which  impact  its 
business  operations  and  expenses. 


1309 
Mr.  HOAGLAND.  Mr.  Schmidt. 

STATEMENT  OF  HENRY  W.  SCHMIDT,  JR.,  PARTNER,  KPMG 
PEAT,  MARWICK,  ON  BEHALF  OF  CALIFORNIA  LEAGUE  OF 
SAVINGS  INSTITUTIONS 

Mr.  Schmidt.  Thank  you,  Mr.  Chairman.  My  name  is  Henry 
Schmidt.  I  am  a  partner  with  KPMG  Peat,  Marwick,  a  pubHc  ac- 
counting firm.  I  am  appearing  here  today  on  behalf  of  the  CaHfor- 
nia  League  of  Savings  Institutions.  They  represent  some  one-third 
of  the  Nation's  thrift  assets  and  9  of  the  10  largest  thrift  institu- 
tions in  the  United  States.  I  am  testifying  today  on  the  proposal 
to  treat  mortgage  points  as  earned  for  tax  purposes  when  a  loan 
is  originated. 

League  members  were  surprised  at  this  proposal,  specifically  be- 
cause just  7  months  earlier  tne  Treasury  Department  issued  a  pro- 
posed regulation  dealing  with  the  same  issue  and  that  Treasury 
regulation  proposes  to  treat  mortgage  points  in  accordance  with 
their  economic  substance.  The  issue  involves  a  form  of  circular  flow 
of  cash  and  involves  the  question  of  when  one  individual  element 
of  a  lending  transaction,  in  this  case  points,  as  earned.  We  have 
submitted  a  more  thorough  written  statement. 

My  comments  today  are  intended  as  a  brief  overview.  A  little  bit 
of  history.  Almost  40  years  ago  the  Internal  Revenue  Service  first 
published  industrywide  guidance  to  lenders  in  the  mortgage  busi- 
ness regarding  the  treatment  of  mortgage  points.  This  has  been 
readdressed  by  the  IRS  and  Treasury  from  time  to  time  and  fine 
tuned  in  major  industrywide  rulings  in  1964  and  1970,  and  it  was 
the  subject  of  some  40  plus  private  technical  advices  issued  to  in- 
dustry members  during  the  1980s. 

During  the  course  of  this  period,  most  industry  members  have 
adopted  the  IRS-approved  methods  as  first  indicated  in  1953.  Con- 
gress then  addressed  this  issue  in  the  1984  Tax  Act  and  expanded 
what  have  been  called  the  economic  accrual  concepts,  also  known 
as  original  issued  discount  rules,  to  loans  to  individuals. 

Proposed  Treasury  regulations  issued  in  1986  generally  touched 
on  this  subject  and  then,  as  I  said  earlier,  in  December  1992  Treas- 
ury regulations  were  proposed  that  dealt  specifically  with  mortgage 
loan  points.  The  December  1992  proposed  regulations  eliminate 
any  formalistic  distinction  in  lending  transactions  between  discount 
on  loans  and  stated  interest  on  loans,  something  the  lending  busi- 
ness has  long  understood. 

During  the  1980s,  FASB,  the  private  sector  accounting  body,  also 
addressed  the  very  same  issue  from  a  financial  accounting  perspec- 
tive, and  in  1987  the  FASB  published  FAS  91,  concluding  that 
points  did  not  represent  immediate  income  but  rather  another  form 
of  yield.  This  is  because  FASB  recognized  that  points  compensate 
lenders  over  the  entire  term  of  a  loan.  The  fact  that  one  lender 
charges  zero  points  and  another  perhaps  two  to  three  points  with 
compensating  differences  in  the  stated  interest  rate  is  proof  of  this 
in  the  marketplace.  So,  the  standard  setters  for  financial  account- 
ing in  the  private  sector,  beginning  in  1988,  insisted  on  the  deferral 
points  over  the  life  of  a  loan.  This  was  then  adopted  by  the  SEC 
and  all  bank  regulatorv  and  thrift  regulatory  bodies,  and  is  todav 
the  financial  and  regulatory  accounting  law  of  the  land.  Througn 


77-130  0-94-10 


1310 

a  combination  of  FAS  91  and  these  Treasury-proposed  regulations, 
we  have  now  arrived  at  consistent  treatment  of  points  by  all  Fed- 
eral agencies  that  have  examined  the  subject. 

The  proposal  before  this  committee  would  reverse  this  40-year 
process.  We  can  only  speculate  that  the  proposal  is  perhaps  in- 
tended solely  to  raise  revenue  and  not  based  on  sound  tax  policy 
nor  a  particular  understanding  or  appreciation  of  the  economic  sub- 
stance of  lending  transactions.  Perhaps  the  proposal  is  also  an  ef- 
fort to  address  continuing  disputes  between  mortgage  lenders  and 
the  Internal  Revenue  Service,  as  evidenced  by  some  recent  tax 
court  activity.  We  think  the  source  of  disputes  has  already  been  re- 
solved with  the  publication  of  the  December  1992  proposed  regula- 
tions. In  fact,  we  feel  treating  points  as  different  from  stated  inter- 
est economically  will  only  prolong  disputes  and  cause  new  ones  into 
the  future  by  encouraging  the  elevation  of  form  over  substance. 

The  California  League  of  Savings  Institutions  opposes  this  return 
to  form  over  substance.  Thank  you. 

Mr.  HoAGLAND.  Thank  you,  Mr.  Schmidt. 

[The  prepared  statement  follows:] 


1311 


<$> 


September  8,  1993 


Ms.  Janice  Mays 

Chief  Counsel  and  Staff  Director 

Committee  On  Ways  And  Means 

U.  S.  House  Of  Representatives 

1102  Longvorth  House  Office  Building 

Washington,  D.C.  20515 


Set   Hearings  On  Miscellaneous  Revenue  Provisions 
Comments  On  Proposal  To  Tax  Mortgage  Lenders 
On  The  Receipt  Of  Points 


Dear  Ms.  Mays: 

We  are  responding  to  your  request  for  public  comments  on  the 
miscellaneous  revenue  proposals  that  will  be  the  subject  of 
hearings  scheduled  for  September  8,  1993.  We  are  particularly 
concerned  with  the  proposal  that  would  require  thrift  institutions, 
or,  in  the  alternative,  all  mortgage  lenders,  to  include  in  income 
at  the  time  of  receipt  points  paid  in  connection  with  mortgage 
lending  transactions.  The  California  League  of  Savings 
Institutions  is  the  trade  association  representing  the  savings 
institutions  of  California.  Our  members  hold  one  third  of  thrift 
assets  nationwide  and  include  nine  of  the  ten  largest  savings 
institutions  in  the  country. 

We  strongly  recommend  that  the  subcommittee  reject  this  proposal. 
To  require  mortgage  lenders  to  include  points  in  income  upon 
receipt  would  be  discordant  with  the  underlying  economic  substance 
of  mortgage  lending  transactions,  and  would  not  represent  sound  tax 
policy. 

Points  paid  by  a  borrower  in  a  lending  transaction  do  not  represent 
economic  income  to  a  lender.  The  Treasury  Department  and  the 
Internal  Revenue  Service  (hereinafter,  "IRS")  affirmed  that  points 
do  not  economically  represent  income  to  a  lender  in  proposed 
regulations  promulgated  December  22,  1992.'  The  proposed 
regulations  reflect  the  economic  reality  that  points  represent  a 
reduction  in  the  net  loan  proceeds  disbursed  by  the  lender  to  or  on 
behalf  of  the  borrower  at  closing. 

As  is  explained  in  greater  detail  below,  the  Treasury  Department's 
and  the  IRS's  decision  to  treat  points  in  accordance  with  their 
economic  substance  was  made  only  after  extensive  deliberation  of 
the  proper  treatment  of  points.  In  fact,  the  decision  to  treat 
points  in  accordance  with  their  economic  substance  reverses  the 
IRS's  long-standing  position  as  expressed  in  their  published 
rulings,  their  position  as  litigated  in  the  courts,  and  their 
position  as  espoused  in  proposed  regulations  issued  in  1986. 

Failure  to  tax  financial  transactions  in  accordance  with  their 
economic  substance  invariably  leads  to  controversies  between 
taxpayers  and  the  IRS  that  turn  upon  the  form  in  which  a  taxpayer 
casts  a  transaction.  If  the  proposal  is  adopted,  the  subcommittee 
can  be  assured  that  economically  identical  transactions  will 
receive  disparate  tax  treatment. 


'      57  Fed.  Reg.  60750,  1993-3  I.R.B.  21. 

980C  S  Securveoa  Bobie--ar3 


1312 


Background 

Loan  origination  fees,  or  points,  may  be  charged  by  mortgage 
lenders  in  loan  origination  and  refinancing  transactions.  Points, 
if  charged,  are  computed  as  a  percentage  of  the  face  amount  of  the 
loan,  each  point  being  equal  to  one-percent  of  the  face  amount  of 
the  loan.  Generally,  the  interest  rate  on  residential  mortgage 
loans  that  require  the  payment  of  points  is  lower  than  the  rate  on 
residential  mortgage  loans  that  do  not  require  points.^  In 
charging  points,  a  lender  reduces  its  prepayment  or  reinvestment 
risk  because  the  effective  yield  on  a  loan  which  required  the 
payment  of  points  increases  if  the  loan  is  repaid  early. 

A  borrower  generally  has  several  options  in  handling  the  payment  of 
points: 

•  The  borrower  can  pay  points  in  cash  at  closing; 

•  The  borrower  can  have  the  points  withheld  from  the  face  amount 
of  the  loan  and  receive  only  the  net  proceeds  at  closing;  or 

•  The  borrower  can  have  the  points  added  to  the  face  amount  of 
the  loan,  but  receive  only  the  gross  amount  of  the  loan  net  of 
the  points. 

Economically,  the  three  transactions  are  equivalent.  For  instance, 
there  is  no  economic  difference  between  a  transaction  in  which  an 
institution  lends  $200,000  to  a  borrower  in  exchange  for  a  note 
with  a  face  amount  of  $200,000  euid  receives  $6,000  in  points  from 
the  borrower  at  closing  (i.e.,  the  circular  flow  of  cash),  and  a 
transaction  in  which  the  institution  simply  lends  $194,000  to  the 
borrower  in  exchange  for  a  note  with  a  face  amount  of  $200,000. 
The  tax  law  however,  has  not  always  recognized  this  equivalence. 

In  Rev.  Rul.  70-540,'  the  IRS  set  out  five  situations  concerning 
the  proper  tax  accounting  for  fees  received  by  lenders  in  various 
mortgage  lending  transactions.  Situation  1  parallels  the  first 
transaction  described  above  in  that  the  borrower  paid  the  points  to 
the  lender  with  "fresh  funds."  The  ruling  holds  that  the  lender 
must  include  the  points  in  income  upon  receipt.  In  Situation  2, 
the  borrower  did  not  pay  the  points  at  closing,  but  instead,  the 
lender  increased  the  principal  balance  of  the  loan  by  the  amount  of 
the  points.  Here,  the  ruling  holds  that  the  points  are  includible 
in  income  by  the  lender  ratably  as  payments  are  made  on  the  loan. 

Rev.  Rul.  70-540  appears,  therefore,  to  have  drawn  a  bright  line. 
If  a  borrower  paid  points  with  "fresh  funds,"  the  points  would  be 
treated  as  the  receipt  of  income  by  the  lender.  If,  on  the  other 
hand,  the  lender  simply  withheld  the  points  from  the  loan  proceeds, 
the  points  would  be  viewed  as  having  been  financed  and  would  be 
taken  into  income  over  the  life  of  the  loan  as  the  borrower  made 
payments . 

Notwithstanding  the  apparent  bright  line  drawn  by  Rev.  Rul.  70-540, 
numerous  controversies  arose  between  the  IRS  and  lenders  concerning 
the  proper  tax  treatment  of  points.  The  issue  raised  in  these 
controversies  was  whether,  in  any  given  transaction,  the  borrower 
had  in  fact  paid  points  with  fresh  funds,  thereby  requiring  current 
income  recognition  by  the  lender.   For  example,  assume  a  borrower 


'  For  example,  a  mortgage  lender  in  the  Washington,  D.C. 
metropolitan  area  recently  quoted  interest  rates  for  30  year 
residential  mortgages  as  either  6.75  percent  plus  one  point,  or 
alternatively,  7.125  percent  and  zero  points. 

'     1970-2  C.B.  101 


1313 


agreed  to  pay  $150,000  for  a  new  home,  and  asked  the  lender  to  loan 
$135,000  (other  closing  costs  and  escrow  charges  will  be 
disregarded) .  The  lender  agreed  to  make  the  loan  but  charged  the 
borrower  one  point  ($1,350) .  At  closing,  the  borrower  would  pay  to 
the  escrow  agent  $16,350.  The  lender  would  disburse  to  the  escrow 
agent  $133,650.  ($135,000  loan  amount  less  the  $1,350  in  points 
charged  the  borrower) .  Even  the  most  astute  observer  has 
difficulty  in  determining  whether  the  points  were  discounted  from 
the  loan  proceeds  or  paid  at  closing  unless  the  loan  documents 
clarify  whether  the  points  are  paid  up  front  or  financed. 

The  Tax  Court  in  1991  faced  this  dilemma.  Based  on  the  unique 
facts  in  a  particular  lenders  case,  it  upheld  the  IRS's 
determination  that  the  lender  had  received  the  points  in  cash  and 
must  include  the  "prepaid  interest"  (points)  in  income  because  the 
lender's  loan  documents  did  not  contain  an  agreement  to  finance 
points.*  Notwithstanding  the  Tax  Court's  decision  on  the  specific 
issue  of  points,  and  other  precedent  requiring  the  taxation  of 
prepaid  income',  the  Treasury  Department  and  the  IRS  subsequently 
determined  that  points  do  not  economically  represent  prepaid  income 
and  should  be  treated  as  a  reduction  in  the  issue  price  of  a  debt 
instr\iment. 


Tha  Proposed  OZO  Regulations 

On  December  22,  1992,  the  IRS  revised  previously  proposed 
regulations  interpreting  the  original  issue  discount  (OID) 
provisions  found  in  sections  1271-1275  of  the  Internal  Revenue 
Code.  Generally,  OID  is  the  difference  between  a  debt  instrument's 
issue  price  and  its  stated  redemption  price  at  maturity.  Section 
1272  requires  the  inclusion  of  OID  in  a  holder's  income  as  it 
accrues  without  regard  to  the  holder's  method  of  accounting.  The 
proposed  regulations  provide  detailed  rules  for  determining  the 
issue  price  and  stated  redemption  price  at  maturity  for  debt 
instruments. 

As  indicted  above,  the  proposed  OID  regulations  provide  specific 
rules  dealina  with  a  borrower's  payment  of  points  in  a  cash  lending 
transaction.*  These  regulations  provide  that  any  payment  from  a 
borrower  to  a  lender  (other  than  a  payment  for  services  provided  by 
the  lender,  such  as  commitment  fees  or  loan  processing  costs) 
reduces  the  issue  price  of  the  debt  instrument  evidencing  the  loan. 


*  Bell  Federal  Savings  and  Loan  Assn.  v. Commissioner. 

T.C.M.  1991-368,  addressed  this  issue.  The  court  held  that  the 
points  were  in  fact  paid  any  time  the  borrower  brought  fresh  funds 
to  closing  in  an  amount  sufficient  to  cover  the  points. 

'  Generally,  prepaid  income  for  services  must  be  included 

in  income  when  it  is  paid.  Schlude  v.  Commissioner.  372  U.S. 
128  (1963)  (advance  payments  for  dance  lessons);  American 
Automobile  Association  v.  United  States.  367  U.S.  687  (1961) 
(prepaid  dues);  RCA  Corporation  v.  United  States.  664  F.2d  881  (2d 
Cir.  1981,  cert,  denied.  457  U.S.  1133  (1982)  (television  service 
contracts) .  The  IRS  has  determined,  however,  that  the  method  of 
accounting  prescribed  in  the  above-cited  cases  (prepayments  are 
income  upon  receipt)  does  not  clearly  reflect  income  in  the  case  of 
lump  sun  payments  received  with  respect  to  notional  principal 
contracts.  Notice  89-21,  1989-1  C.B.  651;  Prop.  Treas.  Reg.  S 
1.446-3(e) (3) (ii) .  These  IRS  releases  recognize  that  financial 
instruments  that  require  performance  over  a  fixed  period  of  time 
are  fundamentally  different  from  service  contracts  where  the  amount 
and  timing  of  future  services  is  not  fixed  but  is  solely  within  the 
discretion  of  the  purchaser. 

*  Prop.  Treas.  Reg.  S  1.1273-2(j). 


1314 


Further,  the  regulations  make  it  clear  that  the  payments  of  points 
by  a  party  other  than  the  borrower  fe.a. .  the  seller)  will  also  be 
treated  as  a  reduction  in  issue  price. 

Thus,  by  charging  points  on  a  loan,  a  lender  is  treated  as  issuing 
the  loan  at  a  discount.  Generally,  the  lender  must  treat  the 
discount  as  OID  and  take  it  into  income  based  on  the  loan's  yield 
to  maturity  over  the  life  of  the  loan.^  The  loan's  yield  to 
maturity  is  the  discount  rate  that  when  applied  to  the  stream  of 
payments  to  be  made  on  the  loan  produces  an  amount  equal  to  the 
loan's  issue  price.' 

He  believe  the  treatment  in  the  proposed  010  regulations  of  cash 
points  incident  to  a  lending  transaction  results  in  the  proper 
economic  treatment  and  is  supported  by  and  consistent  with  the  tax 
policy  that  led  to  the  overhaul  of  the  OID  provisions  of  the  Code 
as  part  of  the  Deficit  Reduction  Act  of  1984  (DRA  1984) . 

Congress  recognized  in  enacting  DRA  1984  that  debt  instruments 
should  be  taxed  in  accordance  with  their  economic  substance.' 
Because,  from  an  economic  perspective,  income  accrues  on  a  loan  at 
a  constant  rate  over  the  life  of  the  loan.  Congress  adopted  tax 
rules  that  paralleled  economic  accirual.  Taxpayers  were  thereby 
prevented  from  structuring  loans  that  front-loaded  or  back-loaded 
taxable  income.  Requiring  a  lender  to  take  points  into  income  at 
closing  would,  of  course,  result  in  an  extreme  front-loading  of 
income  on  that  loan  and  would,  therefore,  be  entirely  inconsistent 
with  the  tax  policy  underlying  the  010  rules. 

Furthermore,  if  the  position  taken  by  the  IRS  and  Treasury  in  the 
proposed  regulations  is  rejected,  and  lenders  are  forced  to  treat 
points  paid  by  borrowers  as  income  upon  receipt,  controversies  will 
once  again  arise  between  the  IRS  and  lenders  as  to  whether  points 
are  paid  or  discounted.  Such  controversies  are  expensive  for  both 
taxpayers  and  the  government,  and  their  outcomes  typically  depend 
upon  subtle  nuances  in  the  form  of  a  transaction  rather  than  any 
issue  of  economic  substance. 

Section  461(g) 

Although  we  can  only  speculate  concerning  the  reasons  for  the 
proposal  to  require  current  inclusion  of  points  in  a  lender's 
income,  it  may  be  that  the  proposal's  sponsor  was  concerned  that 
failure  to  tax  points  upon  receipt  would  provide  asymmetrical  tax 
treatment  for  borrowers  and  lenders.  Generally,  section  461(g) 
prohibits  a  cash  method  taxpayer  from  deducting  prepaid  interest. 
Section  461(g)  (2) ,  however,  provides  that  this  prohibition  does  not 
apply  to  points  paid  in  connecticm  with  a  loan  for  the  purchase  or 
improvement  of  a  principal  residence  if  the  loan  is  secured  by  the 
residence.  Points  paid  on  loans  to  refinance  an  existing  loan,  and 
points  paid  on  loans  whose  proceeds  are  not  used  to  acquire  or 
improve  a  principal  residence  (a  home  equity  loan  to  buy  a  car)  are 
not  eligible  for  deductibility  under  section  461(g)(2). 


^  Prop.  Treas.  Reg.  SS  1.1273-1  and  1.1272-1.  If,  however, 
the  amount  of  OID  on  a  debt  instrument  is  de  minimis  (less  than 
.0025  times  the  weighted  average  maturity  of  the  loan,  or  less  than 
.00167  times  the  number  of  complete  years  to  maturity) ,  then  OID  is 
recognized  as  the  borrower  makes  principal  payments. 

•     Prop.  Tfeas.  Reg.  S  1.1272-l(b) (1) (i) . 

'  See  generally  Staff  of  the  Joint  Committee  on  Taxation, 
General  Explanation  of  the  Revenue  Provisions  of  the  Deficit 
Reduction  Act  of  1984.  at  108-127. 


1315 


Congress  enacted  section  461(g)  to  prevent  abusive  tax  shelter 
transactions  in  which  interest  expense  was  front-loaded.'"  As 
indicated  in  the  discussion  of  the  OID  provisions,  front-loading  of 
interest  is  inconsistent  with  the  economic  accrual  of  income  on 
debt  instruments.  Apparently,  Congress,  as  a  matter  of  legislative 
grace,  enacted  section  461(g)(2)  to  allow  a  deduction  for  prepaid 
interest  (points)  in  residential  lending  transactions  to  facilitate 
the  purchase  of  residential  real  estate.  Neither  section  461(g) (2) 
nor  its  legislative  history  suggests  that  Congress  intended  that 
symmetry  exist  between  the  timing  of  the  borrower's  deduction  of 
points  and  the  lender's  inclusion  of  the  points  in  income.  As 
indicated  above,  the  proposed  OID  regulations  would  treat  all 
points  received  by  the  lender  as  a  reduction  of  a  loan's  issue 
price  regardless  of  whether  the  borrower  is  allowed  to  deduct  the 
points  under  section  461(g)(2). 

No  need  exists  for  symmetry  between  the  borrower's  deduction  of 
points  and  the  lender's  inclusion  of  points  in  income.  The 
treatment  of  points  as  a  reduction  of  issue  price  is  appropriate  as 
a  matter  of  tax  policy  because  it  treats  points  in  accordance  with 
their  economic  substance.  Section  461(g)(2)  represents  a  decision 
made  by  Congress  for  a  valid  non-tax  policy  reason  (encouraging 
home  ownership)  to  treat  a  borrower's  payment  of  points  in  a  manner 
that  does  not  accord  with  the  economic  substance  of  the  underlying 
mortgage  lending  transaction.  Thus,  no  tax  policy  would  be  served 
by  requiring  lenders  to  include  points  in  income  solely  because 
some  borrowers  can  deduct  those  points  under  section  461(g)(2). 
Moreover,  requiring  current  inclusion  of  points  in  a  lender's 
income  will  created  asymmetry  for  all  loans  other  than  those 
subject  to  the  special  provisions  in  section  461(g)(2). 


Conclusion 

To  reiterate,  we  strongly  recommend  that  the  subcommittee  reject 
the  proposal  to  subject  lenders  to  tax  upon  the  receipt  of  points 
paid  incident  to  mortgage  lending  transactions.  Transactions 
should  be  taxed  in  accordance  with  their  economic  substance,  which 
in  this  case  requires  treatment  of  points  as  a  reduction  in  the 
issue  price  of  the  loan  to  which  the  points  rel^^te. 

Mr.  Henry  Schmidt,  partner  in  the  accounting  firm  KPMG  Peat 
Marwick,  assisted  in  the  drafting  of  this  comment  letter  and  is 
scheduled  to  testify  on  behalf  of  the  California  League  at  your 
hearings  on  September  8,  1993. 


Sincerely  yours, 

Louis  H.  Nevins 
President 


'"    Sss.    H.  Rep.  No.  658,  94th  Cong.  1st  Sess.  97  (1976), 
1976-3  (Vol  2)  C.B.  789. 


1316 

Mr.  HoAGLAND.  Mr.  James  O'Connor. 

STATEMENT  OF  JAMES  E.  O'CONNOR,  TAX  COUNSEL,  SAVINGS 
&  COMMUNITY  BANKERS  OF  AMERICA,  PRESENTING  TESTI- 
MONY  FOR  MICHAEL  PALKO,  SENIOR  VICE  PRESIDENT  AND 
DIRECTOR  OF  CORPORATE  TAX,  GREAT  WESTERN  FINAN- 
CIAL CORP.  ON  BEHALF  OF  THE  SAVINGS  &  COMMUNITY 
BANKERS  OF  AMERICA 

Mr.  0'Co^fNOR.  Mr.  Chairman,  members  of  the  committee,  good 
afternoon.  My  name  is  James  O'Connor.  I  am  the  tax  counsel  of  the 
Savings  and  Community  Bankers  of  America.  The  Savings  and 
Community  Bankers  of  America  is  the  trade  association  of  more 
than  2,000  federally  and  State-chartered  stock  and  mutual  savings 
banks  and  savings  and  loan  associations. 

Mr.  Chairman,  I  am  testifying  as  well  in  opposition  to  the  reve- 
nue proposal  before  the  subcommittee  that  would  require  thrift  in- 
stitutions to  take  into  income  when  received  points  on  single  family 
mortgages  or  alternatively  to  require  all  mortgage  originators  to 
take  such  points  into  income  when  received.  This  proposal  in  either 
form  would  single  out  for  unfair  treatment  thrifts  that  originate 
mortgages  and  hold  them  in  portfolio. 

Mortgage  bankers  and  thrifts  that  sell  mortgages  they  originate 
would  not  be  affected  by  the  proposal  because  of  the  fact  that  the 
mortgages  they  originate  are  disposed  of  shortly  after  origination, 
making  this  proposal  irrelevant  in  denying  a  lender  the  right  to  ac- 
crue points  over  the  holding  period  of  a  loan.  Points  are  computed 
as  a  percentage  of  the  face  value  of  a  note,  each  point  being  equal 
to  1  percent  of  the  face  value. 

The  points  referred  to  in  the  proposal  are  an  adjustment  to  the 
stated  interest  rate  of  a  loan  to  reflect  the  actual  costs  of  borrowing 
funds.  The  determination  of  when  points  are  received  has  been  one 
of  the  single  greatest  sources  of  controversy  in  the  IRS  examina- 
tions of  thrift  institutions.  Before  1970  many  thrifts  had  received 
rulings  permitting  them  to  accrue  points  over  the  life  of  the  loan. 
The  controversy  began  in  1970  with  the  publication  of  an  IRS  reve- 
nue ruling  that  sought  to  make  the  tax  treatment  of  points  by  lend- 
ers dependent  upon  the  form  of  payment  by  the  borrower.  Points 
that  had  been  paid  in  cash  at  closing  would  be  immediately  in- 
cluded in  the  lender's  income.  If,  on  the  other  hand,  the  borrower 
received  a  loan  disbursement  equal  to  the  face  amount  of  the  loan 
but  reduced  by  the  points,  in  other  words  if  the  points  had  been 
financed,  the  ruling  permitted  the  points  to  be  accrued  over  the  life 
of  the  loan. 

The  controversy  existed  because  the  facts  of  almost  every  lending 
transaction  are  ambiguous,  and  the  parties  will  be  motivated  to 
disagree  as  to  whether  or  not  the  points  are  paid  or  financed.  Lend- 
ers will  be  motivated  to  say  that  the  points  have  been  financed  so 
that  they  can  spread  them.  Borrowers,  on  the  other  hand,  will  be 
motivated  to  say  that  points  were  paid  in  cash  so  that  they  can  de- 
duct them  up  front  under  section  461(g)(2).  Because  of  the  IRS's  de- 
sire for  symmetry  in  the  tax  treatment  of  borrowers  and  lenders, 
the  litigating  position  of  the  IRS  has  been  that  in  order  for  lenders 
to  accrue  points,  the  loan  documentation  must  evince  a  clear  un- 
derstanding of  the  parties  that  the  points  are  being  financed. 


1317 

In  practice,  however,  IRS  agents  created  symmetry  between  bor- 
rower and  lender  by  insisting  that  any  funds  brought  to  closing 
went  first  to  pay  points.  The  1970  IRS  ruling  created  a  20-year  con- 
troversy that  was  without  economic  substance,  and  that  undercut 
the  subsidy  that  Congress  had  granted  to  home  buyers  in  section 
461(g)(2).  Economically  it  makes  no  difference  whether  a  lender 
disburses  $98  in  exchange  for  the  borrower's  $100  note  or  the  lend- 
er disburses  $100  in  exchange  for  the  $100  note  and  the  payment 
of  $2  either  from  the  loan  proceeds  or  from  the  borrower's  separate 
funds.  The  cash  payment  of  $2  is  simply  a  reduction  of  the  amount 
loaned. 

The  IRS  view  that  if  the  borrower  were  taking  a  deduction  for 
paying  points,  the  lender  should  include  the  points  in  income  failed 
to  appreciate  that  the  borrower's  deduction  was  a  subsidy  for  home 
buyers  that  had  nothing  to  do  with  the  economics  of  the  trans- 
action. To  require  the  lender  to  make  up  the  revenue  lost  by  the 
subsidy  was  unfair  to  the  lender.  In  fact,  it  can  be  argued  that  by 
raising  the  cost  of  lending,  the  IRS  undercut  the  subsidy  because 
some  portion  of  that  increased  cost  had  to  be  passed  along  to  the 
borrower.  The  IRS  position  on  loan  points  was  heavily  criticized  by 
authors  and  practitioners  and  after  thorough  reconsideration  the 
Treasury  and  IRS  clearly  and  unequivocally  reversed  the  position 
taken  in  the  1970  ruHng. 

Proposed  regulations  published  in  December  of  last  year  inter- 
preting the  1984  OID  provisions  state  that  even  though  points  are 
paid  in  cash  at  closing,  they  represent  a  reduction  of  the  loan 
amount  that  will  be  accrued  as  original  issue  discount  over  the  life 
of  the  loan.  These  proposed  regulations  are  expected  to  be  pub- 
lished in  final  form  shortly.  If  the  subcommittee  were  to  adopt  the 
current  proposal  and  contravene  Treasury's  position  in  the  pro- 
posed regulations,  it  would  be  setting  the  stage  to  resurrect  and 
perpetuate  an  insoluble  controversy  that  has  no  basis  in  economic 
reality. 

Once  again,  I  would  like  to  thank  the  committee  for  providing 
the  opportunity  to  testify  today,  and  I  would  be  happy  to  answer 
any  questions. 

[The  prepared  statement  follows:] 


1318 


TESTIMONY  OF  MICHAEL  PALKO 

ON  BEHALF  OF  THE 

SAVINGS  &  COMMUNITY  BANKERS  OF  AMERICA 

Mr.  Chainnan,  thank  you  for  this  opportunity  to  appear  today  before  your  Subcommittee. 
My  name  is  Michael  Palko  and  I  am  Senior  Vice  President  and  Corporate  Tax  Director  of 
Great  Western  Financial  Corporation,  a  multi-regional,  consumer-oriented  financial  services 
company  with  a  substantial  mortgage  lending  business.   I  am  speaidag  before  the 
Subcommittee  today  as  the  rqiresentative  of  the  Savings  &  Community  Bankers  of  America. 
SCBA  is  the  trade  association  of  the  more  than  2000  member  institutions  comprising  the 
savings  associations  and  saving  bank  businesses,  collectivdy  referred  to  as  thrift  institutions. 
The  membo^p  includes  all  types  of  institutions  -  fedoal  and  state  cbaiteied,  stock  and 
mutual.  "'  

DcsCTiptign  Of  The  Proppsal 

I  am  here  today  to  testify  in  opposition  to  a  revenue  raising  pn^x>sal  that  un£airiy  singles  out 
tiirift  institutions.  This  proposal  would  require  thrift  institutions  to  take  into  income  points 
on  single  family  mortgages  when  received  au  alternatively,  to  require  all  mortgage 
originators  to  take  such  points  into  income  when  received.   The  prtqxKal  would  effectively 
distinguish  between  points  that  have  been  paid  and  points  that  have  been  financed.  Points 
that  have  been  financed  would  be  taken  into  income  over  the  life  of  the  loan.  Those  tiiat 
have  beoi  paid  by  the  borrower  at  closing  would  be  taken  into  income  by  tiie  lender  when 
paid. 

Both  Forms  Of  The  Proposal  Single  Out  TTirifts 

This  proposal  would  essentially  codify  a  form-over-substance  view  of  lending  transactions 
that  has  made  their  tax  treatment  uncertain,  generated  needless  controversy  and  litigation, 
and  therd)y  imposed  significant  administrative  burdens  on  the  IRS  and  costs  on  taxpayers. 
Conceptually,  the  proposal  would  mandate  a  difference  in  the  lax  treatinoit  of  lenders  based 
on  a  distinction  -  whetbo-  points  are  paid  or  financed  -  that  is  factually  ambiguous  and, 
even  if  the  distinction  is  made,  is  without  economic  significance.  The  Treasury  in  recentiy 
published  proposed  original  issue  discount  regulations  rejected  this  difference  in  tax  treatment 
by  prescribing  consistent  treatment  for  loan  points  regardless  of  whether  tiiey  are  paid  or 
financed. 

Even  if  the  proposal  were  to  be  made  applicable  to  all  mortgage  originators,  its  impact  would 
fall  almost  exclusively  on  thrift  institutions.  Points  may  be  charged  on  all  types  of  loans, 
e.g.,  commercial  real  estate  loans,  consumer  loans,  business  loans,  as  well  as  residoitial 
mortgage  loans.   The  tax  difference  between  treating  points  as  paid  at  closing  or  financed  is 
greatest  in  the  case  of  residential  mortgage  loans  because  of  the  relatively  long  terms  of  such 
loans,  assuming,  of  course,  that  the  lender  keeps  the  loan  in  portfolio.   With  re^iea  to  loans 
originated  by  mortgage  bankers  and  those  originated  by  thrifts  for  sale  into  the  secondary 
mortgage  market,  the  timing  difference  created  by  the  proposal  would  be  minimal  because  of 
tiie  short  time  between  the  closing  and  sale  of  the  loan.   The  pn^xwal  will,  thus,  confer  a 
competitive  advantage  on  mortgage  banking  q)erations  and  create  an  incentive  for  thrifts  to 
emphasize  zero-point  mortgages. 

The  Proposal  b  Unfair  To  Low-income  Homcbuym 

In  addition  to  the  unfairness  to  thrifts  of  this  proposal,  the  pn^>osal  will  be  unfiair  to  low- 
income  and  minority  borrowers.   Loans  made  to  poor  and  minority  borrowers  are  often 
categorized  as  'nonconforming  loans'  because  the  borrowers  have  not  established  sufficient 
credit  and  have  spotty  job  histories.   Nonconforming  loans  usually  have  to  be  kept  in 
portfolio  by  the  origiiiating  lender  because  tiiey  are  not  considered  suitable  for  sale  into  the 
secondary  mortgage  market   In  £act,  these  are  sound  loans  and  it  is  only  the  narrow 
standards  of  suitability  of  the  formal  secondary  mortgage  market  that  limit  tiieir 
marketability.  Thrifts,  as  has  been  rq»rted  in  the  press,  have  a  much  better  record  tiian 
otho-  lenders,  of  making  nxHtgage  loans  to  low-income  borrowers.   In  part  this  better  record 
is  attributable  to  the  &ct  that  thrifts  can  and  are  willing  to  hold  in  portfolio  loans  that  the 
secondary  mortgage  market  is  unwilling  to  buy. 

Enactment  of  the  proposal  before  this  Committee,  which  subjects  mortgage  loans  held  in 
portfolio  to  disadvantageous  tax  treatment,  would  be  an  additional  disincentive  for  thrifts  to 
make  the  kinds  of  loans  that  are  often  made  to  low-income  homebuycrs.   At  the  very  least. 


1319 


implementation  of  this  proposal  may  deprive  low-income  borrowers  of  the  opportunity  to 
negotiate  a  lower  rate  in  exchange  for  paying  points,  because  institutions  will  be  forced  to 
consider  limiting  the  availability  of  points  on  portfolio  loans. 

The  Proposal  Would  Continue  An  InspluMc  Cgntrovcrsy 

Points  or,  more  technically,  loan  discount  fees  are  amounts  charged  borrowers  by  lenders  as 
a  percentage  of  the  face  amount  of  a  loan  —  each  point  equaling  one  percent  of  the  face 
amount  oflhe~loan.~As'tbelerm  is  geiieiallyuiiderTUuod  and  used,  puinls  aie  'amounts  paid 
for  the  use  and  forbearance  of  money,"  in  other  words,  interest.   (Rev.  Rul.  70-540,  1970-2 
C.B.  101.)  Points,  in  this  sense,  are  to  be  distinguished  from  commitment  fees  and  loan 
origination  fees  paid  for  services.   Points  are  effectively  a  yield  adjustment,  with  the  inverse 
relationship  between  the  stated  rate  of  interest  and  the  amount  of  points  reflecting,  in  addition 
to  present  value  discounting,  the  offset  of  prqayment  risk  created  by  the  increase  in  yield 
that  results  from  prepayment  where  points  are  charged. 

The  proposal  before  the  Committee  would  codify  a  distinction  made  by  the  IRS  in  Rev.Rul. 
70-540,  1970-2  C.B.  101,  as  ampUfied  by  Rev.  Rul.  74-607,  1974-2  C.B.  149,  which 
specified  the  tax  treatment  of  lender  fees  in  five  different  situations.   In  the  first  situation 
described  in  the  ruling,  the  lender  disbursed  the  face  amount  of  the  loan  and  the  borrower 
paid  points  from  funds  not  obtained  from  the  lender.   The  ruling  provides  that  in  this 
sitaiation  the  lender  must  include  the  points  in  income  when  received  if  it  is  a  cash  basis 
taxpayer  or  at  the  earlier  of  receipt  or  establishment  of  the  right  to  receipt  if  it  is  an  accrual 
basis  taxpayer.   In  the  second  situation  presented  in  the  ruling  the  loan  amount  included  both 
the  points  and  the  purchase  price.  The  ruling  held  that,in  this  situation,  a  cash  basis  lender 
would  include  the  points  in  income  ratably  as  principal  payments  are  received  and  that  an 
accrual  basis  lender  would  include  the  points  at  the  earlier  of  the  time  that  principal  payments 
are  due  or  received. 

Unfortunately,  both  the  ruling  and  the  proposal  before  the  Committee  take  a  simplistic  view. 
In  reality,  it  can  be  very  difficult  to  tell  whether  points  have  been  paid  or  financed,  but  the 
IRS  view  of  reality  seems  to  have  been  colored  by  a  perceived  neeid  to  maintain  symmetry  in 
the  tax  treatment  of  borrowers  and  lenders.   Particularly  in  the  case  of  discounted  loans,  the 
result  has  been  considerable  controversy  between  thrifts  and  the  IRS.   In  a  discounted  loan 
the  lender  disburses  at  closing  a  net  check  equal  to  the  face  amount  of  the  loan  reduced  by 
the  points  charged  and  the  borrower  brings  a  check  in  the  amount  of  the  required 
downpayment  and  the  points  that  have  been  withheld  from  the  face  amount  of  the  loan.  The 
problem  -  whether  this  net  disbursement  is  best  described  in  sihiation  "1"  or  "2"  of  Rev. 
Rul.  70-540  -  can  best  be  illustrated  by  an  example. 

Assume  the  sales  price  of  a  home  is  $130,000  and  the  borrower  agrees  to  make  a 
downpayment  of  $30,000.   A  lender  agrees  to  lend  $100,000  at  a  certain  rate  and  two 
points.   If  the  loan  is  discounted  for  the  points,  the  lender  will  disburse  $98,000  at 
closing  in  exchange  for  the  borrower's  $100,000  note.  The  borrower  will  have  to 
bring  a  check  for  $32,000  to  the  closing. 

Under  these  facts  the  lender  will  undoubtedly  contend  that  the  points  were  financed.  The 
borrower,  however,  will  be  just  as  adamant  that  the  points  were  paid  in  cash  because  he  or 
she  will  wish  to  qualify  for  the  up-firont  deduction  of  the  points  permitted  under  section 
^l(g)(2)  of  the  Internal  Revenue  Code.   In  general,  section  461(g)  provides  that  cash  basis 
taxpayers  cannot  deduct  'prepaid  interest,'  but  paiagr^h  (2)  was  added  to  permit  points  to 
be  deducted  when  paid  if  paid  in  connection  with  the  purchase  or  improvement  of  a  principal 


Because  the  facts  are  often  ambiguous  and  because  of  the  Swvice's  quest  for  symmetry,  the 
litigating  position  of  the  IRS  has  been  that  the  loan  documentation  must  evince  the  clear 
understanding  of  the  parties  that  the  points  are  being  financed;  otherwise  the  points  will  be 
treated  as  paid  at  closing  under  an  assignment  of  income  theory.   (See  Bell  Federal  Savings 
and  Loan  Association  v.  Commissioner.  1991-368  T.C.M.)  In  practice,  however,  IRS 
Examination  has  been  requiring  the  inclusion  of  points  in  the  year  of  closing  by  treating  any 
amounts  paid  by  the  borrower  at  closing  as  having  gone  first  to  pay  points  -  regardless  of 
how  clear  and  specific  the  loan  documentation  is  that  the  points  have  bem  financed. 


1320 


The  result  of  the  Service's  attempt  to  determine  the  tax  consequences  of  loan  transactions 
based  on  an  artificial  distinction  that  is  impossible  to  apply  to  an  ambiguous  reality  has  been: 
years  of  insolvable  controversy  between  IRS  examining  agents  and  ^ypellate  officers;  the 
revocation  of  a  number  of  private  letter  rulings  issued  to  thrifts  under  the  authority  of  Rev. 
Rul.  54-367.  1954-2  C.B.  109  and  Rev.  Rul.  64-278,  1964-2  C.B.  120  that  permitted  the 
accrual  of  points  using  eiOer  the  "composite*  or  'liquidation*  methods;  rqj^ted  lustration 
by  IRS  Examination  of  taxpayer  requests  to  the  IRS  National  Office  for  section  7805(b)  relief 
to  prevent  retroactive  revocation  of  such  private  letter  rulings;  and  the  continuous  refusal  by 
the  IRS'National  Office  tu  review  uiuUeHuuu  ducuiueuUi;  and  issue  guidiuicc  as  tu  auu^table 
forms  of  such  documents  so  that  standards  would  exist  for  determining  whether  points  ate 
paid  or  financed.  The  effect  of  the  prcqx>sal  now  before  the  Committee  would  be  to 
perpetuate  this  controversy. 

The  Controversy  Has  No  Economic  Substance 

Whether  points  are  paid  or  financed  by  the  borrower  is  a  distinction  without  economic 
substance.   A  transaction  in  which  the  lender  disburses  $98  for  the  borrower's  note  of  $100 
is  no  different  economically  firom  a  transaction  in  which  the  lender  disburses  the  full  $100  in 
exchange  for  the  borrower's  payment  of  $2  from  the  loan  proceeds  or  from  another  source. 
In  both  cases  the  lender  has  advanced  $98  to  the  borrower  and  will  receive  ovct  the  term  of 
the  loan  a  return  on  a  $98  investment  of  $2  of  discount  plus  interest  on  $100.  The  payment 
of  $2  in  the  latter  situation  does  not  create  immediate  wealth  in  the  lendo-,  instead  by 
lowering  the  actual  investment  of  the  lender,  it  just  raises  the  yield  on  the  investment  without 
affecting  the  cash  flow. 

The  recent  history  of  the  controversy  over  the  tax  treatment  of  points  has  been  of  a  gradual 
movement  toward  a  resolution  that  conforms  the  tax  treatment  to  economic  reality  and 
reconciles  the  diqnrate  treatment  of  borrowo^  and  lenders  by  recognizing  that  it  was  created 
by  political  decisions.   The  means  to  this  resolution  has  been  the  original  issue  discount 
regulations.  The  original  issue  discount  rules  of  the  Internal  Revenue  Code  were  made 
applicable  to  obligations  of  individuals,  including  residential  mortgages,  by  the  Tax  Reform 
Act  of  1984,  effective  for  transactions  on  or  afier  March  2,  1984.  Section  1273(a)  of  the 
Code  defines  OID  as  the  excess  of  the  stated  redemption  price  at  maturity  over  the  issue 
price  of  the  dd>t.  In  a  loan  transaction  the  issue  price  of  the  debt  is  the  amount  of  money 
loaned.   Original  issue  discount  (OID)  may  be  thought  of  functionally  as  interest 
denominated  as  principal.   In  general,  OID  is  required  to  be  recognized  over  the  term  of  the 
obligation  using  an  economic  accrual  method. 

On  April  8,  1986,  the  Treasury  published  proposed  regulations  (51  FR  12022)  interpreting 
the  changes  to  the  OID  provisions  nuule  by  TRA  1984.  Section  1.1273-2(0(2)  of  the  1986 
proposed  r^ulations  took  a  significant  theoretical  st^  toward  conforming  the  tax  treatment 
of  points  to  economic  reality  by  providing  that  cash  payments  from  the  borrower  to  the 
lender  at  the  time  of  the  loan  —  providing  the  payments  are  not  for  sovices  —  will  generally 
reduce  the  issue  price  of  the  loan  and,  thus,  create  OID.  The  practical  effect  of  the  1986 
proposed  r^idations  in  eliminating  the  points  controversy  was,  however,  nullified  by  two 


The  first  excq>tion,  section  1.1273-2(f)(l)  of  the  1986  proposed  r^ulations,  provided  that 
the  payments  by  the  borrower  do  not  reduce  the  issue  price  if  they  are  points  that  are 
deductible  under  section  461(g)(2).  No  explanation  was  provided  in  the  proposed  regulation 
for  the  creation  of  this  excqjtion,  although  it  has  the  effect  of  maintaining  symmetry  of  tax 
treatment  between  borrower  and  lender.  That  a  need  to  maintain  such  symmetry  motivated 
the  drafters  of  the  proposed  regulation  can  be  inferred  from  the  treatment  of  the  lend«-  where 
the  seller  pays  the  points.  Economically  it  is  irrelevant  to  the  lender  whether  points  are  paid 
by  the  buyer  or  seller,  but  it  is  very  relevant  to  the  lender's  tax  treatment 

Section  1 .  1273-2(f)(5)  of  the  1986  proposed  r^ulations  provided  that  a  payment  of  points  by 
the  seller  may  be  recharacterized  as  a  payment  from  the  seller  to  the  buyer  followed  by  a 
payment  to  the  lender.  The  same  paragraph  also  provided,  however,  that  section  461(g)(2) 
will  not  apply  to  the  amount  recharacterized,  so  that  points  paid  by  the  seller  will  reduce  the 


1321 


issiie  price  of  the  loan  and  create  OID.  The  treatment  of  seller-paid  points  in  the  1986 
proposed  regulations  provides  further  evidence  that  elevating  form  over  substance  in  the  tax 
treatment  of  points  creates  inconsistent  treatment  for  transactions  that  are  economically  the 


Creation  of  the  excq)tion  in  the  1986  proposed  OID  regulations  that  prevented  points  that  are 
deductible  by  the  borrower  from  creating  OID  in  the  hands  of  the  lender  was  a  mistake.  The 
immediate  deductibility  of  points  under  section  461(g)(2)  was  a  subsidy  created  by  Congress 
for  homd)uyers.  It  wara  mtetakEtonhe'IRS  to  require' symmetrical  treatment laf  points  by 
lenders  based  on  a  provision  that  created  a  subsidy  by  a  departure  from  sound  tax  policy.  In 
fact,  this  imposition  of  symmetry  reduces  the  value  of  the  subsidy  to  the  extent  that  the 
increase  in  the  lenders*  tax  is  p^sed  on  to  borrowers. 

The  second  excq>tion,  also  in  section  1.1273-2(0(1),  provides  that  if  the  OID  is  de  minimis, 
the  amount  of  OID  will  be  treated  zero  and  prior  law  will  continue  to  ^Jply.   This  provision 
was  actually  intended  to  be  an  administrative  convenience  to  taxpayers  permitting  the  holder 
of  the  debt  obligation  to  avoid  having  to  include  any  OID  in  income  until  the  principal 
payment  was  received  and  to  possibly  permit  the  OID  to  be  treated  as  a  capitsd  gain.  The 
effect  in  the  case  of  points  charged  on  residential  mortgages,  however,  was  to  continue  the 
controversy  over  whether  they  were  paid  or  financed. 

Liberalized  Treatment  Of  Borrowers 

As  an  ancillary  matter,  if  the  proposal  before  this  Committee  were  to  be  enacted,  it  is 
possible  the  treatment  of  lenders  would  be  even  more  unfavorable  than  it  was  for  most  of  the 
years  of  controversy.    Ironically,  this  result  could  occur  because  of  a  benefit  recently 
conferred  on  borrowers  by  the  IRS.   In  Notice  90-70,  1990-2  C.B.  351,  the  IRS  adopted  for 
the  benefit  of  borrowers  the  'fresh  funds'  s^roach  that  IRS  Examination  has  been  using 
informally  for  some  time  to  deny  lenders  accrual  treatment  of  points  even  where  the  facts 
indicate  the  parties  intended  to  finance  the  points.   Notice  90-70  provides  that  any  fimds 
brought  to  closing  for  any  purpose  by  the  borrower  will  be  deemed  to  be  used  first  to  pay 
points. 

Conceivably,  if  the  IRS  had  continued  to  insist  on  symmetry  in  the  treatment  of  points,  or  if 
the  proposal  before  the  Committee  were  to  be  enacted,  creating  a  fiction  of  points  payment 
on  the  borrower's  tax  return  could  be  used  against  the  lender.   Although  no  inference  was 
made  in  the  notice  with  respect  to  the  treatment  of  points  by  lenders,  imposing  symmetry  on 
lenders  consistent  with  the  treatment  of  borrowers  under  the  notice  would  only  be  an 
extension  of  the  symmetry  previously  insisted  upon  with  the  treatment  of  borrowers  under  the 
general  provisions  of  section  461(g)(2). 

Be  IRS  Cgnforms  Tsu^  Treatment  To  Economic  Reality 

In  the  years  following  their  publication  a  number  of  practitioners  and  authors  criticized  the 
1986  proposed  OID  regulations  for  the  section  461(a)(2)  and  de  minimis  exceptions.    (See 

e.g.,  Gariock,  Federal  Income  Taxation  of  Pet?t  Instruments.  Prentice  Hall,  2d  edition,  at 

pp.  79-80  and  Peaslee  and  Klembard,  The  Treatment  of  Deferred  Loan  Fees  Paid  To  Thrift 
Institutions.  Tax  Notes,  January  16.  1989,  pp.  377-80.)  After  long  and  careful 
reconsideration,  the  Treasury  on  December  22,  1993,  rq>roposed  the  OID  regulations.  (See 
57  FR  60750.)  The  new  proposed  r^ulations  completely  conformed  the  treatment  of  points 
by  lenders  to  economic  redity,  first,  by  making  borrower  deductibility  of  points  under 
section  461(g)(2)  irrdevant  and,  second,  by  completely  lefocusing  the  de  minimis  rule  of  the 
1986  proposed  r^ulations. 

Section  1.1273-l(d)(l)  of  the  new  proposed  regulations  once  again  provides  that  if  the 
amount  of  OID  is  less  than  a  de  minimis  amount,  there  will  be  zero  OID.   It  should  be  noted 
that  the  points  charged  in  connection  with  the  typical  residential  mortgage  loan  will  be  de 
minimis  under  the  definition  of  section  1.1273-l(d)(3).  Unlike  the  1986  proposed 
regulations,  however,  that  simply  threw  the  lender  back  on  prior  law  if  the  points  were  de 
minimis,  section  1.1 273- 1(d)(6)  of  the  new  proposed  r^ulations  provides  that  the  lender  may 
include  a  proportional  amount  of  de  minimis  OID  with  each  principal  payment.   It  may  be 
said  that  the  new  proposed  OID  regulations  have  brought  the  controversy  over  the  treatment 


1322 


of  points  by  bonowo^  full  circle.  The  method  authorized  for  the  accrual  of  de  mimmis 
points  is  the  same  liquidation  method  G>ut  on  an  individual  loan  basis)  that  was  authorized  for 
cash  basis  taxpayers  by  the  IRS  in  a  number  of  private  letter  rulings  under  the  authority  of 
Rev.  Rul.  64-278,  1964-2  C.B.  120.  These  rulings  were  then  revoked  by  the  IRS  during  the 
subsequent  years  of  controversy.   In  addition,  under  the  new  proposed  r^ulations,  the  fact 
that  the  mortgage  provides  for  a  teaser  rate  or  interest  holiday  is  no  longer  likely  to  make  the 
de  minimis  excqMion  unavailable.  It  is  expected  that  the  1992  proposed  OID  r^ulations  will 
be  made  final  very  soon. 

Conclusion 

SCBA  strongly  urges  the  Committee  to  reject  this  proposal  to  tax  points  in  the  year  received. 
This  proposal  would  only  popetuate  an  insoluble  controversy  that  has  been  draining  the 
resources  of  both  thrifts  and  the  IRS.  It  is  a  controversy  that  should  be  irrelevant  as  a  matter 
of  sound  tax  policy  as  it  is  irrelevant  in  terms  of  economic  reality.  In  fact,  the  proposal  is 
inconsistent  with  sound  tax  policy  and  would  codify  a  position  that  the  Treasury  has  just 
rejected  after  thorough  deh'boation  and  dd>ate.  In  addition,  to  the  extent  the  proposal 
provides  a  disincentive  to  make  loans  that  must  be  held  in  portfolio,  it  may  discourage 
community-minded  institutions  from  making  loans  to  low-income  homebuyers  that  are  not 
readily  salable  into  the  secondary  mortgage  market. 

I  would  like  to  thank  die  subcommittee  for  the  opportunity  to  testify  today  and  would  be 
h^>py  to  respond  to  any  questions  you  may  have. 


1323 

Mr.  HOAGLAND.  Well,  thank  you,  Mr.  O'Connor. 

Mr.  McCrery. 

Mr.  McCrery.  No  questions. 

Mr.  HoAGLAND.  Mr.  O'Connor,  as  your  testimony  recognizes,  bor- 
rowers are  often  able  to  deduct  points,  such  as  home  mortgage 
points  when  paid.  If  lenders  can  delay  the  recognition  of  such  in- 
come, doesn't  the  Federal  Treasury  get  shorted  both  ways? 

Mr.  O'Connor.  I  think  we  have  to  look  at  what  is  happening  eco- 
nomically. It  is  no  different  whether  you  finance  points,  as  f  say, 
disbursing  net  amount  of  $98  in  the  case  of  a  $100  note  as  opposed 
to  the  borrower  paying  $2  of  points  in  that  situation — pardon  me, 
the  lender  disbursing  a  $100  note,  the  borrower  perhaps  taking  $2 
from  that  $100  note  and  using  it  to  pay  the  points. 

Economically  you  have  what  Mr.  Schmidt  called  the  circular  flow 
of  funds  that  in  other  contexts  the  code  is  quick  to  ignore.  All  we 
are  saying  here  is  that  same  concept  of  ignoring  a  flow  of  circular 
funds  should  also  be  recognized. 

Mr.  HoAGLAND.  But  is  the  Treasury  getting  shorted  at  both  ends 
under  the 

Mr.  O'Connor.  The  Treasury  said  they  were  not.  The  proposed 
regulations  issued  in  December  1992  said  that  the  treatment  I  am 
advocating  here  is  the  proper  treatment.  This  is  good  tax  policy. 
This  is  the  same  treatment  that  the  FASB  has  advocated;  the  same 
treatment  that  the  SEC  also  has  adopted. 

Mr.  HOAGLAND.  Mr.  Schmidt,  the  claim  of  right  doctrine  provides 
the  prepaid  income  should  be  recognized  when  received.  Shouldn't 
this  doctrine  be  applied  to  the  receipt  of  points? 

Mr.  Schmidt.  No,  I  think  the  analysis  goes  back  to  a  Supreme 
Court  case  involving  advanced  payment  for  dance  lessons,  and  the 
issue  there  was  whether  the  free  use  of  the  funds  by  the  dance 
company  in  fact  caused  the  taxation  to  occur  at  that  time.  Lending 
transactions  have  been  considered  seriously  on  an  economic  basis 
for  the  last  40  years,  and  are  viewed,  I  think,  quite  differently  than 
the  kind  of  transaction  that  was  considered  in  the  dance  case. 

In  all  lending  transactions  if  you  make  a  distinction  in  one  par- 
ticular element,  you  create  disparities  in  the  parallel  treatment 
with  all  other  lending  transactions,  so  in  a  40  year  period  after 
thorough  study  and  debate,  it  was  concluded  that  the  circular  flow 
of  cash  represented  by  this  type  of  transaction,  as  any  other  lend- 
ing transaction  should  be  viewed  on  the  economics.  That  was 
viewed  by  every  regulatory  body  and  came  to  the  same  single  con- 
clusion, so  I  don't  think  a  parallel  to  a  dance  company  case  is  rel- 
evant for  the  lending  business. 

Mr.  HOAGLAND.  Let  me  thank  you,  by  the  way,  for  flying  in  for 
this  hearing  today,  and  let  me  ask  you  about  a  problem  that  Cali- 
fornia experiences  I  am  sure  as  great  a  frequency  as  any  other 
State.  What  else  can  Congress  do  to  encourage  institutions  to  make 
so-called  nonconforming  loans  to  low  income  borrowers  besides  al- 
lowing thrifts  to  defer  income  recognition  on  points? 

Mr,  Schmidt.  I  am  not  sure  I  am  the  right  one  to  answer  that 
unfortunately.  I  don't  know  if  Jim  has  a  comment. 

Mr.  O'Connor.  I  think  the  biggest  single  thing  that  can  be  done 
is  to  persuade,  to  encourage  the  secondary  mortgage  market,  GSEs, 
Fannie,  Freddie,  and  so  forth  to  relax  somewhat,  to  be  more  flexi- 


1324 

ble  in  the  standards  they  use  for  deciding  whether  or  not  a  loan 
is  suitable  for  sale.  I  think  this  is  probably  the  single  biggest  con- 
straint on  institutions  that  would  like  otherwise  to  make  loans  that 
are  sound,  loans  that  they  have  assessed  the  risk  on  and  are  pre- 
pared to  make,  but  have  no  choice  but  to  hold  in  portfolio. 

Mr.  HOAGLAND.  Thank  you,  Mr.  O'Connor.  Mr.  Schmidt,  do  you 
have  any  response  to  that? 

Mr.  Schmidt.  I  agree  with  Jim's  comments. 

Mr.  HoAGLAND.  ^1  right.  Mr.  Merlis,  has  this  idea  of  disallowing 
the  deductibility  of  first  class  airfares  been  floated  previously? 

Mr.  Merlis.  Well,  a  bill  on  this  subject  has  been  introduced  pre- 
viously, but  there  has  not  been  a  hearing  on  it.  I  am  not  aware  of 
any  revenue  estimate  and  I  am  not  aware  of  what  behavioral  pat- 
terns one  would  follow.  If  one  assumes  that  the  Tax  Code  drives 
behavior,  then  people  would  only  fly  coach  so  there  would  be  no 
basic  revenue  improvement.  That  is  not  likely  to  happen.  A  variety 
of  different  kinds  of  behaviors  are  likely  to  take  place,  but  we  can- 
not predict  them  precisely. 

Mr.  HOAGLAND.  All  right.  I  gather  from  your  statement  that  the 
increased  tariff  on  imported  crude  oil  is  something  that  would  not 
be  helpful  to  your  industry? 

Mr,  Merlis.  No.  Six  weeks  ago  we  were  hit  with  $500  million  a 
year  in  increased  costs,  the  transportation  fuels  tax.  This  $500  mil- 
lion a  year  is  more  than  the  airline  industry  has  ever  earned  ex- 
cept four  times.  To  add  $40  million  a  year  is  certainly  not  going 
to  help  us  get  out  of  the  trough. 

Mr.  HoAGLAND.  Ms.  Erlandson,  what  is  your  response  to  the 
problem  raised  by  Mr.  Alfers  of  Morrison  and  Foerster  in  his  testi- 
mony about  the  unfairness  of  requiring  current  mining  operations 
to  pick  up  the  cost  of  tailings  and  waste  left  by  mines  that  had 
been  closed  down  15,  20,  30  years  ago? 

Ms.  Erlandson.  Well,  I  think  ideally  we  could  all  go  back  in  a 
time  machine  and  appropriately  make  those  mining  companies  pay 
for  reclamation  of  the  mining  sites  back  then.  However,  we  can't 
do  that,  so  the  question  becomes  what  is  the  best  of  the  options 
that  remain.  The  other  choice,  of  course,  would  be  to  make  all  tax- 
payers pay  for  it.  I  suspect  many  of  the  mining  companies  that  con- 
tinue to  operate  today  probably  were  operating  in  some  capacity 
then,  and  so  it  is  probably  worthwhile  to  continue  to  hold  them 
somewhat  responsible. 

In  addition,  I  think  it  should  be  noted  that  from  my  understand- 
ing from  experts  on  mining  law  or  on  mining  today  that  it  is  still 
not  an  environmentally  perfect  activity  and  that  there  continue  to 
be,  for  example,  huge  masses  of  material. 

Mr.  HOAGLAND.  But  is  there  a  guilt  by  association  concern?  I 
mean,  let's  take  a  mining  operation  that  has  conducted  its  affairs 
in  an  exemplary  fashion  for  20  years.  Does  it  make  sense  to  assign 
them  the  costs  of  some  of  their  colleagues  that  haven't? 

Ms.  Erlandson.  Ideally,  no,  I  don't  think  you  want  to  hold  cur- 
rent people  responsible  for  past  behavior.  Again,  I  would  say  that 
the  alternative  is  to  either  leave  the  mines  unreclaimed  which  have 
devastating  effects  on  the  localized  areas  or  to  sort  of  spread  across 
the  industry  a  relatively  small  charge.  Of  course,  you  don't  want 


1325 

to  put  a  current  mine  out  of  business  for  a  previous  activity.  I  am 
not  certain  what  the  best  level  of  tax  would  be. 

In  the  case  of  coal  mining,  for  example,  the  companies  continue 
to  pay  reclamation  fees,  I  believe,  that  go  into  an  abandoned  mine 
land  fund.  Mv  understanding  is  that  that  doesn't  exist  right  now 
with  hard  rock  mining,  so  that  could  be  a  model. 

Mr.  HoAGLAND.  You  also  testified  in  support  of  the  proposal  to 
tax  HCFCs.  How  harmful  are  these  chemicals  to  the  environment 
and  are  there  readily  available  alternatives  to  these  chemicals? 

Ms.  Erlandson.  The  answer  to  the  first  question,  how  harmful 
are  they,  is  that  they  are  not  as  harmful  as  the  chemicals  that  they 
are  now  substitutes  for,  CFCs.  However,  they  do  continue  to  de- 
plete the  ozone  layer,  and  as  I  said  in  my  testimony,  some  of  them 
deplete  it  as  much  as  methyl  chloroform  which  is  a  chemical  that 
is  currently  taxed.  In  addition,  HCFCs  tend  to  be  more  damaging 
in  the  short  run  than  they  are  over  the  long  run,  which  is  what 
the  ODPs  are  based  on  or  the  rate  of  tax  that  they  pav. 

As  for  substitutes,  there  are  some.  I  don't  know  that  they  exist 
for  all  use,  but  as  experience  with  this  tax  shows,  as  the  tax  has 
gone  up,  substitutes  have  come  on  to  the  market.  It  is  basically 
supply  and  demand.  Tliere  are  both  ozone-safe  alternatives  and  a 
chemical  called  HFCs  which  do  not  deplete  the  ozone  layer  that  are 
available  today,  but  tend  to  be  more  expensive  than  HCFCs  and 
that  is  why  users  don't  purchase  them.  They  purchase  HCFCs  in- 
stead, so  a  tax  would  make  HFCs  more  competitive. 

Mr.  HoAGLAND.  I  see.  Well,  thank  you. 

Mr.  McCrery. 

Mr.  McCrery.  Nothing. 

Mr.  HOAGLAND.  Thank  you  for  your  testimony.  Now  we  will 
begin  panel  seven. 

All  right.  Let  us  begin  with  Ms.  Lee  Beard. 

STATEMENT  OF  E.  LEE  BEARD,  CHAIRWOMAN,  BUSINESS 
WOMEN'S  GOLF*LINK,  AND  PRESIDENT  AND  CHIEF  EXECU- 
TIVE OFFICER,  FIRST  FEDERAL  SAVINGS 

Ms.  Beard.  Good  aflemoon.  I  am  Lee  Beard.  I  am  here  today  in 
my  capacity  as  chair  of  Business  Women's  Grolf^Link,  which  is 
headquartered  here  in  Washington,  D.C.  I  also  in  mv  9  to  5  life 
serve  as  the  president  and  CEO  for  First  Federal  Savings  of 
Hazelton,  Pa.  Business  Women's  Golf^Link  strongly  supports  the 
proposal  to  deny  Internal  Revenue  Code  section  501(c)(7)  status  to 
clubs  that  engage  in  discrimination,  including  gender  discrimina- 
tion, and  to  deny  any  preferential  tax  treatment  for  tickets  to 
events  at  these  clubs. 

Section  501(i)  of  the  code  currently  denies  tax  exemption  to  any 
organization  for  any  taxable  year  if  at  any  time  during  such  tax- 
able year  the  charter,  bylaws,  or  other  governing  instrument  of 
such  organization  or  any  written  policy  statement  of  such  organiza- 
tion contains  a  provision  which  provides  for  discrimination  against 
any  person  on  the  basis  of  race,  color  or  religion.  We  believe  that 
it  is  important  to  expand  the  section  501(i)  definition  of  discrimina- 
tion to  include  gender. 

I  would  like  to  share  with  you  my  personal  experiences  as  a  busi- 
nesswoman who  has  experienced  discrimination  by  501(c)(7)  tax  ex- 


1326 

empt  clubs,  as  well  as  the  observations  of  our  members  of  Business 
Women's  G<)lPLink.  Let  me  first  tell  you  about  BWGL. 

Business  Women's  GolPLink  was  founded  earlier  this  year  for 
the  purpose  of  creating  networking  and  golf-related  educational  op- 
portunities for  business  women  who  play  golf.  Our  membership  is 
made  up  now  of  over  250  businesswomen  in  the  Washington  area. 
They  are  generally  business  owners  and  managers  of  companies. 
All  of  our  members  play  golf.  These  are  business  people  who  utilize 
golf  to  establish  or  to  maintain  business  relationships.  The  use  of 

golf  and  tennis  in  building  business  relationships  has  successfully 
een  done  by  men  throughout  our  country,  by  having  access  to 
clubs  which  enjoy  tax  exemptions  as  providing  social  and  rec- 
reational benefits  in  a  nonprofit  structure. 

I  know  that  if  I  call  a  client  for  an  appointment,  the  access  is 
certainly  much  more  easy  if  I  have  a  round  of  golf  or  a  tennis 
match  included  in  that.  Statistics  show  that  the  largest  portion  of 
new  golfers  are  women.  Statistics  also  show  that  women  and  mi- 
norities are  the  fastest  growing  segments  of  our  work  force.  We 
also  know  that  women  have  an  ownership  position  in  30  percent 
of  the  businesses  in  this  country,  and  that  position  is  growing  to 
50  percent. 

Four  out  of  every  five  businesses  started  in  this  country  during 
the  past  few  years  are  owned  by  women.  Women  are  creating  tax- 
able revenue  opportunities  across  our  country.  Businesswomen 
need  to  have  access  to  the  private  clubs  where  business  relation- 
ships can  be  built  and  where  business  is  conducted.  Many  of  the 
members  of  BWGL  have  clients  and  customers  who  are  male.  The 
current  Internal  Revenue  Code  allows  tax  exemptions  and  benefits 
to  clubs  where  only  the  male  members  and  guests  can  benefit  from 
full  use  of  the  facilities  and  thus  the  tax  exemption  serves  to  sanc- 
tion discriminatory  practices. 

The  Internal  Revenue  codes  were  not  designed  to  allow  select 
groups  of  citizens  to  benefit  from  discrimination.  On  a  personal 
basis,  I  was  appointed  several  months  ago  to  serve  as  the  president 
and  CEO  for  First  Federal  Savings  in  Hazelton,  Pa.  At  the  time  of 
the  appointment,  the  board  of  directors  interviewed  several  can- 
didates, male  and  female,  for  the  position. 

One  of  the  expectations  of  the  CEO,  regardless  of  gender,  was 
that  the  CEO  would  belong  to  a  personal  club  for  access  to  golf. 
That  is  where  the  business  is  conducted  in  the  Hazelton  commu- 
nity as  it  is  in  most  communities.  This  club  has  allowed  me  to  be 
a  member  and  has  accepted  my  dues  on  the  same  basis  as  the  men, 
but  I  am  not  allowed  to  play  golf  on  Saturday  or  Sunday  mornings, 
not  because  of  my  handicap,  not  because  of  my  skill,  but  simply  be- 
cause of  my  gender.  We  believe  that  is  unfair.  Skill  is  not  the  cri- 
teria that  is  used.  We  are  concerned  that  by  allowing  tax  exemp- 
tions for  clubs  such  as  this  where  the  bylaws  do  not  prohibit  gen- 
der discrimination,  but  the  rules  and  the  practices  dp,  the  tax- 
payers of  our  country  are  providing  a  financial  benefit  for  discrimi- 
nation. The  code  does  not  address  gender  nor  does  it  provide  a 
means  of  rescinding  the  tax  exempt  benefits  for  clubs  whose  rules 
and  practices  are  discriminatory  in  spite  of  clean  bylaws  and  writ- 
ten policies. 


1327 

At  a  time  when  our  Federal  deficit  is  extremely  large,  it  seems 
inappropriate  to  provide  tax  benefits  for  discriminatory  practices. 
Again,  we  are  concerned  with  the  practices  and  the  rules,  not  just 
the  bylaws.  We  believe  that  it  is  also  important  to  not  allow  chari- 
table organizations  to  host  golf  tournaments  and  tennis  matches  at 
clubs  which  discriminate.  Tax  benefits  are  received  by  individuals 
in  those  clubs.  We  think  that  it  is  important  to  add  gender  to  the 
code  so  that  discrimination  covers  not  just  color  and  religion  but 
also  gender. 

I  thank  you  for  the  time  to  address  this  issue  with  you  today. 
Thank  you. 

Mr.  HOAGLAND.  Thank  you  very  much,  Ms.  Beard. 

[The  prepared  statement  follows:] 


1328 


TESTINONX 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

COMMITTEE  ON  HAYS  AND  MEANS 

U.S.  HOUSE  OF  REPRESENTATIVES 

SEPTEMBER  8,  1993 

by:  Ms.  E.  Lee  Beard 

Good  afternoon. 

My  neune  is  Lee  Beard.  I  am  here  today  in  my  capacity  as  the 
Chairwoman  for  the  Business  Women's  Golf*Link  headquartered  here  in 
Washington,  O.C.  I  eun  also  the  President  and  Chief  Executive 
Officer  for  First  Federal  Savings  and  Loan  in  Hazleton, 
Pennsylvania . 

Business  Women's  Golf*Link  strongly  supports  the  proposal  to 
deny  Code  section  501(c)(7)  status  to  clubs  that  engage  in 
discrimination  (including  gender  discrimination)  and  to  deny  any 
preferential  tax  treatment  for  tickets  to  events  at  these  clubs. 
Section  501 (i)  of  the  Code  currently  denies  tax  exemption  to  any 
organization  for  any  taxable  year  if,  at  any  time  during  such 
taxable  year,  the  charter,  bylaws,  or  other  governing  instrument, 
of  such  organization  or  any  written  policy  statement  of  such 
organization  contains  a  provision  which  provides  for  discrimination 
against  any  person  on  the  basis  of  race,  color,  or  religion.  We 
believe  that  it  is  important  to  expand  the  Section  501 (i) 
definition  of  discrimination  to  include  gender. 

I  cun  here  today  to  share  with  you  my  personal  experiences  as 
a  business  woman  who  has  experienced  discrimination  by  501(c)(7) 
tax  exempt  clubs  as  well  as  the  observations  of  the  members  of  an 
organization  of  250  business  women  who  play  golf  at  various  clubs 
here  in  the  Washington,  D.C.  area. 

Let  me  begin  by  sharing  with  you  the  nature  of  Business 
Women's  Golf*Link.  BWG*L  was  founded  early  in  1993  for  the  purpose 
of  creating  networking  and  golf  related  educational  opportunities 
for  business  women  who  play  golf.  Our  membership  is  made  up  of 
over  250  women  who  own  businesses  or  are  managers  in  companies. 
All  of  our  members  play  golf.  The  association  is  not 
discriminatory  -  there  is  a  male  member  -  but  rather  has  been 
created  for  the  purpose  of  providing  support,  primarily  from  an 
education  standpoint,  for  business  women  who  play  golf  .  These 
busines  people  often  utilize  golf  to  establish  or  strengthen 
business  relationships.  They  often  conduct  business  on  the  golf 
course. 

The  use  of  golf  and  tennis  in  building  business  relationships 
has  been  successfully  done  for  years  by  men  throughout  our  country 
by  having  access  to  clubs  which  enjoy  tax  exemptions  as  providing 
social  and  recreational  benefits  in  a  non-profit  structure. 
Business  men  and  women  often  find  that  if  they  call  a  potential 
client  for  an  appointment  the  calendar  is  more  accessible  if  the 
invitation  includes  a  round  of  golf  or  a  geune  of  tennis.  The  use 
of  a  private  club  for  meetings,  meals  and  entertainment  can  be 
critical  in  business.  Statistics  gathered  in  1991  by  the  National 
Golf  Association  and  shared  with  vendors  and  the  golf  community 
during  the  first  Women  in  Golf  Summit  sponsored  by  the  LPGA  reveal 
that  the  largest  portion  of  new  golfers  are  women.  Information 
shared  in  the  Department  of  Labor's  report  during  the  late  1980 's 
regarding  the  Workforce  2000  reveals  that  women  and  minorities  are 
the  fastest  growing  segments  of  the  workforce.  In  1987  the 
National  Organization  of  Women  Business  Owners  reported  that  women 
had  an  ownership  position  in  30%  of  the  businesses  in  this  country 
and  that  is  expected  to  increase  to  closer  to  50%  during  the  next 
few  years.  Four  out  of  every  five  businesses  started  in  this 
country  during  the  past  few  years  are  owned  by  women.  Women  are 
creating  taxable  revenue  opportunities  across  the  country. 
Business  women  need  to  have  access  to  the  private  clubs  where 
business  relationships  can  be  built  and  where  business  is 
conducted. 


1329 


Many  of  the  members  of  BWG*L  have  clients  and  customers  who 
are  male.  Business  women  who  play  golf  are  hindered  from 
conducting  business  in  the  seune  way  as  their  male  peers  when  the 
private  clubs  discriminate  against  the  business  person  for 
membership  or  access  to  the  facilities  of  the  club  based  on  gender. 
The  current  IRS  Code  allows  teuc  exemptions  and  benefits  to  clubs 
where  only  the  male  members  and  guests  can  benefit  from  the  use  of 
the  facility  and,  thus,  the  tax  exemption  serves  to  sanction 
discriminatory  practices.  The  IRS  teuc  codes  were  not  designed  to 
allow  groups  of  citizens  to  benefit  from  discrimination. 

On  a  personal  basis ,  I  was  appointed  to  serve  as  the  President 
and  Chief  Executive  Officer  for  a  savings  and  loan  in  northeast 
Pennsylvania  in  early  1993.  At  the  time  of  the  appointment,  the 
Board  of  Directors  had  interviewed  several  candidates,  male  and 
female,  for  the  position.  One  of  the  expectations  for  the  CEO  of 
this  institution,  as  is  true  for  most  banks,  is  to  be  a  member  of 
the  area  country  club  where  most  of  the  area  business  owners  and 
officers  are  members.  This  particular  club  provides  an  important 
service  to  these  business  people  as  a  place  to  conduct  business  in 
private  during  lunch  or  dinner,  a  facility  for  large  group  meetings 
and  meals,  and  a  place  to  entertain  on  the  golf  course  or  the 
tennis  courts.  The  membership  is  open  to  area  business  men  and 
women.  The  area  does  not  have  alternative  facilities  with  the  same 
services  close  by.  Thus,  this  club  has  become  the  primary  place 
for  business  people  to  meet,  develop  business  contacts,  and 
entertain.  Membership  by  the  CEO  for  my  financial  institution  is 
important  as  a  part  of  the  business  community.  The  Board 
recognized  that  I  would  benefit  from  the  business  contacts  at  this 
club  especially  since  I  am  new  to  the  community.  One  of  the 
expectations  of  my  appointment  was  membership  in  the  club.  I  have 
been  accepted  as  a  member  of  the  club  in  my  neune  with  a  full  golf 
fcunily  membership.  I  understand  that  I  am  one  of  less  than  ten 
women  who  are  a  member  of  the  club.  Most  of  these  women  also  have 
fauaily  memberships. 

After  I  was  accepted  as  a  member  in  the  club  the  Board  of 
Directors  for  the  club  considered  a  recommendation  to  change  the 
rule  which  the  club  currently  has  which  does  not  allow  women  to 
play  on  the  golf  course  on  Saturdays,  Sundays  and  holidays  prior  to 
1:00  pm.  This  rule  also  does  not  allow  men  to  have  tee  times  on 
Tuesday  mornings  nor  women  to  tee  off  for  a  three  hour  period  on 
Thursday  afternoon.  Each  of  these  rules  are  open  for  the  club  golf 
professional  to  make  exceptions  to  as  he  sees  fit.  The  ruling  for 
limiting  access  to  the  course  on  Saturday  and  Sunday  mornings  has 
prevented  me  from  developing  some  business  relationships. 
Development  of  relationships  with  the  key  business  men  in  the 
community  is  important  for  my  position  as  the  CEO  for  the 
institution.  The  club's  Board  of  Directors  considered  changing  the 
rule  to  limit  play  on  Saturday  and  Sunday  mornings  not  based  on 
gender  but  rather  on  primary  membership.  The  Board  voted  not  to 
change  the  rule.  Thus,  business  women  are  still  denied  access  to 
the  golf  course  based  on  gender  even  if  they  can  play  as  quickly  as 
the  men  or  if  they  have  the  same  or  a  lower  handicap  as  the  men. 
Skill  is  not  the  criteria  for  play  at  many  clubs.   Gender  is. 

I  am  concerned  that  by  allowing  tax  exemptions  for  clubs  such 
as  this,  where  the  bylaws  do  not  exhibit  gender  discrimination  but 
the  rules  and  the  practices  do,  the  tax  payers  of  our  country  are 
providing  a  financial  benefit  for  discrimination.  The  current  IRS 
code  does  not  allow  discrimination  based  on  race,  color,  or 
religion  in  the  bylaws  and  written  policies  of  clubs  with  a  tax 
exemption.  The  code  does  not  address  gender  nor  does  it  provide  a 
means  of  rescinding  the  tax  exemption  benefits  for  clubs  whose 
rules  and  practices  are  discriminatory  in  spite  of  "clean"  bylaws 
and  written  policies.  At  a  time  when  our  federal  deficit  is 
extremely  large,  it  seems  inappropriate  to  provide  tax  benefits  for 
discriminatory  practices . 


1330 


I  am  here  today  to  strongly  urge  the  subcommittee  to  support 
the  proposal  to  deny  Code  section  501(c)(7)  status  to  clubs  that 
engage  in  gender  discrimination,  in  addition  to  the  current  wording 
which  defines  discrimination  for  this  section  as  being  on  the  basis 
of  race,  creed,  or  color.  I  £un  also  here  today  to  urge  that  the 
subcommittee  support  denying  section  501(c)(7)  status  to  clubs 
whose  practices,  customs  or  rules  as  well  as  bylaws  and  written 
policies  allow  for  discrimination  based  on  gender,  race,  creed,  or 
color. 

While  a  club's  bylaws  might  be  "clean",  i.e.,  have  no 
discriminatory  language,  the  club  could  still  have  practices, 
customs  and  rules  (written  or  unwritten)  which  are  discriminatory. 
We  must  be  sure  to  close  the  "loopholes"  sometimes  utilized  by 
clubs  whose  actual  practices  are  more  restrictive  than  their 
bylaws.  I  urge  the  subcommittee  to  add  appropriate  language  which 
will  not  allow  the  501(c)(7)  nor  any  tax  exemption  to  clubs  whose 
charter,  bylaws,  policies,  rules,  customs,  or  practices  are 
discriminatory . 

I  believe  that  it  is  important  to  take  away  any  tax  benefits 
that  clubs  which  discriminate  enjoy.  Two  other  benefits  which 
clubs  enjoy  are  the  revenues  provided  by  events  conducted  to 
benefit  local  or  national  charitable  organizations  and  the  revenues 
provided  by  business  persons  eating  and  entertaining  at  the  club. 
The  charitable  organizations  host  events  such  as  golf  tourneunents 
and  tennis  matches  at  clubs  as  fund  raising  events.  The 
individuals  purchasing  tickets  to  these  events  are  benefiting  by 
deducting  from  their  taxable  income  the  portion  of  the  ticket  cost 
which  is  deemed  to  be  a  charitable  contribution.  Once  again,  a  tax 
benefit  is  being  provided  to  those  who  support  clubs  with 
discriminatory  practices.  Business  people  who  deduct  the  cost  of 
meals  and  entertainment  at  clubs  with  discriminatory  practices  are 
also  enjoying  tax  benefits.  Again,  at  a  time  when  our  nation's 
deficit  is  very  high,  it  seems  a  shcune  that  tax  benefits  are 
directly  and  indirectly  being  afforded  to  clubs  with  discriminatory 
practices . 

I  want  to  thank  the  committee  for  allowing  me  the  time  to 
discuss  this  important  matter  with  you.  I  would  be  happy  to  answer 
questions  which  you  might  have  at  this  time.  If  you  or  any  of  your 
staff  members  would  like  to  contact  me  or  Business  Women |s 
Golf*Link  to  answer  any  questions  the  Committee  may  have  as  this 
legislation  is  considered,  please  contact  Ms.  Patty  Sheehan, 
President,  at  the  Business  Women's  Golf*Link  3050  K  Street,  NW 
Suite  400,  Washington,  D.C.  20007  (phone  202-342-8631)  or  me  c/o 
First  Federal  Savings  P  O  Box  950  Hazleton,  Pa.  18201. 


1331 

Mr.  HOAGLAND.  Mr.  Lehrfeld. 

STATEMENT  OF  WILLIAM  J.  LEHRFELD,  COUNSEL,  PRESENT- 
ING TESTIMONY  FOR  EDWIN  J.  FEULNER,  JR.,  PHX).,  PRESI- 
DENT, HERITAGE  FOUNDATION 

Mr.  Lehrfeld.  Mr.  Chairman,  my  name  is  Bill  Lehrfeld.  I  am 
the  general  counsel  of  the  Heritage  Foundation.  I  am  substituting 
for  Mr.  Feulner,  who  was  unable  to  meet  this  schedule  when  it  was 
changed  for  the  hearing.  Mr.  Feulner  wanted  to  express  his  per- 
sonal opposition  to  the  proposed  30  percent  excise  tax  on  lobbying 
expenditures.  The  Heritage  Foundation  is  a  public  policy  research 
institution  which  does  not  engage  in  propaganda  or  attempt  to  in- 
fluence legislation  contrary  to  section  501(c)(3)  of  the  Internal  Rev- 
enue Code.  It  deals  in  the  marketplace  of  conservative  ideas  and 
American  ideals.  It  has  no  control  over  what  others  do  to  translate 
its  research  into  concrete  legislative  proposals  nor  does  it  seek  to 
advance  or  inhibit  pending  or  proposed  legislation  once  introduced. 

Saying  that  is  not  to  say  it  is  in  complete  compliance  with  exist- 
ing law.  As  the  members  of  this  committee  know,  section  501(c)(3) 
provides  that  no  substantial  part  of  our  resources  can  be  devoted 
to  attempts  to  influence  legislation.  We  do  not  know,  nor  does  the 
Congress,  nor  the  public,  what  secret  rules  the  Internal  Revenue 
Service  uses  and  what  tests  are  involved  in  determining  what  is  an 
"attempt  to  influence"  legislation  and  when  advocacy  of  a  legisla- 
tive topic  becomes  "substantial."  These  rules,  enacted  in  1934,  have 
been  a  constant  source  of  friction  and  intimidation  between  the  In- 
ternal Revenue  Service  and  the  charitable  community.  I  believe 
that  the  public  and  the  Congress  would  be  better  served  by  a  re- 
peal of  the  lobbying  limits  in  501(c)(3),  its  alleged  liberalization  in 
501(h),  and  the  repudiation  of  this  proposal. 

Herbert  Hoover  said  that  a  good  many  things  go  around  in  the 
dark  other  than  Santa  Claus.  One  way  to  assure  that  Congress 
does  not  go  around  in  the  dark  is  to  make  it  easy  for  the  501(c)(3) 
sector  to  communicate  with  the  Members  of  Congress  in  as  many 
ways  as  possible.  One  of  the  most  efficient  and  enlightened  ways 
to  communicate  with  members  is  through  charitable  organizations 
which  channel  the  views  of  their  own  constituency. 

Today's  proposal  discounts  the  Congress  because  it  seeks  to  de- 
prive you  of  the  resources  for  the  conduct  of  your  own  responsibil- 
ities. Some  of  your  own  members  would  rather  have  you  guess  than 
know  the  information  and  ideas  percolating  in  the  public  interest. 
In  our  opinion  a  retroactive  excise  tax  on  advocacy  by  charities  is 
unacceptable  tax  policy  and  contrary  to  every  principle  of  account- 
able (jrovemment  contained  in  our  Constitution. 

The  excise  tax  proposal  seems  to  spring  from  the  discredited  no- 
tion that  a  tax  exemption  or  deductible  contribution  is  some  form 
of  Federal  financial  assistance  and  that  as  a  price  for  such  assist- 
ance it  can  control  our  Nation's  intellectual  resources.  The  Su- 
preme Court  recognized  that  Congpress  does  not  infringe  on  free 
speech  when  it  disallows  lobbying  deductions  nor  does  it  deny  the 
equal  protection  of  the  law  to  charities  when  it  takes  away  their 
tax  exemption,  but  not  the  tax  exemption  of  veterans  organizations 
which  lobby  on  the  same  topic.  However  safe  these  precedents  are 


1332 

from  being  overturned,  it  does  not  mean  that  an  expenditure  tax 
is  safe. 

Affecting  tax  exemptions  or  tax  deductions  involving  excess  lob- 
bying is  not  the  same  as  imposing  an  actual  tariff  on  any  lobbying. 
An  excise  tax  on  lobbying  expenditures  is  an  open  suppression  of 
constitutional  rights  because  it  taxes  the  very  value  of  the  lobbying 
message.  Such  a  tax  should  not  survive  a  constitutional  challenge, 
but  that  aside,  the  real  point  is  not  the  proposal's  constitutional 
flaws,  but  that  Congress  should  even  consider  enacting  a  law  which 
plainly  devalues  itself  and  stigmatizes  a  fundamental  freedom. 

Do  you  believe  that  the  public's  confidence  in  its  elected  rep- 
resentatives is  enhanced  by  tax  policies  evidenced  by  this  proposal? 

In  conclusion,  if  all  publicly  supported  charities,  right,  left,  and 
center  are  free  to  participate  in  shaping  the  public  policy,  how  can 
the  public  be  the  loser?  Some  Members  of  Congress  may  feel  that 
they  have  too  much  to  read  on  too  many  issues,  but  the  Heritage 
Foundation  believes  that  you  have  always  benefited  from  vour  own 
conscientious  efforts  to  widen  the  debate,  to  give  unheard  voices  a 
hearing,  and  to  distill  from  open,  unfettered,  and  antagonistic  com- 
ments the  best  approach  to  problems  and  the  best  avenues  to  solu- 
tions. 

Allowing  501(c)(3)  lobbying  will  not  automatically  accomplish 
that  desirable  goal,  but  it  would  signal  a  new  openness,  a  welcome- 
ness,  if  you  will,  to  charities,  to  churches,  and  educational  institu- 
tions to  assume  a  rightful  role  in  the  legislative  arena.  As  Thomas 
Jefferson  noted  in  his  first  inaugural  address,  error  of  opinion  may 
be  tolerated  where  reason  is  left  free  to  combat  it.  Fifty  years  of 
fear,  ignorance,  and  intimidation  cannot  be  reversed  by  the  repeal 
of  the  lobbying  limits  today  or  the  repudiation  of  this  proposal.  We 
want  to  make  sure  that  errors  of  opinion  may  be  fought  by  institu- 
tions of  independence,  fair  partisanship,  and  sensitivity  to  our  na- 
tional well-being.  Thank  you,  Mr.  Chairman. 

Mr.  HOAGLAND.  Thank  you,  Mr.  Lehrfeld. 

[The  prepared  statement  follows:] 


htitage^oundathfi 


Written  Statement  of 

Edwin  J.  Feulner.  Jr..  Ph.D.,  President  of 

The  Heritage  Foundation 

214  Massachusetts  Avenue,  N.E. 

Washington,  D.C.  20002 

As  Presented  by  William  J.  Lehrfeld 


My  statement  is  in  response  to  the  invitation  by  the 
Subcommittee  on  Select  Revenue  Measures,  Committee  on  Ways  and 
Means,  to  testify  on  a  501(c)  (3)  issue  set  out  in  Press  Release  No. 
10,  August  18,  1993.  I  wish  to  offer  my  personal  comments  about  a 
proposal  involving  political  activity  limits: 

'(3)  A  proposal  to  impose  a  30-percent  excise  tax  on  expenditures  of  tax- 
exempt  organizations  for  lobbying  (including  amount  paid  as  salaries  and  an 
allocable  portion  of  support  costs). ' 

The  Heritage  Foundation,  as  a  IRC  501(c)(3)  research 
institution,  does  not  engage  in  propaganda  or  otherwise  attempt  to 
influence  legislation  or  engage  in  political  campaign  activities. 
We  deal  in  the  marketplace  of  conservative  ideas  and  American 
ideals.  We  have  no  control  over  what  others  do  to  translate  our 
research  into  concrete  legislative  proposals  nor  do  we  seek  to 
advance  or  inhibit  pending  or  proposed  legislation  once  it  has  been 
introduced. 

Saying  that  is  not  to  say  that  we  are  necessarily  in  complete 
compliance  with  existing  law.  As  the  members  of  this  Committee 
know.  Section  501(c) (3)  of  the  Internal  Revenue  Code  provides  that 
"no  substantial  part"  of  our  resources  can  be  devoted  to  "attempts 
to  influence"  legislation.  We  do  not  know,  nor  does  the  Congress, 
nor  the  public,  what  secret  rules  the  Internal  Revenue  Service  uses 
to  determine  what  tests  are  involved  in  an  "attempt  to  influence" 
and  when  advocacy  of  a  legislative  topic  becomes  "substantial". 
These  rules,  enacted  in  1934,  have  been  a  constant  source  of 
friction  between  the  IRS  and  the  charitable  community. 

Many  501(c)(3)  organizations  operate  on  the  assumption  that 
there  is  a  "safe  harbor"  expenditure  test  of  five  percent  of  their 
budget.  However,  the  Internal  Revenue  Service  has  refused  to  say 
if  there  is  such  a  "safe  harbor, "  or  if  its  test  measures  hours  of 
employees  time  and  coordinated  volunteer  efforts.  Similarly 
missing  from  the  Internal  Revenue  Service  is  some  form  of  per  se 
irule  which  specifies  that,  for  example,  an  expenditure  of  twelve 
percent  of  the  budget  will  per  se  justify  challenge  to  the  tax 
exemption. 

I  believe  that  the  public,  and  the  Congress,  would  be  better 
served  by  a  repeal  of  all  lobbying  limits  in  501(c)(3)  and  its 
alleged  attempt  at  liberalization,  IRC  501(h) .  Herbert  Hoover  said 
that  a  good  many  things  go  around  in  the  dark  besides  Santa  Claus. 
Congress  need  not  be  one  of  those  things.  One  of  the  best  ways  to 
provide  Congress  with  needed  light  is  to  make  it  as  easy  as 
possible  for  the  501(c)(3)  sector  to  communicate  with  Members  of 
Congress  in  as  many  ways  as  possible.  One  of  the  most  efficient, 
enlightened,  informed,  and  concise  ways  for  the  public  to 
communicate  with  Members  is  through  the  charitable  organizations 
which  organize  and  channel  the  views  of  their  particular 
constituencies.  Today's  proposals  discount  the  Congress  because  it 
seeks  to  deprive  you  of  resources  for  the  conduct  of  your  own 
responsibilities.  Some  of  your  own  Members  would  rather  have  you 
guess  than  know  of  the  information  and  ideas  percolating  in  the 
public  interest. 


1334 


Someone  now  proposes  to  make  the  already  difficult  process  of 
legislative  advocacy  a  taxable  exercise.  In  my  opinion,  a 
retroactive  excise  tax  on  advocacy  by  charities  is  unacceptable  tax 
policy  and  contrary  to  every  principle  for  accountable  government 
contained  in  our  Constitution.  The  excise  tax  proposal  seems  to 
spring  from  the  discredited  notion  that  a  tax  exemption  or 
deductible  contribution  is  some  form  of  financial  assistance  from 
government  and  that  as  a  price  for  such  assistance  it  can  control 
our  Nation's  intellectual  resources. 

The  Supreme  Court  recognized  that  Congress  does  not  infringe 
on  free  speech  when  it  disallows  lobbying  deductions  nor  does  it 
deny  equal  protection  to  charities  when  it  takes  away  their  tax 
exemption  but  not  that  of  veterans  groups,  when  both  lobby 
substantially.  (Regan  v.  Taxation  Without  Representation  of 
Washington.  461  US  540  (1983)) .  However  safe  these  precedents  are 
from  being  overturned,  it  does  not  mean  that  an  expenditure  tax  is 
safe.  Affecting  tax  exemptions  or  tax  deductions  involving  excess 
lobbying  is  not  the  same  as  imposing  an  actual  tariff  on  lobbying, 
however  defined;  an  excise  tax  on  lobbying  expenditures  is  an  open 
suppression  of  Constitutional  rights  because  it  taxes  the  very 
value  of  the  message  sent  to  your  offices.  It  is,  literally,  the 
taxation  of  ideas.  In  my  opinion,  such  a  tax  would  not  survive  a 
Constitutional  challenge;  but  even  so,  the  real  point  is  not  the 
proposal's  constitutional  flaws  but  that  Congress  should  even 
consider  enacting  a  law  which  plainly  devalues  itself  and 
stigmatizes  a  fundamental  freedom.  Do  you  believe  that  public 
confidence  in  its  elected  representatives  would  be  enhanced  by  tax 
policies  evidenced  this  sort  of  stifling  behavior? 

In  conclusion,  Mr.  Chairman,  if  all  publicly  supported 
organizations,  right,  left,  and  center,  are  free  to  participate  in 
shaping  public  policy,  how  can  the  public  itself  be  a  loser?  Some 
Members  of  Congress  may  feel  they  have  too  much  to  read  on  too  many 
issues.  But  I  believe  you  have  always  benefited  from  your  own 
conscientious  efforts  to  widen  the  debate,  to  give  unheard  voices 
a  hearing,  and  to  distill  from  open,  unfettered,  and  even 
antagonistic  comments  the  best  approach  to  problems  and  the  best 
avenues  to  solutions.  Surely  repeal  of  the  lobbying  rules  will  not 
automatically  accomplish  that  desirable  goal.  But  it  would  signal 
a  new  openness  --  a  welcomeness  if  you  will  --  to  charities,  to 
churches  and  to  educational  institutions  to  assume  a  rightful  role 
in  the  legislative  arena. 

As  Thomas  Jefferson  noted  in  his  first  Inaugural  Address: 
"Error  of  opinion  may  be  tolerated  where  reason  is  left  free  to 
combat  it."  Fifty  years  of  fear,  ignorance  and  habits  of 
indifference  can  perhaps  be  reversed  so  that  errors  of  opinion  may 
be  fought  by  institutions  of  independence,  fair  partisanship  and 
sensitivity  to  our  national  well-being. 

September  8,  1993 


1335 
Mr.  HOAGLAND.  Ms.  Bitter  Smith. 

STATEMENT  OF  SUSAN  BITTER  SMITH,  CHAIRMAN,  GOVERN- 
MENT AFFAIRS  COMMITTEE,  AMERICAN  SOCIETY  OF  ASSO- 
CIATION EXECUTIVES,  AND  EXECUTIVE  DIRECTOR,  ARIZONA 
CABLE  TELEVISION  ASSOCIATION 

Ms.  Bitter  Smith.  Thank  you,  Mr.  Chairman.  My  name  is  Susan 
Bitter  Smith.  I  am  the  executive  director  of  the  Arizona  Cable  Tele- 
vision Association,  the  trade  association  of  the  cable  TV  industry 
in  the  State  of  Arizona.  I  currently  serve  on  the  board  of  directors 
of  the  American  Society  of  Association  Executives,  and  as  such, 
chair  their  government  affairs  committee. 

ASAE  is  the  professional  society  of  over  21,000  association  execu- 
tives representing  more  than  10,400  national,  State,  local  and 
trade  and  professional  associations.  Most  of  our  members  work  for 
associations  with  less  than  10  employees.  My  organization  has  a 
staff  of  two.  However,  organizations  represented  by  ASAE  include 
more  than  287  million  members.  These  memberships  include  indi- 
viduals, businesses,  and  institutions. 

Mr,  Chairman,  I  want  to  commend  you  and  the  subcommittee  for 
providing  us  an  opportunity  to  testify  before  Congress  on  the  issue 
of  whether  an  excise  tax  of  30  percent  should  be  levied  on  tax-ex- 
empt organizations  for  expenditures  related  to  lobbying  activities. 
Your  generosity  is  particularly  appreciated  in  light  of  tne  very  re- 
cent and,  in  our  opinion,  unfortunate  events  which  resulted  in  the 
general  loss  of  association  membership  dues  deductibility  related  to 
lobbying  expenses. 

America's  associations  oppose  an  excise  tax  on  lobbying  activities 
and  want  to  restore  the  dues  deductibility  related  to  lobbying  ex- 
penses. The  tax  treatment  of  lobbying  expenses  already  galvanized 
America's  association  community.  During  the  recent  debate  in  the 
Omnibus  Budget  Reconciliation  Act  of  1993  (OBRA  1993)  thou- 
sands of  associations  and  thousands  of  their  members  commu- 
nicated with  congressional  offices  in  opposition  to  this  proposal. 
You  will  see  a  partial  list  of  these  opponents  attached  to  our  writ- 
ten testimony. 

When  Congress  narrowly  repealed  lobbying  expense  deductibility 
in  OBRA  1993,  it  enacted  what  we  believe  is  an  ill-conceived,  con- 
stitutionally suspect  law  without  the  benefit  of  our  input  through 
congressional  hearings.  So,  again,  we  appreciate  the  chance  to  com- 
ment on  this  particular  proposal.  An  excise  tax  will  exacerbate  an 
already  bad  situation  and  dialog  with  Congress  on  this  issue  is  es- 
sential. Many  of  our  21,000  members,  whose  organizations  rep- 
resent 287  million  members,  are  upset  about  the  excise  tax  on  lob- 
bying because  they  see  it  as  an  indirect  assault  on  their  political 
rights. 

Our  members  believe  that  the  associations  represent  them  in  pol- 
icy debates. 

In  addition,  they  feel  shut  out  of  debate  on  lobbying  policy  which 
affects  organizations  so  profoundly.  To  date,  they  have  not  been  al- 
lowed to  demonstrate  the  important  role  that  associations  play  in 
the  public  policy  debate,  and  they  have  not  had  an  opportunity  to 
articulate  all  the  positive  contributions  that  associations  bring  to 
our  country.  Use  of  a  tax  power  to  effectively  raise  the  cost  of  free 


1336 

speech  for  associations  naturally  creates  a  distrust  within  our 
membership,  especially  when  they  feel  the  revenues  to  be  gained 
are  so  limited,  but  the  potential  to  thwart  political  expression  and 
public  input  of  association  members  is  so  great. 

While  the  revenue  gained  from  a  lobby  excise  tax  may  be  mini- 
mal, the  potential  for  discouraging  lobbying  activities  and  public 
input  through  the  use  of  a  tax  mechanism  is  very  great.  Since  the 
power  to  tax  is  the  power  to  destroy,  thousands  of  associations 
which  represent  millions  of  voting  Americans  fear  Congress  will 
eliminate  this  important  means  of  communication.  As  best  we  can 
determine,  the  antilobbying  issue  became  popular  in  media  circles 
during  last  year's  campaign  cycle. 

I  think  there  is  a  misunderstanding  of  what  lobbyists  do.  We,  in 
fact,  expand  the  public's  access  to  elected  officials  and  do  not  create 
a  limitation  on  this  necessary  part  of  Government.  Many  of  us  like 
myself  do  not  reside  within  the  beltway  nor  do  we  spend  money  on 
wining  and  dining  policymakers.  Our  government  relations  budgets 
are  spent  on  information  pieces,  research,  and  providing  answers 
to  questions  posed  to  us  by  policymakers. 

A  recent  letter  in  The  New  York  Times  said  the  Congress  should 
ban  lobbying  because  somehow  it  is  "corrupt."  The  author  of  the 
letter  suggested  that  in  place  of  getting  information  from  indus- 
tries, professions,  associations,  and  academic  sources  that  Congress 
should  depend  with  great  reliability  on  its  own  bureaucracy,  the 
Congressional  Research  Service.  Interestingly  enough,  the  source  of 
much  information  for  the  CRS  typically  is  the  association  commu- 
nity. We  provide  many,  many  answers  to  their  questions  over  time 
on  public  policy  issues. 

ASAE  has  specific  objections  to  the  imposition  of  an  excise  tax 
on  lobbying  activities.  We  have  seen  a  lack  of  evidence  and  a  need 
to  change  the  current  policy.  We  are  particularly  disturbed  by  the 
tenor  of  debate  over  lobbying  what  appears  to  many  of  us,  an  all 
out  attack  on  associations  and  the  members  we  represent.  The  poli- 
cies which  associations  and  businesses  espouse  through  lobbying 
are  arrived  at  in  a  representative  manner.  Lobbyists  do  not  speak 
for  themselves.  They  speak  for  often  a  vast  number  of  volunteers, 
members  and  other  stakeholders. 

Association  policies  are  a  group  of  positions.  Association  policies 
are  developed  through  representative  processes  and  consensus 
building.  ASAE,  for  example,  derives  its  policy  positions  through  a 
careful  process  of  research,  analysis  and  volunteer  involvement 
which  ultimately  leads  to  a  formal  board  approval.  A  lobby  excise 
tax  would  further  stigmatize  lobbying  activities  and  impede  open 
communication  between  citizens  and  Congress.  It  would  discourage 
the  little  guy  and  create  unwieldy  administrative  burdens  which 
would  hit  at  the  main  street  of  our  public  policy  debate. 

Anticipated  penalties,  and  the  cost  of  compliance,  may  cost  asso- 
ciations more  than  the  amount  of  the  excise  tax  raised.  Worse  than 
that,  any  provisions  of  this  nature  will  contain  penalties  for  non- 
compliance which  could  severely  discourage  the  appetite  to  conduct 
lobbying  activities. 

We  find  it  amazing  that  nobody  really  knows  how  many  lobbyists 
there  are  overall.  The  number  of  associations  that  actually  lobby  on 
Capitol  Hill  number  about  2,800  and  about  62  percent  of  them  indi- 


1337 

cate  they  monitor  Federal  activities.  So  it  makes  no  sense  to  de- 
prive Congress  and  its  staff  of  the  input  that  associations  provide 
in  public  policymaking  and  information  to  lawmakers,  and  we  re- 
gard efforts  to  discourage  lobbying  activities  as  an  indirect  effort  to 
silence  associations  on  a  selective  basis. 

ASAE  would  like  to  take  this  opportunity  to  request  broader  con- 
gressional hearings  on  the  role  of  lobbying  in  the  context  of  modem 
politics.  Ultimately,  we  feel  the  victim  of  this  rush  to  judgment  on 
taxation  of  lobbying  activities  may  be  the  institution  of  Congress  it- 
self. 

In  conclusion,  we  would  like  to  remind  you  that  lobbying  of  the 
Grovemment  should  be  a  tax  deductible,  necessary  and  ordinary  ex- 
pense, not  subject  to  an  excise  tax  for  five  reasons.  Lobbying  is  in 
the  public  interest.  It  is  an  important,  free  information  flow  be- 
tween Government  and  citizens.  Individuals  and  associations  are 
forced  into  a  relationship  with  Government  because  Government 
insists  that  it  is  our  partner  in  running  our  businesses,  whether  we 
want  it  or  not. 

Lobbying  is  an  "ordinary"  expense  akin  to  other  legal,  marketing 
and  communications  costs  which  should  be  borne  as  part  of  doing 
business.  Given  the  intense  degree  of  Government  interest  in  the 
workplace,  such  expenses  are  at  least  "ordinary"  if  not  pervasive. 
Lobbying  is  advocacy.  It  is  a  constitutionally  protected  right  to  peti- 
tion our  lawmakers  and  to  make  sure  that  all  of  us  have  a  say  in 
the  way  laws  are  made. 

Tax  policy  should  encourage  communications  between  lawmakers 
and  those  individuals,  groups,  and  other  interests  concerned  by  the 
legislation.  Not  only  do  we  oppose  this  proposal,  we  respectfully 
ask  for  Congress  to  reconsider  the  damage  which  is  now  ongoing. 

We  seek  repeal  provisions  of  OBRA  1993  which  affect  association 
membership  dues  deductibility  related  to  lobbying  expenses.  We  be- 
lieve there  needs  to  be  more  openly  debated  conversations  about 
this  proposal  and  the  proposal  that  was  contained  in  the  Budget 
Act  of  1993. 

Mr.  Chairman  and  members  of  the  subcommittee,  again  on  be- 
half of  ASAE,  we  do  want  to  express  our  gratitude  for  allowing  this 
opportunity  for  input  in  what  is  going  to  be  and  is  a  vital  issue  to 
our  associations  and  to  their  members.  Thank  you  very  much. 

Mr.  HOAGLAND.  Thank  you. 

[The  prepared  statement  follows,  and  an  attachment  will  be  re- 
tained in  committee  files:] 


1338 


WRITTEN  TESTIMONY  OF 

SUSAN  BITTER  SMITH,  CAE 

DIRECTOR 

AMERICAN  SOCIETY  OF  ASSOCIATION  EXECUTIVES 


before  the  Subcommittee  on  Select  Revenue  Measures 
Committee  on  Ways  and  Means 
U.S.  House  of  Representatives 


Mr.  Chairman,  my  name  is  Susan  Bitter  Smith.   I  am  the  Executive  Director  of  the  Arizona 
Cable  Television  Association,  the  trade  association  of  the  cable  television  industry  in  Arizona 
and  I  currently  serve  on  the  Board  of  Directors  of  the  American  Society  of  Association 
Executives  (ASAE)  as  well  as  serve  as  Chairman  of  the  ASAE  Government  Affairs 
Committee. 

ASAE  is  the  professional  society  of  over  21,000  associations  executives  representing  more 
than  10,400  national,  state  and  local  trade  and  professional  associations.    Most  of  our 
members  work  for  associations  with  less  than  10  employees.    My  organization  has  a  staff  of 
two.   However,  organizations  represented  by  ASAE  include  more  than  287  million  members. 
These  memberships  include  individuals,  businesses,  and  a  diversity  of  institutions. 

INTRODVCnON 

Mr.  Chairman,  we  commend  you  for  providing  us  an  opportunity  to  testify  before  Congress 
on  the  issue  of  whether  an  excise  tax  of  30  percent  should  be  levied  on  tax-exempt 
organizations  for  expenditures  related  to  lobbying  activities  (including  amounts  paid  as 
salaries  and  an  allocable  portion  of  support  costs).    Your  generosity  is  particularly 
appreciated  in  light  of  the  very  recent,  and  in  our  opinion,  unfortunate  events  which  resulted 
in  the  general  loss  of  association  membership  dues  deductibility  related  to  lobbying  expenses. 

America's  Associations  oppose  an  excise  tax  on  lobbying  activities  and  wants  to  restore  the 
dues  deductibility  related  to  lobbying  expenses.   The  tax  treatment  of  lobbying  expenses  has 
already  galvanized  America's  association  community.   More  than  3,000  organizations,  a 
partial  list  of  which  is  appended,  and  thousands  of  additional  individuals  have  already 
expressed  their  outrage  over  loss  of  business  and  dues  deductibility  for  lobbying  expenses, 
which  occurred  only  last  month  in  the  Omnibus  Budget  Reconciliation  Act  of  1993  (OBRA 
'93).   A  special  ASAE  analysis  of  OBRA  '93  is  appended  to  my  testimony. 

During  the  recent  debate  over  lobbying  tax  deductibility,  thousands  of  associations  and 
countless  thousands  of  their  members  communicated  with  Congressional  offices  in  opposition 
to  this  proposal.   When  Congress  narrowly  repealed  lobbying  expense  deductibility  in  OBRA 
'93,  it  enacted  an  ill-conceived,  constitutionally  suspect  law  without  the  benefit  of  our  input 
through  Congressional  hearings. 

An  excise  tax  will  exacerbate  an  already  bad  situation  and  dialogue  with  Congress  on  this 
issue  is  essential.    We  are  now  certain  that  an  even  greater  hue  and  cry  will  rise  from  the 
association  community  (and  many  of  the  287  million  members  of  organizations  represented 
by  ASAE)  when  they  become  more  fully  aware  of  efforts  to  impose  an  excise  tax  on 
lobbying  activities.   This  is  another  reason  why  we  are  so  appreciative  for  a  chance  for 
dialogue  on  this  important  issue. 


1339 


WHAT  IS  THE  PROBLEM? 

Why  are  so  many  of  our  21,000  members  whose  organizations  represent  287  million 
members  upset  about  an  excise  tax  on  lobbying?  They  see  it  as  an  indirect  assault  on  their 
political  rights.    Our  members  believe  that  their  associations  represent  them  in  policy 
debates. 

In  addition,  associations  feel  shut  out  of  the  debate  on  lobbying  policy  which  affects  their 
organizations  so  profoundly.   To  date,  they  have  not  been  allowed  to  demonstrate  the 
important  role  that  associations  play  in  the  public  policy  debate.   They  have  also  not  had  an 
opportunity  to  articulate  all  of  the  positive  contributions  that  associations  bring  to  our 
country.   A  special  report  on  "The  Value  of  Associations  to  American  Society,"  part  of 
ASAE's  Associations  Advance  America  Program,  is  attached  to  my  testimony. 

THE  TAX  CREATES  UTTLE  REVENUE  -  BUT  LOTS  OF  POTENTIAL  FOR  LIMITING 
INPUT 

Use  of  the  tax  power  to  effectively  raise  the  costs  of  free  speech  for  associations  (30  cents  on 
the  dollar)  naturally  creates  discomfort  within  our  membership  -  especially  when  they  feel 
that  the  revenues  to  be  gained  are  so  limited,  but  the  potential  to  thwart  political  expression 
and  public  input  of  association  members  is  so  great. 

ASAE  doubts  that  there  is  significant  revenue  in  taxing  lobbying  activities.   As  we  attempt  to 
demonstrate  below,  only  anecdotal  data,  guesswork,  and  inflated  figures  have  been  used  in 
revenue  estimates.   Some  press  accounts  of  lobbying  activity  have  conveyed  a  false  image  of 
the  scope  and  nature  of  lobbying  activity  wiUi  Members  of  Congress  as  well. 

While  the  revenue  gained  from  a  lobby  excise  tax  may  be  minimal,  the  potential  for 
discouraging  lobbying  activities  and  public  input  through  the  use  of  the  tax  mechanism  is 
very  great.   Since  "the  power  to  tax  is  the  power  to  destroy,"  thousands  of  associations, 
which  represent  millions  of  voting  Americans,  fear  that  Congress  will  eliminate  this 
important  means  of  communication. 

WHAT  IS  LOBBYING  REALLY? 

As  best  we  can  determine,  the  entire  anti-lobbying  issue  became  popular  in  media  circles 
during  last  year's  campaign  cycle.  I  think  there  is  a  distinct  misunderstanding  of  what 
lobbyists  do.  We,  in  fact,  expand  the  public's  access  to  elected  officials,  we  do  not  create  a 
limitation  on  this  necessary  communication.   Many  of  us,  like  myself,  do  not  reside  within 
the  beltway,  nor  do  we  spend  money  on  wining  and  dining  policy  makers.   Our  government 
relations  budgets  are  spent  on  information  pieces,  research,  and  providing  answers  to 
questions  posed  to  us  by  public  policy  players. 

WHERE  SHOULD  INFORMATION  COME  FROM? 

A  recent  letter  in  the  New  YoHc  Times  suggested  that  Congress  should  ban  lobbying  because 
it  is  somehow  "corrupt."   The  author  of  the  letter  suggested  that,  in  place  of  getting 
information  from  industries,  professions,  unions,  academe  and  otiier  interests,  that  Congress 
could  depend  with  great  reliability  upon  its  own  bureaucracy,  the  Congressional  Research 
Service  (CRS)  for  information.   Interestingly  enough,  the  primary  source  for  CRS  statistics  is 
the  100,000  strong  association  community,  which  promulgates  the  lion's  share  of  the 
technical,  marketing,  econometric  and  other  research  data  used  by  CRS. 

David  Broder  may  have  hit  the  nail  on  the  head,  when  he  opined  in  his  Washington  Post 
column  of  April  25, 

"If  lobbying  were  outiawed  or  severely  curbed,  who  would  lose  influence  -  the 
average  small  employer  who  belongs  to  the  Chamber  of  Commerce  or  Ross  Perot,  the 
famous  advocate  of  lobbying  controls?  What  sort  of  people  do  you  think  hire 


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lobbyists:  those  who  already  have  access  to  government  decisions-makers  or  those 
who  believe  that  otherwise  they  would  not  have  access?   My  guess  is  the  same  as 
yours.    They're  the  people  who  fear  they  would  not  get  their  foot  in  the  door  without 
a  lobbyist.    ...In  a  world  without  paid  lobbyisu  access  and  influence  would  still  exist, 
but  they  would  be  distributed  very  differently,  and  the  winners,  at  least  in  my  view, 
would  once  again  be  the  elite." 

That's  where  associations  fit  in.  In  effect,  associations  are  a  key  part  of  Congress'  own 
intelligence  system.    We  perform  an  auxiliary  service  to  Congress  that  is  provided  efficiently 
and  voluntarily.   To  not  understand  -  and  appreciate  and  encourage  -  the  public  benefits 
which  association  lobbyists  provide  to  Congress  jeopardizes  a  precious  resource  of 
information,  research,  communications,  and  accountability.    We  feel  that  Congress  needs  to 
define  what  the  problem  is  more  succinctly,  develop  more  information  on  that  perceived 
problem  and  then  consult  with  the  public,  associations,  and  the  lobbying  community  before 
making  arbitrary  and  dangerous  decisions  about  political  "reform." 

WHAT  ARE  ASAE'S  SPECIHC  OBJECTIONS  TO  AN  EXCISE  TAX  ON  LOBBYING? 

ASAE  has  specific  objections  to  the  imposition  of  an  excise  tax  on  lobbying  activities: 

1)  We  have  seen  a  lack  of  evidence  or  a  demonstrated  need  to  change  the  current  policy. 
We  are  particularly  disturbed  by  the  tenor  of  debate  over  lobbying  and  what  appears  to  many 
of  us  to  be  an  all  out  assault  on  associations  and  the  members  we  represent.    Associations 
represent  people  and  institutions.    Buried  in  the  "politically  correct"  discourse  on  the 
"corrupt"  nature  of  lobbying  is  a  mistaken  premise  -  namely  that  a  few  individuals  who  lobby 
on  behalf  of  associations  do  not  represent  the  underlying  constituencies  they  speak  for. 

The  policies  which  associations  and  business  espouse  through  lobbying  are  arrived  at  in  a 
representative  manner.   Lobbyists  do  not  speak  for  themselves,  they  speak  for  often  vast 
numbers  of  members,  volunteers,  and  other  stakeholders.    All  interests  are  "special"  and 
lobbyists  are  empowered  to  serve  a  representative  function.   We  have  always  been  a  nation 
of  special  interests  and  are  proud  of  the  fact  that  associations  serve  to  help  communicate  that 
function. 

If  we  as  lobbyists  or  spokesmen  for  our  association,  err  or  misinterpret  our  charge,  then  we 
cannot  possibly  perform  our  function  appropriately.  Rest  assured,  if  we  fail  to  perform  that 
function  correctly,  our  job  security  is  limited. 

2)  Association  positions  are  group  positions.    Association  policies  are  developed  through 
representative  processes  and  consensus  building.   ASAE,  for  example,  derives  its  policy 
positions  through  a  careful  process  of  research,  analysis,  and  volunteer  involvement  which 
ultimately  leads  to  formal  Board  approval,  when  and  if,  consensus  is  achieved.   Countless 
other  associations  use  similar  processes  to  develop  consensus  to  determine  positions  and 
priorities. 

About  40  percent  of  ASAE  associations  surveyed  develop  policy  recommendations  from  a 
government  affairs  committee  or  its  equivalent  in  1992,  another  39  percent  are  governed  by 
the  organization's  executive  committee,  and  the  remainder  of  associations  receive 
recommendations  from  a  combination  of  staff  and  volunteer  committees.   These  structures 
are  democratic  and  representative  in  nature.   They  are  more  open  than  many  Congressional 
proceedings.    Most  of  these  volunteer-driven  committees  set  term  limitations  for  service  - 
normally  a  three-year  cycle. 

3)  A  lobbying  excise  tax  would  further  stigmatize  lobbying  activities  and  impede  open 
communications  between  citizens  and  Congress.    It  is  wrong  to  tax  the  expression  of  political 
ideas,  opinion,  and  communications  on  a  selective  basis.    If  Congress  were  to  suggest  that  an 
excise  tax  be  placed  on  political  speech  contained  in  the  New  York  Times  or  Washington 
Post,  we  can  only  imagine  the  outrage  that  would  occur  from  the  same  journalists  who 
criticize  Congress  and  lobbyists.    Yet  such  taxation  might  be  theoretically  permissible. 


1341 


according  to  recent  legal  doctrine,  so  long  as  it  were  consistently  and  fairly  applied  to  all 
such  communications. 

In  fact,  Congress  would  err  in  placing  an  excise  tax  on  opinion  contained  in  association 
controlled  publications  and  not  general  media,  since  the  same  content  would  be  receiving  a 
beneficial  treatment  in  one  case,  and  be  burdened  in  another.   The  so-called  trade  press 
reports  to  many  millions  of  Americans.    The  independent,  mass-circulation  trade  press, 
including  magazines,  newsletters,  fax  sheets,  technical  bulletins,  etc.,  deserve  equal  treatment 
with  the  big  media  and  newspapers.    In  fact,  there  is  no  difference  between  their  functions. 
Depending  upon  how  we  define  "lobbying,"  it  would  be  virtually  impossible  for  our 
association-based  media  to  separate  out  communications  to  members,  analysis  of  public 
policy  issues,  and  protected  advocacy  speech. 

4)  Taxing  lobbying  discourages  the  "little  guy"  and  creates  unwieldy  administrative  burdens. 
Any  proposal  which  attempts  to  impose  an  excise  tax  for  lobbying  in  fact  strikes  at  "main 
street"  and  the  little  guy.    We  believe  that  increasing  the  cost  of  lobbying  through  imposition 
of  a  30  percent  excise  tax  will  discourage  the  marginal  players  from  joining  in  policy  debates 
-  i.e.  smaller  associations  and  smaller  businesses. 

Many  association  executives  have  already  told  us,  during  the  recent  dues  deductibility  battle, 
that  they  simply  will  not  get  involved  in  lobbying  activities  rather  than  be  second-guessed  by 
tax  auditors,  regulators,  and  other  officials.    Such  associations  have  limited  access  to 
computer  technology,  accounting  expertise,  and  general  legal  and  tax  assistance.    The  typical 
associations  affected  most  by  an  excise  tax  include  those  whose  primary  missions  relate  to 
community  service,  education,  standards-setting,  research  and  technical  data  sharing.    This 
detrimental  effect  will  doubtless  spread  throughout  the  association  community  at  all  levels  of 
involvement.   Associations  can  be  expected  to  adopt  a  "when  in  doubt,  don't"  attitude  over 
lobbying  and  providing  public  input  to  Congress. 

Keeping  double  books  and  requiring  excessive  record-keeping  activities  will  also  stifle 
lobbying.   In  fact,  compliance  costs  for  the  private  sector  will  probably  exceed  the  entire 
amount  of  revenue  raised  by  the  government. 

The  added  accounting  burden  implicit  in  any  such  proposal  is  tremendous  disincentive  to 
lobby  as  well.    Imagine  what  it  will  cost  an  organization  like  mine  to  set  up  a  separate  set  of 
accounting  books,  reporting  procedures,  and  compliance  mechanism  to  pay  this  excise  tax. 
New  computer  modifications,  more  accounting  hours,  more  reports  and  paperwork,  added 
time  -  it  all  adds  up  to  lots  of  money,  which  many  smaller  organizations  simply  cannot 
afford. 

Lack  of  consistent  financial  reporting  between  related  organizations  will  be  a  major 
impediment.    For  nationally-based  organizations,  there  is  great  disparity  in  fiscal  year 
reporting  between  component  organizations.   There  is  frequently  great  difficulty  in 
standardizing  reporting  data  between  related  entities.   Few  organizations  harmonize  their 
fiscal  years.    Many  national  organizations  can  contain  as  many  as  several  thousand  chapters 
or  branches.    A  small  majority  (52  percent)  even  begin  their  fiscal  year  in  January,  according 
to  the  Policies  and  Procedures  in  Association  Management  1992,  a  biennial  study  conducted 
by  ASAE. 

Anticipated  penalties,  and  the  cost  of  compliance,  may  cost  associations  more  than  the 
amount  of  the  excise  tax  raised.  Worse,  any  provision  of  this  nature  would  contain  penalties 
for  noncompliance,  however  inadvertent  the  noncompliance,  which  could  severely  discourage 
the  appetite  to  conduct  lobbying  activities. 

The  recent  lobbying  deductibility  provisions  initially  contained  a  penalty  of  $50  per 
individual  member  for  even  the  most  innocent  of  reporting  mistakes  -  a  prospect  which 
would  have  bankrupted  many  organizations,  some  of  which  have  hundreds  of  thousands  of 
members.    Fortunately,  the  Conference  Committee  struck  this  particular  provision  in  the  final 
hours  of  debate  on  the  budget  package. 


TT  <  on  r\ 


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5)  There  will  be  a  negative  impact  on  the  ability  of  associations  to  attract  and  retain 
members  -  especially  in  today's  difficult  economic  climate.    I  have  serious  doubts  that 
associations  can  afford  to  pay  a  30  percent  excise  tax  on  lobbying.    In  general,  the  nonprofit 
sector  has  been  forced  through  the  same  type  of  consolidations  and  productivity  crisis  as  for- 
profit  businesses.    In  fact,  some  of  our  current  financial  challenges  stem  from  a  downturn  in 
public  funding  and  a  concomitant  increase  in  non-dues  sources  of  revenue  generation.    In 
order  to  survive,  many  of  our  associations  have  had  to  become  more  creative,  offer  unique 
services  and  run  themselves  like  any  other  business. 

In  a  sample  of  780  associations,  about  $2  billion  was  spent  on  all  economic  activities.   The 
average  expenditure  for  Government  Affairs  activities  by  all  associations  amounted  to  only 
4.5  percent.  Surprisingly,  75  percent  of  those  associations  surveyed  reported  no  expenditures 
in  this  category.    A  totai  of  $70,507,425  was  spent  by  the  sampling  overall.    About 
$673,966,294  was  raised  from  membership  dues  by  so-called  regular  members,  an  additional 
$36,610,552  by  Associate  members,  and  $44,532,976  by  other  categories  of  membership. 

Generally,  membership  dues  averaged  about  42  percent  of  the  typical  association's  income 
budget.   Interestingly,  our  figures  indicate  that  regional,  state  and  local  membership 
organizations  spend  slightly  more  on  government  affairs  (6. 1  percent)  than  do  national 
groups  (4.8  percent).    "Lobbying"  activities  constitute  a  much  smaller  percentage  of  overall 
association  activities  than  even  the  limited  budgets  for  government  affairs.    Our  best  estimate 
is  that  only  about  one-third  of  the  4.5  percent  (i.e.  0.0145  percent  of  total  budget)  of  all 
association  government  affairs  activities  could  be  construed  as  "lobbying,"  even  under  the 
expanded  definition  of  that  term  which  was  adopted  by  Congress  last  month. 

In  fact,  data  like  this  leads  us  to  question  the  validity  of  the  Congressional  Budget  Office 
revenue  estimates  on  this  topic.   Nobody  seems  to  have  valid  data  on  lobbying  activities  and 
it  would  seem  ill-advised  to  propose  sweeping  policies  without  such  basic  information. 

HOW  MANY  ASSOCIATION  LOBBYISTS  ARE  THERE? 

We  can  try  to  estimate.    According  to  ASAE's  Policies  and  Procedures  in  Association 
Management  1992,  2>1  percent  of  association  employ  government  relations  staff.    Local 
associations  and  international  associations  are  the  least  likely  to  support  a  government 
relations  staff,  and  state/regional  associations  are  the  most  likely.   On  average,  those 
associations  involved  in  government  affairs  employ  three  government  relations  staffers. 

More  than  one-third  of  associations  employ  registered  lobbyists  as  staff  (about  the  same 
percent  as  in  1987)  with  local  associations  and  international  associations  the  least  likely  to 
have  them.   The  average  number  of  staff  lobbyists  registered  at  the  state  and  local  levels 
remained  at  two  people  between  1987  and  1992,  but  the  average  number  registered  at  the 
federal  level  actually  dropped  to  two,  from  three  in  1987. 

The  number  of  associations  lobbying  on  Capitol  Hill  may  be  as  many  as  2,800.   About  62 
percent  of  the  sample  responded  that  they  monitor  federal  legislation,  but  only  38  percent 
reported  that  they  had  one  or  more  lobbying  individuals  on  staff.    This  figure  doubtless 
understates  the  actual  scope  of  association-based  lobbying  activity.   For  example,  associations 
participate  in  a  number  of  coalitions,  which  is  more  cost  effective  and  representative  way  of 
communicating  their  messages.    Associations  often  may  also  be  involved  in  lobbying  through 
outside  law  firms  and  legislative  specialists.   Then  too,  much  of  the  lobbying  activity  in  the 
state  capitals  and  locally  is  also  conducted  by  associations  and/or  their  chapters,  affiliates, 
etc. 

IF  NOBODY  KNOWS  HOW  MANY  LOBBYISTS  THERE  ARE,  HOW  CAN  YOU 
GENERATE  REVENUE  ESTIMATES? 

We  find  it  quite  amazing  that  nobody  knows  how  many  lobbyists  there  actually  are  overall. 
Our  best  estimate,  based  upon  registrations  with  Congress,  the  Directory  of  Washington 
Lobbyists,  Lawyers  and  Interest  Groups,  the  annual  compendium  Washington 


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Representatives,  and  other  sources  is  between  17,000  and  18,000.   This  does  not  include 
certain  attorneys  who  may  claim  an  attorney-client  privilege  and  refuse  disclosure,  nor  some 
registered  foreign  agents,  nor  the  many  lobbyists  operating  at  the  state  level.  Obviously,  a 
much  smaller  number  actually  participate  in  direct  lobbying  activities. 

ASAE  wants  Congress  to  develop  better  data  about  lobbying  before  it  devises  more  ill- 
conceived  legislation.   ASAE  believes  that  for  every  dollar  Congress  appropriates  to  the 
public  till,  a  given  number  of  association-sponsored  programs  will  be  damaged,  including 
key  community  service,  technical  standard-setting,  self-regulatory,  research,  and  educational 
programs  managed  by  associations. 

In  addition,  ASAE  is  in  the  process  of  analyzing  the  Constitutional  issues  raised  by  the 
theoretical  imposition  of  an  excise  tax  on  lobbying.   Intrusion  into  Constitutionally  protected 
political  speech  and  the  right  to  petition  Congress  clearly  is  an  issue  here.    In  a  nutshell, 
ASAE's  preliminary  thought  on  the  matter  is  that  an  excise  tax  on  lobbying  may  be 
constitutionally  deficient  for  the  following  reasons: 

1)  Any  Congressional  action  to  withdraw  a  benefit,  such  as  favorable  tax  treatment  of 
lobbying,  may  operate  as  a  penalty  on  speech  and  thus  involve  the  First  Amendment; 

2)  The  Supreme  Court  has  on  various  occasions  analyzed  the  loss  of  a  tax  benefit  as  a 
penalty;  and 

3)  Any  Congressional  scheme  which  uses  the  content  of  speech  or  the  identity  of  the  speaker 
(associations,  lobbyists)  to  discriminate  between  those  entitled  to  a  benefit  and  those  who  are 
not  entitled  to  the  benefit  may  also  burden  speech. 

ASAE  will  rigorously  analyze  any  violation  of  association  First  Amendment  Rights  and  will 
defend  its  members'  interests. 

DISCOURAGING  LOBBYING  IS  BAD  IDEA  AND  HINDERS  CONGRESS  AS  WELL 

It  makes  no  sense  to  deprive  Members  of  Congress  and  their  staff  from  essential  information 
about  our  profession  or  industries.    Congress  and  the  Executive  Branch  don't  make  bad  laws 
and  unworkable  regulations  on  purpose.    Flawed  policy  normally  results  from  a  failure  to 
understand  the  consequences  of  well-intentioned  acts. 

Associations  must  have  a  role  in  providing  information  to  lawmakers.   We  regard  efforts  to 
discourage  lobbying  activities  as  an  indirect  effort  to  silence  associations  on  a  selective  basis. 
This  proposal,  although  not  clearly  articulated,  presents  other  problems  as  well.   Consider 
the  following: 

1)  To  the  extent  that  the  moneyed  or  otherwise  powerful  interests  in  our  society  wish  to 
communicate  to  Congress,  cost  is  a  minor  consideration. 

2)  Businesses  can  easily  pass  on  increased  costs  for  lobbying  through  the  price  mechanism  - 
either  directly  or  indirectly. 

3)  In  many  states,  union  membership  is  compulsory,  and  therefore  dues  increases  can  be 
absorbed  without  much  protest  by  members. 

4)  Associations,  on  the  other  hand,  have  much  more  difficulty  in  passing  along  such  cost 
increases,  especially  given  the  economic  conditions,  competition,  and  down-sizing  occurring 
in  the  non-profit  world. 

WHERE  DOES  THE  MONEY  GO? 

Mr.  Chairman,  an  important  issue  that  needs  to  be  addressed  is  what  Congress  will  do  with 
the  revenue  raised  from  the  proposed  excise  tax  on  lobbying.    As  I  mentioned  earlier,  OBRA 


1344 


'93  eliminated  the  deduction  for  lobbying  expenses.   The  American  people  were  told  that  the 
revenue  raised  from  that  bill  would  go  toward  deficit  reduction. 

Even  before  OBRA  '93  was  enacted,  however,  the  Senate  had  already  passed  legislation 
creating  public  fmancing  of  Congressional  elections,  which  ASAE,  most  associations,  and  an 
overwhelming  majority  of  the  American  electorate  oppose.    Because  the  Federal  Election 
Commission  is  running  a  massive  deficit  for  the  Presidential  Campaign  fund,  the  check  off 
for  individual  tax  returns  was  quietly  raised  from  $1  to  $3. 

Earlier  this  year,  the  Senate  leadership  said  that  the  money  for  public  financing  of  their 
campaigns  would  be  paid  for  from  revenue  raised  by  eliminating  the  deductibility  of  lobbying 
expenses.    While  it  is  unclear  where  the  revenue  will  go  for  this  new  lobbying  excise  tax,  in 
the  Senate's  eyes  the  revenue  raised  by  the  lobbying  deduction  loss  was  spent  even  before  it 
was  raised  and  it  was  not  going  toward  deficit  reduction.  1 

In  a  nutshell,  Mr.  Chairman,  what  we  are  talking  about  is  taxing  the  American  people's  First 
Amendment  rights  to  provide,  as  some  political  pundits  have  put  it  "food  stamps  for 
politicians."    ASAE  does  not  believe  this  is  a  wise  or  politically  supportable  position. 

ASAE  would  like  to  take  this  opportunity  to  request  broader  Congressional  hearings  on  the 
role  of  lobbying  in  the  context  of  modem  politics.   Ultimately,  we  feel  that  the  greatest 
victim  of  this  "rush  to  judgement"  on  taxation  of  lobbying  activities  may  be  the  institution  of 
Congress  itself.   Congress  may  have  unwittingly  blinded  itself  by  impeding  the  free  flow  of 
information  and  data  which  is  essential  to  the  formation  of  sound  legislation. 

CONCLUSION 

Lobbying  the  government  should  be  a  tax-deductible  "necessary  and  ordinary"  expense,  not 
subject  to  an  excise  tax  for  five  reasons: 

1)  Lobbying  is  in  the  public  interest.    Lobbying  is  important  for  information  flow  between 
government  and  citizens.    Congress  needs  to  encourage  such  activities; 

2)  Individuals  and  associations  are  forced  into  a  relationship  with  government  because 
government  insists  that  it  is  our  partner  in  running  our  businesses,  our  industries,  and  our 
professions  -  whether  we  want  it  or  not; 

3)  Lobbying  is  an  "ordinary"  expense,  akin  to  other  legal,  marketing  and  communications 
costs  which  should  be  borne  as  a  part  of  doing  business.    Given  the  intense  degree  of 
government  interest  in  the  work  place,  such  expenses  are  at  least  "ordinary"  if  not  pervasive. 
In  fact,  scrutiny  of  the  Congressional  debate  which  resulted  in  lobbying  expense  tax 
deductibility  in  the  early  1960s  demonstrates  that  Congress  considered  such  factors  in  the 
first  place.   If  anything,  the  same  factors  which  drove  Congress  to  grant  deductions  in  1962, 
including  the  growth  and  intrusiveness  of  government  at  all  levels,  are  even  more 
pronounced  today  than  they  were  30  years  ago. 

4)  Lobbying  is  advocacy.   It  is  a  constitutionally  protected  right  to  petition  our  lawmakers 
and  to  make  sure  that  all  interests  have  a  say  in  the  way  laws  are  made,  not  just  society's 
elites. 

5)  Tax  policy  should  encourage  communications  between  lawmakers  and  those  individuals, 
groups,  and  other  interests  which  are  affected  by  legislation.    ASAE's  members  manage 
organizations  with  more  than  287  million  members.    These  are  only  some  of  the  individuals, 
businesses,  and  other  organizations  which  are  represented  by  lobbyists.    Lobbying  means  our 
right  to  tell  our  own  story  to  lawmakers. 

Mr.  Chairman,  this  proposal  is  not  only  egregious,  it  needs  to  be  more  openly  debated  by  a 
broader  spectrum  of  people  and  institutions  affected.  We  also  urge  Congress  to  reconsider 
the  original  proposal  to  eliminate  dues  deductibility.   This  should  be  challenged  as  equally 


1345 


problematic  to  cherished  ideals  of  pluralism. 

Not  only  do  we  oppose  this  proposal  we  respectfully  ask  for  Congress  to  reconsider  the 
damage  which  is  now  ongoing.   We  seek  repeal  of  the  provisions  of  OBRA  '93  which  affect 
association  membership  dues  deductibility  related  to  lobbying  expenses. 

Mr.  Chairman,  again  on  behalf  of  ASAE,  we  want  to  express  our  gratitude  for  allowing  us 
this  first  opportunity  for  input  on  what  is  a  vital  issue  to  associations  and  their  members. 


1346 

Mr.  HoAGLAND.  Mr.  Gill. 

STATEMENT  OF  CHARLES  B.  GILL,  GOVERNOR  AND  CHIEF  EX- 
ECUTIVE OFFICER,  NATIONAL  RURAL  UTILITIES  COOPERA- 
TIVE FINANCE  CORP.,  HERNDON,  VA. 

Mr.  Gill.  Thank  you,  Mr.  Chairman.  My  name  is  Chuck  Gill.  I 
am  Governor  and  chief  executive  officer  of  the  National  Rural  Utili- 
ties Cooperative  Finance  Corp.,  commonly  known  as  CFC.  On  be- 
half of  our  1,000  cooperatives  and  public  power  district  members, 
I  appreciate  the  opportunity  to  appear  before  you  today. 

My  oral  statement  summarizes  my  testimony,  and  I  would  appre- 
ciate my  full  statement  to  be  made  part  of  the  record.  I  am  appear- 
ing before  you  today  to  seek  a  clarification  in  the  potential  legisla- 
tion that  will  affect  the  operation  of  501(c)(4)  organizations.  The 
National  Rural  Electric  Cooperative  Association  and  their  mem- 
bers, which  are  also  members  of  CFC,  strongly  support  this  testi- 
mony. It  is  my  understanding  Executive  Vice  President  Bob 
Bergland  will  be  submitting  a  separate  written  statement  for  the 
record. 

CFC  was  incorporated  as  a  private,  not-for-profit  cooperative  as- 
sociation under  tne  laws  of  the  District  of  Columbia  in  1969.  The 
principal  purpose  of  CFC  is  to  provide  its  members  with  a  source 
of  financing  to  supplement  the  loan  programs  of  the  Rural  Elec- 
trification Administration  of  the  United  States  Department  of  Agri- 
culture. 

The  REA  requires  that  cooperatives  receive  up  to  30  percent  of 
their  capital  from  private  sources.  CFC  is  specifically  recognized  in 
the  Rural  Electrification  Act  of  1936  as  amended.  CFC's  rural 
members  provide  service  to  about  70  percent  of  the  land  mass  of 
the  United  States,  serving  an  estimated  29  million  ultimate  users 
of  electricity. 

CFC  can  be  described  in  many  ways.  It  is  a  not-for-profit  financ- 
ing institution  whose  operations  are  focused  solely  on  meeting  the 
unique  needs  of  its  rural  utility  svstems.  It  is  a  member-owned, 
member-controlled  organization.  All  of  the  benefits  of  CFC  oper- 
ation are  specifically  returned  to  its  members. 

Potential  legislation  affecting  501(c)(4)  organizations  could  have 
a  severe  negative  impact  on  CFC's  operations.  In  response  to  al- 
leged abuses  that  were  committed  by  some  501(c)(4)  organizations 
which  are  unrelated  in  purpose  or  structure  to  that  of  CFC,  Rep- 
resentative Pete  Stark  introduced  legislation  last  year  that  would 
prohibit  these  corporations  fi-om  allowing  any  part  of  their  net 
earnings  to  benefit  any  shareholder  or  individual.  His  bill  entitled, 
"Application  of  Private  Inurement  Rule  to  Tax  Exempt  Civic  Asso- 
ciations," was  part  of  H.R.  11,  the  1992  tax  bill  vetoed  by  President 
Bush. 

CFC  is  concerned  that  applying  private  inurement  rules  under 
section  501(c)(4)  would  severely  hamper  its  allocation  and  retire- 
ment of  capital  credits,  thus  adversely  affecting  CFC's  ability  to  op- 
erate as  a  cooperative  and  maintain  its  role  as  a  social  welfare  or- 
ganization. CFC  is  not  an  organization  which  is  abusing  its 
501(c)(4)  tax  exempt  status. 

Applying  private  inurement  provisions  to  501(c)(4)  without  rec- 
ogfnition  and  clarification  of  CFC's  unique  situation  would  force 


1347 

CFC  into  a  massive  financial  restructuring  to  retain  its  longstand- 
ing, unchallenged  tax  exemption  when  the  intent,  we  do  not  be- 
lieve, was  not  to  affect  an  organization  like  CFC. 

At  CFC's  request  the  IRS  reaffirmed  CFC's  tax  exempt  status  in 
1987.  The  IRS  indicated,  and  I  quote, 

"CFC  would  also  help  relieve  the  increasing  fiscal  pressures  on  several  Federal 
programs  and  agencies,  thereby  contributing  to  lessening  the  burden  of  the  Govern- 
ment. Based  on  the  above  facts,  we  respectfully  rule  that  your  tax  exempt  status 
under  section  501(cX4)  of  the  code  will  not  be  adversely  affected." 

It  has  been  suggested  that  an  alternative  form  of  organization 
under  subchapter  T  rules  would  allow  CFC  to  continue  its  present 
operations.  However,  due  to  its  unique  structure,  it  is  possible  that 
CFC  would  incur  a  new  and  severe  tax  liability.  The  new  tax  obli- 
gation vvould  be  incurred  because,  number  one,  CFC  must  retain 
some  of  its  earnings  to  pay  interest  on  its  subordinated  debt  which 
was  contributed  by  our  member  cooperatives  and  public  power  dis- 
tricts; and,  two  as  a  prudent  lender  CFC  must  make  provisions  for 
potential  loan  and  guarantee  losses,  yet  these  would  not  be  deduct- 
ible unless  the  loss  was  realized. 

When  considered  on  the  basis  of  impact  on  the  rural  cooperative 
and  PPD  members  of  CFC,  the  financial  impact  is  quite  negative. 
Nationwide  a  conservative  estimate  would  indicate  an  annual  cost 
increase  of  $13  to  $20  million.  These  costs  would  be  borne  by  the 
ultimate  consumers  of  the  nonprofit  utilities  which  serve  the  rural 
areas. 

Some  70  percent  of  the  rural  electric  cooperatives  currently  have 
rates  higher  than  neighboring  utilities.  CFC  is  sympathetic  to  the 
concerns  expressed  by  Representative  Stark  regarding  the  abuses 
by  some  501(c)(4)  organizations  which  have  resulted  in  unjustified 
benefits  to  individuals.  However,  language  outlining  the  private 
inurement  amendments  proposed  by  Representative  Stark  would 
have  the  net  effect  of  inadvertently  restricting  the  ability  of  CFC 
to  return  benefits  of  its  operations  to  its  members,  all  of  which  are 
not-for-profit  organizations,  not  individuals. 

We  have  researched  the  Tax  Code  and  developed  a  suggested  al- 
ternative which  would  allow  Representative  Stark  to  keep  the 
original  intent  of  his  bill  intact  while  allowing  CFC  to  continue  to 
serve  the  needs  of  rural  America.  We  would  ^adly  share  this  with 
the  committee  if  desired.  It  is  important  to  keep  in  mind  no  Fed- 
eral dollars  are  used  to  support  CFC,  and  our  proposal  will  not  cost 
the  Treasury  any  funds.  Our  simple  request  is  to  allow  us  to  con- 
tinue to  operate  as  we  have  done  for  the  past  25  years.  It  is  unfor- 
tunate that  through  no  fault  of  our  own  that  we  are  caught  in  the 
legislative  crossfire.  We  ask  for  the  subcommittee's  support  in  curb- 
ing abuses  by  501(c)(4)  organizations  while  allowing  CFC  to  con- 
tinue its  present  operations. 

We  thank  you  for  allowing  us  to  present  this  testimony  and  obvi- 
ously we  would  be  glad  to  answer  any  questions  you  might  have. 

Mr.  HOAGLAND.  Thank  you,  Mr.  Gill. 

[The  prepared  statement  and  attachments  of  Mr.  Gill  and  the 
statement  lor  the  record  of  Bob  Bergland  follow:] 


1348 


STATEMENT  OF  CHARLES  B.  GILL, 

GOVERNOR  AND  CHIEF  EXECUTIVE  OFFICER, 

NATIONAL  RURAL  UTIUTIES  COOPERATIVE  RNANCE  CORTORATION 

Good  afternoon,  Mr.  Chairman  and  Members  of  the  Subcommittee,  my  name  is  Chuck  Gill 
and  I  am  Governor  and  Chief  Executive  Officer  of  the  National  Rural  Utilities  Cooperative 
Finance  Corporation,  commonly  referred  to  as  CFC.  On  behalf  of  the  1000  members  I 
appreciate  the  opportunity  to  appear  before  you  today. 

I  am  appearing  before  you  today  to  seek  a  clarification  in  potential  legislation  that  will  affect 
the  operations  of  501(c)(4)  organizations. 

The  National  Rural  Elearic  Cooperative  Association  (NRECA)  and  their  members  most  of 
whom  are  members  of  CFC  strongly  supports  this  testimony.  It  is  my  understanding  Bob 
Bergland,  Executive  Vice  President  of  the  National  Rural  Electric  Cooperative  Association 
wall  be  submitting  a  separate  written  statement  for  the  record. 


It  would  perhaps  be  helpful  to  Members  of  the  Subcommittee  to  give  some  background  on 
CFC.  We  opened  our  doors  in  1969,  after  leaders  in  the  rural  electric  program  felt  it  was 
important  to  develop  an  additional  source  of  private  market  financing  to  supplement  the 
Rural  Electrification  Administration  (REA),  an  agency  within  the  U.S.  Department  of 
Agriculture,  loan  program  for  the  growing  capital  needs  of  America's  rural  electric 
cooperatives  (RECs). 


MISSION  STATEMENT 

Our  mission  is  a  simple  one: 

CFC  is  a  not-for-profit  cooperative  whose  mission  is  to  provide  its  member  utility  systems, 
through  their  unified,  collective  strength,  an  assured  source  of  low-cost  private  capital  and 
state  of  the  art  financial  services. 


CFC's  role  is: 


To  provide  rural  electric  distribution  systems  with  an  assured  source  of  capital  at  the 
lowest  possible  cost  at  whatever  level  is  required; 

To  provide  rural  elearic  power  supply  systems  an  assured  source  of  capital  and  where 
possible,  add  economic  value  to  market  entry  by  power  supply  systems; 

To  provide  resources,  as  required,  to  meet  the  evolving  needs  of  the  rural  electric 
program  for  capital  and  financial  services; 

To  operate  and  maintain  CFC  in  a  manner  that  will  foster  and  develop  cooperative 
principles  of  organization  and  philosophy; 

To  foster  and  support  the  maintenance  and  strengthening  of  the  common  goals  and 
unity  of  purpose  of  the  rural  electric  program;  and 

To  foster,  develop  and  protect  the  cooperative  form  of  organization  in  the  utility 
sector. 


CFC  -  PROVIDING  SUPPLEMENTAL  CAPITAL 
TO  RURAL  AMERICA 

National  Rural  Utilities  Cooperative  Finance  Corporation  ("CFC")  was  incorporated  as  a 
private,  not-for-profit  cooperative  association  under  the  laws  of  the  District  of  Columbia  in 
April  1%9.  The  principal  purpose  of  CFC  is  to  provide  its  members  with  a  source  of 
financing  to  supplement  the  loan  program  of  the  Rural  Electrification  Administration 
("REA")  of  the  United  States  Department  of  Agriculture. 


1349 


CFC,  headquartered  in  Hemdon,  Virginia,  makes  loans  primarily  to  its  rural  utility  system 
members  to  enable  them  to  acquire,  construct  and  operate  electric  distribution,  generation, 
transmission  and  related  facilities.  Most  CFC  long-term  loans  to  Utility  Members  have  been 
made  in  conjunction  with  concurrent  loans  from  REA  and  are  secured  equally  and  ratably 
with  REA's  loans  by  a  single  mortgage.  CFC  also  provides  guarantees  for  tax-exempt 
financing  of  pollution  control  facilities  and  other  properties  constructed  or  acquired  by  its 
members,  and,  in  addition,  provides  guarantees  of  taxable  debt  in  conneaion  with  certain 
lease  and  other  transactions  of  its  members. 


History 

A  significant  gap  developed  in  the  mid  1960 '  s  between  the  money  available  for  REA  loans 
and  the  actual  needs  of  the  program.  It  had  become  apparent  that  some  alternative  source 
of  capital  would  have  to  be  found  if  the  rural  electric  cooperatives  were  to  meet  their  service 
obligation  to  their  rural  patrons. 

Through  the  efforts  of  the  National  Rural  Electric  Cooperative  Association,  the  national 
trade  association  representing  rural  cooperatives,  a  26-member  Long-Range  Study  Committee 
of  program  leaders  was  appointed  to  make  an  in-depth  study  of  future  financing  needs  and 
to  formulate  rural  electric  viewpoints  and  objectives. 

Attempts  to  interest  traditional  lenders  in  providing  capital  to  supplement  REA  funds  were 
rebuffed.  As  a  result,  the  rural  electric  systems  themselves  determined  that  the  only 
reasonable  method  to  assure  the  availability  of  capital  and  relieve  some  of  the  pressure  on 
government  loan  programs  was  to  form  their  own  organization  to  meet  their  needs. 

In  March  1969,  the  Final  Report  and  Recommendations  of  the  Long-Range  Study  Committee 
was  presented  to  and  approved  by  the  rural  electric  systems.  Essentially,  this  report  called 
for  the  establishment  of  a  supplemental  financing  program  to  be  coordinated  through  an 
independent,  cooperative  institution;  and  provided  that  this  institution  should  be  financed 
through  the  resources  of  its  member-systems. 

In  July  1970,  an  "Invitation  to  Subscribe  to  Capital  Term  Certificates"  was  mailed  to  all 
rural  electric  systems  in  order  to  establish  the  new  finance  cooperative.  By  accepting  the 
"Invitation",  the  rural  electrics  agreed  to  capitalize  their  own  supplemental  finance 
organization  through  the  investment  of  their  own  funds  and  without  government  assistance. 
CFC  was  launched  on  its  way  toward  becoming  a  full-service,  supplemental  financing 
institution  for  the  nation '  s  rural  electric  cooperatives. 


CFC  Tpdgy 

CFC's  1,029  members  as  of  May  31,  1993,  included  894  rural  electric  Utility  Members, 
virtually  all  of  which  are  consumer-owned  cooperatives,  72  service  members  and  63  associate 
members.  The  Utility  Members  included  830  distribution  systems  and  64  generation  and 
transmission  systems  operating  in  46  states  and  U.S.  territories.  At  December  31,  1992, 
CFC's  member  rural  electric  systems  provided  service  to  about  70%  of  the  contiguous 
continental  land  territory  of  the  United  States,  serving  approximately  12.2  million  consumers 
representing  an  estimated  28.8  million  ultimate  users  of  electricity  and  owned  approximately 
$60.8  billion  in  total  utility  plant. 

To  assist  yet  another  element  of  rural  America  which  has  traditionally  financed  its  operations 
through  the  REA  loan  program,  the  Rural  Telephone  Finance  Cooperative  ("RTFC")  was 
incorporated  as  a  private,  not-for-profit  cooperative  association  in  the  state  of  South  Dakota 
in  September  1987.  RTFC  is  a  controlled  affiliate  of  CFC  (six  of  its  eleven  directors  are 
appointed  by  CFC)  and  was  created  for  the  purpose  of  providing  financing  to  its  rural 
telecommunication  members  and  affiliates.   CFC  is  the  sole  source  of  funding  for  RTFC. 


1350 


Guaranty  Funding  Cooperative  was  organized  in  December  1991  as  a  private,  not-for-profit 
cooperative  owned  by  its  member  rural  electric  systems  and  CFC  to  provide  a  source  of 
funds  for  members  to  refinance  their  debt  to  the  Federal  Financing  Bank  of  the  United 
States  Treasury.   GFC  is  a  controUed  affiliate  of  CFC. 

CFC '  s  primary  objective  as  a  cooperative  is  to  provide  its  members  with  the  lowest  possible 
loan  and  guarantee  rates.  Therefore,  CFC  marks  up  its  funding  costs  only  to  the  extent 
necessary  to  cover  its  operating  expenses  and  a  provision  for  loan  and  guarantee  losses  and 
to  provide  for  margins  sufficient  to  preserve  interest  coverage  in  light  of  CFC's  financing 
objectives.  To  the  extent  members  contribute  to  CFC's  base  capital  with  subordinated 
certificates  carrying  below-market  interest  rates,  CFC  can  offer  proportionally  lower  interest 
rates  on  its  loans  to  members. 

CFC  can  be  described  in  many  ways.  It  is  a  private,  not-for-profit  cooperative.  It  is  an 
independent  financing  institution  whose  operations  are  focused  solely  on  meeting  the  unique 
needs  of  its  rural  utility  systems.  It  is  a  member-owned,  member-controlled  organization. 
All  of  the  benefits  of  CFC's  operations  are  specifically  returned  to  its  borrowers.  Any 
margins  remaining  after  all  operating  expenses  are  paid  are  returned  to  its  members  on  a 
patronage  basis.  Most  importantly,  CFC  has  played  a  vital  role  as  the  primary  supplemental 
lender  to  the  government  loan  programs  offered  by  the  Rural  Electrification  Administration. 
In  brief,  it  is  a  cooperative  organization  in  every  sense  of  the  word,  organized  and  controlled 
by  its  member-systems  to  meet  a  need  that  was  previously  not  being  met. 


CFC  -  A  SOCIAL  WELFARE  ORGANIZATION 

CFC  has  played  a  key  role  in  the  construction,  maintenance,  and  operation  of  electric  and 
telephone  utility  infrastructure  in  the  sparsely  populated  areas  of  rural  America.  By  relieving 
some  pressure  on  federally-funded  loan  programs,  CFC  has  functioned  as  the  vehicle  for 
providing  public  market  access  by  consolidating  the  needs  of  rural  utility  systems  which  would 
otherwise  be  too  small  to  efficiently  access  the  market  individually. 

CFC  is  specifically  identified  in  the  Rural  Electrification  Act  of  1936,  as  amended,  as  a 
legally  organized  lending  institution.  The  vast  majority  of  CFC '  s  direct  loans  are  secured 
under  a  single  common  mortgage  witii  the  Rural  Electrification  Administration. 


CFC'S  TAX  EXEMPT  STATUS 

CFC's  role  as  a  social  welfare  organization  has  been  recognized  since  inception  by  the 
Internal  Revenue  Service  and  as  such  CFC  has  remained  exempt  from  Federal  income  taxes 
under  IRC  Section  501(c)(4). 

Section  501(c)(4)  of  the  Code  provides  for  the  exemption  of  civic 
leagues  or  organizations  not  organized  for  profit  but  operated 
exclusively  for  the  promotion  of  social  welfare. 

Section  1.501  (c)(4)-l  (a)(2)  of  tlie  Income  Tax  Regulations  provides 
tliat  an  organization  is  operated  exclusively  for  the  promotion  of 
social  welfare  if  it  is  primarily  engaged  in  promoting  in  some  way 
the  common  good  and  general  welfare  of  the  people  of  the 
community.  An  organization  embraced  within  this  section  b  one 
which  is  operated  primarily  for  the  purpose  of  bringing  about  civic 
betterment  and  social  improvements. 

In  fact,  CFC '  s  tax-exempt  status  under  501(c)(4)  was  first  set  forth  in  a  ruling  dated  October 
30,  1969.  The  ruling  was  most  recently  confirmed  in  1987  when  CFC  first  considered 
extending  the  benefits  of  its  not-for-profit  service  to  telephone  organizations  and  their 
affiliates.  In  general,  the  Internal  Revenue  Service  noted  that  CFC  met  its  social  welfare  test 
by  lending  support  and  helping  to  relieve  the  increasing  fiscal  pressures  on  federal  programs 
and  agencies  thereby  contributing  to  lessening  the  burden  of  the  government.  CFC '  s  mission 
remains  unchanged  today. 


1351 


Legislation  Threatens  CFC's  Operations 

Potential  legislation  affecting  501(c)(4)  organizations  could  have  a  severe  negative  impact  on 
CFC's  operations.  In  response  to  alleged  abuses  that  were  committed  by  some  501(c)(4) 
organizations  (unrelated  in  purpose  or  structure  to  that  of  CFC),  Rep.  Pete  Stark  (D-CA) 
introduced  legislation  that  would  prohibit  these  corporations  from  allowing  any  part  of  their 
net  earnings  to  benefit  any  shareholder  or  individual.  His  bill,  entitled  Application  of  Private 
Inurement  Rule  to  Tax-Exempt  Civic  Leagues,  was  part  of  H.R.  1 1  (the  1992  tax  bill  vetoed 
by  President  Bush). 


CFC  Pylaws 

CFC  was  incorporated  under  the  District  of  Columbia  Cooperative  Association  Act.  Its  by- 
laws (which  set  out  matters  required  by  the  enabling  aa)  specify  that  it  shall  at  all  times  be 
operated  on  a  cooperative  nonprofit  basis  for  the  primary  and  mutual  benefit  of  its  patrons. 

All  net  savings,  representing  the  excess  of  revenues  over  operating 
costs  and  expenses,  shall  be  received  by  the  Association  with  the 
understanding  that  they  are  furnished  by  its  patrons  as  capital  and 
that  the  Association  is  obligated  to  pay  by  credits  to  a  capital 
account  and  the  reserve  funds  set  up  in  Section  2  of  this  Article  for 
each  patron  all  such  amounts  in  excess  of  operating  costs  and 
expenses,  to  patrons  in  proportion  to  their  patronage. 

In  the  event  of  dissolution  of  the  Association,  outstanding 
Patronage  Capital  Certificates,  if  any,  or  the  amount  of  patronage 
capital  reflected  on  the  books  and  records  of  the  Association  shall 
be  retired  without  priority  on  a  pro  rata  basis  in  accordance  with 
the  provisions  of  Article  IX  of  the  Articles  of  Incorporation.  If  at 
any  time  prior  to  dissolution,  the  Board  of  Directors  shall  determine 
that  the  financial  condition  of  the  Association  will  not  be  impaired 
thereby  the  capital  then  credited  to  patrons'  accounts  and  the 
Patronage  Capital  Certificates  evidencing  same,  if  any,  may  be 
retired  in  full  or  in  part.  After  February  11,  1992,  the  Board  of 
Directors  shall  determine  the  method,  basis,  priority,  and  order  of 
retirement,  if  any,  for  all  amounts  thereafter  furnished  as  capital 


Each  year  CFC  allocates  its  net  margins  (operating  margin  plus  nonoperating  income)  among 
its  members  in  proportion  to  interest  earned  by  CFC  from  such  members  within  various  loan 
pools.  These  allocations  are  evidenced  by  Patronage  Capital  Certificates  which  bear  no 
interest  or  dividends  and  have  no  stated  maturity.  These  amounts  are  available  for  use  in 
CFC '  s  operations  pending  their  retirement.  It  is  currently  CFC  •  s  policy  to  retire  Patronage 
Capiul  Certificates  on  a  seven-year,  or  shorter,  cycle  if  permitted  by  CFC's  contractual 
obligations  and  to  the  extent  that  the  Board  of  Directors  in  its  discretion  may  determine  from 
time  to  time  that  the  financial  condition  of  CFC  will  not  be  impaired  as  a  result.  RTFC '  s 
current  policy  is  to  retire  25%  of  the  current  year '  s  margins  within  84  months  of  the  end  of 
the  fiscal  year  w\h  the  remainder  to  be  retired  at  the  discretion  of  RTFC's  Board  of 
Directors.  GFC '  s  current  policy  is  to  retire  100%  of  current  year '  s  margins  shortly  after  the 
end  of  the  fiscal  year. 

Implications 

CFC  is  concerned  that  applying  private  inurement  rules  under  section  501(c)(4)  would 
severely  hamper  its  allocation  and  retirement  of  capital  credits,  thus  adversely  affecting 
CFC '  s  ability  to  operate  as  a  cooperative,  maintain  its  role  as  a  social  welfare  organization 
and  retain  its  standing  in  capital  markets.  CFC  is  not  an  organization  which  is  abusing  its 
501(c)(4)  tax-exempt  status. 


1352 


Applying  private  inurement  provisions  to  IRC  501(c)(4)  without  recognition  and  clarification 
of  CFC '  s  unique  situation  would  force  CFC  into  a  massive  financial  restructuring  to  comply 
with  cooperative  tax  law  and  to  retain  its  long-standing,  unchallenged  tax  exemption  when 
the  intent  was  not  to  affect  an  organization  like  CFC. 


POSSIBLE  ALTERNATIVES 


Subchapter  T 

It  has  been  suggested  that  CFC  pursue  incorporating  under  Subchapter  T  rules.  That 
alternative  has  been  thoroughly  investigated.  In  general,  however,  while  some  organizations 
of  a  like  nature  find  Subchapter  T  to  be  an  acceptable  fit,  CFC '  s  unique  structure,  which 
was  established  when  CFC  obtained  its  tax-exempt  status,  does  not  fit  well  with  the 
specifications  of  the  rule. 

Interest  paid  on  CFC '  s  capital  term  certificates  which  provide  the  underlying  equity  of  CFC 
might  not  be  deductible  for  income  tax  purposes.  Therefore,  CFC  would  have  to  pay  that 
interest  out  of  retained  earnings.  However,  under  Subchapter  T,  the  IRS  requires  that  if  tax 
margins  are  allocated  to  the  membership  of  a  cooperative,  a  demonstration  must  be  made 
that  those  allocations  can  actually  be  paid.  CFC  would  not  be  able  to  allocate  all  of  its 
earnings  to  the  members  to  get  a  full  patronage  capital  deduction,  because  some  portion  of 
the  retained  earnings  would  have  already  been  obligated  to  pay  interest  on  the  capital  term 
certificates.  This  might  result  in  a  conclusion  that  CFC  could  not  be  in  compliance  with 
Subchapter  T  rules. 

Therefore,  the  amount  of  interest  to  be  paid  to  capital  term  certificate  holders  would  have 
to  be  excluded  from  the  patronage  capital  deduction,  in  order  for  CFC  to  demonstrate  that 
it  can  actually  pay  patronage  allocations  under  Subchapter  T.  Any  amount  excluded  from 
the  patronage  capital  deduction  would  then  be  taxable.  However,  the  amount  being  excluded 
is  interest  Pn  capital  tgnn  cgnific?tC?  which  arg  deemgij  to  be  equity.  Under  Subchapter  T 
rules,  CFC  would  be  asked  to  pay  tax  on  its  underlying  capital  structure,  rather  than  on 
margins. 

In  addition,  like  any  other  lending  institution,  CFC  must  make  provisions  for  loan  and 
guarantee  losses.  However,  that  "book"  expense  would  not  be  deductible  for  tax  purposes 
under  Subchapter  T  until  an  actual  loss  occurs.  As  a  result,  CFC  would  be  taxed  on  a 
reserve  it  hopes  never  to  use. 


Negative  Effect  of  Subchapter  T  organizations  on  CFC's  Operations 

Subchapter  T  tax  treatment,  because  of  its  deleterious  effect  on  CFC '  s  capital  structure  is 
therefore  not  an  option  should  the  potential  legislation  be  enacted.  It  has  been  estimated 
that  the  negative  tax  effert  of  transferring  CFC  from  filing  under  501(c)(4)  to  Subchapter  T 
would  involve  an  additional  annual  state  and  federal  expense  of  $18-23  million.  This  has  the 
effea  of  diminishing  CFC '  s  ability  to  function  as  a  social  welfare  organization  by  increasing 
the  costs  on  its  operations  which  must  be  flowed  through  to  its  member-borrowers. 


Impact  on  Rural  Electric  Co-ops 

When  considered  on  the  basis  of  impaa  on  the  rural  utility  members  of  CFC,  the  financial 
impact  is  quite  negative.  Nationwide,  a  conservative  estimate  would  indicate  an  annual  cost 
increase  of  $13-20  million.  As  CFC  grows,  the  burden  will  increase  substantially.  These 
costs  will  be  borne  by  the  ultimate  consumers  of  the  non-profit  utilities  which  serve  the  rural 
areas. 


1353 


Some  70  percent  of  the  rural  electric  cooperatives  currently  have  rales  higher  than 
neighboring  utilities.  They  have  undertaken  the  arduous  task  of  providing  electric  service  to 
the  most  sparsely  settled  areas  of  the  country,  requiring  more  than  two  million  miles  of 
electric  lines  to  serve  three-fourths  of  the  countryside.  The  co-ops  have  formed  a  covenant 
with  REA  to  assume  responsibility  for  area  coverage  with  this  vital  infrastructure  service  in 
return  for  favorable  REA  financing. 

In  fact  the  REA  program  is  going  through  substantial  revisions  during  this  Congress.  It  is 
expected  that  the  loan  subsidy  to  RECs  will  be  greatly  reduced.  The  appropriation  bill  that 
has  passed  the  House  calls  for  a  subsidy  redurtion  of  43%  in  FY  94  from  FY  93  figures. 

Our  fellow  electric  providers,  municipals  and  Investor-owned  Utilities  (lOUs)  are  not 
receiving  any  reduction  in  their  federal  subsidy. 

RECs  serve  almost  1 1.9  million  people,  or  10.7%  of  the  population,  but  we  cover  a  land  mass 
equal  to  75%  of  the  nation.  We  average  5.5  consumers  per  mile  of  line,  where  as  the 
industry  average  is  36. 

Lending  to  utilities  has  become  a  highly  competitive  endeavor  where  basis  points  can  literally 
make  or  break  a  deal.  Losing  its  501(c)(4)  tax-exempt  status  would  clearly  make  CFC 
significantly  less  competitive. 


CFC  -  501(c)(4)  SUGGESTED  REVISIONS 

CFC  is  sympathetic  to  the  concerns  expressed  by  Representative  Stark  regarding  the  abuses 
by  some  501(c)(4)  organizations  which  have  resulted  in  unjustified  benefit  to  individuals. 
However,  language  outlining  the  private  inurement  amendments  proposed  by  Rep.  Stark 
would  have  the  net  affect  of  inadvertently  restricting  the  ability  of  CFC  to  return  benefits  of 
its  operation  to  its  members,  all  of  which  are  not-for-profit  organizations,  not  individuals. 

We  have  searched  the  Code  and  developed  suggested  alternatives  which  would  allow  Rep. 
Stark  to  keep  original  intent  of  his  bill  intact  while  allowing  CFC  to  continue  to  serve  the 
needs  of  rural  America.   We  will  gladly  share  this  with  the  committee. 


Conclusion 

CFC  was  formed  to  supplement  the  diminishing  resources  of  the  federal  government.  CFC 
has  been  a  part  of  a  successful  public/private  partnership. 

It  is  important  to  keep  in  mind  no  federal  dollars  are  used  to  support  CFC  and  our  proposal 
will  not  cost  the  Treasury  any  funds. 

Our  simple  request  is  to  allow  us  to  continue  to  operate  as  we  have  done  for  the  past  25 
years.  It  is  unfortunate  through  no  fault  of  our  own  we  are  caught  in  the  legislative  crossfire. 
We  ask  for  the  subconrniittees  support  in  curbing  abuses  by  501(c)(4)  organizations  and  allow 
CFC  to  continue  its  present  operations. 


1354 


QO©  ITlToascai?^  ©©(paolJouDODDQ 


Internal  Revenue  Service 

"""  OCT  3  0  I9G9 


Matioiul  Rural  Utilities  Cooperative 

Finance  Corporation 
2006  Florida  Avenue,  N.17. 
'./ashington,  D.C.  20009 


i.R.  Co<i.t  Section  501(c)(4) 

Addr«>(  Inquiries  and  Fll*  Returns  »l>h 

District  DIraelor  s(  Internal  R*v«nu«i  DaltlJIlOre 

Aeeeunting  Period  Ending:  June   30 


On  the  basis  of  your  stated  purposes  and  the  understanding  that  your 
operations  will  continue  as  evidenced  to  date  or  will  conform  to  those 
proposed  in  your  ruling  application,  we  have  concluded  that  you  are 
exempt  from  Federal  income  tax  under  the  provisions  of  the  Internal 
Revenue  Code  section  indicated  above.  Any  changes  in  operations  from 
those  described,  or  in  your  character  or  purposes,  must  be  reported 
immediately  to  your  District  Director  for  consideration  of  their  effect 
upon  your  exempt  status.  You  must  also  report  any  change  in  your  name 
or  address. 

You  are  not  required  to  file  Federal  income  tax  returns  so  long  as  you 
retain  an  exempt  status,  unless  you  are  subject  to  the  tax  on  unrelated 
business  income  imposed  by  section  511  of  the  Code,  in  which  event  you 
are  required  to  file  Form  990-T.  You  are  required  to  file  an  informa- 
tion return,  Form  990,  annually,  on  or  before  the  15th  day  of  the  fifth 
month  after  the  close  of  your  annual  accounting  period  indicated  above. 

You  are  liable  for  the  taxes  imposed  under  the  Federal  Insurance  Con- 
tributions Act  (social  security  taxes);  and  for  the  tax  imposed  under 
the  Federal  Unemployment  Tax  Act  if  you  have  four  or  more  individuals 
in  your  employ. 

Any  questions  concerning  excise,  employment  or  other  Federal  taxes 
should  be ^submitted  to  your  District  Director. 

Your  District  Director  is  being  advised  of  this  action. 


FOBM  M.4279  (REV 


1355 


Every  exanpt  organization  is  i-equii-ed  to  have  an  Dnployer  Identification 
Number,  regardless  of  ulieiher  it  lias  any  employees.  This  number  shoxild 
be  entered  in  tiie  designated  space  on  oil  Federal  returns  filed  and  re- 
ferred to  on  all  Gon-espondence  with  the  Internal  Revenue  Service.  If 
you  do  not  have  sucli  a  number,  your  District  Director  will  take  steps 
to  see  that  one  is  issued  to  you  at  an  early  date. 


Very  truly  yours, 


■'"'Chief,  Rulings  Section, 
Exen^Jt  Organizations  Branch 


1356 


Internal  Revenue  Service 


National   Rural  Utilitiss 
Cooperative  Finance  Corporation 
1115   SOtli  Street,   H.H. 
Washington,   DC.     20007 


Department  of  the  Treasury 

Washington.  00  20224 

Person  to  Contact: 
Teleplwne  Number: 
Beler  Reply  to: 


Employer  Identification  Munber: 
Key  District: 


52-0891669 
SaltiBore 


Dear  Sirs: 

Ve  have  received  your  request  for  a  ruling,  dated  March  27,    1987, 
that  your  exempt  status  under  section  501(c)(4)   of  the  Internal  Revenue 
Code  will  not  be  adversely  affected   by  the  creation,   start-up  funding 
and  operation  of  a  new  cooperative  association  to  serve  as  a  suppletnsntal 
source  of   financing  for  the  nation's  rural  telephone  and  telecommunications 
systems. 

Tou  expect   that  the  new  telephone  cooperative  will  qualify  for  taoc 
treatment  as  a  cooperative  pursuant  to  Subchapter  T  of  the  Code,  that 
the  anounts  paid  as  patronaje  dividends  by  the  new  telephone  cooperative 
will  be  deductible  by  it  pursuant  to  section  1382(b)   of  the  Code  and, 
accordingly,  that  the  new  telephone  cooperative  will  incur   little  or  no 
Federal  income  tax  Uability.     For  this  reason,  the  new  telephone  coopera- 
tive is  not   applying  for  its  own  determination  of  tax-exempt  status  at 
the  present  time. 

Tou  are  a  nonprofit  cooperative  association  fbrmed  on  April  10,  1969. 
and  have  been  determined  to  be  exempt  from  Federal  income  tax  section 
501(c)(iJ)  of  the  Code.  Tfou  vere  formed  to  meet  a  perceived  need  for  a 
nongovernmental  sotrce  of  financing  to  supplement  the  rural  electric  loan 
progran  of  the  Federal  goverrtnent.  Your  overriding  purpose  in  sedcing  to 
meet  this  financing  need  was  to  help  in  the  effort  to  improve  the  quality 
of  life   in  rural  America. 

As  of  Hay  31,    1936,   you  had  96H  oenbers,   including   885  rural  electric 
systems,   virtually  all  of  which  were  consumer-ovmed  cooperatives,   72 
service  sieiobers   and  7  associate  aembers.     The  electric  system  members 
included  822  distribution  systems  and  63  generation  and  transmission   ("power 
supply")   systems  operating  in  H6  states.     As  of  December  31,    1985,   your 
member  systems  were  serving  approximately  9,500,000  consumers,   representing 
service  to  an  estimated  23,600,000  ultimate  users  of  electricity. 

Tou  ma!a  loans  to  your  neobers  to  enable  them  to  acquire ,  construct 
and   operate  electric  distribution,  generation,  transmission  and   related 
facilities.     Most  of  your  long-tera  loans  to  menfcers  are  made  in  conjwc- 
tion  with  concurrent  loans   fran  the  governnent  and  are  secured  equally 
and  ratably  with  their  loans  by  a  single  nortjige.     You  also  provide  guaran- 


1357 


tees  for  tax-exempt   financings  of  pollution  control  facilities  and  other 
properties  constructed  or  acquired  by  your  members,  and,  in  addition,   pro- 
vide guarantees  in  connection  with  certain  lease  transactions  of  your 


You  believe  that  tlie  social  welfare  purpose  you  have  served  and  the 
experience  you  have  3ained  in  helpin;  to  finance  the  nation's  rural  elec- 
tric systems  should  be  extended  to  the  nation's  rural  telephone  systems 
and  their  telecooimunications  affiliates.     The  need  is  for  a  supplementary 
source  of  financing  to   enable  these  systans  to  maintain,   enhance  and 
diversify  the  services  which  they  provide  to  the  rural  consumer. 

As  a  supplement   to   existing   government  loan  prograns,  the   Implemen- 
tation  of  your  proposal  to  establish  a   new  telephone  cooperative  you  be- 
lieve would  both  lessen  the  burden  on  government   and   benefit  the  consuner 
by  enabling  the  systems  Involved  to  acquire  and  maintain  the  physical 
facilities  necessary  to  provide  service  to  the  consimer  at  affordable  rates. 
In  addition,   you  believe  you  would  be  benefitting  the  rural  electric 
consuners  whom  you  already  serve  since  a  large  majority  of  those  consumers 
are  also  consumers  of  telephone  and  teleconmiiiicatlons  services. 

The  neu  telephone  cooperative  will  be  incorporated  under  the  state 
law  which  will  provide  the  flexibility  required  for  its  efficient 
operation.     As  a  cooperative  operating  in  a  manner  similar  to  you  the  neu 
telephone  cooperative  will  conduct  its  lending  activities  on  a  breal:-even 
basis,  setting  its  lending  rates  at  the  lowest  level  commensurate  with 
sound  manageoent  and  in  keeping  with  non-profit  cooperative  principals. 
All  "net  savings"  (that  Is,  the  excess  of  revenues  over  operting  costs 
and  expenses)  generated  by  the  cooperative  will  be  allocated  accng  its 
patrons  as  patronage  capital.     Such  allocations  will  have  the  effect  of  a 
proportionate  rebate  or  readjustment  of  the  cost  to  each  patron  of  its 
borrowings.     The  new  cooperative  will  also  contribute  to  the  education  of 
its  patrons. 

The  emphasis  of  the  new  telephone  cooperative's  operations  vri.ll  be 
on  achieving  financial  efficiencies  so  as  to  reduce  the  cost  of  rural 
telephone  and  telecanmunications  services  to  the  consuner.     Mich  in  the 
manner  you  do,  the  new  telephone  cooperative  expects  to  be  able  to 
raise  large  anounts  of  capital  in  the  private  capital  markets  to  relend 
to  patrons  whose  individual  capital  requirements  would   generally  be 
relatively  small  and  would,  thus,   require  a  pranlum  in  the  market  place. 

The  new  telephone  cooperative  would  offer  memberships  to  all  of  the 
independent  telephone  operating  companies  in  the  United  States  which 
presently  are  either  actively  borrowing,  or  are  eligible  to  borrow,   fj-om 
the  goverment.     You  would  also  become  a  member  of  the  nerj  telephone 
cooperative. 


1358 


In  ordsr  to   accanplish  Its  lending  purposes   as  efficiently  as 
possible,  the  new  teleptone  cooperative  expects  that  its  patrons  Hill 
include   not  only  the  telephone  operating   canpany  members,   but   also   (i) 
their  subsidiaries  and  sister  companies  engaged  in  furnishing  tele- 
comniunioations   services  to  rural   consumers   and,   (ii)   where  appropriate, 
the   holding  companies.     Neither  the  teleccmnuiications  affiliates  nor 
the  holding   canpanies  referred  to   are,   or  would  be,   eligible   to   borrow 
from  the  government  since  its  telephone   lending  program  is  limited  to 
telephone  operating   canpanies  and  has  not  kept  pace  with  modern  techno- 
logical developments.     The  inclusion  of  holding  companies   for  such  tele- 
phone and  telecanmunications   affiliates   is  Intended   to   give   the  nevi 
telephone  cooperative  lending  flexibility  where,    for   example,   regulatory 
or  other  business  considerations  may  require  that  the   funds   available 
from  the  new  telephone  cooperative  be  invested  or   advanced  through  the 
holding   canpany  rather  than  directly  by  it  to  the  operating   canpany,  or 
that  the  acquisition  of  another  rural  telephone  or  telecommunications 
company  be  made   by  the  holding    company  rather  than  by  the  operating 
company. 

It   is  anticipated  that  the  members   and  other  patrons  iri.ll  look  to 
the  new  telephone  cooperative   for  long-term  loans  to  finance   additions 
to  plant  and  to   replace  existing  facilities,  to  refinance  existing  debt, 
to  develop  diversified  telecommunications  facilities,  to  establish  rural 
toll  networks   and  to  facilitate  the  acquisition  of  other  rural  systems 
to  provide  efficiencies  of  scale.     As  in  yoir  case,  the  new  telephone 
cooperative's  long-term  loans  to  government  telephone  borrowers  irtll  be 
secured  with  government  loans  by  a  single  mortgage  whereever  applicable. 

The  new  telephone  cooperative's  equity  funds  would  be  derived 
principally  from  three   sources.     First,  eligible  organizations,  as  a 
condition  to  membership,    would  make   a  one  time  permanent   investment   in 
the   form  of  a  $1,000  membership   fee,  to  be  evidenced  by  a  raerabership 
certificate.      Second,  as  a  condition  to  eligibility  to   borra;,   borrowers 
would  be  required  to  pvrchase   equity  certificates.     Presently,   it   is 
contonplated  that  such  certificates  would  be  in  the  anount  of   10«   of  the 
face   amomt   of  each  loan.     The  new  telephone  cooperative  would  retain  one- 
half  of  the  proceeds    fran  the  issuance  of  such  certificates   for  the  entire 
term  of  the  loan  but  would  be  obligated  to  repay  the  remaining  one-half 
to  the  borrower  periodically,  as  the  loan  is  anortized.     Meabership 
certificates,   equity  certificates  and  patronage  capital  would  be  sub- 
bordlnate  to   the  claims  of  creditors.     The  third  source  of  equity   finds 
would  be  the  "net  savings"   (patronage  capital  or  margins) ,  allocated  as 
patronage   capital  to   the  patrons  on  the  basis  of  their  respective   patronage, 
A  portion   of  patronage  capital  so   allocated  to  its  patrons  would  be  the 
patronage   capital  which  you  allocate  to  the  new  telephone  cooperative 
based  on  its  borrowings   from  you.     Although  you  would  lend  credit   to 
the  new  teleptvsne  cooperative  during  its  start-up  phase,    you  would  not  be 
a  patron  or  a  borrower.     Hence,   you  would  not  receive  patronage  allocations 
froo  the  new  teleplxjne  cooperative  or  otherwise  be  entitled  to   any  share 
of  its  accumulated   equities. 


1359 


The   above-described   equity   sources  will  not  be   sufficient  during  the 
new  telephone   cooperative  start-up  phase   to  fund  its  lending   program. 
Although   it   is  expected   and   intended  that   it  eventually  irtll   be   able   to 
sell  its  ovm  debt  securities  in  the   private  capital  narlcets  without  your 
assistance,   additional  finding  requiranents  during  its  start-up  phase 
would  be  supplied  by  you,  either  by  loans  to  it  or  by  guaranteeing  borrow- 
ings  in  the  private  capital  markets.     In   order  to  qualify  for  such  credit 
support  by  you,  the  new  cooperative  would  become  your  associate  Cnon- 
voting)   member  you  v«3uld  charge   the  new  cooperative   an  interest  rate 
commensurate  with  those  rates  charged  you-  other  associate  members,  such 
rates   set  to   reflect  your   non-profit  cooperative  principles.     As   in  the 
case  of  any  other  of  your  members,  the  new  cooperative  would  be  required 
to  meet  your   equity  investnent  requiranents  in  connection  with  its 
borrowings   from  you.      The  new  cooperative  would   also  be   charged  guarantee 
fees  for  your  guarantees  of  the  new  cooperative's  debt   similar  to  those 
charged  your  other  members   which  obtain  your  guarantees. 

The  members  of   the  new  cooperative,  including  you,    would  enter  into 
an   agreement  pursuant   to  viiich  eleven  members   (i.e.,   a  majority)   of  the 
twenty-one  member  board   of  directors  vwuld  be  nominated   for  election  by 
you,  and  the  remaining  ten  members  of  the  board  would  be  nominated  by  the 
rural  telephone  aysten  members  of   the  new  telephone  cooperative.     At  the 
annual  meeting,  the  members  would,   in  accordance  with  the  members   agreement, 
elect  these  nominees. 

It   is  also  proposed  that  the  new  telephone  cooperative  would  enter 
into  a  management   agreement  with  you,   pursuant  to  which  you  would  ajree 
to  provide   the  management  services  necessary   for  the  day-to-day  conduct 
of  its   activities.     Tou  would  be  compensated  for  your   administrative  and 
overhead   expenses   in  connection  with  these   services   in  one  of  two  ways. 
For  each  loan  made  by  you,    you  would  charge  the  same  interest  rate  you 
charge   other  associate  members  on   comparable  loans,    such    interest  rate 
to  include  a   factor   for  your   overall   administrative  and   overhead   expenses 
expressed  as  a  percentage  of  y3ur   total   loan  volume.     In   addition,  to  the 
extent  that  the  amotnt  described  above  does  not  adequately  compensate  you 
for  your   administrative   and   overhead  expenses,    you  would  submit,   from  time 
to  time,   invoices  setting  forth  in  reasonable  detail  your   expenses   for 
which  you  have   not  been  compensated,  and  the  new  telephone  cooperative 
would,   promptly   following  receipt  of  any  such  invoice,   pay  to  you  the 
amount   set  forth  therein. 

You   have   received  sUsstantlal   expressions  of   interest  ft*an  the  rural 
telephone  and  telecomninications  conmiaiity  concerning  the  development  of 
a  supplementary  source  of   financing  for  that  community  and  have   received   a 
number   of  loan  applications  relating  thereto.     Because  you  lend  only  to 
your  members,    you,   pending  the  formation  of  the  new  telephone  cooperative, 
have  referred  these  loan   applications  to  one  of  your  members. 

Section  501(c)(4)  af  the  Code  provides   for  the  exemption  of  civic 
leagues  or  organizations  not  organized  for  profit  but  operated  exclusively 
for  the  pranotion  of  social  welfare. 


1360 


Section  1 .501(c)  ("0-1  (a)  (2)   of  the  Income  Tax   Regulations  provides 
that  an  organization  is  operated   exclusively   for  the  pronotion  of  social 
welfare  if  it  is  primarily  engaged   in  prcoioting  in  some  way  the  ccainnn 
good  and   general  welfare  of  the  people  of  the  oomminity.     An  organization 
embraced  within  this  section  is  one  which   is  operated  primarily  for  the 
purpose  of  bringing  about  civic  betterment  and  social   improvements. 

Organizations   primarily  engaged   in  activities  defined   as  charitable 
under  section   1 .501(c)  (3)-1  (d)  (3)   of  the  regulations  may  qualify   under 
section  501(c)(U).     The  tenn   "charitable"   includes  relief  of   the  poor  and 
distressed  or   the  under-privlLedged,   lessening  of  the  burdens  of  government, 
combatting   coninunity  deterioration,   and  the  conservation  and  preservation 
of  natural  resources. 

In  Rev.   Rul.   6ii-187,    196U-1    C.B.   187,  a   nonprofit  corporation  was 
formed  to   lend   additional  funds   to   individuals  and  organizations   eligible 
to    borrow  from  the  Federal   Area  Redevelopment  Administration.      In   ruling 
that  the  organization  was  exempt   under  section  501(c)(H)   of  the  Code  it 
was   stated : 

(t)he   instant  organization,   in  carrying  out   is  purposes  of   providing 
funds  through  loans  to  assist  in  eliminatine  unemployment   in  further- 
ance of   the  public  purposes  of  the  Area  Redevelopment  Act,   is  being 
operated  primarily  to  bring  about  civic  betterment  and  social  improve- 
ment.    Accordingly,   it  is  held  that  the  organization  qualifies  for 
exemption   from  Federal  income  tax  under  section  501(c)(4)   of  the 
Code   as  a  civic   league. 

If  a  nonprofit  organization  uses  profit-oriented   business  organi- 
zations merely  as   instruments   for  the  accomplishment  of   social  welfare 
purposes,   incidental  private  benefits  to  sush  businesses  will  not  disqua- 
lify the  nonprofit  organization   from  exemption.     See   Rev.   Rul.    81-23U, 
1981-2  C.B.   130;    Rev.   Rul.   74-537,    1974-2  C.B.    162;  Rev.   Rul.   67-294, 
1967-2  C.B.    193:   and  Rev.   Rul.   64-187,   supra.      (All  four   rulings   involve 
organizations   formed  to  make   loans   to   businesses   in  order  to   alleviate 
unemployment  and  generally   promote  the  economic  development  of  a  community.) 

In  Rev.   Rul.   64-187,  supra. ,  the  nonprofit  organization  was  author- 
ized to  make  loans   to  "proprietorships,   partnerships,  corporations,   govern- 
mental  bodies,   public   nonprofit  corporations   and  state  and   local   develop- 
ment companies"   which  met  the  requirements  of  the  Area  Redevelopment  Act. 
In  Rev.   Rul.  74-587,   supra.,  as  anplified   by  Rev.   Rul.    81-204,   supra.,  a 
nonprofit  organization  was  created  to  provide  financial  assistance  "in 
the  form  of  low-cost  or  long-term   loans   for  the  pirchase  of  equity  inte- 
rests" in  minority-owned  businesses  in  certain  economically  depressed 
areas.     In  granting  section  501(c)(3)   tax-exempt  status  to  the  organiza- 
tion, the  Service  held  that  through  its   program  of  financial  assistance,  the 


1361 


organization  is  devoting  its  resources  to  uses  that  benefit  the 
in   a  way  that  the  law  regards  as  charitable. 

The   regulations   mder  section  501(c)(4)   hold  that  a  social   welfare 
organization  will  qualify   for  exemption  as  a  charitable  organization   if  it 
falls  within  the  definition  of  charitable  set  forth  in  section  501(c)(3)- 
1(d)(2).     The  term   "charitable"  includes  "lessening  the  burdens  of  government" 

In  Rev.   Rul.   7t-361,    197«-2   C.B.    159,   a   nonprofit  organization  which 
provides  fire  and  rescue   service  to  the  general  oommmity  was    found  to 
lessen  the  burdens  of  governnent.      Although  tax   exemption  was  requested 
and   granted  under  section  501(c)(3)   of  the  Code,  the  ruling  observed  that 
because  the  activities  of   this  organization  may  also   be  regarded   as 
promoting  the  comirnn  good  and   general  welfare  of  the  community,  the 
organization  could  have   applied  for  and   received   a  ruling   recognizing   its 
exemption   from  Federal  income  tax  as  a   social  welfare  organization  described 
in   section  501(o)(i))   of   the  Code.     See  also  Rev.   Rul.   85-1,    1935-1    C.B. 
177,  and   Rev.    Rul.   85-2,    1985-1   C.B.    178. 

Your  proposal  to  form  the  new  telephone  cooperative   is  in  furtherance 
of  your   social  welfare  purpose  and,  accordingly,   you  would  continue  to  be 
viewed   as  "not  organized   or  operated  for  profit"   and   "operated   exclusively 
for  the   promotion  of  social  welfare"   within  the  meaning  of  section  501(c)(y) 
of  the  Code.     The  fact   that  you,   in  lending  to  the  new  cooperative,  and 
that  it,  in  lending  to  its  patrons,    will  each  provide   for  the  realization 
of  "net  savings"   (or  margins)  does  not  detract   fVaa  your   nonprofit  character. 

As   previously  demonstrated  herein,    you,  by  lending  support   to 
the  fmding  and   operation  of   the  new  cooperative,   would  also   help  relieve 
the  increasing  fiscal  presstres  on  several  federal  irogram  and   agencies 
would  thereby  contribute  to   the  lessening  the  burden  of   the  governaent. 

Based  on  the   above   facts,    we  respectfully  rule  that  your  tax-exempt 
status  under  section  501(c)  (U)   of  the  Code  will  not  be   adversely  affected 
by  the  creation,  start-up  funding  and  operation  of  the  new  telephone 
cooperative. 

A  copy  of  this  ruling  should  be  kept  in  your  permanent  records. 

A  copy  of  this  ruling  will  be   forwarded  to  your  key  District  Director. 

Sincerely  yours, 

Hilton  Cerny  ^^^ 

Chief,   Exempt  Organizations 
Rulings  Branch 


1362 


STATEMENT  OF  BOB  BERGLAND,  EXECUTIVE  VICE  PRESIDENT, 
NATIONAL  RURAL  ELECTRIC  COOPERATIVE  ASSOCIATION 

Mr.  Chairman,  distinguished  members  of  the  Subcommittee,  my  name  is  Bob  Bergland  and  I 
am  executive  vice  president  of  the  National  Rural  Electric  Cooperative  Association  (NRECA). 
I  submit  this  statement  for  the  hearing  record  on  behalf  of  the  nation's  1,000  not-for-profit, 
consumer-owner  rural  electric  systems  that  provide  central  station  electric  service  to  more 
than  25  million  people  in  46  states. 

Rural  electric  lines  span  70  percent  of  the  nation's  land  mass  to  serve  1 0  percent  of  the 
nation's  population.   These  rural  electric  systems  continue  to  face  the  traditional  obstacles  that 
make  serving  rural  areas  difficult  -  rugged  terrain,  harsh  weather  and  distance. 

Another  obstacle  is  rate  disparity.    Seventy  percent  of  rural  electric  systems  have  higher  rates 
than  their  neighboring  utilities.    Part  of  that  rate  disparity  is  attributable  to  the  higher  per- 
consumer  investment  in  plant  necessary  to  serve  in  rural  areas.   In  addition,  mral  electric 
systems  serve  primarily  residential  loads  ~  two-thirds  residential  as  compared  to  two-thirds 
commercial  and  industrial  loads  served  by  investor-owned  and  municipally-owned  utilities. 

Rural  electric  systems  are  consumer-owned,  and  organized  as  not-for-profit  cooperatives. 
Everyone  who  receives  service  is  a  member-owner  of  the  rural  electric  system  and  any 
revenues  that  exceed  expenses  are  returned  to  consumers  in  the  form  of  capital  credits.    There 
is  no  profit. 

The  majority  of  rural  electric  systems  obtain  the  bulk  of  their  financing  in  the  form  of  loans 
fix)m  the  Rural  Electrification  Administration  (REA),  an  agency  within  the  U.S.  Department 
of  Agriculture.    Most  cooperatives  are  required  to  obtain  30  percent  of  their  capital 
requirements  fi-om  private  sources  at  market  rates. 

This  is  where  National  Rural  Utilities  Cooperative  Finance  Corporation  (CFC)  steps  in. 


Background 

Back  in  the  late  1960's,  the  leaders  of  NRECA  realized  the  need  to  develop  additional 
sources  of  capital  to  meet  the  growing  needs  of  rural  America. 

In  1969,  utilizing  start  up  capital  provided  by  the  cooperative  members  themselves,  CFC 
opened  its  doors.   For  the  past  nearly  25  years  it  has  been  a  reliable  source  of  private  funding 
for  rural  utility  systems  and  a  leading  practitioner  in  maintaining  a  strong  cooperative 
business  philosophy. 


Issue 

The  IRS  initially  determined  that  CFC  was  a  501(cX4)  organization  and  this  ruling  was 
reaffirmed  in  1987.   As  a  cooperative,  CFC  must  return  any  margins  exceeding  the  costs  of 
operations  back  to  the  members. 

Legislation  proposed  by  Representative  Pete  Stark  would  directly  prohibit  501(cX4) 
corporations  from  allowing  any  part  of  their  net  earnings  to  benefit  any  shareholder  or 
individual. 

We  are  sympathetic  to  the  objectives  of  Representative  Stark,  which  is  to  curb  the  abuses  by 
some  501(c)(4)  organizations.    CFC  is  not  abusing  its  tax  exempt  status  and  we  seek  the 
Subcommittee's  support  to  allow  CFC  to  maintain  its  current  operations. 


1363 


Alternatives 

It  has  been  suggested  that  CFC  could  reorganize  as  a  Subchapter  T  corporation.    This  idea 
has  been  thoroughly  researched  and  it  has  been  determined  that  the  potential  cost  is  between 
$13-20  million. 

This  new  tax  obligation  would  be  incurred  because: 

1)  CFC  must  retain  some  of  its  earnings  to  pay  interest  on  its  subordinated-debt 
which  was  contributed  by  its  members;  and 

2)  As  a  prudent  lender,  CFC  must  make  provisions  for  potential  loan  and 
guarantee  losses,  yet  these  would  not  be  deductible,  unless  the  loss  was 
realized.    Something  no  lender  wants  to  see  happen. 


This  new  and  severe  cost  would  ultimately  be  borne  by  the  rural  consumers  who  already  on 
average  pay  more  for  their  electric  service. 

We  feel  that  with  a  relatively  minor  change  we  can  still  curb  all  the  abuses  practiced  by  some 
501(c)(4)  groups,  while  preserving  CFC's  tax-exempt  status. 

CFC  is  not  dependent  on  the  Federal  government.    It  is  a  totally  private  cooperative 
corporation.    This  proposal  will  in  no  way  cost  the  U.S.  Treasury  any  funds,  yet  will  allow 
CFC  to  continue  its  fine  tt^adition  of  service  to  rural  America. 


thank  the  Subcommittee  for  the  opportunity  to  submit  this  statement. 


1364 

Mr.  HoAGLAND.  Mr.  Payne. 

Mr.  Payne.  Thank  you,  Mr.  Chairman. 

Mr.  Gill,  I  would  like  just  to  ask  a  couple  questions  because  some 
of  your  member  organizations  are  rural  electrical  cooperatives  that 
are  in  my  district,  and  I  have  heard  from  them  about  this  particu- 
lar subject  and  this  issue.  They  generally  receive  a  substantial  part 
of  their  private  source  funds,  the  30  percent  that  you  mentioned, 
from  CFC. 

In  1969  when  the  CFC  was  established,  the  IRS  ruled  that  it  was 
clearly  in  compliance  with  the  law  then  and  it  continues  to  be 
today.  It  provides  a  source  of  financing  that  is  important  to  these 
rural  electric  co-ops.  They  have  a  great  deal  of  difficulty  because 
the  homes  they  serve  are  far  apart.  As  a  result,  they  have  to  make 
large  plant  investments  in  order  to  provide  electrical  service  to 
eacn  and  every  home.  They  are  constantly  looking  at  ways  that 
they  can  be  as  competitive  as  possible  in  a  very  large  marketplace. 

Now,  it  is  my  understanding  that  the  changes  that  you  proposed 
to  the  legislation  that  Representative  Stark  has  proposed  would  in 
no  way  take  away  from  the  intent  of  his  legislation.  In  other  words, 
what  you  are  doing  takes  the  CFC,  but  leaves  behind  the  language 
to  deal  with  the  abuses  that  Pete  Stark  was  attempting  to  deal 
with  as  he  wrote  this  legislation.  Am  I  correct  in  assuming  that? 

Mr.  Gill.  Yes,  sir.  Congressman.  We  are  sympathetic  with  Rep- 
resentative Stark's  proposal.  What  we  drafted  would  uniquely 
apply  to  CFC  only  and  would  not  provide  any  other  exemptions  for 
other  types  of  organizations,  and  obviously  the  committee  could 
look  at  that  language  if  thev  chose  and  determine  that  themselves, 
but  we  are  sympathetic  with  the  purpose  of  Representative  Stark's 
approach.  We  are  merely  attempting  to  save  dollars  for  our  rural 
electric  cooperatives  which  you  mentioned  have  very  low  densities 
and  are  attempting  to  save  their  costs. 

Mr.  Payne.  It  would  seem  to  me  that  this  is  a  situation  that  cur- 
rently works.  It  is  important  for  rural  areas.  The  whole  subject  of 
the  REA  is  one  that  has  been  brought  up  this  year.  It  has  been 
taken  up  by  the  Agriculture  Committee  which  oversees  the  REA. 
It  has  been  looked  at  thoroughly  and  I  am  sure  will  continue  to  be 
because  of  the  public  policy  implications  of  below-market  financing 
for  REAs. 

It  seems  that  is  a  proper  forum  in  which  such  a  review  should 
occur.  While  it  is  important  that  this  legislation  be  enacted  to  do 
away  with  the  potential  abuses  or  the  existing  abuses,  the  CFC 
should  be  taken  out.  I  appreciate  you  coming  here  today  and  shar- 
ing this  testimony  with  us. 

Mr.  Gill.  Thank  vou  very  much. 

Mr.  Payne.  Thank  you. 

Mr.  Hoagland.  Ms.  Beard,  now  you  have  pointed  out  in  your  tes- 
timony that  there  are  two  problems  with  the  current  tax  law  provi- 
sions. First,  a  list  of  prohibited  discriminations  does  not  include  sex 
discrimination,  and  second,  the  prohibition  extends  only  to  official 
written  policy,  such  as  articles  and  bylaws  and  not  to  discrimina- 
tory practices.  Is  that  right? 

Ms.  Beard.  That  is  correct, 

Mr.  Hoagland.  So  what  do  you  suggest  the  committee — what  ac- 
tion do  you  suggest  the  committee  take? 


1365 

Ms.  Beard,  Our  suggestion  is  that  the  code  be  expanded  to  in- 
clude gender  discrimination  along  with  the  other  discriminations 
that  are  currently  in  the  code,  and  that  in  addition  to  written  poli- 
cies that  rules,  practices,  customs  also  be  included  in  the  code,  so 
we  are  suggesting  that  those  expansions  be  included. 

Mr.  HOAGLAND.  Has  legislation  been  introduced  to  that  effect? 

Ms.  Beard.  There  was  legislation  introduced  in  January  1991. 
There  has  been  no  legislation  that  we  are  aware  of  introduced  in 
this  Congress. 

Mr.  HOAGLAND.  All  right.  Now,  if  an  organization's  tax  exemp- 
tion can  be  denied  on  the  basis  of  discriminatory  practices,  do  you 
believe  that  IRS  would  be  capable  of  monitoring  such  behavior? 

Ms.  Beard.  I  certainly  believe  that  that  would  be  difficult.  It 
would  occur  through  audits.  It  is  the  practical  matter.  I  certainly 
don't  suggest  that  they  would  go  out  and  become  the  regulatory 
body  of  that.  As  they  are  now,  the  discrimination  is  currently  in 
the  code.  It  just  doesn't  extend  to  gender,  so  we  are  asking  simply 
that  it  be  the  same  kind  of  regulation. 

Mr.  HOAGLAND.  IRS  would  enforce  it  presumably  by  responding 
to  complaints  among  other 

Ms.  Beard.  To  complaints  or  through  audits. 

Mr.  HoAGLAND.  Mr.  Lehrfeld,  now  the  Heritage  Foundation  cur- 
rently enjoys  tax  exempt  status.  Is  that  right? 

Mr.  Lehrfeld.  That  is  correct,  it  is  under  section  501(c)(3). 

Mr.  HoAGLAND.  And  the  language  you  have  here  in  your  state- 
ment, "does  not  engage  in  propaganda  or  otherwise  attempt  to  in- 
fluence legislation  or  engage  in  political  campaign  activities";  is 
that  one  of  the  preconditions  for  tax-exempt  status? 

Mr.  Lehrfeld.  That  is  one  of  the  conditions  contained  in  section 
501(c)(3). 

Mr.  HOAGLAND.  So  if  that  is  violated,  presumably  your  tax-ex- 
empt status  could  be  revoked. 

Mr.  Lehrfeld.  If  the  legislative  limitation  is  exceeded  under  the 
substantiality  test,  revocation  is  appropriate.  That  is  correct.  The 
political  campaign  activity  limitation  has  no  quantitative  floor  on 
it. 

Mr.  HOAGLAND.  On  page  2  you  quote  the  language  "No  substan- 
tial part  of  your  resources  can  be  devoted  to  attempts  to  influence 
legislation." 

Is  that  right? 

Mr.  Lehrfeld.  Correct. 

Mr.  HOAGLAND.  I  understand  you  have  a  budget  of  about  $20 
million  a  year. 

Mr.  Lehrfeld.  I  think  that  is  correct. 

Mr.  HOAGLAND.  I  am  curious  as  to  what  the  purpose  of— I  under- 
stand that  there  was  an  issue  bulletin  published  recently  by  the 
Heritage  Foundation,  "Six  Reasons  Why  Bill  Clinton's  National 
Service  Program  Is  a  Bad  Idea." 

I  am  curious  what  the  purpose  of  that  issue  bulletin  would  be  if 
not  to  influence  legislation. 

Mr.  Lehrfeld.  I  have  not  read  that  bulletin,  but  I  would  say 
that  under  existing  IRS  rulings  on  the  legislation  clause,  a  full  and 
fair  presentation,  one  that  permits  the  reader  to  make  a  judgment 
independent  of  that  advocated,  it  is  not  lobbying.  It  is  not  regarded 


1366 

as  an  attempt  to  influence  legislation.  If  the  bulletin  is  full  and 
fair,  it  is  not  an  attempt  to  influence  legislation. 

If  the  bulletin  is  not  full  and  fair,  it  would  be  an  attempt  to  influ- 
ence legislation. 

Mr,  HOAGLAND.  You  are  giving  us  a  technical  interpretation 
though,  right? 

Mr.  Lehrfeld.  As  counsel,  all  I  do  is  give  technical  interpreta- 
tions. 

Mr.  HoAGLAND.  Of  IRS  rulings?  So  you  are  telling  us  that  the 
IRS  has  previously  adopted  that  position? 

Mr.  Lehrfeld.  Certainly. 

Mr.  HOAGLAND.  Look  at  this  title  again,  "Six  Reasons  Why  Bill 
Clinton's  National  Service  Program  Is  a  Bad  Idea."  The  National 
Service  Program  is  pending  legislation  here,  is  it  not? 

Mr.  Lehrfeld.  I  don't  know.  I  must  plead  ignorance  on  that  par- 
ticular piece  of  legislation.  If  it  is  pending  or  proposed  legislation, 
then  it  is  something  that  has  to  be  dealt  with  under  the  full  and 
fair  test. 

Mr.  HOAGLAND.  Can  you  give  me  a  reason  why  Heritage  Founda- 
tion would  publish  a  bulletin  called,  "Six  Reasons  Why  Bill  Clin- 
ton's National  Service  Program  Is  a  Bad  Idea"  unless  it  were  to  in- 
fluence legislation  concerning  that? 

Mr.  Lehrfeld.  I  suppose  it  is  to  alert  the  members  and  to  alert 
the  public  about  what  is  in  the  bill  and  one  way  to  do  that  is  to 
provide  a  teaser  headline.  I  think  if  things  came  to  you  in  a  rather 
dull  format,  you  might  not  bother  to  look  at  it.  The  text  would  have 
to  be  read  to  see  whether  or  not  it  is  an  attempt  to  influence  legis- 
lation. 

Mr.  HOAGLAND.  Let's  look  at  the  plain  language  meaning  of  at- 
tempt to  influence  legislation  and  set  aside  any  IRS  technical  con- 
structions of  that  language.  Surely  the  plain  language  understand- 
ing of  a  title  like  that  would  be  that  it  is  intended  to  prevent  that 
bill  from  being  considered  seriously. 

Mr.  Lehrfeld.  If  that  is  the  conclusion  you  would  draw  from  it, 
then  that  is  the  appropriate  conclusion  for  vourself  I  think  that 
the  problem  is  that  the  lobbying  limitation  has  not  been  dealt  in 
that  fashion.  As  a  consequence,  we  look  at  what  the  IRS  has  said 
in  published  rules.  Also  important  is  what  has  been  accepted  by 
the  auditors  who  have  done  examinations  of  all  the  Heritage  Foun- 
dation materials  in  three  examinations  from  1974  forward. 

Mr.  HoAGLAND.  Can  you  give  me  a  purpose  for  that  piece  other 
than  an  attempt  to  influence  legislation? 

Mr.  Lehrfeld.  I  think  the  purpose  is  to  give  the  public  informa- 
tion about  the  proposed  legislation.  Whether  they  choose  to  accept 
or  reject  any  of  the  facts  that  are  in  there  is  their  choice.  Whether 
they  accept  or  reject  Heritage  opinions  in  there  is  also  their  choice. 
Heritage  gives  them  access  to  all  that  information. 

Mr.  HOAGLAND.  At  the  bottom  of  the  front  page  of  that  report 
was  the  language  "Note:  Nothing  written  here  is  to  be  construed" — 
and  there  is  an  omission — "as  an  attempt  to  aid  or  hinder  the  pas- 
sage of  any  bill  before  Congress." 

That  appeared  on  the  same  page  that  the  language  "Six  Reasons 
Why  Bill  Clinton's  National  Service  Program  Was  a  Bad  Idea"  ap- 
peared. 


1367 

Is  that  your  understanding? 

Mr.  Lehrfeld.  I  think  that  the  disclaimer  is  there  because  of  the 
belief  taken  from  IRS  opinions  that  if  something  represents  the 
personal  opinion  of  an  individual  associated  vsath  an  institution,  it 
will  be  regarded  as  such  rather  than  an  institutional  point  of  view. 

Mr.  HoAGLAND.  You  don't  see  any  inconsistency  between  that 
disclaimer  and  the  title  of  the  piece? 

Mr.  Lehrfeld.  Professionally  or  personally?  I  would  prefer  not 
to  see  a  disclaimer  because  if  Heritage  is  going  to  influence  legisla- 
tion by  going  beyond  the  full  and  fair  test,  then  they  should  be 
proud  of  the  piece  they  put  before  the  public. 

But  if  they  choose  to  limit  their  efficacy  by  putting  on  a  dis- 
claimer, I  think  they  have  been  intimidated  by  the  tax  law.  In 
turn,  the  right  of  the  Congress  to  know  the  facts  and  opinions  of 
others  is  diminished.  Congressmen  are  the  ones  who  are  the  losers. 

Mr.  HOAGLAND.  How  about  the  title,  "Economist  Calls  Clinton's 
Economic  Plan  Dishonest,  Deceptive"?  That  was  from  Heritage 
Foundation  News. 

What  would  the  purpose  of  that  news  item  using  the  word 
"news" 

Mr.  Lehrfeld.  I  would  say  it  is  again  to  get  someone's  attention. 
It  is  no  different  I  suppose  than  a  fundraising  letter  in  the  mail 
showing  a  diseased  or  crippled  child  and  promoted  by  a  charity 
that  is  soliciting  your  financial  support.  It  is  an  attention  getter 
and  if  you  do  read  the  article  and  you  do  absorb  the  text  and  find 
in  the  text  matter  there  of  value  to  you,  that  attention  getter 
served  its  purpose.  In  making  a  judgment  about  whether  or  not  you 
should  pass  or  deny  passage  to  a  piece  of  legislation,  then  the  pub- 
lic is  better  served  by  an  attention  getter. 

These  kinds  of  questions  are  why  the  Heritage  Foundation  op- 
poses any  lobbying  limits. 

Mr.  HoAGLAND.  But  designed  to  get  the  attention  of  who? 

Mr.  Lehrfeld.  Anyone  who  is  interested  or  who  has  the  same 
ideology  as  the  Heritage  Foundation. 

Mr.  HoAGLAND.  How  about  this  title:  "The  National  Competitive- 
ness Act:  A  High-Tech  Boondoggle."  We  voted  on  the  National 
Competitiveness  Act  just  a  few  months  ago. 

Mr.  Lehrfeld.  I  have  not  read  any  of  these  bulletins. 

Mr.  HoAGLAND.  Doesn't  that  sound  like  an  attempt  to  influence 
legislation  pending  before  Congress? 

Mr.  Lehrfeld.  Was  that  matter  pending  before  Congress  at  the 
time?  Is  that  the  headline?  Is  it  the  introduction?  Is  it  the  teaser? 
What  is  the  text  of  the  item? 

If  you  read  that  piece  and  you  come  to  a  conclusion  that  was 
other  than  the  conclusion  advocated,  then  under  Internal  Revenue 
laws  that  is  not  an  attempt  to  influence  legislation. 

Mr.  HOAGLAND.  Do  you  think  the  Internal  Revenue  laws  should 
be  amended  to  make  it  clear  that  something  that  is  so  obviously 
an  attempt  to  influence  legislation  is  in  fact  an  attempt  to  influ- 
ence legislation? 

Mr.  Lehrfeld.  No.  We  believe  that  all  the  limits  on  lobbying 
should  be  repealed  because  you  are  not  best  served  by  having  the 
charitable  sector  suppressed. 


1368 

Mr.  HoAGLAND.  What  about  radio  advertisements  that  are  run  in 
communities  around  the  country  that  seriously  distorted  the  actual 
effect  of  the  Clinton  economic  package  operated  by  tax-exempt  or- 
ganizations that  claim  tax-exempt  status? 

Mr.  Lehrfeld.  You  may  have  those  same  messages  by  labor 
unions  who  do  not  follow  Mr.  Clinton.  Mis-messengers  may  be 
trade  associations  which  are  also  tax-exempt.  They  may  be  social 
welfare  organizations.  They  may  be  charities.  Tax  exemption  covers 
25  different  classifications  of  organizations. 

Mr.  HoAGLAND.  It  is  your  opinion  that  their  tax-exempt  status 
should  not  be  jeopardized  by 

Mr.  Lehrfeld.  Absolutely  not. 

Mr.  HOAGLAND.  Radio  and  newspaper  ads  run  in  congressional 
districts 

Mr.  Lehrfeld.  That  is  the  position  of  the  Heritage  Foundation, 
which  I  subscribe  to  personally  as  well. 

Mr.  HoAGLAND.  But  by  putting  out  publications  with  these  sorts 
of  inflammatory  titles,  the  Heritage  Foundation  is  certainly  push- 
ing the  envelope,  isn't  it,  on  what  is  allowable? 

Mr.  Lehrfeld.  Well,  I  suppose  if  you  had  a  liberal  Democrat 
over  here  reading  it  and  you  had  a  conservative  Republican  over 
here  reading  it,  you  might  come  to  two  diflFerent  conclusions  about 
whether  or  not  it  was,  but  again  you  have  to  get  to  the  text  and 
beyond  the  teaser. 

Mr.  Hoagland.  It  would  have  to  be  a  poorly  written  text  if  it  car- 
ried the  title  "The  National  Competitiveness  Act:  A  High-Tech 
Boondoggle,"  and  didn't  make  the  point. 

Mr.  Lehrfeld.  If  it  did  make  the  point  but  if  you  were  able  to 
draw  a  conclusion  other  than  that  advocated  because  of  what  was 
in  the  text,  then  the  point  of  it  is  it  is  not  lobbying  under  how  the 
IRS  enforces  the  lobbying  limit  today. 

Mr.  Hoagland.  When  Congress  passed  the  legislation,  it  prohib- 
ited use  of  tax-exempt  funds  for  institutions  that  engage  in  propa- 
ganda or  otherwise  attempt  to  influence  legislation  or  engage  in  po- 
litical campaign  activities.  Congress  provided  "no  substantial  part" 
of  the  resources  can  be  devoted  to  "attempts  to  influence"  legisla- 
tion. 

It  seems  to  me  that  regardless  of  Internal  Revenue  Service  rul- 
ings and  what  technical  positions  the  Service  may  have  taken,  the 
Heritage  Foundation,  in  putting  out  reports  of  this  sort,  is  flouting 
the  plain  meaning  of  that  language. 

Mr.  Lehrfeld.  Let's  accept  for  purpose  of  this  discussion  that 
premise.  Then  the  question  becomes  how  much  is  substantial.  We 
would  like  to  know  that.  In  our  written  text,  we  have  questioned 
why,  since  1934,  has  the  Service  chosen  not  to  put  any  kind  of  a 
safe  harbor  into  its  regulations  so  that  an  organization — whether 
it  is  the  Birth  Defects  Foundation  or  the  Cancer  Society  or  Johns 
Hopkins  University — what  the  safe  harbor  is  for  allowable  lobby- 
ing. Nor  is  there  a  ceiling  that  says  "If  you  go  beyond  this,  you 
have  gone  too  far." 

Mr.  Hoagland.  It  sounds  like  you  think  this  whole  area  of  the 
law  should  be  reviewed? 

Mr.  Lehrfeld.  Absolutely. 


1369 

Mr.  HOAGLAND.  What  is  your  opinion  on  whether  organizations 
that  go  into  the  field,  go  into  congressional  districts,  take  a  piece 
of  pending  legislation,  grossly  distort  the  provisions  and  the  effects 
of  that  legislation  in  radio  and  newspaper  ads?  They  should  be  al- 
lowed to  claim  tax-exempt  status? 

Mr.  Lehrfeld.  I  don't  think  anyone  can  condone  educational  ac- 
tivity which  is  based  on  lies,  or  any  kind  of  activity  which  is  a  dis- 
tortion of  facts.  But  the  tax  laws  are  not  enacted  to  control  that 
type  of  behavior.  We  are  dealing  with  tax  laws  that  are  meant  to 
in  part  provide  assistance  to  nonprofit  organizations  generally, 
whether  they  are  farmers  co-ops  or  charities  or  social  clubs,  be- 
cause of  the  general  activity  they  do.  If  you  have  illegal  activity, 
that  can  be  remedied;  if  you  have  other  sorts  of  improper  activities, 
that  can  be  remedied.  But  distortion  of  the  truth  is  too  subjective; 
putting  truth  controls  into  the  hands  of  an  auditing  agent 

Mr.  HoAGLAND.  We  can  never  make  illegal  distortions.  The  First 
Amendment  protects  wrong  statements  as  much  as  correct  state- 
ments, but  I  think  what  we  can  do  is  deny  tax-exempt  status  to  ac- 
tivities that  we  don't  think  merit  it. 

Mr.  Lehrfeld.  The  provision  was  enacted  in  1934  by  a  group  of 
Senators  who  found  that  an  organization  called  the  National  Econ- 
omy League  was  fighting  President  Roosevelt  over  some  of  his  New 
Deal  proposals.  That  type  of  behavior  of  intimidation  by  Members 
of  Congress  continues.  You  get  letters  going  to  the  Internal  Reve- 
nue Service  from  Members  who  want  to  take  away  the  tax-exempt 
status  of  any  number  of  different  organizations  because  they  are 
making  them  uncomfortable  in  the  ideas  that  they  propagate.  It  is 
not  helpful  to  the  tax-exempt  sector  to  have  that  type  of  intimida- 
tion. 

Mr.  HoAGLAND.  Does  it  surprise  you  that  if  the  law  provides  that 
no  substantial  part  of  an  organization's  resources  can  be  devoted 
to  attempts  to  influence  legislation  and  reports  are  published  by 
the  Heritage  Foundation  with  these  kinds  of  titles — here  is  another 
one.  "Heritage  Foundation  Backgrounder:  Advantage  Incumbents: 
Clinton's  Campaign  Plan  Proposal." 

Does  it  surprise  you  that  with  those  kinds  of  titles  people  aren't 
going  to  send  letters  to  the  IRS  complaining? 

Mr.  Lehrfeld.  I  am  not  concerned  about  people  sending  letters. 
I  am  concerned  about  the  effect  on  officials  of  the  United  States, 
Members  of  Congress  who  would  attempt  to  use  their  position  of 
power  to  intimidate  the  public  sector  into  following  the  beliefs  that 
they  happen  to  have.  I  am  not  concerned  about  the  general  public. 

Mr.  HOAGLAND.  These  titles  appear  to  me  to  flout  the  plain  lan- 
guage of  the  statute. 

Mr.  Lehrfeld.  Whatever  the  titles  are,  I  think  the  audit  proc- 
ess— and  the  Foundation  has  been  through  the  audit  process  three 
times — they  have  survived  challenges  that  have  been  brought  and 
the  IRS  is  the  best  judge  of  what  the  law  is. 

Mr.  HOAGLAND.  Thank  you. 

It  does  not  surprise  me  you  have  been  audited  three  times  as  I 
see  this  material. 

Mr.  Gill,  one  final  comment  with  respect  to  your  testimony.  Let 
me  associate  myself  with  the  comments  made  by  Mr.  Payne.  That 
certainly  reflects  my  view  as  well. 


1370 

As  you  know,  most  of  our  electric  power  in  Nebraska  is  sold 
through  public  power  districts.  We  are  the  only  public  power  State, 
one  of  George  Norris'  great  reforms  that  we  still  benefit  from.  I 
know  that  the  individual  public  power  districts  raise  capital 
through  the  tax-exempt  bond  market. 

Does  CSC  play  a  role  in  Nebraska? 

Mr.  Gill.  We  have  played  a  role  in  Nebraska  in  that  respect. 
Like  most  cooperatives  in  public  power  districts,  they  are  too  small 
to  enter  the  market  individually.  We  have  used  our  credit  strength 
to  guarantee  the  tax-exempt  bonds  of  the  public  power  districts, 
thereby  enhancing  their  entry  into  the  market  and  lower  cost. 

Mr.  HOAGLAND.  Ms.  Bitter  Smith,  as  you  a  know,  a  provision  in 
the  recently  enacted  budget  reconciliation  bill  disallows  a  business 
deduction  for  trade  association  dues  that  are  allocable  to  lobbying. 
The  current  proposal  would  make  all  exempt  organizations,  wheth- 
er or  not  they  have  business  members,  subject  to  a  flat  30  percent 
excise  tax  on  their  lobbying  expenditures. 

In  your  view,  which  of  tne  two  provisions  is  fairer  and  which  is 
more  administrable? 

Ms.  Bitter  Smith.  Mr.  Chairman,  bear  in  mind  the  existing  pro- 
vision that  was  enacted  in  the  Budget  Act  implicates  only 
501(c)(6)s,  of  which  my  association  happens  to  be  categorically. 
These  proposed  provisions  which  could  reach  across  the  board  to 
501(c)(3)s,  501(c)(4)s,  501(c)(6)s  and  501(c)(7)s. 

On  the  surface  it  may  appear  to  be  fair,  but  let  me  remind  you 
that  in  fact  what  will  happen  is  all  those  organizations  will  now 
be  impacted  into  providing  information  and  communication  to  you 
as  a  Member  of  Congress. 

The  C-6  community  will  be  hit  doubly.  Not  only  will  they  not  be 
allowed  to  deduct  their  dues,  but  on  top  of  that,  they  will  be  hit 
with  a  30  percent  excise  tax.  ASAE's  position  is  that  neither  provi- 
sion is  palatable  and  appropriate  and  certainly  this  provision  of  the 
excise  tax  should  not  be  enacted. 

We  encourage  you  to  go  back  and  relook  at  the  provision  that 
was  recently  passed  as  it  impacts  this  deductibility  issue. 

Mr.  HoAGLAND.  Would  it  help  you  to  have  an  excise  tax  as  a  op- 
tion, as  an  alternative? 

Ms.  Bitter  Smith.  There  is  an  option  that  currently  exists  for 
the  association  to  pay  the  tax  directly,  a  proxy  tax,  as  opposed  to 
the  dues  deduction.  Both  are  problematic  and  difficult  to  calculate. 

I  don't  know  that  our  members  know  which  is  better,  yet  they 
both  believe  that  they  are  both  problematic  in  terms  of  calculating 
what  is  appropriate  and  what  isn't  and  how  to  sell  that  to  our 
members. 

I  think  we  would  urge  you  that  both  concepts  are  faulty. 

Mr.  HOAGLAND.  Thank  you. 

There  being  no  further  testimony,  thank  you  for  coming  and  the 
hearing  is  adjourned. 

[Whereupon,  at  4:35  p.m.,  the  hearing  was  adjourned,  to  recon- 
vene on  Tuesday,  September  21,  1993,  at  10  a.m.] 


MISCELLANEOUS  REVENUE  ISSUES 


TUESDAY,  SEPTEMBER  21,  1993 

House  of  Representatives, 
Committee  on  Ways  and  Means, 
Subcommittee  on  Select  Revenue  Measures, 

Washington,  D.C. 

The  subcommittee  met,  pursuant  to  call,  at  10:10  a.m.,  in  room 
1100,  Longworth  House  Office  Building,  Hon.  Michael  R.  McNulty 
presiding. 

Mr.  McNuLTY.  Good  morning. 

Today  the  Subcommittee  on  Select  Revenue  Measures  is  continu- 
ing its  hearings  on  miscellaneous  revenue  issues.  Chairman  Rangel 
has  been  called  away  to  attend  to  another  matter,  but  he  will  be 
joining  us  later.  The  chairman  has  asked  that  the  subcommittee 
begin  promptly,  since  some  of  the  invited  witnesses  have  time  con- 
straints. 

Today  the  subcommittee  will  receive  testimony  from  three  of  our 
colleagues:  Representatives  Gerald  Kleczka  of  Wisconsin;  Tom  Lan- 
tos  of  California;  and  Alan  Wheat  of  Missouri.  We  will  also  hear 
from  the  Department  of  the  Treasury  and  the  U.S.  General  Ac- 
counting Office. 

The  testimony  of  the  Treasury  Department  will  cover  all  the  rev- 
enue-raising proposals  that  were  set  forth  in  subcommittee  press 
releases  No.  9  and  No.  10.  In  addition,  we  will  hear  from  several 
business  associations  and  corporations. 

The  focus  of  today's  hearing  will  be  on  revenue-raising  proposals 
in  the  areas  of  foreign  taxation,  classification  of  workers,  compli- 
ance, tax-exempt  entities,  and  some  excise  tax  issues.  The  sub- 
committee anticipates  that  this  hearing  will  create  a  framework  by 
which  the  various  proposals  can  be  fully  evaluated. 

However,  because  of  the  time  constraints  and  the  wide  variety  of 
topics  we  will  consider  today,  I  ask  our  nongovernmental  witnesses 
to  limit  their  presentations  to  5  minutes.  Of  course,  the  full  written 
statements  of  the  witnesses  will  be  entered  into  the  record  in  their 
entirety. 

At  this  time  I  would  yield  to  my  colleague,  Mr.  Hancock,  for  any 
opening  statement  he  may  have. 

Mr.  Hancock.  No  statement,  Mr.  Chairman. 

Mr.  McNuLTY.  We  will  proceed  and  welcome  Mr.  Kleczka  of  Wis- 
consin. 


(1371) 


1372 

STATEMENT  OF  HON.  GERALD  D.  KLECZKA,  A  REPRESENTA- 
TIVE IN  CONGRESS  FROM  THE  STATE  OF  WISCONSIN 

Mr.  Kleczka.  Mr,  Chairman,  thgmk  you  for  this  opportunity  to 
speak  on  behalf  of  my  proposal  to  repeal  section  530  of  the  Revenue 
Act  of  1978.  The  debate  centers  on  the  misclassification  of  employ- 
ees as  independent  contractors.  ]Last  year,  as  a  member  of  the 
Committee  on  Government  Operations,  we  considered  this  problem 
and  I  learned  a  lot  about  how  section  530  is  used  to  deliberately 
misclassify  workers.  I  remain  deeply  concerned  about  this  problem. 

Before  describing  how  and  why  section  530  results  in  the  unfair 
treatment  of  workers,  I  want  to  provide  some  context  for  under- 
standing it.  There  are  many  classifications  of  jobs,  but  only  two 
matter  for  Federal  tax  purposes — employee  and  independent  con- 
tractor. If  a  worker  is  an  employee,  the  employer  is  responsible  for 
the  FICA  tax,  the  FUTA  tax,  and  withholding  on  wages  paid. 

If  the  worker  is  an  independent  contractor,  the  service  recipient 
has  no  tax  liabilities  toward  the  independent  contractor.  The  inde- 
pendent contractor  pays  all  applicable  taxes.  This  creates  a  strong 
incentive  for  businesses  to  misclassify  their  workers  as  independ- 
ent contractors. 

Not  surprisingly,  many  contractors  came  to  this  conclusion  years 
ago.  During  the  late  1960s,  a  number  of  employers  were 
misclassifying  their  workers  and  were  forced  to  correct  it.  This  re- 
sulted in  significant  tax  penalties  for  those  employers. 

The  basis  for  the  legislative  relief  was  that  the  test  for  determin- 
ing whether  a  worker  is  an  employee  or  not  is  too  subjective.  While 
section  530  eliminates  much  of  the  subjectivity,  it  permits  and  pro- 
motes abusive  classification. 

In  broad  terms,  section  530  states  that  if  an  employer  has  a  rea- 
sonable basis  for  treating  its  workers  as  independent  contractors, 
the  IRS  may  not  challenge  that  classification.  One  reasonable  basis 
is  where  the  employer  was  audited  once  by  the  IRS  and  the  classi- 
fication of  be  workers  was  not  challenged.  This  is  troublesome  be- 
cause the  IRS  has  limited  budget  resources,  and  it  means  that 
after  one  audit,  the  employer  is  free  to  misclassify  at  will. 

Consequently,  there  is  no  fear  of  review  by  the  IRS.  The  two 
most  obvious  examples  of  the  problem  is  the  loss  to  the  Federal 
Treasury.  Two  1989  IRS  reports  found  that  1  of  7  employers 
misclassified  over  3  million  workers  with  $15  billion  in  compensa- 
tion. This  resulted  in  a  reported  loss  of  $1.6  billion  to  the  Federal 
Treasury. 

This  report  also  stated  that  there  was  no  reason  to  believe  that 
this  amount  has  declined  since  1984. 

In  testimony  before  the  Ways  and  Means  Committee  last  July, 
the  General  Accounting  Office  reported  that  the  IRS  reclassified 
337,000  workers  as  employees  of  small  businesses  and  proposed 
$467  million  in  tax  assessments. 

The  IRS  testified  before  the  Committee  on  Government  Oper- 
ations that  general  contractors  in  the  construction  industry  have 
one  of  the  highest  rates  of  misclassification  of  any  industry  group. 
One  of  their  studies  revealed  that  over  6,000  informational  returns 
or  Form  1099  could  not  be  matched  to  taxpayers  accounts.  That  re- 
sulted in  an  estimated  loss  of  $91  million  to  the  Federal  Treasury. 


1373 

In  another  example,  the  IRS  testified  that  in  one  district,  20  per- 
cent of  the  employers  in  the  residential  construction  industry 
misclassified  64  percent  of  employees  as  independent  contractors. 
This  resulted  in  a  revenue  loss  of  some  $3.8  million  to  the  Treas- 
ury. 

Mr.  Chairman,  these  figures  are  staggering.  I  believe  they  are 
only  the  tip  of  the  iceberg.  At  the  very  least,  they  demonstrate  just 
how  serious  the  problem  of  misclassification  is. 

In  addition  to  the  loss  to  the  Federal  Treasury,  misclassification 
hurts  America's  workers  because  employees  are  entitled  to  work- 
men's compensation;  independent  contractors  are  not.  Employees 
are  eligible  for  employer-provided  health  benefits;  independent  con- 
tractors are  not.  Employees  may  participate  in  pension  plans  spon- 
sored by  their  employers  to  save  for  the  future;  independent  con- 
tractors may  not. 

As  I  am  sure  you  can  see  workers,  who  are  misclassified  as  inde- 
pendent contractors  are  seriously  injured  and  the  IRS  can  do  noth- 
ing to  correct  the  problem.  Section  530  prevents  them  from  acting. 
Perhaps  the  worst  problem  caused  by  section  530  is  the  effect  on 
the  construction  industry  as  a  whole.  The  market  in  which  general 
contractors  bid  for  jobs  is  extremely  competitive.  Bids  are  won  and 
lost  over  small  differences  in  price.  Consequently,  if  one  contractor 
can  treat  its  employees  as  independent  contractors,  it  can  lower  its 
labor  costs  and  afford  to  bid  less  on  jobs. 

In  some  cases  labor  costs  can  drop  by  25  percent.  The  net  result 
of  this  is  that  it  forces  honest  contractors  to  engage  in  dishonest 
practices  in  order  to  remain  competitive.  We  simply  cannot  allow 
this  situation  to  continue. 

Section  530  was  enacted  to  eliminate  subjectivity  and  make  clas- 
sification of  job  status  easier.  However,  its  enactment  opened  the 
door  for  tremendous  abuse.  Eliminating  section  530  for  the  con- 
struction industry  in  my  estimation  will  end  this  abuse.  It  will  re- 
store the  IRS  oversight  role  in  reviewing  job  classification  in  an  in- 
dustry noted  for  its  abuse  of  the  employment  tax  laws. 

Finally,  it  will  restore  a  level  playing  field  for  all  contractors.  Mr. 
Chairman  and  members,  thank  you  tor  this  opportunity  to  speak 
on  behalf  of  this  proposal  to  eliminate  section  530  from  the  con- 
struction industry.  I  look  forward  to  working  with  you  on  this  legis- 
lation. 

[The  prepared  statement  follows:] 


77-130  0-94-12 


1374 

statement  of  Gerald  D.  Kleczka 

Before  the  Subcommittee  on  Select  Revenue  Measures 

Committee  on  Ways  and  Means 

September  21,  1993 


Thank  you,  Mr.  Chairman,  for  this  opportunity  to  speak  on 
behalf  of  my  proposal  to  repeal  section  530  of  the  Revenue  Act  of 
1978  for  the  construction  industry.  The  core  of  the  debate 
surrounding  section  530  is  the  misclassification  of  workers  as 
independent  contractors.  This  is  not  a  new  issue  to  me.  As  a 
member  of  the  Committee  on  Government  Operations  last  year,  we 
considered  the  nature  and  extent  of  the  problem  of 
misclassification.  At  that  time,  I  learned  a  great  deal  about  how 
and  why  employers  try  to  classify  their  workers  as  independent 
contractors,  and  that  section  530  is  frequently  used  by  these 
employers  to  deliberately  misclassify.  I  remain  deeply  concerned 
that  the  problem  continues  today,  and  believe  that  my  proposal 
takes  an  important  step  toward  curbing  abusive  misclassification. 

Before  describing  how  and  why  section  530  perpetuates  unfair 
treatment  of  workers,  I  want  to  provide  some  context  for 
understanding  it.  The  American  workplace  contains  a  great  many 
types  of  jobs  as  well  as  classifications  of  jobs.  However,  only 
two  are  important  for  federal  tax  purposes.  They  are  employee  and 
independent  contractor.  The  status  of  a  worker  as  either  an 
independent  contractor  or  an  employee  largely  determines  how  their 
federal  tax  liabilities  are  determined.  If  a  worker  is  an 
employee,  the  employer  must  withhold  certain  amounts  from  the 
employees'  wages,  the  employer  must  also  pay  the  FICA  tax,  and  the 
employer  must  pay  the  FUTA  tax.  However,  if  the  worker  is  an 
independent  contractor,  the  person  paying  for  the  work  owes  no  FICA 
tax,  owes  no  FUTA  tax,  and  is  not  required  to  withhold  any  sums 
from  the  amount  paid.  The  independent  contractor  pays  all  the 
applicable  taxes.  Thus,  I  think  it  is  quite  clear  that  the  person 
paying  for  work  has  a  very  strong  incentive  to  classify  its  workers 
as  independent  contractors,  regardless  of  whether  the  workers  are 
employees  or  independent  contractors. 

Not  surprisingly,  many  contractors  in  the  construction 
industry  came  to  this  conclusion  years  ago.  During  the  late  1960s, 
a  number  of  employers  who  were  found  to  be  engaging  in  this 
practice  were  forced  by  the  IRS  to  reclassify  their  workers  as 
employees.  As  a  result,  the  employers  were  liable  for  substantial 
sums  of  unpaid  federal  employment  taxes.  In  response  to  these 
assessments,  employers  lobbied  for  and  Congress  enacted  section 
530.  The  basis  for  this  legislative  relief  was  that  the  test  for 
determining  whether  a  worker  was  an  employee  or  independent 
contractor  was  too  subjective.  In  all  fairness,  this  was  true  to 
a  degree,  and  some  clarity  was  needed.  However,  while  section  530 
eliminates  subjectivity,  it  also  permits  and  promotes  abusive 
classification . 

Section  530  eliminates  the  subjectivity  by  providing  a  safe 
harbor  for  classifying  workers  as  independent  contractors.  In 
broad  terms,  it  states  that  if  an  employer  has  a  reasonable  basis 
for  treating  its  workers  as  independent  contractors,  the  IRS  may 
not  challenge  that  classification.  One  of  the  reasonable  bases  is 
where  the  employer  was  audited  by  the  IRS  once,  and  the 
classification  of  its  workers  was  not  challenged.  If  this  occurs 
the  IRS  may  not  review  the  classification  at  a  later  date. 

While  this  prior  audit  rule  helped  employers  who  made  honest 


1375 


mistakes  in  classifying  their  workers,  it  was  quickly  exploited  by 
employers  seeking  to  evade  paying  their  fair  share  of  employment 
taxes,  and  is  particularly  troublesome  given  the  fact  that  the  IRS 
has  only  limited  resources.  It  essentially  means  that  if  the  IRS 
does  not  examine  every  possible  aspect  of  an  employer's  return,  the 
employer  is  free  to  misclassify  its  workers,  and  is  not  subject  to 
any  reasonable  review  by  the  IRS.  It  amounts  to  a  license  to  evade 
taxation. 

Armed  with  section  530,  a  significant  number  of  employers  now 
misclassify  their  workers  as  independent  contractors  with  impunity, 
knowing  the  IRS  cannot  stop  them. 

The  harm  caused  by  this  misclassif ication  is  great  and  occurs 
on  many  different  fronts.  Beginning  with  the  most  obvious,  the 
loss  of  funds  to  the  federal  treasury,  two  1989  IRS  reports  found 
that  1  of  7  employers  misclassif  ied  over  3  million  workers  with  $15 
billion  in  compensation.  This  reportedly  resulted  in  a  loss  of 
$1.6  billion  in  revenue  in  1984.  Moreover,  the  reports  state  that 
there  is  no  reason  to  believe  that  the  1984  loss  has  declined. 

More  recently,  in  testimony  before  the  Ways  and  Means 
Committee  in  July  1992,  the  General  Accounting  Office  reported  that 
in  a  special  program,  which  focused  on  small  businesses,  the  IRS 
reclassified  337,000  workers  as  employees  and  proposed  $467  million 
in  tax  assessments. 

The  IRS  testified  before  the  Committee  on  Government 
Operations  that  general  contractors  in  the  construction  industry 
have  one  of  the  highest  misclassif ication  rates  of  any  industry 
group.  One  IRS  study  revealed  over  6,000  informational  returns  or 
Forms  1099  that  could  not  be  matched  to  taxpayers'  accounts.  The 
IRS  estimated  that  this  resulted  in  a  loss  of  $91  million  to  the 
federal  treasury. 

In  another  example,  the  IRS  testified  that  in  one  district, 
20  percent  of  employers  in  the  residential  construction  industry 
misclassif ied  64  percent  of  employees  as  independent  contractors. 
This  resulted  in  a  $3.8  million  revenue  loss  for  the  federal 
treasury . 

Mr.  Chairman,  these  figures  are  staggering.  I  believe  the 
numbers  are  only  the  tip  of  the  iceberg,  and  I  believe  the  loss  to 
the  U.S.  Treasury  is  far  greater  than  even  these  studies  indicate. 
At  the  very  least,  the  studies  demonstrate  just  how  serious  the 
problem  of  misclassif  ication  is  for  America.  In  a  time  when  the 
federal  government  is  strapped  for  money,  and  is  cutting  Medicare 
benefits,  veterans  pay,  retirees  benefits,  etc.,  we  simply  cannot 
afford  to  allow  such  huge  losses  in  revenue  to  occur  through 
deliberate  abuse  of  the  law. 

In  addition  to  the  loss  to  the  treasury,  misclassif  ication 
endangers  America's  workers.  Employees  are  entitled  to  such 
protections  as  workers'  compensation  benefits  for  on  the  job 
injuries.  Independent  contractors,  however,  are  not.  Employees 
are  eligible  for  employer  provided  health  benefits.  Independent 
contractors  are  not.  Employees  may  participate  in  pension  plans 
sponsored  by  their  employer  to  save  for  the  future.  Independent 
contractors  may  not.  As  I'm  sure  you  can  see,  workers  who  are 
misclassif ied  as  independent  contractors  are  seriously  injured,  and 
the  IRS  can  do  nothing  to  correct  the  problem.  Section  530 
prevents  them  from  acting. 

In  addition  to  all  the  harms  I  have  mentioned,  perhaps  the 
worst  problem  caused  by  section  530  is  its  effect  on  the 
construction  industry  as  a  whole.  The  market  in  which  general 
contractors  bid  for  jobs  is  extremely  competitive.  Bids  are  won 
and  lost  over  very  small  differences  in  price.  Consequently,  if 
one  contractor  can  treat  its  employees  as  independent  contractors 
and  lower  its  operating  costs,  that  contractor  can  afford  to  bid 


1376 


lower  than  its  competitors  which  correctly  treat  the  workers  as 
employees.  In  fact,  by  deliberately  misclassifying  workers,  a 
contractor  can  lower  its  costs  by  up  to  25  percent. 

The  net  result  is  that  such  deliberate  misclassif ication 
forces  honest  contractors  to  engage  in  dishonest  practices  in  order 
to  remain  competitive.  Thus,  section  530  not  only  permits 
individual  contractors  to  abuse  the  employment  tax  laws,  but  forces 
others  to  follow  suit  in  order  to  survive. 

We  simply  cannot  afford  to  allow  this  situation  to  continue. 
I  realize  that  section  530  was  enacted  to  eliminate  subjectivity 
and  make  the  classification  of  job  status  easier.  However,  I  also 
realize  that  its  enactment  opened  the  door  for  tremendous  abuse 
that  could  not  be  foreseen  at  the  time.  We  must  act  now  to  end 
this  abuse.  Eliminating  section  530  for  the  construction  industry 
does  just  that.  It  terminates  the  unfair  provision  that  prevents 
the  IRS  from  reclassifying  deliberate  abuses  and  restores  oversight 
to  an  industry  noted  for  its  abuses  of  the  employment  tax  laws. 
It  protects  workers  from  unfair  denial  of  protections  enacted  for 
their  health  and  safety.  And  finally,  it  restores  a  level  playing 
field  for  all  contractors  to  compete  in. 

Mr.  Chairman,  thank  you  for  this  opportunity  to  speak  on 
behalf  of  my  proposal  to  eliminate  section  530  for  the  construction 
industry.  I  look  forward  to  working  with  you  on  this  legislation. 


1377 

Mr.  McNuLTY.  We  thank  our  colleague. 

Jerry,  the  proposal  to  repeal  the  section  530  safe  harbor  for  con- 
struction workers  would  result  in  employee  status  being  forced 
upon  some  workers  who  would  otherwise  have  met  the  require- 
ments for  independent  contractor  classification,  for  example,  sub- 
contractors who  are  self-employed. 

What  provisions  would  your  proposal  make  for  people  in  this  cat- 
egory? 

Mr.  Kleczka.  For  those  who  have  been  categorized  as  independ- 
ent contractors,  I  believe  my  repeal,  an  audit  of  IRS,  would  reveal 
those  employees  to  be  independent  contractors  and  their  status 
would  remain  as  it  is. 

Mr.  McNuLTY.  In  a  report  issued  by  the  GAO  entitled  "Ap- 
proaches for  Improving  Independent  Contractor  Compliance,  July 
1992,"  there  is  a  recommendation  to  apply  the  income  tax  with- 
holding rules  to  all  compensation  paid  for  services  without  regard 
to  the  classification  used  by  the  worker  performing  the  services. 

What  is  your  view  on  this  recommendation? 

Mr.  Kleczka.  Mr.  Chairman,  I  believe  that  is  an  option  that  not 
only  this  subcommittee  but  the  full  committee  could  look  at. 

Mr.  McNuLTY.  Thank  you. 

Do  other  colleagues  have  questions  of  Congressman  Kleczka? 

Mr.  Hancock.  Thank  you,  Mr.  Chairman. 

You  know,  one  of  the  things  that  we  have  talked  about  here  in 
the  Congress  is  the  creation  of  new  jobs  and  small  businesses.  I  do 
deal  in  some  of  these  construction  jobs.  Some  are  legitimate  and 
hopefiilly  we  won't  get  into  a  situation  where  we  force  the  small 
businesses,  the  truly  independent  contractor,  to  have  to  be  reclassi- 
fied, where  he  will  nave  to  become  an  employee  of  the  general  con- 
tractor. 

I  would  caution  us  on  that.  We  do  not  want  to  do  anything  in 
this  regulation  that  would  prohibit  or  make  it  illegal  for  the  truly 
independent  contractor  to  operate  as  an  individual.  I  recognize  that 
if  he  has  8  or  10  employees,  he  would  be  considered  an  independ- 
ent contractor. 

I  would  like  to  caution  that  we  don't  want  to  do  anything  to  jeop- 
ardize the  opportunities  of  individuals  to  operate  as  independent 
contractors  by  making  this  law  so  arbitrary  that  it  is  the  only  way 
that  the  truly  independent  individual  can  work  in  the  construction 
industry. 

Mr.  Kleczka.  I  agree.  In  fact,  it  is  not  the  intent  of  this  author 
to  change  anything  for  the  bona  fide  independent  contractor.  How- 
ever, for  those  employers  in  an  effort  to  skirt  their  liabilities,  be  it 
the  FICA  or  pension  or  health  benefits,  those  are  the  ones  we  are 
trying  to  get  at  today. 

Mr.  Hancock.  I  understand.  When  you  take  an  individual  who 
works  for  two  or  three  different  construction  companies  during  the 
year,  that  individual  is  still  an  independent  contractor  and  I  think 
should  be  able  to  maintain  his  independence.  I  would  hope  that  we 
don't  get  into  the  situation  where  that  individual  can't  operate 
under  those  terms. 

Thank  you  very  much. 

Mr.  Kleczka.  Thank  you. 


1378 

Mr.  McNuLTY.  If  there  are  no  further  questions  for  Congressman 
Kleczka,  we  thank  him  for  his  testimony. 

Mr.  Kleczka.  Thank  you. 

Mr,  McNuLTY.  Congressman  Tom  Lantos  was  due  to  appear  as 
a  witness  this  morning,  but  is  now  unable  to  attend.  I  ask  unani- 
mous consent  that  his  statement  appear  in  the  record. 

Without  objection,  so  ordered. 

[The  statement  of  Mr.  Lantos  follows:] 


1379 
CongrejfiS  of  tfje  Winitth  ^taiti 

$ou£te  of  ^epre^entatibeis 
masHtmton.  BC  20515 


Statement  of  Rep.  Tom  Lantos 

Before  the  Subcommittee  on  Select  Revenue  Measures 

Committee  on  Ways  and  IVIeans 

September  21,  1993 


Thank  you,  Mr.  Chairman,  for  including  the  important  issue  of  independent  contractors  among 
the  diverse  topics  you  are  considering  today.  My  esteemed  colleague  from  Connecticut  and  I 
appreciate  this  opportunity  to  discuss  the  proposal  to  eliminate  Section  530  coverage  of  the 
construction  industry  and  our  related  suggestions,  which  are  embodied  in  H.R.  3069  which  we 
introduced  last  week. 

The  controversial  subject  of  independent  contractors,  to  which  you  devoted  a  lengthy  day  of 
hearing  in  the  last  session  of  Congress,  looms  even  larger  today.  The  so-called  "jobless  recovery"  we 
are  undergoing  points  to  major,  structural  changes  in  the  American  labor  market.  Whether  we  call  it 
"downsizing",  "just-in-time",  "core  and  ring",  "out-sourcing",  "privatization  of  government  functions" 
or  simply  "contracting  out",  we  are  seeing  a  decline  in  the  traditional  pattern  of  long-term,  full-time 
employment.  Increasing  reliance  on  contingent  workers,  including  temporary,  part-time  and  contractor 
personnel,  characterizes  most  industries.    It  affects  both  workers  and  employers  significantly. 

During  the  six  years  I  chaired  the  Employment  and  Housing  Subcommittee  of  the  Government 
Operations  Committee,  I  learned  much  about  the  uses  and  abuses  of  contract  labor.  My  colleague  and 
I  have  introduced  legislation  in  an  effort  to  remedy  some  of  the  abuses  which  were  brought  to  our 
attention. 

But  first  let  me  quote  again  the  words  of  Chairman  Rostenkowski  at  a  1979  hearing  on 
independent  contractors.  He  said:  "We  in  this  country  have  benefitted  much  from  the  spirit  and 
independence  of  the  truly  self-employed  individual.  It  is  not  the  purpose  of  this  hearing  to  dampen  the 
spirit  and  creativity  of  these  individuals." 

I  certainly  agree  and  recognize  the  appropriate  and  valuable  roles  of  many  who  work  as  independent 
contractors,  it  is  the  misuse  of  independent  contractor  status  and  its  serious  adverse  effects  on  both 
employers  and  workers,  in  construction  and  numerous  other  industries,  that  so  concerns  me. 

An  employer  who  deals  with  a  contractor  instead  of  an  employee  escapes  many  obligations 
including  paying  half  of  Social  Security  tax,  unemployment  tax,  workers  compensation  insurance, 
withholding  income  taxes,  and  providing  benefits  such  as  vacation,  sick  and  family  leave,  health  and 
life  insurance,  pensions,  etc.  The  employer  also  is  not  required  to  comply  with  the  wage-hour  and  child 
labor  provisions  of  the  Fair  Labor  Standards  Act,  occupational  safety  and  health,  or  civil  rights  laws. 
Benefits  can  add  as  much  as  35%  to  payroll  costs  today;  we  may  face  additional  taxes  on  employers 
under  a  new  health  care  program.  Clearly,  these  costs  weigh  heavily  on  the  bottom  line;  they  can 
determine  whether  a  company  wins  bids  and  makes  a  profit.  Before  hiring  an  employee,  an  employer 
will  certainly  consider  the  possibility  of  a  contingent  work  arrangement  such  as  a  contract.  This  may 
be  a  legal  and  appropriate  arrangement,  but  it  also  may  be  an  illegal  cost-cutting  maneuver,  harmful 
to  workers,  competitors,  and  the  Federal  treasury. 

My  colleague  can  describe  in  detail  the  serious  harm  suffered  by  his  law-abiding  constituents 
who  lost  on  bids  for  Connecticut  construction  projects  to  out-of-state  competitors  who  misclassified 
their  workers  and  treated  them  as  independent  contractors. 

What  does  this  mean  to  the  worker?  As  a  contractor  he  or  she  may  receive  higher  take-home 
pay  and  may  be  allowed  to  deduct  more  business  expenses  from  income  taxes.  Unfortunately,  in  all 
too  many  cases  there  is  collusion  between  an  employer  and  a  contract  worker  which  enables  the 
worker  to  avoid  paying  income  taxes.  Cash  payments  fuel  an  underground  economy  of  worrisome 
dimensions. 

But  the  law-abiding  independent  contractor  loses  a  safety  net  of  protection  available  to 
employees.  He  or  she  may  not  even  be  aware  until  misfortune  strikes  that  there  is  no  unemployment 
insurance,  worker's  compensation,  emergency  leave,  or  even  social  security  available.  Whether  the 
worker  realizes  the  implications  of  being  treated  as  a  contractor  or  not,  he  or  she  usually  cannot  argue 
with  an  employer  about  such  classification.    In  today's  economy  it  is  likely  to  be:    "Take  it  or  I'll 


1380 


contract  with  one  of  the  crowd  of  applicants  at  my  door!" 

When  the  Internal  Revenue  Service  determines  that  an  employer  has  misclassified  employees 
as  independent  contractors,  it  assesses  back  taxes,  interest  and  penalties,  which  can  amount  to  a 
devastating  blow.  Faced  with  complaints  of  overzealous  enforcement  by  IRS  in  the  1970's,  Congress 
enacted  Section  530  which  provides  several  safe  harbors  for  employers  to  escape  IRS  assessments  for 
past  misclasssification  and  to  permit  continued  misclassification  in  the  future.  Strong  evidence  at  many 
Congressional  hearings  shows  that  this  law  has  several  negative  effects:  one,  it  results  in  similarly 
situated  employers  being  treated  very  differently  under  the  tax  law;  two,  it  allows--and  actually 
encourages-businesses  to  undercut  competitors  through  unfair  practices;  three,  it  leaves  workers 
exploited  and  unprotected;  and  four--surely  an  issue  of  prime  importance  to  all  of  us--it  deprives  the 
Federal  government  of  significant  revenue. 

This  is  not  a  small  problem  we  are  addressing.  IRS  reported  that  in  1 984  one  in  seven 
employers  misclassified  some  three  million  workers  with  $16  billion  in  compensation.  The  Social 
Security  system,  state  unemployment  funds  and  the  general  treasury  are  all  losing  money.  More 
significantly,  these  estimates,  according  to  IRS,  "...are  conservative.  They  represent  employers  with 
employment  tax  filing  requirements  but  dd  not  include  withholding  and  employment  tax  noncompliance 
for  employers  who  are  completely  noncompliant  with  employment  taxes  regulations."  In  other  words, 
they  do  not  include  the  submerged  bulk  of  the  iceberg,  the  willful  violators. 

Eventually  it  may  be  desirable  to  repeal  Section  530  altogether,  but  today  we  see  the  problem 
of  noncompliance  as  so  rampant  in  the  construction  industry  that  we  are  pleased  to  support  the 
proposal  before  you  to  eliminate  Section  530  coverage  of  this  industry.  Since  use  of  bona  fide 
independent  contractors,  such  as  a  truly  freelance  craftsman,  is  available,  we  recommend  elimination 
of  the  safe  harbors  --loopholes,  really- which  530  gives  for  past  and  future  misclassification. 

In  addition  to  removing  Section  530  protection  from  those  construction  employers  who 
misclassify  employees  as  independent  contractors,  we  recommend  that  530  be  modified  for  all  other 
industries.  Our  major  proposal  is  a  one-year  amnesty  or  waiver  of  tax  liability  for  employers  who 
misclassified  their  employees  based  on  a  good  faith  misinterpretation  of  common  law  rules  and  who 
filed  the  required  tax  forms,  such  as  1099's.  We  believe  that  such  an  opportunity  will  induce  many 
employers  to  "enter  the  system",  which  would  be  a  win-win  event  for  them,  their  workers  and  the  IRS. 

We  also  recommend  deletion  from  Section  530  of  the  safe  harbor  based  on  any  prior  IRS  audit 
unless  the  audit  was  conducted  for  employment  tax  purposes  within  the  previous  three  years. 

Although  very  few  cases  have  arisen  in  which  state  or  local  government  entities  have  sought 
530  protection  for  misclassification  of  their  employees,  we  believe  that  no  such  exemptions  are 
appropriate  and  therefore  would  exclude  them  from  Section  530. 

Our  bill  eliminates  Section  1 706  of  the  Tax  Reform  Act  of  1 986  which  gave  unjustified  special 
treatment  to  a  group  of  technical  services  professionals.  This  repeal  was  advocated  by  several 
witnesses  in  your  committee's  1 992  hearing. 

Our  proposal  requires  employers  to  include  with  payments  for  services  provided  by  contractors 
a  statement  informing  the  worker  of  1)  obligations  for  payment  of  FICA  and  other  taxes,  2)  the 
procedure  for  requesting  IRS  to  review  the  contract  status,  3)  the  absence  of  fringe  benefits  and 
statutory  protections,  and  4)  potential  tax  benefits  available  to  the  self-employed.  The  IRS  could 
prepare  standardized  information  which  legitimate  employers  would  not  object  to  providing  to  their 
contractors.  We  have  heard  of  too  many  instances  where  workers  suffered  because  they  were  not 
aware  of  what  contractor  status  meant  to  them  financially  or  otherwise. 

Mr.  Chairman,  I  am  well  aware  that  the  independent  contractor  issue  is  an  emotional  one  which 
has  been  before  your  committee  many  times.  I  urge  you  and  your  colleagues  to  deal  with  it  this  year 
as  a  valid  source  of  revenue,  a  measure  of  equity  for  law-abiding  employers,  and  a  small  step  to  assist 
victims  of  the  movement  toward  a  contingent  workforce.  You  will  restore  the  safety  net  we  have 
established  for  countless  thousands  of  workers-skilled  craftspersons,  immigrant  janitors,  nurses,  taxi 
drivers  and  others  from  all  walks  of  life. 

Thank  you  for  your  attention  to  this  issue. 


1381 

Mr.  McNuLTY.  I  would  ask  for  the  same  consideration  for  Con- 
gressman Christopher  Shays.  Without  objection,  his  statement  will 
appear  in  the  record. 

[The  statement  of  Mr.  Shays  follows:] 


1382 


STATEMENT  OF  CONGRESSMAN  CHRISTOPHER  SHAYS 

WAYS  AND  MEANS  COMMITTEE 

SUBCOMMITTEE  ON  SELECT  REVENUE 

September  21,  1993 

Mr.  Chairman,  thank  you  for  considering  the  issue  of  misclassifying 
employees  as  independent  contractors  as  part  of  today's  hearing. 
My  friend.  Congressman  Lantos,  and  I  appreciate  this  opportunity  to 
testify  in  support  of  eliminating  Section  530  coverage  of  the 
construction  industry  as  well  as  the  other  aspects  of  our  bill, 
H.R.  3069. 

First,  I  would  like  to  join  Congressman  Lantos  in  acknowledging  the 
need  to  protect  the  rights  of  contractors  who  are  truly  independent 
and  self-employed  —  our  nation's  spirited  entrepreneurs  who  are 
hard-working  and  conscientious. 

When  employees  are  improperly  classified  it  hurts  the  worker,  who 
does  not  receive  the  benefits  to  which  he  or  she  is  entitled;  it 
hurts  the  honest  employer,  who  loses  bids  to  competitors  who  are 
able  to  illegally  cut  their  labor  costs;  and  finally,  it  hurts  the 
government,  which  loses  billions  of  dollars  in  tax  revenues. 

Last  year,  our  Government  Operations  Subcommittee  on  Employment  and 
Housing  held  a  hearing  to  examine  the  implications  of  this 
pernicious  problem,  with  particular  attention  to  how  it  affects  the 
employee. 

We  listened  to  testimony  from  several  employees  who  worked  for 
unscrupulous  contractors  who  intentionally  misclassified  them.   The 
workers  described  how  their  employers  cut  corners  on  overtime  pay. 
Social  Security  taxes,  federal  unemployment  taxes,  unemployment 
compensation,  workers'  compensation  and  federal  withholding  taxes 
as  well  as  other  employees  benefits. 

The  employees  said  they  knew  their  bosses  were  breaking  the  law  and 
knew  they  were  being  cheated  out  of  important  health  and  welfare 
benefits,  but  in  each  case,  the  employees  said  they  could  not 
protest  because  they  needed  the  work. 

Employees  discover  the  real  disadvantage  to  their  independent 
status  when  crisis  strikes.   The  New  York  State  Unemployment 
Commissioner  told  us  how  some  employees  do  not  know  they  are  being 
treated  as  independent  contractors  and  only  discover  this  fact  when 
they  lose  their  jobs  and  apply  for  unemployment  benefits.   They  are 
shocked  to  learn  that  they  are  not  eligible  for  benefits  and  their 
only  recourse  is  to  engage  in  a  legal  battle  with  their  former 
employer. 

The  law-abiding  employer  is  seriously  hurt  by  misclassif ication 
since  he  cannot  compete  on  a  level  playing  field  with  those  who 
illegally  cut  labor  costs. 

One  employer  from  my  state  told  our  subcommittee  how  he  lost  a  $3.5 
million  contract  to  a  low  bidder  who  hired  all  50  employees  as 
individual  subcontractors.   As  a  result,  the  state  and  the  federal 
government  failed  to  receive  any  taxes,  unemployment  or  workers 
compensation  payments. 

Our  subcommittee  was  disturbed  to  learn  that  to  cover  themselves, 
some  employers  put  a  handful  of  employees  legitimately  on  the 
payroll  so  that  in  the  event  an  uncovered  workers  is  injured  on  the 
job,  they  can  use  the  covered  employee's  name  and  compensation 
benefits.   We  were  troubled  to  learn  this  kind  of  scam  is  not 
uncommon . 

While  we  understand  that  Section  530  of  the  Revenue  Act  of  1978, 
the  so-called  "Safe  Harbor"  clause,  was  passed  to  protect  employers 
from  overly  aggressive  enforcement  by  the  Internal  Revenue  Service 
(IRS) ,  and  particularly,  the  imposition  of  very  harsh  fines  and 
penalties,  we  are  concerned  this  provision  has  limited  the  ability 
of  the  IRS  to  address  this  problem. 


1383 


As  you  know,  because  of  Section  530,  employers  are  allowed  to 
continue  to  misclassify  workers  if  they  can  demonstrate  they  have  a 
reasonable  basis  for  classifying  employees  as  independent 
contractors.   This  would  include  a  past  IRS  audit,  an  established, 
long-standing  recognized  industry  practice  or  an  IRS  ruling  or 
judicial  precedent. 

Our  subcommittee  heard  testimony  from  a  high  ranking  IRS  official 
who  stated  that  Section  53  0  hamstrings  the  IRS  from  effectively 
enforcing  the  laws  and  dealing  with  the  misclassif ication  problem. 

After  listening  to  these  witnesses.  Chairman  Lantos  and  I  concluded 
it  was  imperative  we  introduce  H.R.  3069  to  try  to  put  a  stop  to 
these  abuses. 

First,  our  bill  would  provide  amnesty  for  one  year  from  back  taxes 
and  penalties  to  employers  who  in  "good  faith"  misclassified  their 
employees.  These  employees  would  have  to  prove  they  filed  all  the 
required  tax  forms,  including  1099s,  and  they  would  have  to  pledge 
that  they  would  reclassify  their  workers  for  the  future.  Moreover, 
we  would  encourage  the  IRS  to  maintain  a  "watch  list"  of  these 
employers  to  ensure  they  continue  to  classify  correctly. 

Our  intent  in  offering  this  one-year  amnesty  is  to  give  employers 
who  feel  they  have  unintentionally  misclassified  the  opportunity  to 
come  into  compliance.   We  believe  there  are  many  honest  employers 
out  there  —  one  of  whom  testified  at  our  hearing  —  who  would  take 
advantage  of  the  opportunity  to  set  the  record  straight.   We  do  not 
feel,  however,  those  who  willfully  misclassified  for  financial  gain 
and  failed  to  file  forms  with  the  IRS  should  be  afforded  this 
protection. 

Second,  our  bill  would  eliminate  the  "prior  audit"  safe  haven  under 
Section  530,  which  allows  employers  to  continue  to  misclassify 
employees  solely  because  they  were  previously  audited  by  the  IRS. 

We  strongly  feel  this  protection  should  be  eliminated.   It  makes 
little  sense  to  us  to  continue  to  allow  the  wrongful  classification 
of  employees  just  because  the  company  received  a  previous  audit, 
which  may  have  had  nothing  to  do  with  the  issue  of 
misclassif ication. 

Third,  our  bill  would  require  the  states  to  follow  the  Federal 
definition  of  employee  for  the  purposes  of  unemployment 
compensation.   We  feel  this  provision  would  help  clarify  a  great 
deal  of  confusion  between  differing  federal  and  state  statutes  and 
interpretations . 

Fourth,  if  workers  are  legitimately  independent  contractors,  our 
legislation  would  require  that  prime  contractors  notify  them  of  all 
their  tax  obligations  as  well  as  their  statutory  rights  and 
protections  as  subcontractors. 

We  urge  the  subcommittee  to  consider  the  proposals  before  it  today 
and  in  its  great  wisdom  craft  the  most  effective  solution  to  this 
problem. 

Mr.  Chairman,  thank  you  again  for  allowing  us  to  testify  on  this 
important  issue. 


1384 

Mr.  McNULTY.  At  this  time,  I  would  like  to  welcome  another  col- 
league to  the  hearing,  Congressman  Alan  Wheat  of  Missouri. 

STATEMENT  OF  HON.  ALAN  WHEAT,  A  REPRESENTATIVE  IN 
CONGRESS  FROM  THE  STATE  OF  MISSOURI 

Mr.  Wheat.  Thank  you,  Mr.  Chairman.  I  appreciate  the  oppor- 
tunity to  testify  before  you  this  morning.  I  would  ask  unanimous 
consent  that  my  entire  statement  be  made  a  part  of  the  record  and 
I  would  summarize  it  and  also  the  statement  of  Mr.  Mike  Herman, 
who  is  the  managing  partner  of  the  Kansas  City  Royals  baseball 
organization  at  this  time. 

Mr.  McNuLTY.  Without  objection. 

[The  statement  of  Mr.  Herman  follows:] 


1385 


STATEMENT  OF  MICHAEL  E.  HERMAN 

ON  PROPOSED  CIVIC  ASSETS  LEGISLAT:[0N 

HEARING  OM  MISCELLANEOUS  REVENUE  ISSUES 

SOBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

COMIITTEE  ON  WAYS  AND  MEANS 

U.S.  HOUSE  OF  REPRESENTATIVES 

SEPTEMBER  21,  1993 

Mr.  Chairman  and  members  of  the  Committee,  I  greatly 
appreciate  the  opportunity  to  present  a  statement  in  support  of  the 
legislation  that  Congressman  Alan  Wheat  will  introduce  in  the  near 
future.  This  legislation  is  necessary  to  answer  questions  in  the 
Internal  Revenue  Code  with  respect  to  a  proposed  gift  by  the  late 
Mr.  Ewing  M.  Kauffman. 

Before  his  death  this  year,  Mr.  Kauffman  worked  on  a 
Succession  Plan  for  the  Kansas  City  Royals  so  that  the  team  could 
remain  in  Kansas  City  aftex  his  death.  I  can  attest  to  this  as  I 
had  the  extreme  privilege  of  working  closely  with  this 
extraordinary  individual  for  over  20  years.  He  was  a  father  figure 
to  me  and  to  a  great  many  others  in  our  community.  He  will  be 
greatly  misised. 

Because  of  our  close  association,  Mr.  Kauffman  often 
asked  me  to  represent  him  with  respect  to  the  Royals.  Now  under 
the  Trust  which  holds  the  Royals  stock,  Mrs.  Kauffman  and  I,  as 
trustees,  have  the  responsibility  of  administering  the  stock  in 
accordance  with  his  wishes.  His  fervent  desire  was  that  the  Royals 
remain  in  Kansas  City  for  as  long  as  possible. 

Mr.  Kauffman  early  on  realized  just  how  important  a  major 
league  baseball  team  would  be  to  our  City.  Kansas  City  has  a  great 
baseball  tradition,  with  the  Kansas  City  Blues,  the  Kansas  City 
Monarchs  and  the  Kansas  City  Athletics.  After  we  lost  the 
Athletics,  Mr.  Kauffman  took  an  enormous  financial  risk  by 
purchasing  the  expansion  franchise  offered  by  the  American  League. 

Mr.  Kauffman,  never  one  to  settle  for  second  best,  then 
set  out  to  build  a  first-rate  organization.  Mr.  Kauffman  had  a 
knack  of  generating  enthusiasm  in  others  which  caused  them  to  excel 
beyond  their  expectations.  Mr.  Kauffman  was  able  to  work  his  magic 
on  the  Royals  and  the  te.im  responded  by  winning  six  division 
titles,  two  American  Leagutj  Championships,  and  one  World  Series, 
all  within  24  years  of  its  founding.  (I  also  note  with  pride,  the 
Royals  are  the  only  team  in  Major  League  history,  never  to  have 
finished  last. ) 

Duri.ng  the  two  anl  one  half  decades  that  the  Royals  have 
existed,  they  have  become  an  integral  part  of  Kansas  City,  not  only 
from  a  financial  and  recreational  standpoint,  but  also  because  many 
players  (non-Kansas  Citians  at  first)  have  chosen  to  live  in  our 
City  during  and  after  t.heir  careers.  The  team  and  the  players  are 
truly  part  of  our  community.  The  players  continually  donate  their 
time  and  talents  for  charitable  activities,  and  in  turn,  the 
community  responds  to  them.  I  believe  Mr.  Kauffman  fostered  within 
the  Royals,  this  sense  of  community  service.  In  this  vein,  Mr. 
Kauffman  by  his  example  made  his  people  aware  of  what  was 
appropriate  behavior  on  and  off  the  field. 

It  is  self  evident  and  goes  without  saying  that  the 
existence  of  the  Royals  in  Kansas  City  is  vital  to  our  community  in 
many,  many  other  ways. 

As  you  may  know,  Mr.  Kauffman  died  on  August  1.  However, 
before  his  death  he  developed  a  Succession  Plan  for  the  Royals  so 
that  after  he  was  gone,  there  would  be  a  way  to  keep  the  Royals  in 
Kansas  city.  Mr.  Kauffman  worked  on  this  plan  for  almost  two 
years. 


1386 


Under  the  Plan,  Mr.  Kauff man's  stock  in  the  Royals  would 
be  split  into  two  clasisas,  class  A  voting  common  and  Class  B  non- 
voting common,  and  another  class  (Class  C  non-voting)  would  also  be 
authorized. 

Mr.  Kauffman's  Trust  would  sell  the  class  A  stock  to  a 
partnership  of  --five  individuils  who  would  control  the  team  with  one 
of  the  five  acting  as  the  decision  maker.  This  individual  would  be 
obligated  to  operate  the  team  under  the  rules  that  govern  Major 
League  Baseball. 

His  Trust  would  donate  the  Class  B  stock  to  the  Greater 
Kansas  City  Community  Foundation,  a  well  recognized  public  charity, 
as  well  as  donate  $40,000,000  in  cash  to  this  Foundation  to 
purchase  additional  sihares  of  Royals'  Class  B  stock.  Mr. 
Kauffman's  Trust  and  Mrs;.  Kauffman  would  also  donjite  an  additional 
$10,000,000  to  the  Foundation  to  purchase  Class  C  stock.  Others  in 
Kansas  City  would  then  donatr.  another  $4  0,000,000  -co  the  Foundation 
to  purchase  the  remaining  shares  of  Class  C  stock. 

Thereafter,  the  Royals  would  continue  to  operate  in 
Kansas  City  as  a  taxable  entity  with  cash  reserves  available  to 
fund  the  foreseeable  operating  losses  for  the  next  several  years. 
During  this  time  the  Partnership  would  attempt  to  sell  the  team  to 
a  local  purchaser.  For  a  period  of  six  years,  the  Partnership 
would  be  restricted  from  selling  the  Class  A  stock  to  anyone  other 
than  a  person  who  would  agree  to  keep  the  team  in  Kansas  City. 
After  the  six  year  period,  this  restriction  would  disappear. 

The  Class  B  and  Class  C  stock  held  by  the  Community 
Foundation  would  have  no  restrictions  as  to  sale  except  that  Major 
League  Baseball  would  have  the  right  to  approve  the  buyer  of  the 
stock  (as  it  does  with  respect  to  all  transfers  of  ownership 
interests  in  baseball  franchises) .  Moreover,  the  purchaser  of  the 
Class  A  stock  would  also  be  required  to  purchase  the  Class  B  and 
Class  C  stock,  but  only  if  the  Community  Foundation  elected  to 
sell. 

Thereafter  when  the  Royals  are  sold,  the  proceeds  would 
be  distributed: 

(i)  first,  to  the  Community  Foundation  as  the  sole 
holder  of  the  Class  C  stock  in  an  amount  equal 
to  its  purchase  price  for  the  Class  C  stock; 

(ii)  then  to  the  Partnership,  the  holder  of  the 
Class  A  stock,  in  an  amount  equal  to  its 
purchase  price  for  the  Class  A  stock; 

(iii)  then  to  the  Community  Foundation  as  the  holder 
of  the  Class  C  stock,  in  an  amount  equal  to  5% 
of  the  remaining  proceeds; 

(ivj  then  to  the  Partnership  as  the  holder  of  all 
Clas!5  A  stock,  an  amount  all  of  which  will  be 
dona~ed  to  charity;  and 

(v)  lastly,  the  remaining  amount  to  the  Community 
Foundation  as  the  holder  of  the  Class  B  stock. 

In  March,  1993,  Mr.  Kauffman  submitted  a  ruling  request 
to  the  Internal  Revenue  Service  with  respect  to  the  tax  treatment 
of  the  transactions  contemplated  in  the  Succession  Plan.  Although 
the  Internal  Revenue  Service  has  yet  to  issue  its  ruling,  it  has 
raised  a  number  of  questions  which  they  believe  may  not  be  capable 
of  being  resolved  in  the  Internal  Revenue  Code  as  presently 
drafted.  It  is  anticipated  that  we  should  have  a  determination 
from  the  Internal  Revenue  Service  within  the  next  30  to  60  days. 


1387 


Mr,  Kauffman  had  anticipated  that  he  laight  not  live  long 
enough  to  be  assured  that  the  Succession  Plan  would  be  implemented 
as  proposed.  Therefore,  in  the  Trust  Agreement,  Mrs.  Kauffman  and 
I  as  Trustees  are  directed  to  exert  all  reasonable  efforts  to 
proceed  with  the  Succession  Plan  and  if  that  is  not  possible,  then 
to  transfer  the  Royals  stock  to  the  Ewing  M.  Kauffman  Foundation. 

In  essence,  there  should  be  no  distinction  drawn  between 
the  transfer  of  the  Royals  stock  in  accordance  with  the  Succession 
Plan  and  the  transfer  of  the  stock  to  the  Kauffman  Foundation. 
Both  should  be  treated  as  charitable  contributions. 

Mr.  Kauffman  first  looked  to  see  if  the  gift  of  the 
Royals  could  be  made  to  the  Kauffman  Foundation.  However,  he  was 
advised  that  the  Kauffman  Foundation  could  not  be  the  recipient  of 
the  Royals  stock,  in  as  much  as  this  Foundation  is  a  "private 
foundation"  subject  to  its  own  special  rules  in  the  Internal 
Revenue  Code.  As  such,  the  Kauffman  Foundation  should  not  fund  the 
team's  operating  losses  and  so  would  have  no  alternative  but  to 
sell  the  Royals  quickly.  This  would  be  disadvantageous  to  the 
people  of  Kansas  City  in  t.hat  it  would  be  ver^^  likely  that  an 
outsider  would  come  in,  buy  the  team  and  move  it.  Moreover,  Major 
League  Baseball  would  not  be  comfortable  with  a  charity  owning  and 
operating  a  baseball  team.  Also,  the  strings  on  the  gift  to  assure 
that  the  team  remain  in  Kansas  City  might  disqualify  the  donation. 

Mr.  Kauffman  was  a  very  generous  individual  and  the 
Succession  Plan  is  evidence  of  this.  Under  the  Plan,  he  and  Mrs. 
Kauffman  will  give  assets  worth  over  $175,000,000  for  the  benefit 
of  Kansas  city,  all  of  this;,  in  order  to  keep  the  Royals  in  our 
community.  The  transactions  have  been  scrutinized  carefully  and  I 
can  assure  you  that  under  the  Plan,  no  one  will  benefit  except  the 
people  of  Kansas  City. 

We  understand  tha":  Congressman  wheat  will  be  submitting 
a  carefully  crafted  bill  that  addresses  the  problems  that  may  exist 
in  the  Internal  Revenue  Codis .  This  bill  has  been  reviewed  by  the 
staff  of  the  Joint  Committee  on  Internal  Revenue  Taxation.  The 
bill  will  make  clear  that  the  activities  of  preserving  long 
standing  comnunity  assets  or  enterprises  that  are  integral  to  the 
life  of  the  comiaunity  are  ac'-ivities  that  are  charitable  in  nature. 
In  addition,  the  bill  goes  a  long  way  to  avoid  potential  abuses  by 
providing  that  the  donor  will  be  allowed  only  an  estate  tax 
deduction  provided  the  donor  gives  all  of  his  interest  to  a 
community  foundation.  Furthermore,  the  family  of  the  donor  cannot 
have  any  continuing  interest  in  the  enterprise.  Also,  requirements 
on  the  gift  that  further  the  civic  asset  remaining  in  the  community 
or  that  are  required  by  another  authority,  such  as  in  this  case 
Major  League  Baseball,  will  not  defeat  the  charitable  deductions. 

In  closing,  T  want  to  thank  you  for  this  opportunity  to 
present  this  statement  in  support  of  Congressman  Wheat's  bill. 


1388 

Mr.  Wheat.  Thank  you,  I  appreciate  the  opportunity  to  testify. 

I  want  to  make  it  clear  I  am  not  speaking  just  on  my  own  behalf, 
but  on  behalf  of  the  two  Senators  who  represent  the  State  of  Mis- 
souri, both  of  whom  have  been  very  active  in  legislation  that  we 
seek  to  present  to  you  today,  as  well  as  the  Kansas  City  Royals 
baseball  team  and  the  great  majority  of  the  citizens  of  the  greater 
Kansas  City  area  who  have  expressed  their  support  through  public 
solicitation,  direct  support,  as  well  as  having  both  the  Jackson 
County  Legislature  and  the  Kansas  City  Missouri  City  Council 
pass  resolutions  in  support  of  what  I  propose  today. 

You  may  be  aware  that  a  gentleman  by  the  name  of  Ewing 
Kauffman  died  recently  who  had  for  many  years  been  the  owner 
of  the  Kansas  City  Royals  baseball  club.  Mr.  Kauffman  was  a  man 
who  was  admired  and  revered  in  the  greater  Kansas  City  area  and 
was  very,  very  generous  in  terms  of  charitable  contributions 
throughout  his  lifetime,  so  generous  that  in  fact  his  carryover  de- 
duction for  income  tax  purposes  is  in  the  hundreds  of  million  dol- 
lars range  at  this  time. 

Mr.  I^uflfman  and  his  wife  were  the  sole  owners  of  the  Kansas 
City  Royals  baseball  team,  but  made  provisions  before  Mr. 
Kauffman  died  to  set  up  what  we  believe  is  a  very  generous  succes- 
sion plan  so  that  the  Kansas  City  Royals  baseball  team  could  re- 
main in  the  Kansas  City  area. 

The  way  that  Mr.  Kauffman  proposed  to  do  this  was  to  donate 
the  baseball  team  to  a  community  trust  in  Kansas  City  that  is  a 
charitable  organization.  I  have  legislation  here  that  explains  how 
that  is  done  and  I  could  go  through  all  the  different  classes  of  stock 
that  are  involved  and  all  the  regulations. 

Let  me  sum  it  up  by  saying  the  problem  is  that  a  community 
trust  might  be  required  to  sell  the  baseball  team  because  it  is 
frankly  a  losing  proposition  on  an  annual  basis  and  it  is  one  of 
some  significant  assets.  The  law  is  not  clear  at  this  point  in  time 
whether  a  community  trust  could  in  fact  hold  a  significant  asset 
like  this  for  a  period  of  time  for  the  purpose  of  maintaining  it  with- 
in a  city.  That  is  what  we  seek  to  do  today,  to  present  legislation 
which  will  clarify  that  law  and  allow  a  community  trust  on  a  chari- 
table basis  to  continue  to  operate  the  baseball  team. 

I  should  also  mention  that  the  baseball  team  itself  would  be  op- 
erated in  such  a  way  that  it  would  continue  to  be  a  full  taxpaying 
corporate  entity  and  only  for  the  purposes  of  the  transfer  would 
there  be  no  tax  liabilities. 

I  should  also  add  that  in  our  particular  case,  there  would  be  no 
revenue  effect  to  the  Federal  Treasury  because  whether  the  base- 
ball team  is  donated  to  the  community  trust  or  whether  it  is  do- 
nated to  a  private  charitable  entity  that  Mr.  Kauffman  had  set  up 
over  the  last  few  years,  it  was  his  intention  that  it  be  donated  to 
a  charitable  entity.  The  only  real  question  for  this  committee  is 
whether  that  charitable  entity  can  then  maintain  the  baseball  team 
for  a  period  of  time  until,  in  accord  with  Mr.  Kauffman's  wishes, 
a  local  buyer  can  be  found  or  whether  that  charitable  entity  would 
then  be  required  to  sell  the  baseball  team  immediately. 

If  the  baseball  team  were  sold  immediately,  I  don't  think  there 
is  any  doubt  because  of  the  economics  of  major  league  baseball 


1389 

today  that  in  a  small  market  town  like  Kansas  City  the  team 
would  be  sold  to  an  outside  buyer  and  outside  of  Kansas  City. 

Understanding  that  there  is  no  revenue  impact  for  the  Federal 
Grovemment,  that  Mr.  Kauffman  has  been  very  generous  with  his 
succession  plan,  that  the  money  is  being  raised  locally  to  pay  for 
the  operating  losses  of  the  team,  and  that  all  that  we  are  asking 
in  essence  is  time  in  order  to  find  a  local  buyer.  We  would  ask  that 
this  committee  support  the  legislation  that  we  are  introducing  that 
would  allow  the  charitable  entity  in  Kansas  City  to  continue  to  op- 
erate the  baseball  team  for  a  period  of  time  until  a  local  buyer  can 
be  found. 

With  that,  Mr.  Chairman,  I  would  submit  my  statement  and  be 
very  happy  to  answer  any  questions  that  you  would  have  about 
how  this  plan  would  operate  or  what  its  ultimate  effect  would  be. 

[The  prepared  statement  follows:] 


1390 


STATEMENT  OF 

THE  HONORABLE  ALAN  WHEAT 

ON  PROPOSED  CIVIC  ASSET  LEGISLATION 

HEARING  ON  MISCELLANEOUS  REVENUE  MEASURES 

SUBCOMMITEE  ON  SELECT  REVENUE  MEASURES 

COMMITTEE  ON  WAYS  AND  MEANS 

U.S.  HOUSE  OF  REPRESENTATIVES 

September  21,  1993 

Mr.  Chairman  and  members  of  the  committee,  I  appreciate  the  opportunity  to 
appear  before  you  today.  I  am  here  to  discuss  legislation  that  I  will 
introduce  soon  that  attempts  to  solve  a  troubling  tax  problem  that  could 
hinder  efforts  to  preserve  a  major  civic  asset  for  the  citizens  of  Kansas 
City.  That  asset  is  the  Kansas  City  Royals  Major  League  Baseball  team. 

You  may  have  read  in  the  newspapers  that  Ewing  Kauffman,  the  owner  of  the 
Kansas  City  Royals,  died  recently  of  cancer.  Mr.  Kauffman's  death  puts  the 
future  status  of  the  Royals  in  a  kind  of  tax  code  limbo.  The  intent  of  my 
legislation  is  to  remove  the  cloud  the  tax  code  places  over  the  remarkably 
generous  succession  plan  Mr.  Kauffman  put  together,  a  plan  designed 
specifically  to  allow  his  fellow  citizens  to  keep  the  Royals  in  Kansas  City. 

Ewing  Kauffman,  for  those  of  you  who  don't  know  of  him,  was  a  long-time 
benefactor  of  Kansas  City.  A  famed  entrepreneur  and  philanthropist,  he  made 
a  lot  of  money  in  his  lifetime,  and  gave  a  lot  of  it  back  to  charitable 
purposes  in  Kansas  City.  "Mr.  K",  as  he  was  affectionately  known,  had  a 
special  interest  in  helping  children  help  themselves.  He  gained  national 
notice  some  years  ago  with  his  promise  of  a  college  education  to  whole 
graduating  classes  of  students  at  a  Kansas  City  high  school  if  those  young 
people  would  stay  in  school  and  stay  off  drugs.  True  to  his  word,  he 
delivered  on  that  promise. 

One  of  Mr.  Kauffman's  greatest  legacies  in  Kansas  City  is  the  Royals 
baseball  team.  After  our  previous  baseball  team  --  the  Athletics  --  left 
Kansas  City  for  Oakland,  Kansas  City  acquired  an  expansion  franchise,  the 
Royals,  in  1969,  but  only  because  Mr.  Kauffman  was  willing  to  put  up  the 
money  and  take  the  risk  when  no  one  else  would  do  so.  At  that  time,  serious 
questions  existed  about  the  economic  realities  of  the  Kansas  City  baseball 
market,  questions  that  Mr.  K  and  fans  from  across  the  Midwest  have  since 
answered  with  25  years  of  enthusiastic  fan  support  and  sound  financial 
management. 

Today,  Mr.  Chairman,  it  is  hard  to  exaggerate  the  bond  between  the  Royals 
and  Kansas  City.  We  have  an  area  population  of  only  about  1.5  million  -- 
the  smallest  of  any  major  league  baseball  city.  But  the  Royals  have  enjoyed 
attendance  exceeding  2  million  per  year--a  number  that  many  other  teams  can 
only  dream  about.  Based  on  population,  Mr.  Chairman,  that  would  be  like  the 
Yankees  and  Mets  drawing  10  million  fans  each. 

The  Royals  have  rewarded  us  with  success- -numerous  division  titles,  two 
American  League  Championships,  and  victory  over  St.  Louis  in  the  memorable 
all-Missouri  World  Series  in  1985.  They  are  the  only  team  in  baseall  never 
to  have  finished  last  in  their  division.  But  more  importantly,  they  have 
gradually  been  woven  into  the  very  fabric  of  the  community.  As  the  Royals 
celebrate  their  25th  anniversary  in  Kansas  City,  we  celebrate  over  two 
decades  of  a  civic  treasure  that  has  created  bonds  between  hometown  people 
from  diverse  backgrounds  and  joined  them  together  in  civic  and  charitable 
work  throughout  the  community. 

The  Royals  have  become  an  important  source  of  jobs  in  Kansas  City,  an 
economic  anchor  that  is  key  to  Kansas  City's  present  and  future.  The  team 
draws  over  a  million  fans  a  year  from  outside  the  metropolitan  area,  and  it 
is  estimated  that  these  fans  create  at  least  $200  million  in  economic 
activity  for  the  area  economy.  For  example,  if  you  live  in  Iowa  and  want  to 
get  away  for  a  few  days,  stay  in  a  nice  hotel  ands  see  a  good  basebiiH  game, 
Kansas  City  is  the  obvious  choice.  In  fact,  we  have  season  ticket  holders 
in  Iowa  --  as  we  do  in  Nebraska,  Oklahoma,  Arkansas,  and  other  states  in  the 
Midwest. 


1391 


The  Royals  also  help  us  attract  national  conventions  and  new  businesses. 
When  a  business  Is  deciding  whether  to  locate  In  L.A.  or  Atlanta  or  Houston, 
local  sports  franchises  probably  are  not  going  to  enter  Into  the  decision. 
But  a  lot  of  businesses  come  to  Kansas  City  partly  for  the  quality  of  life 
--  and  the  Royals  are  significant  factor  in  that  regard,  raising  Kansas 
City's  visibility  and  allure  as  a  "major  league"  city  with  major  league 
sports  and  entertainment. 

So  what  happens  to  the  team  now  that  Mr.  Kauffman  has  passed  away?  The 
short  answer  is  that  if  we  don't  pass  this  legislation,  no  one  can  be  sure 
what  will  happen  to  the  team.  It  is  very  possible  that  without  passage  of 
the  legislation  I  am  proposing,  the  team  will  soon  be  forced  to  leave  our 
city. 

Here's  the  problem:  because  of  our  limited  population,  the  Royals  also  have 
limited  TV  revenue.  TV  revenue  is  the  name  of  the  game  these  days.  In  a 
larger  market  such  as  New  York,  George  Steinbrenner  could  probably  keep  the 
Yankees  afloat  without  a  single  fan  in  the  stadium. 

Not  so  in  Kansas  City.  With  player  salaries  soaring,  the  Royals  are  now 
losing  money  each  year,  a  loss  that  Mr.  Kauffman  was  willing  to  absorb  (and, 
in  fact,  his  estate  will  continue  to  absorb  a  portion  of  the  losses  under 
the  plan  he  has  proposed  until  a  new  buyer  Is  found).  But  if  the  Kauffman 
plan  is  not  allowed  to  go  forward,  it  is  at  best  questionable  whether  a  new 
buyer  can  be  found  soon  who  will  agree  to  keep  the  team  in  Kansas  City  and 
continue  to  absorb  the  losses. 

What  we  hope  is  that  in  the  near  future  a  buyer  will  emerge,  and  that 
changes  in  the  way  Major  Leage  Baseball  operates  financially  will  soon  come 
to  pass  that  will  help  such  a  buyer  emerge.  For  example,  baseball  has  been 
discussing  adopting  TV  revenue  sharing,  like  professional  football.  That 
would  make  the  Royals  much  more  attractive  to  a  buyer.  Still,  if  no  buyer 
can  be  found,  then  major  league  baseball  ultimately  will  have  to  decide  on 
the  fate  of  the  franchise,  and  on  whether  the  Royals  are  moved  from  Kansas 
City. 

What  the  Royals  need  right  now  is  time  --  time  for  a  local  buyer  to  emerge, 
and  time  for  baseball  to  deal  with  revenue-sharing  and  other  financial 
Issues.   Essentially,  that's  what  my  legislation  would  provide  --  time. 

Without  enactment  of  this  bill,  the  team  will  be  transferred  to  the  Kauffman 
Foundation,  under  the  terms  of  Mr.  Kauffman's  estate  plan.  Because  of 
fiduciary  obligations,  this  private  foundation  would  then  have  to  act 
quickly  to  find  a  buyer  for  the  team.  Under  this  scenario,  it  is  likely 
that  an  out-of-town  buyer  with  deep  pockets  would  then  arrange  with  Major 
League  Baseball  to  move  the  franchise  out  of  Kansas  City  to  a  larger  TV 
market,  before  a  local  buyer  could  step  forward. 

What  Mr.  Kauffman  had  Intended,  Instead,  is  for  the  team  to  go  to  a  local 
community  trust—the  Greater  Kansas  City  Community  Trust--for  a  period  of 
years  until  a  Kansas  City  buyer  is  found.  During  those  Interim  years, 
private  donors  in  Kansas  City--many  of  whom  have  already  stepped 
forward --would  join  the  Kauffman  estate  in  absorbing  the  team's  losses. 

If  a  Kansas  City  buyer  cannot  be  found,  then  perhaps  the  team  will  be  sold 
out  of  Kansas  City  anyway.  In  any  event,  the  profits  from  the  sale  of  the 
team--estimated  at  well  over  $100  mill1on--wni  go  to  charity,  either  the 
Kauffman  Foundation  or  the  Greater  Kansas  City  Community  Trust. 

The  bottom  line  is,  Mr.  Kauffman  Is  simply  giving  the  profits  from  the 
team's  sale  to  charity,  an  enormous  act  of  personal  generosity.  Gifting 
these  profits  to  charity  was  Mr.  K's  first  wish.  We  are  asking  that  Mr. 
Kauffman's  second  w1sh--the  twin  goal  of  his  succession  plan--also  be 
granted:  that  when  his  team  is  given  away,  it  be  given  back  to  the  citizens 
of  Kansas  City.  Unfortunately,  11  is  not  clear  under  current  tax  law  that  a 
charity,  even  a  public  charity  like  a  community  trust,  can  hold  a  baseball 
team  under  these  circumstances. 


1392 


As  you  know,  community  trusts  sometimes  desire  to  participate  in  preserving 
civic  assets.  Such  assets  typically  have  a  long-standing  association  with 
the  region,  are  patronized  by  a  broad  spectrum  of  the  community,  and  are 
important  to  both  its  economy  and  identity. 

My  legislation  amends  the  tax  code  to  make  it  clear  that  a  community  trust 
is  permitted  to  be  involved  in  activities  to  foster  the  preservation  of 
civic  assets-'important  and  long-standing  features  of  the  community. 

If  the  legislation  is  passed,  then  the  ownership  of  the  team  will  be 
transferred  to  the  community  trust  under  the  terms  of  Mr.  Kauffman's  estate 
plan.  Under  the  succession  plan,  there  is  no  financial  cost  or  exposure  to 
the  charity.  It  is  merely  a  holding  entity  for  the  team. 

The  legislation  is  fully  generic.  In  our  particular  case,  the  main  tax 
issue  here  is  whether  the  contribution  to  a  public  charity  of  Kansas  City 
Royals'  stock  by  Mr.  Kauffman  will  qualify  for  a  federal  estate  tax 
deduction  if  the  value  of  the  stock  Is  effectively  restricted  In  the  manner 
prescribed  in  the  plan. 

I  want  to  emphasize  to  the  Committee  that  this  is  not  some  thinly-veiled 
attempt  to  avoid  tax  that  would  otherwise  be  paid  by  the  Kauffman  estate--in 
fact,  If  this  bill  is  not  passed,  the  team  will  go  to  his  private  foundation 
and  the  Kauffman  estate  will  still  receive  the  tax  deduction. 

Although  it  would  apply  to  the  Royals  situation,  it  would  also  apply  to 
other  appropriate  cases  that  meet  the  strict  criteria  outlined  In  the  bill. 
At  the  same  time,  the  legislation  is  rigidly  circumscribed  to  restrict  its 
application  and  avoid  any  potential  abuse.  We  have  done  that  with  the  help 
of  the  Joint  Tax  Committee  staff. 

Mr.  Chairman,  since  Mr.  Kauffman's  death,  the  Kansas  City  community  has 
rallied  behind  this  cause.  Millions  of  dollars  have  been  pledged  from 
various  corporate  and  charitable  entities  to  support  the  plan.  A  limited 
partnership  has  been  set  up  to  guide  the  management  of  the  team  in  the 
interim  period. 

Major  League  Baseball  does  not  oppose  the  succession  plan,  and  I  am  unaware 
of  any  local  opposition  to  the  plan.  Its  success  depends  on  the  cooperation 
of  civic  leaders,  charities.  Major  League  Baseball,  and  finally,  the  federal 
government.  In  that  regard,  I  ask  your  cooperation. 

Every  city  in  the  country  has  some  civic  assets  that  its  residents  have  deep 
pride  In  and  that  have  become  a  part  of  the  fabric  of  the  community.  In 
most  of  those  cases,  the  tax  problem  that  the  Royals  face  does  not  exist; 
for  operas,  libraries,  museums,  and  most  other  such  assets,  the  tax  code 
already  clearly  allows  charities  to  engage  in  activities  to  preserve  those 
assets  in  the  community.  Currently,  though,  it  is  not  so  clear  for  sports 
franchises  and  other  civic  assets. 

However,  a  sports  franchise  can  be  as  much  of  an  asset  to  a  city  as  an  opera 
or  a  museum.  From  the  strictly  economic  perspective  of  a  smaller  city  like 
Kansas  City,  some  may  view  a  sports  frachise  as  even  more  Important.  Even 
in  cases  where  there  is  no  private  benefit  from  efforts  to  preserve  the 
civic  asset--as  is  clearly  the  case  under  Mr.  Kauffman's  succession 
plan--the  tax  code  is  unclear  in  its  treatment  of  charities  that  seek  to 
preserve  sports  franchises  in  the  community. 

I  am  not  personally  familiar  with  the  development  of  the  federal  tax  code  in 
this  area.  Perhaps  Its  failure  to  allow  a  charity  to  help  preserve  a  civic 
asset  explicitly  in  the  form  of  a  sports  franchise  is  one  more  of  oversight 
than  of  forethought.  It  seems  to  me  that  Congress  ought  to  encourage  and 
foster  activities  that  preserve  civic  assets  while  at  the  same  time 
providing  millions  of  dollars  to  charity.  Mr.  Chairman,  that  is  exactly 
wRat  this  legislation  would  do. 

You  should  be  aware  that  the  legislation  does  not  in  any  way  indicate  that  a 
baseball  team  can  be  operated  on  a  tax-exempt  bas1s--even  though  operas, 
museums,  etc.  can  be.  We're  merely  saying  that  activities  to  preserve  a 
sports  franchise  or  other  such  civic  assets  in  a  community  should  be 
permissible  for  a  community  trust. 


This  legislation  Is  of  the  utmost  importance  to  my  hometown.  It  is  a 
straightforward  proposal  that  has  been  carefully  crafted  to  involve  the 
entire  community,  and  the  community  has  responded  with  its  support.  We 
spend  a  lot  of  time  around  here  talking  about  the  importance  of  restoring  a 
sense  of  community  In  our  society,  of  encouraging  selfless,  charitable  work 
on  behalf  of  others.  Mr.  Kauffman  lived  by  that  creed.  With  this 
legislation,  we  too  have  the  opportunity  to  live  by  that  creed  and  make  it  a 
reality. 

It  is  difficult  to  imagine  Kansas  City  without  the  Royals,  and  I  believe 
most  of  my  constituents  feel  the  sane  way.  Mr.  Chairman,  I  am  a  proud 
member  of  this  body,  and  I  am  proud  of  nuch  of  what  the  Congress  has 
accomplished.  Still,  the  public  if  often  skeptical  of  the  work  we  do  here, 
and  all  too  often  we  have  acted  to  deepen  that  skepticism. 

My  constituents  are  no  exception  to  this  trend.  Still,  they  want  us  to 
succeed,  they  want  to  help  their  own  coanunlty,  they  want  us  all  to  work 
together  to  do  what's  right. 

With  your  help,  I  hope  we  can  do  what's  right. 

I  hope  that  this  committee  will  act  on  the  legislation  favorably  and  as 
expeditiously  as  possible. 

Once  again,  Mr.  Chairman,  I  appreciate  the  opportunity  to  testify  today. 


1394 

Mr.  McNULTY.  Thank  you. 

Any  successful  business  activity  arguably  provides  services  to  a 
community  and  enhances  the  economic  well-being  of  the  commu- 
nity. Why  should  the  particular  activities  defined  in  this  proposal 
as  civic  assets  receive  more  favorable  tax  treatment  than  other 
business  activities? 

Mr.  Wheat,  Mr.  Chairman,  I  think  it  is  very  clear  in  our  society 
that  major  league  sports  while  they  are  not  charitable  entities 
enjoy  a  place  that  is  exalted  above  many  others  in  terms  of  busi- 
ness. The  Kansas  City  Royals  baseball  team  is  not  just  a  private 
business  asset  that  was  held  by  one  person  in  Kansas  City  for  a 
very  long  time.  It  is  a  community  asset,  a  part  of  the  very  fabric 
of  our  society  and  the  entire  community,  in  fact  the  entire  Mid- 
western area — because  there  is  not  another  baseball  team  within 
250  miles  of  Kansas  City — would  suffer  a  great  loss  if  this  team 
were  to  leave. 

The  timing  is  extraordinarily  bad  in  terms  of  the  economics  that 
would  almost  require  the  team  to  leave  unless  this  succession  plan 
were  approved.  Major  league  baseball  does  not  have  a  commis- 
sioner currently.  They  are  working  on  a  number  financing  plans, 
including  the  possibility  of  a  salary  cap  for  major  league  baseball 
and  most  major  league  baseball  teams  make  their  profit  based  on 
television  revenue. 

If  George  Steinbrenner  has  set  up  this  succession  plan,  it 
wouldn't  be  a  problem  for  New  York.  They  would  be  able  to  con- 
tinue to  operate  the  team  strictly  based  on  the  TV  revenues  of  New 
York  City,  We  cannot  do  that  in  Kansas  City,  Even  though  we 
draw  more  than  2  million  people  a  year,  the  TV  revenues  are  so 
small  from  the  team  continues  to  lose  money. 

Mr.  Kauffman  was  able  to  bear  those  losses  personally  while  he 
was  alive  and  it  was  not  a  major  problem.  He  has  in  fact  donated 
a  significant  amount  of  cash  in  addition  to  the  baseball  team  in 
order  to  cover  operating  losses  and  a  number  of  other  community 
entities  have  donated  millions  of  dollars  for  the  purpose  of  covering 
the  operating  losses  of  the  baseball  team.  But  unless  we  clarify 
whether  the  charitable  entity  can  hold  the  team  for  a  period  of 
time  instead  of  being  forced  to  sell  it  because  of  the  operating 
losses,  this  generous  succession  plan  will  not  be  able  to  go  into 
effect. 

I  would  remind  you  that  there  is  no  loss  to  the  Federal  Treasur>' 
from  the  plan.  It  is  a  matter  of  whether  the  charitable  entity  can 
keep  the  baseball  team  for  a  time  until  ultimately  it  is  sold  to  a 
private  owner,  hopefully  one  in  the  greater  Kansas  City  area. 

Mr.  McNULTY.  I  presume  that  you  are  aware  that  the  proposal 
does  confer  a  retroactive  tax  benefit  and  also  the  overall  revenue 
impact 

Mr.  Wheat.  Mr.  Chairman,  we  had  tried  to  deal  with  this  matter 
earlier  this  year  once  it  became  clear  that  Mr.  Kauffman  was 
gravely  ill,  and  obviously  more  ill  than  anyone  had  realized  prior 
to  that  time.  We  were  not  able  to  get  this  matter  considered  in  the 
reconciliation  bill,  and  I  imagine  it  probably  was  not  appropriate 
to  consider  it  in  the  reconciliation  bill.  We  ask  for  the  retroactive 
tax  status  to  be  applied  to  the  donation  of  the  Kansas  City  Royals. 


1395 

I  would  point  out  to  you  that  in  other  areas  of  the  tax  law,  retro- 
activity is  not  seen  to  be  a  major  problem,  especially  when  people 
were  on  notice  that  the  action  was  likely  to  occur.  In  this  situation, 
there  would  be  no  loss  of  any  dollars  to  anyone  as  a  result  of  the 
application  of  the  retroactive  status. 

Mr.  McNuLTY.  With  regard  to  tiie  revenue  impact  generally,  I 
presume  vou  are  also  aware  that  the  impact  is  fairly  significant.  I 
was  wondering  if  you  had  thought  about  any  possible  offsets  for  it? 

Mr.  Wheat.  The  impact  is  significant  in  terms  of  the  future  of 
the  baseball  team,  but  we  believe  that  there  is  no  impact  to  the 
Federal  Treasury  in  this  specific  circumstance  because  there  are 
two  options  that  are  available  here.  One,  the  team  can  be  donated 
to  the  community  trust  and  the  community  trust  can  hold  the  base- 
ball team  until  such  time  as  it  is  sold  to  a  private  donor. 

In  the  alternative,  the  team  will  be  donated  to  the  Kauffman 
Foundation,  a  private  charitable  organization  that  already  exists, 
and  because  of  the  current  law  that  private  charitable  foundation 
\yill  then  be  forced  to  sell  the  team  immediately  and  the  team  will 
likely  be  sold  to  someone  outside  of  Kansas  City. 

In  either  case,  whether  it  is  donated  to  the  community  trust  and 
held  for  the  community  or  donated  to  the  charitable  trust  and  then 
sold  immediately,  there  will  be  no  revenue  impact  to  the  Federal 
Government. 

Mr.  McNuLTY.  I  presume  that  you  have  not  yet  received  a  letter 
on  the  revenue  impact  fi^om  the  joint  committee? 

Mr.  Wheat.  No.  We  have  been  requesting  that  revenue  impact, 
the  letter  that  would  officially  verify  what  I  have  indicated  to  you 
in  regard  to  the  revenue  impact,  but  we  have  not  yet  received,  it. 

Mr.  McNuLTY.  I  think  that  will  be  coming  to  you  shortly  and 
then  I  think  that  we  should  have  further  discussions. 

Mr.  Wheat.  Mr.  Chairman,  I  would  be  very  happy  to  continue 
to  work  with  this  committee  in  order  to  facilitate  the  passage  of 
this  legislation  or  whatever  legislation  you  believe  is  appropriate  to 
help  accomplish  the  goals  that  we  have  set  out. 

Mr.  McNuLTY.  I  thank  my  colleague. 

Mr.  Hancock. 

Mr.  Wheat.  Mel,  I  want  you  to  know  this  is  your  baseball  team, 
too. 

Mr.  Hancock.  I  am  very  interested  in  this  situation.  I  appreciate 
your  bringing  it  to  the  attention  of  the  committee  and  taking  your 
time  to  work  on  it. 

I  am  familiar  with  what  Ewing  Kauffman  did  in  Kansas  City, 
not  only  in  Kansas  City,  but  in  his  entire  life  as  far  as  charitable- 
type  work. 

I  have  a  couple  of  questions.  This  charity  that  you  are  going  to 
set  up,  the  Kansas  City  Community  Foundation — are  you  consider- 
ing setting  up  a  completely  separate  organization  to  accept  the 
stock? 

Mr.  Wheat.  No.  This  is  a  community  trust  fund  that  already  ex- 
ists. It  is  a  major  charity  within  the  greater  Kansas  City  area  that 
has  agreed  to  accept  the  donation  of  the  Kansas  City  Royals  base- 
ball club  under  certain  conditions  and  obviously  those  conditions 
include  either  new  legislation  or  an  IRS  ruling  that  would  deter- 
mine that  they  could  hold  the  team  for  a  period  of  time. 


1396 

Mr.  Hancock.  But  this  is  just  a  standard;  in  other  words,  the 
Kansas  City  Community  Foundation  is  already  in  existence? 

Mr.  Wheat.  Definitely. 

Mr.  Hancock.  It  is  the  same  type  of  community  foundation  that 
individuals  can  set  up  self-directed  charitable  trusts  and  that  type 
of  thing? 

Mr.  Wheat.  I  would  not  comment  on  other  kinds  of  trusts  that 
could  be  set  up  by  individuals.  This  is  a  major  trust  that  has  been 
operated  in  Kansas  City  for  many,  many  years.  Someone  might 
contradict  me,  but  I  believe  it  is  probably  the  single  largest  charity 
within  the  greater  Kansas  City  area. 

Mr.  Hancock.  Isn't  it  an  organization  that  individuals  can  set  up 
trusts  within  that 

Mr.  Wheat.  Yes;  definitely. 

Mr.  Hancock.  In  other  words,  it  is  a  standard  community  foun- 
dation-type operation? 

Mr.  Wheat.  Yes. 

Mr.  Hancock.  I  hope  you  won't  mind  if  I  become  kind  of  a  devil's 
advocate,  because  I  think  these  questions  need  to  be  asked.  Would 
this  be  a  major  change  to  allow  anv  charity  to  operate  an  ongoing 
for-profit  business?  We  are  talking  here  about  making  an  exception 
under  the  circumstances?  The  Kansas  City  baseball  team  is  an 
asset  of  the  city  more  than  it  is  a  personal  asset  of  Ewing 
Kauflfman.  He  lost  money  on  it. 

Mr.  Wheat.  That  is  correct.  On  a  continual  basis. 

Mr.  Hancock.  And  the  citizens  of  Kansas  City  actually  bene- 
fitted from  that  team  being  in  Kansas  City? 

Mr.  Wheat.  Not  only  the  psychic  rewards  of  owning  the  baseball 
team,  but  it  is  a  major  economic  factor  within  Kansas  City.  The 
citizens  built  a  stadium  for  the  Kansas  City  Royals  baseball  club 
and  when  there  was  turmoil  surrounding  the  stadium  situation  in 
other  cities  where  the  teams  were  losing  money,  the  relationship 
between  Mr.  Kauffman  and  the  city  of  Kansas  City  and  Jackson 
County,  Mo.,  have  always  been  strong. 

There  was  never  hint  or  suggestion  that  our  team  would  leave 
even  though  the  team  lost  money  perpetually,  and  it  has  always 
been  operated  as  if  it  were  a  community  asset  rather  than  the  pri- 
vate asset  of  Mr.  Kauffman. 

Mr.  Hancock.  Needless  to  say,  I  am  interested  in  keeping  the 
Royals  in  Kansas  City.  I  am  looking  forward  to  the  year  maybe 
that  we  can  get  the  activity  in  the  State  of  Missouri  where  the  Car- 
dinals and  the  Royals  are  in  the  World  Series  again.  That  was  a 
major  benefit  to  the  economy  of  the  State  of  Missouri. 

As  I  understand  the  terms  of  this  sale  of  the  stock,  and  I  have 
read  the  details  here,  there  would  be  various  classes  of  stock,  class 
A,  class  B,  and  there  would  be  a  designated  operator  to  operate  the 
franchise  itself.  I  understand  that  it  would  be  required  to  sell  the 
team,  to  find  a  buyer  within  8  years. 

Mr.  Wheat.  That  is  correct. 

Mr.  Hancock.  Or  are  they  allowed  to  take  8  years? 

Mr.  Wheat.  They  would  be  allowed  to  take  up  to  8  years  in  order 
to  find  a  buyer.  If  in  fact  they  could  not  find  a  local  buyer,  private 
buyer  within  the  8  years,  then  they  would  sell  it  to  the  highest  bid- 
der and  it  is  likely  that  ultimately  if  no  Kansas  City  owner  were 


1397 

found,  the  team  would  be  sold  to  a  bidder  outside  Kansas  City  and 
it  would  leave  the  Kansas  City  area.  All  the  profits  would  go  to  the 
charitable  trust  for  use  within  the  greater  Kansas  City  area  con- 
tinuing, so  the  charity  would  receive  the  profits  of  the  sale  just  as 
Mr.  Kauffman  intends. 

If  this  committee  or  the  IRS  does  not  approve  this  request,  the 
Kauffman  Foundation  will  receive  the  profits  of  the  sale  of  the 
baseball  team  at  this  point  in  time. 

Mr.  Hancock.  But  I  understood  you  were  attempting  to  restrict 
the  transfer  of  the  baseball  team. 

Mr.  Wheat.  During  the  8-year  period  of  time  when  the  commu- 
nity trust  would  own  the  baseball  team,  it  could  only  be  sold  to 
someone  who  would  agree  to  maintain  the  team  within  the  greater 
Kansas  City  area. 

Mr.  Hancock.  What  happens  when  the  8  years  expires? 

Mr.  Wheat.  Then  the  team  would  be  required  to  be  sold  to  the 
highest  bidder  wherever  that  bidder  were  from.  We  are  asking  for 
a  period  of  time  to  seek  out  a  local  buyer,  not  to  perpetually  avoid 
having  to  sell  the  team  or  put  the  team  on  the  open  market. 

Kansas  City  is  a  small  market  team  and  there  are  very  few  peo- 
ple with  assets  and  resources  of  a  Ewing  Kauffman.  We  are  hoping 
that  over  the  next  8  years  someone  will  come  forward  and  be  able 
to  operate  the  team  in  largely  the  same  manner  that  Mr.  Kauffman 
did.  I  should  also  add  that  while  major  league  baseball  has  a  pre- 
disposition to  having  a  single-owner  situation,  they  have  been  con- 
tinually apprised  of  Mr.  Kauffman's  succession  plan.  The  manage- 
ment committee  has  met.  They  have  talked  about  this  plan.  They 
have  encouraged  us  to  go  forward,  and  I  believe  they  will  be  sup- 
portive of  this  plan  if  this  committee  approves  it. 

Mr.  Hancock.  Thank  you  very  much.  I  appreciate  the  work  you 
are  doing  on  this. 

Thank  you. 

Mr.  McNuLTY.  Thank  you,  Mel. 

If  there  are  no  further  questions,  we  thank  our  colleague  and 
congratulate  him  and  Mr.  Hancock  also  on  the  success  of  the  Chiefs 
last  night. 

Thank  you  very  much. 

Mr.  Wheat.  Thank  you. 

Mr.  McNuLTY.  I  would  also  like  to  welcome  our  colleague  Mr, 
Kleczka  to  the  panel. 

At  this  time,  we  will  proceed  to  the  Department  of  the  Treasury, 
Hon.  Leslie  B.  Samuels,  Assistant  Secretary  for  Tax  Policy,  and  a 
frequent  guest  before  this  panel. 

Your  statement  will  appear  in  the  record  in  its  entirety  and  you 
may  proceed  to  summarize  in  any  way  you  see  fit. 

STATEMENT  OF  HON.  LESLIE  B.  SAMUELS,  ASSISTANT 
SECRETARY  FOR  TAX  POLICY,  U.S.  DEPARTMENT  OF  THE 
TREASURY 

Mr.  Samuels.  Mr.  Chairman  and  members  of  the  subcommittee, 
I  am  pleased  to  present  the  views  of  the  administration  on  the  mis- 
cellaneous revenue  proposals  that  are  the  subject  of  this  hearing. 
I  plan  to  briefly  summarize  my  testimony. 


1398 

These  hearings  are  a  continuation  of  a  series  of  public  hearings 
which  began  in  June  1993  relating  to  miscellaneous  revenue  pro- 
posals siibmitted  by  members  of  the  Committee  on  Ways  and 
Means.  We  testified  on  the  first  group  of  over  170  miscellaneous 
tax  proposals  on  June  22,  1993.  The  subcommittee  has  before  it 
today  over  80  proposals  covering  a  broad  range  of  topics.  In  the 
process  of  considering  these  proposals,  we  believe  that  it  is  impor- 
tant to  keep  in  mind  that  Confess  has  recently  enacted  and  the 
President  has  signed  a  major  piece  of  tax  le^slation,  the  Omnibus 
Budget  Reconciliation  Act  of  1993,  so-called  OBRA  1993.  We  would 
urge  the  subcommittee  in  its  deliberations  on  miscellaneous  reve- 
nue proposals  to  consider  the  importance  of  stability  in  the  tax  law. 
An  argument  can  be  made  that  additional  changes  to  the  Internal 
Revenue  Code  should  be  minimized  for  a  period  of  time  sufficient 
to  allow  the  government  as  well  as  taxpayers  and  their  advisors  to 
absorb  the  significant  changes  just  made  in  OBRA  1993.  Further- 
more, we  recognize  that  any  tax  bill  that  moves  through  Congress 
prior  to  the  end  of  this  year  could  become  a  vehicle  for  numerous 
amendments.  Although  many  of  those  proposals  could  be  meritori- 
ous, collectively  they  could  result  in  further  instability  in  our  tax 
laws. 

We  have  taken  a  position  on  most  of  the  proposals  under  consid- 
eration today.  However,  we  have  not  taken  a  position  with  respect 
to  proposals  that  are  currently  under  study  or  those  that  we  be- 
lieve should  be  considered  in  the  context  of  comprehensive  health 
care  reform. 

In  developing  our  views  on  revenue-raising  proposals,  we  have 
relied,  as  we  did  during  the  budget  reconciliation  process  and  in 
our  June  22,  1993  testimony,  on  a  number  of  tax  policy  principles 
and  goals.  These  principles  and  goals  are  stated  in  the  written  tes- 
timony. I  would  like  to  note  in  this  regard  that  we  generally  oppose 
any  proposals  that  have  the  effect  of  reversing  policy  decisions 
made  in  OBRA  1993.  We  have  however  identified  several  technical 
corrections  to  that  legislation  and  would  like  to  encourage  members 
of  the  subcommittee  to  aid  us  in  our  attempt  to  ensure  the  imple- 
mentation of  congressional  intent. 

Ig^  Finally,  we  understand  that  the  subcommittee  is  also  interested 
in  the  tax  simplification  proposals  and  technical  corrections  in- 
cluded in  H.R.  13  and  H.R.  17.  While  we  generally  support  these 
proposals  and  recognize  the  importance  of  simplifying  the  tax  law 
and  providing  technical  corrections,  we  would  like  to  work  with  the 
subcommittee  to  suggest  technical  modifications  and  to  identify 
areas  in  which  we  have  policy  concerns. 

That  concludes  my  summary  and  I  would  be  pleased  to  answer 
any  questions. 

[The  prepared  statement  follows:] 


1399 


For  Release  Upon  Delivery 
Expected  at  10:00  a.m. 
September  21,  1993 

STATEMENT  OF 

LESLIE  B.  SAMUELS 

ASSISTANT  SECRETARY  (TAX  POLICY) 

DEPARTMENT  OF  THE  TREASURY 

BEFORE  THE 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES  OF  THE 

HOUSE  COMMITTEE  ON  WAYS  AND  MEANS 

Mr.  Chairman  and  Members  of  the  Subcommittee: 

I  am  pleased  to  present  the  views  of  the  Administration  on 
the  miscellaneous  revenue  proposals  that  are  the  subject  of  this 
hearing.   These  proposals  are  described  in  the  September  16,  1993 
pamphlet  prepared  by  the  staff  of  the  Joint  Committee  on  Taxation 
(JCT  Pamphlet) .' 

These  hearings  are  a  continuation  of  a  series  of  public 
hearings,  which  began  in  June  1993,  relating  to  miscellaneous 
revenue  proposals  submitted  by  Members  of  the  Committee  on  Ways 
and  Means.   We  testified  on  the  first  group  of  over  170 
miscellaneous  tax  proposals  on  June  22,  1993.^  The  Subcommittee 
has  before  it  today  over  80  proposals  covering  a  broad  range  of 
topics.   They  deal  with  issues  relating  to  individual  taxation, 
excise  taxes,  tax-exempt  entities,  tax  accounting,  compliance, 
and  numerous  other  areas.   Some  of  the  proposals  are  narrowly 
drawn,  while  others  represent  significant  changes  to  current  law. 

Many  of  the  proposals  that  are  the  subject  of  today's 
hearing  have  been  proposed  as  revenue-raising  offsets  to  the 
provisions  we  addressed  on  June  22.   In  our  previous  testimony  we 
stated  that  the  Administration's  views  concerning  those  proposals 
and  the  revenue  losing  proposals  considered  today  assume  that 
appropriate  offsetting  revenue  measures  would  be  proposed.   As  we 
stated  at  that  hearing,  and  reiterate  today,  we  want  to  work  with 
the  Subcommittee,  and  the  Congress  as  a  whole,  to  set  priorities 
for  the  use  of  any  acceptable  revenue  offsets  that  may  be 
identified. 

In  the  process  of  considering  these  proposals,  we  believe 
that  it  is  important  to  keep  in  mind  that  the  Congress  has 
recently  enacted,  and  the  President  signed,  the  most  significant 
deficit  reduction  legislation  in  the  history  of  our  Nation.   The 
Omnibus  Budget  and  Reconciliation  Act  of  1993  (OBRA  '93)  included 
significant  changes  in  the  tax  law.   It  raised  the  tax  burden  for 
some  while  lowering  the  burden  for  others,  all  with  a  view  toward 
meaningful  deficit  reduction  and  improving  the  overall  fairness 
of  the  tax  system.   We  would  urge  the  Subcommittee  in  its 
deliberations  on  the  miscellaneous  revenue  proposals  to  consider 
the  importance  of  stability  in  the  tax  law.   An  argviment  can  be 
made  that  additional  changes  to  the  Internal  Revenue  Code  (Code) 
should  be  minimized  for  a  period  of  time  sufficient  to  allow 
taxpayers  and  their  advisers  to  absorb  the  significant  changes 
that  have  just  been  made  in  OBRA  '93.   Furthermore,  we  recognize 
that  any  tax  bill  that  moves  through  Congress  prior  to  the  end  of 
this  year  could  become  the  vehicle  for  numerous  amendments. 


'  Joint  Committee  on  Taxation,  Description  of  Miscellaneous 
Revenue  Proposals  (JCS-12-93) ,  September  16,  1993. 

'  A  number  of  the  items  on  which  we  testified  on  June  22, 
1993  are  included  in  the  JCT  Pamphlet.   In  this  testimony  we  do 
not  repeat  positions  that  were  provided  in  our  June  22,  1993 
testimony.   In  addition,  we  do  not  address  the  proposals  relating 
to  the  health  benefits  of  retired  coal  miners,  on  which  we 
presented  testimony  to  the  Ways  and  Means  Committee  on  September 
9,  1993. 


1400 


Although  many  of  those  proposals  could  be  meritorious, 
collectively  they  could  result  in  further  instability  in  our  tax 
laws. 

We  have  taken  a  position  on  most  of  the  proposals  under 
consideration  today.   However,  we  have  not  taken  a  position  with 
respect  to  proposals  that  are  currently  under  study  or  those  that 
we  believe  should  be  considered  in  the  context  of  comprehensive 
health  care  reform. 

In  developing  our  views  on  revenue  raising  proposals,  we 
have  relied,  as  we  did  during  the  budget  reconciliation  process 
and  in  our  June  22,  1993  testimony,  on  a  number  of  tax  policy 
principles  and  goals.   These  principles  and  goals  continue  to 
include  deficit  reduction;  economic  growth;  equitable  treatment 
of  taxpayers;  simplification  within  the  constraints  of  deficit 
reduction;  and  improved  compliance  and  enforcement  of  our  tax 
laws.   In  addition,  our  ultimate  position  on  each  of  the  revenue- 
raising  proposals  under  consideration  will  depend  upon  the 
intended  use  of  the  revenue  raised  and  upon  whether  the  bill  as  a 
whole  is  consistent  with  these  principles  and  goals.   Moreover, 
we  generally  oppose  any  proposals  that  have  the  effect  of 
reversing  policy  decisions  made  in  OBRA  '93.   We  have,  however, 
identified  several  technical  corrections  to  that  legislation  and 
would  like  to  encourage  Members  of  the  Subcommittee  to  aid  us  in 
our  attempt  to  ensure  the  implementation  of  Congressional  intent. 

Finally,  we  understand  that  the  Subcommittee  also  is 
interested  in  the  tax  simplification  proposals  and  technical 
corrections  included  in  H.R.13  and  H.R.17.   While  we  generally 
support  these  proposals,  and  recognize  the  importance  of 
simplifying  the  tax  law  and  providing  technical  corrections,  we 
would  like  to  work  with  the  Subcommittee  to  suggest  technical 
modifications  and  to  identify  areas  in  which  we  have  policy 
concerns. 

The  remainder  of  my  written  statement  is  a  detailed 
discussion  of  the  Administration's  positions  on  the  miscellaneous 
revenue  proposals  that  are  the  subject  of  this  hearing.   The 
discussion  follows  the  order  of  the  proposals  described  in  the 
JCT  Pamphlet. 

I.   MISCELLANEOUS  REVENUE  PROPOSALS 

A.  ALTERNATIVE  MINIMUM  TAX 

1.   Use  of  the  200-percent  Declining  Balance  Depreciation  Method 
for  Automobiles  for  Alternative  Minimum  Tax  Purposes. 

Administration  position.   Do  not  support.   Congress  recently 
determined,  in  OBRA  '93,  that  the  use  of  the  150%  declining 
balance  method  was  an  appropriate  method  of  depreciation  for 
alternative  minimum  tax  purposes.   In  light  of  this  recent  change 
of  law,  it  is  inappropriate  at  this  time  to  change  the  method  of 
depreciation  for  alternative  minimum  tax  purposes,  particularly 
for  a  single  class  of  property. 

B.  FINANCIAL  INSTITUTIONS 

1.   Deductibility  of  Bad  Debt  Losses  of  Nonbank  Lending 
Institutions. 

Administration  position.   Proposal  addressed  in  the  June  22,  1993 
testimony. 

C.  INSURANCE 

1.    Extension  of  Tax  and  Loss  Bond  Treatment  Applicable  to  all 
Tvpes  of  Financial  Guarantv  Insurance. 


1401 


Administration  position.   This  proposal  does  not  raise  a 
significant  federal  income  tax  issue,  but  instead  relates 
primarily  to  regulatory  matters.   Because  a  company  that  claims  a 
deduction  under  section  832(e)  must  purchase  noninterest-bearing 
federal  government  bonds  equal  to  the  amount  of  the  tax  savings 
attributable  to  the  deduction,  the  amount  that  the  company  pays 
the  government  in  a  given  year  is  the  same  regardless  of  whether 
it  claims  the  deduction.   The  principal  effect  of  the  provision 
is  to  allow  the  company  to  report  an  asset  for  regulatory 
purposes  as  a  result  of  the  payment. 

2.   Treatment  of  Policy  Accmisition  Expenses  Related  to  Certain 
Accident  and  Health  Insurance. 

Administration  position.   Do  not  support.   Present  law  requires 
that  insurance  companies  capitalize  prescribed  percentages  of  net 
premiums  for  three  categories  of  insurance  contracts  as  a 
surrogate  for  determining  the  facts  and  circumstances  of  actual 
policy  acquisition  costs.   Should  Congress  decide  that  current 
law  results  in  an  excessive  deferral  of  acquisition  expenses  and 
consider  lowering  the  statutory  percentage  for  a  type  of 
insurance,  it  may  wish  to  consider  whether  acquisition  costs  are 
understated  for  other  types  of  insurance  and  make  corresponding 
adjustments  to  the  percentages  for  those  types  of  insurance. 
Moreover,  we  note  that  the  Secretary  of  the  Treasury  is 
authorized  to  provide  that  a  specified  type  of  contract  is 
treated  as  a  separate  category  and  prescribe  a  percentage  for 
that  category  if  present  law  results  in  substantially  greater 
deferral  of  acquisition  expenses  than  would  capitalization  of 
actual  expenses.   If  he  exercises  this  authority,  the  Secretary 
is  required  to  adjust  the  percentages  for  remaining  categories  of 
insurance  contracts  to  avoid  a  revenue  loss. 

D.    EMPLOYEE  BENEFITS 

1.  Tax-Credit  Emplovee  Stock  Ownership  Plans  fESOPs) . 

Administration  position.   Do  not  support.   We  do  not  believe  that 
it  is  appropriate  at  this  time  to  expand  the  tax  benefits  for 
ESOPs.   Current  law  already  provides  incentives  for  employers 
that  desire  to  compensate  their  employees  through  an  ESOP.   In 
addition,  we  do  not  believe  that  it  is  consistent  with  broader 
retirement  policy  goals  to  increase  the  level  of  tax  subsidy  for 
ESOPs  in  comparison  to  other  types  of  retirement  plans  that 
provide  more  diversified  savings  for  employees. 

2.  Permit  ESOPs  to  Prohibit  Rollover  of  In-Service 
Distributions . 

Administration  position.   Do  not  support.   Some  employers  are 
concerned  that  employees  will  take  in-service  distributions  from 
ESOPs  in  order  to  reinvest  the  amounts  in  their  own  individual 
retirement  accounts  (IRA) ,  rather  than  the  employer  plan. 
However,  general  expansion  of  the  rollover  rules  has  been 
beneficial  to  employees  and  the  retirement  system  as  a  whole,  in 
part  by  encouraging  employees  to  invest  their  distributions  in  an 
IRA  rather  than  spend  them.   In  the  context  of  encouraging  these 
goals,  it  would  be  a  step  backwards  to  exclude  these  in-service 
withdrawals  from  the  definition  of  eligible  rollover 
distributions . 

3.  Rollover  of  Certain  Separation  Payments. 

Administration  position.   Do  not  support.   We  do  not  believe  that 
it  is  generally  appropriate  to  expand  the  individual  retirement 
account  rollover  provisions  to  distributions  that  have  not  been 
dedicated  to  retirement  savings  under  a  tax-qualified  plan.   In 
addition,  we  are  concerned  that  the  proposal  may  result  in 
substantial  revenue  loss. 


1402 


E.  INDIVIDUAL  INCOME  TAX 

1.  Increase  Eligible  Income  Level  for  Performing  Artist 
Employee  Exemption  from  the  Limitation  on  Deduction  for 
Unreimbursed  Business  Expenses. 

Administration  position.   Do  not  support.   Present  law  provides  a 
deduction  in  computing  adjusted  gross  income  (and  thereby  also  an 
exemption  from  the  2-percent  floor  on  miscellaneous  itemized 
deductions)  for  a  limited  class  of  low-income  performing  artists. 
We  are  unaware  of  any  justification  for  expanding  this  relief  by 
more  than  doubling  the  income  limitation.   Doing  so  would 
represent  an  erosion  of  the  policies  underlying  the  calculation 
of  adjusted  gross  income  and  the  establishment  of  the  2-percent 
floor  on  miscellaneous  itemized  deductions. 

2.  Waiver  of  Statute  of  Limitations  Relating  to  Certain 
Severance  Payments. 

Administration  position.   Do  not  support.   Statutes  of  limitation 
provide  both  taxpayers  and  the  government  with  certainty  that 
disputes  will  not  arise  concerning  events  in  the  distant  past, 
and,  thus,  as  a  general  matter,  should  not  be  waived  on  a 
selective  basis. 

F.  TAX-EXEMPT  BONDS 

1.    Certain  Airport.  Dock,  and  Wharf  Facilities. 

Administration  position.   Proposal  addressed  in  the  June  22,  1993 
testimony. 

G.  TAX-EXEMPT  ENTITIES 

1.  Permit  a  Qualified  Scholarship  Funding  Corporation  to 
Transfer  Assets  and  Debts  to  a  For-Profit  Corporation  Without 
Causing  Tax-Exempt  Bond  Interest  to  be  Taxable. 

Administration  position.   Do  not  support.   It  appears  that  the 
proposal  would  enable  taxable,  for-profit  corporations  to  obtain 
the  benefit  of  tax-exempt  financing.   The  benefit  is  equal  to  the 
built-in  arbitrage  of  the  difference  between  the  tax-exempt 
interest  rates  on  the  debt  issued  by  the  qualified  scholarship 
funding  corporations  and  comparable  taxable  interest  rates.   For- 
profit  entities  should  not  be  entitled  to  such  arbitrage.   The 
proposal  also  creates  an  exception  to  the  excess  business 
holdings  rule.   The  excess  business  holdings  rule  was 
specifically  created  to  prevent  private  foundations  from 
controlling  for-profit  entities. 

2.  Provide  Favorable  Tax  Treatment  for  Preservation  of  Civic 
Assets  by  Community  Trusts. 

Administration  position.   Do  not  support.   There  is  no  apparent 
justification  for  special  rules  that  provide  more  favorable  tax 
treatment  to  the  preservation  of  a  civic  asset  than  the  treatment 
provided  by  current  law. 

H.    EMPLOYMENT  TAXES 

1.  Eliminate  Statutory  Rule  for  Bakery  Distributors. 

Administration  position.   Proposal  addressed  in  the  June  22,  1993 
testimony. 

2.  Treat  State  Universities  and  Agency  Accounts  as  Related 
Corporations  for  FICA  Tax  Purposes. 


1403 


Administration  position.   Proposal  addressed  in  the  June  22,  1993 
testimony. 

3.   Exempt  Certain  Religious  Schools  from  Federal  Unemployment 
Tax. 

Administration  position.   Proposal  addressed  in  the  June  22,  1993 
testimony. 

I.    OTHER  PROVISIONS 

1.  Enhanced  Deduction  for  Contributions  of  Computer  Equipment  to 
Arts  Institutions. 

Administration  position.   Proposal  addressed  in  the  June  22,  1993 
testimony. 

2.  Require  Treasury  to  Issue  Certificates  Evidencing  Obligations 
of  the  United  States  Held  by  the  Social  Security  Trust  Funds. 

Administration  position.   Oppose.   The  Treasury  Department  and 
administrators  of  the  Social  Security  Trust  Funds  already  have 
detailed  records  that  delineate  the  amounts  and  kinds  of 
obligations  held  by  the  fund.   Issuing  certificates  to  this 
effect  would  increase  administrative  costs  and  provide  no 
additional  benefit  to  beneficiaries. 

3.  Limit  Applicability  of  Generation-Skipping  Transfer  Tax. 

Administration  position.   Do  not  oppose.   The  policies  that 
underlie  the  special  rule  for  transfers  to  grandchildren  (Code 
section  2612(c)(2))  generally  would  support  the  proposed 
expansions  to  cover  collateral  heirs  and  to  apply  the  rule  to 
taxable  terminations  and  taxable  distributions  as  well  as  direct 
skips. 

II.   MISCELLANEOUS  REVENUE-RAISING  PROPOSALS 

A.    ALTERNATIVE  MINIMUM  TAX 

1.  Increase  the  Alternative  Minimum  Tax  Recovery  Period  for 
Assets  Used  in  Manufacture  of  Tobacco  Products. 

Administration  position.   The  Administration  is  currently 
preparing  a  comprehensive  health  care  reform  package  that  may 
include  changes  in  the  tax  treatment  of  tobacco  products.   Any 
tax  issues  relating  to  tobacco  products  and  businesses  producing 
tobacco  products  should  be  addressed  in  the  context  of  health 
care  reform. 

2.  Lengthen  Alternative  Minimum  Tax  Recovery  Period  for  Coal 
Mining  Eguioment. 

Administration  position.   Do  not  support.   Congress  recently 
considered,  in  OBRA  '93,  modifications  to  the  alternative  minimum 
tax  depreciation  system,  and  concluded  that  the  use  of  the  150% 
declining  balance  method  over  a  10  year  period  was  an  appropriate 
method  of  depreciation  for  alternative  minimum  tax  purposes.   In 
light  of  this  recent  determination,  and  absent  economic  analysis 
supporting  a  change,  it  is  inappropriate  at  this  time  to  change 
the  alternative  minimum  tax  class  life  for  a  particular  class  of 
property. 

3.  Lengthen  the  Alternative  Minimum  Tax  Amortization  Period  for 
Coal  Mining  Exploration  and  Development  Costs. 

Administration  position.   Do  not  support.   Congress  recently 
considered,  in  OBRA  '93,  modifications  to  the  alternative  minimum 
tax  depreciation  system,  and  did  not  alter  the  recovery  period 
with  respect  to  mining  exploration  and  development  costs.   In 


1404 


light  of  this  recent  legislation,  and  absent  economic  analysis 
supporting  a  change,  it  is  inappropriate  at  this  time  to  change 
the  alternative  minimum  tax  recovery  period  for  a  particular  type 
of  mining  and  development  costs. 

B.  ACCOUNTING 

1.  Change  the  Five-Year  Maturity  Date  Requirement  to  Four  Years 
for  High  Yield  Discount  Obligations. 

Administration  position.   Do  not  support.   The  high-yield 
discount  rules  are  complex  and  should  not  be  expanded  on  a 
piecemeal  basis.   Moreover,  relatively  short-term  obligations  do 
not  raise  to  the  same  degree  the  policy  concerns  that  motivated 
the  original  high-yield  discount  rules  (i.e.  .  the  ability  to 
deduct  equity-like  returns  with  payments  deferred  until  some 
future  date) . 

2.  Require  Organizational  Expenses  to  Be  Amortized  Over  an 
Extended  Period. 

Administration  position.   Do  not  support.   Under  current  law,  the 
organizational  expenses  of  corporations  and  partnerships  are  both 
amortizable  over  a  period  of  60  months.   It  is  desirable  that  the 
treatment  of  the  organizational  expenses  of  both  types  of 
entities  remain  similar.   While  the  existing  60-month  period  can 
be  viewed  as  a  relatively  arbitrary  period,  any  change  in  the 
period  should  be  made  after  a  review  of  whether  a  longer  period 
can  be  justified,  on  the  basis  of  economic  and  related  facts  and 
circumstances,  as  more  appropriate. 

3.  Require  Portion  of  Advertising  Expenses  to  be  Capitalized 
and  Amortized. 

Administration  position.   Oppose.    We  believe  that  advertising 
expenses  typically  are  not  directly  associated  with  the  creation 
of  a  benefit  extending  beyond  the  current  year,  and  consequently 
generally  should  be  currently  deductible.   Thus,  this  proposal 
can  be  viewed  as  an  arbitrary  deferral  of  an  ordinary  and 
necessary  business  expense. 

C.  FINANCIAL  INSTITUTIONS 

1.  Immediate  Recognition  of  Points  Paid  to  Mortgage  Lenders. 

Administration  position.   Oppose.   When  a  lender  simultaneously 
makes  a  loan  and  receives  points  paid  by  the  borrower,  the  net 
economic  effect  is  the  making  of  a  loan  at  a  discount  fe.q. .  a 
transaction  involving  a  $100,000  loan  and  a  payment  of  3  points, 
or  $3,000,  represents  a  loan  of  $97,000  with  $100,000  payable  at 
maturity) .   We  believe  that  the  appropriate  treatment  of  this 
discount  is  provided  under  the  original  issue  discount  provisions 
of  the  Code  (i.e. .  the  discount  must  be  taken  into  income  by  the 
lender  over  the  term  of  the  loan  on  a  constant  yield-to-maturity 
basis) .   Therefore,  we  oppose  this  proposal,  which  would,  in 
effect,  treat  the  loan  and  the  payment  of  points  as  two  separate 
transactions. 

2.  Bad  Debt  Reserve  Deduction  for  Thrifts. 

Administration  position.   Support.   We  agree  with  the  proposed 
rule,  which  we  believe  generally  follows  current  law.   Our  only 
concern  is  that  the  proposal  be  crafted  so  as  not  to  create 
negative  implications  concerning  the  treatment  of  net  operating 
losses  incurred  before  the  effective  date. 

D.  COST  RECOVERY 

1.   Lengthen  Recovery  Period  for  Water  Utility  Property. 


1405 


Administration  position.   Do  not  support.   Changes  in  the 
depreciable  life  of  particular  categories  of  property  should  be 
made  only  after  a  detailed  evaluation  of  the  relevant  economic 
and  related  facts  and  circumstances.   The  Administration  is  not 
aware  of  any  information  or  analysis  justifying  a  longer  recovery 
period  for  water  utility  property. 

2.   Increase  Regular  Tax  Recovery  Period  for  Certain  Assets  Used 
in  Printing  and  Publishing. 

Administration  position.   Do  not  support.   Changes  in  the 
depreciable  life  of  particular  categories  of  property  should  be 
made  only  after  a  detailed  evaluation  of  the  relevant  economic 
and  related  facts  and  circumstances.   The  Administration  is  not 
aware  of  any  information  or  analysis  justifying  a  longer  recovery 
period  for  assets  used  in  printing  and  publishing. 

E.    PASS-THROUGH  ENTITIES 

1.  Clarification  of  Rules  Relating  to  the  Timing  of  the  Flow- 
Through  of  Income  to  Estates  that  Own  Interests  in  Partnerships 
and  S  Corporations. 

Administration  position.   Support.   The  proposal  requires  that 
partnership  and  S  corporation  items  be  allocated  to  an  estate  for 
the  period  of  time  the  interest  is  held  by  the  estate.   Thus, 
this  proposal  would  make  the  rules  for  estates  similar  to  those 
applicable  to  individuals. 

2.  Repeal  the  Taxable  Income  Limitation  on  the  Recognition  of 
Built-in  Gain  of  S  Corporations. 

Administration  position.   Do  not  support.   The  taxable  income 
limitation  under  Code  section  1374  prevents  S  corporations  from 
paying  a  built-in  gains  tax  on  amounts  greater  than  their  taxable 
income.   As  a  result,  the  effect  of  the  built-in  gains  tax  is 
spread  to  periods  where  the  S  corporation  has  taxable  income. 
Repeal  of  the  limitation  would  make  some  corporations  worse  off 
as  S  corporations  than  they  would  have  been  if  they  had  remained 
C  corporations.   If  significant  changes,  such  as  this  proposal 
and  other  proposals  discussed  in  our  testimony  on  June  22,  1993 
are  to  be  made  to  the  S  corporation  regime,  the  proposals  should 
be  fashioned  pursuant  to  a  comprehensive  deliberate  process, 
rather  than  on  a  piecemeal  basis. 


F.    INDIVIDUAL  INCOME  TAX 

1.  Denial  of  Certain  Travel-Away-from-Home  Expenses. 

Administration  position.   Do  not  support.   This  proposal  would 
deny  deductions  for  a  particular  class  of  ordinary  and  necessary 
expenses  incurred  in  generating  income  from  rental  property, 
while  income  from  such  property  would  remain  fully  taxable.   If 
substantial  abuse  involving  these  types  of  travel  expenses  is 
found,  then  legislative  changes  might  be  necessary. 

2.  Computation  of  Standard  Mileage  Rate. 

Administration  position.   Do  not  support.   We  are  unaware  of 
evidence  that  the  current  procedure  used  by  the  Internal  Revenue 
Service  (IRS)  to  determine  the  standard  mileage  rate  overstates 
the  costs  of  operating  a  vehicle.   Prescribing  an  unduly  low 
standard  mileage  rate  would  encourage  more  taxpayers  to  deduct 
their  actual  costs,  resulting  in  increased  administrative  burdens 
for  both  the  taxpayers  and  the  IRS  of  the  type  that  the  standard 
mileage  rate  was  intended  to  avoid. 


1406 


3.   Limit  the  Deduction  For  Business  Transportation  Expense. 

Administration  position.   Do  not  support.   This  provision  would 
create  considerable  administrative  burdens  and  in  many  cases 
would  impose  an  arbitrary  restriction  on  the  deduction  of  an 
ordinary  and  necessary  business  expenses. 


4.  Repeal  Special  Rules  for  Certain  Rental  Use. 

Administration  position.   Do  not  oppose.   Taxpayers  should  be 
subject  to  tax  on  income  received  with  respect  to  the  rental  of  a 
residence  without  regard  to  the  period  of  such  rental.   The 
repeal  of  the  current  law  de  minimis  provision  should  not  impose 
an  undue  administrative  burden  on  the  affected  taxpayers. 

5.  Limit  the  Deduction  of  Wagering  Losses. 

Administration  position.   Do  not  support.   Wagering  losses  have 
been  considered  deductible  only  to  the  extent  of  wagering  gains 
since  1934.   The  income  tax  system  should  generally  allow  for 
deductions  of  expenditures  made  in  generating  income.   Allowing 
wagering  losses  to  offset  only  80  percent  of  wagering  gains  is  an 
arbitrary  reduction  of  this  otherwise  deductible  expenditure. 

6.  Limit  Airfare  Deductions  to  Coach  Fare  if  Coach  is  Available. 

Administration  position.   Oppose.   Imposing  a  new  limitation  on 
the  deductibility  of  airline  fares  would  create  significant 
administrative  burdens.   In  addition,  it  would  be  inappropriate 
to  single  out  the  airline  industry  in  contrast  to  other  forms  of 
transportation  by  limiting  deductions  for  airfare  to  a  particular 
fare. 

7.  Increase  the  Threshold  for  the  Deduction  of  Casualty  Looses 
from  $100  to  $500. 

Administration  position.   Do  not  support.   Since  1982  the  10 
percent  of  adjusted  gross  income  threshold,  rather  than  the  $100 
threshold,  has  been  the  primary  limitation  on  the  availability  of 
the  deduction.   This  proposal  would  have  the  effect  of  reducing  a 
taxpayer's  otherwise  allowable  casualty  loss  deductions  by  $400 
per  casualty. 

G.    NATURAL  RESOURCES 

1.  Impose  Severance  Tax  on  Hard  Rock  Minerals. 

Administration  position.   Issue  under  study.   The  Department  of 
Interior  has  been  studying  the  economic  implications  of  a  royalty 
system  for  hardrock  minerals  on  federal  lands.   Upon  completion 
of  the  Administration's  evaluation,  the  Administration  will 
consult  with  Congress  regarding  what  actions  are  appropriate. 

2.  Increase  Tariff  on  Imported  Oil  and  Petroleum  Products. 

Administration  position.   Issue  under  study.   The  Department  of 
Energy  Task  Force  on  National  Energy  Initiatives  is  studying 
policies  that  affect  production  of  natural  energy  resources. 
Upon  completion  of  the  Administration's  review  of  the  findings  of 
that  study,  the  Administration  will  consult  with  Congress 
regarding  what  actions  are  appropriate. 

H.    FOREIGN  TAX  PROVISIONS 

1.   Modification  of  the  Sales  Source  Rules. 

Administration  position.   Do  not  support.   The  proposals  to  amend 
the  rules  for  sourcing  income  from  the  sale  of  inventory  property 


1407 


may  raise  significant  technical  question  and  administrative 
concerns  in  a  number  of  cases. 

2.  Increase  Tax  on  Gross  Transportation  Income. 

Administration  position.   Oppose.   By  agreement,  or  otherwise, 
residents  of  over  60  countries  (including  all  major  shipping 
countries)  have  an  exemption  from  this  tax.   The  proposed  tax 
increase,  therefore,  would  fall  disproportionately  on  the 
shipping  companies  of  smaller  developing  countries  with  which  the 
United  States  does  not  have  agreements. 

3.  Repeal  Portfolio  Interest  Exemption. 

Administration  position.   Oppose.   Repeal  of  the  portfolio 
interest  exemption  would  substantially  increase  the  borrowing 
costs  of  the  U.S.  Government  and  U.S.  corporations.   In  order  to 
remain  competitive  in  international  financial  markets,  U.S. 
Government  and  corporate  debt  would  have  to  compensate  foreign 
lenders  for  the  effect  of  a  30%  U.S.  withholding  tax  through 
higher  interest  rates.   U.S.  borrowers  who  could  not  afford  to 
"gross  up"  foreign  lenders  would  be  unable  to  borrow  abroad, 
resulting  in  increased  competition  for  U.S.  capital  and  a 
corresponding  increase  in  domestic  interest  rates. 

4.  Chanqg  Foreign  Tax  Credjt  to  a  Deduction. 

Administration  position.   Oppose.   The  foreign  tax  credit 
protects  U.S.  taxpayers  from  double  taxation  of  income  that  is 
earned  outside  the  U.S.   A  deduction  for  foreign  taxes  would  not 
effectively  avoid  double  taxation.   Without  the  foreign  tax 
credit  there  would  be  a  penalty  for  conducting  business  abroad 
rather  than  in  the  U.S.  even  though  non-tax  considerations  might 
favor  the  foreign  location.   Elimination  of  the  credit  also  would 
unilaterally  override  our  treaty  obligations  and  could  lead  to 
retaliation  by  other  countries.   If  foreign  countries  were  to 
repeal  their  credit  for  U.S.  income  taxes,  there  would  be  a  bias 
against  investment  in  the  U.S.  by  those  countries'  nationals. 

5.  Excise  Tax  on  Certain  Insurance  Premiums  Pajd  tp  Foreign 


Administration  position.   Oppose.   We  do  not  believe  that  the 
necessity  for  a  general  increase  at  this  time  in  the  rate  of  the 
tax  has  been  demonstrated.   In  addition,  we  understand  that  this 
provision  may  have  implications  for  U.S.  efforts  to  reduce 
foreign  trade  barriers  to  U.S.  insurers  that  the  Committee  may 
wish  to  weigh  in  considering  the  issue  of  competitiveness.   We  do 
not  oppose,  however,  efforts  to  facilitate  collection  of  the 
federal  insurance  premiums  tax  now  imposed  by  the  Code  on  the 
reinsurance  of  U.S.  risks  from  one  foreign  insurer  to  another. 
However,  we  oppose  this  proposal  because  we  do  not  believe  it  can 
be  administered  fairly  and  effectively.   For  example,  we  are 
seriously  concerned  about  the  burden  of  negotiating  and 
monitoring  the  hundreds  of  closing  agreements  that  would  be 
required  and  about  the  difficulty  of  determining  the  effective 
rate  of  foreign  tax  in  a  multitude  of  countries.   In  any  event, 
the  proposal  should  be  amended  to  take  into  account  any  current 
U.S.  taxation  of  United  States  shareholders  under  subpart  F  of 
the  Code. 

6.   Taxation  of  a  Tax-Exempt  U.S.  Shareholder  on  Subpart  F 
Unrelated  Business  Taxable  Income  (UBTH . 

Administration  position.   Oppose.   We  understand  that  the  target 
of  this  proposal  is  the  offshore  captive  insurance  industry.   If 
there  is  a  perception  that  offshore  captives  are  engaging  in 
abuse,  a  proposal  that  focuses  more  narrowly  on  that  concern 
should  be  developed.   The  proposal  is  also  overbroad  in  that  it 
applies  to  all  categories  of  subpart  F  income  and  because  it 
applies  to  a  tax-exempt  shareholder  owning  as  little  as  10%  of  a 


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foreign  corporation's  stock,  a  level  of  investment  that  is  closer 
to  the  type  of  portfolio  investment  that  historically  has 
generated  passive,  non-UBTI.   Because  the  proposal  is  based  upon 
subpart  F,  which  applies  at  the  shareholder  level,  it  addresses 
UBTI  in  a  fundamentally  different  way  than  it  is  addressed  in  a 
purely  domestic  context.  In  the  domestic  context,  UBTI  is  not 
taxed  at  the  shareholder  level  and  the  unrelated  business  income 
tax  rules  have  not  generally  sought  to  equalize  the  cost  of 
capital  as  between  tax-exempt  and  taxable  ownership.   Finally, 
the  proposal  inappropriately  uses  subpart  F,  which  is  a  timing 
provision,  to  effectively  impose  a  tax  that  the  tax-exempt 
shareholder  otherwise  would  not  pay. 

I.    EXCISE  TAXES 

1.  Increase  in  Wagering  Excise  Tax. 

Administration  position.   Do  not  support.   It  is  unclear  whether 
an  increase  in  the  existing  wagering  excise  tax  would  promote 
appropriate  policy  goals.   Any  proposal  to  increase  the  rate  of 
tax  should  be  considered,  if  at  all,  as  part  of  a  comprehensive 
review  of  the  purpose  and  design  of  the  tax. 

2.  Excise  Tax  on  Foreign-Controlled  Corporations. 

Administration  position.   Oppose.   The  proposal  would  impose  an 
excise  tax  on  purchases  by  a  foreign  controlled  corporation  from 
foreign  related  parties  unless  the  foreign  controlled  corporation 
consents  in  writing  to  provide  the  information  described  in  Code 
section  6038A.   Section  6038A  does  not  require  "consent"  to 
provide  information.   To  the  contrary,  the  statute  and  the 
regulations  require  that  the  described  information  be  provided 
annually  on  a  Form  5472  that  is  filed  with  the  taxpayer's  tax 
return.   Moreover,  the  substantial  penalties,  including  monetary 
penalties  and  disallowance  of  deductions  for  goods  transferred 
between  related  parties,  already  may  be  imposed  on  taxpayers  that 
fail  to  provide  the  required  information.   Given  these 
substantial  penalties,  compliance  with  section  6038A  has  not  been 
considered  a  problem,  and  an  additional  5  percent  penalty  is 
unlikely  to  improve  further  compliance  with  section  6038A. 

3.  Increase  Excise  Tax  on  Prohibited  Transactions. 

Administration  position.   Do  not  support.   We  believe  that 
current  law  adequately  deters  prohibited  transactions.   The  5- 
percent  tax  under  Code  section  4975  is  cumulative  and  can  result 
in  significant  penalties.   In  addition,  if  a  taxpayer  does  not 
correct  the  prohibited  transaction  prior  to  an  assessment  of  the 
5-percent  tax,  the  taxpayer  can  be  assessed  with  a  100-percent 
penalty.   A  prohibited  transaction  also  may  result  in  civil 
penalties  and  lawsuits  by  plan  participants  or  the  Department  of 
Labor . 

4.  Increase  Tobacco  Excise  Taxes. 

Administration  position.   The  Administration  is  currently 
preparing  a  comprehensive  health  care  reform  package  that  may 
include  changes  in  the  tax  treatment  of  tobacco  products.   Any 
tax  issues  relating  to  tobacco  products  should  be  addressed  in 
the  context  of  health  care  reform. 

5.  Extend  Communications  Excise  Tax  to  Cable  Television. 

Administration  position.   Do  not  support.   While  there  are  many 
types  of  communications  services  and  options  available  today,  the 
communications  excise  tax  applies  primarily  to  telephone  service. 
Any  proposed  expansion  of  the  communications  excise  tax  should  be 
considered,  if  at  all,  as  part  of  a  comprehensive  review  of  the 
purpose  and  design  of  the  tax. 


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6.   Repeal  Exemption  from  Communications  Excise  Tax  for  News 
Services. 

Administration  position.   Do  not  support.   News  service 
organizations  have  one  of  a  number  of  specific  exemptions  from 
the  communications  excise  tax.   Any  proposed  expansion  of  the 
communications  excise  tax  should  be  considered,  if  at  all,  as 
part  of  a  comprehensive  review  of  the  purpose  and  design  of  the 
tax  and  of  the  role  of  the  exemption  for  news  service 
organizations  and  the  changes  that  are  occurring  in  the 
communications  industry. 


7.  Excise  Tax  on  Carbon  Dioxide  Sold  by  Ethanol  Producers. 

Administration  position.   Do  not  support.   The  imposition  and 
collection  of  this  new  tax  would  impose  substantial  complexities 
and  administrative  costs. 

8.  Increase  Excise  Tax  on  Heavy  Trucks. 

Administration  position.   Do  not  support.   We  are  unaware  of  any 
justification  for  an  increase  in  the  heavy  truck  excise  tax  at 
this  time. 

9.  Expand  Ozone-Depleting  Chemicals  Excise  Tax. 

Administration  position.   Do  not  oppose.   The  1992  Copenhagen 
amendment  to  the  Montreal  Protocol  freezes  industrialized  country 
consumption  of  methyl  bromide  at  1991  levels  and  phases  out 
industrialized  country  consumption  of  hydrochlorof luorocarbons 
(HCFCs)  and  hydrobromof luorocarbons  (HBFCs) .   Similarly,  the 
Environmental  Protection  Agency  has  proposed  listing  methyl 
bromide  and  HBFCs  as  class  I  substances.   Extending  the  tax  to 
these  chemicals  would  be  consistent  with  the  treatment  of  other 
chemicals  controlled  by  the  Montreal  Protocol  (all  of  which  are 
currently  taxed) . 

J.    TAX-EXEMPT  ENTITIES 

1.   Additional  Restrictions  on  Discriminatory  Social  Clubs. 

Administration  position: 

(a)  Addition  of  gender  discrimination  to  types  of  discrimination 
to  which  section  501 (i)  applies.   Do  not  support.   The  issue 
of  gender  discrimination  by  social  clubs  deserves  attention. 
We  are  concerned,  however,  that  this  particular  proposal 
could  deny  tax  exemption  to  certain  organizations,  such  as 
women's  clubs,  fraternities,  or  sororities,  that  have  long- 
standing and  relatively  noncontroversial  practices  of 
limiting  membership  on  the  basis  of  gender. 

(b)  Denial  of  tax  exemption  to  a  club  found  to  have 
discriminated  on  prohibited  grounds,   support.   There  is 
little  justification  for  allowing  a  club  to  maintain 
exemption  simply  because  its  discriminatory  practices  are 
not  pursuant  to  a  written  document.   The  requirement  that 
the  provision  would  apply  in  the  case  that  there  has  been  a 
final  determination  of  discrimination  by  an  appropriate 
government  agency  or  court  will  facilitate  administration  of 
the  provision. 

(c)  Denial  of  preferential  tax  treatment  for  tickets  at  events 
held  at  discriminatory  clubs.   Do  not  oppose.   The  federal 
tax  laws  should  not  provide  preferential  treatment  to 
discriminatory  clubs.   We  would  note,  however,  that  existing 
law  already  imposes  a  sanction  on  these  clubs  by  denying 


1410 


them  exemption  from  tax.   Thus,  denying  the  benefits  of 
provisions  such  as  section  274(1) (1)(B)  for  tickets  to  a 
charity  sports  event  held  at  a  discriminatory  club  may  have 
little  marginal  impact  on  the  club. 

2.  Taxation  of  Campaign  Committees  of  Federal  Candidates  at  the 
Highest  Corporate  Rate. 

Administration  position.   Do  not  oppose.   There  is  little  tax 
policy  justification  for  taxing  the  campaign  committees  of 
candidates  for  state  and  local  offices  at  a  higher  rate  than  the 
rates  applicable  to  committees  of  candidates  for  federal  office. 
Requiring  all  campaign  committees  of  candidates  for  federal 
office  to  compute  their  tax  using  the  highest  marginal  corporate 
rate  would  be  one  means  of  eliminating  this  disparity. 

3.  Impose  a  30-percent  Excise  Tax  on  Expenditures  of  Tax-Exempt 
Organizations  for  Lobbying. 

Administration  position.   Oppose.   OBRA  '93  included  a  provision 
that  denies  deductions  for  the  lobbying  expenses,  applicable  to 
both  businesses  and  contributors  to  tax-exempt  organizations.   In 
light  of  this  recent  change  of  law,  it  is  inappropriate  at  this 
time  to  change  the  rules  relating  to  the  tax  treatment  of 
lobbying  expenses. 

4.  Include  Contacts  with  Regulatory  Agencies  in  the  Definition 
of  Lobbying  for  Purposes  of  the  Existing  Restrictions  on 
501fc)f3)  Organizations. 

Administration  position.   Oppose.   OBRA  '93  included  a  provision 
that  denies  deductions  for  the  lobbying  expenses,  applicable  to 
both  businesses  and  contributors  to  tax-exempt  organizations  and 
to  lobbying  of  the  Executive  as  well  as  Legislative  branch  of 
government.   This  provision  includes  a  special  rule  to  prevent 
businesses  from  lobbying  through  a  section  501(c)(3) 
organization.   In  light  of  this  recent  change  of  law,  it  is 
inappropriate  at  this  time  to  change  these  rules. 

5.  Extension  of  Private  Inurement  Rule  to  501(c)(4) 
Organizations. 

Administration  position.   We  understand  that  this  proposal  is 
targeted  to  transactions  involving  the  health  services  industry. 
As  such,  the  Administration  will  consider  it  in  the  context  of 
its  comprehensive  health  care  proposals.   The  Administration 
supports  measures  to  ensure  that  the  assets  of  a  section 
501(c)(4)  organization  are  used  in  a  manner  that  is  consistent 
with  the  organization's  exempt  purpose.   An  amendment  of  section 
501(c)(4)  to  include  a  prohibition  against  inurement,  however, 
may  not  be  the  most  appropriate  means  of  achieving  this  goal.   We 
will  work  with  the  Ways  and  Means  Committee  and  its  staff  to 
develop  appropriate  measures. 

K.    COMPLIANCE 

1.  Information  Reporting  on  State  and  Local  Real  Property  Taxes 
and  Refunds. 

Administration  position.   Do  not  oppose.   This  proposal  would 
make  it  easier  for  the  IRS  to  verify  whether  certain  claimed 
deductions  for  real  estate  taxes  are  accurate.   Thus,  it  would 
improve  the  compliance  with  and  enforcement  of  our  tax  laws.   We 
are  concerned,  however,  about  the  ability  of  local  taxing 
jurisdictions  to  comply  with  this  proposal.   This  concern  should 
be  addressed  in  the  general  design  (e.g. .  administrative 
requirements,  effective  date,  etc.)  of  the  proposal. 

2.  Increase  Individual  Estimated  Tax  Payment  Safe  Harbor  from 
110  percent  to  115  percent. 


1411 


Administration  position.   Oppose.   OBRA  '93  included  a  provision 
that  allowed  taxpayers  with  adjusted  gross  income  exceeding 
$150,000  in  the  preceding  tax  year  to  avoid  estimated  tax 
penalties  for  the  current  year  by  paying  110  percent  of  the 
previous  year's  tax  liability  in  estimated  tax  payments 
(taxpayers  with  lower  incomes  may  use  a  100  percent  of  last 
year's  liability  safe  harbor).   In  light  of  this  recent  change  of 
law,  it  is  inappropriate  at  this  time  to  change  the  estimated  tax 
rules  for  these  individuals.   In  addition,  we  believe  that  the 
current  110  percent  safe  harbor  strikes  a  fair  balance  between 
the  government's  need  to  have  taxpayers  pay  income  taxes  during 
the  tax  year  and  taxpayers'  desire  to  have  a  safe  harbor  that 
allows  for  simplification  and  certainty  in  calculating  estimated 
tax  payments. 

3.  Recmire  Written  Substantiation  for  any  Meal  and  Entertainment 
Expense  for  Alternatively  for  Amounts  Over  $10) . 

Administration  position.   Oppose.   OBRA  '93  included  a  provision 
that  reduces  the  deduction  for  business  meals  and  entertainment. 
In  light  of  this  recent  change  of  law,  it  is  inappropriate  at 
this  time  to  change  the  rules.   In  addition,  the  Treasury  has  the 
authority  under  the  statute  to  determine  the  substantiation 
necessary  for  taxpayers  to  support  and  deduct  meal  and 
entertainment  expenditures.   The  Treasury  has  also  determined,  by 
regulations,  the  threshold  level  of  expenditure  for  which 
substantiation  is  not  required.   This  threshold  amount  recognizes 
that  it  would  be  overly  burdensome  for  taxpayers  to  keep  detailed 
records  for  expenditures  under  this  amount,  which  is  currently 
$25  per  expenditure. 

4.  Deny  Corporations  a  Deduction  for  All  or  Part  of  Interest 
Paid  on  Federal  Tax  Underpayments. 

Administration  position.   Oppose.   Current  law  provides  adequate 
incentives  for  corporate  taxpayers  to  pay  their  taxes  in  a  timely 
fashion.   The  increased  rate  of  interest  imposed  on  "large 
corporate  underpayments"  was  enacted  in  1990  in  lieu  of  a 
provision  that  would  have  disallowed  a  deduction  for  interest 
paid  on  tax  liabilities. 

5.  Increasing  the  Rate  of  Interest  Imposed  on  Corporate  Tax 
Deficiencies. 

Administration  position.   Oppose.   Current  law  provides  adequate 
incentives  for  corporate  taxpayers  to  pay  their  taxes  in  a  timely 
fashion.   The  increased  rate  of  interest  imposed  on  "large 
corporate  underpayments"  was  enacted  in  1990  in  lieu  of  a 
provision  that  would  have  disallowed  a  deduction  for  interest 
paid  on  tax  liabilities.   There  is  no  evidence  of  any  need  to 
increase  the  rate  of  interest  imposed  on  corporate  underpayments. 

6.  Increase  Rate  of  Interest  for  Underpayments  of  Estimated  Tax 
for  Certain  Alaska  Native  Corporations  (ANCs)  and  Persons. 

Administration  position.   Do  not  oppose.   In  conjunction  with  the 
proposal  to  grant  ANCs  an  election  to  obtain  standing  (discussed 
in  our  testimony  presented  to  the  Subcommittee  on  June  22,  1993), 
we  do  not  oppose  this  proposal. 

7.  Information  Reporting  for  Discharge  of  Indebtedness  Income. 

Administration  position.  Do  not  support.  OBRA  '93  included  a 
provision  that  requires  information  reporting  for  discharge  of 
indebtedness  income.  In  light  of  this  recent  change  of  law,  it 
may  be  inappropriate  at  this  time  to  extend  the  scope  of  these 
rules  unless  such  change  is  necessary  to  fulfill  Congressional 
intent. 


1412 


8.   Increase  Withholding  on  Bonuses  from  28  percent  to  3  6 
percent. 

Administration  position.   Oppose.   OBRA  '93  included  a  provision 
that  increases  the  withholding  tax  rate  on  bonuses  to  28  percent. 
In  light  of  this  recent  change  of  law,  it  is  inappropriate  at 
this  time  to  change  these  rules.   In  addition,  a  36  percent 
withholding  tax  rate  would  result  in  overwithholding  in  many 
cases  since  the  36  percent  income  tax  rate  enacted  in  OBRA  '93 
applies  to  only  1.2  percent  of  the  highest  income  taxpayers. 
Moreover,  many  employers  are  in  the  process  of  updating  their 
accounting  systems  to  allow  a  timely  change  to  the  new  rules.   A 
change  in  the  law  at  this  time  could  prove  costly  to  these 
employers. 


9.  Increase  in  Rate  of  Withholding  on  Gambling  Winnings. 

Administration  position.   Do  not  support.   A  36  percent 
withholding  rate  would  result  in  overwithholding  in  many  cases 
since  the  36  percent  tax  rate  enacted  in  OBRA  '93  applies  to  only 
1.2  percent  of  the  highest  income  taxpayers. 

10.  Increase  in  Rate  of  Backup  Withholding  on  Reportable 
Payments. 

Administration  position.   Do  not  support.   A  36  percent 
withholding  rate  would  result  in  overwithholding  in  many  cases 
since  the  36  percent  tax  rate  enacted  in  OBRA  '93  applies  to  only 
1.2  percent  of  the  highest  income  taxpayers.   Moreover,  many 
businesses  are  in  the  process  of  updating  their  accounting 
systems  to  allow  a  timely  change  to  the  new  rules.   A  change  in 
the  law  at  this  time  could  prove  costly  to  these  businesses. 

11.  Information  Reporting  for  Purchases  of  Fish. 

Administration  position.   Do  not  oppose.   We  understand  that  a 
significant  number  of  cash  sales  of  fish  are  not  included  in 
income.   This  proposal  would  increase  compliance. 

12.  Extension  of  IRS  Offset  Authority  for  Undercover  Operations. 

Administration  position.   Support.   Reinstatement  of  the  offset 
authority  granted  to  the  IRS  in  Code  section  7608(c)  is  necessary 
to  enable  the  IRS  to  continue  undercover  investigations  in  such 
areas  as  money  laundering  and  the  motor  fuel  excise  tax. 
Therefore,  the  Administration  has  consistently  supported 
permanent  extension  of  this  provision. 

13.  Disclosure  of  Returns  on  Cash  Transactions. 

Administration  position.   Support.   The  continued  disclosure  by 
the  IRS,  to  other  Federal  agencies,  of  information  returns  filed 
under  Code  section  60501  improves  the  enforcement  of  federal 
criminal  statutes. 


L.    MISCELLANEOUS  ISSUES 

1.   Repeal  of  Classification  Safe  Harbor  for  Construction 
Industry  Employees. 

Administration  position.   Do  not  support.   We  believe  that  it 
would  be  preferable  as  a  matter  of  tax  policy  to  consider  general 
modifications  to  section  530  of  the  Revenue  Act  of  1978  rather 
than  adopting  industry-specific  rules. 


1413 


2.  Disallow  Deductions  for  Compensatory  Damages  Under  Certain 
Environmental  Laws. 

Administration  position.   Oppose.   We  believe  that  the  current 
law  distinction  between  compensatory  payments  that  are  deductible 
under  Code  section  162  and  nondeductible  fines  and  penalties 
should  be  maintained  with  respect  to  payments  under  environmental 
laws.   Disallowing  any  deduction  for  such  ordinary  and  necessary 
expenses  may  discourage  taxpayers  responsible  for  such  damages 
from  agreeing  to  make  compensatory  payments. 

3.  Restricting  Like-Kind  Exchanges. 

Administration  position.   Oppose.   The  Administration  is  not 
persuaded  that  there  is  presently  any  need  to  revise  the 
standard,  based  on  the  use  of  the  property  received  in  an 
exchange  of  like-kind  property,  for  determining  whether  property 
exchanges  qualify  for  tax  deferral. 


4.  Disallowance  of  Stock  Options  as  Qualified  Research  Expenses. 

Administration  position.   Do  not  oppose.   Qualified  research 
expenditures  should  not  include  wages  paid  in  the  form  of  stock 
options  to  the  extent  that  the  wages  exceed  the  amount 
anticipated  at  the  time  the  employer  decides  to  conduct  the 
research. 

5.  Anti-Abuse  Rules  Applicable  to  the  Rollover  of  Gain  Under 
Section  1071. 

Administration  position.   We  would  not  oppose  a  carefully 
targeted  amendment  to  Code  section  1071  that  would  prevent 
certain  sellers  (e.g. .  those  who  actively  participate  in  sham 
transactions)  from  taking  advantage  of  the  deferral  provided  by 
that  section.   However,  the  amendment  should  not  deny  the 
deferral  to  "innocent"  sellers.   To  our  knowledge,  no  specific 
proposal  has  been  developed  at  this  time.   Thus,  it  would  be 
premature  for  us  to  express  a  definitive  position. 

6.  Amortize  Environmental  Remediation  Costs  Over  a  Period  of 
Years . 

Administration  position.   Issue  under  study.   We  are  currently 
considering  appropriate  ways  to  reduce  the  potentially  large 
costs  likely  to  be  incurred  by  the  IRS  and  taxpayers  in  resolving 
disputes  over  the  proper  treatment  of  these  costs. 

III.   PROPOSALS  RELATING  TO  THE  HEALTH  BENEFITS  OF  RETIRED  COAL 
MINERS 

These  proposals  were  addressed  in  our  September  9,  1993  testimony 
before  the  Ways  and  Means  Committee. 


1414 

Mr.  McNuLTY.  Thank  you,  Mr.  Samuels. 

Your  testimony  regarding  H.R.  2617,  which  would  permit  certain 
militaiy  personnel  to  roll  over  a  portion  of  separation  pay  ex- 
pressed some  concern  over  the  expansion  of  IRAs  and  the  high  cost 
of  such  expansion. 

Would  it  be  possible  for  your  stafT  and  the  committee  to  work  on 
some  limited  version  of  this  proposal  which  would  incorporate  the 
concerns  you  have  expressed  today? 

Mr.  Samuels.  Mr.  McNulty,  we  would  be  glad  to  work  with  you 
and  the  staff  in  reviewing  all  possible  options.  Military  personnel 
separation  pay  presents  a  number  of  unique  issues  that  we  believe 
warrant  further  study. 

Mr.  McNULTY.  Thank  you. 

One  proposal  under  consideration  is  to  clarify  the  tax  treatment 
of  environmental  remediation  costs.  Does  Treasury  support  the 
goals  of  this  proposal? 

Mr.  Samuels.  We  are  sympathetic  with  the  goals  of  the  proposal. 
We  understand  that  the  goals  are  to  keep  significant  controversies 
outside  of  the  courts  and  the  administrative  system. 

Mr.  McNuLTY.  Some  taxpayers  have  suggested  that  such  legisla- 
tion is  not  needed  and  that  these  issues  could  continue  to  be  de- 
cided at  the  administrative  level.  What  potential  problems  do  you 
see  with  that  approach  and  could  we  anticipate  that  your  staff 
would  assist  in  attempting  to  develop  an  equitable  proposal  in  this 
area? 

Mr.  Samuels.  There  is  a  debate  on  the  scope  of  current  law  and 
these  issues  depend  on  facts  and  circumstances  in  many  cases.  Ac- 
cordingly, it  is  not  clear  that  the  issues  will  be  solved  at  the  admin- 
istrative level.  The  issues  are  complex  and  the  area  I  think  needs 
a  great  deal  of  work  to  develop  a  fair  and  equitable  proposal. 

We  would  look  forward  to  working  with  the  committee  and  the 
staff  in  trying  to  develop  an  appropriate  set  of  rules  that  reflect  the 
goals  of  this  proposal. 

Mr.  McNuLTY.  As  you  know,  the  House  passed  a  provision  ear- 
lier this  year  to  beef  up  IRS  reporting  for  payments  to  service  pro- 
viders, including  corporate  service  providers.  However,  the  provi- 
sion met  considerable  opposition  in  the  Senate  primarily  from 
small  businesses  concerned  about  the  potential  paperwork  burden. 

In  your  view,  how  serious  is  the  compliance  problem  that  the 
proposal  seeks  to  address  and  would  it  be  possible  to  redraft  it  so 
that  businesses  would  not  have  to  generate  large  amounts  of  addi- 
tional paperwork? 

I  think  we  would  be  particularly  interested  in  your  answer  to 
this  in  light  of  the  current  initiative  by  the  Vice  President. 

Mr.  Samuels.  At  the  time  that  the  administration  made  the  pro- 
posal on  information  reporting,  the  Treasury  estimated  that  this 
compliance  initiative  would  raise  approximately  $6  billion  over  5 
years.  Accordingly,  we  believe  that  this  initiative  is  quite  important 
and  that  compliance  issues,  especially  during  the  period  of  deficit 
reduction,  should  be  considered  very  carefully. 

We  believe  that  during  the  discussion  of  this  proposal  there  was 
a  certain  amount  of  misunderstanding  and  confusion  over  exactly 
what  paperwork  would  be  required.  We  have  suggested  exclusions 
that  would  reduce  the  paperwork  burden  and  still  allow  the  compli- 


1415 

ance  initiative  to  have  a  material  effect.  We  would  be  pleased  to 
work  with  the  subcommittee  and  the  staff  in  explaining  the  various 
exclusions  that  we  considered  when  objections  were  raised  during 
OBRA  1993  considerations,  and  we  believe  that  when  you  look  at 
those  exclusions,  the  paperwork  burden  on  small  businesses  would 
be  reduced  significantly. 

Mr.  McNuLTY.  Regarding  the  proposal  to  increase  the  rate  of 
withholding  on  gambling  winnings  above  28  percent,  would  you  be 
willing  instead  to  broaden  the  base  of  gambling  that  is  subject  to 
withholding;  for  example,  winners  of  high-stakes  bingo  and  keno, 
and  how  would  you  suggest  defining  high  stakes? 

Mr,  Samuels.  The  administration  would  be  willing  to  consider 
broadening  the  base  of  gambling  subject  to  withholding  to  cover,  for 
example,  high-stakes  bingo  and  keno. 

With  respect  to  the  definition  of  what  constitutes  "high  stakes," 
we  would  like  to  discuss  that  with  the  staff  and,  in  those  discus- 
sions, arrive  at  a  common  understanding  of  the  facts  on  the  types 
of  games  that  are  now  existing  and,  based  on  that  examination,  de- 
termine what  the  level  should  be  for  high  stakes. 

Mr,  McNULTY,  Your  written  testimony  indicates  the  Treasury 
has  some  concerns  about  a  proposal  to  add  sex  discrimination  to 
the  existing  list  of  discriminations  that  could  cause  a  social  club  to 
lose  its  Federal  tax  exemption. 

Could  you  spell  out  the  nature  of  your  concerns  in  this  area? 

Mr,  Samuels.  We  have  concerns  that  the  proposal  could  affect 
longstanding  and  noncontroversial  practices.  For  example,  the  pro- 
posal would  apply  to  sororities  and  fraternities  and  we  think  that 
the  proposal  is  not  intended  to  cover  those  types  of  organizations. 
We  think  that  once  you  decide  that  certain  social  clubs  should  not 
be  affected  by  the  proposal,  it  then  becomes  difficult  to  draw  lines 
between  which  social  clubs  can  continue  their  practices  and  which 
social  clubs  cannot. 

Mr,  McNuLTY,  Mr,  Hancock. 

Mr.  Hancock.  Thank  you,  Mr.  Chairman, 

You  know,  back  in  1986  and  prior  to  that,  we  talked  about  sim- 
plifying the  tax  law.  Now,  the  President  is  talking  about  coming  up 
with  one  form  for  health  care,  which  will  be  really  interesting.  It 
may  be  one  form,  but  it  will  probably  take  three  computers  to  cal- 
culate and  use  it. 

The  exercise  we  have  been  going  through  with  revenue 
enhancers  and  revenue  reductions,  if  in  fact  all  of  the  things  that 
we  are  talking  about,  should  become  law,  roughly  how  many  pages 
do  you  think  we  will  be  adding  to  the  Internal  Revenue  Code? 

Mr,  Samuels,  Mr,  Hancock,  I  think  it  would  be  significant.  The 
number  of  proposals  on  which  we  have  testified  going  back  to  our 
June  testimony  and  today  is  over  250,  So  that  would  be  a  very  sig- 
nificant addition  to  the  Internal  Revenue  Code,  and  that  is  why  in 
the  summary  of  my  statement  I  mentioned  that  we  are  concerned 
about  having  too  many  changes  in  the  tax  law  and  giving  both  the 
government  and  taxpayers  and  their  advisors  time  to  adjust.  So  I 
share  your  concerns, 

Mr.  Hancock.  I  just  came  back  from  a  weekend  and  I  got  a  re- 
port from  my  accountant,  just  on  what  already  has  become  law, 
how  the  changes  in  the  income  tax  were  going  to  affect  me  and  my 


1416 

business.  I  got  a  stack  of  paper  like  this,  and  I  spent  Saturday 
evening  reading  it  and  looking  at  it.  I  am  hearing  from  the  busi- 
ness community  that  as  long  as  we  are  doing  this,  they  don't  know 
what  to  do. 

Now  are  we  benefiting  the  economy  by  basically  holding  a  threat 
in  front  of  the  people  that  want  to  operate  a  little  bit,  so  they  don't 
know  what  to  do?  What  is  your  position?  Should  we  put  out  the 
word  that  yes,  we  are  going  to  give  you  guys  a  chance  to  get  a  little 
breather  before  we  start  making  a  lot  of  these  changes? 

Does  the  Department  of  the  Treasury  take  the  position  that  we 
ought  to  compound  what  we  have  already  done  by  another  250 
pages  of  regulations? 

Mr.  Samuels.  Mr.  Hancock,  I  think  that  in  all  of  these  matters, 
one  has  to  balance  various  considerations.  I  would  note  that  a  sig- 
nificant number  of  the  proposals  that  we  are  considering  have 
been,  I  am  sure,  suggested  by  particular  groups,  including  various 
business  groups,  so  they  have  an  interest  in  some  of  these  propos- 
als. 

As  reflected  in  our  testimony,  we  think  that  there  are  several  of 
the  proposals  that  are  meritorious  and  should  get  serious  consider- 
ation by  the  committee.  There  also  is  a  whole  series  of  proposals 
that  we  would  not  support  and  some  we  would  actually  oppose. 

We  think  that  on  balance  if  the  subcommittee  wants  to  have  a 
markup  and  consider  a  bill,  that  they  should  consider  doing  it  in 
a  rather  modest  way  in  terms  of  the  issue  of  adding  complexity  to 
the  tax  law  and  that  that  is  a  valid  consideration  for  the  committee 
to  take  into  account  in  making  its  decisions  on  what  should  be  in- 
cluded in  the  markup. 

Mr.  Hancock.  Well,  I  appreciate  that  and  I  think  you  are  exactly 
right.  I  think  that  my  constituents,  the  small  business  people — I 
am  a  small  businessman — are  saying  give  us  a  moratorium.  Let  us 
digest  what  you  have  already  done  and  make  plans.  But  as  you 
know,  they  don't  know  how  to  operate  with  all  this  pending  legisla- 
tion. 

One  gentleman  tells  me  that  he  made  a  telephone  call.  He  said, 
"I  had  planned  on  buying  an  additional  inventory,  $450,000  worth 
of  machinery."  He  said,  "I  am  not  going  to  do  it  now."  That  is 
$450,000  worth  of  machinery  that  he  was  ready  to  buy  that  some- 
body is  not  going  to  manufacture. 

The  reason:  He  said,  "I  don't  know  what  is  going  to  happen 
under  these  depreciation  schedules,  et  cetera."  I  suggest  that 
maybe  we  could  hold  off  a  little  bit  on  a  lot  of  these  changes.  I  rec- 
ognize that  certain  things  need  to  be  changed,  but  I  don't  know  but 
that  we  might  not  be  better  off  to  go  back  and  look  at  existing  in- 
come tax  law  and  see  if  we  can  come  up  with  one  form,  one  sheet 
of  paper  where  the  average  Ph.D.  could  fill  out  his  own  income  tax 
return. 

Thank  you,  Mr.  Chairman. 

Mr.  McNuLTY.  Mr.  Kopetski? 

Mr.  Kopetski.  Thank  you,  Mr.  Chairman. 

I  have  a  question  on  your  testimony,  Mr.  Samuels.  Actually  I 
want  to  go  to  the  last  page  first,  "No.  2:  Disallow  deductions  for 
compensatory  damages  under  certain  environmental  laws." 


1417 

Your  policy  here  is  that — I  assume  the  administration's  policy  is 
to  encourage  the  cleanup  and  therefore  you  are  going  to  allow  the 
deduction  for — you  favor  existing  law  of  continuing  the  deduction 
for  compensatory  payments. 

Mr.  Samuels.  That  is  correct. 

Mr.  KOPETSKI.  Essentially  what  the  policy  is  saying  is  that  those 
who  are  not  complying,  unless  there  is  a  punitive  damage  situa- 
tion, all  they  have  to  do  is  wait  and  if  they  get  caught,  then  there 
is — they  are  not  out  any  money;  the  Federal  Treasury  is. 

Mr.  Samuels.  As  we  understand  the  proposal,  Mr.  Kopetski, 
fines  and  penalties  will  continue  to  be  nondeductible.  What  is  at 
issue  in  the  proposal  is  whether  compensatory  damages  would  con- 
tinue to  be  deductible. 

In  that  case,  for  example,  damages  paid  to  people  who  have  been 
adversely  affected  by  the  pollution  would  be  able  to  be  paid  by  the 
polluter  to  compensate  them  for  their  lost  income  and  that  type  of 
payment  to  innocent  parties  would  continue  to  be  deductible  if  it 
was  in  the  nature  of  compensatory  damages. 

It  seems  to  us  that  at  this  point  there  is  not  a  need  to  change 
the  rule,  which  generally  has  permitted  over  the  years  payment  of 
compensatory  damages  to  innocent  people  to  be  aeductible.  If  you 
deny  the  deduction,  you  may  discourage  the  polluter  from  wanting 
to  make  appropriate  settlements  with  the  people  who  have  been 
adversely  affected. 

There  is  a  balance  of  trying  to  decide  what  is  an  appropriate  tax 
rule  for  someone  who  has  polluted  and  balance  that  with  payments 
to  people  who  have  been  adversely  affected. 

Mr.  KoPETSKL  So  these  are  payments  that  are  going  to  a  third 
party,  not  the  actual  cost  of  the  cleanup  that  is  involved? 

Mr.  Samuels.  The  cost  of  the  cleanup  is  a  separate  issue.  As  I 
understand  this  proposal  it  covers  payments  primarily  going  to 
third  parties,  or  reimbursements  to  a  person  who  had  to  clean  up 
the  site  by  the  person  who  had  polluted  the  site. 

Mr.  Kopetskl  So  our  policy  in  the  Tax  Code  therefore  is  for  the 
American  taxpayer  to  pay  for  the  injuries  done  to  third  parties,  be- 
cause that  is  really  what  is  going  on? 

Mr.  Samuels.  It  is  correct  that  the  Tax  Code  would  allow  for  de- 
ductions for  ordinary  and  necessary  expenses.  We  generally  don't 
disallow  deductions  as  long  as  the  payments  are  not  fines  or  pen- 
alties, depending  on  the  nature  of  the  business  or  the  activity  that 
gave  rise  to  the  payments. 

Mr.  Kopetskl  But  in  essence,  it  is  the  American  taxpayer  that 
is  compensating  injured  third  parties  for  environmental  degrada- 
tion caused  by  the  principal? 

Mr.  Samuels.  That  is  correct. 

Mr.  Kopetskl  Well,  I  think  that  is  something  that  I  hope  the  ad- 
ministration would  take  another  look  at.  But  then  if  you  go  back 
to  page  18 — I  always  like  to  have  consistency  of  policy  as  much  as 
I  can.  That  way  I  don't  get  in  too  much  trouble  with  my  constitu- 
ents. 

If  I  understand  the  hydrochlorofiuorocarbons  issue,  HCFCs — the 
code  currently  tries  to  move  people,  businesses  away  from  utilizing 
CFCs  to  HCFCs  and  it  is  my  understanding  that  this  is  actually 
a  temporary  bridge  because  as  they  move  to  HCFCs  the  next  step 


1418 

is  to  go  to  something  else,  and  that  won't  have  a  potential  environ- 
mental degradation  as  HCFCs  do. 

So  it  is  my  understanding  that  we  are  trying  to  encourage  busi- 
nesses to  go  to  HCFCs  and  yet  the  proposal  would  tax  HCFCs  and 
it  seems  to  me  if  on  the  one  hand  on  the  compensatory  damage  is- 
sues you  were  trying  to  encourage  environmental  cleanup  that 
under  this  proposal,  under  No.  9,  that  you  are  actually  going  to 
have  the  effect  of  discouraging  more  environmentally  benign  action. 

Do  I  make  myself  clear  on  tnat? 

Mr.  Samuels.  Yes,  sir. 

Mr.  KoPETSKi.  Is  that  OK  with  you  to  have  this  inconsistency  in 
environmental  policy? 

Mr.  Samuels.  We  prepared  this  testimony  in  conjunction  with 
EPA  and  they  reviewed  this  and,  as  I  understand  it,  one  aspect  of 
the  decision  with  respect  to  this  proposal  is  that  it  basically  was 
following  the  1992  Copenhagen  Amendment  to  the  Montreal  Proto- 
col. In  the  past  when  chemicals  have  been  added  pursuant  to  the 
Montreal  Protocol,  those  chemicals  have  then  been  added  to  the 
group  of  chemicals  that  would  be  subject  to  this  particular  excise 
tax. 

Mr.  KoPETSKi.  But  isn't  it  the  case  that  these  chemicals  have  not 
been  listed  officially  as  of  yet,  so  we  may  be  taxing  them  before 
they  are  actually  placed  on  this  list? 

Mr.  Samuels.  Mr.  Kopetski,  I  am  not  aware  of  that.  We  will 
check  and  be  happy  to  get  back  to  you. 

Mr.  Kopetskl  If  you  could  ask  EPA  also  to  reflect  upon  the  con- 
sistency or  inconsistency  of  policy  that  I  perceive  between  those 
two  differing  tax  measures.  In  addition,  while  you  are  asking  them, 
it  is  my  understanding  also  that  one  of  the  chemicals  at  issue  is 
methyl  bromide  which  in  the  forest  product  industry  is  something 
that  is  used  to  treat  logs  coming  in  or  going  out  of  this  country  for 
insects,  et  cetera;  yet  there  is  a  scientific  question  still  as  to  wheth- 
er that  particular  chemical,  a  scientific  question  of  whether  that  is 
harmful  and  whether  it  should  be  listed. 

Again,  the  issue  is  whether  we  should  tax  these  substances  be- 
fore they  are  actually  officially  put  on  the  list? 

Mr.  Samuels.  We  will  consult  with  EPA  and  get  back  to  you  on 
that. 

[The  following  was  subsequently  received:] 


1419 


DEPARTMENT  OF  THE  TREASURY 

WASHINGTON 


ASSISTANT  SECRETARY 


m  0  3  1993 


The  Honorable  Michael  J.  Kopetski 
House  of  Representatives 
Washington,  D.C.   20515 

Dear  Mr.  Kopetski: 

On  September  21,  1993,  I  testified  before  the  Subcommittee  on 
Select  Revenue  Measures  on  several  miscellaneous  revenue  issues, 
including  a  proposal  to  expand  the  ozone-depleting  chemicals 
excise  tax.   At  the  hearing  you  raised  questions  regarding  this 
proposal.   Because  your  questions  involved  issues  involving  the 
Environmental  Protection  Agency  (EPA) ,  we  have  consulted  with 
them  to  respond  to  your  questions.   I  am  also  sending  a  copy  of 
this  letter  to  Chairman  Rostenkowski  so  his  record  of  the  hearing 
will  be  complete. 

Your  first  question  related  to  hydrochlorof luorocarbons  (HCFCs) , 
which  are  less  environmentally  damaging  than  chlorof luorocarbons 
(CFCs) .   You  asked  whether  it  was  appropriate  to  tax  HCFCs  when 
industry  is  being  encouraged  to  use  these  chemicals  as  a 
substitute  for  CFCs. 

HCFCs  are  viewed  under  the  Clean  Air  Act  and  the  Montreal 
Protocol  as  a  transitional  CFC  substitute  the  use  of  which  will 
allow  a  speedy  phase-out  of  CFCs.   HCFCs,  however,  also 
contribute  to  ozone  depletion,  although  to  a  lesser  degree  than 
CFCs.   Accordingly,  the  use  of  HCFCs  is  restricted  and  their 
production  phased  out. 

Imposing  the  ozone-depleting  chemicals  tax  on  HCFCs  is  not 
expected  to  encourage  firms  to  continue  their  use  of  CFCs.   The 
tax  on  a  compound  is  based  on  the  compound's  ozone-depletion 
potential,  which  is  substantially  lower  for  HCFCs  than  for  CFCs. 
Thus,  a  tax  on  HCFCs  would  not  eliminate  the  incentive  to  switch 
from  more  heavily  taxed  CFCs.   Moreover,  a  tax  on  HCFCs  would 
provide  an  incentive  for  industry  to  continue  its  efforts  to  find 
and  shift  to  non-ozone-depleting  substances. 

You  also  expressed  concern  that  HCFCs,  hydrobromof luorocarbons 
(HBFCs) ,  and  methyl  bromide  have  not  been  officially  listed  as 
ozone-depleting  chemicals  and  that  they  might  be  taxed  before 
they  were  actually  listed.   In  addition,  you  suggested  that  there 
is  still  a  scientific  question  as  to  whether  methyl  bromide, 
which  is  used  as  a  pesticide  in  the  forest  products  industry,  is 
harmful. 

At  their  meeting  in  1992,  the  Parties  to  the  Montreal  Protocol 
added  HCFCs,  HBFCs,  and  methyl  bromide  to  the  list  of  controlled 
substances  (i.e. ,  substances  subject  to  limitations  on  production 
and  use  because  of  their  ozone-depletion  potential) .   This 


1420 


amendment  to  the  list  of  controlled  substances  will  enter  into 
force  after  ratification  by  20  of  the  Parties.   It  is  possible 
that  this  will  occur  before  the  end  of  the  year,  and  it  is  likely 
that  the  United  States  will  ratify  the  amendment  within  the  next 
month . 

In  addition,  the  Clean  Air  Act  specifies  limits  on  HCFCs  and 
calls  for  EPA  to  add  to  the  list  of  regulated  substances  any 
compound  with  an  ozone-depletion  potential  of  0.2  or  more.   The 
best  available  scientific  information  (from  the  Montreal  Protocol 
Scientific  Assessment)  concludes  that  the  ozone-depletion 
potential  of  both  HBFCs  and  methyl  bromide  is  well  above  the  0.2 
threshold.   Accordingly,  EPA  issued  proposed  regulations  in  March 
of  this  year  that  would  add  HBFCs  and  methyl  bromide  to  the  list 
of  Class  I  compounds  (i.e. .  substances  that  must  be  phased  out 
within  seven  years  of  listing) .   EPA  expects  to  finalize  this 
proposed  rule  before  the  end  of  the  year,  and  the  listing  will 
take  effect  30  days  after  the  rule  is  finalized. 

I  hope  this  is  responsive  to  your  concerns.   Please  let  me  or  my 
staff  know  if  we  can  provide  any  additional  information  on  this 
issue. 

Sincerely, 

Leslie  B.  Samuels 

Assistant  Secretary 

(Tax  Policy) 


cc:   The  Honorable  Dan  Rostenkowski 


1421 

Mr.  KOPETSKI.  I  appreciate  that  very  much.  Thank  you  very 
much. 

Thank  you,  Mr.  Chairman. 

Mr.  McNULTY.  Thank  you  very  much  for  your  testimony,  Mr. 
Secretary. 

Mr.  Samuels.  Thank  you. 

Mr.  McNULTY.  We  now  call  the  GAO,  Mr.  Natwar  Gandhi,  Asso- 
ciate Director  for  Tax  Policy  and  Administration  Issues. 

Welcome,  Mr.  Gandhi.  You  may  proceed  to  summarize  your  testi- 
mony if  you  wish.  The  testimony  in  its  entirety  will  be  made  a  part 
of  the  record. 

STATEMENT  OF  NATWAR  M.  GANDHI,  ASSOCIATE  DIRECTOR, 
TAX  POLICY  AND  ADMINISTRATION  ISSUES,  GENERAL  GOV- 
ERNMENT  DIVISION,  U.S.  GENERAL  ACCOUNTING  OFFICE, 
ACCOMPANIED  BY  TOM  SHORT,  ASSIGNMENT  MANAGER, 
AND  DAVID  PASQUARELLO,  EVALUATOR,  PHILADELPHIA 
GENERAL  ACCOUNTING  OFFICE 

Mr.  Gandhi.  Thank  you,  sir. 

I  am  pleased  to  have  this  opportunity  to  offer  our  views  on  the 
need  to  improve  taxpayer  compliance  with  real  estate  deduction  tax 
law.  Joining  me  on  my  left  is  Mr.  Pasquarello  of  our  Philadelphia 
General  Accounting  Office  and  on  my  right  is  Assignment  Manager 
Tom  Short,  who  has  worked  on  these  and  other  tax  issues. 

As  you  may  know,  Mr.  Chairman,  we  recently  issued  a  report 
that  recommended  ways  to  improve  the  compliance  of  taxpayers 
who  overstate  their  real  estate  tax  deductions.  At  the  end,  I  will 
also  briefly  comment  on  two  other  reports  and  proposals  before  the 
subcommittee,  the  debt  forgiveness  and  automated  verification  of 
taxpayer  identification  numbers. 

I  will  make  three  major  points  about  overstated  deductions  for 
real  estate  tax  payments.  First,  individual  taxpayers  mostly  over- 
stated their  deductions  for  real  estate  taxes  by  including  non- 
deductible payments  such  as  user  fees. 

Two,  confusion  over  which  payments  were  and  which  were  not 
deductible  real  estate  taxes  contributed  to  taxpayer  noncompliance. 

Last,  IRS  can  improve  compliance  by  simplifying  tax  documents 
and  redirecting  its  enforcement  efforts,  working  cooperatively  with 
State  and  local  officials. 

IRS's  compliance  data  showed  that  individual  taxpayers  over- 
stated their  real  estate  tax  deductions  by  an  estimated  $1.5  billion 
for  1988.  Projecting  these  figures  to  1992,  we  estimated  that  this 
noncompliance  led  to  a  Federal  tax  loss  of  some  $400  million.  We 
believe  these  estimates  understate  the  scope  and  tax  effects  of  non- 
compliance. We  found  that  in  one  large  urban  county,  IRS  auditors 
identified  just  7  percent  of  the  $21.6  million  in  overstated  real  es- 
tate taxes  for  1  year. 

As  a  result,  we  estimated  that  lost  Federal  tax  revenue  totaled 
$6  million  and  lost  county  and  State  tax  revenue  totaled  $1.6  mil- 
lion. In  this  county,  taxpayers  overstated  the  $21.6  million  by  de- 
ducting user  fees  along  with  their  real  estate  tax  payments. 

Our  1992  survey  of  171  large  local  governments  showed  that  the 
taxpayers  in  about  half  of  these  localities  also  were  likely  to  in- 
clude user  fees  in  their  real  estate  tax  deductions. 


1422 

In  reviewing  IRS  files,  Mr.  Chairman,  we  could  not  determine 
whether  taxpayers  intentionally  overstated  the  deductions.  How- 
ever, we  were  able  to  conclude  that  at  a  minimum,  two  types  of 
confusion  contributed  to  this  noncompliance. 

First,  we  found  that  many  taxpayers  were  unaware  that  they 
should  not  deduct  user  fees.  IRS's  tax  instructions  did  not  clearly 
and  completely  tell  taxpayers  that  user  fees  were  nondeductible. 
We  discovered,  that  even  private  tax  return  preparers,  who  are 
more  likely  to  know,  misapply  the  deduction  groups. 

Second,  local  governments'  real  estate  tax  bills  created  confusion 
also.  Although  it  is  not  required,  these  bills  often  did  not  distin- 
guish between  deductible  real  estate  taxes  and  nondeductible  user 
fees.  As  a  result,  taxpayers  who  relied  on  these  bills  to  compute 
their  real  estate  tax  deductions  could  easily  but  improperly  deduct 
their  user  fees,  too. 

We  found  a  similar  situation  for  taxpayers  who  relied  on  annual 
statements  from  mortgage  companies  to  compute  their  real  estate 
tax  deductions.  As  witn  many  of  the  local  government  bills,  these 
mortgage  statements  did  not  distinguish  between  deductible  and 
nondeductible  payments  to  local  governments. 

We  concluded,  Mr.  Chairman,  that  both  IRS  and  local  govern- 
ments had  key  roles  to  play  in  improving  taxpayer  compliance.  We 
envision  these  roles  being  played  in  tandem  as  IRS  worked  coop- 
eratively with  local  officials. 

Underlying  such  cooperation,  we  recommended  that  IRS  clarify 
its  rules  and  instructions  on  real  estate  tax  deductions,  that  IRS 
help  local  governments  to  revise  their  bills  so  that  taxpayers  could 
readily  identify  the  nondeductible  user  fees  and  know  that  IRS 
may  also  receive  this  information;  that  IRS  require  its  auditors  to 
contact  local  governments  to  identify  the  actual  tax  payments  made 
by  the  taxpayers  being  audited;  and  finally,  Mr.  Chairman,  we  also 
recommended  that  IRS  negotiate  agreements  with  local  govern- 
ments to  receive  data  on  actual  real  estate  tax  payments  by  each 
individual  taxpayer  and  use  that  data  to  identify  noncompliance. 

Since  we  issued  a  report  in  January  of  this  year,  we  have  contin- 
ued to  talk  with  IRS  and  local  government  officials  about  improv- 
ing compliance  with  real  estate  tax  deductions.  We  commend  IRS 
for  starting  to  work  cooperatively  with  local  government  officials, 
particularly  the  National  Association  of  Counties,  so-called  NACo, 
which  has  acknowledged  this  compliance  problem  and  has  proposed 
Federal  legislation  to  implement  the  spirit  if  not  the  letter  of  our 
recommendations. 

NACo's  proposal  also  called  for  Federal  funding  to  reimburse 
local  governments  for  changes  they  would  need  to  make  to  their  ac- 
countmg  systems  to  track  tnese  types  of  payments  and  to  their  tax 
bills. 

Although  we  have  not  fully  analyzed  this  proposal,  we  view  it  as 
a  reasonable  first  step.  For  the  first  time,  the  taxpayers  across  the 
country  would  begin  to  receive  consistent  information  that  distin- 
guishes between  deductible  taxes  and  nondeductible  fees  or  other 
payments.  Besides  improving  tax  compliance  and  revenues,  these 
changes  would  add  fairness  and  certainty  to  our  tax  system. 

If  these  changes  do  not  improve  compliance,  then  IRS  and  Con- 
gress may  wish  to  try  another  approach.  One  approach  would  be 


1423 

to  require  local  governments  to  file  an  information  return  on  the 
amount  of  realistic  taxes  that  a  taxpayer  may  deduct. 

In  requiring  reporting,  Congress  would  have  to  consider  giving 
local  governments  the  authority  to  collect  taxpayers  Social  Security 
number  so  that  the  reported  information  can  be  used  effectively.  In 
recent  years,  we  have  stronglv  supported  information  reporting.  It 
helps  taxpayers  to  comply  voluntarily  and  IRS  to  identify  any  re- 
maining noncompliance.  However,  it  also  imposes  costs  and  bur- 
dens on  IRS  as  well  as  on  the  third  party  that  reports  the  informa- 
tion. 

In  the  context  of  real  estate  tax  payments,  local  governments  be- 
lieve and  we  agree  that  the  cost  of  information  reporting  may  at 
least  initially  exceed  its  benefits.  For  this  reason,  we  prefer  trying 
first  the  proposal  that  we  and  NACo  have  recommended. 

Before  closing,  Mr.  Chairman,  I  would  like  to  comment  on  two 
other  proposals.  These  proposals  involve  debt  forgiveness  and  auto- 
mated verification  of  Federal  tax  identification  numbers,  so-called 
TINs.  I  will  be  brief,  but  I  am  willing  to  provide  more  information. 

Regarding  debt  forgiveness,  we  issued  a  report  in  February  1993 
on  individual  taxpayers  who  had  not  reported  income  from  having 
their  debts  forgiven  by  FDIC  and  RTC.  We  found  that  individual's 
compliance  in  reporting  this  income  from  debts  forgiven  by  FDIC 
skyrocketed  from  1  percent  to  48  percent  when  information  returns 
were  filed. 

We  also  found  that  these  federally  forgiven  debts  were  loans  that 
had  been  made  by  private  financial  institutions  that  had  been  for- 
giving large  amounts  of  debts  themselves,  some  $40  billion  in  1990 
alone. 

We  recommended  that  Congress  require  FDIC  and  RTC  to  file 
such  information  returns  when  the  annual  forgiven  debts  totaled 
$600  or  more.  If  this  information  reporting  proves  to  be  cost  effec- 
tive, we  also  suggested  that  Congress  consider  extending  this  re- 
porting to  other  institutions. 

Recently  Congress  acted  on  our  recommendations.  The  Joint 
Committee  on  Taxation  estimated  that  this  provision  would  raise 
$484  million  in  fiscal  years  1994  through  1998. 

We  understand  that  the  proposal  being  considered  today  would 
extend  such  information  reporting  to  all  financial  institutions  that 
make  or  acquire  loans.  We  believe  the  proposal  before  you  today, 
sir,  would  improve  tax  compliance.  Also,  including  all  private  finan- 
cial institutions  would  better  insure  that  no  segments  of  this  com- 
munity have  a  competitive  advantage  by  being  able  to  avoid  the 
cost  of  reporting. 

We  also  have  done  some  reports  that  discuss  the  benefits  of  auto- 
matically verifying  the  Federal  tax  identification  number  of  tax- 
payers before  sending  in  an  information  return  on  payments  made 
to  them.  We  understand  this  proposal  has  been  withdrawn  for  now. 
Even  so,  we  wish  to  state  our  support  for  such  a  verification 
system. 

Although  IRS  still  needs  to  work  out  technical  bugs  in  the  ver- 
ification system,  we  believe  this  system  will  benefit  not  only  IRS, 
but  also  those  who  need  the  valid  TIN  to  file  an  accurate  informa- 
tion return.  To  the  extent  that  this  system  allows  things  to  be  veri- 


1424 

fied  in  advance  rather  than  years  later,  the  cost  and  burden  on  all 
affected  parties  should  be  reduced. 

This  verification  also  should  limit  opportunities  for  submitting 
false  TINs,  which  some  taxpayers  may  try  to  escape  Federal  taxes. 
Closing  off  these  opportunities  is  crucial  to  help  insure  that  the 
correct  amount  of  taxes  is  paid  and  the  millions  of  honest  tax- 
payers are  treated  fairly. 

Mr.  Chairman,  this  concludes  my  oral  statement.  I  request  that 
my  written  testimony  be  made  part  of  the  record. 

Thank  you  for  the  opportunity  to  present  our  views.  I  welcome 
any  questions  that  you  may  have. 

Mr,  McNuLTY.  Thank  you.  Your  statement  will  appear  in  the 
record  in  its  entirety. 

[The  prepared  statement  follows:] 


1425 


TESTIMONY  OF  NATWAR  M.  GANDHI 

ASSOCIATE  DIRECTOR 

TAX  POUCY  AND  ADUINISTRATION  ISSUES 

GENERAL  GOVERNMENT  DIVISION 

U^  GENERAL  ACCOUNTING  OFFICE 

Mr.  Chairman  and  Members  of  the  Subcommittee: 

I  am  pleased  to  have  this  opportunity  to  offer  our  views  on  the 
need  to  improve  taxpayer  compliance  with  real  estate  tax 
deduction  law.   As  you  may  know,  we  recently  issued  a  report, 
requested  by  Chairman  David  Pryor,  Senate  Finance  Subcommittee  on 
Private  Retirement  Plans  and  Oversight  of  the  Internal  Revenue 
Service  (IRS),  that  recommended  ways  to  improve  the  compliance  of 
taxpayers  who  overstate  their  tax  deductions  for  real  estate  tax 
payments.'  To  conclude  my  statement,  I  will  briefly  comment  on 
two  other  proposals  before  the  Subcommittee — debt  forgiveness  and 
automated  verification  of  taxpayer  identification  numbers  (TIN) . 

I  will  make  three  major  points  about  overstated  deductions  for 
real  estate  tax  payments,  on  the  basis  of  the  work  we  did  for  our 
report.   These  points  are: 

--  Individual  taxpayers  mostly  overstated  their  deductions  for 
real  estate  tax  payments  by  including  nondeductible  payments 
such  as  user  fees. 

—  Confusion  over  which  payments  were  and  were  not  deductible 
real  estate  taxes  contributed  to  taxpayer  noncompliance. 

—  IRS  can  improve  taxpayer  compliance  by  simplifying  tax 
documents  and  redirecting  its  enforcement  efforts,  working 
cooperatively  with  state  and  local  officials. 

BACKGROUND 

Before  discussing  these  three  points,  let  me  describe  the 
deduction  for  real  estate  tax  payments.   Under  tax  law,  taxpayers 
may  deduct  real  estate  tax  payments  from  their  federal  taxable 
income.   Real  estate  taxes  are  uniform  payments  that  are  based  on 
the  value  of  a  taxpayer's  real  estate;  they  are  used  to  fund 
general  services.   Other  payments  to  local  governments,  such  as 
user  fees,  generally  cannot  be  deducted  because  they  do  not  meet 
these  criteria.   User  fees  fund  the  use  of  specific  services  such 
as  water,  sewerage,  and  trash  collection  and  are  not  based  on  the 
value  of  real  estate. 

OVERSTATED  REAL  ESTATE  TAX  DEDUCTIONS 
REDUCED  INCOME  TAX  REVENUES 

IRS  compliance  data  showed  that  individual  taxpayers  overstated 
their  real  estate  tax  deductions  by  an  estimated  $1.5  billion  for 
1988.   Projecting  these  results  to  1992,  we  estimated  that  this 
noncompliance  led  to  a  federal  tax  loss  of  $400  million. 

We  believe  these  estimates  understate  the  scope  and  tax  effect  of 
the  noncompliance.  We  analyzed  the  IRS  audits  that  generated  the 
compliance  data.^  We  found  that  in  one  large  urban  county,  IRS 
auditors  identified  just  7  percent  of  the  $21.6  million  in 
overstated  real  estate  taxes  for  1  year.   As  a  result,  we 
estimated  that  the  lost  federal  tax  revenue  totaled  $6  million 
and  lost  county  and  state  tax  revenue  totaled  $1.6  million.^ 


^Tax  Administration: Overstated  Real  Estate  Tax  Deductions  Need 

to  Be  Reduced  (GAO/GGD-93-43,  Jan.  19,  1993). 

^IRS  did  these  audits  to  measure  con^liance  through  its  Taxpayer 
Compliance  Measurement  Program  (TCMP).   TCMP  audits  constitute  a 
detailed,  rigorous  examination  of  taxpayer  compliance  in 
reporting  all  types  of  income,  deductions,  credits,  etc.. 

^Reducing  overstated  real  estate  tax  deductions  boosts  federal 
tax  revenue  as  well  as  state  and  local  tax  revenue  in  those 
states  that  levy  income  taxes  and  use  the  federal  tax  liability 
as  a  starting  point  for  computing  the  state  income  tax  liability. 


1426 


In  this  county,  taxpayers  overstated  the  $21.6  million  by 
deducting  user  fees  along  with  their  real  estate  tax  payments. 
Our  1992  survey  of  171  large  local  governments  showed  that 
taxpayers  in  about  half  of  these  localities  also  were  likely  to 
include  user  fees  in  their  real  estate  tax  deductions.   Although 
we  did  not  have  resources  to  estimate  the  noncompliance  within 
these  localities,  we  concluded  that  our  $400  million  estimate  of 
the  1992  nationwide  tax  loss  is  probably  understated. 

TAXPAYER  CONFUSION  CONTRIBUTED 
TO  THE  OVERSTATED  DEDUCTIONS 

In  reviewing  IRS'  files,  we  could  not  determine  whether  taxpayers 
intentionally  overstated  the  deductions.   However,  we  were  able 
to  conclude  that,  at  a  minimum,  two  types  of  confusion 
contributed  to  taxpayers'  noncompliance. 

First,  we  found  that  many  taxpayers  were  unaware  that  they  should 
not  deduct  user  fees.   IRS'  instructions  for  1988  tax  returns  did 
not  tell  taxpayers  that  user  fees  were  nondeductible.   For  these 
taxpayers  to  find  this  information,  they  had  to  consult  multiple 
IRS  publications.   In  order  to  comply  voluntarily,  these 
taxpayers  had  to  persist  in  finding  and  interpreting  the 
publications.   We  discovered,  however,  that  even  private  tax 
return  preparers,  who  are  more  likely  to  know,  misapplied  the 
deduction  rules. 

Second,  local  governments'  real  estate  tax  bills  created 
confusion.   Although  it  is  not  required,  these  bills  often  did 
not  distinguish  between  deductible  real  estate  taxes  and 
nondeductible  user  fees.   We  identified  83  of  the  171  large, 
local  governments  that  each  collected  at  least  $100  million 
annually  in  real  estate  taxes  and  used  the  same  bill  for  both 
user  fees  and  real  estate  taxes.   We  asked  them  for  copies  of 
their  bills.   Of  the  55  sample  bills  that  we  received,  we  found 
unclear  distinctions  between  user  fees  and  real  estate  taxes  on 
49  bills.   Of  these  49  bills,  31  made  little  or  no  distinction 
between  them. 

As  a  result,  taxpayers  who  relied  on  these  bills  to  compute  their 
real  estate  tax  deductions  could  easily,  but  improperly,  deduct 
their  user  fees  too.   We  found  a  similar  situation  for  taxpayers 
who  relied  on  annual  statements  from  mortgage  companies  to 
compute  their  real  estate  tax  deductions.   As  with  many  of  the 
local  government  bills,  these  mortgage  statements  did  not 
distinguish  between  deductible  and  nondeductible  payments  to 
local  governments. 

IRS  CAN  WORK  WITH  LOCAL  GOVERNMENTS 
TO  IMPROVE  TAXPAYER  COMPLIANCE 

We  concluded  that  both  IRS  and  local  governments  had  key  roles  to 
play  in  improving  taxpayers'  compliance.   We  envisioned  these 
roles  being  played  in  tandem  as  IRS  worked  cooperatively  with 
local  officials.   Underlying  such  cooperation,  we  recommended 
ways  to  improve  compliance  with  the  real  estate  tax  deductions. 
We  recommended  that  IRS 

—  clarify  its  rules  and  instructions  on  the  real  estate  tax 
deduction, 

—  help  local  governments  to  revise  their  bills  so  that  taxpayers 
could  readily  identify  the  nondeductible  user  fees  and  know 
that  IRS  may  also  receive  this  information, 

—  require  IRS  auditors  to  contact  local  governments  to  Identify 
the  actual  real  estate  tax  payments  made  by  the  taxpayers 
being  audited,  and 


1427 


—  negotiate  agreements  with  local  governments  to  receive  data  on 
actual  real  estate  tax  payments  by  each  individual  taxpayer 
and  use  that  data  to  identify  taxpayer  noncompliance. 

Since  we  issued  our  report  in  January  1993,  we  have  continued  to 
talk  with  IRS  and  local  government  officials  about  improving 
compliance  with  real  estate  tax  deductions.   We  commend  IRS  for 
starting  to  work  cooperatively  with  local  government  officials, 
particularly  with  the  National  Association  of  Counties  (NACo), 
which  represents  almost  all  the  local  governments  we  contacted. 
Similarly,  we  are  pleased  that  NACo  has  acknowledged  this 
compliance  problem  and  has  offered  a  proposal  to  Improve  the 
compliance. 

NACo  recently  approved  a  resolution  that  proposed  federal 
legislation  to  implement  the  spirit,  if  not  the  letter,  of  our 
recommendations.   As  we  understand  the  proposal,  IRS  would 
clarify  its  instructions  and  tax  returns  and  local  governments 
would  clarify  their  bills.   IRS  also  would  work  with  mortgage 
companies  to  help  them  in  clarifying  their  annual  statements  to 
taxpayers.   Such  clarifications  should  provide  the  information 
that  taxpayers  need  to  voluntarily  comply.   NACo's  proposal  also 
called  for  federal  funding  to  reioiburse  local  governments  for 
changes  they  would  need  to  make  to  their  accounting  system  to 
track  these  types  of  payments  and  to  their  tax  bills. 

Specifically,  under  NACo's  proposal,  IRS  would  help  local  taxing 
districts  to  determine  the  deductibility  of  various  payments. 
Then  local  tax  bills  would  be  revised  to  distinguish  between 
deductible  and  nondeductible  payments.   In  addition,  IRS  would 
clarify  the  tax  return  line  on  which  individual  taxpayers  can 
claim  the  real  estate  tax  deduction.   Requiring  taxpayers  to 
compute  the  deductible  amount  by  subtracting  the  nondeductible 
payments  should  prompt  them  to  be  more  compliant. 

In  our  view,  NACo's  approach  approximates  the  approach  that  IRS 
envisions  under  its  current  compliance  philosophy.   That  is,  if 
the  noncompliance  appears  to  stem  from  taxpayer  confusion,  then 
nonenforcement  efforts  should  be  tried  first.   NACo's  approach 
requires  IRS  to  provide  taxpayers  with  the  information  needed  to 
comply  and  to  change  its  tax  instructions  and  returns  to  clear  up 
any  confusion. 

Although  we  have  not  fully  analyzed  this  proposal,  we  view  it  as 
a  reasonable  first  step.   For  the  first  time,  taxpayers  across 
the  country  would  begin  to  receive  consistent  information  that 
distinguishes  between  deductible  taxes  and  nondeductible  fees  or 
other  payments.   Besides  improving  tax  compliance  and  revenues, 
these  changes  would  add  fairness  and  certainty  to  our  tax  system. 

We  have  not  received  estimates  on  the  amount  of  money  from 
federal  or  other  sources  that  local  governments  would  need  to 
change  their  systems.   If  the  changes  are  likely  to  lead  to  major 
increases  in  tax  revenues,  we  believe  that  a  one-time  "seed" 
investment  to  reimburse  local  governments,  either  fully  or 
partially,  for  their  costs  makes  sense.   Because  many  state 
governments,  as  well  as  some  local  governments,  also  will  receive 
increased  tax  revenues,  perhaps  they  should  share  a  portion  of 
these  costs. 

If  these  changes  do  not  improve  taxpayer  compliance,  then  IRS  and 
Congress  may  wish  to  try  another  approach.   One  approach  would  be 
to  require  local  governments  to  file  an  information  return  on  the 
amount  of  real  estate  tax  that  a  taxpayer  may  deduct.   In 
requiring  reporting.  Congress  also  would  have  to  consider  giving 
local  governments  the  authority  to  collect  taxpayers'  social 
security  numbers  (SSN)  so  that  the  reported  information  can  be 
used  effectively. 


1428 


In  recent  years,  we  have  strongly  supported  information 
reporting.   It  helps  taxpayers  to  comply  voluntarily  and  IRS  to 
Identify  any  remaining  noncompliance.   However,  it  also  imposes 
costs  and  burdens  on  IRS  as  well  as  on  the  third  party  that 
reports  the  information.   In  the  context  of  real  estate  tax 
payments,  local  governments  believe  and  we  agree  that  the  costs 
of  information  reporting  may,  at  least  initially,  exceed  its 
benefits.   For  this  reason,  we  prefer  trying  first  the  proposals 
that  we  and  NACo  have  recommended. 

Another  approach  would  be  for  Congress  to  eliminate  the  confusion 
by  either  eliminating  a  deduction  for  real  estate  taxes  or 
allowing  a  deduction  for  user  fees.   We  have  not  examined  the 
trade-offs  of  either  denying  or  expanding  the  deduction.   Because 
either  action  would  have  a  significant  impact  on  revenue,  we 
believe  that  careful  consideration  would  be  necessary  before 
choosing  this  approach. 

DEBT  FORGIVENESS  AND  AUTOMATED 
TIN  VERIFICATION 

Before  closing,  I  would  like  to  comment  on  two  other  proposals. 

These  proposals  involve  debt  forgiveness  and  automated 

verification  of  federal  TINs.   I  will  be  brief,  but  I  am  willing 

to  provide  more  information. 

Regarding  debt  forgiveness,  we  issued  a  report  in  February  1993 
on  individual  taxpayers  who  had  not  reported  income  from  having 
their  debts  forgiven  by  the  Federal  Deposit  Insurance  Corporation 
(FDIC)  or  Resolution  Trust  Corporation  (RTC).*  We  found  that 
individuals'  compliance  in  reporting  this  income  from  debts 
forgiven  by  FDIC  skyrocketed  from  1  percent  to  48  percent  when 
information  returns  were  filed.   We  also  found  that  these 
federally  forgiven  debts  were  loans  that  had  been  made  by  private 
financial  institutions  that  had  been  forgiving  large  amounts  of 
debts  themselves  ($40  billion  in  1990). 

We  recommended  that  Congress  require  FDIC  and  RTC  to  file  such 
information  returns  when  the  annual  forgiven  debts  totaled  $600 
or  more.   If  this  information  reporting  proves  to  be  cost 
effective,  we  also  suggested  that  Congress  consider  extending 
this  reporting  to  other  institutions. 

Recently,  Congress  acted  on  our  recommendations.   Congress 
required  FDIC,  RTC,  and  certain  other  financial  institutions  and 
federal  agencies  to  file  information  returns  on  forgiven  debts  of 
$600  or  more  in  a  calendar  year.   The  Joint  Committee  on  Taxation 
estimated  that  this  provision  would  raise  $484  million  in  fiscal 
years  1994  through  1998. 

We  understand  that  the  proposal  being  considered  today  would 
extend  such  information  reporting  to  all  financial  institutions 
that  make  or  acquire  loans.   The  loans  forgiven  by  FDIC  and  RTC 
had  been  made  by  private  financial  institutions.   We  see  no 
reason  to  believe  that  individuals'  compliance  in  reporting  the 
income  from  loans  forgiven  by  these  institutions  would  be  any 
better,  without  information  reporting,  than  the  1-percent 
compliance  we  found  in  our  sample  of  taxpayers  with  federal  loans 
forgiven.   Thus,  the  proposal  before  you  today  should  improve  tax 
compliance.   Further,  including  all  private  financial 
institutions  would  better  ensure  that  no  segments  of  this 
community  have  a  competitive  advantage  by  being  able  to  avoid  the 
cost  of  reporting. 


*Tax  Administration;   Information  Returns  Can  Improve  the 
Reporting  of  Forgiven  Debts  (GAO/GGD-93-42,  Feb.  17,  1993), 


1429 


We  also  have  done  some  reports  that  discussed  the  benefits  of 
automatically  verifying  the  federal  TIN  of  taxpayers  before 
sending  in  an  information  return  on  payments  made  to  them.*  We 
understand  this  legislative  proposal  has  been  withdrawn  for  now. 
Even  so,  we  wish  to  state  our  support  for  such  a  verification 
system. 

Although  IRS  still  needs  to  work  out  technical  bugs  in  the 
verification  system  that  it  is  developing,  we  believe  this  system 
will  benefit  not  only  IRS  but  also  those  who  need  the  valid  TIN 
to  file  an  accurate  information  return.   To  the  extent  that  this 
system  allows  TINs  to  be  verified  in  advance  rather  than  years 
later,  the  costs  and  burdens  on  all  affected  parties  should  be 
reduced.   This  verification  also  should  limit  opportunities  for 
submitting  false  TINS,  which  some  taxpayers  may  try  to  escape 
federal  taxes.  Closing  off  these  opportunities  is  crucial  to  help 
ensure  that  the  correct  amount  of  taxes  is  paid  and  the  millions 
of  honest  taxpayers  are  treated  fairly. 


Mr.  Chairman,  this  concludes  my  statement.   Thank  you  for  the 
opportunity  to  present  our  views.   I  welcome  any  questions  that 
you  may  have. 


(268619) 


'Tax  Administration;   Approaches  for  Improving  Independent 
Contractor  Compliance  (GAO/GGD-92-108,  July  23,  1992)  and  Tax 
Administration;   Federal  Agencies  Should  Report  Service  Payments 
Made  to  corporations  (GAO/GGD-92-130,  Sept.  22,  1992). 


1430 

Mr.  McNuLTY.  I  just  have  a  couple  of  questions.  On  the  overall 
question  of  paperwork  reduction,  everyone  is  very  interested  in  this 
subject.  Do  you  think  that  the  information  reporting  can  be  ex- 
tended to  the  corporate  service  providers  without  imposing  an  in- 
tolerable paperwork  burden  on  the  private  sector  and  the  IRS? 

Mr.  Gandhi.  I  would  like  to  address  this  issue  of  the  information 
reporting  in  this  fashion.  I  think  above  all  we  must  recognize  the 
basic  compliance  problem.  If  you  were  to  look  at  the  numbers  of  the 
tax  gap,  which  is  a  result  of  the  tax  that  is  owed  but  not  paid,  then 
you  would  see  that  the  tax  gap  for  small  corporations  was  $7  bil- 
lion in  1992.  Half  of  it  results  from  unreported  income;  $3V2  billion, 
and  that  is  growing. 

In  other  words,  unreported  income  by  small  corporations  in  1980 
was  about  $5  billion.  By  1987,  that  had  risen  threefold,  to  $15  bil- 
lion. The  question  is  how  do  you  go  about  closing  that  gap? 

Second,  I  think  there  are  ways  in  which  you  can  modify  the  in- 
formation reporting  to  reduce  the  burden.  For  example,  you  can 
think  in  terms  of  not  issuing  the  information  returns  to  large  cor- 
porations. That  is,  if  a  large  corporation  were  to  provide  these  kind 
of  services  to  a  small  corporation,  then  information  reporting  on 
that  could  be  exempted. 

You  can  also  exempt  information  reporting  for  federally  regu- 
lated corporations.  But  above  all,  we  want  to  keep  in  mind  that  in- 
formation returns  induces  compliance. 

It  does  it  two  ways.  It  reminds  the  recipient  that  he  or  she  has 
received  the  income. 

Second,  it  would  tell  him  or  her  that  IRS  also  has  the  informa- 
tion. 

The  study  I  mentioned  in  my  testimony  about  debt  forgiveness 
provides  an  example.  These  are  the  debts  forgiven  by  FDIC  and 
RTC.  When  these  debts  were  forgiven  say  in  1989,  the  compliance 
was  1  percent.  When  they  had  information  reporting  on  such  debts, 
that  compliance  skyrocketed  to  48  percent.  And  it  also  gave  infor- 
mation to  IRS  to  locate  those  who  did  not  file  returns. 

If  you  add  in  IRS's  part,  then  total  compliance  eventually  was 
something  like  68  percent.  So  you  can  see  that  information  report- 
ing improves  compliance  very  much.  At  the  same  time,  it  really 
saves  IRS  from  going  in  strong  with  harsher  enforcement  measures 
such  as  auditing,  examination,  and  other  matters.  So  I  would 
strongly  urge  that  the  whole  issue  of  information  reporting  should 
be  viewed  in  this  perspective. 

Mr.  McNULTY.  Thank  you. 

In  your  study  on  reporting  of  debt  forgiveness  income,  did  you 
find  any  evidence  that  it  would  be  more  difficult  for  nonbank  finan- 
cial institutions  to  comply  with  the  reporting  requirement? 

Mr.  Gandhi.  I  don't  think  so,  sir. 

Mr.  McNULTY.  Do  you  have  any  figures  on  the  percentages  of 
loans  currently  being  originated  by  nonbanks? 

Mr.  Gandhi.  We  don't.  We  haven't  studied  that  subject. 

Mr.  McNULTY.  It  might  be  interesting  to  look  at  that.  If  we  could 
have  that  information,  we  would  appreciate  it. 

Thank  you  very  much  for  your  testimony. 


1431 
[The  information  follows:] 

One  way  to  answer  this  question  is  to  start  with  the  portion  of  loans  held  by 
banks  and  thrift  institutions.  According  to  data  published  by  the  Federal  Reserve 
Board  on  all  types  of  loans,  banks  ($3  trillion)  and  thrifts  ($1.1  trillion)  held  about 
$4.1  trillion  of  the  current  loans  through  the  second  quarter  of  1993.  This  $4.1  tril- 
lion represents: 

1)  Thirty-five  percent  of  the  $11.8  trillion  in  loans  among  all  financial  institutions. 
As  a  result,  nonoank  financial  institutions  accounted  for  65  percent  ($7.7  trillion). 

Such  institutions  included  insurance,  mortgage,  pension,  mutual  or  money  maricet 
fund,  finance,  and  trust  companies,  among  others. 

2)  Twenty-seven  percent  of  the  $15.3  trillion  in  loans  among  all  institutions.  As 
a  result,  all  nonbanx  institutions,  including  financial  ($7.7  trillion)  and  nonfinancial 
($3.5  trillion)  accounted  for  73  percent  ($11.2  trillion). 

Nonfinancial  institutions  included  nonfinancial  businesses  ($0.3  trillion);  federal. 
State  and  local  governments  ($0.8  trillion);  foreign  institutions  ($1.1  trillion);  and 
households  ($1.3  trillion). 

Mr.  McNuLTY.  We  will  now  proceed  to  panel  No.  1. 

Representing  the  National  Association  of  Manufacturers,  William 
G.  Dakin,  senior  tax  counsel,  Mobil. 

Representing  the  National  Association  of  Home  Builders,  Mark 
PCalish,  executive  vice  president,  Michael  T.  Rose  Associates,  Lau- 
rel, Md. 

Representing  the  U.S.  Chamber  of  Commerce,  Julie  Gackenbach, 
director  of  tax  policy. 

Representing  the  American  Institute  of  Certified  Public  Account- 
ants, Pamela  J.  Pecarich,  chairman.  Tax  Legislative  Liaison. 

STATEMENT  OF  WILLIAM  G.  DAKIN,  VICE  CHAIRMAN,  TAX- 
ATION POLICY  COMMITTEE,  NATIONAL  ASSOCIATION  OF 
MANUFACTURERS,  AND  SENIOR  TAX  COUNSEL,  MOBIL 
CORP. 

Mr.  Daken.  I  am  William  Dakin.  On  behalf  of  the  NAM,  I  appre- 
ciate this  opportunity  to  present  NAM's  views  on  some  of  the  pro- 
posals you  are  considering  today. 

With  respect  to  the  foreign  tax  provisions,  we  agree  that  how  the 
United  States  taxes  the  income  the  U.S.  companies  earn  from  their 
international  operations  should  be  examined  both  for  its  impact  on 
the  competitiveness  of  U.S.  companies  and  for  long  overdue  sim- 
plification. But  we  think  that  that  examination  should  look  at  our 
system  of  taxation  as  a  whole  and  not  piecemeal. 

Each  of  the  individual  proposals  before  you  today  would  increase 
taxes  on  some  or  another  segment  of  our  foreign  trade  and  com- 
merce, but  none  attempt  to  solve  the  problems  that  exist  in  how 
we  tax  the  income  that  our  companies  earn  operating  internation- 
ally. 

As  you  evaluate  these  proposals,  we  think  a  good  question  to  ask 
is  whether  adopting  them  would  help  or  harm  U.S.  jobs.  According 
to  the  Department  of  Commerce,  each  billion  dollars  in  U.S.  ex- 
ports maintains  directly  and  in  directly  about  19,000  jobs  in  the 
United  States.  Exports  currently  sustain  about  9  million  U.S.  jobs, 
of  which  about  half  are  new  jobs  that  were  created  by  export 
growth  since  1985.  So  the  proposal  to  increase  taxes  on  exports  by 
changing  the  sourcing  of  income  from  the  sale  of  inventory  property 
would  damage  a  sector  of  the  economy  that  has  been  a  major 
source  of  job  creation. 


1432 

The  proposal  would  go  further  and  increase  taxes  on  the  world- 
wide trading  activities  of  U.S.  companies  and  handicap  them  vis- 
a-vis their  foreign  competitors.  The  element  of  the  proposal  that 
would  require  an  examination  of  sales  to  foreign  affiliates  and  in- 
clude their  factors  in  the  composition  of  the  mix  would  add  a  great 
deal  of  complexity  to  what  is  already  a  complex  law. 

The  proposal  to  convert  the  foreign  tax  credit  into  a  deduction  is 
more  fundamental.  It  would  raise  the  effective  tax  rate  on  income 
earned  outside  the  United  States  from  the  35  percent  statutory 
rate  to  over  55  percent  if  the  foreign  country  taxed  the  same  way 
we  do  here  in  the  United  States. 

Changing  the  credit  to  a  deduction  would  make  it  difficult  if  not 
impossible  for  U.S.  companies  to  compete  with  foreign  companies 
for  business  opportunities  outside  the  United  States.  We  cannot 
compete  effectively  at  home  unless  we  are  free  to  compete  abroad. 
We  can't  surrender  foreign  markets  to  other  companies  and  retreat 
to  our  own  shores  and  expect  to  prosper. 

With  respect  to  the  compliance  provisions  or  proposals,  the  pro- 
posal to  deny  corporations  a  deduction  for  interest  paid  to  the  IRS 
on  tax  deficiencies  is  at  odds  with  the  fundamental  principle  of  our 
tax  law  that  we  impose  tax  on  the  income  remaining  after  payment 
of  all  ordinary  and  necessary  expenses.  One  of  these  expenses  is 
determining  one's  liability  for  tax. 

Business  today  is  often  complex  and  certainly  the  Tax  Code  is. 
As  the  director  of  taxes  at  General  Mills  put  it,  "There  are  areas 
of  the  Tax  Code  where  you  have  no  way  of  telling  whether  you  are 
coming  up  with  the  right  answer  because  of  the  complexity.  You 
wait  until  the  audit  and  hope  you  can  come  to  an  understanding 
with  the  government." 

Based  on  my  own  experience,  I  would  say  that  is  an  understate- 
ment. It  is  not  uncommon  to  take  many  years  to — ^for  the  IRS  to 
take  different  views  from  taxpayers  leaving  it  to  the  courts  to  de- 
cide who  is  right  many  years  after  the  disputed  transaction  oc- 
curred. If  the  taxpayer  prevails  and  the  IRS  pays  interest  to  the 
taxpayer,  then  the  taxpayer  is  taxable  on  that  interest.  We  think 
that  symmetry  and  fairness  require  that  if  the  IRS  prevails  and 
the  taxpayer  pays  interest,  that  the  interest  should  continue  to  be 
deductible  by  that  taxpayer  as  it  has  been  since  we  have  had  a  cor- 
porate income  tax. 

On  another  proposal,  we  point  out  that  corporations  already  pay 
a  very  high  rate  of  interest  on  tax  deficiencies,  5  points  above  the 
Federal  short-term  rate,  and  it  would  be  unnecessary  and  wrong  to 
add  to  this  burden  by  increasing  the  rates  further  in  some  unspec- 
ified amount  as  another  proposal  would  do. 

We  think  that  the  accuracy  related  penalties  in  the  code  are 
quite  adequate  to  deter  taxpayers  from  taking  unsubstantiated  po- 
sitions on  their  tax  returns  and  that  no  further  action  is  war- 
ranted. 

Under  the  category  miscellaneous  issues,  it  is  not  entirely  clear 
what  the  proposal  with  respect  to  environmental  laws  is.  It  has 
been  variously  described  as  a  proposal  to  deny  deductibility  on 
compensating  a  victim  of  an  environmental  spill  or  to  deny  a  de- 
duction for  cleaning  up  a  spill.  But  whichever  the  proposal  is,  the 


1433 

tax  analysis  is  exactly  the  same.  It  is  an  example  of  attempting  to 
convert  our  system  from  a  tax  on  net  income  into  something  else. 

If  you  spill  something,  you  naturally  want  to  clean  it  up  and  you 
naturally  want  to  compensate  anyone  who  might  have  been  dam- 
aged. Those  are  real  costs  that  you  incur  and  they  should  be  taken 
into  account  in  determining  your  income. 

The  environmental  laws  already  provide  very  substantial  pen- 
alties where  Congress  considered  them  to  be  appropriate  and  those 
are  not  deductible  for  tax  purposes.  To  disallow  deductions,  either 
for  compensating  a  victim  of  a  spill  or  for  cleaning  up  a  spill,  would 
in  effect  be  using  the  Tax  Code  to  penalize  indirectly  what 
Congress  has  not  seen  fit  to  penalize  directly.  We  don't  think  any 
more  penalties  are  needed. 

If  the  issue  is  raised,  it  ought  to  be  addressed  directly  and  not 
through  the  back  door  of  the  Tax  Code. 

With  respect  to  the  expensing  or  capitalization  of  environmental 
remediation  costs,  we  do  not  think  the  legislation  is  timely  at  this 
time.  Both  IRS  and  Treasury  are  considering  these  issues  and  the 
matter  may  well  be  resolved  administratively  without  the  need  for 
any  legislation.  The  issue  is  an  important  one.  The  environmental 
spending  will  amount  to  many,  many  billions  of  dollars  over  the 
next  few  years,  and  to  move  from  the  existing  rules  about 
expensing  to  capitalization  and  to  increase  the  after-tax  cost  of 
complying  with  the  environmental  laws  and  cleaning  up  the  envi- 
ronment would  be  a  very  substantial  burden  and  would  we  think 
be  counterproductive  to  achieving  our  national  environmental 
objectives. 

That  concludes  my  formal  presentation  unless  there  are  ques- 
tions. 

[The  prepared  statement  follows:] 


1434 


TESTIMONY  ON 
MISCELLANEOUS  REVENUE-RAISING  PROPOSALS 

BY 

WILLIAM  G.  DAKIN 

VICE  CHAIRMAN  OF  THE  TAXATION  POUCY  COMMTTTEE 

NATIONAL  ASSOCL\TION  OF  MANUFACTURERS 

BEFORE  THE 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

U.S.  HOUSE  WAYS  AND  MEANS  COMMTITEE 

SEPTEMBER  21,  1993 


I  am  William  G.  Dakin,  Senior  Tax  Counsel  of  MobD  Corporation  and  Vice  Chairman 
of  the  Taxation  Policy  Committee  of  the  National  Association  of  Manufacturers.  The  NAM  has 
some  12,000  members,  of  which  8,000  are  small  manufacturers.  I  appreciate  this  opportunity 
to  present  the  NAM's  views  on  some  of  the  proposals  that  you  will  be  considering  today. 

FOREIGN  TAX  PRQVISIONS 

How  the  United  States  taxes  income  earned  abroad  should  be  examined  both  for  its 
impact  on  the  competitiveness  of  U.S.  companies  and  for  long  overdue  simplification,  but  that 
examination  should  look  at  the  system  as  a  whole  and  not  piecemeal.  Each  of  the  five  proposals 
before  you  today  would  increase  taxes  on  our  foreign  trade  and  commerce,  but  none  of  them 
attempt  to  solve  the  serious  problems  that  exist  in  how  we  tax  the  income  that  our  companies 
earn  outside  the  United  States. 

In  evaluating  these  proposals  a  good  question  to  ask  is  whether  adopting  them  would  help 
or  harm  U.S.  trade  and  U.S.  jobs.  For  example,  U.S.  manufactured  exports  account  for 
between  30  and  40%  of  the  nation's  economic  growth  since  1987.  According  to  the  U.S. 
Commerce  Department,  each  $1  billion  in  U.S.  exports  maintains,  directiy  and  indirectiy, 
19,000  jobs  in  the  U.S.  Exports  sustain  9  million  jobs-about  half  of  these  are  new  jobs  created 
by  export  growth  since  1985.  The  proposed  change  in  how  we  tax  U.S.  exports  (the  sourcing 
of  income  from  the  sale  of  inventory  property  provision)  would  damage  the  one  sector  of  the 
economy  that  has  been  a  major  source  of  job  creation,  as  well  as  being  administratively  very 
complex. 

More  importantiy,  the  proposal  to  convert  the  foreign  tax  credit  into  a  deduction  would 
raise  the  effective  tax  rate  on  income  earned  outside  the  United  States  from  35%  to  55%, 
assunung  that  the  foreign  country  imposes  tax  at  tiie  same  rate  as  the  United  States.  The 
purpose  of  the  foreign  tax  credit  is  to  prevent  double  taxation  of  foreign  source  income. 
Changing  the  credit  to  a  deduction  would  make  it  difficult  if  not  impossible  for  U.S.  companies 
to  compete  with  foreign  companies  for  business  opportunities  outside  the  United  States.  U.S. 
companies  cannot  compete  effectively  at  home  unless  we  are  free  to  compete  abroad.  We  caimot 
surrender  foreign  markets  to  others,  retreat  to  our  own  shores,  and  expect  to  prosper. 

COMPLIANCE 

The  proposal  to  deny  corporations  a  deduction  for  interest  paid  to  the  Internal  Revenue 
Service  on  tax  deficiencies  is  at  odds  with  the  fundamental  principle  of  U.S.  tax  law  that  tax  is 
imposed  on  the  net  income  remaining  after  payment  of  all  ordinary  and  necessary  expenses. 
One  of  these  expenses  is  determining  one's  liability  for  tax. 


1435 


Business  today  is  often  very  complex,  and  so  is  the  tax  code.  As  quoted  in  a  recent 
article,   Sandy  Navin  of  General  Mills  stated: 

There  are  areas  of  the  tax  code  where  you  have  no  way  of  telling 
whetho^  you're  coming  up  with  the  right  answer,  because  of  the 
complexity.  You  wait  until  the  audit  and  hope  you  can  come  to  an 
understanding  with  the  government.' 

It  is  not  uncommon  for  the  IRS  to  take  a  different  view  from  a  taxpayer,  leaving  it  to  the 
courts  to  decide  who  is  right  many  years  after  the  disputed  transaction  occurred.  If  the  taxpayer 
prevails  and  the  IRS  pays  interest  on  an  overpayment  of  tax,  the  taxpayer  must  pay  tax  on  that 
interest.  Symmetry  and  feimess  require  that  if  the  IRS  prevails  and  the  taxpayer  pays  interest 
on  a  deficiency,  the  interest  should  continue  to  be  deductible  by  the  taxpayer,  as  it  has  been 
since  we  have  had  an  income  tax. 

Corporations  already  pay  a  very  high  rate  of  interest  on  tax  deficiencies  (5  points  above 
the  federal  short-term  rate)  and  it  would  be  unjust  to  add  to  this  burden  by  making  the  interest 
non-deductible. 

The  accuracy  related  penalty  provisions  of  the  Code  are  quite  adequate  to  deter  taxpayers 
from  taking  unsubstantiated  positions  on  their  tax  returns.   No  further  action  is  warranted. 

NflSCELLANEOUS  ISSUES 

The  proposal  to  disallow  deductions  for  compensatory  damages  under  certain 
environmental  laws  is  another  example  of  attempting  to  convert  our  system  from  a  tax  on 
net  income  into  something  else.  If  a  truck  containing  milk  were  so  unfortunate  as  to  have  an 
accident,  there  is  no  question  that  the  cost  of  cleaning  up  the  spilled  milk  and  compensating 
anyone  damaged  by  the  spill  would  be  an  ordinary  and  rxessary  expense  of  engaging  in  the 
milk  business.  The  tax  treatment  of  cleaning  up  a  spill  should  not  depend  upon  what  was 
spilled,  for  example  if  the  truck  had  contained  oil  or  hazardous  waste  instead  of  milk. 

The  environmental  laws  provide  substantial  penalties  where  these  are  appropriate.  These 
penalties  are  not  deductible  for  tax  purposes.  To  disallow  a  deduction  for  the  expense  of 
compensating  persons  damaged  by  an  accident  occurring  in  the  course  of  business  would  in 
effect  penalize  indirectly  conduct  that  Congress  has  not  seen  fit  to  penalize  directly.  The  NAM 
does  not  think  that  additional  penalties  are  needed,  but  if  the  issue  is  raised  it  should  be 
addressed  as  such  and  not  through  the  back  door  of  the  tax  law. 

The  proposal  to  clarify  the  treatment  of  environmental  remediation  costs  is  at  worst 
unnecessary  and  at  best  premature.  These  issues  are  under  active  consideration  at  IRS  and 
Treasury  and  nuy  well  be  resolved  administratively,  without  the  need  for  legislation.  Revenue 
considerations  are  only  one  part  of  the  formulation  of  a  national  environmental  policy. 
Environmental  spending  will  amount  to  many  billions  of  dollars  over  the  next  few  years.  The 
impact  on  the  business  community  will  be  substantial.  Raising  the  after-tax  cost  of  improving 
the  environment  would  be  counterproductive. 

CONCLUSION 

This  concludes  my  formal  presentation.   I  would  be  happy  to  take  any  questions. 


Norton,  Rob,  "Our  Screwed-up  Tax  Code,"  Fortune.  September  6,  1993,  p.  34 


1436 

Mr.  McNuLTY.  We  will  go  through  the  whole  panel  first  and  re- 
ceive your  statements,  and  then  go  to  questions. 
Mr.  Kalish. 

STATEMENT  OF  THOMAS  N.  "TOMMT*  THOMPSON,  FHIST  VICE 
PRESroENT,  NATIONAL  ASSOCIATION  OF  HOME  BUILDERS, 
AS  PRESENTED  BY  MARK  KALISH,  EXECUTIVE  VICE  PRESI- 
DENT, MICHAEL  T.  ROSE  ASSOCIATES,  LAUREL,  MD. 

Mr.  Kalish.  Grood  morning,  Mr.  Chairman,  members  of  the  sub- 
committee. 

I  am  Mark  Kalish,  executive  vice  president  of  Michael  T.  Rose 
Associates,  a  homebuilding  and  land  development  company  in 
Laurel  Md.  I  am  also  a  member  of  the  National  Association  of 
Home  Builders,  an  association  of  165,000  member  firms  engaged  in 
all  aspects  of  homebuilding  and  land  development. 

I  am  pleased  to  have  this  opportunity  to  appear  before  the  House 
Ways  and  Means  Subcommittee  on  Select  Revenue  Measures  and 
to  comment  on  certain  of  the  miscellaneous  revenue  raising  propos- 
als which  are  the  subject  of  these  hearings.  Specifically,  my  oral 
testimony  will  be  on  comments  limited  to  the  proposals  on  section 
530  of  the  Revenue  Act  of  1978  and  the  capitalization  and  amorti- 
zation of  certain  environmental  remediation  costs. 

We,  the  National  Association  of  Home  Builders,  oppose  the  re- 
peal of  the  safe  harbor  contained  in  section  530  of  the  Revenue  Act 
of  1978  for  the  construction  industry.  Our  industry,  building  single 
family  houses,  is  comprised  mostly  of  small  businessmen  and  busi- 
nesswomen. Over  50  percent  of  our  members  build  less  than  10 
houses  per  year.  That  is  less  than  one  house  per  month.  Less  than 
2  percent  of  our  builders  build  over  500  houses  per  year. 

The  single  family  homebuilding  business  is  comprised  of  small 
businesses  in  virtually  every  community  in  the  country.  Because 
the  construction  of  a  home  entails  the  transportation  to  a  job  site 
of  a  wide  variety  of  different  materials  which  are  assembled  or  fab- 
ricated by  a  host  of  different  trades  at  the  job  site  and  the  home 
sites  at  which  the  trades  work  are  located  differently  every  day,  the 
relationship  between  the  homebuilder  and  the  person  who  performs 
the  different  trades  varies  widely  in  our  industry. 

Another  complicating  factor,  principally  from  the  IRS  approach 
to  many  homebuilders,  is  the  fact  that  the  homebuilder  routinely 
subs  out;  that  is,  he  hires  independent  subcontractors  to  perform 
services  which  may  in  the  mind  of  the  IRS  constitute  performance 
of  common  labor.  In  those  instances,  the  IRS  often  alleges  that  the 
person  is  an  employee  rather  than  an  independent  contractor. 

The  construction  of  single  family  homes  is  basically  the  coordina- 
tion of  up  to  18  different  subcontractors.  During  the  past  30  years, 
the  role  of  the  subcontractor  and  professional  specialist  in  the 
homebuilding  industry  has  increased  significantly. 

Framing,  roofing,  bricklaying,  foundations,  masonry  are  gen- 
erally done  by  subcontractors  on  a  labor  only  basis,  with  the  mate- 
rial provided  by  the  builder.  Other  jobs,  such  as  flooring,  insula- 
tion, and  painting  involves  subcontractors  which  supply  both  labor 
and  materials.  The  homebuilding  industry  as  well  as  the 
nonresidential  construction  industry  is  characterized  by  extensive 
subcontracting  of  actual  work. 


1437 

The  NAHB  surveyed  builders  in  1987  and  concluded  that  the  ma- 
jority of  the  contractors — that  is  those  people  who  build  for  a  fee 
on  somebody  else's  land — and  the  merchant  builders,  those  people 
who  build  on  their  own  land  and  sell  a  house  and  the  land  to  the 
buyer — ^the  merchant  builder  usually  acts  as  his  own  general  con- 
tractor— ^have  subcontracted  more  than  75  percent  of  the  total  con- 
struction costs.  Larger  builders  subcontract  an  even  larger  share 
than  small  builders. 

The  same  1987  study  indicated  that  residential  builders  subcon- 
tracted approximately  $41  million  or  40  percent  of  their  construc- 
tion receipts. 

The  primary  reason  for  the  extensive  use  of  subcontractors  is  the 
fact  that  a  typical  specialist  is  only  needed  for  a  short  period  of 
time.  It  takes  about  3  days  to  4  days  to  put  in  a  foundation.  If  you 
are  onlv  building  10  houses  a  year,  that  means  that  you  are  only 
using  the  subcontractor  for  maybe  30  or  40  days  a  year,  and  the 
subcontractor  would  then  work  for  other  people. 

The  general  contractor  doesn't  have  the  expertise  or  the  capacity 
to  manage  all  the  activities  that  each  one  of  these  specialists  would 
have  to  take  care  of  such  as  monitoring  the  hours  worked,  purchas- 
ing of  material,  et  cetera.  Therefore,  tne  general  contractor  issues 
a  subcontract  based  upon  negotiation  or  competitive  bids  and 
leaves  the  subcontractor  to  figure  out  how  to  accomplish  his  work. 
The   subcontractor   is  usually   responsible  for   supplying  the   nec- 


essary building  materials.  Although  the  subcontractor's  work  may 

ibiei 
lationsnips  with  their  subcontractors  just  as  consumers  tend  to  pa- 


be  subiect  to  competitive  bids,  most  builders  develop  long  term  re- 


tronize  the  same  doctors  and  dentists  and  law  firms. 

Even  in  long-term  relationships,  the  relationship  between  the 
general  contractor  and  the  merchant  builder  and  the  subcontractor 
is  different  than  between  the  employer  and  the  employee. 

The  general  contractor  merchant  builder  is  not  obligated  to  pro- 
vide continuing  employment  for  the  subcontractor,  but  the  sub- 
contractor still  remains  liable  for  what  he  has  done  and  all  the 
building  practices  that  he  has  employed. 

We  believe  that  the  current  rules  under  section  530  of  the  Reve- 
nue Act  provide  adequate  relief  for  the  construction  industry,  for 
the  taxpayers  who  are  involved  in  disputes  with  regard  to  worker 
reclassification. 

Repeal  of  that  section  with  respect  to  construction  workers  would 
be  most  harmful  to  businesses  in  regions  which  customarily  sub 
out  to  independent  contractors  under  factual  circumstances  and 
longstanding  industry  practices  which  may  not  satisfy  the  20  factor 
tests. 

Finally,  I  read  in  the  Wall  Street  Journal  that  the  health  care 
proposals  would  define  an  employee  to  include  independent  con- 
tractors who  earn  more  than  80  percent  of  their  annual  income 
from  one  employer.  The  President  looked  at  the  proposal  and  be- 
lieved as  we  do  that  it  would  create  a  serious  problem  and  dropped 
it  in  the  package.  We  mention  it  here  because  of  our  serious  con- 
cern and  hope  that  the  committee  will  follow  the  President's  lead. 

The  second  item  that  I  would  like  to  testify  on  is  the  capitaliza- 
tion and  amortization  of  environmental  remediation  costs.  The 
National  Association  of  Home  Builders  opposes  this  proposal  that 


1438 

would  require  environmental  remedy  costs  to  be  capitalized  and 
amortized  over  a  uniform  period.  Any  proposal  to  clarify  the  treat- 
ment of  the  environmental  remediation  costs  by  specifVing  costs 
which  must  be  capitalized  should  not  include  unforeseen  hazardous 
waste  cleanup  costs. 

I  would  like  to  thank  you  on  behalf  of  the  National  Association 
of  Home  Builders  for  the  opportunity  to  present  our  views  on  these 
proposals  and  would  be  pleased  to  answer  any  questions. 

Thank  you. 

Mr.  McNuLTY.  Thank  you  very  much. 

[The  prepared  statement  of  Mr.  Thompson  follows:] 


1439 

STATEMENT 

of 

THE  NATIONAL  ASSOCIATION  OF  HOME  BUILDERS 

before  the 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

COMMITTEE  ON  WAYS  AND  MEANS 

of  the 

UNITED  STATES  HOUSE  OF  REPRESENTATIVES 

on 

MISCELLANEOUS  REVENUE-RAISING  PROPOSALS 

September  21,  1993 


Mr.  Chairman  and  Members  of  the  Subcommittee: 

My  name  is  Thomas  N.  "Tommy"  Thompson,  I  am  a  builder  from  Owensboro, 
Kentucky.  I  am  a  second  generation  builder  and  current  president  of  Thompson  Homes.  My 
company  builds  approximately  fifty  single-family  homes  each  year.  The  company  is  also 
involved  in  multi-family  housing,  seniors  housing,  land  development,  property  management, 
and  general  contracting. 

I  am  currently  serving  as  First  Vice  President  of  the  National  Association  of  Home 
Builders  (NAHB),  an  association  of  165,000  member  firms  engaged  in  all  aspects  of  home 
building  and  land  development.  I  am  pleased  to  have  the  opportunity  to  appear  before  the 
House  Ways  and  Means  Subcommittee  on  Select  Revenue  Measures,  and  to  comment  on 
certain  of  the  miscellaneous  revenue-raising  proposals  which  are  the  subject  of  these  hearings. 
Specifically,  I  will  comment  on  the  proposals  to  repeal  Section  530  of  the  Revenue  Act  of 
1 978,  modify  the  standard  for  nonrecognition  of  gain  on  exchanges  of  like-kind  property,  and 
capitalization  and  amortization  of  certain  environmental  remediation  costs. 

1.  REPEAL  OF  THE  SAFE  HARBOR  UNDER  SECTION  530  OF  THE  REVENUE  ACT  OF 

1978  FOR  CONSTRUCTION  INDUSTRY  EMPLOYERS 

Congress  enacted  §530  of  the  Revenue  Act  of  1978  to  provide  relief  to  taxpayers 
involved  in  tax  controversies.  This  Act  provides  generally  that  if  a  business:  (1 )  did  not  treat 
an  individual  as  an  employee  for  any  period;  (2)  filed  all  tax  returns  (including  Forms  1 099)  on 
a  basis  consistent  with  its  tax  position;  and  (3)  has  a  "reasonable  basis"  for  treating  the 
worker  as  an  independent  contractor,  the  government  is  not  to  raise  the  employment  tax  issue 
in  an  examination. 

A  reasonable  basis  that  is  acceptable  under  §530  includes  having  a  case  or  ruling  that 
supports  the  taxpayer's  position,  a  previous  IRS  audit  in  which  the  independent  contractor 
treatment  resulted  in  no  assessment,  or  a  long-standing  industry  practice. 

When  a  "safe  haven"  under  §530  is  found,  a  company  is  not  subject  to  back  taxes  or 
penalties,  or  obligated  in  the  future  to  withhold  income  taxes  from  contractor  payments  or  pay 
employment  taxes  on  independent  contractors. 

NAHB  strongly  opposes  the  proposal  to  modify  the  existing  safe  harbor  in  section  530 
of  the  Revenue  Act  of  1 978  to  repeal  the  longstanding  practice  of  an  industry  safe  harbor  with 
respect  to  the  construction  industry.  This  safe  harbor  is  of  direct  and  significant  import  to  the 
building  industry.  Repeal  with  respect  to  construction  workers  would  be  most  harmful  to 
businesses  and  regions  which  customarily  "sub-out"  to  independent  contractors  under  factual 
circumstances  which  may  not  satisfy  the  twenty  factor  test. 


1440 


INDUSTRY  PROFILE 

The  industry,  building  single  family  housing.  Is  comprised  mostly  of  small  businessmen 
and  women.  Over  50  percent  of  NAHB  members  build  less  than  10  houses  per  year. 
Approximately  1 5  percent  build  more  than  25  houses  per  year  and  less  than  2  percent  of  the 
builders  build  over  500  houses  per  year.  The  single  family  home  building  business  is  clearly 
comprised  of  small  businesses  in  virtually  every  community  in  the  country. 

Because  the  construction  of  a  home  entails  the  transportation  to  a  job  site  of  a  wide 
variety  of  different  materials  which  are  assembled  and/or  fabricated  by  a  host  of  different 
trades  and  because  such  job  site  necessarily  changes  as  the  homes  are  built,  the  relationship 
between  the  homebuilder  and  the  person  who  performs  the  different  trades  varies  widely  in 
this  industry.  Another  complicating  factor,  principally  from  the  standpoint  of  the  approach  the 
Internal  Revenue  Service  has  made  to  many  homebuilders,  is  the  fact  that  a  homebuilder 
routinely  does  "sub-out"-  that  is,  hire  an  independent  contractor  to  perform  services  which 
may,  in  the  minds  of  the  IRS,  constitute  performance  of  "common  labor".  In  those  instances, 
the  IRS  often  alleges  that  the  person  is  an  employee  rather  than  an  independent  contractor. 
The  construction  of  single  family  homes  is  basically  the  coordination  of  the  work  of  up  to  18 
different  subcontractors. 

Since  the  volume  of  work  in  the  homebuilding  industry  is  very  unpredictable  and 
seasonal,  there  is  a  strong  necessity  for  the  business  owners  to  match  labor  to  business  needs 
and  not  to  be  encumbered  by  large  permanent  payrolls.  Ten  years  ago  when  there  was  a 
booming  housing  market,  homebuilders  found  it  efficient  to  maintain  more  full-time  employees 
in  all  the  skilled  trades.  In  today's  soft  market,  two  out  of  three  builder  firms  are  organized 
as  corporations  and  about  one-fourth  are  sole  proprietorships.  During  the  last  ten  years,  more 
builders  have  been  organizing  as  Subchapter  S  corporations,  so  that  they  can  combine  limited 
liability  with  taxation  on  only  individual  earnings. 

Builders'  business  organizational  structure  tends  to  depend  on  the  size  of  the  business. 
About  25  percent  of  small-volume  builders  are  sole  proprietorships,  whereas  only  8  percent 
of  the  medium-  and  large-volume  builders  choose  to  operate  under  such  entity  structure.  The 
average  remodeling  firm  has  one  office  employee  on  payroll  and  operates  in  one  or  two 
counties.  Approximately  half  of  the  remodeling  firms  are  corporations,  while  44  percent  are 
sole  proprietorships. 

LAND  DEVELOPMENT 

Home  builders  vary  considerably  in  the  degree  to  which  they  directly  perform  all  the 
operations  it  takes  to  develop  land  and  build  and  market  homes.  According  to  NAHB's  1987 
builder  survey,  less  than  half  of  all  builders  buy  the  raw  land,  install  the  infra-structure, 
construct  the  units,  and  then  sell  the  product.  Over  half  buy  lots  from  other  builders  or 
developers,  use  subcontractors  for  all  the  construction  work,  sell  through  real  estate  agents, 
and  generally  only  contribute  their  vision  and  organizing  skills  to  the  project. 

The  difficulty  builders  have  recently  experienced  obtaining  financing  for  property 
acquisition  and  development  may  result  in  land  development  becoming  more  heavily 
concentrated  among  large  firms.  Moreover,  more  stringent  requirements  for  loans  from 
financial  institutions  could  mean  that  builders  will  look  more  often  to  land  developers  to 
provide  financing  for  purchases  of  developed  lots.  Increasing  fees  and  regulation  may  also 
cause  land  development  to  become  more  concentrated  among  well-financed  specialists. 

ROLE  OF  SUBCONTRACTORS 

During  the  past  30  years,  the  role  of  subcontractors  and  professional  specialists  in  the 
home  building  industry  has  increased  significantly.  Most  builders  believe  that  the  trend  toward 
increased  use  of  subcontractors  will  continue.  Framing,  roofing,  bricklaying,  foundations,  and 
masonry  are  generally  done  by  the  subcontractors  on  a  labor-only  basis,  with  materials 
provided  by  the  builder.  Other  jobs,  such  as  flooring,  insulation,  and  painting,  involve 
subcontracts  for  both  labor  and  material. 

In  1 959,31  percent  of  NAHB  survey  respondents  subcontracted  three-quarters  or  more 
of  their  construction  costs.  This  figure  increased  to  55  percent  by  1 987.  Over  the  same 
period,  the  share  of  builders  subcontracting  one-quarter  or  less  of  their  construction  costs 


1441 


declined  from  1  9  percent  to  14  percent.  Large-volume  builders  tend  to  subcontract  a  larger 
share  of  the  construction  cost.  Builders  in  the  South  use  subcontractors  for  a  larger  share  of 
construction  than  builders  in  the  Northeast,  Midwest,  and  West.  NAHB's  1987  Survey  of 
Builders  indicated  that  subcontractors  were  the  most  relied  upon  source  from  which  to  obtain 
materials  and  equipment. 

From  the  worker's  point  of  view,  a  worker  with  a  skill  can  generally  earn  more  as  a 
contractor  working  for  a  variety  of  customers  than  he  could  on  straight  salary  working  for  a 
single  employer.  The  worker  may  also  take  pride  in  being  independent  of  a  boss  supervising 
the  details  of  his  work. 

The  home  building  industry  (as  well  as  the  non-residential  construction  industry)  is 
characterized  by  extensive  subcontracting  of  the  actual  construction  work.  An  NAHB  survey 
of  builders  in  1 987  showed  that  the  majority  of  general  contractors  (those  that  build  for  a  fee 
on  someone  else's  land)  and  merchant  builders  (those  that  build  on  land  they  own  and  offer 
the  house  and  land  for  sale  together)  subcontracted  more  than  75  percent  of  the  total 
construction  cost.  Larger  builders  subcontracted  an  even  larger  share  than  small  builders.  The 
1987  Census  of  Construction  indicated  that  residential  builders  subcontracted  $41  billion,  or 
40  percent  of  the  value  of  their  construction  receipts.  An  earlier  study  by  the  Bureau  of  Labor 
Statistics  found  that  construction  of  the  typical  home  involves  about  15  different 
subcontractor  firms. 

The  primary  reason  for  the  extensive  use  of  subcontractors  is  the  episodic,  uneven 
nature  of  construction  and  the  fact  that  a  particular  type  of  specialist  is  only  needed  for  a 
short  period  during  the  construction  process.  Moreover,  the  general  contractor  does  not  have 
either  the  expertise  or  the  capacity  to  oversee  and  manage  the  activities  of  each  specialist, 
monitoring  the  number  of  hours  worked  and  purchasing  all  the  materials,  so  the  general 
contractor  issues  a  subcontract  based  on  negotiation  or  competitive  bids  and  leaves  it  to  the 
subcontractor  to  figure  out  how  to  accomplish  the  work,  with  the  subcontractor  often 
responsible  for  supplying  the  necessary  building  materials. 

Most  builders  are  small  firms.  The  majority  of  home  builder  members  of  NAHB  build 
less  than  1 0  homes  per  year.  The  majority  of  subcontractor  firms  are  similarly  small,  although 
it  is  not  uncommon  for  a  subcontractor  firm  to  be  larger  than  the  builders  for  whom  it  works. 

In  1987,  there  were  1.4  million  establishments  characterized  by  the  Census  of 
Construction  as  "special  trade  contractors"  working  as  subcontractors  to  residential  and  non- 
residential builders,  as  well  as  serving  consumers  and  non-construction  firms  directly. 
Establishments  with  payrolls,  of  which  there  were  342,000,  had  total  receipts  of  $ 204  billion, 
while  the  1 .06  million  establishments  with  no  payroll  had  receipts  of  $34  billion.  Out  of  total 
receipts,  about  35  percent  went  toward  the  purchase  of  materials  and  supplies  and  another 
7  percent  was  subcontracted  to  other  subcontractor  firms. 

Although  subcontract  work  may  be  subject  to  competitive  bids,  most  builders  develop 
long-term  relationships  with  their  subcontractors,  just  as  consumers  tend  to  patronize  the 
same  doctors,  dentists,  or  lawn  care  firms.  Even  in  long-term  relationships  and  where  the 
subcontractor  has  no  employees,  however,  the  relationship  between  general  contractor  and 
sub  is  different  than  that  between  employer  and  employee.  The  builder  is  not  obligated  to 
provide  continuing  employment  for  the  sub  and  the  sub  remains  liable  to  the  builder  for 
performance  in  ways  an  employee  generally  is  not.  There  are  a  variety  of  other  distinctions, 
many  of  which  are  reflected  in  the  common-law  tests  currently  used  to  distinguish 
independent  contractors  from  employees. 

Construction  of  a  single  family  home  involves  about  1 ,000  hours  of  on-site  labor,  and 
since  it  takes  an  average  of  about  six  months  to  complete  a  house,  that's  equivalent  to  one 
full-time  worker.  Those  1,000  hours,  however,  may  be  performed  by  as  many  as  100 
different  workers,  most  of  whom  are  proprietors  or  employees  of  subcontractor  firms.  Even 
if  a  general  contractor  knew  who  all  the  workers  were  and  how  much  of  the  payment  to 
subcontractors  was  for  labor,  it  would  be  an  overwhelming  burden  for  a  builder  to  account  for 
tax  withholding  for  the  army  of  workers  involved  in  building  a  home. 

The  1989  NAHB  remodelers  survey  showed  that  remodelers  heavily  rely  on 
subcontractors.  Ninety-three  percent  of  the  remodelers  used  subcontractors  during  1988. 
Twenty-five  percent  attributed  50  to  99  percent  of  their  dollar  volume  to  work  done  by 


1442 


subcontractors  and  5  percent  subcontracted  100  percent  of  their  dollar  volume.  The  survey 
also  suggested  that  the  usage  of  subcontractors,  rather  than  hiring  of  employees,  was  market, 
as  opposed  to  tax,  driven. 

COMPLIANCE 

NAHB  fully  supports  the  proposition  that  every  American  must  pay  his  full  share  of 
Federal  income  tax.  It  is  the  job  of  the  Internal  Revenue  Service  to  resolve  the  compliance 
problems  in  a  fair  and  equitable  manner.  Improved  compliance  should  be  achieved  through 
increasing  business's  compliance  with  the  reporting  requirements.  NAHB  opposes  any 
governmental  effort  to  encourage  businesses  to  classify  independent  contractors  as 
employees.  We  recognize  that  the  government  is  concerned  with  improving  the  efficient 
collection  of  revenue  with  respect  to  errors  in  the  classification  of  workers.  NAHB  believes 
that  the  current  rules  under  Section  530  of  the  Revenue  Act  of  1 978  provide  adequate  relief 
for  construction  industry  taxpayers  who  become  involved  in  disputes  with  respect  to  worker 
reclassification. 


2.  AMENDMENT  OF  THE  LIKE-KIND  EXCHANGE  RULES  TO  REQUIRE  THAT  CODE 

SECTION  1031  PROPERTY  BE  "SIMILAR  OR  RELATED  IN  SERVICE  OR  USE"  TO  THE 
PROPERTY  EXCHANGED,  EXCEPT  IN  THE  CASE  OF  CONDEMNATIONS 

Section  1031  provides  for  nonrecognition  treatment  on  the  exchange  of  property  held 
for  productive  use  in  a  trade  or  business  or  for  investment  if  such  property  is  exchanged 
solely  for  property  of  like  kind  which  is  to  be  held  either  for  productive  use  in  a  trade  or 
business  or  for  investment.  Unimproved  real  estate  that  is  exchanged  for  improved  real  estate 
qualifies  as  a  like-kind  exchange.  Except  in  the  case  of  a  condemnation  of  real  estate,  the 
proposal  would  narrow  standard  for  nonrecognition  of  gain  under  section  1031  to  permit 
nonrecognition  only  if  the  property  exchanged  is  "similar  or  related  in  service  or  use",  as  is  the 
standard  under  section  1033,  pertaining  to  involuntary  conversions  of  property.  NAHB 
opposes  any  such  change  to  the  existing  rule. 

The  ability  to  exchange  property  without  incurring  taxes  encourages  the  exchange  of 
rental  real  estate  and  enhances  the  ability  of  real  estate  owners  to  best  match  their  objectives 
with  the  objectives  of  a  rental  project.  With  the  like  kind  exchange  rule,  apartment  building 
owners  who  are  best  suited  to  own  and  operate  a  particular  kind  of  rental  project  will  be  more 
likely  to  continue  owning  and  operating  the  same  kind  of  property  even  if  market  conditions 
change  the  original  property's  focus.  For  instance,  investors  who  operate  low-  or  moderate- 
income  rental  projects  very  efficiently  could  find  that  their  projects  have  become  moderate- 
and  middle-income  because  of  gentrification,  neighborhood  change  or  economic  growth  are 
able,  under  current  rules,  to  exchange  their  original  project  for  unimproved  real  estate  to 
construct  a  new  project  that  better  serves  the  market  with  which  they  are  familiar. 

The  recent  tax  bill  recognized  the  economic  difficulties  facing  the  real  estate 
construction  industry  in  general,  and  low-income  housing  development  in  particular.  The 
proposed  change  would  have  a  countervailing  impact  on  the  economic  stimulative  effect  of 
the  recently  passed  plan. 


3.  CAPITALIZATION      AND      AMORTIZATION      OF      CERTAIN      ENVIRONMENTAL 

REMEDIATION  COSTS 

Under  current  law,  the  cost  of  incidental  repairs  which  neither  materially  add  to  the 
value  of  property  nor  prolong  its  life,  but  keep  it  in  an  ordinarily  efficient  operating  condition, 
may  be  deducted  as  a  business  expense.  Amounts  paid  or  incurred  to  materially  add  to  the 
value,  or  substantially  prolong  the  useful  life,  of  property  owned  by  the  taxpayer,  or  to  adapt 
property  to  a  new  or  different  use,  must  be  capitalized.  Expenditures  that  materially  increase 
the  value  of  property  must  be  capitalized.  Recent  IRS  rulings  have  required  capitalization  of 
asbestos  removal  costs  (TAM  9240004,  reasoning  that  the  property's  value  increased  by 
eliminating  the  human  health  risk)  and  the  costs  of  remediating  PCB  contaminated  soil  (TAM 
9315004,  reasoning  that  the  activities  were  part  of  a  general  plan  of  rehabilitation  which 
increased  the  value  of  the  property). 

We  would  be  inclined  to  agree  that  capitalization  treatment  for  hazardous  waste  clean- 


1443 


up  would  be  proper  where  that  cost  is  accounted  for  in  determining  the  original  sales  price 
of  the  real  property.  However,  where  the  buyer-builder  incurs  hazardous  waste  clean-up  costs 
subsequent  to  construction  of  a  building  project,  such  amounts  should  be  expensed  as  an 
expenditure  which  does  not  make  the  property  more  valuable,  more  useful,  or  longer-lived. 
NAHB  opposes  any  proposal  which  would  require  that  all  environmental  remediation  costs  be 
capitalized  and  amortized  over  a  uniform  period.  Any  proposal  to  clarify  the  treatment  of 
environmental  remediation  costs  by  specifying  costs  which  must  be  capitalized  should  not 
include  unforseen  hazardous  waste  clean-up  costs. 

CONCLUSION 

The  instant  proposal  with  respect  to  section  530  would  unfairly  penalize  compliant 
builders  and  subcontractors  who  have  legitimately  followed  industry  custom.  The  proposal 
to  modify  the  like  kind  exchange  rules  would  have  a  directly  negative  impact  on  a  sustained 
economic  recovery  in  the  real  estate  sector,  at  the  most  inopportune  time.  The  environmental 
remediation  cost  proposal  must  be  crafted  so  as  not  to  unfairly  penalize  real  estate  developers 
for  unforseen  occurrences  in  housing  construction. 

The  National  Association  of  Home  Builders  appreciates  this  opportunity  to  present  our 
views  on  the  proposed  amendments. 


1444 

Mr.  McNuLTY.  Next  we  will  go  to  the  U.S.  Chamber  of  Com- 
merce, Julie  Gackenbach. 

STATEMENT  OF  JULIE  LEIGH  GACKENBACH,  DIRECTOR,  TAX 
POLICY,  U.S.  CHAMBER  OF  COMMERCE;  ACCOMPANIED  BY 
GARY  LaBRANCHE,  MANAGER,  ASSOCIATION  DEPARTMENT 

Ms.  Gackenbach.  Good  morning,  Mr.  Chairman. 

I  am  director  of  tax  policy  for  the  U.S.  Chamber  of  Commerce. 
Accompanying  me  today  is  Gary  LaBranche,  manager  of  our  Asso- 
ciation Department. 

The  Chamber  is  the  world's  largest  business  federation,  rep- 
resenting more  than  215,000  members.  On  behalf  of  the  members 
of  our  federation,  we  appreciate  the  opportunity  to  present  our 
views  on  the  various  revenue  proposals  that  are  the  subject  of  this 
hearing. 

American  business  needs  simplicity  and  stability  in  the  Tax 
Code.  The  Chamber  is  concerned  that  merely  a  month  after 
Congress  enacted  the  largest  tax  increase  in  the  Nation's  history 
the  committee  is  seriously  considering  sweeping  revenue  raising 
proposals.  The  business  community  has  yet  to  have  time  to  react 
to  the  recent  changes.  In  fact,  many  of  the  provisions  are  yet  to 
take  effect. 

Business  men  and  women  across  the  country  are  facing  the 
seemingly  daunting  task  of  figuring  out  how  to  comply  with  the 
host  of  recently  enacted  changes.  They  are  unprepared  at  this  time 
to  deal  with  another  round  of  changes  designed  to  raise  revenue. 
As  such,  we  are  particularly  pleased  that  the  Treasury  shares  our 
concerns  regarding  many  of  these  issues. 

The  committee  today  is  considering  proposals  to  change  several 
of  the  foreign  tax  provisions.  The  Chamber  will  comment  on  two  in 
particular:  the  proposal  to  eliminate  the  foreign  tax  credit  and  the 
proposal  to  modify  the  sales  source  rules. 

The  Chamber  believes  U.S.  tax  laws  should  not  be  utilized  to  im- 
pede investment  by  American  companies  abroad.  Indeed,  such  in- 
vestment should  be  viewed  as  a  complement  to  exports  from  our 
domestic  factories.  The  present  system  of  U.S.  taxation  of  foreign 
sourced  income  is  eroding  our  competitive  position.  The  committee 
should  focus  its  efforts  on  reducing  the  complexity  and  anticompeti- 
tive nature  of  the  current  provisions  rather  than  considering  fur- 
ther penalizing  our  U.S.  multinational  corporations. 

The  foreign  tax  credit  has  been  the  cornerstone  by  which  coun- 
tries have  eliminated  international  double  taxation.  There  can  be 
no  question  that  the  elimination  of  the  credit  for  foreign  income 
taxes  would  be  unfair  and  discriminatory  against  U.S.  taxpayers. 

If  U.S.  tax  were  imposed  on  the  full  amount  of  foreign  source  in- 
come without  recognizing  the  taxes  already  paid  to  host  countries, 
the  tax  burden  of  U.S.  multinational  companies  doing  business  in 
those  foreign  countries  would  be  greatly  increased. 

For  example,  if  the  foreign  country  also  taxes  corporation  earn- 
ings at  the  U.S.  rates  of  35  percent,  the  combined  tax  burden  after 
repeal  of  the  FTC  could  increase  to  approximately  58  percent,  plac- 
ing U.S.  companies  at  a  severe  competitive  disadvantage.  As  a  re- 
sult of  the  heavier  tax  burden,  these  companies  would  be  forced  to 
surrender  their  foreign  markets  to  foreign  controlled  businesses 


1445 

and  the  closing  of  foreign  markets  would  sharply  reduce  the  sales 
of  American-made  goods  and  would  unquestionably  result  in  a  fur- 
ther deficit  in  our  balance  of  trade  and  a  loss  of  American  jobs. 

The  proposed  change  in  the  sales  sourcing  rules  would  revise  the 
historical  U.S.  tax  treatment  of  foreign  sales  of  U.S.  manufactured 
goods.  The  change  would  increase  the  cost  of  U.S.  exports,  add 
complexity  to  the  code  and  create  an  accounting  nightmare  for  U.S. 
companies.  Exports  have  been  one  of  the  engines  of  U.S.  growth 
over  the  past  few  years. 

As  the  Nation  struggles  to  maintain  marginal  levels  of  growth, 
we  can  ill  afford  to  adopt  policies  such  as  this  which  will  harm  our 
export  base. 

Mr.  Chairman,  the  Chamber  is  particularly  concerned  about  a 
pattern  of  legislative  efforts  to  limit  ordinary  and  necessary  busi- 
ness deductions.  In  the  recently  passed  Omnibus  Budget  Reconcili- 
ation Act  alone,  Congress  limited  the  deductibility  of  expenses  for 
meals  and  entertainment,  lobbying  activities,  executive  compensa- 
tion, and  club  dues. 

The  subcommittee  is  now  considering  proposals  to  limit  the  de- 
ductibility of  environmental  remediation  and  cleanup  costs,  adver- 
tising expenses  and  interest  payments  on  corporation  tax  under- 
payments. These  proposals  threaten  the  fundamental  principle  of 
taxation — that  businesses  should  be  taxed  on  income  rather  than 
gross  receipts. 

They  also  substitute  the  judgment  of  politicians  for  those  of  busi- 
ness owners  about  what  expenditures  are  appropriate  and  nec- 
essary to  create  a  successful  business. 

The  Chamber  strongly  opposes  an  attempt  to  require  the  capital- 
ization of  environmental  remediation  costs.  We  believe  that  legisla- 
tion at  this  time  is  not  necessary  to  clarify  the  tax  treatment  of 
these  costs,  and  that  the  matter  can  and  will  be  best  handled  at 
the  regulatory  and  judicial  levels.  Any  uncertainty  with  respect  to 
the  tax  treatment  of  these  costs  has  arisen  as  a  result  of  two  rul- 
ings recently  issued  by  the  IRS  requiring  that  such  costs  be  capital- 
ized. 

The  weight  of  authority  however  supports  the  deductibility  of 
such  costs.  Therefore,  legislation  is  not  necessary  to  resolve  any  un- 
certainty at  this  time. 

The  Chamber  also  opposes  proposals  to  disallow  deductions  for 
all  cleanup  costs  and  compensatory  damages  associated  with  an  oil 
or  hazardous  substance  spill.  No  one  intends  to  cause  environ- 
mental damage.  However,  accidents  can  and  do  happen.  When  they 
occur,  the  cleanup  costs  and  compensatory  damages  represent  real 
cost  to  the  taxpayers,  expenditures  which  are  ordinary  and  nec- 
essary in  the  course  of  business  and  which  reduce  profit. 

Like  proposals  to  capitalize  remediation  expenses,  denying  de- 
ductions for  these  cleanup  costs  sends  the  wrong  message  by  dis- 
couraging the  very  cleanup  expenditures  and  related  settlements 
which  we  hope  to  encourage.  The  punitive  goals  of  such  proposals 
are  better  effectuated  by  existing  penalties  under  Federal  and 
State  environmental  laws,  both  civil  and  criminal. 

Use  of  the  Tax  Code  to  further  penalize  these  companies  is  both 
inappropriate  and  unnecessary. 


1446 

The  committee  is  also  considering  two  proposals  relating  to  cor- 
porate tax  underpayments.  The  first  proposal  would  deny  corpora- 
tions an  income  tax  deduction  for  interest  paid  and  the  second 
would  increase  the  tax  rate  on  under  payments  to  an  unspecified 
rate.  The  Chamber  opposes  both  of  these  proposals. 

The  Internal  Revenue  Code  is  nothing  if  not  complex.  We  believe 
American  taxpayers,  both  individuals  and  businesses,  make  every 
effort  to  comply  with  tax  laws.  We  believe  that  increasing  the  inter- 
est rate  and  denying  interest  deductions  would  cause  great  hard- 
ship. 

The  committee  is  also  considering  a  proposal  to  require  that  tax- 
payers amortize  a  portion  advertising  costs  over  a  period  of  years. 
Effective  advertising  is  one  of  the  hallmarks  of  an  aggressive  and 
prospering  business.  Through  creative  media,  sales,  and  pro- 
motional campaigns,  innovative  products  are  introduced  and  new 
markets  are  created. 

As  trade  barriers  around  the  world  come  down,  the  Nation's  busi- 
ness community  is  now  poised  to  take  advantage  of  these  newly 
open  markets.  Advertising  will  be  a  principal  medium  by  which  for- 
eign consumers  will  become  acquainted  with  the  variety  and  qual- 
ity of  American  products. 

Mr.  Chairman,  it  just  doesn't  make  sense  to  stifle  the  competi- 
tiveness of  U.S.  firms  at  this  crucial  juncture. 

Finally,  Mr.  Chairman,  the  Chamber  is  concerned  about  propos- 
als to  stifle  lobbying  efforts.  The  committee  is  considering  a  pro- 
posal to  impose  a  30  percent  excise  tax  on  the  lobbying  expendi- 
tures of  noncharitable,  tax-exempt  organizations. 

The  U.S.  Chamber  on  behalf  of  its  42  associations  and  Chambers 
of  Commerce  opposes  the  proposal.  Taxing  the  lobbying  activities 
of  these  organizations  crimps  the  fundamental  right  of  citizens  to 
make  their  views  known  to  their  elected  officials.  Ordinary  citizens, 
including  small  businesses,  depend  on  associations  to  make  sure 
their  voice  is  heard  in  Washington. 

Advocacy  by  associations  has  contributed  to  responsible  and  in- 
formed solutions  in  many  areas  of  public  policy  including  equal 
rights,  employee-employer  relations,  public  health  and  nutrition, 
and  protection  of  the  environment. 

The  proposal  before  the  committee  will  have  a  dampening  effect 
on  the  work  of  associations  because  it  incorporates  the  expansive 
definition  of  lobbying  contained  in  the  code  section  162(e).  Thus, 
the  excise  tax  would  discourage  some  of  the  very  nonlobbying  ac- 
tivities which  Congress  looks  to  the  association  community  to  pro- 
vide, including  nonpartisan  analysis  and  technical  advice. 

It  is  time  that  we  stand  up  for  the  work  that  associations  do  in 
Washington.  If  my  appearance  here  or  the  appearance  of  the  other 
members  of  my  panel  have  been  helpful  to  the  committee,  this  is 
a  testament  to  the  value  of  associations  in  the  public  policy  process. 
The  excise  tax  proposal  before  the  committee  would  discourage 
such  contributions. 

Mr.  Chairman,  thank  you  for  allowing  us  to  present  our  views 
and  we  will  be  happy  to  answer  questions. 

[The  prepared  statement  follows:] 


1447 

STATEMENT 

on 

MISCELLANEOUS  REVENUE  PROPOSALS 

before  the 

SELECT  REVENUE  MEASURES  SUBCOMMITTEE 

of  the  i 

HOUSE  COMMITTEE  ON  WAYS  AND  MEANS 

for  the  U.S.  Chamber  of  Commerce 

by 

Julie  Leigh  Gackenbach 

September  21,  1993 


Mr.  Chairman  and  members  of  the  committee,  good  morning.   I  am  Julie  Leigh 
Gackenbach.   The  U.S.  Chamber  of  Commerce  is  the  world's  largest  business  federation 
representing  more  than  215,000  member  businesses,  1,200  associations,  3,000  state  and  local 
chambers  of  commerce,  and  68  American  Chambers  of  Commerce  abroad.   On  behalf  of  the 
members  of  the  Chamber  Federation,  we  appreciate  this  opportunity  to  present  our  views  on 
the  various  revenue  proposals  that  are  the  subject  of  this  hearing.   I  have  provided  the  full 
text  of  our  comments  and  respectfiiUy  request  that  they  be  included  in  the  hearing  record. 

American  business  needs  simplicity  and  stability  in  the  federal  code.   The  U.S. 
Chamber  is  concerned  that  merely  a  month  after  Congress  enacted  the  largest  tax  increase  in 
our  nation's  history  that  the  committee  is  seriously  considering  such  sweeping  revenue 
raising  proposals.   The  business  community  has  not  had  time  to  react  to  the  recent  changes; 
in  fact,  many  of  these  provisions  have  yet  to  take  effect.   Businessmen  and  women  across  the 
country  are  fiacing  the  seemingly  daunting  task  of  figuring  out  how  to  comply  with  the  host 
of  recently  enacted  changes.   They  are  unprepared  at  this  time  to  deal  with  another  round  of 
tax  changes  designed  to  raise  federal  revenue. 

FOREIGN  TAX  PROVISIONS 

Many  of  the  foreign  tax  provisions  of  the  Internal  Revenue  Code,  and  the  proposals 
before  the  committee  today,  are  based  on  the  fallacious  premise  that  investment  overseas  by 
U.S.  multinational  corporations  leads  to  a  loss  of  jobs  for  the  American  work  force  and  less 
revenue  for  the  federal  Treasury.   This  belief  has  resulted  in  U.  S.  tax  policies  which  impose 
higher  burdens  on  the  international  operations  of  U.S.  corporations  than  those  imposed  by 
our  foreign  trading  partners  on  their  multinational  corporations.   U.S.  tax  laws  should  not  be 
utilized  to  impede  investment  by  American  companies  abroad.   Indeed,  such  investment 
should  be  viewed  as  a  complement  to  exports  firom  domestic  factories.   The  present  system 
of  U.S.  taxation  of  foreign-sourced-income  is  eroding  the  competitive  position  of  U.S. 
businesses  in  the  international  marketplace.   The  committee  should  focus  its  efforts  on 
reducing  the  complexity  and  anti-competitive  nature  of  the  current  provisions  rather  than 
considering  further  penalizing  U.S.  multinational  corporations. 

American  multi-national  corporations  (according  to  the  Department  of  Commerce) 
exported  $98.4  billion  dollars  worth  of  goods,  and  accounted  for  nearly  one-fourth  of  the 
$400.8  billions  dollars  worth  of  merchandise  exports  during  that  year. 


1448 


Proposal  to  EUminate  the  Foreign  Tax  Credit 

The  committee  is  considering  a  proposal  to  eliminate  the  foreign  tax  credit.   All 
industrialized  nations  of  the  world  operate  under  the  principle  that  the  country  wherein 
income  is  earned  has  the  first  right  to  tax  that  income.   Many  of  those  same  nations, 
including  the  United  States,  also  tax  the  worldwide  income  of  companies  incorporated  within 
their  borders,  regardless  of  the  source  of  that  income.   The  foreign  tax  credit  has  been  the 
cornerstone  by  which  these  countries  have  eliminated  international  double  taxation. 

There  can  be  no  question  that  the  elimination  of  a  credit  for  foreign  income  taxes 
would  be  unfair  and  discriminatory  against  U.S.  taxpayers.   If  U.S.  tax  were  imposed  on  the 
full  amount  of  foreign-sourced-income  without  recognizing  the  income  taxes  already  imposed 
by  the  host  country  in  which  the  income  was  earned  (which  would  be  the  case  if  the  foreign 
tax  credit  (FTC)  were  eliminated  and  replaced  with  a  deduction),  the  tax  burdoi  of  U.S. 
multinational  companies  doing  business  in  those  foreign  countries  would  be  greatly  increased. 
For  example,  if  the  foreign  country  also  taxes  corporate  earnings  at  the  U.S.  rate  of  35 
percent,  the  combined  tax  burden  on  foreign  earnings  after  repeal  of  the  FTC  would  increase 
to  approximately  58  percent.   Since  local  companies  in  those  foreign  jurisdictions  would  not 
be  subject  to  as  heavy  a  tax  burden  on  their  own  operations,  U.S.  companies  would  be 
placed  at  a  severe  competitive  disadvantage.   As  the  eminent  former  Assistant  Secretary  of 
the  Treasury  Stanley  Surrey  testified  in  1967:  "American  investment  would  not  proceed  at  all 
without  the  foreign  tax  credit  because  then  ...  two  taxes  would  be  imposed  and  the  overall 
burden  of  two  taxes  would  be  so  great  that  international  investment  would  practically  cease." 
This  comment  is  as  true  today  as  when  it  was  made  over  25  years  ago. 

Enactment  of  a  proposal  to  treat  foreign  income  taxes  as  deductions  instead  of 
permitting  a  foreign  tax  credit  would  have  a  disastrous  effect  on  U.S.  corporations  engaged 
in  international  business.   As  a  result  of  the  heavier  tax  burden,  these  companies  would  be 
forced  to  surrender  their  foreign  markets  to  foreign-controlled  businesses.  The  closing  of 
these  foreign  markets  would  sharply  reduce  the  sales  of  Am^can-made  goods  and  would 
unquestionably  result  in  a  further  deficit  in  our  balance  of  trade  with  other  industrialized 
countries,  leading  to  a  loss  of  American  jobs. 

Committee  Chairman  Rostenkowski  recognized  the  importance  of  the  foreign  tax  credit  in  a 
speech  to  the  Chicago  Council  on  Foreign  Relations  in  1976,  asserting  that: 

I  am  firm  in  my  belief  that  the  foreign  tax  credit  is  the  key  to 
U.S.  international  tax  policy,  and  should,  undo*  no 
circumstances,  be  Tepealed  or  modified  in  any  fundamratal  way. 
I  say  this  simply  because  it  seems  to  me  that  if  foreign 
governments  tax  the  foreign  income  of  U.S.  multinational 
corporations,  and  then  the  U.S.  taxes  that  income  in  addition, 
double  taxation  results.   The  tax  burden  of  this  double  taxation 
cannot  help  but  impede  international  trade  and  international 
movement  of  capital.   For  this  reason,  as  one  who  strongly 
believes  in  expanding  international  trade  and  unrestricted  capital 
movement,  I  can  see  no  circumstances  under  which  I  would 
recommoid  any  fimdamental  change  in  the  foreign  tax  credit. 

Although  a  number  of  changes  have  been  made  which  have  lessened  the  benefits  of 
the  foreign  tax  credit  since  Chairman  Rostenkowski  made  this  statemoit,  the  reasons  for  the 
fiindam^tal  principle  of  retaining  the  foreign  tax  credit  are  even  more  persuasive  today  than 
they  were  in  1976.  The  world  has  moved  to  a  global  economy  and  industrialized  nations 
recognize  the  economic  necessity  and  benefit  of  permitting  their  domestic  corporations  to 
operate  abroad  without  bearing  a  higher  tax  burden  than  their  foreign  competitors. 
Accordingly,  if  the  United  States  is  to  participate  in  world-wide  trade  and  the  economy  and 
reap  the  benefits  provided  to  our  nation,  it  is  essential  that  the  foreign  tax  credit  be  kept 
intact. 


1449 


Proposal  to  Revise  the  Inventory  Sourdng  Rules 

The  committee  is  considering  a  proposal  to  reduce  the  amount  of  foreign  source 
income  derived  from  sales  to  related  parties.   Under  current  law,  the  income  from  the  sale  of 
domestically  manufactured  goods  in  foreign  markets  is  treated  partially  as  U.S.-sourced 
income  and  partially  as  foreign-sourced  income.   Generally,  50  percent  of  such  income  is 
apportioned  on  the  basis  of  the  location  of  the  assets  used  in  production  and  SO  percent  on 
the  basis  of  the  place  of  sale.   Therefore,  if  a  U.S.  manufactured  good  is  sold  to  an  unrelated 
foreign  buyer  for  $100,  $50  of  that  income  generally  would  be  treated  as  U.S. -source  income 
and  $50  would  be  treated  as  foreign-source  income.    However,  if  the  U.S.  multinational 
corporation  makes  a  sale  to  its  foreign  sales  subsidiary,  only  the  portion  of  the  income 
related  to  the  sale  is  affected  by  the  split.   Thus,  if  the  U.S.  parent  sells  a  product  to  its 
foreign  subsidiary  for  $70  and  the  foreign  subsidiary  makes  a  sale  to  the  end  user  for  $100, 
income  would  be  sourced  $35  (50%  of  $70)  U.S. -source  and  $65  (50%  of  $70  and  100%  of 
$100  -$70)  foreign  source. 

The  proposed  change  would  revise  the  historical  U.S.  tax  treatment  of  foreign  sales  of 
U.S.  manufactured  products  and  would  increase  the  cost  of  U.S.  exports.   The  change  would 
particularly  hurt  U.S.  manufacturers  who  use  a  foreign  subsidiary  to  market  their  exports. 
Exports  have  been  one  of  the  engines  of  U.S.  growth  over  the  past  few  years.   As  the  nation 
struggles  to  maintain  marginal  levels  of  growth,  we  can  ill  afford  to  adopt  policies  such  as 
this  which  would  harm  the  U.S.  export  base. 

In  addition  to  the  negative  effect  on  exports  and  U.S.  jobs,  the  proposal  would  greatly 
increase  the  compliance  burden  of  U.S.  manufacturers  and  add  to  already  overly  complex 
foreign  tax  rules.   The  combined  calculation  is  complex,  and  administration  would  require 
some  form  of  tracing  rule  as  the  products  move  through  the  distribution  chain  -  creating  an 
accounting  nightmare. 


ENVIRONMENTAL  PROVISIONS 

Capitalization  of  Environmental  Remediation  Costs 

The  committee  is  considering  a  proposal  to  require  that  all  environmental  remediation 
costs  be  capitalized  and  amortized  over  a  uniform  period,  rather  than  deducted  as  current 
expenses.   The  Chamber  strongly  opposes  an  attempt  to  require  the  a^italization  of 
environmental  remediation  costs.   We  believe  that  legislation  at  this  time  is  not  necessary  to 
clarify  the  tax  treatment  of  environmental  cleanup  costs,  and  that  the  matter  can  and  will  be 
best  handled  at  the  regulatory  and  judicial  levels. 

Congress  has  enacted  amortization  provisions  in  the  past  either  to  permit  taxpayers  to 
recover  capital  expenditures  which  would  not  be  subject  to  the  allowance  for  depreciation 
because  they  lack  an  ascertainable  useful  life  or  to  permit  such  expenditures  to  be  recovered 
over  a  shorter  period  than  would  be  allowed  under  the  general  depreciation  rules.  The 
enactment  of  legislation  requiring  the  capitalization  and  amortization  of  environmental 
cleanup  costs  is  not  necessary  to  eliminate  uncertainty  with  respect  to  their  tax  treatment. 
Any  uncertainty  with  respect  to  their  tax  treatment  has  arisen  as  a  result  of  two  rulings 
recently  issued  by  the  Internal  Revenue  Service  (IRS)  requiring  that  such  costs  be  ci^italized 
(TAM  9315004  -  12/17/92  and  TAM  924004  -  06/19/92).   The  weight  of  authority, 
however,  supports  the  deductibility  of  such  costs.   In  general,  they  do  not  add  to  the  value  of 
the  property  which  is  subject  to  remediation,  extend  its  useful  life,  or  adapt  it  to  a  new  or 
different  use,  criteria  established  in  Treasury  Regulation  1.263(a)- 1(a).   Because 
environmental  costs  are  not  capital  and  the  weight  of  authority  supports  the  treatment  of  such 
costs  as  currently  deductible  repair  expenses,  legislation  is  not  necessary  to  resolve  any 
uncertainty. 


1450 


Congress  has  historically  provided  more  favorable  cost  recovery  to  encourage 
activities  which  it  believes  are  socially  beneficial.   Examples  include  accelerated  amortization 
periods  for  certain  assets  and  current  exposing  treatment  for  expenditures  which  would 
ordinarily  have  been  dq)reciable  over  a  period  of  years.  An  example  of  the  latter  case  is  the 
Section  179  expensing  provision,  which  was  expanded  in  the  Omnibus  Budget  Reconciliation 
Act  of  1993.   Examples  of  provisions  permitting  more  favorable  amortization  include  Section 
174  (research  and  experimwitation  expenditures);  Section  169  (pollution  control 
expoiditures);  Section  190  (expenditures  to  remove  handicapped  accessibility  barriers); 
Section  188  (expenditures  for  child  care  facilities);  and  Section  167(k)  (rehabilitation  of  low- 
income  housing),  to  name  a  few.   In  each  instance.  Congress  sought  to  encourage  spending 
by  permitting  more  favorable  cost  recovery.   However,  in  the  case  of  wivironmental  cleanup 
costs,  the  weight  of  the  evidence  clearly  favors  current  deductibility,  and  as  such,  the 
proposed  change  represaits  a  disincaitive  to  cleanup.  As  the  business  community  works  to 
meet  the  nation's  epvironmental  goals,  requiring  remediation  expenses  to  be  capitalized  and 
amortized  would  undercut  these  important  efforts  by  discouraging  environmental  cleanup 
expenditures. 


Deny  Deducdons  for  Certain  Hazardous  Waste  Cleanup  Expenses 

The  Chamber  also  opposes  proposals  to  disallow  deductions  for  all  cleanup  costs  and 
compensatory  damages  associated  with  an  oil  or  hazardous  substance  spill  caused  by  a 
company  found  to  have  unlimited  liability  under  the  Oil  Pollution  Act  (OP A)  or  the 
Comprehensive  Environmental  Response,  Compoisation  and  Liability  Act  (CERCLA). 
Under  current  law,  expaises  related  to  cleaning  up  hazardous  waste  spills  are  generally 
considered  to  be  ordinary  and  necessary  business  expenses  and  therefore  deductible. 

No  one  intoids  to  cause  environmmtal  damage;  howevo',  accidents  can  and  do 
happen.  When  they  occur,  the  cleanup  costs  and  compensatory  damages  rq>resent  real  costs 
to  the  taxpayer,  expoiditures  which  are  ordinary  and  necessary  in  the  course  of  business  and 
which  reduce  corporate  profit.  Like  proposals  to  capitalize  remediation  expMises,  denying 
deductions  for  these  cleanup  costs  sends  the  wrong  message  by  discouraging  cleanup 
expenditures  and  related  settlement  payments.  The  punitive  goals  of  such  proposals  are 
better  effectuated  by  the  existing  poialties  undo^  federal  and  state  environmoital  laws,  both 
civil  and  criminal.   Use  of  the  tax  code  to  further  poialize  these  companies  is  inappropriate 
and  unnecessary. 


COMPLIANCE  PROVISIONS 

Deny  Deductions  for  Interest  Payments  on  Corporate  Tax  Underpayments 
and  Raise  the  Interest  Rate  on  Corporate  Tax  Underpayments 

The  committee  is  considering  two  proposals  relating  to  corporate  tax  underpayments. 
The  first  proposal  would  deny  corporations  an  income  tax  deduction  for  all  interest  paid  or 
accrued  on  tax  obligations.   The  second  proposal  would  increase  the  tax  rate  on  corporate 
underpayments  to  an  unspecified  rate.   The  Chamber  opposes  both  of  these  proposals. 

The  Internal  Revenue  Code  is  nothing  if  not  complex.  We  believe  American 
taxpayers,  both  individuals  and  business,  make  every  effort  to  comply  with  the  tax  laws. 
However,  you,  as  members  of  the  Ways  and  Means  Committee  are  aware,  even  seasoned  tax 
professionals,  when  given  the  same  set  of  circumstances  will  often  differ  greatly  on  the 
proper  amount  of  tax  due.   In  fact,  due  to  the  backlog  in  promulgating  r^ulations,  taxpayo^ 
are  often  left  to  file  returns  based  on  the  their  best  estimate  of  what  the  regulations  will 
require.   As  such,  well-meaning  businessmen  and  women  are  often  fticed  with  bills  for 
underpayments  of  tax  liability,  plus  interest. 

Because  of  Internal  Revenue  Service  backlogs  or  delays,  these  tax  bill  may  come 
several  years  after  the  tax  year  in  question,  resulting  in  hefty  interest  charges.   Some  of  the 
nation's  larger  corporations  are  just  now  closing  their  tax  years  for  the  early  1980s.   As 


1451 


such,  they  could  fece  interest  charges  for  ten  or  more  years.   While  these  taxpayers  will  pay 
their  tax  due  and  an  appropriate  interest  charge,  we  believe  that  increasing  the  interest  rate  or 
denying  the  interest  deduction  would  cause  great  hardship  on  taxpayers  and  would  likely 
undercut  the  spirit  of  the  committee's  work  on  a  Taxpayer  Bill  of  Rights  n. 


ACCOUNTING  PROVISIONS 

Treatment  of  Advertising  Expenditures 

The  committee  is  considering  a  proposal  to  require  that  taxpayers  amortize  a  portion 
of  their  advertising  costs  over  a  period  of  years.   Currently,  advertising  expenditures  are 
fiilly  deductible  if  they  otherwise  qualify  as  ordinary  and  necessary  business  expenses. 

The  Chamber  opposes  this  latest  in  a  wave  of  efforts  to  limit  ordinary  and  necessary 
business  deductions.   In  the  Omnibus  Budget  Reconciliation  Act  of  1992  alone,  Congress 
limited  the  deductibility  of  meals  and  entertainment  expenses  (beyond  the  limitations  imposed 
in  1986),  lobbying  expenses,  executive  compensation,  and  club  dues.   Like  the  lobbying 
excise  tax  proposal  discussed  below,  these  "reforms"  have  great  populist  appeal;  however, 
they  undercut  a  fundamental  principal  of  taxation-that  businesses  should  be  taxed  on  income, 
rather  than  gross  receipts.  They  also  substitute  the  judgement  of  politicians  for  those  of 
business  owners  about  what  expenditures  are  likely  to  advance  sales  and  profits.   Excessive 
or  inappropriate  expenditures  hurt  the  bottom  line.  This  fact,  coupled  with  corporate 
fiduciary  rules,  shareholder  action  against  prodigal  management,  and  existing  Treasury  rules 
and  substantiation  requirements,  effectively  Umit  opportunities  for  abuse. 

The  effort  to  limit  the  deductibility  of  advertising  expenses  is  particularly  troubling. 
Effective  advertising  is  one  of  the  hallmarks  of  an  aggressive,  prospering  business.   Through 
creative  media,  sales,  and  promotional  campaigns,  innovative  products  are  introduced  and 
new  markets  are  created.   The  integrated  nature  of  these  campaigns  raises  administrative  and 
accounting  concerns  if  advertising  costs  are  required  to  be  c^italized.   For  example,  when 
sales  representatives  are  provided  with  logo  T-shirts,  is  this  a  sales,  promotional,  or 
advertising  expwise? 

Likewise,  the  theoretical  basis  for  amortizing  advertising  costs-that  advertising 
provides  the  firm  with  long-term  benefits-is  not  sound  across  the  varied  spectrum  of 
advertising.   In  some  cases,  an  advertising  campaign  will  be  geared  to  the  creation  of  long- 
term  brand  loyalty,  raising  an  analogy  to  goodwill  (amortizable  in  the  wake  of  the  U.S. 
Supreme  Court's  decision  earlier  this  year  in  Newark  Morning  Ledger).   In  many  cases, 
however,  advertising  has  more  immediate  and  short-term  aims,  such  as  introducing  a  new 
product,  or  promoting  a  Labor  Day  sale.   In  a  1990  study,  Kenneth  Arrow  and  George 
Stigler  concluded  that  virtually  all  of  the  benefits  of  the  typical  advertising  campaign 
dissipate  within  one  year. 

As  trade  barriers  around  the  world  come  down,  the  nation's  business  community  is 
now  poised  to  take  advantage  of  newly  open  foreign  markets.   Advertising  is  the  principal 
medium  by  which  foreign  consumers  will  become  acquainted  with  the  wide  array  of  quality 
American  products.   Mr.  Chairman,  it  doesn't  make  sense  to  stifle  the  competitiveness  of 
U.S.  firms  at  this  crucial  juncture. 


TAX  EXEMPT  ENTmES  PROVISIONS 

Lobbying  Expenditure  Excise  Tax 

The  committee  is  considering  a  proposal  to  impose  a  30  percent  excise  tax  on  the 
lobbying  expenditures  of  non-charitable,  tax-exempt  organizations.  The  U.S.  Chamber,  on 
behalf  of  die  4,200  associations  and  chambers  of  commerce  it  represents,  opposes  this 
proposal. 


1452 


Taxing  the  lobbying  activities  of  tax-exempt  organizations  crimps  the  fundamental 
right  of  citizens  to  make  their  views  known  to  their  elected  officials.   Most  merchants, 
shopkeq)ers,  entrepreneurs,  and  professional  and  small  business  owners  do  not  have  the 
resources  to  open  a  Washington  office,  to  continually  monitor  the  stream  of  legislation  and 
regulations  that  affect  them,  or  even  to  visit  Capitol  Hill.   They  must  spend  their  time  and 
resources  making  a  living.  These  citizens  dq)end  on  associations  to  make  sure  their  voice  is 
heard  in  Washington.   Seven  out  of  tai  Americans  belong  to  at  least  one  association.  They 
pay  an  average  of  $168  for  individual  annual  dues  and  $560  in  corporate  dues  to  support  the 
varied  activities  of  thdr  associations  (lobbying  accounts  for  an  average  of  6  percent  of  the 
budgets  of  associations). 

Associations  have  traditionally  set  industry  standards,  established  self-r^ulatoiy 
mechanisms,  and  provided  education  and  training  for  members.  Increasingly,  associations 
are  being  asked  to  play  a  more  active  role  in  a  complex  commercial  and  policy  environment. 
When  r^ulations  are  contemplated,  whoi  legislati(m  is  drafted,  when  trade  policy  is 
discussed,  or  v/hea  governmental  research  needs  to  be  transferred  to  the  private  sector, 
lawmakers  seek  out  associations  for  help  and  advice.  Through  data,  analysis,  and  case 
studies,  associations  allow  members  of  Congress  and  their  staffs  to  bett^  understand  the 
complexities  of  the  sectors  they  rq>resent.   Advocacy  by  assodatioos  has  contributed  to 
re^xtnsible  and  informed  solutions  in  many  areas  of  public  policy,  including  equal  rights, 
employee-employer  relations,  public  health  and  nutrition,  and  protection  of  the  oivironmoit. 
The  U.S.  Supreme  Court  has  recognized  the  value  of  Uiese  organizations  to  society,  noting  in 
NAACP  V.  Alabama,  357  U.S.  449  (1958),  that  "effective  advocacy  of  both  public  and 
private  points  of  view,  particularly  controversial  cmes,  is  undeniably  oihanced  by  group 


The  proposal  before  the  committee  will  have  a  particulariy  dampening  effect  on  the 
work  of  associations  because  it  incorporates  the  expansive  definiti(m  of  lobbying  ctmtained  in 
Code  Section  162(e).  Thus,  the  excise  tax  would  discourage  some  of  the  voy  non-lobbying 
activities  Congress  looks  to  the  association  community  to  provide,  including  non-partisan 
analysis  and  technical  advice  provided  in  response  to  a  written  request  by  congressional 
committees. 

The  political  backdrop  for  this  type  of  proposal  is  wdl-known.  The  villainization  of 
lawmakers  and  govoiunent  relations  professionals  has  advanced  die  careers  of  numerous 
politicians  and  talk  show  hosts.   It  has  already  coapeUed  Congress  to  enact  an  administrative 
nightmare  for  the  sake  of  symbolism:  the  rules  limiting  the  deduction  for  lobbying  expenses 
included  in  the  Onmibus  Budget  Reconciliation  Act  of  1993.  But  like  many  'reforms' 
played  out  for  a  populist  audience,  anti-lobbying  rules  will  miss  their  purported  targets,  and 
instead  undercut  the  conscientious  work  of  thousands  of  tax-exempt  organizations  working 
for  responsible  change  in  Washington.   As  columnist  David  Broder  noted  in  an  April  25, 
1993  piece  in  tiie  Washington  Post. 

Refonners  couch  their  proposals  in  terms  of  eliminating 
ponicious  influoices  on  politics  and  government,  but  they  rarely 
acknowledge  that  the  changes  they  push  would  also  redistribute 
power....  If  lobbying  were  outlawed  or  curbed,  who  would  lose 
influence-the  average  small  employer  who  bel(»gs  to  the 
Chambo'  of  Commerce,  or  Ross  Perot?....  The  winners  would 
once  again  be  the  elite. 

Qearly,  tax-exempt  organizations  are  not  the  only  instituticms  to  take  positions  on 
public-policy  issues.  Wealthy  or  influential  individuals,  newspapers,  magazines,  and 
corporations  regularly  urge  their  audioices  to  take  actioa  on  l^islative  issues.  To  further 
burden  the  political  activities  of  tax-exempt  organizations  is  an  inconsisteocy  which  raises 
fairness  and  equal  protection  concerns. 


1453 


It  is  time  that  we  stand  up  for  the  work  that  we  associations  do  here  in  Washington. 
If  my  appearance  here,  or  the  appearance  of  other  members  of  this  panel  has  been  helpful  to 
the  committee,  this  is  a  testament  to  the  value  of  associations  to  the  public  policy  process. 
The  excise  tax  proposal  before  the  committee  would  discourage  such  contributions  and 
undercut  policymaking  for  the  sake  of  politics. 

Mr.  Chairman,  thank  you  for  allowing  us  to  presoit  our  views  to  the  committee.  We 
would  be  h^py  to  answer  any  questions. 


1454 

Mr.  McNULTY.  Thank  you  very  much  for  your  testimony.  Now  we 
will  go  to  the  American  Institute  of  Certified  Public  Accountants, 
Pamela  J.  Pecarich. 

STATEMENT  OF  PAMELA  J.  PECARICH,  CHAIRMAN,  TAX  LEGIS- 
LATIVE  LIAISON  COMMITTEE,  TAX  DIVISION,  AMERICAN 
INSTITUTE  OF  CERTIFIED  PUBLIC  ACCOUNTANTS 

Ms.  Pecarich.  Thank  you  members  of  the  committee  and  staff. 
I  am  Pam  Pecarich,  chairman  of  the  Tax  Legislative  Liaison  Com- 
mittee of  the  American  Institute  of  Certified  Public  Accountants. 
Our  chairman,  Harvey  Coustan,  could  not  be  here  today  so  I  am 
privileged  to  take  his  place  in  representing  our  310,000  members, 
most  of  whom  advise  on  tax  matters  and  prepare  returns  for  mil- 
lions of  taxpayers.  I  am  also  director  of  tax  policy  for  Coopers  & 
Lybrand  here  in  Washington,  D.C. 

We  particularly  appreciate  the  efforts  of  your  committee  in 
scheduling  this  series  of  hearings  on  these  various  revenue  meas- 
ures in  order  to  allow  the  public  an  opportunity  to  comment.  How- 
ever, we  believe  many  of  the  items  on  the  list  submitted  for  this 
hearing  should  be  rejected  in  the  name  of  sound  tax  policy  and  tax 
administration.  For  some  years,  the  AICPA  has  expressed  its  con- 
cern that  tax  legislation  is  being  driven  significantly  more  by  reve- 
nue needs  to  pay  for  other  proposals  than  by  tax  policy  consider- 
ations. 

There  are  any  number  of  items  on  this  agenda  that  fit  such  a  de- 
scription. And  in  many  cases,  the  revenue  gain  would  seem  to  be 
quite  small  relative  to  the  added  compliance  burdens  or  other  com- 
plexities that  the  proposals  would  entail.  The  tax  writing  commit- 
tees of  Congress  must  be  constantly  concerned  with  inordinate 
complexity  and  reporting  burdens  because  of  the  adverse  effects 
these  factors  have  on  compliance  by  taxpayers. 

A  number  of  the  proposals  would  revise  provisions  that  were  ex- 
tensively debated,  negotiated,  and  ultimately  passed  in  the  revenue 
title  of  the  1993  act.  In  essence,  these  changes  are  proposed  before 
the  OBRA  provisions  have  even  gone  into  effect.  We  remind  the 
committee  that  change  itself  is  a  source  of  complexity  and  we  do 
not  believe  it  unreasonable  to  expect  stability  in  our  tax  laws  that 
last  more  than  a  few  months. 

As  a  case  in  point,  the  estimated  tax  provision  of  the  1993  act 
represents  a  badly  needed  simplification  of  the  individual  esti- 
mated tax  system  that  itself  was  made  substantially  more  complex 
from  a  last-minute  change  in  1991  unemployment  insurance  legis- 
lation. 

OBRA  thus  provides  that  individuals  with  adjusted  gross  in- 
comes of  150,000  or  more  will  have  to  use  110  percent  of  last  year's 
tax  as  a  safe  harbor  for  paying  current  year's  estimates  rather  than 
the  100  percent  used  by  all  other  taxpayers.  This  change  was  the 
result  of  substantial  discussion  and  negotiation  over  a  2-year  pe- 
riod to  reach  what  was  believed  to  be  a  fair  and  workable  solution. 

I  might  add  that  it  was  also  a  revenue  raiser  in  the  1993  legisla- 
tion. Now  it  is  suggested  that  further  changes  be  made  to  the  new 
safe  harbor  before  it  even  takes  effect.  Let  us  point  out  that  in- 
creasing the  safe  harbor  is  inappropriate  because  it  will  diminish 
its  simplification  benefit.  It  will  encourage  many  small  businesses 


1455 

and  individuals  to  opt  out  of  the  safe  harbor  rule  by  doing  more 
complex  calculations  three  and  four  times  a  year. 

Another  worrisome  theme  we  see  represented  in  these  proposals 
is  the  growing  tendency  to  chip  away  at  the  net  income  concept  of 
taxation  by  dusallowing  portions  of  bona  fide  trade  business  ex- 
penses. This  tendency  may  be  seen  today  in  proposed  disallowance 
of  a  portion  of  advertising  expenses,  disallowing  a  deduction  for 
corporate  interest  on  tax  underpayments,  limiting  deductions  for 
valid  business  auto  expenses,  denying  a  deduction  for  environ- 
mental cleanup  costs  and  damages. 

Such  proposals  are  unfair  to  many  taxpayers.  They  move  us 
away  from  a  sound  definition  of  taxable  income  and  increase  tax 
law  complexity.  For  example,  a  current  deduction  for  short-lived  ex- 
penses such  as  advertising  is  well  supported  in  tax  and  accounting 
theory,  while  limiting  the  deduction  will  cause  the  IRS,  the  Treas- 
ury, the  courts,  and  countless  taxpayers  great  difficulty  in  defining 
advertising  and  related  costs  subject  to  capitalization.  We  at  the 
Institute  have  consistently  opposed  efforts  to  erode  the  net  income 
consent  and  reiterate  that  the  slow  move  toward  the  gross  income 
tax  must  be  halted. 

We  oppose  on  policy  grounds  two  other  significant  proposals  for 
change:  replacement  of  the  foreign  tax  credit  with  a  deduction  and 
repeal  of  the  taxable  income  limit  for  S  Corporation  built-in  gains 
tax.  The  foreign  tax  credit  has  been  in  our  tax  system  since  1921 
and  is  the  underpinning  of  our  approach  to  taxing  the  worldwide 
income  of  U.S. -based  companies.  To  casually  suggest  a  change  to 
this  provision  outside  of  the  context  of  a  reconsideration  of  our  sys- 
tem of  international  taxation  is  alarming.  This  proposal  should  be 
rejected. 

The  taxable  income  limit  included  in  the  built-in  gains  tax  for  S 
corporations  is  designed  to  defer  payments  for  corporations  in  eco- 
nomic distress  who  have  no  wherewithal  to  pay  the  tax.  The  pro- 
posed change  would  be  a  significant  reversal  of  past  Congresses' 
view  of  this  tax  and  should  be  dropped  from  consideration. 

In  conclusion,  our  written  statement  outlines  our  positions  on 
several  other  proposals  as  well.  We  were  unable  to  finish  sufficient 
review  to  comment  on  all  of  the  provisions  particularly  because 
some  of  the  earlier  descriptions  of  the  proposals  were  not  suffi- 
ciently detailed.  However,  we  sincerely  stand  ready  to  assist  this 
committee  in  its  work  and  hope  that  you  and  your  staff  will  call 
on  the  Institute  and  its  staff  if  you  need  additional  information  on 
any  of  these  matters  or  want  to  solicit  the  views  of  any  of  our  tech- 
nical committees. 

Thank  you,  Mr.  Chairman  and  members. 

[The  prepared  statement  follows:] 


1456 


TESTIMONY  OF  PAMELA  J.  PECARICH 
AMERICAN  INSTITUTE  OF  CERTIFIED  PUBLIC  ACCOUNTANTS 

Introduction 

Good  morning.  I  am  Pam  Pecarich,  Chairman  of  the  Tax  Legislative  Liaison  Committee  of  the 
American  Institute  of  Certified  Public  Accountants.  Unfortunately,  our  Executive  Committee 
Chairman,  Harvey  Coustan,  is  unable  to  be  with  you  today,  but  I  am  privileged  to  replace  him 
in  representing  our  310,000  members.  The  AICPA  is  the  national,  professional  organization  of 
CPAs  of  whom  many  (if  not  most)  advise  clients  on  tax  matters  and  who  prepare  returns  for 
millions  of  taxpayers.  We,  also,  very  much  appreciate  the  opportunity  to  present  our  views.  We 
have  not  had  the  time  to  look  at  each  proposal  in  detail,  and  many  of  them  are  not  clear  enough 
on  their  face  for  us  to  understand  fully,  but  we  have  focused  on  a  few  proposals  as  the  basis  of 
our  comments. 

Mr.  Chairman,  thank  you  for  your  efforts  in  scheduling  a  series  of  public  hearings  on  these 
various  revenue  measures.  Allowing  the  public  an  opportunity  to  comment  on  the  proposals  can 
only  further  the  interests  of  sound  tax  policy  and  administration. 


General  Comments 

We  believe  many  of  the  items  in  the  list  submitted  for  this  series  of  hearings  should  be  rejected 
without  substantial  discussion.  For  some  years,  the  AICPA  has  expressed  its  concern  that  tax 
legislation  is  being  driven  significantly  more  by  revenue  needs  to  pay  for  other  legislative 
proposals  than  by  tax  policy  considerations.  There  are  any  number  of  proposed  tax  changes  on 
your  agenda  that  seem  to  fit  such  a  description,  and  in  most  instances  the  revenue  increase  from 
a  particular  proposal  is  not  all  that  large.  However,  we  are  concerned  that  we  have  had  great 
difficulty  (or  no  luck  at  all)  in  even  determining  who  is  the  proponent  of  specific  proposals,  much 
less  the  policy  rationale  behind  proposing  most  of  them.  What  is  left,  then,  is  a  perception  that 
many  of  these  items  are  being  suggested  to  raise  revenues  the  use  of  which  will  be  made  known 
at  a  later  point. 

A  number  of  the  proposals  take  provisions  that  were  debated,  negotiated  and  ultimately  passed 
in  the  tax  portion  of  the  1993  Budget  Reconciliation  Act;  but  then  moves  the  1993  Act  provision 
one  or  two  steps  further.  We  fmd  this  back-door  approach  for  getting  still  more  revenue  fi-om 
provisions  that  took  seven  months  to  craft  originally,  to  be  singularly  inappropriate.  For  example, 
the  badly-needed  simplification  of  the  individual  estimated  tax  system  (included  as  part  of  the 
1993  Act)  provides  that  individual  taxpayers  with  adjusted  gross  incomes  exceeding  $150,000  will 
have  to  use  1 1 0  percent  of  last  year's  tax  as  a  safe  harbor  for  paying  current  year  estimated  taxes, 
rather  than  the  100  percent  used  by  all  other  individuals.  That  change  was  the  result  of 
substantial  discussion  and  negotiation,  and  resulted  in  what  was  seen  as  a  "fair"  solution  to  a 
problem  that  had  been  caused  fi-om  a  short-term  need  to  raise  a  certain  amount  of  revenue  back 
in  1991.  The  process  of  correcting  the  difficulties  caused  by  that  casual  1991  change  (made 
without  benefit  of  hearings  or  discussion)  took  almost  two  years.  Now,  someone  is  suggesting 
that  the  1 10  percent  safe  harbor  be  raised  to  1 15  percent,  even  before  the  1 10  percent  safe  harbor 
goes  into  effect.  Analogous  points  may  be  made  about  withholding  on  bonuses,  increased  fi-om 
20  percent  to  28  percent  in  the  1993  law  and  now  proposed  to  rise  to  a  36  percent  rate  before 
the  28  percent  has  even  started. 

We  have  also  commented,  over  some  years  (most  recently  this  spring  to  both  the  Ways  and 
Means  and  Finance  Conunittees  concerning  certain  of  the  proposals  for  the  1993  Budget 
Reconciliation  Act)  about  the  growing  tendency  to  chip  away  at  the  net  income  concept  of 
taxation  by  disallowing  portions  (ranging  up  to  1 00  percent)  of  items  previously  deductible  - 
especially  bona  fide  trade  or  business  expenses.  That  approach  continues  in  the  current  list  of 
proposed  items  (e.g.,  disallow  a  portion  of  advertising  expenses,  disallow  corporate  interest  on 
tax  deficiencies,  limit  otherwise  valid  business  deductions  for  trips  beginning  at  home).  We  have 
recommended,  consistentiy,  that  the  slow  move  toward  a  tax  on  gross  income  needs  to  be  halted, 
and  we  reiterate  that  view  here. 


1457 


Finally,  let  us  -  once  again  -  put  in  a  plea  for  considering  simplification  as  you  enact  tax 
legislation.  Putting  still  more  thresholds  for  partial  nondeductibility  into  the  law  (see  our 
comments  in  prior  paragraph)  gains  relatively  little  revenue  but  adds  complexity.  Requiring 
meals  and  entertainment  substantiation  for  expenditures  over  ten  dollars  (as  opposed  to  today's 
$25)  will  bring  in  virtually  no  revenue  but  will  add  millions  of  required  hours  a  year  to  the 
recordkeeping  process  of  American  business.  The  changes  in  accoimting  and  reporting  systems 
will  impose  burdens  completely  disproportionate  (for  most  of  the  items  on  the  hearing  agenda) 
to  the  small  amount  of  additional  revenues  being  raised  by  those  items. 

We  continue  to  remind  the  Congress  of  the  limited  audit  resources  in  the  Internal  Revenue 
Service.  Complexity  as  a  pervasive  force  in  our  tax  system,  combined  with  limited  govenmiental 
resources  for  coping  with  that  complexity,  leads  to  growing  disrespect  for  a  self-assessment 
system  relying  on  voluntary  compliance. 

With  respect  to  your  present  series  of  hearings,  we  believe  many  of  the  proposals  before  this 
subcommittee  add  complexity  while  raising  only  limited  revenue.  The  hearings  were  announced 
within  only  weeks  of  enactment  of  the  1993  Budget  Reconciliation  Act,  and  we  believe  that 
individuals,  businesses  and  practitioners  should  have  an  opportunity  to  live  with  the  just-enacted 
law  before  numerous  changes  begin  being  made  to  it.  Change,  in  and  of  itself,  is  a  source  of 
complexity,  and  we  do  no  believe  it  is  unreasonable  to  ask  for  stability  in  our  tax  laws  that  lasts 
more  than  a  few  months. 

Thus,  we  do  not  find  much  to  be  enthusiastic  about  in  the  list  of  proposals  for  these  hearings. 
We  are  commenting  on  a  number  of  them,  but  in  relatively  brief  fashion.  Some  of  our  comments 
will  merely  refer  back  to  one  of  these  general  points,  others  will  focus  on  specific  policy  issues. 
And,  prior  to  enacting  any  of  the  large  number  of  revenue  raisers  in  these  proposals,  we  believe 
it  only  fair  to  know  whose  proposals  they  are  and  what  they  are  intended  to  pay  for. 


A  Proposal  to  Increase  Estimated  Tax  Payments  Under  the  Safe  Harbor  Method  to  115 
Percent  of  Last  Year's  Tax  Liability  For  Individuals  with  AGl  Over  $150.000 

The  AICPA  has  worked  with  Congress  to  eliminate  the  harsh  and  unworkable  estimated  tax 
provision  that  was  enacted  at  the  end  of  1991.  The  '93  Act  contains  a  simple,  fair,  and 
administrable  solution  that  was  widely  supported  and  has  been  highly  praised.  Before  it  even 
goes  into  effect,  however,  a  revenue  raiser  is  being  proposed.  We  strongly  oppose  this  proposal 
because  the  estimated  tax  issue  was  raised  by  the  AICPA  only  to  correct  a  very  serious  mistake, 
has  now  been  adequately  addressed,  and  this  troublesome  area  should  not  be  reopened. 

Small  businesses  agreed  to  a  110%  safe  harbor  as  a  simple  and  safe  alternative  to  the  very 
complicated  rules  which  preceded  passage  of  the  law  this  simmier.  Increasing  the  safe  harbor  to 
115%  or  anything  above  1 10%  will  result  in  many  small  businesses  and  individuals  opting  out 
of  this  safe  harbor  rule  and  having  to  do  much  more  complicated  tax  calculations  three  and  four 
times  a  year  as  an  alternative. 


A  Proposal  to  Repeal  the  Section  1374(d)(2)(A)(ii)  Taxable  Income  Limitations  on  the 
recognition  of  Built-in  Gain  of  S  Corporations 

This  proposal  would  remove  the  taxable  income  limitation  used  by  S  corporations  when 
computing  their  built-in  gains  tax  Uability.  The  limitation  defers  the  payment  of  built-in  gains 
tax  in  years  the  corporation  may  be  suffering  real  economic  losses,  and  may  not  have  the 
resources  to  pay  the  tax.  The  proposed  change  would  be  a  significant  reversal  of  Congress' 
application  of  this  tax. 

Section  1374  is  designed  to  maintain  a  double-level  tax  on  appreciation  in  assets  that  accrued  in 
a  corporation  before  it  elected  S  corporation  status.  To  accomplish  this,  section  1374  imposes 
a  potential  corporate-level  tax  on  asset  dispositions  over  the  ten  years  following  conversion  to  S 
corporation  status.  The  amount  of  recognized  built-in  gain  on  which  an  S  corporation  must  pay 
tax  in  any  year  is  limited  to  the  corporation's  taxable  income  for  that  year. 


1458 


Recognizing  taxpayers  could  abuse  such  limitations,  Congress  included  a  suspense  account 
mechanism  in  section  1374  which  causes  any  gain  not  taxed  by  virtue  of  the  taxable  income 
limitation  to  be  taxed  the  following  year,  subject  to  a  taxable  income  limitation  in  that  year. 
Only  after  the  passage  of  the  ten  years  following  conversion  to  S  corporation  status  does  the 
corporation's  exposure  to  the  built-in  gains  tax  expire. 

The  tax  policy  justification  supporting  the  taxable  income  limitation  and  its  predecessor,  the  "net 
income  limitation,"  is  twofold.  First,  without  such  a  limitation,  an  S  corporation  is  in  a  worse 
position  than  a  similarly  positioned  non-S  corporation,  which  is  not  taxed  in  excess  of  its  income. 
Filing  an  S  election  should  not  result  in  an  acceleration  of  the  corporation's  tax  liability. 

Congress  was  clearly  embracing  the  "wherewithal  to  pay"  concept  when  it  modified  section  1374 
in  1988.  In  its  report  on  the  1988  Act,  the  Ways  and  Means  Committee  noted  it  "believes  it  is 
appropriate  not  to  impose  the  built-in  gains  tax  in  a  year  in  which  the  taxpayer  experiences 
losses."  The  AICPA  believes  this  approach  is  the  proper  one  and  a  wherewithal  mechanism  must 
remain  in  section  1374.  To  do  otherwise  would  expxjse  more  than  1.5  million  S  corporations, 
the  vast  majority  of  which  are  small  businesses,  to  tax  assessments  in  situations  in  which  they 
lack  sufficient  resources  to  manage  their  ongoing  operations. 

Last  year,  this  proposal  was  dropped  out  of  H.R.  5646.  Earlier  in  1988,  this  idea  was  proposed 
for  inclusion  in  S.2238,  the  Technical  Correction,  bill  under  consideration  that  year.  Again,  the 
matter  was  dropped.  The  taxable  income  limitation  is  good  tax  policy.  It  should  be  maintained 
and  its  proposed  repeal  should  be  removed  from  the  bill. 


A  Proposal  to  Change  the  Foreign  Tax  Credit  to  a  Deduction 

The  U.S.  has  adopted  a  posture  of  "capital  export  neutrality"  in  taxing  foreign  source  income  of 
U.S.  corporations;  i.e.  U.S.  investors  bear  an  equivalent  tax  burden  regardless  of  the  coimtry  in 
which  that  income  is  earned.  Other  objectives  that  have  fashioned  tax  policy  in  the  international 
context  are:  (1)  preservation  of  the  U.S.  tax  base,  (2)  consistency  vwth  international  norms,  (3) 
efficient  allocation  of  resources  (not  hampered  by  the  tax  law),  and  (4)  allowing  U.S.  companies 
to  successfully  compete  in  the  international  marketplace.  All  of  these  have  been  reflected  for 
generations  in  U.S.  tax  treaty  negotiations. 

U.S.  persons  are  taxed  on  their  worldwide  income,  i.e.  taxable  income  from  both  U.S.  and  foreign 
sources.  To  avoid  international  double  taxation  of  foreign  source  income,  payments  of  foreign 
taxes  have,  since  1921.  been  allowed  as  credits  against  a  U.S.  person's  tax  liability.  The  foreign 
tax  credit  is  one  of  two  internationally  accepted  norms  for  relief  of  double  taxation  -  the  other 
being  exemption  of  foreign  source  income. 

The  foreign  tax  credit  is  limited  to  U.S.  tax  liability  on  foreign  source  income  so  that  foreign 
taxes  paid  at  higher  than  the  U.S.  rate  cannot  offset  U.S.  tax  on  U.S.  source  income.  Moreover, 
the  foreign  tax  credit  is  further  reduced  by  the  allocation  and  apportionment  of  expenses  against 
foreign  source  income,  and  the  separate  limitation  categories  imposed  by  current  law.  The  latter 
restriction  is  to  prevent  cross-crediting  of  high  foreign  taxes  and  the  erosion  of  the  U.S.  tax  base. 

By  allowing  a  credit  (with  limitations  described  above),  rather  than  a  deduction,  for  taxes  paid 
other  nations,  the  United  States  has  -  for  over  70  years  -  recognized  the  concept  that  other 
sovereign  nations'  income  taxes  are  considered  to  be  on  a  par  with  our  own.  If  that  policy  made 
sense  in  the  early  1920s,  it  makes  even  more  sense  in  the  early  1990s  in  which  our  economy,  our 
businesses,  and  our  tax  system  must  reflect  the  realities  of  a  multi-national  (and  highly 
competitive)  world.  To  artificially  increase  the  cost  of  U.S.  businesses  operating  outside  the 
United  States  would  have  serious  and  severe  economic  and  fmancial  consequences.  For  U.S. 
business  to  remain  even  reasonably  competitive,  should  this  provision  be  adopted,  would  require 
massive  negotiations  with  all  our  tax  treaty  partners  to  undo  the  unilateral  damage  that  would 
otherwise  be  caused. 

This  proposal  should  be  totally  rejected. 


1459 


A  Proposal  to  Freeze  the  Standard  Mileage  Rate  Used  to  Determine  Deductible  Automobile 
Expenses  Incurred  for  the  Business  Use  of  Such  Vehicles  at  the  1993  Level  for  the  1994 
Taxable  Year,  and  Thereafter,  to  Round  Down  the  Amount  Computed  by  the  IRS  to  the 
Nearest  Whole  Cent.  A  Proposal  to  Limit  the  Business  Mileage  Deduction  for  Trips 
Beginning  at  the  Taxpayer's  Home  to  Mileage  in  Excess  of  10  Miles 

Freezing  or  limiting  the  use  of  the  standard  mileage  rate  actually  works  against  tax  simplification. 
Use  of  the  standard  rate  is  simple  and  is  designed  to  be  an  alternative  to  the  recordkeeping  that 
would  be  required  to  deduct  actual  expenses.  The  standard  rate  is  computed  annually  by  the  IRS 
to  reflect  realistic  costs  of  driving  a  vehicle.  To  the  extent  that  the  standard  mileage  rate  does 
not  adequately  reflect  costs  because  of  this  proposal,  more  taxpayers  will  use  actual  expenses  with 
the  related  additional  recordkeeping  and  complexity.  In  addition,  these  proposals  seeks  to  deny 
taxpayers  a  deduction  for  the  full  amount  of  expenses  incurred  in  die  business  use  of  an 
automobile.  The  proposal  to  limit  the  business  mileage  deduction  for  trips  beginning  at  the 
taxpayer's  home  to  mileage  in  excess  of  10  miles  adds  recordkeeping  and  complexity.  As 
previously  stated,  such  a  limit  or  disallowance  of  legitimate  ordinary  and  necessary  expenses  is 
not  appropriate. 


A  Proposal  to  Repeal  the  Safe  Harbor  Under  Section  530  of  the  Revenue  Act  of  1978. 
Relating  to  the  Classification  of  Workers  as  Independent  Contractors,  for  Construction 
Industry  Employees 

The  Revenue  Act  of  1978  provided  definite  rules  to  reduce  the  controversy  in  classifying  workers 
as  employees  or  independent  contractors.  The  Act  sought  to  avoid  reclassifications  of  workers 
whom  taxpayers  treated  as  independent  contractors  in  good  faith  and  with  a  reasonable  basis  in 
court  decisions,  IRS  audit  acquiescence,  or  long-standing  recognized  practice  for  a  significant 
segment  of  the  relevant  industry.  The  taxpayer  was  also  required  to  have  fulfilled  tax  filing  and 
reporting  requirements  for  independent  contractors. 

We  have  not  seen  any  evidence  of  widespread  abuse,  and  would  discourage  Congress  from  re- 
opening this  area  of  controversy  and  complexity,  unless  a  more  comprehensive  approach  is  taken. 


A  Proposal  to  Disallow  Deductions  for  Compensatory  Damages  Under  Certain 
Environmental  Laws  and  a  Proposal  to  Clarify  the  Treatment  of  Environmental 
Remediation  Costs  by  (1)  Specifying  the  Types  of  Such  Costs  That  Must  be  Capitalized.  Or. 
Alternatively.  (2)  Requiring  that  all  Such  Costs  be  Amortized  Over  a  Uniform  Period  of 


The  tax  treatment  of  environmental  compensatory  damages  and  remediation  costs  is  extremely 
complex  and  has  tremendous  implications  for  businesses  (including  many  small  businesses)  and 
the  environment.  We  believe  that  these  proposals  should  be  considered  separately  from  the  otiier 
provisions  being  discussed  today.  Resolving  these  issues  will  require  carefiil  study  and  intensive 
legislative  consideration. 


A  Proposal  to  Require  that  a  Portion  of  Advertising  Expenses  be  Capitalized  and  Amortized 
Over  a  Period  of  Years 

This  proposal  is  unfair  to  many  taxpayers  and  will  increase  complexity  in  the  tax  law. 

Like  other  business  expenses,  advertising  costs  are  incurred  to  produce  revenue  and  should  be 
deductible  if  taxpayers  are  to  perceive  our  system  as  being  fair.  These  costs  generally  affect  the 
current  year's  revenue  or  possibly  part  of  the  next,  and  should  be  currently  deductible.  To  the 
extent  that  there  is  only  a  sUght  advertising  benefit  beyond  the  current  period,  allocating  the  costs 
to  additional  periods  adds  complexity  that  is  not  worth  the  revenue.  To  tiie  extent  that 
extraordinary  advertising  affects  later  periods,  the  law  already  requires  capitalization.  As  stated 
by  the  Tax  Court  in  Manhattan  Co.  of  Virginia.  Inc..  50  T.C.  86  (1968): 


1460 


The  reason  advertising  expenses  are  [currently  expensed]  is  that  these  expenses  are 
generally  of  a  yearly  recurring  nature  resulting  from  a  regular  activity  of  a  taxpayer  which 
produces  new  business  on  a  relatively  consistent  basis  each  year.  ...  Under  unusual 
circumstances,  where  extraordinary  advertising  has  developed  assets  with  a  usefiil  life 
extending  over  a  period  of  more  than  one  year,  this  Court  has  held  that  the  expenditure 
should  be  capitalized  and  the  cost  of  such  advertising  amortized  over  the  period  of  the 
useful  life  of  the  asset  developed. 

The  loss  of  the  current  deduction  will  have  an  adverse  impact  on  newspapers,  commercial 
television,  and  advertising  agencies  which  provide  advertising  for  businesses.  Businesses  that  rely 
heavily  on  advertising  will  be  taxed  more  heavily  and  will  have  to  pay  more  tax,  reduce 
advertising,  or  shift  to  other  forms  of  marketing. 

The  proposal  would  add  substantial  complexity  as  the  Internal  Revenue  Service,  the  Treasury 
Department  and  the  courts  try  to  define  advertising  and  related  costs  subject  to  capitalization. 
Interestingly,  even  after  the  U.S.  Supreme  Court's  decision,  in  INDOPCO.  Inc.  v.  Commissioner. 
1 12  S.  Ct.  1039  (1992),  in  which  the  government  was  given  added  flexibility  to  capitalize  costs 
that  benefited  future  tax  periods,  the  Internal  Revenue  Service  confirmed  (in  Revenue  Ruling  92- 
80)  that  advertising  expenses  would,  in  general,  continue  to  be  currently  deductible. 


A  Proposal  to  Tax  Political  Campaign  Committees  of  Federal  Candidates  at  the  Same  Rate 
of  Tax  Applicable  to  Committees  of  State  and  Local  Candidates  (the  Highest  Corporate 
Rate) 

There  is  no  apparent  rationale  for  treating  federal  candidate  campaign  funds  more  favorably  than 
those  of  state  and  local  candidates,  particularly  with  the  often  greater  difficulty  in  raising  fimds 
for  state  and  local  campaigns.  We  believe  that  fairness  and  simplicity  would  support  the  same 
standard  for  both.  Consistency  could  be  achieved  by  the  adoption  of  this  proposal  or  by 
lowering  the  tax  on  state  campaigns  to  the  level  applied  to  federal  campaign  committees. 


A  Proposal  to  Impose  a  30%  Excise  Tax  on  Expenditures  of  Tax-Exempt  Organizations  for 
Lobbying  (Including  Amounts  Paid  as  Salaries  and  an  Allocable  Portion  of  Support  Costs) 

The  1993  Budget  Reconciliation  Act  has  just  addressed  the  issue  of  nondeductible  lobbying 
expenses.  Part  of  the  rules  applicable  to  this  area  require  a  tax-exempt  organization  either  to 
notify  its  members  of  an  allocable  portion  of  dues  which  are  nondeductible  because  of  lobbying 
activities  undertaken  by  the  organization  or,  in  the  alternative,  to  pay  a  "proxy  tax"  at  a  35 
percent  rate  on  the  amount  of  expenditures  allocated  to  lobbying. 

It  is  not  clear  how  this  proposal  fits  into  the  context  of  the  1993  law.  One  would  hope  that  there 
is  not  a  serious  suggestion  to  impose  an  additional  30  p)ercent  excise  tax  on  top  of  the  proxy  tax 
or  disallowance  rules  that  now  exist.  To  the  extent  that  the  proposal  was  initiated  prior  to  the 
conclusion  of  Congressional  debate  on  the  1993  Act,  we  would  assume  it  now  becomes  moot. 


A  Proposal  to  Include  Contacts  with  Regulatory  Agencies  (Except  Local  and  Use  Agencies) 
in  the  Definition  of  Lobbying  for  Purposes  of  the  Existing  Restrictions  on  Section  501(c)(3) 

This  proposal  has  the  same  faults  as  described  for  the  previous  issue,  but  it  expands  the  problem 
to  include  administrative  matters.  Again,  comments  on  proposed  regulations  and  assistance  to 
the  government  on  various  matters,  such  as  the  AICPA  helping  the  IRS  improve  tax  forms, 
should  not  be  discouraged. 


1461 


A  Proposal  to  Deny  Corporations  a  Deduction  for  All  Tor  Part)  of  Interest  Paid  to  the  IRS 
on  Tax  Underpayment 

Interest  paid  by  corporations  to  the  IRS  on  tax  underpayments  is  an  ordinary  and  necessary 
business  expense  and  should  be  deductible.  A  departure  from  the  concept  that  expenses  incurred 
in  the  production  of  revenue  are  deductible  in  arriving  at  income  is  a  shift  from  what  is 
commonly  understood  to  be  an  income  tax  base.  Such  a  change  runs  against  the  tax  policy  of 
matching  costs  with  revenues,  and  it  should  be  rejected. 

There  is  no  tax  policy  reason  for  drawing  a  distinction  between  interest  paid  to  the  government 
and  interest  paid  to  other  lenders.  More  underpayments  are  the  unintentional  result  of  complexity 
and  uncertainty  in  the  tax  law  than  any  effort  to  keep  money  from  the  government  Often  the 
period  for  which  interest  is  calculated  is  prolonged  by  slow  IRS  processing  or  honest 
disagreement  as  to  the  amount  of  tax  due.  Where  a  legitimate  mistake  is  made  in  working  with 
our  complex  tax  law  and  the  correct  tax  is  not  determined  by  the  IRS  for  some  time,  denying  the 
interest  deduction  seems  particularly  unfair.  If  the  taxpayer  is  at  fault,  penalties  may  apply,  and 
the  overly  broad  sanction  of  denying  interest  deductions  unfairly  shifts  an  honest  dispute  into  a 
penalty-type  (i.e.,  nondeductible)  environment 

Interest  paid  by  taxpayers  is  already  biased  in  favor  of  the  government  which  pays  one  or  two 
percent  less  on  overpayments  than  taxpayers  are  required  to  pay  on  imderpayments.  To  disallow 
deductions  assessed  at  a  higher  level  of  interest  and  to  require  mcome  inclusion  of  interest  earned 
at  a  lower  level  compounds  this  imfaimess.  If  taxpayers  proposed  that  interest  received  from  the 
government  should  be  tax  exempt,  this  would  be  immediately  dismissed  based  on  sound  tax 
policy  reasons  as  a  raid  on  the  Treasury.  The  logic  is  identical  for  dropping  this  proposal—only 
the  revenue  is  different,  and  that  is  not  a  distinction  based  on  sound  tax  policy. 


A  Proposal  to  Increase  the  Rate  of  Interest  Payable  on  Corporate  Tai  Delinquencies 

This  proposal  would  compound  the  error  of  the  prior  proposal  to  deny  a  deduction  for  all  or  part 
of  the  interest  paid  to  the  IRS  on  tax  underpayments.  The  tax  burden  on  businesses  is  already 
substantial,  and  adding  to  it  at  this  time  does  not  encourage  cq}ital  or  jobs  formation  and  works 
against  an  economic  recovery. 


A  Proposal  Based  Upon  a  Provision  in  H.1L  5270.  as  Introduced  in  the  102nd  Congress,  to 
Modify  the  Method  by  Which  Income  From  the  Sale  of  Inventory  is  Sourced 

In  1986,  Congress  considered  and  completely  rejected  any  substantive  changes  to  this  area  of  the 
law  since  it  had  been  in  place  and  unchanged  for  more  than  60  years;  it  did,  however,  order  the 
Treasury  Department  to  study  the  matter  and  report  back.  In  re^wnse  to  section  121 1(d)  of  the 
1986  Act,  ordering  the  Secretary  to  study  the  long  range  impact  of  the  sale-source  rules.  Treasury 
issued  an  extensive  report  on  January  15,  1993.  The  report  makes  no  substantive 
reconmiendation,  but  states  that  study  of  the  issue  would  be  appropriate  in  the  context  of  an 
overall  review  of  our  international  tax  system. 

It  would  ^pear  that  after  complete  consideration  of  the  matter  in  1986,  and  a  detailed  study  by 
the  Treasiuy  Department  delivered  in  1993,  no  ftirther  action  could  be  warranted.  Any  loose 
interpretation  that  might  have  existed  in  sections  862  and  863  was  firmly  tightened  by  the  Service 
in  Rev.  Rul.  88-73  and  IRS  Notice  89-10  (dealing  with  independent  factory  prices)  and  the 
various  cases  decided  since  1986.  The  actual  regulations  have  been  in  effect  since  the  mid  1 920' s 
and  are  themselves  heavily  relied  on  by  U.S.  corporations  in  planning  their  international  affairs. 
It  is  also  clear  that  the  sale-source  rule  encourages  exports  and  allows  U.S.  companies  to  compete 
more  effectively  in  international  markets.  Any  ftirther  tinkering  in  this  area  is  clearly 
imwarranted  and  would  only  add  to  the  confusion  that  already  pervades  the  international  tax 
arena.  If  Congress  were  to  replace  the  foreign  tax  credit  with  a  deduction,  then  the  sourcing  rules 
would  become  irrelevant 


1462 


A  Proposal  to  Require  Written  Substantiation  of  Any  Meal  or  Entertainment  Expense 
Claimed  as  a  Business  Deduction;  Alternatively,  a  Proposal  to  Require  Written 
Substantiation  of  Any  Meal  or  Entertainment  Expense  in  Excess  of  $10 

The  additional  recordkeeping  necessitated  by  this  provision  would  be  burdensome  to  businesses, 
and  would  not  yield  enough  revenue  to  make  it  worthwhile.  Section  274  delegates  to  the 
Secretary  of  the  Treasury  the  authority  to  set  a  de  minimis  amount  for  recordkeeping,  and  if  there 
were  a  compliance  problem,  this  could  be  handled  administratively.  Absent  such  a  problem,  we 
believe  that  a  small  amount  of  revenue  should  not  be  exacted  from  generally  complying  taxpayers 
who  have  not  had  to  meet  more  rigid  recordkeeping  requirements. 

It  should  be  noted  that  the  $25  substantiation  threshold  currently  in  the  law  was  enacted  in  1962. 
In  3 1  years,  that  number  has  never  been  adjusted  for  inflation.  The  current  proposal  moves  in 
exactly  the  wrong  direction. 


A  Proposal  to  Limit  the  Deduction  for  Wagering  Losses  to  80%  of  the  Amount  Otherwise 
Deductible 

As  with  a  number  of  other  positions  taken  in  our  testimony  where  expenses  related  to  the 
production  of  income  are  limited  or  denied  (such  as  those  related  to  business  use  of  a  vehicle  or 
business  needs),  we  oppose  limiting  deduction  for  wagering  losses.  This  arbitrary  limit  on 
deductions  is  unfair  to  taxpayers,  who  must  include  gambling  winnings  fully  but  would  have  to 
limit  deductions  of  gambling  losses.  There  is  already  a  limit  on  gambling  losses  to  the  extent 
of  wiimings  to  prevent  the  government  firom  subsidizing  a  taxpayer's  wagering. 


A  Proposal  to  Amend  the  Like-Kind  Exchange  Rules  to  Require  that  the  Code  Section  1031 
Property  Received  Must  be  "Similar  or  Related  in  Service  or  Use"  to  be  Property 
Exchanged.  Except  in  the  Case  of  Condemnations 

The  change  suggested  will  result  in  unneeded  complication  of  well-settled  law.  The  change  vwll 
likely  have  a  chilling  effect  on  real  estate  transactions,  a  result  inconsistent  with  the  intent  of  the 
many  changes  (including  the  passive  loss  rules)  in  OBRA  1993  (PL  103-66).  Taxpayers  who  are 
in  the  real  estate  business  often  invest  in  improved  and  unimproved  property,  which  under  present 
interpretations  qualify  as  property  of  a  like  kind.  However,  improved  and  unimproved  property 
would  not  qualify  under  the  fiinctional  "similar  or  related  in  service  or  use"  test.  If  the  proposal 
is  adopted,  the  real  estate  business  would  be  more  severely  affected  than  other  businesses,  such 
as  manufacturing,  where  assets  already  qualify  under  the  functional  use  test. 

The  concept  embodied  in  section  1031  is  to  not  tax  transactions  where  no  cash  in  realized.  The 
proposed  change  will  stifle  investment  in  property  held  for  productive  use  or  mvestment. 
Although  the  proposal  would  make  the  replacement  property  requirement  the  same  as  under 
section  1033,  there  is  no  simplification  gained. 


Once  again,  we  appreciate  the  opportunity  to  present  our  views  here  today  and  we  stand  ready 
to  assist  you  in  any  way. 


1463 

Mr.  McNULTY.  Thank  you  very  much.  I  thank  you  all  for  your 
testimony.  All  of  your  statements  will  appear  in  the  record  in  their 
entirety.  I  just  have  a  couple  of  questions. 

Mr.  Dakm,  as  you  know,  in  at  least  two  recent  cases  the  IRS  has 
ruled  that  environmental  remediation  costs  must  be  capitalized 
and  apparently  there  is  some  question  as  to  how  the  law  may  be 
applied  in  future  cases.  Now,  I  noted  in  your  testimony  that  you 
do  not  suggest  a  legislative  response  to  this  issue,  but  I  was  just 
wondering  in  the  meantime  how  are  your  members  treating  such 
costs? 

Mr.  Dakin,  I  don't  have  access  to  the  tax  returns  of  the  various 
NAM  member  companies. 

Mr,  McNULTY.  Do  you  have  some  sense  of  what  they're  doing? 

Mr.  Dakin.  I  do  not  know  how  they  are  treating  it.  I  will  say  that 
there  is  case  law  that  distinguishes  between  items  which  should  be 
expensed  for  tax  purposes  and  items  that  should  be  capitalized  and 
I  would  imagine  that  companies  are  following  that  case  law. 

The  two  technical  advice  memoranda  are  well  known,  and  NAM 
and  other  groups  are  having  discussions  on  this  and  have  had  for 
the  last  vear  or  so,  so  we  are  hopeful  that  the  matter  will  be  re- 
solved administratively. 

Mr.  McNULTY.  Thank  you.  Mr.  Kalish,  if  you  were  here  earlier, 
you  know  that  we  talked  about  this  proposed  repeal  of  section  530 
at  the  beginning  of  the  hearing.  I  note  your  strong  opposition  to  the 
repeal. 

I  just  wanted  to  ask  about  the  many  workers  who  perform  serv- 
ices for  the  subcontractor  and  are  misclassified  as  independent  con- 
tractors, manv  times  against  their  choice.  This  results  in  the  loss 
of  necessary  Benefits  such  as  health  benefits  and  Social  Security 
coverage. 

How  would  you  respond  to  that? 

Mr.  Kalish,  I  am  really  not  familiar  with  how  the  subcontractors 
treat  their  employees.  As  a  builder,  we  hire  a  subcontractor  and  we 
pay  him  a  negotiated  amount  and  we  submit  to  him  at  the  end  of 
the  year  a  1099,  so  I  am  not  really  sure  how  he  treats  his  people. 
I  would  assume  he  treats  his  people  as  employees,  but  I  really 
don't  know. 

Mr.  McNULTY.  Well,  apparently  there  are  some  different  opin- 
ions about  that,  so  I  think  that  we  ought  to  pursue  that  a  little  bit 
further.  I  think  that  perhaps  we  can  reach  some  kind  of  a  middle 
ground  on  that  topic, 

Mr.  Kalish,  I  am  sure  that  I  will  speak  to  the  staff  of  the  Na- 
tional Association  of  Homebuilders  and  have  them  do  some  re- 
search and  have  them  get  back  to  the  committee,  sir. 

Mr,  McNULTY.  Thank  you. 

[The  following  was  subsequently  received:] 

During  the  testimony,  Mr.  McNulty  inquired  about  the  "many  workers  who  per- 
form services  for  the  subc»ntractor  and  are  misclassified  as  independent  contractors 
.  .  .  thus  resulting  in  the  loss  of  necessary  benefits  such  as  health  benefits  and  so- 
cial security  coverage."  Mr.  Kalish  indicated  that  NAHB  staff  would  research  the 
treatment  by  subcontractors  of  their  workers. 

As  pointed  out,  the  builder  submits  a  form  1099  to  the  subcontractor  and  is  usu- 
ally unaware  whether  the  subcontractor  classifies  its  workers  as  employees  or  as 
independent  contractors.  The  available  research  does  not  address  this  issue.  We 
would  welcome  an  opportunity  to  discuss  this  matter  further  in  an  attempt  to  de- 
velop a  workable  middle  ground,  as  Mr.  McNulty  suggested. 


1464 

Mr.  McNuLTY.  Ms.  Gackenbach,  I  really  don't  have  a  question 
for  you.  You  very  clearly  outlined  your  view  with  regard  to  this 
controversy  about  the  proper  tax  treatment  of  environmental  costs 
and  we  take  note  of  that.  If  I  understand  you  correctly,  you  don't 
suggest  a  legislative  response  to  that? 

Ms.  Gackenbach.  Not  at  this  time  we  don't  think  it  is  war- 
ranted. 

Mr.  McNULTY.  Thank  you.  But  I  would  like  to  ask  that  question 
of  Ms.  Pecarich  because  I  wasn't  quite  clear  whether  you  felt  that 
way  given  the  current  uncertainty  about  the  proper  tax  treatment 
of  environmental  cleanup  costs. 

Do  you  believe  that  this  is  an  area  where  appropriate  legislation 
could  provide  the  simplification  that  we  are  looking  for? 

Ms.  Pecarich.  Our  statement  suggests  that  this  whole  area  de- 
serves further  consideration  and  study.  The  AICPA  works  through 
the  committee  structure,  so  I  don't  have  the  full  recommendations 
of  the  committee  that  considered  this. 

Mr.  McNuLTY.  So  you  haven't  developed  a  policy,  but  you  are  not 
necessarily  opposed  to  pursuing  a  simplification  legislatively? 

Ms.  Pecarich.  Not  necessarily.  I  think  the  issue  that  you  are 
faced  with  is  much  like  the  amortization  of  intangibles  where  there 
are  a  lot  of  disparate  fact  situations  and  not  enough  guidance  and 
we  are  getting  seriatim  guidance  out  of  the  service  that  isn't  totally 
satisfactory,  and  I  think  the  question  is:  Do  we  wait  for  those  mat- 
ters to  be  resolved  in  the  courts  or  is  some  other  solution  more  ap- 
propriate? 

Mr.  McNuLTY.  On  behalf  of  Chairman  Rangel,  I  want  to  thank 
all  of  you  for  your  testimony.  Thank  you. 

I  would  announce  at  this  time  that  we  will  be  taking  a  very  brief 
recess  for  about  10  minutes,  after  which  Congressman  Neal  will  be 
here  to  chair  the  balance  of  the  hearing.  The  committee  hearing 
stands  in  recess  until  12:10. 

[Recess.] 

Mr.  Neal  [presiding].  Thank  you  for  allowing  us  that  inconven- 
ience. The  second  panel  that  will  now  be  invited  to  submit  testi- 
mony for  the  record  is  represented  by  Peter  F.  McCloskey,  who  is 
the  president  of  Electronic  Industries  Association;  Thomas  G. 
Singley,  who  is  the  general  manager  of  the  Shell  Oil  Corporation 
and  represents  the  Cnemical  Manufacturers  Association;  the  North 
American  Reinsurance  Corp.,  Peter  Gentile,  who  is  the  senior  vice 
president  and  is  accompanied  by  Kenneth  Kies — Kies? 

Mr.  Kies.  Kies. 

Mr.  Neal.  Kies,  OK.  The  National  Association  of  Independent  In- 
surers, represented  by  Robert  Jarratt,  who  is  the  executive  vice 
president  and  chief  executive  officer  of  the  Florida  Farm  Bureau 
General  Insurance  Company;  and  the  American  Nuclear  Insurers, 
Robert  Rahn,  counsel. 

Mr.  McCloskey. 

STATEMENT  OF  PETER  F.  McCLOSKEY,  PRESffiENT, 
ELECTRONIC  INDUSTRIES  ASSOCIATION 

Mr.  McCloskey.  Good  afternoon,  Mr.  Chairman.  I  am  president 
of  the  Electronic  Industries  Association  and  I  am  pleased  to 
present  the  views  of  the  U.S.  electronics  industries  on  the  proposal 


1465 

to  change  the  foreign  tax  credit  to  a  deduction  and  the  proposal  to 
change  the  source  rule  on  the  sale  of  inventory. 

In  addition,  we  are  also  pleased  to  offer  additional  comments  for 
the  record  in  our  written  statements  on  the  denying  of  the  cor- 
porate deduction  for  all  or  part  of  the  interests  paid  to  the  IRS  on 
tax  underpayments,  the  rate  of  interest  applicable  to  tax  delin- 
quencies, and  the  proposal  to  disallow  deductions  for  compensatory 
damages  incurred  under  the  environmental  laws. 

I  am  particularly  pleased  in  the  administration's  testimony  ear- 
lier today  that  they  did  not  support  or  oppose  all  of  these  proposals. 
In  the  interests  of  time,  I  will  keep  my  comments  brief 

EIA  strongly  opposes  the  proposal  to  change  the  foreign  tax  cred- 
it to  a  deduction.  Chief  among  the  reasons  is  that  the  proposal 
would  abrogate  longstanding  U.S.  policy  directed  toward  avoiding 
double  taxation  of  international  income  through  the  use  of  the  for- 
eign tax  credit  system. 

Simply  stated,  the  replacement  of  the  forei^  tax  credit  with  a 
deduction  would  severely  impact  the  competitiveness  of  U.S.  com- 
panies operating  abroad  because  it  would  subject  them  to  economic 
double  taxation.  Under  current  law,  the  foreign  tax  credit  ensures 
that  the  foreign  income  of  U.S.  companies  is  subject  to  the  higher 
of  either  the  foreign  or  the  U.S.  tax  on  such  income,  but  not  the 
sum  of  those  two  corporate  income  levels. 

Our  foreign  competitors  operating  in  the  same  overseas  markets 
as  U.S.  firms  do  not  have  such  a  tax  penalty  placed  on  them.  Rath- 
er, their  home  countries  either  provide  for  a  home  country  tax  ex- 
emption on  such  foreign  income  or  provide  a  comparable  foreign 
tax  credit  system  as  is  currently  available  in  the  United  States. 

The  impact  of  this  proposal  fails  to  take  into  account  the  reality 
of  today's  economy,  namely  that  U.S.  companies  must  compete  in 
a  global  marketplace.  Rather  than  slowing  our  ability  to  work  in 
the  international  economy,  EIA  believes  policymakers  must  make 
the  United  States  the  world's  best  place  in  which  to  manufacture 
and  from  which  to  export.  The  change  in  the  foreign  tax  credit  to 
a  deduction  harms  our  ability  to  accomplish  this  important  goal. 

The  second  one  is  the  change  in  the  export  source  rule.  We  are 
understand  that  that  proposal  is  similar  to  the  provision  contained 
in  H.R.  5270  in  the  last  Congress  and  which  would  have  modified 
the  inventory  income  sourcing  rule  in  two  ways.  First,  income  de- 
rived from  products  manufactured  in  the  United  States  but  sold 
outside  the  United  States  would  be  allocated  by  applying  the  pro- 
duction marketing  split  of  current  law  to  the  combined  income  of 
the  U.S.  producer  and  any  related  foreign  purchaser  of  the  product. 
This  is  a  change  from  current  law  which  applies  the  production 
marketing  split  just  to  the  income  of  the  U.S.  producer. 

Second,  the  proposal  would  mandate  a  U.S.  source  for  any  in- 
come associated  with  the  direct  or  indirect  sale  of  inventory  prod- 
uct for  use,  consumption,  or  disposition  in  the  United  States.  Going 
back  to  that  first  provision,  it  would  detrimentally  affect  the  ability 
of  U.S.  companies  to  compete  in  the  international  marketplace  by 
increasing  their  costs,  thus  requiring  an  increase  in  the  current 
price  of  goods  sold  to  non-U. S.  customers. 

Since  non-U. S. -based  competitors  would  not  be  forced  into  the 
same  price  increase  action,  they  would  naturally  recognize  the  com- 


1466 

petitive  advantage  over  our  American  counterparts.  Several  aspects 
of  U.S.  statutory  and  case  law  are  designed  to  prevent  such  abuses 
including  increased  penalties  under  the  section  482  transfer  pricing 
rules  which  have  just  this  year  been  legislated  and  the  new  section 
482  regulations  also  released  this  year  which  provide  detailed  guid- 
ance on  how  cross-border  transfer  prices  are  to  be  established  so 
as  to  reflect  the  best  possible  estimation  of  fair  market  value. 

The  second  provision  is  objectionable  from  a  practical  standpoint 
in  that  it  would  require  U.S.  exporters  to  trace  the  use  of  their 
products  by  some  three  or  more  customers  down  the  product  sales 
line.  This  will  create  an  additional  paperwork  burden  for  not  only 
the  U.S.  company  but  for  its  customers  as  well;  a  most  unwelcome 
condition  of  sales  in  the  eyes  of  the  customer. 

As  such,  the  proposal  will  increase  the  cost  of  exports  from  the 
United  States  to  foreign  customers  providing  another  competitive 
advantage  to  foreign-based  suppliers  over  U.S.  companies.  Con- 
sequently, it  is  our  view  that  this  is  similar  in  its  effect  to  the  pro- 
posal to  change  the  foreign  tax  credit  to  a  deduction  and  cor- 
respondingly fails  to  address  the  market  realities  of  the  1990s. 

President  Clinton  stated  the  United  States  must  ensure  that  its 
tax  trade  regulatory  and  procurement  policies  encourage  private 
sector  investment  and  innovation.  These  do  not. 

Thank  you. 

Mr.  Neal.  Thank  you  very  much,  Mr.  McCloskey. 

[The  prepared  statement  follows:] 


1467 


Electronic  Industries  Association 


STATEMENT  OF 

PETER  F.  MCCLOSKEY 
President 

ELECTRONIC  INDUSTRIES  ASSOCIATION 

Concerning  Miscellaneous  Revenue  Provisions 

Before  The 

Committee  on  Ways  &  Means 

Subcommittee  on  Select  Revenue  Measures 

Tuesday,  September  21,  1993 


I  INTRODUCTION  AND  EXECUTIVE  SUMMARY. 

Good  morning  Mr.  Chairman.  My  name  is  Peter  McCloskey  and  I  am  President  of  the 
Electronic  Industries  Association.  I  am  pleased  to  present  the  views  of  the  U.S.  electronics 
industry  to  the  Subcommittee  this  morning  on  the  proposals  to  change  the  foreign  tax  credit  to 
a  deduction  and  to  change  the  source  rule  on  the  sale  of  inventory.  In  addition,  we  are  also 
pleased  to  offer  additional  written  comments  for  the  record  on  (1)  denial  of  corporate  deduction 
for  all  or  part  of  the  interest  paid  to  the  IRS  on  tax  underpayments,  (2)  the  rate  of  interest 
applicable  to  tax  delinquencies,  and  (3)  the  proposal  to  disallow  deductions  for  compensatory 
damages  incurred  under  environmental  laws. 

EIA  is  uniquely  positioned  to  discuss  the  broad  range  of  tax  policy  issues  affecting  our 
industry's  international  competitiveness.  As  the  industry's  oldest  full  service  association,  EIA  is 
a  vigorous  trade  organization  with  a  close  connection  to  a  membership  which  represents  the  entire 
spectrum  of  the  U.S.  electronics  industry.  Our  members  comprise  the  most  dynamic,  growing,  and 
forward-looking  sector  of  the  U.S.  economy,  and  their  operations  offer  significant  insight  into  the 
future  prospects  for  U.S.  manufacturing  competitiveness. 

n    CHANGE  OF  THE  FOREIGN  TAX  CREDIT  TO  A  DEDUCTION. 

EIA  opposes  this  proposal  for  a  variety  of  reasons.  Chief  among  them  is  the  proposal's 
effective  abrogation  of  long-standing  U.S.  policy  directed  toward  avoiding  double  taxation  of 
international  income  through  the  use  of  the  foreign  tax  credit  system.  The  law  embodying  this 
policy,  reflected  in  the  Internal  Revenue  Code's  foreign  tax  credit  provisions,  has  been  in  place 
since  1918. 

EIA  believes  that  this  proposal  would  undermine  the  ability  of  U.S.  companies  to  compete 
in  the  global  marke^lace  by  requiring  U.S.  firms  to  pay  tax  twice  on  every  dollar  of  pre-tax  profit 
earned  in  a  foreign  country.  International  competitors  would  not  be  subjected  to  such  double 
taxation  and  would  have,  therefore,  an  immediate  and  substantial  advantage  over  U.S.  companies. 
Such  an  advantage  could  be  parlayed  into  reduced  price  offerings  to  the  customers,  increased 
R&D  or  manufacturing  plant  additions;  but  the  net  result,  in  every  case,  would  be  a  reduction  in 
the  U.S.  share  of  the  world  marke^lace. 


1468 


Simply  stated,  the  replacement  of  the  foreign  tax  credit  with  a  deduction  would  severely 
impact  the  competitiveness  of  U.S.  companies  operating  abroad  because  it  would  subject  them  to 
economic  double  taxation.  Under  current  law,  the  foreign  tax  credit  insures  that  the  foreign 
income  of  U.S.  companies  is  subject  to  the  higher  of  the  foreign  or  U.S.  tax  on  such  income,  but 
not  the  sum  of  those  two  corporate  level  income  taxes.  Our  foreign  competitors  operating  in  the 
same  overseas  markets  do  not  have  such  an  onerous  tax  penalty  placed  on  them  as  their  home 
countries  either  provide  for  a  home  country  tax  exception  on  such  foreign  income  or  provide  a 
comparable  foreign  tax  credit  system  as  is  currently  available  in  the  United  States. 

We  are  also  concerned  that  changing  the  foreign  tax  credit  to  a  deduction  would  likely 
abrogate  most  U.S.  income  tax  treaty  obligations.  Most  treaties  between  the  U.S.  and  other 
developed  countries  contain  a  prohibition  against  the  double  taxation  of  the  income  of  residents 
of  the  treaty  countries.  Typically,  the  U.S.  is  obligated  to  allow  a  U.S.  resident  individual  or 
company  a  credit  against  U.S.  tax  for  income  taxes  paid  in  the  other  treaty  country.  This 
obligation  is  to  be  undertaken  in  accordance  with  the  provisions  of  U.S.  law  as  amended  "without 
changing  the  general  principle  [of  a  foreign  tax  credit]..."  1989  Convention  Between  the  United 
States  of  America  and  the  Federal  Republic  of  Germany  for  the  Avoidance  of  Double  Taxation 
and  the  Prevention  of  Fiscal  Evasion  with  Respect  to  Taxes  on  Income  and  Capital  and  to  Certain 
Other  Taxes,  Art  23  (1).  (Other  examples  include  Art  23(2)  of  U.S./Italy  Treaty,  Art  23(1)  of 
the  U.S./  France  Treaty,  Art  24  (2)  of  the  U.S./Spain  Treaty,  Art  23(1)  of  the  U.S./U.K.  treaty, 
Art  24(1)  of  the  proposed  U.S./Mexico  Treaty,  and  Art  25(4)  of  the  proposed  U.S./Netheriands 
Treaty.) 

In  addition,  such  a  change  would  require  an  enormous  revamping  of  the  current  income 
tax  system.  This  would  involve  a  great  administrative  expenditure  on  the  part  of  both  the 
government  and  the  taxpayer  at  a  time  when  both  government  and  taxpayers  are  attempting  to 
streamline  their  operations. 

We  caution  that  both  the  recent  macro-level  and  individual  product-level  achievements  of 
the  U.S.  high  technology  sector  are  by  no  means  guaranteed  and  that  the  pressures  associated  with 
international  competition  will  remain  intense  for  the  U.S.  economy.  The  imposition  of  a  large, 
new  tax  expense  will  most  assuredly  have  an  adverse  affect  upon  this  progress  and  will  harm  the 
President's  plan  to  boost  U.S.  high-tech  leadership  in  worid  markets. 

ni       CHANGE  IN  THE  EXPORT  SOURCE  RULE. 

We  understand  that  this  proposal  is  similar  to  the  provision  contained  in  Section  203  of 
H.R.  5270  from  the  102nd  Congress  which  would  have  modified  the  inventory  income  sourcing 
rules  in  two  ways.  First,  income  derived  from  products  manufactured  in  the  U.S.  -  but  sold 
outside  the  U.S.  -  would  be  allocated  by  applying  the  "production/marketing  split"  method  of 
current  law  to  the  combined  income  of  a  U.S.  producer  and  any  related  foreign  purchaser  of  the 
product  (instead  of  just  to  the  income  of  the  producer  as  is  the  case  under  current  law).  Second, 
it  would  mandate  a  U.S.  source  for  any  income  associated  with  the  direct  or  indirect  sale  of 
inventory  property  for  use,  consumption,  or  disposition  in  the  U.S. 

The  first  provision  would  detrimentally  affect  the  ability  of  U.S.  companies  to  compete  in 
the  international  marketplace  by  increasing  their  costs,  thus  requiring  that  the  current  price  of 
goods  sold  to  non-U.S.  based  customers  be  increased.  Since  non-U.S. -based  competitors  would 
not  be  forced  into  the  same  price-increase  action,  they  would  naturally  recognize  a  competitive 
advantage  over  their  American  counterparts. 

V/e  disp'jte  the  arg-jmestE  used  in  the  past  in  support  of  this  proposal  which  claim  that  the 
inventory  source  rules,  as  they  currently  exist,  can  be  taken  advantage  of  by  U.S.  exporters.  In 
fact,  several  aspects  of  U.S.  statutory  and  case  law  designed  to  prevent  such  abuses  are  already 
in  place.  For  example,  increased  penalties  under  the  Section  482  transfer  pricing  rules  have  just 
this  year  been  legislated,  and  new  Section  482  regulations  (also  just  released  this  year)  provide 
detailed  guidance  on  how  cross-border  transfer  prices  are  to  be  established  so  as  to  reflect  the  best 
possible  estimation  of  fair  market  value. 


1469 


The  second  provision  is  objectionable  from  a  practical  standpoint  in  that  it  would  require 
U.S.  exporters  to  trace  the  use  of  their  products  by  up  to  three  or  more  customers  down  the  line. 
This  will  create  an  additional  paper  burden  for  not  only  the  U.S.  company  but  for  its  customers 
as  well,  an  unwelcome  condition  of  sale  to  the  customer.  The  proposal  will  also  obviously  increase 
the  cost  of  exports  from  the  U.S.  to  foreign  customers,  providing  a  competitive  advantage  to 
foreign-based  suppliers  over  U.S.  companies.  Perhaps  less  obvious,  however,  is  the  overall  sales 
disadvantage  associated  with  the  paperwork  burden  required  of  the  customer  under  the  provision. 
In  today's  highly  competitive  global  market,  cost  is  assessed  by  customers  through  a  variety  of 
means,  including  the  cash  price  of  the  product  or  service,  and  a  number  of  "soft"  costs.  This 
provision  would  raise  the  "soft"  cost  expense  of  U.S.  products  by  prompting  customers  to  invest 
scarce  staff  time  and  administrative  resources  into  complying  with  U.S.  supplier  requirements 
occasioned  by  this  provision.  In  short,  Mr.  Chairman,  we  live  in  a  world  where  customers  ask  not 
only  "how  much?"  but  also  "how  long  does  this  take?"  and  "how  many  people  are  required?".  This 
provision  fails  to  understand  this  key  market  reality. 

Finally,  we  reiterate  our  continued  support  of  our  industry's  joint  testimony  on  this  subject 
from  the  July  21,  1992  full  committee  hearing  on  H.R.  5270: 

"The  export  source  rule  is  one  of  the  few  GATT-legal  provisions  in  the 
tax  code  that  operates  as  an  export  incentive.  No  one  should  question 
the  significant  role  our  exports  have  played  in  our  economy.  Our 
exports  have  continued  to  create  and  sustain  significant  U.S.  jobs. 
Many  of  these  jobs  are  high  paying  manufacturing  jobs." 

"The  export  source  rule,  while  it  did  not  start  out  as  an  incentive,  has 
since  1986  become  a  powerful  export  incentive.  Many  foreign  tax 
provisions  were  cut  back  and  amended  to  retain  this  powerful  incentive 
in  the  1986  Act  We  strongly  urge  you  to  reject  this  temptation  to 
shoot  U.S.  exporting  companies  in  the  foot  Keep  this  incentive  and 
we'll  keep  fighting  for  an  export-led  improvement  to  our  economy."  [at 
18-19]. 

rv       DENIAL  OF  THE  CORPORATION  DEDUCTION  FOR  INTEREST  PAID  ON  TAX 
UNDERPAYMENTS. 

Again,  our  comments  mirror  concern  voiced  in  prior  Congresses  over  similar  proposak. 
As  many  in  industry  noted  in  their  opposition  to  a  comparable  proposal  considered  and  dropped 
from  the  Omnibus  Budget  Reconciliation  Act  of  1990,  Congress  should  reject  this  proposal  on  the 
grounds  that  it  erodes  the  fundamental  right  of  a  taxpayer  to  contest  an  honest  tax  dispute  with 
the  government  before  paying  the  amount  of  tax  assessed.  Changing  this  policy  effectively  denies 
taxpayers  the  ability  to  exercise  these  rights.  Tax  deficiencies  result  from  uncertainty  over  the  tax 
law  and  the  application  of  the  law  to  particular  facts.  They  are  typically  not  the  result  of  improper 
behavior  by  tsupayers.  The  proposal  would  change  the  dynamics  of  tax  protests  and  result  in  a 
one-way  street  in  favor  of  the  government  by  disallowing  the  deduction  for  deficiency  interest 
owed  to  the  government  while  imposing  a  tax  on  any  refund  interest  received  from  the 
goverament 

Perhaps  the  best  way  to  underscore  our  concern  is  through  an  example  showing  the  inequity 
of  the  rule's  effect  in  instances  connected  with  timing  or  "rollover"  issues  where  income  items  or 
deductions  are  simply  moved  from  one  year  to  another.  Under  the  proposal  and  in  such 
circumstances,  the  interest  due  the  government  in  the  deficiency  year  would  be  nondeductible, 
whereas  the  interest  d-c  the  ta;:payer  is  ic  rztazi  year  would  be  fully  taxable: 


1470 


EXAMPLE.  A  $28.6  million  deduction  taken  in  Year  1  is  deferred, 
per  IRS  audit,  to  Year  2.  This  creates  a  $10  million  tax'deficiency  in 
Year  1  and  a  $10  million  tax  refund  in  the  same  amount  in  Year  2. 
The  tax  treatment  of  the  resulting  interest  on  the  deficiency  and  refund 
is  as  follows: 


Yearl 

Year  2 

Total 

Interest  Eapense 
Interest  Incone 
PBT 

$(700K) 
$(700K) 

$600K 
$600K 

$(100K) 

Tax  Benefit 
Tax  Cost 
Total 
PAT 

-0- 
$(700K) 

$(210K) 
$(210K) 
$  390K 

$(210K) 
$(310K) 

EXPLANATION: 

The  $310K  net  detriment  is 

attributable  to 

the 

$210K  tax  imposed  on  the  $600K  interest  refund  in  Year  2  plus  the 
$100K  of  additional  non-deductible  deficiency  interest  in  Year  1 
because  of  the  1%  differential  between  the  rates  of  deficiency  interest 
and  refund  interest  (This  example  assumes  a  35%  corporate  tax  rate, 
a  7%  deficien<7  interest  rate  and  a  6%  refund  interest  rate,  and  that 
the  interest  runs  for  only  one  year  in  each  case.) 


THE  RATE  OF  INTEREST  APPLICABLE  TO  TAX  DELINQUENCIES. 


This  proposal,  too,  mirrors  a  proposal  raised  in  a  prior  Congress.  And  like  its  predecessor, 
this  proposal  should  also  be  rejected.  There  is  akeady  a  difference  in  favor  of  the  government 
in  the  rate  of  interest  the  government  pays  taxpayers  on  tax  refunds  versus  the  amount  of  interest 
taxpayers  pay  on  delinquencies.  It  is  EIA's  view  that  interest  should  be  applied  equally,  whether 
a  taxpayer  is  due  a  refund  or  is  required  to  pay  a  delinquency.  We  agree  with  the  February  28, 
1992  letter  signed  by  six  former  assistant  Treasury  secretaries  for  tax  policy  to  former  assistant 
secretary  for  tax  policy  Fred  Goldberg,  which,  in  commenting  on  a  similar  proposal  in  the  last 
Congress,  termed  it  "manifestly  unfair  on  its  face."  See  Daily  Tax  Report  (BNA),  No.  41,  G-5 
(March  2,  1992).  We  note  that  the  similar  1992  proposal  was  rebuffed  even  though  it  was 
ostensibly  "justifiable"  on  the  strength  of  its  badly-needed  revenue-raising  capabilities.  The  1993 
proposal  cannot  be  similarly  justified  and,  as  such,  should  also  be  rejected. 


VI 


DISALLOWANCE     OF     DEDUCTION     FOR     COMPENSATORY     DAMAGES 
INCURRED  UNDER  ENVIRONMENTAL  LAWS. 


Unfortunately,  given  the  lack  of  detail  on  this  proposal,  it  is  difficult  to  provide  specific 
industry  reaction.  Nonetheless,  as  a  broad  policy  statement,  the  tax  treatment  of  all  environmental 
remediation  costs  should  be  guided  by  the  "matching  principle".  Under  this  principle, 
environmental  costs  would  be  currently  deductible  because  they  relate  to  past  income-producing 
activities  and  not  to  the  production  of  future  income.  Consequentiy,  most  remediation  costs  would 
meet  the  definition  of  "ordinary  and  necessary"  business  expenses  under  Section  162  of  the 
Internal  Revenue  Code  and  would  be,  therefore,  currentiy  deductible.  Clarification  of  the  recent 
INDOPCO  decision  may  be  warranted,  to  prevent  its  limited  holding  from  being  overextended  in 
the  environmental  area.  In  this  respect,  careful  consideration  must  be  given  to  whether  any  tax 
legislation  will  have  the  effect  of  incentivizing  or  disincentivizing  individuals  and  businesses  to 
engage  in  environmental  cleanup  efforts. 


1471 


Vn      CONCLUSION. 

President  Clinton  has  stated  that  "the  United  States  must  *  *  *  ensure  that  its  tax,  trade, 
regulatory,  and  procurement  policies  encourage  private  sector  investment  and  innovation.  In  a 
global  [economy]  where  capital  and  technology  are  increasingly  mobile,  the  United  States  must 
make  sure  that  it  has  the  best  environment  for  private  sector  investment  and  job  creation." 
Technology  for  America's  Growth,  supra,  at  12. 

The  proposals  we  comment  on  today  would  frustrate  these  important  goals  by  increasing 
the  costs  of  U.S.  business  operations  in  international  and  domestic  markets.  They  have  no 
apparent  overriding  tax  or  economic  policy  justification,  and  will  likely  lead  to  an  export  of  U.S. 
manufacturing,  R&D  activities  and  jobs.  These  are  not  the  items  we  want  to  export  Rather,  we 
want  to  continue  to  export  the  best  products  and  services  that  our  people  and  our  technology  can 
produce.   We  therefore  strongly  urge  that  these  proposals  be  rejected. 


1472 

Mr.  Neal.  We  will  now  have  an  opportunity  to  hear  from  Mr. 
Singley. 

STATEMENT  OF  THOMAS  G.  SINGLEY,  GENERAL  MANAGER, 
TAX  DEPARTMENT,  SHELL  OH.  COMPANY,  HOUSTON,  TEX., 
ON  BEHALF  OF  THE  CHEMICAL  MANUFACTURERS  ASSOCIA- 
TION 

Mr.  Singley.  Thank  you,  Mr.  Chairman.  I  am  Thomas  G. 
Singley,  a  general  manager  of  Shell's  Tax  Department  appearing 
on  behalf  of  the  Chemical  Manufacturers  Association.  I  request 
that  our  written  statement  be  included  in  the  hearing  record  and 
will  summarize  my  remarks. 

CMA  is  a  nonprofit  trade  association.  Our  member  companies 
represent  more  than  90  percent  of  the  productive  capacity  of  the 
basic  industrial  chemicals  in  the  United  States.  In  1992,  the  U.S. 
chemical  industry  was  the  Nation's  leading  exporter  and  now  pro- 
vides 1.1  million  high-wage,  high-tech  jobs  for  American  workers. 

I  will  restrict  my  oral  comments  today  to  only  five  proposals  be- 
fore the  subcommittee.  First,  we  oppose  the  proposal  for  the  cap- 
italization of  environmental  remediation  expenses.  Second,  we  be- 
lieve eliminating  foreign  tax  credit  is  a  bad  idea  and  so  are  any 
proposals  that  would  change  the  inventor  export  source  rules. 

Next,  we  believe  there  is  no  justification  for  adding  new  chemi- 
cals at  this  time  to  the  existing  CFC  tax.  And  last  but  certainly  not 
least,  we  believe  an  oil  import  fee  would  be  disastrous  not  only  to 
our  industry  but  to  all  U.S.  industries. 

I  will  say  a  few  specifics  about  each  one  of  these.  First,  we 
strongly  oppose  proposals  to  capitalize  environmental  remediation 
costs.  Environmental  remediation  costs  to  meet  stringent  Federal 
and  State  requirements  are  expensive,  technically  difficult,  and 
complex.  Providing  more  severe  tax  treatment  for  these  costs  than 
for  other  business  expenses  is  a  bad  idea,  it  seems  to  us,  at  a  time 
when  so  many  Federal  and  State  legislative  and  regulatory  policies 
have  been  aimed  at  encouraging  and  mandating  these  sort  of  ac- 
tivities also.  We  urge  you  to  reject  the  proposals  to  capitalize  these 
expenses. 

Second,  we  oppose  eliminating  foreign  tax  credit.  Allowing  only 
deduction  for  foreign  taxes  would  create  yet  another  serious  im- 
pediment to  the  ability  of  U.S. -based  manufacturers  to  compete 
globally  and  we  are  happy  to  see  the  Treasury  Department  agrees. 

As  you  have  heard  earlier  today,  instead  of  piecemeal  efforts,  we 
think  Congress  should  undertake  a  comprehensive  reform  of  the 
tax  treatment  of  foreign  income  of  which  the  foreign  tax  credit  is 
an  important  part. 

Next,  the  proposed  changes  to  the  inventory  source — export 
source  rule  would  severely  reduce  incentives  to  export  U.S.  prod- 
ucts by  greatly  increasing  a  portion  of  such  income  as  treated  as 
U.S.-sourced.  At  the  same  time,  the  rule  would  increase  complexity 
and  costs  for  U.S.  manufacturers. 

Since,  as  I  mentioned,  the  chemical  industry  is  a  leading  U.S.  ex- 
porter, we  strongly  oppose  changing  the  current  inventory  source 
rules  in  this  way  and,  again  we  are  happy  to  see  Treasury  agrees 
with  this  position. 


1473 

Next,  CMA  objects  to  adding  new  chemicals  to  the  list  of  those 
taxed  under  the  ozone  depleting  chemicals  excise  tax.  One  stated 
objective  of  this  tax  was  to  provide  an  incentive  for  producers  and 
users  of  CFCs  to  accelerate  the  transition  to  HFCs,  most  of  which 
have  about  one-tenth  the  ozone  depleting  potential  of  these  CFCs. 
Taxing  HCFCs  now  would  penalize  the  investment  in  the  alter- 
native technology  before  safe  and  effective  substitutes  are  available 
for  many  applications  and  uses. 

Finally,  we  oppose  fees  on  imported  crude  oil  and  refined  petro- 
leum products.  Energy  intensive  energies  like  the  chemical  indus- 
try would  be  especially  hard  hit  by  an  oil  import  fee. 

We  estimate  this  fee  would  increase  U.S.  chemical,  energy,  and 
feedstock  costs  by  about  a  half  a  billion  dollars  each  year.  Our  ex- 
perience with  these  taxes — and  the  Superfund  excise  taxes  are  a 
good  example — show  that  fees  of  this  type  tend  to  subsidize  imports 
of  untaxed  downstream  products.  They  also  penalize  U.S.  exports 
and  they  add  to  the  Nation's  already  large  trade  deficit. 

Thank  you,  Mr.  Chairman,  that  concludes  my  statement. 

Mr.  Neal.  Thank  you  very  much,  Mr.  Singley. 

[The  prepared  statement  follows:] 


1474 


BEFORE  THE  HOUSE  WAYS  AND  MEANS 
SUBCOMMITTEE  ON  SELECT  REVENUES 

STATEMENT  OF 

CHEMICAL  MANUFACTURERS  ASSOCIATTON 

ON 

MISCELLANEOUS  REVENUE -RAISING  PROPOSALS 

The  Chemical  Manufacturers  Association  ("CMA")  appreciates  this 
opportunity  to  address  the  Subconmittee  on  Select  Revenues  on  the 
miscellaneous  revenue-raising  proposals  submitted  by  committee  members 
as  measures  to  offset  the  revenue  cost  of  other  tax  proposals. 

CMA  is  a  non-profit  trade  association.   Our  member  companies 
represent  more  than  90  percent  of  the  productive  capacity  for  basic 
industrial  chemicals  in  the  United  States.   The  U.S.  chemical  industry 
provides  1.1  million  high-wage,  high-tech  jobs  for  Amprican  workers. 

CMA  is  most  concerned  that  the  subcommittee  has  chosen  to  hold 
these  hearings  so  soon  after  Congress  enacted  comprehensive  budget 
legislation  that  mandates  tax  increases  of  more  than  $250  billion  over 
the  next  five  years.   Moreover,  the  subcommittee  will  review  several 
proposals  that  have  widespread  application  and  that  are  vital  to  our 
nation's  economy  and  to  the  chemical  industry. 

These  subjects  include,  among  others,  the  income  tax  treatment  of 
environmental  remediation  costs  and  settlements,  changing  the  foreign 
tax  credit  to  a  deduction,  sourcing  Income  from  the  sale  of  inventory 
property,  and  adding  new  chemicals  to  the  list  of  taxable  ozone- 
depleting  chemicals.   Moreover,  in  the  first  month  after  the 
Congressional  debate  on  energy  taxes,  the  subcommittee  wHl  consider 
yet  another  proposal  to  tax  energy  by  increasing  the  tariff  on  imported 
crude  oil  by  15-cents  per  barrel  and  on  refined  petroleum  products  by 
1-cent  per  gallon. 

CMA  respectfully  submits  that  it  is  inappropriate  to  take  up  these 
proposals  simply  as  revenue  sources  to  pay  for  other  tax  amendments. 
Moreover,  these  proposals  would  seriously  harm  the  U.S.  chemical 
industry  and  the  nation's  economy,  and  impede  a  jobs -producing 
recovery. 

Mr.  Chairman,  we  recognize  that  the  limitations  created  by  the 
Congressional  budget  process  greatly  strain  the  ability  of  the 
Committee  on  Ways  and  Means  and  the  Congress  to  manage  ongoing  problems 
that  arise  in  a  complex  economy  under  the  Federal  tax  system.   Indeed, 
those  budget  rules  make  it  difficult,  if  not  Impossible,  to  correct  any 
serious  tax  problem  that  would  reduce  Federal  tax  revenues.   However, 
CMA  submits  that  proposals  to  modify  major  aspects  of  the  Federal  tax 
system  should  only  be  considered  in  the  context  of  the  serious  economic 
problems  to  which  they  apply  and  not  as  a  source  of  off-setting 
revenues  for  other  tax  changes. 

U.S.  tax  changes  must  not  be  viewed  in  isolation.   Raising  U.S. 
income  taxes  only  Increases  the  tax  burden  of  U.S.  exports  In  world 
markets  and  the  corresponding  tax  advantage  of  Imported  products  in  the 
United  States.   CMA  has  testified  on  several  occasions  that  the  budget 
problems  of  the  Federal  Government  may  require  an  alternative  tax 
reform  like  the  invoice  credit  value-added  tax  to  replace  portions  of 
the  present  tax  system.   Such  a  reform  could  Increase  overall  revenues 
and  enhance  the  international  competitiveness  of  U.S. -based 
manufacturers  and  the  American  jobs  they  provide. 

In  the  meantime,  CMA  urges  the  Committee  on  Ways  and  Means  to  seek 
amendment  of  controlling  budget  rules  to  permit  the  committee,  subject 
to  some  overall  budgetary  limitation,  to  correct  serious  tax  problems 
without  regard  to  baseline  revenue  projections.   For  many  years  this 
committee  operated  under  procedures  that  permitted  it  to  act  on  these 
limited  revenue  amendments.   Under  those  procedures,  the  committee 
would  report  such  amendments  if  there  were  no  objection  from  members  of 
the  committee,  the  Treasury  Department,  and  the  technical  staffs  of  the 
committee.   The  reported  bill  could  then  be  considered  on  the  House 


1475 


floor  under  the  suspension  or  unanimous  consent  cslend/irs.   CMA  believes 
that  these  procedures  are  equally  justified  today. 

In  addition,  CMA  opposes  using  the  select  revenup.  amendment 
process  to  consider  the  following  proposals: 

1.  Capitallzimt  Envlromiental  Reaediatlon  Costs: 

CMA  strongly  opposes  proposals  to  modify  the  tax  treatment  of 
environmental  remediation  costs  by  specifying  the  types  of  such  costs 
that  must  be  capitalized,  or,  alternatively,  by  requiring  that  all  such 
costs  be  amortized  over  a  uniform  period  of  years.   Mr.  Chairman,  we 
believe  that  these  proposals  raise  many  questions  of  vital  national 
concern. 

For  many  years,  section  162  of  the  Internal  Revenue  Code  has 
provided  that  taxpayers  may  deduct  for  income  tax  purposes  all  ordinary 
and  necessary  business  expenses.   Special  rules  apply  to  disallow 
payments  of  fines,  penalties  and  treble  damage  payments  in  the  nature 
of  penalties.   Under  this  general  rule  the  cost  of  cleaning  up  a 
hazardous  substance  discharge  is  a  deductible  business  expense.   Thus, 
current  Federal  tax  law  does  not  penalize  expenditures  for  prompt  and 
immediate  action  to  cleanup  any  discharge  of  hazardous  substances,  to 
confine  and,  if  possible,  to  mitigate  any  environmental  or  property 
damage  arising  from  the  discharge,  and  to  make  restitution  to  those 
injured  or  damaged. 

Environmental  remediation  activities  to  meet  stringent  Federal  and 
state  requirements  are  expensive,  technically  difficult,  and 
procedurally  complex.   Providing  more  severe  tax  treatment  for  these 
expenses  v  ^.   Id  seriously  impair  the  ability  of  U.S.-  based 
manufacturers  to  compete  both  in  domestic  and  world  markets. 

Allowing  the  current  deduction  of  these  expenses  does  not  create  a 
tax  shelter.   It  simply  recognizes  that  environmpnra I  cleanup  and 
remediation  costs  are  additional  expenses  that  reduce  net  income.  The 
U.S.  chemical  industry's  long  term  practice  has  been  to  encourage 
prompt,  private  response  to  any  discharge  or  spill  of  hazardous 
substances.   For  many  years,  the  industry  has  funded  a  n\imber  of 
private  programs  to  minimize  the  damage  and  loss  attributable  to  these 
events.  Yet,  over  the  years,  the  chemical  industry  lias  consistently 
been  one  of  America's  highest  taxed  Industries. 

CMA  has  commissioned  several  studies  by  Price  Watprhouse  in  recent 
years  to  determine  the  effective  tax  rate  of  the  cliemiral  industry 
under  the  methodology  the  Joint  Committee  on  Taxation  employed  in  the 
"Pease-Dorgan"  studies.   In  the  most  recent  of  these  studies  Price 
Waterhouse  concluded  the  effective  U.S.  tax  rate  of  the  industry  in 
1989  was  34.6  percent.   It  should  be  noted  that  this  rate  is  near  the 
statutory  maximum  corporate  tax  rate  and  was  paid  despite  the  fact  that 
environmental  remediation  costs  are  deductible  as  ordinary  and 
necessary  business  expenses  under  section  162. 

The  deductibility  of  environmental  cleanup  and  remediation 
expenses  as  ordinary  and  necessary  business  expenses  is  driven  by 
enormously  complicated  and  involved  fact  patterns.   The  legal,  tax, 
accounting,  insurance,  scientific  and  technical  aspects  of 
environmental  remediation  expenses  are  myriad.   The  Internal  Revenue 
Service  is  conducting  a  study  of  these  issues  that  will  fundamentally 
affect  both  the  environmental  policies  and  revenues  of  the  Federal 
government,  as  well  as  those  of  state  and  local  governments.   CMA 
strongly  believes  that  the  only  responsible  policy  on  on  this  subject 
is  to  encourage  the  prompt  and  responsible  environmental  cleanup  and 
remediation  efforts  through  current  deduction  of  these  expenses. 

The  resources  of  government  and  industry  should  be  directed  at 
minimizing  situations  that  will  require  environmental  cleanup  and 
remediation.   When  situations  do  occur,  they  should  be  focused  on  doing 
the  job  as  quickly  and  effectively  as  possible.   We  should  not  expend 
limited  government  and  business  resources  to  administer  penalties  and 
blame  through  the  tax  law.   Ample  statutory  authority  and 
administrative  means  already  exist  to  achieve  those  purposes. 


1476 


The  chemical  industry  is  proud  of  its  environmpntnl  record, 
including  the  promotion  of  safe  transportation  of  hazardous  materials. 
On  an  annual  basis,  over  99  percent  of  all  chemical  shipments  arrive 
without  incident  and  the  majority  of  the  incidents  that  do  occur  are 
minor  in  nature. 

We  are  also  proud  of  the  private  programs  that  wp  have  undertaken 
in  the  public  interest  to  minimize  the  consequences  of  incidents 
involving  hazardous  substances.   A  critical  element  of  any  hazardous 
materials  response  is  the  availability  of  timely  and  accurate 
information  and  expertise  on  how  to  deal  properly  with  the  release.  For 
22  years  CMA's  Chemical  Transportation  Emergency  Centfr  (CHEMTREC®) 
has  provided  specific  product  information  to  regional,  state,  and  local 
emergency  response  teams  throughout  the  United  States  and  Canada. 

Moreover,  CMA  and  its  member  companies  actively  maintain  a 
leadership  role  in  providing  training  and  assistance  to  emergency 
response  teams.   Over  the  last  eight  years  almost  three  quarters  of  a 
million  emergency  responders  have  taken  advantage  of  CMA's  library  of 
training  materials.   In  addition,  the  chemical  industry  has  provided 
valuable  public  service  through  its  Responsible  Care®  initiative, 
hands-on  emergency  response  training  programs,  and  numerous  other 
industry  programs  to  address  public  and  industry  concerns.   CMA  is 
continuing  to  expand  and  to  Improve  these  programs  to  meet  current  and 
future  needs. 

This  system  of  private  initiative  and  response  to  minimize  and  to 
confine  the  effects  of  hazardous  materials  emergencies  has  demonstrated 
its  great  importeince  and  public  value.   CMA  urges  the  Subcommittee  on 
Select  Revenues,  therefore,  to  reject  proposals  to  capitalize  or  to 
amortize  environmental  cleanup  and  remediation  costs.   Most 
Importantly,  we  urge  that  the  serious  questions  of  environmental  policy 
and  of  the  international  competitiveness  of  U.S. -based  manufacturing 
that  these  proposals  would  raise  deserve  comprehensivo  hearings  by  the 
full  committee. 

2.  Foreign  Tax  Piopogals: 

Changing  Soarcing  Kales  for  Inventory  Sales 

Last  year,  H.R.  5270  proposed  changes  to  the  rnlo  fnv  determining 
the  source  of  Income  a  U.S.  corporation  derives  from  exporting 
inventory  property  through  a  related  party.  Currently,  U.S. 
manufacturers  can.  In  certain  cases,  use  a  formula  that  generally 
permits  the  manufacturer  to  treat  50  percent  of  the  taxable  income  from 
an  export  sale  as  U.S.  source  production  income,  and  "iO  percent  as 
foreign  source  sales  Income.   The  proposal  would  have  altered  the 
formula  to  the  considerable  disadvantage  of  both  U.S.  exporters  and  the 
U.S.  economy . 

Numerous  taxpayers  expressed  their  strong  opposition  to  the 
change.   Among  their  many  legitimate  concerns  was  the  fact  that  the 
proposal  would  have  resulted  In  Increased  complexity  and  costs  for  U.S. 
manufacturers  while  at  the  same  time  severely  reducing  their  Incentives 
to  export  products  produced  In  the  U.S. 

CMA  wholeheartedly  agrees  with  those  concerns  and  wishes  to  take 
this  opportunity  to  express  our  strong  opposition  to  any  change  to  the 
inventory  sourcing  rules  based  upon  the  proposal  in  H.R.  5270. 

Eliminating  the  Foreign  Tax  Credit 

Since  1918,  U.S.  taxpayers  have  been  allowed  a  credit  against  U.S. 
tax  for  foreign  taxes  paid.   The  credit  is  designed,  generally,  to 
avoid  double  taxation  of  foreign  income  which  has  been  taxed  by  a 
foreign  country. 

CMA  strongly  opposes  the  proposal  to  elirainato  tho  foreign  tax 
credit.   Allowing  only  a  deduction  for  foreign  taxes  would  create  yet 
another  serious  impediment  to  the  ability  of  U.S.  multinationals  to 
compete  effectively  in  our  Increasingly  global  business  environment  by 
causing  significant  double  taxation.   Indeed,  the  substantial  increased 
tax  burden  on  U.S.  taxpayers  caused  by  this  ill-advised  proposal  will 
surely  be  welcome  news  to  their  foreign  competitors. 


1477 


The  proposal  fails  miserably  to  promote  any  rational  international 
tax  policy  objective.   It  is  anti-competitive  at  a  timp  when  U.S. -based 
manufacturers  are  beginning  to  compete  more  effectively  with  foreign- 
based  manufacturers.   Adopting  the  proposal,  therpfom,  would  not  only 
seriously  inhibit  the  ability  of  U.S. -based  mannfactnrprs  to  expand 
into  new  markets  but  also  would  threaten  their  cnrrpnt  market  positions. 

CMA  strongly  objects  to  the  proposal  and  urgps  that  it  be 
rejected.  Congress  should  instead  address  exi.sting  Hpficiencies  in  the 
foreign  tax  credit  system  in  order  to  promote  and  improve  the 
international  competitiveness  of  U.S. -based  mannfactnr ing  in  the  global 
marketplace,  such  as  the  unjustified  limitation  on  thp  credit  faced  by 
companies  paying  the  alternative  minimum  tax. 

New  Five  Percent  Excise  Tax  on  Purchases  by  Foreign  Corporations 

We  have  not  had  the  opportunity  to  study  this  proposed  legislation 
and,  thus,  do  not  know  the  instances  in  which  it  would  apply.   CMA 
would,  however,  point  out  that  severe  penalties  already  apply  when  a 
foreign  corporation  or  foreign-controlled  U.S.  corporation  fails  to 
provide  information  the  Internal  Revenue  Service  requests  in  connection 
with  an  audit. 

Wlthholdlnjt  Tax  on  Certain  Portfolio  Interes t 

A  30  percent  withholding  tax  is  imposed  on  certain  U.S.  Source 
interest  income  received  by  foreign  persons.   However,  in  1984  Congress 
exempted  "portfolio  interest"  from  U.S.  tax.   In  enacting  the 
exemption,  Congress  recognized  that  the  withholding  tax  impaired  the 
ability  of  U.S.  corporations  to  access  international  capital  markets 
which  greatly  increased  their  borrowing  costs.   The  exemption  allows 
U.S.  borrowers  to  borrow  more  efficiently  and,  thus,  at  lower  interest 
rates. 

Reinstating  the  withholding  tax  on  portfolio  interpst  would 
increase  interest  rates  for  all  U.S.  borrowers,  including  the  United 
States  Government.   This  result  was  most  recently  demonstrated  by  the 
dramatic  upswing  in  the  interest  rate  on  the  30-year  U.S.  Treasury 
bonds  caused  in  part  by  the  mere  possibility  that  the  withholding  tax 
would  be  reinstated. 

CMA  believes  the  repeal  of  the  portfolio  interest  exemption  is    / 
unwarranted.   It  would  almost  inevitably  lead  to  an  immediate 
escalation 

in  U.S.  interest  rates,  a  result  that  our  recovering  economy  cannot 
tolerate. 

3.  Additions  to  List  of  Taxable  Ozone-Deplettnit  Chealcals: 

An  additional  revenue  raising  proposal  would  add  methyl  bromide, 
hydrochlorof luorocarbons  (HCFCs),  and  hydrobromof luorocarbons 
(HBFCs)  to  the  list  of  ozone-depleting  chemicals  (ODCs)  that  are 
taxed  under  Section  4682  of  the  Internal  Revenue  Code.   Over  the  past 
decade,  CMA  has  actively  supported  effective  and  efficient  national 
programs  to  improve  the  environment.   When  Congress  reviews  tax 
proposals  to  improve  the  environment,  it  is  important  to  evaluate  their 
objectives  in  the  light  of  national  revenue,  trade,  and  competitiveness 
policies. 

In  this  regard,  CMA  opposes  product  specific  taxes.  Including  this 
new  proposal  to  expand  the  base  of  the  ODC  excise  tax.   Industry  and 
product  specific  taxes  aimed  at  addressing  environmental  issues 
disproportionately  impact  narrow  sectors  of  the  economy  without  a 
guarantee  of  achieving  their  environmental  objective.  Thus,  the  tax 
could  inflict  serious  harm  on  an  industry  with  no  offsetting  societal 
benefits.   If  new  revenues  roust  be  raised,  CMA  maintains  that  those 
revenues  should  be  raised  from  as  broad  a  tax  base  as  possible,  to 
distribute  the  tax  burden  fairly  and  equitably  and  not  to  impose  a 
disproportionate  impact  on  any  single  industry. 

This  certainly  would  be  the  case  with  respect  to  the  users  and 
producers  of  HCFCs.   The  proposed  tax  would  not  change  behavior, 
instead  would  be  an  additional  penalty  imposed  on  the  industry.   As  you 
will  recall,  when  the  ODC  excise  tax  was  first  enacted,  its  stated 


1478 


objective  In  addition  to  raising  revenue  was  to  provide  an  incentive 
for  producers  and  users  to  accelerate  the  transition  to  using  HCFCs . 
Most  HCFCs  have  about  one  tenth  the  ozone-depleting  potential  of  CFCs. 

Moreover,  the  Montreal  Protocol  and  later  the  Clean  Air  Act  had 
provided  for  phasing  out  the  manufacture  and  use  of  CFCs. 
Nevertheless,  industry  invested  hundreds  of  millions  in  research  and 
equipment  after  enactment  of  the  tax  on  CFCs  to  make  this  responsible 
transition  to  HCFCs.   Although  the  transition  is  still  underway,  HCFCs 
are  not  fully  available  for  every  application  today.   Taxing  HCFCs  now 
would  penalize  those  who  have  made  substantial  investments  in  this 
alternative  technology  before  safe  and  effective  substitutes  are 
available  for  many  applications  and  uses. 

Industry-  specific  and  product-specific  taxes  put  U.S.  producers 
and  workers  at  a  competitive  disadvantage  with  their  foreign 
counterparts.  Specifically,  new  environmental  taxes  deplete  industry 
funds  precisely  when  they  are  needed  most  to  meet  mandated 
environmental  standards.   In  the  case  of  this  specific  proposal,  the 
new  taxes  would  further  burden  industries  already  spending  large  sums 
of  money  to  Invest  in  new  equipment  to  transition  away  from  CFCs  and 
would  direct  resources  they  would  otherwise  use  to  develop  better 
alternatives. 

While  CMA  clearly  opposes  adding  new  chemicals  to  the  existing  tax 
base,  if  additional  chemicals  are  added,  we  advocate  that  the  same  tax 
structure  be  maintained  for  the  newly  added  taxable  products.   In  1989, 
when  the  ODC  tax  was  enacted.  Congress  included  provisions  to  tax 
Imported  products  and  provide  a  rebate  for  exported  products . 
Chemicals  that  are  recycled  are  not  subject  to  additional  taxes,  and 
feedstock  uses  of  chemicals  are  not  taxable.   Additionally,  the  tax  due 
is  based  on  the  ozone-depleting  potential  (ODP)  of  the  chemicals, 
recognizing  that  chemicals  that  have  lower  ODP  should  ho  assessed  a 
smaller  penalty.   Finally,  Congress  granted  special  t rontment  to 
products  used  in  the  manufacture  of  rigid  foam  insulaiion,  recognizing 
the  important  energy-conservation  uses  of  rigid 
foam. 


Finally,  CMA  supports  the  goals  of  legislation  to  improve  and  to 
protect  our  environment.   We  believe  that  the  tl.S.  should  continue  to 
be  the  leader  In  the  world-wide  effort  for  a  better,  safer 
environment.   Our  nation's  ability  to  pay  for  an  imprnvod  environment, 
however,  is  dependent  on  maintaining  the  competi tivenoss  of  U.S. -based 
manufacturing.   Tax  policies  that  create  additional  disadvantages  for 
U.S. -based  production  that  must  compete  with  foreign  production  will 
increase  the  overall  cost  to  the  U.S.  economy  of  meeting  national 
environmental  goals. 

4.  Increasimt  Tariffs/Taxes/Fees  on  laported  Oil: 

CMA  strongly  opposes  the  proposal  to  tax  energy  by  increasing  the 
tariff  on  Imported  crude  oil  by  15-cents  per  barrel  and  on  refined 
petroleum  products  by  1-cent  per  gallon.  Viewed  as  a  tariff  or  tax,  an 
oil  import  fee  raises  the  cost  of  U.S. -based  production  relative  to 
that  of  foreign-based  production  and  would  damage  the  international 
competitiveness  of  U.S.  manufacturing. 

Energy- Intensive  manufacturing  industries--  like  the  chemical 
industry  --would  be  especially  hard  hit  by  any  broad-based  energy  tax 
like  an  oil  Import  fee.   An  exemption  from  any  such  tax  for  chemical 
raw  materials  (feedstocks)  would  lessen  the  tax's  severe  adverse  impact 
on  U.S.  international  competitiveness,  but  would  not  eliminate  its 
adverse  Impact.   An  oil  Import  fee  would  have  additional  harmful 
consequences  because  the  fee  would  also  push  the  price  of  domestic  oil 
and  other  energy  resources  up  by  an  equivalent  amount. 

In  1992,  the  U.S.  chemical  industry  consumed  17.9  million  barrels 
(49,000  barrels  per  day)  of  fuel  oil  and  other  oil  products  for  it 
heat,  power,  and  electricity  generation  needs  and  491.4  million  barrels 
(1.346  million  barrels  per  day)  of  liquefied  refinery  gases  and  heavy 
liquids  for  Its  feedstock  needs.   The  higher  oil  product  prices  that 
would  arise  directly  from  the  oil  import  fee  would  add  about  $215 
million  in  annual  energy  and  feedstock  costs  to  the  U.S.  chemical 


1479 


industry.   These  higher  oil  products  prices  would  also  increase  the 
prices  paid  for  other  energy  sources  by  an  additionfl!  S20S  million. 
Thus,  the  proposed  oil  import  fee  would  increase  annual  chemical 
industry  energy  and  feedstock  costs  by  about  $420  million. 

Under  the  General  Agreement  on  Tariffs  and  Tradp  fGATT)  and  the 
U.S. -Canada  Free  Trade  Agreement  there  is  no  practical  means  to 
neutralize  the  harmful  effects  of  an  oil  import  tariff  or  fee   on  the 
international  competitiveness  of  U.S. -based  production  by  Imposing 
comparable  levies  on  U.S.  imports  of  finished  goods.   In  effect,  an  oil 
import  tariff  or  fee  will  subsidize  imports,  penal izo  exports,  and  add 
to  our  already  large  U.S.  trade  deficit. 

For  the  first  eight  months  of  this  year.  Congress  reviewed  the 
proposed  Btu  tax  and  several  alternative  energy  tax  proposals.   It 
seems  most  inappropriate  for  the  Committee  to  revisit  this  subject  so 
soon  after  the  enactment  of  the  Omnibus  Budget  Reconciliation  Act  of 
1993. 

CONCLUSION: 

One  major  goal  of  the  legislative  process  should  be  to  maintain 
the  international  competitiveness  of  U.S. -based  enterprises  in  our  tax 
system.   The  issues  that  we  have  addressed  suggest  that  present 
procedures  that  permit  the  review  of  amendments  to  benefit  some 
taxpayers  at  the  expense  of  others  can  threaten  that  competitiveness. 
Those  procedures  certainly  do  not  help  our  nation's  economy  as  a 
whole.   Paying  for  such  amendments  with  new  or  increased  taxes  on 
others  is  both  Inequitable  and  unacceptable.   CMA,  therefore, 
respectfully  urges  that  the  Committee  on  Ways  and  Means  seek  to  amend 
Congressional  budget  rules  to  permit  the  enactment  of  limited  tax 
amendments  on  their  own  merits  and  without  regard  to  their  impact  on 
baseline  revenues. 


September  20,  1993 


1480 

Mr.  Neal.  We  will  now  hear  from  Mr.  Gentile. 

STATEMENT  OF  PETER  A.  GENTILE,  SENIOR  VICE  PRESIDENT, 
NORTH  AMERICAN  REINSURANCE  CORP.,  NEW  YORK,  N.Y., 
ACCOMPANIED  BY  KENNETH  KIES,  COUNSEL 

Mr.  Gentile.  Thank  you.  Mr.  Chairman,  members  of  the  Select 
Revenue  Subcommittee,  I  am  Peter  Gentile,  senior  vice  president 
of  North  American  Reinsurance  Corp.,  a  corporation  located  in  New 
York.  North  American  Reinsurance's  sole  stockholder  is  SwissRe 
Holding,  North  America,  Inc.,  a  wholly-owned  subsidiary  of  the 
Swiss  Reinsurance  Company  headquartered  in  Zurich,  Switzerland. 

North  American  Reinsurance  with  its  U.S.  affiliates  is  the  fourth 
largest  reinsurer  with  approximately  $700  million  of  capital  and 
surplus.  I  welcome  this  opportunity  to  appear  before  this  sub- 
committee today  to  discuss  the  proposal  to  increase  from  1  percent 
to  4  percent  the  excise  tax  imposed  on  certain  premiums  paid  to 
foreign  persons  for  reinsurance  covering  property  and  casualty  in- 
surance. 

This  proposal  is  based  on  a  proposal  of  H.R.  5270,  which  was  in- 
troduced into  Congress  last  year.  Supporters  of  the  proposal  have 
claimed  that  a  rate  increase  is  necessary  because  U.S.  reinsurers 
are  at  a  competitive  disadvantage  with  respect  to  foreign  reinsur- 
ers. 

North  American  Reinsurance  from  its  perspective  as  a  company 
that  both  reinsures  and  purchases  reinsurance  and  from  its  per- 
spective as  a  member  of  a  coalition  including  over  1,000  insurance 
writers  located  throughout  the  United  States  opposes  the  proposal 
to  raise  the  insurance  excise  tax. 

An  excise  tax  increase  would  make  reinsurance  more  expensive 
to  obtain  and  would  restrict  the  reinsurance  capacity  available  to 
U.S.  insurers.  An  excise  tax  increase  like  that  proposed  in  H.R. 
5270  would  be  difficult  to  administer  fairly  and  effectively.  Fur- 
thermore, it  would  be  inconsistent  with  obligations  under  many  of 
our  tax  treaties,  in  particular  the  United  States-United  Kingdom 
tax  treaty. 

There  is  more  demand  by  U.S.  insurers  for  catastrophe  reinsur- 
ance than  U.S.  companies  are  currently  able  to  satisfy.  A  rate  in- 
crease on  reinsurance  provided  by  foreign  companies  would  result 
in  either  harmful  coverage  gaps  or  increased  costs  for  reinsurance, 
both  of  which  would  be  detrimental  to  U.S.  consumers. 

Because  of  recent  catastrophic  losses,  U.S.  insurers  are  facing  a 
period  of  restricted  capacity  in  the  reinsurance  market.  Any  tax  in- 
crease would  make  this  capacity  problem  worse.  Access  by  U.S.  in- 
surers to  foreign  reinsurers  increases  the  capacity  for  insuring  U.S. 
risk.  Because  particular  types  of  coverages  are  either  unavailable 
or  scarcely  available  from  U.S.  reinsurance  companies,  foreign  rein- 
surers provide  coverage  that  otherwise  simply  could  not  be  ob- 
tained. For  example,  foreign  companies  are  acting  as  a  primary 
source  of  reinsurance  for  medical  malpractice,  earthquake,  and 
hurricane,  aviation,  marine,  nuclear,  and  aerospace  coverage. 

Even  in  the  global  marketplace,  U.S.  insurers  currently  are  expe- 
riencing difficulty  in  placing  reinsurance.  This  is  due  to  the  recent 
high  level  of  losses  incurred  by  the  industry.  We  are  all  aware  of 


1481 

the  disasters,  both  natural  and  manmade,  that  all  areas  of  our 
country  are  currently  experiencing. 

The  magnitude  of  the  1992  catastrophes  was  staggering  and  con- 
tributed to  the  reporting  of  a  record  $34  billion  in  insurance  indus- 
try underwrriting  losses  that  year.  With  the  devastating  floods  this 
summer  in  the  Midwest,  the  March  blizzard,  the  World  Trade  Cen- 
ter explosion,  and  most  recently.  Hurricane  Emily,  1993  is  also  de- 
veloping into  a  costly  year  for  the  insurance  industry. 

The  existing  1  percent  excise  tax  on  reinsurance  should  not  be 
increased  for  the  following  additional  reasons.  As  the  1990  Treas- 
ury report  on  this  issue  concluded,  U.S.  reinsurers  are  not  operat- 
ing under  a  competitive  disadvantage  even  when  the  existing  1  per- 
cent tax  on  reinsurance  premiums  is  waived  by  tax  treaty.  The 
Treasury  report  based  its  conclusion  on  its  independent  analysis  of 
the  impact  of  a  simplified  reinsurance  transaction  with  companies 
located  in  several  different  countries. 

In  addition,  many  of  our  trading  partners  have  made  known 
their  disagreement  with  past  proposals  to  increase  the  insurance 
excise  tax.  These  trading  partners  view  current  and  post  proposals 
as  tantamount  to  tariff  increases  and  they  would  consider  taking 
steps  to  retaliate.  Even  countries  with  tax  treaties  with  the  United 
States  which  contain  the  excise  tax  waiver  view  these  proposals  as 
unilaterally  changing  their  tax  treaties.  Retaliatory  measures  bv 
our  trading  partners  would  have  a  harmful  effect  on  the  overall 
U.S.  economy  and  would  greatly  damage  international  investment 
and  trade  of  U.S.  companies. 

Finally,  enactment  of  an  excise  tax  increase  is  inconsistent  with 
the  spirit  if  not  the  specific  provisions  of  the  NAFTA  agreement. 
For  the  above  reasons,  with  a  particular  emphasis  for  its  impact  on 
U.S.  consumers,  I  urge  the  committee  to  maintain  the  existing  pro- 
visions of  the  excise  tax  on  premiums. 

Thank  you,  and  I  will  be  available  to  answer  any  questions  that 
you  may  have. 

Mr.  Neal.  Thank  you  very  much,  Mr.  Gentile. 

[The  prepared  statement  follows:] 


1482 


STATEMENT  OF  THE 

NORTH  AMERICAN  REINSURANCE  CORPORATION 

CONCERNING  THE  PROPOSAL  TO 

INCREASE  THE  FEDERAL  EXCISE  TAX  ON 

INSURANCE 


I.   Introduction. 

I  am  Peter  Gentile,  Senior  Vice  President  of  the  North 
American  Reinsurance  Corporation  ("North  American  Reinsurance"), 
a  corporation  located  in  New  York.  North  American  Reinsurance's 
sole  stockholder  is  SwissRe  Holding  (North  America) ,  Inc.,  a  wholly 
owned  subsidiary  of  the  Swiss  Reinsurance  Company  headquartered  and 
incorporated  in  Switzerland.  North  American  Reinsurance,  with  its 
U.S.  affiliates,  is  the  fourth  largest  reinsurance  company  located 
in  the  United  States  with  approximately  $700  million  of  capital  and 
surplus.  I  welcome  this  opportunity  to  appear  before  the 
Subcommittee  today  to  discuss  the  proposal  to  increase,  from  one 
percent  to  four  percent,  the  excise  tax  imposed  on  certain  premiums 
paid  to  foreign  persons  for  reinsurance  covering  property  and 
casualty  insurance  and  bonds. 

That  proposal  is  based  on  a  provision  of  H.R.  5270,  the 
Foreign  Income  Tax  Rationalization  and  Simplification  Act  of  1992, 
legislation  introduced  in  the  last  Congress  which  many  of  our 
country's  trading  partners  found  most  controversial.  Supporters 
of  the  proposal  have  claimed  that  a  rate  increase  is  necessary 
because  U.S.  reinsurers  are  at  a  competitive  disadvantage  with 
respect  to  foreign  reinsurers.  North  American  Reinsurance,  from 
its  perspective  as  a  company  that  both  reinsures  and  purchases 
reinsurance,  and  from  its  perspective  as  a  member  of  a  coalition 
including  over  one  thousand  insurance  writers  located  throughout 
the  United  ^States,  opposes  the  proposal  to  raise  the  insurance 
excise  tax.*  An  excise  tax  increase  would  make  reinsurance  more 
expensive  to  obtain,  and  would  constrict  rather  than  expand  the 
reinsurance  capacity  available  to  U.S.  insurers.  An  excise  tax 
increase  like  that  proposed  in  H.R.  5270  would  be  difficult  to 
administer  fairly  and  effectively.  Furthermore,  it  would  be 
inconsistent  with  obligations  under  at  least  the  U.S. -United 
Kingdom  tax  treaty  and  possibly  other  treaties. 

There  is  more  demand  by  U.S.  insurers  for  reinsurance  than 
U.S.  companies  are  able  to  satisfy.  A  rate  increase  on  reinsurance 
provided  by  foreign  companies  would  result  in  either  harmful 
coverage  gaps,  or  increased  costs  for  reinsurance,  both  of  which 
would  be  detrimental  to  U.S.  consumers.  Moreover,  implementation 
of  the  proposal  as  detailed  in  H.R.  5270  could  cause  retaliation 
against  U.S.  companies  by  our  trading  partners. 

Because  of  recent  catastrophic  losses,  U.S.  insurers  are 
facing  a  period  of  restricted  capacity  in  the  reinsurance  market. 
An  excise  tax  rate  rise  would  exacerbate  that  capacity  problem. 


North  American  Reinsurance  is  also  participating  with  a 
coalition  of  trade  associations  opposed  to  the  excise  tax  increase. 
This  coalition  includes  the  following:  American  Council  of 
Education,  Americcin  Insurance  Association,  Alliance  American 
Insurers,  Coalition  of  Independent  Casualty  Companies  of  America, 
National  Association  of  Mutual  Insurance  Companies,  National 
Association  of  Independent  Insurers,  American  Nuclear  Insurers, 
American  International  Group,  American  Association  of  Crop 
Insurers,  National  Association  of  Insurance  Brokers;  MAERP 
Reinsurance  Association,  American  Agricultural  Insurance  Company, 
Physicians  Insurers  Association  of  America,  Crop  Insurance  Research 
Bureau,  Inc.,  Risk  Insurance  Management  Society,  and  American  Farm 
Bureau  Federation. 


1483 


II.  The  Current  Insurance  Excise  Tax  on  Reinsurance. 

When  a  foreign  insurer  or  reinsurer  is  not  subject  to  U.S. 
income  tax,  the  U.S.  imposes  an  excise  tax  on  each  policy  of 
insurance,  indemnity  bond,  annuity  contract,  or  policy  of 
reinsurance  issued  by  the  foreign  insurer  or  reinsurer  to,  or  for, 
or  in  the  name  of,  a  U.S.  person  with  respect  to  risks  wholly  or 
partly  within  the  United  States,  or  with  respect  to  any  foreign 
person  engaged  in  business  within  the  United  States  with  respect 
to  risks  within  the  United  States. 

The  excise  tax  rate  is  currently  4  percent  of  premiums  paid 
on  policies  of  casualty  insurance  and  indemnity  bonds;  1  percent 
of  premiums  paid  for  life,  sickness  or  accident  insurance  policies; 
and  1  percent  of  premiums  paid  on  policies  of  reinsurance  covering 
casualty  or  life  insurance  risks. 

The  excise  tax  is  computed  on  the  basis  of  gross  premiums  paid 
to  the  foreign  insurer  or  reinsurer.  Thus,  the  excise  tax  applies 
to  premiums  paid  without  any  reduction  for  losses  and  expenses 
incurred  by  the  insured  or  the  insurer.  Imposition  of  the  excise 
tax  is  not  dependent  on  the  profitability  of  the  foreign  insurer 
or  reinsurer.  Thus,  even  if  a  foreign  reinsurer  realizes  a  loss 
on  a  particular  reinsurance  transaction,  a  tax  is  imposed  if  the 
risk  is  U.S.  based.  In  light  of  current  market  conditions,  this 
is  precisely  the  situation  facing  many  foreign  reinsurers. 

The  excise  tax  is  waived  in  certain  cases  under  certain  U.S. 
income  tax  treaties. 

III.  The  Specifics  of  the  Excise  Tax  Proposal  of  H.R.  5270. 

Section  303  of  H.R.  5270  proposed  an  increase  in  the  excise 
tax  on  reinsurance  premiums  paid  to  foreign  insurers,  from  the 
current  1  percent  to  4  percent.  However,  reinsurance  premiums 
would  remain  subject  to  only  the  existing  1  percent  rate,  if:  (1) 
premiums  and  other  insurance  income  related  to  the  policy  of 
reinsurance  were  subject  to  tax  by  a  foreign  country  at  an 
effective  rate  that  was  substantial,  and  (2)  the  insured  risk  was 
not  reinsured  by  a  resident  of  another  foreign  country  who  was  not 
subject  to  a  substantial  tax,  i.e.,  the  premium  was  retained  in  a 
high  tax  country.  Any  person  liable  for  the  insurance  excise  tax 
would  bear  the  burden  of  proving  that  the  foreign  taxes  on 
insurance  income  were  imposed  at  an  effective  rate  that  was 
substantial.  This  provision  clearly  would  be  difficult  to 
administer  due  to  the  ambiguous  nature  of  the  statutory  standard. 

Section  303  of  H.R.  5270  also  provided  that,  in  applying  any 
treaty  excise  tax  waiver,  no  person  would  be  relieved  of  the 
requirement  to  remit  the  excise  tax,  unless  the  parties  to  the 
transaction  satisfied  any  requirements  the  Treasury  may  prescribe 
to  ensure  collection  of  tax  due  on  any  reinsurance  of  the  risks. 
The  technical  explanation  to  H.R.  5270  explained  that  the  above 
rule  would  apply  to  premiums  paid  to  a  foreign  insurer  entitled  to 
treaty  benefits  under  a  treaty  waiving  the  excise  tax,  whether  or 
not  that  treaty  had  an  anti-conduit  clause.  (Several  tax  treaties 
have  anti-conduit  provisions**  that  deny  the  insurance  excise  tax 
waiver  with  respect  to  premiums  concerning  risks  that  are  reinsured 
with  a  person  not  entitled  to  a  similar  treaty  exemption.) 
Furthermore,  this  provision  would  override  the  U.S. -United  Kingdom 
tax  treaty  concerning  the  insurance  excise  tax  and  would  be  likely 
to  result  in  retaliation  by  the  United  Kingdom. 


See,  e.g. .  the  U.S.  tax  treaties  with  France,  Italy, 
Spain,  and  Germany. 


1484 


IV.   General  Description  of  Reinsurance  and  the  Reinsurance  Market. 

A.  Reinsurance. 

The  hallmarks  of  insurance  are  risk  shifting  and  risk  sharing. 
An  insurance  company  accepts  the  risk  of  loss  in  return  for  the 
payment  by  the  insured  of  an  insurance  premium.  Further  risk 
shifting  and  risk  sharing  occurs  through  reinsurance.  A 
reinsurance  company  accepts  a  share  of  the  risks  an  insurance 
company  has  assumed,  in  return  for  payment  of  a  premium.  In  many 
cases,  the  reinsurer  has  more  capital  and  surplus  and/or  a  broader 
market  to  facilitate  diversification  of  risk. 

There  are  numerous  types  of  reinsurance  arrangements.  For 
instance,  a  facultative  (policy-by-policy)  reinsurance  treaty 
reinsures  the  insurer's  risks  on  an  individual  policy  basis.  Non- 
proportional  reinsurance,  also  known  as  excess  of  loss  reinsurance, 
is  a  form  of  reinsurance  in  which  the  reinsurer  assumes  the  part 
of  the  insurer's  losses  that  exceed  a  certain  amount,  against 
payment  of  the  specially  calculated  premium.  Under  a  proportional 
reinsurance  treaty,  premiums  and  losses  of  the  insurer  are  shared 
proportionally  by  the  insurer  and  the  reinsurer.  Under  quota- 
share  reinsurance,  the  reinsurer  accepts  a  specified  share  of  each 
risk  of  an  insurer  in  a  specified  class  of  business.  Under  surplus 
reinsurance,  the  reinsurer  reinsures  risks  over  a  specified  amoxint. 
Other  types  of  reinsurance  arrangements  also  exist.  For  some  of 
these  complex  insurance  products,  the  portion  that  could  be 
considered  as  attributable  to  underlying  U.S.  risks  is  sometimes 
extremely  hard,  if  not  impossible,  to  identify. 

B.  The  Reinsurance  Market. 

Insurance  provides  a  function  which  is  critical  for  the 
operation  of  U.S.  industry  and  commerce.  To  have  a  strong  primary 
insurance  market,  it  is  essential  for  insurance  companies  to  have 
access  to  reinsurance  provided  by  companies  with  sufficient 
capacity  to  allow  insurance  companies  to  further  shift  and  spread 
the  risk  of  loss.  In  this  context,  "capacity"  is  the  maximum 
amount  of  a  risk  that  can  be  included  in  reinsurance,  and  is  a 
function  of  the  availeJale  surplus  of  the  reinsurance  company  and 
the  potential  for  economic  reward  given  a  specific  level  of  risk. 

The  reinsurance  market  today  is  a  global  market.  A  U.S. 
insurance  company  can  shop  among  both  domestic  and  foreign 
reinsurance  companies  for  the  appropriate  reinsurance  coverage. 
This  access  by  U.S.  insurers  to  foreign  reinsurance  companies 
increases  the  capacity  for  insuring  U.S.  risks.  Because  particular 
types  of  coverages  are  vmavailable  or  scarcely  available  from  U.S. 
reinsurance  companies,  foreign  reinsurance  companies  provide 
coverage  that  otherwise  simply  could  not  be  obtained.  For 
instance,  foreign  companies  are  acting  as  primary  sources  of 
reinsurance  for  medical  malpractice,  earthquake  and  hurricane, 
aviation,  marine,  nuclear,  aerospace,  and  other  coverage. 

Even  in  the  global  marketplace  U.S.  insurers  currently  are 
experiencing  difficulties  in  placing  reinsurance,  because  of  the 
recent  high  levels  of  losses  experienced  by  the  industry.  We  are 
all  aware  of  the  disasters,  both  natural  and  man-made,  that  all 
areas  of  our  country  seem  to  be  experiencing.  The  insurance 
industry  recognizes  that  it  increasingly  is  susceptible  to 
catastrophic  exposures,  as  shown  by  the  high  losses  sustained  in 
1992  from  Hurricanes  Iniki  and  Andrew,  and  the  Northeast  storms. 
In  fact,  1992  was  the  worst  year  in  history  for  catastrophic 
losses.   As  reported  by  Best's  Review,  in  February,  1993: 

The  dollar  magnitude  of  1992 's  catastrophes 
was  staggering  and  contributed  to  the 
reporting  of  an  estimated  $34  billion  in 
industry  underwriting  losses  for  the  year. 


1485 


This  record  exceeded  by  36%  the  previous 
record  of  $25  billion  set  in  1985. 

"The  Year  of  the  Cats,"  Best's  Review.  February  1993,  at  17. 

With  the  devastating  floods  this  summer  in  the  mid-west,  the 
March  1993  blizzard,  the  World  Trade  Center  explosion  and  most 
recently  Hurricane  Emily,  1993  is  also  developing  into  a  costly 
year  for  insurance  companies. 

Because  of  these  unprecedented  developments,  U.S.  insureds  may 
soon  have  trouble  obtaining  affordable  coverage.  The  choice  facing 
insurance  companies  providing  primary  coverage  is  either  to 
withdraw  from  the  most  catastrophic -prone  areas,  or  purchase  more 
reinsurance.  See  "Catastrophic  Changes,"  Global  Reinsurance. 
September-November  1992,  at  177.  When  reinsurance  is  not 
available,  or  is  not  available  at  the  right  price,  primary  insurers 
are  withdrawing  their  coverage.  In  Florida,  Allstate  Insurance 
Company  announced  that  it  would  not  renew  policies  for  300,000 
Florida  homeowners  and  other  policy  holders,  because  of  its 
inability  to  obtain  affordable  reinsurance.  Wall  Street  Journal, 
April  23,  1993,  A-2.  CNA  will  no  longer  write  property  insurance 
for  large  U.S.  companies  with  multiple  locations,  because  "their 
reinsurance  treaty  fell  apart."  See  "CNA  will  close  National 
Accounts  Property  Division,"  Journal  of  Commerce,  ^ril  19,  1993. 

The  scope  of  the  pressures  facing  insurance  companies  can  be 
gauged  from  these  recent  headlines: 

•  "Blizzard  Claims  Estimated  at  More  than  $1.6 
Billion,"  Journal  of  Commerce.  March  31,  1993. 

•  "Cigna  Expects  $25  Million  in  Blast  Claims"  Journal 
of  Commerce.  April  2,  1993. 

•  "Port  Authority  Pegs  Towers  Blast  Cost  at  $600 
Million."   Journal  of  Commerce.  April  8,  1993. 

•  "Florida  Homeowners  Face  Big  Premium  Increases, 
Scarce  Coverage,"  Journal  of  Commerce .  April  16, 
1993. 

•  "State  Farm  Halts  Growth  of  Texas  Property 
Coverage,"  Journal  of  Commerce.  ;^ril  27,  1993. 

•  "Insurance  Industry  is  Not  Prepared  For  Another 
Disaster,  Analyst  Warns"  Journal  of  Commerce.  May  5, 
1993. 

•  "Capacity  Contractions  Spark  Concern  for 
Reinsurers,"  Journal  of  Commerce.  May  5,  1993. 

Some  have  characterized  1993  as  a  time  of  reduced  reinsurance 
capacity  in  the  market  in  general.  Analysts  expect  reinsurance 
companies  either  to  increase  prices  or  abandon  altogether  costly 
lines  of  coverage  such  as  catastrophic  reinsurance.  See 
"Reinsurance  to  Strive  to  Improve  Returns,"  Journal  of  Commerce. 
March  17,  1993.  Overall,  insurers  could  be  facing  a  reduction  of 
capacity  in  entire  segments  of  the  worldwide  reinsurance  market. 
See  "Capacity  Contractions  Spark  Concern  for  Reinsurance,"  Journal 
of  Commerce.  May  5,  1993.  It  is  likely  that  an  increase  in  the 
excise  tax  could  substantially  worsen  what  already  appears  to  be 
a  contracting  market.  This  is  particularly  true  in  light  of  the 
highly  publicized  problems  which  the  Lloyds  market  has  experienced 
in  the  last  few  years. 


1486 


V.    Treasury  Department  Study  of  Competitive  Effect  on  U.S. 
Reinsurers  of  U.S.  Tax  Treaty  Exemptions  for  Foreign 
Insurers  and  Reinsurers. 

Pursuant  to  a  Congressional  mandate  included  as  section  1244 
of  the  Tax  Reform  Act  of  1986,  the  Department  of  Treasury  in  March 
of  1990  issued  a  report  (the  "Treasury  Report")  analyzing  whether 
U.S.  reinsurance  companies  are  placed  at  a  significant  competitive 
disadvantage  vis-a-vis  foreign  reinsurance  companies,  by  reason  of 
existing  tax  treaties  between  the  United  States  and  certain  foreign 
countries  which  have  provisions  waiving  the  insurance  excise  tax. 

The  Treasury  Report  specifically  noted  that  if  the  reinsurance 
market  is  tight,  the  economic  burden  of  the  excise  tax  may  fall  on 
U.S.  policyholders  rather  than  on  the  foreign  reinsurers.  Treasury 
Report,  at  2. 

According  to  the  Treasury  Report,  there  is  no  indication  that 
waivers  of  the  1  percent  excise  tax  on  reinsurance  premiums 
pursuant  to  tax  treaties  with  countries  that  impose  a  full  income 
tax  cause  a  significant  competitive  disadvantage  to  U.S. 
reinsurers . 

The  Treasury  Report  also  examined  the  consequences  when  no 
treaty  waiver  is  available  if  the  rate  on  reinsurance  premiums  were 
to  be  raised  to  4  percent .  The  Treasury  Report  concluded  that  a 
4  percent  rate  "would  likely  have  a  materially  adverse  impact  on 
the  relative  profitability  of  U.S.  business  for  many  foreign 
reinsurance  companies  located  in  full-tax  countries."  (Treasury 
Report  at  23)  .  Moreover,  reinsurance  companies  located  in  low- 
tax  countries  would  also  suffer  substantially  lower  profitability 
results. 

Based  on  its  analysis,  the  Treasury  testified  at  last  year's 
hearings  on  H.R.  5270  regarding  the  proposal  to  increase  the  excise 
tax  that  it  is  "not  convinced  that  a  general  rate  increase  is 
warranted  at  this  time."  Statement  of  Fred  T.  Goldberg,  Jr., 
Assistant  Secretary  (Tax  Policy),  at  18-19  (July  21,  1992). 

VZ.   Reasons  Why  the  Insurance  Excise  Tax  Rate  Should  Not  Be 
Raised. 

The  existing  1  percent  excise  tax  on  reinsurance  should  not 
be  raised  any  higher,  for  the  following  reasons: 

1.  Raising  the  Insurance  Excise  Tax  Rate  is  Not  Necessary 
to  Protect  the  Competitive  Position  of  U.S.  Insurers. 

As  the  Treasury  Report  concluded,  U.S.  reinsurers  are  not 
operating  under  a  competitive  disadvantage  even  when  the  existing 
1  percent  tax  on  reinsurance  premiums  is  waived  by  treaty. 
Although  the  Treasury  Report  was  not  able  to  examine  in  detail  the 
tax  laws  of  each  country,  it  did  perform  a  relative  after-tax 
return  analysis  of  the  results  in  several  countries  of  a  simplified 
reinsurance  transaction,  and  based  its  conclusion  on  that  analysis. 

2.  Raising   the   Insurance   excise   tax   rate  would  have 
undesirable  consecpiences  to  U.S.  insureds. 

If  the  excise  tax  were  raised,  foreign  reinsurers  would  have 
two  choices:  either  withdraw  from  the  U.S.  market  altogether,  or 
pass  the  increased  costs  on  to  U.S.  insureds,  in  order  to  remain 
profitable.  As  previously  discussed,  the  U.S.  already  is  facing 
a  period  of  tight  reinsurance  capacity  that  will  continue  for  the 
foreseeable  future.  The  withdrawal  of  foreign  reinsurers  from  the 
US.  market  because  of  an  increase  in  the  insurance  excise  tax 
would  only  cause  severe  coverage  gaps.  The  U.S.  reinsurance 
companies  simply  do  not  have  the  capacity  to  accept  all  the  risks 
for  which  U.S.  insurers  need  reinsurance.   U.S.  insureds  would 


1487 


consequently  suffer,  either  because  the  cost  of  coverage  would 
increase,  or  would  not  be  available  at  any  cost.  Because  U.S. 
businesses  would  be  hesitant  to  "go  naked"  without  coverage, 
economic  activity  in  the  U.S.  would  be  hampered,  making  the 
recovery  from  the  recession  that  much  more  difficult. 

3.    Our  Trading  Partners  Would  Retaliate. 

Many  of  our  major  trading  partners  have  made  known  their 
displeasure  with  past  proposals  to  increase  the  tax  rate.  The 
trading  partners  view  the  proposals  as  tamtamoxint  to  a  tariff 
increase,  and  they  would  consider  taking  appropriate  steps  in 
response.  Those  coxintries  with  tax  treaties  with  the  United  States 
containing  the  insurance  excise  tax  waiver  also  viewed  the 
proposals  as  unilaterally  changing  their  treaties.  For  instance, 
Robin  Wrenwich,  the  British  Ambassador  to  the  United  States,  wrote 
the  Secretary  of  the  Treasury  regarding  his  government ' s  concern 
that  the  provisions  of  H.R.  5270  abrogate  the  U.S. -U.K.  income  tax 
treaty. 

Retaliatory  measures  by  our  trading  partners  would  have  a 
harmful  effect  on  our  overall  economy,  emd  could  greatly  damage 
international  investment  and  trade.  We  assume  that  our  trading 
partners  would  again  view  with  displeasure  legislation  proposing 
to  raise  the  insurance  excise  teix. 

In  addition  to  the  potential  for  retaliation,  enactment  of  the 
excise  teix  increase,  with  the  other  excise  tax  provisions  contained 
in  H.R.  5270,  would  result  in  a  situation  where  companies  located 
in  certain  countries  would  be  disadvantaged  compared  with  those 
companies  located  in  countries  qualifying  for  the  lower  tax  rate 
or  complete  exemption.  This  would  inevitably  force  companies  to 
restructure  their  operations  so  as  to  be  located  in  countries 
qualifying  for  exemption  treatment,  thus  potentially  causing  H.R. 
5270  to  actually  lose  revenue  rather  than  gain  revenue. 

VIZ.   Conclusion. 

For  the  above  reasons,  I  urge  the  Committee  to  maintain  the 
excise  tax  on  reinsurance  at  its  current  rate. 

k  jk :  0222 :  B4709 :  93001 :  0917stat .  doc 


1488 

Mr.  Neal.  I  will  now  hear  from  Mr.  Jarratt. 

STATEMENT  OF  ROBERT  JARRATT,  EXECUTIVE  VICE  PRESI- 
DENT AND  CHIEF  EXECUTIVE  OFFICER,  FLORIDA  FARM  BU- 
REAU CASUALTY  INSURANCE  CO.,  AND  FLORIDA  FARM  BU- 
REAU GENERAL  INSURANCE  CO.,  GAIIVESVILLE,  FLA.,  ON  BE- 
HALF OF  THE  NATIONAL  ASSOCIATION  OF  INDEPENDENT 
INSURERS,  ALLIANCE  OF  AMERICAN  INSURERS,  AND  NA- 
TIONAL ASSOCIATION  OF  MUTUAL  INSURANCE  COS. 

Mr.  Jarratt.  Mr.  Chairman,  my  name  is  Robert  Jarratt  and  I 
am  CEO  of  two  Farm  Bureau  insurance  companies  that  engage  in 
business  in  the  State  of  Florida.  I  appear  today  to  express  concern 
and  opposition  of  those  for  whom  I  appear  to  the  proposed  increase 
in  the  Federal  excise  tax  imposed  with  respect  to  foreign  insurance 
policies,  which  I  will  refer  to  today  as  the  FET,  which  increase  was 
contained  in  H.R.  5270. 

While  my  testimony  is  on  behalf  of  the  National  Association  of 
Independent  Insurers,  of  which  my  companies  are  members,  the  Al- 
liance of  American  Insurers,  and  the  National  Association  of  Mu- 
tual Insurers,  and  while  a  discussion  of  overall  market  conditions 
and  their  relevance  to  the  FET  proposal  are  discussed  later,  I  be- 
lieve that  the  circumstances  of  my  particular  companies  dem- 
onstrate why  domestic  property  and  casualty,  or  P&C  insurers 
would  be  adversely  affected  by  the  300  percent  increase  in  the  FET 
rate. 

During  1991,  my  companies  purchased  $100  million  of  reinsur- 
ance coverage  for  1992  at  a  cost  of  approximately  $2.5  million.  By 

1992,  when   my   companies   purchased   reinsurance   coverage   for 

1993,  the  cost  for  $110  million  of  coverage  had  skyrocketed  to  ap- 
proximately $6  million.  The  companies  will  soon  need  to  purchase 
reinsurance  coverage  for  1994. 

While  we  are  very  much  concerned  about  what  the  price  will  be 
for  that  coverage,  we  are  even  more  concerned  about  whether  the 
amount  of  reinsurance  coverage  that  we  believe  is  needed  by  the 
companies  will  be  available  at  any  price. 

To  be  sure,  Florida  has  become  one  of  the  most  difficult  States 
for  obtaining  reinsurance  coverage.  However,  the  cost  of  catas- 
trophe reinsurance  has  increased  dramatically  across  the  country. 
I  know  of  other  Farm  Bureau  companies  where  the  cost  of  reinsur- 
ance coverage  has  jumped  between  60  and  80  percent  depending  on 
geographic  location.  And  I  have  seen  reports  of  reinsurance  costs 
in  the  range  of  30  to  50  percent  with  retention  increases  in  many 
cases  doubling  and  tripling.  The  term  "retention"  refers  to  the 
amount  of  risk  that  an  insurer  retains  itself  and  does  not  transfer 
to  another  through  a  reinsurance  arrangement. 

As  explained  in  detail  in  our  filed  statement,  P&C  insurers  and 
their  policyholders  would  ultimately  bear  the  burden  of  this  pro- 
posal because  as  purchasers  of  foreign  reinsurance,  any  increase  in 
the  FET  rate  will  be  passed  through  by  affected  foreign  reinsurers 
directly  to  the  U.S.  insurers  that  purchase  the  reinsurance  cov- 
erage. The  insurers  in  turn  will  generally  pass  through  to  their  pol- 
icyholders at  least  a  portion  of  the  increased  reinsurance  costs  at- 
tributable to  the  increased  FET. 


1489 

We  believe  that  the  foreign  reinsurers  will  pass  through  the  bur- 
den of  the  increased  FET  faHecause  of,  one,  the  limited  domestic  ca- 
pacity generally,  and,  two,  the  absolute  unavailability  of  any  do- 
mestic sources  for  specific  types  of  reinsurance  coverage. 

For  the  domestic  P&C  companies  that  reguire  catastrophe  rein- 
surance, the  market  conditions  just  described  result  in  sucn  compa- 
nies having  little  bargaining  power  at  this  time  when  negotiating 
with  foreign  reinsurers  on  pricing.  Foreign  reinsurers  know  this. 
Consequently,  if  the  FET  rate  is  increased,  these  foreign  reinsurers 
which  choose  to  continue  devoting  capacity  to  the  U.S.  market  will 
simply  add  the  amount  of  the  FET  increase  to  the  existing  price 
of  the  coverage.  Indeed,  even  the  Reinsurance  Association  of  Amer- 
ica, the  primary  proponent  of  the  FET  proposal,  acknowledges  that 
the  burden  of  the  increased  FET  would  ultimately  fall  on  the  do- 
mestic purchaser  of  foreign  reinsurers. 

While  the  domestic  reinsurers  contend  the  industry  is  suffering 
from  a  competitive  disadvantage,  recent  reportsSndicated  that  the 
net  amount  of  premiums  written  by  U.S.  reinsurers  during  the  first 
6  months  of  1993  was  $6.4  billion,  representing  an  11.7  percent  in- 
crease compared  to  the  first  half  of  1992. 

Another  concern  that  the  domestic  P&C  insurers  have  with  the 
FET  proposal  is  the  effect  on  international  trade.  Many  of  our 
country's  trading  partners  view  the  FET  proposal  as  protectionalist 
and  in  direct  violation  of  existing  treaties.  Consequently  we  are 
very  much  concerned  about  the  possibilities  of  those  companies  re- 
taliating against  U.S.  business. 

Retaliation  could  come  in  many  forms,  including  limiting  domes- 
tic P&C  companies'  access  to  foreign  markets,  imposing  reciprocal 
access  taxes  on  U.S.  insurance  or  reinsurance  covering  risks  in  for- 
eign markets,  and  unilaterally  abrogating  whatever  concessions 
that  were  made  in  consideration  of  obtaining  the  FET  treaty  waiv- 
er from  the  United  States.  We  submit  that  these  risks  clearly  out- 
weigh the  reinsurers'  asserted  justification  for  government  protec- 
tion. 

Finally,  we  urge  that  you  consider  the  administrative  nightmare 
this  proposal  would  create  for  both  the  taxpayers  and  the  IRS.  The 
proposal  would  require  that  the  domestic  P&C  insurers  ascertain 
the  destination  of  all  risks  that  were  reinsured. 

This  tracing  requirement  would  apply  not  only  to  all  risks  or 
parts  thereof  that  are  reinsured  by  initial  reinsurers,  but  also  to 
the  second  and  third  and  other  levels  of  reinsurance  that  might  be 
involved  with  respect  to  each  risk  that  a  property  and  casualty 
company  reinsures  because  the  current  practice  reinsurance  is  to 
bundle  together  a  collection  of  risks,  to  then  reinsure  a  portion 
thereof  with  other  reinsurers  that  in  turn  might  do  the  same. 

The  tracing  requirement  under  the  proposal  would  be  impossible 
to  carry  out  in  many  cases.  When  one  attempts  to  apply  the  FET 
proposal  to  the  real  world,  it  becomes  obvious  that  the  proposal  will 
not  work  and  could  not  be  administered. 


1490 

The  P&C  industry  respectfully  urges  that  the  FET  proposal 
which  would  quadruple  the  FET  unilaterally,  override  carefully  ne- 
gotiated treaties,  and  effectively  transfer  to  the  P&C  insurer  a  por- 
tion of  the  reinsurer's  tax  burden  be  rejected. 

Thank  you. 

Mr.  Neal.  Thank  you,  Mr.  Jarratt. 

[The  prepared  statement  follows:] 


1491 


TESTIMONY  OF  ROBERT  JARRATT 

ON  BEHALF  OF 

THE  NATIONAL  ASSOCIATION  OF  INDEPENDENT  MSURERS 

THE  ALUANCE  OF  AMERICAN  INSURERS 

AND 

THE  NATIONAL  ASSOCIATION  OF  MUTUAL  INSURANCE  COMPANIES 


Mr.  Chairman  and  Members  of  the  Subcomminee,  my  name  is  Robert  Janatt,  and  I  am 
CEO  of  two  small  insurance  companies  that  are  engaged  in  business  in  the  state  of  Florida.  I 
appear  today  to  express  the  concern  and  the  opposition  of  those  for  whom  I  appear  to  the 
proposed  increase  in  the  federal  excise  tax  ("FET")  imposed  with  respect  to  foreign  insurance 
policies,  which  increase  was  contained  in  H.R.  5270,  introduced  in  the  102nd  Congress. 

While  my  testimony  is  on  behalf  of  the  National  Association  of  Independent  Insurers,  of 
which  my  companies  are  members,  the  Alliance  of  American  Insurers,  and  the  National 
Association  of  Mutual  Insurance  Companies,  and  while  a  discussion  of  the  overall  market 
conditions  and  their  relevance  to  the  FET  proposal  are  discussed  later,  I  believe  that  the 
circumstances  of  my  particular  companies  provide  meaningful  insight  into  the  reinsurance 
challenges  that  the  property  and  casualty  ("P&C")  industry  currently  faces,  which  is  relevant  to 
why  P&C  insurers  oppose  the  proposed  FET  increase. 

During  1991,  my  companies  purchased  $100  million  of  reinsurance  coverage  for  1992, 
at  a  cost  of  approximately  $2.5  million.  By  1992,  when  the  companies  purchased  reinsurance 
coverage  for  1993,  the  cost  for  $115  million  of  coverage  had  skyrocketed  to  approximately  $6 
million.  The  companies  will  soon  need  to  purchase  reinsurance  coverage  for  1994.  While  we 
are  verj'  much  concerned  about  what  the  price  will  be  for  that  coverage,  we  arc  even  more 
concerned  about  whether  the  amount  of  reinsurance  coverage  that  we  believe  is  needed  by  the 
companies  will  be  available  at  any  price. 

To  be  sure,  Florida  has  become  one  of  the  most  difficult  states  for  obtaining 
reinsurance  coverage.  However,  the  cost  of  catastrophe  reinsurance  has  increased  dramatically 
across  the  country.  I  know  that  for  other  Farm  Bureau  companies,  the  cost  of  reinsurance 
coverage  has  jumped  b>'  between  60  and  80  percent,  depending  on  geographic  location.  And,  1 
have  seen  reports  of  reinsurance  cost  increases  in  the  range  of  30%  to  50%  ,  with  "retention"  in 
many  cases  doubling.'      The  terra  "retention"  refers  to  the  amount  of  risk  that  an  insurer 
retains  itself,  and  does  not  transfer  to  another  through  a  reinsuraiKe  arrangement. 

A  reported  experience  of  Farmers  Insurance  Group  illustrates  the  plight  of  a  company 
that  encounters  the  current  "retention"  dilemma.  Farmers  Insurance  Group  had  historically 
purchased  its  reinsurance  from  the  Lloyds  of  London  market.  Recently,  Fanners  was  advised 
by  its  reinsurers  that  as  a  condition  of  its  reinsurance  renewal.  Farmers  would  need  to  double 
its  "retention"  to  $200  million.^  Farmers'  treasurer  was  quoted  as  saying  that  in  the  company's 
entire  history,  it  has  never  experienced  a  catastrophe  loss  of  that  magnitude.  In  essence,  the 
new  reinsurance  arrangement  offered  to  Farmers  Insurance  Group  would  provide  the  insurer 
less  reinsurance  protection  that  what  the  company  desired. 

Some  market  analysts  believe  current  market  conditions  threaten  the  very  survival  of 
many  P&C  insurers.'  Factors  contributing  to  this  plight  are  the  recent  large  catastrophe  losses' 
(for  example,  the  $18  billion  in  insured  losses  from  hurricane  losses)  ,  low  interest  rates,  low 
commercial  insurance  rates,  the  expansion  of  surplus  lines  maikcts  and  escalating  catastrophe 
reinsurance  rates. ^ 

It  is  within  the  context  of  the  "real  world"  just  described  that  the  merits  of  the  proposed 
FET  increase  need  to  be  evaluated. 

1.  P&C  insurers,  and  ultimately  their  U.S.  policyholders,  would  be  adversely  affected  by 
this  proposal  because,  as  purchasers  of  foreign  reinsurance,  any  increase  in  the  FET  rate 
will  be  "passed  through"  by  affected  foreign  reinsurers  directly  to  the  U^.  insurers  that 
purchase  the  reinsurance  coverage  and,  to  some  extent,  to  their  policyholders 


1492 


The  reason  P&C  insurers  would  be  adversely  affected  by  the  proposal  to  increase  the 
FET  is  that  if  the  FET  is  increased,  the  P&C  companies  -  and,  to  some  extent,  their 
policyholders  -  will  ultimately  bear  the  burden  of  the  tax  increase. 

Because  of  1)  the  limited  domestic  capacity  generally,  and  2)  the  absolute  unavailability 
of  any  domestic  sources  for  specific  types  of  reinsurance  coverage,  many  P&C  companies 
currently  have  no  choice  but  to  purchase  much  of  their  reinsurance  from  foreign  companies. 
Since  many  such  P&C  companies  require  catastrophe  reinsurance,  they  have  little  bargaining 
power  at  this  time  when  negotiating  with  foreign  reinsurers  on  pricing.  Foreign  reinsurers  know 
this.  Consequently,  if  the  FET  is  increased,  those  foreign  reinsurers  which  choose  to  continue 
devoting  their  capacity  to  the  U.S.  market  will  simply  add  the  amount  of  the  FET  increase  to 
the  existing  price  of  coverage. 

A  recent  article  analyzing  the  causes  and  effects  of  the  limited  reinsurance  capacity 
currently  available'  indicates  that  the  major  factors  contributing  to  the  diminished  capacity  are 
1)  the  withdrawal  from  the  market  of  substantial  amounts  of  capital,  and  2)  the  severe  financial 
problems  currently  experienced  by  the  Lloyds  of  London  market.  The  article  notes  that 
executives  from  some  of  the  world's  largest  reinsurers  expect  the  contracting  capacity  for 
catastrophe  and  other  forms  of  property  reinsurance  to  continue,  applying  upward  pressure  on 
reinsurance  rates. 

While  current  market  conditions  indicate  that  foreign  reinsurers  would  likely  "pass 
through"  the  burden  of  an  increased  FET,  they  represent  only  one  part  of  the  analysis.  In  some 
situations,  the  foreign  reinsurer  would  be  expected  to  "pass  through"  the  burden  of  an  increased 
FET,  irrespective  of  market  conditions.  As  pointed  out  in  the  September  1989  General 
Accounting  Office  Report  on  the  FET'  (the  "1989  GAO  Report"),  the  reinsurance  provided  by 
some  foreign  reinsurers  is  "complementary"  to  U.S.  reinsurers.  "Complementary"  reinsurance 
coverage  refers  to  coverage  for  types  of  risks  that  is  not  offered  by  any  U.S.  reinsurer.  There  is 
no  question  that  a  P&C  insurer  in  need  of  a  particular  type  of  reinsurance  that  is  not  offered  by 
any  U.S.  reinsurer  would  not  likely  succeed  in  convincing  the  foreign  reinsurer  to  absorb  the 
burden  of  an  increased  FET. 

The  1989  GAO  report  provides  an  anecdotal  account  of  the  plight  of  one  specific 
company  that  needed  a  specific  type  of  reinsurance  that  only  a  foreign  reinsurer  was  willing  to 
provide.  Mortgage  Guaranty  Insurance  Corporation  (MGIC)  is  in  the  business  of  providing  a 
type  of  insurance  that  protects  banks  and  savings  and  loans  against  losses  when  homeowners 
default  on  mortgage  payments.  The  GAO  report  found  that  by  1984,  MGIC  was  approaching 
the  point  where  it  could  not  take  on  any  new  business  without  either  increasing  its  capital  or 
obtaining  reinsurance  to  mitigate  its  risk  exposure.  After  failing  in  its  attempts  to  raise  capital, 
MGIC  explored  the  possibility  of  obtaining  reinsurance.  None  of  the  U.S.  reinsurers  that  MGIC 
approached  would  provide  any  reinsurance  to  cover  the  type  of  risk  that  MGIC  underwrote. 
With  no  other  alternative,  MGIC  ultimately  obtained  the  reinsurance  it  needed  from  foreign 
companies.  An  increase  in  the  FET  rate  would,  without  question,  translate  into  a  direct 
increase  in  cost  for  companies  such  as  MGIC,  which  have  no  alternative  but  to  purchase  the 
reinsurance  they  need  from  foreign  sources. 

As  the  foregoing  demonstrates,  domestic  P&C  companies  and  their  policyholders  will 
almost  certainly  bear  the  burden  of  an  increased  FET.  Whether  because  of  1)  limited  capacity 
relative  to  demand  for  reinsurance,  or  2)  a  specific  type  of  reinsurance  that  a  company  needs  is 
not  available  from  any  domestic  source,  the  reinsurance  market  forces  clearly  indicate  that 
affected  foreign  reinsurers  would  "pass  through"  to  reinsurance  purchasers  any  increase  in  the 
FET. 

Indeed,  even  the  Reinsurance  Association  of  America  ("RAA"),  the  primary  proponent 
of  the  FET  proposal,  acknowledges  that  the  burden  of  an  increased  FET  would  ultimately  fall 
on  domestic  purchasers  of  foreign  reinsurance.  Specifically,  in  written  RAA  testimony 
submitted  in  coimection  with  a  hearing  in  1990  on  a  similar  FET  proposal,  the  RAA  stated  for 
the  record  that  an  increase  in  the  FET  "primarily  would  be  absorbed  by  the  direct  insurers 
and/or  the  insureds  (as  is  the  case  currently)."' 


1493 


Because  of  the  fact  that  any  increase  in  the  FET  will  likely  be  borne  ultimately  by 
domestic  P&C  companies  that  purchase  foreign  reinsurance,  such  companies,  and  their 
policyholders,  have  a  direct  stake  in  the  outcome  of  any  proposal  to  increase  the  FET  rate. 

2.  Another  possible  consequence  of  an  increase  in  the  FET,  that  would  be  far  worse,  and 
is  of  more  concern  to  P&C  insurers,  is  that  foreign  reinsurers  that  currently  provide  the 
hard-to-place  reinsurance  (coverage  that  is  not  available  from  any  U.S.  reinsurers) 
would  simply  withdraw  from  the  U.S.  market. 

"When  reinsurance  is  unavailable,  insurers  are  forced  to  choose  between  scaling  back 
operations  and  retaining  more  risk.  For  some  companies  ... ,  however,  neither  choice  was 
viable  and  they  were  forced  to  merge  to  avert  insolvency."' 

Unfortunately  for  many  P&C  companies,  the  debate  over  the  soundness  of  raising  the 
FET  rate  goes  beyond  the  question  of  whether  it  is  appropriate  that  P&C  insurers  be  required  to 
pay  more  for  reinsurance.  Framing  the  issue  in  that  way  presumes  that  a  quadrupling  of  the 
FET  would  not  result  in  foreign  reinsurers  withdrawing  from  the  U.S.  market.  If  this 
presumption  is  found  to  be  wrong,  the  consequence  to  many  P&C  companies  would  be  fatal. 
And,  this  is  no  mere  hypothetical  consideration. 

A  report  on  a  recent  Standard  &  Poor's  survey  of  69  professional  reinsurers'"  revealed 
that  the  global  reinsurance  market  is  expected  to  continue  contracting.  Consolidation  and 
withdrawal  from  the  market  is  expected  to  add  to  the  current  capacity  crunch.  Indeed,  some  of 
the  withdrawals  from  the  reinsurance  market  that  have  already  occurred  have  been  remarkable. 
For  example,  Netherlands  Reinsurance  Group,  which  recently  withdrew  from  the  non-life 
market  last  year  received  $998.3  million  in  net  written  premiums  and  ranked  No.  12  in  the 
annual  Business  Insurance  ranking  for  the  year. 

While  theoreticians  might,  from  the  detached  confines  of  their  offices,  debate  the 
question  of  whether  a  foreign  reinsurer  might  actually  withdraw  its  capital  from  the  U.S. 
market  in  response  to  a  300%  increase  in  the  FET,  P&C  companies  -  whose  continued 
viability  depends  on  foreign  reinsurers  -  cannot  risk  such  a  withdrawal.  That  consequence 
would  bring  them  to  financial  ruin. 

Because  of  the  tremendous  risk  to  which  the  proposed  FET  increase  exposes  P&C 
companies  that  rely  on  foreign  reinsurers,  it  is  submitted  that  the  domestic  reinsurers  should 
bear  an  extremely  heavy  burden  in  justifying  the  propriety  of  an  increase  in  the  FET,  and 
particularly  a  300%  increase.  In  other  words,  the  reinsurers  should  be  required  to  demonstrate 
that  their  continued  viability  as  reinsurers  is  contingent  on  the  FET  increase  that  they  support. 
To  impose  any  lesser  burden  would  represent  a  policy  decision  that  the  possible  destruction  of 
a  portion  of  the  P&C  industry  is  an  acceptable  risk  to  assume  in  exchange  for  enhancing  the 
profitability  of  reinsurers. 

3.  The  domestic  reinsurance  industry  has  demonstrated  no  compelliog  Deed  for  such  a 
drastic  increase  in  the  FET  rate,  especially  under  current  market  coDditions,  where  the 
demand  for  reinsurance  far  exceeds  available  capacity. 

Rather  than  demonstrating  a  compelling  need  for  an  FET  rate  increase,  recent  evidence 
supports  the  conclusion  that  the  domestic  reinsurance  industry  is  prospering.  Recent  reports 
indicate  that  the  net  amount  of  premiums  wrinen  by  U.S.  reinsurers  during  the  first  six  months 
of  1993  was  $6.4  billion,  representing  an  11.7%  increase  compared  with  the  first  half  of 
1992." 

What  is  more,  an  FET  increase  would  accomplish  little  if  any  change  in  the  amount  of 
reinsurance  that  domestic  P&C  companies  purchase  from  U.S.  reinsurers.  The  amount  of  such 
purchases  has  always  been  limited  by  the  supply,  that  is,  by  the  amount  and  types  of 
reinsurance  that  the  domestic  reinsurers  offer.  Indeed,  as  the  P&C  industry  testified  in  1990 
and  again  during  1992,  domestic  P&C  companies  would  almost  always  prefer  purchasing 
reinsurance  from  U.S.  reinsurers  because: 


1494 


1 .  it  is  more  difficult  to  evaluate  a  foreign  reinsurer's  financial  security  and  the  ability  to 
pay  claims; 

2.  medium  and  small-sized  insurers  generally  do  not  possess  the  in-house 
expertise  that  is  needed  to  deal  with  foreign  reinsurers; 

3.  many  foreign  reinsurers  have  become  more  selective  as  to  the  type  of  U.S.  risks 
they  will  reinsure,  due  to,  among  other  things,  the  U.S.  litigation  situation;  and 

4.  obtaining  payment  and  terms  of  coverage  from  domestic  reinsurers  is  easier  than 
from  foreign  reinsurers. 

The  foremost  reasons  previously  noted  for  why  domestic  P&C  insurers  have  traditionally 
turned  to  the  foreign  reinsurance  market  are  that  1)  the  domestic  market  lacks  the  capacity  to 
handle  all  the  reinsurance  needs  of  P&C  companies,  and  2)  domestic  reinsurers  do  not  offer  all 
the  types  of  coverage  that  is  needed.  Current  market  conditions  have  only  exacerbated  these 
problems. 

Indeed,  current  market  conditions  are  so  strong  for  reinsurers,  the  president  and  CEO  of 
Munich  American  Reinsurance  Co.  of  New  York,  who  is  also  Vice  Chairman  of  the  RAA,  was 
reported  as  proudly  announcing  recently  that  large  U.S.  reinsurers  are  gaining  additional  clout  to 
determine  which  risks  they  will  accept  and  the  terms  of  the  arrangements.'^  He  also  opined  that 
this  trend  is  expected  to  continue.  In  other  words,  the  competitive  position  of  U.S.  reinsurers  is 
strong,  and  is  expected  to  strengthen  further. 

We  submit  that  current  market  conditions  confirm  the  wisdom  of  the  admonishments 
contained  in  the  Treasury  Department  report  on  the  FET,'^  that  one  should  not  attempt  to 
evaluate  the  relative  competitive  positions  of  U.S.  and  foreign  reinsurers  by  taxes  alone." 
While  we  do  not  concede  that  the  Internal  Revenue  Code  (the  "Code")  places  U.S.  reinsurers  at 
a  competitive  disadvantage  relative  to  their  foreign  competitors,  we  do  submit  that  current 
market  conditions  heavily  overshadow  any  market  distortions  that  the  Code  might  create. 

In  sum,  the  domestic  reinsurance  industry  is  not  in  need  of  further  government 
protection  along  the  lines  of  an  increased  FET.  No  rational  basis  currently  exists  to  justify 
increasing  an  excise  tax  on  foreign  competitors  in  order  to  protect  the  now  formidable  domestic 
reinsurance  industry. 

4.  Without  a  showing  that  the  tax  increases  of  which  the  U.S.  reinsurers  connplain 
affected  their  industry  more  severely  than  the  U.S.  P&C  industry,  we  submit  that  it 
would  be  unconscionable  to  shift  a  portion  of  the  reinsurers'  tax  burden  to  the  P&C 
industry  —  which  the  Reinsurance  Association  of  America  candidly  admits  is  a  m^jor 
objective  of  the  proposed  FET  increase. 

One  of  the  RAA's  arguments  for  an  FET  increase  is  that  such  an  increase  is  necessary  in 
order  to  inflate  market  reinsurance  prices  to  a  level  that  would  be  sufficient  for  U.S.  reinsurers 
to  completely  "pass  through"  the  burden  of  tax  increases  that  were  imposed  on  the  industry  by 
the  Tax  Reform  Act  of  1986  (the"  1986  Tax  Act").  The  written  testimony  that  the  RAA 
submitted  in  connection  with  a  1990  hearing  concerning  a  proposed  FET  increase  explicitly 
confirms  this: 

To  remain  competitive  in  the  marketplace,  domestic  reinsurers  need  to 
increase  premium  rates.  Yet  competition  from  foreign  companies  immune  from 
the  1986  Act  constrains  the  ability  of  U.S.  companies  to  increase  their 
premiums. 


The  message  from  the  RAA  model  is  clear.  As  a  result  of  the  1986  Act, 
domestic  reinsurers  must  increase  rates  substantially  to  maintain  an  after-tax 
rate  of  return  sufficient  to  permit  companies  to  remain  competitive  in  the  capital 
marketplace  and  to  maintain  investment  support.  Failure  to  compensate  through 


1495 


rate  increases  for  the  impact  of  the  1986  Act  will  reduce  after-tax  return  ... 
Increasing  the  excise  tax  and  its  universal  collection  would  substantially 
diminish  the  unintended  financial  advantage  now  afforded  non-resident  foreign 
reinsurers.... 

Although  the  RAA  acknowledges  that  an  increase  in  the  excise  tax  would 
raise  the  cost  of  foreign  reinsurance,  this  is  not  an  evil  inherent  in  the  proposal 
but  a  simple  manifestation  of  the  Congressional  policy  of  the  1986  Act  ....'* 

The  RAA  is  candid  and  unambiguous  in  its  request  that  the  government  intervene  in  the 
reinsurance  market,  through  the  FET,  to  artificially  increase  the  domestic  price  of  reinsurance, 
so  that  the  domestic  reinsurers  will  be  able  to  "maintain  an  after-tax  rate  of  return  sufficient  to 
permit  companies  to  remain  competitive  in  the  capital  marketplace  and  to  maintain  investment 
support." 

In  evaluating  the  RAA's  pleas,  however,  one  needs  also  to  consider  the  fact  that  the 
1986  Tax  Act  changes  of  which  RAA  complains  were  also  imposed  on  P&C  insurers. 
Consideration  of  the  impact  of  an  FET  increase  on  P&C  companies  is  essential  since,  for 
reasons  set  forth  above,  the  P&C  companies  will  ultimately  bear  the  burden  of  the  increased 
FET. 

While  there  is  no  question  that  the  1986  Tax  Act  changes  imposed  a  significant  extra 
cost  on  U.S.  reinsurers,  the  Act  also  imposed  a  significant  extra  cost  on  U.S.  primary  insurers. 
Reinsurers  complain  that  the  "playing  field"  is  not  level  now,  because  while  the  1986  Tax  Act 
increased  the  tax  burden  on  domestic  reinsurers,  no  similar  tax  increase  was  imposed  on 
foreign  reinsurers.  The  RAA  argues  that  a  consequence  of  foreign  reinsurers  not  being 
burdened  with  a  tax  increase  comparable  to  what  the  1986  Tax  Act  imposed  on  domestic 
reinsurers,  is  that  the  foreign  reinsurers  have  no  cause  to  raise  their  reinsurance  prices. 
Without  the  foreign  competitors  increasing  their  prices,  the  domestic  reinsurers  are  effectively 
denied  the  opportunity  to  do  so.  Consequently,  the  domestic  reinsurers  argue  that  they  have 
been  unfairly  denied  the  opportunity  to  increase  prices  sufficiently  to  "pass  through"  to 
reinsurance  purchasers  the  full  burden  of  the  1986  Tax  Act. 

However,  the  reinsurers  are  not  alone  with  that  problem.  Market  forces,"  combined 
with  regulatory  obstacles,"  have  also  denied  P&C  insurers  the  ability  to  fully  pass  through  the 
burden  of  the  1986  Tax  Act.  Since  the  same  forces  that  have  denied  insurers  the  opportunity  to 
fully  pass  through  to  consumers  the  1986  Tax  Act  increases  still  exist,  such  companies  would 
undoubtedly  not  be  able  to  fully  pass  through  to  policyholders  the  additional  burden  that  will 
result  from  increased  reinsurance  prices. 

However,  whether  the  burden  of  an  increased  FET  would  ultimately  be  borne  by 
policyholders,  P&C  companies,  or  a  combination  thereof,  is  not  the  point  here.  The  issue  that 
the  FET  proposal  poses  to  the  Congress  is  whether  it  is  appropriate  at  this  time  to  transfer  part 
of  the  1986  Tax  Act  tax  increase  affecting  U.S.  reinsurers  to  U.S.  insurers  and  possibly  to 
policyholders.  Rhetoric  aside,  that  is  the  issue. 

5.  Inasmuch  as  the  FET  proposal  is  viewed  by  many  of  this  country's  trading 
partners  as  protectionist,  and  in  direct  violation  of  existing  treaties,  we  are  very  much 
concerned  about  the  potential  for  retaliation.  The  retaliation  could  be  in  many  forms, 
including  limiting  domestic  P&C  companies'  access  to  foreign  markets,  imposing 
reciprocal  excise  taxes  on  U.S.  insurance  or  reinsurance  covering  risks  in  foreign 
countries,  and  unilaterally  abrogating  whatever  concessions  that  were  made  in 
consideration  of  obtaining  the  FET  treaty  waiver  from  the  U.S. 

Concerns  about  the  impact  on  trade  that  an  increase  in  the  FET  might  bring  were  well 
expressed  in  the  1989  GAO  Report: 

An  increase  in  the  excise  tax,  coupled  with  the  elimination  of  excise 
treaty  waivers,  may  encourage  foreign  countermcasures,  jeopardizing  the  ability 
of  U.S.  insurers  to  compete  in  other  markets." 


1496 


Wc  very  much  share  the  concerns  expressed  by  the  GAO.  While  some  might  contend 
that  the  FET  provision  contained  in  H.R.  5270  is  consistent  with  all  existing  U.S.  treaty 
obligations,  wc  believe,  and  it  is  our  understanding  that  some  foreign  countries  would  contend, 
that  the  provision  violates  existing  U.S.  treaties. 

One  aspect  of  the  provision  whose  consistency  with  existing  treaties  is  especially 
controversial  is  the  one  which  conditions  the  availability  of  the  FET  waiver  on  the  effective  tax 
rate  imposed  on  a  foreign  reinsurer  being  "substantial"  in  relation  to  the  effective  U.S.  tax  rate 
(the  "conditional  FET  waiver  provision").  This  provision  has  stirred  controversy  because  some 
foreign  jurisdictions  have  negotiated  in  their  respective  treaties  with  the  U.S.  an  unconditional 
FET  waiver.  It  is  submitted  that  to  require  the  conditional  FET  waiver  provision  to  be  satisfied 
by  a  reinsurer  that  is  taxed  in  a  jurisdiction  whose  treaty  with  the  U.S.  contains  an 
unconditional  FET  waiver  reveals  an  obvious  problem  of  inconsistency. 

The  FET  proposal  could  create  trade  difficulties  irrespective  of  how  one  resolves  the 
controversial  conditional  FET  waiver  provision.  Because  of  the  well-documented  purpose 
sought  to  be  achieved  by  an  increase  in  the  FET,  that  is,  to  enhance  the  competitive  position  of 
U.S.  reinsurers  relative  to  their  foreign  competitors,"  the  proposal  is  viewed  by  many  as 
unabashedly  protectionist.  Indeed,  one  would  suspect  that  from  the  perspective  of  foreign 
competitors,  a  300%  increase  in  the  FET  is  in  many  respects  the  equivalent  of  an  additional 
3%  tariff.^  To  a  foreign  reinsurer  subject  to  the  FET  increase,  the  bottom-line  effect  of  either 
would  be  identical,  that  is,  a  3%  goverrunent-imposed  increase  in  their  cost  of  doing 
reinsurance  business  in  the  U.S. 

Furthermore,  one  must  acknowledge  that  while  the  FET  excise  tax  waiver  is  without 
question  a  benefit  to  foreign  businesses,  it  represents  a  concession  given  in  exchange  for  an 
offsetting  benefit  to  U.S  businesses.  Unilateral  nullification  of  the  excise  tax  waiver  could  well 
result  in  the  affected  foreign  jurisdiction  abrogating  the  offsetting  benefit  that  had  been  granted 
to  U.S.  businesses  in  exchange  for  the  FET  waiver. 

Because  of  the  cunent  climate  of  seemingly  endless  trade  tensions,  for  example,  the 
controversy  pending  over  the  State  of  California's  taxation  of  multinational  companies,  the 
Uruguay  Round,  disputes  over  aircraft  subsidies,  the  continuous  trade  negotiations  with  Japan, 
and  countless  others,  we  submit  that  it  is  wrong  to  compound  such  tensions  by  enacting  the 
FET  increase  proposal. 

And,  in  addition  to  the  widely  publicized  major  trade  developments  that  could  be 
affected  by  enactment  of  the  FET  proposal,  one  must  also  consider  the  proposal's  impact  on 
trade  issues  of  a  smaller  dimension,  but  that  are  of  much  concern  to  specific  industries.  For 
example,  efforts  are  currently  underway  to  expand  the  U.S.  insurance  presence  in  Japan  and  in 
parts  of  Asia.    Japan's  Ministry  of  Finance  is  currently  in  the  process  of  planning  legislation 
for  new  taxation  of  insurance  and  reinsurance  premiums  paid  to  foreign  companies.^' 
Furthermore,  some  companies  are  now  positioning  themselves  for  possible  entry  into  Laos, 
whose  government-imposed  monopoly  will  expire  in  1995,  thereby  opening  that  market  to 
foreign  companies.  ^  Insurers  arc  also  anxiously  awaiting  progress  in  opening  the  Mexican 
market  to  foreign  insurers,  an  opportunity  described  by  an  advisor  to  a  major  U.S.  insurer  as 
"extraordinary." 

Wc  submit  that  with  all  the  trade  tensions  and  potential  opportunities  now  at  issue, 
some  of  which  having  many  hours  of  delicate  negotiations  lying  ahead,  it  would  be  inadvisable 
for  the  U.S.  to  take  any  action  that  might  result  in  other  countries  questioning  whether  the  U.S. 
can  be  relied  on  to  honor  the  commitments  that  it  makes.  From  the  perspective  of  some  foreign 
countries,  a  unilateral  increase  in  the  FET,  especially  when  combined  with  a  new  "conditional 
FET  waiver"  provision,  might  indicate  that  the  U.S.  cannot  be  trusted  to  abide  by  the  treaties 
that  it  negotiates. 


1497 


6.  Even  if  there  were  some  justification  for  modifying  the  FET,  the  proposal  contained  in 
H.R.  5270  is  unworkable. 

We  concur  with  the  evaluation  given  the  FET  proposal  by  the  Treasury  Department  in 
its  prepared  statement  before  a  1992  House  Ways  and  Means  Committee  hearing  on  H.R.  5270: 

wc  do  not  support  the  proposal  because  we  do  not  believe  that  it  can  be 
administered  fairly  and  effectiveh .  For  example,  we  are  seriously  concerned 
about  the  burden  of  the  numerous  closing  agreements  that  would  be  required  and 
about  the  difficulty  of  detemiining  the  effective  rate  of  foreign  tax  in  a  multitude 
of  countries.  We  believe  that  the  proposal  would  further  the  goal  of  [preserving] 
the  U.S.  tax  base  to  an  uncertain  extent  and  only  at  unacceptable  costs  to  the 
goal  of  administrability  and  simplicity.^  (Emphasis  added). 

As  proposed  in  H.R.  5270,  the  increased  FET  that  would  apply  to  reinsurance  premiums 
paid  to  a  foreign  reinsurer  could  be  avoided  only  if  both  of  the  following  requirements  are  met: 

1.  the  income  (including  investment  income)  relating  to  the  policy  of  reinsurance  is 
subject  to  foreign  tax  at  an  effective  rate  that  is  "substantial"  in  relation  to  the  U.S. 
income  tax;  and 

2.  the  reinsured  risk  is  not  reinsured  (directly  or  indirectly)  to  a  company  that  is  not 
subject  to  a  "substantial"  tax  on  the  income  relating  to  the  reinsurance  policy  (the 
"anti-conduit"  rule). 

With  certain  exceptions,  any  party  to  a  transaction  subject  to  the  FET  could  be  held  responsible 
for  remitting  the  applicable  FET.  Consequently,  in  cases  where  the  FET  is  not  applicable,  all 
parties  to  a  transaction  would  need  to  be  able  to  show  that  both  of  the  requirements  set  forth 
above  are  met.    We  submit  that  proving  either  of  the  requirements  could  be  extremely  difficult, 
and  very  demanding  from  an  administrative  perspective,  even  if  they  could  be  accomplished. 

The  first  requirement  apparently  would  be  satisfied  if  it  can  be  shown  that  the  foreign 
reinsurer  is  subject  to  an  effective  rate  of  tax  that  is  at  least  50  percent  of  the  applicable  U.S. 
effective  tax  rate.  In  cases  where  the  foreign  effective  rate  of  tax  is  neither  clearly  above  nor 
clearly  below  the  50%  threshold,  this  requirement  will  result  in  hopeless  controversy.  As  the 
GAO  observed  in  its  1989  report: 

(b]ecause  of  differences  in  the  way  the  various  countries  define  taxable  income, 
we  could  not  compare  the  tax  burden  of  reinsurers  from  different  countries.^ 

The  GAO's  candid  admission  of  its  inability  to  undertake  the  comparison  that  would  be 
demanded  of  taxpayers  by  the  FET  proposal  provides  an  indication  of  the  hopeless  confusion 
that  would  surely  reign  as  taxpayers  and  the  Internal  Revenue  Service  sought  to  resolve  the 


Furthermore,  even  if  it  were  possible  to  compare  the  tax  burdens  of  different  countries, 
a  country's  tax  laws  are  not  static.  The  requirement  would  require  parties  to  foreign 
reinsurance  transactions  to  constantly  monitor  the  tax  laws  of  each  country  that  imposes  a  tax 
on  the  income  of  either  the  reinsurers  with  which  they  deal  or  the  reinsurers  with  whom  their 
reinsurers  deal,  and  so  on. 

The  second  requirement,  the  anti-conduit  rule,  is  also  unworkable.  The  implementation 
of  this  requirement  contemplates  a  procedure  under  which  foreign  reinsurers  would  enter  into 
"closing  agreements"  with  the  Treasury  Department  in  order  to  ensure  compliance.  As  noted 
above,  the  Treasury  Department  testified  that  the  administrative  burden  created  by  this 
requirement  would  be  excessive. 

The  noted  compliance  problems  become  strikingly  evident  when  the  proposal  is 
considered  within  the  context  of  the  "real  world."  In  the  "real  world,"  it  is  common  for  a 
reinsurer  to  retrocede  all  or  a  portion  of  the  specific  risks  that  it  assumed  from  different 


1498 


insurers  to  other  reinsurers.  The  other  reinsurers,  in  turn,  might  retrocede  to  still  other 
reinsurers  all  or  a  portion  of  the  risks  they  respectively  assumed,  and  so  on. 

In  many  cases,  an  insurer  would  find  it  impossible  to  determine  the  destination  of  the 
entire  collection  of  risks  that  it  reinsured.  To  avoid  the  FET  under  the  proposal,  each 
reinsurance  of  each  risk,  and  portions  thereof,  would  need  to  be  carefully  traced  through  each 
and  every  company  involved.  And,  a  determination  of  relative  tax  burdens  (wnich  the  GAO 
confessed  it  could  not  perform)  would  need  to  be  performed  for  all  countries  that  tax  one  or 
more  of  the  foreign  reinsurance  companies  that  assumed  any  portion  of  the  risk. 

In  sum,  when  one  attempts  to  apply  the  FET  proposal  to  the  "real  world,"  it  becomes 
ob\  ious  that  the  proposal  would  not  work,  and  could  not  be  administered. 


The  P&C  industry  respectfully  urges  that  the  FET  proposal,  which  would  quadruple  the 
FET,  unilaterally  override  carefully  negotiated  treaties,  and  effectively  transfer  to  P&C 
insurers  a  portion  of  the  reinsurers'  tax  burden  at  a  time  when  reinsurers  are  boasting  strong 
first-half  increases  while  P&C  insurers  struggle  to  remain  viable,  be  rejected. 

If  Subcommittee  Members  have  any  questions,  I  would  be  pleased  to  seek  to  answer 
them.  Thank  you  for  the  opportunity  to  present  this  testimony  on  a  matter  of  such  serious 
concern  to  the  P&C  industry. 


1499 


'  Business  Insurance.  July  19,  1993,  at  58  . 

"  Ferraiolo,  Walking  The  Reinsurance  Tightrope.  Best's  Review  (Property/Casualty)  35, 

94  (August  1993)  ("Ferraiolo"). 

Business  Insurance.  May  3,  1993,  at  38. 
■*  A  recent  article  described  the  recent  spate  of  catastrophes  as  "beginning  with  the  Los 

Angeles  riots,  followed  by  the  Chicago  flood,  a  record  number  of  tornadoes  (1,300),  numerous 
hailstorms  in  the  Midwest  and  Southeast  and,  on  August  24,  a  shot  that  was  heard  around  the 
world.  Hurricane  Andrew,  which  struck  Florida  and  Louisiana.  Adding  insult  to  injury,  Mother 
Nature  delivered  a  crowning  blow  to  the  industry  with  Hurricane  Iniki  in  Hawaii,  and  just  three 
weeks  before  year  end  battered  the  northeast  coastline  with  a  nor'  caster  December  11-13, 
followed  by  an  ice  storm  December  21."  Snyder,  The  Year  of  the  Cats,  Best's  Review 
(Property/Casualty)  15  (February  1993.  The  author  estimates  that  the  industry  during  1992 
absorbed  more  than  $22  billion  in  catastrophe-related  losses.  Id.  at  16. 
*  Business  Insurance,  May  3, 1993,  at  38  (emphasis  added). 

'  Business  Insurance.  August  30, 1993,  at  55. 

'  General  Accounting  Office,  The  Insurance  Excise  Tax  and  Competition  for  U.S. 

reinsurance  Premiums,  29  (GAO/GGD-89-115BR,  September  1989)  ("1989  GAO  Report"). 
'  Statement  of  Andre  Maisonpierre,  President,  Reinsurance  Association  of  America, 

Hearing  of  the  Select  Revenue  Measures  Subcommittee  on  Proposed  Increase  of  Federal 
Excise  Tax  on  Reinsurance  Premiums  Ceded  Abroad,  February  21, 1990  ("Maisonpicne 
Statement"). 

'  Ferraiolo,  supra  note  2,  at  35. 

'°  Business  Insurance,  August  30,  1993,  at  55. 

"  Business  Insurance,  August  30, 1993,  at  2.  According  to  an  article  in  The  Journal  of 

Commerce,  August  25, 1993,  the  impressive  market  gains  realized  by  U.S.  reinsurers  are 
attributable  to  the  shrinking  capacity  for  property-catastrophe  reinsurance  in  the  London 
market,  coupled  with  an  increase  in  demand  for  the  coverage. 
'^  The  Journal  of  Commerce.  August  25,  1993. 

"  Treasury  Department ,  Report  To  Congress  On  The  Effect  On  U.S.  Reinsurance 

Corporations  Of  The  Waiver  By  Treaty  Of  The  Excise  Tax  On  Certain  Reinsurance  Premiums. 
(March  30,  1991)("1991  Treasury  Report") 

'"  1991  Treasury  Report .  supra  note  13.  at  2  (emphasis  added).     The  Treasury  Report 

was  in  a  sense  prescient  in  cautioning  that,  the  "competitive  effects  of  (the  different  regulatory 
requirements  and  other]  non-tax  factors  may  easily  dominate  the  effects  of  differences  in  tax 
laws. "  Id. 

'*  Maisonpierre  Statement,  supra  note  8. 

"  As  pointed  out  in  Snyder,  The  Year  of  the  Cats,  Best's  Review  (Property/Casualty)  15, 

17  (February  1993),  while  the  industry  entered  a  soft  underwriting  market  phase  in  1987,  the 
industry's  underwriting  results  have  slowly  deteriorated  since  then,  from  a  combined  ratio  of 
104.6  in  1987,  to  a  ratio  of  108.8  in  1991.  By  1992,  the  industry's  combined  ratio  had  spiked  to 
an  estimated  114.8,  due  to  the  major  catastrophes,  a  level  surpassed  only  twice  before. 
"  E^.  the  State  of  California's  Proposition  103,  that  called  for  a  premium  rate  roll-back 

on  certain  lines  of  insurance. 
"  1989  GAO  Report,  supra  note  7,  at  3. 

"  E^.,  Maisonpierre  Statement,  supra  note  8;  and  1989  GAO  Report  supra  note  7,  at  19. 

^  The  additional  FET  would  generally  not  be  creditable  against  the  foreign  reinsurer's 

domiciliary  income  tax,  sec,  c^.,  1991  Treasury  Report,  supra  note  13,  at  3.  . 
"  World  Insurance  Forum:  Japan,  Best's  Review  (Property/Casualty)  66,  68  (September, 

1993). 

^  Skully,  Opportunity  in  an  Unexpected  Place,  Best's  Review  (Property/Casualty)  21 

(September,  1993). 

^  Statement  of  Assistant  Treasury  Seactary  for  Tax  Policy  Fred  Goldberg  Before  House 

Ways  and  Means  Committee  at  Hearing  on  HR  5270,  "Foreign  Income  Tax  Rationalization  and 
Simplification  Act  of  1992,"  July  21, 1992  (Emphasis  added). 
^  1989  GAO  Report,  supra  note  7,  at  27. 


1500 

Mr.  Neal.  Mr.  Rahn. 

STATEMENT  OF  ROBERT  W.  RAHN,  COUNSEL,  AMERICAN  NU- 
CLEAR INSURERS,  ON  BEHALF  OF  AMERICAN  INSURANCE 
ASSOCIATION,  MUTUAL  ATOMIC  ENERGY  LIABILITY  UNDER- 
WRITERS, AND  MAERP-REINSURANCE  ASSOCIATION 

Mr.  Rahn.  Mr.  Chairman,  good  afternoon.  I  am  Robert  Rahn, 
counsel  to  American  Nuclear  Insurers  of  West  Hartford,  Conn.  I 
appear  today  on  behalf  of  the  American  Insurance  Association  to 
present  the  particular  and  perhaps  unique  perspective  of  the  nu- 
clear insurance  pools  on  how  the  proposed  quadrupling  of  the  FET 
would  impact  U.S.  consumers  in  ways  that  Congress  may  not  have 
considered  and  would  not  likely  intend. 

The  insurance  industry  created  three  pools  at  the  urging  of 
Congress  that  we  provide  insurance  to  meet  the  requirements  of 
the  1957  Price-Anderson  Act.  Today  these  pools  consist  of  approxi- 
mately 180  stock  and  mutual  insurance  companies  in  the  United 
States. 

We  operate  as  pools  because  the  large  amounts  of  insurance  and 
the  specialized  underwriting  and  loss  control  techniques  required 
to  write  nuclear  insurance  simply  could  not  be  provided  by  individ- 
ual insurers.  The  pools  provide  nuclear  liability  insurance  for  all 
115  commercial  nuclear  power  plants  in  the  United  States.  This 
lets  the  power  plants  meet  Price- Anderson  public  protection  re- 
quirements in  the  event  of  a  nuclear  incident  such  as  the  one  we 
had  at  Three  Mile  Island  in  1978. 

We  also  provide  insurance  designed  to  comply  with  a  U.S. 
Nuclear  Regulatory  Commission  mandate  that  if  there  is  a  serious 
nuclear  accident  at  any  reactor,  funds  will  be  available  to  stabilize 
that  reactor  and  to  decontaminate  the  site. 

When  the  pools  were  being  formed,  we  gathered  all  available  in- 
surance capacity  that  we  could  from  financially  strong  U.S.  insur- 
ance companies,  those  who  were  willing  to  assume  this  new  risk. 
Similarly,  we  invited  strong  U.S.  reinsurance  companies  to  stand 
behind  them.  Then  we  turned  not  by  choice  but  out  of  necessity  to 
the  worldwide  reinsurance  market  for  the  rest  of  the  capacity  and 
the  spread  of  risk  we  needed. 

Back  in  1957,  we  were  able  to  attract  over  two-thirds  of  the  ca- 
pacity we  needed  from  U.S.  sources.  Today  the  situation  is  re- 
versed. We  must  depend  upon  literally  hundreds  of  overseas  rein- 
surers all  around  the  world  for  over  72  percent  of  our  total  capacity 
of  just  over  $1.5  billion. 

This  has  come  about  because  the  values  of  those  power  plants 
and  the  dollar  amounts  of  financial  protection  required  by  Price- 
Anderson  and  by  the  NRC  have  far  outstripped  the  available  do- 
mestic capacity.  With  this  background,  I  think  you  can  see  why  the 
proposed  FET  increase  troubles  us. 

Our  major  concern  is  that  it  would  cause  our  overseas  reinsurers, 
hundreds  of  them,  to  rethink  their  commitment  to  us  and  perhaps 
decide  to  sell  their  capacity  where  taxes  are  not  a  problem.  If 
enough  of  those  reinsurers  did  that,  we  would  no  longer  be  able  to 
provide  the  current  level  of  protection  that  nuclear  reactor  opera- 
tors must  have  by  law. 


1501 

On  the  other  hand,  if  they  do  stay  with  us,-  they  are  likely  to  de- 
mand higher  prices.  There  is  simply  no  other  realistic  alternative: 
Reduced  capacity  or  higher  prices. 

Perhaps  we  could  find  other  qualified  reinsurers,  ones  that  have 
not  been  attracted  at  our  present  premium  levels.  We  would  very 
likely  have  to  pay  an  even  higher  price  to  attract  them.  In  any 
case,  we  would  have  to  pass  whatever  the  increase  is  on  to  the  nu- 
clear utilities.  They  in  turn  would  have  to  pass  their  increased 
costs  on  to  the  American  consumers  of  electricity.  Because  in  many 
cases  no  one  can  say  whether  a  given  kilowatt  of  electricity  comes 
from  a  nuclear  plant  or  a  nonnuclear  plant,  that  increase  would  be 
passed  to  almost  all  of  us. 

Some  proponents  of  the  increase  argue  that  it  would  raise  reve- 
nue painlessly  because  the  tax  would  be  paid  by  foreign  reinsurers. 
Others  say  it  would  benefit  U.S.  reinsurers  by  leveling  the  playing 
field"  and  therefore  bring  back  business  they  have  lost  to  reinsur- 
ers overseas.  I  did  not  come  to  engage  in  the  overall  debate.  My 
goal  is  simply  to  focus  attention  on  two  points:  One,  the  fact  that 
this  tax  increase  would  not  be  painless  to  U.S.  consumers  as  some 
claim.  Consumers  would  wind  up  paying  for  it  in  their  electric  bills. 

And  two,  there  is  some  reinsurance  business,  particularly  nu- 
clear, that  this  tax  measure  could  not  possibly  bring  back  from 
overseas  because  we  already  use  all  available  U.S.  capacity  that 
meets  our  standards. 

It  has  been  suggested  also  that  our  reinsurers  simply  negotiate 
closing  agreements  with  the  IRS  to  avoid  the  FET.  While  a  few  of 
our  larger  reinsurers  overseas  have  done  that,  they  did  so  as  part 
of  their  overall  business  plan  involving  other  lines  of  business  in 
the  United  States. 

Most  of  our  hundreds  of  overseas  reinsurers  are  reluctant  to  go 
through  the  complex  process  necessary  to  negotiate  a  closing  agree- 
ment, particularly  if  nuclear  is  the  only  or  almost  the  only  business 
they  have  in  the  United  States.  They  can  simply  take  their  capac- 
ity elsewhere  with  less  trouble  and  expense. 

To  summarize,  from  the  perspective  of  the  U.S.  nuclear  insur- 
ance pools,  this  increase  would  undermine  our  ability  to  provide 
adequate  insurance  to  the  electric  utilities,  insurance  they  need  to 
comply  with  the  Federal  requirements  of  Price- Anderson  and  the 
NRC.  It  would  either  reduce  the  availability  of  foreign  reinsurance, 
which  we  must  have  because  U.S.  insurance  and  reinsurance  ca- 
pacity is  not  sufficient,  or  increase  the  cost  of  reinsurance,  or  both. 
Either  way,  U.S.  consumers  and  not  foreign  reinsurers  would  bear 
the  burden. 

Thank  you,  Mr.  Chairman,  for  the  opportunity  to  share  our 
views. 

Mr.  Neal.  Thank  you  very  much,  Mr.  Rahn. 

[The  prepared  statement  follows:] 


77-130  0-94-16 


1502 


I^HMPNY  Of  ROBERT  W.  RAHN 

CTHtfYiMMimiii-  fwi  sin  xfrr  b wktotte  MEASURIjS 

COMMTITEE  ON  WAYS  AND  MEANS 

U.S.  P0U5E  QF  MTMSPffATIVES 
SEPTEMBER  21.  tf» 


Mr.  Chairman,  Members  of  the  Subcommittee,  Ladies  and  Gentlemen,  good  morning. 

I  am  Robert  W.  Rahn,  Counsel  to  American  Nuclear  Insurers  (AND,  of  West  Hartford,  Connecticut. 
I  appear  today  on  bdialf  of  the  American  Insurance  Association  to  present  the  particular  perspective  of 
the  three  nuclear  insurance  pools  on  how  the  proposed  quadrupling  of  the  FET,  from  the  present  1% 
to  4%,  would  impact  U.S.  consumers  in  ways  the  Congress  may  not  have  considered  and  would  not  likely 
intend. 

More  specifically,  I  am  testifying  on  behalf  of  ANI,  and  its  sister  organizations  Mutual  Atomic  Energy 
Liability  Underwriters  (MAELU)  and  MAERP  Reinsurance  Association.  These  are  cooperating  'pools' 
of  approximately  180  U.S.  Property-Casualty  insurers.  At  the  urging  of  Congress,  the  insurance 
industry  created  these  three  pools  to  provide  insurance  that  would  meet  the  requirements  of  the  Hrioe- 
Anderson  Act  of  1957.  We  have  been  insuring  nuclear  risks  for  36  years  now. 

Our  pools  provide  nuclear  energy  liability  insurance  to  the  operators  of  all  of  the  roughly  115  commercial 
nuclear  power  plants  in  the  U.S.  This  lets  them  meet  Price-Anderson's  financial  protection  requirements 
that  are  designed  to  protect  the  public  in  the  event  of  a  nuclear  accident  at  one  of  those  plants.  I'm  sure 
Three  Mile  Island  comes  to  everyone's  mind;  yes,  we  insured  that. 

Reactor  operators  also  purchase  our  property  insurance  to  comply  with  a  U.S.  Nuclear  Regulatory 
Commission  (NRC)  mandate  that  there  be  adequate  funds  available,  in  the  event  of  a  serious  nuclear 
accident,  to  stabilize  the  reactor  and  decontaminate  the  site  to  a  safe  level. 

We  operate  as  'insurance  pools'  because  the  large  amounts  of  insurance,  and  the  specialized  insurance 
underwriting  and  loss  control  techniques  needed  for  nuclear  risks,  simply  could  not  be  provided  by 
individual  insurers.  When  the  pools  were  forming,  we  gathered  all  available  insurance  capacity  from 
highly-rated  U.S.  insurers  willing  to  assume  this  new  risk.  Similarly,  we  invited  financially  strong  U.S. 
reinsurance  companies  to  stand  behind  the  companies  that  would  actually  issue  the  policies.  After 
assembling  aD  such  damestic  capacity,  we  tamed  -  not  by  choice,  bnt  of  necessity  -  to  the  worldwide 
reinsurance  market  to  obtain  the  additional  capacity  and  "spread  of  risk"  we  needed  to  provide  this  new 
kind  of  insurance  in  a  sound  and  responsible  manner. 


1503 


We  have  seen  the  geograpiuc  sources  of  cur  capacity  to  write  nuclear  insurance  change  markedly  over 
the  past  36  years,  as  the  values  of  tiioae  pbnts  and  the  dollar  amounts  of  lunim  iri  |Mii<«tliu«  reqfMHl 
by  Frlce-Anderson  and  the  NRC  have  increased.  In  1957,  we  were  able  to  attract  over  two-thirds  of  the 
capacity  we  needed  from  U.S.  insurers  and  reinsurers.  Today  the  situation  is  reversed;  we  must  depend 
upon  literally  hundreds  of  reinsurers  overseas  to  provide  almost  72%  of  oar  capacity.  That  translates 
to  $1.1  billion  out  of  our  present  total  capacity  of  over  $1^  bSBon.  To  assemble  this  reinsurance  we 
must  go  to  many  countries  around  the  world.  (To  illustrate:  we  are  now  reinsured  by  over  100  British 
companies  and  Lloyd's  syndicates;  65  German;  72  Spanish;  22  Finnish,  etc.)  Although  we  must  go  far 
to  get  it,  we  have  been  successful  in  meeting  the  insurance  needs  of  our  customers,  the  electric  utilities 
and  those  who  provide  services  to  them,  to  protect  both  the  public  and  their  own  property. 

With  this  background  I  think  you  can  see  why  the  proposal  to  increase  the  reinsurance  excise  tax 
troubles  us.  Our  mi^or  concern  is  that  a  fourfold  increase  in  the  FET  would  cause  our  overseas 
reinsurers  to  rethink  their  commitment  to  us.  One  need  not  be  a  mathematician  or  an  economist  to  see 
that  this  could  lead  either  to  reduced  insurance  capacity  or  to  higher  prices  for  it  (or  perhaps  both). 
There  are  simply  no  other  realistic  alternatives. 

A  good  number  of  our  foreign  reinsurers  might  simply  decide  to  stop  reinsiiring  the  U^.  nnclear  pools 
and  sell  their  capacity  where  taxes  are  not  a  problem.  If  enough  of  them  did  that,  we  could  not  continue 
to  provide  the  current  level  of  protection  that  nuclear  reactor  operators  must  have  by  law  to  protect  the 
public.  Please  understand  that  the  member  insurance  companies  in  our  pools  cannot  simply  take  on 
more  risk;  they  must  limit  their  exposure  to  nuclear  or  any  other  potentially  catastrophic  risk  to  a 
prudent  level. 

If  our  capacity  were  to  be  significantly  reduced  because  a  number  of  our  foreign  reinsurers  desert  us, 
we  might  be  able  to  find  other  qualified  reinsurers,  but  we  would  have  to  pay  an  even  higher  price  to 
attract  them.  We  would  have  to  pass  that  increase  on  to  our  customers,  the  nuclear  utilities.  They,  in 
turn,  would  have  to  pass  those  increased  costs  on  to  their  customers,  the  American  consumers  who  are 
the  electric  ratepayers.  That  could  include  virtually  anyone  who  uses  electric  power  since  in  many  cases 
no  one  can  say  whether  any  given  kilowatt  of  electricity  comes  from  a  nuclear  plant  or  a  non-nuclear 
plant. 

Proponents  of  this  increase  argue  that  it  would  raise  revenue  painlessly;  the  tax  would  be  paid  by  foreign 
reinsurers.  Some  also  say  that  it  would  benefit  U.S.  reinsurers  by  "leveBng  the  playing  fidd'  with 
foreign  reinsurers  and  therefore  bring  back  business  they  may  have  lost  to  overseas  competitors. 

There  is  an  ongoing  debate  regarding  how  much  tax  revenue  might  be  produced,  and  whether  the 
playing  fleld  is  or  is  not  level.  I  did  not  come  to  engage  in  that  debate.  My  goal  is  to  focus  attention 
on  two  points;  one,  the  fact  that  this  tax  increase  would  not  be  painless  to  U.S.  consumers;  they  would 
wind  up  paying  for  it  in  their  electric  bills;  and  two,  there  is  some  rriiisiii  incc  busiiiwn,  sadi  as  undear, 
that  this  supposed  tax  advantage  could  not  bring  back  from  overseas,  because  we  already  use  aO 
available  U.S.  capacity  that  meets  our  standards. 


1504 


It  has  been  suggested  that  foreign  reinsurers  in  countries  that  have  tax  treaties  with  the  U.S.  can  avoid 
the  FET  by  simply  obUining  "dosiiig  agreements'  with  the  IRS.  While  a  few  of  our  larger  foreign 
reinsurers  have  negotiated  closing  agreements,  they  did  so  as  part  of  their  ovccd  Irbbmsb  phai 
involving  other  lines  of  U.S.  business,  of  which  nuclear  is  just  a  small  part.  Most  of  our  hundreds  of 
overseas  reinsurers  are  reluctant  to  go  through  the  complex  process  necessary  to  obtain  a  closing 
agreement,  particularly  if  nuclear  reinsurance  is  the  only  business  (or  most  of  the  business)  they  do  in 
the  U.S.  They  can  simply  take  their  capacity  and  reinsure  business  from  other  countries  with  less 
trouble  and  expense.  (Not  one  of  our  72  Spanish  reinsurers  has  a  dosing  agreement;  only  5  of  65 
German  ones  do;  1  of  the  22  Finnish  reinsurers  does.)  And,  of  course,  many  of  our  reinsurers  are  in 
countries  that  do  not  have  tax  treaties  with  the  U.S. 

In  closing,  let  me  say  that  when  this  tax  proposal  came  up  in  Congress  last  year,  as  it  has  in  several 
prior  years,  it  was  again  njected.  From  the  perspective  of  the  U.S.  nuclear  insurance  pools,  this  tax 
increase  could  undermine  our  ability  to  provide  arifgnafr  insiininn'  to  our  cnstoiners,  the  electric 
utilities,  so  they  can  comply  with  the  Hnancial  protection  requirements  of  Price- Anderson  and  the  NRC. 
It  could  either  reduce  the  availability  of  foreign  reinsurance,  which  we  must  have  because  U.S.  capacity 
is  insufTicient,  or  mcrease  its  cost,  or  both.  Either  way,  U^.  consomcn,  and  not  foreign  remsnrers, 
would  bear  the  burden. 

Thank  you,  Mr.  Chairman  and  Members  of  the  Subcommittee,  for  the  opportunity  to  share  the  views 
of  ANI,  MAELU  and  MAERP  Reinsurance  Association  on  this  important  subject. 

I  would  be  glad  to  answer  any  questions  you  may  have. 


1505 

Mr.  Neal.  It  seems  that  we  are  going  to  be  captive  to  some  pro- 
cedural delays  on  the  House  floor  and  what  I  am  going  to  do  is  run 
over  and  vote  and  I  will  come  right  back.  I  have  a  couple  of  ques- 
tions for  you.  I  know  some  of  you  were  hoping  you  might  be  saved 
by  the  bell,  but  we  do  have  just  a  couple  of  questions.  I  will  be 
right  back. 

[Recess.] 

Mr.  Neal,  Thank  you  for  that  indulgence.  Perhaps  we  can  recon- 
vene here. 

Mr.  McCloskey,  at  a  previous  hearing  before  this  subcommittee 
in  June  you  testified  in  favor  of  various  revenue  losing  proposals. 
Today  you  have  testified  in  opposition  to  a  number  of  revenue  rais- 
ing proposals. 

Can  you  suggest  other  means  to  off'set  the  cost  of  the  proposals 
that  you  have  endorsed  in  your  previous  testimony? 

Mr.  McCloskey.  Well,  I  guess  tax  the  other  fellow.  I  am  only 
joking.  My  personal  view,  inasmuch  as  we  do  not  have  an  associa- 
tion position  is  that  I  favor  a  value-added  tax. 

Mr.  Neal.  Pretty  candid,  we  appreciate  that. 

Mr.  Singley,  what  impact  has  the  current  uncertainty  over  the 
proper  tax  treatment  of  environmental  cleanup  costs  had  on  your 
members'  efforts  to  plan  ahead  for  these  costs?  If  current  IRS  rul- 
ing position  requiring  capitalization  is  maintained,  what  impact  do 
you  think  this  will  have  on  your  members? 

Mr.  Se^gley.  Sir,  is  your  question  about  the  impact  of  the  uncer- 
tainty or  whether  the  IRS  position  will 

Mr.  Neal.  If  you  could  give  us  kind  of  a  snapshot  of  both,  that 
would  be  appropriate. 

Mr.  Singley.  Well,  speaking  as  a  tax  professional,  it  is  a  tradi- 
tional thing  that  as  volume  of  any  expenditures  increase,  they  come 
under  scrutiny  by  the  revenue  authorities  when  they  may  not  have 
in  the  past.  I  think  that  is  just  what  you  expect.  And  normally  the 
agency's  actions  are  not  to  continue  expense  treatment,  they  usu- 
ally come  at  you  proposing  that  something  should  be  capitalized. 

There  is  a  lot  of  concern  about  the  proposal — about  the  analysis 
that  these  expenses  should  be  capitalized.  The  problem  in  discuss- 
ing it  in  general  is  that  there  is  a — there  is  a  very  large  number 
of  fact  patterns  which  I  think  is  why  you  hear  so  much  rec- 
ommendation from  various  spokesmen.  I  think  even  the  Treasury 
said  they  are  studying  it. 

It  is  very  difficult  to  make  some  succinct  statement  about  how 
things  ought  to  be  treated.  I  think,  in  general,  what  most  of  the 
members  of  our  industry  are  doing  is  analyzing  these  increasing 
expenditures  in  a  more  or  less  traditional  capital  versus  expense 
way. 

If  I  am  investing  in  a  piece  of  equipment,  an  incinerator  at  a  re- 
mediation site,  then  that  would  tend  to  get  capitalized  like  other 
items  of  capital  equipment.  If  I  have — if  I  am  cleaning  up  some- 
thing that  is  in  the  nature  of  a  repair,  then  it  tends  to  get  ex- 
pensed. 

And  I  think,  as  I  said,  whenever  you  know  someone  is  reviewing 
the  issue,  yes,  you  are  concerned  about  it.  But  if  your  question  is 
directed  to  at  this  time  is  it  causing  any  change  in  industry  pat- 


1506 

terns  on  these — on  response  to  these  sort  of  things,  I  think  the  an- 
swer to  that  is  no. 

There  is  a  very  strong — there  is  a  very  strong  feeling,  almost 
moral  overtones  to  this.  I  mean,  when  some — when  a  problem  de- 
velops, people — ^most  companies  go  and  try  to  do  the  right  thing 
first  and  sort  out  details  later.  I  tnink  that  probably,  candidly,  that 
is  what  most  companies'  response  to  this  is. 

Mr.  Neal.  Thank  you,  Mr.  Singley.  We  will  let  Mr.  Gentile  and 
Mr.  Jarratt  and  Mr.  Rahn  have  a  crack  at  the  next  question. 

In  its  1990  report,  the  Treasury  Department  concluded  that  cur- 
rent law  provides  a  competitive  advantage  for  foreign  reinsurance 
companies  in  tax  havens.  Do  you  disagree  with  this  conclusion  and 
can  you  recommend  another  approach  to  address  this  concern? 

Mr.  Gentile,  would  you  like  to  go  first  and  then  we  will  have  Mr. 
Jarratt  or  Mr.  Rahn. 

Mr.  Gentile.  That  would  be  fine.  The  ultimate  parent  of  the  cor- 
poration I  work  for  is  Swiss  Reinsurance  Company  in  Zurich,  Swit- 
zerland. SwissRe  is  the  second  largest  reinsurer  in  the  world. 
SwissRe  has  a  tax  treaty  with  the  United  States  which  in  effect 
does  not  contain  an  excise  tax  waiver. 

If  the  current  provision  was  enacted,  there  is  considerable  ques- 
tion as  to  whether  or  not  an  increase  in  excise  tax  from  1  to  4  per- 
cent would  be  applicable  to  transactions  with  SwissRe  located  in 
Switzerland.  So  one  of  the  unintended  effects  of  the  increase  in  ex- 
cise tax  would  be  to  tax  premiums  flowing  fi-om  the  United  States 
to  Switzerland  which  in  fact  has  a  relatively  high  tax  rate  but  on 
a  basis  significantly  different  than  the  tax  system  in  the  United 
States. 

Mr.  Neal.  Mr.  Kies. 

Mr.  KiES.  I  would  just  add  one  other  thing,  Mr.  Chairman.  The 
Treasury  report  actually  concluded  that  if  the  existing  1  percent 
tax  was  waived,  that  it  would  give  a  competitive  advantage  to  com- 
panies operating  in  tax  havens  but  I  don't  believe  it  actually  con- 
cluded that  the  1  percent  tax  was  inadequate  to  address  competi- 
tive problems,  and  in  fact,  sometimes  the  1  percent  tax  could  actu- 
ally result  in  a  competitive  disadvantage  because  the  1  percent  tax 
applies  even  if  the  company  makes  no  profit. 

You  could  have  a  U.S.  company  that  didn't  make  a  profit,  it 
would  pay  no  income  tax,  but  a  company  in  a  tax  haven  that  lost 
money  would  still  pay  the  1  percent  excise  tax  because  it  is  paid 
on  gross  premiums,  not  on  net  income.  So  I  think  the  Treasury  re- 
port actually  didn't  come  out  and  say  that  the  1  percent  was  inad- 
equate to  address  competitive  problems.  It  said,  if  you  eliminated 
the  1  percent  and  waived  it,  that  that  could  create  competitive 
problems. 

Mr.  Neal.  Thank  you  for  that  clarification,  Mr.  Kies. 

Mr.  Gentile,  you  want  to  add  anything  else? 

Mr.  Gentile.  Yes.  The  only  thing  I  would  add  is  that  is  precisely 
the  position  that  many  foreign  reinsurers  find  themselves  in  today, 
in  fact  having  lost  a  significant  amount  of  dollars  because  of  Hurri- 
cane Andrew  and  other  catastrophic  losses,  they  find  themselves 
paying  a  current  1  percent  excise  tax  on  a  business  where  the  bot- 
tom line  is  they  lose  money. 

Mr.  Neal.  Mr.  Jarratt. 


1507 

Mr.  Jarratt.  The  only  thing  I  could  add  to  that  is  again  the  dif- 
ficulty of  trying  to  keep  up  with — where  the  reinsurance  premiums 
go  and  the  difficulty  in  trying  to  determine  whether  they  are  for- 
eign or  domestic  and  that  the  cost  of  the  reinsurance  is  just  un- 
available at  the  present  time, 

Mr.  Neal.  Mr.  Rahn. 

Mr.  Rahn.  Our  concern  is  simply  getting  high  quality  reinsur- 
ance. We  are  not  interested  in  tax  havens  in  the  sense  that  tax  ha- 
vens is  a  pejorative  term  in  some  circles.  We  are  searching  the 
globe  for  companies  that  have  good,  stable  reputations  and  we  find 
them  in  major  nations  all  around  the  world.  And  beyond  that,  I 
cannot  elaborate. 

Mr.  Neal.  Thank  you.  Thank  you,  gentlemen,  for  your  testimony 
and  now  the  real  Mr.  Chairman  will  take  over. 

Chairman  Rangel  [presiding].  I  may  have  some  questions  that 
I  will  be  sending  because  I  didn't  have  the  opportunity  to  read  your 
testimony  or  hear  it.  Thank  you  very  much. 

Chairman  Rangel.  The  next  panel,  panel  three,  Robert  Green, 
vice  president  of  tax  policy  for  the  National  Foreign  Trade  Council 
and  the  former  chief  economist  with  the  Joint  Committee  on  Tax- 
ation, Peter  Merrill,  who  is  a  partner  with  Price  Waterhouse  Na- 
tional Tax  Services.  Here  representing  U.S.  Multinational  Corpora- 
tion Tax  Policy  Coalition  is  Tim  Anson,  senior  manager,  Price 
Waterhouse  National  Tax  Services,  and  Raymond  Wiacek,  partner, 
Jones,  Day,  Reavis  &  Pogue,  here  in  Washington  for  Emergency 
Committee  for  American  TVade;  and  John  Allis  from  Houston,  Tex., 
aCPA. 

We  thank  all  of  you.  Your  written  testimony,  without  objection, 
will  be  entered  into  the  record. 

We  will  start  off  with  Mr.  McCloskey  of  the  electronic — no,  we 
won't.  We  will  start  off  with  Mr.  Green  from  the  National  Foreign 
Trade  Council. 

STATEMENT  OF  ROBERT  H.  GREEN,  VICE  PRESmENT,  TAX 
POLICY,  NATIONAL  FOREIGN  TRADE  COUNCIL,  INC. 

Mr.  Green.  Thank  you  very  much.  Mr.  Chairman  and  members 
of  the  subcommittee,  my  name  is  Bob  Green,  vice  president  for  tax 
policy  of  the  National  Foreign  Trade  Council.  We  are  pleased  to 
have  the  opportunity  to  present  our  views  on  various  miscellaneous 
tax  proposals  of  interest  to  our  membership. 

NFTC  is  a  trade  association  with  500  members,  most  of  which 
are  U.S.  companies  that  are  engaged  in  all  aspects  of  international 
business  trade  and  investment.  Our  focus  is  to  promote  policies 
that  expand  U.S.  exports  and  enhance  the  ability  of  our  companies 
to  compete  abroad. 

For  that  reason,  our  testimony  as  well  as  our  written  statement 
will  concentrate  on  certain  proposals  that  affect  the  taxation  of 
international  transactions. 

NFTC  has  consistently  urged  that  a  comprehensive  review  be  un- 
dertaken of  the  international  provisions  of  our  current  tax  system. 
It  is  a  widely  accepted  fact  that  the  international  tax  rules  in  the 
United  States  have  become  exceptionally  complex  and  administra- 
tively burdensome. 


1508 

Unfortunately,  proposals  in  the  international  area  that  are  the 
subject  of  this  hearing  represent  a  further  piecemeal  approach  to 
U.S.  international  tax  policy.  However,  unlike  previous  proposals 
which  were  harmful  in  their  impact,  the  proposal  to  convert  the 
foreign  tax  credit  into  a  deduction  and  the  proposed  repeal  of  the 
exemption  for  portfolio  interest  trade  to  foreign  investors  would 
cause  irreparable  injury  to  U.S.  interests  abroad. 

The  NFTC  must  express  its  strong  opposition  to  these  two  pro- 
posals and  to  a  third  proposal  to  modify  the  rules  for  determining 
the  source  of  income  from  export  sales  of  inventory  property.  The 
proposed  repeal  of  the  election  to  treat  foreign  income  taxes  as  paid 
as  a  credit  instead  of  a  deduction  would  compound  the  disadvan- 
tage our  companies  encounter  when  they  are  competing  against 
multinational  companies  from  other  countries. 

In  1991,  a  report  that  was  prepared  by  Price  Waterhouse  found 
that  U.S.  companies  already  face  a  significantly  higher  effective  tax 
rate  on  foreign  income  than  a  similarly  situated  company  from 
Canada,  France,  Germany,  Japan,  the  Netherlands  or  the  U.K  A 
separate  report  of  the  GAO  estimated  that  the  effective  corporate 
rate  on  worldwide  income  of  U.S.  companies  was  37.1  percent  for 
1989. 

The  GAO  noted  that  one  of  the  most  important  disincentives  to 
foreign  investment  by  U.S.  companies  is  the  potential  for  double 
taxation  that  is  inherent  in  the  various  limitations  on  the  credit 
and  other  special  rules  that  impose  a  U.S.  tax  on  foreign-source  in- 
come that  has  already  borne  a  tax  in  excess  of  the  U.S.  rate.  How- 
ever, these  limitations  to  which  the  NFTC  takes  strong  exception, 
pale  by  comparison  to  the  enormous  tax  increase  that  U.S.  multi- 
national companies  would  experience  if  the  election  to  credit  the 
foreign  income  taxes  paid  were  converted  into  a  deduction  only.  It 
is  estimated  that  converting  the  foreign  tax  credit  into  a  deduction 
could  cause  the  overall  tax  burden  on  foreign-source  income  for 
U.S.  companies  to  rise  as  high  as  70  percent  in  some  cases.  It 
would  be  absolutely  impossible  for  U.S.  companies  to  compete 
abroad  against  their  foreign  counterparts  with  an  overall  tax  bur- 
den at  that  level. 

The  NFTC  strongly  opposes  also  the  proposal  to  remove  the 
present  law  exemption  for  portfolio  interest  received  by  foreign  in- 
vestors from  U.S.  sources. 

First,  repeal  of  the  exemption  would  discourage  the  flow  into  the 
United  States  of  foreign  capital  on  which  the  economy  depends.  It 
is  a  widely  held  view  that  the  influx  of  foreign  capital  and  the  pur- 
chase by  foreign  investors  of  U.S.  debt  has  had  the  effect  of  re- 
straining interest  rates  in  spite  of  soaring  Federal  budget  deficits 
during  the  past  decade. 

If  the  United  States  repeals  its  exemption,  funds  currently  held 
in  U.S.  debt  instruments  will  simply  be  transferred  to  debt  instru- 
ments in  other  countries  that  do  not  impose  a  tax  on  its  interest. 
The  inevitable  consequence  of  this  scenario  would  be  to  raise  inter- 
est rates  for  both  governmental  and  private  purposes,  thereby  ne- 
gating any  short-term  revenue  gain  to  the  United  States. 

Second,  passage  of  legislation  to  repeal  the  exemption  would  ma- 
terially violate  the  terms  of  numerous  treaty  obligations  that  the 
United  States  has  with  its  allies,  unless  the  legislation  expressly 


1509  x^ 

provided  that  repeal  of  the  exemption  did  not  interfere  with  exist- 
ing U.S.  treaties. 

And  finally,  repeal  of  the  exemption  would  provide  a  return  to 
treaty  shopping  in  which  foreign  taxpayers  would  borrow  funds  for 
U.S.  investment  from  t£ix  haven  countries.  NFTC  also  opposes  the 
two  changes  to  the  export  source  rule  that  were  contained  in  H.R. 
5270.  These  changes  would  allocate  more  income  to  U.S.  source  and 
thereby  reduce  the  amount  of  the  credit  to  U.S.  exporters. 

Since  the  only  constant  growth  factor  in  the  U.S.  economy  in  re- 
cent history  has  been  the  growth  of  U.S.  export  sales,  the  NFTC 
opposes  changes  that  would  increase  the  cost  of  sales  by  U.S.  ex- 
porters, which  these  proposals  would  certainly  do. 

It  is  clear  that  the  impact  of  U.S.  exports  on  our  economy  is  sub- 
stantial. As  a  percent  of  GNP,  corporate  profits  from  domestic 
sources  dropped  by  more  than  50  percent  from  the  1950s  to  the 
1980s  while  the  profits  from  foreign  sources  increased  by  50  per- 
cent. 

Moreover,  employment  related  to  export  production  tends  to  be 
high  paying  jobs.  TTie  average  compensation  for  persons  engaged  in 
export  production  in  1986  was  30,100  while  the  average  was  26,300 
for  the  entire  economy. 

Third,  a  recent  study  concludes  that  tax  benefits  derived  from 
the  current  export  source  rule  are  cost-effective  in  producing  addi- 
tional export  sales.  Finally,  the  proposals  would  increase  the  ad- 
ministrative burden  for  U.S.  companies.  Our  companies  simply  do 
not  possess  the  data  necessary  to  reflect  the  profit  for  the  CFCs. 

We  also  would  urge  support  for  the  foreign  simplification  meas- 
ures that  were  introduced  2  years  ago  by  Chairman  Rostenkowski 
and  for  a  proposal  to  extend  the  foreign  tax  credit  carryover  from 
5  to  15  vears. 

Thank  you,  Mr.  Chairman,  for  our  opportunity  to  testify  on  these 
important  measures. 

Chairman  Rangel.  Thank  you,  Mr.  Green. 

[The  prepared  statement  follows:] 


1510 


STATEMENT  OF 
THE  NATIONAL  FOREIGN  TRADE  COUNCIL,  INC. 
PRESENTED  TO  THE  HOUSE  WAYS  AND  MEANS  SUBCOMMITTEE 
ON  SELECT  REVENUE  MEASURES 


Mr.  Chairman  and  Members  of  the  Committee: 

The  National  Foreign  Trade  Council,  Inc.  (NFTC)  is  pleased  to 
present  its  views  regarding  certain  revenue  proposals  on  which 
hearings  are  being  held  by  the  Ways  and  Means  Subcommittee  on 
Select  Revenue  Measures. 

The  NFTC  is  a  trade  association  with  some  500  members,  founded  in 
1914.  Its  membership  consists  primarily  of  U.S.  corporations 
engaged  in  all  aspects  of  international  business,  trade,  and 
investment.  The  primary  focus  of  the  NFTC  is  to  encourage  policies 
that  will  expand  U.S.  exports  and  enhance  the  competitiveness  of 
U.S.  companies  by  eliminating  major  tax  inequities  in  the  treatment 
of  U.S.  companies  operating  abroad.  For  that  reason,  our  testimony 
and  written  statement  will  concentrate  on  certain  proposals 
affecting  the  taxation  of  international  transactions.  • 

By  way  of  historical  perspective,  the  NFTC  testified  in  1992  on 
H.R.  5270  and  earlier  this  year  on  the  President's  deficit 
reduction  plan  urging  that  a  comprehensive  review  be  undertaken  of 
the  international  provisions  in  our  current  tax  system.  It  is  a 
widely  accepted  fact  that  the  international  tax  rules  in  the  U.S. 
have  become  exceptionally  complex,  administratively  burdensome,  and 
have  made  it  more  difficult  for  U.S.  companies  to  compete  in  the 
U.S.  and  abroad.  The  process  for  reform  of  the  international  tax 
rules  was  given  a  major  boost  last  year  when  Chairman  Rostenkowski 
and  then  Congressman  Gradison  introduced  H.R.  5270,  the  Foreign 
Income  Tax  Rationalization  and  Simplification  Act  of  1982.  While 
we  recommended  certain  changes  to  H.R.  5270  in  our  testimony  before 
this  Committee  last  year,  we  strongly  urged  that  the  process  of 
comprehensive  reform  of  the  international  tax  regime  continue.  We 
also  note  that  the  Treasury  study  released  earlier  this  year 
recommended  that  a  comprehensive  review  be  undertaken  of  the  U.S. 
system  for  taxing  international  income. 

Unfortunately,  the  proposals  in  the  international  area  that  are  the 
subject  of  this  hearing  represent  a  further  series  of  piecemeal 
modifications  to  U.S.  international  tax  policy.  However,  unlike 
previous  proposals  which  were  harmful  but  not  lethal  in  their 
impact,  the  proposal  to  convert  the  foreign  tax  credit  into  a 
deduction  and  the  proposed  repeal  of  the  exemption  for  portfolio 
interest  paid  to  foreign  investors  would  wreak  irreparable  injury 
to  U.S.  interests  abroad. 

Specifically,  the  NFTC  must  express  its  strong  opposition  to  three 
proposals  in  the  foreign  area  that  are  the  subject  of  this  hearing: 
first,  the  proposal  to  repeal  the  current  election  to  treat  foreign 
income  taxes  as  a  credit  and  instead  to  allow  only  a  deduction  for 
income  taxes  paid;  second,  the  proposal  to  repeal  the  exemption 
from  withholding  for  portfolio  interest  paid  to  foreign  investors; 
and  third,  a  proposal  to  modify  the  rules  for  determining  the 
source  of  income  from  export  sales  of  inventory  property. 

1.  REPEAL  OF  THE  ELECTION  TO  TREAT  FOREIGN  INCOME  TAXES  PAID  AS 
A  CREDIT  WOULD  FURTHER  UNDERMINE  THE  INTERNATIONAL  COMPETITIVENESS 
OF  U.S.  COMPANIES  CONDUCTING  BUSINESS  ABROAD. 

The  proposed  repeal  of  the  election  to  treat  foreign  income  taxes 
paid  as  a  credit  instead  of  a  deduction  would  cause  a  massive  tax 
increase  for  U.S.  multinational  companies  and  would  exacerbate  the 
disadvantage  that  U.S.  companies  face  in  competing  against 
companies  from  other  countries. 


1511 


Numerous  studies  have  shown  that  U.S.  companies  operating  abroad 
through  foreign  subsidiaries  are  taxed  at  a  higher  rate  than  are 
foreign  multinationals  with  which  they  are  competing.  A  1991 
report  prepared  by  Price  Waterhouse  for  the  National  Chamber 
Foundation  found  that  U.S.  companies  already  face  "a  significantly 
higher  effective  tax  rate  on  foreign  income  than  would  a  similarly 
situated  multinational  company  from  Canada,  France,  Germany,  Japan 
the  Netherlands  or  the  UK."  (U.S.  International  Tax  Policv  for  a 
Global  Economv.  April  15,  1991). 

Similarly,  the  U.S.  General  Accounting  Office  estimated  that  the 
effective  corporate  tax  rate  on  the  worldwide  income  of  U.S. 
multinational  corporations  was  37.1  percent  for  1989.  The  higher 
rate  of  tax  on  the  foreign  income  of  U.S.  companies  is  attributable 
to  a  number  of  factors  including:  a  higher  corporate  tax  rate  in 
many  developed  countries;  restrictive  interest  allocation  rules 
that  contribute  to  excess  foreign  tax  credits  and  a  disallowance  of 
interest  expense  allocated  to  foreign  jurisdictions;  numerous 
foreign  tax  credit  limitation  baskets;  and  recent  changes  to  the 
R&E  allocation  rules  that  alter  the  apportionment  of  R&E  expense 
away  from  the  country  of  performance/ i.e. /the  U.S.  In  the  same  GAO 
report,  it  was  noted: 

"One  of  the  most  important  disincentives  to  foreign 
investments  by  U.S.  companies  is  the  potential  for  double 
taxation  inherent  in  the  myriad  foreign  tax  credit  limitations 
and  other  special  rules  that  can  operate  to  impose  U.S.  tax  on 
foreign  source  income  that  already  has  borne  a  foreign  tax  in 
excess  of  the  U.S.  rate." 

However,  these  limitations,  to  which  the  NFTC  takes  strong 
exception,  pale  by  comparison  to  the  enormous  tax  increase  that 
U.S.  multinational  companies  would  experience  if  the  election  to 
credit  foreign  income  taxes  paid  under  Section  901  were  converted 
into  a  deduction  only.  It  is  estimated  that  converting  the  foreign 
tax  credit  into  a  deduction  could  cause  the  overall  tax  burden  on 
foreign  source  income  for  U.S.  companies  to  rise  to  70  percent  in 
some  cases. 

For  these  reasons  and  those  that  follow,  the  NFTC  believes  that 
disallowance  of  the  foreign  tax  credit  would  represent  an 
extraordinarily  ill-advised  reversal  of  U.S.  tax  policy  and  would 
further  erode  the  competitive  position  of  U.S.  companies  operating 
abroad: 

a.  Repeal  of  the  foreign  tax  credit  would  subject  the  foreign 
source  income  of  U.S.  companies  to  double  taxation.  The 
foreign  tax  credit,  now  codified  largely  in  Sections  901-908 
of  the  Code,  was  designed  primarily  to  avoid  double  taxation 
on  the  foreign  income  of  U.S.  persons,  who,  under  our  system, 
are  taxed  on  their  worldwide  income.  The  credit  prevents 
double  taxation  of  foreign  income  by  reducing  the  U.S.  tax  on 
such  income  by  the  amount  of  income  taxes  paid  to  foreign 
governments  (not  to  exceed  the  maximum  U.S.  corporate  rate). 
On  the  other  hand,  if  the  foreign  income  tax  is  less  than  the 
U.S.  rate,  the  difference  between  the  foreign  and  U.S.  tax  is 
payable  to  the  U.S.  The  legislative  history  surrounding 
enactment  of  Section  901  supports  the  view  that  avoidance  of 
double  taxation  on  the  worldwide  income  of  U.S  residents  and 
citizens  was  the  primary  purpose  underlying  the  foreign  tax 
credit. 

In  general,  the  foreign  tax  credit  attempts  to  achieve  for  the 
U.S.  system  of  worldwide  taxation  a  modified  form  of 
territorial  taxation,  under  which  citizens  or  residents  are 
only  taxed  on  income  from  sources  within  their  boundaries. 
Repeal  of  the  credit  would  subject  U.S.  companies  conducting 


1512 


business  abroad  to  double  taxation,  while  their  foreign 
competitors  in  other  countries,  in  which  the  territorial 
system  of  taxation  prevails,  would  only  be  subject  to  one 
level  of  taxation. 

As  former  Assistant  Secretary  of  the  Treasury  Stanley  Surrey 
once  observed,  the  foreign  tax  credit  should  remain  the 
centerpiece  of  U.S.  international  tax  policy.  In  his 
testimony  before  the  Senate  Relations  Committee  in  1967 
regarding  the  U.S.  tax  Convention  with  Brazil,  then  Assistant 
Secretary  Surrey  stated: 

"American  investment  would  not  proceed  at  all  without  the 
foreign  tax  credit  because  then,  as  the  Chairman  pointed  out, 
two  taxes  would  be  imposed  and  the  overall  burden  of  two  taxes 
would  be  so  great  that  international  investment  would 
practically  cease." 

As  Chairman  of  the  House  Task  Force  on  Foreign  Income  in  1976, 
Chairman  Rostenkowski  reaffirmed  this  rationale  for  the 
foreign  tax  credit: 

"I  am  firm  in  my  belief  that  the  foreign  tax  credit  is  the  key 
to  U.S.  international  tax  policy,  and  should,  under  no 
circumstances,  be  repealed  or  modified  in  any  fundamental  way. 
I  say  this  simply  because  it  seems  to  me  that  if  foreign 
governments  tax  the  foreign  income  of  U.S.  multinational 
corporations,  and  then  the  U.S.  taxes  that  income  in  addition, 
double  taxation  results.  The  tax  burden  of  this  double 
taxation  cannot  help  but  impede  international  trade  and 
international  movement  of  capital.  For  this  reason,  as  one 
who  strongly  believes  in  expanding  international  trade  and 
unrestricted  capital  movement,  I  can  see  no  circumstances 
under  which  I  would  recommend  any  fundamental  change  in  the 
foreign  tax  credit." 

b-     Comparisons between income taxes paid to foreign 

governments  and  similar  taxes  paid  to  state  governments  are 
inappropriate.  One  of  the  purported  justifications  for 
disallowance  of  the  foreign  tax  credit  is  the  assertion  that 
foreign  income  taxes  should  not  be  granted  more  favorable 
treatment  under  our  tax  system  than  is  accorded  the  payment  of 
taxes  to  state  and  local  governments.  Payments  of  state  and 
local  income  taxes  are  deductible,  not  creditable,  under  our 
federal  income  tax  laws. 

The  NFTC  believes  that  this  comparison  is  based  on  a  faulty 
premise.  In  our  judgment,  taxation  should  be  treated  as  a 
price  to  be  paid  for  the  services  and  benefits  of  government. 
In  the  case  of  a  business  operating  in  a  given  state,  it  is 
entirely  appropriate  for  that  state  to  tax  the  income  of  the 
business  derived  within  its  boundaries.  However,  an  American 
enterprise  conducting  business  abroad  should  not  have  to  pay 
tax  to  the  U.S.  Treasury  for  these  benefits  to  the  same  degree 
as  if  the  business  activity  were  being  conducted  in  the  United 
States. 

2.  THE  EXEMPTION  FROM  WITHHOLDING  FOR  PORTFOLIO  INTEREST  PAID  TO 
FOREIGN  INVESTORS  SHOULD  BE  RETAINED.  For  the  following  reasons, 
the  NFTC  strongly  opposes  the  proposal  to  remove  the  present  law 
exemption  found  in  Sections  871(h)  and  881(c)  for  portfolio 
interest  from  U.S.  sources  received  by  foreign  investors. 

a.  Repeal  of  the  exemption  would  discourage  the  flow  into  this 
country  of  foreign  capital  on  which  the  U.S.  economy  so 
heavilv  depends.  It  is  a  widely  accepted  fact  among 
economists  that  the  influx  of  foreign  capital  and  the  purchase 
by  foreign  investors  of  U.S.  debt  in  substantial  amounts  has 
had  the  salutary  effect  of  restraining  interest  rates  even 
though  the  federal  budget  deficit  has  soared  during  the  past 


1513 


decade.  It  is  also  clear  that  the  exemption  from  tax  for 
portfolio  interest  has  contributed  materially  to  the  ability 
of  the  U.S.  economy  to  attract  foreign  capital  that  the 
government  and  private  sector  so  desperately  need. 

b.  Repeal  of  the  exemption  would  cause  U.S.  interest  rates  to 
rise.  Since  the  exemption  for  portfolio  interest  received  by 
foreign  taxpayers  has  contributed  to  the  influx  of  foreign 
capital,  repeal  of  the  exemption  conversely  would  cause  a 
massive  exodus  of  foreign  ownership  of  U.S.  debt  instruments. 
Because  money  is  fungible  in  the  international  marketplace,  it 
seeks  the  highest  yield  available.  Most  nations  provide  an 
exemption  from  tax  for  interest  paid  to  foreign  investors.  If 
the  U.S.  repealed  its  exemption  for  portfolio  interest  paid  to 
foreign  investors,  funds  currently  held  in  U.S.  debt 
instruments  would  simply  be  transferred  to  debt  instruments  in 
other  countries  that  do  not  impose  a  tax  on  interest.  The 
inevitable  consequence  of  this  scenario  would  be  to  raise 
interest  rates  for  both  governmental  and  private  purposes  in 
the  U.S.,  due  to  the  diminished  pool  of  resources  available 
for  lending.  Any  short-term  revenue  gain  that  might  be 
derived  from  a  repeal  of  the  exemption  for  portfolio  interest 
paid  to  foreign  investors  would  be  more  than  offset  by  higher 
interest  costs  to  the  Federal  government  in  financing  its 
deficit  and  to  the  private  sector  in  the  form  of  higher 
borrowing  costs. 

c.  Repeal  of  the  exemption  for  portfolio  interest  would 
constitute  a  material  breach  of  U.S.  treaty  obligations. 
Passage  of  legislation  to  repeal  the  exemption  for  portfolio 
interest  paid  to  foreign  investors  would  materially  violate 
the  terms  of  numerous  treaties  that  the  U.S.  has  with  its 
allies,  unless  such  legislation  expressly  provided  that  repeal 
of  the  exemption  did  not  interfere  with  existing  U.S.  treaty 
obligations.  Otherwise,  repeal  of  the  exemption  provided 
foreign  taxpayers  for  portfolio  interest  received  under 
Sections  871(h)  and  881(c)  automatically  would  cause  the 
general  withholding  rate  of  30%  of  gross  income  to  apply 
under  Sections  871(a)  and  881  to  interest  paid  to  foreign 
taxpayers.  Since  most  U.S.  treaties  provide  for  either  an 
exemption  or  a  nominal  rate  of  withholding  on  interest  paid  to 
residents  of  treaty  partners,  the  imposition  of  a  30% 
withholding  rate  on  gross  interest  clearly  would  constitute  a 
material  breach  of  existing  U.S.  treaty  obligations.  (U.K. 
(Art. XI),  etc.)  Moreover,  if  the  intent  of  the  repeal  were  to 
override  U.S.  treaty  obligations,  such  action  would  be  in 
direct  conflict  with  the  U.S.  model  treaty,  which  exempts 
virtually  all  interest  from  tax,  not  just  portfolio  interest. 
(U.S.  Model  Treaty,  Article  11(1)). 

On  the  other  hand,  if  the  Congressional  intent  behind  a 
proposed  repeal  of  the  exemption  were  not  to  override  U.S. 
treaty  obligations,  then  the  impact  of  the  repeal  is  largely 
negated.   Countries  without  tax  treaties  with  the  U.S.  would 
immediately  initiate  treaty  negotiations  to  reduce  the  tax 
burden  on  the  U.S.  source  interest  income  of  its  residents. 

d.  Repeal  of  the  exemption  would  invite  a  return  to  treaty 
shopping.  One  of  the  primary  reasons  for  passage  of  the 
exemption  for  portfolio  interest  received  by  foreign  taxpayers 
under  Sections  871(h)  and  881(c)  was  the  acknowledgement  by 
both  the  U.S.  Treasury  and  the  Congress  that  imposition  of 
high  withholding  rates  on  interest  only  caused  foreign 
taxpayers  to  borrow  through  tax  haven  countries,  which  had  tax 
treaties  that  provided  for  little  or  no  tax  on  interest  paid 
from  the  U.S.  The  legislative  history  underlying  passage  of 
the  Deficit  Reduction  Act  of  1984  is  replete  with  examples  of 
taxpayers  seeking  refuge  under  treaty  provisions  with 
countries,  such  as  the  Netherlands  Antilles,  that  did  not 
impose  withholding  on  U.S.  source  interest.   Repeal  of  the 


1514 


current  exemption  for  portfolio  interest  paid  to  foreign 
taxpayers  would  trigger  a  return  to  the  period  prior  to 
passage  of  the  1984  tax  bill  that  saw  taxpayers  engage  in 
treaty  shopping  on  a  widespread  basis. 

3.  SOURCE  OF  INCOME  FROM  EXPORT  SALES  OF  INVENTORY  PROPERTY.  H.R. 
5270,  introduced  by  Chairman  Rostenkowski  and  then  Congressman 
Gradison,  proposed  two  changes  that  would  reallocate  more  income  to 
domestic  source  from  certain  export  sales  of  inventory  property. 
One  provision  would  allocate  more  income  to  U.S.  source  by  applying 
the  production/marketing  split  to  the  combined  income  of  the  U.S. 
producer/ taxpayer  and  the  foreign/related  purchaser.  The  second 
provision  would  treat  as  U.S.  source  income  the  gain  derived  from 
the  sale  abroad  to  a  CFC  if  the  ultimate  consumption  of  the 
property  occurs  in  the  U.S.,  and  the  sale  is  not  attributable  to  an 
office  or  fixed  place  of  business  of  the  U.S.  producer  outside  the 
U.S. 

For  the  following  reasons,  the  NFTC  opposes  these  proposed  changes 
to  the  export  source  rule  contained  in  Section  863(b): 

a.  The  proposals  would  increase  the  costs  of  U.S.  export 
sales,  which  tend  to  produce  high  paying  jobs  and  represent  a 
growth  factor  in  the  U.S.  economy.  Taken  as  a  whole,  the  new 
proposals  would  increase  the  costs  for  U.S.  companies  that 
export  their  products.  The  consequence  could  be  to  restrain 
one  of  the  few  areas  of  growth  in  the  U.S.  economy,  namely, 
export  sales,  and  to  reduce  employment  attributable  to  the 
production  and  marketing  of  products  for  export. 

Recent  data  support  the  statement  that  export  sales  materially 
contribute  to  the  growth  of  the  U.S.  economy.  As  a  percent  of 
GNP,  corporate  profits  from  domestic  sources  dropped  by  more 
than  50  percent  from  the  1950 's  to  the  1980 's  (from  10  to  5 
percent) ,  while  profits  from  foreign  sources  increased  by  50 
percent  (from  0.6  to  0.9  percent).  (See  U.S.  International 
Tax  Policv  for  a  Global  Economy,  p. 33).  Exports  of  goods  and 
services  contributed  roughly  12  percent  of  U.S.  GNP  in  1990 
f Survey  of  Current  Business  71,  p. 6). 

Moreover,  employment  related  to  export  production  tends  to  be 
high  paying  jobs.  The  average  compensation  for  persons 
engaged  in  export  production  in  1986  was  $30,100.00,  while  the 
average  was  $26,300.00  for  the  entire  economy  (Statistical 
Abstract  of  the  United  States.  Tables  665  and  1310) . 
Moreover,  multinational  firms  continue  to  produce  over  60 
percent  of  U.S.  merchandise  exports  (Statistical  Abstract  of 
the  United  States.  Table  1.5). 

b.  Higher  taxes  on  foreign  source  income  of  U.S.  companies 
could  decrease  U.S.  employment.  The  implicit  rationale  for 
proposals  to  allocate  a  higher  percentage  of  export  sales 
income  to  U.S.  source  is  the  desire  to  preserve  U.S. 
employment.  However,  recent  evidence  suggests  that  attempts 
to  impose  higher  taxes  on  the  foreign  source  income  of  U.S. 
multinational  companies  is  misguided.  Any  decline  in  the 
competitiveness  of  U.S.  multinational  companies  could  decrease 
domestic  employment.  (See  Bergsten,  Horst,  and  Moran, 
American  Multinationals  and  American  Interests,  pp.  101-104) . 

More  recently,  the  1991  Economic  Report  of  the  President 
rejected  the  argument  that  the  foreign  production  of  U.S. 
multinational  companies  comes  at  the  expense  of  domestic 
employment.  (p.  259)  The  general  view  seems  to  be  that 
production  abroad  by  CFCs  tends  to  complement  U.S.  production, 
not  to  supplant  jobs  associated  with  domestic  production. 

c.  Any  tax  benefits  derived  from  the  current  export  source 
rule  is  cost  effective  in  producing  additional  export  sales  by 
U.S.  companies.   An  analysis  of  recent  data  includes  the 


1515 


statement  that  any  tax  benefits  derived  by  U.S.  multinational 
companies  from  the  current  50-50  rule  is  cost  effective  in 
generating  export  sales  beyond  those  that  would  otherwise  be 
produced. 

According  to  Gary  Hufbauer,  the  implied  boost  to  U.S.  exports 
from  the  50-50  method  was  between  12.9  billion  and  19.0 
billion  in  1990.  These  figures  compare  favorably  with  the 
revenue  costs  attributable  to  the  50-50  method  in  fiscal  year 
1990  of  2.6  billion  and  3.2  billion  for  1992  respectively. 
(See  U.S.  Taxation  of  International  Income,  p.  127) . 

d.  The  proposals  would  be  administratively  burdensome  and 
would  undermine  compliance.  Many  NFTC  member  companies 
believe  that  the  proposals  would  raise  serious  compliance 
concerns  by  imposing  additional  administrative  recordkeeping 
requirements.  The  proposals  would  mandate  that  profits  be 
segregated  between  the  U.S.  producer  and  the  CFC,  which  in 
many  cases  is  not  feasible.  Many  U.S.  companies  do  not 
possess  the  data  necessary  to  reflect  the  profits  on  resale  by 
the  CFCs.  If  U.S.  companies  were  unable  to  accurately 
ascertain  the  apportionment  of  profit  between  the  U.S.  company 
and  the  foreign  affiliate,  then  compliance  would  suffer  with 
the  likelihood  that  litigation  would  increase.  The  two 
proposals  clearly  run  contrary  to  the  stated  intent  of  both 
H.R.  5270  and  the  recent  Treasury  study  that  the  U.S. 
international  tax  regime  is  unduly  complex  and  requires 
simplification. 

The  NFTC  also  wishes  to  express  its  support  for  several  important 
measures  relating  to  the  taxation  of  international  income  that 
could  improve  compliance,  reduce  complexity,  and  enhance  the 
competitiveness  of  U.S.  companies  operating  abroad. 

The  first  two  proposals  were  the  subject  of  hearings  by  this 
Subcommittee  on  June  24.  One  such  proposal,  for  which  the  NFTC  has 
already  expressed  its  strong  support,  is  the  proposal  to  extend  the 
carryover  period  for  excess  foreign  tax  credits  from  the  present  5 
years  to  15  years.  The  reasons  for  our  endorsement  of  this  measure 
stem  primarily  from  our  desire  to  avoid  double  taxation  on  economic 
income  derived  from  multinational  transactions.  We  also  support 
the  proposal  to  raise  the  reporting  threshold  in  Section  6046  to  10 
percent,  instead  of  the  present  5  percent,  of  the  value  of  stock 
ownership  in  a  foreign  corporation.  This  proposal  would  improve 
the  administration  of  the  tax  laws  with  no  corresponding  revenue 
loss  to  the  Treasury. 

In  addition  to  the  proposals  discussed  above,  the  NFTC  urges  the 
Congress  to  adopt  several  measures  contained  in  the  foreign 
simplification  package  introduced  last  year  by  Chairman 
Rostenkowski  and  subsequently  approved  by  the  Congress,  although 
the  legislation  of  which  it  was  a  part  was  not  enacted. 

These  measures  include:  extending  the  application  of  the  indirect 
foreign  tax  credit  under  Section  902  and  960  to  sixth  tier  CFCs; 
simplification  of  the  translation  of  foreign  taxes  into  U.S. 
dollars;  harmonization  of  the  rules  that  exist  under  present  law 
between  the  PFIC  and  the  Subpart  F  rules.  The  NFTC  believes  that 
adoption  of  these  proposals  would  greatly  enhance  compliance  and 
simplify  the  administration  of  the  tax  laws  relating  to 
international  transactions. 

The  NFTC  appreciates  the  opportunity  to  submit  its  comments  on  the 
various  tax  proposals  that  are  the  subject  of  the  Subcommittee's 
hearings. 


1516 

Chairman  Rangel.  Mr.  Merrill. 

STATEMENT  OF  PETER  MERRILL,  PARTNER,  PRICE 
WATERHOUSE,  NATIONAL  TAX  SERVICES  ON  BEHALF  OF 
THE  U.S.  MULTINATIONAL  CORPORATION  TAX  POLICY  COA- 
LITION; ACCOMPANIED  BY  TIM  ANSON,  SENIOR  MANAGER, 
PRICE  WATERHOUSE,  NATIONAL  TAX  SERVICES 

Mr.  Merrill.  Gk)od  morning.  I  am  Peter  Merrill.  I  am  a  partner 
in  Price  Waterhouse's  international  tax  practice  here  in  Washing- 
ton. I  appreciate  the  opportunity  to  appear  before  the  subcommit- 
tee today  on  behalf  of  the  U.S.  Multinational  Corporation  Tax 
Policy  Coalition.  The  coalition  consists  of  more  than  20  U.S.  multi- 
nationals from  a  broad  range  of  industries.  A  list  of  coalition  mem- 
bers is  attached  to  my  written  statement. 

As  the  subcommittee  reviews  foreign  tax  proposals,  it  should  rec- 
ognize that  the  U.S.  position  in  the  global  economy  has  changed 
dramatically.  Three  decades  ago  the  United  States  was  the  world's 
largest  lender  of  capital.  Today  we  are  the  world's  largest  debtor 
nation.  Three  decades  ago,  18  of  the  20  largest  U.S.  corporations 
were  among  the  world's  largest  corporations.  Today  only  9  U.S.  cor- 
porations rank  in  the  top  20. 

In  the  1960s  tax  policymakers  felt  little  need  to  analyze  how  the 
tax  system  affected  the  competitiveness  of  U.S.  companies.  Today 
we  can't  afford  to  ignore  global  competition  in  formulating  our  Na- 
tion's tax  policy. 

In  the  new  international  economic  environment,  the  subcommit- 
tee should  avoid  measures  which  discriminate  against  foreign- 
source  income,  are  inconsistent  with  international  norms,  or  that 
needlessly  increase  complexity.  Last  year  the  committee  began  a 
comprehensive  review  of  the  U.S.  system  of  taxing  international  in- 
come. 

Chairman  Rostenkowski  and  former  Representative  Gradison  in- 
troduced H.R.  5270  as  a  starting  point.  At  that  time.  Chairman 
Rostenkowski  stated  and  I  quote,  "I  do  not  intend  that  any  revenue 
offsets  in  the  bill  be  used  for  deficit  reduction  or  any  purpose  other 
than  funding  this  bill." 

Yet  two  of  the  foreign  provisions  before  the  subcommittee  today 
have  been  cherry  picked  from  H.R.  5270  in  contravention  of  the 
chairman's  intent. 

I  also  would  like  to  call  the  subcommittee's  attention  to  a  major 
study  of  international  tax  reform  initiated  by  the  Treasury  Depart- 
ment in  response  to  H.R.  5270.  An  interim  report  was  released  by 
the  Treasury  Department  in  January  of  this  year. 

As  part  of  this  study,  Treasury  economists  have  begun  to  im- 
prove their  models  to  better  understand  the  effects  of  U.S.  tax  pol- 
icy in  a  global  economy.  Congress  should  have  an  opportunity  to 
consider  the  results  of  the  completed  Treasury  study  before  chang- 
ing the  international  tax  rules. 

I  would  now  like  to  briefly  discuss  three  of  the  foreign  tax  pro- 
posals before  the  subcommittee  today.  That  is  the  repeal  of  the  for- 
eign tax  credit,  changes  in  the  export  source  rules,  and  the  30  per- 
cent withholding  tax  on  portfolio  interest.  I  note  that  Treasury  in 
their  testimony  submitted  this  morning  also  opposed  these  three 
proposals. 


1517 

First,  the  coalition  strongly  opposes  repeal  of  the  foreign  tax 
credit.  The  deduction  system  for  foreign  taxes  is  not  used  by  any 
other  major  industrial  country  and  can  result  in  much  higher  tax 
burdens  on  foreign  income  as  compared  to  U.S.  source  income. 

As  shown  on  mv  written  testimony,  of  the  24  member  countries 
of  the  OECD,  half  utilize  the  foreign  tax  credit  system  like  the 
United  States,  the  other  half  simplv  exempt  foreign  dividends.  No 
country  uses  a  deduction  system  which  is  the  proposal  before  this 
subcommittee  today. 

I  would  also  like  to  point  out  that  repeal  of  the  foreign  tax  credit 
would  override  U.S.  tax  treaty  obligations  and  could  result  in  a  loss 
of  tax  benefits  granted  to  U.S.  persons  under  these  treaties. 

Second,  I  would  like  to  discuss  the  proposed  modifications  to  the 
export  source  rules.  One  of  the  export  source  rules  is  designed  to 
divide  the  income  of  exporters  between  production  and  marketing 
activities.  Under  present  law,  a  U.S.  exporter  divides  its  income 
based  on  a  50/50  split. 

The  proposal  would  require  that  the  50/50  split  be  applied  to  the 
combined  income  of  the  exporter  and  a  related  foreign  subsidiary. 
While  this  would  achieve  branch  subsidiary  conformity,  which  ap- 
parently is  the  goal,  the  coalition  fails  to  discern  any  tax  policy  ra- 
tionale for  including  a  foreign  subsidiary's  income  in  a  calculation 
that  is  designed  to  split  the  U.S.  exporter's  income  between  produc- 
tion and  marketing. 

Last  year.  Treasury  testified  that  they  thought  the  reason  for 
this  provision  was  transfer  pricing  abuse.  We  agree  with  Treasury's 
testimony  last  year  that  the  transfer  pricing  rules  that  were  put 
out  last  year  and  put  out  this  year  in  temporary  form  are  adequate 
to  handle  this  alleged  problem.  The  coalition  also  opposes  these 
proposed  changes  as  did  Treasury  this  morning  because  of  the  high 
compliance  cost  to  U.S.  exporters. 

Finally,  the  coalition  is  concerned  that  this  proposal  taken  from 
H.R.  5270  is  being  considered  outside  the  context  of  international 
tax  reform. 

Finally,  before  the  subcommittee  is  a  proposal  to  reinstate  the  30 
percent  withholding  tax  on  portfolio  interest.  The  coalition  opposes 
this  proposal. 

By  way  of  background,  this  committee  repealed  in  1984  the  30 
percent  withholding  tax  to  allow  U.S.  companies  access  into  the 
Eurobond  market.  On  my  written  statement,  you  will  see  that  since 
repeal  of  the  30  percent  withholding  tax,  U.S.  corporate  debt  bor- 
rowed from  abroad  has  increased  tenfold. 

Reinstatement  of  the  withholding  tax  would  terminate  the  ability 
of  U.S.  corporations  to  access  the  Eurobond  market.  This  would  be 
true  not  only  for  corporate  debt  but  U.S.  Government  securities 
also  would  be  in  the  same  position.  The  effect  on  interest  rates 
would  be  discernible  immediately;  in  fact,  based  on  a  wire  service 
report  on  Thursday,  September  9,  that  Congress  was  simply  consid- 
ering this  proposal  interest  rates  went  up.  In  response,  the  Treas- 
ury Department  the  very  next  day  announced  that  they  opposed 
this  proposal. 


1518 

In  conclusion,  I  would  like  to  thank  the  subcommittee  for  the  op- 
portunity to  testify.  I  urge  the  subcommittee  to  refrain  from  piece- 
meal changes  in  the  Nation's  international  tax  regime.  Such 
changes  will  have  unintended  effects  and  increase  complexity. 

Thank  you. 

Chairman  Rangel.  Mr.  Anson. 

Mr.  Merrill.  He  is  with  Price  Waterhouse. 

[The  prepared  statement  follows:] 


1519 


TESTIMONY  OF  PETER  MERRILL,  PRICE  WATERHOUSE 

ON  BEHALF  OF 

THE  U.S.  MULTINATIONAL  CORPORATION  TAX  POLICY  COALITION 


Introduction 

I  am  Peter  Merrill  and  I  am  an  international  tax  practice  partner  in  Price  Waterhouse's 
Washington  National  Tax  Service  office  here  in  Washington,  D.C.   I  appreciate  the 
opportunity  to  appear  before  the  Subcommittee  today  to  discuss  the  foreign  tax  provisions 
that  are  a  part  of  the  miscellaneous  revenue  raising  proposals  before  the  Subcommittee.   I  am 
testifying  on  behalf  of  a  broad-based  coalition  of  U.S.  multinationals  including 
manufacturing,  natural  resource,  and  financial  service  companies  (see  attached  list  of 
coalition  members). 

The  Subcommittee's  August  18,  1993  press  release  announcing  these  hearings  contains  five 
specific  proposals  under  the  caption  "foreign  tax  provisions."  The  first  part  of  this  testimony 
discusses  the  importance  of  U.S.  international  tax  policy  and  our  view  that  any  substantive 
changes  in  this  area  should  be  considered  carefiilly  in  the  context  of  our  intonational  tax 
rules  as  a  whole  and  the  global  economy  in  which  U.S.  companies  compete. 

The  second  part  of  this  testimony  specifically  addresses  three  of  the  foreign  tax  provisions 
before  the  Subcommittee:   (1)  rqpeal  of  the  foreign  tax  credit;  (2)  modification  of  the  export- 
source  rules;  and  (3)  reinstatement  of  30-percent  withholding  on  portfolio  interest.   In  short, 
the  coalition  strongly  opposes  each  of  these  proposals. 


General  Comments  on  U.S.  International  Tax  Policy 

As  the  Subcommittee  reviews  changes  in  U.S.  international  tax  policy,  it  is  important  to 
recognize  that  the  U.S.  position  in  the  global  economy  has  changed  dramatically  over  the  last 
three  decades. 

Global  economy 

Three  decades  ago,  U.S.  corporations  accounted  for  over  half  of  all  multinational  investment 
in  the  world,  our  nation  produced  about  40  percent  of  world  ou^ut,  and  we  were  the  world's 
largest  lender  of  capital.   U.S.  corporations  now  account  for  less  than  one-third  of 
multinational  investment,  the  U.S.  economy  produces  less  than  30  percent  of  world  output, 
and  we  are  the  world's  largest  debtor.  Three  decades  ago,  18  of  the  20  largest  corporations 
in  the  world  were  headquartered  in  the  United  States;  today,  only  nine  U.S.  corporations 
rank  in  the  top  20. 

In  the  1960's  tax  policy  makers  felt  little  need  to  analyze  bow  the  tax  system  affected  the 
competitiveness  of  U.S.  companies  in  worid  markets.  Today,  the  U.S.  economy  is  no  longer 
so  dominant  that  we  can  afford  to  ignore  global  competition  in  formulating  our  nation's  tax 
policy. 

Comparison  of  countries' foreign  tax  rules 

In  1991,  Price  Waterhouse  completed  a  study,  U.S.  International  Tax  Policy  for  a  Global 
Economy,  which  used  case  study  examples  to  compare  U.S.  rules  for  taxing  foreign-source 
income  with  those  of  other  major  industrial  countries.   The  examples  compare  the  effective 
tax  rate  that  results  when  the  same  operations  are  conducted  by  foreign  affiliates  of  parent 
corporations  based  in  the  United  States,  Canada,  France,  Germany,  J^>an,  the  Netherlands, 
and  the  United  Kingdom.  The  facts  in  the  examples  are  based  on  the  average  characteristics 
of  U.S.  corporations  engaged  in  manufacturing  and  trade  as  rqwrted  by  the  IRS. 

In  these  examples,  the  U.S.  multinational  incurs  a  significantly  higher  effective  tax  rate  on 
foreign  income  than  would  a  similariy  situated  multinational  headquartered  in  any  of  the  six 
comparison  countries.   The  U.S.  multinational  confronts  an  effective  lax  rate  of  35.2  percent 
as  compared  to  an  average  effective  tax  rate  of  29.2  percent  in  the  six  other  countries. 


1520 


The  higher  effective  tax  rate  for  U.S.  companies  results  firom  several  features  of  the  U.S. 
system  of  taxing  foreign  source  income  that  generally  ai.  not  used  in  other  countries, 
including:   (1)  the  water's-edgc  fiingibility  s^roach  to  allocation  of  interest  expense  (under 
which  a  portion  of  U.S.  interest  expense  of  the  affiliated  group  is  treated  as  foreign  source, 
but  no  amount  of  foreign  interest  expense  is  treated  as  U.S.  source);  and  (2)  the  current 
taxation  of  income  from  foreign  base  company  sales. 

The  Price  Waterhouse  report  also  noted  that  U.S.  tax  rules  discourage  participation  by  U.S. 
multinationals  in  foreign  joint  ventures  that  they  do  not  control.   The  U.S.  rule  requiring  a 
separate  foreign  tax  credit  limitation  for  dividends  ^m  each  noncontrolled  foreign 
corporation  results  in  enormous  complexity  as  well  as  a  competitive  disadvantage  for  U.S.- 
headquartered  multinationals. 

ImpUcations  for  U.S.  intemational  tax  policy 

The  new  intemational  economic  environment  and  the  relative  unattractiveness  -  from  a  tax 
perspective  ~  of  the  United  States  as  a  headquarter  location  for  a  multinational  corporation 
have  several  important  policy  implications. 

The  Coalition  firmly  believes  that  revoiue-raising  measures  in  the  intemational  area  should 
be  considered  carefully  in  the  context  of  U.S.  intemational  tax  rules  as  a  whole,  the  systems 
used  in  other  countries,  and  the  compliance  costs  entailed.   In  particular,  we  urge  the 
Subcommittee  to  avoid  measures  that  (1)  discriminate  against  foreign-source  income;  (2)  are 
inconsistent  with  intemational  norms;  and  (3)  increase  complexity. 

Comprehensive  review  of  U.S.  iatemationcd  tax  rules 

A  comprehensive  review  of  the  U.S.  system  of  taxing  intemational  income  was  initiated  last 
year  with  the  introduction  of  H.R.  5270  (The  Foreign  Income  Tax  Rationalization  and 
Simplification  Act  of  1992)  by  House  Ways  and  Means  Committee  Chairman  Dan 
Rostenkowski  (D-IL)  and  former  Rep.  Bill  Gradison  (R-OH).   In  his  statement  of 
introduction,  Chairman  Rostenkowski  declared: 

'I  want  to  emphasize  that  I  do  not  intend  that  the  revenue  offsets  contained  in 
the  bill  be  used  for  deficit  reduction  or  any  purpose  other  than  funding  this 
bill." 

Yet,  two  of  the  foreign  provisions  before  the  Subcommittee  today  have  been  "cherry-picked* 
from  H.R.  5270  in  contravention  of  Chairman  Rostenkowski' s  original  intent.  The  Coalition 
agrees  with  Chairman  Rostenkowski  that  U.S.  rules  for  taxing  foreign  source  income  should 
viewed  comprehensively  and  that  the  revenue  offsets  in  H.R.  5270  should  not  be  used  for 
unrelated  purposes. 

I  also  would  like  to  call  the  Subcommittee's  attention  to  a  major  study  of  intemational  tax 
reform  initiated  by  the  Treasury  Dq>artment  in  response  to  the  introduction  of  H.R.  5270. 
An  interim  report  was  released  by  the  Treasury  Dqartment  in  January  of  this  year.' 
Treasury  economists,  as  part  of  this  study,  have  begun  the  process  of  improving  their  models 
to  better  understand  the  effects  of  U.S.  policies  in  a  global  economy.   Congress  should  have 
an  opportunity  to  consider  the  results  of  the  completed  study  before  making  major  changes  in 
the  intemational  tax  rules. 

The  remainder  of  this  testimony  addresses  three  foreign  tax  provisions  before  the 
Subcommittee  today:   (1)  repeal  of  the  foreign  tax  credit;  (2)  modification  of  the  export- 
source  rules;  and  (3)  reinstatement  of  30-percent  withholding  on  portfolio  interest. 


U.S.  Department  of  the  Treasury,  Intemational  Tax  Refonn:  An  Interim  Report,  January  1993. 


1521 


Repeal  of  the  Foreign  Tax  Credit 

Background 

U.S. -based  multinational  coiporations  are  taxed  on  their  worldwide  taxable  income,  i.e. 
income  from  both  U.S.  and  foreign  sources.   Foreign  income  may  be  earned  directly  by  a 
U.S.  company  through  its  foreign  activities  or  indirectiy  as  a  dividend  received  from  a 
foreign  subsidiary.   Foreign  income  geneally  is  also  subject  to  tax  in  the  local  foreign 
jurisdiction. 

Since  1918,  to  avoid  international  double  taxation  of  foreign  income,  U.S.  residents  have 
been  allowed  to  claim  a  credit  for  foreign  income  taxes  paid  or  deemed  paid  up  to  a 
limitation  equal  to  the  amount  of  U.S.  tax  (before  credit)  on  foreign-source  income.  The 
foreign  tax  credit  limitation  is  calculated  for  eight  sq>arate  statutorily  defined  categories  of 
income.  Credits  in  excess  of  these  limitations  may  be  carried  back  two  years  and  forward 
five  years. 

Under  present  law,  taxpayers  may  deduct  foreign  taxes  in  lieu  of  the  foreign  tax  credit.   The 
generally  disadvantageous  alternative  of  deducting  foreign  taxes  is  used  only  when  foreign 
taxes  cannot  be  credited  as  a  result  of  tiie  foreign  tax  credit  limitation  and  five-year 
carryforward  period. 

The  foreign  tax  credit  is  one  of  two  internationally  accq)ted  means  for  relief  of  international 
double  taxation,  the  other  being  an  exemption  of  certain  foreign  income  generated  from 
active  business  operations.   Every  major  industrial  country  follows  one  of  these  two 
approaches;  none  taxes  foreign  source  income  without  a  credit  for  foreign  taxes  paid  with 
respect  to  this  income. 

As  shown  in  the  following  table,  half  of  the  24  member  countries  of  the  Organization  of 
Economic  Cooperations  and  Development  (OECD)  generally  exempt  foreign-source  dividends 
from  treaty  countries  rather  than,  as  in  the  United  States,  including  the  dividends  in  taxable 
income  with  a  credit  for  foreign  taxes  associated  with  these  dividends.   These  countries 
generally  use  a  'modified'  exemption  system:  exempting  active  foreign-source  income  while 
taxing  passive  income,  usually  on  a  current  basis,  as  under  U.S.  rules. 

The  Burke-Hartke  bills,  introduced  in  1971  and  1973.  would  have  npealeA  the  foreign  tax 
credit,  among  other  changes  in  the  international  tax  rules.   The  fordgn  tax  credit  repeal  was 
opposed  by  the  Treasury  Dqartment  and  was  not  approved  by  either  the  House  Committee 
on  Ways  and  Means  or  the  Senate  Finance  Committee. 

Proposal 

Under  one  of  the  proposals  before  the  Subcommittee,  the  foreign  tax  credit  would  be 
repealed.   The  present  law  alternative  to  deduct  foreign  taxes  would,  as  a  consequence,  be 
the  only  mechanism  for  partially  mitigating  double  taxation  of  foreign-source  income. 

Discussion 

The  Coalition  strongly  opposes  iq>eal  of  the  foreign  tax  credit.  A  deduction  system  for 
foreign  taxes  is  not  used  by  any  other  major  industrial  country  and  would  result  in  much 
higher  total  tax  burdens  on  foreign  as  compared  to  U.S.  source  income. 


1522 


Taxation  of  Foreign-Source  Dividends  in  OECD  Countries 

[Tax  law  as  of  January  1,  1991;  based  on  w'-jlly-owned  subsidiary] 


Country 

Treatment  of  forriim^m.ri*  dividonH  fromr                             1 

Treaty  countries 

J_        Non-treatT  Muntrifis 

Australia 

Exeiiq>tion, 

Worldwide  credit 

Austria 

Exemption 

Exemption 

Belgium 

Exemption  of  90%  of  gross 

Execution  of  90%  of  gross  dividend 

Canada 

Exemption 

Worldwide  credit 

Denmark^ 

Exemption 

Credit  by  source/exemption 

Finland 

Exemption 

Credit  by  source 

France 

Exemption  of  95%  of  gross 

Exemption  of  95%  of  gross  dividend 

Germany 

Exemption 

Credit  by  source 

Greece 

Credit  by  source 

Credit  by  source 

Iceland 

Worldwide  credit 

Worldwide  credit 

Ireland 

Credit  by  source 

Deduction 

Italy 

Credit  by  source 

Credit  by  sourc*» 

Japan 

Worldwide  credit 

Worldwide  credit 

Luxembourg 

Exemption 

Ex^nption 

Netherlands 

Exemption 

Exemption 

New  Zealand 

Credit  by  source 

Credit  by  source 

Norway 

Credit  by  source 

Deduction 

Portugal 

Credit  by  source 

Deduction 

Spain' 

Credit  by  source 

Credit  by  source 

Sweden 

Exenq)tion 

Credit  by  source 

Switzerland* 

Exemption 

Exemption 

Turkey 

Credit  by  source 

Credit  by  source 

United  Kingdom 

Credit  by  source 

Credit  by  source 

United  States' 

Worldwide  credit 

Only  for  tmCy  countiiM  drmgnitfirl  u  having  corponte  tax  syiteiD*  liiiiilar  to  Aiutnlia's. 
'  Dividend  from  a  foreign  lubmdiary  (minimum  25  %  holding)  in  a  country  diat  hai  a  coiporate  tax  system 

similar  to  Denmark's.   This  alio  ^>pUe«  to  noo-treaty  countries. 
'  Spain  exempts  dividends  from  Switzerland. 
*  Strictly,  Switzerland  does  not  have  an  exemption  system;  however,  total  dividends  received  ftom  abroad  are 

divided  by  total  income,  and  this  ratio  is  then  used  to  reduce  the  Fedenl  income  Uui.    Similar  relieb  are 

given  in  most  cantons.    Assuming  that  cantonal  relief  is  precisely  the  same  as  Federal  rdief,  the  net  effect  is 

as  if  diere  were  an  exemption  system. 
'  In  the  U.S.,  the  credit  is  separately  calculated  for  several  categories  of  income, 
lof  60%  forpai 


OECD,  Taxing  Profiti  in  a  Global  Economy:  Domestic  and  International  Ztntet,  pp.  63-64. 


1523 


For  a  U.S.  corporation  operating  abroad  in  a  country  that  imposes  income  tax  at  the  U.S. 
rate  and  has  a  lO-percent  withholding  tax  on  dividends  remitted  to  U.S.  shareholders,  the 
total  corporate  income  tax  burden  (U.S.  and  foreign  combined)  on  foreign  equity  would 
increase  by  about  50  percent  (ftom  41.5  to  62  percent  under  the  proposal).^  A  50-percent 
increase  in  the  tax  burden  on  foreign  direct  investment  would  virtually  eliminate  the  ability  of 
U.S.  multinationals  to  operate  competitively  in  countries  that  impose  corporate  income  tax. 

In  the  new  global  economic  environment,  international  competitiveness  requires  foreign 
presence.    Consequently,  erecting  tax  barriers  to  prevent  foreign  investment  would  have 
adverse  effects  on  the  domestic  economy.  A  large  body  of  research  indicates  that  U.S. 
exports  and  research  expenditures  are  closely  linked  to  foreign  investmait.   Almost  two- 
thirds  of  all  U.S.  exports  are  made  through  the  foreign  subsidiaries  of  U.S.  multinationals, 
and  empirical  studies  show  that  the  industries  with  the  largest  amount  of  foreign  investment 
are  also  the  industries  which  are  the  most  successful  exporters.   Foreign  investment  also 
allows  U.S.  companies  to  utilize  innovation  and  know-how  on  a  worldwide  basis  which 
increases  the  potential  return  ftom  research  eiqienditures.   It  is  estimated  that  elimination  of 
the  ability  of  U.S.  companies  to  invest  abroad  would  reduce  U.S.  research  expenditures  by 
12  to  15  percent.' 

Some  have  argued  that  foreign  investment  should  be  prevented  in  order  to  increase  domestic 
investment.   This  short-sighted  view  ignores  the  fact  that  most  foreign  investment  is  financed 
from  foreign  sources.   On  a  net  basis,  income  rqatriated  by  U.S.  multinationals  has 
exceeded  net  U.S.  foreign  direct  investment  in  every  single  year  since  I960.' 


Modification  of  Export  Source  Rules 

Background 

Under  present  law,  when  a  U.S.  manufacturer  exports  inventory  it  has  produced  in  the 
United  States,  the  income  has  a  divided  source  -  income  deemed  related  to  production 
activities  is  U.S.  source  and  iiKome  deemed  related  to  sales  activities  is  foreign  source. 
Under  Treasury  regulations,  iiKome  is  divided  under  either  the  indq>endent  factory  price 
(IFF)  method  or  the  so-called  '50-50  method." 

Under  the  IF?  method,  income  related  to  production  activities,  and  sourced  in  die  United 
States,  is  determined  based  on  the  price  that  the  exporter  would  charge  on  sales  to 
independent  distributon. 

Under  the  SO-SO  method,  half  of  the  gross  income  from  export  sales  is  sourced  according  to 
the  title  passage  rule,  i.e.,  the  place  where  title  passes,  and  the  other  half  is  ^iportioned  on 
the  basis  of  the  location  of  the  exporter's  assets  held  or  used  to  produce  items  sold.   For 
most  exporten,  use  of  this  medwd  generally  yields  a  nearly  equal  division  of  income 
between  U.S.  and  foreign  sources. 


'  At  a  35-perceitt  foreign  corpor«e  income  tax  rate,  $100  of  foreign  income  would  be  subject  to  S3S 
of  income  tax,  and  a  net  dividend  of  S58.50  could  be  remitted  after  withholding  $6.50  of  tax  (at  an 
assumed  lO-percent  rate)  on  die  $65  of  after  tax  profits.  Under  present  law,  no  U.S.  tax  would  be  due 
on  the  SS8.50  dividend,  so  the  total  tax  burden  would  be  $41.50  ($35  of  foreign  income  tax  plus  $6.50 
of  foreign  withholding  tax).  By  contrast,  under  the  proposal,  $20.48  (35  percent  of  $58.50  dividend)  of 
U.S.  income  tax  would  be  due,  raising  the  combined  tax  burden  to  $61.98  ($41.50  of  foreign  tax  plus 
$20.48  of  U.S.  tax). 

'  See,  Price  Wateihouse.  U.S.  Intenutional  Tea  Policy  far  a  Global  Economy,  National  Oiamber 
Foundation,  1991. 

*  Emergency  Committee  for  American  Trade,  Mainstay  U:  A  New  Account  cfOie  Critical  Role  of 
U.S.  Multinational  Companies  in  Oie  U.S.  Economy,  July  1993,  p.  16. 


1524 


Proposal 

Before  the  Subcommittee  are  two  changes  to  the  method  by  which  income  from  the  sale  of 
inventory  property  is  sourced.  Both  provisions  are  based  on  a  proposal  contained  in  H.R. 
5270. 

Under  the  first  proposal,  where  an  IFF  does  not  exist  and  the  exporter  sells  to  a  related 
foreign  corporation,  the  amount  of  income  treated  as  related  to  production  activities  and 
sourced  to  the  United  States  could  not  be  less  than  the  amount  determined  under  the  50-50 
method  treating  the  exporter  and  its  foreign  subsidiary  as  a  single  entity. 

Under  the  second  proposal,  relating  to  domestic  use  of  exported  property,  income  related  to 
the  export  of  inventory  property  would  be  treated  entirely  as  U.S.  source  if  the  buyer  is  a 
U.S.  resident  and  (1)  the  property  is  used,  consumed,  or  disposed  of  in  the  United  States, 
and  (2)  the  sale  is  not  attributable  to  a  foreign  office  of  the  exporter. 

Discusaon 

Last  year.  Treasury  testified  that  the  first  proposal  is  intended  to  prevent  aggressive  transfer 
pricing  designed  to  increase  foreign-source  income  for  purposes  of  the  foreign  tax  credit 
limitation.'  The  Coalition  believes  that  the  new  intercompany  pricing  regulations  released 
by  the  IRS  on  January  13,  1993  fully  address  any  possible  concerns  in  this  regard. 

Another  rationale  for  the  first  proposal  s^jparently  is  the  view  that  present  law  provides 
different  treatment  of  exports  through  foreign  branches  as  compared  to  foreign  subsidiaries. 
To  address  this  perceived  problem,  the  proposal  would  require  that  the  50-50  split  be  applied 
for  each  product  to  the  combined  imcome  of  a  U.S.  exporter  and  a  related  foreign  subsidary 
that  purchases  the  product.   While  this  would  treat  sales  through  a  subsidiary  in  the  same 
manner  as  sales  through  a  branch,  the  coalition  fails  to  discern  any  tax  policy  rationale  for 
including  a  foreign  subsidiary's  income  in  a  calculation  designed  to  divide  the  U.S. 
exporter's  income  between  domestic  and  foreign  sources. 

The  Coalition  believes  that  the  proposed  remedy  to  this  perceived  problem  would  impose 
extremely  high  compliance  costs  on  U.S.  exporters.  The  proposed  rule  would  require  U.S. 
exporters  and  their  foreign  subsidiaries  to  develop  records  for  reporting  the  profits  associated 
with  individual  saks.   Detailed  combined  taxable  income  calculations  would  be  required  at 
both  the  U.S.  and  the  foreign  affiliate  levels.   Such  calculations  would  require  allocation  and 
apportionment  of  income  and  expenses  for  each  export  sold  through  a  foreign  affiliate.   This 
information  generally  is  not  available  in  the  financial  or  tax  records  of  U.S.  exporters  or 
their  affiliates  and  could  not  be  produced  without  incurring  significant  costs. 

The  second  proposal,  relating  to  domestic  use  of  exported  property,  addresses  a  situation  that 
rarely  is  seen  in  practice.   As  in  the  case  of  the  first  proposal,  the  suggested  remedy  would 
be  extremely  burdensome  to  the  IRS  and  taxpayers  because  it  would  be  necessary  to  trace  the 
ultimate  disposition  of  pnqierty  sold  abroad. 

In  testimony  before  the  Ways  aiid  Means  Committee  on  Ae  so-called  'runaway  plant'  bill 
(H.R.  2889),  which  was  introduced  in  1991  by  former  Rq).  Byron  Dorgan  (D-ND)  and  Rep. 
David  Obey  (D-WI),  Treasury  stated  that  the  determination  of  whether  property  ultimately  is 
imported  into  the  United  States  imposes  an  enormous  burden  on  the  IRS: 

The  ...  task  could  prove  insurmountable  without  the  cooperation  of  all  of  the 
parties.  Such  cooperation  ftom  unrelated  foreign  customers  with  no  financial 
or  legal  interest  in  cooperating,  however,  may  be  unlikely.  The  IRS  may  also 
have  to  trace  sales  through  multiple  unrelated  foreign  parties  in  several 


>  Statement  of  Fred  T.  Goldberg,  Jr.,  Assistant  Seaetary  (Tax  Policy),  Department  of  die  Treasury, 
before  the  Committee  on  Ways  and  Means,  U.S.  House  of  Representatives,  July  21,  1992,  p.  243,  Serial 
102-176. 


1525 


countries,  including  countries  with  which  we  have  no  tax  treaty  relationship 
and  from  which  we.  cannot  readily  obtain  informaaon.  The  likelihood  of 
obtaining  accurate  information  and  of  being  able  to  perform  an  audit  in  such  a 
case  is  very  low.  If  the  transactions  involve  fungible  property,  such  as 
minerals,  agricultural  products,  or  other  commodities,  the  IRS  would  have  no 
practical  way  to  tell  what  was  imported  indirectly  firom  a  U.S.  contiolled 
foreign  corporation  and  what  was  not.   Further,  where  property  produced  by  a 
U.S.  controlled  foreign  corporation  is  substantially  transformed  by  its 
purchaser,  as,  for  example  when  bauxite  mined  by  the  controlled  foreign 
corporation  is  used  to  make  aluminum  which  is  then  imported  into  the  United 
States,  it  is  unclear  whether  the  property  that  was  transformed  (the  bauxite) 
should  be  considered  imported  property  or  not.' 

Both  proposed  changes  to  the  export  source  rules  would  increase  costs  for  U.S.  exporters, 
whether  or  not  they  ultimately  would  pay  more  tax.  This  would  reduce  the  competitiveness 
of  U.S.  exports  as  compared  to  foreign-produced  goods  and  would  reduce  the  incentive  to 
manufacture  in  the  United  States.   Consequentiy,  the  proposals  would  tend  to  reduce  U.S. 
exports  and  associated  U.S.  jobs. 

Finally,  the  Coalition  notes  that  both  of  the  proposed  changes  in  the  sales  source  rules  before 
this  Subcommittee  were  contained  in  the  Rostenkowsld-Gradison  bill  (H.R.  5270).   In  view 
of  Chairman  Rostenkowski's  statement  last  year,  the  Coalition  believes  it  is  inappropriate  to 
consider  these  proposals  as  free-standing  revenue  raisers. 


Reimposition  of  30-F6rceiit  Withholding  Tax  on  Portfolio  Interest  Paid  to 
Foreign  Persons 

Background 

Prior  to  the  Deficit  Reduction  Act  of  1984,  the  United  States  imposed  a  flat  30-percent  tax 
(subject  to  reduction  by  U.S.  tax  treaties)  on  the  gross  amount  of  interest  received  by 
nonresident  aliens  and  foreign  corporations  if  not  effectively  connected  with  the  conduct  of  a 
d^e  or  business  of  the  recipient  within  the  United  States.  The  tax  genoally  was  collected 
by  means  of  withholding  by  the  person  making  the  payment  to  the  foreign  recipient. 

In  addition  to  a  number  of  statutory  exemptions,  the  witiiholding  tax  on  portfolio  interest  was 
reduced  or  eliminated,  prior  to  the  1984  Act,  by  various  income  tax  treaties  of  the  United 
States.  The  U.S.  income  tax  treaty  with  the  Netherlands,  as  extended  to  the  Netherlands 
Antilles,  generally  exempted  U.S.  source  interest  paid  to  recipients  in  the  Netherlands 
Antilles  from  withholding  tax. 

Prior  to  the  1984  Act,  U.S.  corporations  raised  substantial  amounts  of  capital  in  the 
Eurobond  nuirket  by  issuing  debt  through  Netherlands  Antilles  finance  subsidiaries.   The 
Netherlands  Antilles  did  not  impose  any  withholding  tax  on  interest  paid  by  resident  finance 
subsidiaries.   Because  the  Eurobond  market  is  generally  comprised  of  bonds  not  subject  to 
withholding  tax,  an  issuer  of  d*t  subject  to  a  significant  withholding  tax  would  not  be  able 
to  obtain  competitive  rates  (inclusive  of  tax)  in  the  Eurobond  market. 

In  1984,  Congress  eliminated  the  30-percent  withholding  tax  on  certain  portfolio  interest  to 
allow  direct  access  to  the  Eurobond  market  without  the  necessity  of  using  Netherlands 
Antilles  finance  subsidiaries. 


'  Statement  of  Philip  D.  Morrison,  International  Tax  Counsel,  Department  of  the  Treasury,  before 
the  Committee  on  Ways  and  Means,  United  States  House  of  Representatives,  October  3, 1991,  pp.  23-24. 


1526 


Pmposal 

Under  H.R.  889,  the  30-percent  withholding  tax  on  certain  portfolio  interest  paid  to  foreign 
recipients  would  be  reinstated. 

Discussion 

Reinstatement  of  the  30-percent  withholding  tax  on  portfolio  interest  would  terminate  the 
ability  of  U.S.  corporations  to  access  the  Eurobond  market  on  a  direct  and  substantially  tax- 
free  basis  because  Netherlands  Antilles  finance  subsidiaries  are  no  longer  viable  as  a  result  of 
treaty  modifications  and  U.S.  tax  law  developments.   Such  an  action  would  be  completely 
contrary  to  the  stated  rationale  for  repealing  the  30-percent  withholding  tax  in  1984: 

"Congress  believed  it  important  that  U.S.  businesses  have  access  to  the 
Eurobond  market  as  a  source  of  capital.'^ 

Absent  access  to  the  Eurobond  market,  U.S.  interest  rates  would  rise.   This  would  be  true 
not  only  for  corporate  debt  but  for  U.S.  government  securities  as  well.  The  effect  on 
interest  rates  would  be  discernible  immediately.  In  fact,  based  merely  on  a  rumor  that 
Congress  is  considering  reimposing  the  30-percent  withholding  tax,  bond  prices  plunged  and 
the  yield  increased  on  Thursday,  September  9,  1993.'  In  response,  the  Treasury 
DeiKutment  announced  on  September  10,  1993  that  the  Clinton  Administration  opposes 
reimposition  of  the  30-percent  withholding  tax.' 

In  1987,  Germany  announced  that  it  would  impose  a  10-percent  withholding  tax  on 
investment  income  effective  in  1989.  The  proposal  was  withdrawn  six  months  later  after  an 
estimated  DM  80  billion  outflow  of  capital.   At  the  begiiming  of  this  year  Germany  imposed 
a  30-percent  withholding  tax  on  investment  income  but  specifically  exempted  foreign 
investors  to  avoid  the  problems  associated  with  the  original  10-percent  withholding  tax. 

An  increase  in  U.S.  interest  rates  would  run  counter  to  the  purposes  of  the  budget 
reconciliation  bill  passed  by  Congress  last  month.   Proponents  argued  that  the  adverse  effects 
of  the  tax  increases  and  spending  cuts  in  this  legislation  would  be  offset  by  lower  long-term 
interest  rates  due  to  deficit  reduction.   The  hoped  for  reduction  in  interest  rates  would, 
however,  be  jeopardized  by  reinstatement  of  the  30-percent  withholding  tax.   Reinstatement 
would  directly  increase  federal  government  spending  by  increasing  the  interest  rate  that  the 
government  must  pay  on  new  debt  issues. 

Higher  U.S.  interest  rates  also  would  increase  the  cost  of  capital  for  U.S.  companies  vis-a- 
vis their  foreign  based  competiton.   U.S.  reliance  on  foreign  financing  has  grown  ten-fold 
since  rq>eal  of  the  30-percent  withholding  tax:   ftom  $32  billion  in  1984  to  $317  billion  in 
1992.   As  shown  in  the  following  table,  over  one-fourth  of  corporate  borrowings  arc  now 
from  foreign  markets  as  compared  to  only  6  percent  in  1984. 


'  Joint  Conunittee  on  Taxation,  General  ExpUmaiion  of  the  Deficit  Reduction  Aa  of  1984,  p.  391. 

'  Wall  Street  Journal,  September  10,  1993,  p.  1.  'Bond  prices  plunged  after  a  sell-off  that  began 
overseas  swept  through  die  U.S.  bond  market.  The  price  of  the  Treasury's  benchmark  30-year  issue  fell 
nearly  I'A  points.  Its  yield  rose  to  5.96  percent.  Analysts  said  foreign  investors  began  dumping  U.S. 
bonds  overnight  on  rumors  diat  Congress  planned  to  consider  reimposing  a  30%  withholding  tax  on 
foreign  investments  in  U.S.  Treasuries." 

»  Daily  Tax  Report,  September  13,  1993,  pp.  G5-G6. 


1527 


Foreign  Portfolio  Investment  in  U.S.  Corporate  Bonds:  1984,  1992 

[Dollar  amounts  in  billions] 


Item 

1984 

1992 

U.S.  corporate  bonds  held  by  foreign  portfolio  investors 

$32 

$317 

Total  U.S.  corporate  bonds  outstanding 

$525 

$1,118 

Percent  of  U.S.  corporate  bonds  held  by  foreign 
portfolio  investors 

6.2% 

28.4% 

Sources:  U.S.  D^artment  of  Commerce,  Survey  of  Current  Business,  June  1993. 

Board  of  Governors  of  the  Federal  Reserve  System,  Balance  Sheas  For  the  U.S.  Economy, 

1960-1991,  March  1992. 

Board  of  Governors  of  the  Federal  Reserve  System,  Federal  Reserve  Bulletin,  July  1993. 


In  conclusion,  the  Coalition  strongly  opposes  this  proposal.   Congress  was  correct  in  its 
1984  assessment  of  the  importance  to  U.S.  business  of  access  to  the  Eurobond  market.   Over 
the  last  nine  years,  reliance  on  foreign  financing  has  increased  dramatically.  Reinstatement 
of  30-percent  withholding  would  limit  this  access  and  harm  economic  recovery. 


Conclusion 

Foreign  investment  is  critical  to  the  success  of  multinational  corporations  which  play  an 
increasingly  important  role  in  the  global  economy.  Therefore,  U.S.  rules  for  taxing  foreign 
source  income  should  be  formulated  taking  into  account  their  combined  effect,  the  costs  of 
complexity,  and  the  tax  policies  of  other  countries.  Piecemeal  changes  in  the  nation's 
international  tax  regime  will  inevitably  have  unintended  effects  and  increase  complexity. 


MEMBERS  OF  U.S.  MULTINATIONAL  CORPORATION 
INTERNATIONAL  TAX  POUCY  COALITION 


ARCO 

Baxter  International,  Inc. 

Caterpillar,  Lie. 

Citicorp 

Dresser  Industries 

Du  Pont 

Emerson  Electric  Co. 

General  Electric  Co. 

General  Motors  Corporation 

Goodyear  Tire  &  Rubber  Company 

Hewlett-Packard  Company 

IBM  Corporation 

Kellogg  Company 

Merck  &  Co.,  Inc. 

Merrill  Lynch  and  Co.,  Inc. 

Minnesota  Mining  and  Manufacturing 

Owens-Coming 

Philip  Morris  Companies,  Inc. 

Premark  International,  Inc. 

Sara  Lee  Corporation 

United  Technologies  Corporation 


1528 

Chairman  Rangel.  Mr.  Wiacek. 

STATEMENT  OF  RAYMOND  J.  WIACEK,  PARTNER,  JONES,  DAY, 
REAVIS  &  POGUE,  ON  BEHALF  OF  THE  EMERGENCY  COM- 
MITTEE FOR  AMERICAN  TRADE 

Mr.  Wiacek.  Thank  you,  Mr.  Chairman.  My  name  is  Ray 
Wiacek.  I  am  here  today  on  behalf  of  the  Emergency  Committee  for 
American  Trade,  or  ECAT,  an  organization  of  some  60  large  U.S.- 
based  multinationals  concerned  with  issues  that  affect  inter- 
national trade  and  international  taxation. 

ECAT  companies  have  annual  sales  of  approximately  $1  trillion 
and  over  5  million  employees.  The  members  of  ECAT  are  stronglv 
opposed  to  changing  the  foreign  tax  credit  to  a  deduction.  I  think 
that  the  fundamental  deviation  that  this  represents  from  standard 
tax  policy  and  the  double  taxation  that  would  result  are  reasonably 
well  known,  so  I  would  like  to  speak  just  briefly  and  off  the  cuff 
to  what  I  think  is  the  premise  underlying  this  proposal,  which 
comes  up,  oh,  every  3  or  4  years  or  so. 

I  think  that  premise  is,  one,  that  the  foreign  t£ix  credit,  by  re- 
moving the  penalty  of  double  taxation,  serves  as  an  inducement  or 
incentive  to  invest  abroad,  and,  two,  that  investment  abroad  is 
harmful  to  the  U.S.  economy. 

We  see  this  premise  sometimes  phrased  in  terms  of  a  "runaway 
plant"  or  otherwise.  I  think  nothing  could  be  further  from  the 
truth.  ECAT  just  completed  a  major  study  circulated  to  all  Mem- 
bers of  Congress — it  took  about  3  years  to  complete,  and  was  pre- 
pared by  a  number  of  outside  economists  using  governmental  and 
other  data  that  shows  that  overseas  investment  is  vital  to  the 
health  of  the  U.S.  economy. 

In  fact,  the  study  is  replete  with  data.  Among  its  findings  is  that 
the  overseas  business  activities  of  U.S.  companies  contributed  a  net 
surplus  of  $130  billion  in  1990  to  the  U.S.  balance  of  payments, 
and  that  the  net  surplus  contributed  over  the  decade  of  the  1980s 
averaged  some  $83  billion  per  year,  in  a  decade  in  which  the  Unit- 
ed States  was  otherwise  experiencing  large  deficits. 

The  study  also  showed  that  during  1989-91,  89  percent  of  the 
growth  in  the  U.S.  economy  was  attributable  to  exports,  that  com- 
panies with  overseas  subsidiaries  were  responsible  for  two-thirds  of 
these  exports,  that  the  majority  of  these  exports  went  to  their  U.S. 
foreign  subsidiaries,  and  that  93  percent  of  these  exports  were  sold 
in  the  local — that  is  the  foreign  marketplace — and  were  not  round- 
tripped  or  otherwise  sold  back  to  the  United  States. 

There  is  a  lot  of  data  in  the  ECAT  study  that  I  don't  want  to  re- 
peat here.  We  have  a  written  statement  that  we  have  submitted  for 
the  record. 

I  would  like  to  end  my  oral  statement  with  a  couple  of  anecdotes. 
In  thinking  about  this  testimony,  I  remembered  an  article  that  I 
read  yesterday  in  the  Wall  Street  Journal  and  another  one  in  the 
Sunday  Times.  The  article  in  yesterday's  Journal  talked  about  the 
expansion  into  Europe  by  the  U.S.  retail  industry,  particularly  U.S. 
discounters.  You  might  call  this  the  "Walmart  in  Liverpool"  article. 
I  would  like  to  point  out  that  a  U.S.  store  opening  in  the  United 
Kingdom  is  not  a  "runaway"  from  the  United  States  and  does  not 
represent  a  subtraction  from  the  U.S.  economy.  In  fact,  the  man- 


1529 

agement  fees,  the  design  fees,  the  dividends  and  the  royalties  that 
will  be  repatriated  back  to  the  United  States  are  very  important. 
The  U.S.  retail  store  abroad  also  provides  an  outlet  for  U.S.  goods. 

The  other  article  in  the  Sunday  Times  talked  about  the  boom  in 
Southeast  Asia.  It  said  that  the  Malaysian  economy  was  the  most 
rapidly  expgmding  economy  in  the  world  over  the  last  5  years.  The 
article  then  went  on  to  note  and  to  lament  the  lack  of  U.S.  involve- 
ment and  investment  in  this  area.  It  noted  that  there  were  few 
U.S.  firms  with  southeast  Asian  headquarters,  few  U.S.  sales  of- 
fices calling  on  customers  there,  few  U.S.-owned  warehouses  pro- 
viding parts  and  service  to  customers  there,  and  few  U.S.-owned 
plants  producing  U.S. -designed  goods  for  that  area. 

As  a  result  of  the  paucity  of  U.S.  investment,  in  the  region,  the 
article  pointed  to  a  project  worth  $3  billion  for  the  construction  of 
an  airport  in  Kuala  Lumpur  that  had  gone  to  a  group  of  Japanese 
companies  that  are  all  over  the  area  with  investment  and  people, 
and  that  did  not  go  to  the  United  States. 

I  would  suggest  again  that  an  airport  being  built  in  Kuala 
Lumpur  is  not  a  "runaway  plant."  Had  a  U.S.  firm  won  the  con- 
struction project,  then  the  engineering  jobs,  the  architectural  jobs, 
the  supplv  of  radar  and  electronic  proaucts,  and  the  supply  of  parts 
by  special  steel  companies  from  the  United  States  would  have  been 
an  addition  to  and  not  a  subtraction  from  the  U.S.  economy. 

To  conclude,  U.S.  companies  invest  abroad  for  business  reasons. 
Investment  abroad  is  good  for  the  U.S.  economy  and  any  attempt 
to  deter  U.S.  foreign  investment  via  the  Tax  Code  or  in  any  other 
way  would  in  my  view  be  wrongheaded  and  counterproductive. 

[The  prepared  statement  follows:] 


1530 


STATEMENT  OF  RAYMOND  J.  WIACEK,  PARTNER,  JONES,  DAY,  REAVIS 

&  POGUE,  ON  BEHALF  OF  THE  EMERGENCY  COMMITTEE  FOR 

AMERICAN  TRADE,  BEFORE  THE  WAYS  AND  MEANS  SUBCOMMITTEE 

ON  SELECT  REVENUE  MEASURES  HEARING  ON  A  PROPOSAL  TO 

CEIANGE  THE  FOREIGN  TAX  CREDIT  TO  A  DEDUCTION 

SEPTEMBER  21, 1993 

I  am  Ray  Wiacek,  a  partner  in  the  law  firm  of  Jones,  Day,  Reavis  &  Pogue 
and  I  am  here  today  as  tax  counsel  to  the  Emergency  Committee  for  American 
Trade  (ECAT)  to  testify  against  the  proposal  to  change  the  foreign  tax  credit  to  a 
deduction. 

ECAT  is  an  organization  of  about  60  large  U.S.  firms  with  business  activities 
in  competition  against  corporations  from  Japan,  Germany,  and  other  countries  in 
virtually  every  market  in  the  world.  Companies  represented  by  ECAT  have  annual 
worldwide  sales  of  over  SI  trillion  and  they  employ  about  S  million  persons. 

The  members  of  ECAT  have  a  critical  interest  in  U.S.  taxation  of  their 
foreign  source  income.  They  are  strongly  supportive  of  the  foreign  tax  credit  system 
which  is  nearly  universally  practiced  by  those  countries  like  the  United  States  that 
tax  the  foreign  earnings  of  their  citizens.  It  is  not  used  or  needed  by  those  countries 
who  do  not  tax  the  foreign  income  of  their  citizens. 

The  foreign  tax  credit  provides  that  taxes  paid  to  foreign  governments  can  be 
offset  or  credited  against  the  U.S.  income  tax  on  income  earned  abroad.  The  foreign 
tax  credit  does  not  permit  foreign  taxes  to  be  credited  against  U.S.  taxes  imposed  on 
income  earned  within  the  United  States.  U.S.  law  and  regulation  determine  what  is 
U.S.  source  income  and  what  is  foreign  source  income.  The  foreign  tax  credit  is 
designed  to  avoid  double  taxation  while  ensuring  that  income  earned  abroad  by  U.S. 
firms  shall  be  subject  to  the  higher  of  either  the  U.S.  or  the  foreign  tax  rate. 

To  enact  the  proposal  to  convert  the  U.S.  foreign  tax  credit  into  a  deduction 
would  be  to  use  the  power  to  tax  in  the  fashion  our  founding  fathers  feared  -  as  the 
power  to  destroy.  This  is  because  a  deduction  for  foreign  taxes  paid  would  raise  the 
current  U.S.  tax  rate  on  foreign  source  income  to  between  55  -  60  percent.  Our 
foreign  competitors,  however,  would  continue  paying  their  national  tax  rates  of 
about  35  percent. 

Payment  of  such  a  double-tax  rate  by  U.S.  firms  on  their  foreign  earnings 
could  well  prove  fatal  to  their  global  ability  to  compete  and  to  continue  their  vital 
contributions  to  U.S.  employment  and  economic  well  being. 

A  recently  released  study  of  ECAT,  MAINSTAY  H:  A  New  Account  of  the 
Critical  Role  of  U.S.  Multinational  Companies  in  the  U.S.  Economy  documents  the 
role  and  contributions  of  U.S.  multinational  corporations  in  the  U.S.  economy  from 
1980  -  1991.  I  believe  that  an  understanding  of  that  role  is  critical  to  understanding 
why  changing  the  foreign  tax  credit  to  a  deduction  would  severely  impact  the  U.S. 
economy. 

A  brief  summary  of  MAINSTAY  H  is  as  follows: 

This  study  examines  the  role  of  U.S.  multinational  corporations  in  the  U.S. 
economy  from  1980  through  1991,  with  an  emphasis  on  the  manufacturing  sector. 
Most  of  the  data  relating  to  U.S.  multinational  companies  and  their  foreign  afTiliates 
are  derived  from  ofTicial  U.S.  Government  statistics,  principally  the  U.S. 
Department  of  Commerce's  annual  survey,  "U.S.  Direct  Investment  Abroad: 
Operations  of  U.S.  Companies  and  Their  Foreign  Affiliates."  Comprehensive 
benchmark  surveys  were  completed  in  1982  and  1989.  Data  for  intervening  years 
are  based  on  slightly  less  detailed  annual  surveys.  Data  on  international  financial 


1531 


flows  rdated  to  direct  investment  were  obtained  from  U.S.  balance-of-payments 
statistics,  as  reported  quarteriy  in  the  "Survey  of  Current  Business."  International 
comparisons  are  based  primarily  on  Organization  for  Economic  Cooperation  and 
Development  (OECD)  data. 

The  study  shows  conclusively  that  U.S.  multinational  companies  made  strong 
positive  contributions  to  the  U.S.  balance  of  payments  throughout  the  1980's  and 
into  the  1990's.  They  did  so  during  a  decade  characterized  by  a  massive 
deterioration  of  the  U.S.  trade  balance,  its  international  payments  balance,  and  its 
global  Hnancial  position.  Indeed,  multinational  companies  are  now  the  single  most 
positive  factor  in  the  U.S.  balance  of  payments.  Had  it  not  been  for  the  outstanding 
performance  of  multinational  companies  during  the  1980'$,  the  international 
economic  position  of  the  United  States  would  have  been  far  worse,  given  the  weaker 
performance  of  corporations  oriented  primarily  toward  the  domestic  market. 

MAINSTAY  TVs  principal  factual  findings  are  as  follows: 

•  The  overseas  business  operations  of  U.S.  multinational  companies  contributed 
a  record  net  surplus  of  $130  billion  in  1990  to  the  U.S.  balance  of  payments. 

•  For  the  total  period,  1982  to  1990,  U.S  multinational  companies  contributed 
an  average  net  surplus  of  $83  billion  annually  to  the  U.S.  balance  of  payments. 

The  report  demonstrates  that  overseas  investment  by  U.S.  multinational  companies 
contributes  to  the  health  of  the  companies,  to  U.S.  domestic  employment,  and  to  the 
overall  strength  of  the  U.S.  economy.  Following  are  the  detailed  Hndings  of  the 
report. 

I 

American  Companies  With  Overseas  Investments  Have  Been  Waging  A  Hard  Fight 
And  A  Successful  One  -  To  Keep  Exports  Flowing  From  The  United  States 


•  On  the  merchandise  trade  account,  their  surpluses  rose  from  a  net  surplus 
of  $46  billion  in  1984  to  a  net  surplus  of  $80  billion  in  1990. 

•  These  trade  surpluses  were  earned  in  almost  every  industrial  sector. 

By  contrast,  the  overall  U.S.  trade  balance  for  manufactures  deteriorated  steadily  to 
a  deHcit  of  S125  billion  in  1987,  ending  the  decade  in  1990  with  a  deficit  of  S73 
billion.  Without  the  enormous  balance  of  payments  surpluses  of  multinational 
companies,  the  state  of  the  U.S.  balance  of  payments  would  have  been  truly 
calamitous  with  concomitant  adverse  effects  on  the  U.S.  economy. 

•  The  dramatic  deterioration  of  the  U.S  merchandise  trade  balance  in  the 
first  half  of  the  1980's  was  driven  by  clearly  identifiable  macroeconomic 
forces. 

The  most  important  factors  were  the  overvaluation  of  the  U.S.  dollar,  up  37  percent 
in  real  terms  against  40  leading  international  competitors  from  1980-1985,  and  a 
rapid  growth  in  U.S.  domestic  demand  in  1982-1985  relative  to  other  industrialized 
countries.  Similarly,  the  subsequent  recovery  in  U.S.  exports  and  welcome 
improvements  in  the  merchandise  trade  balance  can  be  traced  to  a  reversal  in  these 
macroeconomic  trends.  Had  U.S.  multinational  firms  not  made  foreign  investments, 
the  trade  balance  would  have  been  far  worse. 

•  Exports  by  U.S  multinational  companies  have  risen  sharply  since  1985. 
(Real  U.S  export  growth  averaged  14  percent  annually  from  1986  - 1991, 
the  highest  for  any  five-year  period  in  U.S.  history.) 


1532 


•  U.S.  exports  accounted  for  89  percent  of  U.S.  economic  growth  during 
1989-1991. 

•  U.S.  multinational  companies  accounted  for  approximately  two-thirds  of 
U.&  manufactured  exports. 

n 

The  Net  Return  On  The  Foreign  Investments  Of  U.S.  Multinatirnal  Companies 
Is  The  Most  Positive  Single  Element  In  The  U.S.  Balance  Of  Payments 
Account  With  The  Rest  Of  The  World 

Not  only  have  multinational  Tirms  achieved  huge  surpluses  on  trade  account,  the  net 
repatriated  earnings  from  their  overseas  investments  have  also  been  consistently 
positive  as  have  their  overall  Hnancial  transactions. 

•  For  1992,  their  net  repatriated  earnings  reached  $48  billion.   These 
earnings  -  the  share  actually  brought  home  to  the  United  States  -  have  been 
the  most  positive  single  entry  in  the  U.S.  balance  of  payments. 

•  While  returning  substantial  trade  and  balance  of  payments  surpluses  to  the 
United  States,  multinational  companies  continue  to  build  their  operations 
abroad,  thereby  assuring  future  returns.   They  do  this  primarily  through  the 
reinvestment  of  overseas  earnings  and  not  through  the  export  of  funds  from 
the  United  States. 

m 

Investments  Abroad  Keep  American  Companies  Competitive 

•  Investments  overseas  enable  multinational  companies  to  enjoy  greater 
economies  of  scale,  to  solidify  access  to  foreign  markets,  and  to  sustain  the 
worldwide  research  and  development  activities  indispensable  to  maintaining 
competitiveness  in  an  increasingly  global  environment 

U.S.  firms  and  industries  that  have  been  the  most  aggressive  in  expanding  global 
investments  have  also  been  the  most  successful  in  expanding  both  their  U.S.  exports 
and  global  market  shares. 

•  Industries  with  the  highest  levels  of  foreign  investment  have  the  highest  rate 
of  exports  and  export  growtlu 

Exports  to  overseas  amiiates  accounted  for  a  steadily  rising  share  of  total  exports  by 
multinational  companies  and  are  correlated  strongly  and  positively  with  growth  in 
foreign  alTiliate  sales.  This  demonstrates  a  critically  important  aspect  of  foreign 
investment  by  multinational  companies,  i.e.  that  exports  follow  investment. 

•  The  higher  the  share  of  U.S.  direct  manufacturing  investment  in  a  foreign 
country,  the  more  likely  the  U.S.  is  to  have  a  merchandise  trade  surplus 
with  that  country.   (The  relative  paucity  of  U.S.  direct  investments  in  Japan, 
for  example,  is  a  major  reason  why  U.S.  exports  to  that  country  are 
relatively  small) 

rv 

Foreign  Investment  Serves  Foreign  Markets 

•  The  underlying  motivation  for  foreign  direct  investment  is  to  penetrate 
markets  otherwise  commercially  inaccessible  to  U.S.  firms  and  then  to 
protect  or  expand  market  share.   U.S.  foreign  affiliates  thus  predominantly 
serve  the  foreign  markets  where  they  are  located  -  or  third-country  markets. 


1533 


•     Excluding  Canada,  only  7.2  percent  of  total  sales  by  U.S.  foreign 

manufacturing  affiliates  were  to  the  U.S.  market  in  1990  -  a  percentage  that 
was  remarkably  stable  throughout  the  1970's  and  1980's. 

These  numbers  show  that  the  increasing  imports  that  have  been  entering  the  United 
States  in  the  period  covered  are  rarely  being  produced  by  afllliates  of  American 
companies.  Accordingly,  any  restrictions  on  U.S.  investment  overseas  would  not 
meaningfully  reduce  imports  as  is  often  contended  by  opponents  of  foreign 
investments.  Rather  than  replacing  domestic  production,  foreign  manufacturing  by 
U.S.-based  multinational  companies  has  increased  the  volume  of  American  exports. 

Foreign  investments  result  in  exports  of  intermediate  parts  and  components  and 
may  even  produce  an  immediate  foreign  demand  for  U.S.  capital  goods  for  new 
facilities  or  modernization.  These  investments  establish  a  market  for  exports  of 
products  associated  with  the  goods  produced  abroad  and  for  exports  where  local 
demand  exceeds  local  productive  capacity  but  does  not  warrant  major  expansion. 
Foreign  investment  helps  popularize  U.S.  trademarks  and  brand  names  and  to 
customize  products  to  local  need.  It  enables  U.S.  companies  to  put  in  the  kind  of 
service  and  distribution  networks  that  could  not  be  supported  by  exports  alone. 


The  Growth  In  U.S.  Multinational  Con^anies'  Exports  And  International  Investments 
Has  Generated  Increased  Employment  For  Their  U.S.  Workers. 

•  In  addition  to  their  critical  contribution  to  the  U.S.  balance  of  payments 
noted  above,  U.S.  multinational  companies  have  been  and  continue  to  be 
responsible  for  significant  employment  in  the  U.S.  economy  -  much  of 
which  is  generated  by  their  foreign  investments. 

•  The  total  number  of  jobs  created  directly  or  indirectly  by  the  manufactured 
exports  of  U.S.  multinational  companies  reached  5  million  in  1990,  based 
on  U.S.  Department  of  Commerce  estimates  of  the  number  of 
manufacturing  and  nonmanufacturing  jobs  generated  per  billion  dollars  of 
manufactured  exports. 

During  the  1980's,  manufacturing  multinational  companies  had  a  better  record  on 
employment  than  the  typical  large  U.S.  manufacturing  firm.  With  the  economic 
downturn  and  increased  pressure  from  foreign  competitors,  employment  by  U.S. 
multinational  company  parents  fell  slightly  from  1982  -  1989.  That  decline, 
however,  was  substantially  smaller  than  the  decline  in  employment  by  Fortune  500 
companies  as  a  whole. 

Findings 

The  above  findings  demonstrate  that  the  simple  contention  that  multinational 
companies  are  harming  the  U.S.  economy  by  shifting  jobs  abroad  and  importing 
cheaper  products  into  the  United  States  does  not  bear  up  to  scrutiny.  Rather,  the 
exact  opposite  is  true.    Investment  abroad  by  multinational  companies  provides  the 
platform  for  growth  in  exports  and  creates  jobs  in  the  United  States. 

The  study  provides  data  to  back  up  the  fact  that  companies  that  think  and  act 
globally  set  the  pace  for  U.S.  exports.  For  such  companies,  their  foreign  investments 
create  a  constant  awareness  of  market  opportunities  for  U.S.  exports,  which  might 
otherwise  go  unnoticed. 

As  the  business  and  consulting  economists  who  prepared  the  earlier  ECAT 
"Mainstay"  study  in  1973  stated:  "The  conclusions...about  the  operations  of  the 
multinational  corporation  are  based  on  sound  statistics.  If  they  clash  with 


1534 


judgments  derived  from  a  combination  of  isolated  incidents  and  intuition,  they  can 
stand  their  ground." 

And  A  Renewed  Warning 

There  are,  however,  clouds  on  the  horizon.  As  the  U.S.  economy  continues  its  slow 
recovery  and  unemployment  rates  continue  to  be  a  concern,  proposals  have  been  put 
forward  to  limit  the  ability  of  multinational  companies  to  invest  abroad  such  as  the 
one  to  change  the  foreign  tax  credit  to  a  deduction.  Proposals  have  also  been  made 
to  restrict  the  economic  activities  of  foreign  multinationals  in  the  United  States. 

Enactment  of  such  measures  could  cripple  the  international  competitiveness  of  the 
U.S.  economy.  On  the  one  hand,  the  proposals  would  curtail  needed  foreign  capital 
for  the  U.S.  economy.  On  the  other,  they  would  limit  the  ability  of  U.S. 
multinational  companies  to  compete  globally  with  firms  from  Japan,  Germany,  and 
elsewhere  -  firms  that  are  increasing  their  global  market  share  at  the  expense  of  U.S. 
Tirms.  The  U.S.  share  of  annual  outflow  of  direct  investment  has  dropped  from  two- 
thirds  of  the  worldwide  total  in  1967  to  one-fifth  in  1988-1989.  Over  the  same 
period,  Japan's  share  grew  from  2  percent  to  28  percent.  The  share  of  the  European 
Community  grew  from  28  percent  to  48  percent. 

By  measuring  the  benefits  that  flow  to  the  U.S.  economy  from  the  exports  and 
foreign  earnings  of  multinational  companies,  MAINSTAY  11  shows: 

First,  that  foreign  tax  and  other  investment  restrictions  could  cut  into  our 
major  surplus  balance  of  payments  account  with  the  rest  of  the  world;  and 

Second,  by  its  analysis  of  how  the  exports  of  multinational  companies  exceed 
imports  by  tens  of  billions  of  dollars  each  year,  that  limits  on  investment  would 
reduce  U.S.  exports.   This  could  lead  to  a  chain  reaction,  lowering  the  level  of 
world  trade,  and  diminishing  the  welfare  of  all  participants. 

The  numbers  in  the  report  establish  the  positive  correlation  between  investments 
abroad  by  multinationals  and  the  propensity  of  foreign  countries  to  import 
American  products.  This  gives  statistical  support  to  the  view  that  investments  mean 
more  access  to  markets. 

Perhaps  the  most  important  conclusion  validated  by  the  report's  data  is  that 
multilateral  approaches  to  international  trade  and  investment  issues  work  well.  In 
a  foreword  to  an  early  ECAT  study  (and  reiterated  in  ECAT's  first  "Mainstay" 
publication)  President  Dwight  D.  Eisenhower  warned  against  a  return  to  "an  inept, 
selfish  and  self-defeating  system  of  economic  nationalism."  The  data  in  this  new 
study  makes  even  clearer  the  importance  of  maintaining  the  hard-won  open  system 
of  global  trade  and  investment  In  particular,  it  details  the  improvement  in  the  U.S. 
balance  of  trade  that  began  in  1985  when  governments  worked  together  on  the 
problem  of  the  overvalued  dollar.  And  it  then  shows  how  American  multinationals 
set  the  pace  in  the  turn-around  in  trade  that  followed  -  making  the  case  that  other 
difficulties  can  also  be  dealt  with  in  a  similar  fashion  without  undue  or  unnecessary 
risk  to  U.S.  competitiveness,  domestic  jobs  or  international  economic  progress. 

Mr.  Chairman,  as  can  be  seen  from  the  above  summary  of  MAINSTAY  II. 
the  employment  and  foreign  trade  records  of  multinational  companies  and  their 
foreign  affiliates  demonstrate  convincingly  that  their  foreign  investment  activities 
have  enhanced  their  export  performance,  increased  their  trade  surpluses,  and 
consequently  have  had  a  strongly  positive  effect  on  U.S.  manufacturing 
employment,  resulting  in  an  estimated  5  million  U.S.  workers  who  owe  their  jobs, 
directly  or  indirectly,  to  multinational  companies'  manufactured  exports  —  exports 
that  follow  and  that  in  substantial  part  are  created  by  U.S.  foreign  direct 
investments. 


1535 


In  addition,  hundreds  of  thousands  of  other  U.S.  jobs  are  dependent  on  the 
research  and  development  budgets,  capital  expenditure  programs,  and  corporate 
stafT  Tunctions  that  are  supported  by  the  steadily  growing  stream  of  earnings  being 
repatriated  from  the  overseas  affiliates  of  U.S.  multinational  companies  to  their  U.S. 
parents. 

American  workers  -  like  their  employers  and  the  U.S.  economy  -  have  an 
important  stake  in  the  continued  growth  and  prosperity  of  multinational  companies' 
worldwide  operations. 

In  summary,  to  change  the  foreign  tax  credit  to  a  deduction  as  proposed 
would  be  a  prescription  for  U.S.  withdrawal  from  the  global  economy  and  for 
domestic  economic  stagnation. 


1536 

STATEMENT  OF  JOHN  E.  ALLIS,  CPA,  HOUSTON,  TEX. 

Mr.  Allis.  Mr.  Chairman,  I  am  John  Allis,  a  CPA  from  Houston, 
Tex.  I  would  like  tx)  provide  a  brief  summary  of  my  written  com- 
ments that  I  have  submitted. 

Chairman  Rangel.  Without  objection,  all  written  statements  will 
be  entered  into  the  record. 

Mr.  Allis.  I  am  before  the  subcommittee  in  response  to  the  sub- 
committee's proposal  to  eliminate  the  foreign  tax  credit.  I  am  con- 
centrating on  the  proposal's  effects  on  individuals  who  work 
abroad,  that  work  overseas.  This  proposal  is  unfair  to  individuals 
that  work  overseas.  They  will  be  paying  double  tax. 

First,  they  are  going  to  pay  tax  in  the  foreign  jurisdiction,  not 
only  at  the  country  level  but  also  at  levels  similar  to  our  State  and 
local  taxes.  Then  they  are  going  to  pay  again  to  the  United  States. 

It  is  very  conceivable  that  an  American  working  overseas  could 
pay  tax  over  100  percent  of  his  salary.  While  this  proposal  does 
keep  the  provision  for  deduction  in  foreign  taxes  paid,  this  does  not 
provide  any  relief  to  the  alternative  minimum  tax.  No  one  wants 
to  work  and  pay  tax  at  over  100  percent  tax  rate.  The  taxpayers 
would  either  have  a  choice  of  not  complying  with  the  U.S.  laws  or 
asking  their  employer  to  provide  additional  compensation  to  pick 
up  the  additional  tax  cost. 

A  few  key  high-level  employees  may  be  able  to  get  the  company 
to  pay  for  double  taxation,  but  middle  and  lower  level  American 
workers  will  not  be  able  to  receive  this  type  of  compensation.  They 
will  be  replaced  with  workers  from  other  nationalities.  That  is  al- 
ready happening. 

Since  American  employees  can  be  very  expensive  overseas,  it  will 
accelerate  this  trend.  In  a  global  economy,  we  should  be  encourag- 
ing the  smaller-  and  medium-sized  cornpanies  to  do  more  business 
overseas,  to  go  overseas  and  export  their  products  more. 

With  labor  costs  of  American  workers  so  high,  under  this  pro- 
posal, if  it  is  enacted,  they  will  not  be  able  to  employ  Americans 
abroad.  It  will  stifle  the  growth  of  these  American  companies. 

Thank  you  very  much. 

[The  prepared  statement  follows:] 


1537 


TESTIMONY  OF  JOHN  E.  ALLIS 
CERTIFIED  PUBUC  ACCOUNTANT 


The  Subcommittee  on  Select  Revenue  Measures,  Committee  on  Ways  and 
Means,  announced  a  miscellaneous  revenue-raising  proposal  in  Press 
Release  #10,  Foreign  Tax  Provisions  (4),  "to  change  the  foreign  tax  credit 
to  a  deduction."  This  proposal,  if  enacted,  would  inequitably  subject 
American  workers  to  double  taxation.  American  workers  would  not  be  able 
to  take  jobs  outside  the  U.S.  without  additional  compensation  as 
reimbursement  for  the  double  taxation.  Americans  would  not  be 
competitive  in  the  international  marketplace. 

The  United  States  is  the  only  major  country  which  taxes  its  citizens  and 
residents  on  woridwide  income.  While  the  Sec.  911  exclusions  offer  relief 
in  some  circumstances,  Americans  who  work  abroad  usually  pay  tax  at  the 
greater  of  the  foreign  or  U.S.  tax  rate.  This  makes  Americans  more 
expensive  to  hire  than  other  nationalities.  Under  this  proposal,  Americans 
would  be  prohibitively  expensive  to  employ  abroad. 

Several  examples  below  explain  the  severe  impact  on  individuals  of  this 
proposal,  if  enacted. 

Double  Taxation 

A  taxpayer  may  currently  claim  foreign  taxes  as  an  itemized  deduction  or 
offset  U.S.  tax  on  foreign  source  income  with  a  foreign  tax  credit.  The 
proposal  would  eliminate  this  credit.  The  credit  is  limited  to  the  lesser  of 
foreign  taxes  paid  or  the  percentage  of  U.S.  tax  on  foreign  source  income. 
The  following  example  illustrates  the  current  taxation  of  a  married  American 
with  children  who  works  abroad  for  the  entire  year. 


Current  Law 


Cash  Paid  to  Employee 

Base  Salary 

Bonus 


$35,000 
5,000 


Tell 


John  E.  Allis 
Certified  Public 

Accountant 

2121  San  Felipe 

Suite  141 

Houaton.  Texas  77019 

713.529.8700 

Fax  713.526.3395 


Benefits-in-Kind  Taxable  to  Employee 
Children's  American  Schooling 
Additional  Foreign  Housing  Expenses 
Airfares  for  Home  Leave 
Foreign  Tax  @  50%  of  Gross 

Income  (Reimbursed  by  Employer) 
Gross  Income 
Deduction  (Standard) 
Exemptions 
Taxable  Income 

Federal  Income  Tax 

Foreign  Tax  Credit 

Alternative  Minimum  Tax  (AMT) 

AMT  Credit  (claimed  upon  repatriation) 

U.S.  Tax  Liability 

Foreign  Income  Tax  Liability 

U.S.  Tax  Liability 

PICA  -  OASDI 

PICA  -  Medicare 

Worldwide  Tax  Burden  -  Current  Law 


10,000 
20,000 
10,000 


$160,000 
(6,200) 
(9.400^ 

$144.400 

$37,513 

(37,513) 

3,185 

(3.185) 

?  -9- 

$80,000 

-0- 

3,571 

2.320 

$85.891 


1538 


The  Alternative  Minimum  Tax  (AMT)  paid  by  the  taxpayer  in  the  above 
example  may  later  be  claimed  as  credit  when  the  taxpayer  has  U.S.  source 
income  (e.g.,  upon  repatriation). 

The  Proposed  Provision  eliminates  the  foreign  tax  credit  and  continues  to 
allow  a  deduction  for  the  foreign  taxes  paid.  The  example  below  details  the 
effects  of  the  proposal. 


Proposed 

Law 

Cash  Paid  to  Emplovee 

Base  Salary 

$35,000 

Bonus 

5,000 

Benefits-in-Kind  Taxable  to  Employee 

Children's  American  Schooling 

10.000 

Additional  Foreign  Housing  Expenses 

20,000 

Airfares  for  Home  Leave 

10,000 

Foreign  Tax  @  50%  of  Gross 

Income  (Reimbursed  by  Employer) 

80.000 

Gross  Income 

$160,000 

E)eduction  (Foreign  Taxes  Paid) 

(80,000) 

Exemptions 

(9.400) 

Taxable  Income 

$70.600 

Federal  Income  Tax 

$14,971 

Foreign  Tax  Credit 

N/A 

Alternative  Minimum  Tax  (AMT) 

16,879 

AMT  Credit 

-0- 

U.S.  Tax  Liability 

$?i.??o 

Foreign  Income  Tax  Liability 

$80,000 

U.S.  Tax  Liability 

31,850 

FICA  -  OASDI 

3,571 

PICA  -  Medicare 

2.320 

Worldwide  Tax  Burden  -  Proposed  Law 

ai7  741 

The  taxpayer  may  not  claim  the  above  AMT  as  a  credit  in  future  years. 

Under  the  Proposed  Law  the  worker  is  double-taxed:  once  by  the  foreign 
country  and  again  by  the  U.S.  The  worker's  take-home  (after-tax)  pay  is 
only  $2,259! 


Base  Salary 

Bonus 

Cash  Paid  to  Employee 


$35,000 

5.000 

$40,000 


U.S.  Tax  Liability 
FICA  -  OASDI 
FICA  -  Medicare 


$31,850 
3,571 
2.320  (37.741) 


take-Home  Pay 


$  2.259 


Almost  the  entire  cash  compensation  is  consumed  by  taxes  in  this  scenario. 
An  employee  could  easily  pay  tax  at  rates  of  over  100%  in  some  foreign 
jurisdictions. 


John  E.  Allis 

Certified  Public 

Accountant 

2121  San  Felipe 

Suite  141 

Houston.  Texas  77019 

Telephone  713.529.8700 

Fax  713.526-3395 


1539 


Compensation  Expense 

An  employer  provides  English  language  education  for  the  employee's 
children  when  the  foreign  assignment  location  schooling  is  not  adequate. 
The  company  may  also  pay  additional  housing  expenses  to  keep  the 
employee's  family  in  suitable  housing.  Both  private  and  Federal  employers 
also  provide  other  benefits-in-kind,  such  as  home  leave  and  cost  of  living 
allowances,  to  mitigate  the  higher  costs  of  living  outside  the  United  States. 
These  benefits  attempt  to  keep  the  employee  in  the  same  position  as  at  the 
home  location.  An  employee  will  not  accept  foreign  employment  when  the 
additional  costs  exceed  the  benefits. 

For  the  worker  to  accept  foreign  employment,  the  employer  would  need  to 
reimburse  the  double  taxes  assessed  under  the  proposed  law.  Under 
standard  corporate  tax  reimbursement  policies,  the  employee  pays  tax  on  the 
actual  cash  payments  received  as  if  the  employee  had  stayed  at  home.  The 
employer  reimburses  any  additional  tax  resulting  from  the  foreign 
assignment.  The  following  examples  illustrate  this  concept. 


Stay-At-1 


iTax 


Base  Salary 
Bonus 

Stay-Home-Compensation 
Standard  Deduction 
Personal  Exemptions 
Stay-at-Home  Taxable  Income 


$35,000 
5.000 

$40,000 
(6,200) 
(9.400^ 

$24.400 


Stay-at-Home  Income  Tax 
Stay-at-Home  FICA  -  OASDI 
Stay-at-Home  FICA  -  Medicare 
Employee's  Share  of  Tax  Burden 


$3,660 

2,480 

580 

$6.720 


Worldwide  Tax  Burden  -  Proposed  Law 


$117.741    (B) 


Employer's  Tax  Reimbursement  (B)  -  (A)  $1 1 1 ,02 1 

Foreign  Taxes  80.000 

Employer  Paid  U.S.  Taxes  -  Proposed  Law  $  31.021 

The  employer  paid  taxes  are  an  additional  cost  to  the  employer  for  the 
employee's  foreign  assignment.  The  taxes  are  also  taxable  compensation  to 
the  employee  which  would  need  to  be  grossed  up  for  the  tax-on-tax  in  the 
following  year. 


Employer  Paid  U.S.  Taxes  -  Proposed  Law 
Foreign  Tax  Gross  Up  (50%) 
Federal  Income  Tax  Gross  Up  (26%) 
FICA  -  OASDI  Gross  Up  (at  Maximum) 
FICA  -  Medicare  Gross  Up  (1.45%) 
Additional  Employer  Compensation  Expense 


$31,021 

68,783 

35,767 

N/A 

L225 

1137.566 


In  the  following  year  the  employer  would  pay  $137,566  in  additional  tax 
reimbursements  due  to  the  Proposed  Law.  The  tax-on-tax  gross  up  would 
continue  to  spiral  upwards  until  the  employee  returns  to  the  United  States. 


1540 


Note  on  Sec.  911 

For  simplicity  the  exclusions  available  under  Internal  Revenue  Code  §911 
are  not  discussed  in  the  above  examples.  The  Sec.  91 1  exclusions  do  offer 
relief  to  some  taxpayers.  For  taxpayers  in  higher  tax  countries,  however, 
the  main  benefit  of  these  exclusions  is  a  decrease  in  the  marginal  U.S.  tax 
rate.  In  addition  Internal  Revenue  Code  §9 11  (d)(6)  allows  foreign  taxes  to 
be  claimed  as  a  credit  or  deduction  only  for  income  which  has  not  been 
excluded.  Illustrations  which  detail  the  disallowance  of  the  foreign  tax 
credit  (Current  Law  example)  and  of  the  deduction  for  foreign  taxes  paid 
(Proposed  Law  example)  would  only  complicate  the  comprehension  of  this 
subject  matter. 


Competition  is  intense  in  the  global  marketplace.  American  companies  that 
hire  American  workers  are  already  under  strong  pressure  to  reduce  costs  in 
order  to  secure  business  outside  the  U.S.  Additional  compensation  expenses 
from  double  taxation  under  the  Proposed  Law  would  mean  that  more  foreign 
projects  would  be  awarded  to  Japanese,  European  and  other  non-U. S. 
companies.  American  workers  and  companies  would  suffer.  The 
Subcommittee  on  Select  Revenue  Measures  should  not  give  further 
consideration  to  the  proposal  to  change  the  foreign  tax  credit  to  a  deduction. 


1541 

Chairman  Rangel.  Mr.  Allis,  I  appreciate  vour  remarks  about 
small  business,  but  as  relates  to  the  individual  American  taxpayer 
in  the  foreign  countries,  the  committee  was  criticized  because  of 
what  has  been  perceived  to  be  an  overgenerous  tax  treatment  for 
I  think  upward  of  $70,000  tax  free,  and  I  have  to  assume  that  all 
of  that  was  taken  into  consideration  when  you  were  preparing  your 
statement? 

Mr.  Allis.  Absolutely. 

Chairman  Rangel.  And  that  did  not  make  our  taxpayers  abroad 
feel  on  a  fair  equitable  tax  basis  with  foreigners  from  other  coun- 
tries that  are  located  in  the  same  countries? 

Mr.  Allis.  It  certainly  doesn't  make  it  equitable.  Someone  from 
the  U.K,  once  they  leave  the  U.K,  they  are  subject  to  tax  in  their 
new  location.  They  break  the  ties  with  their  old  location. 

Chairman  Rangel.  Let  me  say  this:  How  we  do  it  is  one  thing. 
If  it  is  bad  tax  policy,  you  can  address  yourself  to  that.  But  the  bot- 
tom line  I  think  is  that  all  members  on  the  committee  and  off  the 
committee  are  trying  to  make  certain  that  our  taxpayers,  individ- 
ually and  corporate,  are  not  held  back  because  of  our  tax  decisions, 
but  feel  that  they  can  go  in  and  compete  with  any  other  nation  and 
pay  an  equitable  share,  but  certainly  not  more  than  that  proportion 
of  their  pay  as  any  other  foreigner  that  is  seeking  the  same  job. 

Leaving  the  corporations  alone  and  getting  back  to  individuals — 
because  an  individual  when  offered  a  job  abroad  has  to  consider 
what  is  the  pay,  what  is  the  cost  of  living,  where  do  I  send  the  kids 
to  school,  what  is  the  housing  situation,  and  how  much  is  Uncle 
Sam  going  to  leave  in  my  pocket  as  well  as  the  other  country?  With 
a  $70,000  exclusion  in  one  pocket,  the  very  least  we  should  hear 
is  that  is  good  and  that  will  influence  our  decision  as  to  how  we 
can  be  competitive  and  you  can  say  it  is  not  enough,  but  you  can- 
not ignore  it  and  then  talk  about  others  getting  a  credit  while  you 
may  be  getting  a  deduction. 

You  wouldn  t  care  what  we  called  it  if  we  increased  the  exemp- 
tion. 

Mr.  Allis.  The  exemption  provides  relief  in  lower  tax  countries, 
but  for  someone  in  a  higher  tax  country,  it  provides  very  little  re- 
lief I  have  seen  tool  pushers  with  base  salaries  of  $20,000  having 
a  $200,000  W-2.  The  type  of  taxes  they  are  paying  under  the  cur- 
rent system,  where  they  are  keeping  from  being  double  taxed,  it  is 
equitable.  The  $70,000,  in  a  high  tax  country,  they  don't  get  the 
benefits  of  that. 

Chairman  Rangel.  Do  you  think  we  should  have  something  to 
index  it,  according  to  the  cost  of  living  in  the  country? 

Mr.  Allis.  That  would  help  in  low  tax  jurisdictions,  but  in  high 
tax  jurisdictions,  that  would  have  no  effect  or  very  little  effect  in 
terms  of  the  Internal  Revenue  Code. 

Section  911(b)(6)  prevents  the  taxpayer  from  getting  a  double 
benefit  of  the  $70,000  a  year  and  the  foreign  tax  credits. 

Chairman  Rangel.  With  the  corporations,  what  if  it  is  a  credit 
or  a  deduction — the  whole  idea  is  to  make  certain  it  doesn't  cost 
our  businesses  more  to  operate  abroad  than  here.  That  is  the  bot- 
tom line — so  that  we  are  competitive  or  indeed  if  there  is  some  way 
to  even  give  you  an  advantage  if  it  is  not  illegal  under  inter- 
national treaties. 


1542 

When  you  get  taxed  by  a  foreign  country,  it  involves  their  tax 
poHcy,  which  may  not  be  our  tax  policy,  but  to  the  corporation,  that 
is  it;  that  is  what  you  pay. 

When  we  give  a  deduction,  and  you  have  to  assume  it  is  going 
to  be  equitable  enough  to  make  you  competitive,  then  the  tax  that 
would  be  directed  at  you  would  be  based  on  our  tax  policy  and  the 
deduction  is  really  a  business  expense  that  whether  you  like  the 

f)olicy  or  not  you  are  doing  business  in  the  country.  This  is  your 
icense.  This  is  your  fee.  This  is  what  you  have  to  pay,  and  you 
don't  debate  it  either  way. 

If  you  were  assured  that  the  deduction  or  that  any  changes  in 
the  law — it  is  not  my  bill — would  not  put  you  at  a  disadvantage 
than  what  you  are  under  existing  law,  as  tax  policy,  do  you  think 
it  would  be  better  to  use  a  deduction  or  credit? 

Mr.  WlACEK.  I  think  it  would  be  very  hard  to  design  a  deduction 
that  wouldn't  be  a  disadvantage  versus  the  credit.  The  real  point 
here  is  to  make  sure  that  we  are  competitive  with  everybody  else 
doing  business  in  foreign  areas  so  that  we  can  take  advantage  of 
those  marketplaces. 

Chairman  Rangel.  I  am  assuming  that. 

Mr.  WlACEK.  When  we  go  to  Germany  or  to  France  and  pay  52 
or  34  percent  t£ix  rate  for  which  the  United  States  only  gives  us 
a  deduction,  then  we  can't  be  competitive  in  those  countries.  U.S. 
firms  would  be  double-taxed  whereas  the  firms  of  all  other  coun- 
tries, would  be  paying  one  tax.  With  that  much  of  a  burden,  U.S. 
firms  could  not  be  competitive. 

One  frequent  misunderstanding  in  the  debate  about  tax  policy  is 
that  when  people  start  talking  about  leveling  the  playing  field  and 
making  things  equal,  they  forget  that  we  don't  control  the  inter- 
national field.  We  can  get  rid  of  incentives  within  the  United 
States,  we  can  do  all  the  1986  fiat  tax  stuff  that  we  want,  but  when 
we  are  talking  about  whether  we  can  land  a  contract  in  Germany, 
we  have  to  remember  that  there  are  other  players  and  other  tax 
codes  as  well. 

So  what  you  need  to  do  is  free  us  up  to  compete  in  Germany  on 
the  same  basis  that  the  Grermans  and  Japanese  and  Koreans  and 
French  compete  in  Germany. 

Chairman  Rangel.  OK.  It  seems  to  me  that  this  is  a  very  impor- 
tant factor  as  to  whether  or  not  you  can  effectively  compete  on  a 
level  playing  field.  Are  all  of  you  satisfied  that  no  other  industri- 
alized country  uses  the  deductions. 

Mr.  Merrill.  Mr.  Chairman,  on  my  written  statement,  there  is 
a  list  of  the  24  major  industrial  countries  in  the  world,  the  mem- 
bers of  the  OECD. 

Of  the  24,  12  used  the  foreign  tax  credit  system  which  was  the 
U.S.  system,  taxing  the  foreign  source  income  of  their  multination- 
als, but  providing  a  credit  for  the  foreign  taxes  up  to  the  domestic 
country's  tax  on  that  income. 

The  other  12  exempt  dividends.  They  take  the  approach  that 
they  are  not  going  to  tax  foreign  source  income  from  active  busi- 
ness at  all  and  they  just  let  the  foreign  country  tax  it.  No  country 
in  the  world  that  I  know  of,  certainly  no  industrial  country,  has  a 
deduction  system,  in  other  words  taxing  the  foreign  source  of  in- 
come of  a  multinational  and  allowing  only  a  deduction. 


1543 

Chairman  Rangel.  I  wasn't  debating  it.  I  wanted  to  make  sure 
you  agreed  with  whomever  said  it. 

Are  you  satisfied  that  if  the  tax  system  is  equitable  and  allows 
you  to  compete  based  on  taxes,  that  U.S.  businessmen  are  properly 
trained  to  negotiate  contracts  with  U.S.  firms  with  the  same  type 
of  knowledge  of  the  foreign  country's  culture  and  language? 

There  is  a  lot  of  criticism  that  tne  Japanese  and  others  know  us, 
but  that  our  people  just  get  over  there  and  they  haven't  the  slight- 
est idea  where  they  are,  what  they  are  doing  there.  That  is  not  a 
criticism.  It  is  whether  you  are  satisfied  that  U.S.  business  people 
that  you  represent  are  just  as  competitive  as  foreign  business  peo- 
ple, leaving  the  tax  question  aside? 

If  you  are  not,  is  there  any  reading  in  the  industry  that  you 
would  suggest  that  most  of  you  look  at  and  could  affirmatively  say 
that  this  is  an  area  that  we  have  to  shore  up  and  make  certain 
that  our  people  are  more  competitive  and  better  understanding  of 
where  we  want  to  go? 

Mr.  WlACEK.  This  is  a  personal  observation  based  on  my  own 
practice  and  experience  and  less  on  member  companies  of  ECAT. 
I  would  say  that  we  are  extremely  competitive  in  Europe.  For  ex- 
ample, in  recent  years  the  profits  of  European  subsidiaries  of  U.S. 
firms  provided  the  necessary  cash  flow  to  keep  the  competitive  door 
open. 

I  spent  the  last  week  in  Japan  and  it  is  quite  different  there.  I 
think  it  is  probably  hard  for  our  people.  I  was  there  with  U.S.  busi- 
nessmen looking  at  their  Japanese  subsidiary  and  their  Japanese 
operations.  The  language  is  a  lot  different  from  European  lan- 
guages, the  alphabet  is  different  as  are  ways  of  conducting  busi- 
ness. 

Chairman  Rangel.  Do  you  see  that  as  a  part  of  our  foreign  pol- 
icy that  we  are  moving  our  educational  systems  toward  a  global 
competitive  position  in  terms  of  languages  and  skills? 

Mr.  WlACEK.  The  fact  that  we  are  talking  about  it  I  think  is  a 
major  improvement  over  maybe  a  decade  ago. 

Chairman  Rangel.  Does  everyone  agree  that  there  has  been  a 
major  improvement  in  terms  of  our  ability  to  deal  in  Asia  gen- 
erally? I  am  talking  about  Singapore  and  Hong  Kong,  Taiwan  and 
China  as  well  as  Japan.  Is  everyone  satisfied  that  when  you  meet 
your  counterparts  in  the  hotel  lobbies  with  your  Japanese  competi- 
tors, that  we  are  OK? 

After  all,  I  am  not  in  that.  You  probably  hear  a  lot  of  unfair  criti- 
cism about  politicians  and  Members  of  Congress,  but  some  of  the 
foreigners  like  to  tweak  us  about  not  being  able  to  live  up  to  our 
reputation.  They  laugh  sometimes  at  what  we  send  over  there. 
Many  times  we  find  ourselves  as  being  salesmen  for  American 
firms  that  are  competing  in  countries  that  we  are  visiting  only  to 
find  out  that  we  were  ignored. 

Some  of  the  responses,  not  necessarily  true,  meant  that  we  never 
really  gave  the  type  of  presentation  that  Japan  had  given  and 
other  countries  had  given.  Again  I  don't  say  this  as  a  criticism,  but 
I  think  the  Congress  has  a  responsibility  if  not  in  this  committee 
but  in  others,  not  just  to  deal  with  taxes  to  make  us  competitive, 
but  to  deal  with  the  whole  ball  of  wax. 


1544 

If  you  have  any  ideas  that  you  could  send  to  me  that  I  could 
present  to  the  full  committee  to  make  our  team  more  competitive, 
taking  into  full  consideration  that  your  primary  purpose  is  to  deal 
with  the  tax  exemption,  I  would  appreciate  it. 

Second,  I  accept  the  fact  that  you  believe  that  exports  create 
more  jobs  and  higher-paying  jobs  and  all  of  you  believe  that  the 
North  American  Free-Trade  Agreement  would  do  just  that  and  all 
of  you  would  support  it. 

1  would  ask  the  same  question  in  a  different  way:  Do  you  believe 
that  Americans  who  would  be  involved  in  manufacturing  and  in 
selling  services  and  in  taking  over  these  high-tech  jobs — are  we 
ready  to  do  it,  assuming  everything  works,  increase  in  commerce, 
increase  in  the  economy? 

Are  you  satisfied  that  our  education  and  training  system  is 
geared  so  that  when  the  opportunity  comes,  we  are  ready,  and  is 
there  any  talk  about  the  number  of  people  in  America  that  are  not 
involved  in  all  this  competition  that  you  are  talking  about?  They 
are  in  jails  or  in  the  streets  or  are  really  unemployable.  The  last 
thing  in  the  world  that  we  can  talk  about  as  a  country  is  support- 
ing them,  losing  the  potential,  losing  the  tax  revenue,  and  losing 
the  skills. 

The  last  administration  said  it  was  costing  us  now  $300  billion 
a  year  when  you  throw  in  productivity  and  lost  revenue.  Is  this 
anything  that  is  discussed  in  board  rooms  or  do  you  just  believe  the 
Congress  and  local  governments  are  going  to  handle  it? 

Is  there  anyone  who  doesn't  understand  the  question? 

Mr.  Green.  I  understand  the  question. 

Chairman  Rangel.  I  am  talking  about  competition.  The  same 
thing  you  are  talking  about  with  taxes,  I  am  just  talking  about  the 
whole  package.  I  would  hate  to  believe  that  we  gave  you  a  favor- 
able tax  package  and  sent  people  to  go  abroad  and  everything 
worked  out  and  then  we  fall  down  in  some  other  area, 

Mr.  Merrill.  Mr.  Rangel,  I  think  I  understand  the  issue,  that 
as  we  compete  in  a  global  economy,  some  of  our  population  will  be 
left  behind  and  some  will  prosper.  Those  that  have  the  skills,  the 
education  and  languages  will  prosper. 

Chairman  Rangel.  Sounds  like  it  is  something  that  we  can  toler- 
ate, and  so  I  am  not  the  least  bit  concerned  that  everyone  doesn't 
make  it  with  those  people  that  do.  This  is  something  you  have  to 
expect,  you  are  handicapped.  Those  that  are  exposed  to  opportuni- 
ties and  don't  accept  it — I  write  that  off.  I  am  really  talking  about 
as  a  percentage  of  our  population  and  a  percentage  of  the  amount 
that  we  have  to  expend  to  support  these  people  that  have  the  po- 
tential— I  am  not  talking  about  some  in  the  sense  that  some  busi- 
ness failed  and  some  business  succeeds  and  therefore  we  just  have 
to  fold  that  in. 

To  reword  it,  is  the  some  that  you  are  thinking  about  sufficient 
enough  to  review  that  it  could  impede  our  progress  in  these  areas, 
or  do  you  believe  that  the  success  will  just  consume  these;  that  it 
is  a  minor  setback? 

Mr,  Merrill,  I  was  going  to  say  that  there  are  perhaps  two 
strategies  for  addressing  the  problem.  One  is  to  wall  off  the  U.S. 
economy  from  competition  with  the  rest  of  the  world,  protect  U.S. 
workers  from  low-wage  workers  in  other  countries. 


1545 

Chairman  Rangel.  Are  you  saying  that  my  question  is  so  insig- 
nificant that  the  only  answer  to  it  would  be 

Mr.  Merrill.  No,  I  am  not. 

Chairman  Rangel.  Does  my  question  make  you  think  that  the 
answer  could  possibly  be — what  would  make  you  think  that  is  one 
answer? 

Mr.  Merrill.  I  think  we  have  in  fact  testimony  submitted  today 
arguing  in  fact  that  we  should  erect  high  tax  barriers  to  U.S.  com- 
panies operating  abroad  to  help  the  domestic  work  force. 

Chairman  Rangel.  I  think  I  made  it  clear  that  assuming  that 
you  are  satisfied  with  the  tax  policy  and  I  was  talking  about  an- 
other policy,  which  I  just  don't  remember  suggesting  that  it  meant 
to  protect  American  labor  and  build  up  a  wall  of  competition — I 
can't  even  see  where  you  got  that  idea.  You  are  looking  at  me  and 
thinking  that  may  be  a  view  I  had  and  didn't  express — I  am  talk- 
ing about  what  I  expressed.  I  am  not  talking  about  those  people 
who  are  working  that  would  lose  their  jobs  or  that  would  get  lost 
in  the  transition. 

You  expect  that  if  you  are  making  trucks  and  converting  them 
to  boats,  somebody  is  going  to  lose  their  job.  I  am  asking  do  you 
have  people  that  can  make  boats?  I  am  also  asking  whether  or  not 
you  believe  we  have  a  sufficient  labor  market,  whether  or  not  the 
burden  of  the  unemployed  and  the  unemployable  is  a  burden  that 
is  so  heavy  that  it  might  impede  or  is  it  just  something  that  every 
industrialized  country  has  to  accept? 

It  has  nothing  to  do  with  building  up  walls  unless  you  can  show 
me  how  that  works. 

Mr.  Merrill.  Perhaps  I  misunderstood  your  question.  The  strat- 
egy that  I  would  advocate  is  a  strategy  that  says  that  we  do  not 
attempt  to  protect  the  U.S.  economy  from  competition  abroad  that 
might  be  injurious  to  some  of  our  workers,  but  instead 

Chairman  Rangel.  Did  I  say  anything  that  inferred  that  we 
should  stop  competition  from  abroad?  I  thought  I  was  suggesting 
that  if  we  can  make  American  firms  more  competitive,  if  we  can 
increase  their  economy  and  get  them  more  involved,  that  would  in- 
crease demand  and  therefore  look  to  the  United  States  as  a  larger 
producer,  increase  our  exports  and  then  deal  with  the  high-tech 
jobs. 

No,  it  is  clear  that  I  don't  have  the  ability  to  make  my  question- 
ing clear  to  you. 

Mr.  WlACEK.  Mr.  Chairman,  you  asked  a  moment  ago  whether 
any  of  us  understand  the  question  and  do  we  know  if  our  clients 
or  member  organizations  are  concerned  with  such  important  issues. 

I  think,  yes,  certainly  they  are.  I  think  it  is  an  interesting  and 
important  discussion  and  catches  a  few  of  us  flat  footed  who  are 
here  to  talk  about  other  issues.  It  is  clearly  the  bigger  issue.  A 
number  of  the  member  companies  in  ECAT  are  companies  that  you 
know  with  headquarters  in  New  York  City,  that  have  CEOs  that 
are  friends  of  yours,  that  have  stayed  in  the  city  as  other  people 
have  left  the  city,  and  I  know  from  these  people  that  they  care  very 
much  and  are  concerned  about  the  educational  abilities  of  the 
American  labor  force,  and  are  also  greatly  concerned  about  the  ef- 
fect of  crack  and  other  things  in  our  cities. 


1546 

I  am  from  Detroit  and  grew  up  in  the  inner  city.  When  I  go  back 
there,  Detroit  is  just  a  wasteland;  it  is  appalHng.  These  discussions 
are  held  and  corporations  support  programs  wnere  they  can,  and 
we  have  to  keep  doing  more. 

I  don't  have  an  answer  for  you. 

Chairman  Range L.  But  you  are  right  on  target  and  I  don't  expect 
that  corporations  would  do  any  more  than  be  helpful  as  they  have 
in  New  York  with  the  partnership  and  the  Chamber  of  Commerce 
and  the  variety  of  other  type  of  agreements  and  working  with  local, 
State  and  Federal  Government  and  we  do  hope  even  the  pilot  dem- 
onstration projects  in  connection  with  the  enterprise  zones  will  be 
a  test  place  for  the  corporate  structure  and  government  to  see  what 
we  are  doing  wrong,  what  we  are  doing  right  and  how  we  can  do 
it  better. 

You  are  right  on  target  with  the  thrust  of  my  question.  I  hoped 
that  maybe  in  the  private  sector  they  might  have  suggestions  as  to 
how  we  could  perfect  a  better  labor  market,  how  we  could  have 
people  that  would  think  in  terms  of  whether  or  not  they  prospered 
this  year  or  the  next  decade  that  there  was  hope  that  maybe  the 
kids  would  be  involved  with  this  rising  tide. 

As  we  had  with  all  of  us  who  came  to  this  country  from  some 
other  country,  it  wasn't  a  question  as  to  whether  we  were  going  to 
get  rich  merely  because  the  corporations  received  more  favorable 
tax  treatment  or  were  able  to  get  large  sums  of  moneys.  We  accept 
the  fact  that  is  where  investment  comes  from,  but  there  is  also  the 
hope  with  the  emigrants  that  the  kids  and  g^andkids  would  do  bet- 
ter. 

To  me  it  is  not  a  problem  of  the  poor  and  communities  that  I  rep- 
resent. It  should  be  an  American  problem  and  I  don't  expect  that 
the  private  sector  would  say  they  have  the  answer,  but  to  use  their 
influence  to  be  able  to  push  their  governments,  local.  State  and 
Federal,  to  make  certain  that  when  they  are  ready  to  move  forward 
and  compete  that  America  gives  us  the  type  of  labor  market  in  all 
areas  that  you  would  be  able  to  be  superior  as  the  United  States 
used  to  enjoy. 

Because  of  the  sensitivity  of  the  question,  many  people  would 
think  that  just  showing  some  concern  and  compassion  about  this, 
that  automatically  you  are  talking  about  protectionism  and  that 
you  want  to  build  a  wall  between  other  countries  and  that  you 
don't  want  to  compete  and  that  we  all  will  just  be  poor  here  to- 
gether, and  I  didn't  mean  to  suggest  that  with  my  question  and  I 
will  work  hard  to  rewrite  those  questions  so  that  it  would  not  be 
offensive  to  any  of  you. 

Thank  you  very  much  and  I  may  send  other  questions  to  you  in 
writing. 

Our  last  panel — I  apologize  for  the  delay  in  getting  to  you.  We 
have  here  contractors — Don  Owen,  executive  vice  president,  P&P 
Contractors,  Associated  Builders  and  Contractors,  Rockville;  Asso- 
ciated General  Contractors  of  America,  Robert  Desjardins,  execu- 
tive vice  president  and  treasurer,  Cianbro  Corp.  from  Maine;  Ger- 
ald Herr,  vice  chairman,  Washington  Interest  Program  Committee; 
Sally  Sumner,  chairperson,  Nurse  Brokers  and  Contractors  of 
America;  James  C.  Pyles,  counsel.  Home  Health  Services  and  Staff- 
ing Association. 


1547 

Your  full  statements  will  be  in  the  record.  I  hope  you  manage  to 
include  the  fact  for  those  who  believe  there  is  a  role  for  the  inde- 
pendent contractors,  that  you  deal  with  the  question  of  abuse 
which  is  probably  the  biggest  problem  that  we  face,  abuse  and  fail- 
ure to  pay  health  benefits  and  Social  Security. 

Don  Owen. 

STATEMENTT  OF  DON  OWEN,  EXECUTIVE  VICE  PRESIDENT, 
P&P  CONTRACTORS,  INC.,  ROCKVILLE,  MD.,  ON  BEHALF  OF 
ASSOCIATED  BUILDERS  &  CONTRACTORS,  INC. 

Mr.  Owen.  Grood  afternoon,  Mr.  Chairman. 

I  am  Don  Owen  and  I  am  pleased  to  testify  on  behalf  of  the  Asso- 
ciated Builders  and  Contractors.  I  am  executive  vice  president  of 
P&P  Contractors.  We  are  a  drywall  contracting  business  located 
here  in  the  Washington  metropolitan  area,  Rockville,  Md. 

ABC  is  a  national  trade  association  which  represents  nearly 
16,000  builders,  contractors  and  construction-related  employers. 
We  acknowledge  that  the  independent  contractor  issue  is  controver- 
sial and  has  been  the  topic  of  many  congressional  hearings  through 
the  years. 

The  Associated  Builders  and  Contractors  is  opposed  to  the  pro- 
posal, which  would  repeal  the  safe  harbor  under  section  530  of  the 
Revenue  Act  of  1978  which  relates  to  the  classification  of  workers 
as  independent  contractors.  We  emphasize  that  section  530  is  not 
the  cause  of  worker  misclassification  problems  that  may  exist  in 
the  construction  industry.  Further,  we  do  not  believe  that  repealing 
section  530  for  construction  employers  will  cause  the  problem  of 
worker  misclassification  to  go  away. 

ABC  is  absolutely  committed  to  upholding  proper  business  prac- 
tices. We  believe  unscrupulous  contractors  who  shirk  their  respon- 
sibilities or  knowingly  misclassify  their  workers  should  definitely 
be  held  accountable  under  the  law.  In  our  business,  contractors 
who  practice  misclassification  have  an  unfair  competitive  edge  over 
those  of  us  who  play  by  the  rules. 

At  the  same  time,  there  are  certain  segments  of  the  construction 
industry  where  the  legitimate  use  of  independent  contractors  is 
common,  particularly  in  drywall  contracting.  These  are  licensed,  in- 
sured small  contractors  or  subcontractors  who  may  work  on  a  sin- 
gle major  project  for  one  contractor  and  then  move  on  to  other  con- 
tractors through  the  years.  But  the  fact  that  they  stay  on  one 
proiect  for  a  long  period  of  time  often  brings  up  this  issue  of  control 
of  the  personnel,  which  leads  to  questions  over  misclassification. 

Under  the  20  common  law  point  test,  these  contractors  can  occa- 
sionally be  misinterpreted  as  employees.  By  virtue  of  standard  in- 
dustry practice,  however,  they  are  not.  Instead  it  is  generally  ac- 
cepted that  they  are  in  fact  independent  contractors. 

Also  it  is  not  uncommon  for  people  who  are  involved  in  our  busi- 
ness as  employees  to  work  during  off  hours  and  weekends  as  inde- 
pendent contractors.  This  is  how  many  small  contractors  get  their 
start,  especially  those  who  are  economically  disadvantaged. 

In  fact,  my  company  was  started  in  this  manner  back  in  1963. 
Our  founders  were  French  Canadian  Americans  who  barely  were 
able  to  speak  English  who  were  given  an  opportunity  by  an  estab- 
lished progressive  contractor.   Today   we  are   one   of  the   largest 


1548 

drywall  contractors  in  the  Nation  and  have  also  empowered  dozens 
of  new  viable  subcontractors  over  the  years.  Some  are  very  strong 
competitors,  I  might  add,  at  this  time. 

ABC  believes  this  particular  proposal  will  hurt  the  gn^owth  poten- 
tial of  new  startup  enterprises  because  established  contractors  will 
be  less  likely  to  risk  creating  subcontracting  opportunities.  This 
comes  at  a  time  when  we  are  actively  pursuing  new  startup  minor- 
ity, women  owned  and  other  DBE  subcontractors  for  both  private 
sector  jobs  and  Federal  projects,  some  of  which  require  this  type  of 
minority  participation  on  jobs. 

We  suggest  that  the  committee  look  back  to  the  concessional  in- 
tent behmd  section  530.  While  there  may  be  room  for  improvement 
to  the  statute,  we  believe  that  section  530  has  served  an  important 
purpose  and  is  not  merely  a  convenient  loophole  for  businesses. 

ABC  recommends  that  the  committee  consider  amending  section 
530  so  that  the  IRS  is  free  to  publish  guidance  on  employee  inde- 
pendent contractor  status  through  regulations  or  rulings.  Congress 
should  tackle  the  ambiguous  20  point  common  law  test  and  work 
on  better  defining  worker  classifications,  while  recognizing  the  va- 
lidity of  independent  contractors,  such  as  small  startup  contractors 
who  deserve  full  opportunity  to  grow  and  prosper. 

ABC  believes  that  targeting  construction  on  the  basis  of  other 
shortcomings  which  exist  in  employment  law  is  unfair.  Therefore 
we  urge  the  committee  to  drop  this  proposal  from  consideration. 

Thank  you  for  this  opportunity.  ABC  looks  forward  to  working 
with  this  committee  on  this  issue  in  any  way  that  we  can  be  help- 
ful. I  will  be  submitting  a  full  statement  for  the  record. 

Thank  you. 

[The  prepared  statement  follows:] 


1549 


TESTIMONY  OF  DON  OWEN,  EXECUTIVE  VICE  PRESIDENT 
P  &  P  CONTRACTORS,  INC  ,  ROCKVILLE,  MARYLAND 

REPRESENTING 


ASSOCIATED  BUILDERS  &  CONTRACTORS 

1300  NORTH  SEVENTEENTH  STREET 

ROSSLYN,  VA  22209 


BEFORE  THE  SELECT  REVENUES  MEASURES  SUBCOMMITTEE 
COMMITTEE  ON  WAYS  AND  MEANS 
US   HOUSE  OF  REPRESENTATIVES 

A  PROPOSAL  TO  REPEAL  THE  SAFE  HARBOR  UNDER  SECT-ON  530  OF  THE 
REVENUE  ACT  OF  1978  (RELATING  TO  THE  CLASSIFICATION  OF  WORKERS  AS 
INDEPENDENT  CONTRACTORS)  FOR  CONSTRUCTION  INDUSTRY  EMPLOYERS 


SEPTEMBER  21,  1993 


MR  CHAIRMAN  AND  HONORABLE  MEMBERS  OF  THE  SUBCOMMITTEE.  MY 
NAME  IS  DON  OWEN  AND  I  AM  PLEASED  TO  TESTIFY  ON  BEHALF  OF  THE 
ASSOCIATED  BUILDERS  AND  CONTRACTORS  (ABC)     I  AM  EXECUTIVE  VICE 
PRESIDENT  OF  P&P  CONTRACTORS,  A  DRYWALL  CONTRACTING  BUSINESS    IN 
ROCKVILLE,  MARYLAND 

ABC  IS  A  NATIONAL  TRADE  ASSOCIATION  WHICH  REPRESENTS  NEARLY  16 
THOUSAND  BUILDERS,  CONTRACTORS  AND  CONSTRUCTION  RELATED 
EMPLOYERS 

AS  THE  MEMBERS  OF  THE  SUBCOMMITTEE  KNOW.  THE  INDEPENDENT 
CONTRACTOR  ISSUE  HAS  BEEN  AROUND  FOR  MANY  YEARS  AND  IS  ALWAYS 
CONTROVERSIAL      TODAY  WE  ARE  HERE  TO  DISCUSS  A  VERY  SPECIFIC 
PROPOSAL  AFFECTING  EMPLOYMENT  LAW     BEFORE  I  GET  TO  THAT  I  WANT  TO 
REITERATE  ABC'S  POSITION  ON  THE  MATTER  OF  INDEPENDEI-JT  CONTRACTORS 
AND  DESCRIBE  HOW  INDEPENDENT  CONTRACTORS  ARE  USED  IN  THE 
DRYWALL  BUSINESS 

ABC  IS  COMMITTED  TO  UPHOLDING  PROPER  BUSINESS  PRACTICES     FROM  TIME 
TO  TIME  OUR  ASSOCIATION  HEARS  FROM  FRUSTRATED  MEMBERS  WHO 
COMPLAIN  THEY  HAVE  BEEN  HARMED  BY  INDEPENDENT  CONTRACTOR  ABUSE 
OUR  MEMBERS  OBJECT  TO  UNSCRUPULOUS    CONTRACTORS  WHO  FAIL  TO  PAY 
FEDERAL  AND  STATE  PAYROLL  TAXES,  WORKERS  COMPENSATION,  PLUS 
HEALTH  INSURANCE  AND  PENSION  CONTRIBUTIONS     BY  AVOIDING   THESE 
TAXES  AND  OTHER  COSTS,  SUCH  CONTRACTORS  HAVE  AN  UMFAIR 
COMPETITIVE  EDGE  IN  THE  BIDDING  PROCESS       THOSE  INDIVIDUALS,  WHO  IN 
BAD  FAITH  WRONGFULLY  CLASSIFY  THEIR  WORKERS  FOR  ECONOMIC  GAIN, 
SHOULD  PAY  THE  PRICE 


IN  MY  BUSINESS,  INDEPENDENT  CONTRACTORS  ARE  USED  FOR  SPECIFIC 
TRADE  TASKS  SUCH  AS  FRAMING  CREWS,  DRYWALL  HANGING  AND  FINISHING 


1550 


CREWS,    THESE  ARE  SMALL,  INSURED  CONTRACTORS  WHO  MOVE  FROM  JOB 
TO  JOB,  COMPANY  TO  COMPANY  AND  WORK  INDEPENDENTLY    THIS  SYSTEM 
IS  USED  ONLY  FOR  MAJOR  PRODUCTION  JOBS,  NOT  SMALL  JOBS  OR  PROJECTS 
WHICH  WE  FULLY  "CONTROL  "    IT  IS  NOT  UNUSUAL  FOR  THESE  INDIVIDUALS 
TO  WORK  AS  EMPLOYEES  DURING  REGULAR  HOURS  AND  AS  INDEPENDENT 
CONTRACTORS  DURING  OFF-HOURS  AND  WEEKENDS    THIS  IS  THE  WAY  MANY 
OF  OUR  MEMBERS  GOT  THEIR  START  RUNNING  THEIR  OWN  BUSINESS.     HENCE, 
THIS  PRACTICE  ALLOWS  SMALL  CONTRACTORS   TO  GROW  AND  PROSPER  AND 
IN  FACT,  BECOME  COMPETITORS.     UNDER  THE  20  COMMON  LAW  POINT  TEST 
THESE  CONTRACTORS  CAN  OCCASIONALLY  BE  MISINTERPRETED  AS 
EMPLOYEES.    BY  VIRTUE  OF  STANDARD  INDUSTRY  PRACTICE,  HOWEVER,  THEY 
ARE  NOT.    INSTEAD,  IT  IS  GENERALLY  ACCEPTED  THAT  THEY  ARE 
INDEPENDENT  CONTRACTORS 

AS  WE  SAID  IN  OUR  TESTIMONY  BEFORE  THIS  SUBCOMMITTEE  IN  JULY  OF 
LAST  YEAR,   ABC  SUPPORTS  EFFORTS  BY  CONGRESS  TO  CLARIFY,  MODERNIZE 
AND  IMPROVE  THE  TAX  TREATMENT  OF  WORKERS     CLEARLY  THE  REPEAL 
PROPOSED  TODAY  WILL  NEITHER  IMPROVE  OR  CLARIFY  THOSE  PROBLEMS  OR 
OTHERS  ASSOCIATED  WITH  SECTION  530 

IT  COMES  AS  NO  SURPRISE  THAT  ABC  STRONGLY  OPPOSES  THE  REPEAL  OF 
THE  SAFE  HARBOR  UNDER  SECTION  530  OF  THE  REVENUE  ACT  OF  1978 
(RELATING  TO  THE  CLASSIFICATION  OF  WORKERS  AS  INDEPENDENT 
CONTRACTORS)  FOR  CONSTRUCTION  INDUSTRY  EMPLOYERS 

THIS  PROPOSAL  WILL  SEVERELY  IMPACT  THE  NURTURING  AND 
ESTABLISHMENT  OF  NEW,  INDEPENDENT  BUSINESSES    MANY  OF  OUR 
MINORITY  BUSINESS  ENTERPRISES  (MBE),  WOMEN  BUSINESS  ENTERPRISES 
(WBE)    AND  DISADVANTAGED  BUSINESS  ENTERPRISE  (DBE)  MEMBERS  COULD 
NOT  BUILD  UP  THEIR  BUSINESSES  IF  THEY  COULD  NOT  WORK  AS 
INDEPENDENT  CONTRACTORS  WHILE  BEING  EMPLOYED  DURING  REGULAR 
HOURS  AS  AN  EMPLOYEE 

THIS  ITEM  IS  ON  THE  AGENDA  SINCE  IT  IS  A  POSSIBLE  REVENUE  RAISER  THE 
IRS  HAS  SINGLED  OUT  THE  CONSTRUCTION  INDUSTRY  AS  AN  ABUSER 
BECAUSE  IRS    RESEARCH   REVEALS  PATTERNS  OF  NONCOMPLIANCE  IN  THIS 
AREA     THE  INDUSTRY,  AS  A  WHOLE,  FACES  A  UNIQUE  PROBLEM  DUE  TO  ITS 
HIGH  NUMBER  OF  TRANSIENT  AND  SEASONAL  WORKERS      AS  RECENTLY  AS 
THIS  SUMMER  THE  HOUSE  APPROPRIATIONS  COMMITTEE    EXPRESSED 
"CONCERN  THAT  SOME  CONTRACTORS  IN  THE  CONSTRUCTION  INDUSTRY  ARE 
MISCLASSIFYING  EMPLOYEES  AS  INDEPENDENT  CONTRACTORS  "    THE 
COMMITTEE  INSTRUCTED  THE  IRS  TO  HIRE  AND  TRAIN  ADDITIONAL  AUDIT 
PERSONNEL  TO  ENFORCE  CLASSIFICATION  RULES  FOR  CONS  FRUCTION    THE 
IRS  IS  ALSO  CHARGED  WITH  REPORTING  BACK  TO  THE  COMVOTTEE  ON  ITS 
FINDINGS  OF  MISCLASSIFICATION  WITHIN  CONSTRUCTION,  IMCLUDING  ,  ON  A 
STATE  BY  STATE  BASIS,  THE  NUMBER  OF  INVESTIGATIONS  IT  HAS 
UNDERTAKEN 

THE  COMMITTEE  MUST  REMEMBER  THAT  SECTION  530  IS  NOT  THE  CAUSE  OF 
WORKER  MISCLASSIFICATION  PROBLEMS  THAT  SUPPOSEDLY  EXIST  IN  THE 
CONSTRUCTION  INDUSTRY    ELIMINATING  THIS  PROTECTION  FOR 
CONSTRUCTION  IS  UNWARRANTED  AND  WILL  CAUSE  THE  DEMISE  OF  MORE 
BUSINESSES  IN  AN  INDUSTRY  THAT  LOST  NEARLY  A  MILLION  JOBS  DURING 
THE  RECENT  RECESSION    BEFORE  ACTING  HASTILY,  ABC  BELIEVES  IT  IS 
IMPORTANT  TO  EXAMINE  THE  ORIGINS  OF  SECTION  530  AND  THE  INTENT  OF 
CONGRESS  IN  CREATING  THE  PROVISION     SECTION  530  WAS  INITIALLY 
INTENDED; 

"TO  PROVIDE  INTERIM  RELIEF  FOR  TAXPAYERS  WHO  ARE  INVOLVED  IN 
EMPLOYMENT  TAX  STATUS  CONTROVERSIES  WITH  THE  IRS  AND  WHO 
POTENTIALLY  FACE  LARGE  ASSESSMENTS,  AS  A  RESULT  OF  THE 


1551 


SERVICE'S  PROPOSED  RECLASSIFICATION  OF  WORKERS,  UNTIL  THE 
CONGRESS  HAS  ADEQUATE  TIME  TO  RESOLVE  THE  MANY  COMPLEX 
ISSUES  INVOLVED  IN  THIS  AREA  "  [General  Explanation  of  the  Revenue  Act  of 
1978  prepared  by  the  Staff  of  the  Joint  Committee  on  Taxation,  p   301] 

THE  TAX  EQUITY  AND  FISCAL  RESPONSIBILITY  ACT  OF  1982  MADE  RELIEF 
PERMANENT  BECAUSE  CONGRESS  FAILED  TO  ESTABLISH  NEW  STANDARDS 
FOR  DETERMINING  INDEPENDENT  CONTRACTOR/EMPLOYEE  STATUS 

SECTION  530  WAS  CREATED  AS  A  WAY  TO  RESOLVE  DIFFICULT  PROBLEMS    IN 
AN  ACKNOWLEDGED  AMBIGUOUS  AREA     SECTION  530  PROHIBITS  THE  IRS 
FROM  CORRECTING  ERRONEOUS  CLASSIFICATIONS  OF  WORKERS  AS 
INDEPENDENT  CONTRACTORS  FOR  EMPLOYMENT  TAX  PURPOSES,  INCLUDING 
PROSPECTIVE  CORRECTIONS,  AS  LONG  AS  THE  EMPLOYER  HAS  A  REASONABLE 
BASIS  FOR  ITS  TREATMENT  OF  THE  WORKERS  AS  INDEPENDENT 
CONTRACTORS      ACCORDING  TO  ACCOMPANYING  REPORT  LANGUAGE 
"REASONABLE  BASIS'  IS  TO  BE  CONSTRUED  LIBERALLY  IN  FAVOR  OF  THE 
TAXPAYER.  (See  H.R.  Rep.  No.  95-1748,  95th  Cong ,  2d  Sess  5  1978,  1978-3  Vol    1  C.B. 
629,633.) 

THE  TAXPAYER  CAN  SATISFY  THE  REASONABLE  BASIS  BY  MEETING  ONE  OF 
THREE  STATUTORY  SAFE  HAVENS  OR  BY  DEMONSTRATING  BY  OTHER 
REASONABLE  MEANS  A  BASIS  FOR  THE  EMPLOYER'S  TREATMENT  OF  THE 
WORKER    THE  THREE  STATUTORY  SAFE  HARBORS  INCLUDE  RELIANCE  ON:  1) 
JUDICIAL  PRECEDENT,  PUBLISHED  RULINGS,  LETTER  RULINGS  OR  TECHNICAL 
ADVICE  MEMORANDA,  2)  A  PAST  IRS  AUDIT.  3)  A  LONG-STANDING 
RECOGNIZED  PRACTICE  OF  A  SIGNIFICANT  SEGMENT  OF  THE  INDUSTRY  IN 
WHICH  THE  WORKER  WAS  ENGAGED    THERE  IS  NO  REQUIRI:MENT  THAT  THE 
PRACTICE  BE  UNIFORM  THROUGHOUT  AN  INDUSTRY. 

RELIEF  UNDER  SECTION  530  IS  CONTINGENT  ON  THE  EMPLOYER 
CONSISTENTLY  TREATING  THE  WORKER  OR  ANY  OTHER  WORKER  SIMILARLY 
SITUATED,  AS  AN  INDEPENDENT  CONTRACTOR    THE  EMPLOYER  MUST 
FOLLOW  THE  STATUTORY  REQUIREMENTS  FOR  PAYMENTS  TO  INDEPENDENT 
CONTRACTORS  AS  WELL 

ABC  NOTES  THAT  IN  ORDER  FOR  A  BUSINESS  TO  QUALIFY  FOR  SECTION  530 
PROTECTION,  STRICT  CONDITIONS  FOR  ELIGIBILITY  MUST  BE  MET    WE  DO 
BELIEVE  THERE  IS  ROOM  FOR  IMPROVEMENT  IN  SECTION  530,  ESPECIALLY 
THAT  PORTION  WHICH  PREVENTS  THE  IRS  FROM  PUBLISHIN(}  GUIDANCE  ON 
EMPLOYEE/INDEPENDENT  CONTRACTOR  STATUS  THROUGH  REGULATIONS  OR 
RULINGS    CONGRESS  SHOULD  START  HERE  TO  CRAFT  A  LEGISLATIVE 
SOLUTION  AIMED  AT  THE  HEART  OF  THE  PROBLEM,  WHICH  IS  CLARIFYING 
WORKER  CLASSIFICATION 

AS  STATED  EARLIER,  THE  ISSUE  OF  WORKER  MISCLASSIFICATION  CONTINUES 
TO  CROP  UP  IN  CONGRESS     ALTHOUGH  TODAY'S  HEARING  DOES  NOT  CALL 
FOR  SPECIFIC  WAYS  TO  REVAMP  THE  SYSTEM,  ABC  HAS  REC  OMMENDATIONS 
FOR  CERTAIN  AREAS  WE  BELIEVE  CAN  BE  IMPROVED  UPON 

FOR  INSTANCE,  THE  CURRENT  IRS  TEST  USING  20  COMMON  LAW  FACTORS  TO 
DETERMINE  WORKER  CLASSIFICATION  LEAVES  TOO  MUCH  ROOM  FOR 
GUESSWORK    THE  VAGUE  GUIDELINES  AND  THEIR  INCONSISTENT 
APPLICATION  CONTRIBUTE  TO  THE  CONFUSICW     IF  CONGRESS  OR  THE  IRS  IS 
SERIOUS  ABOUT  CRACKING  DOWN  ON  ABUSE,  INSTEAD  OF  TAKING  A  SWIPE  AT 
A  SINGLE  INDUSTRY  GROUP,  WE  SUGGEST  ANOTHER  APPROACH    ABC 
BELIEVES  THAT  CONGRESS  AND  THE  IRS  NEED  TO  DO  THE  FOLLOWING  THREE 
THINGS;    1)   RECOGNIZE  THE  VALIDITY  OF  INDEPENDENT  CONTRACTORS  IN 
CERTAIN  SECTORS  OF  THE  WORKPLACE;    2)    PROVIDE  WORKABLE  DEFINITIONS 
AND  A  SET  OF  RULES  TO  DISTINGUISH  INDEPENDENT  CONTRACTORS  FROM 
EMPLOYEES;  3)  ENFORCE  THEM  ACROSS  THE  BOARD 


1552 


ABC  WELCOMES  THE  OPPORTUNITY  TO  WORK  WITH  MEMBERS  OF  THE 
COMMITTEE  AND  OTHERS  IN  CONGRESS  CONCERNED  ABOUT  INDEPENDENT 
CONTRACTORS    WE  URGE  YOU  TO  OPPOSE  THIS  PARTICULAR  PROVISION 
THOUGH,  IN  LIGHT  OF  THE  DETRIMENTAL  EFFECTS  IT  WILL  HAVE  ON 
CONSTRUCTION  EMPLOYERS  AND  ITS  FAILURE  TO  ACCOMPLISH  INCREASED 
COMPLIANCE. 


THANK  YOU  FOR  YOUR  CONSIDERATION 


1553 

Chairman  Rangel.  Thank  you.  All  of  the  witnesses'  entire  writ- 
ten statements  will  be  entered  into  the  record,  without  objection. 
We  will  now  hear  from  Mr.  Desjardins. 

STATEMENT  OF  ROBERT  J.  DESJARDINS,  EXECUTIVE  VICE 
PRESIDENT  AND  TREASURER,  CIANBRO  CORP.,  PITTSFIELD, 
MAINE,  AND  CHAIRMAN,  TAX  AND  FISCAL  AFFAIRS  COMMIT- 
TEE, ASSOCIATED  GENERAL  CONTRACTORS  OF  AMERICA 

Mr.  Desjardins.  Grood  afternoon,  Mr.  Chairman.  I  am  Robert 
Desjardins,  the  executive  vice  president  and  treasurer  of  Cianbro 
Corporation  of  Pittsfield,  Maine.  We  are  one  of  the  larger  construc- 
tion companies  building  projects  in  the  Northeast  and  MidAtlantic 
States.  I  also  serve  as  chairman  of  the  Tax  and  Fiscal  Affairs  Com- 
mittee of  the  Associated  Greneral  Contractors  of  America  and  am 
before  you  today  in  that  capacity. 

My  testimony  will  be  limited  to  the  provision  discussed  at  the  be- 
ginning of  this  hearing  by  Congressmen  Kleczka,  Shays  and  Lan- 
tos.  They  advocate  the  repeal  of  the  safe  harbors  under  section  530 
of  the  Revenue  Act  of  1978  solely  for  construction  industry  employ- 
ers. I  am  here  today  to  tell  the  other  side  of  that  story. 

AGC  strongly  supports  the  safe  harbor  protections  for  individuals 
who  work  as  independent  contractors.  We  feel  that  singling  out  one 
industry,  as  this  provision  attempts  to  do,  does  nothing  to  resolve 
the  problem  of  worker  misclassification. 

Worker  misclassification  is  an  old  issue  for  the  IRS  and  for  the 
employer.  It  has  been  the  subject  of  numerous  hearings  in  this 
committee  and  other  congressional  committees,  extensive  litigation, 
as  well  as  the  topic  of  a  1992  GAO  report;  yet  the  issue  remains 
unresolved. 

The  provision  before  us  today  seeks  to  change  one  aspect  of  this 
contentious  and  problematic  issue,  but  does  nothing  to  help  solve 
it.  AGC  believes  that  repealing  the  section  530  safe  harbor  for  con- 
struction industry  employers  would  further  complicate  the  em- 
ployer-worker relationship  and  strip  away  the  only  protection  gen- 
eral contractors  have  in  dealing  fairly  with  the  IRS. 

Let  me  describe  for  you  a  history  of  section  530  and  why  this  pro- 
vision is  a  step  in  the  wrong  direction.  A  variety  of  occupational  re- 
lationships and  job  classifications  exist  in  the  American  workplace 
and  particularly  in  the  construction  industry.  However,  for  Federal 
tax  purposes,  only  two  classifications  exist.  A  worker  is  either  an 
employee  or  is  an  independent  contractor;  that  is,  self-employed. 
Significant  tax  consequences  result  from  how  a  worker  is  classified. 
Some  of  the  tax  consequences  favor  employee  status  while  others 
favor  independent  contractor  status. 

Section  530  exists  because  Congress  realized  that  independent 
contractors  contribute  a  vast  amount  of  added  value  to  economic 
production  and  because  it  is  not  fair  to  change  the  rules  after  tax- 
payers organize  their  affairs  according  to  good  faith  reliance  on  in- 
dustry practice  or  prior  IRS  determinations.  Congress  enacted 
these  protections  for  a  number  of  reasons,  but  it  is  safe  to  say  the 
legislative  history  of  section  530  supports  the  view  that  taxpayers 
ought  to  be  afforded  wide  latitude  in  asserting  or  maintaining  inde- 
pendent contractor  status. 


1554 

Specifically,  these  protections  were  established  because  individ- 
uals not  under  the  control  of  others  in  the  workplace  bear  all  the 
risk  and  expense  for  their  employment.  They  were  increasingly  vul- 
nerable to  IRS  reclassification  as  employees  subsequent  to  prior  au- 
dits in  which  their  treatment  as  independent  contractors  had  not 
been  challenged  and  after  private  letter  rulings  or  technical  advice 
memoranda  from  the  Service  had  said  that  they  were  independent 
or  after  they  had  relied  on  common  industry  practice. 

In  its  original  explanation  of  section  530  in  the  Revenue  Act  of 
1978,  the  Joint  Committee  on  Taxation  stated  that  section  530  was 
enacted  to  protect  certain  classes  of  taxpayers  fi-om  IRS  reclassi- 
fication of  independent  contractors  as  employees.  The  general  ex- 
planation says,  "Workers  shall  be  deemed  not  to  be  the  taxpayer's 
employees,  unless  the  taxpayers  had  no  reasonable  basis  for  not 
treating  the  workers  as  employees." 

The  Joint  Committee  on  Taxation  further  explained  that  the  Rev- 
enue Act  of  1978  terminated  pre- 1979  employment  tax  liabilities  of 
taxpayers  who  had  a  reasonable  basis  for  treating  workers  other 
than  as  employees.  Clearly  the  legislative  history  of  this  provision 
establishes  that  Congress  acknowledged  that  certain  taxpayers 
have  a  legitimate  basis  for  using  workers  not  considered  as  tradi- 
tional employees. 

This  "reasonable  basis"  standard  has  been  the  guiding  principle 
behind  worker  classification  since  1979.  If  there  is  any  confusion 
about  Congress'  intent  with  regard  to  the  issue  of  classification, 
any  ambiguity  is  removed  by  the  statement  in  the  general  expla- 
nation "that  Congress  intends  that  this  reasonable  basis  require- 
ment be  construed  liberally  in  favor  of  taxpayers." 

In  other  words.  Congress  intends  that  taxpayers,  including  gen- 
eral contractors,  who  use  independent  contractors,  are  to  be  af- 
forded the  benefit  of  the  doubt.  This  presumption  in  favor  of  the 
taxpayer  is  initially  accomplished  through  the  creation  of  three 
statutory  reasonable  basis  standards,  or  safe  harbors. 

The  first  safe  harbor  is  reached  if  the  taxpayer's  treatment  of  an 
individual  as  not  being  an  employee  is  due  to  reasonable  reliance 
on  judicial  precedent,  published  rulings,  or  previous  technical  ad- 
vice from  the  IRS. 

The  second  safe  harbor  is  attained  if  the  taxpayer  shows  reason- 
able reliance  on  a  past  IRS  audit. 

The  third,  and  perhaps  most  significant  safe  harbor  ft-om  the 
viewpoint  of  the  construction  industry,  is  that  the  taxpayer  relies 
on  a  longstanding,  recognized  practice  of  a  significant  segment  of 
the  industry  in  which  the  taxpayer  is  engaged.  There  is  no  require- 
ment that  the  recognized  practice  be  uniformly  followed  throughout 
an  entire  industry. 

For  example,  consider  a  situation  common  to  thousands  of  con- 
struction sites  throughout  the  country.  Individuals  contract  for 
short  periods  with  one  or  more  construction  companies  to  perform 
certain  work  on  construction  projects.  These  individuals  own  their 
own  trucks.  They  own  their  own  tools  and  may  even  pay  into  their 
own  retirement  plans.  They  are  not  told  when  to  report  to  work  or 
how  to  perform  the  work.  And  other  contractors  in  the  general  geo- 
graphic region  are  free  to  contract  with  these  individuals  or  others 
like  them  to  perform  the  same  type  of  short-term  work. 


1555 

By  any  objective  standards,  these  individuals  are  not  employees 
of  the  general  contractor,  but  without  the  protection  of  section  530, 
the  Feaeral  Government  may  determine  that  they  are,  even  after 
both  parties  have  relied  on  historic  industry  practice  or  on  prior 
IRS  advice.  If  the  government  successfully  prevails  in  a  reclassi- 
fication case  against  the  independent  contractor,  that  individual  is 
then  subject  to  withholding.  Social  Security  and  unemployment 
taxes,  none  of  which  have  been  withheld,  nor  paid  to  the  Treasury. 

Congressman  Kleczka's  provision  evolves  from  the  misconception 
that  the  construction  industry  has  greatly  abused  section  530  safe 
harbors  through  intentional  worker  misclassification  and  that  this 
abuse  is  far  greater  than  in  any  other  industry.  This  perception  is 
wrong.  There  is  simply  no  empirical  evidence  that  general  contrac- 
tors engage  in  willful,  systematic  evasion  of  the  law. 

In  fact,  former  Treasury  Assistant  Secretary  for  Tax  Policy  Fred 
Goldberg  testified  that  most  noncompliance  is  unintentional.  The 
Tax  Code  is  far  too  complex.  The  vast  majority  of  general  contrac- 
tors follow  the  law  and  make  good  faith  efforts  to  meet  the  require- 
ments of  the  code  even  when  they  do  not  fully  understand  every 
provision.  Taking  section  530  safe  harbors  away  from  the  construc- 
tion industry  is  excessive,  unnecessary  and  would  further  aggra- 
vate an  industry  experiencing  an  unemployment  rate  consistently 
twice  the  national  average. 

Before  Congress  repeals  section  530  of  the  Revenue  Act  of  1978 
solely  with  respect  to  the  construction  industry  or  for  any  other  in- 
dustry, the  IRS  must  first  augment  and  strengthen  its  manage- 
ment of  existing  programs  with  respect  to  worker  classification. 

With  regard  to  those  few  who  intentionally  violate  the  law,  our 
position  is  clear,  consistent  and  simple.  Don't  do  it.  If  you  do,  you 
should  bear  the  full  consequences  of  the  law. 

AGC  looks  forward  to  working  with  the  Committee  on  Ways  and 
Means  and  with  Congress  to  resolve  the  complex  and  important  is- 
sues relating  to  the  proper  classification  of  workers.  This  provision 
however  goes  too  far  and  would  harm  the  construction  industry. 
We  ask  you,  Mr.  Chairman,  to  refrain  from  adding  it  to  the  many 
other  provisions  that  may  ultimately  be  included  in  the  legislation 
passed  by  the  committee. 

Thank  you  for  your  time  today.  I  would  be  pleased  to  answer  any 
questions. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


1556 


TESTIMONY  OF  ROBERT  J.  DESJARDINS 
THE  ASSOCIATED  GENERAL  CONTRACTORS  OF  AMERICA 

Good  Afternoon.    My  name  is  Robert  J.  Desjardins  and  I  am  the  Executive  Vice  President 
and  Treasurer  of  Qanbro  Corporation  of  Pittsfield,  Maine.    Our  company  is  one  of  the  larger 
construction  compaiues  building  projects  in  the  Northeast  and  Mid-Atlantic  states.    I  also  serve  as 
Chairman  of  the  Tax  and  Fiscal  Affairs  Committee  of  the  Associated  General  Contractors  of 
America  and  I  am  before  you  today  in  that  capacity. 

The  Associated  General  Contractors  of  America  (AGC)  is  a  national  trade  association 
comprised  of  more  than  33,000  Arms,  including  8,000  of  America's  leading  general  contracting 
companies.    They  are  engaged  in  the  construction  of  the  nation's  commercial  buildings,  shopping 
centers,  factories,  warehouses,  highways,  bridges,  tunnels,  airports,  water  works  facilities,  multi- 
family  housing  projects  and  site  preparation/utilities  installation  for  housing  development.    Many 
AGC  member  firms  routinely  contract  with  independent  contractors  to  perform  work  in  many 
different  states  and  localities,  helping  to  add  to  the  value  of  vigorous  competition  on  construction 
projects  in  these  markets. 

On  behalf  of  AGC,  I  welcome  the  opportunity  to  testify  on  the  need  to  retain  Section  530 
of  the  Revenue  Act  of  1978  for  the  construction  industry.    The  provision  before  the  committee 
today  would  repeal  that  safe  harbor  specifically  for  construction  industry  employers.    AGC  strongly 
supports  the  sajfe  harbor  protections  for  individuals  who  work  as  independent  contractors.    We  feel 
that  singling  out  one  industry,  as  this  provision  attempts  to  do,  does  nothing  to  resolve  the  problem 
of  worker  misclassification. 

Background 

Worker  misclassification  is  an  old  issue  both  for  the  IRS  and  employers.    It  has  been  the 
subject  of  numerous  hearings  in  this  committee  and  other  Congressional  committees,  extensive 
litigation,  as  well  as  the  topic  of  a  1992  GAO  report  (GAO/GGD-92-108,  July  23,  1992;  Tax 
Administration;  Apprpaghgs  tP  Imprpvg  Indgpgnjgnt  Cpntragtor  Compliance).    Yet,  the  issue 
remains  unresolved. 

A  variety  of  occupational  relationships  and  job  classifications  exist  in  the  American 
workplace  and  in  the  construction  industry.    However,  for  Federal  tax  purposes  only  lyai 
classifications  exist:    a  worker  is  either  an  employee  or  an  independent  contractor  (i.e.  self- 
employed).    Significant  tax  consequences  result  from  how  a  worker  is  classified;  some  of  the  tax 
consequences  favor  employee  status,  while  others  favor  independent  contractor  status. 

Section  530  exists  because  Congress  realized  that  independent  contractors  contribute  a  vast 
amount  of  added  value  to  economic  production  and  because  it  is  not  fair  to  change  the  rules  after 
taxpayers  organize  their  affairs  according  to  good  faith  reliance  on  industry  practice  or  prior  IRS 
determinations.    Congress  enacted  these  protections  for  a  number  of  reasons,  but  it  is  safe  to  say 
the  legislative  history  of  Section  530  supports  the  view  that  taxpayers  are  to  be  afforded  wide 
latitude  in  asserting  or  maintaining  independent  contractor  status. 

Specifically,  these  protections  were  established  because:  individuals  not  under  the  control  of 
others  in  the  workplace  bear  all  the  risk  and  expense  for  their  employment;  they  were  increasingly 
vulnerable  to  IRS  reclassification  as  employees  subsequent  to  prior  audits  in  which  their  treatment 
as  independent  contractors  had  not  been  challenged  and  after  private  letter  rulings  or  technical 
advice  memoranda  from  the  Service  had  said  that  they  were  independent  contractors;  or  after  they 
had  relied  on  coimnon  industry  practice. 

S^Ctipn  g3Q  Prptg<;tipn? 

In  its  original  General  Explanation  of  Section  530  in  the  Revenue  Act  of  1978,  the  Joint 
Conmiittee  on  Taxation  stated  that  Section  530  was  enacted  to  protect  certain  classes  of  taxpayers 
from  IRS  reclassification  of  independent  contractors  as  employees.    The  General  Explanation  says, 
"workers  shall  be  deemed  not  to  be  the  taxpayer's  employees,  unless  the  taxpayers  had  no 
reasonable  basis  for  not  treating  the  workers  as  employees." 

The  Joint  Committee  on  Taxation  further  explained  that  the  Revenue  Act  of  1978 
terminated  pre- 1979  employment  tax  liabilities  of  taxpayers  who  had  a  reasonable  basis  for  treating 
workers  other  than  as  employees.    Clearly,  the  legislative  history  of  this  provision  establishes  that 
Congress  acknowledged  that  certain  taxpayers  have  a  legitimate  basis  for  using  workers  not 
considered  as  traditional  employees. 

This  "reasonable  basis"  standard  has  been  the  guiding  principle  behind  worker  classification 
since  1979.    If  there  is  any  confusion  about  Congress'  intent  with  regard  to  the  issue  of 
classification,  any  ambiguity  is  removed  by  the  statement  in  the  General  Explanation  that  "Congress 
intends  that  this  reasonable  basis  requirement  be  construed  liberally  in  favor  of  taxpayers." 


1557 


In  other  words,  Congress  intends  that  taxpayers  (including  general  contractors)  who  use 
independent  contractors  are  to  be  afforded  the  benefit  of  the  doubt.    This  presumption  in  favor  of 
the  taxpayer  is  initially  accomplished  through  the  creation  of  three  statutory  reasonable  basis 
standards,  or  safe  harbors. 

The  first  safe  harbor  is  reached  if  a  taxpayer's  treatment  of  an  individual  as  not  being  an 
employee  is  due  to  reasonable  reliance  on  judicial  precedent,  published  rulings,  or  previous 
technical  advice  from  the  IRS. 

The  second  safe  harbor  is  attained  if  the  taxpayer  shows  reasonable  reliance  on  a  past  IRS 
audit. 

The  third,  and  perhaps  most  significant  safe  harbor  from  the  viewpoint  of  the  construction 
industry,  is  that  the  taxpayer  relies  on  a  long-standing,  recognized  practice  of  a  significant  segment 
of  the  industry  in  which  the  taxpayer  is  engaged.    There  is  no  requirement  that  the  recognized 
practice  be  uniformly  followed  throughout  an  entire  industry. 

For  Example 

Consider  a  situation  common  to  thousands  of  construction  sites  throughout  the  country. 
Individuals  contract  for  short  periods  with  one  or  more  construction  companies  to  perform  certain 
work  on  construction  projects.    These  individuals  own  their  own  trucks.    They  own  their  own  tools. 
They  pay  into  their  own  retirement  plans.    They  are  not  told  when  to  report  to  work,  or  how  to 
perform  the  work.    And  other  contractors  in  the  general  geographic  region  are  free  to  contract 
with  these  individuals,  or  others  like  them,  to  perform  the  same  type  of  short  term  work. 

By  any  objective  standard,  these  individuals  are  not  employees  of  the  general  contractor. 
But  without  the  proteaion  of  Section  530,  the  Federal  government  may  determine  that  they  are, 
even  after  both  parties  had  relied  on  historic  industry  praaice  or  on  prior  IRS  advice.    If  the 
government  successfully  prevails  in  a  reclassification  case  against  the  independent  contractor,  that 
individual  is  then  subject  to  withholding,  social  security  and  unemployment  taxes-none  of  which 
had  been  withheld  nor  paid  to  the  Treasury. 


The  provision  evolves  from  the  misconception  that  the  construction  industry  has  greatly 
abused  Section  530  safe  harbors  through  intentional  worker  misclassification  and  that  this  abuse  is 
far  greater  than  in  any  other  industry.    This  perception  is  wrong.    There  is  simply  no  empirical 
evidence  that  general  contractors  engage  in  willful,  systematic  evasion  of  the  law. 

In  fact,  former  Treasury  Assistant  Secretary  for  Tax  Policy  Fred  Goldberg  testified  that  most 
non-compliance  is  unintentional.    The  tax  code  is  far  too  co.nplex.    The  vast  majority  of  general 
contractors  follow  the  law,  and  make  good  faith  efforts  to  ineet  the  requirements  of  the  Code,  even 
when  they  do  not  fully  understand  every  provision.    Taking  the  Seaion  530  safe  harbors  away  from 
the  construction  industry  is  excessive,  unnecessary  and  would  further  aggravate  an  industry 
experiencing  an  unemployment  rate  consistently  twice  the  national  average. 

Before  Congress  repeals  Section  530  of  the  Revenue  Act  of  1978  solely  with  respect  to  the 
construction  industry,  or  for  any  other  industry,  the  Internal  Revenue  Service  must  first  augment 
and  strengthen  its  management  of  existing  programs  with  respect  to  worker  classification. 

With  regard  to  those  few  who  intentionally  violate  the  law,  our  position  is  clear,  consistent 
and  simple:    Don't  do  it!    If  you  do.  you  should  bear  the  full  consequences  of  the  law. 

AGC  looks  forward  to  working  with  the  Committee  on  Ways  and  Means  and  with  Congress 
to  resolve  the  complex  and  important  issues  relating  to  the  proper  classification  of  workers.    This 
provision,  however,  goes  too  far  and  would  harm  the  construction  industry.    We  ask  you  Mr. 
Chairman,  to  refrain  from  adding  it  to  the  many  other  provisions  that  may  ultimately  be  included 
in  legislation  passed  by  the  Committee. 

Thank  you. 


1558 

Chairman  Rangel.  Mr.  Herr. 

STATEMENT  OF  GERARD  J.  HERR,  ASSISTANT  TREASURER, 
BRYN  AWEL  CORP.,  BALTIMORE,  MD.,  AND  VICE  CHAIRMAN, 
WASHINGTON  INTEREST  PROGRAM  COMMITTEE,  CON- 
STRUCTION FINANCIAL  MANAGEMENT  ASSOCIATION 

Mr.  Herr.  Good  afternoon,  Mr.  Chairman.  My  name  is  Gerard 
Herr.  I  am  a  certified  pubhc  accountant  and  assistant  treasurer  of 
the  Bryn  Awel  Corp.,  a  Baltimore-based  asphalt  manufacturer  and 
highway  construction  firm.  Bryn  Awel  operates  as  a  general  con- 
tractor as  well  as  a  subcontractor  on  both  private  and  public  work. 

I  also  am  vice  chairman  of  the  Washington  Interest  Program 
Committee  of  the  Construction  Financial  Management  Association, 
CFMA.  It  is  in  this  capacity  that  I  am  here  today.  CFMA  rep- 
resents more  than  5,000  financial  managers  in  the  construction 
business. 

Our  members  are  employed  by  over  2,000  construction  companies 
across  the  United  States.  More  than  one-third  have  gross  annual 
revenues  ranging  from  $25  million  to  $99  million.  CFMA  members 
consist  of  general  contractors,  subcontractors,  utility  contractors 
and  highway  contractors,  among  others. 

On  behalf  of  CFMA,  I  thank  you  for  this  opportunity  to  testify 
on  an  issue  important  not  only  to  our  members,  but  to  the  entire 
construction  industry. 

We  understand  you  face  a  difficult  task  in  putting  together  reve- 
nue neutral  legislation,  but  we  encourage  you  to  approach  the  inde- 
pendent contractor  issue  carefully. 

CFMA  strongly  opposes  the  proposal  to  repeal  the  section  530 
safe  harbor  for  classifying  construction  workers  as  independent 
contractors. 

Section  530  was  adopted  to  simplify  an  otherwise  confusing  area 
of  tax  law  for  many  taxpayers.  It  has  worked.  Removing  the  safe 
harbor  will  hurt  the  construction  industry  and  will  reinstate  the 
confusion  and  controversy  surrounding  this  issue  in  the  1960s  and 
1970s. 

It  also  will  increase  the  administrative  burden  on  the  industry 
of  complying  with  the  tax  laws.  Additionally,  eliminating  section 
530  for  the  construction  industry  but  not  for  other  taxpayers  runs 
counter  to  a  basic  tenet  of  tax  policy  that  requires  treating  simi- 
larly situated  taxpayers  the  same. 

Singling  out  construction  companies  punishes  a  group  that  his- 
torically has  led  this  country  in  economic  growth  and  in  economic 
recovery  from  bad  times.  Given  the  current  slow  growth  of  our 
economy,  CFMA  questions  the  wisdom  of  any  acts  that  could  im- 
pede economic  growth. 

Congress  adopted  section  530  as  a  stopgap  measure  to  buy  time 
to  produce  a  permanent  solution  to  this  complex  and  controversial 
issue.  Eliminating  section  530  without  enacting  a  replacement  ig- 
nores this  history  of  controversy  and  complexity.  If  Congress  ap- 
proves this  proposal,  we  will  be  right  back  where  we  were  in  1978. 

Section  530  was  enacted  because  the  rules  for  classifying  a  work- 
er as  an  employee  or  as  an  independent  contractor  are  confusing 
and  subjective.  The  rules  basically  require  contractors  to  consider 
20  factors  to  determine  if  a  worker  is  controlled  by  an  employer. 


1559 

On  paper,  the  20  factors  may  look  reasonable.  In  reality,  they  can 
be  a  nightmare. 

It  is  important  that  Congress  understand  industry  practice  with- 
in the  construction  industry  before  changing  the  rules  that  apply 
to  us.  Although  the  statutory  safe  harbor  of  section  530  generally 
is  available  to  all  taxpayers,  in  fact  that  availability  depends  on 
several  factors.  One  of  those  factors  is  longstanding  industry  prac- 
tice. Owners,  contractors  and  subcontractors  now  know  that  if  they 
rely  on  industry  practice,  they  can  establish  an  independent  con- 
tract or  relationship  that  will  be  accepted  by  the  IRS. 

Within  the  construction  industry,  longstanding  industry  practice 
includes  the  general  subcontractor  and  subcontractor-subcontractor 
relationships.  Additionally,  specialty  trade  contractors  are  hired  on 
a  project-by-project  basis  for  short  durations  and  certain  assign- 
ments. 

These  contracts  can  include  lump-sum,  fixed-fee,  cost-plus,  time- 
and-material  or  labor-only  agreements.  The  construction  industry 
has  relied  on  the  contractor-subcontractor  relationship  so  the  gen- 
eral contractor  does  not  have  to  hire  the  various  trade  specialists 
as  employees. 

Removing  the  safe  harbor  would  threaten  this  longstanding  in- 
dustry practice  of  subcontracting.  Consequently,  it  would  threaten 
the  ordinary  way  of  doing  business  for  smaller  contractors,  espe- 
cially sole  proprietors. 

If  section  530  is  not  available,  the  Internal  Revenue  Service 
could  attempt  to  recharacterize  legitimate  independent  contractors 
as  employees,  clearly  producing  uncertainty  and  confusion  for  the 
industry.  To  avoid  such  a  result,  industry  practice  would  have  to 
be  changed  and  before  those  practices  can  be  changed,  many  gen- 
eral contractors  will  find  that  in  the  eyes  of  the  Internal  Revenue 
Service,  they  are  not  general  contractors  but  employers. 

I  have  included  in  mv  written  statement  several  examples  of  sub- 
contractor situations  that  could  be  misconstrued  by  IRS  agents  as 
employer-employee  relationships.  I  will  not  mention  all  of  them, 
but  I  think  you  might  find  some  examples  useful. 

For  example,  I  can  see  how  the  IRS  might  recharacterize  an 
independent  contractor  as  an  employee  in  the  following  cases: 
punch  list  cleanup  work  where  many  miscellaneous  corrections  are 
required;  contracts  which  include  installation  only  with  materials 
supplied  separately,  for  example  an  HVAC  subcontractor  who  in- 
stalls a  central  air-conditioning  system;  remodeling  work  where 
hidden  site  conditions  are  unknown,  and  therefore  the  extent  of  the 
work  is  not  determined  in  advance;  constructing  clean  rooms  for 
manufacturing  of  computer  chips.  In  clean-room  construction,  it  is 
common  industry  practice  for  general  contractors  to  provide  cleanli- 
ness training  for  all  workers,  including  the  subcontractor's  workers, 
to  ensure  that  the  clean  rooms  meet  contract  requirements. 

Mr.  Chairman,  CFMA  feels  strongly  that  it  would  be  irrespon- 
sible for  Congress  to  repeal  section  530  for  the  construction  indus- 
try, for  any  other  industry,  or  completely,  without  first  considering 
the  result.  The  result  of  course  would  be  to  send  a  message  to  the 
construction  industry  that  we  can  no  longer  rely  on  the  longstand- 
ing industry  practice  of  contracting  and  to  throw  the  industry  into 
the  20  factor  test.  That  would  be  an  unfair  result. 


1560 

CFMA  welcomes  the  opportunity  to  work  with  members  of  the 
committee  and  others  in  Congress  with  regard  to  independent  con- 
tractors. 

In  closing,  I  would  like  to  address  a  question  raised  this  morning 
regarding  the  assurance  that  employees  of  subcontractors  are  paid 
their  full  pay  and  benefits.  The  question  was  asked  of  the  gen- 
tleman from  the  National  Association  of  Home  Builders.  A  reply  to 
that  question  is  that  on  all  public  works  which  are  Davis-Bacon 
projects,  we  are  required  either  as  general  contractors  or  sub- 
contractors to  submit  to  the  local  or  State  government  or  Federal 
Government  weekly  certified  wa^e  reports  that  show  what  rates 
were  paid,  and  that  benefits,  union  dues,  FICA  and  FUTA  taxes 
are  paid  for  those  employees  covered  by  that  project. 

These  reports  are  signed  off  by  an  officer  of  the  company  whether 
at  the  subcontractor  or  the  general  contractor  level.  That  is  a 
means  of  guaranteeing  that  proper  wages  are  being  paid  to  sub- 
contractor employees. 

Chairman  Rangel.  Are  you  suggesting  that  be  done  for  jobs  that 
are  not  under  Davis-Bacon.  That  is  a  possible  solution  to  the  prob- 
lem. 

Mr.  Herr.  As  a  possible  solution,  yes.  However,  I  can  also  add, 
Mr.  Chairman,  that  on  most  of  the  private  sector  work  that  we  per- 
form, most  of  our  customers  already  require  us  to  provide  signed 
releases  not  only  from  our  company  as  a  general  contractor,  but 
also  from  each  subcontractor.  The  releases  state  that  employees 
have  been  paid,  unions  have  been  paid  their  dues,  and  suppliers 
and  second  tier  contractors  have  been  paid  in  full.  These  releases 
are  required  in  most  cases  before  our  private  sector  customers  will 
pay  us  for  the  job. 

[The  prepared  statement  follows:! 


1561 


Testimony  of  Gerard  J.  Hen- 
Assistant  Treasurer,  Biyn  Awel  Corporation 
Representing  the  Construction  Financial  Management  Association 
before  tiie  Subcommittee  on  Select  Revenue  Measures 
Committee  on  Ways  and  Means 
U.S.  House  of  Representatives 

September  21,  1993 

Good  afternoon.  My  name  is  Gerard  J.  Herr  and  I  am  a  C.P.A,  and  the  Assistant  Treasurer 
of  the  Bryn  Awel  Corporation,  an  asphalt  manufacturer  and  highway  construction  firm  with 
annual  revenues  in  excess  of  $50  million.  Bryn  Awel  is  located  in  Baltimore,  Maryland  and 
we  build  projects  in  Maryland,  Washington,  D.C.  and  Northern  Virginia.  We  operate  as  a 
general  contractor  as  well  as  a  subcontractor  on  both  private  and  public  works.  I  also  am 
Vice  Chairman  of  the  Wasliington  Interest  Program  Committee  of  the  Construction 
Financial  Management  Association  and  it  is  in  this  capacity  that  I  am  before  you  today. 

The  Construction  Financial  Management  Association  (CFMA)  was  established  in  1981  and 
represents  more  than  5,000  financial  managers  in  the  construction  business.  CFMA 
members  are  employed  by  over  2,000  construction  companies  across  the  U.S.,  more  than 
one-third  of  which  have  gross  aimual  revenues  ranging  from  $25  -  99  million. 

On  behalf  of  CFMA,  I  would  like  to  thank  you  for  the  opportunity  to  appear  before  the 
subcommittee  on  an  issue  important  not  only  to  our  members  but  to  all  members  of  the 
construction  industry.  We  understand  the  difficult  task  this  subcommittee  and  Congress  face 
in  putting  together  revenue  neutral  legislation.  And  we  can  understand  that  you  expect  to 
find  opponents  for  provisions  that  raise  revenue  as  easily  as  you  find  supporters  for 
provisions  that  lose  revenue.  But  we  encourage  this  subcommittee  to  approach  the 
independent  contractor  issue  carefully. 

Because  CFMA  is  an  association  of  financial  managers,  it  cuts  across  industry  lines  and 
represents  all  segments  of  the  industry,  including  general  contractors  and  subcontractors. 
And  it  is  the  long-standing  industry  practice  of  general-subcontractor  and  subcontractor- 
subcontractor  relationships  that  we  will  be  discussing  today. 

I.  CFMA  POSITION  ON  SECTION  530  AND  ITS  EFFECT  ON  THE  INDUSTRY 

There  is  no  question  that  removing  the  safe  harbor  of  section  530  will  hurt  the  construction 
industry.  Such  action  will  reinstate  the  confusion  and  controversy  between  the  industry  and 
the  IRS  that  existed  in  the  1970s.  And  it  will  increase  the  administrative  burden  on  the 
industry  of  complying  with  the  tax  laws.  For  these  reasons,  we  strongly  oppose  the  proposal 
to  repeal  the  safe  harbor  under  section  530  relating  to  the  classification  of  workers  as 
independent  contractors  for  members  of  the  construction  industry. 

Section  530  was  adopted  to  simplify  an  otherwise  confusing  area  of  tax  law  for  many 
taxpayers.  It  has  worked.  It  should  not  be  revised  if  the  result  is  to  increase  the 
administrative  burden  on  taxpayers  rather  than  to  alleviate  that  burdea  Without  section 
530,  many  of  our  members  would  face  the  tasks  of  insuring  first  that  they  accurately  classify 
employees  as  "employees"  and  independent  contractors  as  "independent  contractors"  and 
second  that  nothing  they  subsequently  do  jeopardizes  those  classifications.  Time  and 
resources  spent  on  this  tax  classification  issue  would  be  time  and  resources  not  available  for 
work. 

Additionally,  eliminating  section  530  for  the  construction  industry,  but  not  for  other 
taxpayers,  runs  counter  to  a  basic  tenet  of  good  tax  policy  that  requires  treating  similarly 
situated  taxpayers  similarly.  By  singling  out  the  construction  industry,  this  proposal  also 
punishes  a  sector  of  the  economy  that  historically  has  led  this  country  in  economic  growth 
and  economic  recovery  from  bad  times. 


1562 


The  construction  industry  iiistorically  has  played  an  important  role  in  creating  well-paying 
jobs  for  our  economy.  Denying  section  530  treatment  to  the  industry  almost  certainly  will 
eliminate  some  of  those  jobs;  it  also  could  seriously  jeopardize  the  ability  of  many 
contractors  to  remain  in  business.  Given  the  current  slow-growth  of  the  U.S.  economy, 
CFMA  questions  the  wisdom  of  unnecessary  acts  that  could  impede  economic  growth. 

n.  BACKGROUND  ON  530 

Congress  adopted  Section  530  of  the  Revenue  Act  of  1978  because  the  rules  on  the 
classification  of  workers  as  "employees"  or  "independent  contractors"  were  imprecise.  For 
years  before  section  530  was  enacted,  the  IRS  increased  its  employment  tax  audits  ~  leading 
to  increased  controversies  between  the  IRS  and  businesses.  Section  530  was  a  stopgap 
measure  to  give  Congress  time  to  produce  a  permanent  solution  to  the  complexity  of  the 
independent  contractor  issue  that  would  eliminate  this  source  of  controversy.  Congress  has 
made  some  progress  on  the  issue.  But  Congress  evidently  also  has  learned  the  lesson 
learned  earlier  by  business  and  IRS:  this  is  a  hard  problem  to  solve. 

Congress  acted  on  the  issue  in  1982.  Statutory  standards  were  adopted  for  two  types  of 
workers;  if  the  standards  are  met,  the  workers  (direct  sellers  and  real  estate  agents)  will  be 
treated  as  independent  contractors.  But  Congress  also  decided  ~  as  part  of  the  same  1982 
legislation  -  to  extend  section  530  for  everyone  else.  Clearly  the  decision  was  to  simplify 
and  clarify  the  law  where  possible  -  for  direct  sellers  and  reaJ  estate  agents  ~  and  to  leave 
everyone  else  as  is.  Consequently,  section  530  was  indefinitely  extended  to  give  Congress 
time  to  produce  legislation  on  the  classification  of  workers  as  independent  contractors  or 
employees  without  reigniting  controversy  with  the  IRS  over  the  classification  issue. 
Congressional  actions  in  1978  and  in  1982  clearly  indicate  that  section  530  was  intended  to 
help  taxpayers.  Eliminating  section  530  without  enacting  a  replacement  ignores  the  history 
of  controversy  and  complexity  that  surrounds  the  independent  contractor  issue. 

If  the  provision  is  eliminated  ~  whether  for  the  construction  industry  or  for  all  taxpayers  ~ 
Congress  first  should  determine  if  the  problems  that  led  to  its  enactment  still  exist.  In 
CFMA's  opinion,  those  problems  still  exist  Eliminating  section  530  may  raise  revenue  for 
Treasury.  And  it  may  help  members  of  the  construction  industry  who  choose  to  operate 
with  employees  rather  than  with  independent  contractors.  But  it  does  so  without 
consideration  of  the  history  of  the  issue  or  the  effects  on  a  large  segment  of  the  construction 
industry.  If  Congress  approves  this  proposal,  we  are  going  to  be  right  back  where  we  were 
in  1978. 

HI.  LIFE  WITHOUT  SECTION  530 

Section  530  was  enacted  15  years  ago  because  the  rules  for  classifying  a  worker  as  an 
employee  or  as  an  independent  contractor  are  confusing  and  subjective.  Those  rules 
basically  require  considering  20  factors  developed  by  the  IRS  from  court  decisions  which 
determine  if  a  worker  is  controlled  by  an  employer.  On  paper,  the  20  factors  may  look 
reasonable.  In  reality,  they  can  be  a  nightmare.  It  is  important  that  Congress  understand 
industry  practice  within  the  construction  industry  before  changing  the  rules  that  apply  to  us. 

Although  the  statutory  "safe  harbor"  of  section  530  generally  is  available  to  all  industries  or 
businesses,  it  is  dependent  upon  several  factors,  including  long-standing  industry  practice. 
Owners,  contractors,  and  subcontractors  now  know  that  if  they  rely  on  industry  practices  they 
can  establish  an  independent  contractor  relationship  that  will  be  accepted  by  the  IRS. 

Within  the  construction  industry,  long-standing  industry  practice  includes  the  general- 
subcontractor  and  subcontractor-subcontractor  relationships  that  have  always  been  the  norm 
for  doing  business.  Additionally,  specialty  trade  contractors  are  hired  on  a  project  basis  for 
short  durations  under  various  contract  forms  to  complete  certain  assignments.  Some  of 
these  contracts  can  include  lump-sum,  fixed-fee,  cost-plus,  time  and  material,  or  labor-only 
agreements.  Contractors  can  be  selected  on  a  competitive  bid  or  negotiated  basis  depending 
upon  the  assignment. 


1563 


The  industry  has  always  relied  upon  the  existence  of  a  contractor-subcontractor  relationship 
to  cany  out  construction  so  the  general  contractor  does  not  have  to  hire  all  the  various 
trade  specialists  as  employees.  To  remove  the  "safe  harbor"  would  threaten  the  long- 
standing industry  practice  of  subcontracting  and  would  threaten  the  ordinary  way  of  doing 
business  for  smjiller  contractors  and,  especially,  sole  proprietors. 

If  section  530  is  not  available  for  the  construction  industry,  the  IRS  could  attempt  to 
recharacterize  legitimate  independent  contractors  as  employees  clearly  producing  uncertainty 
and  confusion  for  the  industry.  To  avoid  such  a  result,  industry  practice  would  have  to  be 
changed.  And,  before  those  practices  can  be  changed,  many  general  contractors  will  find 
that  ~  in  the  eyes  of  the  IRS  -  they  are  not  general  contractors  but  employers. 

For  example,  in  construction  management  it  is  longstanding  industry  practice  for  an  owner 
to  contract  directly  with  a  general  contractor  who  will  manage  a  project  and  enter  contracts 
with  trade  specialists  and  other  independent  contractors.  However,  it  also  is  common 
industry  practice  for  an  owner  to  contract  directly  with  a  general  contractor  and  with  trade 
specialists  and  other  independent  contractors.  In  both  cases,  under  industry  practice,  the 
general  contractors  and  the  subcontractors  are  independent  contractors. 

But,  if  section  530  is  repealed,  it  is  all  but  certain  that  some  IRS  agents  will  decide  that 
owners  who  contract  directly  with  subcontractors  are  employers  under  the  20  factor  test. 
Consequently,  owners,  general  contractors,  and  subcontractors  will  face  the  situation  where 
they  can  no  longer  feel  confident  when  they  have  issued  a  contract  or  work  order  that  the 
IRS  will  agree  that  is  what  they  are  dealing  with. 

Several  examples  of  subcontractor  situations  that  could  be  misconstrued  by  IRS  agents  as 
employer-employee  relationships  are: 

Punch  list  clean-up  where  many  miscellaneous  corrections  are  required  in  the  work. 

Contracts  which  include  installation  only  with  materials  supplied  separately,  e.g. 
HVAC  subcontractor  to  install  a  central  air  conditioning  system. 

Remodeling  work  where  hidden  site  conditions  are  unknown  and  therefore  the  extent 
of  the  work  is  not  determined  in  advance. 

We  thought  it  may  be  helpful  for  the  Committee  to  see  how  these  20  factors  -  in  the 
absence  of  the  section  530  safe  harbor  ~  might  be  used  to  recharacterize  a  traditional 
contractor  relationship  as  an  employer-employee  relationship.  Not  all  of  the  20  factors  have 
to  be  met  to  find  the  employer-employee  relationship,  so  contractors  will  be  faced  with  the 
possibility  of  having  to  continually  defend  doing  business  with  subcontractors. 

Examples  of  how  the  20  factors  could  be  interpreted  by  IRS  to  question  the  existence  of 
subcontractor  relationships  and  to  find  an  employer-employee  relationship  are  as  follows: 

1.  Instructions  -  The  general  contractor  has  the  overall  responsibility  for  safety  and 
management  of  the  jobsite  and  will  direct  subcontractors  when  they  can  work  and  the 
safety  rules  to  be  followed  on  the  project. 

2.  Training  -  Certain  work  may  be  very  technical  or  complicated,  which  could  result 
in  the  general  contractor  providing  training  for  subcontractor  workers  regarding 
materials  handling,  installation,  safety,  etc.  For  example,  in  the  construction  of  "clean 
rooms"  for  manufacturing  wafers  and  computer  chips,  it  is  common  industry  practice 
for  the  general  contractor  to  provide  "cleanliness  training"  for  all  workers  ~  including 
the  subcontractors'  workers  -  to  insure  that  the  "clean  rooms"  meet  contract 
requirements. 


1564 


3.  Integration  -  The  general  contractor  will  provide  the  schedule  of  access  and 
completion  times  and  coordinate  work  of  other  specialty  contractors  to  minimize 
interference  and  increase  productivity. 

4.  Service  Performed  Personally  -  A  subcontractor's  principal  may  also  perform  a 
portion  of  the  work,  especially  if  it  is  a  sole  proprietor  or  a  small  contractor. 

5.  Hiring,  Supendsing,  and  Paying  Assistants  ~  It  would  not  be  unusual  to  closely 
supervise  and  direct  workers  of  a  subcontractor  who  are  in  the  process  of  correcting 
punch  list  items. 

6.  Continuing  Relationship  -  A  pattern  of  repeat  business  with  the  same  general 
contractor  could  be  read  as  a  continuing  employer-employee  relationship. 

7.  Set  Hours  of  Work  ~  The  general  contractor  controls  access  to  the  project  and 
therefore  sets  hours  of  work. 

8.  Full  Time  Required  -  The  general  contractor  monitors  the  progress  of  work  and 
can  force  staffing  changes  to  keep  the  work  on  schedule. 

9.  Doing  Work  on  Employer's  Premises  -  By  necessity,  the  work  location  is 
established  and  controlled  by  the  general  contractor  since  it  must  be  done  at  the  job. 

10.  Order  or  Sequence  Set  -  The  general  contractor  is  responsible  for  scheduling  and 
coordinating  subcontractors  and  therefore  sets  the  order  of  work  to  enable  the 
project  to  be  completed  on  time. 

11.  Oral  or  Written  Reports  -  The  general  contractor  requires  regular  reports  from  the 
subcontractors  on  the  progress  of  the  work  in  order  to  continually  update  the 
completion  schedule  and  coordinate  other  trades. 

12.  Payment  by  Hour,  Week,  Month  -  Usually  a  contract  is  done  on  a  lump-sum  basis 
but  can  be  on  a  per  unit,  hourly  or  cost-plus  basis.  Anything  other  than  lump  sum 
could  be  suspected  of  representing  an  employee  situation. 

13.  Payment  of  Business  and  Traveling  Expenses  -  This  is  usually  not  a  factor,  but  if 
it  should  be,  it  is  possible  that  reimbursement  of  these  expenses  would  be  provided 
for  in  the  agreement. 

14.  Furnished  Tools  and  Materials  -  Most  subcontractors  supply  their  own  tools,  but 
it  would  not  be  unusual  for  the  general  contractor  to  supply  materials  purchased 
separately  from  the  subcontract  agreement. 

15.  Significant  Investment  ~  Many  contractors  can  maintain  a  business  with  little 
investment  by  working  out  of  their  homes  or  minimal  rented  space  and  using  rented 
tools  and  machineiy. 

16.  Realization  of  Profit  or  Loss  ~  Independent  contractors  will  most  likely  have  the 
exposure  but  may  have  a  cost-plus  contract  which  could  isolate  them  from  most 
exposiu-e  to  loss. 

17.  Working  for  More  than  One  Firm  at  a  Time  ~  Small  contractors  may  not  have  the 
capacity  to  do  this  but  will  have  multiple  contracts  to  be  done  on  a  rotating  basis. 

18.  Making  Service  Available  to  the  General  Public  -  Independent  contractors  may  be 
available  to  do  work  for  general  contractors  but  not  necessarily  for  the  general 
public. 


1565 


19.  Right  to  Discharge  -  Owner  contracts  typically  contain  language  that  gives  them 
the  right  to  discharge  any  workers  they  find  objectionable.  The  same  right  is  given 
to  the  general  contractor. 

20.  Right  to  Terminate  -  A  subcontractor  under  certain  contracts  can  terminate  a 
relationship,  providing  proper  notice  is  givea 

These  examples  show  that  there  could  be  many  situations  which  could  be  falsely  read  as 
employer-employee  relationships,  resulting  in  the  assessment  of  inappropriate  penalties, 
interest  and  taxes.  The  construction  industry  today  does  business  as  it  always  has  by 
subcontracting  work.  This  is  the  reason  that  long-standing  industry  practice  is  relied  on  by 
law  and  the  courts,  not  only  for  the  construction  industry  but  for  all  industries. 

It  would  be  irresponsible  for  Congress  to  repeal  section  530  for  the  construction  industry, 
any  other  group,  or  completely  without  also  considering  the  result.  The  result,  of  course, 
would  be  to  throw  the  affected  taxpayers  into  the  20  factor  test.  Given  the  industry's  past 
practice  of  classifying  workers  as  employees  or  independent  contractors,  this  would  be  an 
unfair  result.  Better  to  revise  the  20  factors  before  dropping  section  530. 


77-130  0 -94 -U 


1566 

Chairman  Rangel.  Ms.  Sumner. 

STATEMENT  OF  SALLY  SUMNER,  R.N.,  CHAIRPERSON,  BOARD 
OF  DIRECTORS,  NURSE  BROKERS  &  CONTRACTORS  OF 
AMERICA 

Ms.  Sumner.  Good  afternoon,  Mr.  Chairman. 

It  may  seem  unusual  for  an  organization  representing  health 
care  professionals  to  be  testifying  on  a  matter  that  affects  the  con- 
struction industry.  But  to  NBCA,  the  issue  here  is  far  more  broad. 

First,  section  530  provides  the  necessary  employment  tax  safe 
haven  against  arbitrary  IRS  enforcement  of  an  unpredictable  com- 
mon law  employment  test. 

NBCA  members  have  firsthand  experience  of  the  importance  of 
section  530  in  the  nursing  profession,  as  I  will  explain. 

Second,  there  is  no  compelling  reason  to  single  out,  by  repealing 
an  important  law  like  section  530,  the  construction  industry.  In- 
deed, government  data  show  that  tax  compliance  in  that  industry 
is  as  good  as  many  others.  Thus  action  against  the  construction  in- 
dustry will  only  serve  to  encourage  further  legislative  action  to  re- 
peal section  530  for  others. 

Third,  NBCA  recognizes  the  only  industry  currently  denied  sec- 
tion 530  protection  is  the  technical  services  industry  which  is  the 
result  of  section  1706  of  the  1986  Tax  Reform  Act.  NBCA  believes 
that  instead  of  repealing  section  530  for  the  construction  industry, 
Congress  should  repeal  section  1706  and  eliminate  a  discriminatory 
and  unfair  law  against  the  technical  services  industry  that  is  ap- 
parently serving  as  legislative  precedent  for  selectively  targeting 
other  industries. 

Fourth,  NBCA  believes  that  Congress  should  enact  a  version  of 
the  1992  bill  H.R.  5011  if  it  is  really  serious  about  correcting  prob- 
lems associated  with  the  use  of  independent  contractors  by  firms 
which  encourage  tax  cheating. 

I  will  touch  upon  two  of  these  points  in  my  continued  oral  testi- 
mony. 

Mr.  Chairman,  section  530  is  extremely  important  to  registered 
nurses  who  work  as  independent  contractors  and  to  their  broker 
firms.  In  1984,  my  business  was  audited  by  the  IRS.  The  IRS  field 
agent  determined  that  my  business  owed  $22,000  in  back  taxes 
plus  interest  and  penalties  on  the  grounds  that  the  nurses  working 
through  us  were  our  employees.  It  did  not  matter  to  the  IRS  if  the 
nurses  themselves  had  already  paid  these  taxes  in  full. 

Over  the  next  7  years,  we  fought  the  IRS  and  finally  in  1991  a 
jury  found  in  our  favor,  but  it  cost  us  over  $200,000  in  legal  fees 
to  defeat  that  assessment. 

Although  we  were  confident  of  our  position  on  the  common  law 
factors,  the  jury  decided  the  case  on  the  reasonable  basis  theory  in 
section  530.  Judge  Broderick's  charge  to  the  jury  asked  whether  we 
had  a  reasonable  common  law  basis  under  section  530.  He  upheld 
the  jury's  verdict  that  we  had  such  a  basis.  No  company  should 
have  to  go  through  what  we  went  through,  whether  a  construction 
company,  a  computer  firm,  a  nurse  broker,  or  some  other  business. 

Our  case  was  truly  one  of  David  and  Goliath.  The  IRS  is  a  gov- 
ernmental behemoth  with  enormous  resources  while  small  honest 
businesses  Hke  ours  are  financially  strapped  on  a  daily  operational 


1567 

basis.  The  hint  of  an  IRS  audit  scares  away  clients,  prevents  ex- 
pansion and  growth,  and  consumes  human  and  financial  resources. 
In  this  environment,  section  530  relief  for  small,  honest  businesses 
should  not  be  diluted. 

Without  section  530,  our  business  might  have  been  destroyed  and 
the  nurses  whom  we  serve,  all  of  whom  appear  to  have  been  law 
abiding  taxpayers,  may  have  been  forced  to  give  up  the  option  of 
self  employment.  Until  Congress  comes  up  with  a  better  definition 
than  the  common  law  employment  test,  we  all  need  section  530. 

This  brings  me  to  my  second  key  point.  For  a  number  of  years, 
NBCA  has  been  in  touch  with  organizations  in  the  technical  serv- 
ices industry  because  we  wanted  to  see  what  can  happen  when  sec- 
tion 530  is  repealed.  Not  surprisingly,  we  learned  the  following:  Be- 
cause firms  in  the  technical  services  industry  are  covered  only  by 
the  common  law  employment  test,  they  are  ripe  for  picking  by  the 
IRS.  Thus,  even  honest  firms  that  have  acted  reasonably  but  erro- 
neously in  the  eyes  of  the  IRS  have  been  forced  to  fight  tax  assess- 
ments of  hundreds  of  thousands  of  dollars,  despite  the  fact  that 
those  taxes  have  often  already  been  paid  by  the  workers  them- 
selves. 

Even  those  taxpayers  in  the  technical  services  industry  who  win 
their  cases  legally  have  really  lost  in  light  of  the  difficulty  and  cost 
of  defending  their  positions  without  the  ability  to  rely  on  section 
530.  I  saw  what  happened  to  my  own  firm  with  section  530  relief 
and  I  am  saddened  by  the  enormous  fees  paid  by  technical  services 
firms  to  fight  the  IRS  without  section  530. 

We  also  learned  of  thousands  of  legitimate  self-employed  com- 
puter programmers  and  engineers  who  are  effectively  forced  to 
abandon  their  independent  contractor  status  even  if  they  could  pre- 
vail against  an  IRS  reclassification,  because  too  many  firms  simply 
do  not  want  to  invite  IRS  examination. 

In  light  of  the  adverse  impact  from  section  1706,  how  is  it  pos- 
sible to  justify  this  discriminatory  law.  Frankly,  to  NBCA  it  seems 
impossible  to  justify.  Even  the  Treasury  study  of  section  1706 
showed  that  technical  services  workers  and  firms  have  higher  than 
average  tax  compliance,  even  higher  than  construction  and  other 
industries. 

We  need  to  start  making  the  employment  tax  laws  more  fair  by 
getting  rid  of  section  1706  instead  of  using  it  as  a  precedent  to  re- 
peat the  mistake  by  an  ad  hoc  repeal  for  the  construction  industry. 
Otherwise,  waiting  on  your  doorstep  will  be  other  special  interest 
groups  that  want  to  repeal  section  530  for  the  nursing  profession 
and  others,  even  though  we  have  excellent  tax  compliance. 

Until  Congress  tackles  the  common  law  employment  definition, 
we  all  need  section  530  unless  we  want  to  abolish  self  employment. 

Thank  you. 

Chairman  Rangel.  Thank  you,  Ms.  Sumner. 

[The  prepared  statement  follows:] 


1568 


NURSE  BROKH«& 
CONTACTORS  OF /WB^O\  September  21,    1993 

Prepared  Written  Statement  of 

Sally  Sumner,  R.N. 

Chairperson,  Board  of  Directors 

Nurse  Brokers  and  Contractors  of  America 

OPENING  REMARKS 

Mr.  Chairman,  thank  you  for  the  opportunity  to  testify  today. 
My  name  is  Sally  Sumner  and  I  am  a  registered  nurse  and  co-owner  of 
Critical  Care  Registered  Nursing,  Inc.  (aka  Criticare) ,  which  is  a 
nurse  brokerage  firm  referring  specialized  registered  nurses  to 
hospitals  for  temporary,  supplemental  needs.  I  am  here  today  in  my 
capacity  as  Chairperson  of  the  Nurse  Brokers  and  Contractors  of 
America  (NBCA) ,  an  organization  that  represents  over  20,000  nurse 
independent  contractors  registered  with  the  brokers  who  serve  them 
throughout  the  United  States. 

NBCA's  position  on  the  proposal  to  repeal  Section  530  of  the 
1978  Revenue  Act  for  the  construction  industry  is  quite  simple: 

(I)  NBCA  believes  tjiat  Section  53  0  provides  a  necessary 
employment  tax  safe  haven  dgainst  the  arbitrary  IRS  enforcement  of 
an  unpredictable  common  law  employment  test.  NBCA  members  have 
first-hand  experience  of  the  importance  of  Section  530  in  the 
nursing  profession. 

(II)  NBCA  believes  that  there  is  no  compelling  reason  to 
single  out  the  construction  industry  by  repealing  an  important  law 
like  Section  530  for  that  industry. 

(III)  NBCA  recognizes  that  action  against  the  construction 
industry  will  only  serve  to  encourage  further  legislative  action  to 
repeal  Section  530  for  others. 

(IV)  NBCA  recognizes  the  only  industry  currently  denied 
Section  530  protection  is  the  technical  services  industry  in  so- 
called  "three -party"  relationships,  which  is  the  result  of  Section 
1706  of  the  1986  Tax  Reform  Act.  There  have  been  repeated  and 
widespread  calls  for  replacing  Section  1706  because  it  is  an  unfair 
and  discriminatory  law  which  targets  only  one  industry.  NBCA 
believes  that  instead  of  repealing  Section  530  for  the  construction 
industry,  Congress  should  repeal  Section  1706  and  eliminate  a 
discriminatory  law  against  the  technical  services  industry  that 
serves  as  legislative  precedent  for  selectively  targeting  other 
industries . 

(V)  NBCA  believes  that  Congress  should  enact  a  version  of  the 
1992  bill,  H.R.  5011,  if  it  really  is  serious  eibout  correcting 
problems  associated  with  the  use  of  independent  contractors  by 
firms  which  encourage  tax  cheating. 

I  would  like  to  expand  upon  these  points,  one-by-one. 

I.   Th«n  Tmpnrtance  of  Section  530 

There  can  be  little  doubt  about  the  unacceptability  of  the 
common  law  definition  of  "employee"  and  "employer"  which  exists  in 
the  Internal  Revenue  Code.  The  few  who  support  this  definition  are 
merely  interested  in  assuring  that  as  many  workers  as  possible  are 
classified  as  employees.  More  candidly,  however,  even  the  Treasury 
Department  has  repeatedly  conceded  -  -  as  it  stated  in  its  March 
1991  Report  to  Congress  on  "Taucation  of  Technical  Services 
Personnel:  Section  1706  of  the  1986  Tax  Reform  Act"  (Treasury 
Study  of  1706)  --  that  the  common  law  tests  "lack  precision  and 
predictability";  as  a  prior  Treasury  Department  Assistant  Secretary 
told  Congress,  "In  many  cases,  applying  the  common  law  test  in 
employment  tax  issues  does  not  yield  clear,  consistent,  or 
satisfactory  answers,  and  reasonable  persons  may  differ  as  to  the 
correct  classification."  Treasury  Study  of  1706  at  p.  59. 

Because  of  the  problems  with  the  common  law  test.  Congress 
enacted  Section  530  of  the  1978  Revenue  Act.  As  you  know.  Section 
530  states  that  if  a  business  has  a  reasonaJsle  basis  for  treating 


1569 


workers  as  independent  contractors  instead  of  employees,  then  that 
business  need  not  pay  employment  taxes  on  those  workers  as  long  as 
the  business  has  issued  1099  forms  to  the  workers  and  has  not 
treated  similar  workers  inconsistently  (i.e.,  some  as  employees  and 
some  as  independent  contractors) . 

Section  53  0  is  extremely  important  to  registered  nurses  who 
work  as  independent  contractors.  Many  NBCA  member  firms,  including 
my  own  firm,  have  had  personal  experience  with  Section  530.  In 
1984,  my  business  was  audited  by  the  IRS. 

The  IRS  field  agent  determined  that  the  nurses  working  through 
Critical  Care  were  employees  not  independent  contractors  and  that 
we  owed  $22,000  in  back  taxes  plus  interest  and  penalties.  It  did 
not  matter  to  the  IRS  if  the  nurses  themselves  had  already  paid 
these  taxes  in  full. 

Over  the  next  seven  years  we  fought  the  IRS  and  finally,  in 
1991  in  U.S.  District  Court,  Philadelphia  an  eight  person  jury 
found  that  the  nurses  working  through  Critical  Care  were 
independent  contractors.  It  cost  us  over  $200,000  to  defeat  an  IRS 
assessment  of  $22,000  plus  interest  and  penalties. 

While  the  common  law  questions  were  taken  into  consideration 
in  our  trial,  the  jury's  decision  revolved  around  the  reasonable 
basis  theory  provided  in  Section  530.  Reliance  on  the  twenty 
common  law  questions,  which  are  subjective  and  not  weighted  for 
importance,  put  the  taxpayer  at  a  distinct  disadvantage  with  the 
IRS,  while  Section  530  levels  the  playing  field.  Judge  Broderick 
in  his  charge  to  the  jury  in  our  case  gave  preference  to  the 
Section  530  consideration  over  the  twenty  common  law  questions.  He 
believed,  based  on  his  review  of  the  history  of  the  law  and 
Congressional  references  to  "liberal  interpretation",  that  the 
Congressional  intent  behind  Section  530  was  to  assist  honest 
taxpayers.  Our  federal  court  decision  stated,  "based  on  the  common 
law  questions  Critical  Care  did  have  a  'reasonable  basis'  [under 
Section  530]  for  treating  the  nurses  as  independent  contractors". 

No  company  should  have  to  go  through  what  we  went  through. 
Our  case  was  truly  one  of  David  and  Goliath.  The  IRS  as  a 
governmental  behemoth  has  unlimited  resources  while  small,  honest 
businesses  -  -  usually  the  ones  who  benefit  most  from  the  services 
of  independent  contractors  --  are  financially  strapped  on  a  daily 
operational  basis.  The  hint  of  an  IRS  audit  scares  away  clients, 
prevents  expansion  and  growth  and  consumes  human  and  financial 
resources.  The  relief  of  Section  530  for  small  businesses  should 
not  be  diluted.  It  is  a  very  important  safeguard  for  all  companies 
working  with  independent  contractors.  The  loss  of  this  issue  by 
Critical  Care  would  have  meant  the  demise  of  our  business  as  well 
as  that  of  the  nurses  we  serve,  all  of  whom,  to  our  present 
knowledge,  are  law-abiding  taxpayers. 

In  summary,  as  a  member  of  an  industry  under  audit  by  the  IRS 
for  misclassif ication  of  workers,  I  understand  the  components  of 
corporate  challenges  which  I  must  face.  The  IRS  mission  is  to 
provide  for  the  collection  of  taxes  needed  to  furnish  the 
government  services  determined  by  Congress.  In  our  court  case,  the 
government's  expert  witness  and  IRS  representative  could  not 
provide  evidence  or  documentation  of  independent  contractor  nurses 
who  did  not  pay  income  taxes  or  make  contributions  to  social 
security.  Yet,  there  remains  an  effort  by  business  competitors, 
like  HHSSA,  to  promote  within  the  IRS  the  concept  of  wrongdoing. 
These  competitors,  which  are  not  nurse -owned,  have  provided 
"opinions'  and  "recommendations"  regarding  nursing  practice  to 
highly  placed  IRS  employees  which  have  continued  to  be  overruled  by 
the  courts,  with  the  help  of  Section  530.  The  fact  that  we  as 
business  owners  must  continually  defend  this  absurd  position  to  the 
IRS  is  difficult  enough.  Section  530  in  some  cases  is  the  easiest 
and  most  direct  way  for  us  to  put  these  travails  behind  us. 

II.   The  Lack  of  a  Coaipelllng  Reason  to  Target  the  Construction 
Industry  For  Section  53  0  Repeal 

Given  the  importance  of  Section  530  to  all  businesses  which 
may  face  the  same  IRS  threats  encountered  by  NBCA  member  firms,  we 
believe  that  there  must  be  some  compelling  reason  to  justify  repeal 


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of  Section  530  for  any  particular  industry.  We  have  heard  nothing 
that  would  justify  repeal  for  the  entire  construction  industry. 

We  do  not  mean  to  discount  the  seriousness  of  worker 
misclassif ication  in  the  construction  industry  or  any  industry  for 
that  matter.  However,  in  the  Treasury  Study  of  1706,  a  general 
industry-by- industry  breakdown  of  worker  misclassif ication  was 
presented  m  Tcible  5-1  based  upon  IRS  analyses.  The  construction 
industry  was  divided  into  "Heavy  Construction"  and  "Other 
Construction".  The  IRS  concluded  that  20.2%  of  all  Other 
Construction  employers  misclassif ied  some  workers  as  independent 
contractors.  But  this  finding  is  statistically  indistinguishable 
from  the  conclusion  that  19.9%  of  all  employers  in  the  Air 
Transport  industry  misclassif ied  workers,  19.8%  of  all  employers  in 
the  Oil  and  Gas  Mining  industry  misclassif ied  workers,  and  19.3%  of 
all  employers  in  the  Finance,  Insurance  and  Real  Estate  industries 
misclassif ied  workers.  On  what  logical  or  equitable  basis  could 
Congress  remove  Section  530  protection  from  the  construction 
industry  without  doing  the  same  to  these  other  industries? 
Furthermore,  since  only  11.9%  of  all  employers  in  the  Heavy 
Construction  industry  misclassif ied  workers,  how  could  the 
construction  industry  be  treated  as  a  single  industry  that  in  its 
entirely  is  subjected  to  Section  530  repeal? 

We  also  think  that  it  is  important  to  note  that  even  the  IRS 
statistics  are  probably  inflated.  We  know  of  many  instances  in 
which  the  IRS  insists  on  reclassifying  at  least  one  worker  in  many 
firms  under  audit  --  while  99%  of  the  workers  remain  as  independent 
contractors.  Rather  than  fight  this  minimal  reclassification,  most 
firms  will  simply  agree  to  pay  the  small  back  taxes  on  this  one 
worker.  Nonetheless,  this  firm  has  now  become  part  of  the 
statistical  category  of  "Firms  With  Misclassif ied  Workers"  in  the 
IRS's  battle  against  the  use  of  independent  contractors.  Hence, 
there  is  reason  to  believe  that  misclassif ication  is  not  as  great 
a  problem  in  the  construction  or  other  industries  as  the  IRS  would 
lead  one  to  believe. 

In  short,  NBCA  sees  no  reason  for  singling  out  the 
construction  industry  for  repeal  of  Section  530. 

III.   Precedential  Effect  of  Section  530  Repeal  on 

NBCA  is  concerned  that  if  the  construction  industry  is 
subjected  to  Section  530  repeal,  it  will  be  impossible  to  avoid 
subsequent  repeal  of  Section  530  for  other  industries.  As  just 
noted,  IRS  studies  suggest  that  several  other  industries  have 
essentially  the  same  level  of  misclassif ication  as  the  construction 
industry  --  and  even  more  miscxassif  ication  than  the  Heavy 
Construction  industry.  How  can  Congress  avoid  extending  the  repeal 
of  Section  530  to  these  other  industries? 

NBCA  knows  that  some  large  national  firms  in  the  nurse 
staffing  business  --  including  those  affiliated  with  the 
organization  represented  by  one  of  the  other  witnesses  on  this 
panel  --  would  like  to  repeal  Section  530  for  our  industry.  If  the 
construction  industry  loses  Section  530  relief,  will  our  industry  - 
-  despite  its  excellent  tax  compliance  record  --be  among  the  next 
victims? 

IV.  The  Enormous  Unfairness  Against  the  Technical  Services 

Industry  Resulting  Prom  Section  1706  of  the  1986  Teuc  Reform  Act's 

Rgpgal  Of  SgCtipn  530  for  That  Industry 

That  the  construction  industry  is  now  being  singled  out  for 
Congressional  repeal  of  Section  530  should  come  as  no  surprise 
because  of  the  existence  of  Section  1706  of  the  1986  Tax  Reform 
Act.  Section  1706  repealed  Section  530  for  the  technical  services 
industry,  at  least  in  so-called  "three-party"  relationships  (where 
there  is  a  worker,  a  client -service  recipient,  and  an 
"intermediary"  party  like  a  "broker").  Unless  and  until  Section 
1706  is  repealed,  it  will  serve  as  a  precedent  for  arbitrary  action 
against  other  industries. 

For  a  number  of  years  NBCA  has  kept  track  of  IRS  audits  in  the 
technical  services  industry  because  we  wanted  to  see  what  can 
happen  when  Section  530  is  repealed  for  an  industry.  Firms  covered 


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by  Section  1706  are  left  only  with  the  antiquated,  unpredictable 
common  law  employment  test  when  the  IRS  comes  knocking  on  their 
doors  in  an  audit.  As  a  result,  they  are  easy  prey  for  IRS 
auditors.  The  experience  of  technical  services  firms  is 
illuminating. 

In  many  of  these  cases,  we  learned  that  the  technical  services 
firms  legally  prevailed  against  the  IRS  even  under  the  common  law 
test  --  but  these  firms  actually  "lost"  their  cases  in  the  real 
world  because  they  have  spent  anywhere  from  $50,000  to  $200,000  to 
prevail  on  appeal  at  the  IRS.  How  may  firms  can  afford  to  pay  such 
legal  fees  and,  in  doing  so,  have  they  really  "won"?  In  most  of 
these  cases.  Section  530  would  have  allowed  these  firms  to  prevail 
more  expeditiously  and  at  a  lower  price. 

In  other  cases  involving  technical  services  firms,  the  firms 
simply  "gave  up"  because  they  had  no  Section  530  relief.  The  IRS 
examiners  in  many  of  those  cases  admitted  that  the  firms  had  a 
reasonable  number  of  20  common  law  factors  which  pointed  towards  an 
independent  contractor  relationship,  but  the  examiners  found  that 
it  was  not  enough  for  a  firm  to  be  "reasonable":  without  Section 
530,  a  "reasonable  basis"  for  classifying  workers  does  not  count. 
As  a  result,  technical  services  firms  which  acted  reasonably  were 
nonetheless  assessed  tens  or  hundreds  of  thousands  of  dollars  in 
back  taxes;  as  with  my  own  situation  in  the  Critical  Care  case, 
most  if  not  all  of  these  back  taxes  had  already  been  paid  by  the 
workers  themselves  (so  the  IRS  was  actually  attempting  to  collect 
the  same  taxes  twice) .  Most  of  the  technical  services  firms  in 
this  situation  were  unable  to  afford  the  fees  to  fight  the  IRS,  and 
so  they  agreed  to  reclassify  their  workers  as  employees.  It  seems 
clear  to  us  that  in  many  of  these  cases.  Section  530  would  have 
allowed  those  firms  which  acted  "reasonably"  and  in  good  faith  to 
prevail  against  the  IRS  and  avoid  back  tax  assessments. 

Therefore,  we  see  some  of  the  effects  of  Section  1706  and  its 
repeal  of  Section  530: 

*  An  entire  industry  has  been  subjected  to  targeted  IRS 
audits  because  Congress  has  left  the  technical  services  industry 
without  any  employment  tax  safe  haven.  Indeed,  Section  1706 
clearly  discriminates  against  the  technical  services  industry,  as 
every  other  industry  envoys  an  employment  tax  safe  haven. 

*  Because  firms  in  the  targeted  industry  are  subjected 
to  a  determination  of  their  employment  tax  liabilities  solely  on 
the  basis  of  the  unpredictable  and  antiquated  common  law  employment 
test,  technical  services  firms  that  have  acted  "reasonably"  --  but 
erroneously  in  the  eyes  of  the  IRS  --  have  been  forced  to  fight 
assessments  of  hundreds  of  thousands  of  dollars  in  back  taxes  that 
have  often  already  been  paid  by  the  workers  themselves. 

*  Even  those  taxpayers  in  the  technical  services  industry 
who  "win"  their  cases  legally  have  really  "lost",  in  light  of  the 
difficulty  and  cost  of  defending  their  positions  without  the 
ability  to  rely  upon  Section  530. 

*  Thousands  of  legitimate  self-employed  computer 
programmers  and  engineers  are  effectively  forced  to  aibandon  their 
independent  contractor  status  -  -  even  if  they  could  prevail  against 
an  IRS  reclassification  --  because  too  many  technical  services 
firms  simply  do  not  want  to  invite  IRS  examination.  I  want  to 
emphasize  that  we  are  talking  about  legitimate  independent 
contractors,  the  ultimate  small  businessperson  who  is  being  hurt  by 
the  absence  of  Section  530  relief  in  the  technical  services 
industry. 

In  light  of  the  adverse  impact  from  Section  1706,  how  is  it 
possible  to  justify  this  discriminatory  law?  Frankly,  to  NBCA,  it 
seems  impossible  to  justify.  Again,  looking  at  the  Treasury  Study 
of  1706,  technical  services  workers  come  under  the  Services 
category  in  Table  5-1.  The  IRS  claims  that  15.4%  of  firms  in  the 
Services  industry  have  misclassif ied  workers  (assuming,  as  noted 
above  in  our  comments,  that  the  IRS  figures  are  not  inflated)  . 
Looking  solely  at  the  private  sector  "industries"  listed  in  Table 
5-1  (i.e.,  eliminating  reference  to  the  Government  as  an 
"industry"),  we  see  that  there  were  12  industries  studied  by  the 
IRS,  of  which  the  Services  industry  is  one.  Of  these  12  industries 


1572 


listed  in  Table  5-1.  in  7  industries  the  percentage  of  employers 
who  misclassifv  workers  was  greater  than  the  technical  services 
industry-  In  other  words,  Section  1706  removed  Section  530 
protection  for  the  technical  services  industry  even  though  firms  in 
that  industry  have  a  better  than  average  rate  of  worker 
classification  --  indeed,  7  industries  with  worse  worker 
classification  problems  still  have  Section  530  protection. 

Similarly,  the  Treasury  Study  of  1706  shows  in  Table  5-2  that 
technical  services  workers  report  at  least  85.1%  of  their  taxable 
income,  whereas  all  other  workers  in  other  industries  report  only 
79.0%  of  their  taxable  income.  Again,  in  light  of  these 
statistics,  how  is  it  possible  to  justify  the  discrimination 
against  the  technical  services  industry  that  has  resulted  from 
Section  1706? 

We  have  focused  so  much  on  Section  1706  not  to  argue  for 
extending  Section  1706  by  repealing  Section  530  for  other 
industries  with  worse  tax  compliance  records;  we  would  not  take 
that  position  because,  as  we  have  explained  in  detail,  our  own 
experience  is  that  the  common  law  employment  test  is  so 
unpredictable  that  every  industry  must  have  some  type  of  back-up 
employment  tax  safe  haven  like  Section  530.  Rather,  we  have 
focused  on  Section  1706  because  it  demonstrates  the  problems  that 
arise  when  Congress  starts  to  single  out  selected  industries  for 
loss  of  Section  530  relief.  If  Congress  really  wants  to  improve 
the  fairness  of  the  employment  tax  laws,  instead  of  repealing 
Section  530  for  the  construction  industry  --  or  accommodating  other 
groups  that  want  to  repeal  Section  530  for  the  nursing  profession 
and  other  industries  --  Congress  should  repeal  Section  1706  and 
eliminate  that  unfairly  discriminatory  law  that  penalizes  the 
technical  services  industry.  The  Treasury  Study  of  1706  finds  no 
basis  for  this  discrimination  and  subsequent  studies,  including  a 
November  1992  House  Government  Operations  Committee  Report,  have 
called  for  repeal  of  Section  1706. 

V.  Concerns  Relating  to  the  Use  of  Independent  Contractors  Caua  Be 
Adequately  Addressed  bv  Enacting  a  Bill  Like  H.R.  5011 

Just  because  NBCA  supports  the  retention  of  Section  530  does 
not  mean  that  we  believe  that  other  improvements  cannot  be  made 
regarding  the  use  of  independent  contractors.  In  fact,  at  the  July 
23,  1992  hearings  before  this  Subcommittee  on  "Misclassification  of 
Employees  and  Independent  Contractors  for  Federal  Income  Tax 
Purposes",  and  at  the  June  8,  1993  hearings  before  the  Subcommittee 
on  Commerce,  Consumer  and  Monetary  Affairs  of  the  House  Government 
Operations  Committee,  NBCA  officers  testified  in  favor  of  a  1992 
bill  H.R.  5011  (the  June  1993  testimony  was  jointly  submitted  by 
NBCA  and  the  American  Nurses  Association) .  We  will  not  repeat  in 
detail  here  what  our  testimony  stated,  but  its  key  points  are  as 
follows: 

*  Increase  the  penalty  for  non- issuance  and  non- filing  of 
1099  forms  from  the  current  $50  to  a  much  higher  level,  similar  to 
the  §3509  rates  (in  the  neighborhood  of  10%  of  the  compensation) . 
This  will  serve  to  encourage  issuance  of  1099  forms.  It  is  the 
non- issuance  and  non- filing  of  these  forms,  not  the  worker's  status 
as  an  independent  contractor,  which  results  in  losses  of  tax 
revenues . 

*  Decrease  the  penalty  for  unintentional  misclassification  of 
workers  in  cases  where  1099  forms  are  filed  from  the  current 
unreasonably  high  level  of  about  10%  of  compensation  to  2%  of 
compensation,  with  a  maximum  of  $500  per  worker.  If  1099s  are 
filed,  there  is  no  reason  to  penalize  businesses  for  unintentional 
misclassif ications . 

*  Make  changes  to  Section  530  that  improve  this  safe  haven, 
rather  than  repeal  it.   For  example: 

(a)  Congress  should  expressly  reject  the  IRS  view 
of  the  "consistency"  test  (the  IRS  focuses  mostly 
on  job  duties,  rather  than  on  the  workers' 
relationships  with  the  business)  and  instead 
confirm  the  correctness  of  the  decision  in 
Lambert's  Nursery  &  Landscaping.  Inc.  v.  U.S.,  894 
F.2d  154  (5th  Cir.  1990)  (the  court  stated  that  ]ob 


1573 


duties  are  of  minimal  importance  in  determining 
"consistency").  NBCA  believes  that  too  many  firms 
which  want  to  abolish  independent  contractors  are 
using  the  "consistency"  requirement  of  Section  530 
as  an  excuse;  these  firms  claim  that  because  they 
have  employees,  they  cannot  take  advantage  of 
Section  530  and  use  independent  contractors.  As 
Lambert ' s  Nursery  made  clear,  this  is  not  the  case: 
as  long  as  such  firms  treat  their  employees 
significantly  differently  from  how  they  treat  their 
independent  contractors  (and  assuming  that  they 
have  a  reasonable  basis  for  using  independent 
contractors)  ,  Section  530  should  still  be  availaible 
to  them.  Once  this  is  done,  firms  like  those  in 
HHSSA  --  which  claim  that  they  unwilling  to  rely 
upon  Section  530  because  they  use  employees  --  will 
no  longer  have  this  excuse  for  their  attack  on 
competitor  firms  which  have  chosen  to  use 
independent  contractors . 

(b)  Congress  should  revise  the  "prior  audit"  rule 
in  Section  530  so  that  only  prior  employment  tcix 
examinations  provide  a  safe  haven.  This  would 
actually  be  a  narrowing  of  Section  530,  but  we 
believe  it  is  justified  as  loner  as  Congress  defined 
the  term  "audit"  to  include  even  "informal" 
examinations  and  compliance  checks  where  the  IRS 
actually  reviews  employment  tax  documents  and 
records,  and/or  the  20  common  law  questions,  with 
the  taxpayer. 

(c)  Congress  should  repeal  Section  530(d),  which  is 
also  known  as  Section  1706. 

NBCA  believes  that  when  Section  530  is  modified  in  the  small 
but  important  ways  above  (and  as  stated  in  more  detail  in  our  prior 
testimony)  ,  then  abuses  complained  of  in  regard  to  the  use  of 
independent  contractors  will  disappear  or  become  minimal. 

Finally,  we  wish  to  make  another  key  point:  although  firms 
that  use  employees  often  claim  that  they  are  competitively 
disadvantaged  in  doing  so  (and  hence  Section  530  should  be  repealed 
to  put  everyone  on  a  "level  playing  field"),  our  experience  has 
been  to  the  contrary.  Especially  with  the  changes  proposed  by  H.R. 
5011,  the  arguments  of  Section  530  opponents  will  disappear 
(assuming  that  they  have  validity  to  begin  with) . 

In  our  profession,  nurses  face  a  choice  of  working  as 
employees  for  certain  nursing  agencies  or  as  independent 
contractors  through  certain  broker  firms.  When  brokers  attempt  to 
attract  workers  as  independent  contractors,  these  brokers  cannot 
promise  priority  for  work  assignments,  in-house  training,  a  minimum 
amount  of  pay  or  salary  guarantees  each  week,  payment  for  uniforms 
or  nursing  tools,  advancement  within  the  company,  bonuses  and 
benefits,  and  similar  work  terms  with  are  hallmarks  of  employment 
rather  than  independent  contractor  status  (costs  which  are 
subsidized  by  the  government  because  employers  get  tax  deductions 
for  these  payments) .  Rather,  brokers  offer  nurses  only  a 
completely  "hands-off "  referral  (and  the  obligation  of  paying  their 
own  employment  and  income  taxes  from  the  gross  payments  made  to 
them)  --  there  is  the  benefit  of  independence,  but  clearly  the  lack 
of  "job"  security  and  "  employee  perks".  If  anyone  believes  that 
brokers  have  a  competitive  edge  over  employers  in  attracting 
workers  in  such  situations,  such  belief  is  based  upon  a  completely 
unrealistic  view  of  how  the  marketplace  operates.  There  are  trade- 
offs to  be  made  and,  if  anything,  we  believe  that  employers 
generally  have  a  competitive  edge  over  brokers.  But  our  response 
IS  to  compete  in  the  marketplace,  and  not  to  eimend  the  tax  laws 
that  give  employers  the  advantages  that  they  enjoy. 

CONCLUSION 

For  the  above  reasons,  we  urge  this  Committee  to  reject  the 
repeal  of  Section  530  for  the  construction  industry,  and  to  instead 
repeal  Section  1706  and  enact  a  version  of  the  1992  bill  H.R.  5011. 

For  more  information  call  NBCA  at  (202)637-9121 


1574 

Chairman  Rangel.  Mr.  Pyles. 

STATEMENT  OF  JAMES  C.  PYLES,  COUNSEL,  HOME  HEALTH 
SERVICES  &  STAFFING  ASSOCIATION 

Mr.  Pyles.  Thank  you,  Mr.  Chairman.  I  am  James  C.  Pyles,  rep- 
resenting the  Home  Health  Services  and  Staffing  Association.  We 
appreciate  the  opportunity  to  come  testify  today.  The  association's 
members  provide  supplemental  medical  staff  such  as  nurses  and 
nurses  aides  to  health  care  facilities  like  hospitals  and  nursing  fa- 
cilities on  a  temporary  basis  across  the  country.  The  association's 
members,  who  are  both  large  and  small  businesses,  employ  ap- 
proximately 350,000  workers  nationwide  in  every  jurisdiction  in 
the  country. 

All  of  our  companies  treat  those  workers  as  employees  in  accord- 
ance with  the  consistent  application  of  the  employment  tax  laws  by 
the  IRS.  There  is  simply  no  question  about  how  those  employees, 
those  workers,  should  be  treated  in  our  industry. 

The  IRS  rulings  have  been  consistent.  The  misclassification  of 
workers  in  the  supplemental  medical  staff  industry  has  reached 
epidemic  proportions  and  continues  to  grow.  This  misclassification 
we  believe  is  intentional  since,  according  to  some  of  the  testimony 
we  have  heard  on  this  panel,  the  IRS  interpretation  and  applica- 
tion of  employment  tax  laws  to  our  industry  has  been  consistent 
and  well  publicized.  Yet  the  IRS's  ability  to  curb  the  abuse  of  the 
misclassification  is  limited  by  section  530  as  the  subcommittee 
heard  in  the  last  hearing. 

Let  me  be  clear.  We  do  not  oppose  the  legitimate  designation  of 
independent  contractors  as  specified  under  the  20  common  law  fac- 
tors that  appeared  to  be  the  concern  of  the  National  Association  for 
Home  Builders  this  morning.  Our  association  supports  the  proposal 
to  repeal  section  530  for  the  construction  industry  but  strongly 
urges  the  repeal  of  that  provision  for  the  medical  staffing  industry 
as  well.  We  agree  that  there  shouldn't  be  a  piecemeal  approach  to 
this.  There  should  be  a  broader  remedy  to  this  abuse. 

Congressional  action  to  curb  the  waste  and  abuse  resulting  from 
the  misclassification  of  employees  is  long  overdue.  This  abuse  of 
the  employment  tax  laws  has  been  addressed  in  at  least  four 
prior — or  three  prior  congressional  hearings,  now  four  hearings. 
Our  association  has  repeatedly  brought  this  waste  and  abuse  to  the 
attention  of  the  IRS  and  Congress  since  1988. 

With  each  congressional  hearing,  the  following  facts  have  become 
more  and  more  clear:  The  misclassification  of  employees  is  perva- 
sive and  serious  and  it  is  a  growing  problem.  Misclassification  costs 
the  Federal  and  State  governments  tens  of  billions  of  dollars  in  lost 
tax  revenues  each  year. 

Section  530  exacerbates  the  misclassification  problem  both  at  the 
Federal  and  at  the  State  levels  because  it  permits  employers  to  in- 
tentionally violate  the  employment  tax  laws  with  impunity.  It 
wastes  scarce  administrative  resources  by  preventing  the  IRS  from 
effectively  enforcing  the  tax  laws  and  prohibits  the  IRS  from  clari- 
fying the  distinction  between  employees  and  independent  contrac- 
tors. 

Misclassification  of  employees  victimizes  workers  also  by  depriv- 
ing them  of  unemployment  compensation,  workers  compensation. 


1575 

disability  insurance,  quarters  of  coverage  for  Social  Security  and 
Medicare,  protection  under  the  Fair  Labors  Standards  Act,  the  Oc- 
cupational Safety  Act — Safety  and  Health  Act,  the  Americans  with 
Disabilities  Act,  and  even  the  recently  enacted  Family  Medical 
Leave  Act  of  1993. 

Misclassification  also  places  law  abiding  employers  at  a  great 
competitive  disadvantage  by  permitting  competitors  who  ignore  the 
law  to  evade  the  employment  tax  withholding  requirements  and 
the  overhead  costs  of  Federal  and  State  worker  benefit  and  protec- 
tion programs. 

Finally,  misclassification  in  the  medical  staffing  industry  creates 
a  health  quality  hazard  by  placing  nurses  in  critical  areas  of  hos- 
pitals who  ostensibly  are  not  subject  to  anyone's  supervision  and 
control. 

Thus  misclassification  costs  the  government  billions  of  dollars, 
annually  wastes  the  IRS  enforcement  resources,  deprives  workers 
of  benefits,  penalizes  law  abiding  employers,  and  creates  a  health 
hazard. 

The  time  for  study  and  debate  we  believe  has  passed.  It  is  time 
for  Congress  to  put  an  end  to  this  abuse.  The  noble  intent  behind 
section  530  to  ensure  fair  application  of  the  employment  tax  laws 
has  now  been  perverted  by  those  who  would  use  the  provision  to 
gain  an  unfair  competitive  advantage  in  the  marketplace. 

Section  530,  which  was  never  intended  to  be  permanent,  has  now 
been  on  the  books  15  years.  Those  that  have  grown  fat  feeding  at 
this  trough  are  going  to  squeal  if  you  take  it  away,  but  you  have 
the  heavy  responsibility  of  weighing  competing  interests. 

Accordingly,  I  ask  the  committee — subcommittee  to  consider  the 
following.  When  you  are  presented  with  the  question  of  how  to  find 
money  to  provide  access  to  basic  health  insurance  for  37  million 
uninsured  Americans  in  this  country,  think  about  the  billions  of 
dollars  going  into  the  pockets  of  scofFIaws  because  of  section  530. 
When  you  consider  cutting  entitlement  programs  or  a  $124  billion 
out  of  the  Medicare  program,  think  of  the  revenue  lost  to 
misclassification. 

When  you  explain  to  your  constituents  why  Congress  raised  the 
personal  and  corporate  income  taxes,  think  of  misclassification. 
Tens  of  billions  of  dollars  in  revenue  can  be  generated  simply  by 
clarifying  the  existing  employment  tax  laws  and  without  adding  a 
single  tax  or  cutting  a  single  program. 

We  agree  with  Congressmen  Kleczka,  Lantos,  and  Shays  that  the 
abuse  of  the  employment  tax  laws  should  not  be  allowed  to  con- 
tinue. Accordingly,  we  would  urge  you  to  repeal  or  narrow  section 
530.  Fair  and  uniform  enforcement  of  the  employment  tax  laws  is 
simply  good  public  policy. 

I  would  be  glad  to  answer  any  questions. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


1576 


TESTIMONY  BEFORE  HOOSE  SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

MISCELIANEOUS  REVENUE  RAISING  PROPOSALS 

REPEAL  OF  SECTION  530  OF  THE  REVENUE  ACT  OF  1978 

RELATING  TO  THE  CLASSIFICATION  OF  WORKERS 

AS  INDEPENDENT  CONTRACTORS 


James  C.  Pyles 

Home  Health  Services  and  Staffing  Association 

119  South  Saint  Asaph  Street,  #115D 

Alexandria,  VA  22314 

(202)  466-6550 


September  21,  1993 


Mr.  Chainnan  and  honorable  members  of  the  Subcommittee,  I  am 
James  C.  Pyles,  representing  the  Home  Health  Services  and 
Staffing  Association.   The  Association's  members  are  national  ajid 
multistate  companies  that  provide  supplemental  medical  staff, 
such  as  nurses  and  nurse's  aides,  to  health  care  facilities,  such 
as  hospitals  and  nursing  facilities.   The  Association's  members 
employ  between  300,000  and  4  00,000  workers  in  nearly  every  state 
in  the  country  and  treat  those  workers  as  employees  under  the 
IRS'  consistent  rulings  and  interpretations  of  the  employment  tax 
laws.' 

We  support  the  proposal  to  repeal  the  §  530  safe  harbors  for 
construction  industry  employees,  but  strongly  urge  that  any  such 
repeal  include  the  medical  staffing  industry  as  well.   Since  at 
least  1988,  we  have  repeatedly  brought  the  abuse  of  the 
employment  tax  laws  in  the  staffing  industry  to  the  attention  of 
the  IRS  and  Congress.   Most  recently,  we  documented  those  abuses 
in  a  hearing  before  this  Subcommittee  on  July  23  of  last  year.^ 

Congress  should  act  now  to  curb  the  waste  and  abuse  that  is 
resulting  from  the  misclassif ication  of  employees.   An  October 
1992  report  of  the  Committee  on  Government  Operations  summarized 
the  findings  of  at  least  three  prior  congressional  hearings  on 
this  issue  and  found  that: 

(a)  [t]he  misclassif ication  of  workers  as  independent 
contractors  instead  of  employees  is  a  pervasive  and  serious 
problem  .  .  . ;  and 

(b)  [e]quity  and  the  need  for  increased  revenue  collection 
demand  that  there  be  improved  enforcement  and  statutory 
changes  to  combat  the  growing  problem  of  worker 
misclassif ication.' 

The  misclassif ication  of  employees  results  in  the  loss  of 
billions  of  dollars  in  badly  needed  tax  revenues  for  both  the 
federal  and  state  governments.   The  General  Accounting  Office 
reported  to  this  Subcommittee  on  July  23,  1992  that  $20.3  billion 
in  unpaid  taxes  were  attributable  to  self-employed  workers  and 
that  "much"  of  that  tax  gap  was  attributable  specifically  to 


Technical  Advice  Memorandum  9135001  (February  28, 
1991) ,  Technical  Advice  Memorandum  8913002  (December 
1989),  Technical  Advice  Memorandum  8913002  (December  8, 
1988);  Private  Letter  Ruling  9122020  (June  4,  1991); 
Revenue  Ruling  75-101,  1975-1  C.B.  318. 

See  testimony  of  Home  Health  Services  and  Staffing 
Association  (July  23,  1992). 

"Contractor  Games:   Misclassif ying  Employees  as 
Independent  Contractors,"  Committee  on  Government 
Operations,  H.  Rep.  102-1053,  102d  Cong.,  2d  Sess. ,  10 
(October  16,  1992) . 


1577 


independent  contractors.''  At  an  April  1991  hearing  before  a 
Government  Operations  Subcommittee,  the  IRS  testified  that, 
"conservatively,"  billions  of  dollars  were  being  lost  in  tax 
revenue  each  year  due  to  the  misclassif ication  of  employees.' 
Using  1984  IRS  data,  GAO  has  estimated  that  lost  revenue  from 
misclassif ication  of  employees  amounted  to  at  least  $2.1  billion 
in  1992,  and  that  estimate  did  not  include  revenues  lost  due  to 
employers  who  fail  to  comply  with  IRS  reporting  requirements.' 

Further,  GAO  found  in  a  1989  study  that  38%  of  businesses 
using  independent  contractors  misclassif ied  employees,  and  the 
IRS  has  found  in  other  studies  since  1989  that  90%  of  businesses 
audited  had  one  or  more  misclassified  workers.'  Thus,  the 
Government  Operations  Committee  concluded  that  the  available  data 
seems  to  show  "the  tip  of  a  potentially  enormous  iceberg."* 

States  have  reported  losing  more  than  $50  million  annually 
in  employment  taxes  because  of  misclassif ication  of  workers.' 

Section  530  exacerbates  the  misclassif ication  problem  at  the 
federal  and  state  level  because  it  allows  employers  that  have 
intentionally  misclassified  workers  to  avoid  paying  back  taxes  or 
penalties,  discourages  the  IRS  from  expending  scarce 
administrative  resources  to  pursue  misclassif ication  cases,  and 
prohibits  the  IRS  from  issuing  rulings  or  regulations  to  clarify 
the  definition  of  employees.'"  Perhaps  most  significantly,  §  530 
"illogically  allows  continuation  of  a  violation  of  law  and  even 
permits  newcomers  to  an  industry  which  has  established  a  530  safe 
harbor  to  operate  with  misclassified  workers."" 

The  misclassif ication  of  employees  also  victimizes  workers 
by  depriving  them  of  unemployment  compensation,  workers 
compensation,  disability  insurance,  quarters  of  coverage  for 
Social  Security  and  Medicare,  and  the  protection  of  federal  and 
state  programs  such  as  the  Fair  Labor  Standards  Act,  the 
Occupational  Safety  and  Health  Act,  the  Americans  with 
Disabilities  Act,  and  protection  from  discrimination  through  the 
Equal  Employment  Opportunity  Commission.'^  As  the  Government 
Operations  Committee  recognized,  the  loss  of  such  benefits  and 
protections  "can  be  devastating  in  cases  of  illness, 
unemployment,  and  retirement.""  As  prior  congressional  hearings 
have  clearly  shown,  workers  may  be  compelled  to  take  a  job  even 
though  they  are  misclassified,  and  often  they  are  unaware  of  the 
financial  and  legal  obligations  of  misclassif  ication. '■* 


See  "Tax  Administration:   Approaches  for  Improving 
Independent  Contractor  Compliance,"  GAO/GGD-92-108,  23- 
24  (July  23,  1992) . 

"Contractor  Games,"  5. 

GAO  Report,  24;  "Contractor  Games,"  5-6. 

"Contractor  Games,"  6. 

Id. 

Id.  at  6. 

Id.  at  4,  5,  7,  and  8. 

Id.  at  9. 

Id.  at  2-4. 

Id.  at  7. 

Id.  at  7-8. 


1578 


It  has  further  been  conclusively  established  that  employers, 
such  as  the  members  of  HHSSA,  that  comply  with  the  employment  tax 
laws,  are  "placed  at  a  great  competitive  disadvantage"  when 
"illegitimate  competitors"  in  the  same  industry  are  permitted  to 
misclassify  employees."  Such  illegitimate  competitors  can 
thereby  evade  responsibility  for  overhead  costs  related  to 
government  and  private  benefit  programs  that  can  cost  "up  to  37% 
of  wages."'*   "Adding  insult  to  injury,"  according  to  the  recent 
Government  Operations  Committee  report,  the  failure  of  these 
employers  to  pay  their  lawful  share  of  overhead  costs  increases 
the  cost  to  law  abiding  employers  of  programs  such  as 
unemployment  insurance  and  workers  compensation. '^ 

Further,  subjecting  similarly  situated  employers  to 
different  treatment  under  the  employment  tax  laws  leads  to 
"bitterness  and  cynicism  about  our  government  in  general  and  the 
IRS  in  particular."'* 

Finally,  the  "confusion  and  misunderstanding"  that  has 
resulted  from  the  misclassif ication  of  workers  and  the 
application  of  §  530  generally  poses  a  particular  threat  to  the 
health  and  safety  of  patients  in  the  medical  staffing  industry." 
In  order  for  companies  to  market  their  nurses  as  independent 
contractors,  they  must  contend  that  the  nurses  have  the  sole 
right  to  control  how  they  provide  their  services  and  that  no  one 
has  the  right  to  supervise  or  control  how  they  perform  those 
services.   Supplemental  staffing  nurses  often  serve  in  intensive 
care  and  other  critical  care  departments  of  hospitals  where  the 
supervision  and  integration  of  their  services  is  legally  and 
practically  imperative.'"  Thus,  the  misclassification  of 
supplemental  staffing  nurses  is  particularly  pernicious  because 
it  jeopardizes  the  quality  of  health  care. 

Accordingly,  we  support  the  repeal  of  §  530  and  urge  the 
Subcommittee  to  take  action  to  stop  the  widespread  and  growing 
abuse  of  the  employment  tax  laws.   I  would  be  glad  to  answer  any 
questions  from  the  Subcommittee. 

JCP/jhl 


"Contractor  Games,"  2-3,  8;  "Tax  Administration 
Problems  Involving  Independent  Contractors,"  Committee 
on  Government  Operations,  H.  Rep.  101-979,  101st  Cong., 
2d  Sess.,  6-7  (November  9,  1990). 

"Contractor  Games,"  3. 

Id.  at  8. 

Id.  at  9. 

Id.  at  7. 

Accreditation  Standards  for  Hospitals.  Joint  Commission 
on  Accreditation  of  Healthcare  Ogranizations,  §§  NC.2~ 
NC.5.6,  SE.1-SE.4,  SP.l-S.5.4  (1993);  42  C.F.R.  § 
482.23. 


1579 

Chairman  Rangel.  Ms.  Sumner,  are  you  a  nurse? 

Ms.  Sumner.  Yes,  I  am. 

Chairman  Rangel.  And  your  business,  you  provide  nursing  serv- 
ices for  clients? 

Ms.  Sumner.  No,  we  don't  provide  nursing  services.  The  com- 
pany, Criticare,  which  I  co-own,  provides  broker  services  to  nurses 
and  to  hospitals.  We  don't  provide  the  nursing  services.  The  profes- 
sional nurses  provide  nursing  services. 

Chairman  Rangel.  Well,  who  would  your  clients  be? 

Ms.  Sumner.  We  have  two  clients.  We  have  a  nurse  client  and 
we  have  an  institutional  client,  which  could  be  a  hospital  or  a  nurs- 
ing home  or  other  health  care  facility. 

Chairman  Rangel.  So  the  hospital  and  the  nursing  home  would 
be  looking  for  nurses'  services  and  you  broker  it? 

Ms.  Sumner.  That  is  correct. 

Chairman  Rangel.  You  don't  provide  nurses? 

Ms.  Sumner.  The  nurses  provide  the  nursing  service.  We 
provide 

Chairman  Rangel.  Well,  I  am  a  hospital  and  I  need  100  nurses 
and  I  come  to  you.  Would  you  give  me  100  contracts  or  1  contract? 

Ms.  Sumner.  I  am  sorry.  Would  you  repeat?  I  don't  understand 
your  question. 

Chairman  Rangel.  Would  a  hospital  come  to  you  and  ask  for  x 
number  of  nurses?  Would  you  be  able  to  broker  that  for  them? 

Ms.  Sumner.  All  facilities  ask  for  different  things.  They  may 
ask 

Chairman  Rangel.  I  am  asking  if  a  hospital  asks  you  for  100 
professional  registered  nurses,  could  they  ask  you  to  broker  that? 
I  am  trying  to  figure  out  what  you  do.  If  a  hospital  came  to  you 
and  said  this  is  Mt.  Claire  Mercy  Hospital,  I  need  100  nurses,  could 
you  broker  it?  What  would  you  tell  them? 

Ms.  Sumner.  My  company  could  not  provide  that  service. 

Chairman  Rangel.  Suppose  we  came  to  you  and  said,  "Ms.  Sum- 
ner, we  need  100  nurses,  could  you  help  us  in  any  way?"  What 
would  you  tell  them? 

Ms.  Sumner.  We  would  evaluate  the  hospital's  need,  contact 
nurses  who  are  available  to  us  who  had  indicated  their  desire  to 
subcontract  through  our  company. 

Chairman  Rangel.  And  so  here  I  am  an  outstanding  hospital 
and  I  have  an  outstanding  broker  and  I  need  100  nurses,  so  you 
are  going  to  give  me  100  contracts  with  nurses?  How  do  I  get  the 
nurses? 

Ms.  Sumner.  You  would  contact  my  company  and  I  would  con- 
tact nurses  who  might  want  to  work 

Chairman  Rangel.  When  I  end  up,  I  am  going  to  have  100 
nurses,  right? 

Ms.  Sumner.  Pardon  me? 

Chairman  Rangel.  When  I  end  up,  you  are  going  to  have  for  me 
100  nurses,  one  way  or  the  other. 

Ms.  Sumner.  Through  my  company  and  others,  yes,  you  may. 

Chairman  Rangel.  I  am  only  dealing  with  you,  Ms.  Sumner. 
Don't  give  me  a  hard  time.  I  want  to  help.  I  need  100  nurses  and 
I  go  to  you  and  you  provide  the  service  one  way  or  the  other  so 
when  I  end  up  back  there  I  have  100  nurses.  The  contractual  rela- 


1580 

tionships  we  are  not  getting  into  except  to  the  point  that  I  am  ask- 
ing do  I  just  sign  a  contract  with  you  or  do  you  refer  to  me  100 
contractors  and  I  sign  100  different  contracts? 

Ms.  Sumner.  You  sign  a  contract  with  me  that  says  that  I  will 
look  for  those  services  for  you.  The  nurse  signs  a  contract  with  my 
company  that  says  I  want  you  to  try  and  find  me  work.  Now,  that 
nurse  may  or  may  not  work  at  that  institution  on  a  regular  or  con- 
sistent basis,  but  may  work  in  a  variety  of  different  settings.  The 
nurse  has  complete  control  over  where,  when  and  how  they  work. 

Chairman  Rangel.  Now,  suppose  your  services  are  so  good  that 
I  want  this  nurse  for  1  year  or  2  years,  would  I  have  any  problem 
with  you? 

Ms.  Sumner.  No,  but  usually  the  contracts  are  renewed  on  a 
quarterly  or  monthly  basis  and  are  not  written  for  1  year. 

Chairman  Rangel.  Ten  years? 

Ms.  Sumner.  Ten  years?  Well,  that  has  not  happened. 

Chairman  Rangel.  No,  but  I  mean,  if  a  nurse  likes 

Ms.  Sumner.  But  there  is  no  reason  why  that  could  not  happen, 
if  the  nurse  wanted  it  that  way. 

Chairman  Rangel.  Now,  would  I  have — I  would  not  have  to  pay 
anything  as  relates  to  Social  Security,  Medicare.  What  would  the 
benefits  be  to  me  as  the  hospital  in  going  to  you? 

Ms.  Sumner.  The  benefits  have  to  do  with  the  quality  of  the 
service. 

Chairman  Rangel.  I  am  assuming  that  your  service  is  the  best 
in  the  country,  but  I  mean  as  it  relates  to  what  I  have  to  pay  that 
nurse.  I  don't  have  any  payroll  deductions  I  just  pay  you,  right? 

Ms.  Sumner.  There  is  a  flat  fee,  yes,  which  is  competitive  for  all 
other  temporary  nurse  firms.  The  difference  is  an  independent  con- 
tractor nurse  earns  higher  fees. 

Chairman  Rangel.  So  I  don't  have  to  worry  about  what  the 
nurse  has  or  not  have.  I  don't  have  any  employer  responsibilities. 

Ms.  Sumner.  That  is  correct,  including  all  the  indirect  costs  such 
as  tuition  reimbursement,  vacation/sick  pay,  and  so  forth. 

Chairman  Rangel.  Because  I  am  not  an  employer  and  you  are 
not  an  employer,  the  nurse  is  the  employer. 

Ms.  Sumner.  The  nurse  is  self-employed,  that  is  right. 

Chairman  Rangel.  Self-employed. 

So  would  it  be  fair  to  say  that  I  would  have  to  pay  less  to  you 
than  if  indeed  I  hired — you  know  the  prevailing  wage  better  than 
I,  but  it  is  very  competitive  as  I  understand  it. 

Ms.  Sumner.  Than  what;  than  if  you  hired  the  nurse  directly? 

Chairman  Rangel.  Well,  there  is  a  shortage  of  nurses;  is  that 
not  correct? 

Ms.  Sumner.  Yes,  that  is  correct. 

Chairman  Rangel.  So  if  I  wanted  to  pay  the  least  amount  for 
quality  service,  would  I  do  better  dealing  with  a  broker  than  with 
the  individual  nurses?  If  I  just  needed  your  advice 

Ms.  Sumner.  I  think  it  would  be  about  the  same.  You  know,  the 
nurse  gets  the  lion's  share  of  any  fees  that  are  paid. 

Chairman  Rangel.  So  whether  or  not  my  employee  nurse — strike 
that,  self-employed  nurse — has  any  type  of  coverage  at  all,  that 
would  not  be  my  concern. 

Ms.  Sumner.  Coverage  for  what? 


1581 

Chairman  Rangel.  For  health  benefits,  Social  Security,  disabil- 
ity, workmen's  compensation,  anything  that  the  unions  make  me 
pay. 

Ms.  Sumner.  Well,  the  nurses  pay  their  own  self-employment 
tax. 

Chairman  Rangel.  I  know  what  they  do.  I  am  saying  it  would 
not  be  my  worry. 

Ms.  Sumner,  It  would  not  be  your — that  is  correct. 

Chairman  Rangel.  And  it  wouldn't  be  your  worry. 

Ms.  Sumner.  Well,  I  issue  1099s  to  those  people,  but,  I  mean, 
you  are  right,  they  are  responsible  for  paying  self-employment  and 
income  tax  as  any  small  business  would. 

Chairman  Rangel.  It  is  up  to  the  independent  contractor  to  de- 
cide what  they  want  and  don't  want. 

Ms.  Sumner.  That  is  correct. 

Chairman  Rangel.  Now,  we  got  a  problem  with  the  health  care 
bill  which  I  am  certain  you  more  than  the  rest  of  these  people  have 
been  following,  I  guess  we  have  to  assume  that  some  of  these  and 
I  don't  know  the  percentage  of  these  independent  contractors 
whether  they  are  nurses  or  whatever  just,  they  are  just  trying  to 
make  it.  They  can't  afford  the  luxury  of  health  care  and  all  those 
other  government  imposed  benefits.  They  will  just  do  without  it 
until  they  become  successful.  I  assume  a  lot  of  nurses  just  do  with- 
out it.  You  can't  make  them  take  it,  can  you? 

Ms.  Sumner.  I  can't  make  them  take  it  but  it  has  been  my  expe- 
rience that  they  all  have  coverage,  and  the  Clinton  health  bill  may 
help  self-employed  persons  get  better  health  coverage. 

Chairman  Rangel.  Well,  nurses  are  probably  a  cut  above  the 
rest  of  these  in  terms  of  understanding  their  needs  since  they  are 
trained  in  health  care,  but  the  general  national  statistics  have 
shown  that  these  independent  contractors  don't  take  care  of  them- 
selves as  well  as  employees  are  taken  care  of  by  the  unions  and  the 
employers. 

As  a  matter  of  fact,  one  of  the  problems  we  have  is  that  we  are 
not  getting  those  1099s  filed  so  we  don't  even  know  how  much 
money  is  being  paid  out  there.  That  is  an  IRS  problem,  but  assum- 
ing that  you  had  a  broader  responsibility,  and  even  though  it  is 
challenged  the  government  believes  it  does,  to  give  coverage  to  ev- 
erybody and  to  provide  disability  and  unemployment  and  Social  Se- 
curity. We  believe  we  got  to  pay  for  it  anyway  so  we  might  as  well 
get  something  out  of  the  beneficiary,  you  would  not  know  how  to 
help  your  government  to  do  that  under  your  brokerage  outfit, 
would  you? 

Ms.  Sumner.  Well,  it  has  been  my  experience  that  the  nurses 
who  work  through  companies  like  mine  generally  make  a  higher 
taxable  income.  And  in  fact,  in  our  court  case,  the  government's 
own  expert  witness  did  a  comparison  and  indicated  that  nurses 
who  work  as  independent  contractors  generally  pay  more  in  self- 
employment  and  income  taxes. 

I  think  that  you  need  to  file  1099s  and  that  the  compliance  en- 
forcement is  up  to  the  IRS  to  determine  that  those  taxes  have  been 
paid. 

Chairman  Rangel.  Would  any  of  you  object  if  the  IRS  asked  you 
to  help  them  and  if  this  independent  contractor  worked  for  you,  you 


1582 

know,  for  most  of  the  year,  80  percent,  90  percent  of  the  year,  that 
you  just  withhold  something,  some  income  tax  so  that  when  we 
catch  up  to  those  1099s  at  least  we  would  have  the  money. 

Of  course,  if  there  was  overwithdrawal,  then  we  pay  them  some- 
thing, but  they  will  pay  you  something  for  withholding,  so  we  can 
get  our  hands  on  that  money.  I  mean,  if  they  have  been  with  you 
for  a  long  time  and  you  know  them  and  we  don't  as  the  govern- 
ment, there  wouldn't  be  any  objections  to  that  type  of  thinking  to 
help  you  with — to  help  us  with  the  independent  contractors  in  the 
way  you  so  generously  help  us  with  employees? 

Mr.  Pyles.  Our  association,  the  Home  Health  Services  and  Staff- 
ing Association,  certainly  wouldn't  object  to  that  suggestion  which 
I  uiink  was  made  by  GAO  several  times,  but  I  don't  think  that  ad- 
dresses the  whole  question  because  our  companies  also  assume  the 
overhead  costs  of  providing  the  employee  benefits  that  are  pre- 
scribed by  various  Federal  and  State  laws. 

Chairman  Rangel.  That  was  just  one  step  I  was  trying  to  get 
closer  to,  because  a  lot  of  people  really  think  it  is  a  gimmick  and 
we  know  it  is  not,  but  in  order  to  make  certain  that  we  don't  lose 
a  lot  of  money  in  taxes,  you  wouldn't — there  wouldn't  be  an  objec- 
tion to  withhold  from  the  independent  contractor,  if  indeed  the 
independent  contractor  just — ^just  was  associated  with  you  for  so 
long  that  we  needed  to  get  that  money  up  front  like  we  do  with  em- 
ployees, there  wouldn't  be  any  big  objection  to  that? 

Mr.  Desjardens.  Mr.  Chairman,  I  think  philosophically  that  is 
fine,  particularly  if  it  avoids  a  hassle  of  whether  or  not  a  worker 
is  an  independent  contractor  or  employee.  The  problem  we  have 
with  that  in  the  construction  industry,  if  we  can  talk  about  the  con- 
struction industry  for  a  minute,  is  on  what  basis  do  we  withhold 
because  these  independent  workers  are  not  only  paid  for  their 
labor,  but  also  their  materials  that  they  furnish  and  the  equipment 
that  they  have.  So  how  much  do  you  withhold? 

I  mean  it  would  be  unfair  to  withhold  on  materials  that  they  fur- 
nish but  we  as  general  contractor  don't  know  the  makeup  of  what 
they  are  charging  us.  We  don't  know  how  much  is 

Chairman  Rangel.  You  would  have  to  find  out  the  same  way  if 
you  are  a  company  and  he  was  an  employee.  He  would  buy  the  ma- 
terials. Many  times  I  suspect,  you  know,  you  get  an  independent 
contractor  to  paint  your  house  and  you  say  I  buy  the  paint,  or  how 
much  is  it  with  or  without  paint.  I  don't  know  how  they  do  these 
things. 

At  least  there  is  something  that  can  be  worked  out,  if  that  is  the 
only  problem.  We  just  want  you  to  withhold  some  money  on  what 
their  taxable  income  would  be,  certainly  on  not  what  they  need  in 
order  to  perform  the  function.  And  then  I  want  to  get  even  further 
and  see  whether  like  with  Davis-Bacon  that  you  can  help  your  gov- 
ernment to  see  that  these  independent  contractors  have  some  type 
of  coverage  for  their  employees  so  that  the  government  won't  get 
stuck  with  these  people  with  no  coverage  and  no — I  hate  to  say 
benefits,  because  I  assume  that — but  things  that  the  government 
would  think  that  these  would  be  beneficiaries,  so  it  would  cut  back 
the  public  expenditure  for  people  that  are  not  covered  because  they 
have  elected  to  be  treated  as  independent  contractors. 


1583 

Mr.  Desjardins.  Mr.  Chairman,  I  would  submit  that  there 
should  be  no  relationship  on  benefits  whether  a  worker  is  an  em- 
ployee or  independent  contractor,  particularly  in  the  construction 
industry. 

Chairman  Rangel.  How  would  you  handle  it? 

Mr.  Desjardins.  We  find  many  of  our  employees  are  transients. 
We  offer — we  are  a  large  company.  We  offer  benefits  like  health  in- 
surance, vacation  pay  and  retirement  and  so  forth,  benefits. 

Chairman  Rangel.  But  you 

Mr.  Desjardins.  Many  of  our  people  don't  qualify  for  that  be- 
cause they  are  transient  workers. 

Chairman  Rangel.  I  am  talking  about  you  don't  offer  that  to 
your  independent  contractors,  do  you? 

Mr.  Desjardins.  We  don't  know  what  they  provide  for  benefits, 
no.  What  I  am  saying  is 

Chairman  Rangel.  No,  no,  no,  no.  Listen.  You  don't  know  and 
really  you  don't  care.  All  you  want  is  the  job  that  is  done  and  I  am 
not  arguing  with  you. 

Mr.  Desjardins.  We  want  the  work  that  is  done  quality. 

Chairman  Rangel.  All  the  business  people  have  been  talking 
about  a  level  playing  field.  I  assume  that  is  what  you  want,  level 
playing  field  and  if  I  had  come  in,  you  know,  paying  a  whole  lot 
of  benefits  to  employees,  I  may  have  to  charge  you  more  than  my 
competitor  here  that — you  know,  these  people  work  for  him  and  he 
doesn't  pay  anything.  And  there  are  taxes  they  are  obligated  to 
pay.  They  just  pav  them. 

So  I  am  just  asking  from  the  government's  point  of  view  how  you 
could  help  us  to  make  certain  that  the  independent  contractor  is 
providing  benefits  for  his  or  her  employees.  Is  that  too  much  of  a 
burden? 

Mr,  Desjardins.  I  believe  it  is  because  we  aren't  required  to  pro- 
vide benefits  to  our  employees. 

Chairman  Rangel.  Weil,  up  to  the  requirement  that  you  are — 
up  to  the  area  that  you  are  required,  you  wouldn't  have  a  problem 
in  treating  the  independent  and  saying  that  is  what  you  have  to 
do  in  order  to  work  for  my  firm  because  I  make  the  minimum  bene- 
fit requirement  and  if  you  come  here,  you  got  to  sign  something  so 
I  can  file  it  with  the  government  to  say  that  these  people  are  cov- 
ered and  they  are  not  going  to  become  a  burden  just  because  you 
elected  not  to  give  them  the  same  benefits  that  I  as  a  fairminded, 
equitable  business  person  believe  that  as  a  human  being  and  a 
worker  they  are  entitled  and  I  don't  want  to  hire  anybody  that 
doesn't  have  these  same  high  standards  for  the  care  of  the  laborers, 
only  if  you  know  these  people  for  a  long  time. 

I  don't  mean  these  people  that  just  come  in  and  do  a  job  and 
then  they  leave  and  work  for  someone  else.  I  mean,  they  have  an 
unusual  relationship  with  you  because  you  are  friends,  you  are  con- 
siderate, they  like  you,  and  they  have  been  with  you  for  years  as 
independents  and  they  want  the  same  benefits  that  those  people 
who  are  not  independents  get.  You  could  work  out  something, 
couldn't  you? 

Mr.  Desjardins.  Well,  perhaps  we  could,  but  I  think  the  issue 
is  the  payment  of  taxes  and  not  benefits.  That  is  where  I  have  a 
problem  with 


1584 

Chairman  Rangel.  You  don't  mind  the  withholding  of  the  taxes? 

Mr.  Desjardins.  I  think  probably  the  withholding  could  be 
worked  out.  As  I  say,  the  problem  I  have  with  that  is  the  issue  of 
withholding  on  materials  that  the  independent  contractor  furnishes 
or  the  equipment  he  uses  to  perform  his  work.  That  is  what  I  have 
a  problem  with. 

Chairman  Rangel.  We  are  moving  in  to  collect  money  and  people 
have  said,  and  they  are  so  right,  that  two  things  you  shouldn't 
want  to  see  made:  One  is  sausage  meat  and  the  other  is  tax  law. 
And  when  this  committee  is  mandated  by  the  President  and  then 
by  the  Speaker  and  then  by  the  chairman  to  raise  some  money,  we 
raise  the  money  and  we  are  losing  a  lot  of  money  with  independent 
contractors. 

Now,  I  know  that  is  not  your  concern,  but  we  are  losing  a  lot  of 
money,  a  lot  of  the  forms  aren't  being  filed.  We  don't  know  where 
the  tax  is  that  is  due  and  owing.  A  lot  of  the  people  who  don't  work 
for  you  but  have  contracts  with  you  ultimately  end  up  as  charges 
to  the  taxpayers  and  so — and  a  lot  of  us  do  believe  it  is  cheaper 
to  hire  the  independent  contractor  without  benefits  than  it  is  to 
mess  around  with  these  employees  with  these  high  powered  unions. 
But  the  result  is  that  the  unions  sometimes  play  a  government  role 
in  getting  coverage  so  that  we  don't  have  to  come  in  and  give  gov- 
ernment coverage  and  that  is  what  Mrs.  Clinton  is  all  about. 

We  have  to  cover  those  independent  contractors.  You  know  them. 
They  work  cheap,  but  they  don't  take  care  of  themselves.  They 
don't  have  a  union  and  we  take  care  of  them.  So  if  you  can't  think 
of  ways  to  help  us  either  to  collect  the  money  or  to  see  that  they 
take  care  of  themselves  with  some  type  of  self-insurance,  then  of 
course  we  have  to  do  it  in  our  old  sausage-making  way  and  we 
have  to  do  it. 

Ms.  Sumner.  Mr.  Chairman 

Chairman  Rangel.  And  these  are  revenue  raisers  we  are  talking 
about.  The  difference  between — you  see,  when  you — when  you  are 
providing  incentives,  it  doesn't  really  have  to  be  good  tax  law  be- 
cause that  is  just  making  people  happy,  but  when  you  are  raising 
revenues,  it  doesn't  have  to  be  good  tax  policy  because  we  need  the 
money. 

So  we  would  hope  that  you  might  think  of  assisting  us  in  estab- 
lishing good  tax  policy  and  at  the  same  time  raise  the  money  be- 
cause— Ms.  Sumner,  my  sister  is  a  nurse  and  she  is  an  independ- 
ent contractor  and  I  just  wonder  whether  or  not  I  am  going  to  have 
to  pay  for  everything  that  she  is  not  getting,  you  know,  if  she  were 
an  employee. 

But  she  is  more  independent  until  she  gets  into  that  hospital  and 
they  don't  treat  her  like  an  independent  contractor.  They  tell  her 
what  to  do,  they  tell  her  where  to  go,  they  tell  her  when  to  come 
in,  they  tell  her  when  to  leave.  But  when  she  deals  with  you,  she 
is  independent  but  when  she  deals  with  the  hospital,  she  is  a  nurse 
and  sometimes  she  is  not.  Some  of  the  union  people  don't  like  my 
sister  because  they  think  that  she  is  getting  paid  less  money  than 
they  are  and  that  they  will  keep  her  before  they  will  keep  the 
members  of  local  1199.  She  doesn't  belong  to  1199  because  why 
should  an  independent  contractor  belong  to  a  union.  That  is  what 


1585 

my  sister  tells  me.  Why  should  she  belong  to  a  union.  You  know, 
she  is  independent,  iust  one  person. 

But  one  thing,  I  don't  argue  with  my  sister  and  I  am  not  think- 
ing about  arguing  with  you.  I  just  don't  understand  it.  But  if  you 
could  share  with  me  how  your  government  can  avoid  having  other 
people  pick  up  other  people's  expenses  that  don't  take  care  of  them- 
selves, maybe  vou  might  want  to  do  with  it  your  contractors  to  give 
them  a  group  health  insurance  program.  You  think  you  might  con- 
sider charging  them  just  a  little  bit,  saying  I  know  you  are  inde- 
pendent and  you  are  a  contractor,  but  my  broker  firm  offers  group 
insurance  for  you  individually? 

Ms.  Sumner.  There  are  lots  of  resources  available  to  professional 
nurses  to  provide  for  their  own  health  insurance,  life  insurance, 
disability  insurance. 

Chairman  Rangel.  That  is  what  I  tell  all  those  people  who  end 
up  in  the  public  hospitals.  There  are  a  lot  of  resources  out  there 
if  you  had  only  been  responsible  to  take  care  of  yourself  I  tell  that 
to  most  of  the  old  folks  without  Social  Security.  You  got  old,  we 
told  you  not  to  get  old  and  you  should  have  gotten  some  job  where 
you  would  have  made  a  contribution  and  forced  employers  but,  no, 
you  had  to  be  smart  and  be  independent  and  you  are  out  there  now 
and  you  are  sick  and  you  are  old  and  you  got  nothing. 

The  broker  firm,  they  don't  even  know,  you  didn't  sign  up  your 
contract  and  the  plays  you  worked  for  20  years,  they  said  you  were 
an  independent  contractor.  And  so  then  everybody  has  to  pay  for 
this  person. 

Mrs.  Clinton  said  that  is  not  right,  that  is  not  fair,  it  is  not  equi- 
table and  she  wants  everyone  to  have  coverage  one  way  or  the 
other.  If  not  by  you,  the  contractor,  if  not  by  the  brokerage  firm, 
if  not  by  the  general  contractor,  then  somebody  other  than  expend- 
ing more  Federal  funds. 

So  we  are  going  to  do  it  our  way,  but  if  you  can  think  of  some 
way  to  meet  us  halfway  without  causing  undue  embarrassment  to 
your  industry,  it  would  certainly  be  appreciated. 

[The  following  was  subsequently  received:] 


1586 


I  /(Hl|/(ar^^w/ 


October  4,  1993 


Ms.  Janice  Mays 

Chief  Counsel  and  Staff  Director 
Committee  on  Ways  and  Means 
1102  Longworth  Building 
Washington,  DC   20515-6348 

RE:   Committee  on  Ways  and  Means,  Subcommittee  on 
Select  Revenue  Measures  Hearing  on 
Miscellaneous  Revenue  Issues  -  September  21, 
1993 

Dear  Ms.  Mays, 

Pursuant  to  Chairman  Rangel's  invitation  to  do  so, 
thank  you  for  the  opportunity  to  supplement  some 
points  in  my  testimony  on  September  21,  1993  before 
Congressman  Rangel  regarding  the  above-mentioned 
Subcommittee.   Please  append  this  letter  to  that 
testimony. 

Nurses  working  as  independent  contractors  (IC) 
through  brokers  are  independent  professionals. 
They  function  based  on  each  State's  Nurse  Practice 
Act  and  Professional  Standards  of  Practice.   Even 
when  working  as  independent  contractors  in  an 
institutional  setting  the  ICs  enjoy  control  over 
the  critical  aspects  of  their  work  environment 
which  clearly  distinguish  them  from  employees. 
They  are  free  to  accept  or  reject  any  shift,  can 
work  as  often  or  as  little  as  they  want,  do  not 
have  to  attend  institutional  "staff  meetings",  and 
are  responsible  for  their  own  continuing  education 
and  other  expenses.   They  can  select  the 
institution(s)  and/or  unit  in  which  to  practice 
their  profession  and  often  base  this  component  of 
their  decision  on  quality  of  care  issues. 


s 


OONTIVCIDRS  OF  AN«aCA 


1587 


Hospital  policy  and  procedures  are  simply  standards 
of  practice  and  do  not  vary  in  key  points  from  one 
institution  to  another  and  cannot  form  the  basis 
for  concluding  that  a  nurse  cannot  operate  as  an 
IC.   Likewise,  nursing  care  and  its  practice  is 
also  similar  from  one  institution  to  another. 
Following  is  an  example  of  Standards  of  Practice 
and  Hospital  Policies/Procedures: 

A  hospital  may  advise  a  nurse  in  the  method  of 
a  certain  dressing  change,  indicating  a 
particular  piece  of  equipment  to  be  used,  like 
a  kit  for  a  sterile  dressing  change.   The 
nurse  understands  the  concept  of  sterile 
technique  and  can  use  his/her  own  judgement  in 
assembling  the  necessary  supplies  when  the 
specific  equipment  is  not  available.   This 
action  accomplishes  the  goal  of  patient  care 
and  yet  does  not  follow  the  hospital ' s 
policies  and  procedures. 

You  can  see  by  the  example,  all  nurses  must  always 
make  independent,  professional  assessments 
regardless  of  attempts  at  control  and  direction  by 
the  hospital.   In  fact,  nursing  malpractice  would 
occur  if  a  nurse  implemented  an  action,  ordered  by 
the  hospital,   which  was  detrimental  to  the  patient. 
In  short,  one  cannot  distinguish  an  employee  nurse 
from  an  IC  nurse  by  focusing  on  nursing  practice  or 
hospital  policy. 

Congressman  Rangel ' s  statement  about  nursing 
practice  is  understandably  similar  to  that  commonly 
held  by  most  lay  people.   It  tends  to  focus  on  the 
standards  of  nursing  practice  and  sees  them  as 
hospital  requirements,  rather  than  legal  and 
professional  (and  JCAHO)  requirements  that  are 
merely  passed  on  by  any  medical  facility  in  which 
any  health  professional  practices.   One  would 
hardly  doubt,  for  example  that  physicians  can  be 
ICs  in  a  hospital  setting  even  though  they  use 


1588 


hospital  equipment  and  follow  medical  practices 
mandated  by  hospitals  as  the  result  of  legal  and 
professional  (and  JCAHO)  requirements.   Yet  there 
is  often  an  inability  to  see  the  nurse  practitioner 
who  is  an  IC  in  the  same  light,  because  perhaps  of 
a  historical  pattern  of  paternalism  towards  nurses, 
who  are  mostly  female,  by  the  male-dominated 
medical/hospital  industry  in  the  past.   With 
changes  in  health  care  delivery  and  improved 
earnings,  nursing  is  recognized  as  an  integral  and 
independently  professional  part  of  the  entire 
health  care  system. 

Since  there  is  a  recognized  nursing  shortage  in 
most  areas  of  the  country,  nurses  do  not  have  to  be 
independent  contractors  in  order  to  secure  work. 
Most  nurses  continue  to  be  employees  of 
institutions  rather  than  independent  contractors. 
Other  nurses  choose  to  work  as  employees  of 
agencies  which  can  assign  them  at  will,  monitor  and 
train  them,  or  pay  some  of  their  expenses.   Such 
employee  nurses  recognize  the  security  and  benefits 
afforded  them  in  this  role,  and  so  they  are  willing 
to  give  up  many  freedoms  mentioned  earlier  — 
freedoms  which  distinguish  IC  nurses  from  employee 
nurses.   Yet,  there  remains  a  good  number  of 
nursing  professionals  who  desire  self -employment  as 
an  option.   They  should  not  be  discriminated 
against  just  because  they  are  nurses  or  just 
because  they  function  in  a  highly-regulated  work 
environment  like  a  medical  care  facility.   In  fact, 
if  they  were  accountants,  lawyers,  engineers  or 
physicians,  who  are  predominantly  male,  they  would 
not  be  discriminated  against  anywhere  near  the  same 
degree.   I  urge  you  to  retain  Section  530  for  all 
workers  —  including  nurses  —  and  to,  implement  a 
bill  similar  to  HR5011,  and  eventually  to  address 
the  Twenty  Common  Law  Factors  used  in  determining 
worker  status  to  more  accurately  reflect  activity 
in  the  "real"  world. 

Thank  you  for  the  opportunity  to  provide  additional 
comments  for  the  record.   Please  do  not  hesitate  to 
telephone  me  with  any  questions.   I  would  welcome 
the  chance  to  meet  personally  with  Chairman  Rangel 
to  further  explain  how  the  IC  nurse  and  the  nurse 
broker  operate. 


Very  Truly  Yours, 

Sally  M.  Sumner,  RN,  CCRN 


1689 

Yes,  Mr.  Owen. 

Mr.  Owen.  Mr.  Chairman,  I  just  had  a  few  more  comments  on 
the  issue  of  having  us  withhold  for  our  contractors.  It  sounds  like 
a  good  idea  and  I  think  it  is  something  that  we  at  ABC  will  try 
to  look  into  for  you. 

However,  again,  in  our  case,  we  don't  have  independent  contrac- 
tors for  10  years  or  5  years  or  even  1  year.  Our  independent  con- 
tractors are  expected  to  move  from  company  to  company  from  job 
to  job  and  the  goal  is  to  get  them  started,  get  them  to  build  their 
businesses  and  then  create  their  own  benefits,  do  what  they  have 
to  do  for  their  employers,  but  second 

Chairman  Rangel.  Second,  we  can  find  some  criteria  that 

Mr.  Owen.  But  here  is  the  other  problem.  I  think  that  unless 
this  20-point  question  business  by  the  IRS  is  altered,  which  was 
one  of  the  fundamental  issues  that  we  want  to  talk  about,  I  think 
that  having  us  withhold  for  these  people  is  another  foot  in  the  door 
to  us  being  termed  as  misclassifying  these  people  and  that  they 
should  in  fact  be  employees.  I  think  that  issue  has  to  be  looked  at. 

And  overall,  most  contractors  play  by  the  rules.  Most  of  our  peo- 
ple are  employees.  Most  of  us  have  good  benefits.  If  we  are  asked 
to  withhold  for  our  independent  contractors  as  they  build  their 
businesses  and  go  on  to  the  next  job  6  months  later,  if  we  do  that, 
there  is  still  that  segment  in  our  industry  and  all  industry  of  tax 
cheaters.  They  don't  just  cheat  on  misclassifying  employees  they 
cheat  on  everything.  So  that  is  the  segment  of  the  construction  in- 
dustry and  any  other  industry  that  has  really  got  to  be  dealt  with. 

Chairman  Rangel.  Mr.  Owen,  you  are  right  and  I  didn't  mean 
to  suggest  that  I  was  offering  a  solution.  Really  what  I  was  trying 
to  sav  is  that  if  I  were  in  your  shoes  and  I  saw  this  big  train  com- 
ing down  the  tracks  and  I  thought  that  they  had  a  real  economic 
problem,  I  would  try  to  help  them  to  take  care  of  that  problem  in 
a  way  that  I  could  best  live  with. 

I  wish  they  wouldn't  look  at  me  to  take  care  of  it,  but  you  know 
that  there  are  abuses  and  you  know  there  is  a  hemorrhage  in  funds 
with  the  Federal  Government  and  if  you  have  any  idea  how  we  can 
just  inconvenience  you  but  at  the  same  time  take  care  of  this  prob- 
lem, it  would  make  it  a  heck  of  a  lot  easier  than  just  to  wipe  out 
the  whole  thing  and  then  let  you  figure  out,  you  know,  how  to  do 
it,  since  we  can  t  really  do  it  by  ourselves. 

We — the  chairman  is  always  trying  to  work  out  the  differences 
with  any  complex  matter  where  you  are  dealing  with  subjective  lev- 
els of  having  to  make  a  determination.  I  tell  you  because  of  atti- 
tudes where  people  have  got  to  tell  you  it  looks  like  a  duck,  it 
walks  like  a  duck,  it  quacks  like  a  duck  but  it  is  really  not  a  duck 
because  I  said  it  wasn't,  that  is  not  going  to  fly. 

And  so  what  you  are  going  to  have  to  do  is  sit  around  the  table 
and  say  we  are  honest  and  thev  are  not  and  this  is  what  honest 
people  are  prepared  to  do  even  though  it  is  a  tremendous  inconven- 
ience to  us,  because  the  easiest  thing  to  do — it  would  be  unfair  and 
inequitable — is  just  to  take  a  cleaver  and  cut  it,  chop  it  off  and 
start  all  over  and  see  where  the  inequities  are  and  then  repair  the 
laws. 

We  don't  want  to  do  that,  but  this  dog  has  been  around  a  long 
time  and  it  is  causing  us  a  lot  of  political  problems.  It  is  causing 


1590 

us  more  political  problems  than  the  independent  contractors  are 
having.  And  I  recognize  it  is  causing  a  lot  of  problems  for  the  gen- 
eral contractors  and  brokerage  firms,  but  to  the  independent  con- 
tractor— employee  of  the  independent  contractor,  and  we  are  the 
only — I  assume,  Ms.  Sumner,  that  the  independent  contractor  in 
your  business  is  only  the  nurse.  She  is  the  business. 

Ms.  Sumner.  That  is  correct. 

Chairman  Rangel.  That  something  is  going  to  have  to  be 
changed  and  I  don't  know  how  and  that  is  why  we  are  having  these 
hearings,  so  that  when  the  chairman  and  members  get  together 
they  would  ask,  did  you  receive  any  suggestions  that  could  relieve 
your  government  of  this  problem  and  at  the  same  time  increase 
revenue. 

And  I  would  tell — have  to  say  that,  you  know,  we  have  to  study 
all  the  testimony,  but  I  don't  remember  that  those  who  would  be 
adversely  affected  by  this  law  making  any  suggestions  that  could 
do  those  things.  But  I  will  never  say  that  until  after,  one,  I  read 
the  testimony,  discussed  it  with  staff  and  still  had  the  opportunity 
to  review  any  additional  information  that  you  might  want  to  sub- 
mit, if  the  record  was  left  open  for  5  days,  that  would  deal  with 
how  I  report  back  to  the  full  committee. 

I  say  this  with  all  compassion  for  the  role  that  you  play  here 
today,  an  advocate,  the  same  way  I  as  a  lawyer  would  have  to  pro- 
tect my  client  until  the  judge  asks  whether  we  can  talk.  That  is 
what  I  am  saying  now,  that  this  is  a  very,  very  difficult  and  com- 
plex question  and  I  would  strongly  suggest  that  you  find  out  ways 
to  assist  us  in  working  out  something  that  would  be  less  painful 
than  this  bill. 

Yes,  Ms.  Sumner? 

Ms.  Sumner.  Well,  one  of  the  suggestions  that  we  have  consid- 
ered for  a  long  time  in  terms  of  the  ability  of  the  government  to 
collect  money  is  to  alter  the  reporting  requirements.  What  happens 
now  is  I  comply  with  the  law  and  issue  1099s  to  all  the  workers 
who  contract  with  me.  And  to  the  best  of  my  knowledge,  and  I  do 
follow  up  on  that,  they  all  claim  that  money  and  pay  their  taxes. 

The  problem  is  the  people  who  don't  get  1099s  may  not  report 
the  income.  I  would  suggest  that  there  may  be  components  of  that 
H.R.  5011  from  last  year 

Chairman  Rangel.  That  is  just  one  of  the 

Ms.  Sumner  [continuing].  That  may  help. 

Chairman  Rangel.  But  nurses  is  a  real  problem  as  to  whether 
they  are  independent  contractors.  What  is  the  average  length  of 
service  to  one  general  contractor  that  your  independents  would 
have? 

Ms.  Sumner.  It  is  based  on  a  shift.  That  is  really  the  only  length 
of  service. 

Chairman  Rangel.  You  sound  like  one  of  those  witnesses  that  if 
they  didn't  ask  the  question,  you  ain't  going  to  give  the  answer. 

Ms.  Sumner.  I  am  trying  to  give  you  the  answer. 

Chairman  Rangel.  I  know.  What  I  am  trying  to  find  out  is  that 
if  someone  was  to  say  to  one  of  your  independent  contractors,  "How 
long  have  you  contracted  with  this  hospital  as  opposed  to  how  long 
have  you  worked  with  this  hospital" 


1591 

Ms.  Sumner.  I  have  had  hospital  clients  that  I  have  had  for  the 
full  12  years  that  I  have  been  in  business.  The  service  that  has 
been  provided  to  them  by  the  nurse  has  not  been  consistent.  There 
has  not  been  one  nurse  who  worked  consistently  for  one  hospital 
more  than  a  few  weeks. 

Chairman  Rangel.  Why  don't  you  help  me  frame  the  question? 
How  many  nurses  do  you  have  that  are  independent  contractors 
that  have  worked  for  one  of  your  clients  for  over  a  year? 

Ms.  Sumner.  You  are  trying  to  pigeonhole  the  answer  to  be  what 
you  want  and  I  can't  give  it  to  you  that  way. 

Chairman  Rangel.  Why  don't  you  give  an  answer  to  the  question 
that  I  didn't  ask  that  would  be  the  one  that  you  know  that  I  want. 

Ms.  Sumner.  There  are  250  contractors  who  I  have  on  file.  At 
any  given  week  there  may  be  30  of  them  who  work.  Most  of  the 
time  those  people  do  not  work  for  one  hospital  client.  The  nature 
of  the  business  requires  them  to  be  available  to  work  at  a  number 
of  different  clients,  a  number  of  different  shifts  on  a  number  of  dif- 
ferent days.  There  is  significant  inconsistency  in  their  jobs. 

Chairman  Rangel.  Is  your  brokerage  firm  considered  small,  me- 
dium, or  large? 

Ms.  Sumner.  My  firm  would  be  small,  small  to  medium. 

Chairman  Rangel.  I  am  not  even  talking  about  your  firm,  then. 
I  am  talking  about  larger  firms  that  if  you  didn't  know  they  were 
independent  contractors  they  would  be  like — I  started  to  say  like 
crew  chiefs  of  migrant  workers,  but  that  is  almost  the  same  thing 
when  you  get  to  the  building  industry  in  a  sense. 

Mr.  Desjardins.  Mr.  Chairman,  I  might  make  a  comment  re- 
garding withholding.  Withholding  is  an  option.  It  would  increase 
revenue,  I  am  sure,  to  the  government.  I  come  back  to  the  same 
problem  about  what  we  withhold  on.  If  it  is  the  labor,  we  would 
have  to  identify  that  and  break  it  out.  It  would  cause  additional  in- 
convenience to  the  general  contractor  but,  you  know,  I  don't  know 
if  we  would  finally  support  that  or  not,  we  would  have  to  discuss 
it. 

But  my  sense  is  it  would  only  be  supported  if  the  issue  of  the 
independent  contractor  would  go  away.  I  think  we  would  not  want 
to  hassle  with  withholding  while  we  are  still  arguing  the  issue  of 
independent  contractor  status.  So  if  withholding  would  replace  the 
problems  we  have  with  the  independent  contractor  status,  that 
may 

Chairman  Rangel.  We  have  to  do  a  lot  of  things  and  that  would 
be  one,  but  you  would  have  to  admit  that  if  the  criteria  is  that  the 
IRS  did  not  catch  a  misclassification  that  you  have  a  safe  haven 
from  anybody  else  that  you  must  classify  or  that  you  may 
misclassify  that  that  is  not  exactly  fair  to  the  government  in  a 
sense  knowing  the  IRS's  limited  resources.  It  seems  like  if  they 
don't  get  you  that  you  are  free  to  do  what  you  want.  I  am  not  say- 
ing that  many  people  take  advantage  of  that  loophole.  It  really 
means  the  government  did  not  really  provide  the  proper  oversight. 
We  have  a  lot  of  the  problems  and  they  are  all  not  the  industries. 

It  is  the  government  not  making  it  abundantly  clear  to  you  ex- 
actly what  we  expect  and  also  not  making  as  clear  as  you  would 
like  it  as  to  what  we  consider  an  employee  and  who  we  would  con- 


1592 

sider  a  general  contractor.  We  would  start  off  with  nurses  right 
away  and  say  employees  and  work  our  way  up, 

I  mean,  true,  we  will  have  a  lot  of  problems,  but  that  is  the  direc- 
tion which  we  would  go  until  we  actually  got  with  the  person  that 
has  112  different  contractors  and  they  go  from  job  to  job  and  you 
very  seldom  know  who  the  employees  are,  you  just  deal  with  the 
subcontractor. 

But  it  is  difficult  for  us  and  that  is  what  I  am  saying  is  that  we 
are  going  to  have  to  go  beyond  just  saying  no.  That  is  all.  And  I 
accept  the  eloquent  and  reasonable  testimony  in  just  saying  no 
today  and  hope  that  you  do  find  time  to  say,  but  if  you  have  to  hit 
this  again,  I  wish  you  would  take  these  things  into  consideration, 
and  even  to  the  point  of  saying  you  get  back  to  us  if  you  are  orga- 
nized enough  to  do  that,  as  some  industries  are,  to  see  whether  we 
can  work  out  the  sticky  details. 

Mr.  Pyles. 

Mr.  F^LES.  Yes,  I  just  wanted  to  remind  the  chairman  that  this 
is  really  a  tax  miscfassification  and  a  benefit  and  health  quality 
issue  in  our  part  of  the  industry.  Members  of  our  association  have 
expressed  the  opinion  to  me  that  a  lot  of  this  misclassification  by 
new  companies  springing  up  that  happened  since  section  530  was 
enacted  would  probably  go  away  if  you  had  withholding  for 
amounts  paid  to  independent  contractors  and  required  the  distribu- 
tion of  an  information  statement  that  described  the  kinds  of  protec- 
tions and  benefits  that  would  be  foregone  by  this  classification. 

Chairman  Rangel.  How  do  you  answer  Mr.  Desjardins  in  terms 
of  separating  the  labor  costs  from  supply?  How  would  you 

Mr.  Pyles.  The  labor  force  from  supply  help? 

Chairman  Rangel.  No,  no,  material. 

Mr.  Pyles.  I  see,  in  calculating  the  percentage.  A  suggestion  was 
made  I  think  a  year  or  2  ago  by  GAO  that  there  be  a  flat  percent- 
age of  wages  paid.  That  I  would  think  would  be  a  relatively  easy 
thing  to  administer  and  then  materials  wouldn't  be  included  in 
that.  Again  you  wouldn't  be  hoping  go  capture  everything  but  you 
would  just  be  providing — avoiding  this  incentive  which  now  exists 
for  businesses  to  go  out  and  misclassify.  So  I  think  a  low  percent- 
age, for  example,  of  wages  paid  would  be  an  interesting  approach. 

Chairman  Rangel.  Mr.  Desjardins,  what  is  the  big  deal  about  a 
subcontractor  having  receipts  for  what  materials  that  he  bought 
and 

Mr.  Desjardins.  We  don't  ask  for  receipts. 

Chairman  Rangel.  You  don't  have  to. 

Mr.  Desjardens.  We  pay — many  independent  contractors  get 
paid  what  we  call  piecework.  A  person  installing  reinforcing  steel 
gets  paid  by  the  pound  or  someone  installing  tile  gets  paid  by  the 
square  foot.  And  so  we — and  that  is  how  the  work  is  bid.  We  get 
prices  from 

Chairman  Rangel.  You  get  the  prices  the  same  way.  We  won't 
change  those  traditions,  but  you  go  in — and  I  am  just  using  some- 
thing I  am  familiar  with — and  you  say  what  does  it  take  to  fix  the 
car  and  the  guy  says  $2,000  and  then  you  get  your  bill  and  find 
out  that,  you  know,  it  was  $500  for  materials  and  $1,500  for  labor. 
I  assume  there  would  be  a  dramatic  reduction  for  tax  purposes  in 
this  case,  but,  you  know,  they  do  it  and  it  is  an  estimate.  We  don't 


1593 

go  in  and  say  show  us  the  bills  for  the  $500  of  materials  you 
bought,  because  we  got  to  pay  the  $2,000  anyway. 

Anyway,  listen,  all  of  you  have  done  a  good  job.  You  have  been 
very  helpful,  but  we  need  some  more.  Mr.  Pyles  generally  has 
showed  you  the  direction  that  we  would  be  going  and  we  don't 
want  to  go  there  alone.  If  we  make  mistakes,  at  least  we  want  to 
know  that  we  reached  out.  I  don't  think  there  is  any  committee  and 
certainly  subcommittee  that  any  taxpayer  has  more  access  to  than 
our  committee. 

It  doesn't  mean  that  we  always  agree,  but  we  certainly — we  al- 
ways listen.  It  doesn't  mean  we  always  do  what  you  would  want. 
So  we  hope  in  this  area  that  you  might  come  up  with  some  ideas 
that  are  less  painful  but  at  the  same  time  can  catch  us  up  with 
health  reform  and  the  other  things  in  the  direction  that  we  are  try- 
ing— deficit  reduction,  raising  some  money  without  raising  your 
general  taxes. 

We  can  put  a  tax  on  the  general  contractor  but  you  wouldn't 
want  us  to  do  that  in  order  to  get  the  money  that  the  subcontrac- 
tors are  not  paying. 

I  don't  know  what  we  are  going  to  do,  but  I  would  want  to  make 
a  more  positive  report  to  the  chairman,  to  be  more  honest  with  you, 
and  you  can  help  there.  Probably  there  are  some  things  in  some 
trade  magazines  that  should  have  come  across  our  desks.  Maybe 
staff  has  some  ideas  that  they  will  suggest  that  we  get  in  touch 
with  you  and  get  your  opinions  on. 

We  thank  you  very  much  and  the  committee  will  stand  adjourned 
subject  to  the  call  of  the  Chair. 

Thank  you  very  much. 

[Whereupon,  at  3:12  p.m.,  the  heariang  was  adjourned,  to  recon- 
vene on  Thursday,  September,  23,  1993,  at  10  a.m.] 


MISCELLANEOUS  REVENUE  ISSUES 


THURSDAY,  SEPTEMBER  23,  1993 

House  of  Representatives, 
Committee  on  Ways  and  Means, 
Subcommittee  on  Select  Revenue  Measures 

Washington,  B.C. 

The  subcommittee  met,  pursuant  to  call,  at  10  a.m.,  in  room 
B-318,  Raybum  House  Office  Building,  Hon.  Charles  B.  Rangel 
(chairman  of  the  subcommittee)  presiding. 

Chairman  Rangel.  Good  morning.  We  are  starting  today  a 
continuation  of  the  Select  Revenue  Measures  on  miscellaneous 
issues  that  have  been  assigned  to  us  by  the  chairman  of  the  full 
committee. 

Today  we  will  take  testimony  relating  to  generation  skipping  tax 
and  rollovers  of  military  separation  pay  into  individual  retirement 
accounts.  We  also  will  take  testimony  on  various  revenue  raising 
proposals.  They  relate  to  among  other  matters,  real  estate,  ozone 
depleting  chemicals  and  environmental  remediation  expenditures. 

This  is  our  7th  day  in  covering  a  variety  of  subjects  that  have 
been  referred  to  the  committee,  and  I  want  to  thank  the  witnesses, 
the  Members  that  have  participated  in  these  long  hearings,  and  the 
staff  and  subcommittee  for  their  work  on  these  hearings  and  all  of 
the  people  that  have  taken  the  time  out  to  share  their  views  with 
the  subcommittee. 

Because  this  is  the  last  day  that  we  have  and  because  we  have 
several  panels,  I  will  ask  the  witnesses  to  try  to  keep  their  remarks 
to  the  5-minute  limit,  with  the  understanding  that  the  full  state- 
ment, without  objection,  will  appear  in  the  record. 

At  this  time,  I  would  like  to  yield  to  my  friend  for  the  purposes 
of  introducing  one  of  the  witnesses. 

Mr.  Santorum.  That  is  the  next  panel. 

Chairman  Rangel.  I  am  terribly  sorry.  OK,  then  we  have  a 
member  of  this  committee,  a  standing  Member  of  Congress,  as  well 
as  Ways  and  Means,  Jim  Bunning  from  Kentucky. 

STATEMENT  OF  HON.  JIM  BUNNING,  A  REPRESENTATIVE  IN 
CONGRESS  FROM  THE  STATE  OF  KENTUCKY 

Mr.  Bunning.  Thank  you,  Mr.  Chairman,  and  Mr.  Santorum, 
good  to  see  you,  too.  I  want  to  thank  you  for  the  opportunity  to  tes- 
tify before  this  subcommittee  today  in  support  of  a  Tax  Code  provi- 
sion that  will  benefit  military  retirees  for  years  to  come. 

The  provision  is  similar  to  legislation  I  introduced  earlier  this 
year,  the  Military  Separation  Retirement  Benefit  Act.  This  provi- 

(1595) 


1596 

sion  would  allow  military  personnel  to  rollover  their  separation  pay 
into  an  IRA. 

Because  of  the  military  downsizing,  the  Department  of  Defense 
has  been  offering  special  separation  pay  benefits  to  encourage  ac- 
tive service  personnel  to  voluntarily  separate  from  the  military 
service.  The  benefit  is  based  on  military  rank  at  the  time  of  separa- 
tion, as  well  as  years  of  service. 

This  benefit  is  intended  to  compensate  our  military  men  and 
women  who  are  being  forced  to  surrender  the  security  of  their  cho- 
sen jobs  and  end  their  chosen  careers  in  military  service  pre- 
maturely. However,  as  soon  as  service  men  and  women  accept  the 
separation  pay,  they  discover  that  it  is  taxed  as  regular  income.  In 
addition  to  the  cash  incentive,  they  also  are  handed  a  big  tax  bill. 

My  provision  would  give  these  military  personnel  some  flexibility 
at  the  time  when  they  are  faced  with  difficult  career  choices  and 
uncertainty.  My  provision  would  allow  them  to  rollover  their  sepa- 
ration pay  into  an  individual  retirement  account  within  60  days  of 
receiving  it. 

I  think  it  is  just  a  matter  of  simple  fairness.  Many  of  the  folks 
who  are  affected  by  this  tax  provision  have  already  served  their 
country  for  at  least  10  years  or  more.  They  have  been  working  to- 
ward a  pension  which  is  fully  recognized  by  the  IRS.  Military 
earnings  statements  note  that  military  personnel  are  covered  by  a 
pension  plan  and,  as  a  result,  they  are  subject  to  various  tax  regu- 
lations, such  as  being  prohibited  from  fully  deducting  annual  IRA 
contributions. 

Most  of  these  service  men  and  women  intended  to  serve  in  the 
Armed  Forces  for  life  or  at  least  20  years.  It  is  their  chosen  career. 
And  they  counted  on  the  security  of  military  retirement  that  they 
were  working  toward.  But  now,  due  to  the  changing  world  and  con- 
ditions and  economic  constraints  beyond  their  control,  that  promise 
of  future  personal  security  is  gone. 

I  think  that  these  men  and  women,  who  have  served  our  country 
bravely,  deserve  better  than  a  big,  fat  tax  bill  as  they  wind  up  their 
military  careers.  The  least  we  can  do  is  give  them  the  opportunity 
to  hold  on  to  one  small  piece  of  that  security  by  using  their  separa- 
tion pay  to  invest  for  their  future  retirement. 

Rolling  over  separation  benefits  is  not  a  new  idea.  Many  private 
sector  employees  are  provided  with  this  option  through  separation 
benefit  packages  provided  by  their  employers,  when  they  are  faced 
with  a  similar  situation. 

Federal  employees  are  allowed  to  take  the  retirement  funds  that 
they  have  accumulated  through  contributions  to  the  Thrift  Savings 
Plan  and  roll  them  into  an  IRA.  They  can  continue  to  save  for  their 
retirement  without  penalty.  They  are  given  that  option.  I  think  it 
is  only  right  that  we  g^ve  the  same  option  to  the  members  of  the 
Armed  Services.  Right  now,  all  we  give  them  is  a  lump  sum.  and 
a  big  tax  bill. 

It  is  no  secret  that  the  number  of  military  personnel  who  will  be 
affected  by  this  inequity  in  the  Tax  Code  is  growing.  Last  year,  as 
many  as  55,000  military  personnel  took  early  separation  from  the 
military  under  the  current  incentives.  This  year,  pending  approval 
by  Congress,  approximately,  114  military  bases  and  installations 
will  be  closed  or  reduced  in  size. 


1597 

The  1994  Defense  Authorization  Act,  currently  being  debated, 
cuts  the  Defense  Department's  budget  by  $11.5  bilHon  in  1994.  It 
also  sets  a  target  reduction  of  Armed  Service  personnel  at  well  over 
100,000  in  1994. 

With  these  facts  in  mind,  it  is  clear  that  we  need  to  make  this 
retirement  benefit  option  available  as  soon  as  possible.  It  is  the 
only  way  to  insure  that  those  affected  by  the  military  cutbacks  can 
leave  their  service  careers  with  some  sort  of  retirement  security  for 
their  future. 

I  am  pleased  that  my  bill  is  supported  by  the  chairman  of  the 
Veterans'  Affairs  Committee,  Representative  Sonny  Montgomery, 
and  the  ranking  member.  Representative  Bob  Stump.  It  also  has 
received  support  from  members  of  the  Armed  Services  and  the 
Ways  and  Means  Committee. 

A  provision  similar  to  the  Military  Separation  Retirement  Bene- 
fit was  included  in  H.R.  11  last  year,  by  Senator  Murkowski.  It  re- 
ceived wide  support  during  committee  considerations  and  in  con- 
ference. I  think  it  deserves  the  same  support  now. 

I  want  to  thank  you.  Chairman  Rangel,  for  the  opportunity  to 
testify  and  for  your  consideration  of  this  important  provision. 

Chairman  Rangel.  Congressman  Barlow,  would  you  mind  if  I 
just  asked  a  couple  of  questions  since  you  are  here  on  a  different 
subject? 

Mr.  Barlow.  Please. 

Chairman  Rangel.  I  think  what  you  are  saying  makes  a  lot  of 
sense,  and  it  is  my  understanding  that  you  are  not  dealing  with  re- 
tirement pay  for  military  people. 

Mr.  BUNNING.  No,  we  are  dealing  with  those  who  are  RIFd.  "Re- 
duction in  force." 

Chairman  Rangel.  So  this  is  before  they  really  have  a  vested  re- 
tirement income 

Mr.  Bunning.  That  is  correct. 

Chairman  Rangel  [continuing].  And  this  is  to  protect  them,  to 
have  at  least  something  to  depend  on  in  the  longer  term  so  that 
they  can  better  plan  for  whatever  life  they  are  going  to  have  in  the 
private  sector? 

Mr.  Bunning.  I  believe  that  is  correct,  and  I  sincerely  believe 
that  after  someone  spends  10,  12,  14  years  in  the  military,  and 
then  is  asked  to  leave  by  the  military,  and  with  this  incentive  given 
at  that  time,  there  ought  to  be  an  option  at  that  time.  And  that 
is  what  this  is  all  about. 

Chairman  Rangel.  Do  you  have  any  idea — I  mean  there  is  no 
question  about  its  equity  and  fairness;  do  you  have  any  idea  about 
the  cost? 

Mr.  Bunning.  Yes,  sir,  I  do. 

Chairman  Rangel.  What  is  it? 

Mr.  Bunning.  It  is  $190  million  over  5  years,  and  that  is  as  of 
this  morning.  Hank  Gutman  of  the  Joint  Tax  Committee  has  given 
me  that  number. 

Chairman  Rangel.  Now,  there  was  a  similar  provision  that  came 
through  the  Senate  last  year  in  H.R.  11,  and  they 

Mr.  Bunning.  They  said  it  was  $167  million  at  that  time,  over 
5  years. 


Tj  ■i-an  r\  ^r\A 


1598 

Chairman  Rangel.  But  they  had  a  cap.  Are  you  willing  to  ac- 
cept— they  had  a  $25,000  cap  for  the  rollover. 

Mr.  Running.  That  would  be  a  big  plus,  comparatively  speaking, 
if  you  had  a  cap.  But  I  would  prefer  that  there  not  be  one.  We  will 
find  a  way  to  pay  for  it  if  we  get  the  opportunity. 

Chairman  Rangel.  Who  are  "we,"  Congressman? 

Mr.  BUNNING.  Those  of  us  who  are  proposing  it. 

Chairman  Rangel.  OK.  Well,  you  know  that  is  important,  and, 
of  course,  if  it  could  come  from  the  same  budget,  it  makes  it  a  lot 
easier  for  us. 

Mr.  Bunning.  Well,  it  was  paid  for  in  H.R.  11  by  a  provision  that 
would  prohibit  deductions  by  corporations  on  legal  fees  incurred  in 
corporate  buyouts  and  takeovers. 

Chairman  Rangel.  Well,  we  have  to  get  votes  for  both,  and  while 
yours  may  not  be  controversial,  the  funding  mechanism  might  be. 
But  I  would  be  anxious  to  work  with  you  on  this. 

Mr.  Bunning.  Thank  you  very  much. 

Chairman  Rangel.  Mr.  Santorum,  do  you  have  any  questions  for 
him? 

Mr.  Santorum.  No,  thank  you. 

Chairman  Rangel.  Thank  you  so  much.  We  will  work  on  this 
together. 

STATEMENT  OF  HON.  THOMAS  J.  BARLOW  IH,  A  REPRESENTA- 
TIVE IN  CONGRESS  FROM  THE  STATE  OF  KENTUCKY 

Chairman  Rangel.  Mr.  Barlow,  from  Kentucky,  and  we  are  anx- 
ious to  get  your  testimony,  too. 

Mr.  Barlow.  Thank  you,  very  much,  Mr.  Chairman.  I  appreciate 
your  time  and  your  interest  in  this  matter.  It  is  a  very  important 
situation  for  some  of  my  constituents  in  western  Kentucky  and,  in- 
deed, across  the  Nation. 

We  are  dealing  here  really  with  one  of  the  great  success  stories 
of  science  in  the  last  20  years  and  industry  and  science  working  to- 
gether. Science  investigation  early  in  the  1970s,  came  upon  the  fact 
that  CFCs,  chlorofluorocarbons  were  eating  up  the  ozone  as  the 
chemical  was  released  into  the  atmosphere  and  traveled  up  into 
the  higher  regions.  And  industry,  of  course,  as  it  should,  questioned 
science.  But  as  science  convinced  industry  that  this  was  going  on, 
industry  very  responsibly  moved  in  an  international  way  through 
the  Montreal  Protocol,  to  get  on  top  of  the  situation  and  get  CFCs 
out  of  the  industrial  processes  and  commercial  processes. 

One  of  the  ways  it  was  done,  was  to  put  a  punitive  tax  on  CFCs, 
and  then  technology  has  been  pushing  hard  in  this  area  from 
science  and  from  industry  to  move  us  into  other  generations  of 
chemicals  which  will  g^ve  us  the  qualities  we  need.  For  example, 
in  insulation,  and  air  conditioning.  And  we  are  into  second-genera- 
tion chemicals  now,  which  are  called  HCFCs.  Rather  than  get  into 
the  full  chemical  nomenclature,  HCFCs  are  90  percent  better  than 
CFCs,  in  terms  of  reducing  the  eating  of  the  ozone  that  goes  on  by 
the  old  CFCs. 

And  yet,  what  is  being  proposed  here  is  that  that  same  punitive 
tax  be  placed  on  HCFCs  virtually  that  was  placed  on  the  original 
CFCs.  We  have  a  situation  here,  quite  frankly,  Mr.  Chairman,  of 
science  and  industry  working  together  in  a  very  responsible  way. 


1599 

to  move  us  out  of  a  situation  which  was,  frankly,  going  to  put  the 
world  in  peril,  moving  very  quickly  to  the  next  generation  chemical 
products  that  would  give  us  the  same  attributes  as  the  old  chemi- 
cals and  yet  getting  rapped  just  as  hard  in  a  punitive  tax  way,  for 
their  success,  for  their  cooperation. 

We  are  not  talking  about  a  lot  of  money  here.  I  understand  that 
we  are  really  only  talking  about  $10-,  $15  million  in  tax  revenue. 
What  we  are  talking  about,  I  think,  is  just  a  continuation,  a  kind 
of  a  knee-jerk  reaction.  We  had  a  tax  approach  with  the  old  chemi- 
cals, which  were  troublesome,  very  dangerous,  lethal,  in  fact,  in 
terms  of  environmental  characteristics  over  time,  but  now  we  are 
moving  on  to  the  next  generation  of  chemicals. 

We  will  go  on  to  a  third  generation  of  chemicals  within  short 
order,  just  as  soon  as  technology  is  developed,  which  will  take  us 
out  of  that  last  10  percent  of  cleanup  that  we  need.  But  I  don't 
think  that  we  need  and  want  this  tax  if  we  are  going  to  encourage 
industry  in  the  future  in  other  areas,  to  work  together  with  science 
as  we  come  up  with  other  problems  in  other  cnemical  structures 
and  other  market  structures. 

We  want  to  encourage  them  to  move  out  of  problem  areas,  move 
into  the  better  areas  with  the  chemical  technology,  a  better  chemi- 
cal technology  fix,  and  to  do  that,  we  need  to  be  encouraging  peo- 
ple, not  rapping  them  on  the  knuckles. 

This  is  a  very  unwise  tax,  I  think,  to  apply  to  this  next  improved 

f feneration  of  cnemicals,  and  I  would  urge  the  committee  to  strong- 
y  oppose  it. 
[The  prepared  statement  follows:] 


1600 


U.S.  REPRE8EMTATZVB  TOM  BARLOW'S 

TESTIMONY  BEFORE  THE  SUBCOMMITTEE 

ON  SELECT  REVENUE  MEASURES 

Septeober  23,  1993 

Mr.  Chairman,  members  of  this  subcommittee,  I  first  want  to 
salute  Chairman  Rangel  for  his  excellent  leadership  chairing  this 
subcommittee  during  the  budget  reconciliation  battle.  As  a 
freshman  member,  I  especially  appreciate  the  consideration  that  the 
Chairman  and  this  subcommittee  have  shown  me  during  this  busy  year. 

I  am  testifying  today  to  express  my  concerns  and  the  concerns 
of  many  of  my  constituents  regarding  a  proposal  to  levy  a  tax  on 
HCFC's  (hydrochlorofluorocarbons") .  This  proposal  would:  (1)  be  a 
punitive  measure  inflicted  upon  industries  that  are  attempting  to 
be  environmentally  responsible;  (2)  severely  harm  an  industry 
important  to  my  Western  Kentucky  district;  (3)  harm  the  environment 
by  discouraging  movement  away  from  CFC's  that  have  20  times  the 
ozone  depleting  potential  of  HCFC's;  and  (4)  probably  will  not 
raise  the  anticipated  revenues. 

The  Montreal  Protocol  reguires  signatory  nations  to  eliminate 
the  use  of  ozone  depleting  chlorofluorocarbons  by  the  year  1996  and 
HCFC's  by  early  in  the  next  century.  The  Protocol  mandates  the 
elimination  of  ozone  depleting  CFC  and  HCFC  compounds  in  three 
phases  in  recognition  of  technological  problems  associated  with 
developing  new  non-ozone  depleting  compounds.  It  also  provides 
industry  with  a  rational  schedule  for  transitioning  between  1st 
generation  CFC's  to  2nd  generation  HCFC's  and  finally  3rd 
generation  non-ozone  depleting  compounds. 

In  the  first  phase  CFC's  ("chlorofluorocarbons"),  that  caused 
maximum  ozone  depletion,  will  be  eliminated  by  January  1,  1996. 
Industry  is  currently  using  the  second  phase  replacement  known  as 
HCFC's.  HCFC's  are  a  major  environmental  improvement  over  CFC's 
because  HCFC's  have  only  l/20th  of  the  ozone  depletion  potential 
that  existed  with  CFC's.  Industries  that  once  used  CFC's  have  in 
recent  years,  invested  millions  of  dollars  to  convert  from  CFC's  to 
HCFC's.  Some  industries  that  rely  on  HCFC's  have  no  alternative 
chemical  to  use  until  third  generation  chemicals  known  as  HFC's 
("hydrofluorocarbons") ,  are  commercially  available. 

I  understand  that  many  have  criticized  the  industries  for  not 
moving  quickly  enough  to  develop  the  new  generation  of  compounds. 
Replacement  does  not  occur  in  a  short  time  frame.  This  process 
takes  years  of  testing  by  the  user  industry  groups  and  the  EPA 
regarding  such  as  toxicity  and  flammability  before  approval  can  be 
given  by  the  EPA  for  replacement  in  affected  industries. 
Subsequent  to  that  approval  companies  must  make  retrofit  and 
conversion  modifications,  which  in  itself  can  take  years. 

If  this  committee  decides  to  tax  HCFC's  in  a  manner  similar  to 
the  tax  that  is  presently  applied  to  first  generation  CFC's,  such 


1601 


a  policy  could  defeat  the  goals  of  the  Montreal  Protocol  by 
discouraging  on-going  transition  away  from  CFC's.  The  Montreal 
Protocol  wisely  coupled  the  obligation  to  convert  to  more 
environmentally  sound  compounds  with  a  benefit  of  allowing  affected 
industries  time  between  conversion  dates  to  bear  the  economic 
burdens  imposed  by  the  conversion  requirement.  Already,  industries 
have  invested  millions  of  dollars  to  convert  their  equipment  and 
manufacturing  processes  to  HCFC's  rather  than  CFC's. 

Market  and  competitive  forces  are  already  driving  industries 
to  utilize  third  generation  compounds  as  soon  as  they  are 
technologically  and  economically  feasible.  A  tax  will  not  speed 
conversion  to  third  generation  compounds  now  under  development. 
The  phase  out  dates  for  second  generation  HCFC's  are  already 
established  by  the  Montreal  Protocol  and  by  EPA  action  under  the 
Clean  Air  Act. 

Additionally,  taxing  HCFC's  would  adversely  impact  an  industry 
that  is  very  important  to  my  district.  One  of  the  primary 
suppliers  of  HCFC's  across  the  nation  has  a  plant  in  Calvert  City, 
Kentucky  that  employs  almost  300  constituents.  Further,  the 
company  is  investing  over  $150  million  dollars  in  its  Calvert  City 
facility  to  press  ahead  with  the  development  of  third  generation 
HFC's. 

One  industry  segment  utilizing  HCFC's  will  illustrate  why  a 
tax  on  HCFC's  is  a  bad  public  policy  and  bad  environmental  policy. 
That  market  is  the  rigid  foam  insulation  market.  You  may  have  seen 
this  product  before,  but  in  case  you  have  not,  rigid  foam  is  a 
revolutionary  insulation  product  that  combines  high  insulating 
factors  with  certain  performance  characteristics  that  are  not 
achievable  with  other  products.  Builders  use  rigid  foam  insulation 
because  it  fits  within  the  wall  of  a  building  without  taking  up 
much  space. 

The  manufacturers  of  the  high  grade  insulation  find  that 
approximately  30  percent  of  their  raw  material  manufacturing  costs 
involve  HCFC's.  I  understand  a  pound  of  HCFC's  costs  approximately 
$1.32  per  pound.  Imposing  a  tax  of  $1.00  to  over  $4.00  a  pound  on 
HCFC's  would  make  the  cost  of  producing  high  grade  insulation 
prohibitive.  Give  the  price  sensitive  nature  of  the  building 
materials  market,  the  energy  savings  benefit  of  this  material  would 
be  lost  to  less  efficient  materials.  Therefore,  while  the  intent 
in  taxing  HCFC's  may  be  motivated  by  environmental  concerns,  the 
proposal  will  instead  harm  the  environment  while  destroying  an 
industry  in  the  process. 

In  conclusion,  the  proposal  to  tax  HCFC's  will  not  speed 
conversion  to  third  generation  compounds  but  instead  will  harm  an 
industry  important  to  my  constituents  as  well  as  harm  rather  than 
help  the  environment,  and  produce  little  additional  revenue. 
Accordingly,  I  ask  that  this  distinguished  subcommittee  reject  this 
proposal  and  thank  you  for  the  opportunity  to  share  my  concerns 
with  you. 


1602 

Chairman  Rangel.  What  is  happening  to  prepare  the  industry 
and  the  plant  in  your  district;  to  prepare  the  workers  for  the 
change  when  it  does  come? 

Mr.  Barlow.  We  are  finding  our  chemical  plant  there  making  ag- 
gressive investments  in  the  production  of  the  new  product,  this 
second  generation  product. 

I  believe  they  have  scheduled  investments  of  over  $150  million 
at  this  point.  They  also  are  pressing  hard  on  the  technology  and 
the  chemical  breakthroughs  for  the  final  generation,  the  third  gen- 
eration, which  will  get  us  completely  out  of  ozone-eating  chemicals 
in  the  environment.  They  are  pressing  ahead  very  aggressively  on 
that. 

The  first  companies,  as  you  can  understand,  that  achieve  the 
technological  breakthroughs  in  this,  will  have  a  market  edge,  will 
have  people  waiting  for  their  product.  So  it  is  not  a  matter  of  hav- 
ing to  push  people  ahead  here.  People  in  the  industry  are  moving 
as  fast  they  can.  They  know  there  is  a  problem;  they  want  total 
cleanup,  and  the  market  forces  are  out  there  waiting  for  that  last 

feneration,  that  final  generation  chemical  to  come  along.  So  we 
on't  need  to  be  beating  on  them  with  the  same  force  that  might 
have  been  wise  in  the  first  rounds. 

Chairman  Rangel.  Do  you  have  any  idea  whether  there  is  simi- 
lar impact  on  employees  with  the  other  plants?  How  many  workers 
would  be  affectea  nationally  the  same  way  the  plant  affects  your 
constituents? 

Mr.  Barlow.  I  don't  have  the  figures  on  that,  but  I  am  sure 
there  are  other  plants,  not  just  in  me  United  States,  but  around 
the  world,  that  will  be  impacted  on  this  and  we  will  get  those  fig- 
ures to  you. 

Chairman  Rangel.  Well,  the  world  impact,  I  don't  think  is  going 
to  have  as  much  impression  on  the  Congress  as  constituent  impact. 
And  it  could  very  well  be  with  the  panels  we  are  going  to  hear 
from,  we  will  see  what  progress  is  being  made  and  whether  the  tax 
is  causing  more  problems  than  progress.  Politically  speaking,  I 
guess  some  Members  thought,  not  only  would  we  raise  some 
money,  but  we  would  encourage  a  substitute  more  quickly,  but  that 
is  a  scientific  question  I  am  certain  the  experts  will  be  able  to  help 
us  out  with. 

But  the  committee  has  to  consider  the  impact  that  this  is  going 
to  have  on  industries  that  hire  many  people  during  this  time  of  un- 
employment and  transition,  so  your  testimony  is  going  to  be  taken 
into  account  and  I  assume  the  industry  could  help  out  to  see  how 
many  other  members  would  have  the  same  problems  and  whether, 
in  addition  to  your  concern,  that  we  should  be  talking  about  con- 
version and  what  can  we  do  to  help  train  the  workers  so  that  you 
would  not  have  the  full  burden  of  the  emotional  and  political  prob- 
lems that  changes  cause.  Maybe  we  can  think  as  painfully  we  had 
to  think  in  military  conversion,  as  to  what  obligation  would  the 
Government  have  to  assist  people  with  new  skills. 

Mr.  Barlow.  I  appreciate  that  and  we  will  get  that  information 
to  you. 

[The  information  was  not  obtained  at  the  time  of  printing:] 

Mr.  Barlow.  I  would  say  that  we  want  to  be  encouraging  the  in- 
vestment in  this  country  of  the  plants  with  the  jobs  that  go  along 


1603 

with  them  for  the  second-  and  third-generation  chemicals,  and  if 
we  come  along  at  this  stage  of  the  game  with  punitive  taxes  on  the 
second-generation  chemicals,  we  are  sending  a  clear  signal  to  the 
chemical  industry  to  locate  elsewhere,  outside  the  country,  where 
they  might  not  run  into  the  punitive  tax — locate  in  South  America 
or  Europe,  these  new  chemical  plants.  And  I  think  that  would  move 
us  out  of  the  position  of  leadership  that  we  want  from  a  policy 
standpoint,  in  addition  to  the  jobs  that  we  would  lose. 

Chairman  Rangel.  Well,  I  would,  of  course,  there  has  to  be  evi- 
dence that  really  we  could  lose  the  business  because  they  are  not 
competitive  with  foreign  manufacturers,  but  I  would  assume  that 
one  of  the  reasons,  besides  being  punitive,  would  be  to  encourage 
people  to  think  seriously  about  alternatives,  if,  indeed,  the  market 
price  was  more  level  than  with  the  cheaper  HCFCs. 

But,  in  any  event,  the  tax  serves  a  lot  of  purposes  besides  reve- 
nue. And  I  think  your  testimony  is  the  tax  could  be  causing  more 
harm  than  good  and  we  should  review  it,  and  we  certainly  will. 

Mr.  Barlow.  Thank  you,  sir. 

Chairman  Rangel.  Thank  you. 

Chairman  Rangel.  Any  questions,  Mr.  Santorum. 

Mr.  Santorum.  No,  thank  you. 

Chairman  Rangel.  The  Chair  yields  to  my  colleague  on  the  com- 
mittee for  the  purposes  of  introducing  a  witness  on  panel  one. 

Mr.  Santorum.  Great.  Thank  you. 

The  gentleman  I  would  like  to  introduce  is  Mr.  Roy  Hock.  Roy 
is  the  chairman,  president  and  CEO  of  Technitrol,  which  is  a 
Philadelphia-based  company,  but  it  happens  to  have  two  plants  in 
my  district  in  McKeesport.  They  employ  over  1,100  people  all  over 
the  world  in  10  States  in  the  United  States,  and  the  United  King- 
dom and  Puerto  Rico.  So  he  is  here  to  testify  before  the  committee. 

He  is  an  active  member  of  the  Philadelphia  Chamber  of 
Commerce,  where  I  got  to  know  him,  and  is  also  active  in  low-in- 
come housing  in  the  Philadelphia  area,  an  important  problem  fac- 
ing Philadelphia  and  many  other  urban  areas.  He  is  here  to  testify 
concerning  the  deductibility  of  remediation  cost.  And  it  is  my  pleas- 
ure to  introduce  him  to  the  committee,  Mr.  Chairman. 

Chairman  Rangel.  Thank  you,  so  much. 

Other  members  of  the  panels  are  Wayne  Robinson,  director  of 
taxes  of  GrenCorp,  representing  the  Coalition  for  the  Fair  Treat- 
ment of  Environmental  Cleanup  Costs;  Fred  Gentile,  senior  vice 
president  of  The  Brooklyn  Union  Gas  Co.,  Coalition  to  Eliminate 
Tax  Barriers  to  Environmental  Cleanup  Costs.  The  Brooklyn  Union 
not  only  employs  a  lot  of  good  people  in  the  city  of  New  York  in 
the  county  of  Kings,  but  is  involved  with  a  lot  of  community  mat- 
ters that,  even  though  I  seldom  get  a  chance  to  visit  that  wonderful 
borough,  it  helps  our  great  city  a  lot  and  we  appreciate  it.  And  Mi- 
chael Solomon,  partner  in  Ivins,  Phillips  and  Barker. 

We  will  start  now  with  Mr.  Hock. 


1604 

STATEMENT  OF  ROY  E.  HOCK,  PRESIDENrr,  TECHNTTROL,  D^C^ 
TREVOSE,  PA-,  ON  BEHALF  OF  COALITION  TO  PRESERVE 
THE  CURRENT  DEDUCTIBILITY  OF  ENVIRONMENTAL  REME- 
DIATION COSTS 

Mr,  Hock.  Thank  you,  Mr.  Chairman,  for  the  opportunity  to  ap- 
pear today  and  present  views  on  a  proposal  to  clarify  the  treatment 
of  environmental  remediation  costs.  I  appear  on  behalf  of  a  Coali- 
tion of  Companies,  and  my  brief  comments  will  be  covered  in  great- 
er detail  in  the  written  statement  which  has  been  provided  to  the 
committee. 

The  position  of  our  coalition  is  that  environmental  remediation 
costs  should  be  deductible.  I  give  the  following  reasons:  First,  the 
current  law  allows  current  deductibility  of  expenditures  incurred  in 
repairing  and  maintaining  property  and  equipment  if  there  is  no 
increase  in  value,  life  or  function.  Existing  standards  measure  an 
increase  by  comparing  the  attributes  I  have  just  listed  prior  to  the 
condition  that  necessitated  the  expenditure  with  the  condition  after 
the  expenditure. 

The  occurrence  or  discovery  of  a  condition  requiring  environ- 
mental remediation  decreases  the  value  of  the  asset  or  property 
when  it  becomes  known,  and  remediation,  at  best,  restores  the 
value  to  the  original  level  with  no  increase  in  life  or  function. 

My  company,  Technitrol,  I  give  as  an  example  where  we  in  the 
recent  past  removed  two  oil  storage  tanks.  Both  tanks  had  leaked, 
both  tanks  had  contaminated  the  soil  around  the  tanks  and  reme- 
diation was  accomplished. 

In  the  first  case,  the  tank  had  been  abandoned.  It  had  not  been 
in  use  and  was  not  being  restored.  The  ground  then  was  returned 
to  its  original  condition  and  no  increase  in  value  was  obtained. 

In  the  second  case,  the  tank  was  replaced,  in  compliance  with  the 
underground  storage  tank  statute,  in  which  we  now  have  to  have 
a  given  date,  and  we  are  trying  to  get  ahead  of  that  date,  put  in 
tanks  that  meet  the  crude  requirements  and  also  have  the  ability 
to  detect  leakage  if  it  occurs  in  the  future. 

In  both  instances,  remediation  was  expensed,  as  it  did  not  pro- 
vide any  increase  in  value,  life  or  function.  In  the  second  case,  the 
tank  and  the  related  leak  detection  equipment  was  capitalized,  as 
they  provided  this  increase. 

The  second  reason  I  give  is  that  matching  the  future  income  with 
related  expenses  is  one  reason  for  capitalizing  an  expenditure.  En- 
vironmental remediation  costs,  as  a  general  matter,  relate  to  prior 
activities  of  the  taxpayer  or  previous  owner  and  do  not  provide  an 
ongoing  benefit  beyond  that  associated  with  the  general  welfare. 

As  of  today,  current  costs  of  complying  with  the  present  environ- 
mental laws  are  an  allowable  deduction.  My  company,  Technitrol, 
for  instance,  has  12  plants.  Nine  of  these  plants  have  processed 
wastewater  treatment  facilities.  The  cost  of  running  these  and  also 
in  complying  with  other  environmental  laws,  runs  over  $600,000 
per  year.  Our  total  sales  are  about  $100  million.  This  sum  consists 
of  labor,  material,  employee  training  and  are  directly  chargeable  to 
outside  services  to  operate  our  facilities  within  the  law.  All  these 
costs  are  deductible. 

In  addition,  we  average  over  $100,000  per  year  of  capital  expend- 
itures to  meet  new  requirements  or  to  allow  the  use  of  new  cnemi- 


1605 

cals  that  replace  those  being  eHminated.  That  is  in  keeping  with 
the  testimony  we  just  heard  relative  to  CFCs.  Therefore,  it  seems 
only  logical  and  consistent  that  the  remediation  cost  for  correcting 
the  effects  of  prior  practice  or  events,  which  are  now  recognized  as 
an  environmental  problem,  would  also  be  an  allowed  deduction  in 
the  year  that  those  costs  are  incurred. 

All  of  us  in  industry  would  like  to  have  known  years  ago  what 
we  know  today  about  how  to  prevent  such  occurrences.  The  cost 
then  that  would  have  prevented  this  would  then  have  been  ex- 
pensed £ind  would  have  been  matched  with  the  revenue  occurring 
at  that  time. 

Third,  in  an  era  when  preservation  of  our  natural  resources  has 
attained  the  highest  degree  of  prominence,  public  policy  would  jus- 
tify a  tax  policy  that  encourages  environmental  remediation  activi- 
ties. In  contrast,  a  proposal  that  would  single  out  these  activities 
for  less  favorable  treatment  by  capitalization  by  mandating  that, 
must  be  judged  as  a  seriously  flawed  proposal. 

The  members  of  our  coalition,  and  we,  believe  industry  in  general 
would  like  to  get  remediation  of  old  environmental  problems  behind 
us,  and  we  truly  would  like  to  do  that.  Some  of  them  have  hung 
around  a  long,  long  time  and  we  would  like  to  get  on  with  it.  Our 
ability  to  do  this  quickly,  because  of  the  magnitude  of  the  problem, 
is  probably  limited  by  our  ability  to  sustain  the  cost.  And  I  think 
that  is  over  all  of  industry  that  we  have  to  speak  that  way,  not  par- 
ticularly my  firm. 

Any  unfavorable  tax  treatment  of  remediation  expenditures  could 
further  impair  the  timely  cleanup  activities.  My  company, 
Technitrol,  has  a  finite  amount  of  new  capital  to  invest  each  year. 
We  do  earn  money,  we  want  to  invest  it  back  in  the  business.  Our 
corporate  goal  is  to  expand  our  business  and  create  new  products, 
new  jobs,  and  thereby  create  value  for  our  shareholders,  who  are 
the  public.  We  are  a  public  company.  An  unfavorable  treatment  of 
remediation  expenditures  might  someday  put  us  in  the  undesirable 
position  of  not  having  the  wherewithal  to  do  both  and  having  to 
choose  which  we  are  going  to  do. 

In  closing,  I  would  like  to  urge  Congress  to  confirm  that  environ- 
mental remediation  costs  are  deductible  and  I  think  thereby  elimi- 
nate the  concern  that  was  expressed  by  Mr.  Samuels  just  the  other 
day,  and  industry,  of  having  the  IRS  and  the  taxpayers  entering 
into  costly  litigation. 

I  would  be  happy  to  answer  any  questions  at  the  appropriate 
time. 

Thank  you,  Mr.  Chairman. 

Chairman  Rangel.  Thank  you,  Mr.  Hock. 

[The  prepared  statement  follows:] 


1606 


STATEMENT  OF  ROY  E.  HOCK 

on  behalf  of 

THE  COALITION  TO  PRESERVE  THE  CURRENT  DEDUCTIBILITY  OF 
ENVIRONMENTAL  REMEDIATION  COSTS 

REGARDING  PROPOSALS  TO  CLARIFY  THE  TREATMENT  OF 
ENVIRONMENTAL  REMEDIATION  COSTS 

before  the 

SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 

COMMITTEE  ON  WAYS  AND  MEANS 

U.S.  HOUSE  OF  REPRESENTATIVES 

September  23,  1993 


Introduction 

Thank  you,  Mr.  Chairman,  for  the  opportunity  to  appear  today 
and  present  views  on  a  proposal  to  clarify  the  treatment  of 
environmental  remediation  costs.  I  appear  on  behalf  of  the 
Coalition  to  Preserve  the  Current  Deductibility  of  Environmental 
Remediation  Costs . ' 

The  tax  accounting  treatment  of  environmental  remediation  costs  is 
an  issue  that  concerns  all  members  of  the  coalition  and  a 
significant  number  of  other  U.S.  businesses.  In  general,  these 
liabilities  include  the  removal  and  disposal  of  solid  waste  and 
other  contaminants  that  pose  a  threat  to  human  health  and  the 
natural  environment.  U.S.  businesses  have  incurred  and  are 
expected  to  incur  in  the  future  vast  amounts  to  remediate  the 
environment. 

A  proposal  to  enact  legislation  that  would  specify  certain 
environmental  remediation  costs  as  capital  expenditures,  or  require 
all  environmental  remediation  costs  to  be  amortized  over  a  uniform 
period,  is  patently  unsound  from  multiple  perspectives  and  should 
be  rejected.  The  current  tax  law  has  long  provided  rules  that 
allow  a  current  deduction  for  costs  incurred  in  repairing  and 
maintaining  property  used  in  a  trade  or  business.  The  criteria  for 
distinguishing  these  currently  deductible  costs  from  capital 
expenditures  have  been  established  through  long-standing 
regulations  and  case  law  and  have  always  applied  uniformly  to  all 
activities. 

Under  the  current  law,  a  substantial  body  of  existing  case  law 
supports  the  current  deductibility  of  many  types  of  environmental 
remediation  costs.  Under  these  cases,  an  expenditure  that  merely 
restores  property  to  its  value  prior  to  a  condition  of 
deterioration  is  not  required  to  be  capitalized  as  an  improvement. 
Under  the  relevant  case  law,  the  proper  test  is  whether  the 
expenditure  materially  enhances  the  value,  use,  life  expectency, 
strength  or  capacity  as  compared  with  the  status  of  the  asset  prior 
to  the  existence  of  the  condition  necessitating  the  expenditure. 
The  legal  test  for  determining  the  deductibility  of  environmental 
cleanup  costs  should  be  the  same  test  that  applies  to  all  other 
business  expenses. 

The  capitalization  test  set  forth  in  the  case  law  is 
consistent  with  the  fundamental  purpose  of  any  capitalization 
requirement,  which  is  the  matching  of  income  with  related  expenses. 


'  The  Coalition  members  include:  CENEX,  Crysen  Corporation, 
Farmland  Industries,  Inc.,  Grede  Foundries,  Inc.,  Kalama  Chemical, 
Inc.,  Quebecor  Printing  (USA)  Holdings,  Inc.,  and  Technitrol,  Inc. 


1607 


Environmental  remediation  costs  as  a  general  matter  relate  only  to 
prior  activities  of  the  taxpayer  or  a  previous  property  holder  and 
do  not  provide  an  ongoing  benefit  beyond  that  associated  with  the 
general  welfare  of  the  environment. 

Ideally,  from  a  tax  policy  perspective,  a  proper  matching  of 
environmental  remediation  expenses  with  the  income  to  which  they 
relate  could  be  achieved  through  a  mechanism  that  would  allow  a 
deduction  prior  to  the  time  the  remediation  work  is  performed.^ 
Given  the  current  revenue  constraints,  environmental  remediation 
costs  should  be  deductible,  at  the  very  latest,  in  the  year 
incurred.  A  requirement  to  capitalize  and  amortize  these  expenses 
bevond  the  year  incurred  would  distort  income. 

In  an  era  when  preservation  of  our  natural  resources  has 
attained  the  highest  degree  of  prominence,  public  policy  would 
justify  a  tax  policy  that  encourages  environmental  remediation 
activities.  In  contrast,  a  proposal  that  would  single  out 
environmental  remediation  for  less  favorable  tax  treatment  than 
that  afforded  other  types  of  business  activity  by  mandating  the 
capitalization  and  amortization  of  certain  costs  must  ultimately  be 
judged  as  a  seriously  flawed  proposal. 

Background 

Estimates  of  the  total  environmental  remediation  costs  that 
are  expected  to  be  incurred  by  business  over  the  next  few  decades 
have  reached  staggering  levels.  For  example,  the  Associated  Press 
reported  that  the  potential  cleanup  liability  at  existing  hazardous 
waste  sites  had  reached  the  "trillion  dollar"  range  in  1991.' 

Environmental  remediation  is  unique  as  an  issue  of  almost 
universal  concern.  Far  from  being  an  isolated  problem  affecting 
businesses  in  a  few  distinct  industries,  it  has  and  will  continue 
to  have  a  major  impact  on  the  functioning  and  financial  status  of 
a  broad  spectrum  of  businesses.  Beyond  the  more  evident  examples, 
such  as  the  petroleum,  chemical,  mining,  manufacturing,  and 
agricultural  industries,  environmental  remediation  concerns  are 
also  prevalent  in  such  industries  as  real  estate  development, 
construction,  retailing  and  financial  services. 

In  the  less  obviously  affected  industries,  the  problem  of 
dealing  with  environmental  remediation  is  not  readily  associated 
with  the  core  activities  of  the  business  and,  therefore,  can  be 
relatively  more  disruptive.  For  example,  a  financial  institution 
whose  primary  expertise  is  providing  financial  services  could 
easily  suffer  a  competitive  set  back  when  forced  to  deal 
unexpectedly  with  a  severe  and  unexpected  problem  of  environmental 
waste  on  foreclosed  property. 

In  the  petroleum  industry,  the  problem  of  environmental 
remediation  permeates  to  small  businesses,  where  the  economic 
impact  is  potentially  more  severe.  For  example,  the  Petroleum 
Marketers  Association  reported  that  its  membership  of  more  than 
11,000  independent  marketers  could  face  significant  financial 
strain  in  the  cleanup  of  soil  and  groundwater  contaminated  from 


^  For  example,  section  468  of  the  Internal  Revenue  Code 
permits  a  deduction  for  certain  land  reclamation  and  closing  costs 
in  the  year  the  property  is  disturbed  or  produced  in  order  to 
achieve  a  proper  matching. 


Associated  Press  Release,  December  9,  1991, 


1608 


petroleum  leakage.''  Apart  from  the  significant  new  investment 
these  businesses  must  make  to  replace  storage  equipment  and  develop 
pollution  control  equipment,  the  EPA  has  estimated  each  could  face 
a  cleanup  liability  ranging  from  $50,000  to  $100,000. 

The  need  for  environmental  remediation  results  from  legitimate 
business  activities  that  are  vital  to  the  economy.  Environmental 
problems  such  as  chemical  contamination  of  soil,  and  the  dangers  of 
asbestos  insulation,  have  come  about  neither  as  a  result  of 
criminal  nor  negligent  conduct.  In  most  cases,  the  harmful  effects 
of  certain  materials  and  chemicals  were  simply  not  known  before  the 
time  the  materials  created  hazardous  conditions.  Similarly,  the 
instability  of  other  materials  in  the  environment  could  become 
known  only  with  actual  experience. 

Contrary  to  what  certain  environmental  advocacy  groups  may 
claim,  a  mandatory  capitalization  requirement  for  environmental 
remediation  would  undermine .  not  serve,  the  goals  of  these  groups. 
The  common  goal  of  these  environmental  advocacy  groups  and  the 
public  at  large  is  a  safer,  healthier  environment.  This  goal 
coincides  best  with  a  tax  policy  that  encourages  timely  and 
voluntary  environmental  remediation.  A  capitalization  requirement 
would  impose  additional  economic  barriers  to  cleanup  activities 
that  are  financially  burdensome  even  when  they  are  currently 
deductible. 

Current  Law  Supports  the  Deductibilitv  of Environmental 

Remediation 

A  taxpayer  may  currently  deduct  the  cost  of  incidental  repairs 
which  neither  materially  add  to  the  value  of  the  property  nor 
appreciably  prolong  its  life,  but  keep  it  in  an  ordinarily 
efficient  operating  condition.  Repairs  in  the  nature  of 
replacements,  to  the  extent  that  they  arrest  deterioration  and 
appreciably  prolong  the  life  of  the  property,  are  either 
capitalized  and  depreciated  in  accordance  with  section  167  or 
charged  against  the  depreciation  reserve.   Reg.  S  1.162-4. 

Section  263(a)  provides  that  no  deduction  shall  be  allowed  for 
(1)  any  eunount  paid  out  for  new  buildings  or  for  permanent 
improvements  or  betterments  made  to  increase  the  value  of  any 
property  or  estate,  or  (2)  any  amount  expended  in  restoring 
property  or  in  making  good  the  exhaustion  thereof  for  which  an 
allowance  is  or  has  been  made. 

The  Income  Tax  Regulations  provide  additional  guidance  for 
applying  this  test.  In  general,  the  term  "permanent  improvements 
or  betterments"  is  defined  to  include  amounts  paid  or  incurred  (1) 
to  add  to  the  value,  or  substantially  prolong  the  useful  life,  of 
property  owned  by  the  taxpayer,  such  as  plant  or  equipment,  or  (2) 
to  adapt  property  to  a  new  or  different  use.  Reg.  S  1.263  (a) -1(b)  . 

In  determining  whether  an  expenditure  results  in  a  currently 
deductible  repair  or  a  capital  improvement,  the  courts  have  closely 
adhered  to  the  3-factor  test  set  forth  in  Reg.  §1-263 (a) -1(b) . 
Thus,  an  expenditure  is  held  to  be  a  capital  improvement  only  when 
the  court  finds  that  the  expenditure  either: 

(1)  increases  the  value  of  the  property,  (2)  appreciably 
prolongs  its  useful  life,  (3)  adapts  the  property  to  a 
new  and  different  use,  or  results  in  a  combination  of  any 
3  of  these  criteria. 

In  the  case  of  most  environmental  remediation  expenditures. 


*  Letter  dated  Dec.  2,  1992,  from  John  J.  Huber,  Counsel, 
Petroleum  Marketers  Association  of  America,  to  Hon.  Fred  T. 
Goldberg,  Jr.,  Assistant  Secretary  (Tax  Policy),  Department  of  the 
Treasury . 


1609 


the  latter  two  tests  can  be  dispensed  with,  as  these  expenditures 
neither  lengthen  the  useful  life  of  any  property  nor  adapt  any 
property  to  a  new  and  different  use.  In  determining  that  an 
expenditure  results  in  a  material  increase  in  value,  the  courts  in 
a  majority  of  cases  have  required  that  the  expenditure  enhance  the 
functional  characteristics  of  the  property  in  some  fashion. 

This  "increased-value"  test  is  illustrated  in  numerous  cases. 
One  of  the  earliest  cases  to  apply  the  test  is  Illinois  Merchants 
Trust  Co.  V.  Commissioner.  4  B.T.A.  103  (1926) ,  in  which  the  wooden 
foundation  piles  of  a  warehouse  on  a  river's  edge  developed  dry  rot 
when  the  water  level  unexpectedly  receded.  To  prevent  the 
warehouse  from  collapsing,  the  taxpayer  cut  the  rotten  ends  of  the 
pilings  off  below  the  new  water  line,  and  then  replaced  the  severed 
sections  with  concrete  pilings.  The  Service  argued  that  the 
expenditures  were  capital  in  nature  because  they  were  "repairs  in 
the  nature  of  replacements."  In  allowing  the  taxpayer's  current 
deduction,  the  Board  of  Tax  Appeals  concluded: 

In  determining  whether  an  expenditure  is  a  capital  one  or 
is  chargeable  against  operating  income,  it  is  necessary 
to  bear  in  mind  the  purpose  for  which  the  expenditure  was 
made.  To  repair  is  to  restore  to  a  sound  state  or  to 
mend,  while  a  replacement  connotes  a  substitution.  A 
repair  is  an  expenditure  for  the  purpose  of  keeping  the 
property  in  an  ordinarily  efficient  operating  condition. 
It  does  not  add  to  the  value  of  the  property,  nor  does  it 
appreciably  prolong  its  life. 

The  Board  ultimately  concluded  that  the  expenditures  at  issue 
"did  not  add  to  the  value  or  prolong  the  expected  life  of  the 
property  over  what  they  were  before  the  event  which  made  the 
repairs  necessary."  The  Board  further  distinguished  the 
expenditures  from  those  properly  chargeable  to  capital  account 
which  would  include  expenses  incurred  "in  the  original  construction 
of  the  work  or  in  the  subsequent  enlargement  and  improvement 
thereof."  (citing  Union  Pacific  R.R.  Co.  v.  United  States.  99  U.S. 
402  (1879)). 

In  American  Bemberg  Corp.  v.  Commissioner.  lOT.C.  361  (1948), 
aff 'd.  177  F.2d  200  (6th  Cir.  1949),  the  taxpayer's  rayon 
manufacturing  plant  became  prone  to  cave-ins  due  to  its  situation 
on  a  geological  fault.  To  rectify  the  problem,  the  taxpayer 
incurred  over  $900,000  to  fill  the  underground  cavities  with  grout 
and  cement.  The  Service  argued  that  the  taxpayer's  expenditure  was 
incurred  for  permanent  improvements  or  to  restore  property  for 
which  an  allowance  had  been  made. 

In  allowing  the  taxpayer's  current  deduction  the  court 
considered  three  factors:  (1)  the  purpose  of  the  work,  (2)  the 
physical  nature  of  the  work,  and  (3)  the  effect  of  the  work.  The 
court  noted  that  the  expenditures  were  intended  to  avert  a  plant- 
wide  disaster,  and  to  avoid  forced  abandonment  of  the  plant.  The 
court  concluded  that  the  taxpayer's  purpose  was  not  to  improve, 
better,  extend,  or  increase  the  value  of  the  original  plant. 
Although  its  continued  operation  was  endangered,  the  purpose  of  the 
expenditures  was  to  enable  the  taxpayer  to  continue  operating  the 
plant  not  on  any  new  or  better  scale,  but  on  the  same  scale  and  as 
efficiently  as  it  had  operated  before.  The  purpose  was  not  to 
rebuild  or  replace  the  plant  in  whole  or  in  part.  The  court  next 
concluded  that  the  physical  nature  of  the  work  was  not  a  work  of 
construction,  or  the  creating  of  anything  new.  Although  the  effect 
of  the  work  clearly  benefitted  the  taxpayer  by  forestalling 
imminent  disaster,  the  court  concluded  that  this  factor  did  not 
render  the  expenditure  a  capital  improvement. 

In  Midland  Empire  Packing  Co.  v.  Commissioner.  13  T.C.  635 
(1950),  the  taxpayer  incurred  expenditures  to  line  the  walls  and 
floors  of  its  basement  with  concrete.  The  purpose  of  the 
expenditure  was  to  prevent  seepage  of  oil  spilled  by  a  nearby 


1610 


refinery  that  was  threatening  the  continuation  of  the  taxpayer's 
meat  packing  operations.  Finding  that  the  repairs  did  not  make  the 
building  more  desirable  for  the  purpose  for  which  it  has  been  used, 
but  merely  served  to  keep  the  property  in  an  operating  condition 
over  it  probable  useful  life  for  the  purpose  in  which  it  was  used, 
the  court  allowed  the  taxpayer's  current  deductions. 

In  Plainfield-Union  Water  Co.  v.  Commissioner.  39  T.C.  333 
(1962),  nonacg. .  1964-2  C.B.  8,  the  court  approached  the  increased- 
value  test  in  much  the  same  way  as  the  Board  of  Tax  Appeals  did 
years  earlier  in  Illinois  Merchants  Trust.  In  this  case,  the 
taxpayer  had  replaced  the  eroded  tar  lining  in  its  water  pipes  with 
a  new  cement  lining.  This  process  restored  the  pipe's  original 
water-carrying  capacity,  which  had  been  reduced  by  a  process  known 
as  tuberculation  (erosion  from  the  carrying  of  acidic  water) .  In 
upholding  the  current  deductibility  of  the  taxpayer's  expenditures 
the  court  found  that  the  repair  did  not  form  a  part  of  an  overall 
plan  of  improvement,  the  cleaning  and  lining  did  not  materially 
increase  the  useful  life,  value,  or  structural  strength  of  the 
pipes  involved,  nor  did  it  render  those  pipes  suitable  for  any  new 
or  additional  use.   In  rendering  its  decision,  the  court  stated: 

Respondent  contends  that  the  value  of  the  pipe  to 
petitioner  was  materially  increased  by  the  expenditure 
and  that  it  is,  therefore,  a  capital  expenditure.  But 
any  properly  performed  repair  adds  value  as  compared  with 
the  situation  existing  immediately  prior  to  the  repair. 
The  proper  test  is  whether  the  expenditure  materially 
enhances  the  value,  use,  life  expectancy,  strength  or 
capacity  as  compared  with  the  status  of  the  asset  prior 
to  the  condition  necessitating  the  expenditure. 

Later  cases  have  consistently  focused  on  the  need  to  measure 
"added  value"  with  respect  to  the  original  operating  condition  of 
the  property.  In  Oberman  Manufacturing  Co.  v.  Commissjopeg ,  47 
T.C.  471  (1967)  ,  the  court  held  that  the  taxpayer's  expenditures  to 
correct  the  leakage  in  a  factory  roof  were  ordinary  and  necessary 
repairs.  The  court  emphasized  that,  in  applying  the  increased- 
value  test,  it  is  important  to  note  that  any  properly  performed 
repair  adds  value  as  compared  with  the  situation  existing 
immediately  prior  to  the  repair.  The  proper  test,  however,  is 
whether  the  expenditure  materially  enhanced  the  value,  use,  life, 
strength,  or  capacity  as  compared  with  the  status  of  the  asset 
prior  to  the  condition  necessitating  the  expenditure.  In  applying 
this  test  to  the  facts,  the  court  stated: 

The  testimony  establishes  that  the  petitioner's  only 
purpose  in  having  the  work  done  to  the  roof  was  to 
prevent  the  leakage  and  thus  keep  the  leased  property  in 
an  operating  condition  over  its  probable  useful  life  for 
the  uses  for  whi6h  it  was  acquired,  and  not  to  prolong 
the  life  of  such  property,  increase  its  value,  or  make  it 
adaptable  to  a  different  use.  There  was  no  replacement 
or  substitution  of  the  roof.  It  is  true  that  the  work 
included  some  structural  change,  namely,  the  insertion  of 
an  expansion  joint  in  the  roof.  However,  the  evidence 
establishes  that  was  the  most  economical  way  to  repair 
the  leaks  and  thus  keep  the  leased  property  in  an 
ordinarily  efficient  operating  condition. 

Similarly,  in  Niagara  Mohawk  Power  Corp.  v.  United  States.  558 
F.2d  379  (Ct.  CI.  1977),  the  court  concluded  that  the  cost  of 
repairing  leaking  pipes  did  "not  increase  the  value  of  the  cast 
iron  pipelines  in  comparison  with  their  original  leak-free 
condition."  The  court  also  found  that  the  repairs  were  not  part  of 
a  systematic  improvement  plan. 

As  the  cases  discussed  above  illustrate,  a  remedial 
expenditure  does  not  "materially  increase  the  value  of  property"  if 
there  is  no  improvement  in  the  functioning  of  the  property  or  its 


1611 


usefulness  over  and  above  the  purpose  for  which  it  was  originally 
acquired.  Environmental  remediation  expenses,  such  as  asbestos 
removal  in  a  building,  or  the  removal  of  chemical-contaminated  soil 
on  land  adjacent  to  the  taxpayer's  business  as  a  general  matter  do 
not  improve  the  functioning  or  usefulness  of  any  assets  used  in  the 
business.  Although  the  removal  and  disposal  of  environmental 
contaminants  benefits  the  environment  and  the  general  public,  the 
expenditures  do  not  materially  add  to  the  property's  value  under 
the  test  applied  in  this  long  line  of  settled  case  law. 

Apart  from  the  increased-value  test,  a  capital  expenditure  may 
result  from  an  expenditure  that  physically  enlarges  an  asset.  It 
is  incorrect  to  assume  that  the  application  of  the  increased-value 
test,  as  described  in  these  cases,  would  always  lead  to  the 
conclusion  that  an  expenditure  is  currently  deductible.  This  is 
not  the  case  because  many  expenditures  do  not  merely  maintain  the 
status  quo  but  enhance  the  functioning  of  the  property,  physically 
enlarge  the  property,  or  prolong  the  useful  life  of  the  property. 

The  requirement  to  compare  the  value  of  the  property  before 
and  after  the  condition  necessitating  the  repair  is  an  easily- 
applied  litmus  test  for  identifying  those  expenditures  that  do  not 
functionally  enhance  or  physically  enlarge  the  property  beyond  it 
preexisting  state  and,  therefore,  are  not  appropriately  viewed  as 
currently  deductible  repairs. 

A  significant  number  of  cases  have  held  that  an  otherwise 
deductible  ordinary  repair  cost  must  be  capitalized  if  it  is 
incurred  in  the  context  of  an  overall  plan  of  rehabilitation  or 
refurbishing  of  property  used  in  a  trade  or  business.  For  example, 
while  the  cost  of  repainting  an  existing  building,  if  performed 
separately,  would  correctly  be  treated  as  a  currently  deductible 
repair  cost,  the  cost  of  painting  performed  as  part  of  the  original 
construction  or  in  conjunction  with  a  major  overhaul  of  the 
building  is  required  to  be  capitalized.  See  Moss  v.  Commissioner. 
831  F.2d  833  (9th  Cir.  1987);  United  States  v.  Wehrli.  400  F.2d  686 
(10th  Cir.  1968)  ;  Wilbur's  Estate  v.  Commissioner.  43  T.C,  322 
(1964),  acq. .  1965-2  C.B.  7);  Jones  v.  Commissioner.  24  T.C.  563 
(1955),  aff 'd.  242  F.2d  616  (5th  Cir.  1957).  The  plan  of 
rehabilitation  doctrine  is  based  on  the  theory  that  the 
capitalization  provisions  of  the  Code  do  not  envision  the 
fragmentation  of  an  overall-project  but  require  an  inquiry  into  the 
scope  and  effect  of  a  project  as  whole. 

The  general  plan  of  rehabilitation  doctrine  would  generally 
not  apply  to  environmental  remediation  activities.  While  a 
taxpayer  that  undertakes  an  environmental  remediation  program 
generally  must  incur  several  distinct  categories  of  expenses,  which 
may  arise  from  such  activities  as  the  removal  and  disposal  of 
contaminants,  monitoring,  assessment,  and  attorneys  fees,  the 
program  as  a  whole  merely  restores  the  property  to  its  pre-damaged 
condition  and  therefore  does  not  involve  a  plan  of  rehabilitation. 

Under  the  regulations,  capital  expenditures  are  distinguished 
from  "incidental"  repairs  that  are  currently  deductible.  Courts 
have  held  that  the  amount  of  dollars  involved  in  an  expenditure, 
either  in  relative  or  absolute  terms,  is  not  dispositive  of  whether 
an  expenditure  results  in  a  permanent  improvement  under  section 
263(a)  or  an  incidental  repair  under  Reg.  §  1.162-4. 

In  American  Bembera.  for  example,  the  taxpayer  made  a  one-time 
expenditure  of  over  $900,000  in  1941  and  1942  to  fill  underground 
cavities  with  grout.  The  court  reached  its  conclusion  that  the 
expense  was  a  currently  deductible  repair,  however,  by  analyzing 
the  nature,  purpose,  and  effect  of  the  work  on  the  taxpayer's 
property.  In  R.R.  Hensler.  Inc.  v.  Commissioner.  73  T.C.  168 
(1979),  the  court  upheld  the  current  deductibility  of  a  large 
expenditure  to  repair  equipment  and  machinery,  stating  that  the 
size  of  the  amounts  involved  should  not  be  controlling. 


1612 


In  Buckland  v.  United  States.  66  F.  Supp.  681  (D.C.  Conn. 
1946),  the  taxpayer's  restoration  of  damaged  property  was  held  to 
be  a  currently  deductible  repair  because  there  was  no  substitution 
of  a  major  unit  or  structural  part  such  that  "the  building  as  a 
whole  may  be  considered  to  have  gained  appreciably  in  expectancy  of 
useful  life,"  despite  the  fact  that  the  total  expenditure  was  so 
large  that  it  amounted  to  35  percent  of  the  value  of  the  building. 
Thus,  the  term  "incidental,"  as  used  in  the  regulations,  refers  to 
the  nature  of  the  work  being  performed  in  relation  to  the 
taxpayer's  specific  property  being  improved  as  opposed  to  either 
the  relative  or  absolute  amount  of  dollars  expended  in  the 
activity. 

Current  Deductibility  of  Environmental  Remediation js  an 

Appropriate  Tax  Treatment 

The  proper  application  of  the  repair  versus  improvement  case 
law  leads  inexorably  to  the  conclusion  that  environmental 
remediation  costs,  as  a  general  matter,  are  not  subject  to 
capitalization.'  Regardless  of  the  current  law,  however,  sound  tax 
policy  dictates  that  environmental  remediation  costs  should  be 
deductible  no  later  than  the  tax  year  in  which  incurred. 

The  capitalization  rules  seek  to  require  those  expenses  having 
a  significant  long-term  future  benefit  to  be  matched  with  the 
income  stream  that  is  expected  to  be  generated  in  the  future.* 
Environmental  remediation  generally  results  from  past  activities  of 
a  business  and  from  the  earning  of  income  in  prior  years.  It  would 
be  irrational  to  require  such  expenses  to  be  capitalized  merely 
because  they  are  significant  in  amount  and  bunched  into  a  short 
period  of  time  as  a  result  of  a  remediation  program.  A  far  greater 
distortion  would  result  from  a  capitalization  requirement  than  from 
permitting  a  deduction  for  these  expenses  in  the  year  inciurred. 

Because  these  expenditures  relate  to  the  earning  of  income  in 
prior  periods,  a  theoretically  correct  approach  would  provide  for 
a  deduction  in  the  year  in  which  the  condition  requiring 
remediation  arises.  This  approach  has  been  adopted  by  Congress 
with  respect  to  certain  qualified  mining  reclamation  and  solid 
waste  disposal  costs  under  section  468  of  the  Code.  Similarly,  the 
Financial  Accounting  Standards  Board  is  currently  considering  a 
proposal  to  affirmatively  require  companies  to  accrue  for  financial 
reporting  purposes  a  "loss  contingency"  for  anticipated 
environmental  liabilities.'  It  is  possible  that  concerns  regarding 
the  time  value  of  money  may  make  it  infeasible  for  Congress  to 
enact  such  a  statutory  scheme  for  environmental  remediation. 
Because  these  expenditures  do  not  produce  a  future  income  stream, 
however,  it  is  manifest  that  a  far  greater  distortion  would  result 
from  a  capitalization  requirement  than  permitting  a  current 
deduction  for  environmental  remediation  costs. 

Present   law   provides   several   relevant   factors   for 


*  The  Internal  Revenue  Service  has  recently  issued  two 
informal  technical  advice  memoranda  concluding  that  certain 
environmental  remediation  costs  must  be  capitalized.  See  TAM 
9315004  (Dec.  17,  1992)  (requiring  capitalization  of  PCB 
contaminated  soil  remediation);  TAM  9240004  (June  29,  1992) 
(requiring  capitalization  of  asbestos  insulation  removal) .  Due  to 
the  strong  consensus  among  taxpayers  that  the  law  was  misapplied  in 
these  TAMs,  the  IRS  has  indicated  that  the  TAMs  are  being 
reconsidered . 


*  In4ppco.  Tn<?,  V.  commissioner,  112  S.  Ct.  1039  (1992). 

'  Emerging  Issues  Task  Force,  Issue  93-5,  Minutes  of  March  16, 
1993  Meeting. 


1613 


distinguishing  between  a  repair  cost  and  a  capital  improvement. 
These  factors  appropriately  relate  to  the  nature  of  the  expenditure 
in  relation  to  the  value  and  functioning  of  property  used  in  the 
taxpayer's  business.  Although  these  factors  have  generally  been 
applied  uniformly  to  all  activities,  Congress  has  on  occasion 
waived  these  tests  in  order  to  provide  specific  incentives  for 
certain  types  of  business  activities.'  In  these  situations,  the 
expenditures  incurred  in  connection  with  a  specified  type  of 
activity  are  deemed  to  be  currently  deductible  in  all  cases  and  the 
ordinary  criteria  are  waived. 

Environmental  remediation  is  a  significant  public  policy 
concern  today.  As  a  result  of  increasingly  stringent  legal 
requirements,  the  financial  burden  of  environmental  remediation  on 
private  industry  is  becoming  heavier  and  heavier.  At  the  same 
time,  environmental  advocacy  groups  have  an  interest  in  maximizing 
the  amount  of  environmental  remediation  effort.  A  tax  policy  that 
increased  the  after-tax  cost  of  environmental  remediation  by 
requiring  capitalization  would  only  frustrate  and  delay  these 
environmental  remediation  efforts.  Instead  of  providing  a  less 
favorable  tax  treatment,  and  thus  a  disincentive  for  faster  and 
more  comprehensive  voluntary  and  involuntary  environmental 
remediation,  these  environmental  advocacy  groups  should  logically 
support  specific  tax  incentives  to  hasten  these  efforts.  (This 
coalition  is  not  promoting  new  incentives,  recognizing  the  revenue 
implications. ) 

Legislation  that  would  require  capitalization  of  environmental 
remediation  would  subject  these  activities  to  less  favorable  tax 
treatment  than  other  business  activities.  Given  the  extent  and 
nature  of  the  environmental  costs  issue,  public  policy,  would 
dictate  that  it  is  appropriate  at  a  minimum  to  allow  these 
activities  to  remain  subject  to  the  same  capitalization  criteria  as 
all  other  activities. 


'  E.g.,  section  174  (research  and  experimentation);  section 
263(c)  (intangible  drilling  and  development  costs). 


1614 

STATEMENT  OF  MICHAEL  F.  SOLOMON,  PARTNER,  IVINS, 
PHILIPS  &  BARKER,  WASHINGTON,  D.C. 

Chairman  Rangel.  Mr.  Solomon. 

Mr.  Solomon.  Crood  morning,  Mr.  Chairman,  I  am  not  before 
this  subcommittee  today  to  argue  why  expensing  environmental  re- 
mediation costs  makes  good  policy.  Certainly,  encouraging  the 
cleanup  of  our  environment  is  an  important  national  goal. 

The  point  I  want  to  make  is  that  Congress  should  not  retro- 
actively change  existing  law  to  the  detriment  of  taxpayers  under- 
taking important  cleanup  activities  in  the  guise  of  a  clarification  of 
the  law. 

I  have  three  very  brief  comments  on  this  subject  that  will  aug- 
ment my  written  testimony,  that  I  submitted  the  other  day,  and 
ask  be  admitted  for  the  record. 

First,  current  law,  as  reflected  in  a  long  line  of  decided  cases  and 
in  the  Treasury's  own  regulations,  stands  clearly  for  the  point  that 
most  environmental  remediation  expenses  are  deductible  not 
capitalizable.  As  Mr.  Hock  has  just  pointed  out,  they  are  deductible 
either  as  repair  expenses,  or  under  the  theory  of  properly  matching 
the  income  of  the  taxpayer  derived  in  prior  periods  against  the 
costs  of  those  prior  periods. 

Taxpayers  who  made  higher  profits  over  the  years  because  their 
production  expenses  were  not  incumbered  with  the  cost  of  prevent- 
ing pollution,  now  must  pay  these  costs,  and  they  are  properly 
matched  against  the  income  m  these  prior  periods. 

The  second  point  involves  the  Internal  Revenue  Service,  which 
has  issued  two  recent  technical  advice  memoranda,  taking  a  posi- 
tion contrary  to  this  ^eat  weight  of  authority  on  the  subject  and 
require  the  expenses  mcurred  m  two  very  common  environmental 
remediation  situations  to  be  capitalized.  The  rationale  used  by  the 
Service  to  justify  their  position  is  weak,  is  inconsistent,  even  be- 
tween the  two  technical  advice  memoranda,  and  even  the  Service 
has  questioned  its  own  conclusions  by  providing  on  the  face  of  the 
last  technical  advice  that  it  may  not  stand  behind  the  legal  conclu- 
sions in  that  submission  since  it  was  continuing  to  restudy  its 
position. 

And  well,  they  should  restudy,  because  that  technical  advice 
memoranda  and  the  other  one  cannot  be  reconciled  with  67  years 
of  precedent.  This  latter  technical  point  is  dealt  with  in  detail  in 
my  written  submission. 

My  final  point,  my  third  point,  really  is  a  question.  What  should 
this  Congress  and  this  committee  do?  If  Congress  clarifies  the  law 
by  accepting  the  Service's  technical  advice  memoranda  as  the  law, 
it  will  have  effectively  changed  the  law  retroactively.  It  will  also 
have  pulled  the  rug  out  from  taxpayers  who  have  spent  hundreds 
of  millions  of  dollars  in  good  faith,  relying  on  accepted  interpreta- 
tions of  existing  precedent,  expecting  to  be  able  to  deduct  these  re- 
mediation expenses. 

This  Congress  just  went  through  a  very  painful  debate  on  retro- 
active tax  legislation.  If  this  Congress  accepts  the  Service's  tech- 
nical advice  memoranda  as  current  law  and  clarifies  current  law  as 
requiring  capitalization  of  these  environmental  remediation  activi- 
ties, then  the  possible  retroactive  effect  of  any  such  clarification 
will  be  much  more  significant  than  OBRA  1993. 


1615 

Chairman  Rangel.  You  don't  have  any  problem  if  it  is  prospec- 
tive? 

Mr.  Solomon.  Prospective?  Obviously,  this  Congress  can  decide 
to  change  the  law  prospectively.  I  only  have  a  problem  in  the  sense 
of  whether  that  is  a  viable  policy  goal  for  Congress  which,  if  it 
changes  the  law  prospectively,  would  have  some  cnilling  effect  pre- 
sumably on  this  remediation  activity. 

Chairman  Rangel.  We  have  already  taken  the  heat  for  retro- 
active. 

Mr.  Solomon.  Yes,  sir. 

In  closing.  Chairman  Rangel,  I  should  just  say  that  I  don't  be- 
lieve that  this  subcommittee  should  allow  a  retroactive  change  to 
be  clothed  as  a  so-called  "clarification."  And  with  that,  I  thank  you. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


1616 


Statement  of  Michael  F.  Solomon 

Partner,  ivins,  Phillips  &  Barker 

Before  the  House  Subcommittee  on  Select  Revenue  Measures 

Concerning  the  Federal  Income  Tax  Treatment  of 

Environmental  Remediation  Expenditures 


Mr.  Chairman  Rangel  and  members  of  the  Select  Revenue  Measures 
Subcommittee,  on  behalf  of  my  firm  and  its  clients  generally,  my  testimony 
addresses  the  limited  question  of  the  proper  federal  tax  treatment  to  be  given 
environmental  remediation  expenditures  under  present  law.  I  believe  that  I  am 
qualified  to  address  this  subject  since  I  have  been  engaged  exclusively  in  the  practice 
of  tax  law  for  over  seventeen  years;  I  have  written  articles  and  handled 
controversies  related  to  this  question  of  the  proper  tax  treatment  to  be  accorded 
environmental  remediation  costs;  and  I  taught  for  nine  years  the  income  tax 
accounting  course  at  the  graduate  division  of  the  Georgetown  University  Law  Center 
which  dealt  with,  inter  alia,  distinguishing  between  capital  and  expense  items. 

The  stated  intent  of  the  Subcommittee,  as  set  forth  in  the  Joint  Committee 
staff  description  of  this  proposal,  is  to  clarify  the  treatment  of  environmental 
remediation  costs  by  specifying  which  costs  must  be  capitalized.  •  Alternatively,  the 
Subcommittee  proposal  states  that  it  may  require  the  capitalization  of  all 
environmental  remediation  costs  and  the  amonization  of  such  capitalized  costs  over 
a  uniform  period.  I  intend  to  leave  for  others  the  reasons  why  the  latter  alternative 
course  of  action  is  bad  policy.  It  is  a  self-evident  proposition  that  providing 
taxpayers  a  deduction  for  the  costs  of  environmental  remediation  costs  encourages 
such  remediation  efforts.  What  is  not  self  evident,  however,  from  the  Joint 
Committee  staff  description  is  that  current  law,  the  law  that  this  Subcommittee 
intends  to  clarify,  provides  for  the  deduction  of  most  environmental  remediation 
costs.2  In  clarifying  this  law,  it  is  incumbent  on  this  Subcommittee  to  reach  this 
same  conclusion,  since  the  results  of  pending  audits  and  the  plans  of  numerous 
taxpayers  currently  undertaking  environmental  remediation  projects  would  be 
unfairly  affected  were  this  Subcommittee  to  reach  a  different  conclusion.  Also,  any 
clarification  will  serve  to  establish  the  proper  revenue  baseline  against  which  any 
change  in  law  on  this  subject  would  validly  be  measured.  If  the  treatment  available 
under  c  irrent  law  is  misinterpreted  by  this  Subcommittee,  the  economic  and  policy 
implications  of  any  change  in  law  that  may  be  jjroposed  will  be  seriously  flawed. 

The  balance  of  my  testimony  will  address  the  major  areas  of  the  Internal 
Revenue  Service's  misunderstanding  of  the  law  on  this  subject  as  reflected  in  two 
very  recent  technical  advice  memoranda  issued  by  the  Service. ^  A  more  complete 
discussion  of  how  environmental  remediation  costs  are  properly  treated  under 
current  law  can  be  found  in  a  September  17,  1993  letter  to  Stuart  L.  Brown, 
Internal  Revenue  Service  Associate  Chief  Counsel  (Domestic),  that  I  jointly  authored 
with  Claude  B.  Stansbury  of  my  firm. 

It  is  my  opinion  that  the  Internal  Revenue  Service  has  seriously 
misinterpreted  the  applicable  law  in  five  imponant  areas:  (1)  the  standard  for 
determining  whether  an  expenditure  materially  adds  to  value;  (2)  the  scope  of  the 
so-called  "plan  of  rehabilitation"  doctrine;  (3)  the  relevance  of  indirect  and 
incidental  effects  of  a  cleanup  expenditure  on  the  taxpayer's  operations;  (4)  the 


1  Staff  of  the  Joint  Committee  on  Taxation,  DESCRIPTION  OF  CURRENT  REVENUE 
PROPOSALS  72-74,  (JCS- 12-93),  Sept.  20,  1993. 

2  Significantly,  we  note  that  the  Description  of  Current  Revenue  Proposals  prepared  by 
the  Staff  of  the  Joint  Committee  on  Taxation  addresses  only  the  Internal  Revenue  Service's 
analysis  as  set  forth  in  two  recent  technical  advice  memoranda  without  any  substantial  analysis 
of  the  opposing  interpretation  of  the  same  and  other  authorities.  Id.  at  72-74. 

3  Tech.  Adv.  Mem.  924004  (June  29.  1992)  (regarding  removal  of  asbestos  insulation) 
(hereinafter  "Asbestos  TAM");  Tech.  Adv.  Mem.  93150004  (Dec.  17.  1992)  (regarding 
remediation  of  polychlorinated  biphenyl  contamination)  (hereinafter  "PCB  TAM"). 

-1- 


1617 


relevance  of  an  expenditure's  permanence;  and  (5)  the  proper  focus  of  inquiry  in 
examining  any  cleanup  expenditure. 

The  result  of  this  misinterpretation  of  the  law  is  an  over-inclusive 
requirement  that  taxpayers  capitalize  environmental  remediation  expenditures  which 
will  have  the  effect  of  producing  a  distortion  of  their  taxable  incomes. 
Capitalization  and  cost  recovery  through  depreciation  or  amortization  is  a  tax 
accounting  concept  designed  to  match  the  deduction  of  costs  incurred  with  the 
income  produced  by  incurring  such  costs.^  This  "matching"  principle  requires  that 
where  an  expenditure  merely  repairs  an  asset  to  its  pre-repair-necessitating-event 
operating  condition,  the  cost  of  any  such  repair  should  be  matched  against  the 
current  income  of  the  taxpayer,  since  the  full  cost  of  the  underlying  asset  is  already 
being  depreciated  or  amortized  over  the  asset's  productive  life.  This  "matching" 
principle  also  requires  that  where  an  expenditure  creates  nothing  of  value  which  will 
be  used  or  consumed  in  the  production  of  future  income,  there  is  neither  reason  nor 
justification  for  capitalization,  since  the  income  against  which  such  costs  should 
properly  be  matched  was  reported  by  the  taxpayer  in  prior  taxable  periods. 
Accordingly,  while  the  Service  has  twice  ruled  that  environmental  cleanup  costs  are 
capital  expenditures  under  current  law,  the  tax  accounting  rules,  the  Service's  own 
regulations,  and  the  weight  of  decided  cases  all  require  one  to  conclude  that  most 
environmental  remediation  expenditures,  including  those  analyzed  in  the  two  Service 
TAMs,  are  currently  deductible  under  present  law. 

I.        THE  PROPER  Standard  for  Determining  whether  an  Expenditure 
Materially  adds  To  Value. 

The  initial  focus  of  the  tax  accounting  issue  presented  by  environmental 
remediation  expenditures  is  whether  such  expenditures  qualify  as  repairs  which  are 
ordinarily  deductible  under  section  162(a)  and  Treasury  regulations  section  1.162-4. 
Treasury  regulation  section  1.162-4  permits  the  current  deduction  of  the  "cost  of 
incidental  repairs  which  neither  materially  add  to  the  value  of  the  property  nor 
appreciably  prolong  its  life,  but  keep  it  in  an  ordinarily  efficient  operating 
condition."  Section  263(a)  of  the  Code  requires  capitalization  of  expenditures  which 
provide  enduring  benefits  to  the  taxpayer,  including  "any  amount  paid  out  for  new 
buildings  or  for  permanent  improvements  or  betterments  made  to  increase  the  value 
of  any  property  or  estate."  I.R.C.  §  263(a)(1). 

The  primary  definitional  ambiguity  in  applying  these  general  statutory  and 
regulatory  rules  for  distinguishing  between  capital  and  expense  items  is  the 
determination  of  whether  an  expenditure  materially  adds  value.  The  courts  have 
long  recognized  that  any  properly  performed  repair  adds  value  when  the  base 
reference  is  the  value  of  the  property  after  the  onset  of  the  condition  necessitating 
repair.  Accordingly,  courts  have  consistently  held  that  only  repair  expenditures 
which  materially  add  to  the  value  of  property  as  compared  to  the  value  of  the 
property  before  the  onset  or  occurrence  of  the  condition  necessitating  repair  are 
properly  capitalized  (the  "Plainfield-Union  test").* 


*  Indopco.  Inc.  v.  Commissioner U.S. 112  S.  Ct  1039,  1043  (1992) 

("through  [sections  162,  167  and  263],  the  Code  endeavors  to  match  expenses  with  revenues 
of  the  taxable  period  to  which  they  are  properly  attributable,  thereby  resulting  in  a  more 
accurate  calculation  of  net  income  for  tax  purposes.");  Commissioner  v.  Idaho  Power,  418 
U.S.  1,  16  (1974);  Massey  Motors.  Inc.  v.  United  States,  364  U.S.  92,  104  (1960);  Ellis 
Banking  Corp.  v.  Commissioner,  688  F.2d  1376,  1379  (11th  Cir.  1982);  Hertz  Corp.  v. 
United  States,  364  U.S.  122,  126  (1960). 

5  Plainfield-Union  Water  Co.  v.  Commissioner,  39  T.C.  333,  338  (1962),  nonacq., 

1964-2  C.B.  8;  Oberman  Manufacturing  Co.  v.  Commissioner,  47  T.C.  471.  483  (1967), 
acq.,  1967-2  C.B.  3.  Illinois  Merchant  Trust  Co.  v.  Commissioner,  4  B.T.A.  103,  106-107 
(1926),  acq.,  V-2  C.B.  2;  Midland  Empire  Packing  Co.  v.  Commissioner,  14  T.C.  635.  641 
(1950),  acq.,  1950-2  C.B.  3;  Niagara  Mohawk  Power  Corp.  v.  United  States,  558  F.2d  1379. 
1387  (Ct.  CI.  1977). 


1618 


While  this  standard  for  determining  whether  an  expenditure  materially  adds 
to  value  is  straight-forward,  rational,  and  supported  by  the  great  weight  of  judicial 
authority,  the  Service  has  attempted  to  distinguish  the  Plainfle Id-Union  test  in  both 
the  Asbestos  TAM  and  in  the  PCB  TAM.  In  the  two  cleanup  TAMs,  the  Service 
rejected  each  taxpayer's  reliance  on  Plainfie Id- Union  on  at  least  four  grounds:  (1) 
that  the  Tax  Court's  reasoning  was  only  applicable  in  cases  involving  so-called 
"progressive  deterioration";  (2)  that  the  Plainfield-Union  holding  is  fact  specific  and 
is  but  one  measure  of  addition  to  value;  (3)  that  the  Plainfield-Union  test  is 
inapplicable  to  repairs  of  "latent"  defects,  e.g.  use  of  a  hazardous  material  like 
asbestos;  and  (4)  that  all  expenditures  mandated  by  law  or  regulation  are  per  se 
capital  expenditures.  Each  of  these  grounds  is  against  the  weight  of  the  available 
authorities. 

A.  Progressive  Deterioration  is  irrelevant  to  Plainfield-Union  test 

The  question  of  whether  the  damage  being  repaired  is  the  result  of 
progressive  deterioration  or  of  a  sudden  occurrence  is  a  red  herring.  Cases 
involving  both  circumstances  are  abundant.  E.g.,  Midland  Empire  Packing  Co.,  14 
T.C.  at  641  (sudden  onset);  Illinois  Merchant  Trust  Co.,  4  B.T.A.  at  107  (sudden 
onset);  Plainfield-Union  Water  Co.,  39  T.C.  at  338  (progressive  deterioration).  See 
also  Oberman  Mfg.  Co.,  47  T.C.  at  483  (latent  defect,  onset  neither  sudden  nor 
progressive). 

Ironically,  the  Service  presented  exactly  the  opposite  argument  in  Plainfield- 
Union,  an  argument  that  was  rejected  by  the  Tax  Court  in  no  uncertain  terms. 
Plainfield-Union  Water  Co.,  39  T.C.  at  340  ("We  do  not  agree  that  the  deduction  in 
the  instant  case  requires  a  relatively  sudden,  unexpected,  or  unusual  external  factor 
which  results  in  casualty  damage.").  The  Tax  Court's  point  was  not  that 
"progressive  deterioration"  was  a  necessary  condition  for  deduction,  but  rather  that 
the  factor  of  sudden  versus  progressive  onset  was  irrelevant  to  the  question  of 
whether  a  repair  expense  is  currently  deductible  or  a  capital  expenditure. 

a.  The  Plainfield-Union  test  is  the  only  standard  and  is  not  fact  si?ecific. 

The  Service's  conclusion  that  the  Plainfield-Union  test  is  fact  specific  and  but 
one  measure  of  additions  to  value  is  unsupported  in  the  case  law.'  The  Service's 
reliance  upon  the  Tax  Court's  decision  in  Wolfsen  Land  <t  Cattle  Co.  v. 
Commissioner,  72  T.C.  1  (1979),  is  misplaced.  The  decision  in  Wolfsen  only 
supports  the  proposition  that  repairs  which  are  in  the  nature  of  replacements  and 
which  arrest  gradual  deterioration  and  appreciably  prolong  a  property's  useful  life, 
are  capital  expenditures.  This  is  hardly  a  novel  holding  in  light  of  the  Treasury 
regulation's  twice  repeated  provisions  establishing  that  such  expenditures  are 
capital.'  Accordingly,  outside  of  the  context  of  repairs  in  the  nature  of 
replacements  arresting  deterioration  and  prolonging  useful  life,  the  Wolfsen  decision 
has  no  significance. 

More  importantly,  this  decision  does  not  address  the  proper  standard  for 
determining  whether  an  expenditure  materially  adds  to  value  and  does  not 
undermine  or  provide  an  alternative  to  the  long  established  Plainfield-Union  test.  In 
fact,  in  Wolfsen,  the  Tax  Court  cited  its  earlier  decision  in  Plainfield-Union  with 
approval.  Wolfsen,  72  T.C.  at  16.  More  to  the  point,  the  Tax  Court  also  restates 
the  holding  in  the  seminal  case  establishing  the  so-called  "Plainfield-Union"  test, 
Illinois  Merchant  Trust  Co.,  4  B.T.A.  103,  with  approval.    Wolfsen,  72  T.C.  at  15. 


6  PCB  TAM  (citing  Wolfsen  Land  &  Cattle  Co.  v.  Commissioner,  72  T.C.  1  (1979)). 

'  Treas.  Reg.  §  1.162-4  ("Repairs  in  the  nature  of  replacements,  to  the  extent  that  they 

arrest  deterioration  and  appreciably  prolong  the  life  of  the  property,  shall ...  be  capitalized."); 
Treas.  Reg.  §  1.263(a)- 1(a)(2)  (treating  as  capital  "[a]ny  amount  expended  in  restoring 
property  or  in  making  good  the  exhaustion  thereof  for  which  an  allowance  is  or  has  been  made 
in  the  form  of  depreciation,  amortization,  or  depletion."). 


1619 


In  contrast  to  the  Service's  analysis,  Wolfsen  only  stands  for  the  proposition  that 
there  need  be  no  addition  to  value,  in  the  Plainfield-Union  sense,  to  properly  require 
capitalization  where  another  provision  in  the  Code  or  Treasury  regulations 
establishes  an  independent  basis  for  capitalization. 

Thus,  in  the  context  of  measuring  an  expenditure's  effect  on  an  asset's  value, 
the  Service's  conclusion  that  "if  the  Plainfield-Union  'increase  in  value'  test  was  the 
only  factor  used  in  determining  whether  an  expenditure  should  be  categorized  as  a 
deductible  repair  or  capital  expenditure,  then  any  replacement  of  a  capital  asset 
would  also  be  deductible",  is  self-evidently  wrong.  PCB  TAM.  Under  existing 
Treasury  regulations  both:  (1)  a  replacement  arresting  deterioration  and  appreciably 
prolonging  life;  and  (2)  a  replacement  restoring  property  or  making  good  the 
exhaustion  of  property  for  which  an  allowance  has  been  made,  are  capital 
expenditures  whether  or  not  they  produce  any  increase  in  the  underlying  property's 
value.  Treas.  Reg.  §  1.162-4;  I.R.C.  §  263(a)(2).  Nevertheless,  the  Plairfield- 
Union  test  remains  the  only  standard  for  determining  whether  a  cost  incurred  by  a 
taxpayer  with  respect  to  property  so  materially  adds  to  its  value  as  to  constitute  a 
capital  expenditure. 

Q.  The  Plainfield-Union  test  is  applicable  to  repairs  of  latent  defects. 

The  Service  has  also  argued  that  the  Plainfield-Union  test  is  inapplicable  to 
repairs  of  latent  defects  as  it  is  "impossible  to  value  the  asset  prior  to  the  existence  of 
the  [defect)."  Asbestos  TAM.  This  line  of  reasoning  is  at  odds  with  the  available 
judicial  precedents  interpreting  the  Code  and  Treasury  regulations.  For  example,  in 
Oberman  Mfg.  Co.,  considerable  expenditures  made  to  insert  an  expansion  joint 
down  the  length  of  a  leased  building's  original  roof,  which  was  prone  to  thermal 
cracking,  were  held  deductible.  47  T.C.  at  483.  The  Tax  Court,  applying  the 
Plainfield-Union  test,  held  that  the  insertion  of  the  expansion  joint  merely  restored 
the  roof  to  its  ordinarily  efficient  operating  condition  and  did  not  materially  add  to 
the  value  or  useful  life  of  the  underlying  asset,  the  building,  notwithstanding  that  the 
expenditure  eliminated  the  need  to  perform  frequent  spot  repairs  in  the  future,  i.e. 
the  latent  defect.  Ibid.  See  also  Midland  Empire  Packing  Co.,  14  T.C.  at  641 
(concrete  lining  in  basement  cold  storage  room  added  to  prevent  oil  seepage  stopped 
groundwater  seepage  which  had  existed  throughout  taxpayer's  use  of  the  building). 

In  the  Asbestos  TAM,  the  Service  rejected  the  taxpayer's  argument  that  the 
baseline  for  measuring  any  incremental  addition  to  value  should  have  been  the  value 
of  the  equipment  "before  asbestos  was  known  to  be  a  health  hazard."  Asbestos 
TAM.  The  taxpayer's  argument  correctly  states  the  rule  which  may  be  derived 
from  numerous  decisions.  In  Plainfield-Union,  the  removal  of  a  tar-lining  and  its 
replacement  with  a  cement  lining  in  the  utility's  cast  iron  water  main  was  made 
necessary  by  a  switch  from  neutral  well  water  to  more  acidic  river  water.  In  short, 
in  Plainfield-Union,  a  change  in  the  underlying  circumstances  rendered  the  existing 
lining  unsuitable  to  the  continued  transportation  of  water.  The  Tax  Court  rejected 
the  Service's  argument  that  the  addition  of  the  cement  lining  added  value  to  the 
water  main  or  adapted  it  to  a  new  use.  39  T.C.  at  338.  The  switch  to  a  more  acidic 
water  source  which  rendered  the  original  tar-lining  unsuitable  is  little  different  from 
the  discovery  that  a  piece  of  equipment's  original  insulation  poses  a  health  hazard 
which  can  be  abated  by  replacing  it.  In  each  case  the  original  component  became 
unsuitable  in  light  of  later  developments  and  was  replaced  without  adapting  the 
underlying  property  to  a  new  use.  Thus,  repairs  involving  latent  defects  only 
restore  ordinary  operating  efficiency  of  the  asset  to  its  inherent  operating  efficiency 
in  its  intended  use. 

D.  Compliance  with  governmental  directives  does  not  mandate  capitalization. 

Finally,  the  Service  has  rejected  the  Plainfield-Union  test  in  situations  in 
which  the  taxpayer's  "repair"  is  in  response  to  a  law  or  regulation.  The  Service 
appears  to  have  adopted  a  per  se  capital  rule  for  any  remediation  expenditure  made 


1620 


to  comply  with  environmental  or  worker  safety  laws.  There  is  little  if  any  authority 
for  this  position.  Each  of  the  cases  cited  and  relied  upon  by  the  Service  in  the  two 
TAMs  would  have  been  capital  expenditures  in  the  absence  of  the  factor  of 
governmental  compulsion. ^ 

The  unimportance  of  the  factor  of  governmental  compulsion  is  also  evident  in 
the  analysis  employed  by  the  United  States  Court  of  Claims  (now  the  Court  of 
Federal  Claims)  in  RKO  Theatres,  Inc.  and  by  the  Tax  Court  in  Hotel  Sulgrave,  Inc. 
and  in  Blue  Creek  Coal,  Inc.,  each  of  which  tested  the  current  deductibility  of  the 
compelled  expenditures  under  the  requirements  set  forth  in  the  Treasury  regulations 
and  found  them  to  be  improvements  rather  than  repairs.'  In  none  of  these  decisions 
is  there  any  hint  of  a  per  se  capitalization  rule. 

In  contrast  to  the  Service's  cited  authorities,  which  are  at  best  ambiguous, 
numerous  authorities  have  held  an  expenditure  compelled  by  law  to  have  been  a 
currently  deductible  repair.  E.g.,  Midland  Empire  Packing  Co.,  14  T.C.  at  641 
(taxpayer  installed  a  concrete  lining  in  a  basement  cold  storage  room  to  avoid  forced 
shut  down  at  direction  of  federal  meat  inspectors);  Regenstein  v.  Edwards,  121 
F.  Supp.  952.  953-54  (M.D.Ga.  1959)  (installation  of  steel  beams  and  column 
required  by  city  inspector  held  deductible  as  repair);  Commodore,  Inc.  v. 
Commissioner,  46  B.T.A.  718  (cost  of  replacing  loose  stone  cornices  with  copper 
sheeting,  pursuant  to  a  city's  safety  directive,  was  a  currently  deductible  repair 
expense),  affd,  135  F.2d  89  (6th  Cir.  1943). 

II.  THE  PROPER  SCOPE  OF  THE  "PLAN  OF  REHABILITATION"  DOCTRINE. 

The  judicially  crafted  "plan  of  rehabilitation"  doctrine  is  properly  used  to 
require  otherwise  deductible  repair  expenditures  to  be  capitalized  when  incurred: 
(1)  contemporaneously  with  capital  expenditures  relating  to  the  same  property  or 
properties;  and  (2)  pursuant  to  a  common  plan  for  the  permanent  improvement, 
betterment,  addition  of  value,  or  prolongation  of  life  of  the  underlying  property. •<> 
Stated  differently,  the  "plan  of  rehabilitation"  doctrine  provides  a  broom  permitting 
the  Service  and  the  courts  to  sweep  up  ordinarily  deductible  repair  expenditures 
along  with  the  capital  expenditures  to  which  thev  are  integrally  related  by  a  common 
plan. 

However,  in  the  PCB  TAM,  the  Service  relied  upon  the  "plan  of 
rehabilitation"  doctrine  to  support  its  ruling  requiring  capitalization  of  integrated 
and  extensive  repairs,  na  part  of  which  would  constitute  a  capital  expenditure  if 
incurred  separately."  This  unsupported  expansion  of  a  narrow  judicial  doctrine 
goes  far  beyond  the  narrow  parameters  of  the  doctrine's  two-pronged  rule  of 
application.  In  short,  the  plan  of  rehabilitation  doctrine  does  not  support  treating  a 
series  of  repairs  with  no  related  capital  spending  as  a  capital  expenditure. 

The  Service's  discussion  of  the  plan  of  rehabilitation  doctrine  in  the  PCB 
TAM  relies  primarily  upon  the  decision  of  the  Court  of  Appeals  for  the  Tenth 
Circuit  in  Mountain  Fuel  Supply  Co.  v.  United  States,  449  F.2d  816  (1971),  cert. 


8  Teitlebaum  v.  Commissioner,  294  F.2d  541  (7th  Cir.  1961)  (replacement  of  direct 
current  wiring  with  alternating  current  wiring),  cert,  denied,  386  U.S.  987  (1962),  reh. 
denied,  369  U.S.  842  (1962);  RKO  Theatres.  Inc.  v.  United  States,  163  F.Supp.  598  (CX  Q. 
1958)  (installation  of  fire  exits);  Hotel  Sulgrave,  Inc.  v.  Commissioner,  21  T.C.  619  (1954) 
(installation  of  fire  suppression  sprinkler  system);  Beaven  v.  Commissioner,  6  T.C.M.  (CCH) 
1344  (1943)  (replacement  of  existing  oil  fired  furnace  with  coal  burning  furnace);  Cerda  v. 
United  States,  84-1  U.S.T.C.  H  9,490  (N.D.IU.  1984)  (variety  of  expenditures  arresting 
deterioration  and  prolonging  useful  life  of  rental  property);  Blue  Creek  Coal,  Inc.  v. 
Commissioner,  48  T.C.M.  (CCH)  1 504  (1984)  (addition  of  driver  cabs  on  bulldozers). 

9  RKO  Theatres.  Inc.,  163  F.Supp.  at  602;  Blue  Creek  Coal,  Inc.,  48  T.C.M.  (CCH)  at 
1508;  Hotel  Sulgrave,  lnc.,2\  T.C.  at  621. 

■0         Moss  V.  Commissioner,  831  F.2d  at  833,  840  (9th  Cir.  1987). 
1 1         PCB  TAM  at  n.3  &  accompanying  text. 


1621 


denied,  405  U.S.  989  (1972).  The  Tenth  Circuit's  decision  in  Mountain  Fuel  Supply 
Co.  involved  expenditures  which  not  only  appreciably  extended  the  useful  life  of  the 
underlying  asset,  a  natural  gas  pipeline,  but  also  improved  upon  the  original  asset  by 
doubling  its  operating  pressure  and  thus  materially  increasing  its  carrying  capacity. 
449  F.2d  at  819.  Thus,  having  found  a  purpose  and  effect  in  certain  of  the 
reconditioning  expenditures  which  mandated  capitalization,  the  Tenth  Circuit 
properly  required  the  taxpayer  to  capitalize  all  costs  associated  with  its  pipeline 
reconditioning  operations  under  the  plan  of  rehabilitation  doctrine.  Ibid.  449  F.2d 
at  820. 

The  Service's  analysis  of  this  decision  in  the  PCB  TAM  seriously  misstates 
this  holding,  contradicts  the  opinion's  express  language,  and  is  irreconcilable  with 
the  facts  presented  in  the  case.  PCB  TAM  at  n.  3  ("The  fact  of  whether  the 
pipeline's  useful  life  was  extended,  however,  was  a  separate  issue  from  whether  the 
general  plan  of  rehabilitation  doctrine  required  the  costs  to  be  capitalized."). 
Notwithstanding  the  Service's  discussion  of  this  decision,  it  is  impossible  to  separate 
the  Tenth  Circuit's  consideration  of  the  plan  of  rehabilitation  doctrine  from  its 
conclusion  that  the  expenditures  incurred  to  recondition  the  pipeline,  much  of  which 
was  admitted  to  be  capital,  had  improved  the  property  and  prolonged  its  life. 
Moreover,  it  is  impossible  to  find  support  for  the  Service's  summary  of  the  decision 
in  light  of  the  fact  that  the  circumstances  before  the  court  did  not  involve  a  situation 
in  which  no  part  of  the  total  expenditures  would  have  been  a  capital  item  if 
considered  separately.  Indeed,  there  exists  no  authority  for  the  proposition  that 
deductible  repair  expenditures  may  be  treated  as  capital  expenditures  under  the  plan 
of  rehabilitation  doctrine  where  those  deductible  repairs  are  not  made  in  conjunction 
with  an  overall  plan  including  capital  improvements. '^ 

In  contrast  to  the  Service's  understanding  of  the  plan  of  rehabilitation 
doctrine,  the  existing  decisional  law  establishes  that  two  factors  are  required  for  the 
doctrine's  proper  application:  (1)  otherwise  deductible  repair  expenses  incurred 
contemporaneously  with  capital  expenditures  and  with  respect  to  the  same  property; 
and  (2)  a  common  plan  for  the  improvement,  betterment,  addition  of  value  or 
prolongation  of  life  of  the  underlying  property  pursuant  to  which  both  the  repair 
and  the  capital  expenditures  are  incurred.'^ 


iii.     relevance  of  intdirect  and  incidental  benefits  resulting  from  a 
Cleanup  expenditure  On  a  Taxpayer's  Overall  Operations. 

In  both  the  Asbestos  TAM  and  the  PCB  TAM.  the  Service  relied  extensively 
upon  the  existence  of  incidental  and  indirect  future  benefits  to  support  its  ruling  that 
the  remediation  expenditures  in  question  should  be  capitalized  as  improvements  or 
betterments  or  expenditures  adding  to  value.  Asbestos  TAM  (value  increased 
through  reduction  in  human  health  risks  and  associated  risk  of  civil  liability; 
equipment  improved  by  eliminating  the  need  to  undertake  OSHA  mandated  safety 
precautions  each  time  equipment  is  serviced  and  by  reducing  down-time);  PCB  TAM 
("  .  .  .  betterments  include,  but  are  not  limited  to,  transforming  sections  of 
contaminated  land  into  land  that  is  no  longer  contaminated,  avoiding  further 
government  penalties  by  bringing  the  properties  into  compliance  with  government 


12  See  Moss,  supra,  831  F.2d  at  839  (*To  our  knowledge,  every  case  in  which  the 
rehabilitation  doctrine  has  been  applied  to  date  has  involved  substantial  capital  improvements 
and  repairs  to  the  same  specific  asset,  usually  a  structure  in  a  state  of  disrepair."). 
»3  Kaonis  v.  Commissioner,  37  T.C.M.  (CCH)  792,  796  (1978),  affd  mem.,  639  F.2d 
788  (9th  Cir.  1981)  (permitting  current  deduction  of  repair  expenses  not  related  to  capital 
expenditures  by  a  common  plan  or  rehabilitation);  Keller  Street  Dev.  Co.  v.  Commissioner,  37 
T.C.  559,  568  (1961)  (capital  expenditures  made  by  the  taxpayer  to  increase  its  brewery's 
productive  capacity  found  not  to  be  the  type  which  indicate  the  existence  of  a  general  betterment 
program,  contemporaneous  repair  items  deductible),  acq.,  1962-2  C.B.  5,  c^  din  pan  and 
rev'd  in  part  on  other  grounds,  323  F.2d  166  (9th  Cir.  1963). 


1622 


regulations,  providing  a  safe  environment  for  workers  and  adjoining  property 
owners,  increasing  the  marketability  of  the  properties  . .  ."). 

In  the  Asbestos  TAM,  the  Service  rehes  upon  the  decision  of  the  United  States 
Claims  Court  in  Electric  Energy.  Inc.  v.  United  States,  13  CI.  Ct.  644  (1987).  In 
Electric  Energy,  the  taxpayer,  a  public  utility,  undertook  a  multi-million  dollar 
four-year  program  to  substitute  all  of  the  horizontal  tubing  elements  within  a  power 
plant's  boilers'  heat-exchanging  "economizers."''*  The  original  economizers  were 
installed  in  1953  and  used  "finned"  tubes  designed  to  increase  the  total  heat- 
exchanging  surface  area.  /d.  at  662-63.  The  taxpayer's  substitution  program  began 
in  1977.  Because  of  the  original  tube  array  and  the  use  of  finned  tubes,  unexpected 
accelerated  erosion  problems  developed  resulting  in  ever  increasing  repair 
expenditures  and  forced  stoppages  of  the  related  boiler.  •  5 

The  taxpayer  in  Electric  Energy,  Inc.  elected  to  undertake  the  phased 
replacement  of  the  six  original  economizers  with  a  redesigned  model  which  included 
extra-tube  length,  finless  tubing  and  a  new  tube  array.  Id.  at  664.  Characterizing 
the  economizers  as  but  a  component  of  the  whole  power-plant's  boilers,  the  taxpayer 
argued  that  the  replacement  program  did  not  add  to  the  boilers'  useful  lives,  increase 
their  value,  or  adapt  them  to  a  new  use.  Id.  at  665.  The  Claims  Court,  however, 
concluded  that  the  economizers  were  separate  and  distinct  assets  and  that  the  tube 
replacements,  constituting  roughly  87%  of  the  entire  economizer,  substantially 
prolonged  the  useful  life  of  the  economizer.  Id.  at  666  ("The  prolonged  useful  life 
of  the  economizers  alone  supports  capitalization.  The  correction  of  a  defect  which 
contributes  to  prolonging  the  life  of  equipment  is  a  replacement,  not  a  repair,  and 
must  be  capitalized. ").i6 

While  it  is  true  that  the  economizer  replacements  in  Electric  Energy,  Inc. 
implemented  a  redesign  which  was  anticipated  to  reduce  the  erosion  problem 
associated  with  the  original  tube  array  of  the  economizers,  an  obvious  operating 
efficiency  improvement,  this  factor  was  not  the  basis  of  thg  Claims  Court's  holding 
and  probably  would  not  have  required  capitalization  in  the  absence  of  a  substantial 
prolongation  of  the  economizers'  useful  lives.  Electric  Energy,  Inc.,  13  CI.  Ct.  at 
667  ("Overall  the  court  deems  this  evidence  more  probative  of  prolonging  the  life  of 
the  economizers  than  constituting  a  betterment."). 

In  short.  Electric  Energy,  Inc.,  does  not  support  the  Service's  proposition  that 
replacements  that  produce  incidental  operating  efficiencies  unrelated  to  the  inherent 


1*  An  economizer,  essentially  a  large  tightly-packed  array  of  nearly  nine  miles  of  thin 
metal  tubing,  is  an  "add-on"  component  in  a  power  plant  boiler  which  increases  the  plant's 
overall  electric  generating  efficiency  by  pre-heating  steam  feed-water  with  waste  gases  from  the 
furnace.  Electric  Energy,  Inc.,  13  CI.  Ct.  at  662. 

'5  This  is  the  fact  upon  which  the  Service  pins  its  application  of  the  Electric  Energy 
decision  to  asbestos  removal  expenditures.  Asbestos  TAM  ("By  removing  asbestos,  the 
taxpayer  increases  the  value  of  its  assets  because  it  eliminates  the  neeid  to  take  such  [OSHA  and 
state  mandated]  precautions.  Therefore,  similar  to  the  petitioner  in  Electric  Energy,  the  removal 
of  asbestos  enhances  cenain  operating  efficiencies."). 

1*  This  holding  simply  applies  the  rule  that  "repair"  expendinires  which  are  "in  the  namre 
of  a  replacements,"  must  be  capitalized  where  the  expenditures  "arrest  deterioration  and 
appreciably  prolong  the  life  of  the  propeny."  Treas.  Reg.  §  1.162-4.  Compare  Electric 
Energy,  Inc.,  13  CI.  Ct.  644  with  Gloucester  Ice  &  Cold  Storage  Co.  v.  Commissioner,  19 
T.C.M.  (CCH)  1015  (1960)  (cost  of  replacing  corroded  salt  water  pumps  in  ice  making  plant 
which  did  not  appreciably  prolong  life  were  deductible).  See  also  Phillips  &  Easton  Supply 
Co.  V.  Commissioner,  20  T.C.  455  (1953)  (replacement  of  floor  after  46  years  in  service,  old 
floor  was  so  deteriorated  further  repairs  were  impractical,  replacement  floor  had  appreciably 
longer  useful  life);  Hudlow,  Jr.,  30  T.C.M.  (CCH)  at  923  ("forklift  trucks  .  .  .  were 
substantially  worn  out,  and  .  .  .  work  done  .  .  .  was  in  the  nature  of  an  overhaul,  which 
served  to  prolong  the  life  of  the  machines  and  to  increase  their  value.");  Almac's  Inc.  v. 
Commissioner,  20  T.C.M.  (CCH)  56,  59  (1971)  (replacement  of  boiler  tubing  after  27  years 
in  service  appreciably  extended  the  useful  life  of  the  boiler);  Ruane  v.  Commissioner,  17 
T.C.M.  (CCH)  865,  871  (1958)  (relining  coke  ovens  with  glass  brick  gave  oven  new  life 
expectancy  of  three  to  four  years,  roughly  equal  to  their  original  life  expectancy). 


1623 


operation  of  the  repaired  asset,  are  capital  expenditures.  Indeed,  ample  decisional 
law  establishes  that  an  expenditure  which  permits  a  taxpayer  to  avoid  future 
expenses  does  not  create  a  capital  asset.'"'  Rather,  only  where  the  replacement 
produces  increased  operating  efficiency  of  the  asset  which  is  a  material  improvement 
over  and  above  its  ordinarily  efficient  operating  efficiency  or  appreciably  prolongs 
the  life  of  the  underlying  asset,  as  in  Electric  Energy,  Inc.,  is  capitalization  justified. 
Thus,  in  Midland  Empire  Packing  Co.,  14  T.C.  635,  where  the  taxpayer's  purpose 
was  simply  to  restore  the  former  utility  of  its  meat-packing  plant's  cold  storage 
room  by  arresting  oil  seepage,  the  fact  that  the  repairs  incidentally  improved  the 
room's  utility  over  its  prior  condition  by  stopping  all  groundwater  seepage,  was 
ignored:  the  "improvement"  was  an  unintended  and  unavoidable  result  of  preventing 
the  seepage  of  oily  water  into  the  room  and  resulted  in  no  improvement  in  its  utility 
in  the  context  of  the  taxpayer's  continuing  business  activities.  Midland  Empire 
Packing  Co.,  14  T.C.  at  641.  The  same  point  can  be  made  about  the  addition  of  an 
expansion  joint  in  a  building's  roof  in  Oberman  Mfg.  Co.,  47  T.C.  471,  and  about  a 
taxpayer's  expenditures  to  grade  and  fill  a  parcel  of  land  as  a  means  of  eliminating  a 
drainage  problem  caused  by  an  adjoining  landowner  in  Southern  Ford  Tractor  Co. 
V.  Commissioner,  29  T.C.  833  (1958).'« 

The  Service  cites  no  direct  authority,  nor  has  any  been  found,  for  the 
proposition  that  incidental  future  benefits  are  sufficient  grounds  for  capitalizing  an 
expenditure,  particularly  in  cases  where  the  purpose  of  the  taxpayer  in  incurring  any 
such  expenditure  is  not  to  produce  an  amorphous  future  intangible  benefit  but  rather 
to  place  a  damaged  operating  asset  in  a  repaired  condition." 

IV.        A  REPAIR'S  PERMANENCE  IS  IRRELEVANT  TO  CAPITALIZATION. 

In  the  Asbestos  TAM,  the  Service  also  relied  upon  the  Tax  Court's  decision  in 
American  Bemberg  Corp.,  10  T.C.  361.  376  (1948).  affd,  177  F.2d  200  (6th  Cir. 
1949)  for  the  proposition  that  the  duration  of  the  effect  of  the  expenditure,  i.e. 
whether  the  repair  is  permanent,  is  a  significant  factor  in  determining  whether  an 
expenditure  is  deductible  as  a  repair  expanse,  ^o    Though  the  court  discusses  the 


•'  Moreover,  established  decisional  law  makes  clear  that  where  a  one-time  expenditure 
reduces  funire  deductible  expenses,  but  does  not  create  or  enhance  a  separate  capital  asset,  the 
one  time  expendinire  is  deductible.  Indemnity  Insurance  Co.  v.  Commissioner,  lYI  F.2d  901 
(7th  Cir.  1956)  (payments  to  terminate  unfavorable  agency  agreement  deductible);  Cleveland 
Allerton  Hotel  v.  Commissioner,  166  F.2d  805  (6th  Cir.  1948)  (payment  styled  liquidated 
damages  for  release  from  onerous  contract  deductible  as  no  capital  asset  was  acquired);  Stuart 
Co.  V.  Commissioner,  195  F.2d  176  (9th  Cir.  1952)  (payment  to  obtain  release  ftx>m  above 
market  fixed  price  supply  contraa  deductible);  Montana  Power  Co.  v.  United  States,  171 
F.Supp.  943  (Ct.  CI.  1959)  (same).  Compare  Darlington-Hartsville  Coca  Cola  Bottling 
Company.  Inc.  v.  United  States,  393  F.2d  494  (4th  Cir.  1968)  (payment  by  bonlers  to  Coca 
Cola  Company  to  terminate  business  arrangement  involving  middlemen  was  for  acquisition  of 
a  capital  asset,  the  right  to  purchase  syrup  directly  from  Coca  Cola  Company  at  potentially 
lower  prices);  Rodeway  Inns  of  America  v.  Commissioner,  63  T.C.  414  (1974)  (franchisor's 
payment  to  terminate  a  franchisee's  exclusive  rights  to  a  territory  acquired  a  capital  asset,  the 
right  to  expand  business  into  the  territory).  These  cases,  and  the  avoidance  of  future 
maintenance  expenses  by  incurring  a  one-time  repair  expenditure,  are  distinguishable  from  a 
mere  prepayment  of  future  expenses  or  the  establishment  of  a  reserve  for  future  expenses 
which  will  b£  incurred  in  later  taxable  periods. 

18  See  also  E.V.  Scott  v.  Commissioner,  38  T.C.M.  (CCH)  115  (1979)  (installation  of 
sprinklers  to  raise  water  table  under  a  building  and  stabilize  its  foundation  was  deductible 
repair:  lawn-watering  as  an  end  was  not  the  taxpayer's  purpose);  J.  H.  Collingwood  v. 
Commissioner,  20  T.C.  937, 942  (1953)  (cost  of  grading  earthen  terraces  on  hilly  farmland  to 
reduce  soil  erosion  caused  by  use  of  increasingly  modem  agricultural  techniques  was 
deductible  repair). 

•'         See  FCB  TAM  (citing  Indopco,  Inc.  v.  Commissioner U.S. .  112  S.  Cl 

1039,  1045  (1992),  for  the  proposition  that  sections  162  and  263  "envision  an  inquiry  into  die 
duration  and  extent  of  the  benefits  realized  by  the  taxpayer.'^. 

20  The  Asbestos  TAM  misstates  the  literal  language  of  the  Tax  Court's  opinion  in 
American  Bemberg  Corp.,  supra,  which  refers  to  "intermediate"  consequences  rather 
"immediate"  consequences.    American  Bemberg  Corp.,  supra,  10  T.C.  at  377.    More 


1624 


remediation  of  "intermediate"  consequences,  the  holding  in  no  way  relies  upon  the 
fact  that  the  expenditures  in  question  were  impermanent.  To  the  contrary,  though 
the  taxpayer  was  required  to  maintain  vigilance  for  future  areas  of  subsidence,  the 
former  areas  of  subsidence  were  permanently  repaired.  American  Bemberg  Corp., 
10  T.C.  at  376. 

More  importantly,  numerous  other  authorities  directly  hold  that  a  repair  may 
be  permanent  without  requiring  the  expenditure  to  be  capitalized.^!  For  example,  in 
Oberman  Manufacturing  Co.,  the  taxpayer's  considerable  expenditures  to  insert  a 
copper-coated  wood-framed  expansion  joint  down  the  length  of  a  leased  building's 
roof  were  held  deductible.  Oberman  Mfg.  Co.,  47  T.C.  at  483.  The  repair  in 
Oberman  was  unquestionably  "permanent"  and  resulted  in  the  taxpayer's  avoidance 
of  the  anticipated  need  to  perform  frequent  future  "spot"  repairs,  of  which  it  had 
already  performed  more  than  twenty. 22 

Likewise,  in  Niagara  Mohawk  Power  Corp.,  supra,  a  public  utility,  which  had 
experienced  a  significant  number  of  leaks  in  the  jute  packed  joints  of  its  o-ost  iron 
pipelines  following  the  introduction  of  natural  gas  in  place  of  manufactured  gas, 
clamped  rubber  gaskets  around  leaking  joints  which  rendered  the  old  jute  packed 
joints  redundant.  558  F.2d  at  1387.  The  United  States  Court  of  Claims  held  that  the 
clamps  did  not  add  value  to  the  pipeline,  extend  its  useful  life,  or  otherwise  improve 
it  The  Court  of  Claims  stated: 

A  repaired  joint  obviously  represents  an  "improvement"  over  a  leaking 
joint,  but  that  is  not  the  test  of  a  nondeductible  capital  "improvement"  within  the 
contemplation  of  the  Code.  . . . 

.  .  .  It  is  not  surprising  that  these  repairs  both  eliminated  an  existing 
defect,  and  made  it  less  likelv  that  the  defect  would  again  occur  at  that  point. 
That  is  the  usual  purpose,  and  effect,  of  any  repair. 

The  fact  that  the  clamp  installed  to  remedy  a  leak,  may  outlast  the 
pipeline  on  which  it  is  installed,  does  not  mean  that  the  originally  contemplated 
useful  life  of  the  pipeline  has  been  thereby  extended. 

Niagara  Mohawk  Power  Corp.,  558  F.2d  at  1387-88  (emphasis  added).  As  is 
evident  from  the  language  of  the  opinion  set  forth  above,  the  focus  of  judicial 
inquiry  is  the  expenditure's  effect  upon  the  asset  being  repaired.  Where  an 
expenditure  improves  that  asset's  essential  functions,  appreciably  prolongs  its  useful 
life,  or  materially  adds  to  its  value,  the  expenditure  is  capital  in  nature.  However, 
the  fact  that  the  expenditure  reduces  future  maintenance  expenditures  is  not  relevant 
where  the  expenditure  produces  no  such  proscribed  effect  on  the  repaired  asset  as  a 
whole.23 

In  summary,  there  is  no  basis  for  the  Service's  position  that  a  repair  must 
remedy  "immediate  consequences"  and  not  provide  a  "permanent  cure." 


importandy,  however,  the  Asbestos  TAM  misstates  the  holding  of  the  Tax  Court  which  directly 
analogized  its  reasoning  to  that  of  the  United  States  District  Court  in  Buckland  v.  United 
States,  66  F.Supp.  681,  683  (D.Conn.  1946).  Ibid.,  10  T.C.  at  378  (quonng  in  particular 
from  the  decision  in  Buckland,  the  following,  "Defendant's  [U.S.]  contention  appears  to  be 
that  repairs  are  only  those  mending  the  fabric  which  recur  year  to  year.  This  is  not  consistent 
with  the  meaning  given  "ordinary  and  necessary"  in  Welch  v.  Helvering,  Commissioner,  290 
U.S.  111."). 

21  Although  the  Service  treated  its  discussion  of  the  enhanced  operating  efficiency  of 
"avoided  future  repairs"  and  the  issue  of  "permanent  repairs"  as  separate  issues,  they  are  m  faa 
two  sides  of  the  same  coin.  Nevertheless,  for  purposes  of  our  testimony,  we  have  addressed 
these  two  misstatements  of  the  present  law  under  different  headings. 

22  See  also  Illinois  Merchant  Trust  Co.,  4  B.T.A.  103  (permanent  repair  expenditures 
deductible). 

23  See  also  Kansas  City  S.  Ry.  v.  United  States,  1 12  F.Supp.  at  164,  165  (Ct.  Q.  1953) 
("When  a  building  or  a  machine  is  repaired,  it  is  not  unusual  that  the  repaired  portion  is  better 
than  and  will  oudast  the  parts  that  have  not  yet  needed  repairs."). 


1625 


V.  THE  PROPER  FOCUS  OF  INQUIRY  IN  EXAMINING  ANY  CLEANUP  EXPENDITURE. 

The  tax  rules  governing  environmental  remediation  expenditures  will,  in 
large  part,  be  affected  by  the  legal  distinctions  between  repairs  and  capital 
expenditures  and  by  the  application  of  the  matching  principle  associating  income  and 
related  expense.  However,  the  decision  as  to  whether  certain  environmental  cleanup 
expenditures  should  be  treated  as  currently  deductible  or  as  capital  expenditures  with 
enduring  future  benefits  will  depend  upon  the  perspective  which  frames  the 
question.  If  the  Service  looks  for  the  existence  of  any  future  benefit  as  justifying 
capitalization,  then  almost  no  expenditure,  including  nearly  all  environmental 
remediation  expenditures,  will  escape  capitalization.  If,  however,  the  focus  is  on  the 
taxpayer's  immediate  purpose  of  repairing  assets  previously  damaged  by 
environmentally  unsafe  activities  and  operations,  then  many,  if  not  most, 
remediation  expenditures  will  qualify  for  current  deduction.  Decisional  law 
establishes  that  the  question  is  properly  framed  in  the  light  of  the  taxpayer's 
immediate  purpose,  the  physical  nature  of  the  work  involved,  and  the  effect  of  the 
expenditures  upon  the  taxpayer's  property  in  the  context  of  its  business  operations. 
American  Bemberg  Corp.,  supra,  10  T.C.  at  376.  The  taxpayer's  purpose  is  given 
primary,  and  often  controlling,  weight.  Illinois  Merchant  Trust  Co.,  supra,  4 
B.T.A.  at  106;  Oberman  Mfg.  Co.,  supra,  47  T.C.  at  482. 

The  Service's  analysis  of  the  available  authorities  in  the  two  cleanup  TAMs 
does  not  give  due  regard  to  the  consideration  of  the  taxpayer's  purpose  in  incurring 
the  remediation  expenditures.  As  a  result,  the  Service  has  ruled  that  expenditures 
plainly  incurred  to  restore  business  assets  to  their  original  ordinarily  efficient 
operating  condition  are  capital  in  nature,  primarily  on  the  basis  of  incidental, 
indirect,  and  inconsequential  future  benefits  which  have  long  been  disregarded  by 
the  courts  in  reaching  decisions  allowing  the  current  deduction  of  repair 
expenditures. 


CONCLUSION 

The  Service  may  be  understandably  concerned  about  the  enormous  amount  of 
environmental  clean-up  costs  waiting  to  be  deducted,  but  its  TAM  rulings  cannot  be 
squared  with  the  Treasury's  regulations,  the  Plainfield-Union  Water  case,  the 
Niagara  Mohawk  Power  Corp.  case,  Illinois  Merchant  Trust  Co. ,  Oberman,  Midland 
Empire  Packing,  Buckland,  American  Bemberg  Corp.,  Electric  Energy,  Mountain 
Fuel  Supply,  Moss,  and  the  other  cases  cited  above,  no  matter  how  hard  the  Service 
tries  to  distinguish  their  holdings.  If  the  intent  of  this  Subcommittee  is  to  clarify 
existing  law  in  this  area,  then  it  has  no  recourse  but  to  determine  that  environmental 
remediation  expenses  of  the  type  presented  in  the  two  TAMs  and  in  most  common 
cleanup  situations  are  currently  deductible  under  the  rules  that  currently  control  the 
tax  result. 


1626 

STATEMENT  OF  WAYNE  ROBINSON,  DIRECTOR  OF  TAXES, 
GENCORP,  ON  BEHALF  OF  THE  COALITION  FOR  THE  FAIR 
TREATMENT  OF  ENVIRONMENTAL  CLEANUP 

Chairman  Rangel.  Mr.  Robinson. 

Mr.  Robinson.  Mr.  Chairman,  members  of  the  subcommittee,  my 
name  is  Wayne  Robinson,  and  I  am  here  on  behalf  of  the  Coalition 
for  the  Fair  Treatment  of  Environmental  Cleanup  Costs.  The  coali- 
tion is  made  up  of  companies  representing  a  wide  range  of  indus- 
tries, including  automotive  parts,  manufacturing,  banking,  chemi- 
cal manufacturing,  mining,  natural  gas  production,  pharmaceutical 
manufacturing,  and  precision  tool  manuiacturing. 

We  have  also  submitted  a  written  statement  that  I  ask  be  in- 
serted in  the  record. 

Chairman  Rangel.  Without  objection. 

Mr.  Robinson.  Cleaning  up  the  environment  is  a  vital  and  far- 
reaching  national  priority,  one  that  every  member  of  this  coalition 
firmly  supports.  It  is  an  immense  task,  however.  The  fair  tax  treat- 
ment of  environmental  cleanup  costs,  therefore,  is  an  important 
issue  that  concerns  either  directly  or  indirectly  a  great  number  of 
U.S.  businesses.  Thorough  cleanups  and  prompt  compliance  with 
our  environmental  laws  are  critical  if  the  task  of  cleaning  up  the 
environment  is  to  be  successfully  completed. 

Mr.  Chairman,  proposals  to  require  companies  to  capitalize  their 
environmental  cleanup  costs  or  to  deny  their  current  deductibility 
would  effectively  discourage  prompt  and  thorough  cleanup  and 
compliance.  In  addition,  such  proposals  would,  for  the  most  part, 
distort  income,  thereby  violating  a  fundamental  rule  of  our  income 
tax  system. 

As  you  know,  a  basic  rule  of  our  tax  law  is  that  the  tax  deduction 
for  an  expenditure  should  be  matched  with  the  income  to  which  it 
relates.  This  clearly  reflects  income.  A  rule  that  would  require  the 
capitalization  of  environmental  cleanup  costs  would  violate  the 
clear  reflections  of  income  rule. 

This  is  because  most  environmental  cleanup  costs  are  backward 
looking.  They  relate  to  past  events  and  to  income  generated  in  the 
past,  not  to  income  to  be  produced  in  the  future. 

Consider  as  an  example,  a  company  that  disposed  of  scrap  mate- 
rial in  a  landfill  in  full  compliance  with  all  laws  at  the  time.  A  few 
years  later,  however,  the  scrap  is  determined  to  be  a  health  hazard 
and  must  be  removed  from  the  landfill  and  incinerated.  To  comply 
with  the  revised  law,  the  company  will  incur  significant  costs  to  re- 
move and  incinerate  the  scrap. 

Clearly,  in  this  example,  the  cost  of  this  remediation  does  not  re- 
flect or  does  not  relate  to  the  ongoing  business  of  the  company.  In 
fact,  if  the  current  law  had  been  in  effect  when  the  company  first 
disposed  of  its  scrap,  the  business  would  have  had  a  higher  dis- 
posal cost  which  would  have  been  properly  deductible  as  a  legiti- 
mate business  expense  at  the  time. 

We  believe  it  violates  the  clear  reflection  of  income  rule  to  deny 
a  deduction  for  these  backward  looking  expenses.  It  is  also  inac- 
curate to  suggest  that  environmental  policy  is  somehow  being  sub- 
verted by  allowing  a  tax  deduction  for  cleanup  expenses.  Our  most 
important  Federal  and  State  remediation  laws,  including  CERCLA, 
require  cleanup  on  a  no-fault  basis.  Where  penalties  are  imposed 


1627 

by  the  environmental  laws,  they  are  clearly  not  deductible.  The 
members  of  this  coalition  agree  with  this  result. 

Capitalization  of  environmental  cleanup  costs  for  tax  purposes 
would  materially  increase  the  cost  of  most  cleanup  projects.  These 
increased  costs  will  inevitably  discourage  companies  from  promptly 
undertaking  new  cleanup  projects. 

The  disparate  effects  of  the  present  proposal  become  obvious 
when  certain  basic  facts  concerning  environmental  cleanups  are 
considered: 

First,  environmental  remediation  is  already  very  expensive  and 
is  becoming  increasingly  expensive.  Between  1984  and  1989,  for  ex- 
ample, average  annu^  outlays  related  to  CERCLA  cleanups  nearly 
tripled.  There  are  approximately  25,000  waste  sites  under 
CERCLA  alone.  Current  estimates  are  that  the  total  cost  of  clean- 
ing up  existing  hazardous  waste  sites  will  range  anywhere  from 
$500  billion  to  $750  billion  over  the  next  30  years,  a  substantial 
impact  on  companies  for  some  time  to  come. 

Second,  most  environmental  cleanups  do  not  maintain  or  improve 
a  company's  productive  capacity  or  competitiveness.  In  this  context, 
denying  or  delaying  the  tax  aeduction  for  environmental  cleanup 
costs  will  discourage  companies  from  undertaking  prompt,  thor- 
ough cleanup  and  compliance. 

Let  me  conclude  by  reiterating  that  each  company  in  this  coali- 
tion believes  in  the  importance  of  cleaning  up  our  environment.  We 
believe  that  sound  tax  and  environmental  policy  dictate  that  the 
present  law  treatment  that  allows  a  current  tax  deduction  for  envi- 
ronmental cleanup  cost  be  continued. 

We  respectfully  request  that  Congress  take  whatever  steps  are 
necessary  to  ensure  that  the  tax  law  continues  to  encourage 
prompt  and  thorough  cleanup. 

Thank  you  very  much,  and  I  will  be  happy  to  address  any  ques- 
tions. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


1628 


STATEMENT  OF  WAYNE  ROBINSON 

ON  BEHALF  OF  THE  COALITION 

FOR  THE  FAIR  TREATMENT  OF  ENVIRONMENTAL 

CLEANUP  COSTS 

REGARDING  PROPOSALS  TO  CLARIFY  THE 

TREATMENT  OF  ENVIRONMENTAL  REMEDIATION  COSTS 


Mr.  Chairman,  members  of  the  Subcommittee,  my  name  is  Wayne 
Robinson.  I  am  here  on  behalf  of  the  Coalition  For  The  Fair 
Treatment  Of  Environmental  Cleanup  Costs. 

The  Coalition  is  made  up  of  companies  representing  a  broad 
range  of  industries.'  Our  members  are  engaged  in  automotive  parts 
manufacturing,  banking,  chemical  manufacturing,  mining,  natural  gas 
production,  pharmaceutical  manufacturing,  and  precision  tool 
manufacturing,  among  many  other  activities.  Many  of  our  members 
are  Fortune  500  companies.  I  am  the  Director  of  Taxes  at  GenCorp. 
GenCorp  is  engaged  in  the  manufacture  of  aerospace,  automotive,  and 
polymer  products. 

Mr.  Chairman,  the  fair  tax  treatment  of  environmental  cleanup 
costs  is  an  issue  that  concerns,  directly  or  indirectly,  a  vast 
number  of  U.S.  businesses.  It  has  been  estimated,  for  example, 
that  under  the  Comprehensive  Environmental  Response,  Compensation 
and  Liability  Act  of  1980  (CERCLA) ,  alone,  there  may  be  as  many  as 
2  5,000  hazardous  waste  sites  requiring  remediation.  Yet,  CERCLA  is 
only  one  of  over  4  0  federal  statutes  (not  to  mention  state 
statutes)  devoted  to  the  objective  of  remediating  environmental 
contamination  and  protecting  the  environment. 

Cleaning  up  the  environment  is  an  important  and  far-reaching 
national  priority,  one  that  every  member  of  this  Coalition  firmly 
supports.  It  is  an  immense  task,  however,  that  will  take  decades 
to  carry  out.  Thorough  cleanups  and  prompt  compliance  with  our 
environmental  laws  are  critical  if  the  task  is  to  be  successfully 
completed. 

Mr.  Chairman,  proposals  to  require  companies  to  capitalize 
their  environmental  cleanup  costs  or  to  deny  the  current 
deductibility  of  those  costs  would  effectively  discourage  prompt 
and  thorough  cleanup  and  compliance.  In  addition,  such  proposals 
would,  for  the  most  part,  distort  income,  thereby  violating  a 
fundamental  rule  of  our  income  tax  system. 

In  short,  such  proposals  represent  unsound  environmental 
policy  and,  more  important  from  this  Subcommittee's  perspective, 
unsound  tax  policy.  I  would  like  briefly  to  expand  on  these  two 
points  with  you  today. 

I.    Capitalization  Would  Be  Contrary  To  Fundamental  And  Long 
Established  Tax  Rules 

Under  longstanding  federal  income  tax  law,  a  company  is 
required  to  capitalize  its  current  expenditures  (and,  thus,  delay 
deducting  the  expenditures)  if  the  expenditures  will  produce  future 
income  or  benefit  for  the  company.  By  contrast,  expenditures  that 
do  not  produce  a  future  benefit  for  the  company  are  deductible. 
The  policy  behind  this  law  is  simple:   it  allows  the  deduction  of 


'The  Coalition's  members  include:  Arkla,  Inc.,  Brush-Wellman, 
Inc.,  Delaware  North  Companies,  Eastman  Kodak  Co.,  GenCorp,  Laidlaw 
Corporation,  Merck  &  Co.,  Inc.,  North  American  Coal  Corporation, 
Savings  and  Community  Bankers  of  America,  SCM  Chemicals,  Textron, 
Inc.,  Union  Carbide  Corporation,  and  Whittaker  Corporation. 


1629 


the  expenditure  to  be  'Imatched"  with  the  income  that  it  produces. 
The  rule  is  called  the  "clear  reflection  of  income"  rule,  and  it 
underlies  a  large  portion  of  our  income  tax  laws. 

In  most  cases,  a  rule  requiring  the  capitalization  of 
environmental  cleanup  costs  would  violate  this  fundamental  clear 
reflection  of  income  rule.  This  is  because  most  environmental 
cleanup  costs  are  "backward  looking"  —  they  relate  to  past  events, 
and  to  income  that  was  generated  in  the  past,  not  to  income  that 
will  be  produced  in  the  future. 

To  take  a  simple  example,  under  CERCLA,  a  company  is  often 
required  to  clean  up  property  that  it  has  never  owned  or  no  longer 
owns.  In  these  circumstances,  the  cost  of  the  cleanup  clearly 
produces  no  future  income  or  benefit  for  the  company.  Thus,  there 
is  no  reason  to  delay  the  company's  deduction  for  its  cleanup  cost. 
Simply  stated,  there  is  no  future  income  to  "match"  the  cost 
against.  The  cost  is  a  true  current  cost  of  doing  business  and 
should  be  deducted  accordingly. 

Similarly,  where  a  company  is  required  to  expend  cleanup  costs 
related  to  operations  that  have  been  discontinued  by  the  company, 
the  costs  should  be  currently  deductible.  Such  costs  relate  to 
past  operations  and  past  income.  Again,  there  is  no  reason  to 
delay  the  company's  deduction  because  there  is  no  future  income  or 
benefit  with  which  the  deduction  can  be  "matched."  The  cleanup 
cost  is  a  cost  of  doing  business  in  the  past. 

For  example,  one  of  the  members  of  our  Coalition  has  a  current 
environmental  cleanup  liability  arising  out  of  various  production 
operations  that  it  discontinued  over  20  years  ago.  Another  has  a 
current  environmental  cleanup  liability  arising  out  of  operations 
discontinued  over  15  years  ago.  Many  of  our  members  have  such 
liabilities  arising  out  of  production  operations  that  they 
discontinued  between  five  and  10  years  ago. 

In  all  of  these  cases,  no  future  income  or  benefit  will  be 
produced  by  the  company's  cleanup  costs.  The  costs  relate  to  an 
income  stream  that  existed  in  the  past  (when  the  discontinued 
operations  were  ongoing) .  Accordingly,  the  clear  reflection  of 
income  rule  requires  that  the  cleanup  costs  be  deducted  currently. 

Even  where  the  property  is  still  in  productive  use  by  the 
company,  the  cleanup  costs  related  to  the  property  usually  have 
little  to  do  with  producing  future  income  or  benefit. 

For  example,  one  of  the  members  of  our  Coalition  owns 
contaminated  real  estate  that  would  be  worth  approximately  $2.5 
million  in  a  fully  cleaned-up  state.  The  company's  best  estimate 
of  the  cost  of  cleaning  up  the  real  estate  is  $20  million.  It  has 
accrued  the  $20  million  cost  as  an  expense  on  its  financial  books 
(and  reduced  its  reported  earnings  to  its  shareholders  by  this 
amount).  Thus,  this  company  will  have  to  spend  $20  million  to 
clean  up  property  that  is  only  worth  $2.5  million. 

Clearly,  this  company's  cleanup  costs  are  not  being  expended 
to  produce  future  income  or  benefit  (no  one  spends  $20  million  to 
obtain  $2.5  million  of  benefits).  Just  as  clearly,  the  costs 
should  be  currently  deducted,  not  capitalized. 

As  a  general  matter,  the  great  majority  of  cleanup 
expenditures  are  not  incurred  in  order  to  produce  future  benefit. 
Currently,  however,  the  IRS  seems  to  have  a  different  view.  Under 
the  IRS's  view,  for  example,  asbestos  replacement  costs  produce 
future  benefits,  even  where  it  is  acknowledged  that  the  replacement 
material  is  less  effective  in  the  company's  operations.  We  believe 
that  when  a  company  downgrades   its  operations  in  order  to  comply 


77-130  0-94-20 


1630 


with  environmental  laws,  it  should  not  be  treated  as  if  it  has 
received  a  benefit. 

Furthermore,  in  most  cases,  cleanup  expenditures  are  incurred 
to  remediate  the  effects  of  past  production  operations.  As  I 
stated  previously,  cleanup  expenditures  are  predominantly  "backward 
looking"  —  they  relate  predominantly  to  past  income  streams. 
Thus,  the  long  established  clear  reflection  of  income  rule  mandates 
that  the  costs  be  deducted  cxirrently. 

II.   Prompt  Cleanups  Would  Be  Discouraged 

Capitalization  of  environmental  cleanup  costs  for  tax  purposes 
would  materially  increase  the  costs  of  most  cleanup  projects  (by 
denying  companies  a  current  deduction  for  their  cash  outlays 
related  to  the  projects) .  These  increased  costs  will  inevitably 
discourage  companies  from  promptly  undertaking  new  cleanup 
projects.  At  best,  given  companies'  limited  resources  in  this 
persistently  difficult  economy,  the  increased  costs  associated  with 
capitalization  will  encourage  companies  to  delay  environmental 
cleanups  for  as  long  as  possible. 

The  disparate  effects  of  the  present  proposal  become  obvious 
when  several  facts  concerning  environmental  cleanups  are 
considered.  First,  under  CERCLA  and  many  state  statutes,  companies 
frequently  are  required  to  underteJce  environmental  cleanups  when 
they  are  not  at  fault  for  the  underlying  environmental 
contamination.  As  a  result,  companies  are  required  to  clean  up 
contaminated  properties  even  if  the  contamination  was  caused  by  a 
prior  owner  or  even  if  the  compamy  was  diligent  and  used  state-of- 
the-art  care  at  the  time  the  contamination  occurred.  As  I 
mentioned  at  the  outset  of  my  remarks,  there  are  approximately  25 
thousand  waste  sites  under  CERCLA  alone,  and,  contrary  to  what  some 
have  implied,  the  cleanup  of  these  sites  will  not  be  premised  on 
fault.  I  should  note  that  where  a  fine  or  penalty  is  imposed  on  a 
company  in  respect  of  environmental  contamination,  the  amount  of 
the  fine  or  penalty  is  not  deductible.  Let  me  emphasize  that  the 
members  of  our  coalition  agree  with  this  result. 

Second,  most  environmental  cleanups  do  not  improve  a  company's 
productive  capacity,  and  many  cleanups  actually  reduce  productive 
capacity.  Cleanup  costs  sure  incurred  not  because  they  help  the 
taxpayer's  business  —  they  generally  do  not  —  but  because 
Congress  and  the  various  states  have  declared  them  to  be  an 
important  priority.  So,  while  environmental  cleanups  do  produce  a 
societal  benefit,  they  generally  do  not  directly  benefit  the 
company  that  undertakes  the  cleanup. 

Third,  environmental  remediation  is  already  very  expensive  and 
is  getting  more  expensive  all  the  time.  Between  1984  and  1989,  for 
example,  average  annual  outlays  related  to  CERCLA  cleanups  nearly 
tripled.  Current  estimates  are  that  the  total  cost  of  cleaning  up 
existing  hazardous  waste  sites  will  range  anywhere  from  $500 
billion  to  $750  billion  over  the  next  30  years.  Thus,  the  costs  of 
cleaning  up  the  environment  are  already  immense  and  will  continue 
to  have  a  substantial  impact  on  companies  for  some  time  to  come. 

Again,  prompt  and  thorough  cleanups  are  essential  if  our 
national  objective  of  remediating  the  environment  is  to  be  met.  As 
matters  presently  stand,  however,  companies  are  asked  to  engage  in 
cleanups  although  (1)  they  frequently  are  not  at  fault  for  the 
contamination  they  are  required  to  clean  up,  (2)  their  productivity 
generally  does  not  benefit  from  the  cleanups,  and  (3)  the  cleanups 
are  expensive  and  financially  burdensome. 


1631 


viewed  in  this  context,  the  substantial  additional  costs  that 
would  be  imposed  by  proposals  to  capitalize  cleanup  expenditures 
would  make  it  extremely  difficult  for  cleanup  projects  to  compete 
for  limited  company  resources.  Clearly,  capitalizing  these  costs, 
or  denying  their  deductibility,  would  significantly  discourage 
prompt  cleanup  and  compliance. 

III.  Conclusion 

In  conclusion,  we  believe  that  any  proposal  to  capitalize  the 
costs  of  environmental  cleanups  would  have  adverse  consequences  for 
both  the  environment  and  business.  The  overriding  policy  objective 
must  be  to  ensure  that  environmental  cleanups  are  undertaken  in  a 
prompt  and  thorough  manner.  The  current  tax  treatment  of  cleanup 
costs  provides  legitimate  encouragement  to  businesses,  consistent 
with  longstanding  tax  principles  to  act  responsibly  and  clean  up 
such  sites  promptly  and  thoroughly.  Congress  should  not  change 
this  treatment.  Moreover,  we  respectfully  request  that  Congress 
take  whatever  steps  are  necessary  to  ensure  that  the  IRS  not 
frustrate  this  most  important  policy  goal. 

Thank  you  very  much  Mr.  Chairman.  I  would  be  happy  to  address 
any  questions  that  the  Committee  might  have. 


1632 

STATEMENT  OF  FRED  J.  GENTILE,  SENIOR  VICE  PRESIDENT, 
THE  BROOKLYN  UNION  GAS  COMPANY,  REPRESENTING  THE 
COALITION  TO  ELIMINATE  TAX  BARRIERS  TO  ENVIRON. 
MENTAL  CLEANUP 

Chairman  Rangel.  Mr.  Gentile. 

Mr.  Gentile.  Yes,  good  morning,  Mr.  Chairman,  and  members  of 
the  committee. 

My  name  is  Fred  Gentile.  I  am  senior  vice  president  of  the 
Brooklyn  Union  CJas  Co.,  a  gas  utility  regulated  by  the  New  York 
State  Public  Service  Commission.  We  provide  gas  sales  and  service 
to  1.1  million  customers,  the  majority  of  which  are  residential  in 
the  New  York  City  boroughs  oi  Brooklyn,  Queens,  and  Staten 
Island. 

I  am  pleased  to  address  you  briefly  today  on  the  matter  of  wheth- 
er the  tax  law  treatment  of  environmental  remediation  costs  should 
be  changed  or  clarified  as  a  revenue  raising  measure  and  on  the 
proposea  denial  of  a  tax  deduction  for  amounts  paid  as  compen- 
satory damages  in  environmental  matters. 

I  ask  that  my  complete  statement  be  submitted  for  the  record, 
Mr.  Chairman. 

Chairman  Rangel.  Without  objection. 

Mr.  Gentile.  Bv  way  of  background,  I  am  representing  today  an 
ad  hoc  coalition  of  companies  that  share  my  own  company's  concern 
that  tax  barriers  to  environmental  cleanup  be  eliminated.  The 
members  of  this  coalition  comprise  a  multi-industry  group,  includ- 
ing representatives  from  such  industries  as  manufacturing, 
consumer  products,  regulated  utilities,  timber,  transportation,  pulp 
and  paper,  mining,  pipelines,  and  environmental  services. 

It  is  a  fact  that  virtually  every  business  in  this  country  will  incur 
costs  of  environmental  cleanup,  if  for  no  other  reason  than  to  ad- 
dress historical  conditions.  Therefore,  we  are  vitally  concerned 
about  the  matter  before  this  committee. 

We  are  testifying  today  because  we  believe  it  would  be  a  serious 
mistake,  with  no  conceivable  justification  to  impose  arbitrary  cap- 
italization and  amortization  rules  that  change  the  present  tax  law 
treatment  of  environmental  remediation  costs  to  raise  revenues. 

Tax  simplification  and  clarification  are  worthy  goals  when  pur- 
sued for  their  own  sake,  but  they  should  not  be  pursued  as  a 
means  of  raising  revenue.  These  two  proposals  under  consideration 
by  this  subcommittee  would  change  the  current  law  in  a  way  that 
would  distort  income,  penalize  environmental  remediation  activi- 
ties, and  thereby  reduce  or  delay  those  mediation  activities. 

Thus,  we  oppose  these  proposals  to  raise  revenue  by  changing 
the  treatment  of  environmental  remediation  expenditures,  because 
these  proposals  would  harm  environmental,  economic  and  tax  poli- 
cies. 

From  an  environmental  policy  standpoint,  the  most  obvious  rea- 
son for  not  increasing  the  cost  of  environmental  remediation  is  the 
goal  that  underlies  the  Comprehensive  Environmental  Response 
Compensation  and  Liability  Act  of  1980,  called  CERCLA,  and  other 
environmental  protection  laws:  Namely,  to  promote  a  cleaner 
environment. 

While  CERCLA  requires  cleanup  of  compromised  sites  by  the  re- 
sponsible party,  CERCLA  is  not  self-executing.  It  is  necessary  for 


1633 

the  government  to  identify  the  responsible  parties  and  to  success- 
fully pursue  a  civil  claim  against  them. 

A  tax  proposal  that  requires  more  remediation  costs  to  be  cap- 
italized would  hinder  government  efforts  to  secure  clean  commer- 
cial and  industrial  sites.  This  is  due  to  a  simple  economic  situation. 
The  resulting  higher  costs  of  environmental  cleanup  would  discour- 
age some  responsible  parties  from  coming  forward  to  begin  remedi- 
ation in  advance  of  government  action. 

At  the  very  least,  it  would  cause  them  to  want  to  delay  cleanup 
efforts  and  to  seek  less  costly,  perhaps  less  effective  means  of  reme- 
diation. Thus,  such  a  proposal  would  lead  to  the  cleanup  of  fewer 
sites  within  a  given  period  of  time. 

Clearly,  public  policy  is  better  served  by  a  tax  treatment  that 
does  not  increase  the  cost  of  remediation  but  rather  reduces  the  in- 
centive for  proactive  litigation  and  mitigates  the  negative  external- 
ity. 

From  an  economic  policy  standpoint,  any  proposal  that  further 
burdens  the  environmental  cleanup  process  merely  adds  to  the  al- 
ready high  cost  U.S.  firms  must  pay  to  improve  the  environment. 
Such  additional  costs  would  have  far-reaching  impact  on  the  ability 
of  U.S.  firms  to  compete  effectively  in  the  global  marketplace. 

The  competitiveness  of  U.S.  businesses  has  already  been  severely 
strained  as  a  result  of  the  cost  that  will  be  incurred  by  business 
under  other  environmental  laws.  It  is  counterproductive  to  further 
increase  that  cost,  thereby  reducing  the  funds  available  for  these 
remediation  activities. 

At  a  time  when  environmental  cleanup  is  already  burdening  U.S. 
firms,  enacting  a  tax  on  these  activities  would  reduce  already 
scarce  reinvestment  dollars  and  would  be  a  self-defeating  policy. 

From  a  tax  policy  standpoint,  an  arbitrary  capitalization  rule  or 
a  uniformed  amortization  period  for  all  designated  cleanup  costs  is 
also  undesirable  and,  I  might  add,  inequitable.  Such  treatment 
would  not  improve  on  the  accurate  measurement  of  income  for  tax 
purposes  relative  to  the  current  law. 

Current  law  recognizes  the  difference  between  remediation  costs 
that  add  value  to  existing  property  or  increase  its  productivity  or 
extends  its  useful  life,  and  those  that  do  not. 

This  treatment  tends  to  match  the  expenditures  that  provide  an 
ascertainable  future  benefit  with  income  that  is  likely  to  flow  from 
that  benefit.  Moreover,  it  tends  to  do  so  over  the  period  that  the 
affected  property  will  be  in  service.  On  the  contrary,  arbitrary  cap- 
italization and  amortization  rules  designed  specifically  to  depart 
from  the  more  accurate  matching  obtained  under  current  law,  so 
as  to  raise  revenues,  will  distort  income. 

We  believe  that  expenses  incurred  to  remediate — I  am  sorry  I  am 
going  over,  sir — ^to  remediate  an  asset  to  usable  condition  are  de- 
ductible under  the  present  law,  including  expenses  to  remediate 
soil  and  groundwater. 

Three  months  ago.  Assistant  Treasury  Secretary  for  Tax  Policy, 
Leslie  B.  Samuels,  spoke  before  the  Subcommittee  on  Select 
Revenue  Measures  of  the  House  Ways  and  Means  Committee  about 
allowing  wine  producers  to  deduct  the  cost  of  replacing  vines  and/ 
or  vineyards  that  had  been  destroyed  by  parasitic  infection.  He 
said: 


1634 

"From  a  tax  policy  perspective,  it  appears  appropriate  to  permit 
current  deductions  for  costs  incurred  to  replace  a  grove,  orchard  or 
vineyard  back  into  the  state  it  was  prior  to  destruction.  In  the  case 
of  a  vineyard,  for  example,  these  deductions  include  the  cost  of  re- 
moval of  infested  plants,  removal  and  disposal  of  old  assets,  land 
preparation,  and  the  planting  of  new  plants."  The  testimony  was 
on  June  22,  1993. 

The  situation  is  the  same  with  environmental  remediation, 
where  the  property  is  returning  to  usable  condition.  However,  we 
are  concerned  this  understanding,  one  embraced  by  the  administra- 
tion and  the  code,  regulations  and  case  law  has  been  lost  on  the 
Internal  Revenue  Service  who,  in  two  technical  advice  memoranda, 
have  required  capitalization  of  the  costs  of  removing  asbestos  and 
PCBs.  We  believe  these  two  technical  advice  memoranda  incor- 
rectly require  capitalization  of  certain  environmental  costs. 

If  the  tax  clarification  is  necessary,  it  would  be  to  confirm  de- 
ductibility of  remediation  expenditures  not  as  a  guise  for  changing 
the  law  for  the  sake  of  raising  revenue. 

Regarding  compensatory  damages  under  environmental  laws,  the 
proposal  to  deny  deduction  for  payments  of  compensatory  damages 
relating  to  actual  or  potential  violations  of  specific  environmental 
laws,  including  H.R.  2441,  are  ill-advised  and  should  be  rejected. 
Under  the  present  law,  any  fine  or  similar  penalties  paid  to  a  gov- 
ernment for  the  violation  of  any  law  is  not  an  allowable  deduction 
for  tax  purposes.  However,  compensatory  or  remedial  payments  are 
allowed  as  deductions  in  determining  taxable  income.  This  is  as  it 
should  be. 

Whereas  it  would  frustrate  public  policy  to  permit  a  business  de- 
duction for  penalties  imposed  to  punish  the  payor,  the  exact  oppo- 
site is  true  when  it  comes  to  payments  that  are  compensatory. 
Thus,  denying  a  deduction  for  a  payment  in  the  nature  of  compen- 
satory damages  would  frustrate  the  public  interest  in  having 
claims  swiftly  and  justly  settled  and  the  alleged  damages  corrected. 

Compensatory  expenses  are  a  legitimate  cost  of  doing  business 
and  of^n  represent  the  most  efficient  way  to  resolve  conflicts  with- 
out resort  to  lengthy  and  expensive  litigation. 

The  primary  reason  for  opposing  proposals  that  would  deny  a  de- 
duction for  compensatory  damages  is  that  they  seek  to  use  the  tax 
law  to  punish  actions  that  the  substantive  law  does  not  consider 
worthy  of  punishment.  This  is  not  a  legitimate  use  of  the  Tax  Code. 

In  conclusion,  enacting  the  proposed  changes  to  the  tax  treat- 
ment of  remediation  expenses  and  compensatory  damages  >yould  be 
contrary  to  good  tax,  environmental  and  economic  policy  interest. 
These  proposals  would  retard  efforts  to  clean  up  the  environment, 
would  inaccurately  measure  income  and  would  impose  serious, 
even  damaging  costs  on  U.S.  businesses  in  an  increasing  competi- 
tive global  economy.  These  proposals  have  nothing  to  recommend 
them  and  should,  accordingly,  be  rejected. 

We  believe  Treasury  should  review  IRS  policy  and  issue  guid- 
ance. That  is  within  their  purview,  to  clarify  deductibility,  not  only 
to  address  asbestos  and  PCBs  but  also  residual  byproducts  from 
historical  manufactured  gas  plant  sites. 


1635 

We  would  be  pleased  to  work  with  the  administration  and  the 
members  of  this  committee  to  confirm  current  law,  not  to  change 
it.  We  believe  it  is  bad  economical,  environmental  and  tax  policy 
to  use  a  clarification  in  this  area  as  a  revenue  raiser. 

Thank  you  for  allowing  me  to  testify  before  this  subcommittee. 

Chairman  Rangel.  Thank  you,  Mr.  Gentile. 

[The  prepared  statement  follows:] 


1636 


STATEMENT 

on 

PROPOSED  CLARIFICATION 

of  the 

TREATMENT  OF  ENVIRONMENTAL  REMEDIATION  COSTS 

THROUGH  REQUIRED  CAPITALIZATION 

OR  UNIFORM  AMORTIZATION  PERIOD 

and 

DENIAL  OF  DEDUCTION  FOR  COMPENSATORY  DAMAGES 

before  the 

SUBCOMMITTEE  OF  SELECT  REVENUE  MEASURES 

OF  THE 

HOUSE  COMMITTEE  ON  WAYS  AND  MEANS 

on  behalf  of 

COALITION  TO  ELIMINATE  TAX  BARRIERS  TO  ENVIRONMENTAL  CLEANUP 

by 

Fred  J  Gentile 

Sr.  Vice  President  of 

The  Brooklyn  Union  Gas  Company 

September  23,  1993 

Summary 

Adopting  the  proposed  changes  in  the  tax  treatment  of  environmental  remediation 
expenses  both  to  deny  deductibility  of  remediation  expenses  and  compensatory  damages 
would  be  a  serious  mistake  on  a  variety  of  grounds    First,  such  a  change  would  harm 
environmental  policy  goals  by  making  cleanup  more  expensive.  Second,  the  change  would 
harm  tax  policy  goals  relating  to  the  accurate  reflection  of  income  and  value.  Finally,  the 
change  would  harm  the  ability  of  U.S.  firms  to  compete  in  the  global  marketplace. 

Introduction 

Mr  Chairman  and  members  of  the  Committee,  my  name  is  Fred  J.  Gentile.  I  am  Senior 
Vice  President  of  The  Brooklyn  Union  Gas  Company,  a  gas  utility  regulated  by  the  New 
York  State  Public  Services  Commission.  We  provide  gas  sales  and  service  to  1  1  million 
customers,  almost  all  of  which  are  residential,  in  the  New  York  City  boroughs  of 
Brooklyn,  Queens  and  Staten  Island.  I  am  pleased  to  address  you  today  on  the  matter  of 
whether  the  tax  law  treatment  of  environmental  remediation  costs  should  be  changed  or 
clarified  as  a  revenue  raising  measure  and  on  the  proposed  denial  of  a  tax  deduction  for 
amounts  paid  as  compensatory  damages  in  environmental  matters.  For  the  record,  I  am 
representing  today  an  ad  hoc  coalition  of  companies  that  share  my  own  company's 
concern  that  tax  barriers  to  environmental  cleanup  be  eliminated.  In  addition  to  The 
Brooklyn  Union  Gas  Company,  the  coalition  includes  Ameritech  Corp  ,  Georgia  Pacific, 
Commonwealth  Edison  Co.,  Greyhound,  Inc.,  Joslyn  Corp  ,  North  American  Coal  Corp., 
Occidental  Petroleum  Corp.,  Public  Service  Company  of  Colorado,  Texaco  Inc.,  WMX 
Technologies,  Inc.  The  members  of  this  coalition  comprise  a  multi-industry  group 
including  representatives  from  such  industries  as  manufacturing,  consumer  products, 
regulated  utilities,  timber,  transportation,  pulp  and  paper,  mining,  pipelines  and 
environmental  services.  It  is  a  fact  that  virtually  every  business  in  this  country  will  incur 
costs  of  environmental  cleanup  in  order  to  rectify  the  effects  of  past  practices.  Therefore, 
we  are  vitally  concerned  about  the  matter  before  this  Subcommittee. 

We  are  testifying  today  because  we  believe  it  would  be  a  serious  mistake  with  no 
conceivable  justification  to  impose  arbitrary  capitalization  and  amortization  rules  that 
change  the  present  tax-law  treatment  of  environmental  remediation  costs  to  raise 
revenues.  From  the  standpoint  of  environmental  and  business  policy,  it  makes  no  sense  to 
penalize  and  thereby  discourage  ~  through  the  imposition  of  higher  taxes  —  desirable 
cleanup  activities.  If  anything,  these  activities  should  be  encouraged.  Nor  would  it  be 
good  tax  policy  to  seek  to  raise  revenues  from  "taxing"  environmental  cleanup  activities. 
Environmental  remediation  is  a  complicated  process  and  many  factors  must  be  considered 
when  developing  an  appropriate  cleanup  plan,  selecting  fi-om  a  wide  range  of  possible 


1637 


remedies.  This  process  should  not  be  further  complicated  through  the  blunt  mechanism  of 
the  tax  law.  The  institution  of  arbitrary  capitalization  and  amortization  rules  would 
inevitably  have  the  effect  of  raising  the  relative  costs  of  some  cleanup  methods  over  the 
costs  of  others  without  serving  any  coherent  tax  policy  other  than  to  satisfy  the  quest  for 
more  revenue 

Tax  simplification  and  clarification  are  worthy  goals  when  pursued  for  their  own  sake,  but 
they  should  not  be  pursued  as  a  means  of  raising  revenue  These  two  proposals  under 
consideration  by  the  Subcommittee  would  change  the  current  law  in  a  way  that  would 
distort  income,  penalize  environmental  remediation  activities  and  thereby  reduce  or  delay 
those  remediation  activities    Thus,  we  oppose  these  proposals  to  raise  revenue  by 
changing  the  treatment  of  environmental  remediation  expenditures  and  payments  of 
compensatory  damanges  in  environmental  matters. 


Present  Law  Treatment  of  the  Costs  of  Environmental  Remediation 

The  concept  of  "environmental  remediation"  encompasses  a  wide  range  of  possible 
activities  and  expenditures    Most  commonly  it  refers  to  the  treatment  and/or  removal  of 
soil  or  water  that  have  become  contaminated  either  abruptly  or  over  a  period  of  time  as  a 
result  of  the  discharge  of  substances  now  considered  to  be  toxic  or  through  the  seepage  of 
substances  into  the  soil  or  ground  water  from  sites  or  containers  that  were  damaged  by 
accident  or  were  subsequently  determined  to  be  inadequately  designed  to  control  those 
substances.   "Environmental  remediation"  also  refers  to  the  encapsulation  or  replacement 
of  materials  —  such  as  asbestos  used  for  insulation  purposes  ~  that  were  once  considered 
safe  but  have  now  been  identified  as  posing  an  unacceptable  level  of  risk  to  people  and  the 
environment 

The  alternative  means  for  remediation  are  many  and  varied,  and  include  treatment  with 
chemicals  or  biological  agents,  controlled  burning,  removal  and  disposal,  and  isolation  and 
monitoring    Many  of  these  processes  would  not  be  particularly  challenging  or  expensive 
but  for  the  presence  of  toxic  substances  and  the  need  to  take  extraordinary  precautions 
against  further  damage  to  persons  or  the  environment    Other  remediation  processes  are 
indeed  very  expensive  because  they  are  technically  advanced  or  because  they  are  very  time 
consuming  —  sometimes  years  are  required  to  accomplish  the  desired  degree  of 
remediation 

The  one  thing  each  of  these  remediation  activities  has  in  common,  besides  the  tremendous 
expense  that  is  of^en  involved,  is  that  none  of  them  receives  any  preferred  tax  treatment 
under  the  current  tax  law    Some  of  these  expenditures  are  deductible  as  ordinary  and 
necessary  business  expenses  while  others  must  be  capitalized  and  amortized  or  depreciated 
under  general  principles  of  the  tax  law    However,  there  are  no  special  tax  credits,  no 
special  deduction  provisions  and  no  "bonus"  allowances  that  are  granted  as  incentives  for 
undertaking  these  expenditures  because  they  have  the  effect  of  cleaning  up  the 
environment. 

On  the  contrary,  an  expenditure  for  environmental  remediation  is  treated  the  same  as 
virtually  any  other  business  related  expenditure  made  with  respect  to  other  property    That 
is,  the  expenditure  is  classified  as  either  a  deductible  ordinary  and  necessary  business 
expense  or  as  a  capitalizable  expenditure  in  accordance  with  standards  already  coruained 
in  the  Internal  Revenue  Code,  Treasury  regulations  and  in  case  law. '  These  standards 
generally  look  to  whether  the  expenditure:  a)  increases  the  value  of  the  property  as 
compared  to  its  value  at  some  previous  time,  b)  increases  the  productivity  of  the  property, 
or  c)  significantly  extends  the  useful  life  of  the  property  beyond  its  originally  expected  life. 
Granted,  it  is  not  always  easy  to  apply  these  tests  in  a  given  circumstance;  however, 
taxpayers  are  familiar  with  the  tests  and  apply  them  every  year  in  many  circumstances. 
There  is  nothing  unique  about  environmental  remediation  costs  that  makes  it  more  or  less 


'(See  Internal  Revenue  Code  Sections  162  and  263;  Reg.  Sec.  1. 162-4  and  1.263(a)-l;  Illinois  Merchants 
Trust  Co.  V  Commissioner.  4  BTA  103  (1926)  a^.  V-2  C  B  2.  American  Bemberg  Corp.  v 
Commissioner.  10  T  C.  361  (1948),  affd  per  curiam  177  F  2d  200  (6th  Cir.,  1949),  Plainfield-Union 
Water  Co  v  Commissioner  39  T.C.  333  (1962),  nonacq.  1964-2  C.B.  8.) 


1638 


difficult  to  apply  these  same  tests  to  those  costs  than  to  literally  hundreds  of  other 
situations  involving  other  property-related  costs. 

We  believe  that  expenses  incurred  to  restore  an  asset  to  its  original  condition  are 
deductible  under  the  present  law,  including  expenses  to  remediate  soil  and  groundwater. 
Three  months  ago.  Assistant  Treasury  Secretary  for  Tax  Policy  Leslie  B  Samuels  spoke 
before  the  Subcommittee  on  Select  Revenue  Measures  of  the  House  Ways  and  Means 
Committee  about  allowing  wine  producers  to  deduct  the  cost  of  replacing  vines  that  had 
been  destroyed  by  a  parasitic  infestation    He  said. 

From  a  tax  policy  perspective,  it  appears  appropriate  to  permit  current  tax 
deductions  for  costs  incurred  to  place  a  grove,  orchard  or  vineyard  back  into  the 
state  it  was  prior  to  destruction.  In  the  case  of  a  vineyard,  for  example,  these 
deductions  include  the  costs  of  removal  of  infested  plants,  removal  and  disposal  of 
old  assets,  land  preparation  and  the  planting  of  new  plants  (Testimony  of  June  22, 
1993) 

The  situation  is  the  same  with  environmental  remediation,  where  the  property  is  returned 
to  its  original,  uncontaminated  condition.  However,  we  are  concerned  that  this 
understanding,  one  embraced  by  the  Administration  and  the  Code,  regulations,  and  case 
law,  has  been  lost  on  the  Internal  Revenue  Service,  who  in  two  technical  advice 
memoranda  have  required  capitalization  of  the  costs  of  removing  asbestos  and  PCBs. 
These  memoranda  are  in  clear  conflict  with  the  apposite  authority    If  tax  clarification  is 
necessary,  it  should  be  to  confirm  the  deductibility  of  remediation  expenditures,  and 
should  not  be  undertaken  in  the  guise  of  changing  the  law  for  the  sake  of  raising  revenue. 
We  would  be  very  pleased  to  work  with  the  Administration  and  the  members  of  this 
Committee  in  this  endeavor  -  namely  to  confirm  current  law,  not  to  change  it 


What  Is  Being  Proposed? 

The  question  must  then  be  asked:  what  is  the  proposed  clarification  of  the  treatment  of 
environmental  remediation  that  would  raise  revenues?  As  we  have  stated,  environmental 
remediation  costs  receive  no  preferred  treatment  under  current  law  and  do  not  represent  a 
particularly  unique  type  of  expenditure.  Therefore,  any  such  "clarification"  could  raise 
revenue  only  if  it  were  to  impose  a  penalty,  relative  to  current  law,  on  those  that  incur 
these  expenses.  This  penalty  would  be  in  the  form  of  a  higher  cost  of  doing  business  for 
those  that  incur  costs  to  clean  up  the  environment    Revenue  would  only  be  raised  by  a 
proposal  that  requires  the  capitalization  of  expenditures  that  are  deductible  under  current 
law  -i  e  ,  those  that  do  not  add  value,  increase  productivity  or  extend  the  useful  life  of 
other  property  —  or  by  a  proposal  that  requires  expenditures  to  be  amortized  over  a  longer 
period  than  the  statutory  recovery  periods  that  would  otherwise  apply  under  current  law 
Thus,  in  essence,  the  proposal  would  be  to  impose  a  tax  on  the  act  of  cleaning  up  the 
environment. 

So  far  as  we  are  aware,  no  details  or  justification  for  such  a  proposal  has  been  suggested, 
let  alone  proposed  in  a  formal  manner.  That  is  not  surprising.  The  very  thought  of 
imposing  a  tax  on  environmental  cleanup  activities  seems  so  counterproductive  to  the 
more  important  policy  of  encouraging  environmental  cleanup,  that  it  is  hard  for  us  to 
imagine  a  policy  justification  that  might  be  offijred  in  support  of  such  a  proposal.  For 
example,  this  proposal  cannot  be  justified  on  the  basis  of  reducing  or  eliminating  a  costly 
tax  break  or  incentive,  as  is  often  the  reason  given  for  revenue-raising  proposals    As  we 
have  mentioned  earlier,  environmental  remediation  costs  cannot  possibly  be  considered  a 
tax-favored  expenditure.  Rather,  we  are  aware  only  of  the  unsupported  notion  that  here  is 
an  area  where  more  revenue  might  be  raised. 

There  are,  however,  strong  policy  reasons  not  to  look  to  environmental  remediation 
expenditures  for  raising  revenues.  These  include  sound  environmental  and  tax  policy 
reasons  as  well  as  economic  policy  reasons. 


1639 

Policy  Considerations 

Environmental  policy 

The  most  obvious  policy  reason  for  not  increasing  the  costs  of  environmental  remediation 
is  the  goal  that  underlies  the  Comprehensive  Environmental  Response,  Compensation,  and 
Liability  Act  of  1980  (CERCLA)  and  other  environmental  protection  laws,  namely  to 
promote  a  cleaner,  environment    While  CERCLA  requires  cleanup  of  compromised  sites 
by  the  responsible  party  (or  its  successor),  CERCLA  is  not  self-executing    It  is  necessary 
for  the  government  to  identify  the  responsible  parties  and  to  successfully  pursue  a  civil 
claim  against  them.   A  tax  proposal  that  requires  more  remediation  costs  to  be  capitalized 
would  hinder  government  efforts  to  secure  clean  commercial  and  industrial  sites    This  is 
due  to  simple  economics    The  resulting  higher  costs  of  environmental  cleanup  would 
discourage  some  responsible  parties  from  coming  forward  to  begin  remediation  in  advance 
of  government  action    At  the  very  least,  it  would  cause  them  to  want  to  delay  cleanup 
efforts  or  to  seek  less  costly,  perhaps  less  effective,  means  of  remediation.  Thus,  such  a 
proposal  would  lead  to  the  cleanup  of  fewer  sites  within  a  given  period  of  time    Clearly, 
public  policy  is  better  served  by  a  tax  treatment  that  does  not  increase  the  cost  of 
remediation,  but  rather  reduces  the  incentive  for  protracted  litigation  and  mitigates  the 
negative  externality  and  dead-weight  loss  to  society  that  pollution  brings. 

Tax  policy 

From  a  tax  policy  standpoint,  an  arbitrary  capitalization  mle  or  a  uniform  amortization 
period  for  all  designated  cleanup  costs  is  also  undesirable    Such  treatment  would  not 
improve  on  the  accurate  measurement  of  income  for  tax  purposes  relative  to  current  law 
Current  law  recognizes  the  difference  between  remediation  costs  that  add  value  to  existing 
property  or  increase  its  productivity  or  extend  its  usei\il  life,  and  those  that  do  not    This 
treatment  tends  to  match  the  expenditures  that  provide  an  ascertainable  future  benefit  with 
the  income  that  is  likely  to  flow  from  that  benefit.  Moreover,  it  tends  to  do  so  over  the 
period  that  the  affected  property  will  be  in  service    On  the  contrary,  arbitrary 
capitalization  and  amortization  rules  ~  designed  specifically  to  depart  from  the  more 
accurate  matching  obtained  under  current  law  so  as  to  raise  revenue  —  would  distort 
income 

Even  if  the  proposal  is  viewed  as  penalizing  polluters  and  not  as  penalizing  the  cleanup 
activities  themselves,  proper  tax  policy  requires  that  the  proposal  be  rejected    The 
environmental  laws  and  regulations  of  this  country  are  voluminous,  containing  many 
requirements  and  sanctions,  both  criminal  and  civil,  for  violations    Persons  designated  to 
enforce  those  laws  are  best  suited  to  making  the  necessary  distinctions  between  actions 
that  merit  penalty  and  those  that  do  not    In  contrast,  the  tax  system  is  not  at  all  well- 
suited  as  a  vehicle  for  delivering  a  penalty  for  polluters    A  tax  law  that  penalizes 
expenditures  for  environmental  cleanup  through  mandatory  capitalization  makes  no 
distinction  between  the  innocent  and  the  culpable    The  tax  system  is  too  indiscriminate  to 
be  used  as  an  enforcement  tool  for  non  tax-related  matters. 

Economic  Policy 

Any  proposal  that  further  burdens  the  environmental  cleanup  process  merely  adds  to  the 
already  high  costs  US  firms  must  pay  to  improve  the  environment    Such  additional  costs 
would  have  a  far-reaching  i.Mpact  on  the  ability  of  U.S.  firms  to  compete  effectively  in  the 
global  marketplace    The  competitiveness  of  US  businesses  has  already  been  severely 
strained  as  a  result  of  the  staggering  costs  that  will  be  incurred  by  business  under  our 
environmental  laws.  It  is  counterproductive  to  fijrther  increase  that  cost,  thereby  reducing 
the  fljnds  available  for  these  remediation  activities.  At  a  time  when  enviommental  cleanup 
already  is  imposing  significant  costs  on  US.  firms,  enacting  a  a  tax  on  those  activities 
would  reduce  already  scarce  reinvestment  dollars  and  would  be  a  self-defeating  policy. 

In  summary,  there  are  many  reasons  to  eliminate  tax  barriers  to  environmental  cleanup,  but 
there  are  no  reasons  to  erect  new  ones.  This  Committee  should  reject  proposals  to  raise 
revenue  by  "clarifying"  the  law  to  require  that  certain  environmental  cleanup  costs 
deductible  under  current  law  be  capitalized  or  by  extending  the  amortization  period  for 


1640 


capitalizable  costs.  These  proposals  would  impose  an  unjustifiable  and  counterproductive 
tax  on  environmental  remediation  and  would  hinder  the  pace  of  progress  in  achieving  a 
cleaner  environment. 


Compensatory  Damages  Under  Environmental  Laws 

Proposals  to  deny  a  deduction  for  payments  of  compensatory  damages  relating  to  actual 
or  potential  violations  of  specified  environmental  laws,  including  H.R.  2441,  are  ill- 
advised,  and  should  be  rejected    Under  present  law,  any  fine  or  similar  penalty  paid  to  a 
government  for  the  violation  of  any  law  is  not  an  allowable  deduction  for  tax  purposes 
This  would  include  an  amount  paid  as  a  civil  penalty  imposed  by  a  federal,  state  or  local 
law  as  well  an  amount  paid  in  settlement  of  the  taxpayer's  actual  or  potential  liability  for  a 
fine  or  penalty  (civil  or  criminal).  (See  Treas.  Reg.  1. 162-21(b).)  The  disallowance 
applies  to  penalties  that  are  intended  to  sanction  or  punish  conduct  which  some  well- 
defined  public  policy  seeks  to  proscribe.  {True  v.  U.S.  90-1  USTC  1150,062  (CA  10, 
1990) )  However,  compensatory  or  remedial  payments  are  allowed  as  deductions  in 
determining  taxable  income    This  is  as  it  should  be.  Whereas  it  would  fi^strate  public 
policy  to  permit  a  business  deduction  for  penalties  imposed  to  punish  the  payor,  the  exact 
opposite  is  true  when  it  comes  to  payments  that  are  compensatory.  Thus,  denying  a 
deduction  for  a  payment  in  the  nature  of  compensatory  damages  would  fiiistrate  the 
public's  interest  in  having  claims  swiftly  and  justly  settled  and  the  alleged  damage 
corrected    Compensatory  expenses  are  a  legitimate  cost  of  doing  business  and  often 
represent  the  most  efiHcient  way  to  resolve  conflicts  without  resort  to  lengthy  and 
expensive  litigation. 

The  primary  reason  we  oppose  proposals  that  would  deny  a  deduction  for  compensatory 
damages  is  that  they  seek  to  use  the  tax  law  to  punish  actions  that  the  substantive  law 
does  not  consider  worthy  of  punishment    This  is  not  a  legitimate  use  of  the  tax  code    The 
purpose  of  the  tax  laws  is  to  raise  revenue  for  the  legitimate  needs  of  the  government 
The  tax  laws  should  not  be  used  as  a  mechanism  by  which  select  behaviors  or  business 
practices,  unrelated  to  the  tax  collection  process,  are  singled  out  and  penalized.  This  is 
especially  true  when  the  particular  behavior  that  is  being  singled  out  -  in  this  instance, 
resolving  disputes  about  who  should  be  responsible  for  environmental  remediation  —  is  a 
desirable  one  fi-om  a  public  policy  standpoint.  Indeed,  settlements  of  disputes  about  who 
is  responsible  for  alleged  damage  to  the  environment  should  be  encouraged.   And  those 
who  agree  to  resolve  the  matter  and  to  share  the  responsibility,  even  though  there  may  be 
legitimate  legal  grounds  to  resist  such  responsibility  or  to  dispute  the  means  of 
remediation,  should  not  be  discouraged  fi-om  reaching  such  a  resolution  by  a  tax  rule  that, 
in  effect,  treats  the  resolution  as  if  it  were  an  admission  of  culpability. 

Moreover,  the  tax  law  is  ill-suited  as  a  mechanism  for  determining  the  proper  penalty  and 
imposing  it  even  if  one  is  merited.  If  punishment  is  merited,  why  is  the  marginal  rate  of 
tax  on  the  compensatory  payment  a  relevant  measure  of  the  appropriate  penalty''  If  there 
has  indeed  been  some  violation  of  the  environmental  laws  that  merits  a  penalty,  there  are 
ample  sanctions  that  can  be  imposed  within  the  framework  of  existing  law  that  measures 
the  particular  harm  and  takes  into  account  all  circumstances,  not  just  the  fact  of  an 
agreement  to  correct  an  alleged  harm. 


Conclusion 

Enacting  the  proposed  changes  to  the  tax  treatment  of  remediation  expenses  and 
compensatory  damages  would  be  contrary  to  good  tax,  environmental,  and  economic 
policy  interests.  The  proposals  penalize  environmental  cleanup  activities  in  the  name  of  a 
"clarification"  whose  sole  purpose  is  to  raise  revenue.  These  proposals  would  retard 
efforts  to  clean  up  the  environment,  would  inaccurately  measure  income,  and  would 
impose  serious,  even  damaging  costs  on  U.S  businesses  in  an  increasingly  competitive 
global  economy.  These  proposals  have  nothing  to  recommend  them  and  should 
accordingly  be  rejected. 


1641 

Chairman  Rangel,  As  you  notice,  we  have  been  joined  by  Mr. 
McCreiy,  as  well  as  Mr.  Kopetski. 

All  01  you  are  saying  you  support  existing  law?  There  is  no  one 
here  opposing  existing  law? 

Mr.  Gentile.  That  is  correct. 

Chairman  Rangel.  And  even  though  you  have  some  disputes 
with  the  IRS  interpreting  existing  law,  you  feel  sure  you  would  pre- 
vail in  court  under  existing  law? 

Mr.  Gentile.  Correct. 

Mr.  Robinson.  Right. 

Chairman  Rangel.  So  if  we  say  we  are  from  the  Government,  we 
are  here  to  help  you,  and  to  avoid  any  further  problems,  to  clarify 
the  law  and  to  limit  your  exposure  to  further  court  cases,  you 
would  say  you  don't  need  any  help  and  existing  law  is  good  enough 
protection  for  you? 

Mr.  Hock.  No. 

Chairman  Rangel.  You  want  clarification? 

Mr.  Hock.  We  want  clarification  that  the  existing  law  is  what  we 
think  it  is  and  not  what  the  IRS  is  tending  to  say  it  is. 

Chairman  Range L.  You  would  agree  that  there  are  some  cases 
where,  while  you  are  trying  to  clean  the  environment,  that  you  ac- 
tually are  involved  in  a  capital  expenditure  and  it  should  not  be 
currently  deducted?  Under  existing  law  that  can  be  done? 

Mr.  Hock.  There  are  cases  where  certainly  there  has  to  be  inter- 
pretation of  the  actual  situation. 

Chairman  Rangel.  Yes,  I  know. 

Mr.  Hock.  There  is  a  gray  area. 

Chairman  Rangel.  You,  being  a  fair-minded  American,  you 
would  say  you  could  find  cases  that  you  believe  it  should  be  capital- 
ized rather  than  deducted? 

Mr.  Gentile.  The  rules  are  there  to  determine  whether  it  is  use- 
ful, extends  the  property's  life  or  productivity  involved.  The  current 
rules  allow  that  interpretation. 

Mr.  Solomon.  I  think,  Mr.  Chairman,  if  you  have  67  years  of 
court  cases,  you  can  find  one  or  two  that  are  going  out  there  that 
might  muddle  the  water.  The  great  overwhelming  bulk 

Chairman  Rangel.  We  would  not  change  the  law  for  one  or  two 
cases. 

If  you  feel  secure  that  you  are  protected  under  existing  law,  and 
that  when  you  are  just  doing  these  things  because  it  is  the  right 
thing  to  do  and  you  want  to  protect  your  employees  and  the  citi- 
zens of  America,  and  there  is  no  limit  to  whether  or  not  just  as  a 
side  effect  the  property  is  substantially  and  dramatically  increased 
in  value,  that  is  just  one  of  the  things  we  have  to  accept. 

You  are  doing  the  right  thing,  and  if  you  put  a  couple  billion  dol- 
lars in  it  in  doing  it,  and  get  a  new  plant  to  get  rid  of  an  environ- 
mental thing,  then  we  should  look  at  it  strictly  from  the  health 
point  of  view  and  the  good  citizenship  and  just  discount  whether 
or  not  while  you  are  doing  the  right  thing  that  you  have  increased 
the  value  of  your  property;  or  we  will  leave  it  to  IRS,  rather? 

Mr.  Gentile.  That  is  a  fact.  In  our  case,  we  have  an  old  manu- 
facturing site  that  is  appraised  as  the  market  value,  say  $1.3  mil- 
lion. But  we  are  incurring  to  date,  site  investigation  and  evalua- 
tion, of  over  $3  million.  And  that  property  is  not  worth  any  more 


1642 

than  the  ordinary  necessary  expenses  to  get  that  site  in  usable  con- 
dition. So  there  is  no  benefit  to  added  value,  and  the  tax  law 

Chairman  Rangel.  That  is  your  plant. 

Mr.  Gentile.  My  site. 

Chairman  Rangel.  You  are  from  Brooklyn,  so  you  would  nor- 
mally do  the  right  thing  in  Brooklyn,  especially  when  you  employ 
our  constituents.  But  if  you  came  from  some  other  community  and 
you  looked  at  the  plant,  you  think  the  appraised  value  would  just 
be  too  high  and  ridiculous  because  you  are  just  doing  what  you  nad 
to  do? 

Mr.  Gentile.  In  most  cases,  it  is  just  vacant  land,  old  plant  sites 
that  had  been  manufacturing  plants  with  coal  back  at  the  turn  of 
the  century,  and  there  are  still  existing  in  that  particular  site  the 
residual  byproducts. 

Chairman  Rangel.  Did  I  miss  in  the  testimony — everyone  wants 
to  help  the  committee  to  do  the  right  thing  and  to  be  fair  and  to 
certainly  not  have  you  to  change  decisions  that  have  already  been 
made  as  relates  to  existing  law,  and  I  don't  think  there  is  enough 
money  involved  for  us  to  take  that  political  hit,  even  though  those 
things  have  to  be  weighed — fairness  and  the  revenues. 

But  I  don't  think  we  are  going  to  take  that  route  again.  There 
is  not  that  much  money  involved  and  we  don't  want  to  discourage 
people  from  doing  the  right  thing  and  penalize  them  for  having  al- 
ready made  the  decision. 

Having  said  that,  were  there  guidelines  that  I  missed  in  your 
statements  as  to  what  you  think  we  should  do  as  relates  to  making 
the  determination? 

Mr.  Gentile.  Yes,  under  current  law,  Mr.  Chairman,  the  reve- 
nues will  be  there  for  the  Government  if  it  is  capitalized.  If  there 
is  an  improvement. 

So  there  are  cases  when  there  is  a  depreciation,  amortization  pe- 
riod, for  any  major  improvement  under  the  current  law.  So  there 
are  cases  when  it  is  an  ordinary,  necessary  business  expense  to 
make  other  expenditures.  So  the  current  law  does  give  the  Govern- 
ment its  due  revenues  from  code  and  case  law. 

Chairman  Rangel.  So  we  don't  have  to  change  that? 

Mr.  Gentile.  We  do  not  have  to  change  that.  There  is  enough 
protection  for  the  Government  to  prevent 

Chairman  Rangel.  To  prevent  abuse  or  to  prevent  creative 
accounting. 

Mr.  Gentile.  That  is  correct,  proper  accounting,  Financial 
Standards  Accounting  Board  allows  for  that  determination  also. 

Mr.  Solomon.  I  think  we  were  concerned  that  you  would  clarify 
it,  as  might  have  been  suggested  in  the  joint  committee  report^  that 
you  would  clarify  it  that  these  types  of  expenses  are  capital  and  not 
expense.  And  then,  if  that  were  the  case,  there  would  be  a  signifi- 
cant change  in  the  law,  and  I  think  certainly  we  did  not  want  that 
to  happen. 

Chairman  Rangel.  But  you  were  saying  you  were  concerned 
with  retroactivity  and  seemed  more  receptive  to  where  we  would  go 
in  the  future  in  terms  of  clarification. 

Mr.  Solomon.  That  is  right,  but,  obviously,  if  you  would 
clarify 


1643 

Chairman  Rangel.  Are  your  clients  as  big  as  the  other  people  at 
the  table?  Who  are  your  clients? 

Mr.  Solomon.  We  represent  a  lot  of  Fortune  500  companies. 

Chairman  Rangel.  All  of  you,  really 

Mr.  Gentile.  Basically,  yes,  that  is  correct. 

Mr.  Hock.  We  are  not  Fortune  500.  We  are  way  down  there. 

Chairman  Rangel.  Well,  I  don't  think  that  we  will  be  moving 
with  any  speed  on  this  matter.  It  is  a  thorn  in  the  side  of  a  lot  of 
people.  Some  want  to  do  the  right  thine  by  the  environment  and, 
of  course,  we  have  to  have  an  existing  basis  of  law  as  to  what  is 
increasing  value  and  whether  or  not  the  tax  law  is  being  avoided 
by  doing  the  right  thing  on  the  one  hand  and  writing  off  a  heck 
of  a  lot  that  has  nothing  to  do  with  that  on  the  other  hand. 

If  you  are  satisfied  that  existing  law  does  it,  we  will  just  have 
to  review  and  study  that  again.  And  none  of  you  are  concerned 
about  your  liability  in  court  under  existing  law,  you  think  you  can 
hold  your  own  under  that? 

Mr.  Solomon.  I  think  that  is  true.  But  the  one  point  that  would 
be  helpful  in  terms  of  clarification,  you  just  raised  this  in  response 
over  here,  is  what  happens  if  a  tree  falls  on  my  plant  and  damages 
my  plant  and  I  go  out  and  fix  it?  The  plant  is  going  to  be  a  lot  more 
valuable  after  I  fixed  it  up  than  it  was  immediately  after  the  tree 
fell  on  it. 

Chairman  Rangel.  Don't  they  handle  replacement  value  and  all 
that?  Isn't  that  taken  care  of  under  the  law,  for  your  tree  and  your 
house?  That  is  not  a  problem. 

Mr.  Solomon.  That  is  exactly  the  way  we  read  the  law,  Mr. 
Chairman.  But  the  Service  said  that  they  might  want  to  look  at  the 
value  of  the  plant  after  the  tree  fell  on  it  and  compare  that  value 
to  what  it  is  after  you  fix  it  up.  And  that  certainly  does  not  seem 
to  be  a  fair  comparison  in  that  case.  And  as  we  have  said,  it  is  in- 
consistent with  all  the  law  that  is  out  there. 

Chairman  Rangel.  OK.  Mr.  McCrery. 

We  have  also  been  joined  by  Mr.  Thomas. 

Questions? 

Mr.  Kopetski. 

Mr.  Kopetskl  Thank  you,  Mr.  Chairman. 

Mr.  Gentile 

Mr.  Gentile.  Gentile. 

Mr.  Kopetski.  Gentile.  I  agree  with  you  in  terms  of  supporting 
the  current  status  of  law  for  deductibility  of  remediation  costs. 

I  want  to  turn  your  attention  to  page  5  of  your  testimony  with 
the  compensatory  damages,  whereupon  you  say  that  the  purpose  of 
the  Tax  Code  is  to  raise  revenue  for  the  legitimate  needs  of  govern- 
ment. 

That  is  one  of  the  purposes  of  the  law.  Another  purpose  of  the 
law  is  to  get  corporations,  businesses,  to  do  something  that  we  as 
policymakers  feel  that  is  good  for  the  economy,  and  that  is  why  we 
establish  all  kinds  of  tax  credits,  and  we  just  did  that  renewal  of 
the  R&D  tax  credit,  for  example;  isn't  that  the  case? 

Mr.  Gentile.  That  is  true. 

Mr.  Kopetski.  So  it  is  not  just  to  raise  revenue.  We  also  spend 
money  through  the  Tax  Code,  if  you  will,  or  not  bring  in  as  much 
money,  to  get  businesses  to  do  something  they  may  not  do  as 


1644 

strongly  as  we  want  them  to  do  or  not  do  them  at  all — tax  credits 
for  low-income  housing,  et  cetera. 

Mr.  Gentile.  That  is  correct. 

Mr.  KOPETSKI.  Under  the  current  Tax  Code,  I  wonder  if  the  in- 
centives actually  are  not  there  to  do  the  cleanup  or  remediation, 
when  we  talk  about  compensatory  damages,  because  what  is  going 
on  here  is  litigation  of  some  sort,  whether  it  is  through  an  adminis- 
trative agency  or  a  State  or  local  government.  It  would  seem  to  me 
that  the  incentive  is  not  to  clean  up  until  the  dispute  is  resolved, 
because  what  we  are  talking  about  is  some  sort  of  judicial  deter- 
mination that,  yes,  you  have  to  clean  up. 

And  I  think  in  almost  all  cases  accompanying  that  is  some  sort 
of  fine  or  penalty.  We  say  the  fines  and  penalties  are  not  deducted, 
and  the  issue  before  us  is  whether  the  compensatory  damages 
should  be  allowed  as  a  deduction.  Well,  all  you  have  to  do  is  stall 
it  out  and  maybe  you  will  pay  a  fine,  you  will  challenge  the  amount 
of  the  fine,  but  the  incentive  is  not  there  to  do  the  remediation. 

So  if  you  take  away  that  deduction,  then  the  incentive,  therefore, 
is  to  do  the  remediation;  is  to  settle,  and  maybe  even  avoid  the  fine 
or  penalty.  So  you  move  that  incentive  forward. 

Mr.  Gentile.  On  this  issue,  I  think  it  was  the  administration's, 
Treasury's  official,  who  testified  on  this  that  he  believes  it  is  a  cur- 
rent and  ordinary  deduction,  compensatory  damages  payments.  It 
was  before  this  committee;  that  it  is  a  legitimate  ordinary,  nec- 
essary business  deduction. 

Mr.  Kopetski.  Under  current  law.  We  are  talking  about  chang- 
ing the  law.  They  don't  get  to  do  that,  we  do. 

Mr.  Gentile.  But  if  that  encourages — ^it  would  actually  make 
more  litigation;  more  costly.  I  think  it  has  an  opposite  effect,  I 
think.  Because  you  look  at  the  economics  of  your  decision  as  a  busi- 
nessman: Do  you  want  to  settle  and  pay  your  compensatory  pay- 
ments to  resolve  this  issue  and  still  be  a  good  citizen  to  clean  up 
what  you  have  to  do  under  the  environmental  laws? 

Mr.  Kopetski.  What  I  am  challenging  is  that  logic  itself  If  you 
take  away  the  deductibility,  the  incentive  is  to  do  the  cleanup,  the 
remediation,  beforehand,  because  now  you  can  write  it  off. 

Mr.  Gentile.  That  is  true,  but  it  is  the  least  cost  to  protect  the 
environment.  At  the  same  time,  you  would  still  be  obligated  under 
the  environmental  laws.  There  are  penalties  there  you  have  to  pay 
if  you  do  not  abide  by  the  environmental  laws;  this  is  the  expense 
incurred  to  do  that. 

Mr.  Kopetski.  That  is  right,  and  currently,  if  you  do  it  on  your 
own,  you  get  to  deduct  it. 

Mr.  Gentile.  Correct. 

Mr.  Kopetski.  And  currently,  if  you  are  told  to  do  it,  currently 
you  get  to  deduct  it.  So  where  is  the  incentive? 

Mr.  Gentile.  Well,  it  is  necessary  to  make  these  payments  to  re- 
solve this  issue.  So  it  is  a  legitimate,  ordinary  business  deduction. 
It  is  a  cost  of  doing  business.  It  is  not  improving  anything,  it  is  not 
adding  value,  it  is  not  adding  productivity,  it  is  not  doing  it  for  a 
different  reason,  the  property,  so  it  is  a  legitimate  expense,  these 
payments. 


1645 

Mr.  KOPETSKI.  But  if  you  take  away  the  deduction  then  there  is 
a  significant  degree  of  economic  incentive  to  do  the  remediation  be- 
fore a  judicial  determination. 

Mr.  Robinson.  Mr.  Kopetski 

Mr.  Kopetski.  I  think  he  is  going  to  figure  out  another  answer. 

Mr.  Gentile.  As  my  attorney  is  telling  me,  you  have  to  resolve 
the  problem  and  find  out  what  has  to  be  done  and  then  you  evalu- 
ate what  are  the  costs  of  remediation  and  then  you  go  ahead  and 
make  that  determination.  You  don't  make  the  payments  until  you 
see  what  is  the  cost  to  clean  up  the  particular  environmental  issue. 

Mr.  Kopetski.  In  these  cases,  it  is  not  what  has  to  be  done,  it 
is  whether  you  have  to  do  it,  and  that  is  why  there  is  a  contested 
case. 

Mr.  Gentile.  Correct. 

Mr.  Kopetski.  The  company  is  saying,  no,  we  don't  have  to  do 
this. 

Mr.  Gentile.  They  are  interpreting  the  law.  They  look  at  the  re- 
quirements. Are  they  obligated  to  do  and  spend  a  full  amount  of, 
exorbitant  amount  of  the  cost.  And  they  work  with  the  environ- 
mental agencies  to  resolve  this  'ssue. 

Mr.  Kopetski.  They  are  fighting  not  to  do  it;  right? 

Mr.  Gentile.  Right. 

Mr.  Kopetski.  So  I  am  saying  if  we  do  away  with  that  deduction, 
there  will  be  even  more  incentive  for  them  to  do  it. 

Mr.  Robinson.  I  was  just  going  to  say,  many  times  a  lot  of  envi- 
ronmental sites,  under  the  environmental  laws,  there  are  a  number 
of  different  parties  who  are  identified  as  being  potentially  respon- 
sible. And  any  businessperson,  any  corporate  officer,  has  a  fidu- 
ciary duty  to  look  at  and  determine  whether  the  costs  that  are 
being  imposed  on  their  company  are  reasonable  and  do  they  rep- 
resent their  fair  share  of  the  cost  of  cleaning  up. 

There  is  also  another  issue,  and  that  involves  if,  in  fact,  you  be- 
lieve you  have  coverage  under  liability  insurance,  you  may  basi- 
cally have  to  be  compelled  to  clean  up.  If  you  voluntarily  do  it,  you 
may  be  surrendering  a  claim  against  your  insurance  carriers  for 
property  damage  coverage. 

But  in  the  meantime,  the  fines  and  penalties  are  provided  under 
the  environmental  laws.  If  you  are  at  fault,  if  you  have  done  some- 
thing negligently  or  willfully,  you  can  be  fined  and  the  fines  are 
nondeductible. 

Compensatory  damages — for  the  most  part,  what  is  really  hap- 
pening is  the  environmental  agency  probably  has  gone  ahead  and 
begun  cleaning  up  and  you  are  effectively,  through  compensatory 
damages,  reimbursing  them  for  not  only  their  cost  of  cleanup  but 
for  the  oversight  charges  that  they  are  charging  you  for  overseeing 
the  cleanup  of  the  site.  Thev  are  effectively  just  calling  it  "compen- 
satory damages,"  the  cost  of  cleaning  up. 

Mr.  Kopetski.  And  that  is  what  it  is.  And  that  is  the  entire 
issue. 

Mr.  Robinson.  But  companies  have  a  legitimate  need 

Mr.  Kopetski.  If  you  do  it  vourself  voluntarily,  you  get  to  deduct 
it  and  that  is  in  the  Tax  Code  policy  and  that  is  well  and  good.  If 
you  take  away  the  deductibility,  that  puts  more  pressure  and  in- 


1646 

centive  on  businesses  in  this  country  to  enter  into  settlement 
agreements  before  this  whole  thing  is  litigated;  isn't  that  the  case? 

Mr.  Gentile.  I  don't  think  it  is  the  case. 

Mr.  KoPETSKi.  I  am  asking  this  gentlemen,  and  that  is  a  yes  or 
no  question.  Isn't  there  more  incentive? 

Mr.  Robinson.  You  are  right,  it  would  accelerate  things.  The 
problem  is  it  is  causing  you  to  accelerate  a  decision  that  is  not  a 
reasonable  decision.  The  decision  really  needs  to  be  one  of  how  do 
we  fairly  measure  what  our  share  of  the  responsibility  at  a  site  is 
when  the  cost  of  cleaning  up  the  site  is  being  imposed  on  a  no-fault 
basis. 

Mr.  KOPETSKI.  Thank  you,  Mr.  Chairman. 

Chairman  Rangel.  Well,  I  assume  you  are  working  very  closely 
with  the  environmental  groups  to  hold  on  to  existing  law,  but  you 
do  know  there  are  some  loopholes  in  it  and  we  hope  that  if  we  try 
to  clarify  the  decisions  and  interpretations,  that  you  will  work  with 
us  on  that  so  that  we  won't  make  your  life  more  difficult.  But  I 

{"ust — I  cannot — these  IRS  opinions,  none  of  those  are  being  chal- 
enged  in  court  that  went  against  the  industry? 

Mr.  Gentile.  Not  yet. 

Mr.  Solomon.  It  takes  time,  but,  yes,  they  are  being  challenged. 

Chairman  Rangel.  So  vou  are  talking  still  about  some  liability 
in  terms  of  having  to  challenge  the  courts. 

If  there  is  a  difference  in  an  existing  law,  in  its  interpretation, 
and  you  have  all  of  these  decisions,  I  would  think  that  somebody 
would  want  a  clarification.  I  mean,  I  know  which  way  you  would 
want  it  cleared  up,  but  still,  there  has  to  be  some  line  drawn  where 
we  could  do  it  and  keep  the  cases  out  of  court,  save  taxpayers' 
money,  allow  you  to  make  long-range  decisions  and  get  rid  of  the 
rip-off  artists  that  give  well-intended  firms  a  bad  image? 

Mr.  Gentile.  Yes. 

Chairman  Rangel.  Brooklyn  excluded? 

Mr.  Gentile.  Brooklyn  excluded. 

Chairman  Rangel.  Thank  you  very  much. 

The  next  panel  will  be  the  California  Association  of  Winegrape 
Growers,  Robert  Hartzell,  president;  the  Western  Growers  Associa- 
tion and  Western  Pistachio  Association,  Joseph  C.  Macllvaine,  the 
chairman  of  research,  California  Pistachio  Commission  and  presi- 
dent of  the  Paramount  Farming  Co.  in  Bakersfield,  Calif;  and  the 
California  Carrot  Board,  John  Guerard,  agronomist,  William 
Bolthouse  Farms,  Inc.,  from  Bakersfield. 

The  Chair  will  now  yield  to  my  friend,  the  distinguished  gen- 
tleman and  protector  of  pistachios,  whatever  country  we  are  in,  Mr. 
Thomas. 

Mr.  Thomas.  Thank  you,  Mr.  Chairman. 

Briefly,  two  of  the  gentlemen  in  front  of  you,  Joe  Macllvaine  and 
John  Guerard,  are  constituents  of  mine.  Bob  Hartzell  has  been  a 
long-time  associate. 

What  you  are  looking  at  is  a  significant  segment  of  the  specialty 
agriculture  of  California,  which  has  been  a  very  bright  spot  in  our 
balance  of  trade  payments  for  a  number  of  years.  Not  only  that,  the 
testimony,  especially  the  testimony  from  Mr.  John  Guerard  with 
regard  to  what  is  going  to  happen  to  carrots,  will  show  that  wheth- 


1647 

er  or  not  we  impose  an  excise  tax  on  methyl  bromide,  will  have  a 
significant  impact  on  the  domestic  market. 

I  would  invite  the  chairman  to  recall  the  role  that  we  played  in 
the  Superfund  in  which  there  was  some  zealous  folk  who  wanted 
to  classify  a  number  of  items  as  having  to  share  the  cost  of  clean- 
ing up  the  Superfund.  And  after  we  went  through  a  careful  sci- 
entific examination  of  products,  such  as  boron  and  others,  our  role 
as  the  taxing  committee  actually  played  a  significant  role  in  mak- 
ing sure  that  evidence  that  had  not  been  presented  elsewhere  was 
presented  to  the  extent  we  decided  not  to  impose  taxes  on  certain 
chemicals. 

The  analogy  is  not  100  percent  here,  but  it  is  an  important  prece- 
dent. And  having  served  on  the  Select  Revenue  Committee  with  the 
chairman  in  the  past,  I  know  that  we  have  a  concern  that  we  get 
all  of  the  facts  on  the  table  before  we  make  a  decision.  And  what 
you  will  hear  from  these  gentlemen,  I  think,  is  a  very  well  argued 
position  that  if,  in  fact,  this  excise  tax  goes  forward,  there  are  not 
only  dire  economic  consequences,  but  there  probably  are  virtually 
no  significant  benefits  for  those  who  wish  to  place  methyl  bromide 
on  the  excise  tax  list  as  an  ozone-depleting  chemical. 

They  will  give  you  more  specifics.  But  one  of  the  things  that  is 
occurring  now,  pleasing  to  me,  is  an  adjustment  back  from  the 
hysteria  that  we  had  a  number  of  years  ago.  Even  the  EPA  has  ad- 
mitted perhaps  some  of  the  decisions  they  had  made  were  not 
based  upon  the  kind  of  evidence  that  they  would  like  to  make  their 
decisions  on. 

This  is  primarily  a  money  question  in  terms  of  economics.  I  think 
the  economic  argument  is  there,  without  question.  I  also  believe 
the  scientific  argument  is  there  as  well. 

I  thank  the  gentlemen  for  coming. 

They  have  some  exhibits,  which  I  think  graphically  portray  what 
the  result  would  be  if,  in  fact,  we  did  go  forward  with  the  decision 
to  place  an  excise  tax  on  methyl  bromide,  and  they  can  do  far  bet- 
ter than  I.  They  argue  it  is  a  constant  fight  between  civilization 
and  the  jungle  and  that  this  is  one  chemical  that  is  currently  being 
used  in  a  very  careful  way  to  make  sure  that  the  jungle  does  not 
encroach  into  every  supermarket  in  America. 

I  thank  the  chairman. 

Chairman  Rangel.  Well,  Mr.  Guerard,  you  should  know  that  I 
have  not  seen  my  colleague  in  any  country  or  any  community, 
urban  or  jungle,  that  he  has  not  gone  to  the  full  length,  notwith- 
standing scorn  and  ridicule,  to  protect  the  pistachio  industry.  So 
that  whatever  you  are  using,  I  am  certain  that  whatever  the  sci- 
entific basis,  you  can  really  count  Mr.  Thomas  to  be  there  for  you. 

You  didn't  bring  pistachios,  along  with  those  carrots? 

Mr.  MacIlvaine.  So  happens,  we  did. 

Chairman  Rangel.  You  did. 

We  are  glad  to  have  you. 

How  long  do  you  intend  to  stay  this  morning? 

Mr.  Thomas.  Until  you  have  enjoyed  as  many  pistachios  as  you 
would  like. 

I  want  to  stay  for  the  questions  for  a  while,  Mr.  Chairman.  It  is 
a  pleasure  to  be  back. 


1648 

Chairman  Rangel.  I  figured  that.  Well,  we  wall  start  with  Mr. 
Hartzell  and  dealing  with  the  wine. 

Do  you  have  grape  growers  in  your  district  as  well? 

Mr.  Thomas.  I  have  a  number  of  winegrape  growers  in  my  dis- 
trict. We  are  a  major  source  of  winegrapes.  Although  I  don't  rep- 
resent the  Napa,  the  Sonoma  or  Mendocino  Counties,  it  is  not  com- 
monly known  that  in  our  area  we  do  grow  a  lot  of  winegrapes. 

Chairman  Rangel.  But  this  methyl  bromide  issue  being  included 
on  the  taxable  ozone  depleting  chemicals,  you  are  familiar  with 
that? 

Mr.  Thomas.  I  am  very  familiar  with  it,  and  they  are  going  to 
give  you  some  graphic  economic  and  scientific  reasons  why  we 
should  not  do  it. 

Chairman  Rangel.  So,  none  of  these  bills  here,  you  believe, 
makes  any  sense  as  relates  to  what  is  before  us? 

Mr.  Thomas.  It  is  the  question  of  placing  an  excise  tax  on  methyl 
bromide  that  brought  me  here,  along  with  my  constituents  willing 
to  help  us  understand. 

Chairman  Rangel.  So  this  should  be  treated  differently  from  the 
HCFCs  that  are  on  the  list  for  the  protocol.  I  know  you  have  done 
a  lot  more  work  on  this. 

Mr.  Thomas.  I  have  a  concern  about  a  number  of  chemicals  being 
placed  on  a  list  without  having  sufficient  scientific  evidence  or  a 
full  appreciation  of  the  economic  impact,  but  my  narrow  concern 
right  now  is  methyl  bromide  and  I  will  entertain  other  concerns 
later. 

Chairman  Rangel.  Mr.  Hartzell. 

Mr.  KoPETSKl.  Mr.  Chairman. 

Chairman  Rangel.  Yes. 

Mr.  KOPETSKI.  Having  both  probably  the  best  grapes  or  wine  in 
the  world  in  my  district,  as  well  as  some  of  the  finest  timber  in  the 
district  as  well — I  have  a  very  diverse  district,  as  you  can  see — ^the 
methyl  bromide  issue  is  very  important.  And  the  first  question  I 
think  which  has  to  be  answered  is  whether  it  should  be  listed  as 
an  ozone-depleting  substance,  and  it  has  not  been  listed. 

In  fact,  there  are  other  Federal  agencies,  such  as  the  Department 
of  Agriculture,  that  are  challenging  whether  it  should  be  on  the 
list,  and  mv  position  is  it  is  premature  to  tax  that  until  it  is  actu- 
ally officially  placed  on  the  list. 

Chairman  Rangel.  Well,  notwithstanding  scientific  data,  do  the 

ape  growers  in  New  York  have  the  same  problem  you  have  in 

alifomia? 

Mr.  Hartzell.  Yes,  they  have  some  problems  with  phylloxera. 
Whether  or  not  they  use  methyl  bromide  or  not,  I  am  not  sure. 

STATEMENT  OF  ROBERT  P.  HARTZELL,  PRESIDENT, 
CALIFORNIA  ASSOCIATION  OF  WINEGRAPE  GROWERS 

Mr.  Hartzell.  Good  morning,  Mr.  Chairman,  Congressman 
Thomas,  members  of  the  committee.  I  would  first  like  to  thank  you 
for  allowing  us  to  give  testimony.  Unfortunately,  unlike  my  col- 
leagues, I  did  not  bring  samples  of  wine  this  morning. 

My  name  system  Robert  Hartzell,  I  am  president  of  the  Califor- 
nia Association  of  Winegrape  Growers.  We  represent  the  State's 
4,000  winegrape  growers  on  State,  national  and  international  is- 


Ee 


1649 

sues.  And  I  am  here  to  express  our  strong  opposition  to  the  pro- 
posed inclusion  of  methyl  bromide  on  the  IRS'  list  of  taxable  ozone- 
depleting  chemicals. 

In  the  full  text  of  my  testimony,  I  have  given  your  subcommittee 
the  important  statistics  for  the  California  grape  and  wine  industry. 
It  supplies  90  percent  of  our  Nation's  grape  production,  employs 
110,000  Califomians,  pays  over  $500  million  in  direct  and  indirect 
taxes,  and  contributes  $9  billion  to  the  economic  activity  of 
California. 

In  fact,  in  the  United  States,  grapes  are  the  9th  largest  crop  on 
the  basis  of  value.  When  you  turn  those  grapes  into  wine,  it  be- 
comes the  7th  largest  crop  in  the  United  States. 

Unlike  annual  crops  that  require  methyl  bromide  each  year  for 
soil  or  post  harvest  ftimigation,  grape  growers  use  methyl  bromide 
as  a  soil  fumigant  prior  to  planting  vineyards.  Our  vineyards  aver- 
age 20  to  30  vears  productive  life,  with  some  vineyards  lasting  30 
years,  others  less  than  10  years. 

Major  threats  to  the  longevity  of  our  vineyards  are  infestations 
of  root-destroying  insects,  primarily  nematodes  and  phylloxera  and 
the  fungus  known  as  oak  root  fungus.  All  three  of  these  major 
problems  are  currently  dealt  with  by  treating  with  methyl  bromide 
prior  to  planting. 

Nematodes  are  a  major  problem  for  growers  of  table  wine,  raisin 
grapes,  and  all  three  types,  particularly  in  Congressman  Thomas' 
district  and  other  parts  of  the  Central  Valley,  where  80  percent  of 
the  grapes  grown  in  California  are  produced.  The  common  practice 
is  to  fumigate  the  bare  ground  with  methyl  bromide  after  removal 
of  the  old  vineyard  or  before  planting  a  vineyard  infested  with 
nematodes  from  the  previous  crop. 

As  members  of  the  subcommittee  may  have  read,  winegrape 
vineyards  in  the  north  coast  counties  of  California,  including  the 
premium  wine  growing  regions  of  Napa  and  Sonoma  Counties,  are 
currently  being  invaded  by  a  new  strain  of  phylloxera.  Phylloxera 
is  the  soil  louse  that  devastated  the  vineyards  of  California  and 
Europe  in  the  late  1800s  and  was  finally  brought  under  control 
through  the  development  of  resistant  rootstocks.  The  new  strain  of 
phylloxera  is  a  mutant  that  has  broken  through  the  rootstock 
resistance. 

The  cost  of  renovating  a  north  coast  vineyard  by  completely  re- 
moving the  old  vines,  preparing  the  soil,  fumigating  with  methyl 
bromide  to  kill  phylloxera  and  oak  root  ftingus,  the  planting  of 
vines,  trellising,  irrigation  system  installation  is  $15,000  to  $20,000 
per  acre.  Once  replanted,  the  new  vineyard  will  not  begin  to  yield 
until  the  third  year  and  not  reach  productive  capacity  until  it  is  5 
to  7  years  old.  Consequently,  the  grape  supply  of  Napa  and  Sonoma 
Counties  will  probably  decrease  by  about  70,000  tons  to  about 
180,000  tons  by  1997. 

The  total  cost  to  growers  for  replanting  the  acreage  on 
phylloxera-susceptible  roots  in  those  two  counties  alone  is  esti- 
mated to  be  $2  billion  by  the  end  of  the  decade.  The  current  cost 
to  fumigate  a  north  coast  vineyard  where  the  treatment  is  needed 
to  kill  phylloxera  and  oak  root  fungus  is  around  $1,200  per  acre. 
Of  that  amount,  $500  is  for  material  and  $600  is  for  tarping. 


1650 

In  the  parts  of  the  State  where  oak  root  fungus  is  not  a  problem, 
primarily  the  Central  Valley,  the  cost  of  fumigation  is  between 
$550  and  $660  per  acre. 

It  is  my  understanding  that  at  this  time  methyl  bromide  has  not 
been  officially  listed  as  an  ozone  depleter  and  there  is  no  scientific 
agreement  as  to  the  ozone  depletion  potential  for  methyl  bromide. 
However,  if  the  full  $3.25  per  pound  excise  tax  were  imposed,  it 
would  increase  the  fumigation  cost  per  acre  by  $1,300. 

In  other  words,  it  would  more  than  double  or  in  some  cases  triple 
the  cost.  A  completely  unrealistic  and  destructive  amount. 

If  applied,  the  proposed  tax  would  be  a  second  excise  tax  on  our 
winegrape  growers,  in  that  in  1990,  the  Congress  imposed  a  529 
percent  increase  in  the  excise  tax  on  wine,  which  is  now  being 
passed  back  to  farmers.  I  might  add  that  we  are  currently  in  har- 
vest, and  the  price  of  winegrapes  in  Congressman  Thomas'  district 
is  about  half  of  what  it  was  a  year  ago  on  some  of  the  primary  vari- 
eties. It  is  a  very  devastating  picture  price-wise  in  the  lower  San 
Joaquin  Valley. 

Our  industry  is  well  aware  of  the  need  to  find  an  alternative  to 
methyl  bromide.  I  would  hope  the  members  of  this  subcommittee 
would  understand  that  the  imposition  of  an  excise  tax  on  this  criti- 
cal production  tool  will  destroy  our  industry's  ability  to  be  competi- 
tive, will  not  raise  significant  revenue  for  the  national  Treasury, 
penalize  our  4,000  grape  growers,  most  of  whom  are  small  inde- 
pendent farmers  already  struggling  from  the  previously  imposed 
excise  tax  on  wine. 

Any  change  in  the  current  policy  on  methyl  bromide  must  be 
based  on  sound  science.  There  are  too  many  unknowns  with  regard 
to  methyl  bromide's  impact  on  the  environment  and,  therefore, 
much  more  research  is  needed.  It  concerns  me  that  while  EPA  has 
not  yet  listed  methyl  bromide  for  phaseout,  this  subcommittee  is 
preparing  to  supersede  EPA's  decisionmaking  process  and  tax 
methyl  bromide  as  if  it  were  a  proven  ozone  depleter. 

We  have  assisted  EPA  and  USDA  in  their  efforts  to  find  an  alter- 
native and  we  will  continue  to  do  so.  Members  of  the  subcommittee 
must  understand  that  taking  money  fi-om  the  industry's  pocket 
will,  in  all  likelihood,  delay  the  discovery  of  an  effective  alternative. 

Thank  you,  Mr.  Chairman. 

[The  prepared  statement  follows:] 


1651 


California  Association  of  Winegrape  Growers 

225  iOlh  Sirei-I.  Suite  306.  Sacramento.  California  95«J6  -  (976)  44S-2t7<,    FAX  (9161  448-047 


Tastimony  of 

Mr.    Robert  B»rti*ll 

President,  California  Association  of  Winegrape  Growers 

Presented  to 

the  Bouse  Ways  and  Means  Committee 

Subconnittee  on  Select  Revenue  Measures 

September  23,  1993 

Introduction 

Good  morning  Mr  Chairman.   I  would  like  to  thank  you  and  the 
members  of  the  Subcommittee  for  this  opportunity  to  present 
testimony  today.   My  name  is  Robert  Hartzell,  and  I  am  President 
of  the  California  Association  of  Winegrape  Growers  (CAWG) .   I  am 
here  today  to  express  CAWG's  strong  opposition  to  the  proposed 
inclusion  of  methyl  bromide  on  the  IRS'  list  of  taxable  ozone 
depleting  chemicals. 

Economics  of  Wine  and  Winegrape  Industry 

Before  I  begin,  I  would  like  to  take  a  moment  to  provide  some 
background  information  on  our  industry. 

California  is  responsible  for  providing  90%  of  our  Nation's  grape 
production  from  just  under  700,000  acres  of  vineyards.   The 
production  of  about  425-430,000  of  these  acres  is  crushed  for 
wine  or  grape  concentrate.   In  1992,  there  were  3.1  million  tons 
crushed,  with  a  total  value  slightly  over  $1  billion. 

The  wine  and  grape  industries  play  a  tremendous  role  in 
California's  economy.   We  provide  full-time  employment  for 
approximately  110  thousand  Californians.   We  pay  over  S500 
million  in  direct  and  indirect  taxes.   All  told,  our  industry 
contributes  over  $9  billion  to  the  economic  activity  in 
California. 

In  1991,  California  producers  supplied  75.3  percent  of  the  wine 
consumed  in  the  U.S.   Our  wineries  shipped  375  million  gallons  of 
wine  to  all  markets,  and  7  percent  of  this  was  exported.   This  7 
percent  reflects  a  533  percent  increase  in  American  wine  exports 
from  1985  to  1992,  with  a  total  value  of  $174.4  million. 

Purpose  of  Methyl  Bromide 

Unlike  annual  crops  that  require  methyl  bromide  each  year  for 
either  soil  or  post  harvest  fumigation,  grape  growers  use  methyl 
bromide  as  a  soil  fumigant  prior  to  planting  vineyards.   Our 
vineyards  average  20  to  30  productive  years,  with  some  vineyards 
lasting  30+  years  and  others  less  than  10  years. 

Major  threats  to  the  longevity  of  our  vineyards  are  infestations 
of  root  destroying  insects,  primarily  nematodes  and  phylloxera, 
and  the  fungus  Amillaria  (sp) ,  known  commonly  as  oak  root  fungus. 
All  three  of  these  major  problems  are  currently  dealt  with  by 
fumigation  with  Methyl  Bromide  prior  to  planting. 

Nematodes  are  a  major  problem  for  growers  of  table,  wine  and 
raisin  grapes  in  the  great  Central  Valley  of  California,  where 
80%  of  the  state's  grapes  are  produced.    The  common  practice  is 
to  fumigate  the  bare  ground  with  Methyl  Bromide  after  removal  of 
the  old  vineyard,  or  before  planting  a  vi. eyard  on  ground 
infested  with  nematodes  from  the  previous  crop. 


1652 


There  are  currently  some  rootstocjcs  that  appear  to  be  more 
tolerant  than  others  to  nematodes,  but  the  majority  of  grapes  in 
the  main  production  areas  of  the  central  valley  are  planted  on 
their  own  roots  and  are,  therefore,  susceptible  to  nematode 
infestations.   Therefore,  fumigation  with  Methyl  Bromide  is 
essential. 

As  members  of  this  Subcommittee  may  have  read,  winegrape 
vineyards  in  the  North  Coast  Counties  of  California,  including 
the  premium  wine  growing  regions  of  Napa  and  Sonoma  Counties,  are 
currently  being  invaded  by  a  new  strain  of  phylloxera. 
Phylloxera  is  the  soil  louse  that  devastated  the  vineyards  of 
California  and  Europe  in  the  late  1800's  and  was  finally  brought 
under  control  through  the  development  of  resistant  rootstocKs. 
The  new  strain  of  phylloxera  is  a  mutant  that  has  broken  through 
rootstock  resistance. 

The  cost  of  renovating  a  North  Coast  vineyard  by  completely 
removing  the  old  vines,  preparing  the  soil,  fumigating  with 
Methyl  Bromide  to  kill  phylloxera  and  oak  root  fungus,  vines, 
trellising,  and  installation  of  an  irrigation  system  is  $15,000- 
$20,000  per  acre.    Once  replanted,  the  new  vineyard  will  not 
begin  to  yield  fruit  until  the  third  year,  and  not  reach  its 
production  capacity  until  it  is  5-7  years  old.   Consequently,  the 
grape  supply  from  Napa  and  Sonoma  Counties  will  probably  decrease 
around  70,000  tons  to  about  180,000  tons  by  1997. 

The  total  cost  to  growers  for  replanting  the  acreage  planted  on 
phylloxera-susceptible  roots  in  Napa  and  Sonoma  Counties  alone  is 
estimated  to  be  $2  billion  by  the  end  of  the  decade. 

The  current  cost  to  fumigate  a  North  Coast  vineyard,  where  the 
treatment  is  needed  to  kill  phylloxera  and  oak  root  fungus,  is 
$1,200  per  acre.   Of  that  amount,  $500  is  for  material  and  $600 
is  for  tarping.   In  the  parts  of  the  state  where  oak  root  fungus 
is  not  a  problem,  the  cost  for  fumigation  is  $550-$600  per  acre. 

It  is  my  understanding  that,  at  this  time,  Methyl  Bromide  has  not 
been  officially  listed  as  an  ozone  depletor  and  that  there  is  no 
scientific  agreement  as  to  the  Ozone  Depletion  Potential  (ODP) 
for  Methyl  Bromide.   If  the  full  $3.25  per  pound  excise  tax  were 
imposed  on  the  4  00  pounds  per  acre  of  Methyl  Bromide  used  for 
fumigation  prior  to  planting  grapes,  it  would  increase  the 
fumigation  cost  per  acre  by  $1,300.   A  completely  unrealistic  and 
destructive  amount. 

Industry  Depends  on  Methyl  Bromide 

Without  the  use  of  methyl  bromide,  grape  production — and  this 
includes  raisins,  table  grapes,  and  winegrapes — would  be 
significantly  diminished.   An  April  1993  report  entitled  "The 
Biologic  and  Economic  Assessment  of  Methyl  Bromide"  published  by 
the  U.S.  Department  of  Agriculture's  National  Agricultural 
Pesticide  Impact  Assessment  Program  gave  two  grim  scenarios  for 
our  industry  should  methyl  bromide  use  be  prohibited. 

Scenario  A  -   Methyl  bromide  canceled,  other  fumigants 
available 

1.  Twenty  percent  of  the  acreage  would  be  allowed  to  lie 
fallow  for  four  years  in  order  to  allow  infestations  to 
diminish.   This  would  mean  a  100  percent  loss  of 
production  of  these  lands  for  four  years. 

2.  Seventy  percent  of  the  acreage  would  receive  metam- 
sodium  at  a  cost  of  $525  per  acre. 

3.  Five  percent  would  be  treated  with  non-fumigant 
nematicides  with  variable  costs. 

4.  Five  percent  of  the  acres  would  be  planted  without 
treatment  and  be  predisposed  to  abandon  production. 


1653 


Scenario  B  -   No  furaigants  available 

1.  Sixty-five  percent  of  the  acreage  would  be  allowed  to 
lie  fallow  for  four  years  with  100  percent  loss  of 
production. 

2.  Production  would  be  abandoned  on  thirty  percent  of  the 
acreage  because  it  is  infested  with  Amillaria  sp.,  and 
grapes  cannot  be  grown  on  such  land  without  methyl 
bromide. 

3.  Five  percent  of  the  acres  would  be  planted  without 
chemical  control  and  would  be  predisposed  to  abandoning 
production. 

The  report  also  concluded  that  " [ultimately] , the  forty 
percent  first  year  loss  would  be  compounded  each  year, 
eventually  resulting  in  a  one  hundred  percent  loss  of 
production." 

So  you  can  understand  the  concern  we  have  for  this  proposed  tax. 

The  industry  has  also  invested  a  substantial  amount  of  time  and 
money  through  our  governmental  and  nongovernmental  scientists  to 
develop  an  alternative  to  methyl  bromide,  but  to  date,  we  have 
been  unsuccessful. 

Wine  Industry  Mo  Stranger  to  Excise  Tax 

The  contemplated  excise  tax  on  methyl  bromide  would  be  a  second 
excise  tax  on  growers.   In  1990,  Congress  increased  the  excise 
tax  on  table  wine  by  529%.   The  tax  went  from  17  cents  per  gallon 
to  $1.07  per  gallon  -  and  the  reality  is  that,  substantially,  all 
of  this  increase  has  turned  out  to  be  paid  by  grape  farmers  in 
the  form  of  reduced  grape  prices.   Let  me  explain. 

During  the  time  Congress  was  debating  the  increase,  I  kept 
hearing  throughout  the  halls  of  Congress  -  "Sin  Tax"  and 
S1.07/gallon  is  only  21  cents/750  milliliter  bottle.   Surely  a 
consumer  who  can  pay  $12  to  $15  for  a  bottle  of  wine  can  afford 
21  cents. 

Here's  the  reality.   The  $l.07/gallon  is  paid  to  the  Department 
of  the  Treasury  by  the  winery  at  the  time  the  wine  is  removed 
from  bond.   Now,  the  winery  can  do  one  of  three  things  to  recover 
that  additional  cost: 

1.  It  can  absorb  the  additional  cost. 

2.  It  can  add  the  additional  cost  to  the  bottle  of 
wine. 

3 .  It  can  reduce  the  price  it  pays  growers  for  grapes 
by  the  amount  of  the  increase. 

Our  experience  is  that  the  latter  is  what  occurs.   First,  because 
a  business  that  tries  to  absorb  those  kinds  of  costs  isn't  around 
long  (and  certainly,  there  are  plenty  of  wineries  in  financial 
trouble).   Second,  with  the  recession  and  extremely  competitive 
retail  wine  market  that  is  so  price  sensitive,  passing  the  cost 
forward  is  not  realistic.   Therefore,  the  federal  Excise  Tax  is 
passed  back  to  the  grape  farmer.  — 

NAFTA '9  impact 

Just  last  week,  your  Committee  began  hearings  on  the  North 
American  Free  Trade  Agreement  (NAFTA)  and  this  trade  agreement  is 
important  because  winegrape  concentrate  and  grape  juice  is 
produced  in  Mexico. 

One  of  the  concepts  of  the  NAFTA  was  to  revise  the  tariff  and 
non-tariff  barriers  to  permit  the  business  person  with  the 
comparative  advantage  to  excel.   But  a  methyl  bromide  excise  tax 


1654 


will  make  it  more  difficult  for  us  to  compete  against  the  Mexican 
vineyard  industry  as  Mexican  producers  do  not  pay  any  tax  on 

methyl  bromide. 

U.e.  Industry  Put  at  a  Competitive  DisadvaBtaae 

It  is  estimated  that  over  90  percent  of  U.S.  table  grape  imports 
were  fumigated  with  methyl  bromide  in  1989/1990.   These  grapes 
fill  an  important  niche  in  U.S.  supplies.   For  example,  the 
United  States  imports  table  grapes  from  Chile  when  U.S. 
production  is  zero  or  near-zero.   In  1989/1990,  during  the  months 
when  table  grapes  fumigated  with  methyl  bromide  arrived  in  the 
United  States,  they  represented  over  50  percent  of  total  U.S. 
supplies. 

U.S.  growers  will  be  unable  to  compete  in  the  domestic  or 
international  market  if  this  tax  is  imposed. 

Our  industry  is  well  aware  of  the  need  to  find  an  alternative  to 
methyl  bromide.   I  would  hope  that  members  of  this  Subcommittee 
would  understand  that  the  imposition  of  an  excise  tax  on  this 
critical  production  tool  will  destroy  our  industry's  ability  to 
be  competitive;  will  not  raise  significant  revenue  for  the 
national  treasury;  and  will  penalize  our  4,000  grape  growers, 
most  off  whom  are  small,  independent  farmers  already  struggling 
from  the  529%  wine  excise  tax  increase  just  imposed  in  1991. 

While  we  understand  the  impetus  behind  the  proposed  tax,  our 
industry  is  already  working  with  researchers  to  try  to  find  an 
alternative,  but  that  takes  time.   The  proposed  tax  will  only 
serve  to  take  away  from  the  resources  available  to  allocate  to 
research.   Please  keep  in  mind  that  our  grape  growers  must  remain 
profitable  for  any  of  the  research  and  tax  income  to  be  realized. 

Any  change  in  the  current  policy  on  methyl  bromide  must  be  based 
on  sound  science.   There  are  too  many  unknowns  with  regard  to 
methyl  bromide's  impact  on  the  environment,  and  therefore,  more 
research  is  needed.   It  concerns  me  that,  while  EPA  has  not  yet 
listed  methyl  bromide  for  phase-out,  this  Subcommittee  is 
preparing  to  supersede  EPA's  decision  making  process  and  tax 
methyl  bromide  as  if  it  were  a  proven  ozone-depletor . 

We  have  assisted  EPA  and  USDA  in  their  efforts  to  find  an 
alternative,  and  we  will  continue  to  do  so  in  the  future. 
Members  of  the  Subcommittee  must  understand  that  taking  money  out 
of  industry's  pockets  will,  in  all  likelihood,  delay  the 
discovery  of  an  effective  alternative. 

Thank  you  again,  Mr.  Chairman,  for  the  opportunity  to  testify 
here  today. 


1655 

Chairman  Rangel.  Thank  you.  Your  argument  is  persuasive. 
This  is  not  in  the  Montreal  Protocol  nor  is  it  listed  as  a  dangerous 
drug  anywhere?  It  is  just 

Mr.  Hartzell.  As  I  understand,  in  the  Montreal  Protocol  it  is 
scheduled  for  phaseout  by  the  year  2000,  if  I  am 

Chairman  Rangel.  What  was  the  scientific  basis  for  that  deci- 
sion? 

Mr,  Hartzell.  I  am  not  aware  of  that.  I  am  not  that  deep  in  the 
subject. 

Cfhairman  Rangel.  But  you  have  to  become  aware  of  it? 

Mr.  Hartzell.  Yes,  but  I  don't  know  the  scientific  basis  for  the 
Montreal  Protocol. 

Chairman  Rangel.  So,  therefore,  you  cannot  challenge  it? 

Mr.  Hartzell.  I  can't  answer  your  question,  is  what  I  am  saying. 

Chairman  Rangel.  Do  you  know  whose  bill  this  is,  Mr.  Thomas? 

Mr.  Thomas.  I  do  not. 

Chairman  Rangel.  You  don't  know  who  is  the  advocate  of  this 
bill  you  are  challenging;  do  you? 

Mr.  Hartzell.  I  understand  it  was  advocated  by  Congressman 
Pete  Stark. 

STATEMENT  OF  JOSEPH  C.  MacILVAINE,  CHAIRMAN  OF  RE- 
SEARCH, CALIFORNIA  PISTACHIO  COMMISSION;  AND  PRESI- 
DENT, PARAMOUNT  FARMING  CO.,  BAKERSFIELD,  CALIF.,  ON 
BEHALF  OF  THE  WESTERN  GROWERS  ASSOCIATION  AND 
WESTERN  PISTACHIO  ASSOCIATION 

Chairman  Rangel.  Mr.  Macllvaine. 

Mr.  MacIlvaine.  Grood  morning,  Mr.  Chairman,  members  of  the 
subcommittee.  My  name  is  Joe  Macllvaine  and  I  am  appearing 
today  on  behalf  of  the  Western  Growers  Association  and  Western 
Pistachio  Association. 

In  my  private  life,  I  am  the  president  of  Paramount  Farming  Co. 
which  g^ows  almonds,  citrus,  olives,  pistachios,  and  other  crops  in 
the  San  Joaquin  Valley. 

Western  Growers  Association  membership  is  involved  in  the  pro- 
duction of  every  type  of  fruit,  vegetable,  and  nut.  The  proposed  no- 
tice that  methyl  bromide  may  be  listed  as  a  potential  ozone 
depleter  came  as  a  real  shock  to  our  membership.  Today,  methyl 
bromide  stands  as  the  only  fumigant  to  combat  and  control  pests 
on  numerous  crops,  both  for  preplant  soil  fumigation  and 
postharvest  purposes. 

The  removal  of  the  fumigant  from  the  market,  either  through  an 
excise  tax  or  through  the  Clean  Air  Act,  will  strike  a  devastating 
blow  to  many  sectors  of  the  agricultural  community. 

Growers  of  numerous  crops  in  California  and  Arizona  have  been 
experimenting  with  possible  alternatives  to  methyl  bromide;  how- 
ever, none  come  close  to  performing  as  effectively  as  methyl  bro- 
mide and,  in  fact,  for  many  crops,  there  are  really  no  alternatives. 
It  is  not  a  case  of  attempting  to  hold  onto  a  cheaper  fumigant. 
Study  after  study  has  demonstrated  yields  will  be  impacted  by  up 
to  50  percent. 

When  we  are  attempting  to  make  a  10  percent  return  on  our  in- 
vestment, a  50  percent  loss  in  production  removes  any  prospect  of 
remaining  in  business.  I  urge  the  members  of  this  subcommittee  to 


1656 

study  the  publication  "The  Biologic  and  Economic  Assessment  of 
Methyl  Bromide,"  prepared  by  the  National  Agricultural  Pesticide 
Impact  Assessment  Program,  U.S.  Department  of  Agriculture.  In 
fact,  I  would  urge  the  subcommittee  to  incorporate  this  study  into 
today's  hearing  record.  It  supports  all  the  growers'  contentions  that 
are  made  that  no  available  alternatives  to  methyl  bromide  exist  at 
the  present  time. 

The  list  of  crops  requiring  the  fumigant  both  for  import  and  ex- 
port purposes  is  extensive.  For  example,  a  crop  grown  by  my  com- 
pany, pomegranates,  cannot  be  exported  to  certain  countries  de- 
manding fumigation.  Other  crops  with  a  similar  dilemma  are  apri- 
cots, broccoli,  grapes,  grapefruit,  lemons,  nectarines,  peaches, 
plums,  oranges,  and  walnuts. 

Watermelon,  cited  by  the  Center  for  Science  for  the  Public 
Interest  as  one  of  the  most  nutritious  fruits,  requires  methyl  bro- 
mide for  its  production  at  certain  times  of  the  year  in  California. 
Without  methyl  bromide,  or  with  additional  costs  associated  with 
methyl  bromide,  the  winter  watermelon  industry  could  not  exist 
and  very  likely  would  move  out  of  the  country. 

Another  consequence  of  the  excise  tax  is  its  discriminatory  na- 
ture. For  example,  not  all  soils  are  infested  with  nematodes.  Con- 
sequently, the  farmer  or  rancher  that  has  lands  with  a  nematode 
infestation  will  be  forced  to  either  stop  producing  or  will  pay  a  very 
high  price  for  methyl  bromide. 

In  addition,  some  growers  have  developed  an  export  market,  and 
the  removal  of  methyl  bromide  through  an  excise  tax  would  vir- 
tually eliminate  that  market  for  those  growers. 

In  many  of  our  commodities,  we  are  working  in  partnership  with 
the  Government  to  open  markets  to  U.S.  products  throughout  the 
world.  It  would  be  ludicrous  to  adopt  tax  barriers  within  this  coun- 
try which  would  prevent  our  products  from  entering  these  newly 
opened  markets. 

Speaking  just  briefly  on  the  subject  of  pistachios,  there  are  in  the 
world  today  two  major  producers  of  pistachios,  the  United  States 
and  Iran,  and  although  Iranian  pistachios  are  currently  excluded 
from  the  United  States  market  and  face  duties  of  approximately 
300  percent,  we  compete  directly  with  Iranian  pistachios  all  around 
the  world,  and  30  percent  of  the  U.S.  crop  is  exported.  The  export 
market  is  very  important  to  the  industry  from  an  economic  point 
of  view. 

Pistachios  require  fumigation  for  export  to  certain  countries, 
some  of  our  most  important  export  destinations,  and  the  taxing  of 
methyl  bromide  would  make  that  export  noncompetitive  with  pis- 
tachios from  Iran. 

I  think  when  the  committee's  economists  review  the  potential 
revenue  from  the  tax  on  methyl  bromide,  we  would  recommend  sev- 
eral considerations: 

Will  the  production  simply  move  out  of  the  country,  to  Mexico, 
for  example?  Will  production  decrease  because  of  the  added  eco- 
nomic burden?  Will  the  export  crop  simply  be  moved  to  another 
country  for  fumigation,  sort  of  a  second  stop  in-between?  Will  the 
excise  tax  cause  the  buyers  to  import  the  crop  instead  of  buying  do- 
mestically grown  product? 


1657 

In  conclusion,  we  urge  the  members  of  this  subcommittee  to  re- 
ject the  methyl  bromide  excise  tax.  The  Clinton  administration  has 
not  designated  the  fumigant  as  an  ozone  depleter,  and  the  action 
by  the  subcommittee  would  be  premature.  Even  in  the  scientific 
community,  there  is  not  consensus  on  the  actual  impact  of  methyl 
bromide  and  additional  research  is  necessary.  Perhaps  this  would 
be  one  subject  that  could  warrant  the  subcommittee's  members  to 
visit  our  growing  areas  in  California  to  gain  firsthand  experience 
on  the  necessity  for  methyl  bromide. 

I  appreciate  your  attention. 

Some  of  you  may  not  be  fully  familiar  with  pistachios  and  I  have 
brought  a  sample  nere  to  submit  for  your  edification. 

Thank  you  very  much. 

[The  prepared  statement  follows:] 


1658 


Testimony  of 

Dr.  Joe  Maellvalne 

on  behalf  of 

Western  Growers  Association 

and 

Western  Pistachio  Association 

Presented  to 

The  House  Ways  and  Means  Committee 

Subcommittee  on  Select  revenue  Measures 

September  23,  1993 

Introduction 

Good  morning  Mr.  Chairman,  members  of  the  Subcommittee. 

My  name  is  Joe  Macllvaine,  and  I  am  appearing  today  on  behalf  of 
Western  Growers  Association  and  the  Western  Pistachio 
Association.   I  appreciate  having  the  opportunity  to  share  WGA's 
and  WPA's  views  on  the  proposed  tax  on  methyl  bromide. 

I  serve  on  the  Board  of  Directors  for  the  Western  Growers 
Association  and  serve  on  the  California  Pistachio  Commission 
where  I  am  the  Chairman  of  the  Research  Committee.   In  my  private 
life,  I  am  the  President  of  Paramount  Farming  Company  which  grows 
almonds,  citrus,  olives,  pistachios  and  other  crops. 

Western  Growers  Association 

The  Western  Growers  Association  represents  over  1,500  growers  and 
shippers  of  fresh  produce  in  California  and  Arizona.   The  members 
of  Western  Growers  produce  approximately  50%  of  the  fresh  fruits 
and  vegetables  grown  in  the  United  States. 

Our  membership  grows  in  excess  of  some  200  horticultural  products 
as  described  in  the  Harmonized  Tariff  System.   Consequently,  my 
testimony  will  focus  on  the  fresh  fruit  and  vegetable  sector  as  a 
whole. 

Methyl  Bromide  in  the  Fresh  Fruit  and  Vegetable  Industries 

WGA  membership  is  involved  in  the  production  of  every  type  of 
fruits,  vegetables  and  nuts.   The  proposed  notice  that  methyl 
bromide  may  be  listed  as  a  potential  ozone  depletor  came  as  a 
real  shock  to  our  membership.   Today,  methyl  bromide  stands  as 
the  only  fumigant  available  to  combat  and  control  pests  on 
numerous  crops  both  for  preplant  soil  fumigation  and  post  harvest 
purposes.   The  removal  of  the  fumigant  from  the  market,  either 
through  an  excise  tax  or  through  the  Clean  Air  Act,  will  strike  a 
devastating  blow  to  many  sectors  of  the  agricultural  community. 

Growers  of  numerous  crops  in  California  and  Arizona  have  been 
experimenting  with  possible  alternatives  to  methyl  bromide; 
however,  none  comes  close  to  performing  as  effectively  as  methyl 
bromide.   This  is  not  the  case  of  attempting  to  hold  on  to  a 
cheaper  fumigant.   Study  after  study  has  demonstrated  yields  will 
be  impacted  by  up  to  50  percent.   When  we  are  attempting  to  make 
a  10  percent  return  on  our  investment,  a  50  percent  loss  in 
production  removes  any  prospect  of  remaining  in  business. 

The  removal  of  methyl  bromide  because  of  a  tax  will  result  in  the 
following: 

production  will  decrease; 

retail  prices  will  increase  significantly;  and 

where  possible  production  will  move  to  another 
nation  such  as  Mexico  where  growers  do  not  face  a 
methyl  bromide  tax. 


1659 


I  urge  members  of  the  Subcommittee  to  study  the  publication,  The 
Biologic  and  Economic  Assessment  of  Methyl  Bromide,  prepared  by 
The  National  Agricultural  Pesticide  Impact  Assessment  Program, 
U.S.  Department  of  Agriculture.   In  fact  I  urge  you  to 
incorporate  the  study  into  today's  hearing  record.   It  supports 
all  the  growers'  contentions  that  there  are  no  available 
alternatives  to  methyl  bromide. 

Fresh  Fruit  and  Vegetable  Industry  Dses  of  Methvl  Bromide 

The  list  of  crops  requiring  the  fumigant  both  for  import  and 
export  purposes  is  extensive.   For  example,  a  crop  grown  by 
Paramount  Farming  Company,  pomegranates,  could  not  be  exported  to 
nations  demanding  fumigation.   Other  crops  with  a  similar  dilemma 
are  apricots,  broccoli,  grapes,  grapefruit,  lemons,  nectarines, 
peaches,  plums,  oranges,  pistachios,  and  walnuts. 

Watermelon,  cited  by  the  Center  for  Scientific  for  the  Public 
Interest  as  one  of  the  most  nutritious  fruits,  requires  methyl 
bromide.   The  winter  watermelon  crop  is  grown  in  Kern,  Imperial 
and  Riverside  Counties  in  California.   This  year,  there  were  over 
1,500  acres  of  winter  watermelon  plantings,  and  in  1994  the 
number  of  acres  is  expected  to  increase  to  1,800.   Historically, 
this  watermelon  crop  is  the  first  planted  and  harvested  in 
California  each  year,  and  it  is  a  forced  planting  when  the 
temperature  is  too  cold  for  open  field  planting. 

Methyl  bromide  is  the  vital  link  that  enables  the  watermelon 
industry  to  plant  early.   To  compensate  for  the  low  winter 
temperatures,  plastic  tarping  (plastic  mulch)  is  used  to  provide 
the  additional  heat  retention  necessary  to  accelerate  maturity. 
The  plastic  mulch  creates  a  greenhouse  effect  which  creates  ideal 
growing  conditions.   Unfortunately,  this  condition  is  also 
perfect  for  weeds,  soil  disease,  and  insects.   For  this  reason, 
prior  to  planting,  the  soil  is  treated  with  methyl  bromide  to 
provide  a  sterile  environment  for  the  crop. 

Without  methyl  bromide  or  with  any  additional  costs  associated 
with  methyl  bromide,  the  winter  watermelon  industry  could  not 
exist  and  will  move  to  Mexico. 

Western  Pistachio  Association 

The  U.S.  pistachio  industry  is  relatively  young.   While 
pistachios  were  first  planted  in  California  in  the  1880s, 
pistachios  were  not  commercially  harvested  until  the  1970s,  and 
the  first  significant  crop  was  not  produced  until  1976.   Since 
that  time,  the  pistachio  industry  has  expanded  to  include 
significant  orchards  in  Arizona,  Nevada,  New  Mexico,  and  Utah. 
And  recently,  growers  have  experimented  with  orchards  in  Texas. 
There  are  approximately  550  pistachio  growers  in  the  U.S.   Our 
industry  has  grown  from  almost  zero  farm  gate  revenue  in  1975  to 
some  $135  million  to  $155  million  in  1992. 

The  Western  Pistachio  Association  is  comprised  of  members  from  16 
states  and  several  foreign  countries.   The  Association  works  to 
ensure  the  economic  vitality  of  the  entire  pistachio  industry. 
Its  goal  is  to  keep  members  informed  of  political  and  legislative 
issues  that  will  impact  the  pistachio  industry  while  protecting 
the  interests  of  the  industry  in  Congress  and  federal  agencies. 

In  the  world  today,  there  are  only  two  major  producers  of 
pistachios  -  the  United  States  and  Iran.   In  1986,  the 
International  Trade  Administration  approved  unfair  trade  action 
duties  of  approximately  300  percent  ad  valorem.   While  we  do  not 
compete  against  Iran  in  the  U.S.  because  of  the  duty  and  a 
Presidential  embargo,  thirty  percent  of  production  is  exported, 
and  we  face  Iran  in  these  export  markets. 


1660 


Pistachio  Industry's  Pse  cf  Methvl  Bromide 

Certain  nations  require  the  imported  pistachios  to  receive  post 
harvest  fumigation.   Methyl  bromide  is  used. 

If  an  excise  tax  is  imposed  on  the  post  harvest  methyl  bromide 
fumigation,  it  will  be  a  severe  penalty  as  U.S.  exports  will  no 
longer  be  allowed  into  one  of  our  most  profitable  markets,  and 
Iran  will  continue  use  methyl  bromide  for  their  pistachio 
exports. 

Methvl  Bromide  Tax  is  an  Inequitable  Solution 

Another  consequence  of  the  excise  tax  is  the  discriminatory 
nature  of  the  excise  tax.   For  example,  not  all  soils  have 
nematodes.   Consequently,  the  farmer  or  rancher  that  has  land 
with  nematode  problems  will  be  forced  either  to  stop  producing 
the  crop  or  pay  a  high  price  for  methyl  bromide.   In  addition, 
some  growers  have  developed  an  export  market;  if  he  or  she  cannot 
use  methyl  bromide  for  the  post  harvest  fumigation  because  of  the 
costs,  then  the  market  will  be  lost  to  another  nation. 

As  we  are  working  to  open  markets  to  U.S.  products  throughout  the 
world,  it  would  be  ludicrous  to  adopt  tax  barriers  within  this 
country  which  would  prevent  our  products  from  entering  these 
newly  opened  markets. 

Tax  will  Hurt  Consumers  Too 

Both  growers  and  consumers  would  be  adversely  affected  by  a  tax 
on  methyl  bromide,  as  the  grower's  costs  will  be  passed  on  to  the 
consumer.   Under  the  proposed  excise  tax  methyl  bromide  would  be 
taxed  on  a  per  pound  basis.   As  we  understand  this  proposal,  in 
1994,  methyl  bromide  would  be  taxed  at  a  rate  of  $3.05  per  pound 
and  $3.75  per  pound  in  1995  and  increased  45  cents  per  pound  each 
year. 

By  the  year  2000,  growers  will  pay  $5.32  per  pound  for  methyl 
bromide.   So  each  year,  we  can  expect  growers  to  pass  this  added 
burden  on  to  the  consumers.   Unfortunately,  this  will  not  always 
be  possible.   Some  industries  will  be  unable  to  pass  the  costs 
along.   Eventually,  this  added  burden  will  force  U.S.  producers 
out  of  these  industries. 

Prospective  Federal  Revenue  from  Excise  Tax 

When  the  Committee's  economists  review  the  potential  revenue  from 
a  tax,  on  methyl  bromide,  we  recommend  several  considerations: 

-  will  the  grower  move  production  to  Mexico; 

-  will  production  decrease  for  the  crop  using  methyl 
bromide ; 

-  will  the  export  crop  be  moved  to  another  nation  for 
fumigation  before  it  is  sent  to  the  nation  requiring 
post  harvest  fumigation;  and 

-  will  the  excise  tax  cause  the  buyers  to  import  the 
crop  instead  of  purchasing  the  domestic  crop  at  a 
higher  price. 

Conclusion 

We  urge  the  members  of  the  Subcommittee  to  reject  the  methyl 
bromide  excise  tax.   The  Clinton  Administration  has  not 
designated  the  fumigant  as  an  ozone  depletor,  and  the  action  by 
the  Subcommittee  would  be  premature.   Even  in  the  scientific 
community  there  is  not  consensus  on  the  actual  impact  methyl 
bromide  has  on  the  environment,  and  additional  research  is 
needed.   Perhaps  this  would  be  one  subject  that  would  warrant  the 
Subcommittee  members  to  visit  our  growing  areas  to  have  a  first 
hand  experience  on  the  necessity  for  methyl  bromide. 


1661 


Furthermore,  the  hidden  tax  to  the  consumer,  a  potential  decrease 
in  crop  production  and  the  decrease  in  exports  are  goals  I  am 
sure  this  Subcommittee  is  not  advocating.   And  lastly,  Mr. 
Chairman,  we  do  not  believe  the  excise  tax  will  reach  your 
revenue  expectations. 

I  appreciate  your  attention.   If  you  have  any  questions.   I  will 
be  happy  to  try  to  answer  them. 


77-130  0-94-21 


1662 

Chairman  Rangel.  Your  doctorate  is  what  discipline? 

Mr.  MacIlvaine.  Actually,  it  is  unrelated  to  my  present  testi- 
mony. I  am  a  Doctor  of  Philosophy  from  MIT  and  my  degree  is  in 
oceanography. 

Chairman  Rangel.  But  the  ozone  depleting  problem,  you  are  just 
saying  it  is  bad  business  to  tax,  really,  pistachios? 

Mr.  MacIlvaine.  No,  it  is  not  just  pistachios,  and  certainly — this 
tax  would  have  a  devastating  economic  impact  on  a  very  broad 
spectrum  of  agricultural  and  forestry  products  throughout  the 
United  States. 

Chairman  Rangel.  But  if,  indeed,  this  chemical  was  put  on  a  list 
where  scientifically  it  was  proven  to  be  dangerous  to  the  ozone, 
then  you  would  have  had  a  different  argument  rather  than  just  the 
tax? 

Mr.  MacIlvaine.  Certainly  my  understanding  is  that  the  subject 
on  the  table  today  is  specifically  this  tax. 

Growers  are  working,  I  might  even  say,  frantically,  to  discover 
alternatives  to  the  use  of  methyl  bromide.  We  understand  methyl 
bromide  faces  challenges  from  a  number  of  different  fronts.  But  our 
point  today  is  that  we  should  not  add  to  those  burdens  with  an  ex- 
cise tax. 

Chairman  Rangel.  Especially  when  the  chemical  has  not  been 
proven  to  have  that  negative  impact. 

Mr.  MacIlvaine.  That  is  correct. 

STATEMENT  OF  JOHN  GUERARD,  AGRONOMIST,  WILLIAM 
BOLTHOUSE  FARMS,  INC.,  BAKERSFIELD,  CALIF.,  REP- 
RESENTING  THE  CALIFORNIA  CARROT  BOARD 

Chairman  Rangel.  Mr.  Guerard. 

Mr.  Guerard.  Mr.  Chairman,  members  of  the  subcommittee,  I 
am  John  Guerard,  and  I  am  appearing  on  behalf  of  the  California 
Fresh  Carrot  Advisory  Board  in  opposition  to  the  proposed  methyl 
bromide  excise  tax. 

The  California  carrot  industry  is  quite  specialized  and  grows  ap- 
proximately 56,000  acres  in  California  12  months  of  the  year, 
which  is  60  percent  of  the  Nation's  production,  with  other  signifi- 
cant carrot-producing  regions  in  Florida  and  Michigan.  The  total 
value  of  the  Nation's  carrot  industry  is  approximately  $320  million. 

The  growing  period  for  carrots  is  approximately  24  weeks  and 
they  are  harvested  mechanically.  Most  of  our  production  is  for 
fresh  consumption  and  for  the  baby-cut  carrots.  Consumers  eat 
about  1.4  million  tons  of  carrots  each  year. 

Chairman  Rangel.  Mr.  Guerard,  the  value  to  America  and  the 
world  about  the  quality  of  carrots,  I  think,  has  been  embedded  in 
us  from  childhood.  I  would  want  you  to  know  I  take  notice  these 
things  go  unchallenged. 

Mr.  Guerard.  Thank  you. 

So,  consumption  has  increased  over  the  years  and  we  expect  that 
to  continue,  especially  as  more  and  more  reports  come  out  about 
the  nutritious  and  health-related  benefits  of  carrots. 

Fresh  carrots  are  available  year-round,  are  inexpensive,  they 
have  little  waste  and  are  easy  to  store.  They  are  low  in  calories  and 
a  good  source  of  fiber  and,  of  course,  they  are  high  in  beta-carotene. 


1663 

Why  is  methyl  bromide  so  essential  for  the  growing  carrots?  It 
is  because  carrots  are  very  sensitive  to  and  attacked  by  plant  para- 
sitic nematodes,  which  are  small  microscopic  worms  found  in  the 
soil  which  damage  the  roots  by  feeding  on  them. 

Today  I  brought  a  few  samples  of  carrots  you  would  normally 
buy  in  the  store  and  that  you  would  have  available  to  you.  I  have 
also  brought — we  just  harvested  a  few  days  ago,  carrots  that  were 
damaged  by  nematodes.  These  are  infected  with  galls  from  root- 
knot  nematodes,  carrots  being  one  of  the  most  sensitive  crops  to 
nematodes. 

These,  by  the  way,  were  fumigated  with  an  alternative  product — 
in  fact,  our  only  alternative  fumigant  to  methyl  bromide — ^and  you 
can  see  it  is  highly  ineffective  as  a  comparative  material. 

[The  prepared  statement  follows:] 


1664 


California 

FRESH  CARROT  Phone:  209/591-5675 

Advisory  Board  Fax:  209/5915744 

531-D  North  Alta  Avenue 
Dinuba.  California  93618 

Testimony  of 

Mr.  John  Guerard 

of  Bolthouse  Farms 

on  behalf  of  the  California  Fresh  Carrot  Advisory  Board 

before  the  House  Ways  and  Means  Committee 

Subcommittee  on  Select  Revenue  Measures 

September  23,  1993 

Introduction 

Good  morning.   I  am  John  Guerard,  and  I  am  appearing  on  behalf  of 
the  California  Fresh  Carrot  Board  in  opposition  to  the  proposed 
methyl  bromide  excise  tax. 

The  California  Fresh  Carrot  Board  is  a  quasi-government 
organization  created  by  state  law.   Its  purpose  is  to  conduct 
education,  market  development,  research,  merchandising,  and 
advertising  on  behalf  of  growers  in  California. 

Description  of  California  Carrot  Industry 

The  California  carrot  industry  grows  carrots  on  approximately 
56,000  acres  twelve  months  a  year,  which  is  60  percent  of  the 
nation's  production  -  with  the  other  significant  production 
regions  in  Florida  and  Michigan.   The  total  value  of  our  nation's 
carrot  industry  is  approximately  $320  million  per  year. 

The  growing  period  is  approximately  24  weeks,  and  the  carrots  are 
harvested  mechanically.   Most  of  our  production  is  for  fresh 
consumption  such  as  whole  or  baby  cut  carrots. 

The  Carrot 

Consumers  eat  some  1.4  million  tons  of  carrots  each  year,  and  we 
expect  this  to  increase  as  more  and  more  consumers  understand  the 
nutritious  and  health  related  benefits  of  carrots.  Fresh  carrots 
are  available  year  round,  are  inexpensive,  have  no  waste,  and  are 
easy  to  store.  Low  in  calories,  they  are  a  good  source  of  fiber, 
potassium,  and  other  minerals  and  are  extremely  high  in  beta- 
carotene. 

Fresh  fruits  and  vegetables  are  an  important  part  of  everyone's 
diet,  but  most  specifically  children's.   Of  all  the  fruits  and 
vegetables,  carrots  are  richest  in  beta-carotene,  the  precursor 
of  vitamin  A.   Children  lacking  sufficient  vitamin  A  are  more 
susceptible  to  infections.   Their  bones  and  teeth  may  not  develop 
properly,  and  their  growth  can  be  retarded.   An  extremely  severe 
vitamin  A  deficiency  in  young  people  can  cause  xerophthalmia  and 
ultimately  blindness.   Insufficient  vitamin  A  is  also  known  to  be 
the  primary  cause  of  blindness  in  American  children.   In  third 
world  countries  the  problem  is  even  worse  and  accounts  for  an 
estimated  80,000  cases  of  childhood  blindness  each  year. 

Vitamin  A  is  also  very  important  for  adults.   Adults  who  lack 
adequate  vitamin  A  provided  by  beta-carotene  may  suffer  from 
night  blindness  and  are  frequently  very  sensitive  to  sunlight 
glare.   Their  fingernails  often  split,  peel  and  become  ridged; 
their  skin  develops  blemishes,  wrinkles,  and  becomes  dry,  while 
their  hair  becomes  dry  brittle  and  dull. 

As  you  can  see  for  yourselves,  our  carrots  are  visibly  appealing. 
However,  I  have  brought  with  me  today  fresh  examples  that  have 
been  attacked  by  nematodes.   These  carrots  are  good  to  eat  but  we 
have  learned  that  for  obvious  reasons  consumers  do  not  find  these 
carrots  appetizing. 


1665 


Methyl  Bromide  Use 

The  carrot  industry  has  used  methyl  bromide  since  Telone  was 
suspended  as  a  pre-plant  soil  fumigant  in  California  in  1989. 
Methyl  bromide  is  applied  once  per  growing  season  at  least  three 
days  before  planting.   The  proposed  dilution  rate  is  300  pounds 
per  acre.   I  can  assure  you  at  $3.05  per  pound,  we  will  not  plant 
carrots  because  this  translates  to  $1,000  per  acre  in  additional 
costs.   At  this  rate  you  will  be  eating  Mexcican  carrots.   Methyl 
bromide  is  only  effective  as  a  pre-plant  fumigant.   No  post- 
planting  treatment  will  effectively  control  pests. 

Despite  the  importance  of  methyl  bromide  to  our  industry,  EPA  has 
only  approved  methyl  bromide  for  use  on  just  over  one-half  of  our 
crop.  After  a  tolerance  is  established,  then  all  the  crop  can  be 
treated  with  methyl  bromide.  Even  with  this  limited  approval,  we 
still  have  problems  treating  our  acreage.  In  1992,  methyl 
bromide  use  was  suspended  for  a  period  of  several  months  to 
conduct  studies. 

The  carrot  industry  has  dedicated  thousands  of  dollars 
researching  alternatives.   I  have  in  my  hand  a  folder  containing 
the  results  of  several  studies  the  carrot  board  has  funded  in  the 
past,  and  still,  we  have  no  effective  alternatives  to  methyl 
bromide. 

In  one  study  completed  this  year,  when  methyl  bromide  was  used, 
the  yield  of  carrots  averaged  3.0  tons  more  than  the  next  best 
alternative. 

Need  for  an  Effective  Fumigant 

The  proposed  methyl  bromide  excise  tax  is  a  real  threat  to  our 
carrot  production  industry.   The  proposal  will  be  the  first 
indirect  excise  tax  of  food.   Yes,  the  consumer  will  not  see  the 
excise  tax  labeled  on  the  carrot  bag,  but  clearly  the  consumer 
will  notice  it  on  the  price  paid  for  carrots. 

Carrot  growers  do  not  have  any  good  alternatives  to  methyl 
bromide,  and  the  tax  would  cause  further  disruption  in  our 
industry.   This  disruption  will  create  an  imbalance  between 
supply  and  demand  and  drive  the  price  to  the  level  that  low 
income  consumers  can  not  afford.   The  excise  tax  will  become  a 
regressive  tax  for  our  low  income  consumers. 

Why  is  methyl  bromide  so  essential  for  the  growing  of  carrots? 
Carrots  are  attacked  by  plant  parasitic  nematodes  which  are 
small,  worms,  round  in  cross  section,  with  smooth,  unsegmented 
bodies,  without  legs  or  appendages.   They  are  invisible  to  the 
naked  eye  but  are  easily  observed  under  the  microscope.   All 
nematodes  have  four  larval  stages  and  a  life  cycle  may  be 
completed  in  3-4  weeks.   Soil  temperature,  moisture,  and  aeration 
affect  the  movement  and  survival  of  nematodes.   Nematodes  move 
very  slowly  through  the  soil.   Their  movement  is  faster  when  the 
pores  are  lined  with  a  thin  film  of  water. 

Nematodes  damage  plants  by  a  secretion  of  saliva  injected  into 
the  plant.   The  nematodes  puncture  the  cell  wall,  inject  saliva 
into  the  cell,  and  suck  part  of  the  cell  contents.   The  feeding 
injures  the  plant  which  results  in  dead  root  tips  and  buds, 
lesion  formation,  swellings,  galls,  and  stinted  foliage  growth. 
In  addition  nematode  damaged  plants  are  susceptible  to  secondary 
plant  diseases.   In  some  cases  an  association  develops  between 
nematodes  and  pathogen  forming  a  diseased  complex. 

Carrot  crops  rely  heavily  on  methyl  bromide  fumigation.   Even  if 
alternative  fumigants  were  used,  without  methyl  bromide,  ten 
percent  of  the  acres  would  need  to  be  rotated  to  other  crops 
losing  three  to  five  years  production.   If  neither  methyl  bromide 
nor  an  alternative  were  available,  one  hundred  percent  of  the 


1666 


treated  acres  would  be  placed  in  rotation,  resulting  in  a  drastic 
cut  in  production  for  three  to  five  years. 

Conclusion 

The  carrot  industry  was  hit  hard  in  1989  when  Telone  was 
suspended  in  California.   We  switched  to  methyl  bromide  which  is 
two  to  three  times  more  expensive  than  Telone.   If  we  are  hit  by 
this  proposed  tax,  methyl  bromide  will  no  longer  be  economically 
practical  to  use.   As  I  stated  above,  without  methyl  bromide,  the 
industry  could  suffer  drastic  production  loss  in  three  to  five 
years. 

We  do  not  understand  the  impetus  behind  this  tax.   Last  year,  56 
million  pounds  of  methyl  bromide  were  used.   If  methyl  bromide  is 
taxed  at  $3.05  per  pound,  revenues  raised  from  this  tax  would 
only  be  $170  million  dollars  per  year.   In  terms  of  a  simple 
cost-benefit  analysis,  the  costs  of  this  tax,  lost  jobs,  lost 
production,  and  higher  prices  at  the  checkout  line,  far  outweigh 
the  benefits.   If  the  food  industry  is  prohibited  from  using 
methyl  bromide,  the  U.S.  Department  of  Agriculture  estimates  a 
$1.4  Billion  loss  just  from  crops  using  fumigation  in  soil  and 
for  importing  purposes.   This  does  not  include  U.S.  Exports. 

We  ask  members  of  the  Subcommittee  to  reconsider  this  tax,  and 
allow  us  to  use  this  money  for  a  more  important  purpose  -  finding 
an  effective  alternative  to  methyl  bromide. 

Thank  you,  Mr.  Chairman. 


1667 

Mr.  Thomas.  Want  to  try  one  of  those,  Mr.  Chairman? 

Chairman  Rangel.  Listen,  I  am  impressed  with  everything,  and 
most  of  all,  before  I  yield  to  Mr.  Thomas,  I  just  wanted  to  make 
it  clear  that  Mr.  Thomas  has  the  ability  to  bring  these  things  in 
very  graphic  scientific,  and  many  times,  lengthy  ways,  to  the  sub- 
committee. 

He  has  already  persuaded  me  this  legislation  is  premature,  and 
I  do  hope  you  know  that  there  are  some  questions  about  the  impact 
this  chemical  has  on  the  environment.  And  so,  therefore,  we  all 
should  do  what  we  can  to  find  alternatives. 

But,  meanwhile,  if  the  scientists  reach  a  conclusion,  then  you 
know  that  we  probably  will  treat  it  the  same  way  we  do  others.  But 
until  it  is  involved  in  a  protocol,  until  there  is  evidence  to  show  the 
damage,  I  really  don't  see  why  we  should  report  this  to  the  fiill 
committee. 

And  now  I  yield  to  Mr.  Thomas. 

Mr.  Thomas.  Thank  you,  Mr.  Chairman. 

The  graphic  nature  of  the  carrot  is  obvious  once  you  understand 
that  when  Mr.  Hartzell  talked  about  the  roots  of  the  grapevine, 
and  Mr.  Macllvaine  talked  about  the  roots  of  the  pistachio  and 
other  products,  that  our  friend,  the  carrot,  is,  in  fact,  the  root  and, 
therefore,  you  see  the  kind  of  damage  that  is  done  very  graphically. 

Chairman  Rangel.  We  are  moving  ahead  swiftly  on  this,  I  can 
see. 

Mr.  Thomas.  And,  in  conclusion,  Mr.  Chairman,  the  root  of  the 
problem  is  that  without  conclusive  scientific  evidence,  and  with  the 
enormous  economic  impact  of  the  loss  of  methyl  bromide,  I  appre- 
ciate the  chairman's  understanding  that  we  should  not  move  for- 
ward until  there  is  clear — clear — scientific  evidence. 

The  industry  is  working  night  and  day  to  find  reasonable  alter- 
natives, but  to  move  an  excise  tax  now  because  someone  thinks  it 
is  a  good  idea,  in  fact,  validates  some  of  the  silly  decisions  that 
were  made  earlier. 

Once  we  have  sufficient  scientific  basis,  we  then  also,  in  my  opin- 
ion, still  need  to  weigh  the  economic  damage,  if  we  do  not  have  a 
substitute  for  methyl  bromide.  I  think  you  will  find  it  is  far  down 
the  list  in  terms  of  environmental  damage.  It  is  at  the  top  of  the 
list  in  terms  of  our  ability  to  compete  economically  in  the  agricul- 
tural world. 

I  thank  the  chairman  for  his  wisdom. 

Chairman  Rangel.  Well,  let  me  thank  the  panelists  and — off  the 
record. 

[Discussion  off  the  record.] 

Chairman  Rangel.  Thank  you  very  much. 

Panel  three  consists  of  National  Realty  Committee,  Stefan  F. 
Tucker,  counsel;  Chicago  Title  and  Trust  Company,  Wycklifife 
Pattishall;  John  W.  Lee,  professor  of  law,  College  of  William  & 
Mary,  Howard  Levine,  managing  partner,  Roberts  &  Holland  here 
in  Washing^n. 

We  do  change  subjects  fast. 

Suppose  we  start  with  Mr.  Tucker. 


1668 

STATEMENT  OF  STEFAN  F.  TUCKER,  COUNSEL,  TUCKER, 
FLYER  &  LEWIS,  ON  BEHALF  OF  THE  NATIONAL  REALTY 
COMMITTEE 

Mr.  Tucker.  Good  morning.  Thank  you  very  much,  Mr.  Chair- 
man and  staff. 

I  am  Stefan  Tucker.  I  am  a  member  of  the  law  firm  of  Tucker 
Flyer  &  Lewis,  in  Washington,  D.C.  I  am  tax  counsel  to  the  Na- 
tional Realty  Committee. 

By  way  of  analogy  from  real  estate  to  the  agricultural  products 
you  have  just  seen,  I  would  point  out  until  the  Tax  Reform  Act  of 
1986,  real  estate  was  considered  a  24-karat  investment.  Unfortu- 
nately, that  has  changed  over  the  past  few  years. 

The  National  Realty  Committee  is  the  real  estate  roundtable  in 
Washington  on  national  issues  affecting  real  estate.  Its  members 
are  America's  principal  commercial  and  multifamily  real  estate 
owners,  advisers,  builders,  investors,  lenders,  and  managers. 

The  proposal  that  we  are  focusing  on  today  is  to  impose  upon  the 
present  rules  of  like-kind  exchanges,  the  similar  or  related  in- 
service,  in-use  rule  of  1033-A  of  the  Internal  Revenue  Code  apply- 
ing generally  to  involuntary  conversions. 

I  would  recall  the  fact  that  in  1958,  the  Senate  Small  Business 
Committee  on  behalf  of  the  Nation's  small  business,  introduced  an 
act,  that  ultimately  became  a  1958  Tax  Act,  that  brought  into  the 
Internal  Revenue  Code  Section,  1033-G  of  the  Internal  Revenue 
Code  with  regard  to  involuntary  conversions  or  condemnations  of 
real  estate,  that  said  that  you  would  have  the  same  like-kind  provi- 
sions as  to  involuntary  conversions  or  condemnations  that  we  now 
have  in  other  like-kind  exchanges  under  section  1031. 

It  is  interesting  to  see  there  is  now  a  proposal  to  move  from  the 
straightforward  simplicity  of  section  1031  for  like-kind  exchanges, 
into  the  difficult  and  extraordinary  situations  that  result  into  a  lot 
of  litigation  under  section  1033-A,  as  to  what  is  or  may  be  similar 
or  related  in  service  or  use. 

The  Treasury  Department,  we  are  pleased  to  note,  opposed  this 
particular  provision  on  the  basis  that  the  administration  is  not  per- 
suaded that  there  is  presently  any  need  to  revise  the  standard 
based  on  the  use  of  property  received  in  exchange  of  like-kind  prop- 
erty for  determining  whether  property  exchanges  qualify  for  tax  de- 
ferral. We  agree  with  the  Treasury  Department  in  this  context. 

The  concept  of  similar  or  related  in  service  or  use  is  a  far  nar- 
rower provision  that  focuses  on,  with  respect  to  an  investor,  the 
kind  of  services  that  go  into  the  property,  and  with  respect  to  an 
owner-user,  the  kind  of  use  that  goes  into  a  property,  and  has  re- 
sulted, under  section  1033-A,  in  a  number  of  what  we  see  as  ex- 
tremely strange  rulings  of  the  Internal  Revenue  Service  that  have, 
at  times,  had  to  have  been  reversed  by  the  courts  in  terms  of  this. 

For  example,  in  1976,  in  Revenue  Ruling  76-319,  there  was  a  bil- 
liards center  that  had  been  reinvested  in  by  a  taxpayer,  which  had 
a  lounge.  And  they  had  invested  the  proceeds  from  a  fire  on  a  bowl- 
ing center,  which  likewise  had  a  lounge.  And  the  Internal  Revenue 
Service  said  that  a  billiards  center  and  a  bowling  center  simply  are 
not  similar  or  related  in  service  or  use. 

In  1970,  the  Internal  Revenue  Service  focused  on  a  hotel  that 
had  been  destroyed  by  fire.  Revenue  Ruling  70-399.  The  hotel  had 


1669 

been  subject  to  a  net  lease.  When  it  was  rebuilt  with  the  proceeds 
from  insurance,  they  then  did  the  hotel  as  an  owner-operator  hotel. 

The  holding  of  the  Internal  Revenue  Service  was  this  was  not 
similar  or  related  in  service  or  use  because,  on  the  one  hand,  it  had 
been  net  leased  and,  on  the  other  hand,  it  had  been  owner- 
operated. 

Now,  we  all  can  get  around  these  kinds  of  things  if  we  want  to 
,0  through  the  intricacies  of  getting  around  them  and  result  in  a 
ot  of  audit  issues  and  a  lot  of  litigation  and  a  lot  of  misuse  of  the 
courts  for  what  ought  not  to  be  used.  But  we  think  that  the  present 
standard,  which  encourages  like-kind  exchanges,  which  results  in 
some  one  or  more  parties  in  the  chain  resulting  in  recognition  of 
income  from  the  trading  or  selling  of  property  ought  to  be  retained. 

And  with  that,  I  thank  you  for  your  time. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


i 


1670 

STATEMENT  OF  NATIONAL  REALTY  COMMITTEE 

TO  THE  SUBCOMMTITEE  ON  SELECT  REVENUE  MEASURES 

COMMTITEE  ON  WAYS  &  MEANS 

REGARDING 

PROPOSAL  TO  RESTRICT  LIKE-KIND  PROPERTY  EXCHANGES 

September  23, 1993 


My  name  is  Stefan  F.  Tucker  and  I  am  a  stockholder  in  the  law  firm  of 
Tucker,  Hyer  &  Lewis  in  Washington,  D.C.  I  am  pleased  to  have  the  ooportunity  to 
present  testimony  today  on  behalf  of  National  Realty  Committee  (NRC)  regarding  a 
proposed  revision  to  the  rules  relating  to  tax-deferred  real  property  exchanges. 
NRC  serves  as  Real  Estate's  Roundtable  in  Washington  on  national  issues  affecting 
real  estate.  Its  members  are  America's  principal  commercial  and  raultifamily  real 
estate  owners,  advisors,  builders,  investors,  lenders  and  managers. 

Summary 

When  Congress  authorized  non-recognition  of  gain  or  loss  on  property 
exchanges  in  1924,  it  did  so  because  of  a  desire  not  to  impose  a  tax  on  a  theoretical 
gain  where  a  taxpayer  continued  his  investment  in  a  "like-kind"  property.  In 
addition,  Congress  recognized  that  severe  administrative  burdens  would  result  if  all 
property  exchanges  had  to  be  evaluated  to  ensure  that  each  property  precisely 
matched  the  other.  We  believe  that  these  concepts  remain  sound  policy 
considerations  today  and  we  support  retention  of  the  current  law. 

The  proposal  before  the  Committee  would  replace  the  current  law  "like- 
kind"  standard  with  a  much  narrower  "similar  or  related  in  service  or  use"  standard. 
The  proposed  standard  is  the  one  now  used  in  determining  whether  a  tax  is  imposed 
on  the  reinvested  proceeds  received  from  an  involuntary  conversion  (e.g.,  property 
destruction  or  theft).  Tias  standard  is  appropriate  in  cases  of  involuntary  conversion 
because  in  such  cases  cash  proceeds  have  oeen  provided  to  the  taxpayer  and  the 
taxpayer  has  direct  control  over  their  reinvestment.  However,  to  apply  this  standard 
to  all  property  exchanges,  as  is  proposed,  where  the  taxpayers  do  not  receive  cash 
proceeds,  would  eliminate  many  economically  beneficial  exchanges  of  commercial 
and  residential  real  estate,  farms,  ranches,  small  business  real  estate,  parks, 
timberlands,  mineral  interests  and  other  types  of  real  property. 

The  proposed  "similar  or  related  in  service  or  use"  standard  represents  a 
significant  narrowing  of  the  types  of  exchanges  which  would  qualify  for  tax  deferral. 
For  owners  who  use  their  property,  it  would  require  that  both  the  physical 
characteristics  and  the  end  uses  of  the  two  properties  be  closely  similar  to  qualify. 
For  owners  who  lease  their  property,  the  "similar  use"  rules  require  a  close 
examination  of  the  nature  of  the  taxpayer's  relation  to  the  properties.  This  would 
present  severe  administrative  difficulties  and  taxpayer  uncertainty.  It  is  interesting 
to  note  that  the  proposed  "similar  use"  standard  is  one  which  existed  previously  for 
cases  involving  condemnations  of  real  property.  Because  of  the  administrative 
difficulties  it  posed  for  the  Internal  Revenue  Service  and  because  it  resulted  in 
significant  taxpayer  unfairness.  Congress  modified  and  liberalized  the  "similar  use" 
standard  for  condemnations  in  1958  to  reflect  the  like-kind  concept 

Taxing  exchanges  which  meet  a  "like-kind"  but  not  a  "similar  use"  standard 
would  result  m  taxing  phantom  income  because  no  cash  is  received  in  the  exchange 
to  pay  the  tax  -  such  a  result  would  be  grossly  unfair  to  taxpayers.  Most  exchanges 
simply  would  not  go  forward  if  they  were  taxed  as  such;  therefore,  the  proposal  v^all 
not  increase  Federal  revenue  by  the  amount  projected.  Additionally,  taxable 
transactions  now  affiliated  with  multi-party  excnanges  would  in  many  cases  be 
discouraged  because  the  affiliated  exchange  would  riot  be  undertaken. 

The  balance  of  my  statement  presents  a  synopsis  of  current  law  regarding 
like-kind  property  exchanges,  explains  the  proposal  to  narrow  current  law  and 
presents  several  reasons  and  examples  why  current  law  should  be  maintained. 


1671 


Current  Like-Kind  Exchange  Rules 

Since  1924  Congress  has  recognized  that  gain  or  loss  should  not  be  taxed 
currently  when  property  held  for  productive  use  in  a  trade  or  business,  or  for 
investment,  is  exchanged  solely  for  property  of  a  like-kind  (Internal  Revenue  Code 
section  1031).  The  reason  for  this  rule  is  that  Congress  appropriately  determined 
that  taxpayers  exchanging  like-kind  property  have  not  altered  the  level  or  type  of 
their  investment  and  therefore  the  economic  position  of  the  taxpayer  has  not 
changed.  Additionally,  because  an  exchange  of  like-kind  property  is  exactly  that,  no 
cash  IS  generated  to  pay  a  current  tax. 

The  key  concept  underlying  these  rules  is  the  requirement  that  the  property 
exchanged  and  that  received  be  ofa  "like-kind."  The  like-kind  standard  refers  to  the 
nature  or  character  of  the  propertv.  not  to  its  grade  or  quality.  For  example, 
improvements  on  real  estate  relate  to  its  grade  or  quality,  not  to  its  character  as  real 
estate.  Therefore,  unimproved  real  property  may  qualify  as  like-kind  to  improved 
property.  In  addition  to  looking  to  tne  nature  or  character  of  the  exchanged 
properties,  the  BRS  also  seeks  to  ensure  that  the  rights  created  in,  and  to,  the 
properties  are  not  substantially  different  Under  this  standard,  an  assignment  of  oil 
payments  and  an  interest  in  real  estate  are  not  like-kind.  That's  as  it  should  be. 

Finally,  to  ensure  that  abuse  does  not  occur,  current  law  specifically  excludes 
certain  types  of  property  (e.g.,  partnership  interests),  requires  that  the  property  to 
be  received  in  an  exchange  be  identified  within  45  days,  and  mandates  that  the 
exchange  be  completed  within  180  days  following  the  original  transfer. 

Although  the  general  current  law  rule  is  that  no  gain  is  taxed  when  like-kind 
property  is  exchanged,  in  many  transactions  there  are,  in  fact,  taxes  paid.  This 
occurs  because  cash  or  other  non-like-kind  property  (boot)  received  in  the  exchange 
is  subject  to  current  taxation  if  such  boot  exceeds  the  adjusted  basis  of  the  property 
transferred.  Importantly,  boot  may  also  include  mortgage  debt  liability  which  is 
assumed  by  the  party  receiving  the  property  in  an  exchange.  Therefore,  to  the 
extent  that  a  taxpayer  has  received  non-like-kind  property  in  an  exchange,  the 
existing  rules  require  current  taxation. 

Moreover,  often  there  are  taxable  sales  which  occur  before,  and  in 
anticipation  of,  a  qualifying  like-kind  exchange.  In  such  multi-party  transactions,  a 
party  on  one  end  of  the  transaction  is  purchasing  property  to  be  exchanged  for 
property  that  is  like-kind.  This  happens  when  the  owner  of  like-kind  property  will 
not  sell  but  will  exchange  only  because  of  the  high  tax  cost  of  selling. 

The  Proposal  and  Why  It  Should  Be  Rejected 

The  proposal  which  is  the  subject  of  today's  hearing  would  significantly 
narrow  the  range  of  transactions  qualifying  for  tax-tree  treatment  by  replacing  the 
section  1031  "like-kind"  standard  with  the  "similar  or  related  in  service  or  use" 
standard  now  used  under  section  1033  in  determining  the  taxation  of  proceeds  that 
are  received  from  an  involuntary  conversion  and  reinvested. 

We  believe  that  the  current  like-kind  exchange  rules  are  fundamentally 
sound  and,  for  the  following  reasons,  we  support  retention  of  current  law. 

Current  law  is  non-abusive  and  should  be  maintained.  The  current  rules 
permitting  deferral  of  tax  in  a  like-kind  exchange  exist  because  a  taxpayer  who 
exchanges  like-kind  property  has  not  altered  the  level  or  type  of  its  investment,  and, 
therefore,  the  economic  position  of  the  taxpayer  has  not  changed.  These  rules  have 
worked  well  for  over  60  years.  Their  flexibility  has  helped  enable  all  manner  and 
kind  of  productive  exchanges,  from  single  family  rental  homes  to  large  multi-user 
rental  properties,  from  farm  or  ranch  property  to  large  unimproved  tracts  of  real 
property.  For  example,  the  rules  have  helped  park  management  programs  obtain 
unimproved  property  adjacent  to  parks  by  offering  developed  property  in  exchange. 
Farmers  and  ranchers  otherwise  faced  with  once-in-a-litetime  capital  gains  taxes 
have  retired  and"  exchanged  their  farm  or  ranch  property  for  property  that  could 
provide  retirement  income.  Many  of  these  beneficial  transactions  would  be 
curtailed  under  the  proposal  to  restrict  exchange  transactions. 


1672 


The  proposed  'similar  or  related  in  service  or  use  standard"  should  be  rejected 
because  it  is  too  narrow.  A  "similar  or  related  in  service  or  use"  standard  represents  a 
significant  narrowing  of  the  types  of  exchanges  which  will  Qualify  and  produces 
results  which  are  simply  unfair  to  taxpayers.  It  is  the  one  which  must  be  met  under 
current  IRS  section  1033  to  assure  deferral  of  gain  when  the  cash  proceeds  from  an 
involuntary  conversion  are  reinvested.  It  would  clearly  disallow  exchanges  of  raw 
land  for  developed  real  estate.  Thus,  owners  of  ummproved  real  estate  facing 
extremely  high  selling  costs  would  not  be  encouraged  to  put  the  land  to  productive 
use  through  an  exchange  for  existing  income-producing  property,  and  park 
managers  would  not  be  able  to  entice  trades  for  unimproved  park  land  by  offering 
developed  property. 

TTie  proposed  standard  would  be  difficult  to  administer  and  would  create 
taxpayer  uncertainty.  The  similar  use  standard  also  would  produce  a  rule  which  is 
administratively  much  different,  depending  on  whether  the  taxpayer  is  an  owner 
who  uses  the  property  or  an  owner  who  leases  the  property. 

It  requires  that,  in  the  case  of  owners  who  use  the  property,  both  the  physical 
characteristics  and  the  end  uses  of  the  two  properties  must  be  closely  similar  to 
qualify  for  deferral.  Under  this  test,  an  owner-occupied  billiard  center  has  been 
ruled  to  not  qualify  as  replacement  for  an  owner-occupied  bowling  center.  The 
standard  also  has  disallowed  replacing  a  owner-managed  motel  with  an  owner- 
managed  mobile  home  park. 

For  owners  who  lease  their  property,  the  "similar  use"  rules  require  a  close 
examination  of  the  nature  of  the  taxpayer's  relation  to  the  properties.  That  is,  are 
the  management  activities  the  same,  are  the  amount  of  the  kmd  of  services  rendered 
to  tenants  the  same,  and  are  the  business  risks  the  same?  Under  this  standard,  a 
leased  restaurant  is  not  similar  to  an  operated  motel,  nor  is  a  building  used  for  bank 
purposes  similar  to  a  building  leased  as  office  space.  There  are  countless  other 
examples  of  why  the  "similar  use"  standard  would  be  unfair,  unworkable  and  would 
thwart  many  exchanges  currently  qualifying  as  like-kind. 

The  bulk  of  the  revenue  projected  to  be  derived  from  taxing  these  transactions 
will  not  materialize.  If  these  proposed  changes  take  effect,  most  transactions  now 
qualifying  as  "like-kind"  but  not  qualifying  as  "similar  use"  will  not  be  consummated 
either  as  exchanges  or  sales.  In  fact,  revenue  from  taxable  sales  in  the  chain  of  the 
multi-party  transaction  might  be  lost  if  the  ultimate  exchange  no  longer  qualifies  for 
deferral.  Overall,  this  would  result  in  a  chilling  of  real  estate  markets  across-the- 
country  and  lessened  economic  activity  in  the  marketplace. 

"Die  proposed  standard  would  impose  a  tax  on  phantom  income.  Taxing  like- 
kind  exchanges  as  sales  would  result  m  taxing  phantom  income.  Since  any  cash 
received  in  a  like-kind  exchange  is  already  subject  to  tax  under  current  law,  and  no 
other  cash  is  received  for  the  property  exchanged,  insufficient  fiinds  are  generated 
with  which  to  pay  any  additional  tax  required  under  this  proposal.  Moreover,  if  the 
taxpayer  borrows  against  the  property  to  satisfy  the  tax  liability,  the  interest  on  the 
borrowed  amount  is  non-deductible. 

Conclusion 

The  proposal  to  restrict  the  types  of  transactions  qualifying  for  tax-free  status 
by  replacing  the  current  law  "like-kind"  standard  with  a  "similar  or  related  in  service 
or  use"  standard  should  be  rejected.  It  is  unnecessary  as  there  are  no  examples  of 
abuse  under  current  law.  The  proposal  would  be  administratively  very  difficult  for 
the  IRS  to  implement.  It  would  undermine  taxpayer  confidence  and  compliance 
with  the  tax  system  and  it  would  halt  many  economically  beneficial  property 
exchanges  that  otherwise  would  occur. 

Enactment  of  this  proposal  would  be  inconsistent  with  the  steps  taken  this  past 
summer  by  this  Committee  and  Congress  in  the  Tax  Act  of  1993  to  rationalize  the 
tax  treatment  of  real  estate  -  an  important  sector  of  the  economy,  the  stability  and 
efficiency  of  which  is  key  to  our  national  economic  recovery  and  growth. 

Thank  you  for  the  opportunity  to  present  testimony  to  the  Committee  on  this 
important  issue.  National  Realty  Committee  is  prepared  to  respond  to  any 
questions  regarding  this  issue. 


1673 

STATEMENT  OF  B.  WYCKLIFFE  PATTISHALL,  JR.,  VICE 
PRESroENT,  CHICAGO  TITLE  &  TRUST  CO. 

Chairman  Rangel.  Mr.  Pattishall. 

Mr.  Pattishall.  Mr.  Chairman,  members  of  the  committee  and 
staff,  I  am  \^^'ck  Pattishall,  a  businessman  vice  president  of  Chi- 
cago Title  &  Trust  Co.,  parent  of  the  Nation  s  largest  family  of  title 
insurance  companies. 

The  benefits  to  society  which  result  from  a  public  policy  promot- 
ing the  reinvestment  rather  than  the  consumption  of  the  proceeds 
of  sale  of  capital  assets  have  been  acknowledged  for  centuries. 
Under  feudal  property  systems,  the  proceeds  from  the  sale  of  ap- 
preciated property — usually  land — were  corpus,  or  capital  that  had 
to  be  reinvested  for  the  oenefit  of  remaindermen,  or  those  who 
follow. 

The  gains  were  not  part  of  the  income  interest,  usually  the  har- 
vest from  the  land,  and  could  not  be  consumed.  Well,  such  restric- 
tions rarelv  exist  under  modem  property  law  and  so  the  question 
remains,  if^it  is  good  public  policy  to  foster  the  reinvestment  of  cap- 
ital, how  can  this  policy  be  promoted  and  enforced?  The  like-kind 
exchange  provisions  of  section  1031  promote  exactly  that  type  of  ac- 
tivity and  the  proposal  to  restrict  like-kind  exchanges  to  similar 
use  property  is,  therefore,  not  good  tax  policy. 

The  proposal  inappropriately  discriminates  against  investment  in 
real  estate  at  a  time  when  the  industry  is  struggling  to  recover 
from  the  >yorst  recession  in  four  decades.  While  it  may  be  argued 
that  reducing  the  number  of  nonrecognition  opportunities  is  a  good 
idea,  it  is  inappropriate  to  do  so  with  real  estate. 

The  Tax  Reform  Act  of  1986  exacted  an  enormous  toll  on  real  es- 
tate investment  and  this  contributed  strongly  to  the  national  reces- 
sion and  the  weakness  of  the  current  recovery. 

The  recovery  period  for  depreciation  on  new  nonresidential  real 
estate  was  lengthened  from  15  years  in  1980,  to  18  years  in  1984, 
to  3IV2  years  in  1986,  and  to  39  years  by  the  Omnibus  Budget 
ReconciHation  Act  of  1993.  The  change  made  by  the  1993  Tax  Act 
alone  will  reduce  construction  spending  by  more  than  $3  billion  per 
year  according  to  economists  at  DRI  McGraw-Hill. 

Section  1031  is  merely  one  of  several  nonrecognition  provisions 
which  allow  property  to  be  exchanged  for  other  property  on  a  tax- 
deferred  basis.  For  example,  the  stock  of  a  privately-held  corpora- 
tion can  be  exchanged  on  a  tax-deferred  basis  for  the  stock  of  a 
large  publicly  held  corporation. 

Tnere  is  no  reason  to  allow  the  owner  of  a  corporation  to  trade 
his  stock  for  General  Motors'  stock  without  incurring  tax,  but  to  re- 
quire the  owner  of  real  estate  to  pay  tax  if  he  trades  for  other  real 
estate.  Most  people  would  view  the  stock  of  a  publicly  traded  For- 
tune 500  company  as  closer  to  the  equivalent  of  cash  than  any  real 
estate  could  possibly  be. 

There  is  no  guarantee  that  the  proposal  will  result  in  increased 
revenues.  Many  taxpayers  with  appreciated  property  will  not  trade 
or  sell,  instead  preferring  to  obtain  their  profits  through  refinanc- 
ing. And,  furthermore,  most  like-kind  exchanges  actually  increase 
revenues. 

This  is  because  in  the  typical  exchange  the  replacement  property 
is  acquired  in  a  taxable  sale  that  may  have  not  occurred  in  the  ab- 


1674 

sence  of  the  like-kind  exchange.  I  suspect  that  the  proposed  change 
will  result  in  what  economists  call  a  deadweight  loss,  reflecting  a 
cost  imposed  on  some  individuals  without  any  offsetting  benefit  to 
others.  A  pure  economic  inefficiency. 

An  example  of  a  deadweight  loss  was  the  luxury  tax  imposed  on 
airplane  sales  which  the  joint  committee  estimated  would  raise  $6 
million  in  revenue  in  1991.  The  actual  revenues  were  $53,000. 

Applying  the  similar  related  in  service  or  use  test  to  like-kind  ex- 
changes, and  the  like-kind  test  to  condemnations  of  real  property, 
simply  makes  no  sense  at  all. 

When  Congress  first  enacted  le^slation  on  like-kind  exchanges 
in  1921,  it  provided  for  nonrecognition  of  gain  only  when  both  prop- 
erties were  of  the  same  like-kind  or  use.  Congress  amended  the 
test  in  1924,  dropping  the  "or  use"  provisions  and  leaving  the  like- 
kind  provisions,  which  have  remained  in  effect  for  the  last  69 
years.  The  reason  the  use  requirement  was  dropped  was  because 
it  quickly  became  apparent  that  in  order  to  prove  the  use  require- 
ment an  inquiry  must  be  made  to  discover  the  taxpayer's  intention 
at  the  time  of  the  exchange. 

A  taxpayer's  intent  at  a  particular  point  in  time  can  only  be  es- 
tablished Dy  a  close  examination  of  the  facts  in  each  case.  Such  an 
overwhelmingly  fact-based  test  is  not  the  kind  of  legal  standard 
that  lends  itself  to  interpretation  by  regulatory  agencies  or  appel- 
late courts.  If  enacted,  the  proposal  will  result  m  substantial  confu- 
sion, increased  litigation,  reduced  velocity  and  liquidity  in  the  real 
estate  markets  and  probably  no  revenue  gain. 

Thank  you  very  much. 

Chairman  Rangel.  Thank  you. 

[The  prepared  statement  follows:] 


1675 


U.S.  HOUSE  OF  REPRESEhTTATTVES 

WAYS  AND  n/EANS 

SELECT  REVENUE  MEASURES  SUBCOIVMTTEE 

CHARLES  RANGEU  CHAIRMAN 


Septerrber23, 1993 


To  amend  the  like-kind  exchange  rules  under  IRC  Section  1031  to 
require  that  the  replacement  property  be  "similar  or  related  in  service 
or  use"  to  the  property  exchanged,  except  in  the  case  of 
condemnation. 

VMtness:  B.  VWcWiffe  Pattishall,  Jr. 

Vice  President 

Chicago  Title  and  Tnjst  Company 
171  North  Qark  Street 
Chicago,  Illinois  60601-3294 
312-223-2931 

Reconnnervlation:  That  the  proposal  not  k)ecome  part  of  any  bill. 

Testhmy:  I  am  B.  \/\^ckliffe  Pattishall,  Jr. ,  Vice  President  of  Chicago  Title  and 

Trust  Conpany,  parent  of  the  nation's  largest  family  of  title  insurance 
companies. 

I  am  concerned  that  the  proposal  is  not  good  tax  policy  and  will  only 
serve  to  unnecessarily  complicate  an  area  that  so  many,  both  within  the  govemment  and 
outside  the  government,  have  tried  with  some  success  to  simplify  in  the  last  few  years. 
Most  importantly,  I  suspect  that  the  proposed  change  will  result  in  what  econornsts  call 
a  "dead  weight  loss",  reflecting  a  cost  imposed  on  some  individuals  without  any  offsetting 
benefit  to  others  -  a  pure  economic  inefficiency.  An  example  of  a  "dead  weight  loss"  was 
the  luxury  tax  imposed  on  airplane  sales  which  the  Joint  Committee  on  Taxation 
estimated  would  raise  revenues  of  $6  nrillion  in  1 991 .  The  actual  revenues  were  $53,000. 

The  benefits  to  society  which  result  from  a  public  policy  promoting  the 
reinvestment,  rather  than  consumption,  of  proceeds  from  the  sale  of  capital  assets  have 
been  acknowledged  for  centuries.  Under  feudal  property  systems,  the  proceeds  of  sale 
of  appreciated  property,  (usually  land),  were  "corpus"  or  capital  that  had  to  be  reinvested 
for  the  benefit  of  remaindermen.  The  gains  were  not  part  of  the  income  interest,  (usually 
the  han/est  from  the  land),  and  could  not  be  consumed.  Such  restrictions  rarely  exist 
under  modem  property  law,  and  so  the  question  remains;  if  it  is  good  public  policy  to 
foster  the  reinvestment  of  capital,  how  can  this  policy  be  promoted  and  enforced?  The  like 
kind  exchange  provisions  of  Section  1 031  of  the  Code  achieve  exactly  that  goal,  and  the 
proposal  to  restrict  those  provisions  is  not  good  tax  policy. 

Section  1031  is  merely  one  of  several  non-recognition  provisions 
which  allow  property  to  be  exchanged  for  other  property  on  a  tax-deferred  basis.  For 
exanriple,  the  stock  of  a  privately  held  corporation  may  be  exchanged  on  a  tax-deferred 
basis  for  the  stock  of  a  large,  puWidy  traded  corporation.  There  is  no  reason  to  allow  the 
owner  of  a  corporation  to  trade  his  stock  for  General  Motors  stock  without  incurring  tax, 
but  to  require  the  owner  of  real  estate  to  pay  tax  if  he  trades  for  otfier  real  estate.  Most 
people  would  view  the  stock  of  a  publicly  traded  Fortune  500  company  as  closer  to  the 
equivalent  of  cash  than  any  real  estate  could  possibly  be. 

\Nh\\e  it  may  be  argued  that  reducing  the  number  of  nonrecognition 
opportunities  is  a  good  idea,  it  is  inappropriate  to  start  with  real  estate  at  a  time  when  the 
industry  is  struggling  to  recover  from  the  worst  recession  in  four  decades.  The  Tax 
Reform  Act  of  1 986  exacted  an  enomx)us  toll  on  real  estate  investment  which  contributed 
strongly  to  the  national  recession  and  the  weakness  of  the  current  economy.  The  recovery 


1676 


period  for  depreciation  on  new,  non-residential  real  estate  investment  was  lengthened 
from  1 5  years  in  1 980,  to  1 8  yeais  in  1 984,  to  31 .5  years  in  1 986,  and  to  39  years  by  the 
Omnibus  Budget  Reconciliation  Act  of  1993.  The  change  rrade  by  the  1993  Tax  Act 
alone  will  reduce  constnxtion  spendmg  by  more  \han  $i  billion  per  year  according  to 
economists  at  DRI/McGraw  HII.  The  passive  loss  nies,  the  extension  of  the  at-risk  rules, 
the  installment  sales  rules,  and  the  unifomn  capitalization  rules  also  had  a  severe  adverse 
effect  on  the  real  estate  industry. 

There  is  no  guarartee  that  the  proposal  will  result  in  increased 
revenues.  Many  taxpayers  with  appreciated  real  estate  will  not  trade  or  sell,  prefening 
instead  to  obtain  their  profits  by  refinancing.  Furthenrore,  most  like  kind  exchanges 
actually  increase  revenues.  This  is  because  in  the  typical  excharige,  ttie  replacement 
property  is  acquired  in  a  taxable  sale  that  might  net  hiave  occurred  in  \he  absence  of  the 
like  kind  exchange. 

Applying  the  "sinriiar  or  related  in  service  or  use"  test  to  like  kind 
exchanges,  and  thie  "like  kind"  test  to  oorxlennnations  simply  makes  no  sense  whatsoever. 

There  are  two  pragnfBtic  reasons  vt^iy  the  "similar  or  related  in  sen/ice 
or  use"  test  should  not  be  applied  to  IB<e  kind  exchanges.  Rrst,  the  cases  interpreting  the 
similar  use  test  in  the  involuntary  conversion  area  demonstrate  no  dear  doctrine  or  set 
of  guidelines;  the  various  Qraits  have  proposed  four  dfferent  tests,  with  much  debate 
between  the  courts  over  the  content  of  two  of  those  tests.  The  relevance  of  the  physical 
characteristics  of  propaty  field  for  rent^  inoooe  has  never  been  deariy  addressed  by  tfie 
courts,  ensuring  extensive  litigation  if  Congress  adopts  the  proposed  amendment.  Beyond 
\he  unsettled  nature  of  tfie  case  law,  the  proposed  change  \Axxjld  lead  to  increased 
litigation  because  application  of  the  sanTar  use  test  is  unusually  feet-based  and  therefore 
less  sut3ject  to  precedential  authority  developed  by  ttie  courts.  Secondly,  Section  1031 
once  contained  a  'like  kind  or  use"  test  Congress  dropped  the  "or  use"  language 
because  it  found  the  intention  of  the  party  using  ttie  property  is  difficult  to  determine  and 
unfeir  as  a  t)asis  of  tax  liability.  The  passing  yesrs  have  nrade  the  detemination  no 


I.        The  Case  Law  Urvler  IRC  Sedion  1033  DernxGirates  substantial  Unoeitaiiily  in 
the  Application  of  the 'Siriar  or  ReialBd  h  Service  or  Use"  Test 

A.       Six  Ciiaifs  and  the  Iriemal  Revenue  Servioe  ha>«  developed  far  dffeient 
standards  for  application  of  the  sirriar-use  test  to  an  owner-tessor. 

1.  TheSecond,SixHi,  and  Seventti  Circuits,  as  well  as  the  IRS  (Rev  Rul  64- 
237)  apply  tfie  Uant  test:  "a  court  nrust  oonnpare,  inter  alia  the  edent  and  type  of  the 
lessor's  management  activity,  ttie  anount  and  kind  of  sen/ices  rendered  by  him  to  ttie 
tenants,  and  tfie  nature  of  his  business  risks  connected  vwtti  the  properties."  Uant  9  AI=TR 
2d  1557,  1560  (2d  Or.  1962).  The  Service  and  ttie  courts  have  diverged  in  ttieir 
application  of  ttiis  standard. 

2.  Bghtfi  Qrcuit  (Loco  Really  10  AFTR  2d  5359,  5366  (8tti  Or.  1962)):  "(l)t  is 
suffident  if,  coupled  with  ttie  leasehoki  characteristics  of  the  taxpayer's  properties,  tfiere 
is  also  a  reasonable  similarity  in  ttie  leased  prenrised  ttiemselves."  This  standard  does 
not  seem  to  have  tieen  e^ied  in  any  subsequent  cases. 

3.  Ninth  Qrcuit  (HIippini.  11  AFTR  2d  1720, 1722  (9tti  Or.  1963)):  "The  test 
is  a  practical  one.  The  trier  of  fad  must  determine  from  all  tfie  drojnstances  whettier  the 
taxpayer  has  achieved  a  suffident  oortfnuity  of  investment  to  justify  non-recognition  of  ttie 
gain,  or  wtiettier  the  differences  in  ttie  relationsfiip  of  ttie  taxpayer  to  tfie  two  investments 
are  such  as  to  compel  tfie  conduston  ttiat  he  has  taken  advaritage  of  tfie  condemnation 
to  alter  tfie  nature  of  his  investment  for  he  own  purposes." 


1677 


The  Rlippni  court  specified  a  list  of  factors  tiiat  should  be  considered  in 
making  the  determination: 

The  txoad  range  of  the  appropriate  inquiry  is  suggested  t>y 
Liants  enumeration  of  relevant  fectors  as  including  "the  extent 
and  type  of  tfie  lessor's  management  activity,  the  anx)unt  and 
kinds  of  services  rendered  by  him  to  the  tenants,  and  the 
nature  of  his  business  risks  connected  with  the  properties." 
Since  the  essential  inquiry  is  whether  the  taxpayer  has 
committed  the  condemnation  award  to  a  substantially 
equivalent  investment,  the  relevant  facts  include  all  those 
which  \Nodd  influence  an  investor  in  determining  the 
attractiveness  of.  the  respective  uses  for  his  capital;  the 
character  and  location  of  the  particular  properties,  their 
potential  and  actual  employment,  the  state  of  the  market  of 
which  each  is  a  part.  As  Liant  suggests  and  Qiflon  Investment 
errphasizes,  the  relevant  facts  also  include  the  derrands 
vwhich  the  respective  investments  may  make  upon  the 
taxpayer  for  supervision  and  service. 

1 1  AFTR  2d  at  1722  (citations  omitted). 

Fourth  Qrcuit  (Steuart  Bros..  3AFTR  2d  318  (3rd  Or.  1958)):  This  is  thefirst  case  making 
the  owner-use/owner-lessor  distinction.  Steuart  does  not  dearly  articulate  limitations  on 
the  similarity  of  real  property  held  for  rental  income.  Some  later  cas^  understand  Steuart 
to  hold  that  all  rental  properties  are  similar;  other  cases  interpret  Steuart  as  employing  a 
"same  general  dass  test."  See  Part  B(1)  infra. 

B.       The  LfiOOEsal^  and  Stei^lL  tests  are  IherTBelvesiiiciear. 

1.  Steuart  Bros..  3AFTR  2d  318  (3d  Or.  1958), 

Steuart  was  the  first  case  drawing  an  owner-user/owner-user  lessor  distindion,  and 
its  statement  of  the  law  is  ambiguous  as  to  whether  all  rental  properties  are  of  similar  use 
or  whether  the  properties  must  be  in  the  "same  general  dass."  In  Loco  Realty.  10  AFTR 
2d  5359,  5365  (8th  Cir.  1962),  the  court  noted  the  ambiguity  in  Steuart  equally  broadly. 
On  the  other  hand,  McCaffrey.  5AFTR  2d  774  (3d  Qr.  1960),  which  is  the  only  drcuit  to 
apply  tiTe  functional  use  test  to  an  owner-lessor  (a  position  the  Service  rejected  in  1964), 
understood  Steuart  as  creating  the  "same  general  dass"  test.  The  distrid  court  in  Rlippini. 
9AFTR  2d  313(N.D.Ca.  1971),  afPdll  AFTR  2d  1720  (9th  Qr.  1963),  reached  the  same 
condusion.  (The  Ninth  Circuit  rejeded  the  "same  general  dass"  test.) 

The  Pohn  court,  10  AFTR  2d  5780,5782  (7th  Qr.  1962),  reviewed  the  overall 
situation  in  1962,  before  Rlippini  added  yet  another  test,  as  follov\s:  'There  is  a  basic 
difference  of  opinion  between  the  Third  and  Second,  Fourth  and  Bghth  Qrcuits,  and 
among  the  latter  three  there  are  shades  of  difference  in  the  test  applied." 

2.  Loco  Realty 

Loco  Realty's  requirement  of  "reasonable  similarity  of  the  leased  premises"  has 
been  subjed  to  different  interpr^ations  by  two  courts  that  have  dted  it  In  Pohn,  the  court 
interpreted  the  Loco  Realty  test  as  nx)re  restrictive  than  the  Second  Qrcuits  Liant  test, 
asserting  that  "the  (Loco  Realty)  court  avoided  the  extreme  statement  of  the  Steuart  and 
Liant  doctrine  that  both  properties  need  only  qualify  as  investments."  However,  the 
concurring  opinion  in  Qifton  Investment  Co..  11  AFTR  2d  649,  651  (6th  Qr.  1963), 
construed  Loco  Realty  as  more  liberal  than  Liant.  In  his  concurrence,  Judge  Miller  wrote: 

"I  think  that  the  investment  charader  of  the  properties 
involved  should  be  given  more  consideration  than  what  seems 
to  me  is  given  by  ttie  ruling  in  the  Liant  case,  although  I  do 
not  think  that  investment  basis  alone  is  suffident  to  comply 
with  the  statute,  as  Steuart  Brothers.  Inc.  v. 


1678 


might  be  construed  as  holding.  As  pointed  out  in  Loco  Realty 
Co.  V.  Commissioner,  the  statute  was  not  intended  to  penalize 
but  to  protect  persons  whose  property  may  be  taken  on 
condemnation  and,  accordingly,  should  be  construed  liberally. 
I  agree  with  the  standard  adopted  in  the  opinion  in  that  case, 
although  for  our  present  purposes  I  do  not  think  that  it  results 
in  a  reversal  of  the  decision  of  the  Tax  Court. 

M  at  651  (dtations  omitted). 

Judge  Miller  cites  Loco  Realty  here  as  nx»re  liberal  than  the  Jjaot  test,  in  direct 
contradiction  with  the  Pohn  court. 

0.       A  cmdal  issue  regardng  the  siriiar  use  test  remains  indedded 

Unlike  the  functional  use  test  applied  to  an  owner-user,  which  looks  to  the 
property's  physical  characteristics  and  end  uses,  the  Service,  following  Liant,  applies  a 
management  activity  test  to  an  owner-lessor.  As  long  as  both  properties  are  used  by  the 
taxpayer  for  rental  irxxxne,  the  properties  are  of  similar  use  if  they  demand  from  the 
tax|Dayer  the  same  amount  and  kind  of  management  activity,  services  and  relations  to 
tenants,  and  give  rise  to  the  same  business  risks.  This  test  seems  to  completely  disregard 
the  physical  characteristics  of  the  properties.  Indeed,  Johnson,  43  TC  736  (1965), 
permitted  the  replacement  of  improved  farmland  leased  to  a  riding  dub  with  urtian  land 
leased  to  a  gas  station. 

In  conflict  with  this  line  of  reasoning,  a  nunrter  of  courts  seem  to  have 
understood  that  Reg.  Section  1 . 1 033(a)-2(c)(9){i)  applies  to  prevent  even  an  owner-lessor 
from  repladng  unimproved  with  improved  realty.  These  cases  imply  that  similar  use 
requires  similar  physical  characteristics  even  for  an  owner-lessor.  The  unresolved 
question  is  the  extent  to  which  the  character  of  the  property  is  relevant  in  the  case  of  a 
replacement  by  an  owner-lessor. 

D.       TheFlJ[E$i[itestprT7vides1brcase43yKasedectsk]nmakingbylowero^^ 
ensuing  a  substantial  increase  in  litigaliGn  if  this  proposal  is  enacted 

The  Filippini  test  examines  "all  the  drcumstances"  to  reach  an  overall  sense 
of  whether  the  taxpayer  has  maintained  continuity  of  investment.  The  Rlippini  court 
expressly  rejected  any  more  definite  standard.  Any  test  consisting  of  a  broad  survey  of 
the  drcumstances  is  likely  to  be  an  oven«tielmingly  fact-based  exerdse.  However,  the 
Rlippini  court  vwsnt  even  further,  when  in  n.  4,  it  dted  Duberstein,  363  U.S.  278,  279 
(1960): 

Dedsion  of  the  issue  presented  in  these  cases  must  be  based 
ultimately  on  the  application  of  the  fact-finding  tribunal's 
experience  with  the  mainsprings  of  human  conduct  to  the 
totality  of  the  facts  of  each  case.  The  non-technical  nature  of 
the  statutory  standard,  the  dose  relationship  of  it  to  the  data 
of  practical  human  experience,  and  the  multiplidty  of  relevant 
factual  elements,  with  their  various  combinations,  aeating  the 
necessity  of  ascribing  the  proper  force  to  each,  confirm  us  in 
our  condusion  that  primary  weight  in  this  area  must  be  given 
to  the  condusions  of  the  trier  of  fad. 

The  court  thus  expressed  its  condusion  that  the  similar  use  test  is  not  the  kind  of  legal 
standard  that  allows  appellate  courts  to  deariy  guide  the  lower  courts.  Instead,  each  case 
is  different,  with  the  lower  courts  applying  their  experience  "with  the  mainsprings  of  human 
condud  to  the  totality  of  the  case."  This  delegation  to  the  lower  courts  will  substantially 
increase  litigation  if  applied  in  the  context  of  like  kind  exchanges. 


1679 


II.       IRC  Section  1031  Wlas  Amended  To  Remove  the  Use  Test 

In  1921,  when  Congress  first  enacted  the  section  1031  equivalent,  section 
202(c)  provided  for  nonrecognition  when  both  properties  were  of  the  same  like  kind  or 
use.  In  1924,  Congress  amended  the  test  to  "like  kind"  and  its  reasoning  is  particularly 
instnjctive. 

According  to  a  document  entitled  the  "Gregg  Statement"  released  for  publication 
by  Chairman  Green  of  the  House  \Afeys  and  Means  Committee,  and  the  Senate  R nance 
Committee  Report,  (Sen.  Rep.  No.  398,  April  1924),  the  change  was  intended  to  respond 
to  the  contention  that  the  "like  kind  or  use"  test  created  two  classes  of  property:  property 
held  for  investment,  and  property  held  for  productive  use  in  a  trade  or  business. 
Consequently,  it  was  argued,  the  "use"  language  prevented  the  exchange  of  properties 
in  different  classes.  The  Gregg  Statement  and  the  Senate  Report  rejected  this  reliance 
on  use  because  "the  intention  of  the  party  at  the  time  of  the  exchange  is  difficult  to 
determine,  is  sulDject  to  change  by  him,  and  does  not  represent  a  fair  basis  of  detemrining 
tax  liability."  Gregg  Statement  at  11-12;  Sen.  Rep.at  14. 

The  "use"  requirement  was  dropped  because  it  quickly  became  apparent  that  in 
order  to  prove  a  taxpayer's  "use",  an  inquiry  must  be  made  to  discover  tfie  taxpayer's 
intention  at  the  time  of  the  exchange.  A  taxpayer's  intent,  at  a  particular  point  in  time,  can 
only  be  established  by  a  dose  ©camination  of  tfie  facts  in  each  case.  Such  an 
oven«tielmingly  fact  based  test  is  not  the  kind  of  legal  standard  that  lends  itself  to 
interpretation  by  regulatory  agencies  or  appellate  courts. 

If  enacted,  the  proposal  will  result  in  substantial  confusion,  increased  litigation, 
reduced  velocity  and  liquidity  in  the  real  estate  markets,  and  probably  no  revenue  gain. 


1680 

STATEMENT  OF  HOWARD  J.  LEVE^,  MANAGING  PARTNER, 
ROBERTS  AND  HOLLAND,  WASHINGTON,  D.C. 

Chairman  Rangel.  Mr.  Levine. 

Mr.  Levine.  Good  morning,  Mr.  Chairman,  I  am  Howard  Levine, 
partner  with  the  Washington,  D.C.  and  New  York  law  firm  of  Rob- 
erts and  Holland,  which  specializes  only  in  tax  matters.  I  have 
been  practicing  tax  law  for  over  21  years,  the  first  four  with  the 
chief  counsel's  office  of  the  Internal  Revenue  Service.  I  am  also  an 
adjunct  professor  of  tax  law  at  Georgetown  University  Law  School. 

My  interest  in  like-kind  exchanges  spans  my  entire  career  as  a 
lawyer.  Although  I  have  several  clients  who  would  be  affected  by 
this  proposal,  I  have  deep  academic  and  nonclient  professional  in- 
terest as  well,  having  written  extensively  on  the  area  over  the 
years,  including  authoring  the  BNA  Tax  Management  Portfolio 
publication  on  like-kind  exchanges. 

In  addition,  I  have  previously  chaired  the  American  Bar  Associa- 
tion Tax  Section  Subcommittee  on  Like-Kind  Exchanges.  I  now 
chair  the  ABA  Tax  Section's  Sales,  Exchanges  and  Basis  Commit- 
tee, which  has  primary  jurisdiction  over  like-kind  exchanges,  al- 
though I  am  testifying  today  in  my  individual  capacity  and  not  as 
an  officer  of  the  American  Bar  Association. 

I  am  concerned  that  the  proposal  is  not  good  tax  policy  and  will 
only  serve  to  unnecessarily  complicate  an  area  that  so  many,  both 
within  the  Government  and  outside  the  Grovernment,  have  tried 
with  some  success  to  finally  simplify  in  the  last  few  years.  There 
are  basically  two  reasons  for  opposing  application  of  the  similar  use 
test  to  like-kind  exchanges: 

First,  the  cases  interpreting  the  similar-use  test  and  the  involun- 
tary conversion  area  demonstrate  no  clear  doctrine  or  guidelines. 
The  various  circuits  have  proposed  four  different  tests,  with  much 
debate  between  the  courts  over  the  content  of  two  of  those  tests. 
The  relevance  of  the  physical  characteristics  of  property  held  for 
rental  income  has  never  been  clearly  addressed  by  the  courts, 
ensuring  extensive  litigation  if  Congress  adopts  the  proposed 
amendment. 

Beyond  the  unsettled  nature  of  the  case  law,  the  proposed 
changes  would  lead  to  increased  litigation  because  application  of 
the  similar-use  test  is  unusually  fact-based  and,  therefore,  less  sub- 
ject to  precedential  authority  developed  by  appellate  courts. 

Second,  section  1031  once  contained  a  like-kind  or  use  test. 
Congress  dropped  the  "or  use"  language  because  it  found  the  inten- 
tion of  the  parties  using  the  property  is  difficult  to  determine  and 
unfair  as  a  basis  of  tax  liability.  The  passing  years  have  made  the 
determination  no  easier. 

The  gist  of  much  of  my  written  statement,  which  I  will  not  go 
over,  basically  outlines  and  explores  the  various  tests  that  have 
been  adopted  in  the  different  circuits  and  the  conflicting  and  incon- 
sistent positions  that  have  been  adopted  among  those  circuits  and 
how  difficult  it  has  been  to  apply  those  tests. 

A  crucial  issue  regarding  the  similar-use  test  also  remains.  Un- 
like the  functional-use  test  that  has  been  applied  to  an  owner  user, 
which  looks  to  the  property's  physical  characteristics  and  end  uses, 
the  IRS  applies  a  management  activity  test  to  an  owner-lessor.  As 
long  as  both  properties  are  used  by  the  taxpayer  for  rental  income, 


1681 

the  properties  are  of  similar  use  if  they  demand  from  the  taxpayer 
the  same  amount  and  management  activity,  services  and  relations 
to  tenants  and  give  rise  to  the  same  business  risks. 

However,  in  conflict  with  this  line  of  reasoning,  other  courts  have 
understood  that  the  existing  regulations  in  the  involuntary  conver- 
sion area  prevent  even  an  owner-lessor  from  replacing  unimproved 
with  improved  realty.  The  question  left  open,  then,  is  the  extent  to 
which  the  character  of  the  property  is  relevant  in  the  case  of  a  re- 
placement by  an  owner-lessor. 

The  question  is  a  crucial  one.  It  is  particularly  inappropriate  for 
Congress  to  apply  to  transactions  as  common  as  exchanges  a  test 
with  such  an  important  issue  unresolved. 

There  was  also,  as  I  said,  a  prior  amendment  to  section  1031  to 
remove  the  use  test.  In  1921,  when  Congress  first  enacted  the 
equivalent  to  1031,  it  provided  nonrecognition  if  properties  were  of 
the  same  like-kind  or  use.  Congress  specifically  amended  1031  to 
take  out  the  "or  use"  provision  oecause  it  simply  was  unworkable 
and  not  administrate. 

The  passage  of  time  has  made  intent  no  easier  to  determine.  In 
fact,  the  frequency  of  exchanges  today  compound  the  difficulties  of 
applying  the  use  test  with  the  likelihood  that  such  a  test  would 
have  to  he  applied  on  a  regular  basis. 

Congress  should  follow  its  1924  decision  to  provide  for  a  test 
based  solely  on  the  nature  and  character  of  the  property.  There  is 
no  overriding  necessity  to  make  the  proposed  change. 

In  fact,  if  the  change  is  made.  Congress  will  have  to  rethink  leg- 
islation it  has  recently  passed,  and  is  likely  to  pass  in  the  future, 
that  allows  exchanges  of  ancient  forest  and  mineral  rights  held  by 
private  corporations  and  individuals  for  less  ecologically  sensitive 
government-owned  lands.  Unless  there  is  a  special  provision  in  the 
legislation  exempting  those  transactions  from  income  tax,  the 
transferrers  of  the  land  could  not  be  assured  that  the  transactions 
are  not  taxable,  even  though  such  transactions  were  historically 
tax  deferred. 

For  all  of  the  reasons  stated,  as  well  as  the  reasons  stated  in  my 
written  testimony,  I  believe  the  proposed  amendment  should  not 
become  part  of  any  bill.  The  IRS,  Treasury  and  taxpayers  have 
worked  hard  over  the  past  few  years  to  simplify  the  area  of  like- 
kind  exchanges  so  that  not  every  transaction  needs  the  assistance 
of  expensive  tax  lawyers.  The  bill  would  only  serve  to  reverse  this 
trend  and  to  create  substantial  uncertainty. 

Thank  you  for  your  consideration. 

[The  prepared  statement  follows:] 


1682 


U.S.  HOUSE  OF  REPRESENTATIVES 

WAYS  AND  MEANS 

SELECT  REVENUE  MEASURES  SUBCOMMITTEE 

CHARLES  RANGEL,  CHAIRMAN 


September  23,  1993 

Proposal ;      To  amend  the  like-kind  exchange  rules  under  IRC 

§1031  to  require  that  the  replacement  property  be 
"similar  or  related  in  service  or  use"  to  the 
property  exchanged,  except  in  the  case  of  condem- 
nation. 

Witness:       Howard  J.  Levine,  Esq. 
Roberts  &  Holland 
1001  22nd  Street,  N.W. 
Washington,  D.C.    20037 
(202)  293-3400 

Recommendation:     That  the  proposal  not  become  part  of  any 
bill. 

Testimony: 

I  am  Howard  J.  Levine,  a  partner  with  the  Washington, 
D.C.  and  New  York  law  firm  of  Roberts  &  Holland,  which  I  believe 
is  the  largest  law  firm  in  the  country  specializing  only  in  tax 
matters . 

I  have  been  practicing  tax  law  for  over  21  years,  the 
first  four  with  the  Chief  Counsel's  office  of  the  Internal 
Revenue  Service.   I  am  also  an  adjunct  professor  of  tax  law  at 
Georgetown  University  Law  School. 

My  interest  in  like  kind  exchanges  spans  my  entire 
career  as  a  lawyer.   Although  I  have  several  clients  who  would  be 
affected  by  this  proposal,  I  have  deep  academic  and  non-client 
professional  interests  as  well,  having  written  extensively  on  the 
area  over  the  years,  including  authoring  the  BNA  Tax  Management 
Portfolio  publication  on  like  kind  exchanges.   In  addition,  I 
have  previously  chaired  the  American  Bar  Association  Tax  Section 
Subcommittee  on  Like  Kind  exchanges.   I  now  chair  the  ABA  Tax 
Section's  Sales,  Exchanges  and  Basis  Committee,  which  has  primary 
jurisdiction  over  like  kind  exchanges,  although  I  am  testifying 
today  in  my  individual  capacity,  and  not  as  an  officer  of  the 
American  Bar  Association. 

I  am  concerned  that  the  proposal  is  not  good  tax  policy 
and  will  only  serve  to  unnecessarily  complicate  an  area  that  so 
many,  both  within  the  government  and  outside  the  government,  have 
tried,  with  some  success,  to  simplify  in  the  last  few  years. 

There  are  basically  two  reasons  for  opposing  applica- 
tion of  the  similar  use  test  to  like  kind  exchanges.   First,  the 
cases  interpreting  the  similar  use  test  in  the  involuntary 
conversion  area  demonstrate  no  clear  doctrine  or  guidelines;  the 
various  Circuits  have  proposed  four  different  tests,  with  much 
debate  between  the  courts  over  the  content  of  two  of  those  tests. 
The  relevance  of  the  physical  characteristics  of  property  held 
for  rental  income  has  never  been  clearly  addressed  by  the  courts, 
ensuring  extensive  litigation  if  Congress  adopts  the  proposed 
amendment.   Beyond  the  unsettled  nature  of  the  case  law,  the 
proposed  change  would  lead  to  increased  litigation  because 
application  of  the  similar  use  test  is  unusually  fact-based  and 
therefore  less  subject  to  precedential  authority  developed  by 
appellate  courts.   Secondly,  section  1031  once  contained  a  "like 
kind  or  use"  test.   Congress  dropped  the  "or  use"  language 
because  it  found  the  intention  of  the  party  using  the  property  is 


1683 


difficult  to  determine  and  unfair  as  a  basis  of  tax  liability. 
The  passing  years  have  made  the  determination  no  easier. 

I.    The  Case  Law  Under  ^103  3  Demonstrates  Substantial 

Uncertainty  in  the  Application  of  the  Similar  Use  Test. 

A.    Six  Circuits  and  the  IRS  Have  Developed  Four  Different 
Standards  for  Application  of  the  Similar  Use  Test  to  an  Owner- 
Lessor. 

1.  The  Second,  Sixth  and  Seventh  Circuits,  as  well  as 
the  IRS  (Rev.  Rul.  64-237)  apply  the  Liant  test:  "a  court  must 
compare,  inter  alia,  the  extent  and  type  of  the  Lessor's  manage- 
ment activity,  the  amount  and  kind  of  services  rendered  by  him  to 
the  tenants,  and  the  nature  of  his  business  risks  connected  with 
the  properties."   Liant  9  AFTER  2d  1557,  1560  (2d  Cir.  1962). 
The  Service  and  courts  have  diverged  in  their  application  of  the 
standard. 

2.  According  to  the  Eighth  Circuit  fLoco  Realtv  10 
AFTR  2d  5359,  5366  (8th  Cir.  1962)):  "[I]t  is  sufficient  if, 
coupled  with  the  leasehold  characteristic  of  the  taxpayer's 
properties,  there  is  also  a  reasonable  similarity  in  the  leased 
premises  themselves."   This  standard  does  not  seem  to  have  been 
applied  in  any  subsequent  cases. 

3.  According  to  the  Ninth  Circuit  (Filippini.  11  AFTR 
2d  1720,  1722  (9th  Cir.  1963)):  "The  test  is  a  practical  one. 
The  trier  of  fact  must  determine  from  all  the  circumstances 
whether  the  taxpayer  has  achieved  a  sufficient  continuity  of 
investment  to  justify  non-recognition  of  the  gain,  or  whether  the 
differences  in  the  relationship  of  the  taxpayer  to  the  two 
investments  are  such  as  to  compel  the  conclusion  that  he  has 
taken  advantage  of  the  condemnation  to  alter  the  nature  of  his 
investment  for  his  own  purposes." 

The  Filippini  court  specified  a  list  of  factors  that 
should  be  considered  in  making  the  determination: 

The  broad  range  of  the  appropriate  inquiry  is 
suggested  by  Liant 's  enumeration  of  relevant  factors  as 
including  "the  extent  and  type  of  the  lessor's  manage- 
ment activity,  the  amount  and  kind  of  services  rendered 
by  him  to  the  tenants,  and  the  nature  of  his  business 
risks  connected  with  the  properties."   Since  the 
essential  inquiry  is  whether  the  taxpayer  has  committed 
the  condemnation  award  to  a  substantially  equivalent 
investment,  the  relevant  facts  include  all  of  those 
which  would  influence  an  investor  in  determining  the 
attractiveness  of  the  respective  uses  for  his  capital: 
the  character  and  location  of  the  particular  proper- 
ties, their  potential  and  actual  employment,  the  state 
of  the  market  of  which  each  is  a  part.   As  Liant 
suggests  and  Clifton  Investment  emphasizes,  the  rele- 
vant facts  also  include  the  demands  which  the  respec- 
tive investments  may  make  upon  the  taxpayer  for  super- 
vision and  service. 


11  AFTR  2d  at  1722  (citations  omitted) . 

4.    According  to  the  Fourth  Circuit  (Steuart  Bros. .  3 
AFTR  2d  318  (3d  Cir.  1958)):  This  is  the  first  case  making  the 
owner-use/ owner-lessor  distinction.   Steuart  does  not  clearly 
articulate  limitations  on  the  similarity  of  real  property  held 
for  rental  income.   Some  later  cases  understand  Steuart  to  hold 


1684 


that  all  rental  properties  are  similar;  other  cases  interpret 
Steuart  as  employing  a  "same  general  class  test."  See  Part  B(l) 
infra. 


Unclear. 


The  Loco  Realty  and  Steuart  Tests  are  Themselves 


1.  Steuart  Bros. .  3  AFTR  2d  318  (3d  Cir.  1958) . 

Steuart  was  the  first  case  drawing  on  owner-user/owner- 
lessor  distinction,  and  its  statement  of  the  law  is  ambiguous  as 
to  whether  all  rental  properties  are  of  similar  use  or  whether 
the  properties  must  be  in  the  "same  general  class."   In  Loco 
Realty.  10  AFTR  2d  5359,  536405  (8th  Cir.  1962),  the  court  noted 
the  ambiguity  in  Steuart,  leaning  toward  an  interpretation  that 
all  rental  property  is  similar  under  §1033.   Pohn,  10  AFTR  2d 
5780,  5782  (7th  Cir.  1980),  cited  below,  reads  Steuart  equally 
broadly.   On  the  other  hand,  McCaffrey.  5  AFTR  2d  774  (3d  Cir. 
1960) ,  which  is  the  only  circuit  to  apply  the  functional  use  test 
to  an  owner-lessor  (a  position  the  Service  rejected  in  1964), 
understood  Steuart  as  creating  the  "same  general  class"  test. 
The  district  court  in  Filippini.  9  AFTR  2d  313  (N.D.Ca.  1971), 
aff 'd  11  AFTR  2d  1720  (9th  Cir.  1963),  reached  the  same  con- 
clusion.  (The  Ninth  Circuit  rejected  the  "same  general  class" 
test.) 

The  Pohn  court,  a  n.4,  reviewed  the  overall  situation 
in  1962,  before  Filippini  added  yet  another  test,  as  follows: 
"There  is  a  basic  difference  of  opinion  between  the  Third  and 
Second,  Fourth  and  Eighth  Circuits,  and  among  the  latter  three 
there  are  shades  of  difference  in  the  test  applied." 

2.  Loco  Realty 

Loco  Realty's  requirement  of  "reasonable  similarity  of 
the  leased  premises"  has  been  subject  to  different  interpreta- 
tions by  two  court  that  have  cited  it.   In  Pohn.  10  AFTR  2d  5780, 
5782  (7th  Cir.  1962) ,  the  court  interpreted  the  Loco  Realty  test 
as  more  restrictive  than  the  Second  Circuit's  Liant  test,  assert- 
ing that  "the  CLoco  Realty]  court  avoided  the  extreme  statement 
of  the  Steuart  and  Liant  doctrine  that  both  properties  need  only 
qualify  as  investments."   However,  the  concurring  opinion  in 
Clifton  Investment  Co..  11  AFTR  2d  649,  641  (6th  Cir.  1963), 
construed  Loco  Realty  as  more  liberal  than  Liant.   In  his  concur- 
rence. Judge  Miller  said: 

I  think  that  the  investment  character  of  the 
properties  involved  should  be  given  more  consideration 
than  what  seems  to  me  is  given  by  the  ruling  the  Liant 
case,  although  I  do  not  think  that  investment  basis 
alone  is  sufficient  to  comply  with  the  statute,  as 
Steuart  Brothers.  Inc.  v.  Commissioner  might  be  con- 
strued as  holding.   As  pointed  out  in  Loco  Realty  Co. 
V.  Commissioner,  the  statute  was  not  intended  to 
penalize  but  to  protest  persons  whose  property  may  be 
taken  on  condemnation  and,  accordingly,  should  be 
construed  liberally.   I  agree  with  the  standard  adopted 
in  the  opinion  in  that  case,  although  for  our  present 
purposes  I  do  not  think  that  it  results  in  a  reversal 
of  the  decision  of  the  Tax  Court. 


Id.  at  651  (citations  omitted) . 

Judge  Miller  cites  Loco  Realtv  here  as  more  liberal 
than  the  Liant  test,  in  direct  contradiction  with  the  Pohn  court. 


1685 

C.    A  Crucial  Issue  Regarding  the  Similar  Use  Test  Remains 
Open. 

Unlike  the  functional  use  test  applied  to  an  owner- 
user,  which  looks  to  the  property's  physical  characteristics  and 
end  uses,  the  Service,  following  Liant,  applies  a  management 
activity  test  to  an  owner-lessor.   As  long  as  both  properties  are 
used  by  the  taxpayer  for  rental  income,  the  propeirties  are  of 
similar  use  if  they  demand  from  the  taxpayer  the  same  amount  and 
kind  of  management  activity,  services  and  relations  to  tenants, 
and  give  rise  to  the  same  business  risks.   This  test  seems  to 
completely  disregard  the  physical  characteristics  of  the  proper- 
ty.  Indeed,  Johnson.  43  TC  736  (1965) ,  permitted  the  replacement 
of  improved  farmland  leased  to  a  riding  club  with  urban  land 
leased  to  a  gas  station. 

In  conflict  with  this  line  of  reasoning,  however,  a 
number  of  courts  seem  to  have  understood  that  Reg.  §  1.103 3(a) - 
2(c) (9) (i)  applies  to  prevent  even  an  owner-lessor  from  replacing 
unimproved  with  improved  realty.   These  cases  imply  that  similar 
use  requires  similar  physical  characteristics  even  for  an  owner- 
lessor.   The  question  left  open,  then,  is  the  extent  to  which  the 
character  of  the  property  is  relevant  in  the  case  of  a  replace- 
ment by  an  owner-lessor.   This  question  is  a  crucial  one;  it  is 
particularly  inappropriate  for  Congress  to  apply  to  transactions 
as  common  as  exchanges  a  test  with  such  an  important  issue 
unresolved. 


D.    The  Filippini  "Test"  Provides  for  Case-by-Case  Decision 
Making  by  Lower  Courts,  Implying  Substantially  Increased  Litiga- 
tion. 

The  Filippini  test,  cited  above,  examines  "all  the 
circumstances"  to  reach  an  overall  sense  of  whether  the  taxpayer 
has  maintained  continuity  of  investment.   The  Filippini  court 
expressly  rejected  any  more  definite  standard  or  "rule  of  thumb." 
Any  test  consisting  of  a  broad  survey  of  the  circumstances  is 
likely  to  be  an  extremely  fact-based  exercise.   However,  the 
Filippini  court  went  even  further,  when,  in  n.  4,  it  cited 
Duberstein,  363  U.S.  278,  279  (1960): 

Decision  of  the  issue  presented  in  these  cases 
must  be  based  ultimately  on  the  application  of  the 
fact-finding  tribunal's  experience  with  the  mainsprings 
of  human  conduct  to  the  totality  of  the  facts  of  each 
case.   The  nontechnical  nature  of  the  statutory  stan- 
dard, the  close  relationship  of  it  to  the  data  of 
practical  human  experience,  and  the  multiplicity  of 
relevant  factual  elements,  with  their  various  combina- 
tions, creating  the  necessity  of  ascribing  the  property 
force  to  each,  confirm  us  in  our  conclusion  that 
primary  weight  in  this  area  must  be  given  to  the 
conclusions  of  the  trier  of  fact. 


With  this  quotation,  the  court  expressed  its  feeling 
that  the  similar  use  test  is  not  the  kind  of  legal  standard  that 
allows  appellate  courts  to  clearly  guide  the  lower  courts. 
Instead,  each  case  is  different,  with  the  lower  courts  applying 
their  experience  "with  the  mainsprings  of  human  conduct  to  the 
totality  of  the  case."   This  delegation  to  the  lower  courts  will 
substantially  increase  litigation  if  applied  to  §1031. 

In  one  subsequent  case,  the  Tax  Court  cited  Filippini 
as  "[t]he  general  test  to  be  applied  in  a  qualification  under 


1686 


§1033  controversy."   Scheuber.  25  TCM  559,  566  (1966).'   It 
appears  then  that  the  Filippini  test  is  likely  to  be  applied  by 
at  least  some  courts  even  outside  the  Ninth  Circuit.   The  concern 
about  increased  litigation  is  therefore  relevant  far  beyond  the 
reach  of  the  Ninth  Circuit.   Congress  would  only  exacerbate  the 
problems  of  an  already  overloaded  judiciary  by  adopting  the 
similar  use  test  for  §1031  exchanges. 

II.   There  was  a  Prior  Amendment  to  §1031  to  Remove  the  Use  Test. 

In  1921,  when  Congress  first  enacted  the  §1031  equi- 
valent, §202 (c)  of  the  Code  provided  for  nonrecognition  when  both 
properties  were  of  the  same  like  kind  or  use.   In  1924,  Congress 
shortened  the  test  to  "like  kind,"  and  its  reasons  are  par- 
ticularly instructive. 

According  to  both  a  document  called  "the  Gregg  State- 
ment," released  for  publication  by  Chairman  Green  of  the  House 
Ways  and  Means  Committee,  and  the  Senate  Finance  Committee 
Report,  Sen.  Rep,  No.  398,  April  1924,  the  change  is  intended  to 
respond  to  a  contention  that  the  "like  kind  or  use"  test  created 
two  classes  of  property:  property  held  for  investment  and  proper- 
ty held  for  productive  use  in  a  trade  or  business.   Consequently, 
it  had  been  argued,  the  "use"  language  prevented  the  exchange  or 
properties  in  different  classes.   The  Gregg  Statement  and  the 
Senate  Report  rejected  this  reliance  on  use  because  "[t]he 
intention  of  the  party  at  the  time  of  the  exchange  is  difficult 
to  determine,  is  subject  to  change  by  him,  and  does  not  represent 
a  fair  basis  of  determining  tax  liability."   Gregg  Statement  at 
11-12;  Sen.  Rep.  at  14. 

The  passage  of  time  has  made  intent  no  easier  to 
determine.   In  fact,  the  frequency  of  exchanges  today  compound 
the  difficulties  of  applying  a  use  test  with  a  likelihood  that 
such  a  test  would  have  to  be  applied  on  a  regular  basis.   Con- 
gress should  follow  its  1924  decision  to  provide  for  a  test  based 
solely  on  the  nature  and  character  of  the  property.   There  is  no 
overriding  necessity  to  make  the  proposed  change.   In  fact,  if 
the  change  is  made.  Congress  will  have  to  rethink  legislation  it 
has  recently  passed,  and  is  likely  to  pass  in  the  future,  that 
allows  exchanges  of  ancient  forest  and  mineral  rights  held  by 
private  corporations  and  individuals,  for  less  ecologically 
sensitive  government  owned  lands.   Unless  there  is  a  special 
provision  in  the  legislation  exempting  those  transactions  from 
income  tax,  the  transferors  of  the  land  could  not  be  assured  that 
the  transactions  are  not  taxable  even  though  such  transactions 
were  historically  tax  deferred. 


For  all  of  the  above  reasons,  I  believe  the  proposed 
amendment  should  not  become  part  of  any  bill.   The  IRS,  Treasury 
and  taxpayers  have  worked  hard  over  the  last  few  years  to  some- 
what simplify  the  area  of  like  kind  exchanges,  so  that  not  every 
transaction  needs  the  assistance  of  expensive  tax  lawyers.   The 
bill  would  only  serve  to  reverse  this  trend  and  to  create  sub- 
stantial uncertainty,  not  to  mention  numerous  and  expensive  law- 
suits.  Thank  you  for  your  consideration. 


progeny. 


1687 

STATEMENT  OF  JOHN  W.  LEE,  PROFESSOR  OF  LAW,  COLLEGE 
OF  WnXLVM  AND  MARY,  MARSHALL-WYTHE  SCHOOL  OF 
LAW,  WnXL^MSBURG,  VA. 

Chairman  Rangel.  Mr.  Lee, 

Mr.  Lee.  I  am  John  Lee,  a  professor  at  William  &  Mary. 

Chairman  Rangel.  Move  that  mike  a  little  closer  to  you. 

Mr.  Lee.  And  I  actually  requested  to  speak  on  two  topics,  the  soil 
remediation  and  this,  so  I  will  do  a  brief  one  on  soil  remediation 
first. 

And  I  think  the  major  thrust  I  would  like  to  make  is  that  the 
law  is  not  as  clear  as  the  previous  panelists  indicated;  that  they 
should  be  able  to  currently  deduct  the  soil  remediation  costs.  There 
are  a  few,  I  think,  leading  precedents,  more  recently,  that  would 
indicate  distortion  of  income  is  really  what  is  involved  when  you 
are  talking  about  current  deduction  or  capitalization.  And  if  you 
have  an  extremely  large  amount,  particularly  if  it  accrued  over 
years,  then  capitalization,  but  amortization  over  some  period,  is 
necessary. 

Now,  that,  I  think,  would  answer  to  some  degree  the  retroactivity 
argument  made  by  the  previous  panelists.  More  than  that,  I  think 
this  committee's  greatest  concern  should  be  in  the  fact  there  are 
tremendous — the  IRS  is  auditing,  there  are  tremendous  amount  of 
cases  going  to  be  building  up  there,  and  if  we  let  this  develop,  if 
Congress  lets  this  develop,  as  the  intangibles  developed,  one  day 
probably  Congress  will  have  to  come  back  in,  clean  it  up  anyway, 
and  then  handle  the  retroactivity  problems. 

So  it  is  much  better  now  to  avoid  the  litigation  costs  from  both 
the  private  bar  and,  for  the  private  taxpayers,  and  for  the  Grovem- 
ment  to  address,  to  give  an  answer  to  soil  remediation.  And  I 
would  suggest,  probably  the  answer  is,  in  most  cases,  a  60-month 
amortization. 

This  is  not  really  a  repair,  in  most  cases.  It  is  just  like  the  pollu- 
tion control,  the  mine  safety.  It  is  something  the  Government  is  im- 
posing. Probably  for  good  reasons.  Certainly  for  good  reasons.  And 
typically  the  pattern  there  is  60-month  amortization.  And  there  is 
a  future  benefit  because  they  don't  get  closed  down. 

And,  as  far  as  the  subsidy  to  doing  it,  they  have  a  big  stick  al- 
ready. If  they  don't  do  it,  they  don't  get  closed  down.  So  I  don't 
know  that  they  need  the  tax  incentive. 

And  very,  very  briefly,  if  you  buy  my  argument  that  our  real  con- 
cern is  avoiding  litigation  costs  on  both  sides,  then  the  whole  area 
of  capitalization,  in  which  I  have  been  writing  for  20  years  and 
have  influenced  the  tax  law,  committee  reports,  various  things, 
and,  indeed,  that  technical  advice  memorandum,  I  think,  was  influ- 
enced by  me,  that  area  is  probably  one  of  the  big  investor  speciali- 
zation programs.  By  my  count,  a  quarter  of  the  issues  are  capital- 
ization or  amortization  linked  to  it. 

And  the  GAO  study  of  the  12  most  common  code  sections  that 
generate  half  of  the  items  in  audit  and  60  percent  of  the  settle- 
ments, one  of  those  is  263  capitalization.  A  subissue  under  162  is 
capitalization.  In  short,  alreadv  it  is  a  big  issue  and  it  is  going  to 
get  much  bigger.  And  it  would  be  so  simple  for  this  committee  to 
simply  pick  out,  with  the  remediation,  simply  say  60  months.  And 


1688 

there  are  some  other  narrow  areas  that  probably  should  get  cur- 
rent deduction. 

And  for  the  broader  thing  of  capitalization,  if  you  would  simply 
say  if  it  is  big — or  if  it  is  small,  it  can  be  deducted.  If  it  is  recur- 
rent, it  can  be  deducted.  If  it  is  big,  you  have  to  amortize.  Give 
guidelines  to  the  Service  to  let  them  start  doing  the  rulings  they 
are  doing  to  build  up  to  regs.  That  will  cut  down  on  litigation. 

And  the  similar  thought  with  1031,  the  academic  writers  all 
agree  as  to  real  estate  like-kind  is  too  broad.  The  real  underlying 
notion  being  that  you  should  be  able  to  exchange  because  you  have 
not  really  economically  changed. 

We  are  going  from  raw  land  to  an  apartment  building  for  a  little 
old  lady  that  has  held  the  land  for  30  vears  and  then  she  becomes 
a  passive  investor — I  am  told  anecdotally  that  often  happens — that 
is  not  economically  "like." 

In  every  other  area,  personal  property  exchanges  under  1031,  in- 
voluntary conversions,  the  better  cases  do  apply  in  economic  analy- 
sis. But  the  panel  is  absolutely  right  that  the  wrong  thing  to  do  is 
simply  incorporate  1033  and  say,  hey,  go  at  it.  They  are  absolutely 
rirfit.  The  cases  are  in  conflict  there.  There  are  better  recent  cases. 

But,  again,  there,  pick  out  what  should  be  the  factors.  Probably 
risk,  return  and  activities.  And  pick  them  out,  set  them  in  the  com- 
mittee report,  and  then  let  the  service,  by  rulings  and  then  regs 
build  it  up. 

Don't  do  it  the  opposite  way  of  detailed  legislative  regs,  263  Cap- 
A  capitalization  comes  to  mind.  Instead,  build  up,  and  vou  can  end 
up  with  something  as  beautiful  as  the  355  regs  which  allow  the 
fact  fmder  to  make  the  right  decision,  looking  at  a  number  of  dif- 
ferent factors.  We  need  evolution,  but  we  need  direction,  and  sim- 
ply doing  1033  won't  do  it. 

Thank  you. 

[The  prepared  statement  follows:] 


1689 


Tax  Policy  Issues  related  to  Like-Kevd  Exchanges  and  to  Soil  Remediation  Costs 

I  am  John  W.  Lee,  Professor  of  Law,  College  of  WilHam  &  Mary,  appearing  on  my  own  behalf.  I 
favor,  with  modifications,  the  proposals  listed  in  Miscellaneous  Issues  U#  3  (§§  1031  and  1033)  and  6 
(soil  remediation  costs)  in  Press  Release  #  9,  August  17,  1993. 

Substitution  of  Section  1033's  "5tMiLAR  or  JIelated  /n  .Service  or  Use"  for  "Lke-Kjnd"  in 
Section  1031  voluntary  Exchanges:  Sorcerer's  Apprentice  or  Alchemist's  Stone? 

L  Introduction 

In  1987  the  Joint  Staffs  of  the  Joint  Committee  on  Taxation  and  the  House  Ways  &  Means 
Committee  suggested  either  (a)  adding  real  estate  to  the  tainted  property  exclusions  to  §  1031  (which 
the  House  effected  in  OBRA  1987  with  a  $100,000  cap  on  §  1031  real  estate  exchanges  odier  than 
personal  residences,  or  (b)  applying  the  §  1033  "similar  or  related  in  service  or  use"  ("SORISOU") 
standard  in  lieu  of  the  current  "like-kind"  standard  (which  the  House  also  effected  in  OBRA  1989,  but 
both  times  these  §  1031  restrictions  were  deleted  from  the  Senate  bill  and  died  in  Conference).  The 
Joint  Staffs  reasoned  that  "1.  Nonrecognition  on  like-kind  exchanges  is  justified  only  when  the  taxpayer 
remains  in  a  similar  economic  position  after  the  exchange.  The  like-kind  standard  as  applied  to  real 
estate  is  too  broad  and  flexible  to  ensure  that  a  taxpayer's  economic  position  is  not  significantly  altered 
by  the  exchange,  giving  investors  a  tax  preference  in  comparison  to  investors  in  productive  assets  such 
as  stocks  and  equipment.  2.  The  like-kind  standard  for  comparing  the  property  transferred  with  the 
property  received  should  be  no  broader  than  the  general  standard  applying  for  involuntary  conversions. 
Involuntary  conversions  are  not  a  tool  for  tax  planning,  and  give  rise  to  stronger  equity  reasons  for  not 
taxing  gain  than  voluntary  exchanges."  Staff  of  Joint  Committee  on  Taxation  with  Staff  of  the 
Committee  on  Ways  &  Means,  Description  of  Possible  Options  to  Increase  Revenues  Prepared  for  the 
Committee  on  Ways  &  Means,  240-41  (JCS- 17-87,  June  25,  1987);  accord,  H.R.  Rep.  No.  247,  101st 
Cong.,  1st  Sess.  1340  (1989X"The  committee  believes  that  it  is  appropriate  to  accord  nonrecognition 
only  to  exchanges  and  conversions  where  a  taxpayer  can  be  viewed  as  merely  continuing  his 
investment.  The  'similar  or  related  in  service  or  use'  standard  contained  in  section  1033  (relating  to 
involuntary  conversions)  better  describes  the  types  of  transactions  that  the  committee  wishes  to  accord 
nonrecognition  treatment.").    The  revenue  is  in  the  range  of  1  billion  over  3  to  4  years. ' 

Today  this  Subcommittee  is  again  considering  a  "proposal  to  amend  the  like-kind  exchange  rules 
to  require  that  Code  section  1031  property  received  must  be  'similar  or  related  in  service  or  use'  to  the 
property  exchanged,  except  in  the  case  of  condemnations."  I  recommend  that  the  Subcommittee  adopt 
this  proposal  with  the  modification  that  its  legislative  history  set  forth  the  factors  (principally  risk 
and  management  activities)  that  the  Service  will  apply  in  rulings  which  are  to  evolve  from 
experience  into  "legislative"  regulations  administering  structured  "discretionary  justice".  Mere 
adoption  of  the  current  SORISOU  standard  probably  would  not  exclude  as  many  voluntary  exchanges 
of  different  grades  of  real  estate  as  the  revenue  estimates  anticipate  due  to  the  quite  liberal  §  1033 
precedent.  Although  not  a  Mickey  Mouse  solution,  substitution  of  SORISOU  for  "like  kind"  in 
voluntary  exchanges  without  further  Congressional  guidance  will  create  many  administrative  problems 
as  old  issues  are  needlessly  played  out  again.  Just  as  Disney's  Sorcerer's  Apprentice  did. 

n.         Origins  of  §§  1031  and  1033  Standards  for  Non-Recognition 

The  policy  basis  for  non-recognition  in  like-kind  exchanges  (as  well  as  involuntary  conversions  to 
some  extent)  is  preventing  taxation  of  realizations  of  "paper"  or  theoretical"  gains  or  losses,  constituting 
a  mere  change  in  form,  with  continuity  of  investment  without  "cashing  in".^  The  earlier  Treasury  1918 


'  Conference  Comparison  of  H.R.  3299,  Estimated  Revenue  Effects  of  Revenue  Reconciliation  Provisions  3  (JCX-70-89 
Oct  26,  1989)($1.341  billion  for  1990-94);  Levine,  Tax-free  Swap  Popular  among  Investors,  Nat'L  Tax  J.  18  (Monday  April 
10,  1989);  Celis,  Tax-Free  Exchange  is  Again  at  Stake,  Wall  St.  J.  B-1,  col.  1  (Wed,  March  1,  1989)(J500  million  a  year). 
The  down-and-dirty  $100,000  annual  ceiling  on  deferrals  of  gain  from  real  estate  exchanges  passed  by  the  House  in  1987  would 
have  generated  slightly  more  revenue  on  the  average  that  the  more  policy  based  adoption  of  the  §  1033  "similar  or  related  in  use" 
standard  Staff  Joint  Comm.  on  Taxation,  Description  of  Additional  Tax  Proposals  Submitted  by  Members  for  Ways  and  Means 
Committee  Revemte  Reconciliation  Consideration  (Oct.  13,  1987)  (JCT-I3-87);  RR.  Rep.  No.  391,  100th  Cong.,  1st  Sess.  1638 
(1987X$992  million  for  1988-90).  The  argument  has  been  raised  that  so  restricting  like-kind  exchanges  will  due  to  "lock-in" 
decrease  multi-party  transactions  and  hence,  the  attendant  recognition  (and  resulting  revenues)  by  at  least  one  other  party  to  the 
multi-party  transaction.  See  Wassennan,  Mr.  Mogul's  Perpetual  Search  for  Tax  Deferral:  Techniques  and  Questions  Involving 
Section  1031  Uke-Kind  Exchanges  in  a  World  of  Changing  Tax  Alternatives,  65  TAXES  975,  978  n.4  (1987).  Shades  of  1921. 

^  Compare  H.R.  Rep.  No.  704,  73rd  Cong.,  2d  Sess.  (1934),  with  S.  Rep.  No.  1983,  88th  Cong.,  2d  Sess.  (1958),  and  Staff, 
Sen.  Fia  Comm,  Explanation  of  Deficit  Reduction  Act  of  1984,  98th  Cong.,  2d  Sess.  242  (Comm.  Pmt  1984);  accord,  Koch  v. 
Comm  'r,  71  T.C.  54,  63-64  (1978).  See  generally  Jensen,  The  Uneasy  Justification  for  Special  Treatment  of  Like-Kind  Exchanges, 


1690 


Act  Regulation's  deferral  of  tax  on  gains  from  involuntary  conversions  if  "the  taxpayer  immediately 
proceeded  in  good  faith  to  replace  the  property"  or  established  a  "replacement  fund"  was  bottomed  on 
the  notion  that  losses  in  an  involuntary  conversion  and  gains  or  losses  on  exchanges  of  substantially 
similar  property  were  not  "closed  transactions."  Treas.  Reg.  45,  Art.  49.  The  causes  for  the  early 
involuntary  conversion  rule  (without  statutory  authority)  were  WW  I  government  condemnations  for 
war  production  and  "submarining"  of  vessels  by  "U-Boats".  Treasury,  Notes  on  the  Revenue  Act  of 
1918  (1919);  (Confidential)  Hearings  on  H.R.  824  (Revenue  Act  of  1921)  before  the  Senate  Finance 
Committee,  67th  Cong.,  1st  Sess.  203  (1921X"Dr.  Adams'  Statement").'  The  1918  Act  regulations  also 
contained  a  skeletal  form  of  the  continuity  of  investment  concept  and  a  "like-kind'  requirement  as  to 
non-recognition  exchanges  of  property  in  its  definition  of  "realization"  as  arising  upon  a  conversion  of 
property  into  cash  or  other  property  to  the  extent  of  replacement  property  "(a)  that  is  essentially 
different  from  the  property  disposed  of  and  (b)  that  has  a  market  value.  In  other  words,  both  (a)  a 
change  in  substance  and  not  merely  in  form,  and  (6)  a  change  into  the  equivalent  of  cash,  are  required 
to  complete  or  close  a  transaction  from  which  income  may  be  realized."  Treas.  Reg.  45,  Art.  1563. 
Treasury  and  the  courts,  however,  interpreted  the  1918  Act  property  exchange  provision  narrowly,  e.g., 
taxing  an  exchange  of  farms  (which  then  and  now  are  more  readily  marketable  than  stock  in  close 
corporations).* 

The  Revenue  Act  of  1921,  in  which  the  predecessors  to  §§  1031  and  1033  first  appeared,  was 
enacted  by  a  Republican-controlled  Congress  and  a  new  Republican  Administration  which  had 
campaigned  on  cutting  income  taxes.  Special  Treasury  Adviser  Dr.  Adams  was  more  worried  about 
taxpayers  taking  losses  during  the  post-World  War  I  depression  than  their  deferring  gains.  1921 
Confidential  Senate  Hearings,  supra  at  28-9,  199,  200.  He  therefore  persuaded  the  Senate  to  limit 
realization  in  exchanges  of  property  to  where  the  property  received  in  the  exchange  had  a  readily 
realizable  market  value.  But  even  if  it  had  such  a  readily  realizable  market  value,'  "no  gain  or  loss 
shall  be  recognized— (1)  when  any  such  property  held  for  investment,  or  for  productive  use  in  trade  or 
business  (not  including  stock-in-trade  or  other  property  held  primarily  for  sale),  is  exchanged  for 
property  of  a  like-kind  or  use").  1921  Confidential  Senate  Hearings,  supra  at  200  (Dr.  Adams  reading 
statute)(£mphasis  supplied).  Dr.  Adams  was  in  such  a  quandary  as  to  nonrecognition  of  investment 
losses  and  gains  that  he  left  to  the  Senate  Finance  Committee  the  decision  whether  to  include 
investment  property  in  the  non-recognition  net  of  "like-kind  or  use".  Id.  at  201.  It  deleted  "for 
investment"  from  this  first  like-kind  exchange  provision  under  the  rationale  that  "whatever  will  make 
the  bill  least  complicated  and  less  calculated  to  drive  people  to  insanity  is  the  thing  to  do."  Id.  at  201. 
(Statement  of  Chair  Penrose,  R-Pa.).  Secretary  of  the  Treasury  Mellon,  however,  persuaded  the 
Conference  Committee  to  restore  non-recognition  to  exchanges  of  investments.  These  developments 
set  the  stage  for  populist  Ways  and  Means  Member  John  Nance  "Cactus  Jack"  Gamer,  D-Tex.  (early 
1930s  Speaker  of  the  House  and  then  Vice  President  during  the  first  two  terms  of  President  Franklin 
D.  Roosevelt),  to  declaim  in  the  House 'debate  on  the  Conference  bill  in  1921  about  Congress  following 
the  mandates  of  a  Treasury  Department  which  desires  "to  relieve  the  heavy  taxpayer  from  his  taxes  and 
continue  the  taxes  upon  the  masses  of  the  people  ...",  and  a  Treasury  expert  changing  his  mind  at 
Mellon's  direction.'  Incredibly,  there's  more  to  the  story.  High  income  taxpayers  responding  to 
brokerage  firm  advertisements  "swapped"  appreciated  public  stock  or  securities  which  were  covered  by 
the  original  predecessor  to  §  1031,  perhaps  even  receiving  cash  "boot"  then  tax-free  up  to  their  basis, 
and  sold  their  loss  securities  which,  due  to  Senate  intransigence,  then  resulted  in  an  ordinary  loss. 
Congress  estimated  the  revenue  loss  to  be  $20,000,000  to  $50,000,000  a  year.  64  Cong.  Rec.  (Part  3) 
2851  (House  Februaiy  1,  1923)(RemaTks  of  House  Ways  &  Means  Chair  Greene,  R-IowaXabout  5% 


4  AMER.  J.  Tax  Policy  193,  203,  205  (1985);  Scott,  Like  Kind  Replacement  Property:  Animal.  Vegetable,  or  Mineral,  23  San 
OlECO  L.  Rev.  1067,  1068-69,  1076-77  (1986)  (traces  histoiy  of  "continuity  of  investment"  back  to  Civil  War  niling). 
HistoricaJly  this  policy  was  effected  primarily  through  the  "exchange"  requirement  and  secondarily  through  the  "like-kind" 
prerequisite.  See  Scott,  supra  at  1069;  Bryce,  Deferred  Exchanges:  Son-recognition  Transactions  after  Starker.  56  TULANE  L. 
Rev.  42,  45-46  (1983).  For  development  of  the  "continuity  of  investment"  concept  in  the  regulations  see  Komhauser,  Section 
1031:  We  Don't  Need  Another  Hero.  60  So.  Cal.  L.  Rev.  397,  407  al9  (1987);  Scott,  supra  23  San  Dieco  L.  Rev.  1068-7^ 
1091-94. 

'  Carlton  Fox  so  designated  these  Hearings.  Dr.  Adams,  was  the  Tax  Adviser  to  the  Secretary  of  the  Treasury-  a  Yale 
Professor  of  Economics  who  had  been  at  Treasury  since  1917  or  so  and  was  the  leading  income  tax  expert  in  part  because  he 
had  directed  the  Minnesota  experiment  with  the  first  state  income  tax  commencing  around  1909. 

*  O.D.  429,  2  C.B.  38  (1920);  1921  Confidential  Senate  Hearings,  supra  at  27  (Dr.  Adams);  Pearce.  et  al..  Trustees  v. 
Commr.  13  B.TA.  150,  151  (1928). 

'  Publicly  traded  probably  was  meant,  see  1921  Confidential  Senate  Hearings,  supra  at  199-20O  (Statement  of  Dr.  Adams); 
Treas.  Reg.  45,  Art  1563. 

"We  had  a  Treasury  expert  there  who  came  in  in  the  morning  and  made  a  very  interesting  and,  I  thought,  conclusive 
argument;  then  the  Secretary  of  the  Treasury  would  give  him  different  instructions,  and  in  the  afternoon  he  would  make  the  most 
conclusive  argument  on  the  other  side  of  the  same  proposition  that  1  ever  heard  in  my  life.  61  CONC.  Rec.  (Part  8)  8073 
(November  21,  1921  House)(Remarks  of  Rep.  Gamer,  D-Tex.). 


1691 


of  income  tax  revenue  from  individuals).  In  1923  Congress  held  a  special  Fourth  Session  just  to  wrestle 
with  the  tax  problems  of  like-kind  exchanges.  Both  tax  writing  committees  took  the  straightforward 
1921  Senate  Finance  Committee  path  of  deleting  "for  investment"  from  the  required  purpose  for  holding 
the  exchanged  properties.  H.R.  Rep.  No.  1432,  Exchange  of  Property,  67  Cong.,  4th  Sess.  1-2  (1923). 
This  time  the  Congress  itself  added  back  "for  investment"  in  a  floor  amendment  at  the  suggestions  of 
Ways  and  Means  Member  and  former  Chair  Rep.  Fordney,  R-Mich.,  (1)  to  keep  investments  in  general 
under  the  predecessor  to  §  1031  and  instead  (2)  list  tainted  assets  not  qualifying  for  a  tax-fiw  like-kind 
exchange  including  securities.  Cactus  Jack  explained  that  Fordney  had  been  "out  in  the  West"  and 
absent  from  the  Ways  and  Means  Committee  meeting  adopting  the  bill,  "perfect  in  form  and  substance", 
that  deleted  "for  investment"  and  hurried  back  "post  haste"  to  preserve  non-recognition  for  "blocking 
up"  swaps  with  the  Department  of  the  Interior  of  coal  and  timber  lands  out  West.  64  CONG  Rec.  (Part 
3)  2852  (House  Feb.  1,  1923XRemarks  of  Rep.  Gamer,  D-Tex.).'  Fordney  responded  that  Gamer  was 
a  "big  ear  of  com  in  a  little  shuck".   (By  1940  FDR  may  have  shared  that  sentiment) 

The  origin  of  the  existing  distinction  in  the  Treasury  regulations  between  (a)  real  estate  with  all 
grades  or  qualities  being  like  and  (b)  personal  property  which  implicitly  is  like  only  as  to  narrow 
categories  is  also  interesting  if  less  titillating.  Dr.  Adams  provided  in  the  Confidential  1921  Senate 
Hearings  a  widely  quoted  (as  not  too  helpful)  example  of  like-kind  exchanges  (including  investments): 
"Dr.  Adams.  An  illustration  would  be  where  stocks  were  exchanged-stocks  for  stock  or  bonds  for 
bonds  for  bonds— or  where  a  factory  was  exchanged  for  another  factory."  Notice  implicit  narrow 
categories.  The  principle  that  all  real  estate  is  "like  kind"  appears  extrapolated  from  Dr.  Adam's  less 
well-known  example  of  a  qualifying  trade  of  a  farm  for  a  depreciable  (rental)  house.  J 921  Confidential 
Senate  Hearings,  supra  at  205  (Statement  of  Dr.  Adams  explaining  substituted  basis).  The  1921  Act 
regulations  faithfully  followed'  the  above  hints  dropped  by  Dr.  Adams,  adopting  the  following 
"standards"  still  contained  in  Treas.  Reg.  §  1.103  l(a)-I(b)  or  administrative  rulings  and  current  case  law. 
(1)  "Like  kind"  refers  to  the  "nature  or  character  of  the  property  and  not  its  grade  or  quality."  Treas. 
Reg.  62,  Art.  1566(a);  still  contained  in  Treas.  Reg.  §  1.1 03 1(a)- 1(b).  Thus,  "the  fact  that  any  real 
estate  involved  in  an  exchange  is  improved  or  unimproved  makes  two  differences,  for  such  facts  relate 
only  to  grade  or  quality  of  the  property  and  not  to  its  kind  or  class."  Id.  The  courts  soon  thereafter  and 
to  this  day  have  applied  the  "like  kind"  standard  liberally  to  interests  in  real  estate  of  all  grades  and 
qualities.' 

More  recently  both  Congress  and  the  courts  have  taken  an  "economic  analysis"  of  "like  kind" 
as  to  personal  property.  Cal.  Fed'l  Life  Ins.  Co.  v.  Comm'r,  76  T.C.  107  (1981),  qff'd,  680  F.2d  85 
(9th  Cir.  1982X"where  a  taxpayer's  economic  situation  after  the  exchange  is  fundamentally  different 
from  its  economic  situation  prior  to  the  transaction,  the  exchange  does  not  encompass  like-kind 
properties.");  Cf  S.  Rep.  No.  552,  91st  Cong.,  1st  Sess.  102  (1969X"male  calves  ...  are  not  held  for 
breeding  purposes  and,  in  fact,  are  not  of  a  'like-kind'  with  females.").  Cutting  to  the  chase,  a  similar 
economic  analysis  now  prevails  under  §  1033,  sometimes  quite  liberally  applied.  Many  but  not  all 
commentators  believe  that  such  an  economic  analysis  goes  a  long  way  towards  rationalizing  the  host 
of  like-kind  rulings  and  fewer  cases  as  to  personal  property.  While  such  economic  analysis  appears 
correct  on  a  policy  basis,  i.e.,  sufficient  shifting  in  risk  makes  property  not  "economically  similar,"  cf, 
H.R.  Rep.  No.  391,  100th  Cong.,  1st  Sess.  1039  (1987),  its  current  inapplicability  to  real  property 
exchanges  creates  economic  inefficiencies.  See  Joint  Staff's  Possible  Revenue  Options,  supra  at  241. 
The  revised  "like-class"  safe  harbor  for  exchanges  of  personal  property  take  an  overly  restrictive 
definitional  approach  to  "like  class"  safe  harbors  possibly  due  to  the  absence  of  case  law  or  statutory 
support.  Such  strictness  probably  arises  as  well  from  the  Service's  well-taken  opposition  to  the  notion 
that  entire  businesses  could  be  exchanged  under  §  1031.'°    Should  Congress  wish  to  follow  such  a 


This  was  such  a  good  story  that  it  grew  with  the  telling  to  account  for  the  capital  gains  preference  itself  65  Cong.  Rec 
(Part  3)  2846  (House  FebtMar>-  20.  1924XRcmarks  of  Rep.  Oldfield,  D-Ait)  Former  House  W^  &  Means  Chair  Wilbur  Mills, 
D-Ark,  recounted  that  memories  of  sitting  on  the  knee  of  Congressman  [Oldfield]  lead  him  to  aim  for  business  and  Congress  in 
life  rather  than  his  father's  goals  for  him. 

'  Carlton  Fox,  the  original  compiler  of  the  1909-1950  Legislative  Histories  (reprinted  in  1979  by  William  S.  Hein,  Reams, 
Ed.),  annotated  "Dr.  Adams'  Statement"  in  the  1921  Confidential  Senate  Hearings  crossreferencing  Act  Sections,  floor  debate, 
etc.  See  vols.  95  and  95A  Reams,  Internal  Revenue  Acts  of  the  Unhted  States  1909-1950  Histories,  Laws  and 
Administrative  Docs  (William  S.  Hein  &  Co.  1979).  I  suspect  that  the  regulation  drafters  did  the  same. 

'  Koch  V.  Commr,  71  T.C.  54,  65  (I978X"§  1031(a)  requires  a  comparison  of  the  exchanged  properties  to  ascertain 
whether  the  nature  and  character  of  the  transferred  rights  in  and  to  the  respective  properties  are  substantially  alike.  In  making 
tliis  comparison,  consideration  must  be  given  to  the  respective  interests  in  the  physical  properties,  the  nature  of  the  title  conveyed, 
the  rights  of  die  parties,  the  duration  of  the  interests,  and  any  other  factor  bearing  on  the  nature  or  character  of  the  properties  as 
distinguished  from  their  grade  or  quality.  Significantly,  as  the  standard  for  comparison,  section  1031(a)  refers  to  property  of  a 
like-not  an  identical-kind.  The  comparison  should  be  directed  to  ascertaining  whether  the  taxpayer,  in  making  the  exchange, 
has  used  his  property  to  acquire  a  new  kind  of  asset  or  has  merely  exchanged  It  for  an  asset  of  like  nature  or  character."). 

'"    See  Rev.  Rul.  89-121,  1989-2  C.B.  203;  Multi-Asset  Exchanges.  Business  Swaps,  73  J.  Tax'n  18  (1990). 


1692 


narrow  approach  as  to  exchanges  of  personal  and  intangible  property  in  revising  §  1031,  it  should 
approve  the  concept  of  such  "like  class"  personal  property  regulations.  I  recommend  in  Part  IV  a 
hopefiilly  sounder  approach  of  setting  forth  guidelines  as  to  an  economic  analysis  (risk  and  management 
activities)  of  SORISOU  for  IRS  rulings  which  in  an  evolutionary  fashion  ultimately  would  be  "codified" 
in  structured  "discretionary  justice"  regulations  in  the  manner  of  the  1989  revised  regulations  under  § 
355. 

How  the  §  1033  "similar  or  related  in  service  or  use"  standard  came  to  be  more  narrow  as  to 
real  estate  than  §  1031  too  makes  a  long  story,  also  largely  turning  on  historical  accidents.  The 
"classic"  involuntary  conversion  was  loss  of  an  ocean  freighter  to  "submarining"  or  "condemnation"  of 
a  factory  by  the  government  for  war  production  during  World  War  I  when  (a)  immediate  replacement 
was  often  impossible  and  (b)  high  wartime  taxes  (including  corporate  excess  profits  taxes)- 10%  x 
preWar  rates— on  gain  (inflated  in  part  by  war  shortages),  all  taxed  as  ordinary  income,  would  render 
replacement  impossible  after  taxes.  See  American  Nat  7  Gas  Co.  v.  United  States,  279  F.2d  220,  225 
(Ct.  CI.  1960).  Albeit  without  statutory  basis,  the  1918  Act  Regulations  (Treas.  Reg.  45,  Art.  47) 
provided  that  the  amount  received  by  the  taxpayer  (a)  for  property  lost  or  destroyed  in  whole  or  in  part 
through  fire,  storm,  shipwreck,  or  other  casualty  or  (b)  where  title  was  lost  through  requisition  or 
eminent  domain  (or  voluntary  conveyance  induced  by  reason  that  a  proceeding  for  such  a  purpose  is 
imminent)  was  taxable  only  to  extent  gain  exceeded  the  amount  actually  and  reasonably  expended  to 
"replace  or  restore  the  property  substantially  in  kind,  exclusive  of  any  expenditures  for  additions  or 
betterments.  The  new  or  restored  property  effects  a  replacement  in  kind  only  to  the  extent  that  it  serves 
the  same  purpose  as  the  property  which  it  replaces  without  added  capacity  or  other  element  of 
additional  value."  Id.  (Emphasis  added).  The  regulation  was  not  explicitly  elective,  only  transactional ly 
so.  Treasury  Staff  suggested  a  statutory  amendment  (even  more  bare  bones  than  the  regulation) 
providing  for  a  "replacement  fimd  for  the  replacement  in  kind  of  lost  or  damaged  property"  based  on 
a  hardship  policy.   Notes  on  the  Revenue  Act  of  1918,  Section  213(e),  supra  at  15. 

The  Revenue  Act  of  1921  which  introduced  the  first  "like-kind"  tax-fi«e  exchange  provision  also 
birthed  the  first  statutory  involuntary  conversion  provision  (actually  2,  one  for  corporations  and  one  for 
individual  taxpayers)  retroactively  applicable  to  1918.  The  1921  Act  involuntary  conversion  regulations 
added  little  to  the  statute,  Treas.  Reg.  62,  Art's  261-63,  probably  because  1918  Act  regulations  already 
existed.  Although  the  1921  predecessor  to  §  1033  employed  a  deduction  mechanism  (changed  to  an 
exclusion  of  gain  in  1924),  the  drafters  of  the  Revenue  Act  of  1921  clearly  saw  involuntary  conversions 
and  like-kind  exchanges  as  related  as  evidenced  by  their  propinquity  in  discussion  in  the  1921 
Confidential  Senate  Hearings  and  even  more  by  the  similarity  in  descriptive  terms  of  the  continuity  of 
investment  standard  in  those  Hearings  and  in  the  1921  Floor  Debate  on  the  predecessor  to  §  1033.  1921 
Confidential  Senate  Hearings,  supra  at  55,  203;  61  Cong.  Rec.  (Part  5)  5201,  5296  (House  Aug.  18- 
19,  1921)(Remarks  of  Rep.  Hawley,  R-Ore.);  Scott,  supra  23  San  DiEGO  Rev.  at  1075;  see  also 
Filippini  v.  United  States,  200  F.  Supp.  286,  295  (N.D.  Calif  1961),  affd,  318  F.2d  841  (9th  Cir.  1963). 
Furthermore,  the  1921  version  of  both  provisions  employed  parallel  "kind"  and  "use"  tests:  "like  kind 
or  use"  in  the  case  of  the  predecessor  to  §  1031  and  "character  similar  or  related  in  service  or  use" 
in  the  case  of  the  predecessor  to  §  1033.  This  parallelism  disappeared  in  the  Revenue  Act  of  1924.  I 
suspect  that  Congress  thought  that  at  least  the  two  original  formulations  of  the  qualifying  standard  under 
the  predecessors  to  §§  1031  and  1033  were  essentially  the  same. 

The  involuntary  conversion  provision  in  the  succeeding  revenue  acts  and  the  income  tax 
regulations  under  them  continued  largely  unchanged  until  the  regulations  under  the  Revenue  Act  of 
1934  were  reworked  apparently  to  reflect  ruling  and  litigation  experience  over  the  preceding  decade, 
particularly  heavy  on  the  eve  of  these  regulatory  revisions.  Treas.  Reg.  86,  Art.  112(0-(1)."  For 
example,  the  1934  Act  regulation's  involuntary  conversion  provisions  for  the  first  time  set  forth  rules 
in  the  following  areas:  (A)  tracing  requirement  for  proceeds  of  involuntary  conversion  expended  for 
replacements;  (B)  amounts  retained  by  the  govenunent  from  a  condemnation  award  to  satisfy  liens  and 
liabilities  are  included  in  the  amount  of  the  net  condemnation  award,  (C)  expenditures  for  replacement 
property  in  excess  of  recovery  for  the  loss  are  not  currently  deductible  as  a  loss,  (D)  the  involuntary 
conversion  provisions  apply  to  "residential"  and  "farming  purposes",  (E)  use  and  occupancy  insurance 
proceeds  do  not  constitute  involuntary  conversion  proceeds,  and  (F)  "[tjhere  is  no  investment  in 
property  similar  in  character  and  devoted  to  a  similar  use  if-  (1)  The  proceeds  of  unimproved  real  estate, 
taken  upon  condemnation  proceedings,  are  invested  in  improved  real  estate.  (2)  The  proceeds  of 
conversion  of  real  property  are  applied  in  reduction  of  indebtedness  previously  incurred  in  the  purchase 
of  a  leasehold.  (3)  The  owner  of  a  requisitioned  tug  uses  the  proceeds  to  buy  barges.  (4)  An  award  for 


Ironically  the  Revenue  Act  of  1934  itself  had  not  changed  the  involuntary  conversion  pixjvision  and,  indeed,  there  was 
significant  statutory  change  through  the  original  1939  Code.    See  Filippini  v.  United  Stales,  supra  at  295. 


property  taken  for  street  widening  is  applied  toward  payment  of  special  assessments  for  benefits 
accruing  to  the  remaining  property."  Treas.  Reg.  86,  Art.  1 12(f)-l.  Pre-1935  case  law  authority  existed 
on  all  of  the  above  rules  except  (D)  and  (FX3)  and  (4)  and  cases  were  in  the  pipeline  as  to  (FX4).  The 
then  extant  (and  later)  precedent  did  not  always  support,  however,  the  positions  taken  in  the  regulations. 

Courts  initially  relying  upon  the  remedial  policy  of  the  predecessors  to  §  1033,  particularly  prior 
to  the  1934  Act  regulations,  fashioned  a  host  of  liberal  rules'^  and  in  particular  early  on  applied  the 
SORISOU  standard  liberally  as  to  involuntary  conversions  of  real  estate."  But  in  the  1950s  the  Tax 
Court  and  some  other  tribunals  adopted  a  "functional"  test  for  determining  whether  replacement  property 
for  involuntarily  converted  real  estate  was  "similar  or  related  in  service  or  use"  which  in  devolution 
spawned  "too  many  different  'tests'  and  an  acute  case  of  hardening  of  categories."  Johnson  v.  Comm'r, 
43  T.C.  736,  736  (1965)(ct.  reviewedXabandoning  functional  test).  The  Tax  Court  dealing  with  fact 
patterns  where  the  taxpayer  itself  was  the  actual  user  came  to  compare  the  actual  physical  use  to  which 
the  exchanged  properties  were  put,  but  extended  this  analysis  to  the  lessee's  end  use  where  the  taxpayer 
was  the  lessor.  Loco  Realty  Co.  v.  Comm'r,  306  F.2d  207,  210-13  (8th  Cir.  1962Xsketching  evolution 
of  test  and  rejecting  it  as  to  lessor  exchanges).'*  In  1958  Congress  disapproved  of  application  of  the 
functional  test  as  to  involuntarily  converted  real  estate  but  took  the  easy  way  out  with  new  §  1033(g) 
deeming  §  1033's  SORISOU  standard  satisfied  by  meeting  the  §  1031  like-kind  test  in  the  case  of  real 
estate  involuntarily  converted.  S.  Rep.  No.  1983,  85th  Cong.,  2d  Sess.  72-73  (1958).  I  suspect  that  this 
view  of  the  relative  strictness  of  SORISOU  as  to  real  estate  compared  to  "like  kind",  which  many 
commentators  share,  underlay  the  Joint  Staffs  reasoning  in  1987  that  the  standard  for  voluntary 
exchanges  of  real  estate  should  be  no  broader  than  the  involuntary  conversion  standard.  However,  the 
1958  amendments  and  legislative  history  rekindled  the  remedial  flame— courts  again  wrought  creative 
solutions. 

Af^er  1958  courts  proceeded  to  reconstruct  the  "similar  or  related  in  service  or  use"  standard 
in  a  line  of  cases  culminating  during  the  early  1960's  in  Liant  Record,  Inc.  v.  Comm'r,  303  F.2d  326 
(2d  Cir.  1962),  and  its  brethren,  if  not  progeny.  Liant  Record  stresses  the  service  or  use  which  the 
properties  have  to  the  taxpayer-teior,  not  the  lessees,  measured  by  management  activity,  services 
rendered  to  the  tenants,  and  business  risk.  Ultimately  the  Service  and  the  Tax  Court  adopted  this  test 
as  to  SORISOU."  Davis  v.  United  States,  589  F.2d  446,  450  (9th  Cir.  1979),  tests  the  limits  of 
analyzing  the  taxpayer's  "relationship  to  the  property"  (management  activities  and  investment  risk) 
under  the  SORISOU  standard,  holding  that  the  taxpayer's  reinvestment  of  condemnation  proceeds  from 
disposition  of  a  fishery  plant  and  adjacent  agricultural  land  into  improvements  to  its  existing  industrial 
park  land  qualified  under  SORISOU.  (The  Ninth  Circuit,  famous  for  its  liberality  as  to  §  1031,  noted 
that   "given   the   change    in   the   Hawaiian    economy,    reinvestment    in   agricultural  property   was 


"[F]orthwith  .  .  .  acquisition"  permitted  a  2-year,  diligent  search  for  replacement  property,  Haberland  v.  Comm  >,  25 
B.T.A.  1370  (I932)(also  sizing  manufacniring  for  textile  industry  is  "related"  but  not  "similar"  in  use  to  old  textile  plant  self- 
manufacturing  its  own  sizing);  anticipatory  replacement,  Washington  Market  Co.  v.  Comm'r,  25  B.T.A.  576  (1932);  liberal 
"related  use";  Henderson  Overland  Co.  v.  Commr,  4  B.T.A.  1088,  1092  (1926)(land  with  foundation  put  in,  construction  halted 
by  external  cirounstances  for  replacement  improved  real  estate  used  similarly  to  end  goal  of  converted  property).  Remedial  policy 
also  gave  birth  later  to  liberal  doctrines.  E.g.,  economic  unit  rule,  Masser  v.  Comm'r,  30  T.C.  741  (1958);  timely  replacement 
by  purchased  controlled  corporation  after  its  purchase  (pursuant  to  step  transaction  doctrine),  John  Richard  Corp.  v.  Comm  'r,  46 
T.C.  41  (1966);  contingencies  in  purchase  price,  Cusack  v.  Comm'r,  48  T.C.  156(1%7);  "threats"  of  condemnation,  S  &  B  Really 
Co.  V.  Comm'r,  54  T.C.  863  (1970);  sales  under  "threat"  to  third  party,  S.H.  Kress  <S  Co.  v.  Comm'r,  40  T.C.  142  (1%3);  and 
"severance"  and  reimbursements,  Graphic  Press  v.  Comm  >,  523  F.2d  586  (9th  Cir.  1975). 

"  See,  e.g.,  Henderson  Overland  Co.  v.  Comm'r,  4  B.T.A.  1088,  1092  (1926)(lot  with  taxpayer  excavations  and 
foundations  for  structure,  where  constru«ion  for  auto  sales  office  building  not  completed  because  WW  I  war  shortages  and  then 
condemnations,  for  lot  with  building  already  improved  for  that  purpose);  Washington  Market  Co.  v.  Comm  >,  25  B.T.A.  576,  584 
(1932Xice  plant,  cold  storage  refrigeration,  and  wholesale  stalls  replaced  with  property  used  for  all  these  purposes  except 
wholesale  stalls);  Haberland  v.  Comm'r,  25  B.T.A.  1370  (1932Ktextile  manufacniring  plant  including  self-production  of  sizing 
materials  for  own  use  replaced  with  plant  for  making  sizing  materials  for  sale  to  textile  mills);  Davis  Regulator  Co.  v.  Comm  'r, 
36  B.T.A.  437  (1937Xmanufacturing  business  in  leased  building  replaced  by  self-construction  of  plant  for  same  business  on  land 
owned  by  taxpayer);  Kimbell-Diamond  Milling  Co  v.  Comm'r,  10  T.C.  7  (1948)(nour  plant  replaced  by  flour  and  feed  processing 
plant);  Massitlon-Clevetand-Akron  Sign  Co  v.  Comm'r,  15  T.C.  79  (1950)(plant  replaced  by  plant  for  similar  manufacture  but 
with  disproportionate  mix  of  assets);  Gaynor  News  Co.  v.  Comm'r,  22  T.C.  1172,  1179  (1954Xunimproved  real  estate  acquired 
as  plant  site  for  real  estate  with  existing  improvements  usable  in  part  for  the  new  plant;  "we  think  it  unrealistic  to  set  up  a 
ftmctional  classification  in  terms  of  improved  or  unimproved  property"). 

"  Liant  Record  Inc.  v.  Comm'r,  303  F.2d  326,  328-29  (2d  Cir.  1962),  in  dicmm  accepted  the  "ftmctional"  test  only  where 
the  taxp^er  him  or  herself  used  the  converted  property.  Pohn  v.  Comm'r,  309  F.2d  427,  429  (7th  Cir.  1962),  would  reconcUe 
Lynchburg  Bank  &  Trust  Co.  v.  Comm'r,  208  F.2d  757  (4th  Cir.  1953),  and  Steuart  Bros.,  Inc.  v.  Comm'r,  261  F.2d  213  (4th 
Cir.  1958)(both  written  by  able  Judge  Soper  of  the  Fourth  Circuit)  by  reading  Steuart  as  adopting  a  Liant  Records-Vike  double 
standard.  However,  an  excellent  smdent  note  convincingly  argues  that  a  Liant  Records-aan-Filippini  markets  risk  analysis  should 
apply  to  both  investment  and  productive  business  use  property  for  purposes  of  §  1033.  See  Note,  Involuntary  Conversions  and 
the  Questions  of  Qualified  Replacement  Property,  38  OHIO  ST.  L.  J.  331,  350  (1977). 

"  Rev.  Rul.  64-237,  1964-2  C.B.  319;  Johnson  v.  Comm'r,  43  T.C.  736,  739-41  (l%5Xct  reviewed).  See  also  Loco  Really 
Co  V.  Comm'r.  306  F.2d  207  (8th  Cir.  1%2);  Filippini  v.  United  States,  318  F.2d  841,  845  (9th  Cii.  1%3). 


77-130  0-94-22 


1694 


unreasonable,  and  purchase  of  another  sea  fishery  was  virtually  impossible."  Id.  at  450  (Emphasis 
added).)  Under  such  analysis  most  business  (or  investment)  real  property  could  be  swapped  for  most 
business  real  property  (or  investment  real  property,  respectively).  But  raw  land  could  not  be  swapped 
for  a  developed  real  estate  investment  due  to  the  shift  in  risk  (and  current  return  in  most  cases).  Nor 
could  improved  real  estate  used  in  a  business  be  swapped  for  otherwise  identical  realty  held  for 
investment  use  due  to  the  change  in  management  activities. 

In  short  the  conventional  wisdom  that  courts  apply  §  1033  more  strictly  than  §  1031  appears 
more  wrong  than  right  early  and  late-less  so  in  between.  Nevertheless  due  to  the  controversies  under 
§§  103 1's  and  I033's  standards,  Congress  this  time  should  not  simply  adopt  the  §  1033  standard  lock- 
stock-and-barrel  in  §  1031  (as  the  House  did  in  1989),  while  keeping  the  old  §  1031  standard  for 
involuntary  conversions  of  real  estate  under  §  1033.  It  should  address  at  least  the  known  conflicts  or 
uncertainties,  if  only  by  approving  or  disapproving  of  specific  precedent.  For  example  since  Davis  was 
deliberately  decided  under  §  1033(a),  simple  adoption  of  §  1033's  "similar  or  related  in  service  or  use" 
test  would  support  application  of  Davis  to  a  like-kind  exchange  as  well  as  an  involuntary  conversion. 
If  Congress  wants  this  result,  then  there  is  little  need  to  retain  a  §  1033(g)  like-kind  test  for 
involuntarily  converted  real  estate.   Please  don't  create  more  clutter  in  the  Code. 

m.        Tax  Policy  and  Politics 

Continuity  of  investment  was  criticized  just  over  a  decade  after  enactment  of  the  first  predecessor 
to  §  1031  as  a  rationale  for  nonrecognition.  See  Prevention  of  Tax  Avoidance,  Preliminary  Report  of 
a  Subcommittee  of  the  Committee  on  Ways  and  Means  Relative  to  Methods  of  Preventing  the  Avoidance 
and  Evasion  of  the  Internal  Revenue  Laws  Together  with  Suggestions  for  Simplification  and 
Improvement  Thereof  73rd  Cong.,  2d  Sess.  8-9,  38-9  (1933KSubcommittee  and  Joint  Committee  Staff 
discounted  "paper  profits"  rationale).  More  recently  criticism  of  §  1031  has  centered  on  (a)  its  overly 
restrictiveness~in  inconsistent  treatment  of  cash-outs  with  (contractually)  required  reinvestment  and  non- 
like-kind  exchanges  of  illiquid  property,  Komhauser,  supra  60  So.  Cal.  L.  Rev.  at  409-11;  Jensen, 
supra  4  Amer.  J.  OF  Tax  Policy  at  204;  Comment,  Exchange  Requirement  in  Multiparty  and 
Nonsimultaneous  Exchanges:  A  Critical  Analysis  and  Statutory  Solution,  37  Sw.  L.J.  645,  646-41 
(1983);  (b)  its  over  liberality  in  providing  non-recognition  for  transactions  which  substantially  change 
the  form  of  investment  as  to  the  nature  of  risks  and  rewards,  Bryce,  supra  56  Tulane  at  46;  and  (c)  the 
overly  narrow  "like  class"  safe  harbors  for  personal  property  and  particularly  the  new  like  kind  rules 
in  these  regulations  as  to  intangibles,  Bogdanski,  On  Beyond  Real  Estate:  the  New  Like-Kind  Exchange 
Regulations,  48  Tax  Notes  903,  904,  908  (Aug.  30,  1990). 

The  primary,  usually  (unstated  policy)  in  allowing  non-recognition  for  like-kind  exchanges  is  the 
economic  analogy  to  unrealized  appreciation  or  depreciation,  which  in  a  continuing  investment  is  not 
taxed  or  recognized  until  realized.  See  Jensen,  supra  4  American  J.  OF  Tax  POLICY  at  199-201 
(1985).  However,  there  the  principal  (non-political)  basis  for  non-recognition  is  (a)  administrative 
convenience—annual  valuations  and  self-reporting— and  (b)  lack  of  taxpayer  liquidity.  The  focus  in 
administrative  difficulties  is  on  (1)  difficulty  of  "valuation"  in  "thousands  of  horse  trades  and  similar 
barter  transactions  each  year."  H.R.  Rep.  No.  704,  supra  at  564;  Hearings  on  Tax  Shelters,  Accounting 
Abuses,  and  Corporate  and  Securities  Reforms,  before  the  House  Ways  &  Means  Comm.,  98th  Cong., 
2d  Sess.  11,  24  (1984XStatement  of  Ass't  Sec'ty  Chapoton);  and  (2)  hence,  difficulty  in  compliance, 
Jensen,  supra  at  208-1 1.  As  to  valuation,  at  least  "boot"  and  multi-party  transactions  practically  require 
valuations.  See  Jensen,  supra  4  Amer.  J.  OF  Tax  POLICY  at  209;  Komhauser,  60  So.  Cal.  L.  Rev. 
at  409;  Comment,  37  Sw.  L.J.  at  648  (boot  requires  valuation);  Briar,  Like-Kind  Exchanges  of 
Partnership  Interests:  A  Policy  Oriented  Approach,  38  TAX  L.  REV.  389,  401  n.47  (1983).  As  to 
compliance,  this  too  probably  is  only  a  problem  in  true  barter  situations,  hence,  the  appropriate  remedy 
is  a  ceiling  on  the  dollar  amount  of  deferrable  gain  in  non-recognition  transactions.  Cf  the  $100,000 
aimual  taxpayer  ceiling  on  §  1031  exchanges  of  real  estate  under  the  House  version  of  OBRA  1987. 

The  1921  enactment  of  the  like-kind  exchanges  was  part  of  a  package  (including  limiting 
"amount  realized"  to  property  with  a  readily  realizable  market  value)  designed  to  make  more  trades  not 
currently  taxable  in  order  to  defer  recognition  of  stock  losses  during  the  then  current  post-war 
depression.  See  Hearings  on  H.R  8245  (Revenue  Act  of  1921)  before  Sen.  Fin.  Comm.,  67th  Cong., 
1st  Sess.  199-202  (1921XStatement  of  Dr.  Adams);  accord,  Greene  v.  Comm'r,  15  B.T.A.  401,  407 
{\929Y,Board  reviewed),  cffd,  42  F.2d  852  (2d  Cir.  1930).  Congress'  continuation  in  1934  of  the  non- 
recognition  provisions  in  general,  which  the  House  would  have  repealed,  also  was  based  on  the  fear  that 
recognized  losses  in  the  heart  of  the  Depression  would  have  exceeded  recognized  gains.  Jensen,  4 
Amer.  J.  Tax  Poucy  at  211-12  and  n.86.  However,  with  chronic  and  at  times  substantial  inflation 
over  the  past  25  years,  this  policy  has  become  anachronistic.    Id.  at  212. 


1695 


Professor  Komhauser,  utilizing  historical  research,  has  convincingly  hypothesized  several  factors 
involved  in  the  enactment  of  §  1031  in  1921  and  the  amendments  in  1923  and  1924:  (1)  concern  about 
whether  capital  gains  were  income;  (2)  confusion  about  when  realization  occurs;  (3)  sympathy  for  a 
consumption  theory  of  income  taxation;  and  (4)  economic  and  political  conditions  encouraging  an 
economic  policy  in  the  tax  laws  to  foster  investment.  Komhauser,  60  So.  Cal.  L.  Rev.  at  41 1;  iee  also 
id  at  400,  438-39  (trick  was  for  Congress  to  encourage  investment  while  maintaining  nominally 
progressive  rates,  which  capital  gains  preference  and  tax-free  like-kind  exchanges  accomplished),  accord 
id.  at  440-41.  The  legislative  history  in  Part  II  confirms  that  the  architects  of  §  1031  at  least  intended 
for  the  predecessors  to  §  1031  and  to  the  corporate  reorganization  provisions  to  act  as  a  back-door 
consumption  tax  for  high  income  individuals,  i.e.,  reinvest  and  you  won't  be  taxed;  don't  and  you  will 
albeit  at  not  very  high  capital  gains  rates. 

The  economic  efficiency  argument  too  was  present  in  the  genesis  of  §  1031:  mere  changes  in  form 
should  not  impede  business  transactions,  H.R.  Rep.  No.  350,  67th  Cong.,  1st  Sess.  10  (1921);  64  Cong. 
Rec.  (Part  3)  2855  (House  Feb.  1,  1923)  (Remarks  of  Rep.  Green,  R-Iowa);  Komhauser,  60  So.  Cal. 
L.  Rev.  408  n.25,  and  underlies  the  limitation  to  business  or  investment  property  and  even  more  the 
exclusion  ab  initio  of  personal  use  property.  Jensen,  4  AMER.  J.  Tax  Policy  at  213  n.94.  However, 
this  rationale  too  is  flawed  in  that  the  "like-kind"  test  actually  channels  otherwise  "locked  in"  assets  only 
to  "like-kind"  investments  rather  than  to  the  best  user  and  uses  the  barter  mechanism  entailing  high 
transactional  costs.  Jensen,  4  A.MER.  J.  Tax  Policy  at  214-15;  Komhauser,  60  So.  Cal.  Rev.  at  408 
and  n.24.  Thus,  economic  efficiency  would  call  for  universal  roll-over.  See  authorities  cited  in 
Komhauser,  60  So.  Cal.  L.  Rev.  at  411  n.31;  Blum,  Rollover:  An  Alternative  Treatment  of  Capital 
Gains,  41  Tax  L.  Rev.  383  (1986).  In  1987  the  Joint  Staffs  concern  focused  on  continuity  of 
investment,  arguing  for  a  §  1033  standard,  to  prevent  (a)  significant  altemation  of  economic  position 
and  (b)  favoring  of  real  estate  with  its  broadest  definition  of  "like"  over  personalty  divided  into  a  host 
of  dissimilar  investments.  See  also  Komhauser,  60  So.  Cal.  L.  Rev.  at  409-1 1.  The  general  mobility 
of  capital  argument  cuts  too  broadly  in  that  it  would  call  for  a  general  roll-over  of  asset  approach  (thus 
fatally  eroding  distributional  equity  as  well  as  vertical  and  horizontal  equity).  See  Komhauser,  60  So. 
Cal.  Rev.  at  410.  And  if  incentives  for  investment  are  desired-and  advisable-better  techniques  can 
be  designed.  Id.  at  449-50  (IRA-like  90-day  rollover  technique). 

The  House  Ways  &  Means  Committee  in  1987  modified  the  Joint  Staffs'  altemative  of 
proscribing  real  estate  from  §  1031  exchanges  by  caping  at  $100,000  the  amount  of  gain  from  a  like- 
kind  exchange  of  real  estate  (other  than  involuntary  conversions  and  exchanges  of  principal  residences) 
any  taxpayer  could  have  deferred  in  any  one  taxable  year  (presumably  responding  to  the  overly  liberal 
application  of  the  like-kind  standard  to  real  estate  and  possibly  to  fact  that  most  of  the  abuse  was  here). 
H.R.  3445,  100th  Cong.,  1st  Sess.  §  10105  (1987).  The  Committee  looked  as  much  at  deferral  at  high 
income  levels  as  at  the  traditional  continuity  of  investment  criterion  (economic  similarly  to  cash  or 
property  not  of  a  like-kind).  H.R.  Rep.  No.  391,  100th  Cong.,  1st  Sess.  1039  (1987).  Probably  the 
former  concem  relates  to  the  distributional  equity  of  the  1986  Code.  However,  the  1987  House  bill 
attracted  significant  attention  from  real  estate  professionals  who  launched  an  active  and  successful 
lobbying  effort  against  the  measure.  15  J.  Real  Est.  Tax'n  267.  Such  distributional  and  special 
interest  group  concems  are  matters  of  tax  politics  more  than  policy.  Here  too  the  picture  is  mixed. 
Governor  Clinton's  primary  income  tax  theme  in  the  1992  Presidential  Campaign  was  "faimess"  or 
increasing  individual  income  taxes  only  on  the  rich.  Restricting  the  scope  of  like-kind  exchanges  of 
investment  and  business  real  estate  surely  would  have  that  effect.  On  the  other  hand  President  Clinton's 
goal  was  to  couple  rate  increases  at  the  top  with  "offsetting  incentives  to  invest."  See  Lee,  President 
Clinton's  Capital  Gains  Proposals,  59  Tax  Notes  1399,  1410  n.62  (June  7,  1993).  Similarly  while 
real  estate  interests  successfully  opposed  in  1987  the  $100,000  cap  on  deferred  gain  in  §  1031  exchanges 
of  real  estate  and  the  1989  extension  of  the  §  1033  standard  to  real  estate  exchanges  under  §  1031,  at 
the  time  such  exchanges  were  highly  touted  as  the  only  intact  individual  real  estate  preference  with  the 
repeal  of  any  capital  gains  preference  and  imposition  of  §  469's  Passive  Activity  Loss  disallowance 
rules.  OBRA  1993  restored  a  substantial  capital  gains  preference  and  carved  out  from  PAL  real  estate 
losses  of  those  in  the  industry.  See  Lee,  supra.  Thus  the  political  case  of  the  real  estate  sector  is 
weakened.  (As  an  aside,  it  would  have  made  better  policy  and  politics  to  have  used  the  revenues  from 
restricting  §  1031  to  help  pay  for  the  PAL  changes  rather  lengthening  the  depreciable  life  of  real  estate 
so  much.) 

Commentators  and  the  courts  themselves  agree  that  the  trend  injudicial  interpretation  of  §  1031  (as 
to  "exchange"  and  "holding"  as  well  as  the  like-kind  standard  as  to  real  estate)  has  been  liberal.  See 
Bryce,  supra  56  TUL.  L.  Rev.  at  58  (citing  Starker);  Note,  Section  1031  Nonrecognition  of  Gain  for 
Deferred  Exchanges-Starker  v.  United  States,  16  Wake  FOREST  L.  REV.  645,  650-53  (1980);  Starker 
V.  Comm'r,  602  F.2d  1341,  1352  (9th  Cir.  1979).  The  above  discussion  shows  that  the  like-kind 
deferral  of  investments  from  its  inception  was  based  on  benefitting  private  interests  (helping  businesses 


1696 


and  high  income  individuals  maintain  their  capital  while  maintaining  the  "facade  of  progressive  rates") 
especially  as  to  like  kind  exchanges  of  investments,  and  indisputably  in  1987  and  1989  was  maintained 
as  a  preference  for  private  interests.  Some  but  not  all  academic  writers  believe  that  in  such 
circumstances  special  interest  benefit  legislation  should  be  strictly  construed.  I  would  apply  this  "strict 
construction"  notion  to  exchanges  of  investment  property.  To  the  contrary  the  liberal  §  1031 
"exchange"  judicial  precedents,  coupled  with  the  regulation's  broad  classification  ab  initio  of  all  real 
estate  as  "like"  long  firmly  embedded  in  the  case  law,  violate  both  sound  tax  policies-economic 
efficiency  (tax  rules  encourage  real  estate  swaps  over  other  swaps  and  sales);  horizontal  equity 
(disparate  treatment  of  taxpayers  holding  investment  real  estate  and  swapping  real  estate  while 
diversifying  risk),  and  vertical  equity  (benefits  concentrated  in  high  bracket  taxpayers).  A  rationalized 
post-Z,;aw/  Records  SORISOU  test  applied  under  §§  1031  and  1033  (probably  more  liberally  under  the 
latter)  to  all  types  of  property  would  help  maintain  continuity  of  investment/business  characteristics 
parallel  to  unrealized  appreciation  in  non-exchanged  property. 

rV.        Proposed  Modifications  to  §  1031  Standard 

I  respectfully  urge  this  Subcommittee  to  revise  the  §  1031  standard  for  exchange  to  the 
SORISOU  standard  of  §1033  because  the  current  generosity  to  voluntary  real  estate  exchanges  violates 
sound  tax  policy  and  comes  fiom  tainted  historical  origins  as  to  investment  property  swaps.  More 
importantly  I  implore  it  not  to  just  adopt  the  §  1033  "similar  or  related  in  service  or  use"  standard 
(perhaps  with  a  "like  kind"  standard  exception  for  involuntarily  converted  real  estate),  but  instead 
address  in  the  legislative  history  how  a  standard  comparing  risk  and  management  activities  (and  any 
other  appropriate  factors)  should  be  applied  in  voluntary  and  involuntary  exchanges."  Congress 
should  direct  in  revised  §§  1031  and  1033  (or  combined  into  a  single  section  covering  voluntary  and 
involuntary  conversions  and  exchanges)  implementation  of  such  policies  through  revenue  rulings  which 
would  evolve  into  regulations  employing  a  "structured  discretionary  justice"  approach.  Detailed 
regulations  promulgated  by  an  administrative  agency,  here  Treasury  and  the  Service,  increase  the 
principled  discretion  of  the  agency  as  a  decision  maker,  according  to  Professor  Davis'  landmark  book 
"Discretionary  Justice  -  A  Preliminary  Inquiry"  and  subsequent  administrative  law 
scholarship."  Moreover,  Professor  Davis  posits  that  such  detailed  rules  channeling  agency  exercise 
of  discretion  can  develop  fit)m  first  considering  one  concrete  problem  at  a  time,  announcing  the 
hypothetical  cases  as  rulings  and  refraining  from  generalizing;  then  fashioning  generalized  principles 
or  standards  fix^m  this  experience;  and  finally  formulating  regulations  to  implement  the  standard  in  the 
form  of  structured  discretion." 

On  another  thought,  the  narrower  the  range  of  permitted  exchanges  under  revised  §  1031,  the 
stronger  the  case  for  permitting  reinvestment  within  a  stated  period  (say  90  days)  of  cash  proceeds 
in  qualifying  replacement  property  under  such  revision. 

Most  importantly  the  Subcommittee  should  take  advantage  of  this  opportunity  and  address  in 
the  legislative  history  known  problems  under  §§  1031  and  1033  including  the  areas  set  forth  below. 
The  cast  of  players  in  the  following  hypotheticals  include  A  who  holds  the  "exchange  property"  and  B, 
the  other  party  to  the  exchange  who  holds  the  "replacement  property",  except  in  some  3  or  4  cornered 
or  party  exchanges,  and  who  always  winds  up  holding  the  exchange  property. 

1.  Built-toSuit.  A's  transfer  of  real  property  in  exchange  for  B's  construction  of 
improvement  on  other  property  held  by  A  does  not  qualify  under  §  1031.  Bloomington  Coca-Cola 
Bottling  Co.  V.  Comm'r,  189  F.2d  14  (9th  Cir.  1950);  Wasserman,  supra  65  Taxes  at  979;  P.L.R. 
8701015.  What  if  to  aviod  these  tax  results,  B  makes  the  improvements  on  parcel  X,  not  previously 
owned  by  A,  and  then  exchanges  improved  parcel  X  for  a  parcel  of  real  estate  (usually  unimproved) 
held  by  A.  OK.  J.  H.  Baird  Publishing  Co.  v.  Commr,  39  T.C.  608  (1962),  acq.  1963-2  C.B.  4  {A 
picked  parcel  X);  accord.  Coastal  Terminal,  Inc.  v.  United  States,  320  F.2d  333  (4th  Cir.  1963).  B  is 
not  entitled  to  like-kind  treatment  on  exchange  of  parcel  X.   Rev.  Rul.  75-291.  1975-2  C.B.  332.  For 


In  involuntary  conveniens  but  not  voluntary  exchanges  difficulty  of  replacement  could  and  should  be  a  factor.  See  Davis 
V.  United  States,  589  F.2d  446,  450  (9th  Cir.  1979).  Similarly  construction  of  improvements  on  already  owned  property  might 
qualify  in  an  involuntary  conversion  but  all  of  the  current  built-to-suit  techniques  for  like-kind  exchanges  might  be  denied  deferral 
in  a  voluntary  exchange. 

"  Davis,  Discretionary  JusncE,  A  Preliminary  Inquirv,  103  (LSU  Press  1969);  see  also  Mashaw, 
Bureaucratic  Justice,  Managing  Social  DiSABiLriY  Claims  103-22  (Yale  Univ.  Press  1983);  Lee,  Structured 
Discretionary  Justice  Under  Section  355,  44  TAX  NOTES  1029,  1030  (August  28,  1989).  An  agency  issuing  regulations  (rule 
making)  sening  forth  specific  factors  to  be  used  in  balancing  tests  implementing  the  desired  standards  and  policies  can  implement 
standards  effectively  while  maintaining  the  desirable  bureaucrat's  discretionary  judgement  in  application.  Id.  at  1032. 
Lee,  supra  note  17  at  1032. 


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a  perverse  §  1031  flip-flop  here  by  Government  see  Barker  v.  United  States,  668  F.  Supp.  1199  (D.C. 
III.  1987XGovemment  argued  for  like-kind  exchange).  What  if  A  locates  and  negotiates  for  property 
to  be  acquired?  OK.  Coupe  v.  Comm'r,  52  T.C.  394,  405-09  (1969),  acq.  in  result  only.  Oversees 
improvements  on  land  to  be  acquired?  J.H.  Baird,  supra.  See  generally  Guerin,  A  Proposed  Test  for 
Evaluating  Multi-Party  Like  Kind  Exchanges,  35  T.KX  L.  REV.  545,  612  (1980);  Rev.  Rul.  75-291, 
1975-2  C.B.  332.  A  1980s  ploy  was  for /I  to  sell  high  basis  parcel  Xto  B,  who  concurrently  contracted 
with  A  to  build  the  improvements  and  then  to  transfer  improved  tract  Xlo  A  in  exchange  for  A's  low 
basis  (usually  unimproved)  parcel  Y.  Again  B  does  not  qualify  for  deferral  under  §  1031.  Goldstein 
&  Lewis,  supra  5  REV.  OF  Tax'n  OF  LvD'v's  at  207.  But  A  does,  so  long  as  risk  of  economic  loss 
as  to  parcel  X  rests  with  B  between  acquisition  and  exchange.  P.L.R.  7823035  {B  bears  the 
fundamental  risk  of  ownership  of,  the  property  and  of  the  constructon  to  take  place  thereon);  accord, 
P.L.R.  8217106  ("including,  but  not  limited  to,  liability  for  real  estate  taxes  or  for  obligations  under  hte 
loan  or  construction  agreements,  and  Corp  A  will  not  be  entitled  to  any  income,  insurance  proceeds  or 
condemnation  proceeds  prior  to  the  exchange  date.");  Goldstein  &  Lewis,  supra  5  Rev.  of  Tax'n  OF 
iND'v's  at  207.  Query,  was  risk  of  loss  truly  on  B?  See  Wasserman,  supra  65  Taxes  at  980.  Also 
the  Eighth  Circuit  went  the  opposite  way  on  similar  facts  under  the  step-transaction  doctrine.  Smith  v. 
Comm'r,  537  F.2d  972  (8th  Cir.  1976).  What  if  B  does  not  buy  parcel  X,  but  instead  becomes  tenant 
on  a  30-year  ground  lease?  See  Wasserman,  supra  65  TAXES  at  980-81;  1984  Tax  Shelter  Hearings, 
supra  at  159  (Statement  of  Professor  Martin  Ginsburg).  If  B  is  related  to  the  taxpayer,  new  problems 
emerge.  The  deferred  exchange  regulations  contemplate  built-to-suit  exchanges.  Treas.  Reg.  § 
1.1031(k)-l(e)(3Xii)  and  (iii).  Congress  should  provide  that  if  the  improvements  are  made  on  property 
owned  by  A  within  the  last  previous  2  years,  an  exchange  of  that  property  back  to  A  will  not  qualify 
under  §  1031. 

In  Davis  Regulator  Co.  v.  Comm'r,  36  B.T.A  437,  443  (1937),  the  Board  relying  on  remedial 
nature  of  the  predecessor  to  §  1031  pennitted  tax-free  reinvestment  of  the  proceeds  of  an  involuntary 
conversion  of  a  leasehold  interest  in  improved  real  estate  used  in  the  taxpayer's  manufacturing  business 
in  construction  of  a  plant  to  continue  business  on  property  already  owned  by  the  taxpayer.  Accord, 
Davis  V.  United  States,  589  F.2d  446  (9th  Cir.  1979).  Contra  P.L.R.  8119029.  To  the  contrary,  going 
from  raw  land  used  in  a  cemetery  business  to  construction  of  an  administrative  office  for  the  business 
on  retained  land  did  not  qualify  under  the  since-discredited  "functional  or  end  use"  test.  United 
Development  Co.  v.  United  States,  212  F.  Supp.  664,  667-67  (E.D.  Mo.  1962Xeffect  of  investing  in  an 
administration  building  is  to  replace  the  old  building  and  to  enhance  the  remaining  property  of  the 
corporation;  not  a  replacement  of  its  income  producing  asset,  the  condemned  land).  Please  address  this 
in  the  Report. 

2.  Purpose  for  Holding.  Problems  have  arisen  as  to  the  purpose  for  holding  when  the 
taxpayer  has  recently  acquired  the  exchange  property  (typically  in  an  exchange  basis  transaction)  to 
exchange  it  or  disposed  of  the  replacement  property  shortly  after  the  exchange.  The  "holding 
requirement"  corresponds  to  the  Subchapter  C  "continuity  of  interest"  doctrine.  Therefore,  acquiring 
property  for  an  exchange  (at  least  in  a  cost-basis  acquisition)  fails  the  "holding"  requirement.  Rev.  Rul. 
75-291,  supra.  Conversely,  immediate  sale  of  the  property  received  in  the  exchange  may  equally  cause 
such  replacement  property  to  fail  the  "holding"  test  and,  hence,  the  exchange  to  fail  §  1031.  See  Black 
V.  Comm'r,  35  T.C.  90  (1960);  Regals  Realty  Co.  v.  Comm'r,  43  B.T.A.  194  (1940),  acq.  1931-1  C.B. 
9,  qfTd,  127  F.2d  931  (2d  Cir.  1942).  A  2-year  qualified  "holding"  before  and  after  probably  will 
suffice.  See  Section  103  J  applied  to  property  held  two  years,  61  J.  Tax'n  224  (Oct.  1984).  The  Tax 
Court  views  holding  the  replacement  property  for  a  gift  as  failing  the  "holding"  test  where  the  "step 
transaction"  doctrine  applies.  Compare  Click  v.  Comm'r,  78  T.C.  225,  232-34  (1982Xtax  plan  to  give 
residences  to  children  plan  was  completed  7  months  after  exchange  of  ranch  for  residences)  with 
Wagensen  v.  Comm'r,  74  T.C.  653,  660  (1980Xtaxpayer  had  eventual  goal  but  no  "concrete"  plans  to 
make  gift  of  replacement  ranch  property;  discussions  with  tax  advisers  only  after  exchange;  gift  made 
9  months  after  exchange).  Clearly  a  bright-line  say  1-year  before-  and  after-exchange  holding 
period  as  called  for  by  the  House  in  1989  is  infinitely  preferable  to  the  current  unpredictability. 
H.R.  Rep.  No.  247,  101st  Cong.,  1st  Sess.  1339-40,  142  (1989). 

i.  Taxpayer  Involvement  in  Acquisition  of  Replacement  Property. 

Taxpayers  understandably  often  want  to  play  a  major  part  in  the  acquisition  of  the  replacement 
property.  TTie  taxpayer  may  want  to  locate  the  replacement  property  and  negotiate  (or  at  least  approve) 
the  terms  of  the  replacement  property  contract  and  any  financing  to  be  secured  by  the  replacement 
property.  See  Rev.  Rul.  77-297,  1977-2  C.B.  304.  However,  if  a  taxpayer  is  too  actively  involved,  it 
may  appear  that  fl  (in  a  3-party  exchange)  or  D  (the  "intennediary"  in  a  4-party  exchange)  is  acting  as 
the  taxpayer's  agent.  Guerin,  supra  at  603.  Cases  have  questionably  allowed  the  taxpayer  to  advance 
money  to  the  exchange  "intermediary"  towards  the  purchase  price  of  the  replacement  property.  Biggs 


1698 


V.  Commr,  69  T.C.  905,  914-15  (1978),  afd,  632  F.2d  1171  (5th  Cir.  1981);  See  124  Front  St..  Inc.. 
V.  Comm'r,  65  T.C.  6,  17-18  (1975)  (taxpayer  can  advance  money  toward  purchase  price  of  parcel  to 
be  acquired);  Guerin,  supra  at  608-09.  But  see  P.L.R.  8035049  (prohibiting  loans  between  the  parties 
for  construction).  Cf.  No  ruling  "red  flag"  in  financing  lease/" leveraged  leasing"  context.  One 
commentator  has  stated  that  it  may  be  preferable  for  a  taxpayer  to  guarantee  a  loan  than  for  the  taxpayer 
to  make  that  loan.  Wasserman,  supra  65  Taxes  at  987.  Possibly  such  in  effect  acting  as  the  taxpayer's 
agent  in  the  purchase  will  be  ignored  under  the  qualified  intermediary  portion  of  Treas.  Reg.  § 
1.1031(k)-l(k).  See  Cuff  &  Wasserman,  Understanding  the  New  Regulations  on  Deferred  Exchanges, 
68  Taxes  475,  493  (1990);  Committees  on  Income  from  Real  Property  and  Personal  Properties,  New 
York  State  Bar  Association,  Section  of  Taxation,  Report  on  Section  1031  Deferred  Exchange 
Regulations,  48  Tax  NOTES  1405,  1415  (Sept.  19,  1990). 

4.  Scope  of  Condemnation.  The  Subcommittee  may  want  to  consider  whether 
"condemnation"  should  be  limited  to  eminent  domain.  See,  e.g.,  American  Nat 'I  Gas  Co.  v.  Comm'r, 
279  F.2d  220  (Ct.  CI.  1960);  Rev.  Rul.  57-314,  1957-2  C.B.  523;  S &  B  Realty  Co.  v.  Comm'r,  54  T.C. 
863  (1979),  acq.  1970-2  C.B.  xxi. 

5.  Tax  Benefit  Rule.  .An  uncertain  area  is  whether  the  tax  benefit  rule  overrides  § 
1033.  Compare  Mager  v.  United  States,  499  F.  Supp.  37  (M.D.  Pa.  1980),  qff'd  in  unpub.  opinion.  (3rd 
Cir.  1981)(condemnation  of  property  in  flood  plain  based  upon  pre-flood  value  resulted  in  "tax  benefit" 
to  extent  of  casualty  loss  previously  taken  by  taxpayer  as  to  uninsured  flood  damage  to  residence); 
Bimbaum  v.  Comm'r,  T.C.  Memo.  1978-429  (same),  and  Rev.  Rul.  74-206,  1974-1  C.B.  197  (same), 
with  Buffalo  Wire  Works  Co..  v.  Comm'r,  74  T.C.  925  (1980),  non-acq,  qffd  in  unpublished  opinion 
(2d  Cir.  1981Xno  tax  benefit  "recovery"  of  moving  expenses  when  condemnation  award  was  based  in 
part  on  reimbursement  of  moving  expenses  because  of  doctrine  that  components  of  award  are  not  to  be 
broken  out  but  all  treated  as  compensation  for  property  taken).  See  Edwards,  Involuntary  Conversions 
BNA  T.M.  PortfoUo  #  33-7th  at  A-46  (1984). 


Soil  Remediation  Costs:  TAMs,  Taxes,  Toxins  and  Beyond 

L  Introduction 

Treasury's  highest  regulatory  priority  is  the  tax  accounting  treatment  of  environmental  cleanup 
costs  because  it  hopes  to  avoid  tremendous  litigation  costs  down  the  road. '  The  [high-end]  estimate 
of  such  cleanup  costs  is  in  the  $1  trillion  range  over  30  years.^  I  hope  that  this  Subcommittee  will  take 
the  first  steps  to  head  off  another  costly  imbroglio  like  the  amortization  of  intangibles/A'eH'ar^  Morning 
Ledger  mess  Congress  just  cleaned  up  after  with  the  §  197-prospective  fix.  This  time  Congress  has  the 
opportunity  to  lock  the  bam  door  in  time  to  prevent  wasteful  Government  and  taxpayer  litigation  costs 
over  the  deductibility  of  soil  remediation  costs  (and  of  expenditures  with  some  future  benefit  in  general). 
From  both  a  policy  and  political  perspective,  the  proper  tax  accounting  for  most  tosic  waste  removal 
or  cleanup  costs  surely  is  amortization  as  self-created  intangibles  over  a  stated  period.  Such  costs  are 
substantial  which  tends  to  distort  income  if  allowed  as  a  deduction  in  one  year  and  usually  yield  a  future 
benefit  by  permitting  business  operations  to  continue.'  Handy  models  for  such  amortization  are  either 


Avakian-Martin  &  Caison,  Environmental  Cleanup  Issue:  A  Recwimg  Theme  at  ABA  Meeting,  60  TAX  NOTES  925,  926 
(August  16,  I993))(Treasury  estimate  of  $1  trillion). 

*  Peat  Marwick  Requests  Guidance  on  Proper  Treatment  of  Environmental  Cleanup  Costs,  93  Tax  NOTES  TODAV  148-25 
(July  15,  I993)("trillion  dollar"  range  at  37,000  hazardous  waste  sites  based  on  Associated  Press  Release,  December  9,  1991). 
Nexis  research  disclosed  do  such  AP  release.  TTie  actual  source  appears  to  be  a  University  of  Tennessee  study.  Butler,  UT 
Researchers  Release  Report  on  EPA  Stqxrfimd,  Gannett  News  Service  (Monday  December  9,  199I)(December  6,  1991  University 
of  Tennessee  Study,  Hazardous  Waste  Remediation:  The  Task  at  Hand,  estimates  costs  from  $500  billion  (containing  or  managing 
waste  in  place)  to  $1.2  trillion  (destroy  more  site  contamination,  e.g.,  more  remediation)  over  the  next  30  years,  with  the  "best 
guess"  figure  being  $750  billion  (cominuation  of  current  cleanup  policies  under  Superfund,  Resource  Conservation  and  Recovery 
Act,  federal  facilities,  underground  storage  tanks,  state  and  private  cleanup  efforts);  study  estimated  that  it  will  cost  about  $151 
billion  to  correct  environmental  problems  at  the  highly  publicized  Superlimd  sites,  which  could  be  dwarfed  by  work  needed  at 
more  than  37,000  hazardous  iiidustrial  sites  and  landfills  covered  by  RCRA;  cleaning  up  leaking  underground  petroleum  storage 
tanks  alone  could  cost  $67  billion;  and  $240  billion  needed  to  clean  up  DOE's  nuclear  weapons  production  facilities).  In  short 
the  "deductible"  cost  of  cleanup  costs  paid  by  taxable  entities  is  likely  to  be  less  than  $500  billion  over  30  years. 

Environmental  Cleanup  Guidance  May  Be  Cha  By  July.  Official  Says,  1993  Daily  Tax  REPORT  89  dI5  (M^  II, 
1993)("IRS  effectively  told  taxpayers  in  the  TAM,  citing  the  Wolfsen  case,  that  'you  can't  wait  until  Year  10,  bunch  your 
deduction  and  distort  income,  when  this  large  cost  is  going  to  have  a  beneficial  eflfect  over  the  remaining  useful  life  of  the 
property,"  Canrington  said."XStateinent  of  Glenn  Carrington,  Ass't  Chief  Counsel,  Individual  and  Tax  Accounting); 
Avakian-Martin,  Does  the  IRS  need  to  clean  up  its  ruling  on  cleanup  costs:".  59  Tax  Notes  728,  729  (May  10,  1993)("Lee  said 
the  regime  properly  prevents  a  taxpayer  from  deducting  costs  when  a  deduction  would  result  in  the  distortion  of  income. 
According  to  Lee,  if  a  taxpayer  is  permitted  to  immediately  deduct  large  extraordinao   expenses,  such  as  multimillion  dollar 


1699 


(a)  60  months  as  Congress  usually  provides  for  Government-required  environmental,  safety-based,  etc., 
capital  expenditures  such  as  rapid  amortization  of  pollution  control  devices'  or  coal  mine  safety 
equipment  (repealed)',  which  arguably  added  no  value  to  the  taxpayer's  property;  or  as  a  compromise 
between  hotly  litigated  extreme  all-or-nothing  positions  as  in  §  195,  or  less  likely  politically  (b)  15 
years  as  new  §  197  provides  for  purchased  intangibles.  (Such  a  long  period  is  not  needed  for  revenue 
neutrality  here.  Amortization  over  any  period  longer  than  1  year  would  generate  revenue  since  cleanup 
costs  appear  universally  to  have  been  currently  deducted  or  expensed.')  Where  Congress  has  provided 
a  current  deduction  for  such  Government  required  capital  expenditures,  as  in  the  costs  of  removing 
barriers  to  the  elderly  and  the  handicapped,  it  has  imposed  a  low  cap  ($15,000).'  Current 
deductibility  might  be  appropriate  in  the  case  of  cleanups  of  waste  sites  abandoned  or  no  longer 
owned  by  the  taxpayer  or  less  likely  where  the  costs  exceed  the  fair  maricet  value  of  the  property.  I 
urge  this  Subcommittee  not  to  stop  with  cleanup  costs,  but  address  as  well  the  looming  question  of 
tax  accounting  for  self-created  intangibles  in  general  also  likely  to  be  a  big  ticket  item  in  time  and 
money  soon  if  not  already. 

Over  the  past  15  years.  Congress  has  carved  out  "self-created  intangibles"  from  its 
capitalization/amortization  reforms,  viz.,  §§  195,  263 A  and  197.  I  understand  that  at  least  initially  a 
reason  for  such  carve  out  was  preservation  of  court  victories  permitting  current  deduction  of 
expenditures  producing  intangibles  with  future  benefit  won  by  special  interest  taxpayers  (e.g.,  banks) 
under  the  "separate  asset"  rubric  (recently  and  fatefiilly  overruled  by  the  Supreme  Court  in  INDOPCO). 
Roughly  1/4  of  the  125  "significant  issues"  in  the  IRS  Industry  Specialization  Program  involve 
capitalization/amortization  versus  expense  issues.  And  capitalization  issues  account  for  one  Code 
Section  (§263)  and  a  subissue  under  another  (§162  of  course)  out  of  the  14  Code  Sections  identified 
by  GAO  as  accounting  for  almost  half  of  the  12,000  appealed  issues  awaiting  resolution  in  court.* 
While  the  revenue  now  involved  in  such  appeals  appears  to  be  at  the  median,  I  expect  that  absent 
Congressional  intervention  the  revenue  adjustments  set  up  and  ensuing  Government  and  private  sector 
litigation  costs  will  explode  as  auditing  agents  apply  INDOPCO  and  the  capitalization  ISPs.  I  propose 
an  easy  fix  here  too:  Congress  should  authorize  legislative  regulations  to  be  formulated  by  the 
experience  the  IRS  gains  from  "rulings"  applying  capitalization  factors  which  either  a  code 


cleanup  costs,  this  would  cause  a  taxpayer  to  understate  income  for  the  year.  If  large  expenditures  are  incurred  every  year,  or 
every  few  years,  however,  deducting  the  expenditures  would  not  distort  income,  Lee  maintained.  ...  Lee  argues  that  cleanup  costs 
do  create  future  benefits  because  they  allow  the  taxpayer  to  continue  operating  its  business  in  ftrture  years."). 

*  I.R.C.  of  1986  §  169. 

'  I.R.C.  of  1954  §  187,  repealed  Pub.  L.  94-455,  §  1901(a)(31)    [1976]. 

'  This  is  a  largely  intuitive  assumption  supported  by  anecdotal  evidence  and  the  fact  that  the  types  of  amortizable  intangibles 
challenged  by  the  IRS  according  to  the  GAO  do  not  appear  to  encompass  capitalized  soil  remediation  costs.  Government 
Accounting  Office  Report  to  the  Joint  Committee  on  Taxation.  Issues  and  Policy  Proposals  regarding  Tax  Treatment  of  Intangible 
Assets  (August  9,  1 99 1)( Appendix  I,  Taxpayer-Claimed  Intangible  Assets)(£/ecB-onica//y  reproduced),  91  Tax  Notxs  Today 
169-1  (August  1991).  Whether  any  such  revenue  should  be  used  to  fund  a  "Member's  provision",  see  Unofficial  Transcript  of 
this  Subcommittees  Hearings  on  September  8.  1993.  electronically  reproduced  93  TAX  NOTtS  TODAY  190-32  (September  14, 
1993  (Statement  of  Chair  Rangel)("We  have  had  four  hearings  that  focused  on  these  maners.  All  of  those  were  the  revenue  losing 
issues.  ...  At  this  time,  we  will  concentrate  on  those  issues  that  raise  revenue.  As  those  of  you  who  are  familiar  with  the 
committee  are  aware  Chairman  Rostenkowski  and  our  committee  have  a  strong  commitment  to  deficit  reduction  and  responsible 
fiscal  policy  and  in  keeping  a  long  tradition  any  miscellaneous  issue  that  the  committee  brings  up,  the  member  must  offset  it  by 
appropriate  revenue  raising  items."),  as  contrasted  with  a  related  revenue  need  like  funding  DOE  cleanups,  is  another  question. 

'  §  190. 

'  GAO,  Report  to  the  Chairman.  Subcommittee  on  Oversight.  Recurring  Tax  Issues  Tracked  by  IRS'  Office  of  Appeals 
(GAO/GGD-93-93-101Br  May  4,  1993).  Fourteen  tax  code  sections  account  for  almost  half  of  the  12,000  appealed  issues  awaiting 
resolution  in  court.  Such  sections  account  for  more  than  half  of  the  $100  billion  in  proposed  adjustments  being  disputed  by 
corporations,  partnerships,  estates,  and  individuals.  "We  found  that  14  tax  code  sections  account  for  about  45  percent  -  5,279 
-  of  those  issues  and  57  percent  -  $  56  billion  -  of  the  proposed  adjustment  amount"  GAO  also  Identified  the  53  subsections 
within  the  14  code  sections  that  were  most  firequently  appealed  or  had  the  highest  dollar  amount  of  proposed  adjustments.  Section 
263  mandating  capitalization  of  capital  expenditures  was  one  of  the  14.  Additionally  at  least  one  subsection  under  Section  162, 
another  of  the  14  most  controversy-generating  provisions,  involved  capitalization.  "Data  also  show  that  issues  related  to  these 
14  code  sections  accounted  for  an  average  of  44  percent  of  all  issues  resolved  or  closed  by  Appeals  during  fiscal  years  1991  and 
1992,  52  percent  of  the  proposed  adjustment  amounts,  and  59  percent  of  the  proposed  adjustment  amounts  sustained  by  Appeals. 
Further,  53  subsections  within  these  14  code  sections  occur  the  most  frequently  or  account  for  the  highest  dollar  amount  of 
proposed  adjustments.  Each  of  the  53  subsections  accounts  for  1  percent  or  more  of  the  number  of  open  issues  and  proposed 
adjustments  for  all  14  code  sections.  In  addition,  data  on  issues  closed  in  fiscal  years  1991  and  1992  show  that  the  53  subsections 
fcpresented  a  significant  number  of  the  issues  and  proposed  a^ustment  amounts."  "The  14  code  sections  also  accounted  for  an 
average  of  52  percent  ($  34  billion)  of  the  $  67  billion  in  proposed  adjustments  and  59  percent  ($  13  billion)  of  the  $  21  biUion 
in  pnqwsed  adjustments  sustained  by  Appeals."  Capitalization  accounted  for  between  S3.047.000  and  S3.I22.000  of  the 
SS6,029,000  in  proposed  adjustments  under  the  !4  Code  sections  (and  S99,034,000  in  total  proposed  adjustments  as  of  September 
30,  1992  or  .054%  to  .056%  of  the  proposed  adjustments  under  the  14  Code  sections.  Adjusonents  under  5263  atone  were  the 
6«h  largest  The  Service's  rate  of  success  on  capitalization  was  comparatively  tow.  but  this  data  reflects  the  simation  prior  to 
INDOPCO.  Conventional  wisdom,  confirmed  by  the  trend  in  ISPs,  holds  thai  proposed  capitalization  adjustments  wiU  greatly 
increase,  and  I  suspect  that  the  RS'  success  rate  here  too  will  improve  greatly  ctitris  paribus. 


1700 


Section  or  the  legislative  history  would  supply. 

I  have  in  mind  capitalization/expense  factors  that  some  Service  officials  find  comfortable  and 
are  supported  by  a  few  "strawfs  in  the  winds"-  Wolfsen  Land  &  Cattle  Co.  v.  Comm  r,'  Cincinnati, 
New  Orleans  &  Texas  Pacific  RR  v.  United  States;^"  and  Southland  Royalty  Co.  v.  United  States.'^ 
The  guidepost  should  be  minimum  distortion  of  income,  promoting  "rough  justice"  rather  than  exact 
matching  of  income  and  expense.  Rough  justice  is  a  laudable  goal  of  the  IRS  1992  and  1993  "Business 
Plans".  The  starting  point  for  minimum  distortion  of  income  is  that  business/investment  e:q>enses  that 
typically  don 't  provide  on  the  average  a  benefit  much  beyond  a  year  (say  truck  tires)  should  be 
currently  deductible  in  the  year  of  purchase.  Other  expenditures  providing  longer  benefits  should  be 
capitalized  unless  (1)  they  are  relatively  small  (say  hand  tools,  and  professional  journals'^)  or  (2J 
regularly  recurring  (say  repainting  eveiy  3  years  or  so"  or  steady  state  advertising'*)  in  which  case 
current  deduction  would  also  be  in  order.  Capitalization  might  also  be  in  order  where  the  benefit  was 
not  so  long  lived  but  the  expenditure  was  a  one-time  very  large  outlay.'^  Once  capitalized,  the 
expenditure  would  be  treated  as  z  fi-eestanding  amortizable  intangible,  a  deferred  charge  in  financial 
accounting  terms,  in  the  manner  of  Wolfsen  Land  &  Cattle.  Administratively  and  judicially  the  period 
of  amortization  of  intangibles  has  been  on  a  case-by-case  basis.  Sixty  years  of  experience  with 
depreciation  of  tangible  property  has  taught  that  uniform  lives  is  the  only  administrable  way.  Congress 
should  provide  factors  for  the  Service  to  employ  in  determining  first  in  rulings  and  after  refinement  later 
in  regulations  whether  the  standard  life  for  classes  of  such  amortizable  expenditures  would  be  as  short 
as  60  months  or  as  long  as  15  years. 


'  72  T.C.  1,  13  (I979)(substantial  maintenance-type  expense  [dredging  irrigation  canal]  restoring  subject  with  indefinite  life 
to  original  operating  condition  which  need  be  repeated  only  every  10  years  created  "a  free-standing  intangible  asset  with  an 
amortizable  10-year  life.");  NCNB  Corp.  v.  United  States,  651  F.2d  942,  %2-63  (4th  Cir.  1981),  vacated  and  remanded  en  banc, 
684  F.2d  285  (4th  Cir.  1982).  Tbe  en  banc  NCNB  decision  in  turn  was  overruled  by  INDOPCO.  Inc.  v.  Comm  r,  1 12  S.  Cl  1039 
(Feb.  26,  1992). 

'°  424  F.2d  563,  572-73  (Cl  a.  1970Xexpensing  small  amounts  ($500),  pursuant  to  regulatoiy  requirements,  did  not  distort 
income  and  burden  of  capitalizing  and  amortizing  would  be  great);  accord,  Sharon  v.  Comm'r,  66  T.C.  515.  527  (1976),  a^d, 
591  F.2d  1273  (9th  Cir.  1978),  cert  denied,  442  U.S.  941  (1979). 

"  582  F.2d  604,  618  (Ct.  Cl.  1978Xsurveys  of  oil  reserves  subject  to  change  at  anytime  [due  to  shifting  of  underground 
oil  and  water  due  to  nearby  drilling  and  extraction]  used  in  management  plaiming  currently  deductible;  have  to  be  updated  ever>- 
few  years  so  that  useful  life  very  uncertaitL  "In  such  circumstances,  it  is  not  compulsory  to  amortize  such  a  recurring  item  over 
a  fixed  time-interval.  Neither  is  it  appropriate  to  require  capitalization  without  amortization;  such  a  requirement  would  clearly 
distort  Southland's  income.");  Encyclopaedia  Brilannica.  Inc.  v.  Commr,  685  F.2d  212,  215  (7th  Cir.  1982XdictumXPosner, 
J.)(pTactical  reason  for  allowing  author's  recurring  expenditures  with  future  benefit  to  be  currently  deducted:  (a)  hard  to  allocate 
among  specific  books;  and  (2)  "allocating  these  expenditures  among  the  different  books  is  not  always  necessary  to  produce  the 
temporal  matching  of  income  and  expenditures  thai  the  Code  disiderates,  because  the  taxable  income  of  the  author  ...  who  is  in 
a  steady  state  (that  is,  whose  income  is  neither  increasing  nor  decreasing)  will  be  at  least  approximately  the  same  whether  his 
costs  are  expensed  or  capitalized  Not  the  same  on  any  given  book-  on  each  book  expenses  and  receipts  will  be  systematically 
mismatched-  but  the  same  on  the  average.  Under  these  conditions  the  benefits  of  capitalization  are  unlikely  to  exceed  the 
accounting  and  other  administrative  costs  entailed  in  capitalization."). 

"  Treas.  Reg.  §  1.162-12(a);  see  authorities  cited  in  note  10  supra. 

"  Official  Gives  Update  on  Series  of  Guidance  on  Tax  Accounting  Issues,  1993  Daily  Tax  REPORT  46  d6  (March  11, 
\99Z)(Eleclronically  reproduced)C' As  Wolfsen  pointed  out,  if  [the  taxpayer]  had  cleaned  the  PCBs  every  year,  it  would  have 
been  deductible.  But  if  you've  waited  four  or  five  years,  it's  noL  I  gotta  draw  the  line.  I've  got  to  say,  'If  you  do  it  every  second 
year,  you're  fine.  If  you  wait  six  years,  it's  noL'  That's  a  tough  one.  I  haven't  resolved  in  my  mind,"  he  said.")(Stalement  of 
Glenn  Carrington,  Ass't  Chief  Counsel,  Individual  and  Tax  Accounting);  accord.  Service  Ponders  Environmental  Cleanup  Costs; 
Carrington  Uncertain  of  Outcome,  93  Tax  Notk  Todav  102-10  (May  12,  1993)("The  TAM  found  that  the  cleanup  expense 
was  not  merely  incidental  because  the  costs  had  been  accumulating  over  many  years,  and  that  allowing  the  deduction  of  the  enti'-e 
cleanup  costs  in  a  single  year  would  excessively  distort  the  income  in  that  year.  Carrington  admitted  that  the  bulk  of  the  cleanup 
cost  would  have  been  deductible  had  it  been  incurred  as  part  of  a  regular  maintenance  program.").  See  authorities  cited  in  note 
11  supra.  See  generally  Lee,  Start-Up  Costs,  Section  195  and  Clear  Reflection  of  Income:  A  Tale  of  Talismans,  Tacked-On  Tax 
Reform,  and  a  Touch  of  Basics,  6  Va.  Tax  Rev.  1,  18-21  (1986);  Lee,  Doping  out  the  Capitalization  Rules  After  INDOPCO. 
57  Tax  Notes  669,  679-83  (November  2,  1992). 

See  authorities  cited  in  note  13  supra;  Lee,  supra  note  13. 

"  Seniice  Ponders  Environmental  Cleanup  Costs:  Carrington  Uncertain  of  Outcome,  93  Tax  NOTES  TODAY  102-10  (May 
12,  1993X"CatTington  said  three  of  the  four  tests  to  determine  whether  a  cost  is  capital  are  stated  in  reg.  sec.  1.263(a)-l(b): 
Whether  the  cost  materially  increases  (fae  value  of  the  property,  whether  it  substantially  prolongs  die  usefiil  life  of  the  propert>-, 
and  whether  the  costs  are  incurred  to  alapt  the  property  to  a  new  and  different  use.  The  fourth  test  is  derived  from  Wolfsen  Land 
and  Cattle  Co.  v.  Comm.,  72  T.C.  I  (1979),  which  asks  whether  the  repairs  are  merely  incidental  to  continued  operation  or  are 
more  of  a  replacemenL  The  TAM  found  that  the  cleanup  expense  was  not  merely  incidental  because  the  costs  had  been 
accumulating  over  many  years,  and  diat  allowing  the  deduction  of  the  entire  cleanup  costs  in  a  single  year  would  excessively 
distort  the  income  in  that  year.  Carrington  admitted  that  the  bulk  of  the  cleanup  cost  would  have  been  deductible  had  it  been 
incurred  as  part  of  a  regular  maintenance  program.").  Lee,  supra  57  Tax  Notes  at  67-9  (distortion  of  income  should  be  key  to 
repair  but  by-and-iarge  repair  cases  didn't  go  thai  way  except  for  Wolfsen  and  Moss.) 


1701 


n.   Anatomy  of  TAM  9315004 

The  immediate  source  of  the  current  controversy  over  the  tax  accounting  treatment  of  the  costs 
of  toxic  waste  removal  is  Technical  Advice  Memorandum  9315004."  Years  ago  the  taxpayer  there 
had  dumped  PCB-contaminated  waste,  generated  by  using  PCB-laced  oil  to  run  its  equipment  hotter, 
in  pits  and  trenches  on  its  property  out  back.  About  10  years  after  the  taxpayer's  last  such  dump,  the 
Environmental  Protection  Agency  sued  it,  PCBs  having  turned  out  to  be  powerful  carcinogens. 
Pursuant  to  an  agreement  with  the  EPA,  the  taxpayer  began  to  clean  up  the  toxic  waste  site,  spending 
millions  for  remediation,  transportation,  and  disposal  of  the  PCB-contaminated  soil.  The  taxpayer 
expensed  the  cleanup  costs  as  a  repair  cost.  Upon  audit,  the  Service  ruled  in  TAM  93 1 5004  that  the 
cleanup  costs  were  not  incidental  repairs  and  should  be  capitalized.  In  a  "surprisingly  friendly" 
manner,"  the  TAM  permitted  the  expenditures  to  be  added  to  the  cost  of  the  taxpayer's  piping  system 
and  deducted  over  its  remaining  useful  life."  Nevertheless,  tax  lawyers  and  accountants  immediately 
criticized"  the  IRS'  attempt  to  be  "nice",  in  the  words  of  one  Treasury  official.  Had  he  capitalized 
the  costs,  he  would  have  added  them  to  the  cost  of  the  taxpayer's  land^"—  presumably  amortizable  over 
the  hopefully  billions  of  years  remaining  in  the  Earth's  useful  life.   This  is  where  I  fu^t  came  in. 

Twenty  years  ago  this  coming  winter  while  a  practitioner,  I  first  began  to  describe  in  articles 
the  then  inequity  in  the  start  up  cost  area  (capitalization  of  short-lived  or  recurring  expenditures  with 
no  amortization)  and  how  that  lead  some,  but  of  course  not  all,  tribunals  to  permit  a  current  deduction 
of  such  costs  under  the  "separate  asset"  doctrine.^'  My  article  in  The  Tax  Lawyer  supplied  the 
definition  of  start-up  costs  used  in  the  legislative  history  of  §  195."  (And  now  that  I  know  about  it, 
I  thank  you.)  But  special  interests  relying  on  their  judicially  sanctioned  deductions  under  the  "separate 
asset"  doctrine  obtained  a  carve  out  for  business  expansions  costs  in  §  195,"  a  kind  of  self-created 
intangible.  I  collaborated  with  Professor  Bittker  on  his  treatise  in  the  description  of  that  doctrine  in  the 
"Capital  Expenditures"  section  of  the  Business  Expenses  Chapter  of  I  B.  BiTTKER,  FEDERAL 
Taxation  of  Income,  Estates  and  Gifts,"  which  in  turn  provided  the  conceptual  foundation  for 
the  exclusion  of  self-created  intangibles  from  §  263 A  as  currently  deductible."    Similarly  Congress 


"  Avakian-Martin,  Does  the  IRS  need  to  clean  up  its  ruling  on  cleanup  costs?,  59  Tax  Notes  728  (May  10,  1993). 

"  ABA  Tea  Section  Panel  Wrestles  with  Impact  of  INDOPCO.  93  Tax  NOTES  TODAY  101-8  (May  11,  1993Xquoting  Dan 
L.  Mendelson  of  Deloitte  &  Touche). 

"  Emironmental  Cleanup  Costs  Addressed  at  two  ABA  Tax  Section  Meetings,  93  Tax  Notes  Today  165-7  (August  6. 
1993X"Camngton  also  said  he  still  finds  persuasive  the  reasoning  used  in  a  recent  technical  advice  memorandum  concerning  the 
cleanup  of  PCBs,  which  relies  on  the  Wolfsen  case.  He  let  it  slip  that  in  that  TAM.  the  cleanup  costs  were  amortized  to  the 
piping  system.    That  fact  was  blacked  out  when  the  TAM  was  released. "XEmphasis   supplied). 

"  Avakian-Maitin,  Does  the  IRS  need  to  clean  up  its  ruling  on  cleanup  costs?,  59  Tax  NOTES  728,  729-30  (May  10,  1993); 
Environmental  Cleanup  Guidance  May  Be  Out  By  July.  Official  Says,  1993  DaU-Y  Tax  REPORT  89  dl5  (May  U, 
1993)(£/ecO-omc  Reproduction);  IRS  Says  Environmental  Remediation  Costs  Must  be  Capitalized  to  Related  Asset,  1993  DAILY 
Tax  Report  32  dl2  (Friday  Febmary  19,  1993)(£/ec/romc  Reproduction);  IRS  Said  Seeking  Bright-line  Tests  in  Review  of 
Environmental  Cleanup  TAM,  1993  Dah-Y  Tax  REPORT  102  d6  (May  28,  1993)(£/ecrrom<:  Reproduction)CSo  far,  IRS  has 
received  about  three  responses  and  several  telephone  calls  promising  more  comments  by  mid-June,  he  [Carrington]  said.  The 
comments  have  not  given  IRS  much  guidance,  but  rather  have  expressed  objections  to  the  Service's  reasoning  in  the  two 
TAMs.");  Peat  Marwick,  supra  93  Tax  NOTES  Today  148-25;  Akin-Gump  Says  IRS'  Position  on  Environmental  Cleanup  Costs 
Distorts  Case  Law,  93  Tax  Notes  Today  158-18  (July  29,  1993);  Payment  of  Former  Subsidiary  s  Cleanup  Costs  Should  be 
Deductible.  Attorney  Says,  93  Tax  Notes  Today  158-32  (July  29,  1993).  (state  of  law  synopsu| 

'°  Avakian-Martin  &  Carson,  supra  note  1  at  927  ("Kilinskis  [Treasury  official]  also  said  he  disagreed  with  a  conclusion 
in  the  PCB  TAM.  According  to  Kilinskis,  if  the  costs  iconsidered  in  that  TAM  should  be  capitalized,  they  should  be  capitalized 
to  the  land.  The  IRS  was  trying  to  be  'nice'  in  reaching  the  conclusion  that  costs  were  not  capitalized  to  the  land,  he  said,  and 
yet  the  IRS  still  was  criticized"). 

^'  Lee,  Pre-Operating  Expenses  and  Section  174:  Will  Snow  Fall?,  27  Tax  Law.  381,  390-401  (1974);  see  also  Lee,  A 
Blend  of  Old  Wines  in  a  New  Wineskin:  Section  183  and  Beyond,  29  Tax  L.  Rev.  347,  454-64  (1974). 

"  Compare  RR.  Rep.  No.  1278,  96th  Cong.,  2d  Sess.  9-11  (1980),  with  lee,  supra  27  Tax  Law.  at  384-85;  see  generally 
Lee,  supra  6  Va.  Tax  Rev.  at  73-4  and  a  315. 

"    See  Lee,  supra  6  Va.  Tax  Rev.  at  79  and  a  337. 

"  I  B.  BriTKER,  Federal  Income  Taxation  of  Income,  Estates  and  Gifts  20-67  (1st  Ed.  Warren  Gotham  & 
Lament  1981).  My  research  on  capitalization  is  presented  in  another  form  in  Lee  &  Murphy,  Capital  Expenditures:  A  Result  in 
Search  of  a  Rationale,  15  U.  RICHMOND  L.  REV.  473  (1981);  see  also  Note,  Distinguishing  Between  Capital  Expenditures  and 
Ordinary  expenses:  A  Proposal  for  a  Universal  Standard,  19  U.  MICH.  J.  OF  LAW  REFORM  711,  718-30  (1986)(relying  heavily 
on  Lee  &  Murphy  for  then  current  doctrine). 

"  The  Senate  Committee  Report  staled  that  §  263A  was  not  intended  "to  modify  present-law  principles  governing  the 
determination  of  whether  an  expenditure  results  in  a  separate  and  distinct  asset  that  has  a  useful  life  substantially  beyond  the  tax 
year.  See  Tieas.  Reg.  sec.  1.263(a)-l,  (a)-2;  Commissioner  v.  Lincoln  Savings  and  Loan,  403  U.S.  345  (1971).  Thus,  if  the  costs 
of  producing  an  intangible  item  such  as  goodwill  are  deductible  under  current  law,  such  costs  will  continue  to  be  deductible  under. 
.  .  [Section  263A].  The  uniform  capitalization  rule  merely  will  prescribe  which  costs  associated  with  an  asset  required  to  be 
capitalized  must  be  included  in  its  basis  or  otherwise  capitalized.  S.  Rep.  No.  313,  99  Cong.,  2d  Sess.  141  and  n.38 
(1986Xfootnote  combined  with  text).    The  Senate  provision  reached,  however,  production  of  intangible  property  as  well  as 


197. 


1702 

just  a  few  months  ago  carved  out  self-created  intangibles  from  § 

The  special  interests'  victories  proved  ephemeral,  just  as  one  witness  warned  in  the  §  195 
hearings  of  the  possible  expansion  of  capitalization  doctrines  in  the  business  expansion  area."  And 
so  it  happened,  first  with  business  expansion  costs  at  the  circuit  court  level  and  then  v/ith  INDOPCO 
at  the  Supreme  Court  level  as  to  self-created  intangibles  in  general.  Enlightened  by  Professor  Gunn's 
The  Requirement  that  a  Capital  Expenditure  Create  or  Enhance  an  Asset^^  discovered  in  researching 
for  the  Bittker  Treatise  and  the  case  law  business  expansion  cases  of  the  late  1970s  and  early  1980s  and 
especially  Wolfsen  Land  &  Cattle  and  NCNB  I,  I  then  described  in  1986  in  the  VmGlNU  Tax  Revtew 
(1)  the  conceptual  and  policy  weaknesses  of  the  "separate  asset"  doctrine  in  business  expansion  and 
elsewhere;  (2)  developed  the  minimum  distortion  of  income  model  for  distinguishing  ordinary 
deductions  from  capital  expenditures,  set  forth  above,  along  with  its  case  law  and  policy  support;  and 
(3)  in  particular  noted  the  judicial  tendency  to  reject  an  income  distorting  "nothing"  under  capitalization 
without  adequate  capitalization  and  to  choose  instead  an  also  income  distorting  immediate  deduction.^' 
(I  also  criticized  on  a  technical  basis  §  195  far  more  than  with  hindsight  I  would  today.^') 

Last  year  responding  to  the  post-INDOPCO  practitioner  panic,  the  Service  announced  that  it 
would  address  INDOPCO  in  its  1992  Business  Plan.  I  took  the  opportunity  to  present  my  research  and 
minimum  distortion  of  income  model  in  Tax  NOTES,"  a  copy  of  which  I  enjoyed  the  opportunity  of 
handing  to  Glenn  Carrington,  IRS  Assistant  Chief  Counsel,  Individual  and  Tax  Accounting,  at  a 
Virginia  Tax  Group  meeting  about  6  weeks  before  the  TAM  was  issued.  Carrington  has  said  that  he 
"heard  about  the  TAM  on  the  way  out  the  door.""  1  believe  that  the  Service  provided  in  the  TAM 
amortization  (over  the  remaining  life  of  the  taxpayer's  piping  system  it  turns  out'^)  in  part  in  order 
to  avoid  the  all-or-nothing  dichotomy  (current  expense  or  capitalization  without  amortization)  which  was 
my  principal  object  in  writing  the  article."  The  key  rationale  of  the  TAM,  that  the  cleanup  expense 
was  not  merely  "incidental"  because  (a)  the  costs  had  been  accumulating  over  many  years  and  (b) 
allowing  the  deduction  of  the  entire  cleanup  costs  in  a  single  year  would  excessively  distort  the  income 
in  that  year  was  bottomed  on  the  distortion  of  income  notion  of  Wolfsen  Land  &  Cattle}* 


tangible  personal  property.  The  earlier  Treasury  Proposals  had  excepted  (without  explanation)  from  the  Uniform  Capitalization 
Rules  marketing,  selling,  and  advertising  expenses  and  research  and  development  costs  unrelated  to  particular  production  activities. 
2  Treasury  Report  to  the  PREsroENT,  Tax  Reform  for  Fairness,  SiMPUcrrv  and  Economic  Growth  207  (1984); 
The  President's  Tax  Proposals  to  the  Congress  for  Fariness,  Growth,  and  SiMPLicrrv  203  (1985).  The  Joint 
Committee  Staff  had  read  Lincoln  Savings  &  Loan  as  adopting  "a  rule  of  reason"  approach  to  applying  section  263, 
acknowledging  the  impracticality  of  requiring  that  every  cost  with  some  conceivable  future  benefit  be  capitalized.  Joint  Comm. 
Staff,  Tax  Proposal:  Accounting  50  (I985)("Case  law  has  generally  adopted  a  rule  of  reason  approach  in  applying  section  263, 
tacitly  acknowledging  the  impracticality  of  requiring  that  every  cost  with  some  conceivable  future  benefit  be  capitalized.  In 
Comm  >  V.  Lincoln  Savings  i  Loan  Ass  'n,  the  U.S.  Supreme  Court  stated  that  capitalization  was  required  under  section  263  only 
if  the  expenditure  serves  'to  create  or  enhance  ...  what  is  essentially  a  separate  and  distinct  additional  asset  ...  ."  The  Court  held 
that  'the  presence  of  an  ensuing  benefit  that  may  have  some  future  aspect  is  not  controlling,'  noting  that  '  many  expenses 
concededly  prospective  effect  beyond  the  taxable  year."*)(paraphrasing  I  B.  BrmCER,  supra  at  20-67  (1st  Ed.  Warren  Gorham 
&  Lamont  1981).  The  Conference  Report  attempted  to  "clarify"  with  the  ill-proofiead  statement  "that,  in  addition  to  the  costs 
specifically  excepted  from  capitalization  under  the  conference  agreement  (e.g.,  research  and  experimental  costs,  selling,  marketing, 
advertising,  and  distribution  expenses)  are  not  subject  to  capitalization  under  the  uniform  capitalization  rules."  H.R  Rep.  No. 
841,  99th  Cong.,  2d  Sess.  11-305  (1986).  The  Bluebook  shifted  to  a  new  rationale  and  proves  that  the  parenthetical  was  meant 
to  close  with  "experimental  costs. "[CJonsistent  with  the  long-term  contract  regulations  under  section  471,  selling,  marketing, 
advertising,  and  distribution  expenses  were  not  intended  to  be  subject  to  capitalization  under  these  rules.  Joint  Committee  Staff. 
General  Explanation  of  the  Tax  Reform  Act  of  1986  (H.R.  3838,  99th  Congress:  Pub.  L  99-514,  100th  Cong.,  1st  Sess.  510 
(Comm.  Pmt  1987).  But  even  more  directly,  the  Conference  Bill  modified  the  Senate  bill  by  adding  "tangible"  as  a  limitation 
on  produced  personal  property. 

"  Hearings  on  H.R  6883.  H.R  5616.  H.R  5729.  H.R  6039,  H.R  6140.  H.R  6247.  H.R  6824.  and  H.R  7009  Before  the 
House  Ways  &  Means  Subcomm.  on  Select  Revenue  Measures,  96th  Cong.,  2d  Sess.  110  (1980)(Statement  of  Gerald  Padwe). 

"    15  B.C.  Indus.  &  Comm.  L.  Rev.  443  (1974). 

^'    Lee,  supra  6  Va.  Tax  Rev.  I-I2I  (1986). 

"    Cf  Mundstock.  Taxation  of  Business  Intangible  Capital.  135  PENN.  L.  Rev.  1179,  1187-92,  1240-43  (1987). 

"    Lee,  supra  57  Tax  Notes  669. 

"  Environmental  Cleanup  Guidance  May  Be  Out  By  July.  Official  Says,  1993  Daily  Tax  Report  89  dl5  (May  11, 
1993XS«c/ron/c  Reproduction).  This  is  why  he  asked  for  a  notation  on  the  public  version  of  the  TAM  stating  that  the  memo  was 
being  reviewed  in  connection  with  an  IRS  study  project  on  environmental  cleanup  costs.  Id. 

Avakian-Maitin  &  Carson,  supra  note  1  at  926.  I  had  earlier  implied  that  the  Service  should  pick  a  number,  any  number, 
for  period  of  amortization  at  least  as  to  small  taxpayers.  Lee,  supra  57  Tax  NOTES  at  683  and  note  124. 

"    See  Lee,  supra  57  Tax  Notes  at  670,  677;  Avakian-Martin,  supra  note  3  at  730  (quoting  John  Lee). 

Official  Gives  Update  on  Series  of  Guidance  on  Tax  Accounting  Issues,  1993  DAILY  TAX  REPORT  46  d6  (March  11, 
l993)(£Vecfromc  Reproduction);  accord,  ABA  Tax  Section  Panel  Wrestles  with  Impact  of  INDOPCO.  93  Tax  NOTES  TODAY 
101-8  (May  1 1,  1993);  Service  Ponders  Environmental  Cleanup  Costs:  Carrington  Uncertain  of  Outcome,  93  Tax  NOTES  TODAY 
102-10  (May  12,  1993);  Environmental  Cleanup  Guidance  May  Be  Out  By  July.  Official  Says,  1993  DAILY  Tax  REPORT  89  dl5 
(May  1 1,  1993)(aecrromc  Reproduction)(''\BS  effectively  told  taxpayers  in  the  TAM,  citing  the  Wolfsen  case,  that  'you  can't 


1703 


m.   Approaches  under  IRS/Treasury  Consideration 

Treasury  and  Service  officials  are  debating  "the  form  the  guidance  [on  INDOPCO]  should  take 
-  whether  rulings,  regulations,  or  legislation  ~  and  what  position  the  government  ought  to  adopt  with 
respect  to  cleanup  costs  —  whether  deductible  in  all  cases,  capitalizable  with  no  recovery,  or  capitalize 
it  with  some  sort  of  recovery.""  After  repeatedly  requesting  practitioner  guidance  and  receiving  about 
25  written  comments.  Treasury  officials  have  outlined  several  practitioner  suggestions  under 
consideration":  (1)  a  series  of  factual  rulings,  (2)  capitalization  of  ahnost  all  cleanup  costs  with 
amortization  over  a  fixed  period  such  as  60  months,  and  (3)  following  Generally  Accepted  Accounting 
Principles.  The  Service  also  has  indicated  circumstances  in  which  the  costs  of  soil  remediation  or  other 
expenditures  should  be  currently  deductible:  (a)  prior  abandonment  of  the  property;"  and  (b)  where 
the  future  benefit  occurs  at  some  immeasurable  point  in  the  future." 


1.  Factual  Rulings  to  establish  "Bright  Line"  Rules. 

One  approach  is  to  issue  revenue  rulings  dealing  with  typical  fact  patterns  establishing  bright- 
line  tests."  This  lends  itself  best  to  current  deduction  situations  such  as  advertising  or  garden  variety 
repairs.  While  a  few  such  rulings  might  account  for  75%  or  so  of  the  cases,  they  are  less  likely  to  reach 
the  grey  areas,  particularly  where  capitalization  and  amortization  are  appropriate.  An  underlying 
problem  here  is  that  published  Revenue  Rulings  are  generally  thought  to  reflect  the  Service's 
understanding  of  primary  authorities,  such  as  Code,  Regulations  and  cases.  The  above  "straws  in  the 
wind"  are  just  that—  a  few  probably  destined  to  be  leading  cases  among  a  sea  of  conflicting  and  often 
directionless  cases.  Repair  precedent  in  particular  is  creaky,  with  the  main  exceptions  of  (a)  Moss  v. 
Comm'r^  where  the  Ninth  Circuit  endorsed  currently  deducting  replacements  (repainting  and 
repapering)  concentrated  in  a  single  year  of  a  3  to  5  year  cycle  consistent  with  Southland  Royalty,  and 
(b)  Wolfsen  Land  &  Cattle. 

2.  Fixed  Amortization  Period. 

Practitioners  have  recommended  and  the  Service  is  studying  establishment  of  an  amortization 


wait  until  Year  10,  bunch  your  deduction  and  distort  income,  when  this  large  cost  Is  going  to  have  a  beneficial  effect  over  the 
remaining  useful  life  of  the  property,'  Carrington  said."). 

"  Treasury  Official  Sees  Emironmenlal  Clean-up  Guidance  this  Year  as  Warranted,  1993  DAILY  Tax  REPORT  88  d23 
(May  10,  \993){Electronically  Reproduce({)("lA]n  administrative  solution  may  not  be  ideal,  Kilinskis  said.  "Frankly,  1  think  the 
better  solution  is  a  legislative  solutioa  We  at  Treasury  would  like  to  work  with  you  to  come  up  with  a  solution  that  you  can  live 
with  and  we  can  live  with  and  that  gets  to  the  right  answer,"  Kilinskis  said.'). 

"  IRS  Said  Seeking  Bright-line  Tests  in  Review  of  Environmental  Cleanup  TAM.  1993  DAILY  TAX  REPORT  102  d6  (May 
28,  1993X£'ec/ron;c  Reproduction);  Avakian-Martin  &  Carson,  supra  note  1  at  926. 

"  1993  DAaY  Tax  Report  89  dl5,  supra  (electronically  repra/ucerf)("Asked  whether  the  result  in  the  TAM  would  have 
been  different  if  the  taxpayer  involved  had  abandoned  the  property,  Carrington  said  perhaps,  because  no  fimire  income  would 
exist  for  matching  the  expense.  'People  have  argued  that  the  land  fill  cases  are  deductible  because  more  or  less  when  you  do  this 
land  fill,  you  are  closing  the  door,'  he  said.");  Environmental  Cleanup  Costs  Addressed  at  two  ABA  Tax  Section  Meetings,  93 
Tax  Notes  Today  165-7  (August  6,  1993X"Carrington  said  a  few  bright-line  tests,  suggested  by  commentators,  are  stirring  up 
interest  among  government  officials.  He  said  one  such  proposal  would  permit  a  deduction,  rather  than  capitalization,  of  the  cost 
of  cleaning  up  property  whenever  the  taxpayer  does  not  own  the  land.  Another  proposal  generating  interest  would  permit  a 
deduction  for  cleanup  costs  when  a  taxpayer  owns  the  land  but  stops  production  on  the  land.  A  third  bright-line  test,  said 
Carrington,  would  permit  a  deduction  for  remediation  costs  to  the  extent  that  the  costs  exceed  the  value  of  the  land.  He  added 
that  the  issues  are  far  from  resolved  within  the  government"). 

"  IRS  to  Issue  Additional  Technical  Advice  on  Environmental  Cleanup,  Official  Says,  1993  Daily  Tax  REPORT  152  d4 
(August  10,  I993XaecO-omc  Reproduction)(ci^g  Rev.  Rul.  92-80,  1992-1  C.B.  57.  Cf.  NCNB  I,  651  F.2d  at  %l-62  TITlhere 
is  a  residuum  of  current  expenditures  which  will  have  some  future  bnefit  but  which  'cannot,  as  a  practical  matter,  be  associated 
with  any  other  period'  and  allocation  of  which  'either  on  the  basis  of  association  with  revenue  or  among  several  accounting 
periods  is  considered  to  serve  no  useftil  purpose. "')(Footnotes   omitted)(relying  on  GAAP). 

"  Sen/ice  Ponders  Environmental  Cleanup  Costs:  Carrington  Uncertain  of  Outcome,  93  Tax  NOTES  TODAY  102-10  (May 
12,  1993);  IRS  Environmental  Cleanup  Guidance  May  Be  Out  By  July.  Official  Says,  1993  Daily  Tax  REPORT  89  dl5  (May 
II,  \99i){ElectronicaIty  reproduced);  Treasury  Official  Sees  Environmental  Clean-up  Guidance  this  Year  as  Warranted,  1993 
Daily  Tax  Report  88  d23  (May  10,  \993)(Electronically  Reproduced)('l{  we  can  decide  that  there  are  three,  four,  or  five  fact 
patterns  that  cover  75  or  85  percent  of  all  the  liabilities  that  are  out  there,  then  I  think  it's  worth  taking  a  stab  and  analyzing  dmse 
situations  and  coming  up  with  an  answer.  I  am  not  against  taxpayers  deducting  environmental  liabilities.  All  I'm  saying  is  thai 
it's  an  area  that  we  need  to  do  more  work,  carve  through  all  these  rules,  and  come  up  with  what  we  agree  is  the  right  answer," 
he  [Kilinskis]  said.");  IRS  to  Issue  Additional  Technical  Advice  on  Environmental  Cleanup,  Official  Says,  1993  DAav  Tax 
Report  152  d4  (August  10.  \993)(Electronically  reproduced)CSeTvice  is  closest  to  issuing  guidance  for  ordinary  repair  costs"); 
Service  to  Issue  Guidaru:e  on  Deductions  for  Environmental  Cleanup.  Says  Carrington,  93  TAX  NOTES  TODAY  167-6  (August 
II,  I993)(same). 

"  831  F.2d  833,  842  (9th  Cir.  1987). 


1704 


period,  such  as  5  or  10  years,  and  writing  off  the  cleanup  expenses  over  that  period.*'  The  Service 
recently  took  a  similar  approach  as  to  the  cost  of  package  design/^  "The  question  here  is  whether  the 
industry  will  sign  on  to  such  an  approach."*'  With  a  revenue  procedure  or  ruling  format  the  Service 
would  not  be  able  to  require  all  taxpayers  with  toxic  waste  cleanup  costs  to  capitalize  and  amortize. 
The  likely  result,  following  Treasury's  reasoning  as  to  §  197,  would  be  that  taxpayers  with  really 
questionable  deductions  would  choose  capitalization  and  amortization  while  the  stronger  cases  would 
continue  to  deduct  currently.  Therefore  Congressionally  mandated  capitalization  with  amortization  is 
advisable  as  in  §  197  and  the  1984  version  of  §  195. 

Additionally  some  have  questioned  whether  the  Service  can  just  pick  an  amortization  period 
without  statutory  authority.**  While  it  has  done  so  in  the  past,*'  absence  of  a  statutory  mandate 
surely  would  lead  to  many  taxpayers  ignoring  the  amortization/certainty  option.  This  was  the  case  with 
the  original  version  of  §  195. 

3.  GAAP. 


Another  approach  is  to  follow  "generally  accepted  accounting  principles"  for  the  tax  treatment 
of  cleanup  expenditures.**  But  this  might  not  be  popular  among  those  seeking  current  deductions  for 
cleanup  costs  since  GAAP  may  require  capitalization  in  many  cases.*'  The  Fourth  Circuit  panel 
decision  in  NCNB  I  offers  a  glimpse  into  the  dangers  of  trying  to  resolve  capitalization/amortization 
versus  expensing  by  GAAP.  There  the  panel  adopted  the  GAAP  hierarchy  of  expense  recognition  in 
descending  order  of  preference:  (1)  by  cause  and  effect  with  revenue  generated,  (2)  by  systematic 
rationale,  and  (3)  year  of  expenditure.*'  This  lead  to  an  impermissible  allocation  between  current  and 
future  years  on  actual  use,  where  as  amortization  of  an  intangible  property  properly  is  straightline  for 
die  number  of  years  in  the  property's  useful  life. 

4.  Abandonment 

A  few  bright-line  teste,  suggested  by  commentators,  are  stirring  up  interest  among  government 
officials  but  are  far  from  resolved.  Commentators  have  suggested  that  abandonment  of  the  toxic  waste 
property  (or  whenever  the  taxpayer  no  longer  owns  the  contaminated  real  estate)  should  give  rise  to 
ordinary  deduction  on  the  grounds  that  no  future  income  could  exist  for  matching  the  expense.*'    A 


IRS  Said  Seeking  Bright-line  Tests  in  Review  of  Environmental  Cleanup  TAM,  1993  DaU-Y  Tax  REPORT  102  d6  (May 
28,  \993)(Electronic  Reproduction); 

Rev.  Proc.  90-63,  1990-2  C.B.  664,  offers  taxpayers  three  alternative  mediods  of  accounting  for  package  design  costs; 
(1)  capitalization,  (2)  design-  by-design  capitalization  and  60-month  amortization,  and  (3)  pool-of-cost  capitalization  and  48-month 
amortizatioa  See  Environmental  Cleanup  Costs  Addressed  at  two  ABA  Tax  Section  Meetings,  93  Tax  NOTES  Today  165-7 
(August  6,  1993)(Stalement  of  CarringtonX'IRS  is  concerned  that  many  taxpayers  would  not  buy  into  that  system,  he  said.  'It 
m^  help  people  in  the  very  gray  area  and  other  people  would  continue  to  do  what  they're  doing  and  it  won't  be  usefiil,  ... 
[Cairington]  said.  Asked  whether  IRS  believes  it  has  regulatory  authority  to  'arbitrarily'  require  capitalization  over  a  fixed  period, 
such  as  five  years  or  10  years,  Carrington  responded,  'It  would  be  arbitrary,  but  we've  done  arbitrary-reasonably  arbitrary-things 
in  the  past'").  See  note  32  supra. 

*'  Service  Ponders  Emironmental  Cleanup  Costs;  Carrington  Uncertain  of  Outcome,  93  Tax  NOTES  TODAY  102-10  (May 
12,  1993). 

**  IRS  Environmental  Cleanup  Guidance  May  Be  Out  By  My,  Cfficiai  Says,  1993  DaH-Y  Tax  REPORT  89  dl5  (May  1 1, 
l99y)(Electronically  reproduced). 

*'    See  note  42  supra. 

**  IRS  Said  Seeking  Bright-line  Tests  in  Review  of  Environmental  Cleanup  TAM,  1993  Daily  Tax  REPORT  102  d6  (Friday 
May  28,  1993)(£/ecfromc  Reproduction);  Environmental  Cleanup  Costs  Addressed  at  two  ABA  Tax  Section  Meetings,  93  Tax 
Notes  Today  165-7  (August  6,  1993)  ("Third,  IRS  is  exploring  the  adoption  of  the  presumption  tiiat  taxpayers  would  capitalize 
the  expenditures  if  they  already  would  capitalize  them  under  the  rules  under  generally  accepted  accounting  principles,  according 
to  Carrington.  'We  hear  that  agents  are  raising  Indopco  and  long  term  benefit  and  really  causing  problems  out  there  and  maybe 
we  should  look  and  see  what  you're  doing  and  if  you're  saying  it's  capitalized  and  you're  following  the  GAAP  rules  maybe  dial's 
what  we  should  use.  Maybe  that's  a  good  bright  line  test,'  he  said.  Carrington  acknowledged  that  normally  the  GAAP  rules  do 
not  control  for  purposes  of  the  tax  code,  but  that  IRS  would  be  looking  at  those  rules  to  see  whether  they  'are  somewhat  in  line 
with  what  we  think  the  law  is.'"). 

Environmental  Cleanup  Costs  Addressed  at  two  ABA  Tax  Section  Meetings,  93  Tax  NOTES  TODAY  165-7  (August  6, 
1993) 

**    651  F.2d  at  952-3,  962-63.  For  a  criticism  of  this  notion  see  Lee,  supra  6  Va.  Tax  Rev.  at  20-4,  38-41. 

Emironmental  Cleanup  Guidance  May  Be  Out  By  July,  Official  Says,  1993  DAn.Y  Tax  REPORT  89  dl5  (May  11, 
l993)(,Electronically  reproduced)C'?eople  have  aigued  that  the  land  fill  cases  are  deductible  because  more  or  less  when  you  do 
this  land  fill,  you  are  closing  the  door,'  he  [Carrington]  said.").  Two  of  the  5  possible  factors  looked  at  early  by  the  Service  ("(2) 
whether  the  property  to  which  the  cost  relates  is  owned  by  the  taxpayer,  (3)  whedier  the  property  to  which  the  expenditure  relates 
will  generate  future  income",  see  Avakian-Martin,  Dees  the  IRS  need  to  clean  up  its  ruling  on  cleanup  costs?,  59  Tax  NOTES 
728  (May  10,  1993)),  appear  related  to  this  notion.  Those  five  factors  "may  or  may  not  be  relevant  in  deciding  these  issues,"  he 


1705 


similar  proposal  would  permit  a  current  deduction  for  the  cost  of  cleaning  up  property  whenever  a 
taxpayer  owns  the  land  but  has  stopped  production  on  the  land.  A  third  bright-line  test  would  permit 
a  deduction  for  remediation  costs  to  the  extent  that  the  costs  exceed  the  value  of  the  land.'" 

The  policy  for  the  abandonment  exception  is  sound  and  consistent  with  precedent  allowing  an 
ordinary  deduction  for  an  abandormient  loss.  Property  sold  but  for  whose  cleanup  costs  the  taxpayer 
is  liable  (because  in  the  chain  of  title  or  did  the  toxin  dumping)  fits  the  policy  as  well  but  not  the 
current  case  law.  Such  cost  would  be  associated  with  the  sale  of  the  property  under  both  the  origin  of 
the  claim  doctrine  for  capitalization  and  if  the  sale  was  in  a  prior  year  (year  1)  under  the  Arrowsmith 
doctrine."  Whether  the  loss  is  a  capital  loss  or  an  ordinary  loss  under  conventional  analysis  turns  first 
on  whether  the  contaminated  property  was  §  1231  property.  If  so,  as  usually  will  be  the  case,  then 
under  the  view  ihal  Arrowsmith  provides  a  fictional  sale  in  year  2,  the  loss  is  a  §  1231  usually  ordinary 
loss  but  capital  loss  recapture  could  apply  under  the  5-year  lookback.  In  my  view  Arrowsmith  more 
matches  the  year  2  character  with  the  year  1  character  as  the  year  1  transaction  is  backed  out  by  a 
balancing  adjustment."  So  if  the  year  1  sale  yielded  a  §  1231  capital  gain,  at  least  that  gain  would 
be  reversed  by  a  capital  loss  in  year  2.  Add  the  fact  that  a  §  1231  gain  has  not  been  taxed  at  favorable 
rates  to  corporate  taxpayers  since  1986  but  capital  losses  are  treated  harshly  indeed,  and  none  of  this 
makes  much  sense  as  a  matter  of  policy  or  in  general.  Some  of  these  results  could  perhaps  by  obviated 
by  treating  the  cleanup  cost  itself  as  an  intangible  asset  {Wolfsen  Land  &  Cattle)  which  then  could 
amortized  over  the  appropriate  period  (even  as  short  as  1  year  if  recurring  but  that  would  not  be  the 
case  here).    Congressional  dictation  of  the  answer  on  this  point  is  essential. 

Cost  over  value  differs.  The  cost  still  may  so  large  that  current  deduction  would  distort  the 
taxpayer's  income  and  may  yield  future  benefits  in  continuation  of  operations  without  shutdown  by  the 
EPA  or  whomever.  Again  the  origin  of  the  claim  doctrine  would  seemingly  require  capitalization 
adding  the  cost  to  the  non-amortizable  land  but  treatment  as  a  fi^estanding  amortizable  intangible  might 
avoid  this.  Additionally,  the  Congressional  pattern  has  been  to  provide  60-month  amortization  for 
mandated  capital  expenditures  arguably  providing  no  direct  additional  value. 

At  one  time  Service  considered  taking  into  account  whether  the  property  was  akeady 
contaminated  at  purchase.  Under  conventional  repair  doctrine,  making  an  otherwise  deductible  repair 
must  be  capitalized  as  an  acquisition  cost  where  the  taxpayer  acquired  the  property  knowing  of  the 
defect.  From  the  point  of  future  benefit  and  income  distorting  amounts,  the  pre-existence  of 
contamination  is  irrelevant.  But  it  would  be  a  factor  in  any  analysis  trying  to  allocate  the  cleanup  costs 
between  the  taxpayer's  past  operations  and  future  operations  since  such  pre-existing  pollution  could 
hardly  be  related  to  past  operations. 

rV.  Proposed  Solutions  to  Soil  Remediation  Costs 

As  a  general  prospective  rule,  by  statute  all  substantial  soil  remediation  costs  should  capitalized 
and  then  amortized  over  60-months.  Current  deduction  should  be  provided  by  statute  for  such  costs 
incurred  as  to  abandoned  property,  etc.,  as  this  Subcommittee  deems  appropriate. 

V.   Proposed  Solution  to  Capital  Expenditure/Expense/Amortize  of  Self-Created  Intangibles 

The  welcome  new  spirit  of  cooperation  between  the  Service  and  taxpayers  and  of  effecting 
"rough  justice"-  manifested  by  the  IRS  National  Office  developments  such  as  the  annual  "Business 
Plan",  release  of  ISPs,  substantive  participation  by  IRS  and  Treasury  Officials  in  public  (tax) 
conferences,  and  yes  TAM  9315004-  as  well  as  the  notion  of  "Re-Inventing  Government  in  the  air 
indicates  that  the  time  is  ripe  for  Congress  to  try  a  different  approach  to  rule  making  in  an  area  that 
affects  all  business  taxpayers  big  and  small.  Congress  should  establish  the  policies  that  capitalization 
is  to  effect,  e.g.,  minimum  distortion  of  income  which  would  be  illustrated  in  the  legislative  history  to 
an  amendment  of  §  263  authorizing  legislative  regulations  by  factors  such  as  recurring,  smallness,  or 
whatever  Congress  deems  appropriate.  They  could  largely  be  extracted  fixim  the  cases  cited  herein.  So 
far  this  is  exactly  what  Congress  did  in  §385.  To  avoid  the  fate  and  probably  complexities  of  the  late 


said  IRS  Emironmental  Cleanup  Guidance  May  Be  Out  By  July.  Official  Says.  1993  DaH-V  Tax  REPORT  89  dl5  (May  11, 
1993);  Avakian-Maitin  &  Carson,  ABA  Tax  Section  Meeting:  Environmental  Cleanup  Issue:  A  Repeating  Theme  at  ABA  Meeting, 
60  Tax  Notcs  925,  926  (August  16,  1993). 

^  Emironmental  Cleanup  Costs  Addressed  at  two  ABA  Tax  Section  Meetings,  93  Tax  Notes  Today  165-7  (August  6, 
1993XStatement  of  Cairington). 

"    See  Lee  &  Muiphy,  supra  note  24  at  484-509. 

'^  Lee  &  Bader,  Contingent  Income  Items  and  Cost  Basis  Corporate  Acquisitions:  Correlative  Adjustments  and  Clearer 
Reflection  of  Income,  12  J.  CORP'N  L.  137,  212-13  (1987). 


1706 


§  385  regulations,  I  propose  a  model  of  the  Service  first  implementing  the  Congressionaily  sanctioned 
policies  by  issuing  rulings  (PLRs,  TAMs,  and  then  "published"  rulings),  which  then  would  evolve  into 
regulations  employing  a  "structured  discretionary  justice"  approach.  All  of  this  probably  could  be 
accomplished  in  a  shorter  time  than  the  §  385  experience. 

Detailed  regulations  promulgated  by  an  administrative  agency,  here  Treasury  and  the  Service, 
increase  the  principled  discretion  of  the  agency  as  a  decision  maker,  according  to  Professor  Davis' 
landmark  book  "Discretionary  Justice  -  A  Preliminary  iNQuraY"  and  subsequent  administrative 
law  scholarship."  Moreover,  Professor  Davis  posits  that  such  detailed  rules  channeling  agency 
exercise  of  discretion  can  develop  from  first  considering  one  concrete  problem  at  a  time,  announcing 
the  hypothetical  cases  as  rulings  and  refraining  from  generalizing;  then  fashioning  generalized  principles 
or  standards  from  this  experience;  and  finally  formulating  regulations  to  implement  the  standard  in  the 
form  of  structured  discretion.'*  The  issue  of  general  versus  particularized  statute  and  whether  to 
implement  through  Treasury  or  Service  discretion  has  been  before  Congress  many  times  before, 
particularly  in  1921/1923"  and  1934."    Similarly  tax  theoreticians,  including  in  the  late  50's  and 


"  Davis,  Discretionary  Justice,  a  Preliminary  Inquiry,  103  (LSU  Press  1969);  see  also  Mashaw,  Bureaucratic 
Justice,  Managing  SOCUL  DlSABlLrry  Claims  103-22  (Yale  Univ.  Press  1983);  Lee,  Structured  Discretionary  Justice  Under 
Section  355,  44  Tax  NOTES  1029,  1030  (August  28,  1989).  An  agency  issuing  regulations  (rule  making)  setting  forth  specific 
factors  to  be  used  in  balancing  tests  implementing  the  desired  standards  and  policies  can  implement  standards  effectively  while 
maintaining  the  desirable  bureaucrat's  discretionary  judgement  in  application.  Id.  at  1032. 
"  Lee,  supra  note  53  at  1032. 

"  See  1921  Confidential  Senate  Hearings,  supra  at  5  (Statement  of  Dr.  T.  S.  Adams,  Tax  Advisor,  Treasury  DepL;  drafting 
goal  of  "a  rather  simple  tax  lav^  that  the  average  man  can  understand").  See  Hearings  on  H.  R.  6715  before  the  Sen.  Comm.  on 
Finance,  68th  Cong.,  1st  Sess.  7,  57  (1924Xstatement  of  A.  W.  Gregg,  Special  Ass't  to  Treasury,  "complications  come  primarily 
from  a  complicated  policy,"  including  reorganizations.  "[T]he  bill  will  cover  a  given  case  definitely  and  certainly.  Under  the 
existing  law  there  are  hundreds  of  cases  where  nobody  knows  the  effect  of  the  transaction  upon  the  tax.  This  law  is  definite 
enough  so  that  die  taxpayers  will  be  able  to  tell  the  effect  of  a  given  transaction  .  .  ."). 

"  See  Statement  of  the  Acting  Secretary  of  Treasury  Regarding  the  Preliminary  Report  of  a  Subcommittee  9-10  (1934): 
The  reorganization  provisions  are,  as  the  subcommittee  states,  perhaps  the  most  complicated  and  difficult  to 
understand  of  any  sections  of  the  law.  In  addition  to  their  complexity,  they  are  open  to  the  serious  objection  of  being 
overspecific.  When  they  were  adopted  in  1924,  the  draftsmen  attempted  to  state  in  minute  detail  exactiy  how  each  step 
of  a  reorganization  should  be  treated  for  tax  purposes.  Although  this  method  had  the  apparent  advantage  of  enabling 
taxpayers  and  their  lawyers  to  determine  in  advance  exactly  how  proposed  transactions  would  be  taxed,  it  had  the 
disadvantage  of  leaving  the  Department  no  leeway  in  the  administration  of  the  law.  Consequently,  astute  lawyers  could 
and  did  arrange  what  were  really  sales  to  take  the  techiucal  from  of  a  reorganization  within  the  statutory  definition,  with 
resultant  loss  of  revenue.  The  Treasury  has  fought  a  number  of  these  cases  through  the  courts,  with  results  on  the 
whole  favorable.  The  courts  have  attempted  to  work  out  the  general  principles  underlying  the  statute,  and  to  interpret 
the  specific  sections  in  such  a  way  as  to  cany  out  the  general  plan  and  to  prevent  avoidance. 

In  the  light  of  this  experience  of  10  years,  the  Treasury  has  come  to  the  conclusion  that  the  present  provisions 
should  be  completely  redrafted.  The  purpose  should  be  to  express  in  the  statute  as  simply  as  possible  the  general  plan 
for  dealing  with  these  transactions,  leaving  to  the  Department  as  in  other  cases  the  power  to  make  rules  and  regulations 
to  carry  out  the  congressional  intent  Congress  has  previously  dealt  with  the  subject  of  affiliated  corporations  in  this 
way,  with  excellent  results  so  far.  In  the  cases  of  complicated  subjects  of  this  kind,  it  is  ahnost  impossible  to  foresee 
all  the  ingenious  devices  which  lawyers  will  invent,  and  to  provide  against  them  expressly  in  the  statute.  The  more 
effective  plan  is  to  place  the  responsibility  squarely  upon  the  Department  administering  the  law  from  day  to  day.  It 
can  readily  amend  its  regulations  to  cover  new  situations  as  they  arise. 

The  question  then  is  whether  the  present  provisions  should  be  scrapped  in  their  entirety  before  a  satisfactory 
substitute  can  be  framed.  The  committee  should  carefully  consider  several  problems  before  this  is  done.  In  the  first 
place,  depreciation  and  depletion  are  now  calculated  for  thousands  of  corporations  on  the  basis  of  costs  figured  under 
the  present  reorganization  provisions.  These  sections  in  general  required  the  new  corporation  to  take  the  same  cost  as 
the  old  for  depreciation  and  depletion  purposes,  even  though  the  assets  had  greatly  increased  in  value.  If  the  provisions 
were  abolished  outiight,  many  of  these  taxpayers  could  and  would  claim  largely  increased  amounts  of  depreciation  and 
depletion,  with  resultant  loss  of  revenue.  In  the  second  place,  reorganizations  today  are  generally  being  carried  out  in 
order  to  revise  the  capital  structures  of  unsuccessful  or  insolvent  enterprises.  The  immediate  result  of  abolishing  the 
reorganization  provisions  would  be  to  permit  the  thousands  of  bondholders  and  stockholders  of  such  organizations  to 
establish  losses,  even  though  they  obtain  and  retain  securities  in  a  new  enterprise  which  is  substantially  die  same  as 
their  original  investment  Even  though  it  be  required  that  such  losses  can  only  be  deducted  from  capital  gains,  a  wide 
door  will  be  opened  to  reduction  of  tax  liability.  Finally,  there  are  many  legitimate  reorganizations  in  which  the  present 
general  policy  of  the  law  is  sound 


For  these  reasons,  the  Treasury  believes  that  it  would  be  unwise  to  eliminate  completely  the  exchange  and 

reorganization  provisions  at  this  time.    The  Department  is  now  working  upon  a  substitute  for  die  present  provisions, 

which  vrill  be  completed  as  soon  as  possible.    The  task  is  not  easy,  on  account  of  the  complexity  of  die  transactions 

involved.    Until  the  various  alternatives  can  be  carefiilly  studied,  and  a  plan  worked  out  which  will  vrork  fairly  and 

safeguard  the  revenues,  it  does  not  appear  advisable  to  abolish  completely  the  present  statutory  plan.   The  Department 

believes,  as  stated,  that  die  proposal  would  not  only  yield  no  additional  revenue,  but  would  result  in  a  net  loss. 

By  die  time  of  the  House  Ways  and  Means  Committee  Hearings  Dr.  Rosvrell  Magill  had  been  appointed  Assistent  Secretao'  of 

Treasury.    Unfortunately  in  the  1934  House  Hearings  on  Revenue  Revision  Dr.  Rosewell  MagilL  representing  Treasury,  in  fact 

failed  to  argue  forcefully  for  a  "legislative"  regulations  approach,  of  which  the  1933  Ways  &  Means  Subcommittee  Chairman 

Hill,  D-Wash.,  was  skeptical  anyway.   Treasury  instead  argued  for  the  status  quo,  as  did  public  witnesses.  Hearings  on  Revenue 

Revision  1934  before  the  House  Ways  &  Means  Comm.,  73d  Cong.,  2d  Sess.  74-7  (Magill  responded  to  whether  Treasury  had 


1707 


early  60's  Harvard's  Professors  Brown  and  Surrey,  have  debated  for  some  time  the  advantages  of 
generalized  tax  statutes,  i.e.,  standards,  versus  detailed  or  rule-oriented  tax  statutes."  The  recent 
majority  of  students  of  taxation  follow  the  Surrey  school  of  a  more  or  less  generalized  tax  statute 
implemented  and  amplified,  however,  through  undisputably  detailed  Treasury  regulations,  in  large  part 
due  to  the  greater  flexibility  in  amending  regulations  than  statutes  in  light  of  developing  administrative 
and  judicial  experience  under  the  statute."  Notwithstanding  conventional  wisdom,  the  case  for 
agency  discretion  was  never  fiilly  made  nor  the  notion  of  general  statute  with  detailed  regulations  ever 
fairly  tested.  This  Subcommittee  in  this  perhaps  inauspicious  context  (the  witnesses'  tone  is  reminiscent 
of  tiie  1936  Ways  &  Means  Hearings  on  the  ill-fated  Undistributed  Profits  Tax)  has  the  opportunity  to 
start  a  grand  experiment.  Tum  the  Treasury  and  Service  loose,  with  guidance.  I  trust  they  will  effect 
rough  justice  and  substantially  cut  down  on  tax  controversies  in  this  most  controversial  of  areas. 


so  re-<lrafted  the  regulalions  thai  "[w]e  have  not  been  able  to,  because  the  provisions  with  respect  to  reorganizations  are  so 
detailed  and  specific  there  is  no  way  for  us  to  interpret  them  away  from  their  obvious  meaning.  ...  ");  287;  290-91  (capital 
structures  plus  past  legisl.  history);  323  (fairness  in  bituminous  industry )( 1933). 

Mr.  Hnx.  ...  Do  you  believe  it  is  possible  to  write  a  provision  in  the  statute  permitting  tax-free  reorganizations  without 

opening  the  door  to  reorganizations  purely  for  tax  exemption  purposes? 

Mr.  Magill.    It  undoubtedly  would  be  a  very  difficult  job,  because,  as  I  do  not  need  to  tell  you,  reorganizations  are 

the  most  complicated  transactions  anybody  has  to  deal  with. 

To  write  a  provision  to  catch  the  ones  you  want  to  catch  and  perhaps  to  let  others  through  that  are  legitimate 

is  quite  a  job.  I  think  that  was  probably  as  well  done  in  1924  as  it  could  have  been  done.  A  great  deal  of  thought  was 

spent  on  that,  and  it  was  done  very  carefiilly. 

Mr.  Vinson.    We  are  9  years  past  1924,  and  we  are  able  to  see  many  doors  and  outlets  through  which  taxpayers  go 

to  avoid  taxes,  and  it  was  our  purpose  to  close  some  of  those  doors. 
Id.   The  House  Ways  and  Means  Committee  permitted  only  statutory  mergers. 

"  Brown,  An  Approach  to  Subchapter  C,  3  Tax  Revision  COMPENDIUM  1619,  1619-20  (1960Kdetailed  tax  statutes  lead 
to  deficiencies  and  anomalies  appearing  which  requires  even  more  intricate  elaborations  of  pattern;  fundamental  source  is  attempt 
to  eliminate  the  necessity  for  responsible  administration);  Surrey,  Complexity  and  the  Internal  Revenue  Code:  The  Problem  and 
Management  of  Tax  DetaU,  34  LAW  &  CONTEMPORARY  Probs.  695-702,  703-07  (1969Xdebate  between  generalized  and 
particularized  tax  statutes;  concludes  ideal  is  generalized  statute  with  detailed  regulations).  Inteiestingty,  the  Tax  Refbnn  Act 
of  1969,  which  was  Surrey's  brainchild,  see  Let,  supra  8  Va.  Tax  Rev.  at  132  n.  346.  rarely  took  this  lack  (Section  385 
constituiBS  a  conqncuous  exception). 

*•  Eg,  Compladty  and  the  Income  Tax,  supra  note  57  at  348-51.  Bmsee  E  QAen,  Remarta,  26  Nat^L  Tax  J.  311,  311- 
12  (1974).  For  m  excellent,  brief  discussion  oflhe  lecent  patlem.  inclwfing  the  "worst  of  all  worids  .  .  .  extremely  delaikd 
stttites  ...  with  broad  grants  of  regulatory  authority  ...',s*e  Evans,  The  Condition  of  the  Tax  UgisUttivt  f>roeess,  39  TAX 
Nans  1381.  1590  (June  27,  1988). 


1708 

Chairman  Rangel.  Professor  Tucker. 

Mr.  Tucker.  When  Professor  Lee  talks  about  the  academic  writ- 
ers all  agree 

Chairman  Rangel.  You  are  a  professor,  too. 

Mr.  Tucker.  I  am  a  professor  at  both  Georgetown — I  am  not  a 
full  time  professor.  I  also  practice  law. 

Chairman  Rangel.  There  is  a  difference. 

Mr.  Tucker.  It  may  or  may  not  make  a  difference.  I  have  been 
teaching  the  income  taxation,  real  estate  transactions  since  1970, 
at  George  Washington  Law  School  and  since  1990,  at  Georgetown 
Law  School. 

Chairman  Rangel.  Do  you  agree  with  Professor  Lee? 

Mr.  Tucker.  I  also  have  a  two-volume  set  on  the  Federal  tax- 
ation of  real  estate  transactions,  published  by  Cartboard  and 
Callahan,  so  I  think  I  do  have  some  credentials,  OK?  I  have  told 
them  this  for  years,  and  I  think  that^Howard  Levine  is  also  an 
adjunct  professor  at  Georgetown,  and  I  think  we  have  equal  cre- 
dentials with  Professor  Lee. 

I  would  argue  that  that  test  is  not  too  broad.  It  has  been  limited 
over  the  years  by  Congress  in  the  deferred  like-kind  exchange  area, 
foreign  property  for  domestic  property  and  the  like,  and  I  think 
that  was  too  broad  a  statement,  unfortunately. 

Mr.  Levine.  I  disagree  with  Professor  Lee.  I  do  not  think  the 
question  of  the  continued  liberalism  of  the  courts  is  in  issue  these 
days.  The  IRS  published  regulations  a  couple  years  ago.  It  was  a 
1984  amendment.  All  of  this  was  done  to  address  a  liberal  trend 
in  the  courts. 

I  don't  think  there  is  that  concern  now.  I  don't  think  there  is  a 
concern  on  the  part  of  the  IRS.  I  don't  think  there  is  a  concern  on 
the  part  of  Treasury.  Obviously,  there  is  not.  Treasury  is  opposed 
to  any  change  because  there  is  no  need,  there  is  no  necessity  to 
make  this  change.  So  I  do  not  agree  with  the  professor. 

Chairman  Rangel.  Well,  I  think  Mr.  Lee  makes  a  lot  of  sense. 
I  mean  full  Professor  Lee  makes  a  lot  of  sense.  I  don't  know  how 
this  would — ^how  the  courts  would  possibly  handle  a  narrower  ver- 
sion. It  is  a  factual  question;  you  leave  it  up  to  the  court.  I  don't 
see  how  we  can  do  that. 

Mr.  Lee.  Chairman  Rangel,  I  was  not  suggesting  that  we  leave 
it  to  the  courts.  I  was  suggesting  that  you  all,  in  determining  what 
similar,  related  in  service  as  used  for  real  estate,  for  example, 
should  mean,  you  all  should  decide  it  should  focus  on  return,  risk, 
and  management  activities  or  whatever  other  factors  you  want,  and 
then  not  leave  it  to  the  courts  but  leave  it  to  the  service  and  then 
begin  with  that  as  a  base  for  ultimately  having  legislative  regs. 

They  first  issue  rulings  as  the  facts  come  up,  build  up  a  little  ex- 
perience, then  they  build  it  into  regs.  The  problem  is  right  now 
that  under  1033  or  even  the  soil  remediation,  any  of  this,  you  can- 
not police  it  with  substantial  authority.  There  is  enough  stuff"  out 
there  that  on  a  one  out  of  three,  any  of  us  can  find  authority  on 
any  side,  and  therefore  people  will  take  any  side,  and  so  what  we 
need  is  more  direction  and  then  let  the  service  do  what  it  does  best, 
but  with  authority. 


1709 

When  I  say  direction,  I  am  really  almost  saying  authority,  and 
that  is  what  I  am  really  requesting.  No,  we  don't  want  more  litiga- 
tion. You  look  at  those  cases,  they  haven't  done  it  well. 

Mr.  Levine.  Mr.  Chairman,  if  this  change  is  made,  I  think  all 
that  would  be  done  here  is  substituting  this  situation  for  the  amor- 
tization of  intangibles  situation  in  terms  of  the  amount  of  litigation 
that  would  progress,  the  amount  of  the  uncertainty,  and  that  can- 
not be  in  anyone's  interests. 

Chairman  Rangel.  Well,  Mr.  Jacobs,  any  questions? 

Let  me  thank  the  board.  On  something  as  important  as  this,  the 
committee  will  not  be  moving  until  we  get  the  professors  back  in 
to  help  us  out  on  this. 

We  will  break  for  10  minutes  and  then  Chairman  Jacobs  will 
start  with  the  fourth  panel. 

Is  Mr.  Fay  here? 

Thank  you. 

[Recess.] 

Mr.  Jacobs  [presiding].  The  next  panel  is  already  in  place. 

Does  anybody  want  your  names  called  for  the  record  or  shall  we 
just  proceed?  Let's  do  that.  In  the  order  in  which  you  are  listed. 
Maybe  you  don't  have  the  listing.  So  let's  start  with  Mr.  Fay. 

STATEMENT  OF  KEVIN  J.  FAY,  EXECUTIVE  DIRECTOR, 
ALLIANCE  FOR  RESPONSIBLE  CFC  POLICY 

Mr.  Fay.  Thank  you,  Mr.  Chairman. 

Mr.  Chairman,  my  name  is  Kevin  Fay,  and  I  am  executive  direc- 
tor of  the  Alliance  for  Responsible  CFC  Policy.  I  would  like  to  note 
for  the  record  that  I  am  not  a  professor,  but  my  mother  loves  me 
iust  the  same,  adjunct  or  otherwise,  I  will  submit  my  bona  fides 
later,  though,  if  vou  like. 

On  behalf  of  the  alliance  I  am  presenting  testimony  today  in  op- 
position to  the  addition  of  HCFCs  to  the  existing  list  of  taxable 
ozone-depleting  compounds. 

The  alliance  is  a  coalition  of  over  200  companies  and  industries 
and  associations  that  produce  CFCs,  HCFCs  and  HFCs  and  prod- 
ucts that  use  these  chemicals.  I  have  attached  a  list.  The  alliance 
has  been  instrumental  in  promoting  an  effective  global  approach  to 
ozone  protection,  while  minimizing  costly  and  ineffective  regula- 
tions on  user  industries.  We  have  worked  closely  with  Congress 
and  EPA  in  developing  technically  and  economically  feasible  Clean 
Air  Act  regulations. 

I  will  summarize  our  three  key  points  in  opposition  to  this  pro- 
posal. First  of  all,  HCFCs  are  to  be  cautiously  encouraged  in  their 
utilization.  Both  the  Montreal  Protocol  and  the  Clean  Air  Act 
Amendments  of  1990  encourage  the  rapid  phaseout  of  CFCs.  There 
is  no  disagreement  among  the  international  community,  the 
Federal  Government,  and  industry  that  HCFCs  are  necessary  tran- 
sitional compounds  which  must  be  made  available  in  order  to 
achieve  this  rapid  phaseout  of  CFCs.  In  fact,  the  international  and 
domestic  policy  supports  the  continued  production  of  HCFCs  for 
these  applications  on  timetables  ranging  from  2003  to  2030,  nearly 
40  years. 

EPA  has  worked  on  approving  HCFCs,  and  in  advocating  their 
use  has  benefited  society  and  industry  in  this  transition.  Clean  Air 


1710 

Act  Section  612  requires  that  EPA  identify  substitutes  that,  "re- 
duce the  overall  risk  to  human  health  and  environment." 

The  SNAP  program,  Significant  New  Alternatives  Policy,  identi- 
fies HCFCs  as  acceptable  substitutes  for  CFC  compounds  in  a  vari- 
ety of  applications,  including  use  as  refrigerants  in  air  conditioning 
and  refrigeration,  and  the  manufacture  of  energy-efficient  building 
insulation.  I  have  attached  the  EPA  SNAP  list  of  approved  uses. 

As  you  can  see  from  this  list,  HCFCs  in  numerous  instances 
meet  the  congressionally  mandated  standard  of  reducing  overall 
risk  to  human  health  and  the  environment.  Subjecting  these  com- 
pounds to  the  same  tax  which  is  applied  to  the  ozone-depleting 
CFCs  which  they  replace  sends  a  message  inconsistent  with  the 
message  EPA  is  sending  under  SNAP. 

We  urge  the  Congress  to  coordinate  with  EPA  to  promote  the  use 
of  HCFCs  in  these  apphcations  where  they  are  beneficial  in  order 
to  avoid  unnecessary  confusion  as  to  their  impact  on  individuals 
and  to  the  environment. 

Considerable  investment  has  been  made  with  the  Government's 
encouragement  in  HCFCs  and  alternative  technologies  employing 
them.  A  tax  on  these  compounds  could  slow  down  the  shift  to  these 
CFC  alternatives  and  could  potentially  harm  many  companies,  both 
large  and  small,  which  have  relied  on  international  and  domestic 
government  acceptance  of  these  compounds  in  many  industrial  ap- 
plications. This  is  somewhat  akin  to  the  Government  asking  the 
farmers  of  America  to  solve  the  world  hunger  problem  and  then 
putting  an  excise  tax  on  their  crops. 

HCFCs  are  essential  for  the  preservation  of  food,  medicines,  in- 
door climate  control,  and  energy  efficiency.  In  fact,  an  HCFC  tax 
could  threaten  the  viability  of  the  entire  rigid  foam  insulation  in- 
dustry which  supplies  the  most  energy-efficient  building  insulation 
material  available  today.  This  material  is  critical  to  the  United 
States  achieving  its  goals  under  the  climate  change  action  plan 
which  we  agreed  to  last  year  in  the  treaty  at  Rio. 

These  industries  in  the  United  States  have  just  undertaken  the 
tremendous  task  of  making  the  rapid  transition  from  CFCs  and  im- 
plementing these  alternatives,  but  they  also  understand  the  impor- 
tance of  identifying  alternatives  to  the  HCFC  compounds  and  in 
preparing  for  their  ultimate  phaseout  by  the  year  2030,  but  these 
industries  need  to  focus  their  resources  on  the  development  of 
those  alternatives,  not  on  paying  punitive  taxes. 

The  second  key  point,  HCFCs  are  environmentally  beneficial,  as 
is  evidenced  by  EPA's  own  SNAP  program  decisions.  At  the  recent 
Copenhagen  meeting  of  the  parties  to  the  Montreal  Protocol,  UNEP 
science  advisor  Robert  Watson  stated,  "It  is  feasible  to  phase  out 
CFCs  between  1995  and  1997,  assuming  an  aggressive  recycle  and 
retrofit  policy,  and  with  HCFC  substitution  for  some  important 
uses.  HCFCs  will  be  required  for  a  period  of  time  for  a  number  of 
applications,  in  particular  refrigeration,  air  conditioning,  heat 
pumps  and  insulating  foams."  In  other  words,  the  accelerated 
phaseout  schedule  for  CFCs  is  predicated  on  HCFC  utilization. 

The  third  key  point  is  that  HCFC  tax  is  going  to  be  an  ineffective 
revenue  source.  The  CFC  tax  which  was  adopted  in  1989  is  likely 
to  only  raise  approximately  half  of  what  was  projected  to  be  raised 


1711 

when  it  was  originally  proposed  and  adopted.  We  think  that  the 
HCFC  tax  will  be  equally  speculative. 

Industry  has  already  identified  many  technologies  that  do  not 
use  fluorocarbon-based  products.  At  least  50  to  75  percent  of  the 
CFC  substitute  market  is  expected  to  be  replaced  by  conservation 
practices  and  so-called  not-in-kind  substitution.  Prqiected  HCFC 
utilization  is  less  than  15  to  20  percent  of  the  old  CFC  market,  and 
that  projection  is  nearly  50  percent  less  than  a  similar  projection 
just  a  couple  of  years  ago,  so  clearlv  the  HCFC  tax  is  not  likely  to 
raise  the  revenue  that  it  is  projected  to  raise  currently. 

In  sum,  we  ask  the  subcommittee  to  reject  the  addition  of  HCFCs 
to  the  list  of  taxable  ozone-depleting  compounds.  Congress  clearly 
delineated  a  difference  between  class  I  compounds  and  class  II 
compounds  in  Clean  Air.  We  think  that  delineation  should  be 
maintained  in  the  tax  policy  as  well. 

The  ozone  protection  effort  is  succeeding  because  of  the  extraor- 
dinary cooperation  between  government  and  industry.  We  will  con- 
tinue to  work  with  the  Congress  and  EPA  in  minimizing  confusion 
over  the  acceptability  of  these  alternatives,  but  this  proposed  tax 
change  is  inconsistent  with  these  objectives.  We  think  it  is  bad  en- 
vironmental policy  and  is  bad  tax  policy. 

Thank  you. 

[The  prepared  statement  and  attachments  follow.  For  attachment 
2,  please  see  Federal  Register,  Vol.  58,  No.  90,  dated  Wednesday, 
May  12,  1993,  pp.  28160-28187.] 


1712 


TESTIMONY  OF  KEVIN  FAY 
EXECUTIVE  DIRECTOR,  ALLIANCE  FOR  RESPONSIBLE  CFC  POLICY 


My  name  is  Kevin  Fay  and  I  am  Executive  Director  of  the  Alliance  for 
Responsible  CFC  Policy.  On  behalf  of  the  Alliance,  I  am  presenting  testimony 
opposing  the  addition  of  HCFCs  to  the  existing  list  of  taxable  ozone-depleting 
chemicals. 

The  Alliance  Is  a  coalition  of  over  two  hundred  companies  that  produce 
chlorofluorocarbons  (CFCs),  hydrochlorofluorocarbons  (HCFCs),  and 
hydrofluorocarbons  (MFCs),  and  manufacture  products  that  use  these  chemicals. 
(See  Attachment  1).  The  industry  sectors  which  comprise  the  Alliance  include 
chemical  production;  air  conditioning  and  refrigeration;  refrigerant  recovery, 
recycling,  and  reclamation;  foam  insulation;  foam  packaging;  electronics;  motor 
vehicle;  and  medical  products.  The  Alliance  was  organized  in  1980  to  coordinate 
industry  participation  in  development  of  reasonable  international  and  federal 
government  policies  on  the  regulation  of  CFCs  and  their  alternatives,  and 
protection  of  the  ozone  layer. 

The  Alliance  has  been  instrumental  in  representing  industry's  voice  on  the 
international,  federal,  state,  and  local  levels  of  government,  and  in  promoting  an 
effective  global  approach  to  ozone  protection,  while  minimizing  costly  and 
ineffective  regulations  on  user  industries.  We  have  worked  closely  with  Congress 
and  the  Environmental  Protection  Agency  in  developing  technically  and 
economically  feasible  Clean  Air  Act  requirements. 


HCFCs  ARE  TO  BE  ENCOURAGED 

Both  the  Montreal  Protocol  and  the  Clean  Air  Act  Amendments  of  1990 
encourage  the  rapid  phaseout  of  CFCs.  There  is  no  disagreement  among  the 
international  community,  the  federal  government,  and  industry  that  HCFCs  are 
necessary  transitional  compounds  which  must  be  made  available  in  order  to 
achieve  a  rapid  and  successful  CFC  phaseout.  The  Alliance  recognizes  the 
minimal  ozone  depletion  potential  of  the  HCFCs;  and  industry  is  working  to 
identify  alternatives  for  them.  Nevertheless,  international  and  domestic  policy 
support  the  continued  production  of  HCFCs  for  certain  applications  on  timetables 
ranging  from  2003  through  2030.    There  is  no  scientific  or  environmental 


1713 


justification  to  discourage  HCFC  use  prior  to  these  dates  since  they  offer  a 
balance  of  safety,  performance,  economic,  and  environmental  benefits. 

The  imposition  of  a  tax  on  these  compounds  by  the  Congress  would 
impede  efforts  to  encourage  environmentally  responsible  use  of  HCFCs.  EPA's 
work  in  approving  HCFCs  and  in  advocating  their  use  has  benefited  industry  and 
society  in  the  transition  away  from  CFCs.  Clean  Air  Act  Section  612  requires  that 
EPA  identify  substitutes  that  "reduce  the  overall  risk  to  human  health  and  the 
environment."  EPA's  Significant  New  Alternatives  Policy  (SNAP)  Program,  a 
requirement  of  the  Clean  Air  Act  Amendments  of  1990,  identifies  HCFCs  as 
acceptable  substitutes  for  CFCs  in  a  variety  of  applications,  including  use  as 
refrigerants  in  air  conditioning  and  refrigeration,  and  in  the  manufacture  of  energy 
efficient  building  insulation.  (See  Attachment  2). 

Subjecting  the  HCFCs  to  the  same  tax  which  is  applied  to  the  ozone- 
depleting  CFCs  which  they  replace  sends  a  message  inconsistent  with  the 
message  EPA  is  sending  under  SNAP.  We  urge  the  Congress  to  coordinate  with 
EPA  to  promote  the  use  of  HCFCs  in  applications  where  they  are  beneficial,  to 
avoid  unnecessary  confusion  as  to  their  impact  on  individuals  and  the 
environment,  and  to  remove  barriers  which  may  discourage  industries  from  using 
HCFCs  in  applications  where  they  are  an  appropriate  alternative  to  continued 
CFC  use.  In  addition,  an  HCFC  tax  may  place  a  stigma  on  these  compounds 
resulting  in  their  rejection  by  the  lesser  developed  countries.  Since  these 
countries  are  allowed  to  use  CFCs  until  2006,  they  may  wait  for  the  alternatives 
to  HCFCs  rather  than  make  a  conversion  to  HCFCs  now. 

Considerable  investments  have  been  made  in  HCFCs  and  alternative 
technology  employing  HCFC  compounds.  A  tax  on  these  compounds  would  slow 
down  the  shift  to  these  CFC  alternatives  and  could  potentially  harm  many 
companies,  both  large  and  small,  which  have  relied  on  intemational  and  domestic 
government  acceptance  of  HCFCs  in  many  industrial  applications.  Any  reversal 
of  the  federal  government's  encouragement  and  support  for  the  use  of  HCFCs 
would  be  unnecessarily  detrimental  to  the  industry  and  to  the  rapid  phaseout  of 
CFCs,  with  negligible  environmental  benefit. 


1714 


Imposition  of  a  tax  on  the  HCFCs  would  also  add  to  the  confusion  which 
has  already  contributed  to  negative  perceptions  of  HCFCs.  Industry  and  EPA 
have  worked  diligently  to  develop  a  positive  acceptance  of  HCFCs  and  to 
promote  their  short-term  environmental  benefits.  The  federal  government  needs 
to  continue  its  support  for  these  compounds  in  light  of  misguided  activity  at  the 
state  and  local  level  to  ban  HCFCs. 

Establishing  an  HCFC  tax  now  will  only  penalize  consumers  and 
businesses  who  have  just  undertaken  the  cost  of  making  a  transition  away  from 
CFCs.  These  consumers  and  businesses  may  also  have  to  finance  the  cost  of 
retrofitting  motor  vehicle  air  conditioners  and  commercial  and  residential  air 
conditioning  and  refrigeration  equipment  if  there  is  a  scarce  supply  of  CFCs  to 
service  and  maintain  this  equipment  after  the  phaseout. 

HCFCs  are  essential  to  the  preservation  of  food  and  medicines,  indoor 
comfort,  and  energy  efficiency.  In  fact,  an  HCFC  tax  would  threaten  the  viability 
of  the  whole  rigid  foam  insulation  industry  which  supplies  the  most  energy 
efficient  building  insulation.  Penalizing  consumers  for  life's  essential  needs  is  not 
productive.  These  consumers  and  businesses  have  already  accepted  the  tax 
increase  passed  by  Congress  this  summer.  Additional  taxes  at  this  time  are 
unnecessary. 

Every  major  industry  using  HCFCs  is  working  diligently  to  identify 
alternatives  to  HCFCs.  These  industries  need  no  greater  incentive  to  proceed 
quickly  on  this  task  than  the  scheduled  phasedown  in  the  Montreal  Protocol  and 
EPA's  forthcoming  rulemaking  to  accelerate  the  Clean  Air  Act's  HCFC  phaseout. 
These  industries  have  just  undertaken  the  tremendous  task  of  making  a  rapid 
transition  from  CFCs  and  implementing  HCFCs  as  alternatives.  Therefore,  they 
understand  the  importance  of  identifying  alternatives  to  HCFCs  in  order  to 
prepare  for  the  ultimate  HCFC  phaseout.  These  industries  need  to  focus  their 
resources  on  development  of  alternatives  to  HCFCs. 


1715 


HCFCs  ARE  ENVIRONMENTALLY  BENEFICIAL 

HCFCs,  according  to  the  United  Nations  Environment  Programme 
(UNEP),  are  essential  bridging  compounds  that  must  be  commercialized  in  order 
to  allow  for  the  rapid  phaseout  of  CFCs.  The  CFC  phaseout  is  the  most 
important  step  necessary  to  reduce  atmospheric  chlorine.  A  recent  UNEP 
science  assessment  concluded  that  the  HCFCs  are  89%-98%  better  than  the 
CFC  compounds  they  replace.  According  to  UNEP  Science  Advisor  Robert 
Watson  in  November  1992,  "It  is  feasible  to  phase  out  of  CFCs  between  1995 
and  1997,  assuming  an  aggressive  recycle  and  retrofit  policy  and  with  HCFC 
substitution  for  some  important  uses.  HCFCs  will  be  required  for  a  period  of  time 
for  a  number  of  applications,  in  particular  refrigeration,  air  conditioning,  heat 
pumps  and  insulating  foams." 

The  UNEP  November  1991  Synthesis  Report  stated  that  HCFCs  and 
HFCs  "can  be  safely  used  for  refrigeration,  air  conditioning,  insulating  foam,  and 
for  some  aerosol,  sterilization,  and  minor  solvent  uses;  that  these  HCFCs  and 
HFCs  are  environmentally  acceptable;  and  that  they  are  commercially  available 
in  adequate  quantities." 


AN  HCFC  TAX  IS  AN  INEFFECTIVE  REVENUE  SOURCE 

The  ozone-depleting  substances  excise  tax.  which  was  enacted  in  1989, 
has  been  a  poor  policy  for  furthering  ozone  protection  efforts  and  ineffective  as  a 
reliable  revenue  source.  The  rapid  decline  in  CFC  usage  in  the  United  States 
resulted  in  the  collection  of  only  one-half  of  the  projected  revenue  from  the  tax. 
The  acceleration  the  CFC  phaseout  well  ahead  of  both  the  international  and 
domestic  phaseout  schedules  is  attributable  to  the  unprecedented  cooperation  of 
industry  and  government  in  working  to  achieve  the  elimination  of  these 
compounds  on  a  global  basis.  CFC  reductions  in  Europe  and  Japan  are  equally 
impressive  even  though  no  CFC  excise  taxes  have  been  imposed.  By  the  end  of 
1993,  CFC  production  in  the  United  States  will  be  at  25%  of  1986  levels.  A  total 
phaseout  of  CFC  production  will  occur  by  January  1 ,  1 996. 


1716 


Industry  has  already  identified  many  technologies  that  do  not  use 
fluorocarbon-based  products.  At  least  50  -  75%  of  the  CFC  substitutes  market  is 
expected  to  be  replaced  by  conservation  practices  and  so-called  not-in-kind 
substitution.  Projected  HCFC  utilization  is  less  than  15  -  20%  of  the  CFC  market. 
HCFCs  will  be  used  where  essential  and  where  no  other  commercially  viable 
substitutes  are  available  in  order  to  allow  the  rapid  elimination  of  CFC 
technologies. 


CONCLUSION 

We  ask  the  Subcommittee  to  reject  the  addition  of  HCFCs  to  the  list  of 
taxable  ozone-depleting  chemicals,  and  to  work  with  industry  and  the 
Administration  in  encouraging  the  transition  to  HCFCs  for  many  CFC 
applications.  The  ultimate  goal  of  the  work  that  has  been  conducted  by  industry 
and  government  has  been  to  minimize  emissions  of  ozone-depleting  compounds 
to  the  atmosphere.  The  ozone  protection  effort  is  succeeding  because  of  the 
extraordinary  cooperation  between  government  and  industry  at  unprecedented 
levels.  (See  Attachment  3).  Industry  will  continue  to  work  with  Congress  and 
EPA  in  minimizing  confusion  over  the  acceptability  of  CFC  alternatives,  and  in 
adhering  to  a  consistent  position  of  acceptability  of  HCFCs.  This  proposed 
change  to  the  tax  on  ozone-depleting  chemicals  is  inconsistent  with  these 
objectives 


1717 


Attachment  1 


1993  Membership  List 
Alliance  for  Responsible  CFC  Policy 


3M  Company 

A.  Cook  Associates,  Inc. 

Abbott  Laboratories 

Abco  Refrigeration  Supply  Corp. 

Acme  -  Miami 

American  Electronics  Association  (AEA) 

Air  Comfort  Corporation 

Air  Conditioning  Contractors  of  America 

Air  Conditioning  &  Refrigeration  Institute 

Air  Conditioning  Suppliers,  Inc. 

Air  Products  and  Chemicals 

Alliance  Pharmaceutical  Corporation 

AlliedSignal 

American  Auto.  Manufacturers  Assoc. 

American  Frozen  Food  Institute 

American  Pacific  Corporation 

American  Refrigerant  Reclaim  Corporation 

American  Thermafio  Corp. 

American  Trucking  Associations 

Amtrol,  Inc. 

Anderson  Bros.  Refrigeration  Service,  Inc. 

Apex  Ventilations 

ARCA/MCA 

Arizona  Public  Service  Co. 

Arjay  Equipment  Corporation 

Arrow  Air  Conditioning  Service  Company 

Arthur  D.  Little,  Inc. 

Ashland  Chemical  Company 

Astro-Valcour  Inc 

AT&T 

Automotive  Consulting  Group,  Inc 

Bard  Manufacturing  Co. 

Beltway  Heating  &  Air  Conditioning  Co.  Inc. 

Beverage-Air 

Big  Bear  Stores  Co. 

Blue  M  Electric 

Building  Owners  and  Managers  Association  (BOMA) 

Booth  Refrigeration  Services  Conditioning 

Bristol  Compressors 

c/o  Moog  Training  Center 

Carrier  Corporation 


1718 


Center  for  Applied  Engineering 

Central  Coating  Company,  Inc. 

Cetylite  Industries.  Inc. 

Chemical  Packaging  Corp. 

Chemtronics,  Inc. 

Clayton  Auto  Air.  Inc. 

Commercial  Refrigerator  Manufacturers  Association 

Copeland  Corporation 

Day  Supply  Company 

Dow  Chemical  U.S.A. 

E.I.  Dupont  De  Nemours  and  Company 

E.V.  Dunbar  CO. 

Eastman  Kodak 

Ebco  Manufacturing 

Elf  Atochem  North  America,  Inc. 

Elliott-Williams  Company.  Inc. 

Engineering  &  Refrigeration.inc. 

Falcon  Safety  Products.  Inc. 

FES  Inc. 

Flex-0-Lators,  Inc. 

Foam  Enterprises.  Inc. 

Foamseal,  Inc. 

Food  Marketing  Institute 

Foodservice  &  Packaging  Institute 

Forma  Scientific 

Fox  Appliance  Parts  of  Augusta 

Franke  Filling,  Inc. 

Fras-Air  Contracting 

Free-Flow  Packaging  Corp. 

Freightliner  Corporation 

Gardner,  Carton  &  Douglas 

Gebauer  Company 

General  Electric  Company 

General  Motors 

Graineer 

Gulfcoast  Auto  Air 

H.  C.  Duke  &  Son,  INc. 

Hale  and  Dorr 

Halocarbon  Products  Corporation 

Halsey  Supply  Co.,  Inc. 

Harold  Electric  Co. 

Henry  Valve  Company 

Highside  Chemicals 

Hill  Refrigeration  Corp. 

Howard/McCray  Refrigerator  Co..  Inc. 


1719 


Hughes  Aircraft  Company 

Hussmann  Corporation 

ICI  Fluorochemicals  -  ICI  Americas  Inc. 

IG-LO,  Inc. 

Illinois  Supply  Company 

IMI  Cornelius  Company 

Institute  of  Heating  &  Air  Conditioning  Industries 

Institute  of  International  Container  Lessors 

Integrated  Device  Technology  Inc. 

International  Assoc,  of  Refrigerated  Warehouses 

International  Cold  Storage  Co..  Inc. 

International  Mobile  Air  Conditioning  Assoc. 

Interstate  Truckload  Carriers  Conference 

Johnson  Controls 

Keyes  Refrigeration,  Inc. 

King-Weyler  Equipment  Co.,  Inc. 

Kline  &  Company  Inc. 

Kraft  General  Foods 

KYSOR  WARREN 

LaRoche  Chemicals 

Lennox  Industries 

Liggett  Group  Inc. 

Lintern  Corporation 

Lorillard  Tobacco  Company 

Lowe  Temperature  Solutions 

Luce,  Schwab  &  Kase,  Inc. 

Malone  and  Hyde  Inc. 

Manitowoc  Equipment  Works 

Marine  Air  Systems 

MARVCO  Inc. 

Maytag  Corporation 

McGee  Industries,  Inc. 

Mechanical  Service  Contractors  of  America 

Merck  &  Co.,  Inc. 

Metl-Span  Corporation 

Miles  Inc. 

Mintz,  Levin,  Cohn,  Glovsky.  and  Popeo  P.C. 

Mobile  Air  Conditioning  Society 

Monsen  Engineering  Co. 

Montgomery  County  Public  Schools 

Moog  Automotive  Inc. 

Moran,  Inc. 


1720 


MRA 

Nat.  Assoc.  Of  Plumbing-Heating-Cooling  Contractors 

National  Assn.  of  Food  Equipment  Manufacturers 

National  Refrigerants,  Inc. 

National  Training  Centers,  Inc. 

NC  State  Board  of  Refrigeration 

Neaton  Auto  Products  Mfg..  INc. 

New  Mexico  Engineering  Res.  Instit.-U  of  NM 

North  Colorado  Medical  Center 

Northem  Illinois  Gas 

Northern  Research  &  Engineering  Corporation 

Northland  Corporation 

Norton  Company-Sealants  Division 

O'Brien  Associates 

Omar  A.  Muhtadi,  Inc. 

Omega  Refrigerant  Reclamation 

Orb  Industries,  Inc. 

Patterson  Frozen  Foods,  Inc. 

Peirce-Phelps,  Inc. 

Pennzoil  Company 

Perlick  Corporation 

Polyisocyanurate  Insulation  Manufacturers  Association  (PIMA) 

Polycold  Systems  International 

Premier  Brands  Ltd. 

Ralph  Wright  Refrigeration 

Rawn  Company,  Inc. 

Reeves  Refrigeration  &  Heating  Supply,  Inc. 

Refrigeration  Engineering.  Inc. 

Refrigerant  Management  Services 

Refrigeration  Sales  Co.,  Inc. 

Revco  Scientific 

Rhode  Island  Refrigeration  Supply  Comp,  Inc. 

Ritchie  Engineering  Co.,  Inc. 

Rite  Off 

RJR  Nabisco 

Robinair  Division,  SPX  Corp 

RSI  Co. 

Rule  Industries,  Inc. 

SCM  Glidco  Organics 

Scott  Polar  Corporation 

Service  Supply  of  Victoria,  Inc. 

Servidyne  Inc. 

Sexton  Can  Company 

Sheeting,  Metal,  Air-Conditioning  Contractors  National  Association  (SMACNA) 

South  Central  Co.,  Inc. 


1721 


Southern  Refrigeration  Corp. 

Society  of  the  Plastics  Industry  (SPI) 

Sporlan  Valve  Company 

Spray.  Inc. 

Stoelting,  Inc. 

Sub-Zero  Freezer  Company,  \nc. 

Superior  Valve  Company 

TAFCO  Refrigeration  Inc. 

Tech  Spray,  Inc. 

Tecumseh  Products  Company 

Tennessee  Eastman 

Tesco  Distributors.  Inc. 

Thermal  Engineering  Company 

Thermo-King  Corporation 

Thompson  Publishing  Group 

Thompson  Supply  Co. 

Thorpe  Supply 

Tolin  Mechanical  Systems  Co. 

Tomen  America  Inc. 

Trane  Company 

Tropicana  Products  Inc. 

Tu  Electric 

Tyler  Refrigeration  Corp 

Union  Chemical  Lab,  ITRI 

United  Refrigeration,  Inc. 

Unitor  Ships  Service,  Inc. 

University  of  Maryland  at  Baltimore 

University  of  Wisconsin-Madison 

Valvoline  Oil  Company 

Venable,  Baetjer.  and  Howard 

Vulcan  Chemicals  Co. 

W.A.  Roosevelt  Company 

W.M.  Barr  and  Company 

Wawa.  Inc. 

Weinberg  and  Green 

White  &  Shauger,  Inc. 

William  F.  Nye,  Inc. 

Wynns  Climate  Control 

York  Division,  Borg-Wamer  Corp 

Yori<  International  Corporation 

Zero  Zone  Refrigeration  MFG 

Zexel  USA 


1722 


Attachment  3 


>?e?» 


ood  News,  for  Once,  on  Ozone 


It'*  not  oftan  th«i  selcnct.  Industry  and  govtnv- 
m«nt  can  a«ra«  on  itia  causu  of  •  eempUcatad 
probltm  and  then  work  to  wlva  It  Whan  they  do, 
thara'i  reaun  to  celebrate.  Last  week  an  ittua  of 
Nature,  a  British  journal,  carried  nme  unexpected 
good  news  that  It  dlr«etly  traceable  to  a  coUeetlve 
effort:  The  invasion  of  the  stratoephere  by  cheml- 
eaU  that  thin  the  earth's  protective  oione  layer  is 
alowing  down. 

If  the  trend  continues,  the  buildup  of  os0ne> 
'  destroying  chemlcaU  should  stop  by  die  year  MOO. 
Hie  worst  of  the  destruction  —  and  it  will  get  worse 
■fbr  a  while  —  should  come  around  the  turn  of  the 
century  when  the  peak  load  of  chemicals,  now 
wafUng  upward,  reaches  the  stratosphere.  At  that 
point,  assuming  no  new  assaults,  the  otone  layer 
should  begin  a  slow  recovery.       ^   •' 

"Here  Is  a  beautiful  exampto  of  sdenoe  and  ' 
public  policy  working  well.'^-sald  Dr.  Jamu  V. 
EflUns.  a  Oovemroem  scientist  who  led  the  team 


He's  rIghL  Though  it  took  some  do 
Hodel,  President  Reagan's  Energy  Secreury,  once 
suggested  that  the  way  to  deal  with  oxone  depletion 
was  to  apply  mere  suntan  oil),  scientists  finally 
persuaded  the  world's  govemmenu  that  unchecked 
oione  depletion  could,  in  time,  expose  large  paru  of 


the  globe  to  cancer-causing  ultraviolet  rays  from 
the  sun. 

In  IM7  indusiriallted  nations  agreed  (o  a  60 
^rcent  reduction  in  the  main  chemical  culprit  — 
chlorofluorocarbons.  or  CPC's.  commonly  used  ai  a 
coolant  In  refrigerators  and  air  conditioners.  Three 
years  later,  they  agreed  to  eliminate  CFC'i  by  the 
year  3000.  Last  year,  in  Copenhagen,  the  deadllM 
was  moved  up  to  IMI    ' 

Meanwhile,  menufaeiurers  like  du  Pont,  driven 
as  much  by  eompetitlvo  fears  as  by  altruiim. 
moved  swiftly  to  develop  substitutes.  Most  of  next 
year's  new  cars,  for  example,  will  be  aqulpped  with 
non^PC  air  conditioning  systems.  The  steady  de- 
cline in  CPC  emissions,  selenusu  say.  is  almost 
eeruinly  responsible  for  the  slower  growth  in  ai- 
mospheric  eoncentrauons. 

TlUs  sueceu  story  will  not  be  easily  replicated, 
rinding  subsuiutes  for  CPC's  is  one  thing;  finding 
substitutes  for  fossil  fuels  —  the  main  cause  of 
suspecud  glebel  warming  —  Is  quite  another.  Still, 
the  fact  that  bureaucrats  and  business  lesderr 
actually  responded,  onct  ihcy  grasped  some  un- 
pleasant scientific  truths,  might  be  something  u 
remember  the  next  time  that  querulous  eounirie 
get  together  to  ulk  about  the  shrinking  rain  ferav 
or  dlmau  change  or  even  the  fish  in  the  sea. 


/1^^i>9^  yP^S 


1723 


1724 


A10  THmsDAV.  AlcisT  26. 1993 


Decline  of  Ozone-Harming  Chemicak 
Suggests  Atmosphere  May  Heal  Itself 


By  Boyce  Renshereer 


The  amount  of  ozone-destroying 
CFCs  in  the  atmosphere,  which  had 
been  rising  rapidly  for  decades,  sud- 
denly slowed  Its  rate  of  increase  in 
1989  and  has  nearly  leveled  off 
since  then,  scientists  at  the  Nation- 
al Oceanic  and  Atmospheric  Adiran- 
istration  have  found. 

The  NOAA  researchers  credit  a 
surpnsingly  rapid  decline  in  the 
production  and  use  of  the  cheiiu- 
cals — called  chlorofluorocarbons 
and  sold  mainly  as  refrigerants  and 
plastic  foam-blowmg  agents — and 
lorecasi  thai  their  concentration 
will  peak  around  the  year  2000. 

If  current  trends  continue,  thev 
jay.  CFC  levels  will  slowly  decline, 
allowing  the  ozone  iaver  to  heal  it- 
self naturally  and  provide  steadily 
increasing  amounts  ol  protection 
against  the  sun  s  ultraviolet  ravs. 

"This  IS  extremely  good  news  for 


said 

Elkms  of  NOAA's  Climate  Monitor- 
ing and  Diagnostics  Laboratory  in 
Boulder,  Colo.  Elkins  led  the  re- 
search effort,  with  colleagues  at 
NOAA  and  the  University  of  Col- 
orado, that  has  been  tracking  CFC 
concentrations  since  1977.  Elkins 
said  that  when  his  group  first  saw 
the  drop  in  the  CFC  growth  rate,  it 
lias  so  dramatic,  our  first  reaction 
i-as  |that|  we  ve  got  something 
wrong  with  our  instruments." 

The  data — which  have  been  cir- 
'Ulating  pnvatelv  among  scientists 
Ttr  more  than  a  vear.  and  on  which 
The  Washington  Host  based  an  ear- 
lier report  thai  ihe  ozone  problem 
.vould  peak  in  2000— are  published 
n  todav's  issue  iil  the  scientific 
luumal  Nature  The  findings  were 
submitted  lo  Nature  m  June  1992: 
:iut  because  the  lournal  prohibits 
scientists  Irom  presenting  their 
work  pubhciv  while  it  is  unoergoing 
peer-review,  tlkms  and  the  other 
.luthors  .  ould  not  talk  about  their 
•indings  until  now 

I'm  verv  pleased  that  this  is 
.lut,"  said  Richard  Stolarski,  an 
.izone-laver  researcher  at  N.ASA's 
(ioddard  Space  Flieht  Center  in 
(.reenbelt.  "It's  very  welcome  ex- 
penmental  conlirmation  of  what 
many  ol  us  had  projected  on  ihe 
i)asis  01  |CFC|  production  figures, 
lis  actually  amazing  how  last  some 
•  il  these  growth  curves  drop  olt  ' 

CFCs.  which  were  mvented  in 
the  1920s  but  did  not  come  into 
.Moespread  use  until  the  1950s  and 
i)Os,  are  blam-"*  lor  about  three- 


THE  CFC  FLOOD  IS  CRESTING 


The  amounts  ofCFCl  1  and  CFC-12  that  are  being  put  into  the 
atmosphere  each  year  began  to  decline  after  198S  Upper  panel  shorn 
the  average  amounts  released  each  month.  Lower  panel  shows  how  those 
amounts  caused  the  total  concentrations  to  nse  steadily  until  the  late 
1980s,  when  the  curves  began  to  flatten  Measurements  were  made  in  tht 
lower  atmosphere  It  takes  two  to  four  years  for  CFC  changes  there  to 
reach  the  stratosphere,  where  the  ozone  layer  is. 

Gaps  resulted  from  malfunctions  m  analytic  equipment  Fluctuations 
are  caused  by  changes  m  global  wind  pattens  that  spread  CFCs.  which 
art  released  pnmanly  in  the  mdustrialiud  world 


iMiimmm^m 


IN  PARTS  PER  TRILLION 


IMJ.HJ.I'l4.!..:J.t.l.L'I.IJJJJIHJI.I^JJk 


quarters  ot  the  depletion  ni  ozone 


Ini 


,  the  I 


perate  zones  has  been  about  :i  per- 
oent  to  4  percent.  In  the  last  two 
vears.  however,  occasional  losses 
have  surged  to  as  much  as  10  per- 
cent to  15  percent  lor  brict  periods 
These  are  generallv  attributed  to 
effects  from  the   1992  eruption  of 


Mount  Pmatubo.  which  are  expect- 
ed to  fade  in  coming  years. 

The  new  CFC  report  was  based 
on  measurements  of  air  samples  | 
collected  at  seven  stations  around 
the  world  in  polar,  temperate  and 
iropical  regions.  Starting  in  1977, 
samples  of  air  were  taken  weekly 
See  OZONL  All.  Coll 


1725 


CFCs  Threat  to  Earth's  Ozone  Layer 
WUl  Dimmish  After  2000,  Study  Says 


OZONE.  Fran  A 10 


from  each  station  and  shipped  to 
Elkins's  laboratory  lor  analysis. 

The  new  report  concerns  the  two 
most  common  and  fastest  growing 
types  o(  the  chemicals:  CFC-11  and 
CFC-12.  From  1977  through  1984. 
the  concentration  was  nsing  at  an 
annual  average  of  9  parts  per  tnl- 
lion  (ppt)  for  CFC-1 1  and  17  ppt  for 
CFC-12. 

.In  1984  producuon  and  use  of  the 
clKmicaia  increased:  and  from  1985 
t(T  1988.  the  CFC-11  concentration 
grew  at  a  rate  of  11  ppt  each  year 
while  CFC12  grew  19.5  ppt  each 

Then.  Elkins  said,  something  'sur- 
pnsuig"  happened.  After  1988  the 
rale  of  increase  plummeted,  reach- 
ing levels  this  vear  of  2.7  ppt  for 
CFC-11  and  10  5  ppt  for  CFC-12. 

After  establishing  that  the  mstni- 
ments  were  not  malfunctioning, 
EUuns  recalled,  he  became  puzzled 
as  to  why  CFC  release  would  be 
slowing  Its  growth  even  though  the 
Montreal  Protocol— a  global  treaty 
signed  m  1 987  to  phase  out  use  and 
end  the  production  of  ozone-de- 
stroying chemicals — was  not  due  to 
lake  full  effect  until  1996.  He  called 
E.  I.  du  Pont  de  Nemours  &  Co.. 
which  makes  the  chemicals,  and 
learned  that  their  estutiates  of  the 
amount  produced  around  the  world 
showed  a  parallel  declme 

Elkins  and  colleagues  estimated 
that  if  CFC  output  trends  continue  to 
fall  and  production  ceases  in  1996.  as 
planned,  the  concentration  of  CFC- 
1 1  in  the  lower  atmosphere  will  peak 
in  1998  and  CFC12  a  year  later. 
Because  ii  takes  two  to  (our  years 
lor  molecule^  in  the  lower  atmos- 
phere to  reach  the  stratosphere, 
where  the  ozone  layer  is.  the 
.imounts  there  would  not  be  likely  to 
peak  until  shortly  after  2000. 

At  that  lime,  the  group  esti- 
mated, the  concentration  of  chlo- 
rine (the  atom  that  breaks  otf  CFC 
.ind  attacks  uzone)  in  the  strato- 
sphere would  be  about  4  parts  per 
billion,  up  trom  the  current  3.4  ppb. 

After  the  peak,  however,  the 
I'hlorine  would  slowly  fall  out  of  the 
.itmosphere.  Small  amounts  are  re- 
moved all  the  time  as  the  chlorine 
rombines  with  hydrogen  to  form 
hydrochloric  acid  in  water  droplets 
that  eventually  fall  in  rain. 

The  scientists  estimate  that  it 
lOuld  take  50  to  100  years  before 
the  concentration  ol  stratosphenc 
l.;c'ine  returns  to  levels  thought  to 
novp  existed  belui.^  the  widespread 


use  of  CFCs— about  0.5  ppb.  Elkins 
said  that  if  the  world  can  make  it  to 
2000  without  suffering  any  major 
harm  from  ozone  depletion,  he  would 
not  expect  any  caustrophes  to  anse 
during  the  long  recovery  period. 

He  credited  the  CFC  decline  to 
pubhc  pressure.  This  is  all  driven 
by  U.S.  public  opmjon,"  he  said.  Ad- 
verse publicity  about  CFCs  has 
meant  "consumers  won't  buy  prod- 
ucts made  with  CFCs." 

At  the  same  time,  the  chemical 
industry  apparently  has  embraced 
the  goals  of  the  Montreal  Protocol, 
at  least  in  part  because  firms  saw 
profitable  new  markets  in  costlier 
CFC  substitutes. 

"This  IS  a  beautiful  case  study." 
Elkins  said,  "where  science,  the 
law.  industry  and  the  pubbc  worked 
together." 

One  caveat  remains.  Third  World 
signatones.  which  mclude  such 
large  and  growmg  refngeration 
markets  as  China.  India  and  Indo- 
nesu.  are  allowed  to  delay  their 
phaseout  of  CFCs  for  10  years.  To 
help  them  meet  the  higher  costs  of 
substitute  chemicals  and  refriger- 
ation hardware  built  to  use  the  sub- 
sutute.  the  protocol  allows  them  to 
draw  on  a  fund  to  which  the  rich 
countries  would  contnbute. 

Although  these  countries  are  not 
large  users  of  CFCs  now.  there  is  a 
fear  that  in  their  drive  to  develop 
economically  and  to  improve  public 
health  through  wider  use  of  food 
refngeration.    they    ir 


use  of  the  cheap  ozone-destroying 
chemical  rather  than  more  costly 
subsututes. 

In  the  mdustnahzed  world,  the 
phaseout  is  likely  to  be  smoother. 
Accordmg  to  the  Air  Cooditionmg 
and  Regngeration  Institute,  all 
home  air  conditioners,  inchidmg 
central  and  window  umts.  already 
use  one  of  the  substitutes— HCFC- 
22,  or  hydrochk)rofluorocarbon-22. 
Pound  for  pound.  HCFC-22  can  do 
only  about  5  percent  as  much  harm 
to  the  ozone  layer  as  CFCs.  Home 
refrigerators  use  CFC-12  but  rarely 
need  rechargmg  before  the  unit 
wears  out  mechamcally.  Refriger- 
ators that  use  ozone-safer  coolants 
are  starting  to  come  on  the  market. 

Most  automobile  air  conditioners, 
until  the  1994  model  year,  were 
built  to  use  CFC-12.  Nearly  all  94 
models  will  use  a  hydrofluorocarbon 
coolant,  HFC-134a.  that  conlams  no 
chlorine  and  thus  cannot  harm 
ozone.  Because  car  air  conditioners 
are  notonous  for  leakmg  (mamly 
because  of  vibratmg  hose  connec- 
tions), most  existing  units  will  even- 
tually need  rechargmg  with  CFC-12 
or  replacement  with  a  new  unit  that 
works  on  HFC-134a. 

Even  after  the  ban  on  making 
new  CFCs,  however,  experts  say  it 
should  still  be  possible  for  a  few 
years  to  recharge  older  umts  with 
recycled  CFC-12.  The  cost  of  ret- 
rofittmg  a  car  with  an  HFC- 134a  air 
conditioner  has  been  estimated  at 
$200  to  $800. 


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1730 

Mr.  Jacobs.  Thank  you,  Mr.  Fay. 
Ms.  Hecht,  nice  to  have  your  company. 

STATEMENT  OF  MARJORIE  MAZEL  HECHT,  MANAGING 
EDITOR,  2 1ST  CENTURY  SCIENCE  &  TECHNOLOGY 

Ms.  Hecht.  Thank  you,  Mr.  Chairman. 

I  am  Marjorie  Hecht  and  I  am  representing  21st  Century  Science 
Associates,  publishers  of  the  magazine  21st  Century  Science  & 
Technology,  and  the  book  The  Holes  in  the  Ozone  Scare:  The  Sci- 
entific Evidence  that  the  Sky  isn't  Falling. 

We  strongly  oppose  the  proposal  to  add  methyl  bromide,  HCFCs 
and  HBFCs  to  the  list  of  taxable  ozone-depleting  chemicals.  The  ac- 
tual cost  to  the  Nation  of  such  a  tax  would  be  crippling  when  meas- 
ured in  food  losses  and  economic  losses,  and  it  will  not  protect 
lives.  Indeed,  it  will  damage  lives  here  in  the  United  States  and 
worldwide. 

The  proposal  of  such  a  tax  continues  the  unscientific  flight  for- 
ward pattern  that  has  become  U.S.  policy  regarding  ozone  deple- 
tion. This  is  a  policy  based  on  public  perception  and  hypothetical 
models,  not  scientific  evidence.  It  is  a  policy  pushed  very  hard  by 
environmental  organizations  and  some  research  groups,  backed  by 
millions  of  dollars  fi'om  foundations  and  corporations. 

The  alleged  dangers  of  ozone  depletion  have  been  repeated  so 
often  by  these  groups  and  the  media  that  they  have  come  to  be  ac- 
cepted as  truth  without  question.  I  would  like  to  raise  some  of  the 
questions  in  this  testimony  that  I  think  committee  Members  should 
address  before  continuing  this  ozone  flight  forward. 

My  perspective  in  this  is  to  look  at  the  consequences  of  the  Na- 
tion's policy  on  ozone  depletion  in  terms  of  human  lives,  how  many 
lives  will  be  lost  as  a  result  of  these  policies.  I  am  not  a  scientist, 
but  a  science  writer  and  editor  and  have  been  for  20  some  years, 
and  I  have  considered  the  evidence  presented  by  many  experienced 
scientists  worldwide  whose  work  does  often  not  get  printed  in  the 
popular  press  or  even  in  the  scientific  press  because  it  is  not,  "po- 
litically correct." 

First,  what  is  the  worst-case  scenario  if  the  ozone  depletion  theo- 
rists are  correct?  They  say  we  will  have  a  10  percent  ozone  deple- 
tion within  the  next  50  years.  What  does  that  translate  to  in  terms 
of  the  alleged  increase  in  ultraviolet  radiation  reaching  earth?  It 
means  an  increase  equivalent  to  that  you  would  receive  if  you 
moved  100  miles  south  toward  the  equator.  In  other  words,  fi-om 
Washington  to  Richmond,  Virginia. 

When  we  put  this  fact  of  moving  100  miles  south  to  the  inventor 
of  the  ozone  depletion  theory.  Professor  F.  Sherwood  Rowland,  he 
acknowledged  tnat  this  is  not  something  he  would  worry  about, 
moving  100  miles  or  so  south.  Clearly  this  is  not  a  crisis  situation 
for  most  people. 

Is  such  a  worst-case  ozone  depletion  scenario  worth  the  disrup- 
tion of  refrigeration  worldwide  and  trillions  of  dollars  of  cost 
incurred  by  the  ban  on  CFCs  and  now  a  coming  ban  on  methyl 
bromide?  I  don't  think  so. 

Second,  has  any  increase  in  ultraviolet  actually  been  measured? 
No.  There  is  no  trend  of  an  increase  of  ultraviolet  reaching  the 
Earth.  The  most  definitive  study  by  U.S.  researchers  Scotto  and 


1731 

Urban  over  more  than  a  12-year  period  showed  no  significant  in- 
crease in  UVB,  and  some  stations  in  the  U.S.  showed  decreases. 

Third,  is  there  significant  scientific  evidence  to  indicate  that 
ozone  depletion  is  natural,  seasonal,  and  a  cyclical  phenomenon 
that  seems  to  follow  the  sunspot  cycle?  Yes.  I  won't  go  into  the  de- 
tails of  this  evidence  which  is  in  my  written  testimony. 

Fourth,  what  about  natural  sources  of  chlorine?  They  admittedly 
dwarf  manmade  sources.  There  are  millions  of  tons  of  natural 
sources  from  sea  water,  volcanoes,  et  cetera,  but  only  a  few  thou- 
sand tons  of  manmade  sources  of  chlorine  from  CFCs. 

Do  natural  sources  of  chlorine  reach  the  stratosphere?  The  ozone 
depletion  theorists  assert  they  do  not.  The  scientific  evidence  indi- 
cates that  they  do.  Again,  this  evidence,  some  of  it,  is  listed  in  my 
written  testimony. 

There  are  many  more  basic  questions  that  could  be  asked  about 
ozone  depletion.  Global  ozone  has  been  increasing  over  the  last  six 
years,  for  example.  How  could  this  be,  given  the  current  ozone  de- 
pletion theory? 

I  won't  talk  about  methyl  bromide  because  I  think  others  here 
will  talk  about  how  essential  it  has  been.  I  do  want  to  conclude  by 
talking  about  the  human  consequences  of  the  ban  on  CFCs.  I  know 
that  these  were  not  even  considered  when  the  ban  was  proposed. 

We  asked  EPA  Administrator  William  Reilly  at  a  press  con- 
ference in  November  whether  the  EPA  had  evaluated  the  con- 
sequences worldwide  of  a  phaseout  of  methyl  bromide.  They  hadn't. 
In  other  words,  the  EPA  was  making  a  decision  based  on  uncertain 
science,  and  they  hadn't  even  bothered  to  assess  the  damage  it 
would  cause. 

Now,  I  want  to  conclude  by  asking  the  question,  how  could  such 
an  important  U.S.  policy  be  made  without  regard  to  scientific  evi- 
dence or  without  regard  to  the  consequences  on  human  life?  We  do 
environmental  impact  statements;  why  not  human  impact  state- 
ments? 

I  think  to  answer  this  question  you  have  to  go  back  to  the  early 
1970s  and  look  at  how  DDT  was  banned.  In  1972  there  were  7 
months  of  hearings  by  the  Environmental  Protection  Agency  on 
DDT  before  a  hearing  examiner,  Edmund  Sweeney.  At  the  end  of 
those  7  months  and  9,000  pages  of  testimony,  he  ruled  that  DDT 
should  not  be  banned  based  on  the  scientific  evidence.  He  said, 
"DDT  is  not  a  carcinogenic,  mutagenic  or  teratogenic  hazard  to 
man  and  does  not  have  a  deleterious  effect  on  freshwater  fish,  estu- 
arine  organisms,  wild  birds  or  other  wildlife."  He  also  said  it  would 
be  more  harmful  to  ban  it. 

Yet,  within  a  month  after  that,  the  EPA  Administrator  William 
Ruckelshaus  banned  it,  and  he  said  he  did  it  for  political  reasons. 
He  did  this  unilaterally. 

For  this  reason  and  for  the  millions  of  lives  that  have  been  lost, 
particularly  in  the  developing  sector  in  Africa  and  Asia  as  a  result 
of  this  ban  on  DDT,  which  was  probably  the  most  beneficial  chemi- 
cal man  ever  invented,  I  call  DDT  the  "mother"  of  environmental 
hoaxes.  I  think  now  we  have  the  "son  of  DDT"  with  a  ban  on  CFCs 
and  methyl  bromide. 


1732 

I  have  recounted  this  history  because  I  really  don't  think  we  can 
afford  to  continue  killing  millions  of  people  as  a  result  of  basing 
policies  on  political  reasons,  public  perception,  and  not  the  sci- 
entific evidence. 

[The  prepared  statement  follows:] 


1733 


TESTIMONY  OF  MARJORIE  MAZEL  HECHT 
MANAGING  EDITOR,  21  ST  CENTURY  SCIENCE  &  TECHNOLOGY 


Mr.  Chairman  and  Committee  Members} 

I  am  Marjorie  Mazel  Hecht,  representing  2l8t  Century 
Science  Associates,  publishers  of  the  naoazine  2l8t  Century 
Science  &  Technology  and  the  book  The  Holes  in  the  Ozone 
Scare}  The  Scientific  Evidence  That  the  Sky  Isn't  Falling. 

We  strongly  oppose  the  proposal  to  add  aethyl  bromide, 
HCFCs,  and  HBFCb  to  the  list  of  taxable  ozone-depleting 
chemicals  in  Code  section  4682.  The  actual  cost  to  the 
nation  of  such  a  tax  would  be  crippling,  when  measured  in 
food  losses  and  economic  losses,  and  it  will  NOT  protect  any 
lives.  Indeed  it  will  damage  lives,  here  in  the  United 
States  and  worldwide. 

The  proposal  of  such  a  tax  continues  the  unscientific 
flight-forward  pattern  that  has  become  U.S.  policy  regarding 
ozone  depletion.  This  is  a  policy  based  on  public  perception 
and  hypothetical  models,  not  scientific  evidence.  It  is  a 
policy  pushed  very  hard  by  environmental  organizations  and 
some  research  groups,  backed  by  millions  of  dollars  from 
foundations  and  corporations.  The  alleged  dangers  of  ozone 
depletion  have  been  repeated  so  often  by  these  groups  and 
the  media  that  they  have  come  to  be  accepted  as  truth, 
without  question. 

In  this  testimony,  I  would  like  to  raise  the  questions  that 
I  think  committee  members  should  address  before  continuing 
this  ozone  flight-forward.  My  perspective  in  this  is  to  looV: 
at  the  consequences  of  the  nation's  policy  on  ozone 
depletion  in  terms  of  human  lives — how  many  lives  will  be 
lost  as  a  result  of  this  policies.  I  am  not  a  scientist,  but 
a  science  writer  and  editor,  and  I  have  considered  the 
evidence  presented  by  many  experienced  scientists  worldwide 
whose  work  does  not  often  get  printed  in  the  popular  press 
or  even  the  scientific  press  because  it  it  not  "politically 
correct . " 

First,  what  is  the  worst  case  scenario  if  the  ozone 
depletion  theorists  are  correct?  They  say  we  will  have  a  10 
percent  ozone  depletion  within  the  next  50  years.  What  does 
that  translate  into  in  terms  of  the  alleged  increase  in 
ultraviolet  radiation  reaching  the  Earth?  It  means  an 
increase  equivalent  to  that  that  you  would  receive  if  you 
moved  100  miles  or  so  toward  the  Equator— in  other  words, 
from  Washington,  D.C.  to  Richmond,  Virginia.  When  we  put 
this  to  the  inventor  of  the  ozone  depletion  theory.  Prof.  F. 
Sherwood  Rowland,  he  acknowledged  that  this  was  not 
something  that  he  would  worry  about — aoving  100  or  so  miles 
south. 


1734 


Clearly  this  is  not  a  crisis  situation  for  most  people  but  a 
trivial  geographic  move.  Is  such  a  worst-case 
ozone-depletion  scenario  worth  the  disruption  of 
refrigeration  worldwide  and  trillions  of  dollars  of  costs 
incurred  by  the  ban  on  CFCs  and  now  the  ban  on  methyl 
bromide?  I  think  not. 

Second,  has  any  increase  in  ultraviolet  actually  been 
measured?  No,  there  is  no  trend  of  an  increase.  The  most 
definitive  study  by  U.S.  researchers  Scotto  and  Urban  over 
more  than  a  12-year  period  showed  no  significant  trend  of 
increase  in  UV-B,  while  some  stations  showed  decrease. 

Third,  is  there  significant  scientific  evidence  to  indicate 
that  ozone  depletion  is  a  natural,  seasonal,  and  cyclical 
phenomenon  that  seems  to  follow  the  sunspot  cycle?  Yes, 
there  is.  The  renowned  ozone  scientist  Gordon  Dobson 
discovered  low  ozone  levels  in  Antarctica  in  the  1950s.  As 
his  colleague  Marcel  Nicolet  recently  testified,  they  were 
so  startled  to  find  such  low  levels  of  osone  that  they  threw 
out  all  the  readings  below  250  dobson  units.  French 
researchers  also  found  such  low  ozone  levels  in  the  1950s, 
before  the  widespread  use  of  CFCs.  Today's  computer  models, 
based  not  on  observations  but  on  the  conjectures  of  Rowland 
and  Molina,  cannot  explain  why  there  would  be  a  so-called 
ozone  hole  in  the  1950s. 

Fourth,  what  about  natural  sources  of  chlorine?  They 
admittedly  dwarf  the  man-made  sources t  there  are  millions  of 
tons  of  natural  sources  (seawater,  volcanoes,  etc.)  but  only 
a  few  thousand  tons  of  man-made  sources.  But  do  natural 
sources  of  chlorine  reach  the  stratosphere?  Ozone  depletion 
theorists  assert  that  they  do  not.  The  evidence  indicates 
that  they  do.  For  example,  French  volcanologist  Haroun 
Tazieff  pointed  out  in  a  recent  interview  that  in  Antartica 
the  stratosphere  is  very  low  (5,000  meters)  and  the  active 
volcano  there,  Mt.  Erebus,  is  at  a  very  high  altitude  (4,000 
meters),  so  that  the  volcanic  emissions  indeed  reach  the 
stratosphere.  Based  on  studies  of  the  radioactive  fallout 
from  the  Chernobyl  accident,  ZbignieV  Jaworowski  showed 
definitively  that  chlorine  and  other  heavy  elements  do  reach 
the  stratosphere. 

There  are  many  more  basic  questions  that  could  be  asked 
about  ozone  depletion.  I  think  at  best  one  could  say  that 
the  science  here  is  uncertain.  I  would  put  it  more  boldly t  the 
science  is  faulty  and  in  some  cases  nonexistent.  Why  is  this 
nation  making  a  policy  decision  about  ozone  depletion  based 
on  uncertain  science  or  faulty  science  when  the  consequences 
are  so  drastic?  What  is  certain  is  that  lives  will  be 
lost  as  supplies  of  the  benign  and  cheap  refrigerants 
are  cut  off  and  people  here  and  in  the  rest  of  the  world 


1735 


will  not  be  able  to  afford  the  much  acre  expensive 
replacoBents . 

-  Methyl  Bromide  - 

Methyl  bromide  is  an  absolutely  essential,  ubiquitous,  and 
benign  fungicide  and  fumigant.  It  is  used  as  a  soil 
fumigant,  increasing  crop  yields  by  up  to  500%.  It  is  also 
used  in  the  storage  and  transportation  of  food,  including 
grains,  fruits,  nuts,  and  vegetables  to  dranatlcally 
decrease  losses  from  mold,  bacteria,  insects  and  other 
pests.  The  capacity  to  preserve  food  in  a  wholesome  form 
until  it  gets  to  market  is  the  hallmark  of  an  industrialized 
nation.  A  tax  on  methyl  bromide,  an  essential  component  of 
that  capacity,  will  turn  a  nation  from  food  self  sufficiency 
to  dependence  on  increasingly  scare  and  unaffordable  food 
imports . 

Banning  or  taxing  methyl  bromide  will  not  have  any 
appreciable  impact  on  the  amount  of  methyl  bromide  in  the 
atmosphere;  300,000  tons  a  year  are  produced  by  marine  life 
in  the  oceans.  Marine  microorganisms,  seaweed,  and  marine 
invertebrates  use  methylation  to  eliminate  hazardous 
substances.  In  the  process  of  methylation,  they  produce 
methyl  bromide — thousands  of  tons  of  it  yearly.  Many  swamp 
and  bog  organisms  do  the  same  thing,  as  do  some  land  plants. 
Sea  salt  sprays  throws  2,000,000  tons  a  year  of  bromide  into 
the  atmosphere;  volcanoes  throw  an  average  of  78,000  more 
tons  per  year.  The  net  result  is  that  man's  use  of  methyl 
bromide  pales  in  comparison  to  natural  source  of  bromide 
released  in  the  atmosphere.  Natural  sources  add  2,378,000 
tons  of  bromide  to  the  atmosphere  per  year,  while  halons, 
like  methyl  bromide,  add  only  12,040  tons  per  year. 

Banning  or  taxing  methyl  bromide  out  of  existence  will 
exacerbate  national  and  global  food  shortages.  This  food 
shortage,  which  will  be  hitting  Americans  in  the  form  of 
increased  food  prices  within  weeks,  was  generated  by 
disastrous  weather  here  and  internationally,  coupled  with 
collapsing  economic  conditions  for  farming.  The  process  of 
cartelization  of  U.S.  agriculture  is  driving  many  family 
farmers  off  the  land  and  replacing  them  with  huge 
agro-industry  farms  owned  by  the  leading  cartels  that  market 
grain  and  meat.  As  a  result,  much  of  the  trorld  is  dependent 
on  the  very  productive  Midwest  grain  belt.  The  summer  floods 
mean  that  not  only  are  most  of  this  year's  crops  lost,  but 
the  grain  stored  largely  in  that  same  area  from  last  year's 
crops— our  food  reserves — are  also  largely  lost. 

Many  other  countries  experienced  comparable  or  worse  weather 
catastrophes  that  add  up  to  a  global  food  shortage  on  a 
scale  not  seen  for  decades.  Other  agricultural  areas  in  the 
United  States  have  been  hit  with  weather  disasters- 


1736 


from  floods,  some  from  droughts — and  th«re  are  predictions 
of  early  frosts. 

ffhere  does  this  leave  the  issue  of  protecting  the  crops  that 
are  harvested  under  these  food-scarce  conditions?  The 
reality  is  that  in  spite  of  the  push  to  find  substitutes, 
good  economically  realistic  substitutes  for  methyl  bromide 
do  not  exist.  Phosphene  can  be  replace  sone  uses  of  methyl 
bromide,  but  this  is  far  more  toxic  coiq>ound.  Irradiation 
and  controlled  atmospheres  could  replace  smne  uses  of  methyl 
bromide,  but  the  infrastructural  capacity  does  not  exist  to 
use  these  on  a  wide  scale  to  reduce  food  spoilage — and  it  is 
not  likely  to  be  there  soon. 

Under  these  disastrous  conditions,  can  Congress  possibly 
afford  to  tax  or  ban  methyl  bromide,  and  thus  allow  a  good 
percentage  of  what  is  harvested  this  fall  to  be  wasted  by 
spoilage? 

-  The  Consequences  in  Terms  of  Hunan  Lives  - 

We  know  that  the  human  consequences  of  the  ban  on  CFCs  and 
the  ban  on  methyl  bromide  were  not  even  considered.  In  fact, 
21st  Century  asked  EPA  administrator  William  Reilly  at  a 
press  conference  Nov.  12,  1992,  whether  the  EPA  had 
evaluated  the  consequences  worldwide  of  a  phaseout  of  methyl 
bromide.  They  had  not!  In  other  words,  the  EPA  was  making  a 
decision  based  on  uncertain  science  and  they  had  not  even 
bothered  to  assess  the  damage  it  would  cause.  (An  hour 
earlier  on  Nov.  12,  several  environmental  groups,  including 
Friends  of  the  Earth,  the  Natural  Resources  Defense  Council, 
and  a  coalition  of  groups  opposing  methyl  bromide  held  a 
press  conference  demanding  that  methyl  bromide  be  banned. 
They  also  made  no  mention  of  the  consequences  of  such  a 
ban.) 

How  could  it  be  that  such  an  important  U.S.  policy  is  made 
without  regard  to  scientific  evidence  or  consequences  to 
human  life?  One  has  to  go  back  to  the  early  1970s  to  find 
the  answer  to  this  question.  In  1972,  under  heavy  pressure 
from  environmental  groups  that  were  waging  propaganda 
campaigns  against  DDT,  the  Environmental  Protection  Agency 
set  up  hearings  on  the  effects  of  DDT.  There  were  seven 
months  of  hearings  before  an  EPA  hearing  examiner.  Judge 
Edmund  Sweeney,  and  scientists  from  both  sides  of  the  issue 
testified.  Nine  thousand  pages  of  testimony  were  produced. 
The  hearing  examiner  ruled,  on  the  basis  of  the  scientific 
evidence,  that  DDT  should  not  be  banned.  He  said  "DDT  is  not 
a  carcinogenic,  mutagenic,  or  teratogenic  hazard  to  man 
[and]  does  not  have  a  deleterious  effect  on  freshwater  fish, 
estuarine  organisms,  wild  birds,  or  other  wildlife." 


1737 


Despite  this  official  decision,  the  EPA  administrator, 
attorney  William  Ruckelshaus,  unilaterally  banned  DDT,  as  of 
January  1973.  Ruckelshaus  never  attended  a  day  of  the 
hearings  and  admitted  that  he  never  read  the  testimony.  He 
also  admitted  that  his  decision  was  based  on  political 
reasons,  not  scientific  evidence.  As  a  result,  millions  of 
people,  particularly  people  of  color  in  Africa  and  Asia  have 
lost  their  lives.  And  to  this  day  one  still  hears  and  reads 
the  same  fallacious  allegations  about  the  harm  of  DDT  that 
vere  disproved  in  the  EPA's  seven-month  hearing  In  1972. 

I  have  recounted  this  DDT  history  because  I  think  DDT  was 
the  "mother"  of  many  environmental  hoaxes  over  the  past  20 
years  whose  consequences  kill  people.  In  this  sense,  the 
ozone  depletion  theory  is  another  "son  of  DDT,"  and  Its 
consequences  will  also  kill  people.  That  is  what  I  would 
like  this  committee  to  consider. 

Of  course,  there  are  many  well-meaning  people  who  do  not 
know  this  history  and  who  may  be  genuinely  concerned  about 
ozone  depletion.  But  I  think  that  the  committee  should  also 
be  aware  that  many  of  the  promoters  of  the  ozone-depletion 
theory  are  environmental  extremists  and  Malthuslans. 
Sherwood  Rowland,  for  instance,  signed  something  called  the 
Morelia  Declaration.  His  name  was  second  on  the  list  of 
signers  In  a  one-third  page  ad  that  appeared  twice  in  The 
New  York  Times.  The  last  paragraph  of  this  Morelia 
Declaration  ad  reads t  "If  the  latter  half  of  the  20th 
century  has  been  marked  by  human  liberation  movements,  the 
final  decade  of  the  second  millennium  will  be  characterized 
by  liberation  movements  among  species,  so  that  one  day  we 
can  attain  genuine  equality  among  all  living  things." 

Such  genuine  equality  of  species — where  human  lives  are 
treated  as  cheaply  as  blades  of  grass— is  what  we  are  moving 
toward  by  increasing  the  number  of  policies  based  on 
political  perception,  not  scientific  evidence.  This  is  not  a 
practice  worthy  of  this  nation — or  of  this  committee. 


1738 

Mr.  Jacobs.  I  think  we  better  suspend  this  for  a  moment.  I  have 
to  cast  a  vote. 
Mr.  Dinegar,  I  will  be  right  back. 
[Recess.] 
Mr.  Jacobs.  Mr.  Dinegar,  please  proceed. 

STATEMENT  OF  JAMES  C.  DINEGAR,  VICE  PRESIDENT,  GOV- 
ERNMENT  AND  INDUSTRY  AFFAIRS,  BUILDING  OWNERS  AND 
MANAGERS  ASSOCIATION  INTERNATIONAL 

Mr.  Dinegar.  Good  afternoon.  My  name  is  Jim  Dinegar.  I  am 
here  today  to  represent  the  interests  of  the  commercial  real  estate 
industry,  especially  as  they  relate  to  air  conditioning,  its  cost,  and 
its  impact  on  the  environment. 

Membership  of  the  Building  Owners  and  Managers  Association 
International  testifies  that  a  tax  on  replacement  refrigerants  would 
present  unanticipated  problems.  The  proposal  to  apply  an  excise 
tax  to  hydrochlorofluorocarbons,  HCFCs,  stands  to  generate  limited 
revenue  at  great  expense.  The  expense  comes  as  a  result  of  penaliz- 
ing refrigerant  purchasers  for  doing  the  right  thing  to  protect  the 
ozone. 

Presently  CFCs  are  taxed  as  part  of  a  program  to  discourage 
their  use.  Combined  with  the  Clean  Air  Act's  ban  on  production 
and  the  fines  and  penalties  in  place  at  EPA,  the  use  of  CFCs  has 
gone  down  dramatically.  In  many  instances,  the  only  suitable,  rea- 
sonable, and  responsible  alternative  to  CFC  use  is  the  replacement 
refrigerant  HCFC. 

Tax  on  this  replacement  would  do  nothing  to  limit  its  use  since 
it  is  often  the  only  alternative.  The  tax  on  HCFCs  would  do  noth- 
ing to  protect  the  ozone,  since  it  is  proposed  to  be  equal  to  the  tax 
presently  in  place  on  CFCs.  The  tax  on  HCFCs  would,  however, 
raise  a  few  dollars  from  individuals  who  are  already  struggling  to 
incur  the  costs  of  complying  with  the  Clean  Air  Act's  CFC 
provisions. 

Our  industry's  shift  away  from  CFCs  has  been  dramatic,  partly 
because  of  the  tax,  partly  because  of  the  Clean  Air  Act,  and  partly 
because  it  is  just  good  for  the  environment.  To  assess  a  penalty 
upon  those  individuals  looking  to  employ  more  ozone-friendly  alter- 
natives is  counterproductive  and  unfair. 

We  are  working  alongside  the  chiller  manufacturers  and  the 
chemical  companies  to  identify  and  utilize  safe  and  effective  alter- 
native refrigerants.  As  yet  there  are  no  approved  alternatives  ex- 
cept one,  HFCs.  It  is  only  possible  to  use  this  refrigerant  in  certain 
chillers,  and  we  are  seeing  its  use  increase  significantly. 

The  problem  remains,  however,  that  some  chillers  can  only  use 
CFCs  or  HCFCs.  This  is  by  far  the  vast  majority  of  existing 
chillers,  and  as  these  chillers  are  designed  to  last  upwards  of  30 
years  each,  the  proposed  tax  on  HCFCs  would  put  them  in  the  po- 
sition of  being  damned  if  they  do  and  damned  if  they  don't. 

BOMA  International  encourages  you  to  forego  the  short  term  fi- 
nancial gain  in  light  of  the  long  term  loss  to  the  environment. 

Thank  you. 

[The  prepared  statement  follows:] 


1739 


TESTIMONY  OF  THE 

BUILDING  OWNERS  AND  MANAGERS  ASSOCIATION  (BOMA)  INTERNATIONAL 

BEFORE  THE 

SUBCOMMTITEE  ON  SELECT  REVENUE  MEASURES 

HOUSE  COMMITTEE  ON  WAYS  AND  MEANS 


SEPTEMBER  23,  1993 


Thank  you  for  the  opportunity  to  appear  before  this  Subcommittee  to  express  the 
interests  of  the  Building  Owners  and  Managers  Association  (BOMA)  International 
members.    My  name  is  James  Dinegar,  and  I  am  BOMA's  Vice  President  of  Government 
and  Industry  Affairs. 

BOMA  International  is  a  dynamic  federation  of  98  local  associations  whose  members  own 
or  manage  over  5  billion  square  feet  of  commercial  properties  and  facilities  in  North 
America.   The  membership  —  composed  of  building  owners,  managers,  developers,  leasing 
professionals,  facility  managers,  asset  managers  and  the  providers  of  goods  and  services  - 
collectively  represents  all  facets  of  the  commercial  real  estate  industry. 

The  proposal  to  apply  an  excise  tax  to  hydrochlorofluorocarbons  (^CFCs)  stands  to 
generate  hmited  revenue  at  great  expense.   The  expense  comes  as  a  result  of  penalizing 
refrigerant  purchasers  for  doing  the  right  thing  to  protect  the  ozone. 

Presently,  CFCs  are  taxed  as  part  of  a  program  to  discourage  their  use.    Combined  with 
the  Clean  Air  Act's  ban  on  production  and  the  Ones  and  penalties  in  place  at  EPA,  the 
use  of  CFCs  has  gone  down  dramatically.    In  many  instances,  the  only  suitable, 
reasonable,  and  responsible  alternative  to  CFC  use  is  the  replacement  refrigerant,  HCFC. 
Tax  on  this  replacement  would  do  nothing  to  limit  the  use,  since  it  is  often  the  only 
alternative.    The  tax  on  HCFQ  would  do  nothing  to  protect  the  ozone,  since  it  is 
proposed  to  be  equal  to  the  tax   presently  in  place  on  CFCs.   The  tax  on  HCFCs  would, 
however,  raise  a  few  dollars  from   individuals  who  are  already  struggUng  to  incur  the  costs 
of  complying  with  the  Clean  Air  Act's  CFC  provisions. 

Our  industry's  shift  away  from  CFQ  has  been  dramatic  --  partly  because  of  the  tax,  partly 
because  of  the  Qean  Air  Act,  and  partly  because  it  is  just  good  for  the  environment    To 
assess  a  penalty  upon  those  individuals  looking  to  employ  more  ozone-friendly  alternatives, 
is  counterproductive  and  unfair.    We  are  working  alongside  the  chiller  manufacturers  and 
chemical  companies  to  identify  and  utilize  safe  and  effective  alternative  refrigerants.   As 
yet,  there  are  no  approved  alternatives  --  except  one:   HFCs.    It  is  only  possible  to  use 
this  refrigerant  in  certain  chillers,  and  we  are  seeing  its  use  increase  signifrcantly.   The 
problem  remains,  however,  that  some  chillers  can  only  use  CFCs  or  HCFCs   This  is  by  far 
the  vast  majority  of  existing  chillers.   As  these  chillers  are  designed  to  last  upwards  of 
thirty  years  each,  the  proposed  tax  on  HCFCs  puts  them  in  the  position  of  being  "damned 
if  they  do,  and  damned  if  they  don't." 

BOMA  International  encourages  you  to  forego  the  short-term  financial  gain,  because  of 
the  long-term  loss  to  the  environment 


Building  Owners  and  Managers  Association  International 

1201  New  York  Avenue,  NW,  Suite  300 

Washington,  DC   20005 

(202)  408-2684 


1740 

Mr.  Jacobs.  Thank  you,  sir. 

The  next  witness  I  beheve  is  Mr.  Sanner. 

STATEMENT  OF  HARVEY  JOE  SANNER,  EXECUTIVE  VICE 
PRESIDENT,  AMERICAN  AGRICULTURE  MOVEMENT,  INC. 

Mr.  Banner,  Thank  you,  Mr.  Chairman.  It  is  good  to  be  here 
today.  I  appreciate  this  opportunity  for  the  American  Agriculture 
Movement.  I  serve  as  executive  vice  president.  We  are  a  family 
farm  organization.  We  represent  family  farmers  and  rural 
businesses. 

We  are  here  today  in  opposition  to  the  proposed  tax  on  methyl 
bromide  because  quite  frankly  the  science  is  unclear  at  best,  and 
on  top  of  all  the  other  things  we  have  to  contend  with  trying  to 
make  a  living  in  farming,  now  we  have  to  devote  time  and  energy 
to  a  tax  proposed  by  what  we  think  are  a  bunch  of  narrow-minded 
bureaucrats  in  the  Environmental  Protection  Agency.  It  is  a  nec- 
essary fumigant  and  it  has  been  targeted  by  EPA,  as  I  mentioned, 
without  conclusive  scientific  evidence. 

In  fact,  it  is  quite  obvious — I  think  Chairman  Rangel  mentioned 
earlier  before  you  came  in,  perhaps — that  the  science  is  unclear, 
that  it  would  be  premature  to  propose  such  a  tax  and  even  label 
methyl  bromide  as  an  ozone  depleter.  Besides,  the  benefits  to  the 
Treasury  wouldn't  be  that  great,  but  it  would  probably  triple  the 
cost  to  our  farmers  who  are  using  it.  And  from  a  principle  stand- 
point, it  bothers  us  that  we  are  seeing  an  arrogance  from  EPA  in 
particular,  and  they  continue  to  ignore  the  evidence  and  the  testi- 
mony of  hundreds  who  oppose  their  proposal. 

Farmers,  small  business  people,  foreign  governments,  State  and 
Federal  agencies  overwhelmingly  have  shown  the  necessity  and 
benefits  methyl  bromide  provides.  Of  the  517  responses  to  its  pro- 
posed ban  that  EPA  received,  464  opposed  EPA.  Farmers  producing 
apples  and  gprapes  in  New  York,  tobacco  in  Virginia  and  Tennessee, 
com  in  Nebraska  and  Missouri,  fruits  and  nuts  in  Oregon,  and 
vegetables  in  California  and  Florida,  and  rice  in  Louisiana  need 
methyl  bromide. 

EPA  and  some  environmentalists  still  argue  that  it  is  not  impor- 
tant, that  alternatives  are  available  and  that  it  harms  the  ozone 
layer.  Quite  frankly,  we  think  they  are  wrong  on  all  three  assump- 
tions. They  have  suggested  that  it  is  unimportant,  and  even  one 
EPA  official  went  so  far  as  to  say  that  it  was  a  fumigant  used  pri- 
marily with  ornamental  shrubs,  turf,  and  luxury  foods. 

The  fact  is,  Mr.  Chairman,  it  is  used  on  over  100  crops  that  are 
grown,  stored,  transported  and  processed  in  the  United  States,  and 
unless  EPA  regards  wheat,  com,  tomatoes,  and  oranges  and  lettuce 
and  apples  as  luxury  foods,  we  don't  really  know  what  they  do  call 
luxury  foods. 

The  U.S.  Department  of  Agriculture  has  taken  a  strong  exception 
to  the  EPA  proposal,  and  we  are  quite  grateful  to  Secretary  Espy 
for  taking  this  common  sense  approach.  He  recognizes  it  as  being 
necessary  to  production  of  adequate  quantities  of  food.  It  is  essen- 
tial to  agricultural  trade. 

Federal  law  requires  that  most  imported  fruits,  grains,  timbers, 
flowers,  and  vegetables  first  be  fumigated  with  methyl  bromide  be- 


1741 

fore  being  allowed  into  the  United  States.  More  important  to  us  as 
American  farmers,  many  other  nations  have  the  same  policy. 

In  June  of  last  year,  the  director  of  the  plant  protection  division 
of  Japan's  Ministry  of  Agriculture,  Forestry  and  Fisheries  wrote 
the  Northwest  Cherry  Growers  Association  saying,  "If  methyl  bro- 
mide is  restricted,  we  will  not  be  able  to  import  U.S.  cherries,  wal- 
nuts, nectarines,  et  cetera.  In  addition,  since  we  will  not  have  any 
treatment  for  imported  staple  agricultural  products  such  as  wheat, 
com,  soybeans,  et  cetera,  from  the  U.S.,  when  insect  pests  are 
found  appearing  in  an  imported  inspection  in  Japan,  these  infested 
shipments  would  have  to  either  be  destroyed  or  re-exported  to  your 
country." 

So  it  is  easy  to  see  it  is  very  important,  and  we  have  attached 
to  our  formal  testimony  copies  of  the  446  letters  in  opposition  to 
EPA's  proposal.  I  guess  in  plain  language  and  with  a  lot  of  detail 
in  these  letters,  vou  won't  have  any  doubt  recognizing  the  impor- 
tance of  EPA  to  the  farm  community. 

Second,  EPA  and  some  environmentalists  believe  that  there  are 
alternatives  available.  Quite  frankly,  there  are  not.  There  are  no 
alternatives  available  at  this  time.  We  would  have  to  substitute  as 
many  as  seven  different  chemicals  on  the  farm  to  do  the  job  that 
EPA  does  with  no  residue  on  food  and  no  residue  on  soil,  and  we 
think  that  is  two  important  traits  that  we  shouldn't  sacrifice  in  this 
country.  So  it  is  very  important  that  we  keep  it,  and  maybe  at 
some  point  in  time  there  does  need  to  be  an  alternative  produced, 
but  it  is  not  available  now. 

There  was  a  3-day  workshop  that  USDA  conducted  last  year  with 
over  100  disting^shed  scientists  and  many  farmers  to  discuss 
methyl  bromide  and  its  alternatives,  and  the  official  report  hasn't 
been  distributed  yet  but  the  consensus  was  clear  at  that  workshop, 
that  it  is  very  important  that  it  should  be  kept  on  the  market,  and 
we  should  be  allowed  to  keep  using  methyl  bromide. 

That  yellow  light  makes  me  nervous.  I  know  the  red  one  is  fixing 
to  come  on  and  the  bell  is  going  to  follow  that. 

Mr.  Jacobs.  It  is  intended  to  make  you  nervous. 

Mr.  Douglas. 

Mr.  Sanner.  I  think  I  pretty  well  said  everything  that  needs  to 
be  said  before  it  did  ring,  people  this  morning  pretty  well  said  it, 
and  Chairman  Rangel  pretty  well  agreed. 

Mr.  Jacobs.  Now  you  are  taking  Mr.  Douglas'  time. 

Mr.  Sanner.  I  am  soriy. 

[The  prepared  statement  follows:] 


agriculture 

America  Needs  Parity! 


1742 


American  Agriculture  Movement,  Inc. 

1 00  Maryland  Ave.,  N.E.,  Suite  500A,  Box  69,  Washington,  D.C.  20002 
(202)  544-5750 


Remarks  Before  the  Select  Revenue  Measures  Subcosunlttee 

of  the  Ways  and  Means  Committee 

of  the  United  States  House  of  Representatives 

Harvey  Joe  Sanner 

Executive  Vice  President 

American  Agriculture  Movement 

Tuesday,  September  21,  1993 


Mr.  Chairman  and  Members  of  the  Subcommittee,  I  am  Harvey  Joe 
Sanner  and  I  live  on  and  operate  a  family  farm  in  Des  Arc, 
Arkansas.   I  produce  rice  and  soybeans  and  serve  as  the  Executive 
Vice  President  of  the  American  Agriculture  Movement,  Inc.   AAM, 
is  made  up  of  150,000  farm  families  in  34  states. 

Increased  farm  income  for  family  farmers  is  our  primary  reason 
for  existing  and  maintaining  an  office  in  Washington,  D.C. 
Basically,  fairness  is  all  we  have  ever  asked  for.   We  haven't 
had  it  in  the  recent  past  and  too  many  of  our  farmers  have  been 
forced  out  of  farming  as  a  result.   While  working  for  fairness  in 
the  farm  income  arena  we  find  ourselves  devoting  time  to  tax 
fairness  for  the  farm  comaunity. 

Our  research  proves  that  excise  taxes  fall  unfairly  on  rural 
citizens.   Because  the  items  taxed  have  to  be  used  more  heavily 
and  rural  incomes  are  on  average  lower,  so  excise  taxes  take  a 
larger  share  of  our  income. 

Now  we  have  to  devote  time  and  energy  to  a  tax  proposed  by  narrow 
minded  bureaucrats  in  the  Environmental  Protection  Agency.   A 
necessary  fumigant,  methyl  bromide,  has  been  targeted  by  EPA  for 
taxing  and  banning  without  scientific  evidence  to  support  their 
position. 

The  benefit  to  the  treasury  would  not  be  that  great,  yet  it  would 
almost  triple  the  cost  to  the  farmer. 

More  importantly  from  a  principle  standpoint  is  the  arrogance 
from  a  government  agency  that  causes  them  to  ignore  evidence  and 
the  testimony  of  hundreds  who  oppose  EPA's  proposal.   Farmers, 
small  business,  foreign  governments,  state  and  federal  agencies 
overwhelmingly  have  shown  the  necessity  and  benefits  methyl 
bromide  provides.   Of  the  517  responses  to  its  proposed  ban  that 
EPA  received,  464  opposed  EPA.   Farmers  producing  apples  and 
grapes  in  New  York,  tobacco  in  Virginia  and  Tennessee,  corn  in 
Nebraska  and  Missouri,  fruit  and  nuts  in  Oregon  and  vegetables  in 
California  and  Florida  to  rice  in  Louisiana,  need  methyl  bromide. 

EPA  and  some  environmentalists  still  argue  that  methyl  bromide  is 
not  important,  that  alternatives  are  available  and  that  there  is 
no  doubt  that  methyl  bromide  harms  the  ozone  layer.   Because  EPA 
is  wrong  on  all  three  assumptions,  we  urge  the  Subcommittee  to 
remove  methyl  bromide  from  the  prospective  tax  list,  at  least 
until  more  is  known. 

Let  us  examine  these  three  wrong  assumptions. 


Strength  From  The  Land 


1743 


First,  EPA  officials  have  suggested  that  methyl  bromide  is 
unimportant.   Specifically,  last  year  an  EPA  official  was  quoted 
as  saying  that  methyl  bromide  is  "a  fumigant  used  primarily  with 
ornamental  shrubs,  turf  and  luxury  foods." 

The  fact  is,  Mr.  Chairman,  nearly  100  U.S.  crops  are  grown, 
stored,  transported  and  processed  with  methyl  bromide.   Unless 
the  EPA  regards  wheat,  corn,  tomatoes,  oranges,  lettuce  and 
apples  as  "luxury  foods,"  we  do  not  know  where  the  Agency  got  its 
information. 

The  United  States  Department  of  Agriculture,  which  has  taken 
strong  exception  to  the  EPA  proposal,  recognizes  methyl  bromide 
as  essential  to  the  production  of  adequate  quantities  of  safe 
food. 

Methyl  bromide  is  essential  to  agricultural  trade.   Federal  law 
requires  that  most  imported  fruits,  grains,  timber,  flowers  and 
vegetables  first  be  fumigated  with  methyl  bromide  before  being 
allowed  in  the  U.S.   More  important  to  us,  as  American  farmers, 
many  other  nations  have  the  same  policy.   In  June  of  last  year, 
the  director  of  the  Plant  Protection  Division  of  Japan's  Ministry 
of  Agriculture,  Forestry  and  Fisheries,  wrote  the  Northwest 
Cherry  Growers  Association,  saying, 

"If  methyl  bromide  is  restricted,  we  would  not  be  able  to 
import  U.S.  cherries,  walnuts,  nectarines,  etc.   In 
addition,  since  we  will  not  have  any  treatment  for  imported 
staple  agricultural  products  such  as  wheat,  corn,  soybeans, 
etc.  from  the  U.S.  when  insect  pests  are  found  during  an 
important  inspection  in  Japan,  these  infested  shipments 
would  have  to  either  be  destroyed  or  re-exported  to  your 
country. " 

Is  methyl  bromide  important?  We  have  attached  to  our  formal 
comments  copies  of  the  464  letters  in  opposition  to  EPA's 
proposal.   In  plain  language  and  considerable  detail,  those 
letters  describe  the  importance  of  this  vital  fumigant. 

Second,  EPA  and  some  environmentalists  believe  that  there  are,  or 
will  be,  good  alternatives  available  to  farmers  if  methyl  bromide 
is  banned. 

Again,  Mr.  Chairman,  we  do  not  know  where  the  EPA  gets  its 
information.   Just  this  past  June,  the  United  States  Department 
of  Agriculture  conducted  a  three-day  workshop  attended  by  more 
than  100  distinguished  scientists  and  many  farmers.   There  was 
just  one  subject  discussed  —  alternatives  to  methyl  bromide. 

The  official  report  from  the  workshop  is  not  yet  distributed  but 
the  clear  consensus  from  that  meeting  was  as  follows: 

1.  There  are  no  alternatives  to  methyl  bromide  for  most 
uses.  Of  those  that  may  exist,  some  —  for  example, 
steam  and  organic  farming  —  are  totally  impractical 
except  in  very  limited  applications.  Others  —  for 
example  —  irradiation  —  are  unacceptable  politically. 

2.  Federal  and  some  state  authorities  are  removing  other 
chemicals  from  the  marketplace.   Of  the  very  few 
alternatives  sometimes  mentioned,  many  are  suspected  as 
cancer-causing.   Others  simply  aren't  approved  for  use 
with  food  crops. 

3.  It  is  almost  impossible  to  get  approvals  for  new 
agricultural  fumigants. 

Therefore,  not  only  do  we  not  have  alternatives  currently 
available  but  we  have  few  prospects  for  any.   What,  in  specific 
terms  does  this  mean? 


1744 


This  one  chemical  —  methyl  bromide  —  protects  plants  from 
insects,  viruses,  rodents,  nematodes,  fungi  and  weeds. 
Theoretically,  it  could  take  as  many  as  seven  chemicals  —  if 
they  were  available  —  to  have  the  same  effect.   Methyl  bromide 
leaves  no  residue  on  food  or  soil  and  this  is  a  feature  that  we 
should  not  sacrifice.   Increased  imports   and  exports  of  food 
with  possible  contamination  is  a  risk  we  don't  need. 

Finally,  the  EPA  and  some  environmentalists  say  there  is  no  doubt 
that  methyl  bromide  harms  the  ozone  layer. 

Mr.  Chairman,  I  am  not  a  scientist,  I'm  a  farmer  but  I  did  learn 
how  to  read.   Scientists  at  two  other  departments  of  the  federal 
government   the  USDA  and  the  Energy  Department,  each  told  the  EPA 
that  serious  doubts  exist  about  the  case  against  methyl  bromide. 

Let  me  list  just  two  of  those  doubts: 

1.  As  much  as  80  percent  of  methyl  bromide  comes  naturally  from 
the  oceans  and  will  continue  doing  so  whether  or  not  EPA 
bans  this  fumigant. 

2.  Scientists  are  not  sure  how  much  man-made  methyl  bromide 
even  reaches  the  stratosphere  or  whether  it  is  all  in  a  form 
that  harms  the  ozone  layer. 

The  EPA  says  that  methyl  bromide  has  an  ozone  depletion  potential 
number,  or  an  ODP,  of  0.7.   An  ODP  is  a  reflection  of  how  harmful 
a  chemical  is  to  the  ozone  layer.   Under  U.S.  law,  any  ODP  above 
0.2  must  be  banned  within  seven  years. 

If  scientists  are  unsure,  how  did  EPA  arrive  at  0.7?   They 
borrowed  the  number  from  the  United  Nations  Environment  Programme 
which  itself  admits  that  far  more  research  is  needed. 

That  research  is  now  under  way  on  a  cooperative  basis  by  the 
National  Air  and  Space  and  Administration,  the  National 
Oceanographic  and  Atmospheric  Administration  and  by  the  methyl 
bromide  manufacturers.   We  are  told  that  the  first  reports 
indicate  that  the  ODP  is  far  lower  than  0.7  and  could  well  be 
below  the  magic  number,  0.2. 

The  United  Nations  decided  to  wait  for  real  science  before 
deciding  what  to  do  about  methyl  bromide. 

We  would  ask  this  Subcommittee  and  the  Congress  to  do  the  same. 
Whether  or  not  EPA  proceeds  responsibly,  we  urge  the  Subcommittee 
to  proceed  with  caution  here. 

A  tax  on  methyl  bromide  will  do  far  more  than  harm  farmers.   It 
will  severely  limit  our  ability  to  feed  ourselves  and  the  rest  of 
the  world. 

Mr.  Chairman,  I  can't  tell  you  how  many  farmers  will  go  out  of 
business  because  of  the  taxes  in  the  reconciliation  bill.   I 
can't  tell  you  how  many  farmers  would  be  hurt  by  this  tax.   But, 
Mr.  Chairman,  I  know  the  number  will  be  significant. 


1745 

STATEMENT  OF  RICHARD  DOUGLAS,  SENIOR  VICE  PRESI- 
DENT, SUN-DIAMOND  GROWERS  OF  CALIFORNIA,  ON 
BEHALF  OF  THE  CROP  PROTECTION  COALTION 

Mr.  Douglas.  Thank  you,  Mr.  Chairman. 

I  am  Richard  Douglas.  I  am  senior  vice  president  of  Sun- 
Diamond  Growers,  an  agricultural  cooperative  comprised  of  Sun 
Maid  raisins.  Diamond  walnuts,  Sun  Sweet  prunes,  valley  figs,  and 
Oregon  hazelnuts.  I  am  here  today  to  testify  as  a  member  of  the 
executive  committee  of  the  Crop  Protection  Coalition  which  is  a  na- 
tionwide ^oup  of  agricultural  producers,  handlers,  and  agricultural 
organizations  who  have  joined  together  to  meaningfully  participate 
in  the  regulatory  review  of  crucial  crop  protection  tools  used  in  the 
growing,  harvesting,  handling,  storing,  and  transportation  of  agri- 
cultural commodities. 

Mr.  Chairman,  the  coalition  opposes  anv  proposed  tax  on  methyl 
bromide  for  a  number  of  reasons.  I  will  attempt  to  summarize 
these  quickly. 

First,  sucn  a  proposal  is  premature  in  the  fact  that  EPA  has  not 
yet  issued  a  final  regulation  under  the  Clean  Air  Act  that  con- 
cludes that  methyl  bromide  is  a  class  I  ozone-depleting  substance. 
The  agency  must  first  review  the  hundreds  of  comments  that  have 
been  filed  on  this  issue  before  making  a  final  decision  on  the  classi- 
fication of  the  chemical. 

Second,  the  tax  is  based  on  the  GDP  or  the  ozone  depletion 
potential  of  the  chemical.  Clearly  there  is  significant  scientific 
uncertainty  associated  even  with  the  EPA's  proposed  GDP  of  the 
chemical. 

Third,  the  EPA  has  recognized  that  there  is  currently  no  sub- 
stitute for  a  variety  of  agriculture  uses  for  methyl  bromide. 

Fourth,  the  EPA  proposed  regulation,  even  if  finally  adopted, 
would  phase  out  the  use  of  methyl  bromide  by  the  year  2000.  A  tax 
would  unreasonably  increase  the  economic  burden  on  small  farmers 
during  this  phaseout  period  and  would  not  serve  any  legitimate 
purpose.  A  tax  would  increase  the  cost  of  using  the  product  for 
which  no  current  alternative  exists,  and  would  put  U.S.  growers  at 
a  substantial  competitive  disadvantage  in  international  trade. 

It  is  important  that  the  committee  consider  the  entire  methyl 
bromide  issue  in  the  world  context,  particularly  how  it  is  being  ad- 
dressed by  the  parties  to  the  Montreal  Protocol.  The  issue  of  the 
GDP  of  methyl  bromide  recently  was  considered  at  the  fourth 
meeting  of  the  parties  to  the  Montreal  Protocol  in  Copenhagen, 
Denmark. 

Mr.  Chairman,  EPA's  proposal  goes  significantly  further  than  the 
world  community  has  determined  necessary  on  this  issue.  In  the 
future,  this  will  result  in  the  United  States  being  placed  at  a  sig- 
nificant competitive  disadvantage  with  its  world  competitors. 

For  example,  U.S.  exporters  may  be  precluded  from  certain  world 
markets  because  of  the  inability  to  address  quarantine  concerns  of 
the  country  of  import  while  our  trade  competitors  will  be  able  to 
address  these  concerns  due  to  continued  use  of  methyl  bromide. 

Additionally,  the  position  of  EPA  on  methyl  bromide  will  nega- 
tively affect  the  ability  of  many  foreign  producers  to  export  to  the 
United  States,  again  because  of  a  similar  inability  to  treat  agricul- 
tural commodities  to  address  quarantine  concerns.  This  would  also 


1746 

have  a  major  foreign  policy  implication,  one  that  concerns  Chair- 
man Rangel,  and  that  is  the  exportation  and  the  growing  of  illegal 
substances  in  developing  countries. 

At  a  time  when  we  are  encouraging  farmers  to  move  from  pro- 
ducing illegal  crops  to  crops  that  they  can  use  for  exports,  we  are 
going  to  not  be  able  to  import  those  products  into  the  United  States 
simply  because  they  cannot  meet  quarantine  requirements  of  the 
United  States. 

In  conclusion,  Mr.  Chairman,  the  coalition  believes  that  with 
methyl  bromide  the  EPA  is  faced  with  a  different  type  of  chemical 
than  it  has  been  used  to  in  dealing  with  under  the  Clean  Air  Act. 
The  overwhelming  contribution  of  methyl  bromide  to  the  atmos- 
phere appears  to  appear  through  natural  means. 

There  are  significant  scientific  uncertainties  associated  with  de- 
termining the  actual  ODP  of  methyl  bromide  which  remain  unre- 
solved. Tne  economic  costs  from  the  loss  of  this  chemical  would  be 
enormous. 

Just  to  give  you  one  personal  example,  Mr.  Chairman,  10  years 
ago  I  went  to  California;  we  could  not  export  in-shell  walnuts  into 
the  Japanese  market.  I  spent  the  first  3  years  in  California  nego- 
tiating, working  with  our  government  and  the  government  of  Japan 
to  develop  a  protocol  that  would  allow  California  walnut  producers 
to  export  walnuts  to  Japan.  The  Japanese  government  required 
that  California  walnuts  be  fumigated  with  metnyl  bromide. 

If  we  lose  methyl  bromide,  if  the  cost  becomes  prohibitive  for  our 
farmers  to  use,  we  cannot  export  walnuts,  cherries,  apples,  other 
agricultural  products  to  Japan.  This,  Mr.  Chairman,  will  certainly 
place  our  country  at  a  competitive  disadvantage  because  others  will 
use  methyl  bromide  and  fill  that  void. 

[The  prepared  statement  follows:] 


1747 


TESTIMONY  OF  RICHARD  DOUGLAS 

SENIOR  VICE  PRESIDENT,  SUN-DIAMOND  GROWERS 

CROP  PROTECTION  COALITION 


BEFORE  THE  SUBCOMMITTEE  ON  SELECT  REVENUE  MEASURES 
COMMITTEE  ON  WAYS  AND  MEANS 
U.  S.  HOUSE  OF  REPRESENTATIVES 


COMMENTS  OF  THE  CROP  PROTECTION  COALITION 

IN  RESPONSE  TO  THE  PROPOSAL  TO  ADD  METHYL 

BROMIDE  TO  THE  LIST  OF  TAXABLE  OZONE 

DEPLETING  CHEMICALS  IN  CODE  SECTION  4682 


STATEMENT  BY  THE  CROP  PROTECTION  COALITION 


The  Crop  Protection  Coalition  (the  "Coalition")  is  a  nationwide  group  of 
agricultural  producers,  handlers  and  agricultural  organizations  who  have  joined  together 
to  meaningfully  participate  in  the  regulatory  review  of  essential  crop  protection  tools 
used  in  the  growing,  harvesting,  handling,  storing  and  transportation  of  agricultural 
commodities.  The  Coalition  works  with  a  variety  of  interests  including  industry, 
government  and  environmental  organizations  to  assure  that  economically  and  technically 
feasible  crop  protection  tools  are  available  to  address  the  significant  needs  of  the  food 
sector.   Methyl  bromide  and  its  potential  alternatives  are  among  the  tools  of  interest  to 
the  Coalition. 

On  March  18,  1993,  the  U.S.  Environmental  Protection  Agency  ("EPA") 
published  a  notice  of  proposed  rulemaking  concerning  the  Clean  Air  Act.  Specifically, 
the  Agency  is  proposing  to  list  methyl  bromide  as  a  Class  I  substance  with  an  ozone 
depleting  potential  ("GDP")  of  0.7.   It  also  is  proposing  a  production  freeze  for  the 
chemical  at  1991  baseUne  levels,  commencing  January  1,  1994,  and  a  total  phaseout  of 
methyl  bromide  by  January  1,  2000.   Further,  the  Agency  is  also  proposing  that  when 
methyl  bromide  is  used  in  an  "agricultural  process"  i.e.  the  growing,  harvesting,  storing 
and  transporting  of  foods  such  as  fruits  and  vegetables,  such  foods  would  not  be  subject 
to  the  labeling  requirements  of  section  611  of  the  Clear  Air  Act.  58  Fed.  Reg.  15038. 
The  Coalition  has  filed  extensive  comments  on  the  proposal.  In  addition,  there  were 
several  hundred  other  comments  filed  with  the  Agency  concerning  the  proposed  rule. 
All  of  these  comments  are  before  the  Agency  for  its  evaluation  prior  to  taidng  any  final 
action  on  the  proposal. 

The  coalition  opposes  any  proposal  to  tax  methyl  bromide  for  a  number  of 


First,  such  a  proposal  is  premature  in  that  the  EPA  has  not  yet  issued  a 
final  regulation  under  the  Clean  Act  that  concludes  that  methyl  bromide  is  a  Qass  I 
ozone  depleting  substance.  The  Agency  must  review  the  hundreds  of  comments  that 
have  been  filed  on  this  issue.  Further,  relevant  scientific  information  continues  to 
develop,  almost  on  a  daily  basis,  concerning  the  ozone  depletion  potential  ("GDP")  of 
methyl  bromide.  The  Agency  must  review  all  the  relevant  information  and  must  assure 
that  all  relevant  data  have  been  developed  prior  to  making  a  final  decision  on  the 
classification  of  the  chemical. 

Second,  the  tax  is  based  on  the  GDP  of  the  chemical.  Qearly,  there  is 
significant  uncertainty  associated  with  even  the  EPA  proposed  GDP  of  the  chemical. 
Because  of  the  uncertainties,  the  GDP  may  range  from  well  below  02  to  well  above  0.2. 
Consequently,  in  view  of  the  substantial  margin  for  error  in  current  tentative  GDP  value 
for  methyl  bromide,  a  tax  based  on  the  GDP  level  is  imreasonable. 


1748 


Third,  the  EPA  has  recognized  in  the  proposal  noted  that  it  is  generally 
agreed  that  there  is  no  current  substitute  for  a  variety  of  agricultural  uses  of  methyl 
bromide.   Significant  efforts  are  underway  to  try  to  find  alternative  methods  of 
appUcation  and/or  an  equally  effective  substitute.  The  House  Committee  on 
Appropriations  report  for  fiscal  year  1994  recognizes  the  critical  importance  of  methyl 
bromide  in  agriculture.  It  states: 

"Methyl  bromide  -  For  research  on  a 
replacement  for  methyl  bromide,  the 
Conmiittee  has  provided  $8,549,000,  an  increase 
of  $1,000,000  above  the  budget  request.   Methyl 
bromide  is  used  extensively  by  the  agriculture 
industry.  It  is  perhaps  the  most  effective  and 
important  chemical  available  to  protect  a 
variety  of  crops  from  viruses,  fungi,  nematodes, 
and  weeds.  For  many  crops,  viable  alternatives 
are  just  not  available. 

"In  addition,  methyl  bromide  is  the  agent  of 
choice  for  the  USDA's  quarantine  program. 
Further,  many  coimtries  mandate  fumigation 
with  methyl  bromide  before  permitting  the 
importation  of  agricultural  commodities. 
Mexico  mandates  methyl  bromide  fumigation 
for  peaches,  plums,  and  nectarines;  and  Japan 
mandates  it  for  walnuts,  cherries,  and 
nectarines.   Many  other  countries  and  crops 
could  also  be  cited." 

According  to  the  USDA: 

"A  total  of  35  commodity  listings  from  128  coimtries  are  shown  to 
require  MB  fumigation  as  a  condition  of  entry.  Of  these,  17  have 
an  alternative  treatment  presently  approved  -  and  25  have  no 
alternative  treatment.  .  .  . 

"Without  effective  alternatives  to  methyl  bromide,  these  markets  for 
U.S.  exporu  would  be  lost .  .  .  Production  of  some  crops  may  shift 
to  other  countries." 

Fourth,  the  EPA's  proposed  regulation,  even  if  finally  adopted,  would 
phase  out  the  use  of  methyl  bromide  by  January  1,  2000.  A  tax  would  unreasonably 
increase  the  economic  burden  on  small  growers  during  this  phase  out  period  and  would 
not  serve  any  legitimate  purpose.  A  tax  would  inaease  the  cost  of  using  a  product  for 
which  no  current  alternative  exists  and  would  put  U.S.  growers  at  a  substantial 
competitive  disadvantage  in  international  trade. 

I.  BACKGROUND 

It  should  be  noted  that  there  are  two  uses  of  methyl  bromide  which  are 
very  significant  to  this  Nation's  food  industry  including  members  of  the  Coalition.  The 
first  involves  the  use  of  the  pesticide  as  a  pre-plant  soil  fumigant.  The  chemical  helps 
control  significant  pathogens,  pests  and  weeds  in  the  soil.  The  elimination  of  these  plant 
pests  and  diseases  assists  in  the  production  of  various  wholesome  foodstuffs.  This  use 
represents  the  largest  agricultural  use  of  methyl  bromide,  based  upon  the  quantity  of  the 
chemical  that  is  used.  If  methyl  bromide  or  a  similar  crop  protection  tool  is  not 
available,  it  will  be  extremely  difficult,  and  for  some  crops  almost  impossible,  to  produce 
or  market  various  commodities  in  an  economically  viable  manner. 


1749 


The  other  critical  use  of  methyl  bromide  is  as  a  post-harvest  fumigant. 
Frequently,  subsequent  to  harvest,  agricultural  commodities  require  treatment  with 
methyl  bromide  to  meet  federal,  state,  or  international  regulatory  requirements. 
Treatment  may  also  be  required  by  receiving  customers  to  assure  that  the  food  complies 
with  contract  specifications  for  insect  or  rodent  infestation.  Unlike  soil  fumigation  which 
involves  injection  of  the  chemical  into  the  soil,  post  harvest  use  of  the  chemical  involves 
exposure  of  the  food  in  a  fumigation  chamber.  Additionally,  extensive  research  efforts  in 
the  past  and  still  underway  are  attempting  to  identify  modifications  that  can  be  made  to 
fumigation  chambers  to  help  further  reduce  emissions.  This  includes,  for  example 
employing  re-cycUng  technologies  to  eliminate  the  release  of  the  chemical  into  the 
atmosphere.  From  the  Coalition's  perspective,  if  there  is  no  release  of  methyl  bromide 
into  the  atmosphere,  then  it  would  appear  that  a  tax  on  the  chemical  for  agricultural 
uses  would  not  be  warranted. 

II.  ALTERNATIVES  TO  METHYL  BROMIDE 

An  in-depth  review  is  underway  by  the  U.S.  Department  of  Agriculture, 
agricultural  producers  and  chemical  manufacturers  concerning  the  status  of  alternatives 
to  methyl  bromide.  The  Coalition  believes  that  for  both  the  soil  fumigation  and  post- 
harvest  uses  of  the  chemical,  feasible  alternatives  do  not  exist.   Research  efforts  are 
underway  in  the  private  sector  to  identify  possible  alternatives  for  the  soU  and  chamber 
fumigation  uses.   However,  because  we  are  dealing  both  with  a  biological  situation  and  a 
need  for  any  alternative  to  proceed  through  the  appropriate  regulatory  gauntlet  prior  to 
being  commercially  available,  we  are  concerned  that  alternatives  even  for  this  use  of  the 
chemical  will  not  be  available  for  many  years.  Further,  we  must  be  certain  that  any 
potential  alternative  has  acceptable  efficacy  and  does  not  present  an  unreasonable  risk  to 
man  or  the  environment.  The  Coalition  is  working  with  the  EPA,  U.S.  Department  of 
Agriculture  and  various  pesticide  manufacturers  to  help  address  this  problem. 

While  a  research  effort  is  underway  to  address  the  soil  fumigation  uses  of 
the  chemical,  there  are  similar  efforts  underway  to  identify  possible  alternatives  to  the 
post-harvest  uses  of  methyl  bromide.  Overall,  the  amount  of  chemical  sold  for  this  use  is 
very  minor  when  compared  to  the  soil  fumigation  use.   Consequently,  despite  the 
importance  of  the  chemical  to  the  food  industry,  there  is  little  likelihood  that  it  will 
attract  the  resources  necessary  from  the  private  sector  to  identify  possible  alternatives. 
The  Coalition  believes  very  strongly  that  the  U.S.  Department  of  Agriculture  has  an 
important  role  in  this  regard.  The  Department  has  the  expertise  and  resources  necessary 
to  most  effectively  attempt  to  develop  alternatives  for  the  post  harvest  uses  of  the 
chemical.  At  this  time,  it  cannot  be  assured  that  their  research  effort  will  be  successful. 
As  noted  previously,  it  remains  to  be  determined  whether  a  safe  and  effective  alternative 
treatment  to  methyl  bromide  for  post  harvest  uses  can  be  identified. 

In  that  regard,  the  USDA  recently  completed  a  conference  on  possible 
alternative  to  methyl  bromide.  A  report  of  that  conference  is  experted  to  be  issued 
shortly.   At  the  conference,  the  lack  of  viable  alternatives  for  many  critical  agriculnu^ 
uses  of  methyl  bromide  became  readily  apparent.  It  is  believed  that  the  USDA  report 
on  the  company  will  confirm  this. 

III.  SCIENTIFIC  UNCERTAI^mES  CONCERNING  METHYL  BROMIDE 

Regarding  methyl  bromide,  there  are  strong  concerns  that  significant 
scientific  questions  exist  which  may  impact  a  determination  of  the  ODP  of  the  chemical. 
Consequently,  the  Coalition  believes  that  it  is  premature  for  either  the  Agency  or  this 
Committee  to  make  a  final  decision  on  the  regulatory  classification  or  taxation  of  methyl 
bromide,  before  these  questions  are  addressed  by  actual  reliable  scientific  data.  These 
unanswered  scientific  questions  include,  for  example: 

1.         A  determination  of  the  mean  atmospheric  quantify  of  methyl 
bromide. 


1750 


2.  A  determination  of  how  methyl  bromide  is  removed  from  the 
atmosphere;  Le^  are  there  any  natural  processes  (sinks)  which 
remove  the  chemical  and  if  so,  at  what  rate  does  this  process  occur? 

3.  What  percentage  of  methyl  bromide  is  converted  to  hydrogen 
bromine,  a  substance  which  apparently  does  not  affect  the  ozone 
layer? 

4.  What  is  the  actual  lifetime  of  methyl  bromide  in  the  atmosphere? 

5.  The  contribution  of  methyl  bromide  to  the  atmosphere  from  natural 
versus  man-made  sources. 

6.  The  process  by  which  methyl  bromide,  which  is  heavier  than  air, 
actually  reaches  the  ozone  layer  from  fumigation. 

While  the  Coalition  does  not  have  sufficient  scientific  expertise  to  answer 
the  above  questions,  it  is  understood  that  research  is  currently  underway  to  develop  the 
scientific  data  to  address  these  issues.  This  effort  involves  the  manufacturers  of  the 
chemical  and  various  federal  agencies  such  as  the  National  Oceanic  and  Atmospheric 
AdminisUation  ("NOAA")  and  the  National  Aeronautics  and  Space  Administration 
("NASA").  The  data  are  expected  to  be  available  within  the  next  30  months.  Any 
imposition  of  a  methyl  bromide  tax  prior  to  evaluation  of  critical,  relevant  data  to 
determine  the  ODP  of  the  chemical  would  be  unfair  and  unreasonable. 

The  gaps  in  the  data  set  regarding  methyl  bromide  vis-a-vis  the  effect  on 
the  ozone  layer  have  been  well  documented.  For  example,  in  the  report  "Methyl 
Bromide  And  The  Ozone  Layer:   A  Summary  of  Current  Understanding,  June  22,  1992 
by  Daniel  L.  Albritton,  NOAA  and  Robert  T.  Watson,  NASA,  the  significant  number  of 
substantive  uncertainties  in  the  data  get  involving  methyl  bromide  are  highlighted.  For 
example,  the  authors  write: 

'There  are  major  imcertainties  in  the  budget  of  CHjBr, 
(methyl  bromide)  including:   (i)  the  absolute  calibrations  for 
CHjBr  measurements  and  the  quantification  of:   (ii)  natural 
sources;  (iii)  the  fraction  that  escapes  to  the  atmosphere 
when  used  as  a  fumigant,  especially  when  used  in  pre- 
planting  applications;  and  (iv)  possible  oceanic  and  terrestrial 
surface  removal  processes.  The  current  best  estimate  of 
25±_IQ%  for  the  anthropogenic  contribution  to  the  observed 
atmospheric  abundance  of  CHjBr  would  be  lower  if  there 
were  to  be  major  surface  removal  processes  or  if  the  fraction 
of  anthropogenic  production  that  is  released  to  the 
atmosphere  were  to  be  smaller  than  presently  eliminated.   Id. 
at  1-2. 

Similarly,  the  authors  note  that: 

A  major  remaining  uncertainty  in  the  calculation  of  bromine- 
related  ozone  loss  and  ODPs  is  associated  with  quantification 
of  the  rate  of  formation  of  HBr  in  the  stratosphere.   Further 
study  of  the  stratospheric  reactions  that  can  produce  HBr  and 
direct  measurements  of  bromine  reservoir  species  would 
better  constrain  the  model-calculated  partitioning  of  the 
brominated  species.  If  the  rate  of  HBr  formation  were  to  be 
greater  than  currently  estimated,  then  the  calculated  ODP 
and  BrO  (hence  ozone  loss)  would  be  lower.  Although  the 
upper  range  of  the  observed  BrO  would  appear  to  be  in 
conflict  with  a  significant  HBr  source,  the  lack  of  definitive 
data  for  HBr  and  the  large  scatter  in  observed  BrO  make  it 


1751 


difficult  to  rule  out  this  possibility.  In  addition,  the  value  of 
the  ODP  would  be  lower  if  there  were  to  be  significant 
removal  of  CHjBr  by  terrestrial  or  oceanic  surfaces. 
Alternatively,  if  recent  laboratory  measurements  indicating  a 
faster  rate  of  formation  of  HOBr  (via  BrO  +  HOj)  were  to 
be  correct,  then  the  ODP  would  be  larger.  Id.  at  3. 

In  order  to  develop  an  appropriate  data  base  for  methyl  bromide, 
Drs.  Albritton  and  Watson  propose  the  following  research  activities  in  their  report: 

4.1       Human  activities  and  methyl  bromide  abundances. 

Global  Abundances 

•  Recalibrate  and  intercompare  the  methods  employed 
in  current  CHjBr  measurement  programs  to 
understand  better  the  differences  among  the  data  sets. 

•  Synthesize  the  recalibrated  data  to  provide  an 
improved  global  picture  of  CHjBr  concentrations, 
including  spatial  gradients  and  temporal  trends. 

•  Undertake  additional  measurements  of  CHjBr  to 
define  better  the  interhemispheric  gradient  and  the 
magnitude  of  the  seasonal  cycle,  especially  in  the 
Southern  Hemisphere,  which  will  provide  insight  into 
the  relative  importance  of  natural  and  man-made 
sources. 

•  Measure  vertical  profiles  of  CHjBr,  in  conjunction 
with  CFC-U,  over  a  broad  range  of  latitudes  and 
seasons  to  provide  an  improved  determination  of  the 
abundance  of  CHjBr  in  the  stratosphere  and  its  ODP. 

•  Encourage  the  inclusion  of  measurements  of  CHjBr  in 
global  field  campaigns  and  at  existing  atmospheric 
monitoring  stations  (tjg^  Atmospheric  Lifetime 
Experiment/Global  Atmosphere  Gas  Experiment). 

Man-Made  Sources 

•  Continue  the  collection  of  data  on  the  production  and 
use  of  CHjBr,  including  geographical  distributions,  and 
seek  out  unreported  data  to  assure  an  improved  data 
set. 

•  Carry  out  field  and  modeling  studies  to  quantify  better 
the  emission  factors  for  the  major  applications  (e.g.. 
pre-planting  fumigation)  and  to  identify  the  major 
controlling  factors,  which  would  improve  the  estimates 
of  the  contributions  of  hiunan  activities  and  aid  the 
design  of  new  application  techniques. 

•  Investigate  other  possible  sources;  for  example,  those 
fi-om  the  transportation  sector,  inadvertent  industrial 
production,  and  biomass  burning,  to  assess  the 
completeness  of  the  emission  inventory. 


1752 


Natural  Sources  and  Sinks 

•  Conduct  measurements  of  both  CHjBr  and  CHjQ 
concentrations  in  surface  waters,  as  well  as  in  the  air 
immediately  above,  to  explore  how  the  CH3CI  data  set 
can  provide  insight  into  the  oceanic  source  or  sink  of 
CHjBr. 

•  Investigate  the  efficiency  of  different  marine  organisms 
(phytoplankton  and  algae)  to  produce  OrljBr  and 
CH3CI. 

•  Carry  out  field  measurements  with  gradient  and 
enclosure  methods  of  the  atmospheric  deposition  of 
CHjBr  and  CHsQ. 

•  Use  the  improving  data  set  in  budget  analyses  with  a 
hierarchy  of  tropospheric  models  to  improve  the 
understanding  of  human  contributions  to  the  global 
CHjBr  abundances. 

42       Impact  of  Bromine  on  the  Ozone  Layer 

Laboratory  studies 

•  Re-examine  (i)  the  rate  coefficients  and  product 
distribution  (with  an  emphasis  on  the  HBr  generation 
channels)  of  the  reactions  of  BrO  +  HOj,  BrO  +  OH, 
and  Br  +  HO2  (including  their  temperature 
dependence)  to  improve  the  understanding  of  bromine 
partitioning  in  the  stratosphere  and  (ii)  the  BRO  +  O3 
reaction  at  atmospheric  temperatures  to  obtain  a  more 
sensitive  upper  limit  on  the  impact  of  this  reaction  for 
ozone  loss.  Also  examine  the  possible  heterogeneous 
reactions  involving  bromine  species  on  PSC  surfaces 
and  sulfuric  acid  aerosols. 

Observations 

•  Simultaneously  measure  concentrations  of  BrO,  HO^, 
and  CIO  at  higher  stratospheric  altitudes,  at  least  up 
to  25  km,  to  extend  the  knowledge  of  the  ozone- 
depleting  and  related  compounds  to  altitudes  above 
those  of  the  current  data  set.  Further,  a  range  of 
seasonal  conditions  should  be  investigated,  including 
those  in  tropical  regions. 

•  Investigate  the  possibilities  for  measiuing  the 
stratospheric  concentrations  of  HBr,  HOBr,  BrONO^, 
which  are  not  currently  available,  but  which  are 
needed  to  test  the  understanding  of  these  sink  and 
reservoir  species. 

Model  AppHcatipn; 

•  Continue  to  develop  and  apply  a  hierarchy  of  models 
to  simulate  the  response  of  ozone  to  CHjBr,  using 
updated  input  (e.g..  reaction  rate  coefficients  and 
emission  rates),  and  interpret  the  new  field  data  fi'om 
recent  polar  ozone  field  campaigns. 


1753 


•         Model  intercomparisons,  particularly  in  connection 
with  bromide  species  and  their  contribution  to  ozone 
loss  at  different  altitudes,  latitudes,  and  seasons  are 
needed. 

In  view  of  the  current  state  of  the  science  on  the  ODP  of  methyl  bromide, 
it  is  not  reasonable  to  rely  on  such  a  soft  ODP  value  as  a  means  to  tax  the  chemical. 
Once  the  relevant  data  has  been  collected  and  analyzed,  an  appropriate  and  reliable 
ODP  for  methyl  bromide  can  be  developed.  Until  such  time,  any  discussion  of  a  tax  on 
methyl  bromide  on  its  ODP  is  unwarranted. 

IV.  METHYL  BROMIDE  UNDER  THE  MONTREAL  PROTOCOL 

It  is  important  that  the  Committee  consider  the  entire  methyl  bromide 
issue  in  the  world  context,  particularly  how  it  is  being  addressed  by  the  parties  to  the 
Montreal  Protocol.  The  issue  of  the  ODP  of  methyl  bromide  recendy  was  considered  at 
the  Fourth  Meeting  of  the  Parties  to  the  Montreal  Protocol  in  Coperihagen,  Denmark. 
While  the  Parties  did  propose  that  an  ODP  of  0.7  be  adopted  for  the  chemical,  no  action 
was  tsiken  to  eliminate  its  use.   Consequently,  the  EPA's  proposal  goes  significantly 
further  than  the  world  community  has  determined  necessary  on  this  issue.  This  will 
result  in  the  United  States  being  placed  at  a  significant  competitive  disadvantage  with  its 
world  competitors.  For  example,  U.S.  exporters  may  be  precluded  from  certain  world 
markets  because  of  an  inability  to  address  quarantine  concerns  of  the  country  of  import, 
while  our  trade  competitors  will  be  able  to  address  these  concerns  through  the  continued 
use  of  methyl  bromide.   Additionally,  the  position  of  the  EPA  on  methyl  bromide  will 
negatively  affect  the  ability  of  many  foreign  producers  to  export  to  the  United  States, 
again  because  of  a  similar  inability  to  treat  the  agricultural  commodity  to  address 
quarantine  concerns.  This  will  also  have  a  major  impact  on  the  U.S.  foreign  poUcy, 
particularly  as  efforts  are  made  to  induce  growers  to  switch  their  production  practices 
from  growing  and  exporting  illegal  controlled  substances  to  growing  legitimate  crops.   If 
those  farmers  attempting  to  make  the  transition  are  denied  access  to  the  U.S.  market 
because  of  the  inability  to  meet  quarantine  restrictions  which  may  well  result  with  the 
loss  of  methyl  bromide,  then  this  transition  program  will  fail.   Due  to  the  generally 
higher  returns  resulting  from  the  sales  of  foodstuffs  in  the  United  States,  these  foreign 
producers  must  have  access  to  the  U.S.  market  to  encourage  them  to  make  the  transition 
to  growing  legitimate  crops.  This  Committee  should  consider  this  prior  to  imposing 
considering  a  tax  burden. 

V.  CONCLUSION 

In  its  proposal  the  EPA  has  recognized  the  vital  importance  of  methyl 
bromide  to  the  food  industry,  and  the  lack  of  alternatives  to  the  chemical.  The  USDA 
has  provided  detailed  economic  data  on  the  critical  importance  of  the  chemical. 

In  conclusion,  the  Coalition  beUeves  that  with  methyl  bromide  the  EPA  is 
faced  with  a  different  type  of  chemical  than  it  has  been  used  to  dealing  with  under  the 
Clean  Air  Act.   The  overwhelming  contribution  of  methyl  bromide  to  the  atmosphere 
appears  to  occur  through  natural  means.  There  are  significant  scientific  uncertainties 
associated  with  determining  the  actual  ODP  of  methyl  bromide  which  remain  unresolved. 
The  societal  impacts  from  the  loss  of  the  chemical  are  enormous,  both  domestically  and 
internationally.  The  United  States  seems  to  be  well  far  afield  from  the  rest  of  the  world 
community  on  this  issue.  In  view  of  all  the  interests  involved  and  the  current  state  of  the 
science,  it  is  strongly  reconmiended  that  no  action  be  taken  at  this  time  by  the 
Subcommittee  to  consider  a  tax. 


\35556\01 0\80COREMR  OOl 


1754 

Mr.  Jacobs.  Thank  you,  Mr.  Douglas.  It  might  be  nice  if  we 
could  export  some  of  our  nuts.  So  that  is  the  best  argument. 

The  panel  has  made  a  very  concise  and  consequently  refreshing 
presentation.  I,  for  one,  understand  the  argument.  It  is  strong,  it 
is  persuasive.  We  thank  you  all  for  your  contribution. 

Ms.  Hecht,  I  wish  you  would  go  easy  on  Billy  Ruckelshaus.  By 
some  coincidence  he  is  the  one  who  taught  me  to  play  football  when 
we  were  in  grade  school  together. 

Ms.  Hecht.  Perhaps  he  is  better  at  football. 

Mr.  Jacobs.  Yeah,  I  mean  that  may  be  one  of  his  failings  now 
that  I  look  back. 

Thank  you  all  for  your  contribution  to  the  record. 

Mr.  Jacobs.  We  will  call  the  fifth  panel  now.  I  assume  everybody 
knows  who  he  or  she  is.  Mr.  Maheu,  Mr.  Hinely,  Mr.  Pennell,  and 
Mr.  Lockhart. 

I  don't  know  if  I  am  pronouncing  it  right,  Mr.  Maheu,  you  are 
first. 

STATEMENT  OF  RONALD  T.  MAHEU,  COCHAIRMAN,  TECH- 
NOLOGY, VENTURE  CAPITAL,  GRADUATION  STRATEGY, 
COOPERS  &  LYBRAND 

Mr.  Maheu.  Thank  you.  Would  you  like  me  to  proceed? 

Mr.  Jacobs.  For  5  uninterrupted  minutes. 

Mr.  Maheu.  Mr.  Chairman,  members  of  the  committee,  on  behalf 
of  Coopers  &  Lybrand,  I  appreciate  the  opportunity  to  provide  our 
views  on  this  matter. 

As  chairman  of  the  Technology  and  Venture  Capital  Programs, 
I  focus  on  matters  that  allow  our  high-technology  companies  to 
maintain  and  sustain  marketplace  advantages  and  eliminate  or 
avoid  factors  that  reduce  or  diminish  our  ability  to  compete  for  in- 
vestment moneys,  market  share,  or  technology  development  leader- 
ship. 

In  deference  to  your  time  requirements,  I  will  focus  my  remarks 
on  four  issues  on  your  agenda  and  the  impact  that  they  would  have 
on  U.S.  companies'  abilities  to  compete  in  new  technology.  All  are 
important.  You  should  not  infer  any  priority  fi-om  the  order  in 
which  they  are  presented  in  my  testimony. 

U.S.  tax  rules  are  particularly  important  for  high -technology  ven- 
tures because  successful  ventures  find  themselves  subject  to  a  full 
array  of  taxes  early  in  their  product  life  cycle.  They  frequently 
start  competing  globally  even  before  they  learn  to  spell  "inter- 
national." High-tech  companies  generally  must  compete  globally  to 
succeed.  U.S.  companies  are  already  operating  with  the  hindrance 
of  one  of  the  highest  costs  of  capital  in  the  industrial  world.  The 
four  tax  issues  I  will  discuss  all  impact  costs,  and  ultimately  the 
cost  of  our  capital. 

The  proposal  to  disallow  stock  options  from  the  R&D  tax  credit 
calculations  would  handicap  emerging  and  other  high-technology 
companies  that  reward  successful  R&D  based  on  successful  project 
development  performance.  For  many  of  these  companies,  capital  is 
their  most  critical  and  expensive  resource.  The  reduction  of  the 
R&D  credit  would  further  limit  the  capital  available  for  innovative 
research.  The  lack  of  permanence  of  the  U.S.  R&D  tax  credit  is  al- 
ready a  tax  and  funding  planning  problem  for  these  companies,  be- 


1755 

cause  R&D  requires  substantial  cash  over  a  period  of  time  longer 
than  Congress  has  traditionally  provided  when  extending  the 
credit. 

Removing  selected  wage  expenses  from  the  R&D  credit  calcula- 
tion by  denying  the  tax  determined  expense  of  certain  options  exac- 
erbates the  problem  and  discriminates  against  firms  that  have  lim- 
ited cash  to  fund  R&D. 

If  Congress  decides  to  enact  any  legislation  regarding  the  treat- 
ment of  options  under  the  R&D  credit  rules,  a  far  better  alter- 
native would  be  to  make  the  R&D  credit  permanent  and  clarify 
that  the  W-2  related  tax  expense  of  qualified  stock  options  should 
be  treated  as  wages  for  purposes  of  the  R&D  credit  calculation, 
thus  encouraging  more  performance-based  R&D  and  making  avail- 
able additional  financing  for  startups  and  other  high-technology 
companies. 

The  proposal  to  modify  the  export  source  rule  would  increase  the 
cost  to  U.S.  manufacturers  who  must  find  more  markets  for  export. 
So  long  as  the  United  States  continues  to  run  annual  trade  deficits, 
the  United  States  should  focus  on  finding  incentives  for  U.S.  com- 
panies to  export  more  and  increase  global  market  share  and  create 
U.S.  jobs  rather  than  establish  additional  impediments. 

The  proposal  to  eliminate  the  U.S.  foreign  tax  credit  would  hand- 
icap U.S.  companies  with  one  of  the  highest  tax  costs  of  any  com- 
petitor in  foreign  markets.  It  would  result  in  at  least  a  triple  tax 
on  income,  one  by  the  foreign  country,  one  by  the  United  States  at 
the  corporate  level,  and  the  third  level  at  the  United  States  on  the 
shareholder. 

Many  of  our  most  successful  U.S.  companies  must  compete  in  for- 
eign markets  to  succeed.  With  this  handicap,  they  would  have  a 
distinct  and  substantial  disadvantage,  thereby  encouraging  future 
investments  in  other  host  countries  with  more  favorable  tax  and  in- 
vestment environments. 

In  summary,  the  high-tech  industries  and  their  growth,  compa- 
nies are  important  economic  engines  for  the  United  States.  The 
competitiveness  of  our  tax  laws  is  an  important  factor  in  determin- 
ing their  success. 

Thank  you,  Mr.  Chairman. 

[The  prepared  statement  follows:] 


1756 


TESTIMONY  OF  RICHARD  T.  MAHEU 

COCHAIRMAN,  TECHNOLOGY,  VENTURE  CAPITAL  GRADUATION  STRATEGY 

PRACTICE,  COOPERS  &  LYBRAND 

Mr.  Chairman  and  Members  of  the  Committee,  on  behalf  of  Coopers  &  Lybrand,  I 
appreciate  the  opportunity  to  provide  our  views.  In  deference  to  your  time  requirements, 
I  will  focus  my  remarks  on  four  issues  that  impact  U.S.  companies'  ability  to  compete  in  new 
technologies.  All  are  important;  you  should  not  infer  any  priority  from  the  order  of  my 
testimony. 

U.S.  tax  rules  are  particularly  important  for  high-technology  ventures  because  successful 
ventures  find  themselves  subject  to  a  full  array  of  tax  rules  early  in  their  first  product  life 
cycle  -  they  frequently  start  competing  globally  even  before  they  learn  to  spell 
"international."  High-tech  companies  generally  must  compete  globally  to  thrive.  U.S. 
companies  are  already  operating  with  the  hinderance  of  one  of  the  highest  costs  of  capital 
in  the  industrial  world.  The  four  tax  issues  I  will  discuss  all  impact  costs  and  ultimately  the 
cost  of  capital. 

The  proposal  to  disallow  stock  options  from  R&D  tax  credit  calculations 
would  handicap  emerging  and  other  high-technology  companies  that  reward 
successful  R&D  based  on  performance.  For  many  of  these  companies,  capital 
is  their  most  critical  and  expensive  resource.  The  reduction  of  the  R&D 
credit  would  further  limit  the  capital  available  for  innovative  research.  The 
lack  of  permanence  of  the  U.S.  R&D  tax  credit  is  already  a  tax  planning 
problem  for  these  companies,  because  R&D  requires  substantial  cash  over  a 
longer  period  of  time  than  Congress  has  traditionally  provided  when  extending 
the  credit.  Removing  selected  wage  expenses  from  the  R&D  credit 
calculation  by  denying  the  tax  determined  expense  of  certain  options 
exacerbates  the  problem  and  discriminates  against  firms  that  have  limited  cash 
to  pay  for  R&D. 

If  Congress  decides  to  enact  any  legislation  regarding  the  treatment  of  options 
under  the  R&D  credit  rules,  a  far  better  alternative  would  be  to  make  the 
R&D  credit  permanent  and  clarify  that  the  W-2  related  tax  expense  of 
qualified  stock  options  should  be  treated  as  wages  for  purposes  of  the  R&D 
credit;  thus  encouraging  more  performance-based  R&D  and  making  available 
additional  financing  for  startups  and  other  high-technology  companies. 

The  proposal  to  modify  the  export  source  rule  would  increase  the  cost  to  U.S. 
manufacturers  who  must  find  more  markets  for  export.  So  long  as  the  U.S. 
continues  to  run  annual  trade  deficits,  the  U.S.  should  focus  on  finding 
incentives  for  U.S.  companies  to  export  more  and  create  U.S.  jobs  rather  than 
impediments. 

The  proposal  to  eliminate  the  U.S.  foreign  tax  credit  would  handicap  U.S. 
companies  with  one  of  the  highest  tax  costs  of  any  competitor  in  foreign 
markets.  It  would  result  in  at  least  a  triple  tax  on  the  income  (one  by  the 
foreign  country,  one  by  the  U.S.  at  the  corporate  level  and  one  by  the  U.S.  at 
the  shareholder  level).  Many  of  our  most  successful  U.S.  companies  must 
compete  in  foreign  markets  to  succeed  and,  with  this  handicap,  they  would 
have  a  distinct  and  substantial  disadvantage. 

In  summary,  the  high-tech  industries  and  their  growth  companies  are  important  economic 
engines  for  the  U.S.  The  competitiveness  of  our  tax  laws  will  be  an  important  factor  in 
determining  their  success. 

I.         PROPOSAL  TO  EXCLUDE  CERTAIN  OPTIGNS  FROM  THE  R&D  CREDIT  - 
NONQUAUFIED  OPTIONS 


The  proposal  to  exclude  stock  options  from  the  R&D  tax  credit  calculation  except  to  the 
extent  that  the  employee  recognizes  income  at  the  time  the  option  is  granted  (a  rare 
situation)  would  discriminate  against  new  startups  and  other  high-technology  companies  and 
would  hamper  our  ability  to  compete  on  a  global  level. 


1757 


Generally,  the  R&D  tax  credit  rewards  businesses  for  increasing  certain  technological 
research  over  research  in  prior  years.  In  order  to  qualify,  the  process  of  experimentation 
utilized  in  the  research  must  be  one  involving  the  evaluation  of  more  than  one  alternative 
designed  to  achieve  a  result,  where  the  means  of  achieving  that  result  is  uncertain  at  the 
outset;  i£„  high  risk.  As  a  ?,eneral  rule,  the  single  most  significant  expense  of  R&D  is  the 
wages  associated  with  undertaking  the  R&D. 

Under  current  law,  it  is  clear  that  the  amount  paid  for  research  under  so-called 
"nonqualified  employee  stock  option  plans"  is  treated  no  different  from  other  wages  (W-2) 
for  purposes  of  the  R&D  credit.'  Under  the  nonqualified  stock  option  rules,  if  the  options 
provided  to  an  employee  for  research  have  a  readily  ascertainable  fair  market  value  when 
issued,  that  value  is  taxable  to  the  employee  and  deductible  to  the  corporation  when  the 
option  is  issued.  In  the  case  of  high-technology  ventures,  when  options  are  issued,  they 
generally  do  not  have  a  readily  ascertainable  fair  market  value  under  the  appropriate  tax 
regulations,  in  which  case  the  employee  does  not  recognize  income  until  the  option  is 
exercised.  The  income  recognized  when  the  option  is  exercised  is  the  difference  between 
the  fair  market  value  of  the  stock  acquired  and  any  amount  paid  by  the  employee  for  the 
stock.  The  corporation  takes  a  corresponding  deduction  for  the  compensation  at  the  same 
time. 

Treating  the  option  related  tax  expense  more  harshly  than  other  W-2  wage  income  would 
discriminate  against  high-technology  companies  -  stock  options  are  an  important  element 
of  their  employee  recruitment  and  retention  packages.  New  ventures  are  often  unable  to 
compete  with  the  cash  offered  by  other  employers  in  their  industries.  Instead  they  offer 
employees  a  share  in  future  appreciation  resulting  from  successful  R&D  projects.  If  denied 
the  R&D  credit  for  option  compensation,  the  technology  ventures  will  be  less  competitive 
relative  to  foreign  entities. 

New  high-tech  ventures  currently  have  difficulty  planning  R&D,  because  the  research 
generally  takes  longer  than  the  traditional  periods  of  temporary  extension  that  Congress  has 
provided  the  R&D  tax  credit.^  If  Congress  were  to  reach  back  now  and  deny  R&D  credits 
for  the  W-2  wage  expense  that  relates  to  options,  the  value  of  Congress's  commitment  to 
an  effective  R&D  credit  will  be  diminished  even  further. 

Denying  the  R&D  credit  for  the  W-2  tax  expense  related  to  options  would  complicate 
companies'  tax  filings,  as  well  as  increase  the  tax  burden  associated  with  past,  current  and 
future  ventures.  Such  a  policy  change  would  also  appear  to  be  inconsistent  with  the 
preference  that  Congress  demonstrated  in  OBRA  '93  for  performance-based  corporate 
compensation  arrangements. 


CLARIFICATION  FOR  QUAUHED  STOCK  OPTIONS 


Even  though  the  IRS  acquiesced  to  the  inclusion  of  nonqualified  options  in  the  R&D  "wage" 
calculation,  our  experience  is  that  IRS  agents  frequently  attempt  to  disallow  from  the  R&D 
credit  calculation  the  W-2  tax  expense  of  "qualified  stock  options,"  a  term  which  I  am  using 
to  include  incentive  stock  options  (ISO)  under  section  422  and  discounted  stock  options 
under  section  423  (section  423  plans). 

For  qualified  stock  options,  no  income  is  generated  to  the  recipient  upon  the  grant  of  an 
option.  Upon  exercise  of  the  option,  no  taxable  income  will  result  if  certain  requirements 
are  met,  such  as  the  requirement  that  the  taxpayer  must  hold  the  stock  for  at  least  two  years 
from  the  date  of  option  grant  and  one  year  from  the  date  of  stock  transfer.  However,  if  the 
stock  is  disposed  of  prematurely,  the  tax  rules  are  similar  to  those  for  nonqualified  options. 


Apple  Computer.  Inc.  v.  Commissioner.  98  T.C.  232  (1992)  to  which  the  IRS  has 
OBRA  '93  extended  the  R&D  credit  through  June  30,  1995. 


77-130  0-94-24 


1758 


The  amount  of  the  employee's  income  (and  the  deduction  for  the  company)  is  the  difference 
between  the  value  of  the  shares  at  the  time  of  exercise  and  the  amount  paid  for  the  shares. 

The  determining  factor  for  whether  compensation  from  a  qualified  option  is  considered  for 
purposes  of  calculating  the  R&D  research  credit  should  be  whether  the  taxable  amount 
resulting  from  disqualifying  dispositions  is  "wages"  under  IRC  Sec.  3401(a)  upon  exercise. 
The  definitions  of  income  under  IRC  Sec.  61  and  of  "wages"  under  IRC  Sec.  3401(a)  are  not 
identical,  and  that  can  leave  room  for  some  ambiguity. 

The  plain  language  of  section  3401(a)  supports  the  proposition  that  such  amounts  are 
included  within  the  definition  of  wages.  It  defines  wages  as  "all  remuneration  ...  for  services 
performed  by  an  employee  for  his  employer,  including  the  cash  value  of  all  remuneration 
(including  benefits)  paid  in  any  medium  other  than  cash...."'  That  the  IRS  does  not  require 
withholding  on  such  amounts  should  not  be  determinative  of  their  character.  Rev.  Rul.  71- 
52  does  not  require  withholding,  presumably  as  a  matter  of  administrative  discretion.  The 
1983  amendments  to  the  FICA  and  FUTA  tax  statutes  suggest  that  the  IRS  revisit  this 
procedure  at  least  as  to  the  applicability  of  withholding  to  FICA  and  FUTA  taxes,  but  to 
date  it  has  not  done  so. 

Clarifying  that  the  W-2  tax  expense  of  qualified  stock  options  is  treated  as  wages  for 
purposes  of  the  R&D  credit  would  serve  two  significant  tax  policy  objectives  of  the  Ways 
&  Means  Committee.  It  would  simplify  the  tax  code  by  removing  a  potential  controversy 
between  the  IRS  and  taxpayers,  and  it  would  clarify  Congress's  continued  support  for  high- 
technology  ventures. 


EXPORT  SOURCE  RULE 


The  proposal  to  modify  the  export  source  rule  when  U.S.  produced  inventory  is  sold  abroad 
would  increase  the  cost  for  U.S.  companies  that  must  find  more  foreign  markets  for  U.S. 
products.  As  long  as  the  U.S.  continues  to  run  annual  trade  deficits,  we  should  be  looking 
for  incentives  to  increase  exports,  not  for  tax  changes  that  increase  the  cost  of  U.S.  exports. 

Under  current  Treasury  regulations,  when  U.S.-manufactured  property  is  sold  abroad,  the 
amount  of  income  fi-om  the  sale  that  is  treated  as  foreign  source  for  purposes  of  calculating 
the  amount  of  foreign  tax  that  is  creditable  against  the  seller's  U.S.  tax  is  generally 
determined  as  follows: 

50%  of  the  income  from  the  sale  is  apportioned  between  the  U.S.  and  foreign 
sources  based  on  location  of  the  U.S.  company's  production  assets. 

50%  of  the  income  is  sourced  based  on  the  place  of  sale  (which  is  generally  where 
the  title  to  the  property  passes). 

The  proposal  described  in  the  Joint  Committee  on  Taxation  print  would  modify  this 
computation  by  sourcing  more  income  to  the  U.S.  when  property  is  exported,  thus  increasing 
the  relative  cost  of  exports.  The  proposed  changes  would  penalize  those  companies  that 
manufacture  in  the  U.S.  and  have  a  large  investment  in  foreign  marketing  operations.  It  is 
quite  discouraging  that  the  change  would  encourage  companies  that  want  to  pay  no  more 
than  the  U.S.  tax  rate  on  their  worldwide  income  to  move  production  facilities  out  of  the 
U.S. 


The  regulations  also  support  this  proposition  as  they  provide  that  all  remuneration  for  services  is 
included  in  the  definition  of  wages  unless  specifically  exempted  by  statute,  even  if  the 
employer/employee  relationship  no  longer  exists,  Sec.  313401(a)-l(a)(5);  and  that  remuneration  may 
be  paid  in  stock.  Sec  313401(a)-l(a)(4).  The  regulations  further  provide  that  it  is  immaterial  that 
payment  is  made  in  a  form  other  than  cash.   Sec.  31J402(a)-l(c). 


1759 


If  Congress  decides  to  review  the  cost  effectiveness  of  the  sourcing  rules  as  an  export 
incentive,  it  should  be  undertaken  only  as  part  of  an  overall  review  of  how  the  U.S.  taxes 
multinational  income  and  the  impact  any  tax  changes  would  have  on  U.S.  competitiveness 
and  our  long-term  trade  balance. 


IV.       FOREIGN  TAX  CREDIT 


I  am  incredulous  that  this  issue  is  seriously  being  considered,  but  since  it  is  on  the  list  to  be 
commented  on,  I  feel  compelled  to  join  the  ranks  of  severe  critics  on  behalf  of  the  high-tech 
industries. 

The  proposal  to  repeal  the  foreign  tax  credit  and  merely  provide  a  deduaion  against  U.S. 
taxes  for  foreign  taxes  paid  would  assure  that  U.S.  companies  could  only  compete  abroad 
under  the  worst  confiscatory  tax  rules  in  the  industrialized  world.  Generally,  income  taxed 
abroad  would  be  taxed  at  least  once  under  the  foreign  country's  tax  rules,  and  then  whatever 
is  left  would  be  taxed  again  under  the  U.S.  tax  system  ~  once  at  the  corporate  level  and 
again  at  the  shareholder  level.  Quite  simply,  U.S.  companies  would  be  unable  to  do 
business  in  most  parts  of  the  world,  because  the  corporate  level  tax  burden  alone  would  be 
increased  to  a  50-60  percent  rate  in  most  instances  (70-80  percent  in  some  cases).  They 
could  not  gain  sufficient  market  share  under  that  type  of  a  tax  structure  and  thus  could  not 
compete. 

If  the  proponents  of  the  foreign  tax  credit  repeal  believe  that  it  would  encourage  more  U.S. 
companies  to  stop  doing  business  abroad,  that  is  correct.  But  the  result  will  also  be  less 
business  and  employment  in  the  U.S.  For  example,  in  the  computer  field,  any  significant 
large  scale  integrated  circuit  must  be  marketed  worldwide  in  order  to  achieve  sufficient 
market  share  to  recoup  the  significant  investment  in  capital  and  R&D.  Only  foreign 
companies  would  be  left  with  the  ability  to  compete  globally,  i.e.,  companies  that  develop 
technology  abroad,  manufacture  abroad,  and  market  their  products  worldwide  from  a 
foriegn  base. 

I  cannot  recall  any  similar  tax  constraint  placed  on  business.  If  the  international  financial 
markets  interpreted  a  hearing  on  this  subject  as  even  a  potentially  serious  threat,  which  they 
do  not,  you  would  not  have  to  wait  until  date  of  enactment  to  see  the  impact.  The  flight 
of  capital  out  of  the  U.S.  would  be  substantial  and  therefore  raise  our  cost  of  capital  even 
higher. 

Like  many  of  the  other  revenue-raising  proposals  under  consideration  in  this  hearing,  we 
believe  that  a  review  of  the  foreign  tax  credit  rules  should  only  be  undertaken  in  the  context 
of  a  more  serious  review  by  Congress  on  the  broader  issues  of  tax  simplification  and  an 
effort  to  fashion  tax  rules  that  make  U.S.  companies  more  competitive  in  a  global  market. 


1760 

Mr.  Jacobs.  Mr.  Hinely. 

STATEMENT  OF  J.  VERNON  HINELY,  CHAIRMAN  AND  CHIEF 
EXECUTIVE  OFFICER,  CARBONIC  INDUSTRIES  CORP^ 
ORLANDO,  FLA. 

Mr.  Hinely.  Thank  you,  Mr.  Chairman. 

I  am  J.  Vernon  Hinely,  president  and  CEO  and  founder  of  this 
company.  We  are  in  the  carbon  dioxide  business  and  have  been  for 
30  years.  I  want  to  express  my  appreciation  for  this  opportunity 
and  privilege  to  present  our  views  at  this  time,  which  I  have  come 
here  with  a  great  sense  of,  in  fact,  desperation,  if  you  will,  because 
I  feel  a  problem  that  we  have  facing  our  industry  is  very  devastat- 
ing. And  I  know  it  is  unintentional  bv  the  Congress  to  pass  this 
tax  bill  giving  a  subsidy  of  course  and  it  didn't  know  the  full  im- 
pact it  would  nave  on  another  industry  completely. 

This  situation  has  deteriorated  decisively  in  the  last  three  or  four 
years.  In  fact,  my  good  friend  here  from  Carbonaire  in  New  York, 
he  was  forced  out  of  business  to  sell  his  company  three  years  ago 
because  he  could  not  compete  against  this  unfair  subsidy. 

My  company  makes  carbon  dioxide,  manufactures  and  distributes 
it.  We  sell  CO2,  that  is  the  carbonation,  the  freezing  and  chilling, 
water  treatment,  et  cetera,  et  cetera.  Our  source — the  crux  of  my 

Eroblem  is  we  do  not  make,  develop  the  raw  gas;  it  comes  from  a 
yproduct.  We  are  downstream,  if  you  will,  or  the  tail  on  the  dog 
of  anhydrous  ammonia  or  fermentation,  ethanol,  methanol,  et 
cetera,  so  on.  OK  We  do  not  control  that  primary  source,  and  we 
put  a  lot  of  money  in  the  plants. 

The  last  plant  I  built  in  Terre  Haute,  an  ammonia  plant  in  1985, 
it  ran  11  months,  spent  $2.5  million.  It  is  still  there  sitting  on  my 
books  at  $1  million  dollars.  I  don't  control  that. 

What  has  happened  here  in  the  last  4  or  5  years,  the  Congress 
has  given  the  producers,  ethanol  producers  a  subsidy.  You  know 
what  it  is,  54  cents  a  gallon.  I  am  not  here  to  quarrel  about  that 
subsidy.  If  the  Government  is  giving  the  farmers  help,  that  is  fine, 
that  is  one  thing,  but  double-dipping  is  another  thing.  The  ethanol 
producers  now  nave  control  of  the  primary  source,  the  ethanol 
plant.  From  the  ethanol  plant  they  are  getting  free  carbon  dioxide. 
I  don't  have  that  luxury.  My  industry  doesn't  have  it,  or  my  com- 
pany. We  are  being  jeopardized.  In  fact,  like  I  say,  it  is  wreaking 
havoc. 

I  cannot  compete  with  these  kind  of  things  when  they  are  getting 
a  free  product.  Like  I  say,  this  has  been  harmful,  and  tne  President 
spoke  last  night  about  the  American  dream.  I  guess  I  had  a  dream 
46  years  ago  when  I  got  out  of  the  service  and  went  into  business 
and  went  to  Orlando.  My  operation  is  from  Miami  to  Landover.  I 
have  five  dry  ice  plants,  but  I  cannot  continue.  I  am  going  to  find 
myself  in  the  same  predicament  of  Mr,  Julius  Rubin  back  here  in 
Carbonaire  who  was  forced  to  sell. 

All  we  are  seeking  is  some  kind  of  a  fairness,  a  sense  of  fairness 
and  justice  in  the  form  of  a  tax.  We  are  asking  that  the  ethanol 
makers  who  are  getting  the  subsidy  to  make  one  product  can't  dou- 
ble dip  and  then  take  a  free  product  and  go  out  to  the  marketplace 
and  cut  my  prices  $30  and  $40  a  ton.  That  is  what  is  going  on.  We 
are  asking  for  a  minimum  of  $15  surcharge  tax  on  the  ethanol 


1761 

makers  that  produce  carbon  dioxide  and  are  selling  it.  Like  I  say, 
they  are  getting  the  tax  money  one  way  already,  tney  are  getting 
a  break.  It  is  totally  unfair. 

We  just  think  that  some  remedy — it  is  easy  to  remedy  it.  The 
Treasury  Department  said.  Well,  how  can  thev  keep  up  with  some- 
thing like  this.  My  goodness,  at  the  end  of  the  year,  how  do  they 
keep  up  with  tax  returns?  I  report  so  much  revenue  and  income. 
A  producer  of  ethanol  could  say,  "Well,  we  produced  and  sold 
160,000  tons  of  CO2,  OK,  $15  times  that  is  the  tax." 

We  are  not  coming  here  asking  for  a  handout.  I  haven't  asked 
any  quarters  in  46  years  in  business.  The  only  thing  I  got  from 
Uncle  Sam  when  I  was  discharged  in  1946  was  the  "52-20"  and  if 
you  go  into  business,  you  get  equal  to  that  instead  of  being  an  em- 
ployee. That  is  all  I  have  gotten.  I  have  paid  my  taxes.  I  have  got 
200  employees.  I  have  got  my  insurance. 

All  this  fiiss  about  health  insurance,  it  costs  me  a  million  and  a 
half  dollars  a  vear.  My  employees  have  major  medical,  have  been 
covered  for  at  least  25,  30  years.  But  I  wish  in  the  sense  of  fairness 
that  somebody — and  I  talked  to  Mr.  Gibbons — we  are  trying  to  get 
to  anybody  we  can.  We  are  not  asking  for  any  quarters,  we  are  not 
asking  for  any  tax  credit,  we  are  just  seeking  fairness,  is  all,  so  I 
can  continue  to  exist  in  business  and  my  family. 

This  filters  down  even  to  my  distributors.  I  have  two  sons — that 
light  does  make  you  nervous. 

Mr.  Jacobs.  It  is  working. 

Mr.  HiNELY.  I  have  two  sons  in  the  cylinder  gas  business,  the 
fountain  that  they  serve  is  the  mom  and  pop  deal,  vou  know,  foun- 
tain service  where  you  get  your  drinks.  They  can  t  even  compete 
against  these  other  distributors  where  they  are  buying  CO2  so 
cheap.  So  it  is  having  a  filter-down  effect,  the  cancerous,  the  roots 
of  this  thing,  the  tentacles  are  far-reaching. 

I  just  think  that  if  we  can  enlighten  Congress  to  sit  down  and 
realize  what  is  happening,  they  would  take  a  good  look  at  this  and 
try  to  correct  it.  The  complexities  of  the  tax  or  something,  that  is 
minor  to  what  it  has  caused  my  industry  and  to  me  because  I  just 
don't  believe  my  government,  I  didn't  have  any  idea  in  46  years 
being  in  business,  that  my  government  would  be  a  threat  to  my 
survival  in  business.  As  a  man  of  69  years  old,  I  should  be  out  wor- 
rying about  fishing  down  in  the  lakes  of  Florida  somewhere  instead 
of  up  here  fighting  for  my  very  business  survival. 

The  whole  industry  is  in  the  same  situation.  That  is  the  bottom 
line.  The  facts  are  on  a  seven-page  thing  over  there  on  the  table 
for  the  Congress.  I  have  talked  about  this. 

I  appreciate  your  consideration  and  I  beseech  and  plead  with  the 
Congress  to  do  something  about  this  situation  in  the  sense  of 
fairness. 

Thank  you,  Mr.  Chairman. 

[The  prepared  statement  follows:] 


1762 


TestimMiy  of  J.  VenMm  Hmefy 

and  Chief  Executive  Officer 
CarlHMiic  Industries  Coiporation 
Oriando,  Florida 

Before  tfie  Subcommittee  mi  Select  Revome  Measures 

of  the  Committee  <hi  Ways  and  Means 

United  States  House  of  Representatives 

September  23, 1993 

REGARDING  THE  UNINTENDED  AND  THREATENING 

EFFECTS  OF  ETHANOL  SUBSIDIES  ON  THE  CARBON 

DIOXIDE  INDUSTRY 


First  of  all,  I  want  to  thank  the  Honorable  Charles  B.  Rangel, 
Chainnan  and  all  members  of  die  subcommittee  for  the  opportunity 
and  privilege  of  presenting  the  facts  regarding  a  problem  that  is 
plaguing  my  company  and  the  entire  carbon  dioxide  industiy.  I  feel  a 
tremendous  sense  of  responsibihty  as  I  stand  before  this  groi^ 
conveying  the  veiy  critical  nature  and  seriousness  of  a  great  and  on- 
going injustice  \\iiich  has  &r-reaching  consequences.  In  &ct,  it  is  with 
a  sense  of  desperation  that  I  approach  this  distinguished  body  which  is 
a  last  hope  to  save  my  company  and  others  in  my  industiy.  I  hope  and 
pray  that  my  honest  and  heartfelt  entreaty  will  forcefully  and 
convincingly  communicate  the  gravity  of  this  matter. 

Carbonic  Industries  is  in  the  business  of  manu&cturing  and 
distributing  liquid  carbon  dioxide  ("CO2").  Today  I  would  like  to 
specifically  address  the  devastating  efifect  that  tax  subsidies  to  ethyl 
alcohol  (ethanol)  producers  are  having  on  my  company  and  my 
industry.  Hiese  subsidies  have  created  an  un&ir  and  une}q)ected 
advantage  to  ethanol  producers  v^o  also  produce  Uquid  cubon 
dioxide. 

This  unfeir  advantage  exists  only  because  of  these  subsidies.  The 
long-tenn  efifect  of  this  problem,  if  left  unchecked,  will  most  certainly 
be  the  demise  of  a  competitive  CO2  industiy.  And,  in  the  process, 
companies  like  mine  are  actually  being  driven  out  of  business. 

I  want  to  begin  by  giving  you  some  insight  by  explaining  the  elements 
and  fectors  that  drive  the  economics  of  diis  industry.  It  is  absolutely 
imperative,  I  repeat  IMPERATIVE  that  you  understand  the  supply 
side  of  our  business. 


1763 


Over  the  years,  our  industry  has  reUed  on  by-product  sources  fw  its 
supply  of  raw,  crude  CO2.  We  typically  seek  out  companies  that  are 
producing  CO2  as  a  by-product  (which  is  being  or  otherwise  would  be, 
vented  to  the  atmosphere).  We  contract  to  purchase  this  gas  "over-the- 
fence"  for  the  production  of  food-grade  CO2.  Principally  CO2  is  a  by- 
product in  the  production  of  anhydrous  ammonia,  hydrogen,  ethylene 
oxide  and  ethyl  alcohol  (ethanol). 

From  this,  two  things  become  obvious.  First,  we  have  httle  choice  of 
plant  sites  and,  as  a  result,  transportation  expense  becomes  a  major 
cost  component.  Second,  we  cannot  ever  be  assured  that  any  CO2 
plant  will  run  for  10  years,  5  years  or  even  1  year.  Since  the  inception 
of  our  business  in  1965,  eight  of  the  twelve  plants  that  we  built  were 
permanently  closed  due  to  the  loss  of  by-product  sources  from  up- 
stream plant  closures. 

Our  most  recent  plant  closure  occuired  in  Terre  Haute,  Indiana.  Tliis 
plant  cost  $2.5  miUion  and  was  closed  in  1986  after  only  1 1  months  of 
operation.  These  idle  assets  created  a  major  financial  drain  to  my 
company  for  several  years.  We  are  just  now  removing  this  plant  in  the 
hopes  of  using  it  at  another  proposed  site  (which  is  dependent  upon 
our  successfiilly  negotiating  a  contract  for  a  by-product  raw  CO2 
source). 

As  a  by-product  industry,  we  have  httle  control  over  the  supply  side  of 
our  business  in  terms  of  sufficiency  of  supply,  logistics  and  the  cost  of 
raw  CO2. 

Over  the  past  thirty  years,  the  principal  by-product  source  for  CO2  has 
been  the  anhydrous  ammonia  industry  (anhydrous  ammonia  is  a  hquid 
fertilizer  used  extensively  in  agriculture).  In  the  mid-1 970's  domestic 
ammonia  producers  were  forced,  by  government  action,  to  compete 
with  very  low-priced  foreign  ammonia.  Shiploads  of  ammonia  were 
laid  down  in  our  seaports  at  a  cost  that  was  lower  than  our  domestic 
ammonia  producers'  incremental  cost  for  the  feed  stock  (natural  gas). 

This  wreaked  havoc  in  tiie  U.S.  fertilizer  industry  (producers  of 
nitrogen  compounds  including  ammonia)  and  20  to  25  plants  were 
closed  within  a  ten  year  span  beginning  in  1 976.  This  had  a  domino 
effect  on  the  CO2  industry  since  ammonia  production  was  the  primary 
source  for  my  industry. 


1764 


These  plant  closures  prompted  my  industry  to  diversify  its  CO2 
sources,  albeit  at  a  much  higher  cost.  As  a  result,  ethanol  and  acid 
neutralization  sources  were  developed  as  well  as  natural  underground 
CO2  reserves.  This  was  the  backdbrop  of  conditions  as  the  ethanol 
industry  entered  the  food-grade  liquid  CO2  market  a  Uttle  over  a 
decade  ago. 

The  manufecturers  of  ethanol  (which  is  used  to  produce  gasohol)  are 
being  heavily  subsidized  by  the  United  States  government  It  is 
impossible  for  anyone  outside  the  ethanol  industry  to  put  a  dollar 
figure  on  the  total  value  of  the  many  ways  in  ^\iuch  ethanol  is 
advantaged  in  the  law  -  or  even  to  know  about  all  the  incentives  they 
have  won,  for  that  matter.  This  subcommittee  is  in  a  much  better 
position  than  I  am  to  say  what  that  number  is,  but  I  think  anyone 
would  agree  that  it  is  enormous  by  any  definition. 

These  subsidies  have  been  legislated  for  purposes  of  assisting 
agriculture,  development  of  alternate  fuels,  and  the  implementation  of 
the  Clean  Air  Act  Without  the  subsidies,  the  ethanol  industry  as  we 
know  it  today  could  not  exist  in  a  fi-ee  market  system. 

As  I  indicated  earlier,  carbon  dioxide  is  a  by-product  in  the  production 
of  ethanol  (fermentation  process).  The  incremental  costs  of  converting 
raw  carbon  dioxide  to  a  food-grade  liquid  by  an  ethanol  producer  can 
be  minimal.  One  ethanol  producer  manu&ctures  its  own  electrical 
power  and  has  gone  on  record  as  stating  that  its  Uquid  carbon  dioxide 
is  "free". 

I  can  readily  understand  how  ethanol  producers  might  view  their  cost 
of  producing  liquid  carbon  dioxide  as  being  "fijee".  First  of  all,  they 
are  receiving  $.54  per  gall<ni  in  subsidies  for  every  gallon  of  fiiel 
ethanol  that  is  mixed  with  gasoline  to  produce  gasohol.  This  is  a 
guaranteed  revenue  stream,  a  luxury  we  do  not  enioy.  Next,  they  have 
no  worries  of  losing  their  CC)2  source  since  they  will  have  CO2  for  as 
long  as  they  produce  ethanol  (which  production  is  guaranteed  by  the 
subsidies).  And  finally,  ihek  CO2  is  a  waste  product  that  need  not  be 
captured  and  sold  in  order  for  them  to  generate  a  profit  so  long  as  ihe 
subsidies  are  being  received. 

The  ethanol  industry.  vAnch  controls  a  major  primary  source  of  raw 
CO2-  is  now  using  its  govemrP«nf  siihsiHi7Bd  cojrt  advantage  to  cany 
out  one  of  the  most  vigorous  and  widespread  cost  ciitting  nampaigns  in 
the  history  of  the  U.S.  CO?  industry  in  an  atbempi  to  also  control  the 
market  fw  finished  liquid  carbon  dioxide. 


1765 


There  is  evidence  that  the  ethanol  industry  is  combining  the 
distribution  and  maiketing  functions  of  carbon  dioxide  and  fructose 
(com  sweetener),  which  is  also  produced  by  the  ethanol  industry,  for 
an  additional  advantage  over  our  industry,  i.e.,  combined  rail 
rates/shipments  and  common  railhead  truck  depots. 

In  feet,  some  of  our  customers  have  indicated  that  they  have  been 
pressured  by  their  fructose  suppher  to  biry^  their  carbon  dioxide  as  well. 

Approximately  a  month  and  a  half  ago,  we  lost  our  CC)2  business  at 
two  sizable  soft  drink  bottling  plants  to  an  ethanol  producer.  This  is 
business  \^ch  we  have  enjoyed  for  over  a  quarter  century.  We  are 
simply  not  able  to  sell  CO2  at  the  low  prices  being  quoted  by  the 
ethanol  industry  throiighout  our  marketing  area. 

Equally  alarming  is  the  filter-down  efiect  this  ill-advised  subsi(fy  is 
having  on  many  of  our  distributors.  These  distributors  are  typically 
small  "mom  and  pop"  operations.  They  sell  carbon  dioxide  in 
cylinders  and  mini-bulk  tanks  to  fast  food  chains  and  convenience 
stores  to  carbonate  fountain  drinks.  We  have  been  told  by  many  of 
these  small  companies  that  coiiq)eting  distributors  for  the  ethanol 
industry  have  such  a  tremendous  price  advantage,  many  are  being 
forced  to  sell  their  businesses  to  these  competing  distributors.  You  can 
see  fixHn  this  the  extent  to  which  the  roots  of  this  tax-supported 
malignancy  are  imbedded. 

If  this  situation  is  allowed  to  continue  unchecked,  I  predict  that  the 
ethanol  industry  will  soon  have  a  monopoly  on  CC)2.  If  this  is 
permitted  to  happen,  the  ultimate  result  could  be  higher  prices  to  all 
consumers  of  CO2  without  the  checks  and  balances  of  unobstructed 
free  trade. 

This  issue  obviously  stirs  my  emotions.  lAy  company  supports 
approximately  200  families  and  approximately  250  other  fiunihes  own 
stock  in  the  company  and  depend  on  it  for  income. 

It  is  not  unreascmable  to  beheve  that  my  company  could  be  driven  out 
of  business  in  the  same  marmer  that  my  good  friend  Juhus  Rubin's 
company  (Carbonaire,  Inc.,  Palmerton,  PA)  was  driven  out  of  the  CO2 
business  about  three  years  ago.  He  is  also  present  and  would  be  more 
than  happy  to  explain  to  any  interested  Ustener  how  the  unfair 
practices  mentioned  earher  were  responsible  for  the  demise  of  his 


1766 


Moreover,  the  entire  CO2  industry,  wiiich  is  a  half-a-billion  dollar 
industry,  supports  an  estimated  4,000  families  in  all  comers  of  this 
nation  (and  countless  stockholders)  whose  hves  will  be  adversely  and 
irreversibly  affected  if  tiiis  bUght  isnt  quickly  lnx>ught  under  control. 

When  I  retumed  home  torn  World  War  11  after  serving  three  years  in 
the  United  States  Amied  Forces  in  New  Gtiinea,  the  Phihppines,  and 
Japan,  I  never  doubted  that  I  could  achieve  success  as  an  entrepreneur. 
The  ideals  of  my  govranment  and  our  democracy  were  of  great  comfort 
to  me  as  I  invested  nqr  life  and  money  in  a  harmonious  and  free 
enterprise  syston.  Now,  however,  I  feel  betrayed  by  the  establishment 
that  I  had  come  to  rely  vtpcai  for  nearly  a  half  century. 

I  still  have  &ith,  although  somewiiat  shaken  (by  the  &ilure  to  achieve 
rehef  during  the  tgooA  conference  an  the  budget),  that  good  people 
like  you  will,  througji  wiiatever  means  or  methods  it  might  take,  alter 
the  rules  to  the  extent  that  wiiat  is  right  will  prevail.  After  thirty  years 
in  this  business,  wouldn't  it  be  a  paradox,  and  contrary  to  the  great 
American  system,  for  a  small  company  such  as  ours  to  be  forced  out  of 
business  in  this  way.  Yes,  f<Hced  out  of  business  by  giant  corporations 
who  are  enabled  to  oigage  in  un&ir  practices  solely  because  they  are 
beneficiaries  of  hundreds  of  millions  of  dollars  in  subsidies. 

IN  CLOSING,  I  know  that  our  honorable  legislators  did  not  realize 
these  subsidies  would  pomit  the  abusive  practices  now  decimating  our 
industry.  Certainly,  no  <Mie  can  argue  that  it  was  an  intended  result  of 
the  ethanol  subsicfy  pit^ram  to  disrupt  the  CO2  market.  Nevertheless, 
the  fact  remains  that  a  great  travesty  of  justice  exists  in  the  form  of 
governmental  intafoenceofthefiiee  enterprise  system.  Clearly  it  is 
discouraging  and  stifling  American  entrepreneurs  and  the  business 
climate  in  which  diey  ftmction. 

We  are  not  here  to  ask  for  tax  money  or  handouts.  To  my  knowledge, 
which  is  pretty  de^  a&a  30  years  in  the  business,  my  industry  has 
never  asked  the  govranment  for  ag^  tax  break  or  my  subsidy.  We  are 
pleading  with  you  to  equalize  the  competitive  playing  field  by  working 
with  us  to  find  some  way  to  ofi&et  or  otherwise  "undo"  the  damage  the 
ethanol  program  has  dme  to  us. 

Whether  the  remedy  is  an  excise  tax  oa  CO2  sold  by  ethanol  producers 
—  which  is  one  formulation  we  have  proposed  —  or  some  other 
solution,  we  beUeve  that  "where  tiiere's  a  will  there's  a  way"  that  is  feir 
and  enforceable. 


1767 


Finding  and  enacting  that  remedy  would  return  the  business  prospects 
of  my  company  and  others  in  the  CO2  industry  to  the  proper  hands  — 
namely,  our  business  skills,  our  hard  work,  and  regular  market  forces. 
I  might  add  that  it  would  also  raise  some  revenue  \^ch  you  could  put 
toward  deficit  reduction  or  some  other  good  use. 

Hiank  you  very  much  for  the  time  and  consideration  you  have  given  to 
me  and  our  industry.  I  trust  and  pray  that  you  will  respond  in  a  way 
which  will  rectify  this  great  injustice. 

At  this  point  I  would  be  more  than  happy  to  answer  any  questions  you 
may  have. 


J.  Vernon  Hinefy 

Chairman  &  CEO 

Carbonic  hidustries  Corporatian 

September  23, 1993 


1768 


Mr.  Jacobs.  Bravo. 
Mr.  Lockhart. 


STATEMENT  OF  JAMES  H.  LOCKHART,  VICE  PRESIDENT  AND 
GENERAL  COUNSEL.  THE  BAPTIST  FOUNDATION  OF 
OKLAHOMA 

Mr.  Lockhart.  Yes,  sir.  Thank  you,  Mr.  Chairman. 

My  name  is  Jim  Lockhart.  I  am  the  vice  president  and  general 
counsel  of  the  Baptist  Foundation  of  Oklahoma.  I  appear  here 
today  on  behalf  of  the  Baptist  Foundations  of  Oklahoma,  Texas, 
and  Louisiana,  also  Maryville  University,  the  Sierra  Club,  the 
University  of  Arkansas  and  the  National  Society  of  Fund-Raising 
Executives  to  urge  this  subcommittee's  favorable  consideration  of  a 
measure  to  correct  two  minor  defects  in  the  generation-skipping 
transfer  tax  law  which  unintentionally  operate  to  discourage  chari- 
table giving. 

The  Baptist  Foundation  of  Oklahoma  receives  and  administers 
gifts  for  Southern  Baptist  churches,  ministries,  agencies,  and  insti- 
tutions in  Oklahoma  and  elsewhere.  Last  year,  for  example,  we  dis- 
tributed over  $1  million  for  housing,  care,  counseling  and  assist- 
ance to  needy  children,  providing  help  to  some  10,000  youngsters. 
We  hold  and  help  fund  seven  retirement  centers  and  we  also  pro- 
vide funding  for  Oklahoma  Baptist  University. 

Through  the  Southern  Baptist  convention,  we  are  able  to  help 
charitable  and  other  ministries  throughout  the  United  States  and 
the  world.  To  support  the  work  of  our  agencies  and  institutions,  we 
depend  upon  the  support  of  many  donors.  By  far  the  largest  source 
are  thousands  of  small  gpfts,  but  there  are  in  some  cases  very  sub- 
stantial gifts. 

I  work  with  these  donors  on  a  daily  basis.  I  understand  many  of 
the  considerations  that  go  into  their  mind  in  making  these  gifts. 
Based  upon  my  actual  experience,  I  can  tell  you  that  these  two  de- 
fects which  I  will  talk  to  you  about  hurt  charitable  giving. 

First,  I  would  like  to  say  that  we  never  claimed  that  the  sole  or 
even  principal  motivation  for  charitable  giving  is  tax  treatment. 
The  churches  and  ministries  that  our  people  support  were  bene- 
ficiaries of  charitable  gifts  long  before  philanthropy  was  recognized 
in  the  Tax  Code.  Nevertheless,  in  my  experience,  while  the  tax  law 
may  not  aft'ect  an  individual's  initial  desire  to  give,  it  does  often  af- 
fect the  size  of  the  gift  when  it  is  made,  especially  in  cases  of  larger 
gifts  through  an  estate  plan. 

For  this  reason,  we  should  always  make  sure  that  the  tax  law 
does  not  discourage  charitable  giving  where  not  necessary  to  ad- 
vance tax  policy.  Unfortunately,  this  type  of  disincentive  exists  in 
a  little  known  part  of  the  generation-skipping  transfer  tax. 

The  generation-skipping  transfer  tax  is  an  extra  tax  designed  to 
eliminate  the  advantage  of  skipping  a  generation  in  a  gift  or  be- 
quest, for  example,  bv  transferring  property  instead  of  to  a  child 
directly  to  a  grandchild.  An  important  exclusion  in  the  generation- 
skipping  transfer  tax  provides  that  if  a  donor's  child  is  deceased  at 
the  time  of  the  transfer,  then  a  gift  to  that  child's  children,  in  other 
words,  the  donor's  grandchildren,  will  not  bear  generation-skipping 
transfer  tax. 


1769 

With  this  predeceased  parent  exclusion,  Congress  recognized  that 
because  the  child  was  dead  and  not  being  skipped  for  tax  avoidance 
reasons,  it  would  be  unfair  to  add  a  generation-skipping  transfer 
tax  on  top  of  an  estate  or  gift  tax.  This  problem  is  significant  be- 
cause combined  application  of  gift,  estate,  and  other  transfer  taxes 
with  a  generation-skipping  transfer  tax,  in  some  cases,  operates  to 
take  80  percent  of  the  value  of  the  gift. 

The  language  of  the  predeceased  parent  exclusion,  however,  is 
unfairly  restrictive  in  two  respects.  First,  the  exclusion  is  limited 
to  the  donor's  lineal  descendants,  grandchildren  only.  For  example, 
a  donor  who  outlives  his  spouse,  his  brothers  and  sisters,  his  nieces 
and  nephews,  and  wishes  to  make  a  gift  to  his  or  her  grandnieces 
or  grandnephews,  the  donor's  only  living  relatives  will  bear  the  tax 
even  though  there  is  clearly  no  attempt  of  tax  avoidance.  Any  indi- 
vidual facing  this  very  high  level  of  taxation  on  his  or  her  estate 
almost  certainly  will  reduce  the  charitable  gift  in  order  to  make  up 
for  the  additional  tax  and  provide  for  his  or  her  family. 

Second,  the  exclusion  only  applies  to  direct  gifts  to  those  grand- 
children whose  parents  have  died.  It  does  not  apply  to  any  type  of 
transfer  through  a  trust,  including  the  very  common  type  of  trust 
that  provides  mcome  to  a  charity  for  a  period  of  years  and  then 
leaves  the  principal  to  the  grandchildren. 

These  charitable  trusts  are  very,  very  important  to  the  work  of 
the  Baptist  Foundation  of  Oklahoma,  the  other  Baptist  Founda- 
tions, and  the  other  charitable  organizations  we  represent.  Many  of 
our  gifts  are  through  charitable  trusts. 

Under  the  generation-skipping  transfer  tax,  so  long  as  the  inter- 
vening ancestor  is  deceased  at  the  time  of  the  transfer,  there  is  no 
reason  of  tax  policy  to  treat  these  trust  gifts  different  from  direct 
gifts,  yet  by  doing  so  charitable  giving  is  unnecessarily  discouraged. 
Having  careftilly  reviewed  these  provisions  and  the  anomalies  tney 
produce,  we  are  confident  the  Congress  could  not  have  intended 
these  results. 

The  Baptist  Foundation  of  Oklahoma  and  the  other  organizations 
I  represent  here  today  urge  Congress  to  amend  the  generation- 
skipping  transfer  tax  statute  to  correct  these  problems.  We  believe 
that  if  such  changes  are  made,  it  will  help  support  charitable  en- 
deavors of  all  kinds,  while  ensuring  that  the  policy  behind  the  gen- 
eration-skipping transfer  tax  is  maintained. 

Included  with  my  written  statement  is  suggested  language  to  ac- 
complish these  changes,  along  with  the  more  detailed  explanation 
of  how  the  proposed  language  will  accomplish  these  objectives. 

We  thank  you  very  much  on  behalf  of  the  Baptist  Foundation  for 
this  opportunity  to  testify.  Thank  you. 

[The  prepared  statement  follows:] 


1770 


THE  BAPTIST  FOUNDATION 

o{)  OfefiflJuMOflL 


JAMES  H.  LOCKHART 


STATEMENT  OF  JAMES  E.  LOCKHART 
Vice  President  and  General  Counsel 
The  Baptist  Foundation  of  Oklahoma 

3800  North  May  Avenue 

Oklahoma  City,  Oklahoma  73112-6S06 

(40S)  949-9500 

Testimony  In  Support  of  Changes 

in  the 

Predeceased  Parent  Bzelusion  to  the 

Generation-Skipping  Transfer  Taz 

Before  the  Subcommittee  on  select  Revenue  Measures 

Committee  on  Ways  t   Means 

United  states  House  of  Representatives 

Hearings  on  Miscellaneous  Revenue  Issues 

September  23,  1993 


MR.  CHAIRMAN: 

I  am  James  H.  Lockhart,  Vice  President  and  General  Counsel  of 
the  Baptist  Foundation  of  Oklahoma.  I  appear  today  on  behalf  of 
the  Baptist  Foundations  of  Oklahoma,  Louisiana,  and  Texas,  and 
several  other  charitable  organizations  and  institutions — including 
Maryville  University,  the  Sierra  Club,  the  University  of  Arkansas, 
and  the  National  Society  of  Fund  Raising  Executives — to  urge  the 
Subcommittee's  favorable  consideration  of  a  measure  to  correct  two 
minor  defects  in  the  Generation-Skipping  Transfer  tax  law  which 
unintentionally  operate  to  discourage  charitable  giving. 

I  would  especially  like  to  thank  Congressman  Brewster,  of  my 
home  state  of  Oklahoma,  and  Congressman  Gephardt  for  their  special 
request  to  the  Chairman  that  I  be  permitted  to  testify  here  today. 

First,  some  background  on  my  organization.  The  Baptist 
Foundation  of  OkleOioma  is  the  trust  agency  of  the  Baptist  General 
Convention  of  the  State  of  Oklahoma.  Our  role  is  to  receive  and 
administer  gifts  for  Southern  Baptist  churches,  ministries, 
agencies  and  institutions,  which  provide  a  variety  of  educational 
and  social  services  in  Oklahoma  and  elsewhere. 

The  Baptist  Foundation  of  Oklahoma,  for  example,  distributes 
over  $1,000,000  annually  for  direct  services  to  troubled  children 
and  teenagers.  The  Oklahoma  Baptist  Convention  runs  ten  children's 
homes  which  provide  residential  care  for  children  whose  parents  are 
deceased  or  unable  or  unwilling  to  care  for  them.  The  Convention 
also  operates  crisis  pregnancy  centers,  a  maternity  home,  and  youth 
counseling  programs.  Through  these  efforts,  we  provide  help  to 
almost  10,000  young  people  in  Oklahoma  each  year. 

The  Oklahoma  Baptist  Convention  also  owns  and  operates  seven 
retirement  centers,  providing  support  and  assistance  to  senior 
adults  throughout  the  State  of  Oklahoma.  In  addition,  the  Baptist 
Foundation  funds  The  Oklahoma  Baptist  University,  a  school  of  2,4  00 
students  in  Shawnee,  Oklahoma. 

Finally,  through  the  Southern  Baptist  Convention,  charitable 
ministries  supported  by  our  Foundation  are  given  the  opportunity  to 
do  their  work  throughout  the  United  States  and  the  world. 

With  each  year,  it  seems  that  the  need  for  our  services 
continues  to  grow.  To  support  the  work  of  our  agencies  and 
institutions,  the  Baptist  Foundation  depends  upon  the  support  of 
its  many  donors  and  benefactors.  By  far,  the  largest  source  of  our 


1771 


funding  is  gifts  from  individuals,  ranging  from  thousands  of  small 
donations  to,  in  some  cases,  very  substantial  gifts  and  bequests. 

As  someone  who  has  been  involved  in  charitable  fundraising  for 
a  number  of  years,  I  would  never  claim  that  the  sole,  or  even 
principal,  motivation  for  charitable  giving  is  tax  law  treatment. 
Baptist  churches  were  the  beneficiaries  of  charitable  donations 
long  before  philanthropy  was  recognized  in  the  tax  code. 

Nevertheless,  in  my  experience,  while  the  tax  law  may  not 
affect  an  individual's  initial  desire  to  give,  it  often  does  affect 
the  size  of  the  contribution  that  is  made,  especially  in  the  case 
of  larger  gifts  through  an  estate  plan.  For  this  reason,  we  should 
always  take  care  to  ensure  that  the  tax  law  does  not  discourage 
charitable  giving  where  unnecessary  to  advance  other  goals  of  tax 
policy. 

Unfortunately,  this  type  of  needless  disincentive  to 
charitable  giving  exists  today  in  a  little-known  part  of  the 
Generation-Skipping  Transfer  tax  law.  As  this  Committee  is  aware, 
the  GST  statute  imposes  a  separate  tax  in  addition  to  regular 
estate  or  gift  taxes  when  property  is  transferred  to  a  person  more 
than  one  generation  younger  than  the  donor.  The  GST  tax  is 
designed  to  eliminate  the  transfer  tax  advantage  of  "skipping"  a 
generation  in  a  gift  or  bequest — for  example,  by  transferring 
property  to  a  grandchild  instead  of  a  child. 

An  important  exclusion  in  the  GST  law  provides  that  if  a  child 
of  the  donor  is  deceased  at  the  time  of  the  transfer,  then  a  gift 
or  bequest  to  that  child's  children — the  donor's  grandchildren — 
will  not  bear  GST  tax.  With  this  "predeceased  parent  exclusion," 
Congress  recognized  that  because  the  child  was  not  being  "skipped" 
for  tax  avoidance  reasons,  it  would  be  unfair  to  impose  the  GST  tax 
on  top  of  estate  or  gift  taxes.  This  is  important,  because 
combined  application  of  the  GST  tax  and  transfer  taxes  can  be 
extremely  severe — up  to  almost  80  percent  of  the  value  of  the 
property  transferred. 

The  language  of  this  predeceased  parent  exclusion,  however,  is 
unfairly  restrictive  in  two  significant  respects: 

First,  the  exclusion  is  limited  to  the  donor's  lineal 
descendants — grandchildren — only;  a  childless  individual  con- 
fronting similar  circumstances  is  denied  the  exclusion.  For 
example,  a  donor  who  outlives  his  or  her  spouse,  siblings,  nieces 
and  nephews,  and  wishes  to  give  property  to  grandnieces  and 
grandnephews — the  donor's  only  living  relatives — will  be  subjecting 
the  transfer  to  GST  tax,  even  though  there  is  clearly  no  attempt  at 
transfer  tax  avoidance.  Any  individual  facing  this  very  high  level 
of  taxation  on  a  gift  or  bequest  will  almost  certainly  reduce 
charitable  giving  in  order  to  increase  the  available  gift  or 
bequest  to  his  or  her  heirs. 

Second,  the  exclusion  is  only  applicable  to  direct  gifts  or 
bequests  to  qualifying  grandchildren;  it  does  not  apply  to  any  type 
of  transfer  through  a  trust,  including  a  common  type  of  trust  that 
provides  income  to  a  charity  for  a  period  of  years  and  then 
distributes  the  trust  property  to  grandchildren.  These  types  of 
charitable  trusts  are  very  important  sources  of  support  for  the 
Baptist  Foundations  and  the  other  charitable  organizations  I 
represent  here  today.  Under  the  GST  tax,  so  long  as  the  inter- 
vening ancestor  is  deceased  at  the  time  of  the  transfer,  there  is 
no  tax  policy  reason  to  condition  the  exclusion  on  the  form  of  the 
transfer.  Yet,  by  having  this  limitation  in  the  exclusion, 
charitable  giving  is  unnecessarily  discouraged. 

Having  carefully  reviewed  these  provisions  and  the  anomalies 
they  produce,  we  are  confident  that  Congress  could  not  have 
intended  these  results. 


1772 


The  Baptist  Foundation  of  Oklahoma  and  the  other  organizations 
I  represent  here  today  urge  Congress  to  amend  the  GST  statute  to 
correct  these  problems.  We  believe  that  if  such  changes  are  made, 
it  will  help  support  charitable  endeavors  of  all  kinds  while 
ensuring  that  the  public  policy  behind  the  GST  tax  is  consistently 
applied. 

Included  with  my  written  statement  is  suggested  language  to 
accomplish  these  changes,  along  with  a  more  detailed  explanation  of 
the  proposed  amendments. 

I  would  be  pleased  to  answer  your  questions,  if  any,  and  I 
again  express  my  appreciation  for  the  opportunity  to  convey  my 
views  to  you  here  today. 


1773 


PROPOSED  STATUTORY  LANGUAGE 
GENERATION-SKIPPING  TRANSFER  TAX  AMENDMENTS 


(e)   SPECIAL  RULE  FOR  PERSONS  WITH  A  DECEASED  PARENT. - 

(1)  IN  GENERAL. — For  purposes  of  determining  whether  any 
transfer  is  a  generation-skipping  transfer,  if  an  individual  who 
has  an  interest  in  property — 

(A)  is  a  descendant  of  a  grandparent  of  the  transferor  (or 
the  transferor's  spouse  or  former  spouse),  and 

(B)  at  the  time  the  transfer  from  which  such  interest  is 
established  or  derived  is  subject  to  a  tax  imposed  by  Chapter  11  or 
12  upon  the  transferor  (and  if  there  shall  be  more  than  1  such 
time,  then  at  the  latest  such  time),  such  individual's  parent  who 
is  a  lineal  descendant  of  such  grandparent  is  dead, 

such  individual  shall  be  treated  as  if  such  individual  were  a 
member  of  the  deceased  parent's  generation,  and  any  descendant  of 
such  individual  shall  be  treated  as  belonging  to  the  generation  to 
which  a  parent  of  such  descendant  would  be  assigned  without 
application  of  this  subsection. 

(2)  REAPPLICATION  OF  SUBSECTION. —This  subsection  shall  be 
reapplied  until  such  individual  is  treated  as  belonging  to  the 
generation  which  is  1  generation  below  the  lower  of  — 

(A)  the  transferor's  generation,  and 

(B)  the  generation  assignment  of  a  living  ancestor  of  such 
individual  (and,  if  there  shall  be  more  than  1,  then  the  youngest 
of  them)  who  is  also  a  descendant  of  such  grandparent,  and  the 
generation  assignment  of  any  descendants  of  such  individual  shall 
be  adjusted  accordingly. 


1774 


EXPLANATION  OF  PROPOSED  STATUTORY  LANGUAGE 
GENERATION-SKIPPING  TRANSFER  TAX  AMENDMENTS 


The  statutory  provisions  governing  "move  up"  for  lineal 
descendants  of  the  transferor  are  presently  contained  in  paragraph 
(2)  of  Section  2612(c).  Section  2612(c)  deals  entirely  with  direct 
skips.  Since  the  proposed  language  would  make  move  up  possible 
with  respect  to  any  kind  of  generation-skipping  transfer,  and  not 
just  direct  skips,  it  would  seem  appropriate  for  such  language  to 
appear  in  a  Code  section  other  than  Section  2612(c).  Section  2651 
deals  generally  with  generation  assignment.  The  amendments  are 
therefore  proposed  as  a  new  subsection  (e)  to  Section  2651.  Under 
this  format,  present  subsection  (e)  of  Section  2651  would  be 
redesignated  as  new  subsection  (f ) ,  and  present  Section  2612(c)(2) 
would  be  deleted. 

Under  new  Section  2651(e) (1),  move  up  would  be  available  with 
respect  to  persons  having  common  ancestry  with  the  transferor's 
grandparent,  or  the  grandparent  of  the  transferor's  spouse  or 
former  spouse.  There  would  thus  be  a  symmetry  between  the  new 
statute  and  Sections  2651(b)(1)  and  (2),  which  use  the  grandparent 
of  the  transferor  or  the  transferor's  spouse  or  former  spouse  to 
ascertain  generation  assignment  generally. 

If  a  beneficiary  with  an  interest  in  property  is  a  descendant 
of  a  grandparent  of  the  transferor  (or  a  grandparent  of  the 
transferor's  spouse  or  former  spouse) ,  new  Section  2651(e) (1)  would 
move  the  beneficiary's  generation  assignment  to  that  of  his  or  her 
parent.  Move  up  would  occur  if  the  parent  were  also  a  descendant 
of  such  grandparent,  and  if  the  parent  is  deceased  when  the 
transfer  from  which  the  interest  arises  is  subject  to  estate  or 
gift  tax  upon  the  transferor. 

Direct  skips  under  the  proposed  subsection  would  be  treated  in 
the  same  fashion  as  under  present  Section  2612(c)(2).  Application 
of  proposed  Section  2651(e) (1)  to  taxable  terminations  and  taxable 
distributions  can  be  illustrated  by  example. 

If  a  transferor  with  one  living  child  having  children  of  his 
or  her  own  and  with  living  grandchildren  by  a  deceased  child  were 
to  establish  an  irrevocable  trust  for  the  benefit  of  his 
descendants  living  from  time  to  time  in  a  transfer  subject  to  gift 
tax,  the  grandchildren  by  the  deceased  child  would  be  moved  up  to 
the  deceased  child's  generation.  Any  such  grandchild  would  be  an 
individual  having  an  interest  in  property  who  would  be  moved  up  to 
his  or  her  parent's  generation,  because  the  parent  is  deceased  at 
the  time  the  transfer  creating  the  individual's  interest  is  subject 
to  gift  tax.  Any  distributions  during  the  term  of  the  trust  to 
such  grandchild  would  not  be  taxable  distributions  subject  to 
generation-skipping  tax.  Any  distributions  to  the  transferor's 
grandchildren  by  the  surviving  child  during  the  term  of  the  trust 
would  be  taxable  distributions.  If  the  trust  terminates  upon  the 
death  of  the  surviving  child  and  trust  assets  are  distributed 
outright  to  the  transferor's  grandchildren  living  at  such  time,  the 
death  of  the  surviving  child  would  constitute  a  taxable  termination 
with  respect  to  assets  passing  to  such  child's  own  children,  but 
not  as  to  assets  passing  to  the  children  of  the  predeceased  child. 

Under  proposed  Section  2651(e),  if  a  transfer  is  subject  to 
gift  or  estate  tax  more  than  once,  eligibility  for  move  up  is  to  be 
determined  at  the  most  recent  time  the  transfer  is  subject  to  tax. 
As  an  illustration,  assume  that  a  transferor  establishes  an 
irrevocable  trust  retaining  the  right  to  income  for  life,  with 
distribution  upon  his  death  to  his  then  living  descendants,  per 
stirpes.  In  this  illustration,  the  establishment  of  the  trust 
constitutes  a  taxable  gift  of  the  remainder  interest  in  the  trust. 


1775 


If  a  child  of  the  transferor  were  to  predecease  the  transferor  and 
the  trust  were  to  be  included  in  the  transferor's  gross  estate 
under  Section  2036  by  virtue  of  the  retained  income  interest,  the 
grandchildren  of  the  transferor  by  such  child  would  be  moved  up  and 
treated  as  members  of  the  child's  generation.  Distribution  to  such 
grandchildren  after  the  transferor's  death  would  not  be  subject  to 
generation-skipping  tax,  even  though  their  parent  was  living  when 
the  trust  was  established. 

Paragraph  (2)  would  permit  a  move  up  of  several  generations. 
A  beneficiary  could  be  moved  up  until  he  or  she  were  assigned  to  a 
generation  which  is  one  generation  below  the  transferor's 
generation  or,  if  lower,  the  generation  assignment  of  his  or  her 
youngest  living  ancestor  who  is  also  a  descendant  of  a  grandparent 
of  the  transferor  (or  the  transferor's  spouse  or  former  spouse). 
Thus,  if  the  beneficiary  has  no  living  ancestor,  the  beneficiary 
could  be  moved  no  higher  than  one  generation  below  the  transferor's 
generation. 


1776 

Mr.  Jacobs.  Thank  you,  sir. 
Mr.  Pennell. 

STATEMENT  OF  JEFFREY  N.  PENNELL,  RICHARD  A.  CXARK 
PROFESSOR  OF  LAW;  AND  DIRECTOR,  GRADUATE  LL.M.  PRO- 
GRAM IN  TAXATION,  EMORY  UNIVERSITY  SCHOOL  OF  LAW, 
ATLANTA,  GA. 

Mr.  Pennell.  Thank  you,  Mr.  Chairman,  I  am  Jeff  Pennell.  I 
teach  wealth  transfer  taxes  at  Emory  University  School  of  Law  in 
Atlanta.  I  am  here  to  support  these  two  changes  to  the  generation- 
skipping  transfer  tax. 

I  thought  it  might  be  useful  to  speak  for  a  moment  about  what 
the  provision  we  are  dealing  with  was  involved,  designed  to  do  in 
the  code  and  why  the  changes  are  not  at  variance  with  that  objec- 
tive. 

Back  in  1976,  the  original  generation-skipping  transfer  tax  al- 
lowed a  loophole  that  would  permit  a  wealthy  individual  to  do  what 
was  known  as  layering  or  leapfrogging.  The  objective  to  avoid  the 
tax  would  be  for  me  to  split  mv  wealth  and  leave  a  certain  portion 
of  it  directly  to  my  grandchildren;  by  avoiding  a  trust  that  bene- 
fited child  for  life  and  then  out  to  the  grandcnild,  I  could  escape 
the  generation-skipping  tax. 

Congress  concluded  that  this  was  inappropriate,  because  the  op- 
portunity was  typically  available  only  to  the  most  wealthy  donors. 
So  Congress  enacted  the  direct  skip  tax,  which  says  that  if  I  go  di- 
rectly to  a  grandchild  with  my  wealth,  the  generation-skipping  tax 
will  apply. 

At  the  very  last  minute  in  drafting  that  provision,  the  actual  leg- 
islative drafter  recognized  that  there  was  no  tax  avoidance  if  the 
reason  I  left  my  property  directly  to  a  grandchild  was  because  my 
child — ^that  is  the  grandchild's  parent — was  deceased.  So  this  pre- 
deceased parent  exclusion  was  added  to  the  code  at  the  very  last 
minute. 

An  example  illustrates  the  problems  with  this  provision.  If  it 
were  my  sister  whose  child  were  deceased,  she  could  leave  her  es- 
tate directly  to  her  grandchild  free  of  the  generation  skipping  tax. 

The  problem  we  confront,  which  was  not  really  considered  at  the 
time,  was  that  if  I  were  leaving  my  estate  to  my  sister's  family,  be- 
cause I  have  no  relatives,  no  oescendants  of  my  own,  this  particu- 
lar exception  does  not  apply. 

So  that  if  my  sister's  property  goes  to  her  grandchild,  you  escape 
the  tax.  It  does  not  apply.  There  is  no  need  for  this  tax  to  be  im- 
posed at  that  point.  But  if  I  give  my  property  directly  to  her  grand- 
child, this  tax  does  apply. 

As  far  as  we  can  tell  from  the  legislative  history,  there  is  no  rea- 
son for  that  disparity  in  treatment  as  between  her  lineal  descend- 
ants and  my  collateral  heirs.  So  one  of  the  changes  here  is  to  cor- 
rect that  disparity. 

The  other  problem  with  this  provision,  as  Mr.  Lockhart  points 
out,  is  that  it  does  not  apply  if  my  estate,  or  for  that  matter,  my 
sister's  estate,  goes  into  trust  for  a  short  period  of  time.  He  has  il- 
lustrated, for  example,  if  my  sister  or  I  created  a  trust  for  the  bene- 
fit of  charity  for  a  few  years  and  at  the  end  of  that  term,  the  prop- 
erty dropped  to  her  grandchild,  this  tax  will  apply. 


1777 

She  could  avoid  the  tax  by  simply  leaving  her  entire  estate  to  her 
grandchild.  She  would  forego  the  charitable  deduction  and  the 
charity  would  lose  the  benefit. 

The  other  place  where  this  could  come  up.  Let's  imagine,  for  ex- 
ample, as  an  academic,  I  don't  get  paid  as  much  as  some  people; 
I  don't  save  as  well  as  I  should.  My  sister  says  you  are  going  to 
have  trouble  making  it  through  your  later  years;  I  will  put  my  es- 
tate in  trust  for  your  benefit,  Jeff,  and  when  you  die  I  will  send 
it  to  my  grandchild. 

The  same  thing  she  could  have  done  with  her  property  if  I  were 
not  a  beneficiary,  would  have  been  tax  free,  now  where  she  creates 
this  limited  life  estate  in  me,  her  sibling,  or  anyone  else  at  her 
generational  level  and  then  at  the  death  of  the  beneficiary,  the 
property  drops  to  her  grandchild  and  the  tax  applies.  A^ain,  there 
appears  to  be  no  tax  policy  justification  for  that  disparity.  So  the 
other  correction  to  this  statute  is  designed  to  deal  with  that 
problem. 

Thank  you  very  much. 

Mr.  Jacobs  [chairing].  Good  presentation. 

[The  prepared  statement  follows:] 


1778 


STATEMENT  OF  JEFFREY  N.  PENNELL 

Richard  H.  Clark  Professor  of  Law 

Director,  Graduate  LL.M.  Program  in  Taxation 

Emory  University  School  of  Law 

Clifton  Road  at  North  Decatur  NE 

Atlanta,  GA  30322 

(404)  727-6816 

Testimony  In  Support  Of  Changes 

in  the 

Predeceased  Parent  Exclusion  to  the 

Generation-Skipping  Transfer  Tax 

Before  the  Subcommittee  on  Select  Revenue  Measures 

Committee  on  Ways  &  Means 

United  States  House  of  Representatives 

Hearings  on  Miscellaneous  Revenue  Issues 

September  23,  1993 


MR.  CHAIRMAN: 

I  am  Jeffrey  N.  Pennell,  a  Professor  of  Law  at  Emory 
University  School  of  Law  in  Atlanta,  Georgia,  where  I  also  serve  as 
Director  of  the  Graduate  LL.M.  Program  in  Taxation.  I  am  a  Member 
of  the  American  Law  Institute,  an  Academic  Fellow  and  Regent  of  the 
American  College  of  Trust  and  Estate  Counsel,  an  Academician  of  The 
International  Academy  of  Estate  and  Trust  Law,  and  a  Council  Member 
of  the  Real  Property,  Probate  and  Trust  Law  Section  of  the  American 
Bar  Association.  I  have  written  and  lectured  extensively  on  U.S. 
estate  and  gift  tax  law,  including  Chapter  13  of  the  Internal 
Revenue  Code,  known  as  the  Generation-Skipping  Transfer  (GST)  tax 
law.   I.R.C.  SS  2601-2663. 

I  appreciate  the  opportunity  to  testify  in  support  of  two 
minor  changes  to  the  GST  tax  that  would,  if  enacted,  further  the 
stated  policy  of  the  GST  tax  and  improve  the  consistency  and 
fairness  of  its  application.  My  testimony  is  in  my  individual 
capacity  as  a  legal  scholar,  and  not  on  behalf  of  any  organization. 

Although  the  GST  tax  law  is  complex,  the  principle  behind  the 
tax  is  to  ensure  that  federal  wealth  transfer  tax  is  not  avoided 
when  property  is  enjoyed  and  then  transferred  from  one  generation 
to  the  next. 

Prior  to  enactment  of  the  original  GST  tax  in  1976,  it  was 
possible  through  a  variety  of  arrangements  that  suspended  outright 
ownership  of  property  to  transfer  wealth  through  many  generations 
without  incurring  estate  or  gift  tax.  These  transfers  were  the 
target  of  the  GST  tax. 

In  greatly  simplified  form,  the  GST  tax  is  imposed  on  the 
transfer  of  property  to  beneficiaries  more  than  one  generation 
below  the  transferor.  The  most  common  example  of  a  transfer 
subject  to  the  GST  tax  is  a  gift  or  bequest  from  the  transferor  to 
his  or  her  grandchild  that  bypasses  or  "skips"  the  transferor's 
living  child.   This  transfer  is  illustrated  in  Figure  1. 


1779 


Figure  1.   Generation-Skipping  Transfer 


T's  grandchild 


Gift  or  bequest  to  T's 
grandchild  that  "skips' 
living  child. 


The  changes  to  the  GST  tax  that  I  support  concern  a  limited 
exception  in  the  law  known  as  the  "predeceased  parent  exclusion." 
I.R.C.  S  2612(c)(2).  This  exclusion  covers  property  transferred  to 
a  grandchild  of  the  transferor  if  the  grandchild's  parent  who  was 
the  transferor's  child  is  dead  at  the  time  of  the  transfer.  Under 
this  "predeceased  parent  exclusion,"  the  grandchild  is  deemed  to 
"move  up"  one  generation  to  that  of  his  or  her  deceased  parent  and 
the  GST  tax  does  not  apply.   This  situation  is  shown  in  Figure  2. 


Figure  2 . 


Predeceased  Parent  Exclusion 


T's  Child 
Deceased 


T's  grandchild 


Gift  or  bequest  to  grandchild 
if  grandchild's  parent 
(T's  child)  is  dead  at  the 
time  of  the  transfer-no  "skip" 


The  rationale  for  the  predeceased  parent  exclusion  is  that 
there  is  no  tax  avoidance  intent  if  the  child  is  "skipped"  by  the 
transferor  only  because  the  child  predeceased  the  transferor. 

As  currently  drafted,  this  predeceased  parent  exclusion  is 
limited  to  the  transferor's  lineal  descendants  only,  and  does  not 
apply  to  collateral  heirs  in  similar  circumstances.  Thus,  for 
example,  if  a  childless  person  outlives  his  or  her  spouse, 
descendants,  siblings,  and  nieces  and  nephews  and  wishes  to  devise 
property  to  grandnieces  and  grandnephews ,  the  GST  tax  will  be 
imposed  even  though  there  is  no  motive  or  intent  to  avoid  taxes, 
just  as  in  the  case  of  an  individual  who  outlives  his  or  her 
children  and  transfers  property  to  grandchildren.  This  situation 
is  depicted  in  Figure  3. 


1780 


Figure  3.   Gift  to  Collateral  Heir  With  Predeceased  Parent 


(no  children) 


T  has  no  lineal  heirs.   Closest 
living  relative  is  grandnlece. 
Gift  or  bequest  to  grandnlece 
Is  a  "skip"  even  though 
grandnlece 's  parent  (T's  niece) 
is  dead  at  time  of  transfer. 


T's  sibling 
Deceased 


T's  niece 
Deceased 


T's 
grandnlece 


In  my  judgment,  there  is  no  tax  policy  justification  to 
distinguish  between  lineal  and  collateral  heirs  in  these 
circumstances.  Although  there  is  no  legislative  history  on  this 
particular  point,  it  appears  that  the  only  reason  collaterals  were 
not  included  in  the  predeceased  parent  exclusion  when  enacted  is 
because  this  unusual  order  of  death  situation  was  overlooked.  It 
is  Improbable  that  Congress  Intended  to  create  this  inconsistency. 

A  second  problem  with  the  predeceased  parent  exclusion  is  that 
it  applies  only  to  direct  gifts  or  bequests  to  a  grandchild  (a 
"direct  skip"  in  the  language  of  the  GST  statute)  and  does  not 
apply  to  taxable  terminations  or  taxable  distributions  from  a 
trust.  This  means  that  a  transfer  excluded  from  GST  tax  when  made 
by  a  direct  gift  or  bequest  would  be  subjected  to  GST  tax  if  made 
through  a  trust  distribution.  The  most  common  situation  affected 
by  this  limitation  on  the  exclusion  is  if  the  transferor  wishes  to 
establish  a  trust  to  pay  Income  to  a  charity  for  a  specified  number 
of  years,  and  then  distribute  the  remainder  to  his  or  her  heirs. 
This  situation  is  Illustrated  in  Figure  4. 


Figure  4.   Transfer  Through  Charitable  Trust  Termination 


T's  child 
Deceased 


Charitable  Trust: 

1.  Charitable  distributions 
for  term  of  years 

2.  Remainder  to  grandchild 


T's 
grandchild 


Gift  or  bequest  to 
grandchild  following 
termination  of  charitable 
trust.   Even  though 
grandchild's  parent  is  dead 
at  time  of  transfer,  current 
law  treats  this  as  a  "skip". 


The  creation  of  a  charitable  lead  trust,  no  matter  how  short 
in  duration  it  may  be,  has  the  effect  of  disqualifying  this 
transfer  from  the  predeceased  parent  exclusion.  If  a  member  of  the 


1781 


generation  Immediately  succeeding  the  transferor  (a  child,  as  the 
law  stands  now,  or  a  niece  or  nephew  if  changed  to  cover 
collaterals)  dies  before  the  trust  is  created  and  therefore  never 
has  an  interest  in  the  trust,  it  is  inconsistent  with  the  objective 
of  the  predeceased  parent  exclusion  to  impose  the  tax.  Just  as  in 
the  case  of  a  direct  skip,  there  is  no  tax  avoidance  and  no  abuse. 

I  have  suggested  in  my  treatise  on  estate  planning  a  way  to 
avoid  the  imposition  of  the  GST  tax  here  while  accomplishing  the 
same  result.  A  portion  of  the  property  could  be  distributed 
outright  to  the  charity,  so  as  to  produce  the  same  charitable 
deduction  available  under  the  charitable  lead  trust  approach,  and 
the  balance  of  the  property  would  be  distributed  to  the  grandchild. 
See  Casner  &  Pennell,  Estate  Planning  S  IIA.4.3  n.lO  (Supp.  1993). 
This  alternative  plan  would  qualify  for  the  predeceased  parent 
exclusion  under  current  law.  However,  with  certain  types  of 
property,  an  outright  gift  to  the  charity  may  not  be  viable.  For 
example,  because  of  the  difficulty  of  fragmenting  ownership  of  a 
closely-held  business,  the  transferor  may  abandon  the  charitable 
gift  entirely. 

Given  Congress'  recognition  of  the  charitable  lead  trust  as  a 
desirable  mechanism  to  encourage  transfers  that  benefit  charity, 
the  GST  tax  should  not  produce  dramatically  different  results  based 
upon  the  manner  In  which  the  transferor  chooses  to  benefit  the 
charity.  Because  no  abuse  exists  under  either  planning  approach, 
no  tax  policy  justification  appears  to  support  imposition  of  the 
GST  tax  in  the  case  presented  in  Figure  4,  but  not  under  the 
available  planning  alternative. 

Furthermore,  conditioning  the  applicability  of  the  predeceased 
parent  exclusion  on  whether  the  transfer  is  direct  or  indirect 
seems  inconsistent  with  the  overall  design  of  the  GST  law.  As  with 
the  limitation  of  the  exclusion  to  lineal  descendants,  the 
limitation  to  direct  skips  was  most  likely  an  oversight.  The 
legislative  history  of  the  GST  statute  shows  that  Congress  sought 
to  eliminate  differences  in  treatment  between  direct  and  indirect 
transfers.  See  Staff  of  Joint  Comm.  on  Tax'n,  99th  Cong.,  2d 
Sess.,  General  Explanation  of  the  Tax  Reform  Act  of  1986  at  1263. 
The  predeceased  parent  exclusion  does  not  fully  achieve  that  goal 
as  currently  written,  and  the  recommended  legislative  changes  would 
eliminate  the  disparity. 

I  respectfully  urge  the  Subcommittee's  favorable  consideration 
of  amendments  to  the  GST  tax  to  extend  the  predeceased  parent 
exclusion  to  cover  both  collateral  heirs  and  trust  distributions 
and  terminations.  In  making  this  recommendation,  I  am  joined  by 
many  of  my  professional  colleagues  in  the  estate  and  gift  tax 
field,  including  members  of  the  Real  Property,  Probate  and  Trust 
Law  Section  of  the  American  Bar  Association. 

I  again  express  my  gratitude  to  the  members  of  the 
Subcommittee  for  the  opportunity  to  testify  in  support  of  these 
needed  changes  in  the  GST  tax  law,  and  I  would  be  pleased  to  answer 
any  questions. 


1782 

Mr.  Jacobs.  Mr.  Hinelv,  Mr.  Gibbons  wanted  to  ask  you  some 
questions  about  your  problem  and  he  had  to  run  down  to — ^no,  I 
tnink  he  flew — down  to  Florida  to  have  that  meeting,  I  guess,  with 
the  President  today.  So  here  are  the  questions. 

Are  you  ready?  We  have  a  professor.  Are  you  ready  to  take  a 
quiz. 

Mr.  HiNELY.  Yes,  sir,  I  am  ready.  If  I  am  not,  I  shouldn't  be  here, 

Mr.  Jacobs.  Let's  see  if  I  am  prepared  to  give  it  here. 

Question.  Treasury  has  taken  the  position  that  imposing  and  col- 
lecting an  excise  tax  such  as  the  one  proposed,  I  guess  on  the  car- 
bon dioxide,  would  impose  substantial  complexities  and  administra- 
tive costs.  As  a  businessman,  are  you  aware  of  any  recordkeeping 
that  would  be  required,  that  is  not  already  done,  to  trace  the  sales 
of  carbon  dioxide  by  ethanol  producers? 

And,  second,  as  a  businessman,  do  you  think  the  ultimate  tax 
remedy  would  be  many  more  complex  or  administrative  burdens 
that  some  of  the  other  Tax  Code  provisions  with  which  you  might 
be  familiar? 

Of  course,  the  second  one  answers  itself,  but 

Mr.  HiNELY,  Mr.  Chairman,  I  can't — to  me,  it  is  such  a  straight- 
forward simple  answer.  It  is  so  simple,  it  defies,  probably,  expla- 
nation. 

Any  businessman,  and  especially  filling  out  a  tax  form,  has  to  re- 
port income,  revenue,  so  forth,  salary  and  bonuses,  everything.  And 
in  our  business  we  report,  the  company  reports  its  income  as  reve- 
nue. Well,  there  is  a  bottom  line  there,  and  every  month  every  com- 
pany knows  the  total  production  of  its  tonnage  production  in  a 
year. 

Mv  company,  say,  produces  160,000  tons  of  CO2  a  year.  That  is 
the  bottom  line.  Average  price  of  $76.00.  And  the  six  or  eight  etha- 
nol companies,  who  are  making  and  selling  CO2,  they  have  this  in- 
formation. It  is  there,  and  they  can  just  simply  put  it  on  the  bottom 
of  the  tax  form,  the  tonnage  produced  and  tax  it  $15  per  ton. 

They  don't  have  to  keep  any  additional  records.  They  have  the 
information.  They  are  not  going  to  go  out  here  and  chase  around 
all  the  buyers  and  consumers  and  the  bottlers  that  buy 
carbonation. 

Thev  have  that  information  on  their  financial  statement.  It  is 
straightforward  there.  It  is  very  simple. 

And  due  to  the  complexities  of  the  problems  they  are  causing, 
whatever  it  took  to  do  it,  like  I  say  again,  in  the  sense  of  fairness 
and  everything,  I  think  this  is  an  unfair  thing  upon  my  industry. 
We  are  just  talking  about  taxing  the  ethanol  producers  now  that 
sell  CO2.  Not  all  of  them  are  selling  CO2. 

When  they  are  taking  that  tax-subsidized  product  and  making 
another  one  and  selling  it  and  going  out  and  wreaking  havoc — -I 
have  a  bottler  down  in  Charlotte  just  a  few  months  ago.  I  went 
down  and  cut  my  price  $40.  I  told  him  I  can't  meet  that  price,  and 
I  explained  the  situation.  He  says:  "You  mean,  they  are  getting 
theirs  for  free,  this  product  free  from  the  tax  subsidy? 

He  said:  'Well,  he  would  write  his  Senator."  I  said:  "You  can 
write  him,  but,"  I  said,  "he  is  from  a  tax  subsidy  State  and  he  is 
not  going  to  hear  you." 

Mr.  Jacobs.  Let's  try  the  second  question.  There  are  four  in  all. 


1783 

Your  written  statement  says  you  do  not  propose  any  particular 
solution  to  the  problem.  The  committee  has  before  it  a  concrete  and 
precise  proposal  to  impose  a  tax  of  $15  per  ton  excise  tax  on  the 
sales  of  carbon  dioxide  by  ethanol  producers.  Where  did  that  num- 
ber come  from  and  would  it  solve  the  problem? 

Mr.  HiNELY.  That  number  is  a  minimum.  Our  cost  when  we  go 
to  buy  CO2  from  an  anhydrous  ammonia  or  DuPont  over  here  in 
Richmond  where  they  make  acatylar  from  an  acid  neutral  solution, 
we  pay  them  a  "royalty,"  we  call  it,  for  the  raw  gas.  And  that  raw 
gas  runs  from,  right  now,  $13  to  $23. 

We  pay  Shell  off  the  pipeline  in  Mississippi  up  to  $23  a  ton.  $15 
is  a  minimum  number.  I  mean  that  is  the  cost  of  the  raw  gas,  and, 
besides  the  manufacturers  of  the  ethanol,  they  are  even  getting  a 
free  ride  because  the  same  people  producing  the  ethanol  are  pro- 
ducing the  CO2  on  the  side. 

They  don't  even  have  a  dollar,  a  dollar-and-a-half  labor  cost.  And 
incorporated  in  that  is  their  electricity  cost  they  have  thrown  in, 
too.  They  have  a  free  ride  all  the  way. 

So  $15,  we  are  just  saying  tax  it,  at  least  that  much,  that  is  all. 
Or  I  can  turn  it  around  and  say  I  am  not  here  for  a  handout,  but 
how  about  allowing  me  a  $5  tax  credit  then  to  level  the  playing 
field? 

I  would  be  glad  to  put  down  my  160,000  tons  a  year,  plus  a  $5 
tax  credit  on  that.  That  would  be  fine. 

But  I  am  bringing  to  the  Congress  a  method  to  raise  more  in- 
come, and  in  fairness,  that  is  all.  You  don't  have  many  people  com- 
ing in  here  and  saying  here  are  the  means  to  correct  a  terrible 
travesty.  And,  to  me,  for  free  enterprise,  I  have  never  seen  any- 
thing like  this. 

It  is  unbelievable.  I  guess  I  get  very  emotional  about  this  thing. 
Of  course,  when  you  have  something  you  have  been  working  at  it 
for  nearly  40  years,  you  get  emotional  about  it. 

Mr.  Jacobs.  Well,  Mr.  Hinely,  you  are  a  very  special  person  in 
more  ways  than  just  proposing  new  revenues. 

The  third  question  is,  and  this  is  a  Sam  Gibbons-type  question 
the  way  it  is  put. 

Mr.  Hinely.  Yes,  I  know  Sam. 

Mr.  Jacobs.  Yes.  When  did  the  carbon  dioxide  industry  first 
bring  the  existence  of  this  problem  to  the  attention  of  the 
Congress?  How  bad  was  the  problem  then?  How  bad  is  it  now?  And 
here  we  want  a  revelation.  And  how  much  worse  can  it  get  before 
it  is  too  late? 

Mr.  Hinely.  That  is  a  good  question.  Good  question. 

Mr.  Jacobs.  Mr.  Gibbons'  question. 

Mr.  Hinely.  When  the  ethanol  manufacturers  in  Illinois  and 
Iowa  started  this  6  or  7  years  ago,  when  they  started  to  get  this 
tax  credit  for  the  ethanol  makers,  they  found  out,  somebody,  they 
could  make  CO2  plants  and  sell  another  product.  Of  course,  they 
were  only  penetrating  the  Midwest,  the  Chicago  and  Midwest  mar- 
ket, and  it  was  not  touching  me  in  the  Southeast  until  the  last  cou- 
ple of  years. 

But  when  it  really  got  my  attention  and  really  had  an  impact  on 
me,  when  Julius  Rubin  here,  a  carbon ater  who  operates  in  New 
York  and  Pennsylvania,  4  years  ago  he  had  to  sell  his  business.  He 


1784 

could  not  compete  against  it.  I  said,  Julius,  this  is  not  right,  we 
should  do  something  about  it. 

Through  our  association,  we  have  been  battling  and  fighting,  but 
we  just  nave  not  been  able  to  get  to  first  base.  This  is  a  small 
thing.  And  a  lot  of  people — the  (JO2  industry  is  not  a  large,  a  half- 
billion-dollar  industry.  Probably  supports  4,000  families,  we  esti- 
mate. And  not  large.  But,  still,  however  large  and  however  small, 
a  great  injustice  has  been  brought  onto  the  free  enterprise  system 
and  it  can  be  easily  corrected  by  charging  either  $15— and  as  far 
as  administrating  it,  that  is  the  simplest  thing.  They  can  report  x 
number  of  tons  sold  a  year  and  put  15  times  that.  I  would  like  to 
have  the  responsibility  of  doing  it. 

Did  that  answer  your  question,  sir? 

Mr.  Jacobs.  No,  it  does  not.  That  answers  Mr.  Gibbons'  ques- 
tions. 

Mr.  HiNELY.  Oh,  all  right.  But  when  Mr.  Rubin,  when  he  went 
out  of  business,  that  got  all  our  attention  in  the  association  and  we 
started  talking  about  it. 

But  since  then,  in  the  last  2  years,  they  have  penetrated,  sending 
product  from  Illinois,  Illinois  to  Florida,  and  still  competing  like 
that  against  me  down  there  and  it  is  unbelievable.  I  cannot  com- 
pete against  that. 

Mr.  Jacobs.  Mr.  Hinely,  this  is  supposed  to  be  a  quiz  and  it  is 
beginning  to  look  like  a  final  exam. 

Mr.  Hinely.  I  am  happy  to  have  it.  I  am  delighted  to  have  this 
occasion,  and  I  want  to  thank  you  again. 

Mr.  Jacobs.  Don't  thank  me.  There  is  one  more  question  here. 

Mr.  Hinely.  OK,  yes,  sir.  Shoot. 

Mr.  Jacobs.  Don't  thank  me,  you  can  flunk  yet,  I  don't  know.  So 
far  you  have  an  "A." 

The  final  question  is,  and  I  am  quoting  Mr.  Gibbons,  I  know  you 
have  not  gone  this  far  in  your  testimony,  but  wouldn't  one  solution 
to  your  problem  simply  be,  and  you  notice  Mr.  Gibbons  does  not 
split  his  infinitive  here,  simply  be  to  repeal  the  ethanol  subsidies 
which  are  causing  the  problem? 

Mr.  Hinely.  That  is  a  loaded  question. 

Mr.  Jacobs.  I  know. 

Mr.  Hinely.  That  would  be  a  simple  thing  to  stop  a  lot  of  these 
subsidies.  As  far  as  a  businessman,  we  don't  need  them,  period. 
But  I  know  when  you  tell — when  you  are  going  up  against  that 
group,  forget  it.  That  is  like  asking  me  to  get  a  group  together  and 
move  the  Rock  of  Gibraltar  and  put  it  in  the  New  York  Harbor,  be- 
cause we  have  already  ran  up  against  that.  Because  the  people  who 
have  won  the  subsi(w  have  roots  into  the  statehouse,  the  White 
House,  Capitol  Hill.  You  can  forget  that  one. 

We  would  like  to  see  them  eliminate,  yes,  eliminate  the  subsidy 
to  that,  but  they  are  trying  to  help  the  farmers.  And  I  have  no 
problem  with  helping  the  farmers,  but  give  it  to  the  farmers.  Don't 
give  it  to  giant  $3.5  billion  corporations.  And  the  thing  about  it, 
there  are  two  other  big  firms — and  I  will  mention  the  names — 
Cargill — is  starting  up  in  Iowa.  They  are  getting  into  this  business, 
and  there  will  be  one  or  two  others. 

This  is  going  to  get  worse.  This  is  going  to  get  worse.  And  if  we 
don't  start  doing  something  about  seeking  relief,  like  I  say,  in  3  or 


1785 

4  years,  I  will  be  sitting  back  there  with  Mr.  Rubin.  I  will  be  out 
at  the  lake  fishing  there,  but  I  won't  have  much  to  fish  with,  and 
I  have  worked  hard  for  what  I  have. 

Mr.  Jacobs.  You  know  something,  I  am  not  so  sure  you  couldn't 
make  more  money  on  television  on  one  of  these  night  talk  shows. 

Mr.  HiNELY.  Well,  they  said  I  should  go  into  politics.  I  had  din- 
ner with 

Mr.  Jacobs.  Plus,  you  could  carry  on  this  business  and  do  that, 
because  that,  quite  literally,  is  moonlighting  on  a  clear  night. 

Mr.  HiNELY.  I  have  enough  faith  in  my  government.  This  has 
really  shaken  me. 

Mr.  Jacobs.  Well,  I  think  you  make  out  a  very  strong  case. 

Mr.  HiNELY.  I  couldn't  believe,  in  the  sense  of  fairness,  some- 
thing— they  ought  to  do  something  about  it,  and  they  will  do  some- 
thing. I  thmk  an  enlightened  Congress,  knowing  all  the  facts  about 
this  thing,  will  correct  it.  I  have  that  much  confidence. 

Mr.  Jacobs.  Well,  I  hope  so.  I  think  you  are  right. 

Mr.  HiNELY.  And  I  appreciate  very  much  you  and  the  committee 
taking  the  opportunity  and  the  time  to  listen  to  me. 

Mr.  Jacobs.  I  will  say  this,  if  you  have  not  enlightened  the 
Congress  through  the  record,  I  don't  believe  anybody  could. 

Mr.  HiNELY.  Thank  you,  sir,  and  I  will  be  glad  to  come  back  and 
face  them  all. 

Mr.  Jacobs.  Do  you  know  Jake  Pickle? 

Mr.  HiNELY.  Who? 

Mr.  Jacobs.  Jake  Pickle,  the  Congressman  from  Texas.  He  used 
to  be  LBJ's  Congressman. 

Mr.  HiNELY.  No,  sir. 

Mr.  Jacobs.  You  should  get  to  know  him,  because  I  believe  you 
are  related  some  way  or  another. 

Mr.  HiNELY.  Why,  he  talks  as  much  as  I  do? 

Mr.  Jacobs.  Yes,  sir,  and  he  has  a  lot  of  good  one-liners,  too. 

Mr.  HiNELY.  No,  sir,  I  don't  know  him.  I'm  from  Florida.  Bom 
and  reared  in  Miami  and  moved  to  Orlando  when  it  was  just  a 
small  sleepy  little  town. 

Mr,  Jacobs.  Some  great  grandfather  might  have  been  a  traveling 
salesman,  you  don't  know. 

Mr.  HiNELY.  That  is  what  my  wife  calls  me. 

Mr.  Jacobs.  You  said  that  what  you  got  out  of  it  when  you  got 
out  of  the  service.  And  I  used  to  say  that  I  was  in  the  Marine 
Corps  for  2  years,  in  infantry  combat  for  1,  and  I  finally  got  out 
of  it  what  I  wanted:  Me. 

So  we  thank  you  for  your  contribution. 

Mr.  HiNELY.  I  am  having  my  50th  anniversary.  I  joined  a  Port- 
able Surgical  Hospital  50  years  ago  this  week  in  New  Orleans.  In 
fact,  we  are  having  our  50th  anniversary  reunion  week  after  next 
in  Orlando.  Out  of  33  men,  there  are  still  16  of  us  left,  and  two 
of  the  four  officers. 

But  as  I  said,  I  came  back  in  1946  to  go  in  business  and  I  had 
all  the  confidence  in  the  world  and  in  our  country  and  a  fi*ee  de- 
mocracy, free  enterprise.  But  up  to  now,  with  all  this  happening, 
I  have  Deen  a  bit  shaken,  and  thanks  again  for  listening  to  me. 

Mr.  Jacobs.  Well,  I  find  your  testimony  particularly  tasteful,  be- 
cause I  just  finished  reading  Mr.  Halbersam's  new  book  on  the 


1786 

1950s,  and  what  happened  to  the  people  that  came  out  of  World 
War  II,  and  it  is  a  pleasure  to  meet  one. 

Mr.  HiNELY.  In  fact,  I  might  write  one.  Everyone  else  is  doing  it. 
You  know  what  it  would  be: 

The  demise  of  the  American  entrepreneurs.  That  is  what  I  would 
write. 

Mr.  Jacobs.  Yes,  sir. 

Mr.  Hesiely.  Thank  you  again,  sir. 

Mr.  Jacobs.  Thank  you,  sir.  A+.  We  thank  you  for  your  testi- 
mony. You  identify  with  precision  and  logic,  I  think,  something 
that  makes  a  lot  of  sense. 

And,  Mr.  Maheu,  as  far  as  R&D  credits  are  concerned,  you  know 
the  majority  of  the  Ways  and  Means  Committee  have  been  strong 
in  support,  and  if  I  understood  your  testimony  right.  You  are  argu- 
ing for  certaincy. 

Mr.  Maheu.  And  inclusion  of  certain  items  that  are  in  question. 

Mr.  Jacobs.  Yes,  I  understood  that.  too. 

My  father  was  a  lawyer  and  a  judge,  and  he  used  to  say  every 
time  the  Indiana  General  Assembly  met,  it  repealed  his  education. 
So  I  think  there  is  something  to  be  said  for  the  certainty  of  law. 
Even  a  law  that  is  not  entirely  just  right,  it  usually  makes  itself 
right  by  practice. 

But  we  thank  you.  It  has  not  only  been  an  edifying  panel  but  it 
has  been  a  gloriously  entertaining  panel.  So  we  thank  you  all  very 
much. 

Mr.  HiNELY.  Thank  you  very  much. 

Mr.  Jacobs.  That  concludes  our  hearing. 

Mr.  HiNELY.  Thank  you,  sir. 

[Whereupon,  at  1:45  p.m.,  the  hearing  was  adjourned.] 

[See  part  3  lor  submissions  for  the  record.] 

O 


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o  y999  05982  500  8 


ISBN   0-16-044369-5 


780160"443695' 


90000