- REDUCING THE TAX BURDEN

[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]

REDUCING THE TAX BURDEN

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

HEARING

before the

COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

FIRST SESSION

__________

JUNE 16 AND 23, 1999

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Serial 106-24

__________

Printed for the use of the Committee on Ways and Means

U.S. GOVERNMENT PRINTING OFFICE
60-332 CC WASHINGTON : 2000

COMMITTEE ON WAYS AND MEANS

BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida

A.L. Singleton, Chief of Staff

Janice Mays, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.

C O N T E N T S

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Page

ENHANCING RETIREMENT AND HEALTH SECURITY

JUNE 16, 1999

Advisory of June 2, 1999, announcing the hearing................. 2

WITNESSES

American Council of Life Insurance, Jeanne Hoenicke..............
00
American Farm Bureau Federation, Carl B. Loop, Jr................ 182
American Hospital Association, Dan Wilford....................... 91
American Society of Pension Actuaries, Paula A. Calimafde........ 126
Association of Private Pension and Welfare Plans, Jack Stewart... 117
Blue Cross and Blue Shield Association, Mary Nell Lehnhard....... 83
Business Council of New York State, Inc., Paul S. Speranza, Jr... 195
Butler, Stuart, Heritage Foundation.............................. 65
Calimafde, Paula A., American Society of Pension Actuaries,
Profit Sharing/401(k) Council of America, Small Business
Council of America, and Small Business Legislative Council..... 126
Cardin, Hon. Benjamin L., a Representative in Congress from the
State of Maryland.............................................. 40
Coyne, Michael, National Federation of Independent Business and
Tuckerton Lumber Company....................................... 192
Erisa Industry Committee, J. Randall MacDonald................... 139
Florida Farm Bureau Federation, Carl B. Loop, Jr................. 182
Food Marketing Institute, Paul S. Speranza, Jr................... 195
Goodman, John C., National Center for Policy Analysis............ 59
Greater Rochester New York Metro Chamber of Commerce, Paul S.
Speranza, Jr................................................... 195
GTE Corp., J. Randall MacDonald.................................. 139
Health Insurance Association of America, Charles N. Kahn III..... 72
Hill Slater, Inc., Phyllis Hill Slater........................... 176
Hoenicke, Jeanne, American Council of Life Insurance............. 96
Jefferson, Hon. William J., a Representative in Congress from the
State of Louisiana............................................. 43
Johnson, Hon. Nancy L., a Representative in Congress from the
State of Connecticut........................................... 20
Kahn, Charles N., III, Health Insurance Association of America... 72
Lehnhard, Mary Nell, Blue Cross and Blue Shield Association...... 83
Loop, Carl B., Jr., American Farm Bureau Federation, Florida Farm
Bureau Federation, and Loop's Nursery and Greenhouses, Inc..... 182
McCarthy, Jim, Merrill Lynch & Co., Inc., and Savings Coalition
of America..................................................... 152
MacDonald, J. Randall, GTE Corp., and Erisa Industry Committee... 139
Market Basket Food Stores, Skylar Thompson....................... 187
Memorial Hermann Healthcare System, Dan Wilford.................. 91
Merrill Lynch & Co., Inc., Jim McCarthy.......................... 152
National Association of Manufacturers, Ronald P. Sandmeyer, Jr... 178
National Association of Women Business Owners, Phyllis Hill
Slater......................................................... 176
National Center for Policy Analysis, John C. Goodman............. 59
National Federation of Independent Business, Michael Coyne....... 192
National Grocers Association, Skylar Thompson.................... 187
Pomeroy, Hon. Earl, a Representative in Congress from the State
of North Dakota................................................ 46
Portman, Hon. Rob, a Representative in Congress from the State of
Ohio........................................................... 30
Principal Financial Group, Jack Stewart.......................... 117
Profit Sharing/401(k) Council of America, Paula A. Calimafde..... 126
Sandmeyer, Ronald P., Jr., National Association of Manufacturers
and Sandmeyer Steel Company.................................... 178
Savings Coalition of America, Jim McCarthy....................... 152
Slater, Phyllis Hill, Hill Slater, Inc. and National Association
of Women Business Owners....................................... 176
Small Business Council of America, Paula A. Calimafde............ 126
Small Business Legislative Council, Paula A. Calimafde........... 126
Speranza, Paul S., Jr., Business Council of New York State, Inc.,
Food Marketing Institute, Greater Rochester New York Metro
Chamber of Commerce, and U.S. Chamber of Commerce.............. 195
Stark, Hon. Fortney Pete, a Representative in Congress from the
State of California............................................ 25
Stewart, Jack, Association of Private Pension and Welfare Plans
and Principal Financial Group.................................. 117
Thompson, Skylar, Market Basket Food Stores and National Grocers
Association.................................................... 187
Tuckerton Lumber Company, Michael Coyne.......................... 192
U.S. Chamber of Commerce, Paul S. Speranza, Jr................... 195
Wilford, Dan, American Hospital Association and Memorial Hermann
Healthcare System.............................................. 91

SUBMISSIONS FOR THE RECORD

Aetna Retirement Services, Hartford, CT, Thomas McInerney,
statement...................................................... 210
America's Community Bankers, statement and attachment............ 212
American Bankers Association, statement.......................... 226
American Federation of State, County and Municipal Employees, Ed
Jayne; College and University Personnel Association, Ned Gans;
Fraternal Order of Police, Tim Richardson; Government Finance
Officers Association, Tom Owens; International Association of
Fire Fighters, Barry Kasinitz; International Brotherhood of
Police Organizations, Chris Donnellan; International City/
County Management Association, Michael Lawson; International
Personnel Management Association, Tina Ott; International Union
of Police Associations, Kimberly Nolf; National Association of
Government Deferred Compensation Administrator, Susan White;
National Association of Government Employees, Chris Donnellan;
National Association of Counties, Neil Bomberg; National
Association of Police Organizations, Bob Scully; National
Association of State Retirement Administrators, Jeannine Markoe
Raymond; National Association of Towns and Townships, Jennifer
Balsam; National Conference on Public Employee Retirement
Systems, Ed Braman; National Conference of State Legislatures,
Gerri Madrid; National Council on Teacher Retirement, Cindie
Moore; National Education Association, David Bryant; National
League of Cities, Frank Shafroth; National Public Employer
Labor Relations Association, Roger Dahl; Service Employees
International Union, Clint Highfill; and United States
Conference of Mayors, Larry Jones; joint letter................ 229
AMR Corporation, Ft. Worth, TX, statement........................ 230
Associated General Contractors of America, statement............. 233
Certified Financial Planner Board of Standards, Denver, CO,
statement...................................................... 235
Committee To Preserve Private Employee Ownership, statement...... 236
ESOP Association, J. Michael Keeling, statement.................. 240
ESOP Coalition, Somerset, NJ, statement.......................... 242
Financial Planning Coalition, statement and attachments.......... 243
Food Marketing Institute, statement.............................. 248
Investment Company Institute, statement.......................... 250
National Association of Manufacturers, statement................. 255
National Association of Professional Employer Organizations,
Alexandria, VA, statement and attachment....................... 256
National Newspaper Association, Arlington, VA, Kenneth B. Allen,
statement and attachments...................................... 262
Private Citizen, St. Louis, MO, statement........................ 264
Thomas, Hon. William M., a Representative in Congress from the
State of California, statement................................. 268
__________

PROVIDING TAX RELIEF TO STRENGTHEN THE FAMILY AND SUSTAIN A STRONG
ECONOMY

JUNE 23, 1999

Advisory of June 9, 1999, announcing the hearing................. 272

WITNESSES

Alliance to Save Energy, David Nemtzow........................... 439
American Bankers Association, Larry McCants...................... 390
American Council for Capital Formation, Mark Bloomfield.......... 377
American Forest and Paper Association, Hon. W. Henson Moore...... 427
Andrews, Hon. Michael A., National Trust for Historic
Preservation................................................... 431
Associated Builders and Contractors, Inc., Eric P. Wallace....... 448
Baird, Hon. Brian, a Representative in Congress from the State of
Washington..................................................... 312
Baratta, Jeffrey A., Stone & Youngberg, LCC and California-
Federal School Infrastructure Coalition........................ 349
Baroody, Michael E., National Association of Manufacturers....... 366
Bennett, Hon. Marshall, Mississippi State Treasurer, Mississippi
Prepaid Affordable College Tuition Plan, and College Savings
Plans Network.................................................. 331
Bloomfield, Mark, American Council for Capital Formation......... 377
Building Owners and Managers Association International, Arthur
Greenberg...................................................... 395
California-Federal School Infrastructure Coalition, Jeffrey A.
Baratta........................................................ 349
Capps, R. Randall, Electronic Data Systems Corporation and R&D
Credit Coalition............................................... 372
Clement, Hon. Bob, a Representative in Congress from the State of
Tennessee...................................................... 315
Coalition for Employment Security Financing Reform, Hon. Robert
``Bob'' A. Taft, Governor of Ohio.............................. 276
Coalition for Energy Efficient Homes, David Nemtzow.............. 439
Coalition of Publicly Traded Partnerships, Charles H. Leonard.... 403
College Savings Plans Network, Hon. Marshall Bennett............. 331
Crowley, Hon. Joseph, a Representative in Congress from the State
of New York.................................................... 316
Danner, Hon. Pat, a Representative in Congress from the State of
Missouri....................................................... 297
Detwiler Foundation Computers and Schools Program, Jerry Grayson. 343
Eagle-Picher Personal Injury Settlement Trust:
Ruth R. McMullin............................................. 454
Roosevelt Henderson.......................................... 456
Electronic Data Systems Corporation, R. Randall Capps............ 372
Equity Group Investments, Arthur Greenberg....................... 395
First National Bank, Larry McCants............................... 390
Gillespie, Christina, M.D., Tufts University School of Medicine,
and National Health Service Corps Scholarship.................. 346
Graham, Hon. Lindsey O., a Representative in Congress from the
State of South Carolina........................................ 301
Grayson, Jerry, Detwiler Foundation Computers for Schools Program 343
Greenberg, Arthur, Equity Group Investments, National Realty
Committee, National Association of Real Estate Investment
Trusts, National Association of Realtors, National Association
of Industrial and Office Properties, International Council of
Shopping Centers, National Multi-Housing Council/National
Apartment Association, and Building Owners and Managers
Association International...................................... 395
Henderson, Roosevelt, Eagle-Picher Personal Injury Settlement
Trust.......................................................... 456
Hulshof, Hon. Kenny, a Representative in Congress from the State
of Missouri.................................................... 299
International Council of Shopping Centers, Arthur Greenberg...... 395
Kepple, Thomas, Jr., Juniata College and Tuition Plan Consortium. 339
Leonard, Charles H., Texas Eastern Products Pipeline Company and
Coalition of Publicly Traded Partnerships...................... 403
McCants, Larry, First National Bank, and American Bankers
Association.................................................... 390
McIntosh, Hon. David, M. a Representative in Congress from the
State of Indiana............................................... 309
McMullin, Ruth, R. Eagle-Picher Personal Injury Settlement Trust. 454
Mississippi Prepaid Affordable College Tuition Plan, Hon.
Marshall Bennett............................................... 331
Moore, Hon. W. Henson, American Forest and Paper Association..... 427
National Alliance of Sales Representatives Associations, Michael
A. Wolyn....................................................... 425
National Association of Industrial and Office Properties, Arthur
Greenberg...................................................... 395
National Association of Manufacturers, Michael E. Baroody........ 366
National Association of Real Estate Investment Trusts, Arthur
Greenberg...................................................... 395
National Association of Realtors, Arthur Greenberg............... 395
National Multi-Housing Council/National Apartment Association,
Arthur Greenberg............................................... 395
National Realty Committee, Arthur Greenberg...................... 396
National Trust for Historic Preservation, Hon. Michael A. Andrews 431
Nemtzow, David, Alliance to Save Energy.......................... 439
New York City Board of Education:................................
Lewis H. Spence.............................................. 354
Patricia Zedalis............................................. 354
Rangel, Hon. Charles B., a Representative in Congress from the
State of New York.............................................. 289
R&D Credit Coalition, R. Randall Capps........................... 372
Spence, Lewis H., New York Board of Education, as presented by
Patricia Zedalis............................................... 354
Stone & Youngberg, LLC, Jeffrey A. Baratta....................... 352
Taft, Hon. Robert ``Bob'' A., Governor of Ohio and Coalition for
Employment Security Financing Reform........................... 276
Texas Eastern Products Pipeline Company, Charles H. Leonard...... 403
Tuition Plan Consortium, Thomas Kepple, Jr....................... 339
Turner, Hon. Jim, a Representative in Congress from the State of
Texas.......................................................... 303
Wallace, Eric P., Associated Builders and Contractors, Inc....... 448
Wolyn, Michael A., National Alliance of Sales Representatives
Association.................................................... 435
Weller, Hon. Jerry, a Representative in Congress from the State
of Illinois.................................................... 293
Zedalis, Patricia, New York City Board of Education.............. 354

SUBMISSIONS FOR THE RECORD

America's Community Bankers, statement........................... 462
American Association of Colleges of Osteopathic Medicine, Chevy
Chase, MD, and Association of American Medical Colleges, joint
statement...................................................... 00
American Association of Engineering Societies, Theodore T. Saito,
letter and attachments.........................................
.................................................................
American Wind Energy Association, Jaime C. Steve, statement...... 00
AMT Coalition for Economic Growth, statement..................... 00
Arnold, Kristine S., National Rural Health Association, and
University of Health Sciences, College of Osteopathic Medicine,
Kansas City, MO, joint statement............................... 00
Ashe, Hon. Victor, Mayor, City of Knoxville, Tennessee, statement 00
Association of American Medical Colleges, joint statement........ 00
Blue, Hon. Daniel T., Jr., National Conference of State
Legislatures, letter........................................... 00
California Community Colleges, Sacramento, CA, Thomas J.
Nussbaum, letter (forwarded by Hon. Robert T. Matsui, a
Representative in Congress from the State of California)....... 00
Columbia, City of, South Carolina, Hon. Robert Coble, Mayor, and
Hon. Stephen Creech, Mayor, City of Sumter, South Carolina,
joint statement................................................ 00
Construction Financial Management Association, Princeton, NJ,
statement...................................................... 00
Coverdell, Hon. Paul D., a United States Senator from the State
of Georgia, statement.......................................... 00
Creech, Hon. Stephen, Mayor, City of Sumter, South Carolina,
joint statement................................................ 00
CSW Renewable Energy, Central & South West Corporation, Dallas,
TX, Richard P. Walker, statement............................... 00
Enron Wind Corp., Tehachapi, CA, Kenneth C. Karas, statement..... 00
Fraim, Hon. Paul D., Mayor, City of Norfolk, Virginia, statement
and attachment................................................. 00
Gallegly, Hon. Elton, a Representative in Congress from the State
of California, statement....................................... 00
Gary, City of, Indiana, Hon. Scott L. King, Mayor, statement..... 00
Goldstein, David, Natural Resources Defense Council, San
Francisco, CA, statement....................................... 00
Higher Education Community: Accrediting Association of Bible
Colleges, American Association of Community Colleges, American
Association of Dental Schools, American Association of
Presidents of Independent Colleges, American Association of
State Colleges and Universities, American Council on Education,
Association of Advanced Rabbinical and Talmudic Schools,
Association of American Universities, Association of Community
College Trustees, Association of Governing Boards of
Universities and Colleges, Association of Jesuit Colleges and
Universities, Coalition of Higher Education Assistance
Organizations, Council for Advancement and Support of
Education, Council for Christian Colleges & Universities,
Council of Graduate Schools, Council of Independent Colleges,
National Association for Equal Opportunity in Higher Education,
National Association of College and University Business
Officers, National Association of Independent Colleges and
Universities, National Association of Schools and Colleges of
the United Methodist Church, National Association of Student
Financial Aid Administrators, North American Division of
Seventh-Day Adventists, and Mennonite Board of Education, joint
statement......................................................
IRA Charitable Rollover Working Group, Evanston, IL: American
Arts Alliance, American Association of Museums, American Bar
Association, American Council on Education, American Heart
Association, American Hospital Association, American Institute
for Cancer Research, American Red Cross, Association for
Healthcare Philanthropy, Association of American Universities,
Association of Art Museum Directors, Association of Jesuit
Colleges and Universities, Baptist Joint Committee, CARE, Inc.,
Catholic Health Association, Charitable Accord, Council for the
Advancement and Support of Education, Council on Foundations,
Council of Jewish Federations, Goodwill Industries
International, Independent Sector, National Association of
Independent Colleges and Universities, National Association of
Independent Schools, National Committee on Planned Giving,
National Health Council, National Multiple Sclerosis Society,
National Society of Fund Raising Executives, Salvation Army,
and United Way of America, joint statement and attachments..... 00
Jerardi, Maria J., Washington, DC, statement..................... 00
Karas, Kenneth C., Enron Wind Corp., Tehachapi, CA, statement.... 00
King, Hon. Scott L., Mayor, City of Gary, Indiana, statement..... 00
Knoxville, City of, Tennessee, Hon. Victor Ashe, Mayor, statement 00
Mannweiler, Hon. Paul S., National Conference of State
Legislatures, letter........................................... 00
Matsui, Hon. Robert T., a Representative in Congress from the
State of California, letter and attachment (forwarding letter
of California Community Colleges, Sacramento, CA).............. 00
National Association of Home Builders, statement................. 00
National Association of Real Estate Investment Trusts, Steven A.
Wechsler, statement............................................ 00
National Coalition for Public Education: American Association of
Educational Service Agencies, American Association of School
Administrators, American Association of University Women,
American Civil Liberties Union, American Federation of State,
County and Municipal Employees, American Federation of
Teachers, American Humanist Association, American Jewish
Committee, American Jewish Congress, Americans for Religious
Liberty, Americans United for Separation of Church and State,
Council of Chief State School Officers, Council of the Great
City Schools, Mexican American Legal Defense and Education
Fund, National Association of Elementary School Principals,
National Association of School Psychologists, National
Association of State Boards of Education, National
Association of State Directors of Special Education, National
Education Association, National PTA, National Rural Education
Association, National School Boards Association, New York
City Board of Education, People for the American Way, Service
Employees International Union AFL-CIO, Union of American
Hebrew Congregations, Unitarian Universalist Association,
United Auto Workers International Union, and Women of Reform
Judaism, joint letter 00
National Coalition for Public Education, and Rebuild America's
Schools Coalition, joint statement and attachment.............. 00
National Conference of State Legislatures, Hon. Daniel T. Blue,
Jr., and Hon. Paul S. Mannweiler, letter....................... 00
National Council of Farmer Cooperatives, statement............... 00
National Education Association, statement........................ 00
National Rural Health Association, Kristine S. Arnold, joint
statement...................................................... 00
Natural Resources Defense Council, San Francisco, CA, David
Goldstein, statement........................................... 00
Norfolk, City of, Virginia, Hon. Paul D. Fraim, Mayor, statement
and attachment................................................. 00
Nussbaum, Thomas J., California Community Colleges, Sacramento,
CA, letter (forwarded by Hon. Robert T. Matsui, a
Representative in Congress from the State of California)....... 00
Rebuild America's Schools Coalition, joint statement and
attachment..................................................... 00
Saito, Theodore T., American Association of Engineering
Societies, letter and attachments.............................. 00
Steve, Jaime C., American Wind Energy Association, statement..... 00
Sumter, City of, South Carolina, Hon. Stephen Creech, Mayor,
joint statement................................................ 00
Thomas, Hon. William M., a Representative in Congress from the
State of California, statement................................. 00
U.S. Securities Markets Coalition: American Stock Exchange,
Boston Stock Exchange, Chicago Board Options Exchange, Chicago
Stock Exchange, Cincinnati Stock Exchange, NASDAQ Stock Market,
National Securities Clearing Corporation, Options Clearing
Corporation, Pacific Stock Exchange, and Philadelphia Stock
Exchange, joint statement...................................... 00
Walker, Richard P., CSW Renewable Energy, Central & South West
Corporation, Dallas, TX, statement............................. 00
Wechsler, Steven A., National Association of Real Estate
Investment Trusts, statement................................... 00

ENHANCING RETIREMENT AND HEALTH SECURITY

----------

WEDNESDAY, JUNE 16, 1999

House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to call, at 10:08 a.m., in room
1100 Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]

ADVISORY

FROM THE
COMMITTEE
ON WAYS
AND
MEANS

CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE

June 2, 1999

No. FC-10

Archer Announces Hearing Series on

Reducing the Tax Burden:

I. Enhancing Retirement and Health Security

Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing
series on proposals to reduce the tax burden on individuals and
businesses. It will begin with tax proposals to enhance retirement and
health security, including strengthening retirement plans, improving
availability and affordability of health care, and increasing personal
savings by reducing the tax burden on savings. The hearing will begin
on Wednesday, June 16, 1999, in the main Committee hearing room, 1100
Longworth House Office Building, beginning at 10:00 a.m. The hearing is
expected to continue on additional days, which will be the subject of
supplementary advisories.

Oral testimony at this hearing will be from both invited and public
witnesses. Also, any individual or organization not scheduled for an
oral appearance may submit a written statement for consideration by the
Committee or for inclusion in the printed record of the hearing.

BACKGROUND:

The budget resolution adopted by the House of Representatives and
the Senate on April 15, 1999 (H. Con. Res. 68), directs the Committee
on Ways and Means to report a tax relief package by July 16, 1999.
Although the budget resolution does not provide for any net tax relief
in fiscal year 2000, the tax relief reconciliation bill is to include
up to $142 billion in tax reduction during fiscal years 2000 through
2004 and $778 billion during fiscal years 2000 through 2009.

Along with Social Security, employer-sponsored retirement plans and
personal savings are often viewed as the traditional ``three legged
stool'' of retirement security. However, about 50 million Americans, or
nearly 50 percent of the private sector workforce, are not covered by
an employer-sponsored retirement plan--a rate that has remained
stagnant over the last 25 years. Only about 20 percent of the 40
million Americans employed in businesses with 100 or fewer employees
are participating in a retirement plan. Meanwhile, the personal savings
rate has fallen to a record low of minus 0.7 percent, continuing a
long-term trend. At the same time, health security is a continuing
concern to Americans, with the number of people lacking health
insurance growing to more than 43 million.

In announcing the hearing, Chairman Archer said: ``We have already
set aside the Social Security surplus, about $1.8 trillion, to save and
strengthen Social Security and Medicare, and I am committed to working
with the President and Democrats to find long-term solutions. At the
same time, we have an obligation to American taxpayers to provide tax
relief, because taxes are still too high. It is entirely appropriate
that we begin this process by looking at ways to enhance Americans'
retirement and health security.''

FOCUS OF THE HEARING:

The focus of the first hearing day will be retirement and health
security, including strengthening retirement plans, improving
availability and affordability of health care, and increasing personal
savings by reducing the tax burden on savings. Proposals to be reviewed
include pension reforms, health care incentives, long-term care
incentives, estate and gift tax relief, and savings incentives.

DETAILS FOR SUBMISSIONS OF REQUESTS TO BE HEARD:

Requests to be heard at the hearing must be made by telephone to
Traci Altman or Pete Davila at (202) 225-1721 no later than the close
of business, Wednesday June 9, 1999. The telephone request should be
followed by a formal written request to A.L. Singleton, Chief of Staff,
Committee on Ways and Means, U.S. House of Representatives, 1102
Longworth House Office Building, Washington, D.C. 20515. The staff of
the Committee will notify by telephone those scheduled to appear as
soon as possible after the filing deadline. Any questions concerning a
scheduled appearance should be directed to the Committee on staff at
(202) 225-1721.

In view of the limited time available to hear witnesses, the
Committee may not be able to accommodate all requests to be heard.
Those persons and organizations not scheduled for an oral appearance
are encouraged to submit written statements for the record of the
hearing. All persons requesting to be heard, whether they are scheduled
for oral testimony or not, will be notified as soon as possible after
the filing deadline.

Witnesses scheduled to present oral testimony are required to
summarize briefly their written statements in no more than five
minutes. THE FIVE-MINUTE RULE WILL BE STRICTLY ENFORCED. The full
written statement of each witness will be included in the printed
record, in accordance with House Rules.

In order to assure the most productive use of the limited amount of
time available to question witnesses, all witnesses scheduled to appear
before the Committee are required to submit 300 copies, along with an
IBM compatible 3.5-inch diskette in WordPerfect 5.1 format, of their
prepared statement for review by Members prior to the hearing.
Testimony should arrive at the Committee office, room 1102 Longworth
House Office Building, no later than June 14, 1999. Failure to do so
may result in the witness being denied the opportunity to testify in
person.

WRITTEN STATEMENTS IN LIEU OF PERSONAL APPEARANCE:

Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Wednesday,
June 30, 1999, to A.L. Singleton, Chief of Staff, Committee on Ways and
Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
public at the hearing, they may deliver 200 additional copies for this
purpose to the Committee office, room 1102 Longworth House Office
Building, by close of business the day before the hearing.

FORMATTING REQUIREMENTS:

Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.

1. All statements and any accompanying exhibits for printing must
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1
format, typed in single space and may not exceed a total of 10 pages
including attachments. Witnesses are advised that the Committee will
rely on electronic submissions for printing the official hearing
record.

2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.

3. A witness appearing at a public hearing, or submitting a
statement for the record of a public hearing, or submitting written
comments in response to a published request for comments by the
Committee, must include on his statement or submission a list of all
clients, persons, or organizations on whose behalf the witness appears.

4. A supplemental sheet must accompany each statement listing the
name, company, address, telephone and fax numbers where the witness or
the designated representative may be reached. This supplemental sheet
will not be included in the printed record.

The above restrictions and limitations apply only to material being
submitted for printing. Statements and exhibits or supplementary
material submitted solely for distribution to the Members, the press,
and the public during the course of a public hearing may be submitted
in other forms.

Note: All Committee advisories and news releases are available on
the World Wide Web at ``http://www.house.gov/ways__means/''.

The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.

Chairman Archer. The Committee will come to order.
The Chair invites guests and staff to take seats so that
the Members can listen to each other.
Good morning to everybody. The Committee today begins
hearing a series on reducing the tax burden on American
families, individuals, and businesses.
The Congressional Budget Office confirms that the tax
burden on our society today is currently at a record peacetime
high at 21 percent of GDP. President Clinton, on the other
hand, claims the average American is paying lower taxes than at
any time since 1976, which may be why he included over $170
billion in new tax hikes in his budget. But most Americans feel
that they pay more taxes today than they have in the past and
not less, which is why Republicans are committed to cutting
taxes so people can keep more of what they earn.
Likewise, I know several of my Democratic friends have
sponsored bills to cut taxes this year, and I look forward to
working with anyone who has a plausible idea for tax relief for
the American people.
Cutting taxes should not be a partisan issue, just as
saving Social Security and Medicare need not and are not
partisan issues. In that light, these hearings will explore
areas where there is bipartisan interest in providing tax
relief. Today's subjects, health and retirement security,
including a look at pensions and the death tax, clearly qualify
in that category.
Next week, we will focus on family tax relief, including
reducing the marriage penalty and helping families and students
pay for the high cost of education, two more areas that have
attracted bipartisan support. We will also look at ways to
boost savings and investments so that more Americans can enjoy
and participate in our strong economy.
This morning, I am releasing two new studies by the
American Council for Capital Formation that show how the
current Tax Code discourages savings and punishes families with
the confiscatory death tax.
On the death tax, the research shows that of 24 major
industrial countries, only Japan's top tax rate of 70 percent,
is higher than the 55-percent rate in the United States. Fifty-
five percent is way too high, and some estates actually pay a
marginal rate of 60 percent. No American, no matter their
income, should be forced to pay the government up to 55 percent
of their savings when they die, a tax that is triggered by one
event, not an economic transaction, one event, the death of the
person who has saved. And that is why we should significantly
reduce, if not eliminate, the death tax; and I ask my
Democratic colleagues to work with me to do that.
The second study is equally disturbing because it
underscores the one problem that Federal Reserve Chairman Alan
Greenspan and most economists agree is a major cloud on our
economic horizon and that is our negative personal savings
rate. Net private savings in this country today are at an all-
time low for the entire history of our country. As we have
learned through our Social Security debate, retirement is a
three-legged stool of personal savings, pensions, and Social
Security. We know that Social Security is facing serious
problems. What makes that problem even more serious is the
other legs of that stool, personal savings and pensions, are
weak and are being weakened further by the Tax Code.
Today I ask that we look at ways to make retirement
security more secure through lower taxes on savings, lower
taxes on investments, and lower taxes on financial assets on
which people depend. Taxes are too high, Americans are paying
too much, and too often our Tax Code punishes Americans who are
trying to do the right thing for themselves and their families.
That is wrong, and we should commit ourselves to working
together to fix that this year.
I truly believe that we can save and strengthen Social
Security this year and Medicare and give Americans the tax
relief they deserve, and I look forward to having the Committee
work together to try to accomplish exactly that.
[The following was subsequently received:]
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UPDATE: An International Comparison of Incentives for Retirement Saving
and Insurance

ACCF Center for Policy Research Special Reports are published
periodically to serve as a catalyst for debate on current economic
policy issues. Contact the ACCF Center for Policy Research for
permission to reprint the Center's Special Reports
The ACCF Center for Policy Research is the education and research
affiliate of the American Council for Capital Formation. Its mandate is
to enhance the public's understanding of the need to promote economic
growth through sound tax, trade, and environmental policies. For
further information, contact the ACCF Center for Policy Research, 1750
K Street, N.W., Suite 400, Washington, D.C. 20006-2302; telephone: 202/
293-5811; fax: 202/785-8165; e-mail: [email protected]; Web site: http://
www.accf.org.
Experts predict that today's federal budget surpluses are likely to
be a relatively short-lived phenomenon. The long-term prosperity of the
United States remains threatened by the prospect of looming budget
deficits arising from the need to fund the retirement of the baby boom
generation in the next century. In addition, the U.S. saving rate
continues to compare unfavorably with that of other nations, as well as
with our own past experience; U.S. net domestic saving available for
investment has averaged only 4.8 percent since 1991 compared to 9.3
percent over the 1960-1980 period. Though the U.S. economy is currently
performing better than the economies of most other developed nations,
in the long run low U.S. saving and investment rates will inevitably
result in a growth rate short of this country's true potential. A
country's saving rate is strongly correlated with its rate of economic
growth, as shown in Figure 1.
[GRAPHIC] [TIFF OMITTED] T0332.027

The ACCF Center for Policy Research presents this special report in
order to stimulate debate on tax policy reforms that could encourage
additional private saving and social security restructuring as well as
the purchase of various types of mutual fund and insurance products to
assist baby boomers as they retire in the twenty-first century.
This report is an analysis of a recent Center-sponsored survey of
the tax treatment of retirement savings, insurance products, social
security, and mutual funds in twenty-four major industrial and
developing countries, including most of the United States' major
trading partners. The survey, compiled for the Center by Arthur
Andersen LLP, shows that the United States lags behind its competitors
in that it offers fewer and less generous tax-favored saving and
insurance products than many other countries. For example:
Life insurance premiums are deductible in 42 percent of
the surveyed countries but not for U.S. taxpayers; for many individuals
life insurance is a form of saving;
Thirty-three percent of the sampled countries allow
deductions for contributions to mutual funds while the United States
does not;
More than half of the countries allow a mutual fund
investment pool to retain earnings without current tax, a provision
which increases the funds' assets; the United States does not;
Thirty percent of the countries with a social security
system allow an individual to choose increased benefits by increasing
their contributions during their working years; and
Canada provides a generally available deduction of up to
$9,500 (indexed) yearly for contributions to a private retirement
account, compared to a maximum deductible Individual Retirement Account
contribution of $2,000 for qualified taxpayers in the United States;
The Center's study demonstrates that many countries have gone
further than the United States to encourage their citizens to save and
provide for their own retirement and insurance needs.

Retirement Savings (*Indicates Note)
----------------------------------------------------------------------------------------------------------------
Gross
domestic Tax-favored Changes in
Country saving as a retirement Deductible Annual limit on portfolio
percent of accounts? contributions? deduction? composition
GDP, 1997 taxable?
----------------------------------------------------------------------------------------------------------------
Argentina.................... 18.0 No*............. N/A............. N/A............ N/A
Australia.................... 21.0 Yes............. No*............. No............. No
Belgium...................... 22.0 Yes............. Yes............. Yes,* not Generally yes;
indexed. rate: 56.7%
Brazil....................... 19.0 Yes............. Yes............. No............. No
Canada....................... 21.0 Yes............. Yes............. Yes, No
approximately
US $9,439
indexed.
Chile........................ 25.0 Yes............. Yes............. Yes, N/A
approximately
US $20,200
indexed.
China........................ 43.0 No.............. N/A............. N/A............ N/A
Denmark...................... 24.0 Yes............. Yes............. Generally no*.. Generally yes;*
rate: 58%
France....................... 20.0 No.............. N/A............. N/A............ No
Germany...................... 22.0 Yes............. Yes............. Yes, N/A
approximately
US $2,178 not
indexed.
Hong Kong.................... N/A No.............. N/A............. N/A............ N/A
India........................ 20.0 Yes............. Yes............. Yes, 20% of No
contribution,
max. approx.
US $306
indexed.
Indonesia.................... 31.0 Yes............. Yes............. Yes*........... Yes, rate: 30%
or 20% treaty
rate
Italy........................ 22.0 Yes............. Yes............. Yes, 2% of No
wages, max.
approx. US
$306 indexed.
Japan........................ 30.0 No.............. N/A............. N/A............ N/A
Korea........................ 34.0 No.............. N/A............. N/A............ N/A
Mexico....................... 26.0 Yes............. Yes............. Yes, approx. US No
$420 per year
indexed.
Netherlands.................. 26.0 Yes............. Yes............. Yes,* indexed.. Generally yes
Poland....................... 18.0 No.............. N/A............. N/A............ N/A
Singapore.................... 51.0 Yes............. Yes............. Yes, No
approximately
US $8,559* not
indexed.
Sweden....................... 21.0 Yes............. Yes............. Yes, Generally no
approximately
US $2,300
indexed.
Taiwan....................... N/A No.............. N/A............. N/A............ N/A
United Kingdom............... 15.0 Yes............. Yes............. Yes*........... No
United States................ 16.0 Yes............. Yes............. Yes*........... No
Summary...................... 25% 67% of countries 63% of countries 54% of 17% of
(average) answered yes. answered yes. countries countries
answered yes. answered yes
----------------------------------------------------------------------------------------------------------------

Insurance (*Indicates Note)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Deductible national health insurance Tax treatment of insurance annuity
premiums? Deductible private Annual increase in Deductible reserves:
---------------------------------------- long-term health Deductible private life insurance payments to mutual ---------------------------------------
Country insurance life insurance surrender value funds for Investment income Individual taxed
For individuals? For employers? premiums? premiums? taxable each year? retirement on reserves on receipt of
purposes? taxable? annuity payments?
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Argentina....................... Yes............... Yes............... Yes subject to Yes subject to No................ No................ Yes, rate: 33%.... Yes, rate: 33%
limits. limits.
Australia....................... No................ N/A............... No*............... No................ No................ No................ Yes, rate: 36%.... Yes, rate: 33.5%
Belgium......................... Yes............... Yes............... Yes............... Yes*.............. No................ Yes*.............. Yes, rate: 40.2%.. Yes, rate: 56.7%
Brazil.......................... Yes............... Yes............... No................ No................ No................ Yes*.............. Yes, rate: 43%.... Yes, rate: 27.5%
Canada.......................... No................ Yes............... No................ No................ Yes............... No................ Yes, rate: 29.1%.. Yes, rate: 31.3%
Chile........................... Yes............... Yes............... No................ No................ No................ Yes*.............. Yes, rate: 15%.... No
China........................... No................ Yes............... No................ No................ No................ N/A............... Yes, rate: 33%.... No
Denmark......................... N/A............... N/A............... No................ No................ No................ No................ Yes, rate: 34%.... No
France.......................... Yes............... Yes............... No................ No................ No................ Yes, if retirement Yes, rate: 41.7%.. Yes, rate: 58.1%
plan is
compulsory.
Germany......................... Yes, subject to Yes............... Yes, subject to Yes, subject to No................ Yes, under certain Yes, rate: 45%.... Generally yes,*
limits. limits. limits. conditions. rate: 55.9%
Hong Kong....................... N/A............... N/A............... No................ No................ No................ No................ Yes, rate: 16%.... No
India........................... N/A............... N/A............... Yes, up to Yes*.............. No................ No................ Yes, rate: 30%....
approximately US
$255 per year.
Indonesia....................... No................ No................ No................ No................ Yes............... No................ Yes, rate: 30%.... No
Italy........................... Yes............... Yes............... No................ Yes*.............. No................ Yes*.............. Yes, rate: 37%.... Yes, rate: 46%
Japan........................... Yes............... Yes............... Yes, up to Yes, up to N/A............... No................ No................ Yes, rate: 50%
approximately US approximately US
$383 per year. $383 per year.
Korea........................... Yes............... Yes............... No................ Yes............... No................ No................ N/A............... N/A
Mexico.......................... No................ Yes............... No................ No................ No................ No................ N/A............... N/A
Netherlands..................... Yes subject to.... Yes............... Yes subject to.... Yes subject to.... No................ Yes, depending on N/A............... N/A
limits*........... limits*........... limits............ fund type*.
Poland.......................... N/A............... Yes............... No................ No................ No................ No................ Yes, rate: 36%.... Yes, rate: 40%
Singapore....................... Yes*.............. Yes............... No................ Yes subject to No................ Yes subject to Yes, rate: 26%.... Yes, rate: 28%
limits. limits.
Sweden.......................... Yes............... Yes............... No................ No................ No................ No................ Yes, rate: 28%.... Yes, rate: 57%
Taiwan.......................... Yes............... Yes............... Yes*.............. Yes............... No................ No................ Yes, rate: 25%.... Yes, rate: 40%
United Kingdom.................. No................ Yes............... No................ No................ No................ No................ Generally no...... Generally yes
United States................... N/A............... N/A............... Yes subject to No................ No................ No................ Yes*.............. Yes, rate: 39.6%
limits.
Overall number of countries 54% of countries 75% of countries 33% of countries 42% of countries 8% of countries 33% of countries 75% of countries 67% of countries
answering ``yes''. answ- ered yes. answ- ered yes. answ- ered yes. answ- ered yes. answ- ered yes. answ- ered yes. answ- ered yes. answ- ered yes
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Social Security Taxes (*Indicates Note)
------------------------------------------------------------------------
Possibility for individual
Country to choose increased benefits
by increasing contributions?
------------------------------------------------------------------------
Argentina................................. Yes
Australia................................. No social security taxes
Belgium................................... No
Brazil.................................... No
Canada.................................... No
Chile..................................... Yes
China..................................... No
Denmark................................... No
France.................................... No
Germany................................... Yes under certain conditions
Hong Kong................................. No social security taxes
India..................................... No social security taxes
Indonesia................................. Yes
Italy..................................... Yes
Japan..................................... No
Korea..................................... No
Mexico.................................... Yes
Netherlands............................... No
Poland.................................... No
Singapore................................. No social security taxes
Sweden.................................... No
Taiwan.................................... No
United Kingdom............................ No
United States............................. No
Overall number of countries answering 30% of countries answered
``yes''. yes
------------------------------------------------------------------------

Mutual Funds (*Indicates Note)
----------------------------------------------------------------------------------------------------------------
Can an investment pool retain earnings without Preferential capital
current tax? gains treatment for
Country -------------------------------------------------- disposition of interest
Ordinary gain Capital gain in investment pool?
----------------------------------------------------------------------------------------------------------------
Argentina............................ Yes if qualifying fund. Yes if qualifying fund. No
Australia............................ Yes.................... Yes.................... Yes
Belgium.............................. Yes.................... Yes.................... Yes
Brazil............................... Yes.................... Yes.................... No
Canada............................... No..................... No..................... Yes
Chile................................ Yes for individuals.... Yes.................... No
China................................ N/A.................... N/A.................... N/A
Denmark.............................. No..................... No..................... No
France............................... No..................... No..................... Yes
Germany.............................. No..................... Generally no........... No
Hong Kong............................ Yes.................... Yes.................... N/A
India................................ Yes.................... Yes.................... Yes
Indonesia............................ No..................... Yes.................... No
Italy................................ Yes.................... Yes.................... Yes, rate: 12.5%
Japan................................ No..................... No..................... Yes
Korea................................ N/A.................... N/A.................... N/A
Mexico............................... Yes.................... Yes.................... No
Netherlands.......................... Yes depending on type Yes depending on type Generally Yes
of fund*. of fund*.
Poland............................... Yes.................... Yes.................... Yes
Singapore............................ Generally Yes.......... Generally Yes.......... Yes
Sweden............................... N/A.................... N/A.................... N/A
Taiwan............................... Yes.................... Yes.................... Yes
United Kingdom....................... No..................... Yes.................... Yes if qualifying fund
(``PEP'')
United States........................ No..................... No..................... Yes
Overall number of countries answering 54% of countries 63% of countries 54% of countries
``Yes''. answered Yes. answered yes. answered yes
----------------------------------------------------------------------------------------------------------------

*Notes on Retirement Savings
Argentina............................... Col. 1: Contributions to
certain approved private
pension funds may be
deductible.
Australia............................... Col. 2: Superannuation
accounts must be contributed
to by an individual's
employer, currently at a
minimum rate of 6 percent of
salary. Amounts contributed
on behalf of an employee are
not taxable to the employee.
Belgium................................. Col. 3: Limits vary depending
on the type of fund to which
contributions are made.
Denmark................................. Col. 3: The maximum deductible
annual contribution to a
capital pension scheme is DKr
33,100 (US $4,833).
Contributions to other
pensions can be deducted
without limit.
Col. 4: A payout from a
capital pension (which is a
lump sum payment) is subject
to tax at 40 percent.
Indonesia............................... Col. 3: The deductible annual
contribution is limited to
5.7 percent of regular income
for the government-sponsored
program (i.e., Jamsostek) or
20 percent for a Ministry of
Finance-approved private
pension program.
Netherlands............................. Col. 3: The deductible amount
depends upon the amount of
salary, the duration of
employment, and the type of
pension plan.
Singapore............................... Col. 3: The annual deduction
limit of S$14,400 (US $8,559)
applies to contributions on
ordinary wages. Contributions
on additional wages not
accruing on a monthly basis
(e.g., bonuses, incentive
payments) are subject to
separate capping rules.
U. Kingdom.............................. Col. 3: The limit on
deductibility of the
contribution varies depending
upon the type of plan and age
of the individual. The
minimum limit is 15 percent
of earnings up to maximum
earnings of uu87,500 (US
$144,445). The limit is
indexed for inflation at the
discretion of the government.
United States........................... Col. 3: The limitation on
deductibility of the
contribution varies depending
upon the type of plan (e.g.,
for contributions to an
individual retirement account
the annual limit is US
$2,000), the individual's
amount of earned income, the
individual's overall income
level, and the individual's
age.
------------------------------------------------------------------------

*Notes on Insurance
Australia............................... Col. 2: For families with
taxable income less than
A$70,000, a tax rebate of up
to A$450 is allowed to
encourage participation in
private health insurance.
Belgium................................. Cols. 3,5: Belgium provides a
tax credit (computed by
reference to various items)
when premiums are paid on
life insurance or
contributions are made to a
collective pension savings
account.
Brazil.................................. Col. 5: Payments to domestic
pension funds are deductible.
Chile................................... Col. 5: Only payments to the
mandatory retirement system
are deductible.
France.................................. Col. 6: The taxable portion of
an annuity payment decreases
based on the age of the
recipient.
Germany................................. Col. 6: Payments received by
an individual would not be
taxable if the prerequisites
for a tax-exempt life
insurance policy are
fulfilled.
India................................... Col. 3: The individual is
entitled to a tax rebate of
up to 20 percent of life
insurance premium paid,
subject to the overall limit
of Rs 12,000 (US $306) along
with other items (e.g.,
contribution to a retirement
fund).
Italy................................... Col. 3: Up to a maximum of
Lit. 2,500,000 (US $1,414),
life insurance premiums paid
can give rise to a
nonrefundable tax credit of
19 percent of the premium
paid.
Col. 5: For employees, same
limits as for life insurance
premiums. For professionals,
the maximum deductible
contribution to a retirement
fund is 6 percent of income,
not exceeding Lit. 5,000,000
(US $2,828).
Netherlands............................. Cols. 1,2: An individual can
deduct public or private
health insurance premiums
only as an extraordinary
expense and only above a
certain percentage of the
individual's income.
Col. 5: See ``Mutual Funds''
notes section for comments on
mutual funds in the
Netherlands.
Singapore............................... Col. 1: Singapore does not
have national health
insurance per se, but does
have insurance plans
established under the
approved pension scheme
(Central Provident Fund)
instituted by the government.
Taiwan.................................. Col. 2: The deductible
insurance premium is
NT$24,000 (US $735) per
person if the individual
itemizes.
United States........................... Col. 6: Income earned on
reserves is taxable, however,
a deduction is permitted to
the extent the earnings are
credited to the account of
the annuity contract.
------------------------------------------------------------------------

*Notes on Mutual Funds
Netherlands............................. Col. 1: The tax treatment of
mutual funds in the
Netherlands varies
significantly depending on
the type of fund. One of the
most important issues is the
question of whether the fund
is a legal entity or only a
cooperation of a group of
individuals. In the latter
case the fund will be
considered transparent, in
other words, for tax purposes
no fund exists and each
individual will be considered
participating in person for
his share in the fund
capital. In that case capital
gains are nontaxable;
ordinary income is taxable at
progressive rates.
If the fund is a legal entity,
a distinction must be made
between foreign funds and
Dutch funds. Foreign funds
are subject to a special
Dutch tax treatment
(taxability of a fictitious
income); the taxability of
Dutch funds depends upon
whether the fund is a special
qualifying fund. For a
qualifying fund, capital
gains are tax free; ordinary
income is subject to tax at
progressive rates.
------------------------------------------------------------------------

And now I am pleased to recognize my colleague, Charlie
Rangel, for a statement on behalf of the Minority. And, without
objection, each Member may insert written statements in the
record at this point.
Mr. Rangel.
Mr. Rangel. Thank you, Mr. Chairman.
I support the direction in which you are going and taking
the Committee on behalf of the Congress, and I assume your
criticism of the President was just by habit, rather than by
intent, since you are pushing so desperately hard to create a
bipartisan atmosphere, and that can't be done by just knocking
the President in terms of advocating tax increases. I think it
is very important and certainly politically expedient to
concentrate on tax cuts, and it is going to be hard for you to
get rid of me in terms of supporting tax cuts.
Next year, I think we will be supporting even more dramatic
tax cuts. This is especially so if the Majority is convinced
that the President is going to veto anything that is done in an
irresponsible way.
Having said that, I think we all had agreed, however, that
before we move in the direction of reducing revenue that we
would dedicate ourselves to the resolution of the problems that
we face with Social Security and Medicare. I know we have
language that says this money has been put in a lockbox, but I
think it is abundantly clear that the Majority party has the
key to the lockbox to use for whatever funds they have the
votes to use it for.
So I think we would all feel much more comfortable if we
made more progress in a bipartisan way, of course, in resolving
Social Security and Medicare before we entertain reducing
taxes. This is especially so since a large part of your private
sector investment under the Archer-Shaw plan requires general
revenues--and bills we are discussing now, of course, would
reduce general revenues.
But whatever we do look at, I do hope that the Social
Security system and the USA account proposal will be included
in our studies. We should also take into consideration the
number of individuals who have no health insurance at all. I
hope we will be able to take a look at the President's proposal
for tax-exempt bonds so that we will be able to rebuild our
schools and create an atmosphere where kids can get a decent
education in the public school level.
In any event, I look forward to the meetings that we are
going to have in executive session; and I hope, as you have
invited the private sector to participate, I am confident that
you also will invite the administration to participate. These
are going to be some very sensitive days and weeks and months
as we both try hard to create a bipartisan atmosphere.
I agree with you. I know it is doable, that we could come
up with a bipartisan solution to the Social Security problem
that our Nation faces. I know that you and the President of the
United States, both of whom will not be here for the new
Congress, would want a part of your legacy that this was done,
and I would hope that this Congress would be a part of that
history.
I just want the record to be made abundantly clear that
before this Committee moves forward in any public way, that we
expect that we will have the support of the leadership on both
sides of the aisle in the House; and even though it is
difficult to get any commitment from the House, it would seem
to me that at least communication should be made with them as
we move forward.
In order to be successful, Chairman Archer, I think we all
have to be reading from the same page and attempting to move
forward together in a bipartisan way to resolve a problem that
Democrats don't have and Republicans don't have but our Nation
and the kids and the people that will be depending on the
system will have. I want you to know that you can depend on my
support in that area, and I thank you for giving me this
opportunity to express the views of the Minority.
[The opening statements follow:]

Statement of Hon. Charles B. Rangel a Representative in Congress from
the State of New York

I think it's very important, and certainly politically
expedient, to concentrate on tax cuts. And, it's going to be
hard for you to get rid of me when it comes to supporting tax
cuts. Next year, I think we'll be supporting even more dramatic
tax cuts. This is especially so if the Majority understands
that the President is going to veto anything that's done in an
irresponsible way.
Having said that, I thought we all agreed that before we
move in the direction of reducing revenue, we would dedicate
ourselves to the resolution of the problems we face with Social
Security and Medicare. I know we have language that says this
money has been put in a ``lockbox,'' but I think it's
abundantly clear that the Majority Party has the key to the
lockbox and can use the money for what ever purpose they have
the votes to use it for.
I think we all would feel much more comfortable if we made
major progress, in a bipartisan way of course, in resolving
Social Security and Medicare before we entertain using any of
the surpluses to reduce taxes. This is especially so since a
large part of the private sector investment provision under the
Archer-Shaw plan requires general revenue financing, and the
tax bills we are discussing now involve the reduction of
general revenues.
I hope that the effect on saving the Social Security system
and the President's USA Accounts proposal will be considered. I
hope we will take into consideration the number of individuals
who have no health insurance at all. I also hope we will be
able to take a look at the President's proposal for tax credits
for school modernization bonds, which I sponsored, so that we
can re-build our schools and create an atmosphere where our
kids can get a decent education in the public schools.
In any event, I look forward to the bipartisan private
meetings that we are going to have. Since you (Chairman Archer)
have invited the private sector to participate, I'm confident
that you will also invite the administration to participate.
These are going to be some very sensitive days and weeks and
months ahead as we both try hard to create a bipartisan
atmosphere. I agree with you, Mr. Chairman--I know it's doable
for us to come up with a bipartisan solution to the Social
Security problem that our nation faces. I know that you and the
President of the United States, both of whom will not be here
for the new Congress, would want this accomplishment to be part
of your legacy. And I would hope that this Congress would be a
part of that history.
I just want to make it abundantly clear that, before this
Committee moves forward in any public way, we expect that we
will have the support of the leadership on both sides of the
aisle in the House. And, even though it is difficult to get any
commitment from the other House, it would seem to me that at
least communication should be made with the senators as we move
forward. If we are to be successful, Chairman Archer, I think
we all have to be reading from the same page and attempting to
move forward together in a bipartisan way to resolve a problem,
that Democrats don't have, and that Republicans don't have, but
that our nation and future generations have.

Statement of Hon. Jim Ramstad, a Representative in Congress from the
State of Minnesota

Mr. Chairman, thank you for calling this hearing to learn
more about how we can reduce the tax burden facing Americans--
which is at the highest level in history!
As we learned yesterday in our Health Subcommittee, the tax
burden for healthcare services disproportionately hits those
most in need to tax relief to help them afford health coverage.
While low-income Americans have access to government sponsored
healthcare and those with higher incomes tend to have
healthcare coverage through their employers, hard working,
lower-income and middle-income Americans, especially the self-
employed and those working for small businesses, have limited
access to seemingly unaffordable coverage.
A more equitable tax code which provided tax relief for
individuals who purchase healthcare coverage would not only
help address the number of uninsured Americans, it would also
address the issues of portability and greater consumer choice
in the marketplace. Stimulating competition within the health
care industry is greatly needed to improve the entire health
care delivery system.
As I mentioned yesterday, I am proud of this Committee's
attention to this issue through the passage of Medical Savings
Accounts (MSAs). I strongly support the Chairman's bill to
remove the unnecessary restrictions surrounding these truly
patient-oriented plans soon for many of their colleagues who
still remain priced out of the health insurance market.
In outlining my tax priorities for this year, in addition
to health care tax relief, I also listed my strong support for
comprehensive pension reform legislation introduced by Reps.
Portman and Cardin. Tax relief to help Americans save for their
retirement is critical and necessary to improve our nation's
abysmal savings rate.
I look forward to learning more from our witnesses about
the factors that contribute to the number of uninsured in
America today, as well as ways to significantly reduce those
numbers.

Statement of Hon. Richard E. Neal, a Representative in Congress from
the State of Massachusetts

Mr. Chairman, as the sponsor of H.R. 1213, the Employee
Pension Portability and Accountability Act of 1999, I want to
commend the Administration for its proposals to improve the
chances for every American to have a secure retirement of which
an adequate level of retirement income is a crucial factor. The
proposals are aimed at making it easier for employers to offer
pension plans, and for employees to retain their pension
benefits when switching jobs. Proposals to encourage small
businesses to establish pension plans, and to encourage more
individuals to utilize retirement accounts are included, as
well as numerous simplification initiatives.
As we all know, it is assumed that every worker will have
retirement income from three different sources--social
security, private pensions, and personal savings. This so-
called three-legged stool does not exist for many workers,
either because they work for employers who do not offer a
pension plan, or the benefits offered are inadequate, or
because some employees earn too little to save for their
retirement on their own. While the 106th Congress is expected
to address the problems of the social security system, it is
imperative that this Congress expand and improve the private
pension system as well.
Many workers, like federal workers in FERS, are eligible to
save for their retirement through social security, a defined
benefit plan, a defined contribution plan, and hopefully
through personal savings. In general, employers in the private
sector, however, have moved away from offering defined benefit
plans, much to the detriment of overall retirement savings.
Since 1985, the number of defined benefit plans has fallen from
114,000 to 45,000 last year. The number of defined contribution
plans, conversely, has tripled over the last twenty years.
While defined contribution plans have the advantage of being
highly portable, and are an important source of savings, it is
also important to remember that defined contribution plans were
intended to supplement, rather than be a primary source of,
retirement income.
In addition, we cannot ignore the fact that women and
minorities face special challenges in obtaining adequate
retirement savings. For women, this is directly related to
employment patterns. Women are more likely to move in and out
of the workforce to take care of children or parents, work in
sectors of the economy that have low pension coverage rates,
and earn only 72 percent of what men earn. Fifty-two percent of
working women do not have pension coverage, and 75 percent of
women who work part-time lack coverage. For minorities, lack of
pension coverage and a lower pension benefit level is often
related to low wages. While 52 percent of white retirees
receive an employment-based pension at age 55, only 32 percent
of Hispanic Americans and 40 percent of African Americans
receive such pensions.
While these problems cannot be solved overnight, it is
necessary for us to make improvements in the pension system
whenever there is an opportunity. Some argue that the best way
to help low and moderate income workers is to provide an
incentive for the highest income to have more of a personal
investment in the pension plan they control. Others would
argue, perhaps somewhat unfairly, that this is simply a new
version of trickle down economics. It certainly raises the
question as to why some proponents of changes in pension law
rest so much of their case on their assertion that the Chief
Executive Officers of America's corporations are so indifferent
to the future of their loyal employees and their families that
they need an extra $50,000 of pension income themselves in
order to consider better benefits for everyone else.
Speaking for myself, I would give it to them if I thought
those low and moderate income Americans who have little or no
employer pension benefits because they barely survive from
paycheck to paycheck, would also benefit. That case has not
been made. I would be more comfortable if proposals were being
brought to me by the pension community that would require an
increase in benefits for the low and moderate income worker in
conjunction with increasing benefits for the highest paid, but
that has not occurred.
There are, however, many proposals in the major pension
bills that can be supported by all parties, especially but not
solely in the area of portability. I look forward to working
with you, Mr. Chairman, and with the other members of the
Committee on these proposals.

Chairman Archer. Our first panel today is represented by
our colleagues--six of our colleagues, and we are pleased to
have your input to start off this hearing on enhancing
retirement and health security.
Mrs. Johnson, would you lead off?

STATEMENT OF HON. NANCY L. JOHNSON, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF CONNECTICUT

Mrs. Johnson of Connecticut. Thank you very much, Mr.
Chairman. I appreciate your holding this hearing on enhancing
retirement security and health security for all Americans.
First of all, I think this Committee is uniquely positioned
to offer the American people a package of reforms that will
radically enhance retirement security, Social Security reform,
Medicare reform, and pension reform so that more than 50
percent of our people can have access to pensions, and long-
term care insurance reform which would radically change
retirement for Americans in the future. I hope we will get to
that four-part agenda.
In starting, I want to talk about health security for all
of us. Every year, or at least in 1998, the Federal Government
contributed $111 billion toward tax benefits for people to
purchase health insurance. Most of that went to the employers
who purchased health insurance for their employees.
The employee-provided health insurance system has a unique
strength. It allows the pooling of insurance costs to lower the
cost of insurance for the sicker and older individuals in our
society. In other words, the value of employer-based health
insurance is much greater than the wage that the single
employee could receive in the absence of the benefit. It also
means that the current tax subsidy is more meaningful and
worthwhile for those who are in poor health or older.
So the employer system is working extremely well for those
covered by it, which is about two-thirds of Americans who are
under 65, but we must do more to make sure that all Americans
have access to affordable health insurance. Employers find that
covered employees use fewer sick days, worker morale is higher,
and worker loyalty is higher.
It is good business to provide good health benefits to your
employees. So why doesn't everybody? Well, of course, because
it is expensive. That is why. And only 28 percent of employers
with less than 25 workers offer health insurance because it is
not only expensive in premiums but the overhead is high.
A recent survey by Hay Huggins showed that small firms with
fewer than 10 employees carry 35 percent administrative costs
for health insurance plans, really completely unaffordable.
There is one thing we can do that we must do now, I hope we
will do this year, and that is to make the Tax Code fair, to
treat those who don't get insurance through their employers
with equity, to allow them the same tax benefit that people who
receive their health insurance through their employers receive
today.
My bill is unique in the history of bills that I have
proposed in this area and I think in terms of bills on the
table because it tries to match the benefit that the individual
uninsured person who is buying his own health insurance on the
open market gets with the benefit an employee gets in an
employer-provided plan. So it is far richer.
It just doesn't look at the tax consequences of wage
replacement, which is only a very small part of the benefit. It
looks at the real benefit that a person working for an employer
who provides health insurance gets and that is health coverage
at an affordable deductible. So it is very much richer.
It seeks to provide 60 percent of the cost of health
insurance, up to $1,200 for the individual and $2,400 for
couples and families. It would be available for people who
purchase COBRA as well. It is focused on a credit for the lower
earners and a deduction for higher earners.
It is essential to structure any health benefit in that
way, any tax incentive in that way, because so many without
health insurance are in the 15-percent bracket where a
deduction is essentially a very small incentive to purchase. A
credit really does give them the money to purchase.
And in my bill we are still working on how to allow them to
take that credit on a monthly basis so there will be the real
power to purchase, doing it through income withholding to lower
the amount of taxes that they pay during the year.
My bill would create a check off line on the W-2 form to
remind people that the option is available, and the benefit
this option would offer them through withholding over the year
would allow a great majority of those who are uninsured to buy
insurance.
Until we provide tax equity for the uninsured, we cannot
reduce the pool of the uninsured in a way that will allow us to
get at the ultimate problem which is some amount of subsidy.
My time has expired so I will just allude briefly to the
long-term care provisions in my bill.
We are looking at the cost of Social Security. We are
looking at the cost of Medicare. We are not looking at the
costs of long-term care which are going to literally explode
when the baby-boom generation retires. Already HCFA, the Health
Care Financing Administration, is spending $40 billion on long-
term care and expects to spend $148 billion by the year 2007,
which is before the baby boomers start reaching the age when
they will use long-term care. So I commend the bill that Karen
Thurman and I have introduced on long-term care to your
attention.
Thank you, Mr. Chairman.
[The prepared statement follows:]

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

Thank you for calling this hearing today, Mr. Chairman, and
giving me the opportunity to testify on two issues that I care
deeply about: health and retirement security. While our tax
code provides significant benefits in these areas. We must
improve these benefits if we are to reduce the number of
uninsured Americans and meet the challenges that we face as the
number of elderly Americans doubles.
In 1998, the federal government contributed an estimated
$111 billion toward tax benefits aimed at the purchase of
health insurance. The vast majority of these tax breaks went to
those who held employer-sponsored health insurance. Only $4.3
billion was in the form of tax deductions taken by individuals
for out-of-pocket health spending. That leaves $106.7 billion
devoted to workers who received health insurance through their
employers--$70.9 billion through the federal income tax and
$28.2 billion and $7.8 billion in Social Security and Medicare
taxes, respectively. This employer-based tax break equals
approximately $1000 for the average family with coverage.
This favorable tax treatment of employer-based health
insurance has resulted in the coverage of nearly two-thirds of
adults under the age of 65. Through group purchasing, it
spreads the risk of insuring people with varying health needs,
making insurance costs lower for those who are sicker or older.
This makes the value of employer-based health insurance much
greater than the wages that any single employee could receive
in the absence of the benefit. It also means that the current
tax subsidy is more meaningful and worthwhile for those with
poor health.
Health benefits are consistently ranked as the most
important employee benefit among workers. In a competitive
labor market, the promise of health benefits not only makes
workers more likely to take a job but also more likely to stay
at a job. In addition, employers offering benefits have found
that their workers are more productive, through decreased
number of sick days, improved worker morale, and increased
loyalty.
One of the major faults of the employment-based health
insurance system is that many small employers cannot afford to
offer health insurance to their workers. Only 28% of employers
with less than 25 workers offer health insurance, compared with
over 66% of employers with 500 or more employees. The largest
reason for small employers not offering health insurance is the
higher costs they face. Their small size means they cannot
spread the risk associated with a few unhealthy employees. They
also face higher administrative costs. A 1998 Hay Huggins
coverage survey found that overhead costs for firms with few
than 10 employees exceeded 35%, compared with about 12% for
firms over 500.
If we are going to address the problem of uninsured
Americans, we must help more small employers afford to offer
health insurance coverage. People working for small businesses
account for 16% of the under-65 population, but 28% of the
uninsured. And small businesses provide one of the fastest
growing employment opportunities.
The challenge in our voluntary health insurance system is
to provide equal benefits for people who do not have access to
employer-sponsored coverage. It is important to preserve the
current employer-based system because many people prefer
getting coverage through their job and employer coverage has
been very successful in covering two-thirds of the workforce.
As the nature of employment changes, moving to small businesses
and temporary and contract work, it is necessary that we also
allow an individually based tax benefit for those who are not
offered employer-based coverage.
This is not only a matter of equity in the tax code but
also a means of addressing the problem of uninsured Americans
by making health insurance more affordable. Increasing tax
benefits to individuals would by no means solve the uninsured
problem, but it would help those who can afford to purchase
health insurance on their own. If we can isolate this category
of the uninsured, we will have a better idea of how to approach
the remaining uninsured, those who need significant assistance
purchasing health insurance or who lack access to health
insurance because of their health status. There are many
reasons that people do not purchase health insurance, so we
need a multi-faceted approach to solve the problem.
I am advocating a combination of tax credits and deductions
for people who purchase their own health insurance. According
to a Congressional Research analysis of the March 1997 Current
Population Survey, 52% of the uninsured fall in the 15% tax
bracket. For the majority of the uninsured, a deduction would
provide only a 15% discount on the cost of their health
insurance. A credit, on the other hand, would provide the same
benefit to all taxpayers. And studies have shown that a
significant credit is required to encourage people to begin
purchasing health insurance. Kenneth Thorpe demonstrated in a
1999 study that a tax credit of $400 would encourage 18% of
single uninsured workers with incomes at 150% of the federal
poverty level to participate in a health plan. A credit worth
double that amount ($800) would raise the participation rate
among this group to 22%.
My tax credit proposal, found in H.R. 2020, would offer
taxpayers a credit worth 60% of the cost of their health
insurance, up to $1200 for individuals and $2400 for couples
and families. It would be dedicated to those people who do not
have access to an employer-sponsored health plan and have
incomes below $40,000 for individuals and $70,000 for couples
and families.
My credit would be available for people who purchase
individual or COBRA health insurance coverage. Therefore, it
would have the benefit of increasing the number of people who
purchase COBRA coverage and lower the costs to businesses of
providing this coverage. COBRA coverage is costly to businesses
because the people who tend to buy it are sicker people who
most need the coverage. Making it more affordable, as my tax
credit would, has the potential to add more healthy people to
the pool of people purchasing COBRA.
Making individual health insurance more affordable would
also help stimulate the individual health insurance market.
Currently, only 7-9% of individuals purchase coverage on the
individual market. My tax credit would create more demand for
individual insurance and help stimulate the market to come up
with new products. In addition, we may want to consider other
health insurance reforms to create broader pooling for
individual health policies to make them more affordable and
accessible for people with health care needs.
Finally, we should develop a tax credit system that makes
the credits available to people during the year, rather than at
the end of the tax year. Making the money accessible at the
time of purchase would help ensure that people can afford the
coverage. The option that I am examining would allow people to
increase their income tax withholding to lower the amount of
taxes that they pay during the year. It would create a check-
off line on the W-2 form to remind people that the option is
available. The benefit of this option is that people can change
their withholding form at any time during the year, so they
could change the withhold when their insured status changes.
My legislation also would create a tax deduction for
individuals who pay at least 50% of the cost of their health
insurance. The deduction would be available for individuals
whose income is too high to qualify for the health credit or
who are purchasing group coverage and paying at least 50% of
the cost. The deduction would enable small employers to offer
health insurance and take advantage of lower costs through
pooling, even if they could not contribute a significant
portion of the cost, knowing that their employees could take a
deduction for the portion of the cost that they contribute.
The potential benefit for credits and deductions decreasing
the number of uninsured is significant. The General Accounting
Office evaluated a proposal to provide a 30% tax credit and
found that nearly 40 million non-elderly individuals would have
been eligible in 1996. The GAO study shows that this approach
would provide significant assistance to the uninsured--31.9
million of the eligible individuals were uninsured and would
have received a tax credit. The Congressional Research Service
roughly estimated in a 1997 memo that ``allowing taxpayers to
deduct the full cost of health insurance would increase
coverage by about 9% for those with a 15% marginal tax rate
(about 1.4 million adults) and 17% for those with a 28%
marginal tax rate (about 345,000 adults).'' According to CRS, a
100% deduction would reduce the number of uninsured by 1.75
million. Combining a deduction with a credit would, therefore,
reach a significant number of the uninsured.
I also want to talk about the issue of long-term care and
the legislation that I have introduced. Long-term care promises
to be the most significant health issue of the next century as
the Baby Boom generation begins to retire and the number of our
elderly doubles. Medicare and Social Security are two of the
three government sponsored-programs that are critical to the
elderly. The other federal program significantly impacted by
the increasing number of elderly is the Medicaid program
through its coverage of nursing home care.
In 1997, Medicaid paid nearly 50% of nursing home care--at
a cost of $40 billion. Nursing home care averages $50,000 per
year or $136 per day. The Health Care Financing Administration
estimates nursing home costs will be $148.3 billion by 2007. If
Medicaid continues to pay for a significant amount of long-term
care, this will nearly double Medicaid nursing home costs over
the next seven years. And this is before the full impact of the
Baby Boom retirement. Today's 77 million baby boomers start
turning 85 in 2030. If past trends continue, 20% of those over
age 85 will need nursing home care.
How do we deal with these staggering costs? We need to
encourage people to prepare for the largest threat to their
retirement security. If we encourage more people to plan ahead,
we can ensure that we target precious Medicaid dollars to those
who are truly in need. We began this process in 1996 by passing
provisions to give greater tax benefits to long-term care
insurance. But many individuals cannot take advantage of these
provisions because they do not have health expenses that exceed
7.5% of their adjusted gross income.
Congresswoman Karen Thurman and I have introduced the Long-
Term Care and Retirement Security Act of 1999, H.R. 2102, to
create individual tax incentives for people to meet their long-
term care needs. Our legislation would create an above-the-line
tax deduction for people who purchase qualified long-term care
insurance policies, as defined by the Health Insurance
Portability and Accountability Act of 1996. In effect, people
would be able to deduct the cost of their long-term care
insurance policy from their taxable income, eliminating the
need to meet the 7.5% floor and the requirement to itemize.
H.R. 2102 would also create a $1000 tax credit for
caregiving and long-term care services. Family caregivers
provide a tremendous amount of long-term care services. Their
role goes far beyond comforting a family member struggling with
a chronic illness. National studies have demonstrated that
caregivers provide services estimated to value over $190
billion annually. Without the assistance of caregivers, more
people would require institutional care and the public cost of
long-term care services would increase significantly.
The other critical problem in the area of long-term care is
that people are not aware of the need to plan ahead. Seventy-
nine percent of older baby boomers surveyed believe that long-
term care is the greatest risk to their standard of living.
Despite this concern, people are misinformed about the
necessity of planning ahead. Several national surveys have
shown that the majority of people believe that Medicare covers
long-term care, but it does not. And people are unaware that
Medicaid qualification requires that they become impoverished.
H.R. 2102 would address this dire lack of information by
creating an educational campaign within the Social Security
Administration targeted toward individuals and employers. The
legislation would instruct the Social Security Administration
to provide information to people over 50 as part of their
existing annual mailing of earnings statements. It would make
individuals aware of the shortcomings of Medicare and the
requirement that a person impoverish themself to qualify for
Medicaid. In addition, it would illustrate the tax benefits
associated with purchasing long-term care insurance.
Finally, H.R. 2102 would remove the restrictions placed on
states in 1993 and encourage more of them to create long-term
care partnership programs. My legislation would allow people
who purchase partnership plans to pass along to their children
in their estates assets equal to 75% of the value of their
partnership plan. State long-term care partnership programs are
important because they make long-term care insurance affordable
for low and middle-income people. By encouraging more people to
purchase partnership plans, we ensure that people will have
some private coverage of their long-term care expenses before
qualifying for Medicaid. Connecticut was the first state to
form an long-term care partnership, and our experience has been
that one-third of the people who purchase the policies say that
they would have disposed of their assets to qualify for
Medicaid in the absence of a partnership program. As a result,
the availability of partnership programs helps ensure that
people use private long-term care insurance before applying for
the Medicaid program. Most importantly, partnerships are a
means to help us avoid some of the Medicaid financing of long-
term care expenses, the fastest growing aspect of Medicaid
spending.
We need to help Americans protect themselves and their
hard-earned retirement savings from the catastrophic costs of
long-term care. The Long-Term Care and Retirement Security Act
of 1999 would strengthen current law in this area.

Chairman Archer. Thank you, Mrs. Johnson.
Our next witness is another Member of the Committee, the
gentleman from California, Mr. Stark.
Mr. Stark, we will be pleased to hear your testimony.

STATEMENT OF HON. FORTNEY PETE STARK, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF CALIFORNIA

Mr. Stark. Thank you, Mr. Chairman.
I was interested to hear Mrs. Johnson's testimony. This is
an attempt at bipartisanship. Most of what I am about to
present to the Committee is a result of several months of labor
with Republican leadership to attempt to come to an agreement
that would bring some health care benefits to all Americans in
a bipartisan manner. We were unable to reach complete closure,
but I will tell you where we agreed and disagreed as I finish.
The biggest problem facing America today is the one in six
citizens with no health insurance, as we learned yesterday. My
first choice to solve this problem would still be an expansion
of Medicare to everyone, and my second choice would be
Congressman McDermott's single-payer system, but those efforts
are not likely to succeed in a conservative or closely divided
Congress.
I have just introduced legislation to try another approach,
basically the Republican approach, a refundable tax credit
which I believe could be made to work and which is similar to a
number of bills already introduced by various Republicans and
by Congressman McDermott.
Unfortunately, almost all the current tax bills don't work.
The tax deductions for uninsured workers do nothing for the
great number of uninsured in the zero to 15 percent brackets.
Other bills provide a pitiful amount of money that wouldn't buy
a decent policy. The biggest problem with the tax credit bills
is that they waste money by providing basically no wholesale
market. They force people into the retail market where they are
subject to the whims of the insurance companies who take 20 or
30 percent off the top, as Mrs. Johnson said, and they refuse
to insure the sick and raise rates on older people, so the
credit eventually becomes inadequate.
Tax credits to buy insurance without insurance reform are a
waste, and that is exactly where the leadership--your
leadership, Mr. Chairman, and I could not come to an agreement.
We both agreed that there has to be some standard on the
insurance product so you are not letting people throw their tax
credit away on something that won't work or provide a windfall
to the insurance industry. We couldn't find that solution yet.
But those failures could be addressed. The Health Insurance
for Americans Act that I have introduced provides a refundable
tax credit of $1,200 per adult, $600 per child, an aggregate of
$3,600 per family, which is exactly what we get in subsidy for
our Federal Employee Health Benefit. We get about $3,600 for a
family plan, and we have to kick in about $1,200 out of our
paycheck. This would buy that equivalent of insurance.
The credit is available to everyone who is not
participating in a subsidized health plan or eligible for
Medicare. The credit could only be used to buy qualified health
insurance, which is defined to be private insurance sold
through a new Office of Health Insurance in the same general
manner that the Federal employees buy guaranteed-issue,
community-rated FEHBP health insurance through the OPM.
A refundable tax credit sounds like an easy idea, but there
are some serious problems, and I address those in my written
statement. There are two I would like to discuss.
First, how do you limit the credit to those who are
uninsured and avoid employers substituting the credit for their
current coverage? If you limit the size of the credit, most
people will want to continue their current coverage. Still,
there is no question that this credit is likely to erode
gradually the employer-based system. Is that bad?
It is, frankly, probably good that this system would
gradually erode if there is something to replace it. My bill
provides that replacement. To the extent that workers today
have better health care through their employer, their employer
can continue to provide increased pay for the purchase of
supplemental health benefits so that both the workers and the
employers come out ahead.
The evidence shows us that employers are cutting back on
benefits every day anyway, and this would be a replacement for
those who lose it.
The bill I am introducing does not force an overnight
revolution, but the current system is dying, and this provides
a transition.
There is one monstrous question left: How to pay for it. I
haven't addressed this issue in my bill but am willing to offer
a number of options, and I might say the Republican leadership
was willing to leave this unaddressed in the bill we had worked
on cooperatively.
I would like to see the temporary budget surpluses used to
start the program, but you need a permanent source of
financing. The fairest way to finance it would be a tax on the
businesses which do not provide an equivalent amount of
insurance to their workers. Since many small businesses
couldn't afford it, we would have to subsidize them.
Another approach would be that the next minimum wage
increase would be dedicated to the payment of health insurance
premiums by those firms who don't offer insurance. In other
words, a buck an hour is $2,000 a year. That would cover most
of the cost of employees if the company doesn't have health
insurance. So the companies who do offer health insurance would
have a lower minimum wage or there would be a dollar minimum.
That could pay for it.
Other sources would be a provider insurance surtax since
those groups would benefit and no longer have to subsidize the
uninsured. And, finally, a small national sales tax dedicated
to health care could work if the public, in fact, was convinced
that this would insure them.
I have said that the earlier tax deduction and tax credit
proposals have serious structural problems. The biggest problem
is not seeing how they will pay for themselves. Until we are
ready to agree on how to pay for them, the plans that are
offered signify nothing. It is time for us to join the rest of
the world, Mr. Chairman, and insure all of our residents; and
this is an attempt to find a bipartisan common ground that will
do that.
Thank you.
[The prepared statement follows:]

Statement of Hon. Fortney Pete Stark, a Representative in Congress from
the State of California

Mr. Chairman, Colleagues:
The biggest social problem facing America today is that one
in six of our fellow citizens have no health insurance and are
all too often unable to afford health care.
About 44 million Americans have no health insurance.
Despite the unprecedented good economic times, the number of
uninsured is rising about 100,000 a month. It is unimaginable
what will happen when the economy slows and turns down. One
health research group, the National Coalition on Health Care,
has estimated that with rising health insurance costs and an
economic downturn, the number of uninsured in the year 2009
would be about 61.4 million.
The level of un-insurance among some groups is even higher.
For example, in California it is estimated that nearly 40% of
the Hispanic community is uninsured.
An article by Robert Kuttner in the January 14, 1999 New
England Journal of Medicine entitled ``The American Health Care
System,'' describes the problem well:

``The most prominent feature of American health insurance
coverage is its slow erosion, even as the government seeks to
plug the gaps in coverage through such new programs as
Medicare+Choice, the Health Insurance Portability and
Accountability Act (HIPAA), expansions of state Medicaid
programs, and the $24 billion Children's Health Insurance
Program of 1997. Despite these efforts, the proportion of
Americans without insurance increased from 14.2% in 1995 to
15.3% in 1996 and to 16.1% in 1997, when 43.4 million people
were uninsured. Not as well appreciated is the fact that the
number of people who are under-insured, and thus must either
pay out of pocket or forgo medical care, is growing even
faster.''

Does it matter whether people have health insurance? Of
course it does. No health insurance all too often means
important health care foregone, with a minor sickness turning
into a major, expensive illness, or a warning sign ignored
until it is fatal. Lack of insurance is a major cause of
personal bankruptcy. It has forced us to develop a crazy, Rube
Goldberg system of cross-subsidies to keep the `safety net'
hospital providers afloat.
Mr. Chairman, what is wrong with us? No other modern,
industrialized nation fails to insure all its people. I don't
believe we are incompetent, but our failure to provide basic
health insurance to all our citizens is a national disgrace.
Personally, my first choice to solve this problem would be
an expansion of Medicare to everyone. My second choice would be
Rep. McDermott's single payer type program, which is modeled on
Canada's success in insuring all its people for about 30% less
than we spend to insure only 84% of our citizens.
But these efforts are not likely to succeed in a
conservative Congress or in a closely-divided Congress.
Therefore, I have just introduced legislation to try
another approach--a refundable tax credit approach--which I
believe can be made to work and which is similar to a number of
bills recently introduced by various Republican members and by
Rep. McDermott.
Unfortunately, almost all tax bills simply do not work.
Some tax bills throw money at people who already have
health insurance (e.g., 100% tax deductions for health
insurance for small employers). Others try to solve the problem
of lack of insurance by increasing the deduction for uninsured
workers. The fact is, uninsured workers are overwhelming lower
income workers, and they either pay no tax--so have nothing to
deduct--or they are in the 15% bracket, so the deduction does
little to help them with the heart of the problem: health
insurance is expensive. I would like to enter in the Record a
study by the GAO which documents, by income category, who the
uninsured are and why tax deductions do little or nothing to
help them.
Other bills provide a pitiful amount of money that wouldn't
buy a a decent policy. For example, Rep. Shadegg proposes a
$500 credit, leaving an impossible amount to be financed by the
average, working, low-income family.
The biggest problem with all these tax credit bills is that
if they do provide enough money (such as Rep. Norwood's
refundable credit of $3600 a family--HR 1136), they waste it by
providing no `pool' or `wholesale' market and forcing people
into the retail market where insurance companies take 20 to 30%
off the top, refuse to insure the sick, and raise rates on
older people so that for people who really need insurance, the
credit is woefully inadequate. I would like to include in the
Record examples of what health insurance policies cost in the
Washington, DC area for different types of individuals.\1\ You
will note that the sicker and older you are, the less likely a
credit will be of any help.
---------------------------------------------------------------------------
\1\ Excellent documentation of this point is also included in a
Kaiser Family Foundation study by Chollet & Kirk, March, 1998,
entitled, ``Understanding Individual Health Insurance Markets:
Structure, Practices, and Products in Ten States.''
---------------------------------------------------------------------------
To repeat, tax credits to buy insurance, without insurance
reform, are a waste, will only help the easy-to-insure, and
provide a windfall to the insurance industry.
These failures can be addressed. I think my proposal solves
many of these problems. The idea of a tax credit approach to
ending the national disgrace of un-insurance is a new one,
however, and we desperately need a series of detailed,
thoughtful hearings to design a program that will provide real
help and not waste scarce resources on middlemen.
The Health Insurance for Americans Act I have introduced
--provides in 2001 and thereafter a refundable tax credit
of $1200 per adult, $600 per child, and $3600 total per family.
These amounts are adjusted for inflation at the same rate that
the Federal government's plan for its employees (FEHBP)
increases.
--the credit is available to everyone who is not
participating in a subsidized health plan or eligible for
Medicare.
--the credit may only be used to buy ``qualified'' health
insurance, which is defined to be private insurance sold
through a new HHS Office of Health Insurance (OHI) in the same
general manner that Federal employees ``buy'' health insurance
through the Office of Personnel Management.
--any insurer who wants to sell to Federal workers through
FEHBP must also offer to sell one or more policies through OHI.
OHI will hold an annual open enrollment period (similar to
FEHBP's fall open enrollment) and insurers must sell a policy
similar to that which they offer to Federal workers (but may
also offer a zero premium policy), for which there is no-pre-
existing condition exclusion or waiting period, for which the
premium and quality may be negotiated between the carrier and
OHI, and which must be community-rated (i.e., it won't rise in
price as individuals age).
Mr. Chairman, a refundable tax credit sounds like an easy
idea, but as in all things in America's $1.1 trillion health
care system, there are some serious problems that have to be
addressed.
The major problems with a refundable credit are 1) how to
get the money to the uninsured in advance, so that the
uninsured, who tend to be lower income, can buy a policy
without waiting for a refundable credit?
2) how to make sure that the credit is spent on health
insurance and there is no tax fraud?
I solve both of these problems through credit advances to
insurers administered through OHI.
3) how to limit the credit to those who are uninsured, and
avoid encouraging employers and those buying private insurance
on their own from substituting the credit for their current
coverage?
By limiting the size of the credit, most people who have
insurance through the workplace or are participating in public
programs will want to continue with their current coverage. The
credit is adequate to ensure a good health insurance plan, but
most workers and employers will want to continue with the
current system. New Employee Benefit Research Institute data
shows that the great majority of insured Americans like their
employer-based system and want to continue it.
Having said this, there is no question that this credit is
likely to erode gradually the employer-based system. It is hard
to see employers wanting to offer new employees a health plan,
when they can use this new public plan. Indeed, it is likely
that an employer will say,

``I will pay you more in salary if you will go use the tax
credit program, you can use some of the extra salary to buy a
better policy, or a supplemental policy, and we will both come
out ahead.''

But is this bad? The employer-based health insurance system
is an historical accident of wage controls during World War II
where in lieu of higher wages, people were able to get health
insurance as a fringe benefit. This system is collapsing. No
one today would ever design from scratch such a system where
your family's health care depended on where you worked. It is,
frankly, probably good that this system would gradually erode--
if there is something to replace it. The Health Insurance for
Americans Act provides that replacement. To the extent that
workers have better health care through their employer, the
employer can continue to provide increased pay for the purchase
of ``supplemental'' or ``wrap-around'' health benefits and can
even help arrange such additional policies for their workers-
and both workers and employers come out ahead.
The bill I am introducing does not force an over-night
revolution in the employer-provided system. But the current
system is dying, and my bill provides a transition to a new
system in which employees will have individual choice of a wide
range of insurers (instead of today's reality, where most
employees are offered one plan and only one plan).
Some Members are discussing ending the tax preferences for
employer-provided health care, either by ending the deduction
to employers or adding the value of the policy to the income of
the workers. That would be a revolution. It would very quickly
end the employer-provided system. And I don't think Americans
like revolutions on something as important as their family's
healthcare.
To repeat, the employer-based health care system is dying.
The next recession will push it over the edge. It would be wise
to build this refundable tax credit system now, so that people
have someplace to go as the system deteriorates. But the public
opinion polling is very strong: don't legislate the overnight
termination of the current system.
4) another key question is how to make the credit effective
by allowing the individual to buy ``wholesale'' or at group
rates, rather than ``retail'' or individual rates?
5) how to make sure that individuals who most need health
insurance--those who have been sick--are able to use the credit
to obtain affordable insurance?
6) how to minimize the problem created when the healthiest
individuals take their credit and buy policies which are
``good'' for them (e.g., Medical Savings Accounts), but ``bad''
for society because they leave the sicker in a smaller, more
expensive insurance pool (that is, how do we keep the insurance
pool as large as possible and avoid segmentation and an
`insurance death' spiral)?
Again, the OHI/FEHBP idea largely solves these 3 problems,
by giving individuals a forum where they can comparison shop
for a variety of plans that meet the standards of the OHI and
achieve efficiencies of scale and reduced overhead.
These questions are the single biggest problem facing the
refundable credit proposal. Even if we are able to `pool' the
individuals, will insurers offer an affordable policy to a
group which they may fear will have a disproportionate number
of very sick individuals? I think that fear is unfounded. Most
uninsured are young and healthy, but we do not know for sure
how the private insurers will respond.
We may need to develop a national risk pool `outlet' to
take the expensive risks and subsidize them in a separate pool,
so that the cost of premiums for most of the people using OHI
is affordable. Another alternative, and probably the one that
makes the most sense for society, is to mandate that
individuals participate in the OHI pool (if they don't have
similar levels of insurance elsewhere). Only by getting
everyone to participate can we ensure a decent price by
spreading the risk. The danger that young, healthy individuals
will ignore (forego) the tax credit program may be serious
enough that it will cause insurers to price the OHI policies
too high, thus starting an insurance ``death spiral'' as
healthier people refuse to participate and rates start rising
to cover the costs of the shrinking pool of sicker-than-average
individuals.\2\
---------------------------------------------------------------------------
\2\ These are extremely important technical questions. As the July
1999 EBRI Issue Brief will say,
Issues such as adverse selection, ``crowd-out'' of private
insurance by public insurance, or substitution of individual coverage
for group coverage are inherent to the current voluntary employment-
based health insurance system, and will not be resolved by incremental
changes made to improve this system. For example, young and healthy
individuals are more likely than older unhealthy individuals to opt out
of the employment-based system under certain circumstances. As long as
the purpose of insurance continues to be the spreading of risk across
higher-risk and lower-risk individuals, attempts to augment or replace
the employment-based health insurance system may have unintended side
effects that do not benefit the majority of the U.S. population.
---------------------------------------------------------------------------
As I said earlier, previous tax credit proposals fail to
deal with these key questions and problems. But all the bills
have helped focus us on this national crisis. Through hearings
and studies, I hope we can find ways to ensure that these
technical--but very important questions--are addressed.
There is one key, monstrous question left: how to pay for
the refundable credit so we may end the national disgrace of 44
million uninsured?
I have not addressed this issue in my bill, but am willing
to offer a number of options. I would like to see the temporary
budget surpluses used to start this program--but those
surpluses are temporary and we need a permanent financing
source.
The problem of the uninsured is largely due to the fact
that many businesses refuse or are unable to provide health
insurance to their workers. The fairest way to finance this
program would be a tax on businesses which do not provide an
equivalent amount of insurance to their workers. Such a tax, of
course, would slow the tendency of this program to encourage
businesses to drop coverage. Since many small businesses could
not afford the tax, we will need to subsidize them.
Another approach would be to apply the next minimum wage
increase to the payment of health insurance premiums by those
firms which do not offer insurance. A 50 cent per hour minimum
wage increase dedicated to health insurance would pay most of
an individual's premium.
Other financing sources could be a provider and insurer
surtax, since these groups will no longer need to subsidize the
uninsured and will be receiving tens of billions in additional
income.
Finally, to end the national disgrace of un-insurance, a
small national sales or VAT tax would be in order. If we worked
together, we could explain and justify a `national health tax'
to ensure every American decent private health insurance
regardless of their work status.
Again, Mr. Chairman, I have said that the earlier tax
deduction and tax credit proposals have serious structural
problems. The biggest problem they have is not saying how they
will pay for themselves. Until Members talk about financing,
all of these plans are sound and fury, signifying nothing.
These tax credit bills are obviously expensive, but so is
the cost of 1 in 6 Americans being uninsured. In deaths,
increased disability and morbidity, and more expensive use of
emergency rooms, American society pays for the uninsured. If we
could end the national disgrace of un-insurance, we would save
billions in improved productivity, reduced provider costs, bad
debt, personal bankruptcy, and disproportionate share hospital
payments.
Mr Chairman, it is time for America to join the rest of the
civilized world and provide health insurance for all its
citizens.

Chairman Archer. Thank you, Mr. Stark.
Our next witness is Rob Portman.
Mr. Portman, we would be happy to hear your testimony.

STATEMENT OF HON. ROB PORTMAN, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF OHIO

Mr. Portman. Thank you, Mr. Chairman. It is a delight to be
here.
Since this is a hearing in part about retirement security,
I would like to start by commending you and Chairman Shaw for
the fine work you have done on the Social Security front and
the sound proposal that you have given this Committee to
strengthen the Social Security system.
But as you are well aware, Mr. Chairman, I also strongly
believe that this panel should complement that by moving this
year to significantly increase the availability of retirement
security for all Americans by strengthening our private
employer-based pension system. I think it is a great
opportunity for us, as Mrs. Johnson mentioned earlier.
This is a critical issue for all Americans, particularly
the 76 million baby boomers approaching retirement age. That is
why over the past 2 years we have been working hard on putting
together a comprehensive set of changes to improve our pension
system from top to bottom. My partner in this has been my
colleague, Ben Cardin, who will address the Committee in a
moment, but we have also worked with many other Members of this
Committee--Mrs. Johnson, Mr. Weller, Ms. Dunn, Mr. Tanner, and
others, even some from our other distinguished Committees like
Mr. Pomeroy, who is also here today to talk about retirement
security.
We have done it in a comprehensive way because we believe
that is the way to build on the pension expansion and
simplification measures that this Committee has taken the lead
on in the past, including the SIMPLE, Savings Incentive Match
Plan for Employees, plan for small businesses.
I am delighted to say, Mr. Chairman, as of today it is a
bipartisan group of about 26 Ways and Means Members who have
cosponsored H.R. 1102, over 90 members in total, an influential
group, Mr. Chairman; and I ask my colleagues if they would take
a look at a few charts regarding retirement security that will
outline the problem that I think Ben is going to have an
opportunity to go into in some more detail on some of our
provisions.
The first simply makes the point that the retirement stool,
which is the so-called three-legged stool, is very much
supported by employer-based pensions already. Employer-based
pensions are along with Social Security and private savings,
absolutely essential to the retirement security of our
constituents. This includes, of course, not just the
traditional defined benefit plans, but when we talk about
pensions, we are talking about all retirement plans that are
employer-sponsored, including 401(k)s, 457, 403(b)s, and other
arrangements.
The second chart shows that although it is a very important
part of our retirement system in this country, we have a crisis
in pensions. Only half of American workers are covered. It
means about 60 million Americans have no pensions whatsoever.
That chart is interesting because it shows that since 1983 we
have made virtually no progress. It has been flat. Forty-eight
percent of workers were covered in 1983. That chart says, in
1993, about 50 percent. Unfortunately, that is about the number
it is today. It has remained flat despite the need for more
retirement security as a backstop to Social Security.
It is even worse than that when you look at what small
businesses offer in terms of retirement security to their
workers. That chart will show you, at the bottom end toward the
left, that those small companies, that is, companies with 25 or
fewer employees where, frankly, most of the new employment is
occurring, are growing the fastest in terms of adding new
workers, yet only 19 percent offer anything, even a SIMPLE
plan, a SEP, self-employed plan, or a 401(k). It is even worse
than the fact that only half of American workers are covered.
Those in small businesses have very little chance of having a
pension at all.
The next chart gets, Mr. Chairman, to the point that you
made early on, which is that our personal savings rate in this
country is at a dangerously low level. You talked about this in
the context of tax reform in the past, that we ought to focus
on our tax reform proposal this year on trying to increase
that.
Foreigners, frankly, are propping up a lot of our savings
today, and there is a concern that some of that capital may
leave this country at some point. And for capital formation,
for investment, for the economic future of this country, we
have got to increase our savings rate. This chart simply makes
obvious the fact that we are back down to the rates we had
during the Great Depression.
The next chart shows that with regard to distribution of
pension benefits, most pension recipients are middle-income
Americans. A pension, in fact, makes the difference between
retirement subsistence, mere subsistence, and retirement
security for millions of Americans.
I wish you could see that chart better, but the bottom line
is the folks who are currently receiving benefits are primarily
in the middle-income category. In fact, if you look at the
right side of that chart, over 75 percent of workers
participating in pension plans make less than $50,000 a year.
With regard to folks who are participating in pensions,
again this is something that is focused on middle-income
Americans; 77 percent of current pension participants are
either middle- or low-income workers. The Portman-Cardin plan,
again Ben is going to go into more detail on that, basically
says, let's make it less costly and burdensome for employers to
establish these new pension plans. The government ought to be
in the business of encouraging pensions, not discouraging them.
We also ought to modernize the pension laws to address the
needs of the 21st century work force, and this is where Earl
Pomeroy has played a big role in helping us with regard to
portability.
The bottom line, Mr. Chairman, is that we strongly believe
that we ought to preserve our public Social Security system. I
want to work with you toward that end, but we need to do more.
Imagine the impact we could have--this panel could have--by
expanding on the private side so that every American worker
would have access to a 401(k) or some kind of a pension plan.
It is a tremendous opportunity, and I urge us to seize it this
year.
[The prepared statement follows:]

Statement of Hon. Rob Portman, a Representative in Congress from the
State of Ohio

Thank you, Mr. Chairman, for allowing me to testify here
today. I would like to take this opportunity to commend you and
Chairman Shaw publicly for your leadership on increasing
retirement security by strengthening our public Social Security
system.
In addition to taking steps to save Social Security, I feel
strongly that this panel should take steps this year to
significantly increase the availability of secure retirement
savings generally--primarily by strengthening our private,
employer-based pension system.
This is a critical issue for all Americans--not just for
current retirees or those 76 million Baby Boomers who are
nearing retirement age--but also for those young people whose
ability to enjoy a comfortable retirement in the future will
depend on the policy approaches we adopt today.
That's why my Ways and Means colleague from Maryland, Mr.
Cardin, and I have been working on comprehensive reforms to our
pension system over the past two years. This year, we have
introduced H.R. 1102--the Comprehensive Retirement Security and
Pension Reform Act. It builds on the pension expansion and
simplification measures this committee has taken the lead on in
the past--including provisions in the Small Business Jobs
Protection Act of 1996 that took steps to expand retirement
plan options for small businesses by establishing the SIMPLE
plan. And it incorporates pension reform proposals that have
been put forward by a number of Members of this panel.
H.R. 1102 will increase retirement security for millions of
Americans by strengthening that ``third leg'' of retirement
security--our pension system--including traditional defined
benefit plans as well as defined contribution plans like
401(k), 403(b) and 457 arrangements. And it will help those
Americans who need it most--in fact, 77% of current pension
participants are middle and lower income workers.
H.R. 1102 is designed to reverse some disturbing trends in
our pension system.
Right now, only half of all workers have a pension
plan. That means about 60 million Americans don't have access
to one of the key components to a comfortable retirement.
And, far fewer than half of employees who work for
small businesses have access to a pension plan. Today, only 19%
of small businesses with less than 25 employees offer any kind
of pension plan. Why? Over the years, the pension laws have
become so complicated and so costly to set up and administer
that many small businesses simply can't afford to offer them.
And, not enough workers have pension coverage at
the same time that overall savings is dangerously low. In fact,
the personal savings rate in this country--the amount of money
people save for retirement and other needs--is at its lowest
rate since 1933. For economists who are looking beyond our
immediate apparent economic prosperity as a country, this is
the most troubling statistic out there.
Simply put, the Portman-Cardin legislation lets workers
save more for retirement. We make it easier for employers to
establish new pension plans or improve existing ones. And, we
modernize pension laws to address the needs of a changing, 21st
Century workforce.
Let me highlight a few of the key provisions.
Increased Contribution Limits: Over the last 20 years,
Congress has lowered the annual dollar limits on contributions
workers can make and benefits they can accrue. These
restrictions have been an obstacle to adequate private pension
savings. Portman-Cardin substantially increases the limits for
alltypes of plans and repeals the current 25% of compensation
limit on contributions to defined contribution plans--our
proposal generally restores these limits to 1982 levels.
Catch-up Contributions: Portman-Cardin increases the limits
on all employee contributions to all plans by an additional
$5,000 for workers 50 and older so that they can ``catch-up''
for years when they weren't employed, didn't contribute to
their plan or otherwise weren't able to save. We know from
research that many Baby Boomers who are now approaching
retirement age have not saved adequately for their retirement.
In particular, this catch-up provision will benefit women who
have returned to the workforce after taking time away to raise
families.
Increased Portability: We're told that the average worker
in the next century will hold nine jobs by the age of 32, and
workers typically do not stay in any job for more than five
years until age 40. Portman-Cardin reflects the needs of an
increasingly mobile workforce. HR 1102 includes ``portability''
provisions to allow workers who are changing jobs to roll over
retirement savings between 401(k)s, 403(b)s and 457s.
Faster Vesting: Under current law, many employees do not
become fully vested in a pension plan until they have been with
an employer for 5 years. Portman-Cardin would lower the vesting
requirement for matching contributions to 3 years.
Cutting Pension Red Tape: he increasing complexity of the
laws governing pensions--both in the private sector and in the
non-profit and government sectors--has discouraged the growth
of pension plans. In fact, for many small businesses in
particular, the costs and liabilities associated with pension
plans have made it too expensive for many companies to offer
plans. Larger companies, state and local governments and non-
profits have too often been discouraged from improving existing
plans because the rules are so complicated and costly. Portman-
Cardin takes steps to cut the unnecessary red tape that has put
a stranglehold on our pension system.
We now have more than 90 bipartisan cosponsors and more
than 60 endorsing organizations from across the ideological
spectrum--from the U.S. Chamber of Commerce and the NFIB to
labor organizations like AFSCME and the Building and
Construction Trades Department of the AFL-CIO.
I commend Chairman Archer and this entire panel for taking
a leadership role on preserving our public Social Security
system. But imagine the impact we would have on our national
savings rate and overall retirement security if we could give
every American worker access to a 401(k) or another kind of
pension plan. This is a tremendous opportunity that I urge this
panel to seize this year.
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Chairman Archer. Thank you, Mr. Portman.
Mr. Cardin, since your name was mentioned, we would be
happy to receive your testimony.

STATEMENT OF HON. BENJAMIN L. CARDIN, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF MARYLAND

Mr. Cardin. Thank you, Mr. Chairman.
Let me ask unanimous consent that my full statement be
included in the record.
Chairman Archer. Without objection.
Mr. Cardin. Thank you for this opportunity and for holding
these hearings. I think they are extremely important, as your
opening statement pointed out.
I want to thank Mr. Portman for the work he has done on the
bill that we have filed.
The debate over retirement security is desperately needed
in this country. As you have pointed out, our savings ratios as
a nation are deplorable. Economic trends look good. Budget
deficits are over. We have got surpluses in the future.
Unemployment rates are low. Interest rates are low. But the
savings rates of this Nation as we compare ourselves to any of
the nations that we like to compare ourselves to is too low. We
need to do something about it.
As important as Social Security is--and I do hope that we,
like you, address the problems of Social Security this year.
This is the year we should do it. But Social Security alone
will not be enough. Social Security was never intended to be
the sole income source for retired Americans. We must
supplement that with modern, private pension plans.
That is why Rob Portman and I introduced H.R. 1102, the
Comprehensive Retirement Security and Pension Reform Act. It is
rebuilding our Nation's private pension system.
We use the term ``rebuilding'' because we go back and
correct some of the mistakes that we have made over the last 2
decades in pension changes that we have made that have reduced
the opportunity of Americans to put money away and have made it
more complicated.
We have listened to the concerns from Americans across our
entire country, and we have included provisions to strengthen
and expand saving opportunities for Americans who work for
small businesses, large businesses, State and local government,
and nonprofit organizations.
First, we increase the limits on retirement savings to
allow Americans to put more away. We do that for defined
contribution plans, defined benefit plans and qualified
compensation. We make it easier for young people to establish
retirement plans. We take the model that Mr. Thomas and Senator
Roth used for IRAs and use that for 401(k)s and 403(b) plans.
We increase the opportunity of Americans to put their plans
together through portability, recognizing the realities of the
current labor market by allowing portability between 401(k)s,
403(b)s, and 457 plans.
As Mr. Portman pointed out, we simplify dramatically our
pension laws for both large companies and small companies. We
remove many of the restrictions on the multiemployer plans that
discriminate against workers for large companies and unionized
members, and we also deal with small businesses by eliminating
some and reforming many of the tests, including the top-heavy
rules are reformed. We think that will go a long way to make
pension plans more available to the American public.
Mr. Chairman, there are many provisions in the Portman-
Cardin legislation. We have tried to listen to all of the
different interest groups and respond in a reasonable way, but
we have tried to avoid any of the major controversial areas so
that we could work in a bipartisan way to get legislation
enacted this year. And we would urge the Committee in whatever
vehicle moves through this Congress on the Tax Code that we
help Americans take care of their needs when they retire and
include the provisions that are in the Portman-Cardin
legislation.
Thank you, Mr. Chairman.
[The prepared statement follows:]

Statement of Hon. Benjamin L. Cardin, a Representative in Congress from
the State of Maryland

Mr. Chairman, I am pleased to appear this morning to
testify before the most distinguished committee of the United
States Congress.
Let me start by commending you for holding this hearing and
to examine new proposals to strengthen our nation's private
pension and retirement savings system. I am especially pleased
to be here with such a distinguished panel of witnesses,
including my good friend and partner in the enterprise of
pension reform, our colleague Rob Portman.
The debate over retirement security has attained new
significance in the past few years. As the ``baby boom''
generation approaches retirement, the need to help this
generation and future generations of Americans live comfortably
in retirement has gained greater prominence as a legislative
priority.
One indication of this need, of course, has been the on-
going national debate over the future of the Social Security
system. We must all make every effort to make sure that Social
Security, the most successful social program in our nation's
history, will continue to be there for current and future
retirees. I am committed to working with you, Mr. Chairman, and
with every member of this committee, and with the President, to
achieve this vital goal.
As important as Social Security is, however, it is not
enough. Social Security was never intended by itself to provide
an adequate standard of living for retired Americans, and it
cannot fill that role now.
That is why Rob Portman and I have introduced H.R. 1102,
the Comprehensive Retirement Security and Pension Reform Act.
This legislation takes the next step, in a process that began
with pension reforms enacted over the past three years, in
rebuilding our nation's private pension system.
I use the term ``rebuilding'' because in many respects,
H.R. 1102 simply restores the pension law to what it was a
decade or two ago. For over a decade, beginning in the early
1980's, our federal pension policies suffered from a severe
disconnect between rhetoric and action. While we acknowledged
the economic advantages of private retirement savings, and
exhorted Americans to save more, we frequently passed
legislation that imposed obstacles to the achievement of those
goals.
The distressing results are before us in the most recent
savings statistics. Across the spectrum, the domestic economic
news is encouraging. Unemployment is low, inflation is low,
productivity is high, family income is up, economic growth is
strong. Yet private savings has continued to drop, and now
stands at the lowest rate since before the creation of Social
Security.
H.R. 1102 says we can do better. The bill proposes a number
of changes that will expand employer-sponsored retirement
savings opportunities for millions of American workers. In
developing the bill, we have listened to the concerns from
Americans across our entire country, from every sector of the
economy. We have included provisions to strengthen and expand
savings opportunities for Americans who work for small
businesses, large businesses, state and local governments, and
non-profit organizations. We have listened to the concerns of
public school teachers, plan administrators for Fortune 100
companies, women and men who own small businesses, and
representatives of organized labor. We have included specific
reforms that benefit Americans who participate in multi-
employer pension plans. We have included proposals that will
strengthen defined contribution plans and defined benefit
plans, as well as IRAs, 401(k) plans, 403(b) arrangements, or
457 plans.
In short, Mr. Chairman, the message of H.R. 1102 is we want
Americans to save more, and we are determined to help provide
incentives that will allow and encourage them to do so.
Let me mention a few of the major initiatives included in
the bill. Perhaps the heart of the bill is the proposed
increases in the limits on retirement savings. Over the past
eighteen years, we have ratcheted down the benefits and
contributions permitted under qualified retirement plans. These
changes have contributed to a decline in the number of
employers sponsoring plans, and reduced opportunities for
workers to save. We propose turning the clock back to restore
the limits--on defined contributions, defined benefits, and
qualified compensation--that have been in effect in past years.
We would also increase the opportunity for workers to take
their retirement savings with them when they change jobs. The
law imposes too many restrictions that prevent workers from
moving their savings from one type of retirement plan to
another. We would break down the barriers between 401(k),
403(b), and 457 plans, allow workers to roll over their funds
when they move from one job to another.
Despite the success we have had over the past few years,
working on a bipartisan basis, with the support of the Clinton
Administration, in enacting pension simplification reforms, the
current law is still too complex. It still imposes too many
restrictions on multi-employer plans, penalizing workers, and
especially union members, who participate in these plans. H.R.
1102 will make the law work better for these multi-employer
plans.
Current law still imposes too many restrictions on small
businesses. Less than twenty percent of Americans who work for
small businesses have the opportunity to save in an employer-
sponsored retirement plan. H.R. 1102 removes many burdensome
restrictions on small businesses, including reform, but not
repeal, of the ``top heavy'' rules.
Mr. Chairman, there is no single answer to the retirement
savings crisis in our country. In presenting the Portman-Cardin
proposal to the House, however, we have worked to formulate a
plan that will take federal pension law in a new direction. We
want to back up our pro-savings rhetoric with pro-savings
legislation.
I appreciate the opportunity to testify before this
committee today. Two-thirds of the members of our committee,
with strong bipartisan representation, has cosponsored this
bill. I look forward to working with all the members of this
committee to rebuild our nation's private savings system.

Chairman Archer. Thank you, Mr. Cardin.
Our next witness is William Jefferson.
We would be pleased to hear your testimony.

STATEMENT OF HON. WILLIAM J. JEFFERSON, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF LOUISIANA

Mr. Jefferson. Thank you, Mr. Chairman.
Mr. Chairman and Mr. Rangel and Members of the Committee, I
am pleased to have the opportunity to testify regarding the
Small Savers Act. I want to thank Lindsey Graham and Mr. Wexler
for cointroducing this bill with me.
I thank the Chairman for holding this hearing on tax
proposals to enhance retirement and health security through,
among other things, increasing personal savings by reducing the
tax burden on savings.
Retirement security is an important issue to all of us. It
is important to all Americans, and it is important that we have
something that we can do this year on this subject.
By encouraging personal savings, the Small Savers Act
represents sound economic and social tax and fiscal policy. The
Small Savers Act represents sound economic and social policy
because it would result in increased savings and investments by
millions of Americans.
Most economists agree that the best way to ensure
retirement security for future generations is to maintain
continued and sustained growth of the economy. However, this
growth is threatened by the low and approaching negative
personal savings rates in our country. It is alarming that over
one-third of Americans have no personal savings at all, and
most who do have less than $3,000. This is not much to retire
on.
The Small Savers Act provides four modest tax incentives
that will induce low- and middle-income Americans to save and
invest more and reverse this alarming trend.
First, the Small Savers Act raises the 15 percent tax
bracket by $10,000 for joint filers, $5,000 for single filers
phased in over 5 years. As a result, more low- and middle-
income tax payers, actually more than 7 million, will be pushed
into the lower 15 percent tax bracket and therefore pay a lower
tax bill. With more money in their pockets, these families will
have more money available to put toward savings.
Second, the bill allows taxpayers filing jointly to deduct
up to $500 of interest and dividend income. Single filers will
be able to deduct half that amount.
Third, the bill will allow taxpayers to exempt up to $5,000
of long-term gain from taxation. These two provisions will
reduce the tax bias against savings. Under present law, $100
saved is taxed greater than $100 consumed because the earnings
on the $100 saved are also subject to tax.
Finally, the bill allows taxpayers to increase annual
contributions on traditional IRAs from $2,000 to $3,000 and
begins index inflation in 2009. Since IRA contributions have
the attractive feature of being tax deferred, increasing the
contribution limits will encourage additional savings that can
be used to help individuals maintain their standard of living
during retirement.
The Small Savers Act represents good tax policy because it
addresses one of the major problems with our current tax
system, complexity. For most Americans, filling out Federal
income tax forms has long been a daunting task. Now this task
has become increasingly more overwhelming with increased
complexity of the Code. In addition to the complicated form
1040, many Americans must fill out numerous additional forms in
order to determine their tax liability. Americans spend
millions of dollars unnecessarily not on paying their tax
liability but on paying tax preparation fees.
If the Small Savers Act is enacted, millions of taxpayers
will no longer have to pay tax on their interest, dividend or
capital gains income. Thus, more taxpayers will be able to file
their taxes using the simpler form 1040 EZ and will no longer
have to use the complicated form 1040 D or form 1040 schedule A
to itemize their interest, dividends and capital gains income.
Taxpayers will save millions of dollars in tax preparation
fees, money that can be used for further savings.
The Small Savers Act is also good fiscal policy because it
does not require using any of the Social Security surplus. The
Small Savers Act is expensive, to be sure. It costs $134
billion through fiscal year 2004, and $345 billion over 10
years. But this figure is less than half of projected $787
billion in non-Social Security surplus over 10 years. The
remaining non-Social Security surplus can be prudently invested
if the Congress should so desire in education, in defense, and
any other way, perhaps even to pay down the debt.
Mr. Chairman, the Small Savers Act should in no way be
viewed as a panacea for the savings crisis facing our country
or a threat to retirement security. However, this bill is a
bipartisan compromise from which to start, and I can't
emphasize it enough that it is something which I think is
doable this year.
I commend the Chairman for also including legislation to
reform our private pension system in this hearing and having
bipartisan meetings to discuss areas of common ground toward
the plan to save Social Security. I will continue to work with
the Chairman, with the other Members of the Committee, my
colleagues in the House, and with the administration to fashion
legislation to address all areas of improving retirement
security.
Thank you again, Mr. Chairman, for the opportunity to
testify.
[The prepared statement follows:]

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

Mr. Chairman and members of the Committee, I am pleased to
have the opportunity to testify regarding ``The Small Savers
Act.''
I thank the Chairman for holding this hearing on tax
proposals to enhance retirement and health security, through
among other things, increasing personal savings by reducing the
tax burden on savings. Retirement security is an important
issue to me. It is an important issue for my constituents in
Louisiana and it is an important issue for all Americans.
By encouraging personal savings, the Small Savers Act
represents sound economic, social, tax, and fiscal policy. The
Small Savers Act represents sound economic and social policy
because it will result in increased savings and investments by
millions of Americans. Most economists agree that the best way
to ensure retirement security for future generations is to
maintain continued and sustained growth of the economy.
However, this growth is threatened by the low-and approaching
negative-personal savings rates in this country. It is alarming
that over one-third of Americans have no personal savings at
all.
The Small Savers Act provides four modest tax incentives
that will induce low and middle-class Americans to save and
invest more and reverse this alarming trend.
First, the bill raises the 15% tax bracket by $10,000 for
joint filers; $5000 for single filers phased in over 5 years.
As a result, more low and middle income taxpayers--actually
more than 7 million more--will be pushed in the lower 15% tax
bracket and pay a lower tax bill. With more money in their
pockets, these families will have more money available to put
towards savings.
Second, the bill allows taxpayers filing jointly to deduct
up to $500 of interest and dividend income. Single filers will
be able to deduct half that amount.
Third, the bill will allow taxpayers to exempt up to $5000
of long-term gain from taxation. These two provisions will
reduce the tax bias against savings. Under present law $100
saved is taxed greater than $100 consumed because the earnings
on the $100 saved are also subject to tax.
Finally, the bill allows taxpayers to increase annual
contributions on traditional IRA from $2000 to $3000 and begins
indexing for inflation in 2009. Since IRA contributions have
the attractive feature of being tax deductible, increasing the
contribution limits will encourage additional savings that can
be used to help individuals maintain their standard of living
during retirement.
The Small Savers Act represents good tax policy because it
addresses one of the major problems with our current tax
system--complexity. For most Americans, filling out federal
income tax forms has long been a daunting task. Now, this task
has become increasingly more overwhelming with the increased
complexity of the Tax Code. In addition to the complicated Form
1040, many Americans must fill out numerous additional forms in
order to determine their tax liability. Americans spend
millions of dollars unnecessarily; not on paying their tax
liability, but on paying tax preparation fees.
If the Small Savers Act is enacted, millions of taxpayers
will no longer have to pay tax on their interest, dividend or
capital gains income. Thus, more taxpayers will be able to file
their taxes using the simpler Form 1040 EZ and will no longer
have to use the complicated Form 1040 D or Form 1040 Schedule A
to itemize their interest, dividend and capital gains income.
Tax payers will save millions in tax preparation fees. Money
that can be used for further savings.
The Small Savers Act is also good fiscal policy because it
does not require using any of the Social Security surplus. The
Small Savers Act is estimated to cost $134.7 billion through FY
2004 ($345.7 billion through FY 2009). This figure is less than
half of the projected $787 billion in non Social Security
surplus over 10 years. The remaining non Social Security
surplus can still be used to fund important spending
initiatives such as education and defense or to pay down the
debt.
Mr. Chairman, The Small Savers Act should in no way be
viewed as a panacea for the Savings crisis facing our country
or the threat to retirement security. However, this bill is a
bipartisan compromise from which to start. I commend the
Chairman for also including legislation to reform our private
pension system in this hearing and having bipartisan meetings
to discuss areas of common ground towards a plan to save Social
Security. I will continue to work with the Chairman, my
colleagues in the House and with the Administration to fashion
legislation to address all areas of improving retirement
security.
Thank you Mr. Chairman.

Chairman Archer. Thank you, Mr. Jefferson.
Our last witness is Earl Pomeroy.
We are delighted to have you before the Committee and thank
you for your work that you have done on retirement issues. We
would be pleased to hear your testimony.

STATEMENT OF HON. EARL POMEROY, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF NORTH DAKOTA

Mr. Pomeroy. Thank you, Mr. Chairman. It is indeed a great
delight to be in the Ways and Means Committee, even for a brief
time.
I don't think there is an issue before us more important
than retirement savings. I commend you for holding this
hearing.
In my testimony I want to advance four points for your
consideration.
First, retirement savings is a national priority.
Second, tax cuts in this area should begin by increasing
the immediate financial incentive for retirement savings
efforts by families and individuals of middle and modest income
means.
Third, tax cuts should be shaped to increase the prospects
employers will offer and continue pension coverage for their
work force.
Fourth, a tax bill should include provisions that include
the portability of workers' retirement savings.
First, the national priority. Our population is aging. Our
savings rates declining. These are ominous trends, and they
require our attention if we are to avoid the prospect of
growing numbers of Americans without adequate personal
resources to meet their needs in retirement years.
Wonderful breakthroughs in medicine and health care have
increased the number of years we can hope to live, and that not
only makes our problem worse--consider the following facts:
The number of retirees will double as baby boomers move
into retirement age. The national savings rate is at its lowest
point in some 60 years. Seventy percent of those with 401(k)
plans have balances below $30,000 and nearly half below
$10,000.
The conclusion I draw from all of this is that stepping up
retirement savings is a true national imperative. Like the line
from that old muffler ad, it is a ``pay now or pay later''
situation. Either we take steps to help families accumulate
retirement savings so they can meet their needs with their own
resources or we pay later through publicly funded programs
providing the support people require.
I believe tax cuts in this area represent excellent tax
policy and return a long-term dividend of reducing demand on
public programs down the road.
Retirement savings for middle and modest income families:
We have achieved a great deal through retirement savings in the
workplace but, as Mr. Portman mentioned, so many don't have
that retirement savings opportunity. In North Dakota, four out
of 10 workers have retirement savings at work.
Congress needs to enhance incentives for vehicles like
individual retirement accounts. Now, last Congress we took
steps in this area, strengthening IRA incentives in several
areas, none, however, for households in the category $50,000
and below.
It is not surprising that these are the very families that
have the most difficulty saving for retirement. Discretionary
dollars gets stretched thin just covering basic living expenses
ranging from school clothes to car repairs. They need a more
meaningful retirement savings incentive.
I propose increasing the incentive by establishing a 50
percent tax credit for IRA contributions of $2,000 or less each
year for families earning $50,000 or below. An individual is
$25,000 and below.
The President has proposed USA, universal savings accounts,
that is an even more ambitious effort to get savings
comprehensively established. This IRA tax credit proposal is
another way of approaching the same issue. I believe you could
market an IRA tax credit to families like an employer match in
a 401(k) setting. There hasn't been an incentive for retirement
savings more effective in my opinion than that employer match
on the 401(k). Let's apply the same dynamic to the IRA through
this tax credit.
Support for pension plans should be stepped up, too. Of all
the employer-based retirement savings, it is the pension plan
that offers the most predictable stream of income in
retirement, but what we are seeing is a dramatic decrease in
the number of pension plans out there. The number of workers
covered has diminished over the last 10 years, even though the
work force has grown substantially, and the number of employers
offering plans has absolutely just collapsed.
Congress and the administration--several administrations
bear much of the responsibility. We have made it too complex,
too costly; and we need to address that. In 1996, we advanced
regulatory relief for retirement plans, but that was defined
contribution plans through the SIMPLE legislation.
Congresswoman Johnson and I have introduced a bill known as
SAFE, Secure Assets for Employees, which does basically the
same type of regulatory relief for defined benefit plans.
Now, new incentives to save, cost money, and the amount of
money you will have available for your tax bill, Mr. Chairman,
will determine what you can do. But removing disincentives to
save don't cost much money.
And this would be my final point, portability. We have over
the years through happenstance in the Tax Code made it very
difficult for someone to move their retirement savings as they
move through the work force. Take, for example, someone who
works for a private for-profit. They would have a 401(k)
defined contribution plan. If they went to work for a
nonprofit, they would have a defined contribution 403(b) plan.
If they later went to work for State government, they would
have a defined contribution 457 plan. All defined contribution
plans but none of them convertible one to another.
When a person has a bunch of little retirement accounts, we
know what happens. They have them disbursed. When they have
them disbursed, we know what happens. They spend it. In fact,
more than 60 percent of the time the money is not fully
reinvested in retirement savings. So by making it impossible
for someone to keep their retirement funds in one account we
encourage disbursement and therefore spending.
Let's stop that. We introduced a bill called RAP, the
Retirement Account Portability bill, that would allow for this
type of rollover. I think there is no public policy served by
frustrating someone's ability to collect their retirement
accounts in one place. There is very little cost to the
Treasury in addressing this legislation; and whatever you do
with the tax bill, Mr. Chairman, I would hope the portability
issue is included.
Thank you for listening to me.
[The prepared statement follows:]

Statement of Hon. Earl Pomeroy, a Representative in Congress from the
State of North Dakota

Mr. Chairman, members of the Committee, thank you for the
opportunity to appear before you this morning. The topic we
discuss today--how to encourage greater savings for
retirement--is one of critical importance to the economic
health of our people and our nation. No tax cut proposal this
Committee will consider is more important than those that
assist America's families in saving for their retirement, and I
commend you for holding this hearing today.
In my testimony I will advance four points for your
consideration:
1) Retirement savings is an urgent national priority;
2) Tax cuts in this area should begin by increasing the
immediate financial incentive for individual retirement savings
efforts by families and individuals earning modest incomes;
3) Tax cuts should increase the prospects employers will
offer and continue pension coverage for their workforce;
4) A tax bill should include provisions that improve the
portability of workers' retirement savings as they change
employers in the course of their careers.

Retirement Savings as a National Priority

Our population is aging and our savings rate is declining.
These are ominous trends that require our attention if we are
to avoid the prospect of growing numbers of Americans without
adequate personal resources to meet their needs in retirement
years. Wonderful breakthroughs in medicine and health care have
increased the number of years we can hope to live, but that
serves to make the problem of inadequate retirement savings
even worse.
The following collection of facts serve to make the point:
The number of retirees will double as baby boomers
move into retirement age.
The proportion of active workers per retiree will
move from three to one today to two to one by 2030.
The national savings rate ran about eight percent
from World War II to 1980, dropped to four percent thereafter
and languishes today at or slightly below one percent. (Some
contend this data, drawn from the Commerce Dept., does not
capture all of the resources families have available--like home
equity. In any event, however, our rate of savings is declining
when it needs to be increasing.)
70 percent of those with 401(k) plans have
balances below $30,000 and nearly half (48 percent) are below
$10,000.
The fastest growing segment of our population are
Americans 85 years and older.
The conclusions I draw from all of this is that stepping up
retirement savings rates is a true national imperative. Like
the line from the old muffler ad, our choice is a ``pay now or
pay later'' proposition. Either we take steps now to help
families accumulate retirement savings so they can meet their
needs with their own resources or we pay later with publicly
funded programs providing the support people require.
Mr. Chairman and committee members, you will consider many
areas worthy of tax relief. I strongly believe that tax cuts
which help families save for retirement is excellent tax policy
which returns the long term dividend of reducing the demand on
public programs down the road.

Retirement Savings for Middle and Modest Income Families

Perhaps the most successful retirement savings are achieved
through workplace retirement plans, but only half of those in
the workforce today have this savings opportunity. In rural
states the problem is even more severe. In North Dakota, for
example, only four workers out of ten have workplace retirement
savings programs.
Congress needs to continue to enhance the incentive for
private retirement savings through vehicles like Individual
Retirement Accounts (IRAs). Last Congress strengthen IRA
incentives in several ways, most notably the creation of the
Roth IRA. It did not, however, increase or strengthen the IRA
incentive for households that find it most difficult to save,
those earning $50,000 annually or less.
It is not surprising that the more modest the income the
more difficult it is to set money aside for retirement.
Discretionary dollars get stretched thin just covering basic
living expenses ranging from school clothes to car repairs.
Modest income families need a more meaningful savings
incentive.
I propose increasing the incentive by establishing a 50
percent tax credit for IRA contributions of $2,000 or less each
year for families earning $50,000 and individuals earning
$25,000 annually.
This proposal is contained in H.R. 226, the Family
Retirement Saving Act. It would be my expectation that the
credit opportunity could be marketed similar to the employer
match incentive in place in many, many employment based
retirement plans across the country. I believe the employer
match has proven itself to be the single most effective savings
incentive we have going. Let's try to apply this dynamic to the
Individual Retirement Account for our middle and modest income
families.
Remember, the new IRA incentives last Congress went to
those earning between $50,000 and $150,000 annually. It's time
we direct additional help in this area to those who need it
most, households at $50,000 and below.

Support for Pension Plans

Of all employer based retirement savings programs, none
provide a more dependable stream of income in retirement than
the traditional defined benefit pension plans. Over the last 20
years, however, the number of employees covered under pensions
has declined even while the workforce has significantly
expanded. In addition, the number of employers offering defined
benefit plans has collapsed.
Congress and the past several Administrations bear much of
the responsibility for this disturbing trend by reducing
incentives for employers while increasing the complexity and
cost administering a plan to employers. The problem has been
particularly acute for small employers.
In 1996 Congress passed regulatory relief for small
employers offering defined contribution plans. This
legislation, known by its acronym SIMPLE, has proven successful
in the marketplace. Now it's time to advance a similar small
employer initiative for defined benefit plans.
This week Congresswoman Nancy Johnson and I introduced H.R.
2190, which is substantially identical to our SAFE proposal
from the last Congress. This bill would significantly increase
the appeal to employers of offering a defined benefit plan and
would greatly simplify the administrative burden by reducing
complexity and cost of compliance.
I am also pleased to cosponsor the important legislation
proposed by Committee members Rob Portman and Ben Cardin. The
Portman-Cardin bill represents a comprehensive, significant
effort to further stimulate employer based retirement savings
plans.

Making Retirement Savings Portable

Mr. Chairman, it costs money to create new incentives for
retirement savings regardless of whether we expand IRAs or
address employer based plans. I recognize the size of the tax
relief legislation will dictate what, if anything, we can
accomplish in this area.
Regardless of whether we create new incentives to save (and
I hope we do!) It does not cost much money to tackle
disincentives to retirement savings that accumulated over the
years.
One of the most significant barriers to savings is the lack
of portability of retirement savings. In some instances these
barriers are a happenstance creation of the tax code that serve
no public purpose whatsoever.
Take for example the inability to move savings among three
common forms of defined contribution plans: 401(k), 403(b), and
457.
If you begin your career working for state government you
save under a 457 plan. Moving to a nonprofit may avail you of a
403(b) opportunity. In your next job perhaps you would have a
private for profit 401(k) savings plan. Each plan is a defined
contribution plan but rollovers from one to another are
prohibited.
As a result, people often have their accounts dispersed and
all too often these funds do not get fully reinvested. In fact,
at least 60 percent of the time funds dispersed are not put
back into retirement savings.
In order to address this problem, I have introduced H.R.
739, the Retirement Account Portability Act (the RAP Act), with
Rep. Jim Kolbe. This bill unravels the regulatory complexity
and ends the statutory barriers that prevent workers from
moving their pensions with them from job to job.
This bill has industry and labor support, and has been
endorsed by the Clinton Administration and is included in the
bipartisan Portman-Cardin bill. Best of all, RAP has only
negligible cost to the Treasury. Enacting RAP this year is an
achievable goal that will greatly enhance workplace savings.
Mr. Chairman, I thank you for your leadership on this issue
and look forward to working with you.

Chairman Archer. The Chair appreciates the testimony by
each of you, all of which is very constructive, and now the
Chair asks if any Members would like to inquire.
Mr. Thomas.
Mr. Thomas. Thank you very much, Mr. Chairman.
I also want to compliment the Members. You are dealing with
two areas that are absolutely critical, and you have suggested
a number of very, what I would consider simple, commonsense
changes, especially the idea of portability, especially the
ability of setting up a structure which allows for retirement
security. But I listened very carefully and I didn't hear any
mention--I may have been negligent, but I don't think so--of
long-term care proposals.
I tell my friend from North Dakota that Fram oil filters
spent a lot of money on that ad, and they are sorry you
referenced a muffler. The pay me now or pay me later ad is a
good example. The pitch is a cheap oil filter change and--oil
change and oil filter--or pay me for a replaced engine.
Today, given the point that all of you mentioned in terms
of Americans living longer, the simplest fix for long-term care
is the time value of money because of the more predictable need
for that care in later life. So I would just urge you, as you
are looking at the very positive suggested changes, if you are
able to expand by definition or structurally include the
ability to pay for long-term care from a fund created over
time, health insurance today tends to be acute. Medicare in
terms of health care needs for seniors is acute. We have some
surrogates for long-term care today in Medicare, but they,
unfortunately, are the fastest growing and most difficult to
control price areas.
So, in that sense, I would hope that you think about long-
term care as part of a comprehensive retirement security
package.
Mr. Chairman, I tell you just as recently as yesterday the
Health Subcommittee held a hearing on the uninsured. What we
got out of it was basically that there is no single or simple
solution.
Although 43 million Americans are uninsured, when you begin
examining the various groups, you find some that make incomes
of more than $50,000, and they choose not to participate in a
program. What we have been told is that even if you put
billions of dollars into a program, the percentage change,
especially if it is a tax credit to try to buy down the cost of
that insurance, produces only modest increases in the number of
people who participate in the program.
Even in those areas that it is 100-percent paid for, for
low-income, Medicaid and the S-CHIP, State Children's Health
Insurance Program, from the Balanced Budget Act of 1997, 13.4
percent of those who are currently uninsured qualify for that
program. So what we have to do is look at our attempts to
provide assistance to people who do not now have health
insurance. We showed it in a way that maximizes the number of
people who receive it but that, too, shows we are not fooled by
the belief that the solution to this problem is a simple one or
that there is a single approach to the very complex picture of
who is among the uninsured today.
But I want to underscore the ideas that you are presenting,
especially to my friends Mr. Portman and Mr. Cardin, frankly, I
think are just long overdue. No one looked at them. No one
focused on them. No one pulled them together. You folks have. I
give you plenty of credit for that.
Mrs. Johnson, I know, has been wrestling with this
question, as has Mr. Stark on the health care provision. It is
something I think that we need to work on, begin the process,
but that it clearly is not subject to a single fix.
And with that, Mr. Chairman, if anyone wants to respond to
anything I said, I would appreciate it. But, please, long-term
care is an ongoing need. It will increase, and it ought to be
simple, on the time value of money to look into some kind of
pension structure.
Chairman Archer. You have 1 minute to respond.
Mrs. Johnson of Connecticut. If I may just briefly call
your attention to the bill that Karen Thurman and I introduced
that is focused on long-term care. I didn't have time to go
into it in much detail.
It does have four provisions. It not only for the first
time rewards holding of long-term care insurance over time so
the deduction goes up for the number of years that you hold it
for the first 5 years, but it also provides a recognition of
the tremendous contribution that in-home care givers provide
and eliminates this arbitrary limit on partnership, State
partnerships, that help people, induce them to buy long-term
care insurance, an arbitrary provision of Federal law.
Last, it has a very aggressive educational program so
people will really understand that neither Medicare nor
Medicaid provide long-term care except under extraordinary
circumstances. So the educational provisions are about as
important as anything else.
Mr. Thomas. Thank you very much.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Rangel.
Mr. Rangel. Thank you.
Let me first thank my colleagues for the work they have put
into these very meaningful proposals that are before us.
Mrs. Johnson, do you believe that we can handle on this
Committee Social Security, Medicare, and tax cuts this year?
Mrs. Johnson of Connecticut. I think we can certainly do
Social Security reform. I think we can and should do Medicare
reform. I think we can do pension reform. Those are three of
the--and long-term care reform. So I think we can do retirement
security reform, and I think the tax reform bill, the effort to
cut taxes, will have to be paired with the development of
surpluses that are over and above the Social Security
surpluses.
But we do expect to move into years when we have a genuine
surplus over and above Social Security revenues next year and
the years thereafter, and I think it is appropriate for this
Committee to set economic policy, particularly since we have
heard how catastrophically low our savings rate is. I think it
is actually imperative for this Committee to set some course
for this Nation through long-term tax policy and not leave the
Members thinking this is all going to be free dollars to spend
on new programs. Our savings rate is catastrophic. There are
big problems in our providing retirement security, long-term
care security and those things. So I think almost all of the
balls are in the court of this Committee in terms of using our
resources as a nation into the future to provide a strong
economy and retirement security.
Mr. Rangel. And the tax cut would be based on projected
surpluses after Social Security?
Mrs. Johnson of Connecticut. We have all agreed that we are
not going to use Social Security revenues for anything other
than Social Security. So that is a bipartisan agreement and we
are going to stick to it.
Mr. Rangel. And Medicare?
Mrs. Johnson of Connecticut. We did set aside 62 percent
for Social Security and 15 percent for Medicare, so there is
some ability to use that surplus to solve the immediate
problems in Medicare, which I consider to be acute and also for
long-term reform of Medicare.
Mr. Rangel. If we did have a tax cut, what year do you
think that it would become effective?
Mrs. Johnson of Connecticut. First of all, I would hope
that part of it would become effective almost immediately. The
research and development tax credits expire. The work
opportunities tax credit, which is critical to the
reemployment, to the employment of welfare recipients, expires.
Just like we have to budget every year, we have to pass
some kind of tax legislation every year. As to bigger
provisions, they will depend on the estimates as to when the
surpluses exceed the Social Security tax revenues.
The other provisions in my personal, I am not speaking for
anyone but myself, I think the extension of the R&D, the
extension of the work opportunities tax credits demand the same
attention as the appropriations proposals that we have on the
floor because losing continuity or breaks in those--that tax
law are very costly to both the people and the businesses that
we count on to make our economy strong. I want to make sure
that they go ahead immediately.
Mr. Rangel. Do you agree that we ought to enact the revenue
neutral extended tax bill to make certain that we don't have
the extended included in the appropriations bill?
Mrs. Johnson of Connecticut. I think this Congress under
both Republican and Democratic leadership have used a
reconciliation very effectively to make sure that the key
interests of the Nation are addressed across the board, whether
they are in the tax area or the appropriations area. While it
may be necessary to use that instrument to some extent this
year, I think this Committee, under this Chairman, is going to
pass tax legislation that will stake out in a sense the tax
policy that will strengthen our economy over the long-term and
address some of the problems that we have raised today about
retirement security, pension reform and savings rates.
Mr. Rangel. What size tax cuts do you think that we are
talking about?
Mrs. Johnson of Connecticut. We have a large surplus
predicted in the outyears, and I think it is our responsibility
as the tax Committee to help the public understand that sound
tax policy is critical to a strong economy and a secure society
in the future. We are at the threshold of seeing our major
retirement security plans collapse, not just Social Security
but pensions, too.
Mr. Rangel. What size----
Mrs. Johnson of Connecticut. I would say most of that
surplus ought to be in that tax bill and not be available for
new programs. The new program demands should be met by making
government far more efficient than it has been in the past.
Mr. Rangel. What size tax cut do you think we are talking
about?
Mrs. Johnson of Connecticut. I don't know what the
surpluses will be, Mr. Rangel. I can't answer that.
Mr. Rangel. You have no idea what we are looking for in the
tax bill, though?
Mrs. Johnson of Connecticut. The projections are several
hundred billion in 5 years, and many more hundred billions in
10 years.
Mr. Rangel. Would 800 billion over 10 years sound like
what----
Mrs. Johnson of Connecticut. That is what the estimators
are saying. My goal is that we stake out the majority of that
money and demonstrate to the people of America how we can
strengthen the economy and secure us each individually in our
lives and in our retirement, and I think that is the number one
obligation of this Congress and far exceeds our obligation to
spend that on programs in the future.
Chairman Archer. Does any other Member wish to inquire?
Mr. Kleczka.
Mr. Kleczka. A quick question to Mrs. Johnson, you just
indicated that you think the Congress should, and I am
paraphrasing, stake out the majority of that money for programs
that this panel is talking about? For what type of tax cuts?
Mrs. Johnson of Connecticut. This is not a hearing on the
tax bill and so there is no sense in my going into the details.
Mr. Kleczka. Everything that has been discussed by this
panel could be included in the tax bill.
Mrs. Johnson of Connecticut. That is why the Chairman is
very wise to have a hearing on retirement security.
Mr. Kleczka. I was hoping that you were saying that we
should stake out a majority of that surplus for the things that
we are talking about today. Otherwise what this Committee is
doing is raising some false hopes with the public by having an
all-day hearing on retirement security and health security. And
I say if we were to pick up a small portion of all of your good
ideas, 10 percent of Jefferson and 10 percent of Pomeroy and 2
percent of the Stark because of the cost, that would more than
eat up the surplus and there would be no room for estate tax
changes or capital gains tax elimination.
So I think we as a Congress have to make some priorities.
Are these our priorities, the items discussed at this all-day
hearing on things that are so important not only to the economy
but to so many Americans? My answer to that is ``Yes.'' We are
all talking about all sorts of new savings instruments. USA
accounts are proposed by the administration, the Chairman has a
new Social Security account which has a mix of stocks and
bonds. We are recreating the wheel here, my friends. We have
the savings instruments in place today. Let's make them
meaningful. Let's take our IRAs and boost them. Let us increase
the 401K caps. Let us provide for portability and some type of
interweaving of the current pension plans, like Mr. Pomeroy
says.
One of the issues that I have been working on is health
care for retirees. I had a GAO study done which indicated more
and more employers are willy nilly canceling their retiree
health care.
I had a situation in my district with Pabst Brewing Co.
where the retirees woke up 1 day and found that the employer
just canceled their health benefits. I am talking regular
retirees and early retirees. I had a situation with a
constituent, an early retiree who had a wife with MS at home.
With the early retirement package offered to him at age 55
which included coverage for health care for his wife's
condition, he thought that he could make it and go home and
take care of his wife. The day that they canceled his benefits,
he found out that his health insurance premium with a private
insurance plan cost more per month than his entire retirement
benefit.
So what we are talking about today is important, but my
friends, it would take the entire surplus that is projected,
not the Social Security surplus, to address a piece of those
needs.
Mr. Portman, what is the CBO estimate of your pension bill
and Mr. Cardin's pension bill, which I happen to be a supporter
of?
Mr. Portman. You sound like a Chairman talking about
working on priorities. We don't have a Joint Tax Committee
estimate yet for this year. We are promised one this week. We
asked for it back in April.
Last year's bill, which is substantially similar to this
year's bill, was roughly $9 billion exclusive of the minimum
distribution proposal over a 5-year period. But remember, we
are talking about a substantial surplus and a possibility of
substantial tax relief bill. Over the next few days, we will
have an estimate and it may be higher because we do get into
the IRAs, raising the limit from $2,000 to $5,000 in IRAs. If
you take that out, we hope to be close to where we were last
year.
Mr. Kleczka. If we are serious about the dialog that we are
having today in the Committee, if we are even going to put a
dent into these problems, problems facing regular Americans, it
would take the entire surplus.
So as the Chairman talks about the estate tax and others
talk around Capitol Hill about eliminating the capital gains
tax, know that there is not going to be any room for that, plus
the extenders, which is an expensive piece of pie.
Mr. Chairman, I thank you for your time. Let's not forget
our retirees and their health care. I will be introducing
legislation to help retirees age 55 through 64. You can offer
them tax deductions for their health care premiums, but if they
don't have the income to offset it, what is the sense? I will
have a proposal in the next few weeks which would truly help
retirees and hopefully you folks on the panel will cosponsor
what I introduce.
Thank you, Mr. Chairman.
Chairman Archer. The gentleman from Wisconsin has given the
Committee a sneak preview of the real challenge that will be
before the Committee, which is to accommodate the multiplicity
of good ideas within the dollars that are available to us under
the budget. Although we do not have the final estimate on the
Portman-Cardin-Kleczka, and so forth, bill, simply raising the
limit on IRAs from $2,000 to $5,000 a year cost $38 billion
over 10 years. That number I do know.
In the end we are going to have to really examine
priorities. I am always fascinated as chairman that I can't
simply go out and cosponsor every bill for all of the good
things that we want to see done in tax relief in the Tax Code.
Members individually can do that. So when a good idea comes
along, it is easy to jump on board, and then we have bills that
have a hundred, 200 cosponsors. If each Member began to
consider the revenue losses that in the aggregate occur as a
result of all the bills that he or she has cosponsored, we
would find that it is an impossibility to accomplish all of
that.
So the gentleman from Wisconsin has put his finger on a
very sensitive point that we have all got to consider because
retirement security is exceedingly important, and that is not
just the pension side, that is also the health side, which
includes long-term care. But there are many, many other items
that are important, too, in a tax bill. We have to sort through
that.
Mr. Portman.
Mr. Portman. If I can just make one comment which relates
to what Mr. Kleczka and you have raised with regard to the
revenue impact, we need to keep in mind what you have stated a
number of times in reference to the guarantee accounts in your
Social Security proposal, which is with regard to the pension
side, this is going to increase our savings rate in this
country, meaning there will be more money invested in the
markets. There will be more capital formation and increased
revenues from that. If the Joint Tax Committee had the ability
to do a dynamic score, it would look quite different, and I
just raise that because some tax proposals will result in
higher savings and more general revenues coming in as a result
of better economic conditions.
With regard to retirement security, I hope we look at it in
that context and in the context of how cost effective it is. In
the retirement area, as you know, you are leveraging a lot of
private dollars and the nondiscrimination rules ensure that. It
is an awfully good bargain for the Treasury and you will have a
much more cost effective way of handling retirement needs by
making some of these common-sense changes on the retirement
side.
Chairman Archer. The issue before us today is a wonderful
way to kick off our hearings, but we will be holding hearings
on other aspects of tax relief as we go along.
I am particularly looking forward to how we tax foreign-
source income and what that is doing to put barriers before our
ability to compete in the world marketplace, which is going to
be essential to our economy in the next century. If we don't
win the battle of the global marketplace, we are not going to
have the resources to do all of the things that we need to do
in the next century. I hope every Member will try to attend
that hearing.
I think Ms. Dunn wants to be recognized, and then Mr.
Weller.
Ms. Dunn. Before this panel leaves, I want to call
attention to one of the provisions in Mr. Portman's very
excellent pension reform bill that shows how important
education is to retirement. There is an area of tax treatment
of employer provided advice to employees on retirement
planning, and this is currently a benefit that employers
provide to employees. They educate their employees on the
importance of saving for retirement. Currently, this has been
treated as a fringe benefit by the IRS, but there is some
concern that the IRS may change their treatment, their tax
treatment of this particular fringe benefit and calculate it as
part of the employee's income. I have some concerns about that,
and the Portman-Cardin bill would codify current practice so
that it continues to be a fringe benefit. It is not calculated
as part of income and therefore is much more easily given by
employers and received by employees.
Mr. Portman. I thank the gentlewoman. Let me also thank her
for her help with the catchup provisions in this legislation
which we did not have a chance to get into. Ms. Dunn helped us
to focus on that issue which allows for every individual coming
into the work force at age 50 or above to add an additional
$5,000 annually to a defined contribution plan, for instance a
401(k). Who is this going to benefit, all baby boomers but
primarily working moms who are coming back into the work force
and want to be able to set aside enough of a nest egg. When you
are coming in late in the game because of, as Mr. Thomas
indicated earlier, the time value of money and compounding
interest, you want to give these people an additional
incentive.
On the education side, it is a very important provision of
the bill. Additionally, I think the impact of having these
increased contribution limits and encouraging small companies
to get into these plans is based on two things, and this is
based on talks with a lot of folks from around the country. One
is more education because the way that the nondiscrimination
rules work, owners are going to have to get the middle paid and
low-income workers involved in the plans in order for the plans
to meet the nondiscrimination and top-heavy rules. So education
is a more important component of this, which is great for this
country and great for workers.
Second would be bigger matches to encourage again these
workers who are perhaps not as interested in thinking about
their retirement, to have some financial incentive. And those
matches are private money going into the system that might not
otherwise be there which will help us with regard to our
savings rate.
So I thank the gentlewoman for her support and all of her
contributions.
Chairman Archer. Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman, and I will direct my
question to Mr. Portman. I too want to salute you on a couple
of issues, and I want to mention the catch-up issue which you
have already discussed regarding giving an opportunity
particularly to working moms who are trying to make up for
missed contributions when they were out of the work force while
they were home taking care of the kids. And I think of my own
sister Pat, who was out of the work force for years, and who,
of course, I believe deserves the opportunity to make up for
that missed contribution.
I want to direct my question specifically, Mr. Portman, to
the 415 pension issue, and of course I have been working with
you and you have a provision in your legislation and I have
H.R. 1297, which addresses the 415 issue, which I personally
think is an issue of fairness, and Mrs. Johnson is also
cosponsoring our legislation.
The 415 pension limits are arbitrary limits which limit the
ability of construction workers, those who work for several
employers. Many times a construction worker can work for two or
three different contractors. That is why they are in
multiemployer pension funds, but these limitations
unfortunately have really penalized folks who get up early,
sweat and toil, get their hands dirty, and in many cases they
work so hard at a younger age they are burnt out and worn out.
And of course the issue of the 415 when it is brought to my
attention is usually by a group of spouses of laborers,
ironworkers, operating engineers who have gone to work early
and of course they come home late and tired, and they found out
that their pension that they were promised was not quite what
they--it did not turn out quite as it should be because of the
415 limits.
I have a letter here from Laurie Kohr, wife of Larry Kohr,
a construction worker from Peru, Illinois, and I would like to
insert this into the record.
Chairman Archer. Without objection, so ordered.
[The information follows:]

Congressman Weller,
My husband Larry has been a member of a local union for 21
years. He has worked as a laborer and laborer foreman for a
local construction company.
We were delighted when we learned in June 1997 that his
hard work had paid off and that he had in his 30 credits to
retire.
You can only imagine our disappointment when we were told
that he couldn't collect his full pension because of IRC 415.
At age 38, and that he attained his credit hours just one
company his monthly allotment went from $33330.50/mon. To
$1598.21/mon.
For us it was a wake up call. It was the first time we had
heard of IRC 415. Since that time and through a lot of research
we have learned a lot.
We have learned that government employees are exempt from
415. You only have to be in Congress 2 years to have a secure
pension.
We have learned that legislation has been introduced for
the last 3 years and still 415 is affecting many people, not
only Larry.
We have also learned that hard work and loyalty to one
company doesn't always pay-off. This is the hardest lesson of
all.
Again, I ask your help. IRC 415 is unfair in more ways than
I go into here. So, I count on you as my representative to make
it fair, for everyone.
I am sincerely grateful for all you have done and I hope to
hear from you soon.

Lori Kohr
Peru, Illinois

Mr. Weller. Thank you. Laurie points out that her husband,
Larry, because of the 415 limits, he has retired after 20 years
as a construction worker, and as I pointed out earlier,
construction is a pretty physically demanding trade, a
tremendous amount of physical activity, and he recently
retired. And when he was working, he anticipated that under his
pension plan, his multiemployer pension plan, he would receive
almost $40,000 per year, about $3,300 a month before taxes. But
because of the 415 limits, after 20 years of working hard and
contributing because of overtime even more than anticipated
into his pension fund, he is only receiving about $19,178 a
year or about $1,500 a month and that is less than half of what
he is entitled to. So these 415 limits are costing real
families like Laurie and Larry Kohr real money and they are
being punished.
Mr. Portman, my question is when it comes down to it, would
lifting these 415 limits, would they affect the solvency or
jeopardize the integrity of these multiemployer pension funds?
Mr. Portman. No, my understanding is that it won't affect
the solvency of the plans or the funding of the plans. You are
exactly right, the focus of this is not on the higher paid
workers, it is on the workers like the example you used. The
higher paid workers are not going to worry about the 100
percent of compensation limit because they won't bump up
against it. So although this proposal has been opposed by some
people in the past as being helpful to higher paid workers, the
focus in multiemployer plans is on the person who is the
construction worker, who is laying the carpet, because this is
the person based on his years of service and the formula the
contribution is based on who should get a certain amount but
then this arbitrary limit comes in and knocks it down.
Mr. Weller. These 415 limits were established almost 20
years ago. Essentially, they were to go after some corporate
executives who had golden parachutes that they were trying to
create for themselves, but over the years these limits have
changed, and there are some groups which have been taken out.
It is my understanding that both teachers, public employees
were affected by the 415 limits and this Committee and this
Congress saw the merits of lifting them out from under the 415
limits.
Mr. Portman. That is correct.
Mr. Weller. I know that Mrs. Johnson played a role in that.
I consider this a fairness issue for the little guy and little
gal, and I am interested in working with you and the Chairman
and others on the Committee to ensure that we address this
fairness issue and lift those who work hard and play by the
rules, those who work in the construction trades, out from
under these 415 limits, and I appreciate your cooperation.
Mr. Portman. I appreciate all of the work that the
gentleman has put into the multiemployer issue generally in his
own bill which I have cosponsored and in helping ours.
Chairman Archer. The Chair again thanks the Members of the
panel for their participation. It has been very, very helpful.
The next panel is now invited to come sit at the witness
table, Dr. Goodman, Dr. Butler, Mr. Kahn, Ms. Lehnhard, Mr.
Wilford, and Ms. Hoenicke. The Chair welcomes each of you and
looks forward to your presentation.
Dr. Goodman, would you lead off. And would you for the
record identify yourself before you begin your testimony.

STATEMENT OF JOHN C. GOODMAN, PH.D., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, NATIONAL CENTER FOR POLICY ANALYSIS

Mr. Goodman. My name is John Goodman. I am President of the
National Center for Policy Analysis. Mr. Chairman, the number
of Americans who are uninsured is 43 million and rising. This
is occurring in the midst of a booming economy with
unemployment at alltime lows. We are spending an enormous
amount of money on this problem, but the more we spend, the
worse the problem seems to get. We are spending more than a
$100 billion on tax subsidies for private insurance, yet while
some companies have lavish health coverage subsidized by the
Federal Government to the tune of 50 cents on the dollar, other
Americans get no tax relief when they purchase their own
insurance. And among families who have insurance, those in the
top fifth of the income distribution get 6 times as much help
as those in the bottom fifth.
We are also spending an enormous amount of money on health
care for the uninsured, by our count more than $1,000 per year
for every uninsured person on a hodgepodge of programs, yet
there is no overriding mechanism that ensures that resources
are matched with needs and there is no way for an uninsured
person to take his $1,000 and spend it on private insurance
instead. There is a better way.
I propose a compact between the Federal Government and the
American people in which the Federal Government defines its
financial interest in this question and offers to every
individual and every family a fixed-sum refundable tax credit
so that people who have health insurance see their taxes
reduced and when they cease having health insurance, their
taxes are increased. An important part of this proposal is the
idea of the local health care safety net. Under the current
system, people who are uninsured already pay higher taxes
precisely because they don't get the same tax relief as people
who have tax-subsidized insurance. By our count, the uninsured
pay as much in extra taxes each year as the amount of free care
that they get at the Nation's hospitals. The problem is that
these extra taxes go to the Treasury and are folded into
general revenues while the local hospitals must find the
resources to pay for the free care.
As an alternative, I propose that the unclaimed tax credit
money be given to state governments in the form of a block
grant with only one proviso, that it be spent on indigent
health care. So the Federal Government would offer every family
a fixed sum of money. We hope that they choose to spend it on
private insurance, but if they don't, that money becomes part
of a safety net for those people who cannot pay their medical
bills.
I propose that we phase in the system in a reasonable way.
We should begin immediately to give people who purchase their
own insurance the tax credit. We should give the self-employed
the option to remain in the tax deduction system or the tax
credit system, and we should give every employer the option to
remain in the current tax exclusion system or switching to the
tax credit system. Once in the tax credit system, we would no
longer be subsidizing wasteful health insurance plans. The
Federal Government would subsidize only core coverage and
people would buy additional coverage with their own aftertax
dollars. We would put employer-provided insurance and
individually purchased insurance on a level playingfield so
that the role of the employer would be determined in the
marketplace and not by the vagaries of tax law.
We also need to put third-party insurance and self-
insurance through medical savings accounts on a level
playingfield. The current system encourages us to give all of
our money to HMOs and encourages abuses of managed care and
rationing imposed by employers. As an alternative to this, we
need to expand existing MSAs, medical savings accounts, and we
need to offer every American a new kind of MSA, a Roth MSA.
This is an MSA that would wrap around any health insurance
plan, an HMO, a PPO, fee-for-service, and so forth.
This plan, Mr. Chairman, also addresses two characteristics
of the uninsured that have been ignored by previous plans, and
that is most of the uninsured are uninsured only temporarily
for part of a year and that the low-income insured need their
tax refund money at the time the premiums are due in order to
avoid a loss of take-home pay. I believe there are workable
mechanisms already in place to solve these problems.
Finally, Mr. Chairman, this plan could be paid for with
money that is already in the system. The $40 billion that we
now spend on the uninsured is one source. The $100 billion that
we are spending on tax subsidies is another source. And we can
also carve out existing tax preferences. I see no reason why
middle-income families should get the $500 tax credit for a
child if the child is uninsured. I see no reason why middle-
income families should get the full value of its personal
exemption if the family is uninsured, and I see no reason why a
low-income family should get a $1,000 EITC, earned income tax
credit, refund for a child if that child is uninsured.
Clearly, these choices are political and they are yours to
make, but I think the goal is one which the vast majority of
Americans would support.
Thank you.
[The prepared statement follows:]

Statement of John C. Goodman, Ph.D., President and Chief Executive
Officer, National Center for Policy Analysis

Unwise government policies are largely responsible for the
fact that the number of Americans without health insurance is
43 million and rising. Unwise government policies also are
responsible for the fact that people who have health insurance
are turning over an ever-larger share of their health care
dollars to managed care bureaucracies that limit patient
choices and sometimes give providers perverse incentives to
deny care.
After many discussions with others involved in health care
policy, including analysts at other think tanks,
representatives of the industry, the medical community and the
government, as well as members of Congress and their staffs, we
at the National Center for Policy Analysis have concluded that
we must fundamentally alter federal government policies to
eliminate distorted incentives, empower individuals and create
new options in the health insurance marketplace.
What I am proposing would not increase the financial role
of government. The federal and state governments already spend
more than enough on health care and health insurance through
tax subsidies and direct spending programs. Instead, what is
needed is a radical reordering of government programs to make
them efficient and fair.

I. UNIVERSAL COVERAGE

Whether or not people have health insurance is a national
issue in which the federal government has a legitimate
interest. Therefore, we propose that the federal government
commit a fixed sum of money for health insurance for every
American (say, $800 per adult and $2,400 for a family of four).
The commitment should be the same for everyone--rich or poor,
black or white, male or female.
Everyone who purchases private health insurance would be
rewarded with a dollar-for-dollar reduction in income taxes for
health insurance costs up to a maximum amount (e.g., $2,400 for
a family of four). The credit would be fully refundable, so
even those who owe no income taxes would get the same financial
help.
The federal role would be purely financial. Private health
insurance benefits would be determined by individual choice,
competitive markets and state regulations. This plan is not
designed to subsidize the full cost of health insurance for an
average family. In most cases, the federal tax relief probably
would fund only a core benefits package with a very high
deductible. Individuals and their employers would be free to
purchase more complete benefit packages, but they would pay the
difference with aftertax (unsubsidized) dollars.

II. A HEALTH CARE SAFETY NET FOR THE UNINSURED

No one would be forced to purchase private health
insurance. But those who failed to buy private insurance would
pay higher taxes because they would receive no tax subsidy.
Unlike the current system under which higher taxes paid by the
uninsured simply become part of the Treasury Department's
general revenues, the ``tax penalties'' paid by the uninsured
would be rebated to state and local governments for local
Health Care Safety Nets. This would ensure that those who elect
to remain uninsured would have access to a social safety net
with a guaranteed minimum level of funding.
This federal money for local Health Care Safety Nets would
be like a block grant with one condition: the money would have
to be spent on indigent health care. However, no uninsured
person would have the right to demand a particular health care
service from the Safety Net. Local authorities would also be
free to charge fees to the uninsured--especially if it appeared
that their lack of insurance was willful.
Safety Net services may not be as desirable as services
provided by private insurance. Although the commitment of
federal dollars to the two alternatives (private insurance or
Safety Nets) would be the same, the amount of money per capita
available to local Safety Nets is expected to be less than the
resources available through private insurance. Thus Safety Net
doctors might not always be the very best doctors, Safety Net
programs might not be able to meet every health care need, and
there might be some waiting. These features are consistent with
the overall goal of creating some form of universal coverage
while at the same time encouraging private rather than public
provision of health care.
These local Health Care Safety Nets could be partly funded
with federal health dollars currently going to the states and
partly funded by state dollars that currently fund health care
for the uninsured. Under this plan, states would receive more
federal money if their uninsured population expanded and less
money if it contracted--unlike the current system, where there
is no necessarily relationship between the amount of federal
funding and any objective measure of need. Under the plan I am
describing, the federal government could discharge its
commitment to the states by counting against that commitment
dollars in current programs that fund indigent health care,
provided the states gain full freedom and flexibility to use
those funds to meet the needs of the uninsured.
Safety Net dollars could also be used to fund high-risk
pools. Under current law, states must create opportunities for
certain uninsurable individuals--those who were previously
insured--to obtain health insurance; and many have satisfied
this obligation by creating high-risk pools. This plan would
encourage the expansion of such risk pools by allowing Safety
Net money to fund them.

III. TAX FAIRNESS

For the first time, individuals who purchase their own
health insurance would receive just as much tax relief as is
provided to employer-sponsored plans. Under the current system,
employer payments for health insurance are excluded from the
employee's taxable income--cutting the cost of health insurance
in half for some middle-income families. By contrast, many
individuals who purchase their own health insurance must do so
with aftertax dollars--forcing some people to earn twice as
much before taxes in order to purchase the same insurance. This
plan would provide the same tax relief to every taxpayer--
regardless of how the insurance is purchased.
For the first time, low-and moderate-income families would
receive just as much tax relief as is provided to high-income
families. Under the current tax exclusion system, those in the
highest tax brackets get the most tax subsidy for employer-
provided health insurance--the top 20 percent of families get
six times as much help from the federal government as the
bottom fifth. Under this plan, every family would get the same
tax relief--regardless of the family's personal income tax
bracket.

IV. A RATIONAL ROLE FOR EMPLOYERS

Under this reformed system, employer-purchased insurance
and individually purchased insurance would be put on a level
playing field under the tax law. For those who obtain insurance
under the tax credit system, amounts spent by the employer on
health insurance would be included in the employees' taxable
income. However, employees would receive a tax credit on their
personal income tax returns--the same tax credit that would be
available to people who purchase their own insurance. In this
way, people would get the same tax relief for the purchase of
private health insurance, regardless of how it was purchased.
The employer's role would be determined in the marketplace,
rather than by tax law. Some health reform proposals would
require employers to provide health insurance; others would
force employers out of the health insurance business. By
contrast, this plan would allow the market to determine the
employer's role: if employers have a comparative advantage in
organizing the purchase of insurance for their employees,
competition for labor will force them into that role; if
employers have no special advantage, they will avoid that role.

V. PRESERVING EMPLOYER OPTIONS, BUT REWARDING GOOD CHOICES

Employers would have the option of keeping their employees
in the current tax regime. Because many employers and their
employees have made plans and organized their financial affairs
around the current tax law, an abrupt change to the new system
could be unfair. However, most employers would have an economic
incentive to switch to the tax credit system because that would
allow them to cut waste and inefficiency out of their health
care plans without losing tax benefits.
Because the current tax exclusion system rewards those in
the highest tax bracket the most, it favors high-income
employees. Because the tax credit system treats all taxpayers
equally, switching to it would help almost all low-and
moderate-income employees. Even though their higher-income
employees might pay higher taxes as a result, employers who
helped their low-income employees by switching to a tax credit
regime would be rewarded: the new tax regime would lower the
cost of their compensation packages and make it easier for them
to compete for employees in the labor market.

VI. INCENTIVES TO REDUCE WASTE AND INEFFICIENCY

The tax credit system described here would give employers
and employees new opportunities to reduce health care costs.
Under the current tax exclusion system, employees can reduce
their tax liability by choosing (through their employers) more
expensive health insurance plans. As a result, the federal tax
system encourages overinsurance and waste: An employee in a 50
percent tax bracket (including state and local taxes) will tend
to prefer a dollar's worth of health insurance to a dollar of
wages even if the health insurance has a value of only 51
cents. By contrast, under the tax credit system no one would be
able to reduce his or her taxes by purchasing more expensive
insurance. Since marginal improvements in a health benefits
package under the tax credit system could be purchased only
with aftertax dollars, no one would spend an extra dollar on
health insurance unless it produced a dollar's worth of value.
The tax credit system would allow employees to manage some
of their own health care dollars. Current tax law rewards
employees who turn over all their health care dollars to an
employer health plan (by excluding such money from taxable
income), but penalizes (by taxing) income placed in a Medical
Savings Account. The exception is the pilot MSA program for the
self-employed and employees of small businesses. As a result,
current law favors the HMO approach--in which the health plan
controls all the health care dollars and makes all the
important decisions--even though individuals might in many
cases be better managers of their own health care money.
Under the new plan, individuals who chose the tax credit
option would be able to deposit a certain amount of aftertax
income--say, $2,000 per adult with a $5,000 family maximum--
into a Roth MSA. Contributions to Roth MSAs would be allowed
only for individuals who have at least catastrophic insurance.
A Roth MSA would be a ``wraparound'' account, designed to fund
the purchase of any medical expense not covered by a health
plan; it could be used in conjunction with an HMO as well as
fee-for-service insurance. Funds in a Roth MSA could only be
used for medical care or would remain in the account to back up
a health plan for at least one year. At the end of the one-year
insurance period, Roth MSA funds could be withdrawn without
penalty for any purpose, left in the account to grow tax free,
or rolled over into a Roth IRA.
This change would put third-party insurance and individual
self-insurance on a level playing field under the tax law. The
Roth MSA option would correct the bias in the current tax law.
Beyond a basic level of insurance funded by the tax credit,
individuals would choose to spend their aftertax dollars on
more insurance benefits or place those same dollars in a Roth
MSA. No one would have an incentive to turn over additional
dollars to a health plan unless they judged that the extra
benefits were more valuable than of depositing an equal amount
in a Roth MSA.
Just as the tax exclusion for employer-provided health
insurance encourages people to overinsure, the current system
of Flexible Spending Accounts (FSAs) encourages people to
overconsume. As it now stands, employees make pre-tax deposits
to an FSA to pay their share of premiums and to purchase
services not covered by the employers' health plan. A use-it-
or-lose-it rule requires that employees spend the entire sum or
forfeit any year-end balance in the account. This rule
encourages wasteful spending on medical care at year-end. Under
the new plan, employees in the tax credit system would no
longer have an FSA option. Instead, they would have a use-it-
or-save-it Roth MSA option.

VII. OPTIONS FOR THE SELF-EMPLOYED

This plan gives the self-employed a new option: a tax
deduction for the purchase of health insurance or a tax credit.
Currently, the self-employed get a partial deduction for the
purchase of health insurance, and eventually will get a 100
percent deduction. As an alternative, this plan would allow the
self-employed to take a tax credit.
Under the current system, the self-employed may contribute
to a conventional MSA, provided they have catastrophic
insurance. Under this plan, the self-employed who elected the
tax credit would be able to make deposits to a Roth MSA
instead. They would be allowed to contribute to either a
conventional MSA or a Roth MSA, but not both during the
insurance period.

VIII. SOLUTION TO THE SPECIAL PROBLEMS OF THE UNINSURED

A refundable tax credit for the purchase of health
insurance that was previously in the tax code failed because it
did not address the cash flow problems of low-income families.
It forced those families to rely on their own resources to meet
premium payments for the year and wait for reimbursement until
the following April 15. As a result, the program did not make
funds available for the purchase of insurance at the time the
funds were needed. This plan would solve that problem by
allowing people to assign their rights to the credit to an
insurance company month-by-month. The procedure would be
similar to the one under which low-income families can obtain
advance funds based on their right to collect the Earned Income
Tax Credit (EITC) through a bank loan arranged by a firm such
as H&R Block. In this way, individuals would be able to buy
health insurance without reducing their monthly income. This
plan also would allow the health insurance tax credit to be
combined with the Earned Income Tax Credit (EITC), so that
families could afford a more generous package of benefits.
Most people who are uninsured are working, and many have
the opportunity to join an employer plan but decline to do so.
One reason they decline is that they are required to pay a
substantial part of the premium. Some join themselves but do
not insure their dependents. This plan would solve the problem,
using a procedure similar to the one just described. Currently,
low-income employees who qualify for the EITC can file a form
with their employer and receive their EITC ``refunds'' month by
month. In a similar way, the health insurance tax credit could
be accessed month by month and used to pay the employee's share
of the premium. Thus low-income employees could insure
themselves and their families with no reduction in take-home
pay. Employees could also combine the health insurance tax
credit with their EITC refund to obtain more generous
coverage--again, with no reduction in take-home pay.
Employers would not be required to opt into the tax credit
system, but those who did would be able to offer their
employees a more attractive compensation package and gain a
competitive edge in the labor market.
Most people who are uninsured are temporarily uninsured--
usually for a period of less than one year. To meet the needs
of these people, health reform must make a refundable health
insurance tax credit flexible enough to fund health insurance
coverage for part of a year. The techniques described above
will allow low-income employees to pay premiums month by month
or even pay period by pay period.

IX. HEALTH INSURANCE AND WORKFARE

The reforms proposed here would make Workfare work. For
many families, one of the biggest obstacles to getting and
staying off welfare is the lack of a private insurance
alternative to Medicaid. This plan would make it possible for
low-income families to buy into an employer health plan or to
purchase insurance on their own.
A related problem concerns people who are laid off or are
temporarily unemployed while they are between jobs. Periods of
unemployment are typically periods when family financial
resources are very limited. The refundable health insurance tax
credit could bridge the gap, financing the purchase of short-
term insurance or funding COBRA payments that continue coverage
under a previous employer's plan. Funds in a Roth MSA also
could help solve the problem, since such funds could be used to
pay premiums during periods of temporary unemployment.

X. THE ROLE OF STATE AND LOCAL GOVERNMENTS

The plan I have outlined is the first plan that defines the
roles of state and local governments in meeting the needs of
the uninsured. By keeping the federal role purely financial,
which largely continues current practice, the plan would make
state governments responsible for regulating the terms and
conditions under which health insurance would be bought and
sold. However, the plan would retain the ERISA preemption that
exempts from state regulation companies that self-insure
because such companies are not purchasing insurance in the
marketplace and because self-insurance often is a socially
desirable alternative to costly state regulations. State
governments also would be responsible for operating local
Health Care Safety Nets. Once the federal financial obligation
was discharged, state and local governments would assume
funding responsibility for any remaining problems.
Although state governments would be obligated to spend
federal safety net money on the uninsured, they could discharge
this obligation in many ways. One way would be to set up
clinics that dispense free services to the low-income
uninsured. Another would be to enroll the uninsured in an
expanded Medicaid program. A third option would be to
supplement the federal grant and assist people in obtaining
private health insurance.
Many states subsidize the purchase of private insurance by
piggybacking on federal practice. They exclude employer
payments from employee taxable income and/or create special tax
relief for low-income families. These states could continue
their current practices or adopt a tax credit at the state
level. Most would quickly discover that the latter is a better
use of state resources. States also would be allowed to
supplement the federal tax credit with a state tax credit of
their own design, and many probably would do so.
In general, states will find it in their interest to
encourage private insurance, because private insurance will
almost always involve an input of private resources through the
family premium contributions, whereas the state burden will be
greater if people depend on state and local funds to meet all
their health care needs.
Many states have contributed to the growing number of
uninsured through unwise regulations. These states could
continue such practices, but they would pay a heavy (budgetary)
price for doing so. Since the federal commitment under the new
plan would be fixed, the federal government could not be held
hostage to the vagaries of state law.

XI. FUNDING REFORM

Currently, the United States spends more than $100 billion
on tax subsidies for employer-provided health insurance, with
much of the money subsidizing wasteful overinsurance and
rewarding higher-income families who would have purchased
insurance without the subsidy. Moving to a tax credit system
would allow employers and employees to avoid many wasteful
practices without losing tax benefits. As employers and
employees shift to more economical health plans, employer tax-
deductible expenses for health insurance would fall and taxable
wages would rise. The extra taxes the federal government would
collect from the larger taxable wage base would be a source of
funding to insure the currently uninsured.
Federal and state spending on health programs for the
uninsured currently exceeds $1,000 for every uninsured person
in America. If all of the uninsured suddenly became insured,
this would free up more than $40 billion a year in current
spending. Savings made possible by scaling back spending
programs (as the need diminishes) would be a source of funds to
finance the tax credit and the Safety Net program.
America does not need to spend more money on health care--
$1 trillion a year is ample money to meet the nation's health
care needs. The goal of health reform should be to redirect
government subsidies and government spending so that those
dollars are used more wisely and more fairly.

Chairman Archer. Thank you, Dr. Goodman. The next witness
is Dr. Stuart Butler. The Chair would, number one, thank you,
Dr. Goodman, for keeping your oral presentation to 5 minutes.
Your entire printed statements without objection will be
entered into the record.
You may proceed, Dr. Butler.

STATEMENT OF STUART BUTLER, PH.D., VICE PRESIDENT, DOMESTIC AND
ECONOMIC POLICY STUDIES, HERITAGE FOUNDATION

Mr. Butler. Thank you, Mr. Chairman. I am Stuart Butler. I
am the vice president for domestic and economic research at the
Heritage Foundation.
Mr. Chairman, as Mrs. Johnson and Dr. Goodman have noted,
there is a tax no man's land in today's health system between
employer-sponsored health insurance and Medicaid. Working
families receive an often generous tax exclusion if their
employer offers health insurance. But if their employer does
not do so or if dependent coverage is too expensive for the
worker, families get no help through the tax system for
purchasing their own coverage. Also many Americans with
coverage feel locked into their current jobs if a more
attractive job doesn't provide coverage and they would have to
pay for their family's health with aftertax dollars.
Furthermore, there is a growing concern that many Americans
who have been leaving welfare and taking entry level jobs will
find themselves facing prohibitive health costs when their
Medicaid benefits cease. Members of both parties have offered
bills or are developing legislation to begin to correct the
huge tax bias facing families who must seek their own health
insurance. These bipartisan proposals would provide a health
tax deduction or credit to working families who lack employer-
sponsored coverage. I would urge Congress to take the step this
year of enacting a partially refundable tax credit for health
expenses.
Let me make a few comments about the issues this Committee
should consider in designing such a credit. First, it is
important to recognize that a feasible credit this year would
only be an initial step, not the complete solution. Mr. Stark
has noted that insurance issues have to be addressed, but I
believe we should move on the tax side now while we have the
opportunity.
Second, while it is true that much of the benefit of a new
tax credit would go to working people who are already buying
insurance with aftertax dollars, basic fairness and tax equity
demands that Americans should receive equal tax relief under
the new policy to those not now buying insurance. Congress
should not discriminate against those workers who have already
made the costly decision of buying insurance to protect their
families.
Third, those who argue that the value of the credits under
discussion are not enough should note that a Federal tax credit
is just one element of the whole solution. If a larger credit
could be enacted this year, it would certainly have more
impact. But a $1,000 credit for a family in Connecticut or
Texas means that we are $1,000 closer to dealing with that
family's lack of insurance. States could use the Federal credit
as the foundation upon which to use Medicaid, S-CHIP or other
programs in a creative way. States can and should also explore
innovative pooling arrangements for insurance.
Fourth, a tax credit would not be a threat to successful
parts of the employment-sponsored system, especially if it were
limited to workers who are not offered employer-sponsored
coverage or for the purchase of dependent coverage. Indeed,
permitting low-income workers to use a credit to pay for the
out-of-pocket costs of dependent coverage would strengthen
employment-based coverage while reducing uninsureds.
Moreover, to the extent that some smaller employers and
their employees would find it sensible to cash out of an
inefficient health plan and let their workers use their credit
to buy insurance elsewhere, that would improve the coverage for
these families.
I agree with Mr. Stark that it could be a good thing if
some parts of the employment-based system were replaced.
Fifth, some people argue that low-income people would not
be able to wait until they filed their tax return to obtain the
credit, but a family can ask their employer to factor the
health credit into their withholdings, just as many do with the
child care credit.
In addition, Congress can consider incorporating Senator
Daschle's proposal to allow families to assign their credit to
an insurance plan in return for reduced premiums. That is not
unlike of course the way that the Federal Employee Health
Benefits Program operates.
Sixth, different credit designs would have different
implications. For the same revenue cost, a credit of a fixed
amount would provide the biggest bang for the buck to the low-
income workers. On the other hand, the percentage credit is
generally more helpful to those who, because of their medical
situation, need to buy more care.
In addition, making the credit available against all health
costs, not just insurance would mean families could make the
economic decision to buy no frills insurance for major medical
problems but still get tax relief for routine expenses or
savings for health expenses.
It might be best to allow families to choose between a
percentage credit for all health expenses up to a maximum
amount, and a fixed amount for insurance meeting minimum
specifications. Alternatively, Congress could consider a credit
which combines both of these features or a combined credit
deduction such as Mrs. Johnson proposes.
Finally, a health credit would be reasonably compatible
with long-term tax reform, assuming that some tax preference
for health care were retained in a reformed Tax Code. For
instance, a health credit could be folded into the personal
exemption amount and a flat income tax or into an exempt or
reduced tax rate feature of a sales tax.
Mr. Chairman, it is not often that there is such broad
political support for a tax measure that would begin to make a
difference to the daily problems of ordinary Americans. I
believe strongly that the Committee should not let this
opportunity slip away. I believe you should move ahead with a
limited tax credit now and continue the discussions that Mr.
Stark and others have had with the leadership about dealing
with the tough issues associated with insurance. I believe
action now can and should be taken on the tax side.
Thank you.
[The prepared statement follows:]

Statement of Stuart Butler, Ph.D., Vice President, Domestic and
Economic Policy Studies, Heritage Foundation

Mr. Chairman, my name is Stuart Butler. I am Vice President
for Domestic and Economic Policy Studies at The Heritage
Foundation. The views I express in this testimony are my own,
and should not be construed as representing any official
position of The Heritage Foundation. Some of the following
material is taken from a forthcoming article I have co-authored
with David Kendall of the Progressive Policy Institute.
Nevertheless, some of the conclusions I draw differ from our
joint position, and thus do not necessarily represent his
views.
I am pleased that the Committee is giving consideration to
incorporating some form of health tax credit into the tax code.
There is growing support outside Congress for introducing
changes in the tax code to make it more rational concerning
health expenditures and to help the uninsured and to help the
uninsured, and these proposals often include a tax credit
component. Organizations favoring tax-based reforms include the
American Medical Association, the National Association of
Health Underwriters, and scholars in such research
organizations such as Heritage, the Urban Institute, the
American Enterprise Institute, the Cato Institute, and the
National Center for Policy Analysis. Moreover, many members of
this Committee, as well as members of other House and Senate
Committees, have either introduced health tax credit bills or
are considering such legislation. With this growing interest in
the approach, I believe the time is ripe for Congress to act
this year on a health tax credit.
The interest in introducing a health care tax credit stems
from two related features of the current health care system.
First, there is a growing recognition that the current
employer-based system (which is heavily subsidized by the tax
exclusion for employer-sponsored health insurance) is a very
inadequate vehicle for providing health coverage in certain
sectors of the economy. A new health insurance tax credit would
help stimulate the creation of a parallel health insurance
system for working people who are not well served by employer-
sponsored insurance. Second, the support for a tax credit
(rather than, say, a widening of the exclusion or the
introduction of a deduction) recognizes the inefficiency and
ineffectiveness of the tax exclusion as a device to help
Americans afford health care.
The growing level of uninsurance in this country
underscores the need for at least modest steps to be taken, and
its causes reinforce the belief that a tax credit would be a
sensible step to take. As the Committee is well aware, the
number of uninsured individuals is over 43 million, with
uninsurance reaching epidemic proportions in some communities.
Approximately one third of Hispanic-Americans are uninsured,
for example, and about one half of the working poor.
Significantly, the uninsured are predominantly within working
families. Only about 16 percent of the uninsured are outside
such families. And while 24 percent are in families with
workers employed part-time or part of the year, 60 percent are
in families with an adult working full-time year round.
Surveys indicate that about 75% of the uninsured say they
simply cannot afford coverage, or they have lost coverage that
was once available through their employer.
While millions of Americans enjoy the certainty of good,
predictable coverage through their place of work, it is
becoming increasingly clear that the place of employment is not
an ideal method of obtaining coverage for many Americans,
particularly in the small business sector. Unfortunately,
current tax policy is heavily biased against any other method
of obtaining coverage.
Consider the following:
In an economy with increased job mobility, for an
ever-larger proportion of the population an employment-based
group is no longer a stable, long-term foundation for health
insurance. Even if a family can expect to receive coverage
whenever the main earner changes jobs, typically there will be
some change in the benefits available or the physicians
included in the plan. The higher the degree of job mobility for
a family or in an industry, the higher the degree of change and
uncertainty associated with employment-based health insurance.
While major employers, with a large insurance pool
and a sophisticated human resource department, may be
considered a logical institution through which to obtain health
insurance, this is not the case with most smaller employers.
These employers typically lack the economies of scale, and
usually the expertise, to negotiate good coverage for their
employers, and it should be no surprise that uninsurance is
heavily concentrated in the small business sector. In 1996,
just under half of firms below with 50 employees offered
insurance, while the figure was 91 percent for those with 50-99
employees and 99 percent of those with more than 200. For those
firms below 50 employees where most workers earned less than
$10,000, only 19 percent were offered health benefits. Further,
Hay/Huggins has found that, in 1988, average administrative
costs exceeded 35 percent of premiums for firms with fewer than
10 employees, compared with 12 percent for firms with over 500
workers.
Other large, stable groupings exist that could be
sponsors of health insurance, but these are discriminated
against in the current tax system. For example, unions could
carry out exactly the same functions as an employer regarding
health insurance. Indeed, the Mailhandlers union and other
unions or employee associations act as plan organizers in the
Federal Employees Health Benefits Program. But union-sponsored
plans are quite unusual outside the federal government, because
enrollees in union-sponsored plans typically are not eligible
for the tax benefits associated with employer-sponsored
insurance. Yet, many workers who have only a loose affiliation
with their employer, or work for smaller employers who do not
provide insurance, have a long-term, close connection with
their union. Moreover, the union would be a very large
potential insurance pool. Similarly, large religious
organizations, such as consortia of Churches in the African-
American community, would be a far more logical vehicle for
which to obtain health insurance, thanks to the size of the
insurance pool and the sophistication of the church leadership,
than most of the businesses employing members of such churches.
Yet again, the tax system is biased against these alternatives.

How the tax system exacerbates failings of employment-based coverage.

Under the current arrangement for working-age families,
employees receive a tax exclusion if they allow their employer
to allocate part of their compensation for a health insurance
policy owned by that employer. This arrangement helps cause
uninsurance in several ways. For example:
Since this tax exclusion is available only for
employer-sponsored coverage, a working family without employer-
sponsored insurance has no subsidy through the tax code to help
offset the cost of buying its own coverage or health care. Thus
families who lose their work-based insurance for any reason,
such as cutbacks in benefits or jobs by the employer, suffer a
double blow--not only do they lose the insurance, but they also
no longer receive a tax subsidy to pay for care. Not
surprisingly, high degrees of uninsurance are prevalent among
working families with moderate and low incomes
The tax benefits available for employer-provided
coverage are a very inefficient method of helping low-income
workers to afford care. Since compensation in the form of
employer-sponsored insurance is excluded from an employee's
taxable income (avoiding payroll taxes as well as federal and
state income tax), by far the largest tax benefits go to more
affluent workers on the highest tax brackets. Those at the
lowest income levels (especially those who do not earn enough
to pay income tax) receive little or no tax subsidy. According
to John Sheils and Paul Hogan (Health Affairs, March/April
1999) the value of the tax exclusion in 1998 was over $100
billion at the federal level (including income and payroll
taxes) and an additional $13.6 in relief from state and local
taxes. While the average tax benefit per family was just over
$1000, the tax benefits were heavily skewed towards higher-
income families. Sheils and Hogan estimate that families with
incomes in excess of $100,000 benefited to the tune of an
average of $2,357, while families with incomes of less than
$15,000 received benefits worth an average of just $71
(although this includes uninsured families receiving no tax
breaks at all). Some 68.7 percent of all the tax benefits in
1998 went to families with incomes in excess of $50,000.

How a tax credit would help.

Introducing a tax credit for health expenditures for
families lacking employer-sponsored insurance would begin to
rectify the deficiencies in the current tax system and in doing
so would begin to stimulate the provision of health insurance
through organizations other than employers. Non-employer
sponsored coverage would not be intended to replace successful
company-based plans, but to provide an alternative for families
who do not have access to insurance through their place of
work, or where their employer-sponsored coverage is clearly
inadequate or inappropriate.
A tax credit would have three key benefits. First, it would
be worth at least as much to lower-income families as upper-
income families, unlike the tax exclusion which is worth far
more to people in higher tax brackets. Second, it could be made
refundable at least against payroll taxes in addition to income
taxes. This means workers without an income tax liability could
still claim the credit, thereby providing some help to nearly
all the uninsured. In contrast, an individual tax deduction for
health insurance has the potential for reaching only about one-
third of the uninsured, since it would not be refundable and
many low-income workers do not have any income tax liability.
Third, a credit would be available regardless of job status and
would make coverage more affordable for workers between jobs.
Various credit designs proposed in recent years possess
these key features. Credit can be a fixed amount or can vary
according to a variety of factors including a worker's
expenditure on insurance, income, demographic and geographic
factors, and health risks. Major tax credit proposals in the
past have ranged from a sliding-scale credit based on income
and health expenditures, such as the bill introduced in 1994 by
Sen. Don Nickles (R-OK) and Rep. Cliff Stearns (R-FL), a fixed-
sum tax credit such as the bill introduced recently by Rep.
John Shadegg (R-AZ), or a percentage credit against costs, such
as the bill introduced by Reps. James McDermott (D-WA) and
James Rogan (R-CA).
The McDermott-Rogan proposal would provide a refundable tax
credit for 30 percent of a family's expenditure on health
insurance, which is based on the value on the current tax
subsidy for a taxpayer in 15 percent income tax bracket plus
the exclusion from FICA taxes. The Shadegg proposal would
provide a dollar-for-dollar, refundable credit of up to $500
for individuals ($1,000 for families) for the purchase of
health insurance.
These different forms of tax credit have subtly different
effects. For example, a tax credit for a given percentage of
the cost of insurance could encourage overspending by some
families, just as the current open-ended subsidy does in
employment-based coverage although this effect is reduced if
there is an income cap, or if the total credit is capped. A
simple percentage credit also could leave low-income people
still unable to afford coverage. On the other hand, a tax
credit for a fixed-sum of health care coverage can concentrate
the most help on the needy and encourages spending only up to
that amount. That minimizes overinsurance, but families facing
high costs would incur the full marginal price of needed extra
services or coverage mentioned earlier. For workers with a
serious health condition facing higher premiums, the ideal tax
credit would be a sliding scale credit adjusted upward
according to the ratio of cash and income. Such a credit would
have the need to subsidize higher risk workers through
community rating laws that perversely benefit high-income,
high-risk workers at the expense of low-income, low-risk
workers. Most states permit insurance premiums to vary at least
somewhat according to health risks and demographic factors in
both the individual and small group markets, the two markets
mostly likely to be affected by a refundable tax credit. Thus,
a tax credit for a percentage of spending (especially a sliding
scale credit) would take better account of these differences.
A fixed or percentage tax credit could be provided without
regard to income. But clearly that would mean a lower degree of
assistance for the poor--for the same total revenue cost--than
a targeted credit. A tax credit that is targeted toward those
who can least afford coverage, however, means there must be
some form of phase-out based on income. Such phase-outs
necessarily create higher effective marginal tax rates for
taxpayers who fall in the phase out range. This problem is
especially pronounced for certain low-income workers, who can
face marginal tax rates of 100 percent or more due to the
phase-out of several income-based programs such as the earned
income tax credit, welfare, day care and Medicaid subsidies,
housing subsidies, and food stamps. This problem occurs with
any subsidy arrangement, of course, not only with tax credits.
More sweeping tax credit reforms, such as the Nickles-Stearns
bill, resolved this to a large degree by changing the entire
tax treatment of health care, thereby permitting a very gradual
phase-out of the credit.

Some Questions and Answers on Health Tax Credits

Q. Would a tax credit undermine successful employment-based
coverage?

A. Not if designed properly. It would help provide an
alternative with the characteristics of successful employer-
sponsored plans for those currently outside the employment-
based system--such as large, stable group insurance pools and
administrative economies of scale. But it is important that
prudent steps be taken to combine a credit with a ``wall of
separation'' strategy to limit the probability that successful
employer plans would be dismantled, either because of a
decision made by the employer, or because individual workers
preferring the credit undermined the firm's insurance pool.
Certain design elements could be incorporated into a credit
to minimize the risk to good employer-sponsored plans. For
example, the credit might be made available only where
insurance is not available from the employer.

Q. Would workers with little cash be able to front the cost of
insurance before they could claim the tax credit?

A. Yes. The idea that a tax credit means employees would
have to wait until the end of the year to obtain tax relief is
a myth. Just as mortgage interest tax relief, or a child care
credit, is obtained by most families over the whole year by an
adjustment to their withholdings, the same would be true of a
credit. In addition, a novel idea proposed by Sen. Tom Daschle
(D-SD) would simplify things even further for many families.
Daschle would let the insurer reduce its own tax withholdings
for each person who voluntarily assigns the value of their
credit to that insurer for the purpose of purchasing health
insurance. This approach could be particularly helpful to the
unemployed if it applied to COBRA plans as well.

Q. Would a credit be an efficient way to provide help? Wouldn't
much of the money devoted to financing the credit actually go
to people who are already buying insurance?

A. While millions of families are uninsured, there are many
families who lack employer-based coverage but have decided to
purchase their own insurance, typically with no tax relief.
Clearly, these families would immediately take advantage of any
available tax credit to offset the cost of their current
coverage and/or improve it. For this reason, a significant part
of the revenue cost of a tax credit would go to these families,
meaning that only a portion of the revenue costs would be used
by uninsured families to obtain insurance. Depending on the
size of the credit (the larger the amount, the more likely
uninsured families are to take advantage of it), the proportion
of ``tax expenditures'' leading to actual reductions in the
uninsurance rate could vary widely.
Some critics of the tax credit approach conclude that a tax
credit would be ``inefficient'' in that many people who today
buy their own insurance would simply use the credit to offset
their cost without increasing their coverage. But this
presupposes that equity is not an appropriate objective, in
part, of the tax credit strategy. Yet one of the aims should be
to make sure that people of similar circumstances receive the
same help, and that it should not be considered a policy flaw
if tax relief is provided to families who have saved elsewhere
in their household budget to pay for coverage today.

Q. Would a credit be large enough for low-income people to
afford coverage?

A. To be sure, studies and surveys suggest that millions of
low-income Americans still would consider coverage to be
prohibitively expensive even with a refundable tax credit of,
say, 30 percent. This observation is used to argue that the
credit approach would be ineffective. But a tax credit approach
should not be seen in isolation as a complete solution for all
the uninsured. Other subsidies and programs exist and are
needed--but these other approaches are more likely to be
successful if a family can add part of the cost through a
federal tax credit. In particular, states have been using their
own and federal resources (such as Medicaid and SCHIP) to
provide assistance to families needing health insurance. A
refundable federal tax credit of, say, $1,000 for a family
should be seen as a foundation on which to build with these
other programs and resources. A $1,000 credit means that we are
$1,000 closer to financing the cost of insurance for a family.

Q. Can other organizations really be as effective as employers
in organizing coverage?

A. Yes and no. Many large corporations today have the
sophistication, scale of buying power, and presence in the
community to outperform any other organization in organizing
good, economical health coverage. In the system envisioned by
the authors these would be the logical vehicles for coverage,
at least if employment tended to be long term in the firm.
Moreover, a tax credit system could also allow families to buy
into the health plans of corporations for whom they do not even
work, if this makes sense for the corporation. Many large firms
have made the decision to turn an internal service into a
profit center for outside customers. The Sprint telephone
company, for example, grew out of the internal communications
system of the Southern Pacific Railroad. And John Deere & Co.
spun off its health benefits operation as an HMO in Iowa. If
families could obtain tax relief to buy coverage outside their
own firm, one could imagine large corporations with huge health
plans deciding in the future to offer a competitive insurance
service to non-employees.
In many situations, non-employment based groups would have
a comparative advantage and would be more logical and skilled
organizations. Moreover, these groups are not merely potential
pools for coverage. In many instances they have a ``community
of interest'' connection with families that means they could be
expected to work for the long term interest of these families.
Consider, for instance, the potential of union-sponsored
insurance in the restaurant and small hotel sector. In this
sector, firms tend to be small and employee turnover high,
while unions are available that are large and sophisticated.
Unions in general have considerable expertise in bargaining for
health care and would be the health care sponsor of choice for
many Americans--even for those who do not wish to be active
union members. In the FEHBP, for instance, the Mailhandlers
union provides coverage to many federal workers who join the
union as associate members merely to avail themselves of the
health plan.
Groups of churches in the African-American community also
could be preferred sponsors of care in a system in which
subsidies and tax benefits were not confined to employment-
based plans. In many communities served by these churches,
employers are small and employee turnover is high, yet families
have a strong and continuous affiliation with the church.
Moreover, America's black churches have a long history of
serving the secular as well as the spiritual needs of their
congregations, by providing housing, education, insurance and
other services.
To be sure, there are legitimate concerns to be addressed
in considering the role of such organizations in health care.
One is the stability of the insurance pool--if individuals can
easily affiliate or end their affiliation it may be difficult
to secure coverage without wide price fluctuations over time
(of course, this is also a problem with small employer pools in
some industries). Another, linked to this, is the worry that
adverse selection may undermine the group.
It is unclear how large these problems are. In the FEHBP,
for instance, many plans operated by organizations (such as the
Mailhandlers mentioned earlier) allow individuals from outside
the base group to affiliate for a small fee simply to obtain
coverage, and all enrollees are charged the same community
rate. Yet the groups are surprisingly stable, perhaps due in
part to the relatively high costs for individuals to calculate
and make plan choices based on their own predictions of their
own health care costs. Yet even if stability and adverse
selection is accepted as a serious concern, steps at the state
or federal level could be taken to increase the stability of
the group. For instance, there could be waiting period after
joining the group before the family could join its health plan.
In addition, one-year minimum enrollment contracts could be
required. Another protection might be to place a minimum
requirement on the membership of the pool, which might be
achieved through a multi-year consortium of several churches,
say, to make the pool large enough to withstand the inflow and
outflow of members. The groups also could operate under
insurance pooling and rating requirements developed by states.

Q. Would a health care tax credit be a further impediment to
tax reform?

A. In a simpler, flatter tax system, there would be no tax
preference at all for health expenses. If the current tax
expenditures for health care were to be used to help
``finance'' an across-the-board rate reduction, it could
significantly lower the rates in a flat income tax or sales
tax, which would of itself make health insurance more
affordable.
If, however, it is assumed there is little prospect of
eliminating the tax preference for health costs, a tax credit--
especially a credit of a fixed amount per family--would be
reasonably consistent with tax simplification. If over time,
the tax treatment of health care were gradually shifted from
today's exclusion and deduction system to a credit, this would
be more compatible with a flat tax or sales tax than the
current system. The reason for this example, the health tax
credit could be subsumed into the general exemption for
families in a flat income tax.
Growing rates of health uninsurance in the United States
are unacceptable and will lead to steadily rising pressure on
Congress to take action. After recognizing the root causes of
this problem, which lie in the combination of a tax bias toward
employer-sponsored insurance and the inadequacy of that
insurance system in certain sectors of the economy, it would be
prudent for Congress to move quickly but carefully to correct
the problem. A limited tax credit for expenditures on insurance
not provided through the place of employment would be a
sensible step that Congress could take this year. It would not
mean a radical drop in the number of uninsured, unless there
was a very large commitment of funds, but would be an important
first step helping the uninsured and to achieving the general
reform of tax benefits for health care. It would also stimulate
the creation of parallel institutions which would sponsor
insurance in those sectors of the economy where employers are a
very inadequate vehicle for coverage. But if Congress does not
take the first step this year, when federal finances are in
surplus and the economy is strong, it is likely to face far
more difficulties in taking a step in the future if the economy
weakens and deficits return.

Chairman Archer. Thank you, Dr. Butler.
Our next witness is no stranger to the Committee, we are
happy to have you back before us, Chip Kahn. We will be pleased
to receive your testimony.

STATEMENT OF CHARLES N. KAHN III, PRESIDENT, HEALTH INSURANCE
ASSOCIATION OF AMERICA

Mr. Kahn. Thank you, Mr. Chairman. I am Chip Kahn,
president of the Health Insurance Association of America. HIAA
commends the Committee for focusing on the pressing issues of
health and long-term care insurance coverage. Efforts to
encourage coverage in both these areas should be priority for
the Congress. The Tax Code already recognizes the cost of
coverage as justifiable deductible expenses for individuals and
businesses. The Committee should consider ways to broaden
deductibility for insurance premiums to increase tax equity and
to provide additional incentives to increase the number of
Americans protected by health and long-term care insurance.
In response to double-digit inflation in the eighties,
employer became more cost-conscious purchasers of health care.
As a result, premium increases dropped dramatically in the late
nineties. These changes not only kept 5 million more Americans
insured, but between 1993 and 1997, the number of Americans
covered by employer-paid insurance increased from 145 million
to 152 million Americans. Despite what some may say, the
employer-based private health care system has been remarkably
successful in expanding coverage. Regardless of this progress,
however, the number of Americans without health coverage has
also climbed. This is unprecedented in times when the economy
is strong and premium growth is modest.
Today over 44 million Americans are uninsured. That number
may grow to 53 million Americans in the next 10 years. If the
economy sours, one in four working-age Americans could find
themselves without health care coverage. HIAA has developed a
proposal to increase health care coverage, InsureUSA. This plan
combines targeted subsidies, tax relief and tax equity. Through
its implementation, HIAA believes coverage can be expanded to
reduce the number of this Nation's uninsured by two-thirds and
we can provide tax relief to assure that all Americans are
treated equitably by the Tax Code regarding their expenses for
health premiums.
The tax policies proposed in InsureUSA would affect over
100 million Americans. This does not come at a modest cost, but
it could be more affordable if phased-in over a number of
years, as the Committee has done with other health-related tax
relief.
In my written testimony I outlined the details of HIAA's
InsureUSA, but today I will comment briefly on the core
principles underlying the InsureUSA initiative.
First, to increase coverage, health insurance must be more
affordable for certain Americans through some type of premium
subsidization. The primary reason for the high rate of
uninsurance in this country is that many individuals or their
employers lack the financial wherewithal to purchase health
care coverage.
Two, uninsurance is a multifaceted problem which requires a
series of targeted approaches. While affordability is the
primary reason people lack insurance, the uninsured have many
faces. There is still no silver bullet solution to covering
more Americans.
Third, the current private health care market should remain
a cornerstone of our health care system. The public policy
debates over health care have taught that expanded coverage can
only be achieved with policy that does not threaten the private
coverage that the vast majority of Americans already enjoy.
Finally, perhaps most importantly, I feel we should build
on the employer-based system without undermining it. Nine in
every ten Americans with private coverage get their health
insurance through their employer. It is a system that works for
most Americans.
Mr. Chairman, as the Committee considers policy to ramp-up
for the advent of the baby-boomer retirement, it is critically
important to recognize that most Americans have not adequately
prepared for the cost of long-term care when they need it, and
many are not aware that Medicare does not cover long-term care.
Private insurance already plays a critical role in providing
long-term care protection, and we applaud the administration
and the Members of Congress who have put forth proposals
recognizing the role that private coverage can play in
expanding protection against long-term disabilities.
Such an expansion will restrain the growth in Federal and
State expenditures for long-term care over time. Tax policy
clarifications included in the Health Insurance Portability and
Accountability Act of 1996 were an important first step.
However, because HIPAA provides a tax deduction only for
coverage purchased in the employer-based market, additional
measures are needed. Individuals purchase 80 percent of long-
term care policies. Therefore, a deduction for individual
purchase of long-term care insurance would make it more
affordable to many Americans as well as promote interest in the
coverage.
HIAA urges the Committee to include in its tax bill
Representatives Nancy Johnson and Karen Thurman's measure, the
Long-Term Care and Retirement Security Act of 1999. If enacted,
their proposal would make a significant contribution toward
increasing the number of Americans who seek protection against
future long-term care expense.
Thank you, Mr. Chairman, for the opportunity to testify
today.
[The prepared statement follows:]

Statement of Charles N. Kahn III, President, Health Insurance
Association of America

Introduction

Chairman Archer, members of the Committee, I am Charles N.
Kahn III, President of the Health Insurance Association of
America (HIAA). HIAA represents 269 member companies providing
health, long-term care, disability income, and supplemental
insurance coverage to over 115 million Americans. I appreciate
this opportunity to speak to you today about the critical role
tax initiatives could play in making private health insurance
more affordable for all Americans and further expanding access
to private long-term care insurance.

Despite Expanding Economy and Success Controlling Costs, Growing Number
of Uninsured

In response to double-digit health care inflation in the
1980s, employers became much more aggressive purchasers of
health coverage. As a result, the nation has experienced a
dramatic decline in the growth of health insurance premiums
over the past ten years. Double-digit inflation in excess of 20
percent in the late 1980s dropped dramatically to low single
digit rates in the late 1990s, more in line with general
consumer price index trends. This decline in premium growth
during the 1990s coincides with dramatic increases in market
penetration of managed care. Enrollment in PPOs, HMOs, and
other forms of managed care has tripled during the past 10
years from 29 percent in 1988 to 86 percent in 1998.
[GRAPHIC] [TIFF OMITTED] T0332.012

[GRAPHIC] [TIFF OMITTED] T0332.013

It is estimated that the impact of lower insurance prices
resulting from the growth of managed care and other private
sector innovations saved consumers between $24 billion and $37
billion in 1996, and that this savings will grow to over $125
billion by the year 2000. These savings are critically
important because the cost of insurance relative to family
income is the most important factor in determining whether
people will be insured. Without these savings, some employers
would not have been able to afford private insurance and would
have been forced to discontinue coverage for their workers. In
fact, it is estimated that there would be 3 to 5 million
additional uninsured Americans right now were it not for these
lower premium trends during the past few years.
Despite this progress, however, the number of Americans
without health insurance coverage has continued to increase
during the last decade.
[GRAPHIC] [TIFF OMITTED] T0332.011

It is relatively unprecedented for the ranks of the
uninsured to be growing at a time when our nation's economy is
expanding and health insurance premium trends are moderating.
There are nearly 170 million non-elderly Americans who
currently enjoy the security of private health insurance, and
the vast majority receives its coverage at the workplace. But
for too many Americans, private health insurance is
unaffordable, and often, government programs like Medicaid do
not cover these adults.
Affordability is the key deciding factor when purchasing
health insurance. Almost six of every ten uninsured individuals
live in families with incomes less than 200 percent of the
federal poverty level. In addition, the number of people with
insurance has declined as health care inflation has continued
to outstrip the growth in real family income.
[GRAPHIC] [TIFF OMITTED] T0332.010

There are over 44 million Americans without health
insurance, and by the end of the next decade that number will
grow to at least 53 million--one in every five non-elderly
Americans. If health care costs increase at a faster than
projected rate, and the economy experiences a downturn, the
number of uninsured could rise to 60 million--or one in four
working-age Americans.\1\ Clearly, this is a disturbing trend
that we, as a nation, cannot afford to let continue.
---------------------------------------------------------------------------
\1\ Custer, William S., ``Health Insurance Coverage and the
Uninsured,'' December 1998, Center for Risk Management and Insurance
Research, Georgia State University, for the Health Insurance
Association of America.
---------------------------------------------------------------------------

HIAA's InsureUSA Initiative

Last month, the HIAA Board of Directors approved InsureUSA,
a major initiative to help expand health insurance coverage.
Building on the success of employer-based health coverage, this
plan would increase health coverage through a combination of
targeted subsidies, tax incentives, cost-control measures, and
education. We already have provided a copy of our plan to all
members of Congress, including members of this Committee. In
addition, we have developed a special website,
www.InsureUSA.org, that provides detailed information about the
plan and about the uninsured. And, of course, HIAA staff would
be happy to meet with members of Congress at any time to
discuss the proposal.
HIAA's member companies developed InsureUSA after nearly
one year of deliberations. The plan was shaped considerably by
research data prepared on behalf of HIAA by William S. Custer,
Ph.D., as well as other research on the uninsured.
There are five basic precepts underlying the InsureUSA
initiative.
The time is ripe for action. Despite expansions of
the employment-based health insurance market in recent years,
the number of Americans without health insurance coverage will
continue to grow by about 1 million people per year. As noted
previously, one in every four working age Americans could lack
coverage by the end of the next decade if steps are not taken
immediately to stem this tide. Having said that, the individual
components of InsureUSA could be phased-in over a number of
years. In addition, because the proposal attacks the core
causes of uninsurance, specific elements of the proposal could
be enacted first, without jeopardizing others.
To increase coverage, health insurance must be
more affordable for more Americans. The main reason that
Americans are uninsured is because they cannot afford health
insurance coverage. Many well-intentioned attempts at insurance
market reform have had the effect of increasing the cost of
coverage and increasing the net number of individuals without
health insurance. Reform, therefore, should both reduce the
costs of health insurance and provide financial support for
those who otherwise cannot afford coverage.
Multifaceted problem requires multifaceted
approach. While affordability is the primary reason people lack
health coverage, there are many reasons people lack coverage.
Rather than advocating a singular approach to insuring more
Americans, we are advocating a diverse program designed to
attack the underlying reasons that people are uninsured.
A strong, vibrant private health insurance market
should remain a cornerstone of our health care system. Expanded
coverage must be achieved through means that do not threaten
the coverage of other Americans or damage the existing private
market. Competitive markets remain the most efficient and
responsive mechanisms to provide consumers with coverage.
Regulations that stifle innovation, flexibility, and
responsiveness to consumers should be strongly discouraged.
Reforms should make health coverage more
affordable within the context of the employment-based private
health care system, rather than undermining it. Nine in every
10 Americans with health coverage get their health insurance
through their employer. And while coverage has declined
overall, the percentage of Americans with employment-based
health coverage has increased during the past few years.
Therefore, InsureUSA would build upon this base, by providing
targeted subsidies and incentives for those who are less likely
to benefit from employment-based coverage.
For the purposes of today's hearing, I would like to
highlight the tax initiatives proposed in the InsureUSA plan.
As I mentioned earlier, affordability is a key factor for many
Americans when purchasing health insurance, and tax incentives
will help make affordable coverage a reality for those who do
not have insurance. In addition, these tax initiatives will
help provide greater equity in the purchase of health insurance
for small business owners, the self-employed and individuals
without access to employer-sponsored health insurance. The cost
of these tax incentives is large, but HIAA estimates that they
would broadly benefit over 100 million Americans who experience
inequity under the current tax code.

Targeted Tax Credits for Small Businesses

First, I would like to discuss the proposal's tax credits
for small businesses. Studies show that firm size is one of the
major factors affecting the cost of health insurance. Smaller
employers face higher costs when providing health benefits than
larger firms because their size limits their ability to (1)
spread risk, (2) self-insure and avoid expensive state mandates
and taxes, and (3) manage high administrative costs incurred
because of a lack of staff devoted to health benefits. The
smallest firms tend to have low-wage employees who live in low-
income families. In fact, 90 percent of the uninsured whose
family head works for an employer with fewer than 10 employees
also live in families whose income is less than 200 percent of
the federal poverty level.\2\
---------------------------------------------------------------------------
\2\ Custer, William S., ``Health Insurance Coverage and the
Uninsured,'' December 1998, Center for Risk Management and Insurance
Research, Georgia State University, for the Health Insurance
Association of America.
[GRAPHIC] [TIFF OMITTED] T0332.016

Therefore, InsureUSA would like to propose a tax credit for
small employers that could be phased-in beginning with the
smallest firms:
40 percent credit for employers with fewer than 10
employees
25 percent credit for employers with 10-25
employees
15 percent credit for employers with 26-50
employees
These credits could help the nearly 39 million Americans
who belong to families whose head of household works for a
company with ten (or fewer) employees. If eligibility for such
credits was extended to all companies with 50 or fewer
employees, the total would rise to 71 million Americans.
Furthermore, InsureUSA proposes that all employee
contributions for health insurance be excluded from taxable
income (even if not made through a section 125 cafeteria plan).
This would primarily benefit small employers for whom it is
often administratively difficult to set up cafeteria plans.

Targeted Tax Credits for Individuals and the Self-Employed

InsureUSA also includes tax incentives that target
individual health insurance purchasers and the self-employed.
It is a fact that people without access to employer-sponsored
plans have a higher likelihood of being uninsured. Nearly a
quarter (24 percent) of self-employed Americans are uninsured,
and almost three out of ten (28 percent) non-elderly Americans
in families headed by an unemployed individual lack health care
coverage.
Under current tax law, individuals cannot deduct their out
of pocket health insurance premiums until their medical costs
exceed 7.5 percent of their income, and the self-employed will
not have full deductibility until 2003. HIAA's proposal would
extend full tax deductibility of premiums to everyone
purchasing individual health insurance policies and would take
effect upon the date of enactment rather than 2003. As a
result, coverage would become more affordable for over 12
million self-employed workers and for nearly 25 million
Americans living in families headed by a non-worker.

Medical Savings Accounts (MSAs)

While there has not been significant enrollment in medical
savings accounts (MSAs) under the demonstration authorized by
the Health Insurance Portability and Accountability Act of 1996
(HIPAA), statistics compiled by the Department of Treasury show
that a large proportion of those with MSAs were previously
uninsured. Therefore, InsureUSA proposes that Medical Savings
Accounts (MSAs) be made more attractive by:
simplifying the MSA rules under HIPAA,
eliminating the ``sunset'' provision for MSAs
available to the self-employed and small employers,
extending availability to large employers,
permitting both employees and employers to
contribute to MSAs, and
making it easier for PPOs and other network-based
plans to offer MSAs.

Cost of InsureUSA Tax Incentives

Overall, HIAA estimates that changing the current tax
system to encourage greater health insurance coverage and make
health insurance more affordable for over 100 million
Americans, would cost approximately $30 to $36 billion
annually. We estimate that 71 million people (20 million of
whom are currently uninsured) would be eligible for the tax
credit, either through their employer or the employer of their
family head. As a result of this credit, between 2.6 and 4.1
million uninsured will gain coverage at a cost in revenue
expenditures of between $23.8 and $29.3 billion annually. These
figures are broken down by firm size in the table below.

----------------------------------------------------------------------------------------------------------------
Receiving Credit Newly Insured Cost
Firm Size Eligible -----------------------------------------------------
Individuals Low High Low High Low High
----------------------------------------------------------------------------------------------------------------
Under 10................................... 38.6 20.4 26.3 1.9 3.1 15.7 20.2
10 to 24................................... 18.3 11.1 12.5 0.5 0.8 5.3 6.0
25 to 50................................... 14.1 9.9 10.7 0.2 0.3 3.0 3.1
------------------------------------------------------------------
Total.................................. 71.0 41.4 49.5 2.6 4.1 23.8 29.3
----------------------------------------------------------------------------------------------------------------

An additional 1.5 and 3.5 million individuals would gain
coverage through the individual market. Costs to the Federal
government would be between $7.8 and $8.7 billion in annual
lost income tax, and the previously uninsured would account for
between $670 million and $1.5 billion.
The uninsured have many faces, and tax initiatives will not
benefit all of them. These incentives that HIAA is proposing
are part of a broader initiative that includes government
program expansion to low-income individuals, subsidies for the
working poor, and a series of actions that would lower health
care costs and educate consumers.

Polling Data

HIAA released a public opinion survey showing that more
than 4 out of 5 Americans support the elements of the InsureUSA
proposal and that 7 out of 10 believe the large number of
uninsured Americans is a significant national problem requiring
immediate action. While not all were in support of new taxes,
most (43 of the 70 percent) felt that, regardless of new taxes,
the government must act.
[GRAPHIC] [TIFF OMITTED] T0332.017

Of the 83 percent of Americans who favor the proposals in
InsureUSA, 60 percent say they would still favor the plan even
if they were required to pay an extra $100 annually in new
taxes.
[GRAPHIC] [TIFF OMITTED] T0332.018

Based on these polling results, it is apparent that the
majority of Americans believe the time is right for the
government to address the growing uninsured problem, but more
importantly, they are confident in the InsureUSA proposal, and
feel that it meets the challenge.

Long-Term Care

In addition to the critical need to curb the growing number
of uninsured Americans, policymakers must address what many
people consider to be the most pressing financial problem--
long-term care coverage. Long-term care is the largest unfunded
liability facing Americans today, and despite the tremendous
need for long-term care protection, there is a clear lack of
adequate planning for it.
The long-term care insurance market is growing, and the
policies that are available today are affordable and of high
quality. There is a critical role for private insurance to
provide a better means of financing long-term care for the vast
majority of Americans who can afford to protect themselves.
Continued growth of the market will alleviate reliance on
scarce public dollars, enhance choice of long-term care
services for those who may need them in the future, and promote
quality among providers of long-term care. HIAA estimates
reveal that today over 100 companies have sold over 6 million
long-term care insurance policies, and the market has
experienced an average annual growth of about 20 percent. These
insurance policies include individual, group association,
employer-sponsored, and riders to life insurance policies that
accelerate the death benefit for long-term care.
[GRAPHIC] [TIFF OMITTED] T0332.019

HIAA would like to applaud the Administration and the 106th
Congress' call for programs that would encourage personal
responsibility for long-term care, help people currently in
need of long-term care, and increase educational efforts on
long-term care. Administration and Congressional proposals all
have an important common factor, the recognition that private
long-term care insurance plays a vital role in helping the
elderly and disabled, as well as baby boomers, pay for their
future long-term care costs.
The heightened public awareness brought about by these
proposals coupled with the passage of incentives for the
purchase of long-term care insurance in the Health Insurance
Portability and Accountability Act of 1996 (HIPAA) have been
essential first steps in solving our nation's long-term care
crisis; however, these preliminary tax initiatives are not
enough. HIPAA provides little added incentive for individuals
to purchase long-term care insurance because the tax breaks are
only applicable to employer-sponsored long-term care coverage
and fail to address the individual market where 80 percent of
all policies are purchased.

LTC Insurance Products by Percentage of Policies Sold & Average Age of
Buyer
------------------------------------------------------------------------
Percent of
Long-Term Care Product Percent of Policies Average Age
Companies Sold of Buyer
------------------------------------------------------------------------
Individual....................... 82.9 80.0 67
Employer-sponsored............... 17.9 13.2 43
LTC Rider to Life Insurance...... 17.1 6.7 44
------------------------------------------------------------------------

Under current law, tax benefits can range from a full
exclusion from income if one's employer pays the premiums to no
tax benefit if an individual pays and does not have sizeable
medical expenses. These disparities lead to inequitable
results. For many, current law's tax deduction is illusory.
Today, an individual purchasing an LTC policy can deduct
premiums only if they itemize deductions and only to the extent
medical expenses exceed 7.5 percent of adjusted gross income.
Only 4 percent of all tax returns report medical expenses as
itemized deductions.
Recent developments have improved the political climate for
long-term care insurance, but they are not panaceas and will
not, by themselves, achieve the optimum public-private
partnership for long-term care financing. HIAA believes that
other equally important tax-related changes, at both the
federal and state levels, could make long-term care insurance
more affordable to a greater number of people. The expansion of
this market will restrain future costs to federal and state
governments by reducing Medicaid outlays.
Providing additional tax incentives for these products
would reduce the out-of-pocket cost of long-term care insurance
for many Americans, increase their appeal to employees and
employers, and increase public confidence in this relatively
new type of private insurance coverage. In addition, it would
demonstrate the government's support for and its commitment to
the private long-term care insurance industry as a major means
of helping Americans fund their future long-term care needs.
As you know, Representatives Nancy Johnson and Karen
Thurman recently introduced H.R. 2102, ``The Long-Term Care and
Retirement Security Act of 1999.'' This legislation would:
Provide an above-the-line tax deduction for LTC
insurance premiums. The deduction would begin at 50 percent,
but rise each year the insured keeps the policy in force until
the deduction reaches 100 percent. (Joint Tax Committee cost
estimate: $4.0 billion over 5 years and $12.5 billion over 10
years)
Provide a $1,000 tax credit to individuals with
LTC needs, or to their caregivers. The credit would be phased-
in over a three-year period. (Joint Tax Committee cost
estimate: $5.1 billion over 5 years and $14.0 billion over 10
years)
Authorize the Social Security Administration to
carry out a public education campaign on the costs of LTC,
limits of coverage under Medicare and Medicaid, the benefits of
private LTC insurance, and the tax benefits accorded LTC
insurance
Encourage more states to establish LTC
partnerships between Medicaid and private LTC insurance along
the lines of those operating in Connecticut, New York, Indiana,
and California.
HIAA believes that the provisions of ``The Long-Term Care
and Retirement Security Act of 1999'' are the critical next
steps to begin preparing individuals, families, and our society
for the increased LTC needs we know are coming. Congress needs
to ensure that any tax legislation passed this year
incorporates provisions to help private LTC insurance assume an
increasingly prominent role in protecting families from LTC
costs and easing the financial burden on public programs. By
the year 2020, the Congressional Budget Office has estimated
that, at current growth rates in private LTC insurance:
Medicaid will save $12.4 billion (14% of total
program nursing home expenditures);
private LTC insurance will reduce out-of-pocket
costs by 18%; and
private LTC insurance will also reduce Medicare
spending by 4%.
Savings to individuals and public programs will be
much greater in subsequent years, as those presently purchasing
private policies approach and pass 85 years of age. If Congress
enacts legislation that gives Americans enhanced incentives to
protect themselves against the costs of LTC, savings to
individuals and public programs will be still greater.
In summary, HIAA supports policy that would:
Enhance the deduction for long-term care insurance
premiums, such that premium dollars are not subject to a
percentage of income. The deduction should not be limited to
situations where employer-provided coverage is unavailable. If
an employer decides to provide premium contributions, employees
should be entitled to deductions for the portion that they pay.
Allow children to deduct premiums paid to purchase
a policy for their parents and/or grandparents without regard
to whether the child is providing for their support.
Permit premiums to be paid through cafeteria plans
and flexible spending accounts.
Permit the tax-free use of IRA and 401(k) funds
for purchases of long-term care insurance.
Provide a tax subsidy for the purchase of long-
term care insurance.
Encourage state tax incentives for the purchase of
long-term care insurance.
Long-term care tax incentives would largely benefit two
groups: those who did not have the opportunity to purchase such
coverage when they were younger and the premiums were lower,
and as a result, now face the greatest affordability problems
because of their age; and those younger adults, our current
baby boomers, who need incentives or mechanisms to fit long-
term care protection into their current multiple priorities
(e.g., mortgage and children's college tuition) and financial
and retirement planning.
Educational effects of such tax incentives could far
outweigh their monetary value by educating consumers about an
important issue and, as a result, would help change attitudes.
In an effort to inform all Americans about the value of long-
term care insurance, HIAA formed the Americans for Long-Term
Care Security (ALTCS), a broad based coalition of organizations
sharing a common vision to educate policy makers, the media,
and the general public about the importance of preparing for
the eventual need of long-term care and viable private sector
financing options. When state and federal legislation
opportunities to advocate private sector options--such as tax
incentives to purchase long-term care insurance--arise, members
of ALTCS will encourage swift passage through a variety of
advocacy, media, and lobbying means.
Furthermore, ALTCS believes that the government must
continue to provide a safety net for the truly needy. At the
same time, the government should provide incentives for private
sector solutions, such as long-term care insurance, so that
individuals and families are encouraged to take personal
responsibility for long term care planning.

Conclusion

The health insurance industry, working with employers, has
been extremely effective in recent years in slowing premium
increases, improving health care quality, and expanding
coverage in the employment-based market. Yet, without
additional financial support from the government, the number of
Americans without health insurance coverage will continue to
grow by about one million people each year into the next
decade.
Unfortunately, a series of legislative initiatives being
considered at both the state and federal level would move us in
the opposite direction. These mandates and so-called ``patient
protection'' measures would put affordable private coverage out
of reach for even more Americans. Instead, we need to work
together to make the uninsured ``job one.''
Additionally, tax incentives are needed to spur the growth
of private long-term care insurance and help the next
generation of Americans better protect themselves from costs of
long term care. HIAA supports the use of broad-based state and
federal funding to subsidize the cost of health insurance for
those who cannot otherwise afford it. We have witnessed the
success of favorable tax treatment in helping to expand
coverage to a large percentage of working Americans. Therefore,
we believe that providing greater equity under the tax code for
individuals and the self-employed is a reasonable way to make
health coverage more affordable for a large number of the 41
million Americans who currently do not have coverage. H.R. 2102
and other similar measures would be a very good start. We also
would encourage Congress to consider tax credits, vouchers and
other subsidies as a means of making coverage more affordable
for even more Americans.
Again, we are encouraged that Congress is addressing the
issue of the uninsured and considering ways to make private
health coverage more affordable. We look forward to working
with you as you consider ways to expand private health coverage
and provide equitable treatment under the tax code for
individuals who have taken responsibility for their own health
care coverage.
We look forward to working with the members of this
committee, and other members of congress, to help find ways to
expand health insurance coverage in the months and years ahead.
Mr. Chairman, that concludes my testimony. I would be happy
to answer any questions you may have.

Chairman Archer. Thank you, Mr. Kahn.
Our next witness is Mary Nell Lehnhard.

STATEMENT OF MARY NELL LEHNHARD, SENIOR VICE PRESIDENT, BLUE
CROSS AND BLUE SHIELD ASSOCIATION

Ms. Lehnhard. Mr. Chairman, Mr. Rangel, Members of the
Committee, I am Mary Nell Lehnhard, senior vice president of
the Blue Cross and Blue Shield Association. We appreciate the
opportunity to testify today.
Blue Cross and Blue Shield plans across the country have
long supported public and have been active in private
initiatives to expand coverage to more Americans. We believe
coverage for the 43 million people who remain uninsured should
be the top Federal health care priority. We are very pleased
that the Committee is examining tax-based solutions to this
problem. In February of this year we released a proposal for
reducing the number of uninsured built on tax credits and full
deductibility. Let me get quickly to our recommendation.
We think the single most effective thing Congress could do
this year would be to target low-wage workers and small
businesses. Our proposal would provide tax credits to small
businesses for their low-wage workers. Small firms have lower
rates of health coverage than large employers. 35 percent of
workers and firms with less than 10 employees are uninsured.
And if you look at the problem of small firms with low-wage
workers, it is worse. Only 38 percent of small business with
low-wage workers offer coverage compared to 78 percent of small
businesses with high-wage workers.
We believe that expanding--providing a tax credit to small
businesses for their low-wage workers would make the most
effective use of scarce resources. By building on the current
employer-based system, the idea would be simple to implement.
We recommend Congress focus on low-wage workers and businesses
of fewer than 10 employees and expand the program as resources
permit.
In addition to this tax credit we have proposed full
deductibility for the self-employed, providing tax
deductibility for people without employer-sponsored coverage
and providing Federal grants to States to fund other
initiatives that expand coverage.
As I said earlier, we are pleased that Congress is now
considering a number of tax proposals to expand coverage. The
most comprehensive of these would delink health insurance from
employment and move toward an individual coverage-based system.
These proposals embody the notion of individual enpowerment
and merit full consideration. However, altering fundamental
offerings in the way millions of Americans now receive coverage
will require careful consideration by Congress. In all
likelihood, moving to this type of comprehensive reform will be
a long-term process that involves much debate and analysis and
hopefully a good transition period. Other tax proposals such as
accelerating full deductibility for the self-employed and full
deductibility for those who don't have access appear to be
generating bipartisan interest and could be enacted this year,
and we support both of these proposals.
We are concerned about some of the proposals for providing
parity of coverage between the individual and group markets.
For example, we are concerned that providing full deductibility
of individual coverage for those who already have access to
employer-sponsored plans and proposals that require employers
to provide the equivalent value of employer-provided benefits
for employees who opt out of their current employer plan and
purchase individual coverage in the individual market.
Our concern is that these proposals would create serious
unintended consequences for the current employer-based system.
By allowing individuals to opt out of the employer-based plans,
these proposals would undermine the tremendous advantages of
the natural pooling that occurs in an employer plan. Under
these proposals, younger workers with fewer medical costs would
be most likely to leave the group and the premiums for those
who remain would increase significantly. Congress should avoid
this type of adverse selection against employer plans by
providing tax incentives for the purchase of coverage in the
individual and nongroup market only if an individual doesn't
have access to employer coverage. For example, eligibility
could be limited to those employees whose employers have not
offered coverage for some period of time, such as Mrs. Johnson
has done in her bill.
Congress should also consider other ways to keep coverage
as affordable as possible. Our proposal calls on Congress to
adopt a new litmus test. Under this test, Congress would reject
legislation such as managed-care regulation, benefit mandates,
and antitrust exemptions that would increase premiums and
consequently the number of uninsured.
In summary, Blue Cross and Blue Shield Association and its
member plans believe expanding coverage should be the Congress'
top priority, and we urge Congress to enact targeted tax
proposals this year.
[The prepared statement follows:]

Statement of Mary Lehnhard, Senior Vice President, Blue Cross and Blue
Shield Association

Mr. Chairman and members of the committee, I am Mary Nell
Lehnhard, Senior Vice President of the Blue Cross and Blue
Shield Association. BCBSA represents 51 independent Blue Cross
and Blue Shield Plans throughout the nation that together
provide health coverage to 73.3 million Americans. I appreciate
the opportunity to testify on the increasing number of
uninsured and what Congress should do to address this problem.
Since the debate over President Clinton's national health
plan, when Congress last engaged in a serious discussion about
the uninsured, Congress has focused much of its health care
reform efforts on those people fortunate to have access to
health insurance (e.g., passing health insurance portability
reforms and debating managed care regulation). Meanwhile,
despite a robust economy and low unemployment rates, the number
of Americans without health coverage has grown to over 43
million.
BCBSA and Blue Plans across the country have long supported
public and private initiatives to expand health coverage to
more Americans. Many Blue Plans have created Caring Programs to
make available free health coverage to low-income children and
have initiated a variety of other programs to help the
uninsured. In addition, BCBSA recently joined the White House,
other federal officials and children's advocates to launch a
national outreach program promoting the new Children's Health
Insurance Program (CHIP), which Congress enacted in 1997.
But with the number of uninsured continuing to increase,
the Blues recognize the need for additional action. Blue Cross
and Blue Shield Plans have taken their commitment to the
uninsured a step further by creating a two-part program to
address this challenging public policy problem. BCBSA's Board
of Directors approved this two-part program in January of 1999,
and we strongly urge its adoption by Congress.
I will be making three points during my testimony.
First, Congress should enact a tax-based solution
to address the problem of the uninsured.
Second, Congress should carefully assess the
impact of alternative tax-based proposals.
Third, Congress should adopt a ``new litmus test''
to reject legislation that would increase health care costs
and, consequently, increase the number of uninsured.

I. Congress Should Enact A Tax-Based Solution To Address The Problem Of
The Uninsured

Scope Of The Uninsured Problem:

Before devising its uninsured proposal, BCBSA gathered and
analyzed the latest information on who the uninsured are and
why they lack coverage. Most Americans receive health coverage
through private health insurance--either through an employer or
by purchasing health insurance on their own. Others receive
health coverage by enrolling in a government program. But over
43 million people are without health coverage. The number of
uninsured has grown steadily during the past decade and,
without legislative action, is expected to continue to increase
in the years to come.
While the uninsured fall into very different geographic,
age, and racial/ethnic categories, they do have some common
characteristics. One of the most significant subgroups of the
uninsured are working Americans.
The term ``uninsured'' may conjure up images of people out
of work, but the data suggest otherwise. According to a 1997
study from the Kaiser Family Foundation, 73 percent of
uninsured adults are either employed or married to someone who
is employed. The working uninsured tend to be those who work in
low-paying jobs, those who work for small firms, and those who
work in part-time jobs or in certain trades.
Low-Wage Workers. The cost of health insurance can
be prohibitive for low-wage workers who must purchase it on
their own or pay a significant share of an employer-sponsored
health plan. Almost half (43.5 percent) of the uninsured are in
families earning less than $20,000 a year, and 73 percent of
the uninsured are in families earning less than $40,000.
Moreover, low-income workers are less likely to have access to
coverage on the job.
Workers in Small Firms. The working uninsured are
likely to be employed by firms with fewer than 25 employees--
43% of the uninsured employed in the private sector work for
firms with fewer than 25 employees. They are also likely to be
self-employed or dependents of such workers. One of every four
self-employed individuals and nearly 35 percent of workers in
firms with fewer than 10 employees are without coverage.
People In Families with Part-Time Workers. Since
employment-based coverage is usually only provided to full-time
workers, the risk of being uninsured increases for people who
only work part-time. More than one-quarter of people in
families with only part-time workers are uninsured.
Workers in Seasonal Trades. Workers in the
agricultural, forestry, fishing, mining, and construction
trades are more likely to be uninsured, probably reflecting the
seasonal employment and the small firms that are characteristic
of these trades. One third of the 12.5 million workers in these
trades are without health insurance.
Other significant subgroups of the uninsured are young
adults and minority racial and ethnic groups. Adults between
the ages of 18 and 24 are more likely to be uninsured than any
other age group, including children. Young adults are
vulnerable to being uninsured because they may no longer be
covered under their families' policy or Medicaid, may not yet
be established in the workforce, and may earn less than older
adults.
Hispanics and African Americans are also more likely to be
uninsured than the rest of the population. While Hispanics and
African Americans represent 12.3 percent and 13.1 percent of
the nonelderly population, respectively, they represent 24.4
percent and 16.5 percent, respectively, of the uninsured.

Targeted Tax-Based Reforms That BCBSA Urges Congress To Enact:

BCBSA believes Congress needs to adopt targeted reforms
that will reduce the existing number of uninsured. Extending
health coverage to those without it can be achieved quickly and
most effectively through legislation that is aimed at the
specific subgroups of the uninsured, such as low-income
workers, and that builds on the existing employment-based
health system.
BCBSA believes these targeted solutions should include:
Tax Credits To Small Employers For Their Low-
Income Workers. Employees in small firms are more likely to be
uninsured than those employed by larger companies. The primary
reason for this higher uninsured rate is that small firms are
more likely to have a larger share of low-income workers than
larger firms. About 42 percent of workers in small firms (0-9
employees) earn less than 250 percent of the poverty level,
compared to only 27 percent of employees in firms with 100 or
more employees. Offering tax credits to small firms for their
low-income workers would decrease the number of uninsured by
making health coverage more affordable for small businesses and
their low-wage employees.
Focusing on low-wage workers as a subset of those in small
firms targets those most in need of assistance. Workers in
small firms with a high proportion of low-wage workers are half
as likely to be offered health coverage as workers in small
firms with high-wage workers. Only 38 percent of small
businesses with low-wage employees offer health coverage
compared to 78 percent of small businesses with high-wage
employees. A recent analysis by the Alpha Center (see attached
graph) underscores the importance of focusing on low-wage
workers in small firms. It shows that low-wage workers (e.g.,
those earning less than $20,000) have considerably lower rates
of employer-sponsored health coverage than those with higher
wages and illustrates that low-wage workers in the smallest
firms are least likely to have employer-sponsored coverage.
By limiting the tax credit to only low-income employees of
small businesses, the proposal would avoid subsidizing those
who should be able to afford coverage on their own (e.g.,
lawyers working for a small firm). BCBSA recommends, given
scarce resources, that Congress focus on low-income workers in
businesses with fewer than 10 employees and then expand the
program as resources permit.
Employers would administer the tax credit on behalf of
qualifying employees. Because cash flow is critical for small
firms, the proposal envisions that employers would provide the
credit in the form of reductions in the withholding taxes that
the employer would normally pay. The administrative burden of
such a system on the employer would likely be very low since
most employers contract payroll functions to outside firms that
are easily able to administer such credits on behalf of
employees.
Offering tax credits to small firms with low-income workers
also has the advantage of building on the successful employer-
based health coverage system. The majority of Americans receive
health coverage through an employer. By building on the current
employer-based system, BCBSA's tax credit proposal could be
implemented immediately.
Full Tax Deductibility For The Self-Employed.
Expanding the groups of people who can deduct the cost of
health insurance from their taxable income would assist many of
the uninsured. Enabling the self-employed to fully deduct the
cost of health coverage would help the one in four self-
employed people who have no health insurance. Congress has
already enacted legislation to phase in full deductibility for
the self-employed. BCBSA believes this phase-in should be
accelerated.
Full Tax Deductibility For People Without
Employer-Sponsored Coverage. Some people, including young
adults and early retirees, are uninsured because they do not
have access to employer-sponsored coverage. Making health
coverage more affordable for those without access to employer-
sponsored coverage would contribute to an increase in the
overall rate of insurance. This can be achieved by allowing
them to deduct the full cost of insurance. It would also
address parity concerns regarding the tax treatment of health
coverage received through an employer and health insurance
purchased on one's own.
Federal Grants for Initiatives That Expand
Coverage or Provide Care to the Uninsured. Targeted solutions
should also be developed for groups that may remain uninsured
despite tax credits and deductibility, including some non-
citizens, minorities, young people and other low-income groups.
These targeted solutions can best be carried out by offering
grants to states to fund a variety of initiatives, including
private programs to expand health coverage, community health
centers that provide health care to the uninsured, and
subsidies to state high-risk pools, which make coverage more
affordable for those requiring extensive medical care.
We believe this proposal, which is based on tax credits and
deductibility to targeted subgroups of the uninsured, is the
most appropriate way to address this problem. BCBSA's proposal
has several advantages:
It Could Be Enacted Quickly. BCBSA's proposal does
not try to reinvent today's health coverage system. It
recognizes that the current employment-based system works well
for most Americans and would expand coverage through this
system. By building upon the current system, BCBSA's proposed
actions could be implemented quickly. These proposals could be
enacted without the prolonged congressional debate that would
be required of more controversial proposals that seek to
restructure the entire system.
It Would Be Simple To Implement. Building on the
current employment-based system would also assure simplicity in
the execution of BCBSA's proposed reforms. Employers and
employees are already familiar with the employment-based
system. Under BCBSA's proposal, there would be no need to
educate health care purchasers and consumers about new ways of
receiving health coverage. Using the infrastructure that is
already in place would also obviate the need to create a new,
complex bureaucracy to carry out the functions now performed by
employers.
It Would Make The Best Use Of Scarce Resources. By
targeting specific subgroups of the uninsured (e.g., low-income
workers in small firms), BCBSA's proposed reforms would assure
that limited government funds would be directed to those most
in need of assistance and those most likely to take advantage
of such assistance.

II. Congress Needs To Carefully Assess The Impact Of Alternative Tax-
Based Proposals

Numerous proposals to reduce the number of uninsured are
now being considered in Congress. These proposals range from
modest reforms to comprehensive restructuring of the market.
They should each be carefully evaluated in terms of the
potential to improve our health care financing system as well
as the risk of creating unintended consequences.
The most comprehensive proposals are those that would ``de-
link'' health insurance coverage from employment and move
toward an individual-based system. These proposals embody the
powerful notion of individual empowerment and merit full
consideration. However, there are many issues that must be
considered when one contemplates a move that would
fundamentally alter the way millions of Americans now receive
health coverage. Assessing the implications of changing to an
individual-based system in all likelihood will be a long-term
process that involves much debate and analysis.
I will limit my comments today to tax changes that could be
enacted this year since Congress is expected to move forward
with incremental tax provisions to improve the affordability of
health coverage this year. We are encouraged by many of the tax
proposals that are under development. For example, there
appears to be growing interest in accelerating the full
deductibility of coverage for the self-employed and providing
full deductibility for those who do not have access to
employer-sponsored health coverage, both of which we support.
Many in Congress are also considering proposals to provide
for ``parity'' in coverage between the individual and group
markets. These proposals range from providing full
deductibility of individual coverage for those who have access
to employer-sponsored plans--to requiring that employers
provide the equivalent value of employer-provided benefits to
employees who ``opt out'' of their employer-sponsored plan and
purchase their own health coverage in the individual market.
We are concerned, however, that, while the intent of the
parity proposals is to provide individuals with more choice,
they would create unintended consequences for the current
employment-based system. We are concerned that proposals that
would allow individuals to opt out of the employment-based
system in favor of individual coverage would undermine the
advantages of the natural pooling that occurs in the group
health insurance market. Given the opportunity to opt out of
employer-sponsored plans, low-cost workers may be more likely
to leave these group health plans, resulting in premium
increases in these groups' rates. The result would be adverse
selection, which would destabilize group plans.
While not perfect, the current employment-based system is
successfully providing health coverage to the majority of
Americans. For example, one of the advantages of the current
employment-based system is that it facilitates significant
cross subsidies. To illustrate, an employer who has a mix of
young and old, healthy and not so healthy employees will not
vary the contribution based on expected use of medical
services. This represents an accepted mechanism for creating
the cross subsidies that are essential for providing health
insurance. Without a strategy to assure stable cross subsidies,
the insurance market would deteriorate.
To avoid the problems with the parity provisions, BCBSA
strongly believes Congress should provide tax breaks for the
purchase of health coverage in the individual market only if
the individual does not have access to employer-sponsored
coverage. For example, eligibility for the tax breaks could be
limited to those whose employers have not offered coverage for
some defined period of time, have retired or are unemployed.
Congress must be aware that changes--even seemingly minor
changes--that affect the employment-based system could make the
current problem of the uninsured worse. To avoid these
unintended consequences, BCBSA's short-term proposal
strengthens the employment-based system. We believe that
Congress should move quickly on some of these proposals while
debate continues on more comprehensive reform strategies.

III. Congress Should Adopt A ``New Litmus Test'' To Reject Legislation
That Increases Health Care Costs And The Number Of Uninsured

In addition to looking at tax-based solutions to the
uninsured problem, Congress should consider other ways to
preserve the affordability of private health insurance. BCBSA
believes Congress should adopt a ``new litmus test'' to reject
legislation that would increase premiums and, consequently, the
number of uninsured. Federal managed care legislation, new
benefit mandates and antitrust exemptions for health
professionals are examples of proposals that would make health
coverage less affordable for employers and consumers. Congress
should reject these proposals so that it will not exacerbate
the uninsured problem.
In analyzing the uninsured issue, BCBSA found that the cost
of health coverage is the key determinant of whether working
Americans have employer-sponsored coverage. We found that high
annual premium increases were associated with drops in
employment-based coverage and flat premiums were associated
with improvements in employment-based coverage. Examining
premium increases and coverage rates over the past decade
illustrates this point.
When health care costs were rising at double-digit rates
during the late 1980s, the percentage of nonelderly Americans
with employment-based coverage declined. While 69.2 percent of
workers had health coverage through an employer in 1987, only
64.7 percent had employment-based coverage in 1992.
According to the nonpartisan Employee Benefit Research
Institute (EBRI), employers have been more likely to offer
workers health coverage in recent years when health care cost
increases have been relatively flat. Since 1993, there has been
an increase in the percentage of people receiving employer-
sponsored health coverage. While approximately 63 percent of
nonelderly Americans received health coverage through an
employer in 1993, that figure increased to 64.2 percent by
1997. Not surprisingly, the average annual increase in health
benefit costs during this period was only 2.3 percent.
The first step in addressing the uninsured is to not make
the problem worse. Given the link between higher costs and
reduced coverage, Congress should pledge to enact no law that
will make health coverage more expensive.

IV. Conclusion

Expanding the number of Americans with health coverage
should be our nation's top health care priority. No single
solution will solve the uninsured problem, but the targeted
solutions advocated by BCBSA would effectively reduce the
number of uninsured.
We urge Congress to take a series of actions to reduce the
number of uninsured, including providing tax credits to small
firms for their low-wage workers, full tax deductibility for
the self-employed and those without access to employer-
sponsored coverage, and federal grants to states to fund
targeted initiatives to expand health coverage. We also believe
Congress should not enact legislation that would increase
health care costs. Increasing health care costs will only
increase the number of uninsured.
BCBSA's tax-based proposal could be enacted quickly,
implemented simply and would make the best use of scare
resources. It also avoids the problems that could be created by
alternative proposals, such as tax proposals that would all
employees to opt out of employment-based health plans.
Thank you for the opportunity to speak to you on this
important issue. BCBSA looks forward to working with Congress
to address the needs of the uninsured.
[GRAPHIC] [TIFF OMITTED] T0332.008

[GRAPHIC] [TIFF OMITTED] T0332.009

Mrs. Johnson of Connecticut [presiding]. Thank you very
much.
Mr. Wilford.

STATEMENT OF DAN WILFORD, PRESIDENT, MEMORIAL HERMANN
HEALTHCARE SYSTEM, HOUSTON, TEXAS; ON BEHALF OF AMERICAN
HOSPITAL ASSOCIATION

Mr. Wilford. Thank you, Madam Chairman. I am Dan Wilford,
President of the Memorial Hermann Healthcare System in Houston,
Texas. I am testifying today on behalf of the American Hospital
Association and its 5,000 hospitals, health systems, networks
and other providers of care.
The American Hospital Association's vision is a society of
healthy communities where all individuals reach the highest
potential for health. Health care coverage itself does not
ensure good health or access to services, but the absence of
coverage is a major contributor to poor health.
Therefore, the American Hospital Association and its
members have a long tradition of commitment to improving the
health care coverage and access for America's uninsured and
underinsured. AHA has supported incremental steps that can at
least move our Nation closer to health care coverage for all,
examples being the Health Insurance Affordability and
Accountability Act of 1996, the children's health insurance
program for 1997, and AHA's own campaign for coverage which
enlisted 1,500 hospitals and health systems in an effort to
extend coverage in their communities.
It has been said already that 43 million Americans are
without health coverage. In Houston, 31 percent of our citizens
have no insurance coverage compared to 16 percent on a national
average. That is the largest percentage of a major metropolitan
city in the United States.
Congress has a unique opportunity to ease this situation.
The Federal budget surplus offers opportunities to look for and
to fund ways to increase health care coverage for Americans.
With 84 percent of the uninsured living in families that are
headed by someone who has a job but no health coverage, the
low-income working uninsured should be our next priority.
There is a growing consensus that changes in the Tax Code
can make health care coverage more affordable for the working
uninsured. Congress will be considering several options. We
would like to present our views and some ideas that are aimed
at getting health coverage to more Americans. First, make it
affordable to people who cannot afford their employer's
coverage or whose employers don't offer coverage to get
insurance coverage from another source. This can take the form
of a refundable tax credit for low-income tax payers who
qualify for a credit against their income tax for all or part
of what they spend for health insurance. It can be varied by
income and family status.
We can offer tax credits to small employers that purchase
group coverage. This will give small businesses additional
financial resources to provide coverage for their employees and
we can accelerate the deductibility of health payments for
self-employed. Under current law, self-employed taxpayers are
not able to get full deductibility of their insurance payments
until the 2003.
In addition to Tax Code changes, other reforms can make
coverage more accessible to the working uninsured. These
include creating purchasing cooperatives and grants for State
high-risk pools. In addition, States and the Federal Government
can make it easier for families to enroll in public programs
like CHIP and Medicaid.
In conclusion, Madam Chairman, the fact is that people
without health insurance are more likely to become seriously
ill with injuries and illnesses that had they had proper health
insurance could have been a minor problem. Our emergency
departments see this every day.
That is why we support an effort to stem the rising tide of
uninsured and to bring appropriate medical coverage to all who
need it. With the working uninsured growing in numbers, we
agree with the concept of changing the Tax Code to make it
possible for more low-income workers and their families to have
health care coverage. We look forward to working with you on
specific legislation that will do that job properly.
Thank you.
[The prepared statement follows:]

Statement of Dan Wilford, President, Memorial Hermann Healthcare
System, Houston, Texas; on behalf of American Hospital Association

Mr. Chairman, I am Dan Wilford, president of Memorial
Hermann Healthcare System in Houston, Texas. I am testifying
today on behalf of the American Hospital Association (AHA) and
its 5,000 hospitals, health systems, networks, and other
providers of care. We are pleased to have this opportunity to
discuss the critical national goal of getting health care
coverage to more Americans.
The AHA's vision is a society of healthy communities, where
all individuals reach their highest potential for health. While
health care coverage by itself does not ensure good health or
access to health care services, the absence of coverage is a
major contributor to poor health. Therefore, the AHA and its
members have a long tradition of commitment to improving health
care coverage and access for America's uninsured and
underinsured.
According to the Employee Benefit Research Institute
(EBRI), the percentage of uninsured Americans has increased
steadily since 1987. In 1997, 43 million Americans were without
health care insurance. Congress has a unique opportunity to
ease this situation right now. According to the Congressional
Budget Office, the federal budget surplus was $70 billion last
year, will be $107 billion in 1999, and is projected to reach
$209 billion by 2002 and then continue to grow. Now is the time
to look for--and to fund--opportunities to increase health care
insurance coverage for Americans.
We've already made headway in several areas, including
expanding coverage for America's children. With 84 percent of
the uninsured living in families that are headed by someone who
has a job but no health insurance, the low-income, working
uninsured should be our next target.

INCREMENTAL PROGRESS

The AHA believes that every American deserves access to
basic health care services, services that provide the right
care in the right setting at the right time. But we also know
that, as the 1994 health care reform debate clearly
demonstrated, a single, comprehensive proposal to bring
coverage to all Americans is unlikely to be successful.
Incremental steps are a more likely means for increasing
coverage, and the AHA has supported those steps that we believe
can at least move the nation closer to health care coverage for
all.
The AHA supported the Kassebaum/Kennedy legislation that
became known as the Health Insurance Portability and
Accountability Act. We recognized that the immediate impact on
reducing the number of uninsured was not likely to be
overwhelming. Nevertheless, we judged it critically important
to demonstrate that practical, public initiatives could help
reduce the loss of insurance coverage.
And we were strong supporters of the Children's Health
Insurance Program (CHIP). This effort was part of the Balanced
Budget Act of 1997, and helps states provide health care
coverage to low-income children. Fifteen percent--or nearly
eleven million--of children in this country went without health
insurance in 1997.
Under CHIP, states can help alleviate this problem by
purchasing insurance, providing coverage through Medicaid, or
through some combination of both options. The federal
government has appropriated $24 billion through 2002 for the
program. Those funds are allocated based on the number of
uninsured children in each state, with the state matching the
federal allotment.
With almost every state, plus the District of Columbia and
Puerto Rico, opting in to the program, CHIP got off to a good
start. In fact, the Health Care Financing Administration (HCFA)
has reported that, in its first year of operation, the CHIP
program enrolled nearly one million children. This is momentum
that is just beginning, and we urge Congress to resist any
temptation it may feel to divert or reduce federal funds that
have been allocated for this purpose.
The AHA, our state association partners, and individual
hospitals and health systems have been working hard to help
enroll eligible children in CHIP and Medicaid. Last year, the
AHA, HCFA, the March of Dimes and WJLA-TV, the local ABC
affiliate, teamed up with Maryland and Washington, D.C.
governments to develop public service advertisements urging
low-income families to sign their children up for free or low-
cost health insurance. Our partnership with HCFA is ongoing,
and another joint outreach initiative is planned for this
autumn.
And as part of the observance of National Hospital week
from May 9-15, the AHA urged all hospitals to continue their
commitment to enroll children in Medicaid and CHIP, by
encouraging participation in the national campaign to Insure
Kids Now. The campaign has a toll-free hotline with information
on the low-cost state health insurance programs, and the AHA
provided hospitals with Insure Kids Now posters with the 1-877-
Kids Now number for their emergency departments or other
appropriate locations.

AHA'S CAMPAIGN FOR COVERAGE

The AHA's commitment goes beyond these recent efforts. The
AHA Board of Trustees, after the demise of national health care
reform, was concerned that the American public had resigned
itself to the fact that large numbers of Americans were, and
seemingly always would be, uninsured. The AHA explored a number
of approaches with many of the leading health policy thinkers
at a series of policy forums addressing coverage, access, and
improving population health status. Each of the policy forums
concluded that:
incremental initiatives were the most likely path
to progress in reducing the number of uninsured, and
state and local initiatives would provide the most
immediate benefit.
In the absence of comprehensive federal action, the AHA
Board of Trustees in January of 1997 adopted a concrete goal of
reducing the number of uninsured people by four million by the
end of 1998--the AHA's Centennial year. We took on this
challenge because the primary task of hospitals and health
systems is to improve the health of their communities. While
they care for people who are both insured and uninsured, our
members see every day that the absence of coverage is a
significant barrier to care, reducing the likelihood that
people will get appropriate preventive, diagnostic and chronic
care.
The AHA's Campaign for Coverage--A Community Health
Challenge asked each of our members to help reduce the number
of uninsured people in their communities. Our state hospital
association partners worked to reduce the number of uninsured
in their states. Community-based efforts were key, and included
encouraging hospitals as employers to provide coverage to all
employees; working with local employers to develop affordable
coverage; providing care in a school-based or church-based
clinic; working with the state Medicaid program to increase the
participation rate among eligible people; and much more.
The number of hospital and health system participants in
the Campaign grew to about 1,500. They found ways to extend
coverage to nearly 2.5 million uninsured people, and to improve
access to health care services for another 3.4 million people.
And through their partnerships with local physicians, other
caregivers, schools and businesses, health care leaders
continue to carry the Campaign's message: getting more people
covered is not a one-time project, but a lifetime's work.
The next chapter of our campaign is being written. The AHA
has joined with EBRI, the Milbank Memorial Fund, and the
Association of American Medical Colleges to form the Consumer
Health Education Council (CHEC), an organization dedicated to
expanding coverage for the uninsured. This new organization is
educating consumers and employers about the need for coverage,
developing tools to help people choose a health plan, and
providing the media and public policymakers with information
about health care coverage.

THE NEXT STEP

Eighty-four percent of the uninsured live in families that
are headed by workers, some with full-time jobs, others with
part-time positions. Finding ways to make health insurance more
affordable for small companies and for low-income workers could
significantly slow the number of uninsured Americans, by
getting coverage to the workers and to their families.
According to an article in Health Affairs journal co-
authored by Jon Gabel, vice president of health systems studies
at AHA's Hospital Research and Educational Trust, higher-wage
firms are more likely than lower-wage firms to provide health
coverage for their employees.
During the past six years, writes Gabel, the U.S. economy
added more then 12 million jobs, and the unemployment rate fell
to its lowest level since 1969. Yet, at the same time, the
number of uninsured increased from 35 million to 43 million. In
1997 alone, a year in which the unemployment rate fell from 5.3
percent to 4.6 percent, the number of uninsured increased by
nearly 2 million.
Part of this is due to low-income workers not being offered
health insurance by their employers. Using data from KPMG Peat
Marwick's 1998 survey of employers about job-based health
insurance, Gabel and his colleagues calculated that only 39
percent of small firms (those with fewer than 200 workers) with
low-wage employees offered health benefits. Among small firms
that pay high wages, 82 percent offered health benefits.
The findings suggest that low-wage families are more likely
to be insured if they work in firms where most of the employees
earn higher wages. Further analysis points to cost as another
ingredient in the growth of the uninsured. While real wages
declined for low-wage workers, employee contributions for
single and family coverage rose more than threefold from 1988
to 1996. The result is that fewer workers could afford to
accept their employer's health care coverage, and opted to go
without coverage.

INCREMENTAL SOLUTIONS TO TARGET THE WORKING UNINSURED

A look at how our current tax system stimulates health
insurance coverage can help explain the broader question of the
uninsured. Of the 84 percent of the population with health
insurance, employment-based coverage provides the majority with
health care coverage. The most significant tax incentives for
employer-based health insurance are: health coverage as a
deductible business expense; health coverage as an exclusion
from an employee's gross income; and health coverage as an
exclusion from employment tax computations such as Social
Security, Medicare or unemployment compensation.
The tax incentives are less generous for self-employed and
individual taxpayers. Self-employed taxpayers may deduct
payments for health insurance from their adjusted gross income.
The tax deduction is currently only 45 percent of the amount of
the insurance, but will increase to 100 percent in 2003.
Individuals who itemize can deduct any unreimbursed medical
expenses only if those expenses exceed 7.5 percent of gross
income. Questions have been raised over how our federal tax
system creates inefficiencies and market distortions, and
favors individuals who work and have higher incomes.
Congress, in particular, should investigate the question of
how the inequities in the tax code have contributed to the
current diminishment of health care coverage. However,
necessary reforms will take years to be fully vetted. The need
to ensure access to health care for many low-income working
uninsured is far too pressing to wait. The EBRI data shows us
that:
Eighty-four percent of the uninsured lived in
families that are headed by workers, some with full-time jobs,
others with part-time positions.
Adults between the ages of 18-64 accounted for
almost all of the most recent increase in the uninsured,
between 1996 and 1997.
The decline in Medicaid coverage for working and
non-working adults accounted for the overall increase in the
uninsured between 1996 and 1997.
The uninsured are concentrated disproportionately
in low-income families--over 40 percent earn less than $20,000.
Nearly half of the working uninsured are either
self-employed or working in small businesses with fewer than 25
employees. A growing consensus is emerging to look at
incremental steps through the tax code to make health care
coverage more affordable for the working uninsured. The AHA
believes there are several solutions that can help more
employees afford health care coverage. Congress will be
considering several tax credit options. We would like to
present our views on some ideas we support that are aimed at
getting health care coverage to more Americans.

Reform the Tax Code

Make coverage more affordable for the working uninsured
Make it affordable for low-income people who
cannot afford their employer's coverage, or whose employers
don't offer coverage, to get health care insurance from another
source. This could take the form of a refundable tax credit.
Low-income taxpayers would qualify for a credit against their
income tax for all or part of the amount that they spend on
health insurance. The tax credit can be varied by income and
family status. For low-income taxpayers the tax credit is
preferable to tax exclusions and deductions, which favor higher
income workers. The tax credit, essentially a direct transfer
from the government, will help low-income workers purchase
insurance.

Assist employers in offering insurance

Offer tax credits for small employers that
purchase group coverage premiums. This would give small
businesses additional financial resources to provide coverage
to their employees.
Accelerate the deductibility of health payments
for the self-employed. Under current law, self-employed
taxpayers will not be able to fully deduct their health
insurance payments until 2003.

Other Reforms

In addition to changes in the tax code, there are other
reforms that would help make insurance more accessible to the
working uninsured. These include:
Create a mechanism that allows more-affordable insurance
Create purchasing cooperatives that, through
strength in numbers, can give small firms more leverage in
negotiating health care insurance contracts.
Offer grants for state high-risk pools. High-risk
pools would allow access to insurance for people with greater
health care needs.
Make it easier for families to enroll in public programs
Give states the option to expand CHIP to include
families of CHIP-eligible children. Encourage states to use
temporary Medicaid coverage for individuals that are moving
from welfare-to-work.
Expand coverage for low-income pregnant women,
legal immigrant low-income pregnant women and legal immigrant
low-income children
Continue the federal commitment to fund CHIP;
states are demonstrating strong commitments to CHIP, and
momentum would be lost if federal dollars are removed
Encourage outreach to enroll eligible children in
CHIP and state Medicaid programs

Finance reforms and expansions through the federal budget
surplus

The financing of such reforms is a critical policy
question. The booming economy, and a projected federal budget
surplus of $107 billion this year alone, offer a unique
opportunity to help fund many of these initiatives. By
investing surplus dollars, Congress can realize a substantial
return as more Americans receive the right health care, at the
right time, in the right place.

CONCLUSION

Mr. Chairman, America's hospitals and health systems
believe that every man, woman and child in this country deserve
basic health care services, and that no one should lack these
services because they cannot pay for them. It is a fact that
people who do not have health care insurance are more likely to
become seriously ill with an illness or injury that, had it
been treated properly and early, could have been a minor
annoyance instead of an expensive condition. Our emergency
departments see this every day.
That is why we support any effort to stem the rising tide
of the uninsured, and bring appropriate medical care to all who
need it. With the working uninsured growing in numbers, we
agree with the concept of changing the tax code to make it
possible for more low-income workers and their families to have
health care coverage. We look forward to working with you on
specific legislation that would do the job properly.

Mrs. Johnson of Connecticut. Thank you very much, Mr.
Wilford.
Ms. Hoenicke.

STATEMENT OF JEANNE HOENICKE, VICE PRESIDENT AND DEPUTY GENERAL
COUNSEL, AMERICAN COUNCIL OF LIFE INSURANCE

Ms. Hoenicke. Thank you, Madam Chairman. I am Jeanne
Hoenicke, vice president and deputy general counsel of the
American Council of Life Insurance. The nearly 500 member
companies of the ACLI offer annuities, life insurance,
pensions, long-term care, disability income insurance and other
retirement and protection products.
My statement echoes some of the speakers you have heard
before me. It is also a prelude to the retirement panel that
follows. Over the next 35 years, the number of Americans over
age 65 will more than double and nearly half of those will
reach the age of 90. Many of us will spend more than 25 years
in retirement. This calls for broader and more flexible
preparation. That preparation includes having assurances of
many things: That you will not outlive your income; that you
will not become impoverished even if you need long-term care;
and that your retirement savings will be protected during your
working years even if you become disabled or suffer the death
of a key wage provider, child care provider or homemaker.
ACLI believes that we need a comprehensive approach to
retirement security, one that recognizes the increasing
reliance on private sector solutions, personal responsibility,
and retirement risks. As leading providers of both accumulation
and protection products, we are uniquely qualified to assist in
developing strategies that help Americans adapt to the happy
advent of a long retirement, but one that has less formal
guarantees and more uncertainties.
Retirement security is our number one issue. Social
Security as it exists today may not continue to provide a
sufficient level of benefits for the coming generations.
Policymakers should address this issue now while the economy
and demographics provide a window of opportunity. At the same
time, actions taken to preserve and strengthen Social Security
must not unintentionally weaken the private retirement system.
Fortunately, the private pension system continues to grow,
increasing from less than 10 percent of national wealth in 1980
to close to 25 percent in 1993. Our retirement system must
continue to respond to America's changing work patterns,
including the growing importance of small businesses, coupled
with shorter job tenures, both of which have important
implications for the future. The ACLI applauds Representatives
Portman and Cardin for their leadership in ensuring not only
the maintenance but the expansion of the voluntary employer-
sponsored retirement system. We strongly support their
legislation, H.R. 1102, and urge Congress to enact it as
quickly as possible.
We are also keenly aware that tax incentives have played a
key role in the growth of annuities and IRAs. These retirement
products are especially important to the self-employed, a
growing segment of the work force. Over 80 percent of
individual annuity owners have household incomes under $75,000,
close to half have incomes under $40,000. The current tax
treatment of annuities during the retirement savings phase must
be maintained and we are very grateful to this Committee for
its staunch support against efforts to weaken tax incentives
for individuals who plan responsibility for their full lifetime
needs through these retirement annuities.
More Americans need to understand the importance not just
of accumulating savings, but of planning to protect those
savings against the uncertainties of what life might hold. We
should do more to encourage everyone to accept the dual
challenge of accumulating savings and managing risks to those
savings. To manage risks, Americans need to have some portion
of their retirement income in a guaranteed stream of payments
for their whole life: from Social Security; from employer-
sponsored pensions; and from personal annuities. The Tax Code
should provide incentive for individuals to guard against
outliving their savings.
Tax policy should also promote responsibility for guarding
against the devastating costs of a long-term illness. The ACLI
believes that the Code should be amended to permit individuals
to deduct long-term care insurance premiums for themselves and
family members as an adjustment to income like the IRA
deduction. We strongly support the bill introduced last week by
Representatives Johnson and Thurman which includes this
important tax incentive.
Madam Chairman, the future is not what it used to be. We
urge you to adopt tax policies that reward personal
responsibility and provide more flexibility for retirements
that will be longer and very different from the past.
Accumulating savings for retirement is vitally important.
Protecting those savings before and in retirement is equally
important.
Thank you for providing us with this opportunity to express
our views, and I would be happy to answer questions.
[The prepared statement follows:]

Statement of Jeanne Hoenicke, Vice President and Deputy General
Counsel, American Counsel of Life Insurance

Thank you, Mr Chairman. I am Jeanne Hoenicke, Vice
President and Deputy General Counsel of the American Council of
Life Insurance. The nearly 500 member companies of the ACLI
offer life insurance, annuities, pensions, long term care
insurance, disability income insurance and other retirement and
financial protection products. Our members are deeply committed
to helping all Americans provide for a secure life and
retirement.
Over the next 35 years, the number of Americans over age 65
will more than double, and nearly half of those will reach the
age of 90. This means many of us will spend over 25 years in
retirement. This fast approaching reality calls for broader and
more flexible preparation. That preparation includes having
assurance of many things: that you will not outlive your income
even if Social Security is less than expected and you have no
company lifetime pension; that you will not become impoverished
even if you need long-term care; and that your retirement nest
egg will be protected during your working years even if you
become disabled, or suffer the death of a key wage provider,
childcare provider or homemaker.
Congress has provided an important safety net for the truly
needy, and has encouraged individuals to take appropriate steps
to secure their own retirements. The success of today's
retirement system rests on a healthy Social Security system and
on federal income tax incentives for private pensions and
retirement savings. The government role in these programs
remains essential.
ACLI believes, however, that we need a more comprehensive
approach to retirement policy, one that recognizes the
increasing reliance on private sector solutions, personal
responsibility, and retirement risks.
As leading providers of both accumulation and protection
products, the life insurance industry is uniquely qualified to
assist in developing strategies to help Americans adapt to the
happy advent of a long retirement, but one that has less formal
guarantees, and more uncertainties. Retirement and financial
security is our number one issue.
Social Security as it exists today may not continue to
provide a sufficient level of benefits for the coming
generations. We believe policymakers must address this issue
while the economy and demographics provide a window of
opportunity. At the same time, actions taken to preserve and
strengthen Social Security must not unintentionally weaken the
private retirement system.
Fortunately, the private pension system continues to grow,
increasing from less than 10 percent of national wealth in 1980
to close to 25 percent of national wealth in 1993. By 1997,
assets in the private pension system were nearly $7 trillion,
including significant growth in defined contribution plans. The
nation's retirement system has, and must continue to, respond
to the dynamic nature of Americans' changing work patterns,
including the growing importance of small businesses and the
service sector, coupled with the trend toward shorter job
tenures, all have important implications for the future. Tax
policymakers need to take these trends into account.
We have provided the Committee with much information on
employer-provided pensions, for example, that 77 percent of
participants have earnings below $50,000 (1997). The ACLI
applauds Representatives Portman and Cardin for their
leadership in ensuring not only the maintenance, but the
expansion of the voluntary employer-sponsored retirement
system. We strongly support their legislation, H.R. 1102 (the
Comprehensive Retirement Security and Pension Reform Act), and
urge Congress to enact it as quickly as possible. The ACLI
particularly supports the Portman/Cardin proposals to raise the
limitations on contributions to and benefits from pension plans
to or above their former levels and increase the limits on
compensation considered for these purposes. In addition, the
ACLI strongly supports repeal of the current liability funding
limit which restricts the ability of an employer to ensure a
well-funded plan. We also support similar provisions offered by
representatives on this Committee and throughout Congress.
At the same time, we are keenly aware that tax incentives
have also played a key role in the growth of IRAs and
annuities. These retirement products are especially important
to the self-employed, a growing segment of the American
workforce, and to those without employer-sponsored pensions.
Over 80 percent of individual annuity owners have household
incomes under $75,000; close to half have incomes below
$40,000. The current tax treatment of annuities during the
retirement savings accumulation phase must be maintained. We
are grateful to this Committee for its staunch support against
efforts to impose tax dis-incentives for individuals who plan
responsibly for their full lifetime needs through these
important annuity retirement products.
More Americans need to understand the importance not just
of accumulating savings, but of planning to protect one's
savings against the uncertainties of what life might hold;
uncertainties such as becoming disabled or a family provider
dying early; uncertainties such as outliving one's income or
needing long-term care. We should do more to encourage all
Americans to accept the dual challenges of accumulating
retirement savings and managing risks to these savings.
To manage retirement risks, Americans need to have some
portion of their retirement income in a guaranteed stream of
income for life from Social Security, from employer-sponsored
pensions, and from personal annuities. The Tax Code should
promote individual responsibility for guarding against
outliving one's savings.
Government tax policy should also promote individual and
family responsibility for guarding against the devastating
costs of a long-term, chronic illness. The ACLI believes that
the Tax Code should be amended to permit individuals to deduct
long-term care insurance premiums for themselves and family
members as an adjustment to income, like the IRA deduction. We
strongly support H.R. 2102, the bill introduced last week by
Representatives Nancy Johnson and Karen Thurman which includes
this important tax incentive.
Mr. Chairman, the future is not what it used to be. We need
to adopt tax policies that reward personal responsibility and
provide more flexibility for retirements that will be longer
and very different from the past. The life insurance industry
is the only private industry that can provide life insurance
protection against leaving family members without money should
a wage provider, childcare provider or homemaker die early;
that can provide annuities which guarantee income for every
month a person and his or her spouse lives, no matter how long;
and that can protect a nest egg from being wiped out due to
disabilities, or long-term care needs through disability and
long-term care insurance. Accumulating savings for retirement
is vitally important; protecting those savings before and in
retirement is equally important.
Thank you for providing us with this opportunity to express
our views and I would be happy to answer any questions.
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Mrs. Johnson of Connecticut. I thank the panel for their
presentation. It certainly is true that the future is going to
be quite different from the past, and one of the stark
differences is the many, many years that people are going to
live in retirement, and our failure to this point at least to
appropriately respond to the changed nature of retirement in
our public policies.
Social Security reform, as important as it is, is really
the easy piece of that. Unless we do a lot of things that we
have talked about here today, we really won't have retirees
that are as secure and capable and a strong part of the economy
in decades ahead.
I wanted to ask you, Ms. Hoenicke, because the concept of
annuities has not been popular with the Treasury in recent
years and come under attack as a source of new revenues in a
number of subtle ways, could you just talk about the benefits
of annuity products as opposed to other kinds of products as we
look toward retirement security?
Ms. Hoenicke. Surely. The annuity product we believe is
very important and we are grateful to this Committee's support
for it over the years. The unique feature that makes it so
important to this retirement security issue that you are
considering today is that it is the only product that can
provide individuals a guarantee against outliving their income.
If the savings pool they have gathered will not necessarily
provide them enough money throughout their life, if they have
purchased an annuity, the insurance company will, with the
money that they have used to purchase that annuity, provide
that stream of income. That is very important because we do not
know how long we are going to live, and we may live a long
time, happily.
Mrs. Johnson of Connecticut. Thank you. On the subject of
the uninsured, I appreciate the many ideas that are now coming
forth in covering the uninsured. Certainly as we look at the
problems in Medicare, the confluence of Medicare payment
problems and the rise in the number of uninsured are posing a
new threat to hospital services. Hospitals are uniquely
impacted by the rise of the uninsured, both in terms of your
emergency room costs and in terms of hospital stays that are
not compensated by virtue of lack of insured coverage.
So it is of enormous importance to our hospital system that
we move aggressively to reduce the number of the uninsured, not
just from the point of view of their needing better preventive
care and early intervention, but also in maintaining the
strength of the institutional capability that this Nation has
to provide very sophisticated acute care hospital services.
But as we move to work on the uninsured, a number of you
have talked about this problem of how do you cover the
uninsured and not erode the strength of the employer sector.
One of the critical issues that is not addressed by any of
our legislation but I think is very relevant is how do we
stimulate the private sector to provide a broader array of
policies? We are beginning to see some change. I am beginning
in my district to see very exciting pairing of medical savings
accounts with the traditional employer provided accounts giving
people the option of a medical savings account and then the
retirement savings that offers in years of low health care
costs.
Aetna recently came out with a whole different approach to
insuring health costs. One of the reasons we can't reach the
uninsured individual is because the costs are high, whether it
is for the individual or for the small business, and how can we
create a greater challenge to the individual market to think
through the real needs of the variety of people who are
uninsured and stimulate a broader market, at the same time do
something to help with the cost. But if we just help with the
cost, we maintain in a sense the continued rigidity of the
product in the health market. I am not sure that we are going
to achieve our goal so it is kind of a nebulous question, but I
would appreciate your comments on it.
Mr. Goodman. I would suggest two changes. Two changes. One,
I think it is important that we have the same tax system
applying to individuals and to small businesses so that we have
a level playingfield under the tax law. And as long as we have
a level playingfield, we are going to find out what the
employer's role should be in the marketplace and not by the
artificial mechanism of tax law.
The other important change largely has to come at the State
level. In Texas, we are looking very seriously at the idea of
allowing small businesses to buy their employees into
individual insurance pools. So you get all the economies of
group purchasing, whatever economies there are there, and then
what the employee has is a policy which he owns and can, in
principal, take from job to job.
I think if we can open up that mechanism, we will get small
business more in the role of helping people get into pools
instead of tying to run its own health insurance plan which a
small business is not really able to do.
Mrs. Johnson of Connecticut. Dr. Butler.
Mr. Butler. I agree with that. I think providing subsidy or
tax credit will of itself stimulate a lot of activity.
It is very interesting, for example, that in the FEHBP, the
Federal Employee Health Benefit Program, you see a plethora of
employee-sponsored organizations including unions being very
much involved in a provision of care. Why is that so and not so
in the rest of the market? Because those plans are eligible for
the subsidies under the FEHBP.
If you provide a credit or other kinds of assistance that
have been mentioned, I think you will see the development of
those kinds of alternatives. I think if you look at organized
labor, or if you look at church-based organizations,
particularly in the African-American community, there are
natural groupings that are already there as a basis on which to
build larger pools. I think the way to encourage or even work
directly with States on a demonstration basis to allow pooling
to develop. But the credit, which means giving the same tax
treatment for nonemployment based plans, is the key financial
step to stimulate this kind of activity.
Mrs. Johnson of Connecticut. Mr. Kahn.
Mr. Kahn. I think at the end of the day the kind of
subsidization that is being discussed here is critically
important. It will make the difference. But I must say, I think
there is sort of a countervailing trend. On the one hand,
plans, and plan purchasers are trying to be cost conscious. On
the other hand consumers and the employees are demanding more
choice.
So more open network plans are where the growth is, where
the products are and they tend to be more expensive than either
closed-network HMOs or more high-deductible plans. I think over
time, particularly in the small employer market, for it to
work, you are going to see these products, whether they are
HMOs or very high deductible plans, being the only ones that
you can have that you can keep affordable. Because at the end
of the day, whether it is better pooling or whatever, health
care is expensive and people are going to want a combination of
coverage for various kinds of illnesses and diseases that will
be expensive.
Mrs. Johnson of Connecticut. I do think it is sort of a
remarkable failure of the American system that we have been
unable to create pools for individuals, and I have been working
on that for years and many others in the Congress have. I am
interested that you think tax equity would help stimulate or
create the opportunity for a different kind of pooling.
I think we need to be thinking about pools that also can
register people for Medicaid. So they both are sort of, in a
sense public private because we have so many Medicaid-eligible
people who are not in the Medicaid system. I think only if we
begin to really have a more comprehensive approach to coverage
can we do that. As you develop ideas along that line, I would
appreciate it if you would get back to me.
Mr. Rangel.
Mr. Rangel. I have no questions. I want to thank the panel
for their excellent testimony.
Mrs. Johnson. Mr. Foley.
Mr. Foley. This may be slightly off the mark but maybe one
of you can help me. We are in a debate now on minimum wage and
increasing minimum wage, and oftentimes at that level the
employees themselves don't have any health care coverage
whatsoever. I think if given the option of a dollar in their
paycheck per hour or some type of health insurance policy, they
will quickly take the dollar in the paycheck and go without
coverage.
One of the big problems in the insurance industry and the
health care industry and the hospital industry is the fact that
there is an immense amount of cost shifting to those who have
the ability to pay who have Medicare or Medicaid or some other
form. And we are now aggressively debating how should we
increase minimum wage.
One of the thoughts I had was rather than necessarily give
a dollar increase, I would rather figure a way to require
health insurance coverage thereby reducing the burden that is
spread amongst society in getting employees covered. Now, it
may fall on deaf ears in several sectors, but I wondered if any
of you had looked at that potential kind of policy
implementation rather than just throwing money to the wind and
saying now we are going to elevate everybody's paycheck in
order to keep things consistent in America.
Can anybody give me an idea about that?
Mr. Goodman. I can tell you that I prefer the kind of
approach which encourages people to both have a job and to have
health insurance. I would be opposed to an approach which
artificially raises the cost of labor, and therefore is going
to cause people to be unemployed, especially as we go into an
economic downturn. So I prefer the tax credit approach that is
available to people regardless of their wage and for people at
the bottom of the income ladder, since they are fully
refundable, it means essentially the Federal Government is
going to be paying for their insurance.
Mr. Butler. I agree with that. Assuming for the sake of
argument that one supports increasing the minimum wage, if you
go forward with earmarking that for a specific kind of
insurance coverage, it will create more problems than it solves
for lots of people because you won't be able to get a one-size-
fits-all solution.
On the other hand, and whether or not you have an increase
in minimum wage, the tax credit which offsets the cost of
coverage gives you a lot more flexibility to do it either
within the employment base system or outside the employment
base system. You don't have to have the same degree of
regulation and one-size-fits-all approach to how people are
going to use that money for health coverage.
I think Dr. Goodman's point is correct. If you offer credit
and people for whatever reason don't take it, then you can look
at a rebate to the States equivalent to that revenue which has
not been lost by the Federal Government as a way of dealing
with people who somehow refuse to take the credit.
Mr. Kahn. I guess I would have a little concern about
critical mass of dollars. If someone is actually at the minimum
wage and you say only a dollar or some small portion of that
has to go to health insurance, I am not sure there is enough
critical mass. And, if the employer is not already providing
them coverage, I think it is problematic. I am not sure where
it gets you unless you come in with either deductions or
vouchers for people that are under a certain level of income as
we have in our InsureUSA Proposal or something to get them
enough bucks to get a policy that has substance to it and would
give them the kind of coverage that would sort of move them
down the field toward decent health care.
Mr. Wilford. Mr. Foley, I believe the people we experience
in our emergency departments that come in with no coverage that
are minimum-wage people probably would put their money in their
pocket like you are proposing. I think one possible alternative
might be that the employer be required to provide some kind of
at least catastrophic coverage for that group so that the major
catastrophic illnesses could be covered and the more minimum
coverages be covered in public clinics or other services.
Mr. Foley. Catastrophic would be helpful, but the problem
is, as you know, with State mandates on all insurance policies
it causes the premium to go so high, most people can't afford
them.
There are so many things that are added on into a required
policy. Anybody else want to comment on it? Again, it was just
an idea. I know the complications are in fact very real. I am
not suggesting I am for a minimum wage increase, but I think as
we go down this road, we continue to find ways to increase
wages and still negate the basic problem that is with us all in
America, that is the failure to obtain health insurance and
then it falls on society.
Nobody is rejected from an emergency room in a hospital.
They are treated. Somebody pays for it. It is the hospital, it
is Blue Cross, somebody is going to absorb that cost to
society; and I just sense that that is a real, real problem in
insurance coverage. As the fewer become insured, the more the
burden goes to the insured, the higher the premiums, the fewer
continue to maintain coverage and the spiral continues. And I
have got to vote in 3 minutes.
Mrs. Johnson of Connecticut. Some of us do have to vote. I
recognize Mr. Cardin for questioning while we are gone. Others
wanted to come back for questions so we will see how that
develops. Otherwise we will recess until the next panel.
Mr. Cardin. I will try to filibuster until a Republican
gets back, but I am more than happy to take the Chair if you
would like me to take the Chair.
Mrs. Johnson of Connecticut. We sort of do that by default,
Mr. Cardin. Before I leave I did want to mention two things.
First, I think Mr. Wilford's comment about--I hope you all
think about this--we have to do something to require States to
offer at least--because some States don't offer catastrophic
coverage because catastrophic coverage combined with the
community health system, which is very significantly federally
funded, does represent an alternative for--would have
represented an alternative for many. So there are ways in which
we need to better knit together the resources we have.
But last I would like to ask your help once my bill gets in
in evaluating how many of the uninsured it would cover because
it is so much a richer credit than anything that has been
offered. The attempt is to make it equal in goods delivered,
not in tax value, but in goods delivered to those who get
employer-provided insurance, and so unfortunately I do have to
go vote but I would look forward to your input on that once we
get it in and I will recognize Mr. Cardin for as much time as
he may choose to consume.
Mr. Cardin [presiding]. Thank you, Madam Chair. It is nice
to have the whole Committee. We might decide to mark up Social
Security reform first, and then we will go from there.
Let me first thank all of you for your testimony and for
your work on trying to deal with the problems of the uninsured.
I would just like to first get your observations on one
argument that many of you frequently make, that when we pass
policies here in Washington that could add to the cost of a
health care premium such as the Patients Bill Of Rights, the
argument is always made for those who oppose that action that
by adding to the cost of the insurance premium, we will add to
the number of people who are uninsured.
And I accept that as basic economic principal that the
higher the cost, the more likely that a company will not offer
health benefits or will terminate or do something else. My
question is, though, that the projections that I have seen show
that health cost inflation will go up over the next several
years at a higher rate than general inflation in our society.
Therefore, the cost of the current system will continue to
rise. Does that mean that the number of uninsured will continue
to grow unless we take some policy direction here in Washington
to compensate for the additional cost of our system? Is that
likely to occur?
Mr. Goodman. I think it is and it is not simply because of
what is happening in Washington. It is also what is happening
at the State level, and two bad things are happening. We are
passing unwise legislation that unnecessarily raises the cost
of----
Mr. Cardin. Suppose we do nothing. Suppose we do absolutely
nothing. Let's say we don't pass these bills. Medical inflation
goes up at what is projected to be at least three or four or
five points above what inflation goes up. So the effective cost
to an employer is going to continue to escalate to maintain the
current plan. The employer is going to be either, according to
your economic analysis, either going to have to cut back some
place, have the employees pay more, or not provide the
benefits. Is that what is going to happen? And, therefore,
people are going to be underinsured or uninsured in greater
numbers if Congress does nothing.
Mr. Goodman. I think it is a little more complicated than
that. Other things being equal, high health care costs give
people incentive to want to be insured against them. So rising
medical costs can contribute to more people buying health
insurance and, in fact, that was probably what was happening a
decade or so ago.
Mr. Cardin. Then I am a little bit troubled by your
argument that when we provide certain protections to patients
that could add to the health care premium cost, that that adds
to the number of uninsured. That doesn't seem to be logical
from your--because health care cost is expensive.
Mr. Goodman. What I am saying is we have passed a lot of
laws which raise the cost of insuring against those health care
costs. In other words, for an individual to get basic health
care coverage, he has to buy into a very expensive package that
could be less expensive if we didn't have a lot of State
mandates, a lot of what I think are unwise regulations.
But the two things that are going to cause the number of
uninsured to rise are: The increasing cost of the health
insurance itself as opposed to the cost of health care for
healthy people.
And, number two, we are making it increasingly easy for
people to wait until they get sick before they get health
insurance.
Mr. Cardin. Mr. Kahn.
Mr. Kahn. I think you present a dilemma, but clearly if you
have a base inflation and then you build on top of that,
particularly in a given year in one fell swoop, it does affect
coverage. Now, in what you are describing you are saying the
logical conclusion of the argument we have been making is a
death spiral, that there is a point at which you are just
getting to lose and lose and lose. Actually, you can look at
the last few years and in many areas there have been zero
premium increases and there has been, as I described, a
marginal increase of the number of people covered by
employment.
I am concerned over time that, yes, if we don't keep
premium increases corralled, that we are going to have the
problem you are describing but to add on top of that the
mandates in all their various forms, I would argue it just
makes that more severe.
Mr. Cardin. I think I would counter by the fact that if we
keep premiums low by either shifting costs to the patient or
consumer or by denying adequate health care in the policy, that
we are--we are going to have underinsured individuals which can
be just as serious a problem as uninsured. If I can't afford--
if my plan doesn't cover for an emergency visit, and I need to
have emergency care because of their restrictive definition of
what is an emergency visit, and I have to pay for that out of
pocket, I am uninsured; aren't I?
Mr. Kahn. I think we will have to agree to disagree about
the extent to which people receive coverage. I think on your
other point, though, about cost sharing, that study after study
shows that a little cost sharing is a good thing, and that it
involves the individual in the cost of care and makes them cost
conscious, whether it is at the premium level or the
coinsurance and deductible level.
At the other level, I guess I am personally, and obviously
the companies I work for, are not convinced that the set of
requirements are going to assure patients that what you are
describing is their perception of what full coverage is. I
think we will just have to disagree.
Mr. Cardin. Karen, you want to help me out on this.
Ms. Lehnhard. I think there is no question that as premiums
go up, they will go up on their own even without any changes
here in Washington.
As premiums go up, we are going to see more shifting--the
primary thing we will see is more shifting to the employee to
pay part of the premium and the dilemma is the part they pay is
not deductible and I have actually--we didn't think of this.
Some of the proposals actually provide for that deduction which
some people won't like because that is not creating maybe in
their minds tough cost sharing, but I think we are getting up
to the point where it is 50-percent premium sharing by
individuals.
That is why in our proposal, we said go ahead and give a
tax credit to a low-wage worker in a small firm even if their
employer provides coverage because chances are they are paying
a significant part of the premium, even if they have got
coverage.
The other thing I would mention, and I don't expect it to
change anybody's mind; but what our plans are telling us it is
not just patient protection cost, it is confidentiality,
administrative simplification, year 2000, patient protection
Federal and State, and the administrative costs are
significant. But not only that, they are taking the creative
people who would be developing new products and putting them
into major systems changes, reinventing how we pay claims in
some cases and that is what--we are in all lines of business,
and I hear that the diversion from product development is
significant.
Mr. Cardin. I think that is a good point. I don't disagree
with the points of making the system as cost effective as
possible and some of the beneficiaries payments do make the
system more cost effective. You raise a good point about
premium deduction by those employers who do offer health care
plans.
Of course, we are trying to balance between getting more
people adequately insured and just making it easier for
employers to work with employees not to provide health benefits
because they have the tax advantages without the employer-
sponsored plan. So there is a balancing point here, but I think
most of us agree that the Tax Code should help those people who
currently don't have health insurance become insured.
Mr. Chairman, thank you.
Mr. English [presiding]. Thank you. And I appreciate the
opportunity to extend a few questions to the panel myself.
A number of you have made, I think, a very compelling
argument for a tax credit as part of an initiative toward
universal access to affordable care which, to me, is a more
realistic goal than universal coverage, although some of you
may disagree with that.
I would like to get my arms around your notions of how to
design such a credit to have the maximum impact and maximum
effectiveness. Dr. Butler, how large a credit do you think
would be appropriate and what income limits would you suggest?
Mr. Butler. You know, Mr. English, I think that almost begs
the question of what kind of revenue costs are you
contemplating, because the simple fact is that the larger the
credit you provide, the larger the impact is going to be on the
uninsured. There is no question about that.
There is also no question that if you give a relatively
small credit, you are not going to affect many people who are
currently uninsured, but you are going to ease the burden on
people who are struggling paycheck to paycheck to buy insurance
outside the place of work. So, in a sense, it is kind of hard
to answer your question. The proposals that have been put
forward that would, say, provide a 30-percent credit would
probably reduce uninsurance by somewhere between 1.5 and 2
million, something of that order. Much of the value of that
credit would go to people who are currently buying insurance
out of pocket, after tax which I think is a good thing in
itself. So it is a little difficult to answer your question.
Mr. English. Let me assume then for a moment that we have a
$1,000 credit. How far would that go in providing an adequate
level of buying power for most families assuming an interaction
with other programs such as Medicaid?
Mr. Butler. Well, if you assume an interaction with other
programs like CHIP and Medicaid and so on, then it would get
you quite a long way toward your goal. But if you are looking
at people only having that credit available to buy insurance,
and no other method of assistance, then clearly as you go down
the income level the net cost to the person taking the credit
is still getting to be a very substantial portion of their
income. And for some it is probably going to be prohibitive, so
they are not going to accept the credit under those kinds of
cases.
That is why I think the approach is to try to combine a
fixed amount, a larger fixed amount for people at the low end,
maybe in combination with a percentage credit is probably the
right way to go. When we looked at a much more substantial
reform a few years ago which would have replaced the entire tax
exclusion with a credit system, we looked at a sliding scale
refundable credit which would go up to, I believe it was 60 to
70 percent of the cost for those who were at the lowest end.
That would substantially reduce the uninsurance rates.
Mr. English. If we were--Ms. Lehnhard, did you want to add
something to that?
Ms. Lehnhard. I would just add we actually did modeling on
this at $1,200 tax credit for very small firms less than 10 at
225 percent of poverty. As a conservative modeling, we were
very struck by the number of people who don't pick up coverage.
The model showed about 1.9 people out of 7 million potentials
pick up coverage which suggests you really almost have to pay
the full cost, and then you still don't pick up the entire
population.
Mr. English. Dr. Butler, to follow up, I think what you are
contemplating here is clearly refundable tax credit.
Mr. Butler. At least partially refundable against payroll
tax----
Mr. English. Do you see any potential fraud problems with a
credit like that, or is that going to be relatively easy to
enforce?
Mr. Butler. It depends how you design it. A fully
refundable credit does raise lots of issues because you are
dealing with people who don't file taxes and so on. There is a
long history of problems with those kinds of subsidies via the
tax system.
I think if you are looking at a system which is essentially
run through the withholding system, which you can do with a
refundable credit against income taxes and payroll taxes, then
proof of insurance becomes an element. The employer can at
least be your first line of defense in terms of what is this
person actually using it for. I think you can deal with a lot
of problems.
I also mentioned in passing a proposal that Senator Daschle
offered a while ago to say as an additional, as an alternative,
the idea of transferring the credit to an insurer in return for
a lower premium to that person may also be a way of dealing
with less likelihood of fraud in those kinds of situations.
Again, that is not unlike what happens in the FEHBP where you
get an after-subsidy price as an employee.
Mr. English. That brings me to one other question; but
first Mr. Kahn, did you have something to add?
Mr. Kahn. Yes, Mr. English. I think you might want to look
at this structurally differently though. To focus on how big
the credit has to be I think maybe--it is a legitimate question
but maybe the wrong question.
Instead when we did our proposal, we looked at the poorest
of the poor, and those near poor, under 200 percent of poverty
and basically said that either an expansion of the CHIP Program
or some kind of voucher but something that was done probably
through the States probably through the welfare system in terms
of determining what their income was is better than using the
tax structure.
Trying to help people at that level through the tax
structure, one, as you say, leads to fraud and abuse issues,
and two, leads to issues such as to how do you locate them.
Also in our plan, we would give a credit to certain small
employers directly if they purchase insurance. It is a costly
proposal, but on the other hand it gets to the issue that Mary
Nell Lehnhard was talking about which is it is the smallest
employers who provide many of the jobs, particularly for the
poorest people, who cover the least people and, in a sense, if
you can get the bucks to the employer through the tax system,
that may be a more efficient way than trying to get some of
these dollars through to people in a credit that is going to be
very difficult to design.
Ms. Lehnhard. We took one more twist on that. We said just
don't do it for all workers in small firms. Do it for the low-
income workers in small firms.
Mr. English. Mr. Goodman.
Mr. Goodman. First on the fraud question, there is fraud in
the EITC program. The most frequent form of fraud is people
claim kids that aren't their kids. But if you are claiming a
tax credit for health insurance and you have the insurance
company there, well, the insurance company presumably knows who
it is insuring, who it is not.
If an employer is involved as Dr. Butler said, the employer
would be monitoring. So you bring more monitors into the
system. The more monitors in the system means a lot less fraud.
Now, as to the efficient way to do this, almost no one really
is talking about--when they are talking about refundable tax
credit--talking about handing people cash and saying go buy
health insurance.
I think we are all talking about a system under which you
go through employers and you go through insurance companies in
order to reduce the premium to the employee or to the buyer and
pay for that with tax relief and the employer does the
financial transaction or the insurance company does the
transaction.
So we don't have to go find people who are uninsured. It
will happen through the place of work.
Mr. English. Very good. Any other contributions?
Mr. Butler. I would just add one point about the credit to
employers, which I am fairly skeptical about because I think
that one of the key issues, as has been discussed before, is
how to get people into larger groups and larger pools.
Look at a very small employer with five employees who is
trying to buy insurance today in a pretty dismal market that
they face. To say we will give them a credit and argue that
that is more efficient than allowing the employee a credit to
go and join a larger pool somewhere else, I don't think that
argument holds. An individualized credit is much more
appropriate for the very small business sector than subsidizing
the employee-employer through a credit or any kind of system.
Mr. English. Ms. Lehnhard, briefly.
Ms. Lehnhard. I would just make one quick point. On the
pooling of small employers, you don't have cases any more where
groups of five are on their own. Every State has passed laws
which require an insurance company to pool all of their small
employers.
It used to be you would have different products. You would
segregate your risks. You can't do that anymore. Each Blue
Cross and Blue Shield Plan will have all of its small employers
in one pool. So the States have done a great public policy by
stabilizing the small group market and requiring that pooling.
Mr. Kahn. I guess I would argue if you had more money in
the system for those smaller employers so there were more
people participating, it would only enhance the pools that are
being described that are already in the small group market.
Mr. English. Thank you.
Thank you very much for your participation today, and I
will dismiss this panel. Let me turn this over and recognize
Mrs. Thurman to inquire.
Mrs. Thurman. Thank you, Mr. Chairman. You like that sound?
Dr. Butler, I am intrigued because yesterday of course we
had a panel before the medical--or the Health Subcommittee that
talked again about the 43 million and yesterday we did some
press on the issue of expansion of Medicare for 55 to 64 and
with the issue that you brought up where you talk about
nonemployment base groups actually are more logical and skilled
in their organization, do you feel that way about opening up
some of those government programs that are available to help
expand some of the coverage in these areas?
Mr. Butler. I don't think the two points are connected.
What I argued was: First one has got to think about what are
the best vehicles to provide insurance. And there are several
criteria, one of which is there should be a long-term
affiliation, so you are not going in and out of the pool. It
should be large so that it is big enough to spread the risks
and so on. I pointed out that there are organizations that
currently exist to fulfill a lot of those functions, and maybe
we ought to explore how to deal with some of the wrinkles that
you have to deal with. I mean labor unions, churches, other
kinds of groups like that.
Mrs. Thurman. Would this be one that you would feel should
be explored then for the 55-year-old to 64-year-old going into
Medicare because in some cases it could be a spouse who is now
65 whose spouse is younger and has no affiliation because
whatever job or employment they were at no longer exists. So
the idea would be to expand it in some of those areas
particularly for Medicare----
Mr. Butler. I don't think it is necessary to reach the
condition I mentioned because, for example, if you did have
people who had a union-sponsored plan and had tax relief and a
tax credit, whether or not they were employed, then that system
would function for the people who are 60 to 65 who are not
currently in Medicare.
Those people would be able to continue coverage under the
existing organization that they are affiliated with and would
get tax relief if the kind of recommendations we have made
would continue. I think when you start talking about bringing
Medicare down into that group, and I know this is an issue that
has been proposed and we have argued about it before, I think
you have got all sorts of questions about who would choose to
do that, what the liability would be for the government, what
kind of adverse selection would occur against Medicare, whether
Medicare is best for them or whether they should continue in
something we already have.
I don't think it makes a lot of sense to say to somebody
who turns 60 and has good coverage, say through a labor
organization, you are basically going to have to drop this and
go in to Medicare.
Mrs. Thurman. I don't think that has been called for.
Mr. Butler. The ideal situation would be to allow people to
join organizations when they are working, throughout their
working life and to continue into Medicare. My argument would
be that we should look at making Medicare much more flexible so
that these kinds of more indigenous organizations could become
a central part of the Medicare delivery system rather than
doing the opposite.
Mrs. Thurman. I was just looking at your definition of what
you had considered.
Let me ask the panel, the CRS has done a fairly extensive
report on all of the tax benefits in current law as for
providing insurance through, for example, the employment base
plans. There are some tax deductions, medical expense
deduction, all of us know that is a very difficult threshold to
meet, but in fact it is there. You have got cafeteria plans.
You have got self-employed deductions. You have got flexible
spending accounts, medical savings accounts, both military and
Medicare, none of which is considered as part of our income.
I mean, it seems to me that we have a hodgepodge in many
ways of tax credits available to us today, and still we have 43
million people not getting health care. And I personally asked
the question yesterday, and I am going to ask this panel. In
these different categories of insurance tax deductions that we
have, are they working today? How many of that 43 million
people have the advantage of these tax credits that are not
using them, and have we looked at why they are not using them?
Mr. Kahn. I believe, Mrs. Thurman, that they are working
today but there are a lot of gaps. There are people who don't
work in large firms or firms that take advantage for their
employees of all those. And second, if you look at the problem
of uninsurance, it is primarily a problem of income and people
who work in small firms.
Mrs. Thurman. I understand the small firm but let's say for
example, the self-deduction--I mean for somebody who is--owns
their own business. Do we know how many people out there who
are not taking advantage of that? And that is a very small
firm. Those are some issues that I am really concerned that we
are----
Mr. Kahn. We are taking advantage of that based on income.
Law firms that are all partners and they are self-employed,
they are taking advantage of it and Joe's bar and grill that is
just two people, self-employed, are probably not. So I think it
comes down to income at the end of the day. You can only use a
tax benefit if there is income there to enjoy it. That is one
of the issues that is important.
Mr. Goodman. But it is a hodgepodge on the tax side almost
as bad as the hodgepodge over on the spending side. It seems to
me like there is a very strong case to be made with treating
everyone the same, fairness. You say we are going to give a tax
break to you if you buy health insurance and it is going to be
x dollars and it is going to be the same whether or not you get
it through an employer or you are self-employed or you have to
go buy it on your own.
We strongly favor having that tax credit be just as
generous for the low-income person as the high-income person
whereas today it is all geared to the people in the higher
brackets.
Mr. Butler. The overwhelming volume of the tax relief
available for health care is for people who are connected to
the health insurance system through their place of work or are
affluent because for the 7.5-percent threshold, for example,
you have got to itemize, you have got to have significant
expenses, and you have got to be able to afford those expenses.
So the huge gap is the people who are outside the employment
base system and are relatively low income.
That is why I think all of these proposals that have been
put forward are focusing on that group, and I think they should
do.
Mr. Kahn. If I could make one other point too. That 7.5
percent was totally arbitrary, and it was done in tax reform.
Mrs. Thurman. Why does that not surprise me?
Mr. Kahn. Because they needed the money to make the whole
tax reform work, and it was one of the areas. It was lower for
years, I mean, for eons. I can remember the day, I was working
for Senator Durenberger at the time, and I said don't do that
and he went and did it as other Members did.
But the point is that is arbitrary and I think actually if
you are looking at things to help people, that is one item that
even though obviously you have to itemize is arbitrary and
probably too high.
Ms. Hoenicke. If I could add one thing and my only role on
the health side of this panel is with respect to long-term
care, and I think that is clearly an area where there is a huge
gap in the Tax Code. There is no deduction for long-term care
and that is a medical expense.
Mrs. Thurman. Nancy and I are working on that.
Ms. Hoenicke. We know you are, and I wanted to say thank
you again as we did in our statement. Thanks.
Mr. English. I thank the gentlelady for her contribution.
Do any other Members wish to inquire? The Chair recognizes Mr.
McInnis.
Mr. McInnis. Thank you, Mr. Chairman. I would only make one
point. Dr. Goodman, toward the end of your remarks, sir, you
point out that the income tax credit apparently should apply to
the low income as well as the high income. That is not a tax
credit at the low income. Tax credit is applied to income. Once
you go to someone who doesn't have the income but gets the tax
credit instead, that is a welfare program so you should
distinguish between the two.
Mr. Goodman. I don't mind if you rhetorically distinguish
it that way, but what I am saying is presuming the government
has an interest on whether people insure because if they don't
insure, they can show up at hospitals and incur medical bills
that have to be paid for by the rest of us.
Mr. McInnis. I will reclaim my time. I don't disagree with
that, but I think we need to distinguish and I think you need
to distinguish, doctor, when you talk about that at some point
you need to subsidize it in the form of a welfare instead of a
tax credit against income. That concludes my question, Mr.
Chairman, thank you.
Mr. English. Thank you, Mr. McInnis. I want to thank this
panel for their extraordinary contribution to the discussion
here today and I would like to invite forward the next panel
which will consist of Jack Stewart, assistant director for
Pension, Principal Financial Group of Des Moines, Iowa, on
behalf of the Association of Private Pensions and Welfare
Plans; Paula A. Calimafde, chair of the Small Business Council
of America, Bethesda, Maryland, and a member of the Small
Business Legislative Council, and also on behalf of the
American Society of Pension Actuaries and the Profit Sharing/
401(K) Council of America; J. Randall MacDonald, executive vice
president for human resources and administration of the GTE
Corp. of Irving, Texas, and a member of the board of directors
of the ERISA Industry Committee; and Jim McCarthy, vice
president and product development manager of the Private Client
Group for Merrill Lynch & Co., Inc., Princeton, New Jersey, on
behalf of the Savings Coalition of America.
I welcome this panel.
You are invited to give your testimony up until the red
light blinks. We would encourage you to stay within the time
parameters. We still have one more panel to go afterward and we
look very much forward to your contribution. I recognize Mr.
Stewart.

STATEMENT OF JACK STEWART, ASSISTANT DIRECTOR, PENSIONS,
PRINCIPAL FINANCIAL GROUP; DES MOINES, IOWA; ON BEHALF OF
ASSOCIATION OF PRIVATE PENSION AND WELFARE PLANS

Mr. Stewart. Thank you, Mr. Chairman. I am Jack Stewart,
assistant director of Pension at the Principal Financial Group
of Des Moines, Iowa. I am here on behalf of APPWP, the
Association of Private Pension and Welfare Plan, the Benefits
Association.
APPWP is a public policy organization representing
principally Fortune 500 companies as well as other
organizations such as Principal that assist plan sponsors in
providing benefits to employees. It is a privilege for me to
testify before the Committee and I want to extend the APPWP's
thanks for your personal commitment to the issue of helping
American families achieve retirement security.
You have shown steadfast dedication to seeing that all legs
of our retirement income stool, Social Security, employer-
provided pensions, and personal savings are made strong for the
future.
I want to focus my comments on steps we can take together
to strengthen the pension and savings legs of this stool. As
the Committee begins to craft the upcoming tax bill, we urge
you to include in that bill, H.R. 1102, the Comprehensive
Retirement Security and Pension Reform Act of 1999, introduced
by Representatives Portman and Cardin. H.R. 1102 will extend
the benefits of pension coverage to more American workers and
will offer new help to American families saving for retirement.
Ninety Members of Congress have now cosponsored this bill
including 26 Members of this Committee. And the coalition
supporting it includes 64 organizations ranging from major
employer groups such as APPWP to the Building and Construction
Trades Department of the AFL-CIO, to the National Governors'
Association.
I want to focus my remarks on what APPWP considers to be
the backbone of H.R. 1102, how the Federal Government can
encourage employers to create and maintain tax-qualified
retirement plans. I will briefly touch on five areas of the
bill that are critical to this effort, restoration of
contribution and benefit limits, simplification of pension
regulations, small business incentives, enhanced pension
portability, and improved pension funding.
One of the most significant reforms in 1102, and in
Representative Thomas' H.R. 1546, is the restoration to
previous dollar levels of several contribution and benefit
limits that cap the amount that can be saved and accrued in
workplace retirement plans. These caps have been reduced
repeatedly for budgetary reasons and are lower today in actual
dollar terms--to say nothing of the impact of inflation--than
they were many years ago.
Based on my 22 years of experience in the retirement plan
arena, I am convinced that restoring these limits will result
in more employers offering retirement plans. Restored limits
will convince businessowners that they will be able to fund a
reasonable retirement benefit for themselves and other key
employees, will encourage these individuals to establish and
improve qualified retirement plans, and will result in pension
benefits for more rank-and-file workers.
Restored limits are also important to the many baby boomers
who must increase their savings in the years ahead in order to
build adequate retirement income. The catchup contribution
contained in the bill, which would permit those employees who
have reached age 50 to contribute an additional 5,000 each year
to a defined contribution plan, will likewise address the
savings needs of baby boomers and will provide an especially
important savings tool for the many women who return to the
work force after raising children.
Another vitally important component of H.R. 1102 is the
simplification of many Tax Code sections and pension rules that
today still inhibit our private retirement system. I have found
that these complicated rules deter many small employers from
offering retirement plans and make plan administration a costly
and burdensome endeavor for companies of all sizes. The bill
simplification measures include needed flexibility in the
coverage and nondiscriminations tests, repeal of the multiple
use test, and an earlier funding valuation date for defined
benefit plans and reform of the separate lines of business
rules.
H.R. 1102 also contains several important measures aimed at
making it easier for small businesses to offer retirement
plans. First and foremost, the bill streamlines and simplifies
top-heavy rules. The legislation also assists small businesses
with plan startup administration costs through a tax credit,
reduced PBGC insurance premiums and waived IRS user fees as
well as simplified reporting.
Based on my experience working with small companies, I am
convinced that these changes will make our retirement system
more attractive to small employers.
APPWP is also pleased that H.R. 1102 would repeal the 150
percent of current liability funding limit imposed on defined
benefit plans. This would cure a budget-driven constraint that
has prevented employers of all sizes from funding the benefits
they have promised to their workers. In conclusion, I want to
thank you again for the opportunity to appear today to share
APPWP's views on ways to enhance retirement security for
American families.
We look forward to working with you in the weeks ahead to
enact the reforms contained in 1102 as part of your broader
effort to make our Nation's tax laws simpler and less
burdensome. Thanks.
[The prepared statement follows:]

Statement of Jack Stewart, Assistant Director, Pensions, Principal
Financial Group; Des Moines, Iowa; on behalf of Association of Private
Pension and Welfare Plans

Mr. Chairman and members of the Committee, I am Jack
Stewart, Assistant Director--Pension at the Principal Financial
Group of Des Moines, Iowa. I am here today as the
representative of the Association of Private Pension and
Welfare Plans (APPWP--The Benefits Association). APPWP is a
public policy organization representing principally Fortune 500
companies and other organizations such as the Principal that
assist employers of all sizes in providing benefits to
employees. Collectively, APPWP's members either sponsor
directly or provide services to retirement and health plans
covering more than 100 million Americans.
It is a privilege, Mr. Chairman, for me to testify before
the Committee today and I want to extend APPWP's thanks for
your personal dedication to the issue of helping American
families achieve retirement security. You have shown steadfast
dedication to seeing that all legs of our retirement income
stool--Social Security, employer-provided pensions and personal
savings--are made strong for the future.
I want to focus my comments on the steps we can take
together to strengthen the pension and savings legs of this
stool. As you and the Committee begin to craft the upcoming tax
bill, APPWP believes there is a clear step that you can take to
extend the benefits of pension coverage to even more American
workers and to offer new help to American families saving for
retirement. That step is inclusion and passage of H.R. 1102,
the Comprehensive Retirement Security and Pension Reform Act of
1999, which was introduced in March by Representatives Rob
Portman (R-OH) and Ben Cardin (D-MD) together with a large
group of bipartisan cosponsors. Representatives Portman and
Cardin have once again rolled up their sleeves and done the
heavy lifting that is required to master the intricacies of our
pension laws and to craft reform proposals that are responsible
and technically sound. With this bill, they have continued
their long-standing commitment to retirement savings issues and
have demonstrated both leadership and vision in setting a
comprehensive course for improvement of our nation's
employment-based retirement system. Eighty-four Members of
Congress have now cosponsored H.R. 1102--including 25 members
of this Committee--and the coalition supporting it includes 64
organizations ranging from major employer groups such as APPWP
to the Building and Construction Trades Department of the AFL-
CIO to the National Governors Association.
Mr. Chairman, while H.R. 1102 contains a whole series of
important reforms, I would like to focus on the five areas of
the bill that APPWP believes are of particular importance for
advancing our nation's pension policy--(1) restoration of
contribution and benefit limits, (2) simplification of pension
regulation, (3) new incentives for small employers to initiate
plans, (4) enhanced pension portability, and (5) improved
defined benefit plan funding.

Restoration of Contribution and Benefit Limits

One of the most significant reforms in H.R. 1102 is the
restoration of a number of contribution and benefit limits to
their previous dollar levels. These limits cap the amount that
employees and employers may save for retirement through defined
contribution plans as well as limit the benefits that may be
paid out under defined benefit pension plans. Many of these
dollar limits have been reduced repeatedly since the time of
ERISA's passage. Today, they are far lower in actual dollar
terms--to say nothing of the effect of inflation--than they
were many years ago.
During the 1980's and early 1990's, Congress repeatedly
lowered retirement plan contribution and benefit limits for one
principal, if frequently unstated, reason: to increase the
amount of revenue that the federal government collects. It is
time to put an end to that type of short-term policy-making. It
is true that under federal budget scorekeeping rules, proposals
that encourage people to contribute more to retirement savings
cost the federal government money in the budget-estimating
window period. Yet incentives that effectively increase
retirement savings are among the best investments we can make
as a nation. These incentives will pay back many times over
when individuals retire and have not only a more secure
retirement, but also increased taxable income. Increased
retirement savings also generates important investment capital
for our economy as a whole.
It is time that retirement policy--rather than short-term
budgetary gains--guide Congress'actions in the plan limits
area. H.R. 1102 wisely takes this approach by restoring a
series of contribution and benefit limits to their intended
levels. H.R. 1546, introduced by Representative Thomas, also
restores a number of these limits. These limit restorations
give practical significance to the calls by the President, Vice
President and bipartisan congressional leadership last June at
the National Summit on Retirement Savings to allow Americans to
save more effectively for their retirement.
Restored limits are critical for a number of reasons. They
would help return us to the system of retirement plan
incentives intended at the time of ERISA's passage. In our
voluntary pension system, it has always been necessary to
incent the key corporate decision-makers in initiating a
qualified retirement plan in order that rank-and-file workers
receive pension benefits. An important part of generating this
interest is demonstrating that these individuals will be able
to fund a reasonable retirement benefit for themselves. The
contribution and benefit limit reductions of recent years have
reduced the incentives for these decision-makers, giving them
less stake in initiating or maintaining a tax-qualified
retirement plan. Based on my 22 years of experience in the
retirement arena, particularly my work with small and mid-sized
companies, I am convinced that restoring these limits will
result in greater pension coverage. Restored limits will
convince business owners that they will be able to fund a
reasonable retirement benefit for themselves and other key
employees, will encourage these individuals to establish and to
improve tax-qualified retirement plans, and will thereby result
in pension benefits for more rank-and-file workers.
Restored limits are also important so that the many baby
boomers who have not yet saved adequately for retirement have
the chance to do so. A reduced window in which to save or
accrue benefits clearly means one must save or accrue more, and
restoring limits will allow this to occur. Of particular
concern is the fact that it appears that older baby boomers are
not increasing their level of saving as they move into their
mid-to-late 40s. Rather, they are continuing to fall further
behind--with savings of less than 40 percent of the amount
needed to avoid a decline in their standard of living in
retirement.
[GRAPHIC] [TIFF OMITTED] T0332.014

Every day's delay makes the retirement savings challenge
more difficult to meet, and every day's delay makes the
prospect of catching up more daunting. Individuals who want to
replace one-half of current income in retirement must save 10
percent of pay if they have 30 years until retirement. These
same individuals will have to save 34 percent of pay if they
wait until 15 years before retirement to start saving.
[GRAPHIC] [TIFF OMITTED] T0332.015

Along with restored limits, H.R. 1102 contains a specific
tool to help workers meet this savings challenge. The catch-up
contribution contained in the bill--which would allow those who
have reached age 50 to contribute an additional $5,000 each
year to their defined contribution plan--will help address the
savings needs of baby boomers and will be an especially
important savings tool for women. Many workers find that only
toward their final years of work, when housing and children's
education needs have eased, do they have enough discretionary
income to make meaningful retirement savings contributions.
This problem can be compounded for women who are more likely to
have left the paid workforce for a period of time to raise
children or care for elderly parents and thereby not even had
the option of contributing to a workplace retirement plan
during these periods.
The catch-up provision of H.R. 1102 recognizes these life
cycles and also acknowledges the fact that, because Section
401(k) plans have only recently become broadly available, the
baby-boom generation has not had salary reduction savings
options available during much of their working careers. The
catch-up provision would help ensure that a woman's family
responsibilities do not result in retirement insecurity and
would help all those nearing retirement age to meet their
remaining savings goals. While some catch-up contribution
designs would create substantial administrative burden for plan
sponsors, the simple age eligibility trigger contained in the
Portman-Cardin bill does not and will result in more companies
offering this important savings tool to their workers.
There is an additional savings enhancement contained in the
bill that APPWP wishes to highlight briefly. Under current law,
total annual contributions to a defined contribution plan for
any employee are limited to the lesser of $30,000 or 25% of
compensation. Unfortunately, the percentage of compensation
restriction tends to unfairly limit the retirement savings of
relatively modest-income workers while having no effect on the
highly-paid. For example, a working spouse earning $25,000 who
wants to use his or her income to build retirement savings for
both members of the couple is limited to only $6,250 in total
employer and employee contributions. By removing the percentage
of compensation cap, H.R. 1102 would remedy this unfortunate
effect of current law and remove a barrier that blocks the path
of modest-income savers.
Some have expressed concern that restoration of benefit and
contribution limits would not be a good use of tax expenditure
dollars and that dollars spent in this way would
disproportionately benefit high-income individuals. We at APPWP
believe this concern is misplaced and that analyzing pension
reforms purely from a current year tax deferral perspective
misses the point. It should be no surprise, after all, that in
our progressive tax system where many lower-income individuals
have no tax liability, pension tax preferences like other tax
preferences flow in large part to those at higher-income
levels. Yet in reforming the pension system, we should focus
not on who receives the tax expenditure but rather on who
receives the pension benefit. And with respect to pension
benefits, our employer-sponsored system delivers them fairly
across all income classes. Of married couples currently
receiving retirement plan benefits, for example, 57% had
incomes below $40,000 and nearly 70% had incomes below $50,000.
Of those active workers currently accruing retirement benefits,
nearly 45% had earnings below $30,000 and over 77% had incomes
below $50,000.\1\ Restoration of benefit and contribution
limits will bring more employers into the private system, and,
as these figures demonstrate, this system succeeds at
delivering benefits to the working and middle-income Americans
about whom we are all concerned.
---------------------------------------------------------------------------
\1\ Source: Analysis of the March 1998 Current Population Survey
performed by Janemarie Mulvey, Ph.D., Director, Economic Research,
American Council of Life Insurance
---------------------------------------------------------------------------

Simplification

Another vitally important component of H.R. 1102 is the
series of simplification proposals that will streamline many of
the complicated tax code sections and pension rules that today
still choke the employer-provided retirement system.
Unfortunately, in my many years dealing with small and mid-
sized employers, I have seen that the astounding complexity of
today's pension regulation drives businesspeople out of the
retirement system and deters many from even initiating a
retirement plan at all. Not only are businesspeople leery of
the cost of complying with such regulation, but many fear that
they simply will be unable to comply with rules they cannot
understand. We must cut through this complexity if we are to
keep those employers with existing plans in the system and
prompt additional businesses to enter the system for the first
time. Simplifying these pension rules will also further your
goal, Mr. Chairman, of making our tax code simpler and more
understandable for American citizens and businesses.
A more workable structure of pension regulation can be
achieved only by adhering to a policy that encourages the
maximization of fair, secure, and adequate retirement benefits
in the retirement system as a whole, rather than focusing
solely on ways to inhibit rare (and often theoretical) abuses.
This can be accomplished by ensuring that all pension
legislation is consistent with continued movement toward a
simpler regulatory framework. In short, simplification must be
an ongoing process. Proposals that add complexity and
administrative cost, no matter how well intentioned, must be
resisted, and the steps taken in earlier pension simplification
legislation must be continued. Current rules must be
continuously reexamined to weed out those that are obsolete and
unnecessary. Representatives Portman and Cardin have led past
congressional efforts at simplification, and APPWP commends
them for continuing this important effort in their current
bill.
As I indicated, Mr. Chairman, H.R. 1102 contains a broad
array of simplification provisions to address regulatory
complexity. Let me briefly mention a few that APPWP believes
would provide particular relief for plan sponsors. First, the
legislation would provide flexibility with regard to the
coverage and non-discrimination tests in current law, allowing
employers to demonstrate proper plan coverage and benefits
either through the existing mechanical tests or through a facts
and circumstances test. Second, the bill would repeal the
duplicative multiple use test, which will eliminate a needless
complexity for employers of all sizes. Third, the bill would
promote sounder plan funding and predictable plan budgeting
through earlier valuation of defined benefit plan funding
figures. And fourth, the bill would reform the separate lines
of business rules so that these regulations serve their
intended purpose--allowing employers to test separately the
retirement plans of their distinct businesses.
APPWP believes that the cumulative effect of the bill's
regulatory reforms will be truly significant. Reducing the
stranglehold that regulatory complexity holds over today's
pension system will be a key factor in improving the system's
health and encouraging new coverage over the long-term. As H.R.
1102--and pension legislation generally--progress through this
Committee and the Congress, Mr. Chairman, we would urge you to
keep these simplification measures at the very top of your
reform agenda.

Small Business Incentives

While the various changes I have outlined above will assist
employers of all sizes, H.R. 1102 also contains several
important measures specifically targeted at small businesses.
As you may be aware, Mr. Chairman, pension coverage rates for
small businesses are not as high as they are for larger
companies. While the number of small employers offering
retirement plans is growing,\2\ we need to take additional
steps to make it easier and less costly for today's dynamic
small businesses to offer retirement benefits to their workers.
---------------------------------------------------------------------------
\2\ A 1996 survey by the Bureau of Labor statistics revealed that
42% of full-time employees in independently-owned firms with fewer than
100 employees participated in a pension or retirement savings plan.
This was up from 35% in 1990. See Pension Coverage: Recent Trends and
Current Policy Issues, CRS Report for Congress, #RL30122, April 6,
1999.
---------------------------------------------------------------------------
H.R. 1102 takes a multi-faceted approach to making it
easier for small employers to offer retirement plans. First and
foremost, H.R. 1102 streamlines and simplifies the top-heavy
rules, which are a source of unnecessary complexity for small
employers and are one of the largest barriers deterring small
companies from bringing retirement plans on-line. The
legislation will also assist small companies with the costs of
initiating a retirement plan. Small employers will be offered a
three-year tax credit for start-up and administration costs,
they will be eligible for discounted PBGC premiums on their
defined benefit plans, and they will no longer be required to
pay a user fee for obtaining a letter of tax qualification from
the IRS for their plan. Based on Principal's extensive
experience in the small business market, and my own personal
work with small companies, I am convinced that these changes,
in combination with the limit restorations and simplifications
described above, will make our private retirement system
substantially more attractive to American small business. The
important result will be access to employer-sponsored
retirement plans for the millions of small business employees
who today lack the opportunity to save for retirement at the
workplace.

Portability

Another important advance in H.R. 1102 is the cluster of
provisions designed to enhance pension portability. Not only
will these initiatives make it easier for individual workers to
take their defined contribution savings with them when they
move from job to job, but they will also reduce leakage out of
the retirement system by facilitating rollovers where today
they are not permitted. In particular, the bill's provisions
allowing rollovers of (1) after-tax contributions and (2)
distributions from Section 403(b) and 457 plans maintained by
governments and tax-exempt organizations will help ensure that
retirement savings does not leak out of the system before
retirement.
The bill's portability initiatives will also help eliminate
several rigid regulatory barriers that have acted as
impediments to portability. Repeal of the ``same desk'' rule
will allow workers who continue to work in the same job after
their company has been acquired to move their 401(k) account
balance to their new employer's plan. Reform of the ``anti-
cutback'' rule will make it easier for defined benefit and
other plans to be combined and streamlined in the wake of
corporate combinations and will eliminate a substantial source
of confusion for plan participants. We specifically want to
thank Representatives Portman and Cardin for the refinements
they have made to their portability provisions in response to
several administrative concerns raised by APPWP and others. We
believe the result is a portability regime that will work well
for both plan participants and plan sponsors.

Defined Benefit Plan Funding

APPWP is also pleased that H.R. 1102--as well as H.R.
1546--includes an important pension funding reform that we have
long advocated. The bills' repeal of the 150% of current
liability funding limit for defined benefit plans would remove
a budget-driven constraint in our pension law that has
prevented companies from funding the benefits they have
promised to their workers. The calculation of this funding
limitation requires a separate actuarial valuation each year,
which adds to the cost and complexity of maintaining a defined
benefit plan. More importantly, the current liability funding
limit forces systematic underfunding of plans, as well as
erratic and unstable contribution patterns. Limiting funding on
the basis of current liability disrupts the smooth, systematic
accumulation of funds necessary to provide participants'
projected retirement benefits. In effect, current law requires
plans to be funded with payments that escalate in later years.
Thus, employers whose contributions are now limited will have
to contribute more in future years to meet the benefit
obligations of tomorrow's retirees. If changes are not made
now, some employers may be in the position of being unable to
make up this shortfall and be forced to curtail benefits or
terminate plans. Failing to allow private retirement plans to
fund adequately for the benefits they have promised will put
more pressure on Social Security to ensure income security for
tomorrow's retirees.
The problems caused by precluding adequate funding are
compounded by a 10 percent excise tax that is imposed on
employers making nondeductible contributions to qualified
plans. This penalty is clearly inappropriate from a retirement
policy perspective. Employers should not be penalized for being
responsible in funding their pension plans. The loss of an
immediate deduction should, in and of itself, be a sufficient
deterrent to any perceived abusive ``prefunding.''
The net effect of the arbitrary, current liability-based
restriction on responsible plan funding, and the 10 percent
excise tax on nondeductible contributions, is to place long-
term retirement benefit security at risk. With removal of this
limit and modification of the excise tax, H.R. 1102 would
provide the enhanced security for future retirees that comes
with sound pension funding.

Additional Proposals to Boost Retirement Savings

Our testimony today has focused on only a few of the
important changes contained in H.R. 1102. There are many other
proposals in the bill that would help American families to save
for retirement, and I want to touch briefly on a few of them
before concluding.
First, the bill includes an important change in
the tax treatment of ESOP dividends that would provide
employees with a greater opportunity for enhanced retirement
savings and stock ownership. Under current law, deductions are
allowed on dividends paid on employer stock in an unleveraged
ESOP only if the dividends are paid to employees in cash; the
deduction is denied if the dividends remain in the ESOP for
reinvestment. Under H.R. 1102, deductions would also be allowed
when employees choose to leave the dividends in the plan for
reinvestment, encouraging the accumulation of retirement
savings through the employee's ownership interest in the
employer.
Second, H.R. 1102 creates a new designed-based
safe harbor--the Automatic Contribution Trust (ACT)--which
encourages employers to enroll new workers automatically in
savings plans when they begin employment. Automatic enrollment
arrangements such as the ACT have been shown to boost plan
participation rates substantially, particularly among modest-
income workers.
Third, the legislation would remedy the
uncertainty and complexity that today surrounds the tax
treatment of employer-provided retirement counseling. All
employer-provided retirement planning, including planning that
does not relate to the employer's plans, would be excludable
from employee's income under H.R. 1102. The bill would also
make clear that employees could purchase retirement counseling
through salary reduction on a pre-tax basis. Since many
employers provide retirement education to their employees or
would like to do so, it is critical that the law surrounding
the tax treatment of this benefit be clear. Moreover, given the
importance and popularity of 401(k) plans, where the primary
responsibility for saving and investing falls on employees,
employers should continue to be encouraged to provide
information and education about these plans.

Conclusion

Mr. Chairman, the complexity of America's workplace and the
diversity of America's workforce require that we maintain an
employment-based retirement system that is flexible in meeting
the unique needs of specific segments of the workforce and that
can adapt over time to reflect the changing needs of workers at
different points in their lives. For this reason, there is no
single ``magic'' solution to helping Americans toward a more
secure retirement. Rather a comprehensive series of responsible
and well-developed proposals--such as those found in H.R.
1102--is the best way to make substantial progress in
strengthening our already successful private retirement system
and we urge their inclusion in your upcoming tax bill.
Mr. Chairman, thank you again for the opportunity to appear
today to share APPWP's views on ways to improve the retirement
security of American families. We commend your commitment to
this goal and salute Representatives Portman and Cardin, and
those with whom they have worked, for crafting and cosponsoring
a bill that will make this goal a reality. We look forward to
working with you in the weeks ahead to enact these pension and
savings reforms as part of your broader effort to make our
nation's tax system simpler and less burdensome.

June 16, 1999

The Honorable Bill Archer Chairman,
Committee on Ways & Means
U.S. House of Representatives
Washington, DC 20515

Dear Chairman Archer:

The undersigned group of organizations dedicated to promoting long-
term savings for retirement would like to express our strong support
for H.R. 1102, The Comprehensive Retirement Security and Pension Reform
Act of 1999, which has been introduced by Representatives Rob Portman
and Ben Cardin.
Thanks in large part to your efforts and leadership, Congress has
taken important steps in recent years to strengthen the employer-
sponsored retirement system and to aid American families in saving for
retirement. Yet we share your conviction that much more can and should
be done in this area. We believe that The Comprehensive Retirement
Security and Pension Reform Act of 1999 will substantially advance the
goals of expanded pension coverage and increased retirement savings.
Offering a comprehensive retirement reform agenda, H.R. 1102 would
encourage employers, particularly small employers, to establish and
maintain workplace retirement plans and would provide enhanced
opportunities for Americans to save by increasing contribution and
benefit limits in these plans. It would facilitate the portability and
preservation of retirement benefits--for both private and public
retirement systems--and would allow for stronger funding of pension
plans. H.R. 1102 would also simplify many of the overly complex rules
governing retirement plans, reducing the administrative and cost
barriers that have made it difficult for many employers to offer
retirement benefits and ensuring that today's business transactions are
not inhibited by outdated and unnecessary pension regulation. We
believe the reforms contained in H.R. 1102 would mark an important step
forward for our nation's retirement policy and would extend the
benefits of pension coverage and retirement savings to many more
American families.
We look forward to working in close partnership with you to see The
Comprehensive Retirement Security and Pension Reform Act of 1999
enacted this year. Thank you again for your efforts on this critical
policy issue.

Sincerely,

American Council of Life Insurance

American Society of Pension Actuaries

Association for Advanced Life Underwriting

Association of Private Pension and Welfare Plans

College and University Personnel Association

Employers Council on Flexible Compensation

ERISA Industry Committee

Government Finance Officers Association

International Personnel Management Association

Investment Company Institute

National Association of Life Underwriters

National Association of Manufacturers

National Association of State Retirement Administrators

National Conference on Public Employee Retirement Systems

National Council on Teacher Retirement

National Defined Contribution Council

National Employee Benefits Institute

National Rural Electric Cooperative Association

National Telephone Cooperative Association

Profit Sharing/401(k) Council of America

Securities Industry Association

Small Business Council of America

U.S. Chamber of Commerce

Mr. English. Thank you, Mr. Stewart.
Ms. Calimafde, we look forward to your testimony.

STATEMENT OF PAULA A. CALIMAFDE, CHAIR, SMALL BUSINESS COUNCIL
OF AMERICA, BETHESDA, MARYLAND; AND MEMBER, AND DIRECTOR, SMALL
BUSINESS LEGISLATIVE COUNCIL; ON BEHALF OF AMERICAN SOCIETY OF
PENSION ACTUARIES, AND PROFIT SHARING/401(K) COUNCIL OF AMERICA

Ms. Calimafde. I am Paula Calimafde. I am a practicing tax
lawyer for more than 23 years in the qualified retirement plans
and estate planning area. I am the chair of the Small Business
Council of America. I am a director of the Small Business
Legislative Council. I was a delegate appointed by Majority
Leader Trent Lott to the National Summit on Retirement Savings.
I was appointed by the President to the 1995 White House
Conference on Small Business and served as the Commissioner of
Payroll Costs at the 1986 White House Conference on Small
Business where that section covered Social Security and
retirement policy.
Today I am also representing the American Society of
Pension Actuaries whose members provide actuarial consulting
administrative services to approximately one-third of all the
retirement plans in the country, many of which are small
business plans. I am also representing the Profit Sharing/
401(K) Council of America whose members represent about 3
million plan participants.
I want to discuss the reasons why a small business chooses
not to sponsor a qualified retirement plan. We know that the
coverage in the small business area is lagging and lagging
seriously. The best of the statistics show small businesses
cover somewhere in the 35 percent to 40 percent area, and those
are the optimistic numbers. So why don't owners of small
businesses want to sponsor retirement plans? They use a cost-
benefit analysis.
Imagine a company that has three owners, four employees,
and at the end of the year has $100,000 of profit. The owners
can choose to put that money back into the company. They can
also choose to establish a retirement plan and contribute some
or all of that 100,000 for all of the employees, including
themselves, or they can each take out $33,000 in compensation.
And that is the key to understanding why a lot of small
businesses don't sponsor retirement plans. In order to induce
that company to establish a retirement plan and make the
contribution, the owners must perceive that they will be better
off with a retirement plan than they would be putting the money
back into the company or taking it out as compensation. If the
plan is perceived by owners to be a headache, to require extra
paperwork, require extra costs to administer the plan both
inside and outside of the company, as not allowing the owners
to get enough benefits out of the plan, to subjecting the
company to audits from IRS on complex and technical rules and
not being appreciated by employees, then they are not going to
join the system.
If the owners do not think there is sufficient benefit in
the plan for them, they will not join the system. This has been
the situation we have been facing in the late seventies, all of
the eighties and the early nineties. It is only recently that
Congress has begun to realize that extra rules, extra burdens,
and extra costs do not incentivize small businesses to join the
qualified retirement plan system.
H.R. 1102 is the first major piece of legislation to reach
out in a reasonable manner for small businesses to bring them
into the system. We now know because the April 6, 1999 CRS
report for Congress entitled Pension Coverage, Recent Trends
and Current Policy Issues, that once a small business
establishes a retirement plan, that coverage or participation
in that plan is at roughly the same high levels as found in the
larger businesses. This is a key statistic to understand.
What it means is that if a small business will join the
system, and will sponsor a retirement plan, participation is at
the same high level that you would have in a bigger plan. It is
roughly 85 percent--85% of all the employees of the company
participate in that plan. In other words, excellent coverage
results.
I want to take a minute and look at the top-heavy rules.
This is probably not the most important part of this bill. The
limits--returning the limits to where they stood 17 years ago
is more important. Increasing the 404 deduction limit is more
important but make no mistake, the changes to the top-heavy
rules that are in H.R. 1102 will help small businesses sponsor
plans by rolling back some of these unnecessary burdens in the
top heavy area. You know this is a well-grounded piece of
legislation when it is criticized by both ends of the spectrum.
Some criticize this bill because they say it does not go
far enough. These individuals maintain that the top-heavy rules
are an abomination, that they are obsolete, and that they are
the number one reason cited by small businesses why small
business will not sponsor a retirement plan.
On the other hand, some criticize this bill because they
believe in effect by trying to roll back some of the extra
burdens, it is akin to allowing the proverbial camel's nose
under the tent and that repeal will result in a future bill.
Just because you have helped out a little bit in this bill, it
is inevitable that repeal will follow.
Actually H.R. 1102 is a middle-ground approach. It keeps
the meat of the top-heavy rules. It keeps the required minimum
benefits and it keeps the somewhat accelerated minimum
vesting--accelerated vesting, but it rids the system of some of
the onerous burdens. In my opinion and in the opinion of those
I am representing today, ASPA, Profit Sharing Council of
America, Small Business Legislative Council, and the SBCA, this
bill would do a tremendous amount to help small businesses and
let them sponsor retirement plans which would give increased
security to literally millions of Americans.
[The prepared statement follows:]

Statement of Paula A. Calimafde, Chair, Small Business Council of
America, Bethesda, Maryland; and Member, and Director, Small Business
Legislative Council; on behalf of American Society of Pension
Actuaries, and Profit Sharing/401(k) Council of America

The Small Business Council of America (SBCA) is a national
nonprofit organization which represents the interests of
privately-held and family-owned businesses on federal tax,
health care and employee benefit matters. The SBCA, through its
members, represents well over 20,000 enterprises in retail,
manufacturing and service industries, virtually all of which
sponsor retirement plans or advise small businesses which
sponsor private retirement plans. These enterprises represent
or sponsor well over two hundred thousand qualified retirement
plans and welfare plans, and employ over 1,500,000 employees.
The Small Business Legislative Council (SBLC) is a
permanent, independent coalition of nearly one hundred trade
and professional associations that share a common commitment to
the future of small business. SBLC members represent the
interests of small businesses in such diverse economic sectors
as manufacturing, retailing, distribution, professional and
technical services, construction, transportation, tourism, and
agriculture. Because SBLC is comprised of associations which
are so diverse, it always presents a reasoned and fair position
which benefits all small businesses.
The American Society of Pension Actuaries (ASPA) is an
organization of over 4,000 professionals who provide actuarial,
consulting, and administrative services to approximately one-
third of the qualified retirement plans in the United States.
The vast majority of these retirement plans are plans
maintained by small businesses.
The Profit Sharing/401(k) Council of America (PSCA) is a
non-profit association that for the past fifty years has
represented companies that sponsor profit sharing and 401(k)
plans for their employees. It has approximately 1200 company
members who employ approximately 3 million plan participants.
Its members range in size from a six-employee parts distributor
to firms with hundreds of thousands of employees.
I am Paula A. Calimafde, Chair of the Small Business
Council of America and a member of the Board of Directors of
the Small Business Legislative Council. I am also a practicing
tax attorney (over 20 years) who specializes in qualified
retirement plans and estate planning. I can also speak on
behalf of the Small Business Delegates to the 1995 White House
Conference on Small Business at which I served as a
Presidential Delegate. At this conference out of 60 final
recommendations to emerge, the Pension Simplification and
Revitalization Recommendation received the seventh highest
ranking in terms of votes. H.R. 1102, the Comprehensive
Retirement Security and Pension Reform Act, introduced on March
11, incorporates many of the most important recommendations
made by the delegates to the 1995 White House Conference on
Small Business.
Why did the delegates consider this recommendation to be so
important as to vote it as the seventh out of the final sixty
recommendations? The reason is simple--small business wants to
be able to join the qualified retirement system. For small
business, the qualified retirement plan is the best way to save
for its employees' retirement. Based in part on the current tax
law, many small businesses do not provide nonqualified pension
benefits, stock options and other perks. Unfortunately, many,
if not most, small businesses perceive the qualified retirement
plan area to be a quagmire of complex rules and burdens. It is
perceived as a system which discriminates against small
business owners and key employees. The Conference Delegates
understood that if the retirement system became more user
friendly and provided sufficient benefits that they would want
to join it. By doing so, they could provide for their own
retirement security, while at the same time providing valuable
retirement benefits for their other employees.
As a delegate appointed by Senator Trent Lott to the
National Summit on Retirement Savings, I was able to share
information and concerns with fellow delegates in break out
sessions. Even though small business retirement plan experts,
administrators and owners were not well represented, their
ideas came through loud and clear in the break out sessions.
Calls for repeal of the top heavy rules, increases in
contribution limits, particularly the 401(k) limit, elimination
of costly discrimination testing in the 401(k) area, and a
return to the old compensation limits, were repeated across the
break out sessions. There were even individuals calling for
support of a particular piece of legislation--the Portman-
Cardin retirement plan bill (this was last year's bill). Of
course, many ideas were discussed particularly in the
educational area, but an impartial observer would have noticed
that the small business representatives were very united in
their message--increase benefits, decrease costs. In other
words, when undertaking a cost/benefit analysis, small business
currently perceives the costs too high as compared to the
benefits to be gained.
At the Summit, the following problems facing small
businesses in the retirement plan area were brought up: staff
employees' preference for cash or health care coverage, the
revenue of the business beings too uncertain, the costs of
setting up the plan and administering it being too high,
required company contributions (i.e., the top heavy rules)
being too high, required vesting giving too much to short term
employees, too many governmental regulations, and benefits for
owners and key employees being too small. When asked what could
break down these barriers, the following answers were given:
reduce the cost by giving small businesses tax credits for
starting up a plan; repeal the top-heavy rules; reduce
administration; allow owners and key employees to have more
benefits; and change lack of employee demand by educating
employees about the need to save for their retirement now. Some
micro small businesses believed that until they were more
profitable nothing would induce them to join the system.
Today we are here to focus on employer coverage and
employee participation issues, explore ways to remove
burdensome regulatory requirements, improve the level of
benefits that workers may accrue towards their retirement and
overall how to strengthen retirement plans. SBCA, SBLC, ASPA
and PSCA all strongly support the landmark legislation, H.R.
1102. This legislation if enacted, will promote the formation
of new small business retirement plans, significantly reduce
overly complex and unnecessary regulatory requirements,
increase portability and overall provide more retirement
security for all of the Americans who work for small business.
I want to share with you two real life examples. A visiting
nurses association in Vermont just established a 401(k) plan.
The average salary of the roughly 150 participants is $17,000.
90% of the employees decided to participate in the plan by
saving some of their current salary for future retirement
security. The average amount saved from their salaries and put
into the 401(k) plan was 8%. Many were at the 10% to 15%
levels. Some of the employees would have gone beyond 15% if
they had been allowed to do so. Many of these employees live in
very rural areas of Vermont, but they understood the message--
it is imperative to save now for your retirement security
later. They understood it's primarily their responsibility to
provide for their retirement income not the federal
government's responsibility.
A criticism sometimes aimed at the retirement plan system
is that it is used disproportionately by the so-called ``rich''
or the ``wealthy.'' Practitioners who work in the trenches know
better. The rules governing the qualified retirement system
force significant company contributions for all non-highly
compensated employees if the highly compensated are to receive
benefits. The 401(k) plan, in particular, is a tremendous
success story. Employees of all income levels participate, even
more so when there is a company match. The real example set
forth above is not unusual (though perhaps the level of savings
is higher than normal).
Here's another example. This is a local company
specializing in testing new drugs, particularly those designed
to prevent or slow down AIDS. The company started off about 20
years ago with roughly 20 employees. For each of the last 20
years, this company has made contributions to its profit
sharing plan in the amount of 8% to 10%. The company has now
grown to about 220 employees. Their long-timers now have very
impressive retirement nest eggs. The company believes this
money has been well spent. It enjoys the well-deserved
reputation of being generous with benefits and employee turn-
over is way below the norm for this industry.
This is a retirement plan success story--a win-win
situation. The company has a more stable and loyal workforce of
skilled employees. The employees in turn will have retirement
security. This plan benefits all eligible employees regardless
of income level. Every eligible employee in the company has
received in effect an 8% to 10% bonus every year which was
contributed on their behalf into a qualified retirement trust
where it earned tax free growth.

Some Surprising Good News--Participation Is High in Retirement Plans
Sponsored by Companies With Fewer Than 100 Employees and Even With
Fewer Than 25 Employees

Recently, the Congressional Research Service issued a
Report for Congress, entitled ``Pension Coverage: Recent Trends
and Current Policy Issues,'' authored by Patrick J. Purcell,
Analyst in Social Legislation. This report gives an excellent
overview of the current coverage trends for retirement plans,
though it is relying on data through 1997. Thus, in the small
business area, it is not picking up any additional plan
sponsorship and thus, coverage, due to the new SIMPLE and some
of the real simplications that have been accomplished in the
last several retirement plan bills. (Put down the bills) of the
last several Congresses. A quick perusal of the many tables
shows small business lagging in many areas of coverage. For
example, Table 3. Participation in Pension or Retirement
Savings Plans by Size of Firm shows in Panel A, that in 1997,
83.3% of employees in firms with 100 or more employees had
employers who sponsor a pension or retirement savings plan.
This is contrasted to 58.1% of employees in companies with 25
to 99 employees have employers who sponsor such a plan. Worse,
only 30.3%of employees in firms with under 25 employees have
employers who sponsor such a plan. It is clear that the size of
the company impacts retirement plan sponsorship, but in the
very next table a very interesting pattern emerges.
Panel B: Percentage of employees in firms that sponsored a
plan who participated in the plan shows that in 1997, 88.2% of
employees in firms with 100 or more employees that sponsor a
pension or retirement savings plan participated in the plan.
However, 85.5% of employees in companies with 25 to 99
employees which sponsor such a plan participated. And again,
the trend holds--84.8% of employees in firms with under 25
employees whose employers sponsor such a plan participate. In
short, when small businesses sponsor retirement plans, the
employees participate at just about the same levels as in
larger companies. This is a very meaningful statistic and can
be interpreted to mean that the key is to incentivize small
business to sponsor retirement plans--once this occurs,
meaningful participation results. Another way of saying this is
it is critical to make the system attractive to small business.
H.R. 1102 does just this--it strips away unnecessary burdens
and increases incentives to attract small businesses to the
qualified retirement plan system.

Three Major Reasons Why Small Businesses Choose Not To Sponsor a Plan

There are three major reasons why a small business chooses
not to adopt a retirement plan and H.R. 1102 addresses all
three.
First, lack of profitability. H.R. 1102 addresses this
problem by adding a new salary reduction only SIMPLE plan. This
is a plan that a small business will adopt regardless of its
lack of profits because it costs the company almost nothing to
sponsor. This plan rests on an IRA framework so the company has
no reporting requirements or fiduciary responsibilities. Also
the company is not required to make any contributions to the
plan--so profitability is irrelevant. The plan will give every
eligible employee of the company a chance to contribute $5,000
for his or her own retirement security each year.
The second major reason why small businesses do not sponsor
retirement plans is because the system is perceived (and
deservedly so) as too complex and costly. The devastating
legislation of the 80's and early 90's layered additional
requirements on small business with overlapping and
unnecessarily complex rules aimed at preventing abuse in the
system or discrimination against the non-highly compensated and
non-key employees. In fact, it often comes as a shock to those
trying to strengthen the retirement plan system for small
business that the system has harsher rules designed
specifically for small business. Probably the most offensive of
these rules are the so-called ``top heavy rules.'' Because of
the mechanical tests associated with the top-heavy rules,
almost all small business plans are top-heavy. When a plan is
top-heavy, the small business must make special required
contributions which increase the cost of the small business
plan and vesting is slightly accelerated. In addition to extra
rules being placed on small business plans, all plans were
being subjected to constant changes. These annual changes in
the law and the regulations combined with reduced benefits,
first brought the system stagnation and then decline. This
legislation was prompted by the need to get short term revenue
and where better to look then the pension system that no one
understood and few were watching. It was also prompted by a
need to rid the system of some real abuse (for instance back
about 20 years ago, it was possible for a retirement plan to
only make contributions for employees who earned over the
social security wage base, this rule was eliminated and for
good reason). Unfortunately, rather than using a fly swatter, a
nuclear bomb was detonated and we ended up with a system in
real disrepair. H.R. 1102 preserves the safeguards for non-
highly compensated employees so that they are fully protected,
while stripping away the unnecessary and overlapping rules so
that true simplification is achieved.
H.R. 1102 provides reasoned answers. By stripping away
needless complexity and government over regulation in the form
of micro management, the system will have a chance to revive.
This bill would go a long way towards removing the significant
burdens imposed on small business by the top heavy rules. It
would simplify portability. It would repeal the absurdly
complex and unnecessary multiple use test. It would truly
simplify the system without harming any of the underlying
safeguards.
Some have criticized H.R. 1102 for not repealing the top-
heavy rules because they are obsolete, discriminatory and serve
as a real road block for small businesses to enter the
qualified retirement plan system. Others have criticized H.R.
1102 as the first step towards repeal of the top-heavy rules--
this is the camel's nose under the tent theory--if you try to
remove any burdens, it's just a matter of time before all the
rules are repealed. Interestingly, H.R. 1102 by stripping away
the absurd burdens in the top heavy rules (for instance,
requiring companies to look back only 1 year instead of 5 to
determine who is a key employee to reduce extensive
recordkeeping) while keeping the two meaningful provisions of
the top-heavy rules--extra contributions required and
accelerated vesting has tried to reach a middle ground on this
difficult issue.
Costs would be reduced by eliminating user fees and
providing a credit for small business to establish a retirement
plan. This credit would go a long way towards reducing the
initial costs of establishing a plan.
The third reason why small businesses stay away from the
retirement system is that the benefits that can be obtained by
the owners and the key employees are perceived as too low. It
is no secret that small business owners believe that the
retirement plan system discriminates against them. Short
vesting periods and quick eligibility have provided more
benefits for the transient employees at the expense of the
loyal employees. Cutback in contribution levels hurt key
employees and owners, (of course they hurt the non-highly
compensated also, but it took a long time to understand there
was a very real correlation between what the small business
owners could put away for themselves and their key employees
and what would be put in for the non-highly compensated
employees).
H.R. 1102 solves this problem also. This legislation
understands there are two pieces to the puzzle--a reduction in
complexity and costs is essential but is not sufficient by
itself. A second piece is required. Increasing the contribution
limits (in reality reversing the limits) to where they stood in
1982 is equally important.
It is interesting to examine where these limits would be
today if the law in 1982 had not been enacted. The defined
contribution limit which was $45,475 in 1982, assuming a
constant 3% COLA would have been $75,163 in 1999. This is where
401(k) limit would have been also. Only in 1987, was the amount
an employee could save by 401(k) contributions on an annual
basis limited to $7,000 and the ``ADP'' tests could further
limit the amount (below $7,000) for the highly compensated
employees. The defined benefit limit which was at $136,425 in
1982, assuming a constant 3% COLA would be at $225,490 today.
These numbers assume a constant COLA of 3%. The true number
during those years would be closer to an average of 4%-5%.
Given how critical it is for people to start saving for
their own retirement today, it seems most peculiar to have
limits harsher than what they were 17 years ago. Some people
say that these limits will not operate as an incentive to small
businesses to sponsor the plan and will only be used by the so-
called ``rich.'' Not only will the increased limits serve as an
incentive to small businesses to sponsor a retirement plan, but
the higher limits will be enjoyed by employees who are not
``rich''. For instance, it is very common today for both
spouses to be employed. Quite often, these couples decide that
one of the spouse's income will be used as much as possible to
make contributions to a 401(k) plan. Today, the most the couple
can save is $10,000 (and if the participant spouse makes more
than $80,000 or makes less but is a 5% owner of a small
business, then the couple might not even be able to put in
$10,000). Often, the couple would have been willing to save
more. These couples might make $40,000, $50,000 or more, but
they are not ``rich.'' It is only because both spouses are
working, that they are making decent income levels--we should
provide the means by which they can save in a tax advantaged
fashion while they can.
This same principle applies particularly to women who enter
and leave the work force intermittently as the second family
wage earner. They and their families stand to benefit the most
from increased retirement plan limits because the increased
limits will provide the flexibility that families require as
their earnings vary over time and demands such as child
rearing, housing costs and education affect their ability to
save for retirement.
Many mid-size employers rely less on their existing defined
benefit plan to provide benefits for their key employees and
more on non-qualified deferred compensation plans. This is a
direct result of the reduction in the defined benefit plan
limit. In 1974, the maximum defined benefit pension at age 65
was $75,000 a year. Today the maximum benefit is $130,000, even
though average wages have more than quadrupled since 1974.
Thus, pensions replace much less pre-retirement income now than
they did in the past. In order for these ratios to return to
prior levels, the maximum would have to be over $300,000 now.
The lower limits have caused a dramatic increase in non-
qualified pension plans, which provide benefits over the
limits. They help only the top-paid employees. This has caused
a lack of interest in the defined benefit plan since there is
no incentive to increase benefits since the increases cannot
benefit the highly compensated employees or key employees. This
is unfortunate since increases affect all participants. The
importance of bringing these limits back to the 1982 levels
cannot be underestimated. They are crucial if small business is
to be persuaded to join the system.
Prior to the last several Congresses which worked hard to
improve the system, the thrust of the laws was how to prevent
any conceivable abuse and how to limit what the upper middle
income and upper income employees could receive from a
retirement plan. Interestingly, it is often obvious for a
member of Congress to understand that if the upper 2 to 3
quintiles of income earners are removed from the social
security system that it could prove the death knell for the
system because the top earners would be disenfranchised and
would no longer have any interest in the system. Interestingly,
this is exactly what has happened during the mid-70's through
the early 90's in the retirement plan system, but even though
the same concept applied, it was not apparent. By now it should
be apparent to all that we have disenfranchised large numbers
of employees from the qualified retirement system and that this
has brought about its stagnation and decline.
Rumors have been circulating to the effect that 20% of all
retirement plan benefits generated by both the private
retirement plan system and the governmental retirement system
go to the top 1% of taxpayers, 75% go to the top 20% of
taxpayers and less than 10% go to the bottom 60% of taxpayers.
These rumors appear to be attributable to a talking points
sheet entitled ``Distribution of Pensions Benefits under
Current Law'' prepared by the Office of Tax Analysis,
Department of the Treasury, 1/29/99. Even though it is entitled
``Distribution of Pension Benefits,'' it seems clear that all
of the statistics are based on how projected tax expenditures
for pension contributions and earnings are ``received.'' Half
of the total projected ``tax expenditure'' is allocated to
government plans. Even taking into account that 30% of the
taxpayers pay no tax (so would receive no tax expenditure), the
numbers still appear to be out of line. It appears that couples
where both spouses work have been treated as one individual and
income has been imputed to the couple from a variety of
sources. The concept of ``tax expenditure'' itself is
controversial. The theory is based on the premise that all
sources of money should be taxed and ``belong'' to the
government. When the government foregoes its collection of this
money it becomes a ``tax expenditure.'' This is in contrast to
the theory which states that the government is only entitled to
tax certain enumerated items and no others. However, these
rumors have started they are not based on fact and they do a
real disservice to the people who are trying to revitalize the
retirement plan system at a time when it is critical to do so.
Interestingly, the American Council of Life Insurance has
concluded a research project authored by Janemarie Mulvey,
Ph.D, Director of Economic Research, May 19, 1999. This study
defines pension benefits as benefits coming from employer-
sponsored plans, federal, state and local and military, but
does not include lump sum payments. This study shows that the
system provides meaningful benefits for many individuals who
are in the low to middle income ranges. For example, the report
found that:
Among Married Couples Receiving Pensions: \1/3\ had incomes
below $30,000 (median income); 57% had incomes below $40,000
(average income).
Nearly 70% of those receiving pensions had income below
$50,000
These types of statistics are based on real data and show
that meaningful benefits are being received by employees who
have average income.
Another major ``fix up'' in this bill deals with Section
404. This section limits a company's deductible contribution to
a profit sharing plan to 15% of all participant's compensation.
This limit presently includes employee 401(k) contributions.
This means that if an employer chose to make a 15% contribution
to a profit sharing plan, then no employee would be allowed to
make a 401(k) contribution. Realizing the absurdity of this
rule, H.R. 1102 would no longer count employee contributions
(401(k)) towards the 15% overall deduction level.
Even more importantly, the 15% level would be raised to
25%. This change would allow small businesses to sponsor one
plan in place of two plans that are now required to accommodate
a contribution greater than 15%. This would generate real
savings to the small business since only one plan document, one
summary plan description, one annual 5500, etc. would be
required instead of two.
This bill is indeed comprehensive legislation which will
inject needed reforms into the pension system and by doing so
will truly provide retirement security for countless Americans.
It will increase small business coverage and it is important
that we all work hard to see this entire bill enacted into law.
The Department of Labor's ERISA Advisory Council on
Employee Welfare and Benefit Plans recently released its Report
of the Working Group on Small Business: How to Enhance and
Encourage The Establishment of Pension Plans dated November 13,
1998. This report provides eight recommendations for solving
the problems facing small businesses today in the retirement
plan area. Interestingly, these recommendations mirror many of
those that came out of the National Summit on Retirement
Savings.
The Advisory Council report calls for a Repeal of Top-Heavy
Rules, Elimination of IRS User Fees, an Increase in the Limits
on Benefits and Contributions, an Increase in the Limits on
Includable Compensation, the Development of a National
Retirement Policy, Consider the development of Coalitions, Tax
Incentives and the Development of a Simplified Defined Benefit
Plan.
The Report explains the legislative development of the top-
heavy rules and then summarizes the layers of legislation that
occurred subsequent to their passage which made them obsolete.
The Report states, ``The top-heavy rules under Internal Revenue
Code Section 416 should be repealed....Their effect is largely
duplicated by other rules enacted subsequently....They also
create a perception within the small business community that
pension laws target small businesses for potential abuses. This
too discourages small business from establishing qualified
retirement plans for their employees.''
It is important to note that the Portman-Cardin legislation
dramatically improves the top-heavy rules and significantly
reduces administration expenses associated with them.
The Report calls for the elimination of User Fees imposed
by IRS. The Report in part states, ``The imposition of user
fees adds another financial obstacle to the adoption of
qualified retirement plans by small business. Although user
fees apply to all employers--large and small--the cost of
establishing a plan is more acutely felt among small employers.
User fees do not vary by size of employer....Now that the
budget deficit has become a budget surplus, the economic
justification for user fees is much diminished. User fees
should be repealed.''
H.R. 1102 addresses the user fee issue to assist small
businesses in sponsoring retirement plans.
The Advisory Council Report calls for increasing the limits
on benefits and contributions:
``The defined benefit and defined contribution plan dollar
limit were indexed by ERISA and were originally established in
1974 at $75,000 and $25,000 respectively. From 1976 to 1982,
the indexing feature was allowed to operate as intended and the
dollar amounts grew to $136,425 and $45,475. Under the Tax
Equity and Fiscal Responsibility Act of 1982, the dollar limit
on defined benefit plans was reduced to $90,000 and the dollar
limit on defined contribution plans was reduced to $30,000. ...
``These reductions in the dollar amounts are widely
believed to have been revenue driven. These reductions had the
net effect of adjusting downward the maximum amount of benefits
and contributions that highly-paid employees can receive in
relationship to the contributions and benefits of rank and file
employees. ...
``In order to give key employees the incentive needed to
establish qualified retirement plans and expand coverage, we
recommend that the $30,000 dollar limit on defined contribution
plans be increased to $50,000 which will help partially restore
the dollar amount to the level it would have grown to had the
indexing continued without alteration since the dollar limit
was first established in 1974.
``Second, we recommend that the $90,000 dollar limit on
defined benefit plans be increased to $200,000 which will
restore the dollar amounts lost through alterations in the
dollar amount since 1974, while maintaining the 1:4 ratio
established in 1982 as part of TEFRA.
``Third, we recommend, that in the future, indexing occur
in $1,000, not $5,000 increments which has had the effect of
retarding recognition of the effect of inflation.''
And finally the report concludes, ``we recommend, that
actuarial reductions of the defined benefit plans dollar limit
should be required only for benefits commencing prior to age
62. This was the rule originally enacted in 1974 as part of
ERISA.''

The Portman-Cardin legislation increases the contribution limits with
respect to all of the retirement plans. As discussed in more detail
below, this is perhaps one of the most important changes that can be
made to the system to increase small business access.

The Report also calls for a corresponding increase in the
limit on includable compensation for similar reasons. ``Under
ERISA, there was no dollar limit on the amount of annual
compensation taken into account for purposes of determining
plan benefits and contributions. However, as part of the Tax
Reform Act of 1986, a qualified retirement plan was required to
limit the annual compensation taken into account to $200,000
indexed. The $200,000 limit was adjusted upward through
indexing to $235,843 for 1993. As part of the Omnibus Budget
Reconciliation Act of 1993, the limit on includable
compensation was further reduced down to $150,000 for years
after 1994. Although indexed, adjustments are now made in
increments of $10,000, adjusted downward. In 1998, the indexed
amount is $160,000.'' ``We recommend that the limit on
includable compensation be restored to its 1988 level of
$235,000 be indexed in $1,000 increments in the future.''

The Portman-Cardin legislation will return the compensation limit back
to where it stood in 1988. The system is perceived by many small
business owners as discriminatory against key employees; this type of
change will allow it to be perceived as more fair to all employees.

The Report develops a number of recommendations in the area
of education, including using public service spots on
television, radio and in the printed media to educate the
public and raise the awareness of the need to prepare and save
for retirement. Virtually all of the Report's recommendations
in this area also were made at the National Summit on
Retirement Savings. This is a critical area for small business.
Clearly, more small businesses will want to sponsor retirement
plans if retirement benefits are perceived as a valuable
benefit by their employees.

One of the direct benefits to come out of the National Retirement
Summit is the educational spots being put on the air by ASEC and EBRI.
It is critical for the public to become educated about the need to
start saving for their retirement and the benefits of starting early.

The Report calls for tax credits that could be used as an incentive
for a small business to adopt a qualified retirement plan or to offset
administration costs or even retirement education costs.

H.R. 1102 provides tax credits as an incentive for small businesses to
adopt retirement plans.

Finally the Advisory Council calls for a Simplified Defined Benefit
Plan.
The graying of America, and the burden that it will place on future
generations, should not be ignored. The American Council of Life
Insurance reports that from 1990 to 2025, the percentage of Americans
over 65 years of age will increase by 49%. This jump in our elderly
population signals potentially critical problems for Social Security,
Medicare and our nation's programs designed to serve the aged.
While we must shore up Social Security and Medicare, it is clear
that the private retirement system and private sources for retiree
health care will have to play a more significant role for tomorrow's
retirees. The savings that will accumulate for meeting this need will
contribute to the pool of capital for investments that will provide the
economic growth needed to finance the growing burdens of Social
Security and Medicare. The policy direction reflected by H.R. 1102 will
ensure that sufficient savings will flow into the retirement plan
system so as to provide a secure retirement for as many Americans as
possible.
The last two bills passed by this Congress to enhance the
retirement system and retirement savings began the process of
simplifying the technical compliance burdens so that small businesses
are able to sponsor qualified retirement plans. H.R. 1102 represents
another huge step forward. Indeed, if this legislation becomes the law,
only a few changes remain to fully restore the system to its former
health prior to the onslaught of negative and complex changes of the
1980's while retaining the needed reforms introduced during that
period.
SBCA, SBLC, ASPA and PSCA strongly support the following items in
H.R. 1102 which will greatly assist businesses, and particularly small
businesses, in sponsoring retirement plans:

401(k) Changes

The 401(k) Plan is a tremendous success story. The excitement
generated by this plan is amazing. Prospective employees ask potential
employers if they have a 401(k) plan and if so, what the investment
options are and how much does the employer contribute. Employees meet
with investment advisors to be guided as to which investments to
select, employees have 800 numbers to call to see how their investments
are doing and to determine whether they want to change investments.
Employees discuss among themselves which investment vehicles they like
and how much they are putting into the plan and how large their account
balances have grown.
The forced savings feature of the 401(k) plan cannot be
underestimated and must be safeguarded. When a person participates in a
401(k) plan, he or she cannot remove the money on a whim. Savings can
be removed by written plan loan which cannot exceed 50% of the account
balance or $50,000 whichever is less. Savings can be removed by a
hardship distribution, but this is a tough standard to meet. The
distribution must be used to assist with a statutorily defined hardship
such as keeping a house or dealing with a medical emergency. This is in
contrast to funds inside an IRA or a SIMPLE (which is an employer
sponsored IRA program) where the funds can be accessed at any time for
any reason. True, funds removed will be subject to a 10% penalty (which
is also the case for a hardship distribution from a 401(k) plan), but
preliminary and totally unofficial data suggests that individuals
freely access IRAs and SEPs (also an employer sponsored IRA program)
and that the 10% penalty does not seem to represent a significant
barrier. In fact, this is why the SIMPLE IRA starts off with a 25%
penalty for the first two years an individual participates in SIMPLE in
hopes that if a participant can accumulate a little bit he or she will
be tempted to leave it alone and watch it grow. Nevertheless, there is
a distinct difference between asking the employer for a loan or a
hardship distribution and having to jump through some statutorily and
well placed hoops versus simply removing money at whim from your own
IRA.
Increasing 401(k) contributions from $10,000 to $15,000 is
a significant, beneficial change which will assist many employees,
particularly those who are getting closer to retirement age.
Opening up the second 401(k) Safe Harbor, the ``Match Safe
Harbor'' to small businesses by exempting it from the Top-Heavy Rules
is a valuable change which places small businesses on a level playing
field with larger entities.
We believe that the voluntary safe harbors will prove to
be the easiest and most cost effective way to make the 401(k) plan user
friendly for small businesses. If a small business makes a 3%
contribution for all non-highly compensated employees, or makes the
required matching contributions, then the company no longer has to pay
for the complex 401(k) antidiscrimination testing (nor does it have to
keep the records necessary in order to do the testing). We recognize
that many companies will choose to stay outside the safe harbor because
the 3% employer contribution or required match ``cost of admission'' is
too high and because it is more cost-effective to stay with their
current system (including software and written communication material
to employees). Many believed that small business would embrace the
voluntary safe harbors that do away with costly complex testing.
Unfortunately, because of some serious roadblocks placed in the path of
the voluntary safe harbors by the Internal Revenue Service, it is not
clear what the future of the safe harbors will be.
Unfortunately, IRS is imposing a Notice Requirement which
is very restrictive and will probably cause most small businesses not
to be able to use the safe harbor this year. IRS Notice 98-52, which
was published November 16, 1998, requires that a business adopting
either safe harbor give written notice (in the case of a calendar year
plan) by March 1st. Now let's examine the rationale behind the notice
requirement and see whether this type of restriction is justified.
Remember there are two safe harbors--one is a prescribed company match
to employee 401(k) contributions, the other is a non-elective 3%
contribution. A non-elective 3% contribution means that every eligible
employee receives this contribution whether or not he or she makes
401(k) contributions. The rationale for notice in the context of the
match safe harbor is self evident. An employee may very well change his
or her behavior and contribute more 401(k) contributions knowing that a
match is going to be made.
There appears to be no rationale for notice in the context of the
non-elective 3% contribution--no employee is going to change any
behavior on knowing that a contribution will be made for them at the
end of the year.T1 The problem of course is compounded when dealing in
the small business world. Unless an outside advisor has informed a
small business that it must give a fairly extensive written notice by
March 1st and the company complies, it will not be able to take
advantage of the safe harbor for this entire year. My guess is that
there will be many, many small businesses this year who would have
taken advantage of the 3% non-elective safe harbor but will not be able
to do so because they had not been informed of the requirements of this
overly restrictive notice requirement. Thus, they will not be able to
rid themselves of the complex and costly 401(k) anti-discrimination
testing this year.
IRS also has stated that the 3% non-elective contribution must be
paid to every non-highly compensated employee regardless of whether
they have completed 1000 hours and whether he or she is employed on the
last day of the plan year. This is more restrictive than either the
rule for normal plan contributions or the rule for the top-heavy
minimum contributions. Again, there seems to be no rationale for a safe
harbor which is designed to help small business avoid complicated
testing to be made so restrictive.
IRS has also stated publicly that if the notice has not been given
correctly or the plan otherwise failed to satisfy the safe harbor after
electing it (and remember the company is required to elect basically a
month before the beginning of the plan year), then the plan is
disqualified. This type of severe penalty will certainly be the death
knell of the safe harbors for if a small business has to worry about
disqualification, it will simply stay away from them. A cynic might
observe that the IRS is doing everything it can to make sure it does
not carry out Congressional intent. Even statutorily, the Services'
position cannot be sustained, since the safe harbor is entitled as an
alternative means to satisfy the non-discrimination tests.
SBCA, SBLC, ASPA and PSCA suggest that the notice requirement be
changed to within 30 days of the close of the plan year for those
companies selecting the 3% non-elective contribution safe harbor. This
change will allow word to get out to small business about this option
and give them time to comply with the notice requirement. We also
suggest that the 3% non-elective contribution be made to either all
non-highly compensated employees who have worked 1,000 hours or to
those employees who are employed on the last day of the plan year, but
not both. We also suggest that it be made clear in writing that if a
small business does not comply with the safe harbor election, that the
plan falls back to the regular 401(k) discrimination rules not be
disqualified.
Increasing the IRC Section 404 15% deduction limit to 25%
is a major change which will appreciably assist small businesses.
Section 404 limits a company's deduction for profit sharing
contributions to 15% of eligible participants' compensation. Because of
this rule, today many companies, including small businesses, sponsor
two plans because the 15% limit is too low for the contributions they
are putting in for their employees. Most often a money purchase pension
plan is coupled with a profit sharing plan to allow the company to get
up to a 25% deduction level. By requiring companies to sponsor two
plans where one would do, administration expenses and user fees are
doubled. Each year the company is required to file two IRS 5500 forms
instead of one. The company is required to have two summary plan
descriptions instead of one. This change would truly simplify and
reduce administration expenses and exemplifies the outside of the box
thinking found in H.R. 1102. In fact, it is interesting to contemplate
whether Section 404 serves any meaningful function today.
The Qualified Plus Contribution is an exciting concept
which may prove to be sought after by employees contributing 401(k)
contributions.
Excluding 401(k) contributions made by the employees from
the IRC Section 404 15% deduction limit will make these plans better
for all employees. Today, employee 401(k) contributions are included in
the Section 404 limit. Section 404 limits a company's deduction for
profit sharing contributions to 15% of eligible participants'
compensation. This limit covers both employer and employee 401(k)
contributions. This limitation now operates against public policy;
either employer contributions are cut back which works to the detriment
of the employees' retirement security or employee pre-tax salary
deferred contributions must be returned to the employee. Thus,
employees lose an opportunity to save for their retirement in a tax-
free environment. This is particularly inappropriate since the employee
has taken the initiative to save for his or her retirement, exactly the
behavior Congress wants to encourage, not discourage.
Repeal of the complicated ``Multiple Use Test'' is a very
welcome change and will benefit the entire retirement plan system. This
test was nearly incomprehensible and forced small businesses (really
their accountants or plan administrators) to apply different anti-
discrimination tests to employer matching contributions than what may
have been used for the regular 401(k) anti-discrimination tests.
Allowing employee-pay all 401(k) plans for small business
is fair. Portman-Cardin would allow a key employee to make a
contribution to a 401(k) plan sponsored by a small business without
triggering the top-heavy rules were triggered so that the small
business was required to make a 3% contribution for all non-key
employees. Not only is this a trap for the unwary since many small
businesses, including their advisors, are unaware of this strange rule,
but it is also unfair since a larger company would be able to sponsor
an employee-pay-all 401(k) plan and not have to make any employer
contributions to the plan. The regular 401(k) anti-discrimination tests
are more than sufficient to ensure that the non-highly compensated
employees are treated fairly vis a vis the highly compensated
employees.
The so-called ``Catch-Up Contributions'' for people
approaching retirement may be helpful for small business employees,
particularly those who were not able to save while they were younger.

Changes to Plan Contribution Limits

Perhaps the most important change in the retirement
legislation is increasing the dollar limits on retirement plan
contributions, removing the 25% of compensation limitation and
increasing the compensation limitation.
Increasing the $150,000 compensation limit to
$235,000 is an important change which will bring the plan
contributions back into line with 1998 dollars. The $150,000
limit in 1974 (ERISA) dollars is about $46,500 (assuming 5
percent average inflation). This is far below the $75,000 that
represented the highest amount upon which a pension could be
paid under then-new Code Section 415 (back in 1974). This
cutback has hurt several groups of employees--owners and other
key employees of all size businesses who make more than
$150,000 and mid-range employees and managers (people in the
$50,000 to $70,000 range) who are in 401(k) plans and in
defined benefit plans. This cutback was perceived by owners and
other key employees of small businesses as reverse
discrimination and as a disincentive in establishing a
retirement plan.
Increasing the defined contribution limit from
$30,000 to $45,000 and the defined benefit limit from $130,000
to $180,000 are strong changes which will increase retirement
security for many Americans. These numbers are in line with
actual inflation.

Top Heavy Rules

These rules are now largely duplicative of many other
qualification requirements which have become law subsequent to
the passage of the top-heavy rules. They often operate as a
``trap for the unwary'' particularly for mid-size businesses
which never check for top-heavy status and for micro small
businesses which often do not have sophisticated pension
advisors to help them. These rules have always been an unfair
burden singling out only small to mid-size businesses. The
changes made in H.R. 1102 will significantly simplify the
retirement system with little to no detriment to any policy
adopted by Congress during the last decade. The top-heavy rules
have required extensive record keeping by small businesses on
an ongoing 5 year basis. They also have represented a
significant hassle factor for small business--constant
interpretative questions are raised on a number of top-heavy
issues and additional work is required to be done by a pension
administrator when dealing with a top-heavy plan, particularly
a top-heavy 401(k) plan.
SBCA, SBLC, ASPA and PSCA support the repeal of the family
attribution for key employees in a top-heavy plan, as well as
finally doing away with family aggregation for highly
compensated employees. These rules require a husband and wife
and children under the age of 19 who work in a family or small
business together to be treated as one person for certain plan
purposes. They discriminate unfairly against spouses and
children employed in the same family or small business.
We also support the simplified definition of a key employee
as well as only requiring the company to keep data for running
top heavy tests for the current year rather than having to keep
it for the past four years in addition to the current year.

SIMPLE Plans

It is exciting to see that the SIMPLE is attracting so many
small businesses. We believe, though, that the SIMPLE plan
should be viewed as a starter plan and that all businesses,
including the very small, should be given incentives to enter
the qualified retirement plan system as quickly as possible.
The SIMPLE is an IRA program, as is the old SEP plan and in the
long run true retirement security for employees is better
served by strengthening qualified retirement plans rather than
SIMPLES and SEPs. This is simply because employees have a far
greater opportunity to remove the money from IRAs and SEPs and
spend it--the forced savings feature of a qualified retirement
plan is not present. While we appreciate that for start-up
companies or micro businesses, a SIMPLE or the proposed salary
reduction SIMPLE is the best first step into the retirement
plan system, the company should be encouraged to enter the
qualified retirement system as soon as possible. By making the
SIMPLE rules ``better'' than the qualified retirement system,
the reverse is achieved. Thus, we hope that the ``gap'' between
the 401(k) limit ($15,000) and the SIMPLE limit ($10,000) and
the salary reduction SIMPLE limit ($5,000) is carefully
preserved so that the system does not tilt in the wrong
direction.
We do not believe that any other new plans than those set
forth in H.R. 1102 are needed. We now have a very good mix of
plans--from those which provide flexibility and choice to very
simple plans for the companies who do not want administration
costs.

Required Minimum Distribution Rules

We support exempting a minimum amount from the required
minimum distribution rules. We would encourage the Committee to
also consider whether the rule which delays receiving
distributions for all employees, other than 5% owners, until
actual retirement, if later, should be extended to 5% owners.
There seems to be no policy rationale for forcing 5% owners to
receive retirement distributions while they are still working.
We also respectfully suggest the following:
1. Allow direct lineal descendants of the participant, in
addition to a spouse, to be able to roll-over a plan
contribution to an IRA. Today, if a participant dies and names
the spouse as beneficiary, the spouse can ``roll-over'' the
retirement plan assets into an IRA, rather than receiving
payments from the retirement plan. On the other hand, if a
participant dies and names his or her children as the
beneficiaries, the children cannot roll-over the assets into an
IRA and will in most cases be forced to take the distribution
in one lump sum. This triggers the problem set forth in 2
below.
2. Provide an exemption of retirement plan benefits from
estate taxes. As mentioned above, if the children are forced to
take a lump sum distribution (and assuming they have no
surviving parent), the entire retirement plan contribution is
brought into the estate of their parent who was a plan
participant and is subject to immediate income tax. This is the
fact pattern where the plan distribution is reduced by up to
85% due to taxes--federal and state income taxes and federal
and state estate taxes. This is why people often say they don't
want to save in a retirement plan because if they die the
government takes it all and the children and grandchildren
receive way too little.
3. Section 404(a)(7) should be eliminated. Section
404(a)(7) is an additional deduction limitation imposed on
companies that sponsor any combination of a defined benefit
plan and a defined contribution plan. When a company chooses to
sponsor both types of plans, then it is limited to a 25% of
compensation limit. The defined benefit plan is subject to a
myriad of limitations on deductions and contributions. The
defined contribution plan is likewise subject to its own
limitations on deductions and contributions. This extra
limitation often hurts the older employees who would otherwise
receive a higher contribution in the defined benefit plans.
Often companies simply choose not to sponsor both types of plan
because of this limitation.

Plan Loans for Sub-S Owners, Partners and Sole Proprietors

This is a long overdue change to place all small business
entities on a level playing field. We support this change.

Repeal of 150% of Current Liability Funding Limit

This is a very technical issue, but basically defined
benefit plans are not allowed to fund in a level fashion. Code
Section 412(c)(7) was amended to prohibit funding of a defined
benefit plan above 150 percent of current ``termination
liability.'' This is misleading because termination liability
is often less that the actual liability required to close out a
plan at termination, and the limit is applied to ongoing plans
which are not terminating. This provision is particularly
detrimental to small businesses who simply cannot adopt a plan
which does not allow funding to be made in a level fashion. The
changes made to this law by H.R. 1102 are critical for small
businesses to be able to sponsor defined benefit plans.
We also applaud the change in the variable rate premium
which will assist small businesses which are not allowed to
fund in a proper fashion because of this limitation.
A small business will go through a cost-benefit analysis to
determine whether to sponsor a qualified retirement plan. A
number of factors are analyzed including the profitability and
stability of the business, the cost of sponsoring the plan both
administratively as well as required company contributions,
whether the benefit will be appreciated by staff and by key
employees and whether the benefits to the key employees and
owners are significant enough to offset the additional costs
and burdens. The legislation being contemplated by this
Committee will dramatically improve the qualified retirement
plan system. By making the system more user friendly and
increasing benefits, more small businesses will sponsor
retirement plans. Easing administrative burdens will reduce the
costs of maintaining retirement plans. The changes would
revitalize the retirement plan system for small business as it
is perceived by small businesses as more fair to them. Finally,
the positive changes made by Congress in the 1980's would be
retained and the time tested ERISA system would stay in place.
Ultimately, it is essential for this country to do everything
possible to encourage retirement plan savings so that
individuals are not dependent upon the government for their
retirement well-being.

Mr. English. Thank you, Ms. Calimafde.
Mr. MacDonald, we look forward to your testimony.

STATEMENT OF J. RANDALL MACDONALD, EXECUTIVE VICE PRESIDENT,
HUMAN RESOURCES AND ADMINISTRATION, GTE CORP., IRVING, TEXAS;
ON BEHALF OF ERISA INDUSTRY COMMITTEE

Mr. MacDonald. Good afternoon. My name is Randall
MacDonald. I am executive vice president of human resources and
administration of GTE, and a member of the board of directors
of the ERISA Industry Committee on behalf of whom I appear
today.
I am here today to urge that the Full Committee enhance
retirement security by, first, approving H.R. 1102; second, by
extending the current authority of section 420 of the Internal
Revenue Code that permits the use of excess pension assets to
fund current retiree health obligations; third, by permitting
ESOP dividends to be reinvested without loss of dividend
reduction for employers; and finally, by resisting the efforts
to prevent employers from establishing cash balance and other
innovative and creative defined benefit plan designs.
H.R. 1102 corrects many of the problems that are a product
of the multiplication of the many changes during the past 12
years. The law did not always impose the current dizzying array
of limits on the benefits that can be paid from and
contributions that can be made to tax-qualified plans.
Between 1982 and 1994, however, scores of laws were enacted
that repeatedly allowed the ERISA limits on benefit funding.
H.R. 1102 reverses this trend, and none too soon. This
Committee does not need to be reminded that the baby-boom
cohort rapidly is nearing retirement. If we delay action, many
employers will not have the cash available to pay for rapid
increases in pension liabilities, and workers will not have
time to accumulate their savings. H.R. 1102 thus provides an
opportunity that we cannot afford to pass up.
Consider this. While retirement savings are accumulating in
tax qualified plans, they fuel the engine of America's economic
growth. According to the most recently available statistics,
pension funds held 28.2 percent of our Nation's equity market,
15.6 percent of the taxable bonds, and 7.4 percent of cash
securities.
Many of today's workers' savings and benefit opportunities
are significantly restricted by current limits. Limits imposed
on defined benefit plans imprudently delay funding.
Pensions are not a benefit for the rich. Most plan
participants, by the way, are compensated at less than $30,000.
Finally current law has created a world in which an
increasing number of people who make decisions about
compensation and retirement security depend instead on unfunded
qualified plans for the bulk of their retirement savings.
ERIC, the ERISA Industry Committee, believes the restored
limits regarding compensation and regarding the benefits that a
defined benefit plan may provide will be particularly
beneficial in increasing the retirement security available to
American workers.
H.R. 1102 also promotes pension portability by eliminating
a significant number of stumbling blocks created by the current
law. For example, ERIC is especially appreciative that the bill
repeals the same desk rule. ERIC also supports the bill's
provisions that facilitate plan-to-plan transfers by providing
that receiving plan need not maintain all of the optional forms
benefits under the sending plans.
ERIC would expand the bill's provisions to allow rollovers
of after tax contributions. Current rules not only are
confusing to employees but force them to strip a portion of
their savings from their accounts just because the savings were
made with after tax dollars.
Current law relating to ESOP discourages reinvestment of
retirement savings and increases leakage. H.R. 1102 remedies
the law by permitting employers to deduct dividends paid to the
ESOP when the employees are allowed to take the dividends in
cash or to leave them in the plan as a reinvestment vehicle for
retirement security.
The Committee will also consider this year the extension of
420 which permits the use of excess pension assets in support
of companies' retiree health benefits. This has been a highly
successful effort over the past several years and should be
continued.
Finally, we are concerned with the unbalanced, inaccurate,
and inflammatory publicity surrounding the so-called cash
balance and other hybrid defined benefit plan designs. Certain
cash balance and similar plans meet employee demands,
especially our new generation in the work force, by providing
an understandable, portable, and secure benefit where
employers, nonemployees, bear the investment risk and the
participants benefit is guaranteed by the PBGC, Pension Benefit
Guaranty Corporation.
A significant number of large- and medium-size employers
have adopted the new plan design breaking the ``golden
handcuffs'' and letting their workers out of ``pension jail,''
if you will. The plans have become very popular among the
increasing number of workers, particularly women, who expect to
move in and out of the work force and who do not believe that
they will remain with one employer for their entire career.
That completes my prepared statement.
[The prepared statement and attachments follow:]

Statement of J. Randall MacDonald, Executive Vice President, Human
Resources and Administration, GTE Corp., Irving, Texas; on behalf of
ERISA Industry Committee

My name is Randall MacDonald. I am Executive Vice President
Human Resources and Administration for GTE Corp. I also serve
on the Board of Directors of The ERISA Industry Committee,
commonly known as ``ERIC,'' and I am appearing before the
Committee this afternoon on ERIC's behalf.
ERIC is a nonprofit association committed to the
advancement of the employee retirement, health, and welfare
benefit plans of America's largest employers. ERIC's members
provide comprehensive retirement, health care coverage, and
other economic security benefits directly to some 25 million
active and retired workers and their families. ERIC has a
strong interest in proposals affecting its members' ability to
deliver those benefits, their cost and effectiveness, and the
role of those benefits in the American economy.
ERIC has played a leadership role in advocating responsible
solutions to the critical retirement and health care coverage
issue that face our nation. In addition, ERIC recently
published policy papers and studies that have received wide
acclaim. These include:
--The Vital Connection: An Analysis of the Impact of Social
Security Reform on Employer-Sponsored Retirement Plans,
--Getting the Job Done: A White Paper on Emerging Pension
Issues, and
--Policy Statement on Health Care Quality and Consumer
Protection.
ERIC also has proposed numerous amendments to current law
designed to facilitate the provision of employee benefits by
employers and to promote national savings. The organization and
its members have worked closely with the Ways and Means
Committee for over twenty-five years to resolve important
policy questions and to devise practical solutions to the often
vexing problems facing the Committee and the country.
ERIC is gratified that, in holding this hearing, the
Committee and its Chair have displayed a strong interest in
affirmatively addressing long-term retirement security issues.
ERIC believes strongly in the importance of addressing these
security issues now. The need to do so is reflected in
legislation before the Committee. At least five comprehensive
pension reform bills have been introduced in the House of
Representatives in this Congress. They include:
--H.R.739, The Retirement Account Portability Act, by Reps
Earl Pomeroy (D-ND) and Jim Kolbe (R-AZ), et al.,
--H.R.1102, The Comprehensive Retirement Security and
Pension Reform Act, by Reps. Rob Portman (R-OH) and Ben Cardin
(D-MD), et al.,
--H.R. 1213, Employee Pension Portability and
Accountability Act of 1999, by Rep. Richard Neal (D-MA), et
al.,
--H.R.1546, Retirement Savings Opportunity Act of 1999, by
Rep. Bill Thomas (R-CA), and
--H.R.1590, Retirement Security Act of 1999, by
Representative Sam Gejdenson (D-CT), et al.
In addition, H.R.1176, The Pension Right to Know Act, by
Rep. Jerry Weller (R-IL), et al., would have a significant
impact on defined benefit plans sponsored by major employers
such as the members of ERIC. Several of these bills have
companion measures that have been introduced in the U.S.
Senate.
ERIC will be pleased to provide the Committee with detailed
comments on any of these bills. Our testimony today, however,
will focus on H.R. 1102 and H.R. 1176 and comment on the use of
excess pension assets to pay for other critical employee
benefits such as medical benefits for retirees.

H.R. 1102--Effective Pension Reform

ERIC would like to focus the Committee's attention on
H.R.1102, The Comprehensive Retirement Security and Pension
Reform Act, sponsored by Committee members Rep. Rob Portman and
Ben Cardin and cosponsored by many Members of this Committee
and of the House. ERIC thanks Congressmen Portman and Cardin
and their staffs for the vision, wisdom, and commitment that
they have displayed in crafting and introducing ground-breaking
retirement security legislation. H.R.1102 makes significant
reforms that will strengthen the retirement plans that
employers voluntarily provide for their employees and improve
the ability of workers to provide for their retirement.
ERIC advocates the speedy enactment of major provisions in
H.R. 1102 that will (1) increase benefit security and enhance
retirement savings, (2) increase pension portability, and (3)
rationalize rules affecting plan administration.

Increased Benefit Security and Enhanced Retirement Savings

The Internal Revenue Code imposes a dizzying array of
limits on the benefits that can be paid from, and the
contributions that can be made to, tax-qualified plans. It was
not always that way.
The limits originally imposed by ERISA in 1974 allowed
nearly all workers participating in employer-sponsored plans to
accumulate all of their retirement income under funded, tax-
qualified plans. Between 1982 and 1994, however, Congress
enacted laws that repeatedly lowered the ERISA limits and
imposed wholly new limits. [See Attachment A].The cumulative
impact of constricted limits has been to reduce significantly
retirement savings and imperil the retirement security of many
workers.
H.R.1102 turns this tide at a critical time. This Committee
does not need to be reminded that the baby boom cohort is
rapidly nearing retirement, and that it is critical for them
and for our nation that baby boomers have all the incentives
and resources they need to prepare for their own retirement.
Retirement planning is a long-term commitment. If we wait until
this group has begun to retire, it will be too late. Many
employers will not have cash available to pay for rapid
increases in pension liabilities, and employees will not have
time to accumulate sufficient savings. We must act now. The
provisions of H.R.1102 open the door. It is an opportunity we
cannot afford to pass up.
Just as many of the laws restricting retirement savings
were enacted to increase federal revenues, restoring benefit
and contribution limits to the more reasonable levels necessary
to help employees prepare for retirement will reduce federal
revenues over the short term. ERIC recognizes that the
Committee has many needs to consider, but ERIC strongly urges
the Committee to work with us to ensure that the laws enacted
today clearly provide for increased retirement savings
opportunities in the future. In reviewing these provisions,
Congress should consider the following:
Deferred taxes are repaid to the government.
Savings accumulated in tax-qualified retirement plans are not a
permanent revenue loss to the federal government. Taxes are
paid on almost all savings accumulated in tax-qualified plans
when those savings are distributed to plan participants and
beneficiaries. Workers who save now under most types of plans
will pay taxes on those savings when they retire in the future.
In 1997, tax-qualified employer-sponsored retirement plans paid
over $379 billion in benefits, exceeding by almost $63 billion
the benefits paid in that year by the Social Security Old Age
and Survivors Insurance (OASI) program. In future years,
benefits paid from qualified plans will increase dramatically.
For example, the 1991 Social Security Advisory Council predicts
the percent of elderly receiving a pension will increase from
43 percent in the early 1990s to 76 percent by 2018.
Tax-qualified retirement plans help all workers.
Budgetary figures analyzing the distributional impact of
estimated tax expenditures for retirement savings in a way that
indicates that a ``disproportionate'' share of the tax
expenditure inures to higher-income taxpayers can be extremely
misleading in this regard. Such analysis ignores both the fact
that the top few percent of taxpayers pay most of the income
taxes collected and the fact that older workers, who are
nearing retirement often have larger accruals than younger
workers who are just starting out. Such analysis also is
misleading because it obscures the importance of tax deferral
in making it economically possible for lower-income workers to
save for retirement. According to calculations by the American
Council of Life Insurance based on data contained in the March
1998 Current Population Survey, over 50 percent of the pension
benefits paid go to elderly with adjusted gross incomes below
$30,000. Such analysis also overlooks the fact that the vast
majority of participants in employer-sponsored plans are not
highly compensated individuals. The same ACLI study shows that
over 77 percent of individuals accumulating retirement savings
in pension plans in 1997 had earnings below $50,000 and nearly
45 percent had earnings below $30,000. In addition, among
married couples receiving a pension today, 70 percent had
incomes below $50,000 and 57 percent had incomes below $40,000.
Among widows receiving a pension, nearly 85 percent had incomes
below $50,000 and 55 percent had incomes below $25,000.
Retirement savings fuel economic growth. While
retirement savings are accumulating in tax-qualified plans,
they serve as an engine for economic growth and thereby
indirectly produce additional revenue for the federal
government and directly enhance the ability of the nation to
absorb an aging population. In 1994, pension funds held 28.2%
of our Nation's equity market, 15.6% of its taxable bonds, and
7.4% of its cash securities. In a time of increased concern
about national savings rates, retirement plans have been a
major source of national savings and capital investment.
Today's limits restrict workers' savings. Many of
today's workers' savings and benefits opportunities are
significantly restricted by current limits. Recently, in one
typical ERIC company, workers who were leaving under an early
retirement program and who had career-end earnings of less than
$50,000 had the benefits payable to them under their tax-
qualified defined benefit plan reduced by the Internal Revenue
Code limits. Recent studies by the Employee Benefit Research
Institute of contribution patterns in 401(k) plans indicate
that many older workers are constrained by the dollar limits on
contributions to 401(k) plans. The qualified plan limits also
curtail the efforts of women and other individuals who have
gaps in their workforce participation or in their pension
coverage to make significant savings in a timely manner.
Today's limits delay retirement funding. Limits
imposed on defined benefit plans imprudently delay current
funding for benefits that workers are accruing today. Funding
is restricted because tax-law limits arbitrarily truncate
projections of the future salaries on which benefits will be
calculated. As a result, in some cases, the employer is still
funding an employee's benefits after the employee has retired.
This situation will become more burdensome for plan sponsors as
the large baby-boom cohort moves to retirement. One of the
major purposes of ERISA was to avert precisely this kind of
benefit insecurity.
Today's limits divide the workforce. The
retirement security of all workers is best served when all
workers participate together in a common retirement plan, as
was the case until recent years. The current system has created
a bifurcated world in which business decision-makers (as well
as more and more of those who work for them) depend
increasingly on unfunded nonqualified plans for the bulk of
their retirement savings. Not only does this cause unnecessary
complexity in business administration, it diverts energy and
resources away from the qualified plans.
H.R. 1102 does not fully restore all limits to their ERISA
levels. It merely begins that process. Restoring limits to more
rational levels will be critical to providing retirement
security to working Americans in the coming decades. Let me
briefly highlight some of the specific provisions that are of
particular concern to ERIC members:
H.R. 1102 (Sec. 101) restores the limits on early
retirement benefits to more appropriate levels. Under ERISA,
benefits payable from a tax-qualified plan before age 55 were
actuarially reduced from a $75,000 dollar limit. In 1999, the
limit at age 55 is approximately $52,037--more than $20,000
less than the limit set in 1974. The reduction in limits for
early retirement--which already results in reduced benefits for
early retirees and disabled workers earning $50,000 and less--
will become even more severe as the Social Security retirement
age increases to age 67. H.R.1102 eliminates the requirement
for actuarial reductions in benefits that commence between age
62 and the Social Security retirement age.
Currently scheduled increases in the Social Security
retirement age, as well as rapidly changing work arrangements,
mean that early retirement programs will continue to be
attractive and significant components of many employers'
benefit plans. Where an employer maintains only tax-qualified
plans, employees whose benefits are restricted suffer a long-
term loss of retirement benefits. Where the employer also
maintains a nonqualified plan that supplements its qualified
plan, employees might accrue full benefits, but the security
and dependability of those benefits are substantially reduced.
Since benefits under nonqualified plans are generally not
funded, and are subject to the risk of the employer's
bankruptcy, nonqualified plans receive virtually none of the
protection that ERISA provides.
H.R. 1102 (Sec. 101) restores the compensation limit to the
1993 indexed amount. ERISA had no limit on an employee's
compensation that could be taken into account under a tax-
qualified retirement plan. The Tax Reform Act of 1986 imposed a
limit of $200,000 (indexed) per year. The Omnibus Budget
Reconciliation Act of 1993 reduced the limit, and the
Retirement Protection Act of 1994 slowed down future indexing.
The 1999 compensation limit is $160,000. If the Tax Reform Act
limit had remained in effect, the limit today would be
$272,520. H.R. 1102 would increase the limit to $235,000.
Although this limit might appear to be aimed at the most
highly paid employees, it has a substantial effect on employees
much farther down the salary scale. In a defined benefit plan,
the principal consequence of the reduced limit is to delay the
funding of the plan. In plans where benefits are determined as
a percentage of pay, projected pay increases are taken into
account in funding the plan. This protects the plan and the
employer from rapidly increasing funding requirements late in
an employee's career. However, projected salary increases today
are truncated at the compensation limit, or $160,000. The
result is that funding of the plan is delayed--not just for the
highly paid but for workers earning as little as $40,000.
This restriction is particularly troublesome today since it
delays funding for a very large cohort of workers: the baby
boomers. The limit will result in higher contribution
requirements for employers in the future. Some employers will
not be able to make these additional contributions, and they
may have to curtail the benefits under their plans.
H.R. 1102 (Sec. 112) permits employer-sponsored defined
contribution plans to allow employees to treat certain elective
deferrals as after-tax contributions. In 1997, Congress created
a new savings vehicle, commonly known as the Roth IRA. Under
this savings option, individuals may make after-tax
contributions to a special account. The earnings on those
contributions accumulate on a tax-free basis, and no tax is
assessed on distributions if certain conditions are met. H.R.
1102 and H.R. 1546 permit employers to offer a similar option
within the employer's 401(k) plan.
Employer plans offer several advantages to individual
savers. Payroll deduction programs make decisions to save less
painful and regular savings more likely to occur. Where
available, employer matching contributions provide an immediate
enhancement of savings. Because plans generally allow each
participant to allocate his or her account balance among
designated professionally-managed investment funds and index
funds, participants enjoy the benefits of professional benefit
management. Participants in employer-sponsored plans also are
more likely to have free access to information and assistance
(e.g., decision guides or benefits forecasting software) that
enable them to make better informed investment decisions.
Employees who find the tax treatment of these new accounts
attractive will, under the bill's provision, be able to enhance
their savings while not losing the benefits of participating in
an employer plan. To the extent that individuals who find these
accounts attractive are concentrated among the lower-paid,
offering such accounts within the employer's 401(k) plan also
will help to prevent erosion of the plan's ability to comply
with nondiscrimination tests and will preserve the plan and its
savings potential for all employees.
H.R. 1102 (Sec. 202) repeals the 25% of compensation limit
on annual additions to a defined contribution plan. Under
current law, the maximum amount that can be added to an
employee's account in a defined contribution plan in any year
is the lesser of $30,000 or 25% of the employee's compensation.
H.R.1102 and H.R. 1546 repeal the 25% limit.
The 25% limit does not have a practical impact on a
company's upper echelon employees. For example, for an employee
earning $200,000 per year, the dollar limit is lower than the
25% limit. Because of the 25% limit, employers are often forced
by the law to limit the contributions on behalf of lower-paid
employees, especially employees who take advantage of the
savings feature in a Sec. 401(k) plan. Repealing the 25% limit
will eliminate this problem.
Repealing the 25% limit also will benefit the significant
number of employees who want to increase their retirement
savings at opportune times in their careers, including women
who have reentered the work force after periods of child-
rearing and others who need to catch up on their retirement
savings after periods during which other financial obligations
restricted their ability to save.

Increased Pension Portability

Employers and employees are increasingly involved in
mergers, business sales, the creation of joint ventures, and
other changes in business structure.\1\ H.R. 1102 promotes
pension portability by eliminating a number of significant
stumbling blocks to portability created by current law. The
bill will substantially improve employees' ability to transfer
their retirement savings from one plan to another and to
consolidate their retirement savings in a single plan where
they can oversee it and manage it more effectively and
efficiently.
---------------------------------------------------------------------------
\1\ One large pension manager (T. Rowe Price) reported that 40% of
the new plans that it set up in 1995 resulted from mergers,
acquisitions, and divestitures.
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H.R. 1102 (Sec. 303), which allows an employee's after-tax
contributions to be included in certain rollovers, should be
expanded. Under current law, any portion of a distribution that
is attributable to after-tax employee contributions cannot be
included in a rollover to another employer's plan or to an IRA.
The rule unnecessarily and unwisely reduces the employee's
retirement savings, and is inconsistent with the Congressional
policy of encouraging employees to preserve their retirement
savings. H.R.1102 allows after-tax money to be included in a
rollover to an IRA.
While we applaud the direction set by this provision of
H.R. 1102, ERIC proposes that the provision be expanded to
allow after-tax rollovers to qualified employer plans that
accept them. Both H.R. 1213 (by Rep. Neal) and S.741 (by Sens.
Graham and Grassley) provide for rollovers either to an
employer plan or to an IRA.
H.R. 1102 (Sec. 304) facilitates plan-to-plan transfers.
Current Treasury regulations unnecessarily impair an employee's
ability to transfer his or her benefits from one plan to
another in a direct plan-to-plan transfer. The regulations
provide that when a participant's benefits are transferred from
one plan to another, the plan receiving the assets must
preserve the employee's accrued benefit under the plan
transferring the assets, including all optional forms of
distribution that were available under the plan transferring
the assets. The requirement to preserve the optional forms of
benefit inhibits the portability of benefits because it creates
significant administrative impediments for plan sponsors that
might otherwise allow their plans to accept direct transfers
from other plans.
H.R. 1102 resolves this problem by providing that the plan
receiving the assets does not have to preserve the optional
forms of benefit previously available under the plan
transferring the assets if certain requirements are met. The
provision will encourage employers to permit plan-to-plan
transfers and will allow employees to consolidate their
benefits in a single plan where they can oversee and manage
their retirement savings effectively and efficiently.
H.R. 1102 (Sec. 305) repeals the Sec. 401(k) ``same desk''
rule. As a result of the sale of a business, an employee may
transfer from the seller to the buyer but continue to perform
the same duties as those that he or she performed before the
sale. In these circumstances, under the Sec. 401(k) ``same
desk'' rule, the employee is not deemed to have ``separated
from service'' and the employee's Sec. 401(k) account under the
seller's plan must remain in the seller's plan until the
employee terminates employment with the buyer. This prevents
the employee from rolling over his Sec. 401(k) account to an
IRA or consolidating it with his or her account under the
buyer's plan.
Although current law (Internal Revenue Code
Sec. 401(k)(10)) provides some relief where the seller sells
``substantially all of the assets of a trade or business'' to a
corporation or disposes of its interest in a subsidiary, the
relief provided by current law is deficient in many respects.
For example, in the case of an asset sale, the sale must cover
``substantially all'' the assets of the trade or business and
the buyer must be a corporation. In some cases, it is not clear
whether the ``substantially all'' standard has been met; in
others, the transaction does not qualify as a sale; and in
still other cases, the buyer is not a corporation.
More importantly, Sec. 401(k) plans are the only tax-
qualified plans that are subject to the ``same desk'' rule.
[See Attachment B]
As employees continue to change jobs over the course of
their careers, it often is difficult for them to keep track of
their accounts with former employers and difficult for former
employers to keep track of former employees who may or may not
remember to send in changes of address or otherwise keep in
touch with their former employers' plans.
There is no justification for singling out Sec. 401(k)
plans for special restrictions on distributions in this way,
and ERIC strongly supports repeal of the Sec. 401(k) ``same
desk'' rule, included in H.R. 1102, as well as in H.R. 739 and
H.R. 1590.
H.R. 1102 (Sec. 510) allows ESOP dividends to be reinvested
without the loss of the dividend deduction for the employer.
Under current law, an employer may deduct the dividends that it
pays on company stock held by an unleveraged employee stock
ownership plan (``ESOP'') only if the dividends are paid out in
cash to plan participants. By favoring early distributions,
this rule discourages retirement savings and increases
``leakage'' from the retirement system, much like the
prohibition on including after-tax savings in a rollover (see
comments on section 303 of H.R. 1102, above).
Some employers attempt to cope with the restrictions
imposed by current law by allowing participants to increase
their Sec. 401(k) deferrals by the amount of the dividends
distributed to them. However, this arrangement is convoluted,
confusing to employees, and effective only up to the legal
restrictions on Sec. 401(k) deferrals.
H.R. 1102 remedies this unsatisfactory situation by
allowing an employer with an ESOP to deduct dividends paid on
employer securities held by the ESOP whether paid out in cash
or, at the employee's election, left in the plan for
reinvestment.

Rational Rules for Plan Administration

Superfluous, redundant, confusing and obsolete rules
encumber the administration of tax-qualified retirement plans.
These rules unnecessarily increase the cost of plan
administration, discourage plan formation, and make retirement
planning more difficult for employees. Many provisions before
the Committee significantly advance the work Congress began in
earlier bills to strip away these regulatory ``barnacles.'' For
example:
H.R. 1102 (Sec. 22) updates the definition of an ERISA
``excess'' plan. ERISA provided for ``excess benefit plans,''
that is, nonqualified plans maintained exclusively to pay
benefits that have been curtailed by the limits in the Internal
Revenue Code. However, in 1974 the IRC included only the limits
imposed by IRC Sec. 415. Since that time, a limit has been
imposed on compensation that can be taken into account under a
qualified plan [IRC Sec. 401(a)(17)], and several additional
limits have been imposed on contributions to 401(k) plans.
These new limits have never been reflected in ERISA's
definition of ``excess benefit plan.''
Unless ERISA's definition of an ``excess benefit plan'' is
updated to reflect the new IRC limits, a rapidly increasing
numbers of employees will see their retirement benefits
substantially diminished. The new limits are most damaging to
older workers who are at the height of their earning capacity
and ability to save for retirement. Many such workers have been
unable to set aside sufficient retirement savings earlier in
their careers because of family obligations such as housing and
education.
H.R. 1102 (Sec. 523) allows employers to provide suspension
of benefit notices through the summary plan description (SPD).
One of the chief impediments to the creation and maintenance of
defined benefit plans is their administrative cost and
complexity. While some of that complexity is inherent in the
design of these plans, much of it is due to excessive and
wasteful regulation. The Department of Labor's regulation
requiring individual ``suspension of benefit'' notices is a
glaring example of such over-regulation.
Most defined benefit pension plans provide that, in
general, benefits do not become payable until the employee
terminates employment. Pursuant to Department of Labor
Regulations, however, a plan may not withhold benefit payments
after an employee has attained normal retirement age, unless
during the first calendar month or payroll period after the
employee attains normal retirement age, the plan notifies the
employee that his or her benefits are suspended. The notice
must meet complex and detailed specifications. The notice
requirement should be changed for the following reasons:
Employees who continue working past the plan's
normal retirement age do not expect to begin receiving benefit
payments until they actually retire. Thus, many employees who
receive the notice view it as a waste of plan assets. For
others, the notice is perceived as a subtle attempt by the
employer to expedite their retirement.
The notice requirement also creates substantial
record-keeping and paperwork burdens for employers. Regardless
of the number of employees affected, the employer must incur
the cost of installing a system to identify and notify each
employee who works beyond the plan's normal retirement age or
who is re-employed after attaining normal retirement age.
In spite of the most conscientious efforts by plan
administrators to comply with the DOL requirement, errors
inevitably occur. Unfortunately, a plan that fails to provide
the required notice to even a single affected employee risks
losing its tax-qualified status--exposing the plan, the
employer, and all of the plan's participants and beneficiaries
to enormous financial penalties.
The SPD is the primary vehicle for informing plan
participants and beneficiaries about their rights under
employee benefit plans. Plans are required by ERISA to supply
copies of the SPD to participants and beneficiaries, and
participants have been educated to consult their SPD's for
information about their benefit plans. As such, the SPD is the
most appropriate--and effective--mechanism for delivering
information about the payment of benefits to participants.
Other provisions. H.R. 1102 makes other changes that remove
significant regulatory burdens and will enable plan sponsors to
design plans that meet the needs of their individual
workforces. For example, section 504 contains modifications
that will make the separate line of business rules of current
law more workable. Today's separate line of business rules are
so complex that many employers have given up trying to use them
even though the companies involved have significantly diverse
lines of business. The nature of today's business combinations
and alliances differs significantly from just a decade ago,
making it more important to have workable separate line of
business rules. ERIC looks forward to working with the
Committee on this and other similar provisions.
Congress should reject Sec. 501 of H.R. 1102, which changes
the way in which the qualification standards are enforced.
Under current law, a plan may be disqualified for failing to
meet the Internal Revenue Code's qualification requirements
even if the failure was inadvertent and even if the employer
has made a good faith effort to administer the plan in
accordance with the qualification requirements. ERIC has long
been concerned with this serious problem, and it is very
appreciative of the interest that the sponsors of H.R.1102 have
taken in this issue.
ERIC, however, advocates an enforcement policy that
emphasizes correction over sanction; that encourages employers
to administer their plans in accordance with the qualification
standards; that encourages employers to remedy promptly any
violations they detect; that reserves IRS involvement for
serious violations; and that applies appropriate sanctions only
where employers fail to remedy serious violations that they are
aware of.
The Internal Revenue Service has incorporated these
principles in its Employee Plans Compliance Resolution System
(``EPCRS''). In formulating and improving EPCRS, the Treasury
and the Service have been very responsive to the concerns
expressed by ERIC and other groups. Although we believe that
improvements can and should be made in EPCRS, we believe that
improvements are best made at an administrative level, where
changes can readily be made to respond to changing
circumstances and to newly-identified issues. If the Committee
believes that legislation is necessary, we suggest that the
legislation encourage the Treasury and the Service to expand
and improve their existing programs.

Avoiding Misdirected Regulatory Burdens Such Those in H.R. 1176

As pension law evolves, ERIC urges that Congress avoid
imposing new regulatory burdens on employer-sponsored plans.
Several provisions before the Committee, contrary to the
proposals highlighted above, would continue to heap new
requirements on plans. Contrary to Congress's objective of
increasing pension coverage, these requirements, added to those
of existing law, will encourage plan terminations and
discourage any employer not already in the pension system from
entering. ERIC's concerns with H.R. 1176, developed in response
to media analysis of plans that have been changed from
traditional defined benefit plans to cash balance plans are
explained in more detail below.
H.R. 1176 imposes new notice requirements when a change in
plan design results in significant reductions in the rate of
future benefit accruals. Under ERISA Sec. 204(h), plans must
notify participants in advance of any plan amendment that will
result in a significant reduction in the rate of benefit
accruals under the plan.
ERIC's members invest large sums of money and substantial
resources in ensuring that employees have a full understanding
of their benefit plans and any changes to those plans. ERIC is
concerned that modifications currently proposed to legal
disclosure requirements will add significantly to plan costs
without enhancing employee understanding, impose requirements
that are difficult if not impossible to satisfy, and hinder the
ability of employers to adjust their plans to meet changing
business circumstances or changing employee needs. Any of these
results would defeat the purpose of the amendment by making it
more difficult for employers to offer significant retirement
savings opportunities for their employees.
Recently, legislation has been introduced in response to
recent news articles and 90-second ``in depth'' TV reports
concerning conversions of traditional defined benefit plans to
cash balance plans. The media reports have failed to provide
balanced background material for understanding the dynamics of
change in retirement security plans. Attached to this testimony
is a detailed briefing document to assist the Committee in
understanding cash balance and other ``hybrid'' defined benefit
plan designs as well as the recent media controversy and the
impact of the proposed legislation. [See accompanying brief
``Understanding Cash Balance and Other ``Hybrid'' Defined
Benefit Plan Designs'']
ERIC is particularly concerned that H.R. 1176 requires the
distribution of information that frequently will be misleading.
In addition, the bill saddles employers with data collection
and reporting requirements obligations that are oppressive and
impractical.
Cash balance plans are defined benefit plans that express
the benefit in the form of an individual account balance. As
such, these plans are welcomed and understandable by employees,
are easily portable, and accrue benefits more rapidly in an
employee's career than a traditional defined benefit plan. At
the same time, participants in a cash balance plan receive all
the protections of a defined benefit plan that are not
available to individual account plans such as 401(k) plans:
employee participation is automatic, contributions are made by
the employer, the risk of investment return is borne by the
employer, and the benefit is guaranteed by the Pension Benefit
Guaranty Corporation.
Unfortunately, H.R. 1176 requires employers to distribute
information that often will effectively mislead employees.
Under the Pension Right to Know Act, whenever a ``large''
defined benefit plan is amended in a way that results in a
significant reduction in the rate of future benefit accrual for
any one participant, the plan must provide an individually-
tailored ``statement of benefit change'' to every plan
participant and alternate payee. The ``statement of benefit
change'' must be based on government-mandated assumptions and
must project future benefits at several time intervals under
both the old and new plan provisions.
The problem is--
Projections of future benefits are inherently
unreliable. Even minor changes between the interest rates
required to be used under the bill and rates that in fact occur
over time can have a dramatic impact on the value of benefits
accrued by individual employees.
Projections of an employee's possible future
benefits required by the government and provided by the
employer are easily misinterpreted by the employee as
guarantees that benefits will accrue according to the
projections provided.
The benefit statements required by the bill will
lead employees to believe that the plan offers a lump-sum
option that it might not actually provide.
The benefit statements required by the bill ignore
other changes in the employer's ``basket of benefits.''
By requiring projections of future benefit
accruals under the old plan's provisions--which are no longer
operative--the bill falsely implies that participants have the
option to retain the old provisions.
H.R. 1176 also imposes burdens on employers that are
intolerable and unjustified. For example,
Under the bill, whenever a defined benefit plan is
amended, the employer must analyze the effect of the amendment
on every individual participant and alternate payee to
determine whether the amendment significantly reduces the rate
of future benefit accrual for any one of them.
If the employer finds that the amendment
significantly reduces the rate of future benefit accrual for
any one participant or alternate payee, the bill requires the
employer to prepare an individually-tailored statement of
benefit change for every participant and alternate payee.
Existing plans often include numerous features
that apply only to certain individuals. For example, groups of
employees often have been grandfathered under prior plan
provisions frequently attributable to their participation in a
predecessor plan that merged into the existing plan following a
merger or acquisition. Most of the calculations for these
employees (which could easily run into the thousands in a large
company) will have to be performed by hand.
Many employees also are subject to individual
circumstances that will affect their benefits--e.g. an
employee's benefit might be subject to a Qualified Domestic
Relations Order (QDRO) or the employee might have had a break
in service or a personal or military leave. The calculations
for many of these employees also will have to be performed by
hand.
The calculations required by the bill must be
completed before the changes in the plan become effective. This
can take several months. New calculations regarding the
employees' actual accrued benefit values must then be
calculated after the plan becomes effective, since only then
will the applicable interest rate and other variables as of the
effective date be known.
The bill also imposes disproportionate and oppressive tax
penalties. At a time when Congress is properly focusing on
expanding employer-sponsored retirement plans, the Pension
Right to Know Act will have the opposite result. The bill will
have a chilling effect on sponsorship of any form of defined
benefit plan, pushing medium and large employers to turn to
compensation and benefit forms that place employees more at
risk for their own economic and retirement security.

Flexible Funding for Employee Benefits

Retirement security relies not only on adequate cash
resources. For many, the availability of employer-provided
retiree medical coverage has materially enhanced their standard
of living in retirement. Internal Revenue Code (IRC)
Sec. 401(h) allows a pension plan to provide medical benefits
to retired employees and their spouses and dependents if the
plan meets certain requirements.
These restrictions on 401(h) accounts indicate that only
new contributions--not existing plan assets--can be used to
fund a 401(h) account. If the plan is very well funded--so that
the employer is no longer making any contributions to the
plan--401(h) is not available. Recognizing that this arbitrary
restriction unnecessarily imperiled the security of retiree
medical benefits, Congress in 1990 enacted IRC Sec. 420 to
permit a pension plan to use part of its surplus assets to pay
current retiree medical expenses. Although 420 was originally
scheduled to expire at the end of 1995, Congress later extended
the life of 420 until 2000.
Section 420 does not allow advance funding of future
retiree health liabilities. But because it allows pension
assets to be used for current retiree health care expenses, 420
permits excess pension assets to be used productively. In
addition, because 420 relieves employers of the need to make
tax-deductible payments for retiree health benefits, 420 raises
federal tax revenues.
In order to make a 420 transfer, the employer must meet a
number of requirements, including the following:
The transferred amount may not exceed the excess
of the value of the plan's assets over the greater of the
plan's termination liability or 125% of the plan's current
liability. This is designed to assure that the plan retains
sufficient assets to cover the plan's pension obligations.
The transferred amount also may not exceed the
amount reasonably estimated to be what the 401(h) account will
pay out during the year to provide current health benefits on
behalf of retired employees who are also entitled to pension
benefits under the plan. Key employees are not included.
The pension plan must provide that the accrued
pension benefits must become nonforfeitable for any participant
or beneficiary under the plan as well as for any participant
who separated from service during the year preceding the
transfer.
Section 420 also includes a five-year maintenance
of effort requirement. When 420 was originally enacted, the
employer was required to maintain the same retiree health costs
for the five years following the 420 transfer.
In 1994, Congress changed this cost-maintenance
requirement to a benefit-maintenance requirement. Under the
benefit-maintenance requirement, the employer must maintain
substantially the same level of retiree health benefits during
the five years following the transfer.
In addition, ERISA requires the plan administrator
to notify each participant and beneficiary of the amount to be
transferred and the amount of the pension benefits that will be
nonforfeitable immediately after the transfer. Notice must also
be provided to the Labor Department and any union representing
plan participants.
The Senate Finance Committee recently voted to extend
Sec. 420 through September 30, 2009. The Committee also voted
to replace the benefit-maintenance requirement with the pre-
1994 cost-maintenance requirement. We encourage this Committee
to consider the Finance Committee's action.
That completes my prepared statement. I would like to thank
the Chair and the Committee for giving ERIC the opportunity to
testify. I will be happy to respond to any questions that the
members of the Committee might have.

Attachment A

A Historical Summary of Limits Imposed on Qualified Plans

IRC Sec. 415(b) limit of $120,000 on benefits that
may be paid from or funded in defined benefit (DB) plans. Prior
to ERISA, annual benefits were limited by IRS rules to 100% of
pay. ERISA set a $75,000 (indexed) limit on benefits and on
future pay levels that could be assumed in pre-funding
benefits. After increasing to $136,425, the limit was reduced
to $90,000 in TEFRA (1982). It was not indexed again until
1988; and it was subjected to delayed indexing, i.e., in $5000
increments only, after 1994 (RPA). RPA also modified the
actuarial assumptions used to adjust benefits and limits under
Sec. 415(b). The limit for 1999 is $130,000. If indexing had
been left unrestricted since 1974, the limit for 1999 would be
approximately $238,000.
IRC Sec. 415(b) defined benefit limit phased in
over first ten years of service. ERISA phased in the $75,000
limit over the first ten years of service. This was changed to
years of participation in the plan (TRA '86).
IRC Sec. 415(b) early retirement limit. Under
ERISA, the $75,000 limit was actuarially reduced for
retirements before age 55. TEFRA imposed an actuarial reduction
for those retiring before age 62 (subject to a $75,000 floor at
age 55 or above); and TRA '86 imposed the actuarial reduction
on any participant who retired before social security
retirement age and eliminated the $75,000 floor. For an
employee retiring at age 55 in 1999, the limit (based on a
commonly-used plan discount rate) is approximately $52,037.The
early retirement reduction will become even greater when the
social security retirement age increases to age 66 and age 67.
IRC Sec. 415(c) limit of $30,000 on contributions
to defined contribution (DC) plans. ERISA limited contributions
to a participant's account under a DC plan to the lesser of 25%
of pay or $25,000 (indexed). The $45,475 indexed level was
reduced to $30,000 in TEFRA (1982); indexing also was delayed
by TRA '86 until the DB limit reached $120,000. RPA restricted
indexing to $5000 increments. The 1999 limit is still $30,000.
If indexing had been left unrestricted since 1974, the 1999
limit would be approximately $79,600.
5. IRC Sec. 415(c) limit of 25% of compensation on
contributions to defined contribution plans. Prior to ERISA,
the IRS had adopted a rule of thumb whereby contributions of up
to 25% of annual compensation to a defined contribution plan
generally were acceptable. ERISA limited contributions to a
participant's account under a DC plan to the lesser of 25% of
pay or $25,000 (indexed). Section 1434 of Public Law 104-188
alleviates the more egregious problems attributed to the 25%
limit for nonhighly compensated individuals by including an
employee's elective deferrals in the definition of compensation
used for Sec. 415 purposes. Public Law 105-34 alleviates an
additional problem by not imposing a 10% excise tax on
contributions in excess of 25% of compensation where the
employer maintains both a defined benefit and defined
contribution plan and the limit is exceeded solely due to the
employee's salary reduction deferrals plus the employer's
matching contribution on those deferrals.
6. Contributions included in the IRC Sec. 415(c)'s defined
contribution plan limit. ERISA counted against the DC limit all
pre-tax contributions and the lesser of one-half of the
employee's after-tax contributions or all of the employee's
after-tax contributions in excess of 6% of compensation. TRA
'86 included all after-tax contributions.
7. IRC Sec. 415(e) combined plan limit. Under ERISA, a
combined limit of 140% of the individual limits applied to an
employee participating in both a DB and a DC plan sponsored by
the same employer. E.g., if an employee used up 80% of the DC
limit, only 60% of the DB limit was available to him or her.
TEFRA reduced the 140% to 125% for the dollar limits. Section
1452 of Public Law 104-188 repeals the combined plan limit
beginning in the year 2000.
8. IRC Sec. 401(a)(17) limit on the amount of compensation
that may be counted in computing contributions and benefits.
TRA '86 imposed a new limit of $200,000 (indexed) on
compensation that may be taken into account under a plan. OBRA
'93 reduced the $235,000 indexed level to $150,000. RPA
restricted future indexing to $10,000 increments. The 1999
limit is $160,000. If this limit had been indexed since 1986
without reduction the 1999 level would be $272,520.
9. IRC Sec. 401(k)(3) percentage limits on 401(k)
contributions by higher paid employees. Legislation enacted in
1978 that clarified the tax status of cash or deferred
arrangements also imposed a limit on the rate at which
contributions to such plans may be made by highly compensated
employees. TRA '86 reduced this percentage limit. Section 1433
of Public Law 104-188 eliminates this requirement for plans
that follow certain safe-harbor designs, beginning in the year
1999.
10. IRC Sec. 401(m)(2) percentage limits on matching
contributions and after-tax employee contributions. TRA '86
imposed a new limit on the rate at which contributions may be
made on behalf of HCEs. Beginning in the year 1999, section
1433 of Public Law 104-188 eliminates this requirement for
matching payments on pre-tax (but not after-tax) elective
contributions of up to 6% of pay if those payments follow
certain safe-harbor designs.
11. IRC Sec. 402(g) dollar limit on contributions to 401(k)
plans. TRA '86 imposed a limit of $7000 on the amount an
employee may defer under a 401(k) plan. RPA restricted further
indexing to increments of $500. The 1999 indexed limit is
$10,000.
12. IRC Sec. 4980A--15% excise tax on ``excess
distributions.'' TRA '86 imposed an excise tax (in addition to
applicable income taxes) on distributions in a single year to
any one person from all plans (including IRAs) that exceed the
greater of $112,500 (indexed) or $150,000 (or 5 times this
threshold for certain lump-sum distributions). RPA restricted
indexing to $5000 increments. The limit was indexed to $160,000
in 1997. In addition, TRA '86 imposed a special 15% estate tax
on the ``excess retirement accumulations'' of a plan
participant who dies. Section 1452 of Public Law 104-188
provides a temporary suspension of the excise tax (but not of
the special estate tax) for distributions received in 1997,
1998, and 1999. Public Law 105-34 permanently repeals both the
excess distributions tax and the excess accumulations tax, for
distributions or deaths after 12-31-96.
13. IRC Sec. 412(c)(7) funding cap. ERISA limited
deductible contributions to a defined benefit plan to the
excess of the accrued liability of the plan over the fair
market value of the assets held by the plan. OMBRA (1987)
further limited deductible contributions to 150% of the plan's
current liability over the fair market value of the plan's
assets. Public Law 105-34 gradually increases this limit to
170%.
14. ERISA Sec. 3(36) definition of ``excess benefit plan.''
ERISA limited excess benefit plans to those that pay benefits
in excess of the IRC Sec. 415 limits. Other nonqualified
benefits must be paid from ``top hat'' plans under which
participation must be limited to a select group of management
or highly compensated employees.
LEGEND:
ERISA--Employee Retirement Income Security Act of 1974
HCE--highly compensated employee
IRC--Internal Revenue Code
IRS--Internal Revenue Service
OBRA '93--Omnibus Budget Reconciliation Act of 1993 (P.L.103-66)
OMBRA--Omnibus Budget Reconciliation Act of 1987 (P.L.100-203)
P.L.104-188--The Small Business Job Protection Act of 1996
P.L.105-34--The Taxpayer Relief Act of 1997
RPA--The Retirement Protection Act of 1994 (included in the GATT
Implementation Act, P.L.103-465)
TEFRA--The Tax Equity and Fiscal Responsibility Act of 1982 (P.L.
97-248)
TRA '86--The Tax Reform Act of 1986 (P.L. 99-514)

Attachment B

APPLICATION OF SAME DESK RULE TO PAYMENTS FROM TAX-QUALIFIED PLANS
------------------------------------------------------------------------
Type of Plan Does Same Desk Rule Apply?
------------------------------------------------------------------------
Conventional Defined Benefit Pension Plan. No
Cash Balance Pension Plan................. No
Money Purchase Pension Plan............... No
Profit-Sharing Plan....................... No
Stock Bonus Plan.......................... No
Employee Stock Ownership Plan............. No
Employer Matching Contributions........... No
After-Tax Employee Contributions.......... No
Sec. 401(k) Contributions................ Yes \1\
------------------------------------------------------------------------
\1\ The same desk rule also applies to Sec. 403(b) and Sec. 457(b)
plans, which are nonqualified plans sponsored by governmental and tax-
eemployers.

I. Understanding Cash Balance and Other ``Hybrid'' Defined Benefit Plan
Designs

The rapid emergence of new, dynamic technologies and
obsolescence of many existing products and services, the need
to respond to new domestic and global competitors, and the
changing attitudes toward career and work by employees in many
industries, requires that many employers change their
incentives to attract and retain talented employees. For
workers and employers in new and changing industries, and for
those employees who do not anticipate a single career with one
employer but who still value retirement security, the
traditional defined benefit plan design has given way to cash
balance and similar ``hybrid'' defined benefit pension plans.
The new plans are responsive to and popular with many
employees: the benefits are understandable, secured by the
federal Pension Benefit Guaranty Corporation (PBGC), and
provide greater benefits to women and others who move in and
out of the workforce. Moreover, the employer bears the risk of
investment for benefits that are nevertheless portable, and
employees under the new plans avoid ``pension jail'' and
``golden handcuffs.''
Recent news articles and 90-second ``in depth'' TV reports
have failed to provide useful and balanced background material
for understanding the dynamics of change in retirement security
plans. Moreover, legislation based on media coverage in an
effort to correct reported problems has been misdirected and
overreaching.
In order to start fresh and balance the scales, The ERISA
Industry Committee has prepared the accompanying materials that
identify the issues in the present debate and describe why many
employers have shifted from traditional defined benefit plan
designs.
The ERISA Industry Committee (ERIC) is a non-profit
association committed to the advancement of employee
retirement, health, and welfare benefit plans of America's
largest employers and is the only organization representing
exclusively the employee benefits interests of major employers.
ERIC's members provide comprehensive retirement, health care
coverage and other economic security benefits directly to some
25 million active and retired workers and their families. The
association has a strong interest in proposals affecting its
members' ability to deliver those benefits, their cost and
their effectiveness, as well as the role of those benefits in
the American economy.
We hope that these materials will help in understanding the
new direction many employers are taking to provide retirement
security. We hope to be in touch with you directly in the
coming weeks. In the meantime, please feel free to call on any
of us for information or assistance.

Very truly yours,
Mark J. Ugoretz
President
Janice M. Gregory
Vice President
Robert B. Davis
Legislative Representative

[Additional attachments are being retained in the Committee
files. Attachments may be accessed at www.eric.org]

Chairman Archer [presiding]. Thank you, Mr. MacDonald.
Mr. McCarthy, welcome to the Committee. We will be pleased
to receive your testimony.

STATEMENT OF JIM MCCARTHY, VICE PRESIDENT AND PRODUCT
DEVELOPMENT MANAGER, PRIVATE CLIENT GROUP, MERRILL LYNCH & CO.,
INC., PRINCETON, NEW JERSEY; ON BEHALF OF SAVINGS COALITION OF
AMERICA

Mr. McCarthy. Thank you, Mr. Chairman. My name is Jim
McCarthy. I am principally responsible for tax product
development at Merrill Lynch. Today I am here representing the
Savings Coalition. I am honored to be here and pleased that the
Committee is taking such a proactive stance in this area.
The Savings Coalition is a broad-based group of parties
representing 75 member organizations all of whom are interested
in increasing the rate of personal savings in this country. We
represent homebuilders, realtors, health care companies,
financial services industries, a list of the Savings Coalition
members is attached to my commentary.
As you all know, we have a looming savings crisis in this
country and I would--to put it in a larger context, I would
argue that success or failure in this area will cascade either
positive or negative results into the rest of the personal
financial health of Americans. The inadequacy of a retirement
savings pool will have disastrous effects, for example, in
things like the ability to fund education or health care costs.
So, as a result, while the savings shortfall is of sufficient
magnitude to gather everyone's attention, since it is the
largest pot of assets that tends to be held by American
workers, its spillover effect, if dealt with correctly and
solved, is magnified by that preeminent position.
The members of the Savings Coalition ask you, Mr. Chairman
and the Members of the Committee, to enact the provisions of
H.R. 1546, Congressman Thomas' bill also entitled the
Retirement Savings and Opportunity Act of 1999. Among other
changes, that legislation would substantially expand personal
savings by increasing the maximum permitted IRA contribution
from $2,000 to $5,000. It would eliminate a number of
interrelated and complex caps on eligibility, counterproductive
income limits and allow additional catchup contributions to
IRAs for those nearing retirement.
Before going into the provisions of 1546 in more detail,
let me congratulate the Members of the Committee on their work
in 1997 to, in essence, bring the IRA out of retirement. Our
experience at Merrill Lynch indicates, for example, that the
new Roth IRA, which originated in this Committee under the name
of the American dream savings account, could well be the most
effective new savings generator since the successful expansion
of the 401K plans in the early eighties and nineties.
This has been a critical step in strengthening the private
savings leg of the traditional three-legged stool. We think in
large measure the Roth IRA has had the success because of its
relative simplicity. For example, at Merrill Lynch, we have
seen an increase of more than 80 percent in IRA contributions
in the last year. That is an astounding number that I would
like to put in historical context in just a moment, but given
that it is the first year of a financial instrument or an
account vehicle being in place, an 80-percent increase in
contributions is just a staggering kind of launch of acceptance
and internalization by the American public.
Also in our 401(k) business, for example, we have seen less
leakage out of our system because of the heightened--In
defining leakage, I refer to the number of distributions that
are not rolled over to either an IRA or a subsequent employer
plan, in part because we believe of the heightened public
awareness of the need to both quantify and then attack through
aggressive savings the challenge of saving adequately for
retirement.
An interesting aspect of the Roth IRA expansion, for
example, is that we have seen a tremendous increase in the
amount of traditional IRA contributions. We have had almost a
60-percent increase in the number of traditional IRA
contributions that we have had and what we think is that if
people come to the door asking for ways to focus on retirement
savings, they will leave with the solution that fits them best.
We know the personal savings rate in this country has
dropped from roughly 8 percent during the sixties and seventies
down to what many would argue is a very anemic one-half of 1
percent currently, and in certain months we have been negative.
While we believe that the nature of the statistic is not
perfect, we believe that this is an area that needs to be
addressed. Our own research, we have Douglas Bernheim, a
Stanford economics professor, who prepares a baby-boom index
for us. That index currently stands at 32 percent, which means
there is 68 percent inadequacy of retirement savings.
Let me just get into some of the provisions of H.R. 1546.
First and foremost, we need to raise the contribution limit
from $2,000 to $5,000. That limit has been in place since 1981.
It is far short of the $5,000 that would be the limit in the
event that a number had been originally indexed.
We also think that it is increasingly important to
eliminate the complexity and the interrelation between
eligibility and income deductions, especially in a married
couple. Because, in effect, we have imposed a marriage penalty
on savings, for people who want a simple and portable vehicle
in which to make their retirement savings. We think that this
is especially important in that the bulk of job creation is
happening in the small employer market and, as a result,
traditional plan coverage is not rising there as fast as it is
in the larger employer market.
The last provision is catch-up provisions for those over
50, the ability to, in effect, fund a plan that has not been
adequately funded before. We think that it is particularly
important to women who have been out of the work force or who
may be more transitory in the work force, and we urge with all
emphasis and haste that the Committee enact H.R. 1546.
Thank you.
[The prepared statement follows:]

Statement of Jim McCarthy, Vice President and Product Development
Manager, Private Client Group, Merrill Lynch & Co., Inc., Princeton,
New Jersey; on behalf of Savings Coalition of America

Mr. Chairman, let me commend you and the other members of
this Committee for holding this hearing today. Savings, and
particularly retirement savings, is the key to America's long-
term economic prosperity.
I am Jim McCarthy, Vice President and Product Development
Manager, Private Client Group, for Merrill Lynch & Co., Inc. I
am here today representing the Savings Coalition of America.
The Savings Coalition is a broad-based group of parties
interested in increasing personal savings in the United States.
The 75 member organizations of the Savings Coalition represent
a wide variety of private sector organizations including
consumer, education and business groups; senior citizen groups;
home builders and realtors; health care providers; engineering
organizations; and trust companies, banks, insurance companies,
securities firms, and other financial institutions. A list of
the members of the Savings Coalition is attached.
With Americans saving less than at any time since World War
II, we stand at a crossroads. For individuals (including
especially the baby boom generation), inadequate savings today
will lead to a retirement crisis in the next century. If
Americans do not begin saving more for retirement soon, the
pressures on the Social Security system that are caused by the
aging of our population will be compounded. With Americans
living longer, millions of Americans will face prolonged
retirements without the financial wherewithal to meet day-to-
day needs. Moreover, if low savings rates continue at the
national level, they will, over time, lead to higher interest
rates and slower economic growth--further increasing the
difficulty of dealing with the problems raised by the changing
demographics of our population. For these and many other
reasons, doing something now to enhance retirement savings is
critical.
Traditionally, retirement security for Americans has been
based on the so-called ``three-legged stool''--Social Security,
employer-sponsored retirement plans and personal savings.
Dealing with our nation's ongoing savings shortfall effectively
will require that each of those legs be strengthened. In
particular, Congress should not ignore the critical personal
savings leg of the three-legged stool and the Individual
Retirement Account, or IRA, has proven over the last 25 years
to be the most effective method for focusing personal savings.
Mr. Chairman, the members of the Savings Coalition ask you
and the other members of this Committee to enact the provisions
of H.R. 1546--the Retirement Savings Opportunity Act of 1999,
introduced by Congressman Thomas. Among other important
changes, that legislation would substantially expand personal
savings by increasing the maximum permitted IRA contribution
from $2,000 to $5,000, eliminating the complex and
counterproductive income limits on IRA participation, and
allowing additional catch-up contributions to IRAs for those
approaching retirement.

IRAs and Roth IRAs Work

Before going into the provisions of H.R. 1546 in more
detail, let me congratulate the members of this committee for
beginning the process of bringing the Individual Retirement
Account ``out of retirement'' in 1997. Our experience at
Merrill Lynch indicates that the new Roth IRA (which originated
in this Committee under the name American Dream Savings
Accounts) could well be the most effective new savings
generator since the successful expansion of section 401(k)
plans in the 80s and early 90s.
One need go no further than the advertisements in the
newspapers and other media to see that the Roth IRA changes
that Congress enacted in 1997 have revitalized America's
interest in the IRA. With expanded advertising, more and more
people have begun asking questions about the new savings
options available to them. In the process, they are becoming
better educated about the importance of saving for retirement.
For many, there has been a growing awareness of how far behind
they are in saving for a financially secure retirement.
Although it is still early, our Financial Consultants tell
us that many of our customers are responding to the pro-savings
message that the Roth IRA sends. Significantly, they are
increasing their savings not only through Roth IRAs, but also
through traditional IRAs and other savings vehicles.
As with any new financial product, consumer interest builds
over time. But under almost any reasonable measure, the Roth
IRA has been a tremendous success. Industry-wide statistics are
not yet available for 1998, the first year that the Taxpayer
Relief Act of 1997 IRA changes went into effect, but
preliminary results at Merrill Lynch show an unprecedented
increase in IRA activity. Through December 1998, we have seen
an increase of more than 80 percent in the number of total IRA
contributions over the same period in 1997--an astounding
increase for a new savings vehicle. This includes new Roth IRAs
and increased contributions to traditional IRAs. And we can
expect contributions for 1999 and beyond to increase even more
as consumer awareness grows, just as IRA contributions grew
steadily between 1982 (the first year IRAs became universally
available) and 1986 (when IRA access was severely restricted).
One interesting aspect of the Roth IRA expansion is that we
have seen considerable spillover savings resulting from the
Roth IRA advertising. For example, we have experienced a
sizable increase in traditional deductible IRA contributions.
To some extent that increase is attributable to the changes
that were enacted in 1997 expanding the availability of
deductible IRAs. However, we have seen people who were always
eligible for deductible IRAs come back because they did not
realize they were eligible in the past. They have called to ask
about the Roth IRA, but have decided to contribute to a
traditional IRA or another savings vehicle. The Roth IRA
legislation deserves the credit for putting those people back
in the savings habit.
To illustrate how big a success the Roth IRA and other 1997
Act IRA changes have been, one need only compare the early
stages of today's developing IRA market with the early stages
of other new savings vehicles created by Congress--including
earlier versions of the IRA. Once again, we won't have complete
statistics for quite some time, but when you compare the IRA
activity we have seen in 1998 with our early experience with
other products, the success of the 1997 IRA changes becomes
clear.
In calendar year 1998, Merrill Lynch established more than
two and one half times more new IRAs than we established during
the same period in 1982, the first year of universal IRA
eligibility. This despite the fact that the IRA available in
1982 was simpler, available on a fully-deductible basis to most
Americans, and more tax-advantaged (due to higher marginal
income tax rates that were in effect in 1982). Additionally,
with the ongoing popularity of the 401(k) plan, the Roth IRA
has succeeded in the face of a variety of other alternative
choice's. Similarly, the new Roth IRA has been extremely well
received when compared with other recently introduced tax
vehicles. In 1998, for example, Merrill Lynch established one
hundred times more Roth IRAs than Medical Savings Accounts.
These recent developments, confirm what we already knew
from earlier experience, the IRA works at increasing individual
savings. The IRA has proven time and again to be the single
most effective vehicle for encouraging personal retirement
savings by Americans.

Need for More Change

Despite the initial success of the changes enacted in 1997,
there is no question that current savings incentives will not
be sufficient to reverse America's serious savings shortfall.
The 1997 Act IRA changes were important steps in beginning the
process of improving the incentives to save. But more change is
needed.
Since the 1970s the U.S. personal savings rate has declined
steadily. During the 1960s and 70s, our national savings rate
averaged around 8% per year. In the last half of the 80s, it
dropped to about 5.5% and in the 90s it has dropped to a 3.6%
annual average. Last year, the savings rate was an anemic \1/2\
of 1 percent, the lowest level since the Great Depression of
the 1930s.
It is the baby boom generation that is in the most danger.
Research by Stanford University economist Douglas Bernheim, who
compiles an annual Baby Boom Retirement Index for Merrill
Lynch, has consistently shown that the baby boom generation has
fallen as much as two-thirds behind the rate of savings that
they need to maintain their current standard of living in
retirement. It is our responsibility to help the baby boom
generation (and future generations) to start saving more. If we
do not accomplish that goal soon, the financial burden that
will be placed on our Social Security system, our economy, and
ultimately our children and grandchildren, in the next
millennium could be disastrous.
While there are many causes for our national savings
shortfall, one of the main reasons is that our tax system
continues to penalize savings and investment. What became known
as the Roth IRA was an innovative step to correct that
imbalance. The additional proposals made in H.R. 1546, are the
next logical steps toward providing every American with a
meaningful opportunity to save for a secure retirement.
Let me highlight a few of the changes proposed in the H.R.
1546 that we believe would have the most beneficial impact.

Why 2K?

The current $2,000 maximum IRA contribution has been in
place since 1981. H.R. 1546 would increase the maximum IRA
contribution to $5,000 for both Roth and traditional IRAs (and
would index that limit for future inflation). That change is
long overdue--almost 20 years overdue. The limit on IRA
contributions has been stuck at $2,000 since 1981. If the IRA
contribution limit had been adjusted for inflation since IRAs
were created in 1974, Americans could now contribute about
$5,000 per year to an IRA. Of all retirement savings plans,
only the IRA limit has never been indexed for inflation.
As things stand today, the maximum IRA contribution is not
adequate to meet the growing retirement needs of Americans.
Future retirees can look forward to longer life expectancies
and more years in retirement. When combined with continuing
inflation in medical costs (which are especially important for
those in retirement) and the long range financial challenges
facing the Social Security Trust Fund, it becomes clear that
the need for a significant personal savings component in
retirement is becoming even more critical than it was in the
past. A two-legged, stool consisting of Social Security and
employment-based retirement plans, cannot be expected to meet
the increasing need. Also, for many of the more than 50 million
workers who are not covered by an employment-based retirement
plan, IRAs may be the only retirement savings opportunity.
Interestingly, we have found that more than 90% of our
customers contributing to an IRA fund it at the annual $2,000
maximum. They save the maximum amount permitted and commit that
amount to long-term retirement savings. With higher
contribution limits, we fully expect that many of those
individuals will save more.
Even for those who do not contribute the maximum in every
year, the higher contribution limit will allow flexibility to
make IRA contributions in the years that they have the
resources to make the contributions. For example, a family
where one spouse remains at home to care for children will
often not have disposable income for large IRA contributions.
When the children are older, however, the couple may be better
able to make IRA contributions. The higher contribution limit
will allow that couple to make larger IRA contributions during
the years they can afford to do so.
Let me also note that in the course of our experience with
millions of IRAs we have found that there is a very strong
correlation between the size of an account and the attention
and discipline that an individual affords to that account. Put
simply, once an account achieves a certain ``critical mass,''
it becomes the individual's nest egg and they become much more
disciplined with respect to that account balance. They become
less likely to make withdrawals and more likely to continue
adding to the account. Conversely, relatively small accounts
have a tendency to go dormant after only one contribution and
are more likely to be withdrawn. Of course, every person's
``critical mass'' is different, but by raising the maximum
initial IRA contribution, the chances that more people will
start down the savings path (and stick to it) will be increased
substantially.

Eliminate Complexity

Today, eligibility for traditional deductible IRAs, Roth
IRAs and spousal IRAs can be determined only after the taxpayer
works through a complex maze of eligibility requirements that
include a variety of income limitations and phase-outs. Which
of the various eligibility limits applies depends, in part, on
the type of IRA the individual wishes to establish and whether
the individual (or the individual's spouse) actively
participates in certain types of employment-based retirement
plans.
The current IRA eligibility limitations (which were
initially included in the Tax Reform Act of 1986) are
unnecessarily complex and counterproductive--doing far more
harm than good. Those limitations substantially impair the
potential effectiveness of IRAs as a savings promoter and
should be repealed as proposed in H.R. 1546. Without the income
limits, we would see increased savings among all income classes
and would also eliminate the marriage penalties that are
inherent in the structure.
Even with the improvements included in the 1997 Act, many
middle income Americans are still not eligible for a fully
deductible IRA. For couples with income above $51,000 and
individuals with income above $31,000, the fully deductible IRA
is generally not an option. Although the Roth IRA was wisely
made available to a broader segment of the population, the
application of income limits on Roth IRAs remains detrimental.
To begin with, the current income limits impose a severe
marriage penalty on certain couples. Take, for example two
individuals who will earn $30,000 each this year. If they are
unmarried, both are allowed to make fully deductible $2,000
contributions to an IRA. If they marry, however, their IRA
deductions will be reduced to $200 each. Under today's tax
rules, that couple faces an increase of $1,250 in their Federal
income taxes just for getting married, and $1,000 of that
marriage penalty (about 80%) is attributable to the eligibility
limits currently imposed on deductible IRAs. H.R. 1546 would
eliminate that marriage penalty.
Our experience has also shown that the people who are
harmed most by the income limits are not the wealthy. To the
truly wealthy, the relatively small IRA tax advantage has
little affect on their overall tax burden. The people who are
harmed by the income limits are those who are stuck in the
middle. These are people who do not necessarily have
sophisticated tax planners and accountants giving them advice.
They will only proceed in committing their money into an IRA if
they are confident that they will not get tripped up by the
rules. Some of these people will delay contributions to make
sure they will qualify, and then later forget to make the
contribution or spend the money before they get around to
making a contribution. Others may qualify for a full or partial
IRA this year, but still will not contribute because the
contribution permitted this year is too small, or because they
assume they won't qualify in the future and they don't want to
start contributing if they are not sure they will be able to
continue the process in future years. Still others are confused
and believe they may have to withdraw the funds if their income
goes up in the future.
The end result of today's complicated limits on IRA
eligibility is that contributions are not made by many of those
who are technically eligible (or partially eligible) under the
rules in a given year. This same chilling effect has been in
effect since Congress originally imposed income limits on
deductible IRA eligibility in 1986. Before the 1986 Tax Reform
Act, the IRA was available to all Americans with earned income.
The year after the income limits on IRAs went into effect,
contributions by those who remained eligible dropped by 40%.\1\
---------------------------------------------------------------------------
\1\ Testimony of Lawrence H. Summers, currently Deputy Secretary of
the Department of the Treasury, before the U.S. Senate Committee on
Finance, September 29, 1989.
---------------------------------------------------------------------------
In restoring universal IRA eligibility and--the rule that
was in effect before 1986--H.R. 1546 would help all Americans
to save more. By eliminating the complexity in the current
rules, Americans will be presented with a consistent and
understandable pro-savings message--a clear consensus path to
follow toward retirement security. That message will be
reinforced by the general media, financial press, financial
planners, and word-of-mouth. As families gain confidence in the
retirement savings vehicles available to them, more and more
will commit to the consensus path.

Catch-up Contributions

H.R. 1546 would also allow those age 50 and older to make
additional IRA contributions of $2,500 per year. This change
could be a critical step in helping people who are closer to
retirement to save more. We believe that this type of targeted
change could be particularly effective because as people
approach retirement age they become more focused on retirement
needs. In many cases, individuals forego making an IRA
contribution in a particular year because of insufficient
income, illness, temporary unemployment, a decision to stay
home with children, or pay for their children's education.
Annual contribution limitations prevent these individuals from
making-up for lost retirement savings once the cash-flow crisis
is over or their income rises.
Women, in particular, are more likely to have left the paid
workforce for a period of time to care of children or elderly
parents. During those years they were probably not eligible (or
did not have the resources) to make retirement savings
contributions. Allowing an IRA catch-up would help ensure that
a woman's decision to fulfill family responsibilities does not
have to lead to retirement insecurity.
It is also worth noting that many of those in today's
population who are approaching or have reached age 50 did not
have IRAs or 401(k) plans available through most of their
working careers. They did not have the same opportunities to
save that today's generations have. Instead, due to changes in
the structure of the American workplace, they were caught in
the transition from a relatively robust system of defined
benefit pensions to the self-reliance focus of today's defined
contribution landscape. Giving the baby boom generation the
chance to catch-up for years they may not have saved adequately
is not only fair, it is critical to helping them build a bridge
to a financially secure retirement.
In the end, each American must accept significant
responsibility for his or her own retirement security. But the
government must help by reducing the tax burden on those who
save and by making the choices simple and understandable. With
that end in mind, our national retirement savings strategy must
include an effective set of incentives that will expand
personal savings. And the proven IRA vehicle should be the
backbone of that effort.
The IRA changes enacted in the 1997 Act were a significant
first step toward an improved set of rules for promoting
personal savings. But more remains to be done. Today, with an
improved federal budgetary picture, it is time to act on
additional proposals, like those included in H.R. 1546, that
will directly address America's impending retirement savings
crisis. Enhanced retirement savings incentives are the most
effective investments we can make as a nation. Those
investments will pay back many times over in increased
retirement security for Americans and in a stronger economy.
For these reasons we urge the members of this Committee to
include proposals that will strengthen the IRA as part of any
legislation that is reported this year.

SAVINGS COALITION OF AMERICA MEMBER ORGANIZATIONS

Aetna Retirement Services
Alliance of Practicing CPAs
American Association of Engineering Societies
American Century Investments
American Council on Education
American League of Financial Institutions
Americans for Tax Reform
Bank of America
Charles Schwab Corporation
Citigroup
Coalition for Equitable Regulation and Taxation
Consumer Bankers Association
Credit Union National Association
Edward D. Jones & Company
Financial Network Investment Corporation
G.E. Capital
HD Vest Financial Services
Household International
Independent Insurance Agents of America
Investment Company Institute
Institute of Electrical & Electronics Engineers--U. S. Activities
Merrill Lynch & Company, Inc.
Mortgage Bankers Association of America
National Association for the Self-Employed
National Association of Federal Credit Unions
National Association of Independent Colleges and Universities
National Association of Uniformed Services
National Taxpayers Union
Prudential Securities, Inc.
Retirement Industry Trust Association
Savers & Investors League
Securities Industry Association
The Bankers Roundtable
United Seniors Association
United States Chamber of Commerce
Wheat First Butcher Singer
A.G. Edwards, Inc
America's Community Bankers
American Bankers Association
American Council for Capital Formation
American Express Financial Advisors
American Nurses Association
Association of Jesuit Colleges and Universities
Bankers Pension Services
Chase Manhattan Bank
Citizens for a Sound Economy
College Savings Bank
Countrywide Credit Industry
Delaware Charter Guarantee & Trust Company
Fidelity Investments
First Trust Corporation
Gold & Silver Institutes
Home Savings of America
Independent Community Bankers of America
Institute for Research on the Economics of Taxation
International Association for Financial Planning
Lincoln Trust Company
Morgan Stanley Dean Witter
NASDAQ Stock Market
National Association of Enrolled Agents
National Association of Home Builders
National Association of Realtors
National Rural Electric Cooperative Association
PaineWebber, Inc.
Resources Trust Company
Retirement Accounts, Inc.
Scudder Kemper Investments
Sterling Trust Company
USAA
United States Chamber of Commerce

Chairman Archer. Thank you, Mr. McCarthy.
I don't have any questions, but I do want to explore one
aspect of where we are in this country and what concerns me and
that is the dearth of savings.
We have heard a number of times today, the term ``personal
savings.'' And is it not true that really what we need to be
concerned about is total net private savings, not just personal
savings? Because in the end the benefit of personal savings is
to invest, to create jobs and productivity, at least according
to my basic sense of economics. And in that regard all of
private savings, whether they be personal or whether they be
held by a business entity, reaches that goal.
The personal savings, to be productive, must be invested in
some sort of a productive vehicle. If that productive vehicle
is able to accumulate additional savings internally, those are
equal to the personal savings that are invested and become, to
me, a far better measuring tool as to where we are and where we
want to go. And, as I understand it, private--not just personal
but private net savings in this country are at an alltime
historic low and are negative and not positive. Is that correct
as you understand the figures right now?
Mr. McCarthy. I would agree with the Chairman's remarks
regarding the need to look at the savings in aggregation.
The personal savings rate as a statistic compiled by the
Bureau of Economic Analysis is, in fact, negative. I would say
that it is at best an imperfect measure in the sense that it is
a residual effect. It doesn't take into account wealth that
grows outside.
But I don't think anybody is arguing that savings is
adequate as it stands now. It clearly needs improvement--both
ranked with other industrialized nations and to create capital
formation and thus bring down things like equilibrium interest
rates and stimulate economic growth, we believe that H.R. 1546
and a number of other proposals before this Committee right now
are steps in that direction.
Chairman Archer. To go back to your analysis, which I
cannot argue with, because if the accumulation of wealth
increases, then certainly our savings have gone up, but, on the
other hand, if the market goes down and, say, personal savings
rates have gone down, so that works both ways. When the market
goes up, we do not count that in this standard to determine
what our personal savings rate is, but when it goes down, we do
not count it as a negative.
Mr. McCarthy. The Federal Reserve flow of funds data takes
into account equity holdings in-household, and it does meter it
both ways. It catches it up on the upside and catches it on the
downside, and that becomes the basis for our analysis into
things like whether people are adequately prepared.
Chairman Archer. I thank you very much, all of you, for
your testimony.
Does any Member wish to inquire?
Mr. Portman, and then Mr. Weller.
Mr. Portman. Thank you, Mr. Chairman.
I want to thank the panelists who are with us now and also
Jeanne Hoenicke, who spoke earlier regarding the necessity for
reforms in our pension system, to try to increase that savings
rate that the Chairman was just talking about, private and
personal.
APPWP has been very helpful in putting together this
proposal over the years, Mr. Stewart, and has been particularly
helpful in working with us and people in the trenches who every
day deal with these issues; and I want to ask you a couple of
quick questions about limits. Can you explain why it is so
important to raise defined contribution limits?
Mr. Stewart. First of all, it is not really an increase, it
is more of a restoration of the limits that H.R. 1102 would
impose.
Second, the firm that I work for works with mostly small-
to medium-sized businesses. In lot of those, the businessowners
are telling us they have had a tough 5 to 10 years getting
their business started. They can't afford to start a retirement
plan. The key decisionmaker may be in their forties or fifties
at the time they get the business on solid ground. They need to
make up for the past years that they have not been able to
contribute to a plan. The restored limits would incent them to
put enough money away in a qualified tax plan and to get that
tax-qualified status they need to share some of those benefits
with the rank and file workers.
Mr. Portman. That is the point, and we tried to make that
point this morning. This is a question of getting the
decisionmakers to make the right decision and get them to have
the same stake in this plan that the lower-paid workers would
have. Just in terms of limits, in 1986, the limits on 401(k)s
and 403(b)s was $30,000. We are proposing raising it from
$10,000 to $15,000.
Paula, thank you for your testimony. You are representing
so many groups I don't know where to start, but all of them
have been active in the coalition over the last few years and
you tend to represent, when you look at these three groups
listed, more of the small business community.
Can you give us a sense of how important it is to reduce
setup costs and ongoing PBGC premium costs for small business
and whether those provisions of the bill are going to make any
difference in terms of getting more small employers involved in
establishing pensions?
Ms. Calimafde. If I can go back to the limits question
quickly, because from the small business perspective and also I
think it is the large business perspective, it is important to
understand that the upper middle income taxpayers and upper
income earners have, in effect, been disenfranchised from the
retirement plan system. And if you imagine the Social Security
system if you took out all of your upper middle income
taxpayers or your upper income taxpayers or earners and said
you get no benefits or very reduced benefits, what would happen
to that system? Many people believe that it would have serious
consequences to that system being kept energized; and, in a
sense, that is what has happened in a qualified retirement
system. These limits have kept out the key employees of the
companies from having any really meaningful benefits coming
from the retirement plans; and, consequently, the normal
pressure to have a plan or increased contributions isn't there.
Small businesses want to sponsor these plans. As I
mentioned earlier, it is a cost-benefit analysis. If the costs
of the plan are too high in relationship to what the benefits
of the owners and key employees can get, they just simply will
not sponsor the retirement plan.
I think what is interesting about H.R. 1102 is that it
keeps all of the reforms that were put in in the eighties to
stop abuse and it strips away all of the unnecessary
complexity, and so it will definitely reduce costs for small
businesses.
My estimation is this bill, if passed, would encourage
small businesses to sponsor retirement plans.
Mr. Portman. Mr. MacDonald, the Chairman talked about the
need to look at investments in productive vehicles, that is the
key, and I could not agree more, and that is why I think the
pension area is so important.
You mentioned 28 percent of investments in equities are now
pension investments. If you can just touch on that, getting
into the key issues with regard to savings, what will the
impact be on savings by having an expansion of pensions and
having more money being invested in these kinds of vehicles?
Mr. MacDonald. We personally believe, both from a GTE
perspective and an ERIC perspective, that the expansion of the
limits is going to encourage employers to stay with their
plans, particularly defined benefit plans. And what you are
really talking about here is the ability to have a disciplined,
secured, guaranteed approach. It is funded. It is there. It is
in the bank. It creates that savings. It has automatic
participation. And that is what we are ultimately trying to do
with all of our people. We are trying to get them to think
about the retirement security that they need to have when they
end their career.
Mr. Portman. Thank you. Thank you, Mr. Chairman.
Chairman Archer. Thank you, Mr. Portman.
I am constrained to interject another little bit of an
issue into this discussion today, very briefly.
I have long felt that if individual workers realized their
equity ownership as beneficiaries of a pension plan, they would
be better citizens. What would it take to create a system where
every worker would get a statement at the end of each year as
to what their ownership was in the stocks and bonds held by the
pension funds?
Mr. MacDonald. I can only speak for my company, but those
statements exist today in our company. We go to great pains,
and I think many large corporations do, to talk about two
things: What is in the account and what are you accruing as an
accrued benefit and how that is invested. Each year we go to
great pains to talk about the investment of those funds and
provide that information to people. It is a matter of fiduciary
responsibility. It is there.
The people who run those investment funds have to report to
people like myself and tell me. So it is only a matter of
reproducing and providing it to those same people.
I also think that it gives them a spirit of ownership.
Using the ESOP is a good example of that. If they were able to
reinvest in dividends and have the employer tax deduction, in
essence what you are really doing is creating further ownership
in your own company, and that is what we are looking for. We
are looking for loyalty and commitment. That is what will
encourage those types of participations in those types of
plans.
Chairman Archer. In your report to your workers, do you
literally give them how much money is in their account and
identify their beneficial ownership in x number of shares in
each of the corporations to show what their actual ownership
is, beneficial equity ownership in each of corporations? Or do
you simply just list the total number of corporations that the
entire pension fund is invested in?
Mr. MacDonald. In fairness, it is the latter. We list the
total corporations that we are involved in.
However, to your first point, they don't have to wait until
the end of year. They can literally call up every day if they
wanted to and get their pension estimated, their accrued
benefit to date on an IVR system, put in when they want to
retire, what the assumptions are that they want to use, so they
are constantly projecting. That is our way to get them to
understand the criticality of savings.
Chairman Archer. If you went one step further, it would be
even better because if the individual workers saw I have x
thousands of dollars in my account and that means that I own 10
shares of IBM and I own 5\1/2\ shares of--whatever, the various
corporations, it would identify I think more particularly to
each worker their stake. But I applaud you for what you are
doing.
Mr. Neal.
Mr. Neal. Thank you, Mr. Chairman. I thought the panels
were very good, Mr. Chairman, and their presentations were
pretty strong.
Given the current level of activity with respect to
conversion of traditional defined benefit plans to cash balance
plans, in some instances resulting in long-term workers being
disadvantaged, what notification requirements could you support
for the workers whose benefits are being changed and would you
support mandatory individual statements for those employees who
ask for them?
Mr. Stewart. There are provisions in H.R. 1102 that APPWP
supports. As far as disclosure, we feel there needs to be
adequate disclosure for plan members to know what their
benefits are going to be--what their benefits are before the
conversion and what they are going to be after the conversion.
We don't want to necessarily increase the burdens on the
plan sponsors, but I might say about cash balance plans that in
many cases, it is the employees who are asking for cash balance
plans because they don't necessarily appreciate or know enough
about the traditional defined benefit plan. They like the idea
of a cash balance plan because they can see an account building
up in their name, sort of getting back to what the Chairman was
talking about.
But we would support adequate disclosure.
Mr. Neal. Anyone else?
Mr. MacDonald. If I may just interject for a second, the
issue of providing people with information I think most
companies are very comfortable with, but somehow this cash
balance thing has gotten completely out of sync. There appears
to be a feeling that it is all done for savings. That is not
the issue here.
The savings issue is really an accounting process that
people work through the accounting ledger. What is going on is
that the demographics of the work force are changing. Case in
point. We just bought a company in 1997, BBN. It is an Internet
company, 2,000 employees. This year, we will end with 7,000
employees; and, next year, we will end with 14,000 employees.
When I talked about our pension plan, rule of 76, age plus
service for early retirement, they fell asleep. These are
Internet working people. They are basically looking at 3 to 5
years, and then they are going somewhere else. Portability is
becoming the issue. There are a lot of us who would like to
stay and have the handcuffs and keep people in the jail. We are
competing for talent. You have to basically look at the needs
and what the talent is. There is a shortage of labor. We have
to do what employees are demanding. This is not an issue of
savings. This is an issue of the war for talent in the
marketplace.
Mr. Neal. Any other panelists?
Ms. Calimafde. In the small business area, there are
relatively few defined benefit plans, so this is a nonissue for
small business, unfortunately.
Mr. Neal. Thank you, Mr. Chairman.
Chairman Archer. Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman.
I want to thank the panelists for participating today.
Mr. Stewart, just looking back at statistics, when we talk
about cash balance conversions, since the eighties, 7 million
workers have been affected by transition from cash balance
plans involving 400 companies, including 22 Fortune 100
companies. When I think about it, for a worker, their pension
and retirement program is pretty sacred. From the standpoint of
a company, what is in the interest of a company to convert from
a traditional pension plan over to a cash balance plan?
Mr. Stewart. On Friday I was consulting with one of our
existing customers in Chicago. It is a fairly large nationwide
company that has locations in several different parts of the
country. They have a traditional defined benefit plan and a
traditional 401(k). They have a lot of younger workers, as was
alluded to earlier. Their formula is a little bit complicated,
and they want to attract newer, younger workers who are
probably going to be moving on. The statistics would say that
the average U.S. worker would have seven to eight jobs before
they retire.
So it isn't necessarily a cost savings that they are
looking at. In fact, the specific instructions that they gave
us as we went home to prepare a proposal for them, was to keep
costs the same. We just want a plan that will be more
understandable to our employees, that they can appreciate a
little more.
I think in the traditional DB arena, employees just don't
know enough about----
Mr. Weller. Reclaiming my time, the Wall Street Journal
has, of course, highlighted some of the problems with the
conversions, and I am sure that you have read those thoroughly.
And in the Chicago area there have been some conversions
affecting many of my constituents.
Senator Moynihan and I have put in legislation two
companion bills in the House and Senate that would require
individual statements showing a comparison of the benefits
under the old plan and the new plan for each of the employees
because we feel that employees have a right to know the impact
because we assume that the company knows the impact on the
company bottom line, but the employees need to know the same.
What disturbs me, though--and we have an example of where
one consultant pitched a cash balance plan to a potential
client. He said, ``One feature which might come in handy is
that it is difficult for employees to compare prior pension
benefit formulas to the cash balance approach.'' Don't you feel
that employees have a right to know the impact of any
conversion?
Mr. Stewart. That is an unfortunate comment that the
consultant had made. I agree that employees should know about
the change in any benefit plan, whether it is health plan or a
pension plan.
Mr. Weller. Do you feel that employees deserve a comparison
sheet before the conversion showing under their current
situation their current pension plan and the proposed change,
what it will mean for them in retirement?
Mr. Stewart. I think the Association would advocate a
middle ground approach which is not so burdensome as an
individualized statement per member. Here is a scenario for a
30-year-old, 40-year-old, 60-year-old with x number of years of
service, average compensation being different.
Mr. Weller. How can the corporation calculate the impact on
the corporate bottom line without knowing the individual bottom
line for each individual employee?
Mr. Stewart. Most of these conversions would involve plans
with thousands of employees. They wouldn't have it broken down
one by one. It would be on a bottom-line, plan-level basis.
Mr. Weller. Senator Moynihan and I believe that we have
offered some middle ground legislation. We don't prohibit you
from making a conversion. We just believe that employees have a
right to know with individual statements. Would you support the
legislation Senator Moynihan and I have offered?
Mr. Stewart. We would be willing to work with you to try to
come up with an acceptable middle ground approach.
Mr. Weller. I would like to work with you and your
associates. The corporation certainly knows and whether you are
a new employee or long-time employee you should know the bottom
line on the individual impact on your retirement with any
conversion that might occur.
Mr. Stewart. I appreciate your comment. I think employees
do need to be aware, and the more that the employees know about
the plan the better the plan is going to be.
Mr. Weller. Thank you, Mr. Chairman.
Chairman Archer. Mr. Cardin.
Mr. Cardin. Thank you very much, Mr. Chairman.
Let me thank all of our witnesses for their participation,
not just in the hearing today but in helping Mr. Portman and I
on H.R. 1102 and your other work in pension areas.
First, following up on the conversation about employee
education, this morning Ms. Dunn commented on the importance of
making sure that employees are educated on retirement options
and what they need to do to make sure that they have secure
retirement.
H.R. 1102 clarifies when employers offer retirement
planning education that it is not taxable to the employee and
that it clarifies that employers can offer retirement planning
on a nondiscriminatory basis in a fashion similar to a
cafeteria benefit plan without the cost being taxable to the
employee.
Mr. Chairman, I would like to enter into the record a
letter of support of these provisions from the Consumer
Federation of America. CFA points out that education and
planning increases savings. More specifically, those savers who
develop an overall financial plan report roughly twice the
savings of those without a financial plan, but CFA knows that
most Americans are ill-equipped to develop their own retirement
planning guide.
Chairman Archer. Without objection, so ordered.
[The information follows:]
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[GRAPHIC] [TIFF OMITTED] T0332.002

Mr. Cardin. I appreciate your response to some of Mr.
Portman's questions as to the specific provisions in H.R. 1102
as to what impact it would have.
The Chairman raises, I think, the initial challenge. We
need to increase more private savings. Part of what H.R. 1102
does is, as Mr. Stark points out, is restore some of the
previous limits. It doesn't really increase in many cases, it
just restores.
The question is, will that really increase the amount of
money that will be put away for savings and retirement if
Congress were to enact these different limits? I guess that
would be the first question that I would appreciate your
response to.
Mr. Stewart. In our opinion, APPWP, yes, it would lead to
more plan formation. The money contributed to a plan, as you
know, is more difficult to get at. It is going to be saved for
retirement--for long-term retirement needs, yes.
Ms. Calimafde. Mr. Cardin, I would like to give that a
shot.
I think there are sort of two answers or two ways of
looking at this. One is, at the National Summit on Retirement
Savings it became clear that education was going to be critical
to increasing awareness about retirement security. And I don't
know if you have been hearing these ads on TV, and I don't know
if they are on the radio now, by ESOP and EBRI where they are
talking about how important it is to save, to save early and to
save in a tax-free environment, but they are very effective.
And my hope is that, as this information gets disseminated,
young people in their thirties who would probably not put a lot
of money into a 401(k) plan are going to start thinking twice
and say maybe I better participate a little bit more now
because I know what that tax-free growth is going to do when I
am 60.
The other answer is, in the small business area, all of the
employees are carried along with the retirement plan, and a lot
of these employees really can't save. They are just making
enough money to live. So the retirement plan sponsored by the
company is their savings. If they get a 5-percent profit-
sharing contribution or a 7-percent profit-sharing
contribution, that is real money growing tax-free that they
wouldn't have saved otherwise.
To the extent that H.R. 1102 is going to make it easier for
small businesses to sponsor plans, and one of those factors I
think is increasing the limits or returning the limits to where
they were 17 years ago, I think you are going to see greater
savings occurring even amongst the lowest bands of the income
levels because those people are employees, they have to get
retirement benefits, and very often they are very meaningful
retirement benefits.
Mr. Cardin. You really anticipated my second question. We
need to get to younger workers and low-wage workers earlier so
they start putting money away, and the provisions here would
really make a difference on younger people, smaller employers
actually setting up plans.
Mr. MacDonald.
Mr. MacDonald. Yes, just looking at it from a defined
contribution benefit, if you eliminate the 25-percent cap, you
are really affecting the low-paid worker. The high-paid worker
is going to get to the $30,000 maximum. But what you are really
doing is going to the low-paid worker and allowing him or her
to save more. That is number one.
Number two, it bothers me that perhaps some of the
legislation will be driven by Wall Street Journal articles.
Yesterday's article was completely inaccurate. First of all, it
described GTE as going to a cash balance plan. That is not the
case whatsoever. In fact, I looked for the retraction this
morning in the Wall Street Journal. It will be run tomorrow.
The bottom line is if we can increase the limits from 160
to 235, you immediately are securing a benefit, you are
guaranteeing a benefit for that person. That savings exists. So
between taking the 25-percent cap off the defined contribution
as well as securing the defined benefit plan which is a secured
guaranteed plan, you have ensured savings for people.
Mr. Cardin. Thank you.
Thank you, Mr. Chairman.
Chairman Archer. Perhaps the Members of the Committee would
benefit from a brief explanation of the difference between a
defined benefit plan, a cash balance plan and a defined
contribution plan?
Ms. Calimafde. Do you want to try that?
Mr. MacDonald. There is not enough time in the day.
Chairman Archer. It really would take that long?
Ms. Calimafde. I will do defined benefit and defined
contribution. You end up with cash balance plan.
Chairman Archer. What is the difference between a cash
balance and a defined contribution?
Ms. Calimafde. I will try.
They both have individual account balances. The defined
contribution plan, whatever is in that plan when the
participant retires, is what the participant receives. So the
earnings investments, whether good or bad, follow along with
that employee.
As I understand the defined benefit plan, when it converts
to a cash balance, it looks like a defined contribution plan,
but it isn't all the way a defined contribution plan. What is
happening is that there are individual account balances so
participants can see them, but I believe that the investment
earnings are still guaranteed, aren't they? So a cash balance
is really a hybrid type of plan.
Mr. MacDonald. Let me put it a different way.
The employer, in a cash balance plan, still assumes the
risk. It is the employer's responsibility to ensure that the
accrued benefit is paid so that when--it may be on a fixed
scale starting from a younger age to an older age--The fixed
amount is there. The employee has the ability to take it on a
portable basis elsewhere, but the employer still assumes the
risk. In a defined contribution plan, in theory, you could be
putting your money in, and it could be going away.
Chairman Archer. So under the cash balance concept then,
the principal amount cannot decline? The employer guarantees
that that principal amount will not decline?
Mr. MacDonald. Whatever the accrued benefit obligation is,
it is there. It is a defined benefit plan. Everyone gravitated
away from----
Chairman Archer. So what you are doing is converting the
defined benefit into a cash balance so that the employee will
be able to take that with him or with her if they change jobs,
in effect?
Mr. MacDonald. That is one example, yes.
Ms. Calimafde. Another thing, the individual sees their own
account balance.
One of the problems of a defined benefit plan, and it is
unfortunate in a sense, is that it is one big fund and the
employee knows if they stay with the company until retirement,
they might get 50 percent of their salary paid for as long as
they live or their spouse lives, but they have an amorphous
kind of promise.
In a defined contribution plan, they have an account
balance that they see every year. So this is an attempt to try
to give sort of that individual account balance concept to the
defined benefit area.
Mr. MacDonald. Another example, Congressman, the defined
benefit is like a hockey stick. It limps along, and then all of
a sudden when I get the right age and the total amount of
service, in my case age plus service equals 76 points, it jumps
right up. But I have no idea what that accrued benefit is when
it jumps up because it is based on final average earnings. The
accrued benefit in a cash balance plan is an amount of money
that is set aside each and every year and people can track it.
They know what they have.
Ms. Calimafde. It is interesting because the young, more
transitory employees like the defined contribution plans, the
401(k) plans. The older employees understand that the defined
benefit plan will provide a stream of payments following them
throughout their lifetime, and that is why it is sort of hard
for companies to put these plans together in a way that the
employees are appreciating them the most and getting the most
out of them.
Chairman Archer. Thank you for that explanation. I don't
know if I am the only one who needed it.
Does any other Member wish to inquire?
Mrs. Johnson.
Mrs. Johnson of Connecticut. We have mentioned several
times in this hearing the need to set priorities, and one of
the great advantages of the Portman-Cardin bill is that through
its many provisions the hope is that it will bring more people
into the pension system. People not participating in the
private pension system will have a chance to come into that
system.
That will certainly cost some money, but since the goal is
to get people in earlier, to have even small holdings held over
a longer period of time, that seems to me to be of a higher
priority than raising the amount one can contribute to an IRA.
Because even though that is very nice, if you talk to any one
of your kids who is married and raising children, they don't
have the money--they are lucky if they can get one IRA
contribution in, and it is tough to try to be saving as much as
the current law allows.
So to move from $2,000 to $5,000, that is nice; but my
understanding is that will not bring new people into the
system. While it will allow those within the system to retire
with greater comfort, by the criteria of expanding pension
savings opportunities, that proposal is not powerful. Would you
disagree with me on that?
Mr. McCarthy. I would disagree.
First of all, the demographics and work patterns in the
American work force are changing to the point--we talked about
an Internet company, the transitory nature of the worker. As a
result, there are many instances now where, even if the
employer is sponsoring a plan that is an attractive plan and a
generous plan, because of worker transition from place to place
and waiting for vesting or waiting for entrance eligibility
into plans, they are frequently not covered for periods of
time. That is especially true of people who drop in and out of
the work force, whether they are attending to child care or any
other need.
I agree with you that maximum coverage is the goal. What I
am asking that you recognize is that there is a number of
different worker profiles that need to be addressed. One of
those is the fact that 50 percent of workers are not covered
whatsoever and, as a result, need to have a simple and portable
vehicle.
What we are finding is--and I agree with you also,
completely, that the issue is critical mass. We find, and EBRI
(the Employee Benefit Research Institute) will tell you this,
that there is a critical mass and it varies by person. But once
you achieve that critical mass, your mindset changes and your
behavior changes and you go from being a spender and a consumer
to a saver. The savings becomes a thing to be nurtured.
As a result, we think that raising the limit, which is
really where the limit would be if it had been indexed
originally, will help people get to that critical mass. One
contribution and then a dormant account is not anybody's goal.
A contribution of enough size so that you can buy a couple of
different funds or enough shares of a couple of different
companies, so that you can see some investment performance and
at some point you become the owner of a segregated pot of
assets that doesn't leak away to these ancillary demands. And
you have gotten enough size that you begin to care about the
health and well-being of that fund of assets.
Ms. Calimafde. Mrs. Johnson, I would like to try my hand at
that one.
When I think about the marriage penalty--and that would
affect me and it would affect a great number of taxpayers
across the country. When you look at the numbers, it appears
that each family might get $100 or $200. I think the way that
our economy is today, that $100 or $200 probably would not go
very far. When you contrast what that might cost compared to
H.R. 1102 and what this could conceivably do for small business
employees, I have a very hard time justify spending $100 and
spreading it to everybody versus giving what could amount to
real retirement security for many, many Americans. That does
not quite answer the question.
I guess if you ask me directly I would say I would rather
see the money go into H.R. 1102. I think that would ultimately
help the country. But if I had to compare the marriage penalty
to increasing the IRA, I would increase the IRA limits. So I
think there are different steps of priorities.
Mr. MacDonald. I would argue that we can't lose sight of
the fact of section 420. The last panel talked about health
care. The ability to fund retiree health care through pension
assets is important. This is a package, and many of us look at
it that way.
Mrs. Johnson of Connecticut. Thank you.
Chairman Archer. Let me jump in. We are in an area that
intrigues and interests me tremendously. We are now speaking of
personal IRAs as retirement accounts. That is a whole concept
that we are speaking of here. Yet the pressure has been on the
Congress and it has built over the years to permit the
withdrawal of those funds so they are not there for retirement.
Those political pressures are not going to go away.
There is one developing today that is very desirable, a new
widening of the assistance for adoption and a strong push to
allow IRAs to be withdrawn for adoptions, and on and on and on.
So we can't simply discuss this in the vacuum that we are
talking about retirement accounts. We also have to consider the
fact that these funds can be taken out under certain
circumstances for first-time home buyers and for medical care,
and those pressures will continue to mount on the Congress. So
I just want to say that it is more than just talking about it
as a retirement account.
Mr. Cardin. I want to concur in your comments. One of the
frustrating points is that we try to develop policies to
encourage more money being put aside for security or
retirement. On the other hand, we all yield to the easy
pressure to allow invasion of retirement funds for worthwhile
purposes but certainly not for retirement. We make it too easy.
I think as we look to expand the program and do different
things that we really should be reevaluating those policies. It
is hard to retract what has already been done, but as we look
for changes, I would welcome in joining the Chairman to see if
we can't do something about some of these provisions.
Mr. McCarthy. I manage a book of business which is about
$160 billion in IRA accounts. Last year, we paid out slightly
more than $10 billion in distributions. If you look at our
distributions, over 80 percent of them go to people over 59\1/
2\, as the law incents that. About 15 percent--between 15 and
17 percent goes to people under 59 and a half who are
experiencing some type of dislocation, that they need these
funds and funds are not available for them for one of the
enumerated exceptions under the IRS Code 72(t) which is where
all of the medical expense, adoption expense and all those
exemptions come in.
Less than 2 percent in the aggregate of these exception
reasons--we see in the distribution flow that we have, and it
is probably the largest in the industry, less than 2 percent in
the aggregate represents all of these exceptions combined.
What you see is a phenomenon very akin to 401(k) loans. If
you create the perception of access, people will deposit money
because they don't think that they are throwing the money over
a high brick wall and they can only go visit it until they are
59\1/2\. What you see when you put a loan provision into a
401(k) plan is participation jumps up, a multiple of what you
get in actual loan disbursements. So, as a result, the
perception of access creates new savings, and that is what
72(t) and these acknowledgments of other life events do.
EBRI will tell you that employer plans outstrip in value
the value of all of the owner-occupied residences in the
country. And, as a result, since it is such a large portion of
people's holdings, if you don't acknowledge these other life
events, as a result people are not going to save. They are
going to have a zone of paralysis and say I can't afford to
lock my money up until I am past 60.
Mr. McCrery. Mr. McCarthy, are you saying that enabling
people to withdraw their IRA money for purposes other than
retirement actually encourages savings?
Mr. McCarthy. I am saying that absolutely and emphatically.
The perception overweight in people's mind as compared to their
actual behavior, and you get a lot more savings because people
can need it. But once you get that critical mass, you don't
want to take that money out. You are going to find another way
to meet that need unless you absolutely have to.
Mr. McCrery. So if we had a different tax system and we had
an unlimited IRA, you could put in whatever you want tax-free
and you paid tax on it when you brought it out, that would
encourage savings?
Mr. McCarthy. I was wondering when that question was going
to come. I am all for it. It would make my peers in the other
tax product areas jealous, but I would be all for it.
Mr. McCrery. It would be a consumption tax, basically?
Mr. McCarthy. Essentially.
Mr. MacDonald. There would be one fundamental difference
with an IRA, and I am not here to debate my colleague, but in a
401(k) plan when you take that loan out, indeed you can take
that loan out, but you have to repay it and you repay it
through payroll deduction. So you are protecting that savings.
And when you leave the company, that loan has to be paid down
as well. So there is a little difference in having the freedom
of savings in that regard.
Mr. McCrery. But Mr. McCarthy's point is a good one. The
more flexible you make these savings vehicles, the more
attractive the savings vehicles are and the more likely they
are to, in fact, not spend when they get the money but saving.
And that is good, not bad.
Chairman Archer. Well, the gentleman is correct that the
Chairman--one of the aspects of the Chairman's tax nirvana is a
zero tax on savings, and I hope that someday this country can
get there because I believe we will benefit enormously from it
in the future.
But there are so many cross currents in this--and you talk
about human behavior. I know myself that I simply took savings
out of another vehicle to put into an IRA to take advantage of
the tax benefit. That was not an increase in net savings. It
was merely a transfer from one vehicle to another vehicle. An
awful lot of us who are in a position to do that are definitely
going to do that. We are going to do all that we can to lighten
our tax burden within the letter of the law.
To what degree that impacts on behavior, I am sure we have
final studies to be able to analyze, but we need more savings
and we need to do those things that protect existing savings,
which is just as important as increasing new savings.
If we dig a hole in an existing savings, that hole has got
to be filled up before we get an increase in savings. So
protecting existing savings, which is the death tax and other
things of that nature, are just as important as the incentive
for new savings. Then we have to find a way to get new savings,
too, and try to accomplish both of them in the most effective
way.
Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman. I appreciate the
opportunity to respond briefly to a statement made by one of
the witnesses.
As I understood it, you said that by eliminating the
marriage penalty couples would receive $1,400. It is higher for
some and less for others, but on average it is $1,400. I
certainly believe that opportunity to eliminate the marriage
tax penalty and free up $1,400 that otherwise would go to Uncle
Sam that people could deposit into their IRA or 401(k) or
whatever they set aside for retirement is a good idea.
Thank you, Mr. Chairman.
Ms. Calimafde. Mr. Weller, are you referring to if you
completely repealed it? Because I was looking at a phase-in.
Mr. Weller. A complete repeal would be $1,400.
Ms. Calimafde. I can't remember the number. I was talking
about if you phased in, what it would be worth.
Mr. Weller. The Marriage Tax Elimination Act, which has 230
cosponsors, does entirely eliminate the marriage tax penalty.
But you may recall last fall the House passed a partial
elimination of the marriage tax penalty which benefited 28
million couples. That is about $240. So that is real money for
people. That is a month of child care or it is 10 percent of
what you might want to put into your IRA.
Ms. Calimafde. I am not saying that it is not. Don't get me
wrong. But if that same amount of money for that bill went
toward something like H.R. 1102 and you were able to get
literally millions of employees now being covered and receiving
a 5-percent contribution to that plan and it was able to stay
in that plan for a number of years, I don't think that there
would be any comparison as to if you looked at it 20 years
later, which person would be better off, the one who got the
$240 that they would most likely spend versus the person who
might have gotten $500, $600 in a tax-free account that they
couldn't touch for a number of years.
Mr. Weller. As one who desires to eliminate the marriage
tax penalty and supports retirement savings, I would beg to say
if you eliminate the bias against married couples they are
going to have more money to set aside for savings. If you do
nothing about the marriage tax penalty, it is still there.
Ms. Calimafde. Ideally, you could do both. That would be
the ideal world.
Chairman Archer. Thank you.
So often we get a little myopic in the Congress. I fear we
are doing some of that on the floor today as an emotional
response to Littleton.
But as much as I want to get to a zero tax on savings, the
Tax Code is not the real enemy in savings in this country. The
real enemy of savings is a plastic credit card. We had no
greater incentives in the Tax Code when this country did save,
but we didn't have the credit card. So the battle is with
instant gratification and the ability to realize that instant
gratification through the credit card. Do you have any
suggestions as to what, if anything, we might do about that?
Ms. Calimafde. The only thing I can think of is education.
I think what the fellow on my far left mentioned, I have
seen that, too. When someone has an account balance in a 401(k)
plan and it is relatively small, let us say it is $400, they
may take it out in a plan loan to buy a prom dress or
something--things that are not critical. Once that number
starts getting to a level, and in my mind the level seems to be
$1,000 in savings, all of a sudden it seems like something that
they need to protect and they don't want to invade it. If you
just can acquire enough, then it seems that there is a tendency
to leave it alone.
The second is just education. We are all living longer. You
cannot retire only on Social Security and live in the manner
you are accustomed to, in most cases, and you are going to have
to provide for your own retirement; and to do that the
retirement system is the best method to accrue these funds. So
I think it is education.
Chairman Archer. I certainly agree with that. But human
nature is a very, very powerful force. When you are presented
with the opportunity to acquire something that you feel like
you need, you may not need it but you want it desperately
today. You do not have to be concerned about whether you have
money in an IRA or whether you have money anywhere because that
plastic is in your pocket. All you have to do is present it and
you have got it. Then the bill comes at the end of the month
and it is hard to see what your total debt is because the only
thing that is really featured is your minimum monthly payment,
this is the real enemy today in this country for savings.
But I am not dismissing the need to do what we need to do
in the Tax Code, but I think we need to focus some way or other
on the big picture.
I recognize Mr. Portman who has been trying to get into
this discussion.
Mr. Portman. I restrained myself earlier trying to compare
IRAs to pensions and the marriage penalty and so on, but I will
say what Ms. Calimafde just told you is the answer to the
problems is H.R. 1102.
Ms. Calimafde. Here, here.
Mr. Portman. Seriously, I think a key point is education--
what Ms. Dunn raised earlier and then what Ben Cardin followed
up with, this letter from the Consumer Federation of America.
We should do a lot more in terms of education, and more should
be done at the workplace where most Americans are going every
day by getting folks into saving, whether it is an IRA or a
pension plan.
One other point about the distinction--and, as you know,
there is the IRA $2,000 to $5,000 increase in our bill as well,
but I do think we need to keep in mind the power of the
matching contribution and how that generates over time such
additional savings; and, second, how these are forced savings
plans.
When you have this sort of program in place it forces you
to save, and that is going to help those folks who are not
saving now who tend to be in a small business where there is
nothing or they are in a larger business who are low- or
middle-income folks who think they can't save enough, and the
education is a critical part of it, and it is a part of the
legislation.
Thank you for giving all of this time on the pension front
and for the witnesses today.
Chairman Archer. I compliment all of our witnesses and all
of the Members who have expressed an interest in this issue
because I believe it is truly vital as we move forward. We have
got to do everything that we can to increase savings.
Now, the employer contribution, Mr. Portman, that you
mentioned is so important because it magnifies the total
savings, is not counted, as I understand it, in the personal
savings rate. It is counted in the net private savings, and
that is the point that I was trying to make. It is very, very
important that we not just be focused on the personal savings
rate but that we focused totally on net private savings.
Thank you very much.
The Chair invites our final panel of witnesses to take
their place at the witness table: Ms. Slater, Mr. Sandmeyer,
Mr. Loop, Mr. Thompson, Mr. Coyne, and Mr. Speranza. The Chair
invites our guests and staff to take their seats so we can
conclude the hearing today.
Welcome to each member of our final panel. Thank you for
coming and participating today. I am sorry that you perhaps had
to wait a little longer than you wanted to wait, but,
hopefully, it was productive for the Committee.
Ms. Slater, would you lead off. Would you identify yourself
for the record and then proceed with your testimony?

STATEMENT OF PHYLLIS HILL SLATER, PRESIDENT AND OWNER, HILL
SLATER, INC., GREAT NECK, NEW YORK; AND IMMEDIATE PAST
PRESIDENT, NATIONAL ASSOCIATION OF WOMEN BUSINESS OWNERS,
SILVER SPRING, MARYLAND

Ms. Slater. Thank you, Mr. Chairman.
My name is Phyllis Hill Slater, and I am president and
owner of Hill Slater, Inc., a second generation, family-owned
business that has been serving the engineering and
architectural community for 3 decades.
I am also the immediate past president of the National
Association of Women Business Owners and address you today in
both capacities.
I am here today to talk to you about the death tax and its
destructive effect on me and other small business owners,
especially the 9 million women-owned businesses in the United
States.
As a woman-owned business, I am awarded contracts that will
stay in force only if my daughter can continue the business
when I am not here to do so. How can I pass my business with
its employees and contracts on to my daughter if I must pay a
55-percent gift tax or estate tax? The 55-percent tax on the
market value of all of my assets at my death will affect not
only the future of my business but also will require my family
to liquidate assets to pay the tax 9 short months after my
death. And if I want to gift my business or my assets early, I
must pay the same rate of tax. This is a tax on assets on which
I have already paid taxes.
My father started our business, and we have worked hard and
long hours to grow our business to 22 employees. There are
those who say that the death tax is paid only by the rich.
Well, consider this.
In 1997, 89 percent of the estate tax returns filed were
from estates of $2.5 million or less, and more than 50 percent
of the revenue generated is from estates of $5 million or less.
So the small- and the medium-sized estates are spending the
time and money to comply with the death tax. And according to
Alicia Munnell, former member of President Clinton's Council of
Economic Advisers, the costs of complying with estate tax laws
are roughly the same amount as the tax revenue collected.
There are those who say that the tax is needed to
redistribute the wealth. Well, consider this. Alan Binder, a
President Clinton appointee, concluded in his book, ``Toward a
Theory of Income Distribution,'' a radical reform of
inheritance policies can accomplish comparatively little income
redistribution. And Joseph Stiglitz, chairman of President
Clinton's Council of Economic Advisers, in the Journal of
Political Economy found that the estate tax ultimately might
cause an increase in income inequality.
Now some of you may say, but the public views the death tax
as a good tax and a tax on the rich. Wrong.
In numerous surveys, national polls and membership
questionnaires, 75 percent of the respondents concluded that
the death tax should be eliminated.
In a national poll conducted last year, the respondents
concluded that the death tax was more unfair than the payroll
tax, the income tax, capital gains tax, alternative minimum
tax, gasoline tax, and property tax. Of all of these taxes they
are going to pay. Why? Because the death tax, number one, is a
55-percent tax rate, the highest rate in our tax system; two, a
tax at the worst time when a death occurs, and three, a tax on
assets that have been taxed at least two or three times before.
The reason that the Family Business Estate Tax Coalition
comprised of over 6 million members and other groups support
the elimination of the death tax as the right solution is
because we all realize that increasing the lifetime exemption
is a short-term solution to a long-term problem. The lifetime
exemption was raised years ago and it was not enough. It will
never be enough. With a little bit of inflation and profits in
our businesses, we will grow past exemption and be back asking
for more very soon. The families of America need a permanent
fix to the most unfair tax of all that generates no net revenue
and the fix is elimination.
What do NAWBO and I want? We want the death tax, the gift,
estate and generation-skipping tax to be eliminated. We believe
that there is a responsible, bipartisan legislation in both the
House and the Senate to do that now. Congresswoman Dunn and
Congressman Tanner have introduced H.R. 8 and Senators Kyl and
Kerrey have introduced S. 1128. Both bills eliminate the death
tax in a realistic manner. We want families in America to be
freed from being held hostage to the death tax and allow them
to use their resources to plan for the growth of their families
and their businesses. This Congress can do something very
family friendly. Eliminate the death tax now.
Thank you.
[The prepared statement follows:]

Statement of Phyllis Hill Slater, President and Owner, Hill Slater,
Inc., Great Neck, New York; and Immediate Past President, National
Association of Women Business Owners, Silver Spring, Maryland

Good morning, my name is Phyllis Hill Slater and I am the
President and Owner of Hill Slater, Inc. a second-generation
family owned business that has been serving the engineering and
architectural community for nearly three decades. I am also the
immediate Past President of the National Association of Women
Business Owners and speak to you here today in both capacities.
I am here today to talk to you about the ``death tax'' and
its destructive effect on me and other small business owners,
especially the 8.5 million women-owned businesses in the U.S.
today. As a woman-owned business, I am awarded contracts that
will stay in force only if my daughter can continue the
business when I am not here to do so. How can I pass my
business with its employees and contracts on to my daughter if
I must pay a 55% gift or estate tax? The 55% tax on the market
value of all of my assets at my death will affect not only the
future of my business but also will require my family to
liquidate assets to pay the tax, nine short months after my
death. And, if I want to gift my business or my assets early, I
must pay the same rate of tax. This is a tax on assets on which
I have paid taxes.
My father started our business and we have worked hard and
long hours to grow our business to 22 employees. There are
those who say that the death tax is paid only by the ``rich,''
well consider this:
In 1997, 89% of the estate tax returns filed were from
estates of $2.5 or less, and more than 50% of the revenue
generated was from estates of $5 million or less.
So the small and medium sized estates are spending the time
and money to comply with the death tax. And, according to
Alicia Munnell, former member of President Clinton's Council of
Economic Advisors, the costs of complying with the estate tax
laws are roughly the same amount as the tax revenue collected.
There are those who say that the tax is needed to
redistribute the wealth; well consider this:
Alan Binder, a President Clinton appointee, concluded in
his book, Toward a Theory of Income Distribution, ``a radical
reform of inheritance policies can accomplish comparatively
little income redistribution.'' And Joseph Stiglitz, Chairman
of President Clinton's Council of Economic Advisors, in Journal
of Political Economy, found that the estate tax ultimately
might cause an increase in the income inequality.
Now, some of you may be saying, ``but the public views the
death tax as a good tax and a tax on the rich.'' WRONG!
In numerous surveys, national polls, and membership
questionnaires, 75% of the respondents conclude that the death
tax should be eliminated. In a National Poll conducted last
year the respondents concluded;
That the death tax was more unfair than the Payroll Tax,
Income tax, Capital Gains tax, Alternative Minimum Tax,
Gasoline Tax, and Property Tax; all of the taxes that they are
going to pay. WHY Because the death tax is; 1) A 55% TAX RATE,
(the highest rate in our tax system), 2) A TAX, AT THE WORST
TIME,WHEN A DEATH HAS OCCURRED, 3) A TAX ON ASSETS THAT HAVE
BEEN TAXED AT LEAST TWO OR THREE TIMES BEFORE!!
The reason that the Family Estate Tax Coalition of over 6
million members and other groups support the elimination of the
death tax as the right solution is because we all realize that
increasing the lifetime exemption is a short term solution to a
long term problem. The lifetime exemption was raised years ago
and it was not enough. It will never be enough, with a little
bit of inflation and profits in our businesses we will grow
past the exemption and be back asking for more very soon. The
families of America need a permanent fix to the most unfair tax
of all, that generates no net revenue, and that fix is
elimination!
What do I and the NAWBO want. We want the death tax, (the
gift, estate and generation skipping tax) to be eliminated, and
we believe that there is responsible, bi-partism legislation,
in both the House and the Senate, to do that now! Congresswoman
Dunn and Congressman Tanner have introduced HR 8 and Senator
Kyl and Senator Kerrey have introduced S1128. Both bills
eliminate the death tax in a realistic manner. We want families
in America to be freed from being held hostage to the death tax
and allow them to use their resources to plan for the growth of
their families and their businesses.

Chairman Archer. Thank you, Ms. Slater.
Our second witness is Ronald Sandmeyer. If you will
identify yourself for the record, you may proceed.

STATEMENT OF RONALD P. SANDMEYER, JR., PRESIDENT AND CHIEF
EXECUTIVE OFFICER, SANDMEYER STEEL COMPANY, PHILADELPHIA,
PENNSYLVANIA; ON BEHALF OF NATIONAL ASSOCIATION OF
MANUFACTURERS

Mr. Sandmeyer. Mr. Chairman and Members of the Committee,
thank you for the opportunity to appear here today to discuss
estate taxes. My name is Ron Sandmeyer, Jr. I am here today on
behalf of the National Association of Manufacturers. The NAM is
the Nation's largest national broad-based industry trade group.
Its 14,000 companies and subsidiaries include more than 10,000
small- and medium-size manufacturers. I am President and chief
executive officer of Sandmeyer Steel Co., one of more than
9,000 family-owned or closely held small manufacturers in the
NAM.
Every year when NAM surveys small members such as our
company, repeal of Federal estate and gift taxes emerges as the
single most important tax policy issue affecting their ability
to grow. This may surprise some who only see a tax when it is
collected, but I know, Mr. Chairman, that you were once a small
manufacturer and that you have seen what I have seen.
Sandmeyer Steel is a third generation, family-owned
business in Philadelphia, founded by my grandfather Paul
Sandmeyer in 1952. We produce stainless steel plate products
that are sold to fabricators and equipment manufacturers who
make process equipment used in a variety of different process
industries. My brother and I have been working with our father
to try to do what we can to make sure that our company survives
the difficult transition from second to third generation.
A good transition includes both a successful management
succession plan as well as a successful ownership succession
strategy and, if successful, a transition leaves the company
independent, strong and capable of continued growth. This is
important not just to us but also to our 140 employees and
their families.
The death tax can be devastating to the ownership
succession component of the transition between generations in a
family-owned business. Fewer than one in three family-owned
companies survive to the next generation. The 55-percent estate
tax rate does not allow much room to breathe. Very few small-
and medium-size businesses have that kind of liquidity and
almost no manufacturer does. The mere threat and uncertainty of
the death tax is a constant burden to our business. It requires
costly sacrifices today. Meetings with lawyers, meetings with
financial planners are expensive and they drain a lot of time
from the company's key decisionmakers.
Money spent on things such as attorney fees and life
insurance premiums could be better invested by us in new pieces
of equipment or in hiring and training additional employees.
Time and money spent preparing for the death tax achieves no
economically useful purpose but a business has to pay this cost
every year not just at some uncertain date in the future when
an even bigger bill comes do.
Uncertainty is unavoidable in estate planning. First of
all, a businessowner cannot know when the tax will have to be
paid. It is also hard to anticipate how much tax will
ultimately be owed because you do not know what the IRS will
accept as the valuation of your business. Without a fair market
value sale, valuation is subjective and open to debate and
possibly even litigation.
There are no simple tools to solve the liquidity problem.
Electing an extended payoff can burden a business with an IRS
lien for more than a decade.
The family business tax relief available under current law
is so complicated and so narrowly crafted that it is hard to
find an attorney willing to advise a client that the family
business will qualify. Even then there will be times when the
correct business decision will conflict with what might be the
optimum tax strategy. For example, trying to make an owner more
liquid and increase liquidity outside the business so the
estate tax can be ultimately paid can result in the business
being ineligible for the limited relief that might have
existed. Even the increase in the unified credit is of limited
help to the family businessowner. The credit provides a lump
sum of money that survives the tax, but once you have built
that into your plan, all future growth is taxed exactly as
before. Rate reduction is the only relief short of full repeal
that reduces your risk on every decision to reinvest and grow
your company.
There are several proposed bills that repeal the death tax.
The NAM supports all of them. Repeal it any way you can.
Representative Cox has a bill with 200 cosponsors that repeals
the estate, gift and generation-skipping taxes immediately.
H.R. 86 would immediately free thousands of small business
owners to devote more time and attention to growing our
businesses.
Representatives Jennifer Dunn and John Tanner of this
Committee have a different bill, H.R. 8, that phases out the
tax by reducing rates 5 percent a year until the tax is finally
eliminated. Dunn-Tanner has found some supporters who have not
been able to support the Cox bill. Aside from eventually
eliminating the tax also, the phaseout provides real and
immediate relief by lowering rates in the short term.
Repeal unfortunately has not found as firm a footing in the
Senate. It has not gained the bipartisan support that both Cox
and Dunn-Tanner enjoy in the House.
That situation changed recently when Senator Kyl introduced
the Estate Tax Elimination Act, S.1128. His new bill repeals
all the death taxes and does away with a step-up in basis. The
NAM strongly endorses S.1128 with one caveat. We only support
elimination of the step-up in basis for inherited assets as
long as it is coupled with immediate and total repeal of the
death tax. The step-up in basis partially offsets a
confiscatory estate tax regime. It is critically important to
keep the current basis rules in place until the death tax is
totally eliminated. The Kyl bill does permit, however, a
limited step-up to mirror the existing unified credit so that
no dollar free from estate tax today would be taxed as capital
gains under his bill.
This bill has bipartisan support from several Finance
Committee Members. It costs less than the Cox proposal and it
creates a potential revenue stream for the government. But most
importantly, death would no longer be a taxable event. There is
all the difference in the world between taxing at death and
taxing at the time of a voluntary sale. Death, though certain,
is unpredictable and involuntary. When it occurs the money to
pay the taxes is still tied up in the business. A voluntary
sale on the other hand is at a time of one's choosing. The
taxable value is known and the money from the sale is on the
table to pay the resulting capital gains tax. That is why
capital gains taxes don't force companies out of business but
the death tax usually does.
It is clear that momentum has been building for death tax
repeal and I would urge you to eliminate death as a taxable
event.
Thank you.
[The prepared statement follows:]

Statement of Ronald P. Sandmeyer, Jr., President and Chief Executive
Officer, Sandmeyer Steel Company, Philadelphia, Pennsylvania; on behalf
of National Association of Manufacturers

Mr. Chairman and members of the committee, thank you for
the opportunity to appear before you today to discuss estate
taxes.
My name is Ronald P. Sandmeyer, Jr., and I am here today on
behalf of the National Association of Manufacturers. The NAM is
the nation's largest national broad-based industry trade group.
Its 14,000 member companies and subsidiaries, including
approximately 10,000 small and medium manufacturers, are in
every state and produce about 85 percent of U.S. manufactured
goods. The NAM's member companies and affiliated associations
represent every industrial sector and employ more than 18
million people.
I am President and CEO of Sandmeyer Steel, one of the more
than 9,000 family-owned or closely held small manufacturers in
the NAM. Every year when the NAM surveys its small members,
repeal of federal estate and gift taxes emerges as the single
most important tax policy issue affecting their ability to
grow.
This may surprise some who only see a tax when it is
collected, but I know that you, Mr. Chairman, were once a small
manufacturer, and that you have seen what I have seen.
Sandmeyer Steel Company is a third generation family-owned
business in Philadelphia, Pennsylvania. We produce stainless
steel plate products that are sold to fabricators and equipment
manufacturers who make equipment used in a variety of different
process industries. My grandfather, Paul C. Sandmeyer, founded
the company in 1952.
My brother Rodney and I are the third generation at our
company. We have been working with our father to try to make
certain that our company survives the difficult transition from
second to third generation. A good transition includes both a
successful management succession plan and a successful
ownership succession strategy. A successful transition is one
that leaves a company strong and capable of continued growth.
This is important not just to us, but also to our 140 employees
and their families.
The death tax can be devastating to the ownership-
succession component of this transition between generations in
a family-owned business. A Vermont Life study, which shows that
fewer than one in three family-owned companies survives to the
next generation, is not surprising. The 55 percent estate tax
rate does not allow much room to breathe. Very few businesses
or business owners have that kind of liquidity, and almost no
manufacturer does.
It is a mistake to regard the death tax as a one-time
burden for a company. The mere threat and uncertainty of the
death tax looming out there is a constant burden to our
business. Any business that hopes to survive the death tax must
make costly sacrifices today. Meetings with lawyers and
financial planners are expensive and drain a lot of time from a
company's key decision makers. Money spent on attorney fees and
life insurance premiums would be better invested in new pieces
of equipment or in hiring and training additional employees.
Time and money spent preparing for the death tax simply
does not help a business in any other way. This diversion of
valuable human and financial capital achieves absolutely no
economically useful purpose. It does not increase productivity,
expand a workforce or put new product on the shelf. A business
pays this cost every year, not just at some uncertain future
date when an even bigger bill comes due.
There is no simple solution in estate planning. Uncertainty
is unavoidable. To begin with business owners do not know when
they will have to pay the tax. Then it is hard to anticipate
how much tax will be owed, because you cannot know in advance
if the IRS will agree with what you think is a fair valuation
of your business. Without a fair market value sale, the
valuation is purely subjective and is open to costly debate and
dispute.
There are no simple tools that solve the liquidity problem.
Electing an extended pay-off under section 6166(b) can burden
your business with an IRS lien for more than a decade, in
addition to the debt service payments themselves.
What about the family business tax relief available under
current law? Well, it's so complicated and so narrowly crafted
that it is hard to find a single attorney anywhere who is
willing to advise a client that the family business will
qualify. Even then, there will be times when the correct
business decision will conflict with the optimum tax strategy.
For example, trying to increase an owner's liquidity outside of
the business so the tax can be paid ultimately can result in
the business being ineligible for the limited relief that might
have existed.
Even the increase in the unified credit is of limited help
to a family business owner. The unified credit produces a lump
sum of money that survives the tax, but once you have built
that into your plan all future growth is taxed exactly as
before.
Rate reduction is the only relief short of full repeal that
would significantly affect business decisions. Reduce the tax
rate, and you reduce the risk on every decision to reinvest and
grow your company.
There are several proposed bills that repeal the death tax.
The NAM supports all of them. Repeal it any way you can.
Representative Cox has a bill that simply repeals the
estate tax, the gift tax and the generation skipping tax
immediately. His bill, H.R. 86, would immediately free
thousands of small-business owners to devote more time and
attention to growing our businesses. He has attracted 200
cosponsors to the cause of repeal.
Representatives Jennifer Dunn and John Tanner, of this
committee, also have a repeal bill before the House in H.R. 8.
Their bill phases out the death tax by reducing the rates 5
percent per year until the tax is finally eliminated. The Dunn-
Tanner approach has found some supporters who have not been
able to support the Cox bill, particularly those who are
concerned about the budget impact of outright repeal.
The phase-out, aside from eventually eliminating the tax,
also provides real relief in the short term. By lowering
marginal rates, the Dunn-Tanner bill would improve the ultimate
rate of return on every investment made in your company.
Senator Kyl has introduced two bills that repeal the death
tax. The first was a companion to the Cox bill that gained 30
cosponsors in the Senate. Despite the enthusiastic support of
the NAM and numerous other business groups, full and immediate
repeal has not found a firm footing in the Senate, and in
particular it has not gained the bipartisan support that both
the Cox bill and the Dunn-Tanner bill have won in the House.
That situation changed recently when Senator Kyl introduced
the Estate Tax Elimination Act, S. 1128. His new bill repeals
all the death taxes and does away with the step-up in basis. We
strongly endorse S. 1128 with one caveat: we only support
elimination of step-up basis for inherited assets as long as it
is coupled with immediate and total repeal of the death tax.
Lawmakers added the step-up basis provision to the tax code to
partially offset a confiscatory estate-tax regime. It is
critically important to keep the current basis rules in place
until the death tax is totally eliminated.
Actually, the Kyl bill does permit a limited step-up in
basis to mirror the existing unified credit so that no dollar
free from estate taxes today would be inadvertently taxed under
his bill.
This new measure was introduced with bipartisan support
from several Finance Committee members. The bill costs less
than the Cox proposal, but it does this by creating a revenue
stream for the government. Most importantly, however, under the
bill, death would no longer be a taxable event.
From my own personal perspective, the new Kyl bill is so
simple and fundamentally sound that I find it hard to believe
someone hasn't introduced the concept sooner. Don't tax the
transfer of a business from one generation to the next. But
leave the basis unchanged and tax the gain on the sale if and
when it ever occurs.
There is all the difference in the world between taxing at
death and taxing at the time of a voluntary sale. Death, though
certain, is unpredictable and involuntary. When it occurs, the
money to pay the taxes is tied up in the business. A voluntary
sale, on the other hand, is at a time of your choosing, and the
money from the sale is on the table to pay the resulting
capital gains taxes. And of course, the taxable value of a sale
and the amount of the taxes that are payable is certain and
known prior to the transaction, not months or even years later.
That is why capital gains taxes don't force companies out of
business, but the death tax can.
There are few provisions in the tax code that force
successful companies out of business. Few provisions tax
involuntary actions or events. The death tax is one. More often
than not the death tax actually kills the company soon after
the owner dies. And I remind you again, don't lose sight of or
underestimate the costs incurred by people trying to make
reasonable and prudent preparations just to pay the tax.
It is clear that momentum has been building for death tax
repeal. I urge you to eliminate death as a taxable event.

Chairman Archer. Thank you, Mr. Sandmeyer.
Next witness is Mr. Loop. Mr. Loop, we are happy to have
you with us. You may proceed.

STATEMENT OF CARL B. LOOP, JR., PRESIDENT, LOOP'S NURSERY AND
GREENHOUSES, INC., JACKSONVILLE, FLORIDA; PRESIDENT, FLORIDA
FARM BUREAU FEDERATION; AND VICE PRESIDENT, AMERICAN FARM
BUREAU FEDERATION

Mr. Loop. Thank you, Mr. Chairman, and Members of the
Committee. My name is Carl B. Loop, Jr. I come to you today as
vice president of the American Farm Bureau Federation and as
president of Loop's Nursery and Greenhouses, Inc., a wholesale
plant and nursery business in Jacksonville, Florida. It is
indeed an honor for me to be here today to explain why farmers
and ranchers feel so strongly that estate taxes should be
abolished.
I would like to speak first as Carl Loop, vice president of
American Farm Bureau Federation. Eliminating the estate tax is
a top priority for Farm Bureau. We believe that the tax should
be ended because it can destroy family farms and ranches and
because the tax penalizes agriculture producers who work hard
to become successful. When farms are sold to pay estate taxes,
family businesses are ruined, employees jobs can be lost, open
spaces can be destroyed, and communities can be damaged. Estate
tax planning can sometimes help but is a complicated, expensive
and time consuming endeavor. With about half the farm and ranch
operators age 55 years or older, the future of American
agriculture depends on Congress' willingness to eliminate
estate taxes.
Now I would like to speak as Carl Loop, president of Loop's
Nursery and Greenhouses. Eliminating the estate taxes is a top
priority of the Loop family because the tax threatens to
destroy our family business. I started my nursery business in
1949 with a borrowed truck and a $1,500 loan. For 50 years my
family and I have worked hard to build our business into one of
the largest wholesale nursery operations in the southeastern
United States. We now employ between 85 and 100 people year-
round and provide a stable tax base for local government.
Our business consists of nine acres of greenhouses plus the
warehouses, cold storage and equipment needed to grow, harvest
and market our products. Inflation has increased the value of
both our land and equipment to the point that my family would
have to sell part of the nursery to pay the death tax. That
could prove fatal because our assets are single-purpose
structures that can't be easily liquidated and their forced
sale would destroy the business.
My son David and I run the day-to-day operations of Loop's
Nursery and Greenhouses and it gives me great pleasure to know
that he and my daughter Jane want to continue the business
after my death. That may not be possible even though I have
done everything I can to get ready for the taxes that will be
due when I die.
To prepare for my death, I have purchased life insurance. I
have recapitalized the business. I have issued two classes of
stock, set up revocable and irrevocable trusts, gifted assets,
given stock options, and shifted control of the business. After
hours of worry, years of work, and large attorney fees, I still
have no assurance that this plan will work and that estate
taxes will not ruin our business.
If my family is forced out of business, 85-plus families
will lose their incomes and Jacksonville will lose a valuable
part of its business base. My family and I don't understand why
the government wants to penalize us for being successful
especially since we have already paid taxes on what we have
earned. We think our operation is worth a lot more to our
community and our government as an ongoing business when
compared to the amount of a one-time estate tax payment.
Farm Bureau supports passage of H.R. 8, the Death Tax
Elimination Act, which phases out death taxes through rate
reduction. This bipartisan bill takes a common sense approach
to ending the death tax and deserves your support.
Before closing, I would like to mention several other
saving and health security tax proposals that would greatly
benefit farmers and ranchers as outlined in our written
statement. They are the full deductibility of self-employed
health insurance premiums, the FARRM, Farm and Ranch Risk
Management, accounts, capital gains tax cuts, and the fair
imposition of self-employment taxes.
Thank you for this opportunity. I would be glad to answer
any questions.
[The prepared statement follows:]

Statement of Carl B. Loop, Jr., President, Loop's Nursery and
Greenhouses, Inc., Jacksonville, Florida; President, Florida Farm
Bureau Federation; and Vice President, American Farm Bureau Federation

My name is Carl B. Loop, Jr. I am president of Loop's
Nursery and Greenhouses, Inc., a wholesale plant nursery
operation in Jacksonville, Florida. I serve as President of the
Florida Farm Bureau Federation and as Vice President of the
American Farm Bureau Federation. Farm Bureau is a general farm
organization of 4.8 million member families who produce all
commercially marketed commodities produced in this country.

ESTATE TAXES

Farm Bureau's position on estate taxes is straight forward.
We recommend their elimination. The issue is so emotionally
charged that during consideration of the Taxpayer Relief Act of
1997, Farm Bureau members sent more than 70,000 letters to
their representatives and senators calling for an end to death
taxes. I wrote several of those letters because death taxes
threaten the continuation of my family's livelihood.
In 1949, after graduating from the University of Florida, I
started my nursery business with a $1500 loan and a borrowed
truck. In the early years we got by living on the teacher's
salary of my wife, Ruth. Everything that I earned was
reinvested in the business. For 50 years I, along with my wife
and children, have worked hard to build our business into one
of the largest wholesale nursery operations in the southeastern
United States.
I am proud that my nursery has allowed me to support my
family and send my three children, Carol, 43, David, 40, and
Jane, 33, to college. David, earned his degree in ornamental
horticultural and agriculture economics and now runs the
business on a daily basis. Without his involvement I wouldn't
have been able to come here today. My youngest daughter, Jane,
would also like to come into the business.
Loop Nursery and Greenhouses, Inc., grows flowering pot
plants and tropical foliage in 350,000 square feet (nine acres)
of greenhouses. Also part of the business are warehouses, cold
storage and the equipment needed to grow, harvest and market
our products. Between 85 and 100 people are employed year-
round.
My family feels that our operation not only grows a needed
product, but also makes a positive contribution to our
community. In addition to employing 85-plus people, we are a
community minded business that provides a stable tax base for
city, county, state and federal government. We do not
understand why the government wants to penalize us for being
successful, especially since we already paid taxes on what we
have earned.
Inflation has increased the value of both our land and
equipment to the point that my family would have to sell part
of the nursery to pay death taxes. This could prove fatal to
our business because our assets can't be easily liquidated.
Because greenhouses are single purpose structures, they don't
have much market value and the only thing a forced partial sale
would accomplish would be to destroy the viability of our
business.
My son and daughter want to continue our family business
and I would like to pass it on to them. For the last six years,
I have been working with attorneys to plan for my death. I have
purchased life insurance, recapitalized the business, issued
two classes of stock, set up revocable and irrevocable trust
agreements, gifted assets, given stock options, and shifted
control of the business. After hours of worry and large
attorney fees I still don't know if my estate tax plan will
save our family business.
It seems to me and my family that Loop's Nursery and
Greenhouses, Inc., is worth much more to our community and the
government as an ongoing business when compared to the amount
of a one-time estate tax payment. If my family is forced out of
business by death taxes everything that I have worked for will
be lost, my family will lose its livelihood, 85-plus families
will lose their incomes and the community will lose a valuable
part of its business base.
My situation is not unique. As Vice President of the
American Farm Bureau, I talk with farmers and ranchers from
across the country and I can tell you that people everywhere
are concerned that death taxes will destroy their family
businesses. Many don't know how severely they will be impacted
because they don't realize how much their property has
increased in value due to inflation. Others understand the
consequences but fail to adequately prepare because the law is
complicated, because lawyers, accountants and life insurance
are expensive and because death is a difficult subject.
It bothers me and my family that while death taxes can cost
farm and ranch families their businesses and cost them hundreds
of hours and thousands of dollars for estate planning,
relatively little revenue is generated for the federal
government. I am told, that estate tax raise only about 1
percent of federal tax revenues.
The potential impact of estate taxes on the future of
American agriculture is enormous. Individuals, family
partnerships or family corporations own ninety-nine percent of
U.S. farms. About half of farm and ranch operators are 55 years
or older and are approaching the time when they will transfer
their farms and ranches to their children.
The situation in my state of Florida is acute. The value of
farmland there has been inflated far beyond its worth for
agriculture because developers are willing to pay high prices
to convert farmland to other uses. It is not uncommon for land
to be valued at as much as $10,000 an acre. On paper this makes
a Florida farmer look like a wealthy person, but my farm
neighbors aren't rich. They simply don't have the money to pay
a huge estate tax bill without selling part or all of their
business. While estate tax planning can protect some of the
farms, it is costly and takes resources that could be better
used to upgrade and expand their businesses.
Farm Bureau renews its call for the elimination of estate
taxes. Action by Congress is needed to preserve our nation's
family farms and ranches, the jobs they provide and the
contribution they make to their communities. Farm Bureau stands
squarely behind the enactment of H.R. 8, the bipartisan Death
Tax Elimination Act introduced by Reps. Jennifer Dunn and John
Tanner. This bill takes a common sense approach to ending death
taxes by reducing the rates 5 percent a year.

FARRM ACCOUNTS

Like other small business persons, farmers and ranchers
have predictable expenses. Each month they must pay for fuel,
animal feed, equipment repairs, building maintenance,
insurance, utilities, and meet a payroll. They must plan for
seasonal expenses like taxes, seed, heat, and fertilizer. They
must also budget for major purchases like equipment, land and
buildings.
While many expenses can be predicted and to some degree
controlled, farm income is neither predictable nor
controllable. The prices that farmers and ranchers receive for
their commodities are determined by forces that they can't
control, commodity markets and the weather. Farmers and
ranchers don't know from one year to the next if their
businesses will earn a profit, break even, or operate in the
red. Few other industries must face such a challenge year after
year after year.
What all farmers hope for is that the good years will
outnumber the bad ones. Believing that better times are coming,
farmers and ranchers get through tough times by spending their
retirement savings, borrowing money, refinancing debt, putting
off capital improvements and lowering their standard of living.
All of these activities damage the financial health of a farm
or ranch and the well being of the family operating the
business.
Unfortunately, 1998 was a very bad year for agriculture and
many farms and ranches are operating under severe economic
distress. Last year, in some parts of the country, extreme
weather or disease destroyed the fall's harvest or made feed
for livestock scarce. Others were blessed with good crops, but
faced low prices because of troubled overseas markets. 1999 is
also shaping up to be a very difficult year for those who
produce our nation's food and fiber.
Congress saved many farm and ranch businesses from
bankruptcy with emergency aid provided by the omnibus
appropriations bill. Farm Bureau is most appreciative of that
aid but wants Congress to take steps to break the cycle. If
emergencies are to be minimized in the future, farmers and
ranchers must have new and innovative ways to deal with
uncertain incomes caused by weather and markets. Congress must
act to give producers the risk management tools they need to
manage financial jeopardy caused by unpredictable weather and
markets.
Farm Bureau supports the creation of Farm and Ranch Risk
Management (FARRM) Accounts to help farmers and ranchers manage
risk though savings. Using Farm and Ranch Risk Management
Accounts, agricultural producers would be encouraged to save
money in good economic times for the ultimate lean economic
years. I can't help thinking how different things would be now
if FARRM accounts had been put on the books five years ago, and
farmers and ranchers had FARRM savings to use this year.
FARRM accounts will encourage producers to save up to 20
percent of their net farm income by the benefit of deferring
taxes on the income until the funds are withdrawn. The program
is targeted at real farmers, contains guarantees that the funds
will not be at risk, and prevents abuse by limiting how long
savings could be in an account to five years.
Legislation to create FARRM accounts, H.R. 957, has been
introduced by Reps. Kenny Hulshof and Karen Thurman. They've
written their bill so that producers of all commodities, from
all sizes of operations, who come from all parts of the
country, can take advantage of FARRM accounts. That's the
reason over 30 agricultural organizations and more than 150
representatives support the bill. The organizations are:

Agricultural Retailers Association
Alabama Farmers Federation
American Cotton Shippers Association
American Crop Protection Association
American Farm Bureau Federation
American Mushroom Institute
American Nursery and Landscape Association
American Sheep Industry Association
American Society of Farm Managers & Rural Appraisers
American Soybean Association
American Sugarbeet Growers Association
Black Farmers and Agriculturists Association
Communicating for Agriculture
Farm Credit Council
The Fertilizer Institute
National Association of Wheat Growers
National Barley Growers Association
National Cattlemen's Beef Association
National Corn Growers Association
National Cotton Council of America
National Council of Farmer Cooperatives
National Grain Sorghum Producers
National Grange
National Milk Producers Federation
National Pork Producers Council
National Sunflower Association
North American Export Grain Association
North Carolina Peanut Growers
Peanut Growers Cooperative Marketing Association
Society of American Florists
Southeast Dairy Farmers Association
Southern Peanut Farmers Federation
USA Rice Federation
U.S. Canola Association
U.S. Rice Producers Association
United Egg Producers
United Fresh Fruit and Vegetable Association
Virginia Peanut Growers Association

My position as Vice President of the American Farm Bureau
gives me responsibility for the grassroots process that our
organization uses to develop its policy positions. I listen to
hours of debate on farm policy and I can't think of another
idea that has such enthusiastic support as Farm and Ranch Risk
Management Accounts. FARRM accounts are simple and that's why
they are so appealing to farmers. Farmers like the idea that
the government wants to make it easier for them save for a
``rainy day.'' Congress should enact FARRM accounts into law.

CAPITAL GAINS TAXES

Farm Bureau commends Congress for capital gain tax relief
passed as part of the Taxpayer Relief Act of 1997. Lower
capital gains tax rates that took effect two years ago are
providing real benefit to America's farmers and ranchers.
Capital gains taxes do however, continue to cause a
hardship on agricultural producers because farming is capital
intensive and farming assets are held for long periods of time.
According to USDA, agricultural assets total $1,140 billion
with real estate accounting for 79 percent of the assets.
Studies indicate that farmers and ranchers hold real estate
assets for an average of 30 years with farmland increasing in
value 5 to 6 times over that period.
For farmers and ranchers the capital gains tax is
especially burdensome because it interferes with the sale of
farm assets and causes business decisions to be made for tax
reasons rather than business reasons. The result is the
inefficient allocation of scarce capital resources, less net
income for farmers and reduced competitiveness in international
markets.
Farmers also need capital gains tax relief in order to
ensure the cost and availability of investment capital. Most
farmers and ranchers have limited sources of outside capital.
It must come from internally generated funds or from borrowing
from financial institutions. The capital gains tax reduces the
supply of money available because lenders look closely at
financial performance, including the impact of the capital
gains tax on the profit-making ability of a business, when
deciding loan eligibility.
In addition, capital gains taxes affect the ability of new
farmers and ranchers to enter the industry and expand their
operations. While many think of the capital gains tax as a tax
on the seller, in reality it is a penalty on the buyer. Older
farmers and ranchers are often reluctant to sell assets because
they do not want to pay the capital gains taxes. Buyers must
pay a premium to acquire assets in order to cover the taxes
assessed on the seller. This higher cost of land hinders new
and expanding farmers and ranchers.
Farm Bureau believes that capital gains taxes should not
exist. Until repeal is possible, we support cutting the rate of
taxation to no more than 15 percent. We also recommend passage
of H.R. 1503 to expand the $500,000 capital gains exclusion for
homes to include farmland.

SELF-EMPLOYMENT TAXES AND RENTAL INCOME

Farmers, ranchers and other self-employed people pay 15.3
percent self-employment taxes (SE taxes) on net earnings from
self-employment. Recent Internal Revenue Service (IRS)
activities have wrongly expanded this tax so that farmers and
ranchers now have to pay SE taxes on some investment income.
For 40 years, until 1996, farmers and ranchers paid taxes
on self-employment earnings as intended by Congress. In that
year, a Tax Court case and IRS technical advice memorandum
incorrectly expanded the tax to include income from the cash
rental of some farmland. The IRS took this position even though
SE taxes are not generally collected from other property owners
who have cash rental receipts.
Farm Bureau supports enactment of H.R. 1044, introduced by
Reps. Nussle and Tanner, to clarify that farmers and ranchers
should be treated the same as other property owners and not be
required to pay SE taxes on cash rental income.

SELF-EMPLOYED HEALTH INSURANCE DEDUCTION

The majority of farmers and ranchers are self-employed
individuals who pay for their own health insurance. Because of
the high cost of health insurance, many cannot afford high
quality coverage or must go without health insurance. Even
though corporations that provided health insurance for their
employees can deduct premium costs, only 60 percent of the
self-employed person's health insurance premiums are tax
deductible in 1999. The deduction is scheduled to increase over
time until it reaches 100 percent in 2003. Farm Bureau supports
the immediate full deductibility of health insurance premiums
paid by the self-employed.

Chairman Archer. Thank you, Mr. Loop.
Our next witness is Mr. Thompson. If you would identify
yourself, you may proceed.

STATEMENT OF SKYLAR THOMPSON, PRESIDENT AND CHIEF OPERATING
OFFICER, MARKET BASKET FOOD STORES, NEDERLAND, TEXAS; ON BEHALF
OF NATIONAL GROCERS ASSOCIATION, RESTON, VIRGINIA

Mr. Thompson. Thank you. Mr. Chairman and Members of the
Committee, my name is Skylar Thompson, and I am president of
Market Basket Food Stores in Nederland, Texas. I would like to
give you a little background about our family business.
My father, Bruce Thompson, began his career in the retail
food business in 1949. He spent 12 years working for large
chains as department manager, store manager, and later as
supervisor. In 1962, he decided to go into business for
himself. He and my mother invested their entire savings along
with some borrowed capital and bought their first store. They
worked hard and a lot of hours and were able to buy more
stores.
As a young boy I began my career in the business in 1970
working part-time until graduation from Texas Christian
University in 1981. Over the years, I worked in a variety of
positions with the company, gradually working my way up to
president of the company.
After 37 years through a lot of hard work and a lot of
dedicated support from our employees, we very gradually grew
and expanded the business and now operate 32 stores in the
Texas and Louisiana marketplaces. As a family business, we are
committed to serving the needs in the communities where our
stores are located and our associates live and work.
One of the biggest threats to our future viability and
growth is this ominous cloud hanging over our head called the
Federal estate tax. In the grocery industry, we now compete
with multibillion dollar megachains with significant financial
resources. In order to stay competitive, we must continually
reinvest in our business, remodeling older stores, building new
stores, adding services and newer technology to better serve
our customers.
When the unfortunate death of my mother and father occurs
in the future, the company will face substantial estate tax
liability. Having to pay the Federal Government almost 55
percent of our estate will place a substantial drain on our
capital base. It will potentially force us to liquidate assets,
jeopardizing the future growth of our company and the continued
employment of our loyal associates.
I am here today on behalf of the National Grocers
Association to ask for repeal of this unfair and antifamily
tax. This antifamily, antibusiness tax policy forces many
families to face the prospect of selling, going out of business
and denying the next generation of entrepreneurs the
opportunity to take the risk and reap the rewards that this
industry has to offer.
Representatives Jennifer Dunn and John Tanner have
introduced the Estate and Gift Tax Reduction Act, H.R. 8, which
would phase out the estate tax by reducing the tax rate 5
percentage points per year until it reaches zero.
Representative Chris Cox has introduced the Family Heritage
Preservation Act, H.R. 86, which calls for the immediate repeal
of the death tax.
I want to thank the Chairman for his comments this morning,
Representatives Dunn and Tanner for sponsoring the legislation,
and the 22 Members of the Ways and Means Committee who have
sponsored legislation to eliminate the estate tax and for
recognizing its importance to every family-owned business
whether retail or wholesale grocer, farmers, restaurant owners
or other small businesses.
The case for eliminating the estate tax has been studied to
death. Recently the Joint Economic Committee released a
thorough study. The Economics of the Estate concluded that the
estate tax generates cost to the taxpayer, the economy and the
environment that exceed any potential benefits.
More importantly, NGA's own 1995 study of the family-owned
members confirmed the real life need for the elimination of the
Federal estate tax. In the event of the owner's death, 56
percent of the survey responded that they would have to borrow
money using at least a portion of the business as collateral
and 27 percent said they would have to sell all or part of the
business just to pay the Federal estate tax. Grocers reported
that this would result in the elimination of jobs, and that
would surely be a shame.
Now is the time for Congress to act. The Federal estate tax
robs privately owned entrepreneurs of the necessary capital
needed to maintain their competitive position in the
marketplace against multibillion dollar public companies.
Failure to act now places the competitive diversity of our free
enterprise system in serious jeopardy. On behalf of NGA's
members and family-owned businesses across the country, we
encourage the Ways and Means Committee to support repeal or
reduction of the estate tax now.
Thank you.
[The prepared statement follows:]

Statement of Skylar Thompson, President and Chief Operating Officer,
Market Basket Food Stores, Nederland, Texas; on behalf of National
Grocers Association, Reston, Virginia

Mr. Chairman and members of the committee, my name is
Skylar Thompson and I am President and Chief Operating Officer
of Market Basket Food Stores in Nederland, Texas.
I'd like to give you a little background about our family-
owned business. My father, Bruce Thompson, began his career in
the retail food business in July 1949. He spent 12 years
working for large food chains as department manager, assistant
store manager and store manager. In February 1962, my father
decided to strike out on his own and opened his first food
store. As a young boy, I began my career in the business in
1970, working part time until graduation from college in 1981.
Over the years, I have worked in a variety of positions with
the company, gradually working my way up to becoming president
and chief operating officer in November 1992. After 37 years,
through a lot of hard work, long hours and dedicated support
from our employees, we have gradually grown and expanded our
company and now operate 32 grocery stores in the Texas and
Louisiana market-places. As a family business, we are committed
to serving the needs of the communities where our stores are
located and associates live and work.
One of the biggest threats to our future viability and
growth as a family-owned business is the ominous cloud hanging
over our heads--the federal estate tax. In the grocery industry
we now compete with multi-billion dollar mega-chains with
significant financial resources. To stay competitive, we must
continue to reinvest in our businesses; remodeling older stores
and building new ones, adding services and new technology to
better serve our customers. If we were to experience the
unfortunate death of my father or mother, the company would
face substantial estate tax liability. Having to pay the
federal government almost 55 percent of one of our estates
would place a substantial drain on our capital base. It would
potentially force us to liquidate assets, jeopardizing the
future growth of our company and the continued employment of
our loyal associates.
I am here today on behalf of the National Grocers
Association (N.G.A.) to ask for repeal of this unfair and anti-
family tax.
The National Grocers Association is the national trade
association representing retail and wholesale grocers that
comprise the independently owned and operated sector of the
food distribution industry. At one time this industry segment
accounted for half of all food store sales in the United
States. In recent years, however, a number of successful
family-run companies have opted to sell because of the economic
disincentives caused by the estate tax.

Summary of Position

N.G.A.'s retail and wholesale grocers are the backbone of
their communities, whether they operate a single store or a
larger community multi-store operation. Repeal of the estate
tax is N.G.A.'s number one legislative priority. The death tax
deserves to die. It does substantial harm to family business
owners, their companies, their employees, their communities and
to the economy as a whole. On behalf of the nation's
independent retail grocers and wholesalers, N.G.A. strongly
urges the Ways and Means Committee and the entire Congress to
act now to support elimination of the estate tax. Privately-
owned retail grocers are facing unprecedented competition from
multi-billion dollar mega-chains and supercenter competitors.
In order to compete, all businesses need capital to reinvest in
their companies. Keeping up with new technology, remodeling and
expanding their stores, adding new consumer services, building
or buying new stores: all of these business decisions are
predicated on having the necessary capital. The federal estate
tax of up to 55 percent on the value of their business upon the
death of an owner places them at a significant competitive
disadvantage. Instead of using this capital to grow the
company, it is earmarked to pay taxes.
This anti-family, anti-business tax policy forces many
families to face the prospect of selling, going out of
business, and denying the next generation of entrepreneurs the
opportunity to take the risks and reap the rewards that this
industry offers. A week doesn't go by that we don't hear or
read about a successful family-owned grocer selling the
business. Successful family-owned businesses are making the
decision to sell now and pay the capital gains tax, rather than
the punitive, confiscatory estate tax.

Legislative Proposals

Representatives Jennifer Dunn (R-WA) and John Tanner (D-TN)
have introduced the Estate and Gift Tax Rate Reduction Act,
H.R.8, which would phase out the estate tax by reducing tax
rates by 5 percentage points each year until the rates are
zero. Representative Chris Cox (R-CA) has introduced the Family
Heritage Preservation Act, H.R.86, that calls for immediate
repeal of the death tax. Numerous other estate tax elimination
proposals have been introduced as well. I want to thank the 22
members of the Ways and Means Committee who have sponsored
legislation to eliminate the estate tax and for recognizing its
importance to every family-owned business--whether retail and
wholesale grocers, farmers, restaurant owners, or others.
The important point for the Ways and Means Committee is to
act now in support of estate tax repeal legislation. Privately-
owned and operated businesses cannot compete competitively when
the federal government makes small business its indentured
servant. N.G.A. urges the Ways and Means Committee members to
act now to preserve the future of privately-owned and operated
businesses before it is too late.

Studies Confirm the Need for Estate Tax Repeal

The case for eliminating the estate tax has been studied to
death. Recently, the Joint Economic Committee (JEC) released
its study, The Economics of the Estate Tax, concluding that the
estate tax generates costs to the taxpayer, the economy and the
environment that far exceed any potential benefits.
Specifically, the report found the following:
The estate tax is a leading cause of dissolution
for thousands of family-run businesses. Estate tax planning
further diverts resources available for investment and
employment.
The estate tax is extremely punitive, with
marginal tax rates ranging from 37 percent to nearly 80 percent
in some instances.
The existence of the estate tax this century has
reduced the stock of capital in the economy by approximately
$497 billion, or 3.2 percent.
The estate tax violates the basic principles of a
good tax system: it is complicated, unfair, and inefficient.
The distortionary incentives in the estate tax
result in the inefficient allocation of resources, discouraging
saving and investment, and lowering the after-tax return on
investments.
The estate tax raises very little, if any, net
revenue for the federal government. The distortionary effects
of the estate tax result in losses under the income tax that
are roughly the same size as estate tax revenue.
The enormous compliance costs associated with the
estate tax are of the same general magnitude as the tax's
revenue yield, or about $23 billion in 1998.
``The Case For Burying the Estate Tax'' by Tax Action
Analysis, The Tax Policy Arm of the Institute for Policy
Innovation, reaffirmed the JEC study, and found that:
``Estate taxes strike families when they are at their most
vulnerable: along with the family member, families can lose
what the family member built. High marginal tax rates often
force heirs to sell family farms or businesses just to pay the
estate tax bill. Eliminating the estate tax altogether would
eliminate all these complexities and injustices with no revenue
loss to the Treasury. In fact, after ten years, eliminating the
estate tax would produce sizeable economic gains, actually
increasing federal revenues above the current baseline.
Eliminating the federal estate tax in 1999 would cause the
economy to grow faster than in the current baseline, mainly due
to a more rapid expansion of the U.S. stock of capital. By the
year 2010:
Annual gross domestic product would be $117.3
billion, or 0.9 percent, above the baseline.
The stock of U.S. capital would be higher by
almost $1.5 trillion, or 4.1 percent, above the baseline.
The economy would have created almost 236,000 more
jobs than in the baseline.
Between 1999 and 2008, the economy would have
produced over $700 billion more in GDP than otherwise.
The damage that estate taxes do to capital formation
further magnifies the loss to society. Doing away with estate
taxes would produce positive economic growth effects large
enough to offset most of the static revenue loss.
Between 1999 and 2008, elimination of the estate
tax would cost the Treasury $191.5 billion.
But the over $700 billion in additional GDP would
yield $148.7 billion in higher income, payroll, excise and
other federal taxes.
In other words, higher growth would offset 78
percent of the static revenue loss over the first ten years.
By 2006, the dynamic revenue gain from eliminating
the estate tax would be enough to offset the annual static
revenue loss completely.''
More importantly, N.G.A.'s own 1995 study of its family-
owned members confirms the real life need for elimination of
the federal estate tax. In the event of the owner's death, 56
percent of the survey respondents said they would have to
borrow money, using at least a portion of the business as
collateral, and 27 percent said they would have to sell all or
part of the business to pay federal estate taxes. Grocers
reported that this would result in the elimination of jobs.
These findings were similar to those that were conducted as
part of a broader industry-wide study conducted by the Center
for the Study of Taxation.
Here is what other real family-owned grocers have to say
about the effects of the estate tax:
From a New Jersey retailer: ``Estate tax has a negative
impact on what should be positive business decisions. Many
business owners feel that they cannot expand because they have
to pay this tax. Also, Americans should be encouraged to save
and invest to plan for their future. With estate tax, the more
assets one has with death, the more they have to pay the
federal government.''
An Alabama grocer stated: ``As the only son and heir to our
family owned business, our family lives under the constant fear
that we will be forced to sell or liquidate our business upon
the death of my parents in order to pay the estate tax.
Inasmuch as my father, who is eighty-five years of age, and my
mother, who is not far behind, have worked hard to develop a
business that could be passed on not only to their immediate
family, but as a legacy for their four granddaughters. How
would we be able to explain to them that all the hard work and
dedication that has been put into the business for the past
twenty-seven years was only to pay off the Federal Government
because their grandparents passed away.''
A Washington retailer writes: ``I am a small businessman, a
grocer, running 2 small grocery stores in Naselle and Ocean
Park Washington. My wife and I have been operating this
business since 1967. Having recently done extensive & expensive
financial planning, I know first hand how badly we (our
country) need to consider repealing our Death Tax. Without
going into great detail, I will tell you this: Hire a financial
planner, hire a lawyer, set up trusts and limited partnerships
and buy a huge insurance policy and you may survive a tax
burden that is so huge you would have to close your business
and sell your assets in order to pay it. The cost for all of
this planning for my small business is ap-proximately $20,000 a
year. This seams an extreme amount of money. Money that could
be going to capital improvements, extra labor dollars, etc.,
etc.''
An Oregon retailer states: ``My grocery business was
founded by my parents 64 years ago. I am the second generation
in the family business. My son hopes to carry the business to
the fourth generation. This is highly questionable with death
taxes at 55%. If it has to be sold to satisfy the government
for the unfair and excessive tax, then another small
independent business is gone, along with the jobs my stores
offer to this community.''

Conclusion

Numerous studies exist that reinforce the need for
elimination of the estate tax. Now is the time for Congress to
act. Privately-owned and operated retail grocers, as well as
other community businesses, face unprecedented competition and
need capital in order to compete with multi-billion dollar
mega-chains and supercenters, such as Wal*Mart. The federal
estate tax robs privately-owned entrepreneurs of the necessary
capital needed to maintain their competitive position in the
marketplace with multi-billion dollar public companies. Failure
to act now places the competitive diversity of our free
enterprise system in serious jeopardy. On behalf of N.G.A.'s
members and family-owned companies across the country, we
encourage the Ways and Means Committee to support repeal of the
estate tax now.

Chairman Archer. Thank you, Mr. Thompson. Thank you very
much for staying within the 5-minute limit.
Our next witness is Mr. Coyne. If you will identify
yourself for the record, you may proceed.

STATEMENT OF MICHAEL COYNE, MEMBER, TUCKERTON LUMBER COMPANY,
SURF CITY, NEW JERSEY; ON BEHALF OF NATIONAL FEDERATION OF
INDEPENDENT BUSINESS

Mr. Coyne. Yes. Good afternoon, Mr. Chairman and Members of
the Committee. On behalf of the 600,000 members of the National
Federation of Independent Business, the NFIB, I appreciate the
opportunity to present the views of small business owners on
the subject of estate taxes. My name is Michael Coyne. My
family owns and operates Tuckerton Lumber Co., which is
headquartered in Surf City, New Jersey.
My grandfather founded Tuckerton Lumber Co. in 1932. The
company made it through the ravages of the Great Depression and
the material shortages of World War II. Today Tuckerton Lumber
Co. is a community institution. We have three locations and a
separate kitchen and bath business. We have received the Best
Home Center of Southern Ocean County Award and I might add that
we have consistently beaten the largest home center chain in
the country for this distinction.
Tuckerton Lumber Co. supports various community efforts,
including funding for four annual scholarships to graduating
area high school students. We have 75 employees. We truly do
regard our employees as our best asset and we treat them
accordingly. We provide for our employees and their dependents
full health and dental benefits and a 401(k) plan. On average,
our employee turnover rate is very low. One employee has been
with our company for 34 years. Truly, we do regard all of our
employees as family.
Mr. Chairman, the death tax endangers both my family's
business and the jobs of our 75 employees. It literally puts
seven decades of work, planning, blood, sweat, and tears at
risk.
My experience with the death tax began just a decade ago
when my grandfather passed away. The bulk of the estate,
including the lumberyards, was transferred to my grandmother.
Although we had good legal representation and had done the
appropriate planning, it became obvious that the business would
not survive another transition. We were and are facing an
estate tax rate of 55 percent should my grandmother pass away
any time soon.
After my grandfather's passing, we were put in the awkward
position of having to worry about increasing the value of the
business too much. We have always believed in putting any
profit back into the business to keep it strong and healthy and
to help it to grow. Now reinvesting profits can actually
threaten our business.
For the past 10 years we have worked with estate lawyers
and accountants to develop a plan for dealing with the estate
tax and preserving the family business. In that time, we have
invested over $1 million in life insurance policies, lawyers
and accountants' fees and other efforts to ensure that the
family business will remain intact.
I am not an economist but I am aware of studies that show
the cost of the death tax to the economy is greater than the
revenue it raises for the Federal Government. Considering the
cost this tax has already imposed on my business before we have
even paid the tax, I sincerely believe that this is the case.
Mr. Chairman, I have worked for my family's business 6 days
a week, often late into the night, for the past 18 years. That
is not as long as our most senior employee and not even as long
as my brother-in-law, but it still represents a commitment that
has consumed most of my adult life. The business is our life.
It puts food on the table for my family and the families of our
75 employees. It is simply immoral that a tax has the power to
take all of that away. We have played by the rules, played a
key role in the development and success of our community and
paid millions in taxes throughout the years. Despite all of
that, the death tax would take away all that we have worked so
hard to accumulate and preserve.
In closing, Mr. Chairman, I would like to encourage this
Committee and Congress to bury the death tax. There is no
reason to continue a tax that costs more than it raises. I
understand that a majority of House Members have expressed
support for completely eliminating the death tax, either
cosponsoring the Cox bill or the Dunn-Tanner bill. I hope that
this support will translate into action this year and help
protect thousands of family businesses like Tuckerton Lumber
Co.
I thank the Chairman and Members of this Committee for
holding this hearing and for the opportunity to present my
views and experience. I would welcome any questions Members
might have.
[The prepared statement follows:]

Statement of Michael Coyne, Member, Tuckerton Lumber Company, Surf
City, New Jersey; on behalf of National Federation of Independent
Business

Good morning. On behalf of the 600,000 members of the
National Federation of Independent Business (NFIB), I
appreciate the opportunity to present the views of small
business owners on the subject of estate taxes.
My name is Michael. My family owns and operates the
Tuckerton Lumber Company in Surf City, New Jersey.
My grandfather founded Tuckerton Lumber Company in 1932.
The company made it through the ravages of the Great Depression
and the material shortages of World War II. My grandfather
purchased the company from his father and the business has been
in the family ever since.
Today, Tuckerton Lumber is a community institution. We have
grown over the years to an operation with three locations and a
separate Kitchen and Bath business. We have received ``The Best
Home Center of Southern Ocean County'' award, a Reader's Choice
Award presented by The Times Beacon Newspaper. I might add,
that we have consistently beaten the largest home center chain
in the country for this distinction. Tuckerton Lumber Company
supports various community efforts, including funding four
annual scholarships to graduating high school students.
We also have sixty-five employees. We regard our employees
as our best asset and we treat them accordingly. We fully fund
and provide for our employees and their dependents full health
and dental benefits and a 401(k) plan. On average, our employee
turnover rate is very low. One employee has been with our
company for thirty four years. Truly, we regard all of our
employees as family.
Mr. Chairman, the death tax endangers both my family's
business and the jobs of our sixty-five employees. It literally
puts seven decades of work, planning, blood, sweat and tears at
risk.
My experience with the death tax began just ten years ago
when my grandfather-in-law passed away. The bulk of the estate,
including the lumber yards, was transferred to my grandmother.
Although we had good legal representation and had done the
appropriate planning, it became obvious at the time of the
transfer that the business would not survive another
transition. We were facing an accelerated estate tax rate of
55% should my grandmother pass away.
Since 1980, the business has tripled in size in terms of
sales. After my grandfather's passing, we were put in the
awkward position of having to worry about increasing the value
of the business too much. We have always believed in putting
any profit back into the business to keep it strong and healthy
and to help it grow. It also helps to have a cushion in order
to weather times of economic slowdown.
Another problem we face concerns the land on which our main
office and a fully stocked lumber yard is located. It is
situated right in the heart of Long Beach Island, a beautiful
barrier island that is a highly desired location for summer
homes. Real estate values have remained very high for the last
twenty-five years, yet moving our main office is out of the
question. In order to prepare, we have worked with estate
lawyers and accountants to develop a plan for dealing with the
estate tax and preserving the family business. In the ten years
that have passed, we have invested over $1 million in life
insurance policies, lawyers, accountants and other efforts to
ensure that when my grandmother passes away, the family
business will remain intact.
Mr. Chairman, I have worked for my family's business six
days a week often late into the night for the past eighteen
years. That's not as long as our most senior employee, and not
even as long as my brother-in-law, but it still represents a
commitment that has consumed most of my adult life.
That is my story and the story of one family lumber company
in New Jersey. My membership with NFIB has exposed me to the
experiences of other family businesses. Jack Faris, President
of NFIB, recently penned a column that highlighted the efforts
of another family lumberyard in Missouri. That family was
paying premiums of thirty thousand dollars a year for a life
insurance policy against the death tax. I sympathize with that
family, but I would point out our premiums were three times as
high.
In preparation for this hearing, I was also exposed to
several studies, one by the Joint Economic Committee here in
Congress, that show the costs of the death tax to families,
communities, and the economy far outweigh the revenues the tax
raises for the Treasury. That's not news to me. The million
dollars my family has invested to prepare for this tax has
drained resources that could have been used to expand our
business opportunities and create new jobs. Instead of planning
for a better business, we're just working to keep what we have.
In 1997, the Taxpayer Relief Act initiated a series of
reforms designed to reduce the burden on the death tax on
family businesses. I welcome those changes and thank Congress
for taking action, but for my business the relief might be
described as too little, too late. My grandmother is 91 years
old, and though we expect her to outlive us all, increasing the
unified credit to $1 million will still leave her estate
subject to a tax of millions of dollars.
This business is our life. It puts food on the table of my
family and the families of our sixty-five employees. It is
simply immoral that a tax, applied at the future death of my
grandmother, has the power to take all of that away. We have
played by the rules and paid millions in taxes through the
years. The death tax would take away in after tax dollars all
we have accumulated through the years. Although I represent the
third generation involved in the business, we have not
squandered what has been passed on to us. Quite the contrary,
we have made the business grow through a lot of hard work,
discipline and dedication.
In closing, Mr. Chairman, I would like to encourage this
Committee and Congress to bury the death tax. There is no
reason to continue a tax that costs more than it raises. I
understand a majority of House members have expressed support
for completely eliminating the death tax--either cosponsoring
the Cox bill or the Dunn/Tanner bill. I hope this support will
translate into action this year to help protect family
businesses like Tuckerton Lumber.
I thank the Chairman and members of this committee for
holding this hearing and for the opportunity to present my
experience.

Chairman Archer. Thank you, Mr. Coyne.
Our final witness is Mr. Speranza. If you will identify
yourself, you may proceed.

STATEMENT OF PAUL S. SPERANZA, JR., CHAIR, TAX COMMITTEE,
GREATER ROCHESTER NEW YORK METRO CHAMBER OF COMMERCE; MEMBER,
BOARD OF DIRECTORS, AND CHAIRMAN, TAXATION COMMITTEE, U.S.
CHAMBER OF COMMERCE; ON BEHALF OF BUSINESS COUNCIL OF NEW YORK
STATE, INC., AND FOOD MARKETING INSTITUTE

Mr. Speranza. Good afternoon, Mr. Chairman, and Members of
the Committee. My name is Paul Speranza and I am pleased to
appear today before you in my capacity as a member of the board
of directors and chairman of the Tax Committee of the Chamber
of Commerce of the United States. The Chamber represents over 3
million businesses in the United States and is the largest
business federation in the world. I also represent the Business
Council of New York State, which is the largest business
federation in New York State. I am a member of the board of
directors of that organization as well and that organization's
representative on the Chamber of Commerce of the United States
Board of Directors. I also represent the Greater Rochester New
York Metro Chamber of Commerce and, last, I am representing the
Food Marketing Institute, which represents the overwhelming
majority of the Nation's neighborhood supermarkets.
I appreciate the opportunity to be here today and share
with you my experiences with respect to estate and gift tax and
also to share with you the views of the organizations that I
represent.
I would request that my formal written statement be
incorporated into the record and that of Food Marketing
Institute also be included in the record.
The Federal estate and gift tax is complex, unfair, and
inefficient. Number one, it raises approximately 1.5 percent of
the revenue in this country, and coincidentally that is about
the amount that it costs for planning, compliance, and
collection in this economy.
Number two, the 55-percent estate tax rate is by far the
highest in the world. As a matter of fact, the lowest effective
estate and gift tax rate is about the same as the highest
income tax rate, which shows a great disparity.
Number three, people are penalized who have saved, risked
more, and worked hard, many of whom you have heard today. This
estate and gift tax is a tax on the virtue of working hard and
saving.
And last, when this onerous tax applies, workers can be
laid off, businesses have to borrow funds, reduce capital
investment, and liquidate or sell their businesses. This
negatively impacts the owners of those businesses, their
employees, their families, and many others.
Here is just one example of how this tax works. The tax
court decided a case called the Estate of Chenoweth. In that
case the asset in question was the stock of a privately held
company. The stock was valued one way for the adjusted gross
estate purposes for which the tax was applied. That very same
block of stock was valued in a totally different way resulting
in a substantially lower value for marital deduction purposes.
What then happened is an unsuspecting surviving spouse had to
pay a major amount of tax because of this convoluted
interpretation using two different valuations. Now the
interpretation may or may not be right as it relates to the
law, but it is clearly wrong on the issue of logic and
fairness.
I am a retail food industry executive. I work for a closely
held, privately owned business and I am also a tax attorney. I
have worked in the estate and gift tax field for approximately
30 years. When I was in law school, I took every course I could
in the field and wrote a law review article in that area under
the supervision of Professor Steven Lind. After law school, I
went on to get a postgraduate degree in tax law at New York
University School of Law which consistently has the number one
tax program in the United States. There I studied under
professors Guy Maxfield and Richard Stevens. Professors
Stevens, Maxfield, and Lind are the foremost authorities on the
estate and gift tax in the United States. Their treatise is the
definitive work in this field.
Over the course of my career, I have worked with
individuals, families, and their businesses to assist them in
this very difficult and complex field which gets more complex
as time goes by. At this point in time the law is
incomprehensible, it is unfair, it is confiscatory and
downright un-American.
Now, why do I share all of this with you? The reason I
share this with you, is because it is time for Congress to put
estate tax attorneys like me out of business and I am not the
only one who thinks this way. We can do more productive things
with our time. We really can. As a matter of fact, a survey was
recently conducted in upstate New York which is where I live. I
will describe this survey in more detail in a moment. This
survey shows many innocent people are losing their jobs as a
result of this tax.
Over the last 3 months, I have worked closely with the
Public Policy Institute of New York State, it is a research and
educational organization affiliated with the Business Council
of New York State, to complete a survey on the impact of the
Federal estate and gift tax on family-owned businesses in
upstate New York. I have to tell you the economy in upstate New
York is not doing well. This survey has not yet been formally
published but the data submitted by 365 family businesses show
that at least 15,000 jobs are at risk over the next 5 years
just from those 365 companies as a result of the estate and
gift tax.
Now, logic dictates that the number of jobs at risk is
substantially larger in New York State when you consider all of
the businesses in New York State and you then consider all the
businesses in the Nation. I look forward to sharing the details
of this survey when it is complete.
We have worked on this survey with Professor Douglas Holtz-
Eakin, who is the chairman of the economics department at the
Maxwell School of Citizenship and Public Affairs, Syracuse
University, and I note in the Joint Committee's report for
today's hearing that his work is mentioned. Syracuse University
has the number one public administration graduate program in
the United States. One of the most telling points that
Professor Holtz-Eakin makes in this report is that the true
cost of this tax falls upon those individuals who lose their
jobs and their families.
Now, we want to thank you, Congresswoman Dunn and
Congressman Tanner, for supporting and taking the leadership
role on H.R. 8, which obviously phases out the estate tax over
a 10- to 11-year period of time at 5 percent a year. Thank you
very much for your support. Above and beyond that, the U.S.
Chamber and the other organizations that I represent support in
principle S. 1128, the Kyl-Kerrey bill. That bill has been
described earlier so I won't go into great detail. It
eliminates the estate and gift tax immediately. It eliminates
the step-up in basis, provides a carryover basis, and in most
cases provides a tax rate on the disposition of assets at 20
percent. It also eliminates death as a taxable event. If that
approach were to be used, I might add one additional point,
that the Internal Revenue Code section 302 would need to be
modified because family-owned businesses could end up paying a
39.6-percent rate versus a much lower capital gain rate.
So in conclusion, the estate and gift tax depletes the
estates of taxpayers who have saved their entire lives but let
us not forget the most important people. Those are the people
who will lose their jobs as a result of the estate and gift
tax.
Thank you for the opportunity for allowing me to testify
before you today.
[The prepared statement follows:]

Statement of Paul S. Speranza, Jr., Chair, Tax Committee, Greater
Rochester New York Metro Chamber of Commerce; Member, Board of
Directors, and Chairman, Taxation Committee, U.S. Chamber of Commerce;
on behalf of Business Council of New York State, Inc., and Food
Marketing Institute

Mr. Chairman and members of the Committee, my name is Paul
Speranza and I am pleased to appear before you today in my
capacity as a member of the Board of Directors of the U.S
Chamber of Commerce and as Chairman of the Chamber's Taxation
Committee. The U.S. Chamber is the world's largest business
federation representing more than three million business
organizations of every size, sector and region. I also
represent the Business Council of New York State, Inc., which
is the largest business federation in New York. In addition, I
represent the Greater Rochester New York Metro Chamber of
Commerce, where I chair its tax committee. Lastly, I represent
the Food Marketing Institute, which represents more than half
of the food stores in the United States. I appreciate this
opportunity to relate to the Committee my experiences with the
impact of the federal estate and gift tax, and to express the
views of the U. S. Chamber and the other organizations that I
represent on pending legislative proposals providing relief
from the federal estate and gift tax.

BACKGROUND OF THE FEDERAL ESTATE AND GIFT TAX

The federal estate tax was enacted in 1916 principally to
finance this country's involvement in World War I. After 1916,
and despite some early efforts to repeal taxes on wealth
transfers during peacetime, the federal estate tax has remained
a consistent feature of the federal tax system. The history of
the federal estate tax for the years following World War I to
present day essentially involves a gradual expansion of the
estate tax base, coupled with increases in the rates of estate
tax imposed. In 1976, the federal estate tax and gift tax
structures were combined and a single, unified, graduated
estate and gift tax system was created.
Under the current federal estate and gift tax, the rates
are steeply graduated and begin at 18 percent on the first
$10,000 of cumulative transfers and reach 55 percent on
transfers that exceed $3 million. A unified tax credit is
available to offset a specific amount of a decedent's federal
estate and gift tax liability. Under the Taxpayer Relief Act of
1997, this exemption amount was increased to its current
$650,000 level, and will continue to be increased incrementally
until it reaches $1 million by the year 2006. The exemption
amount, however, will not be indexed for inflation after 2006.
In addition, the Taxpayer Relief Act of 1997 created a new
exemption for ``qualified family-owned business interests.''
However, this exemption, plus the amount effectively exempted
by the applicable unified credit, cannot exceed $1,300,000.
Whether a decedent's estate can qualify for the maximum
$1,300,000 exemption amount depends, among other things, on the
mix of personal and qualified business assets in the estate at
the death of the decedent, and satisfaction of an exceedingly
complex array of conditions relating to the structure of the
family business and the conduct of the heirs after the
decedent's death. Indeed, after only two-year's of experience,
it is clear that many family businesses will not qualify for
this exemption.

THE FEDERAL ESTATE AND GIFT TAX IS COMPLEX, UNFAIR AND INEFFICIENT

When the government in a free society uses its power to
tax, it has an obligation to do so in the least intrusive
manner. Taxes imposed should meet the basic criteria of
simplicity, efficiency, neutrality and fairness. The federal
estate and gift tax, even with the credits and exemptions
available under current law, fails miserably to meet any of
these requisites.
Today's federal estate and gift is a multi-layered taxing
mechanism so complex that it literally encourages attempts by
professional advisers to avoid estate tax liability through a
variety of transactions and techniques, many of which would not
(and should not) be undertaken but for the desire to preserve a
family's savings and capital. This in turn has lead to the
allocation of billions of dollars of precious business
resources towards estate tax planning and compliance costs,
despite the fact that the actual revenue generated accounts for
less than 1.5 percent of all federal tax collections.
Coincidentally, the cost of planning, compliance and collection
of this tax equals the amount of the tax collected.
Nor can the estate and gift tax be considered either
neutral or fair to individuals or businesses. The tax is
progressive in the extreme, with the lowest effective tax rate
almost equal to the highest income tax rate. This penalizes
those who have saved more, risked more, and worked harder than
others. In this way, the estate and gift tax is actually a tax
on the virtues of industry and thrift.
Moreover, the estate and gift tax is far more likely to
affect small and medium-sized businesses today than it was
sixty years ago. In fact, in 1995, over half of the estate and
gift tax revenue generated was derived from estates valued at
less than $5 million. Unfortunately, many small and family-
owned business owners are either unaware of the need for estate
tax planning or unable to afford it, which later results in an
estate and gift tax liability that often threatens the
continued viability of the business. In order to pay such
liabilities, these businesses are forced to either lay off
workers, borrow funds, reduce capital investments, liquidate,
or sell to an outside buyer. These actions harm everyone
connected with these businesses, including its owners,
employees, customers, vendors, and families.
I am a retail food industry executive and a tax attorney; I
have been involved with the federal estate and gift tax law for
the last 30 years. While in law school, I wrote a law review
article on this subject under the supervision of Professor
Steven Lind. After law school, I received an advanced tax law
degree from the New York University of Law, where I studied the
Estate and Gift Tax Law with Professor Richard Stevens and Guy
Maxfield. Professors Lind, Stevens and Maxfield are the
nation's foremost authorities in this field and have written
the definitive textbook on the estate and gift tax law.
Throughout my career, I have assisted individuals, families,
and businesses in the estate and gift tax field. The law in
this field has become substantially more complex over the
years. It has also become incomprehensible, unfair,
confiscatory and downright un-American.
I would like to give you one example to make this point,
although there are many. The Estate of Chenoweth, 88 T. C. 1577
(1987), and related cases in certain circumstances value the
same stock in a closely held family business for gross estate
purposes higher than it values the very same asset for marital
deduction purposes. This difference in the valuations of the
very same asset can leave an unsuspecting surviving spouse with
a major estate tax liability. Chenoweth may or may not be a
correct interpretation of the law, but it is definitely wrong
on logic and fairness. Why do I share all of this? Because the
time has come for Congress to put estate tax attorneys like me
out of business. We can find more productive things to do. I
know that there are other estate tax attorneys who agree with
me on this matter. As I will explain in more detail below, a
recent survey conducted in upstate New York shows that innocent
people are losing their jobs as a result of this cruel tax.
Over the last three months, I have worked closely with the
Public Policy Institute of New York State, a research and
educational organization affiliated with The New York Business
Council, to complete a survey on the impact of the federal
estate and gift tax on family business employment levels in
Upstate New York. While the survey has not yet been formally
published, the data submitted by the 365 family businesses
respondents reveals that for these respondents alone, at least
15,000 jobs in Upstate New York are at risk over the next five
years as a direct result of the estate and gift tax. This
figure includes jobs that would not be created because of the
allocation of resources away from business expansion and
towards planning for the estate and gift tax, as well as jobs
that would have to be terminated upon the death of the
patriarch or matriarch of the business. In fact, over one-third
of the respondents indicated that they would be compelled to
take the dramatic and clearly undesirable step of selling or
completely liquidating the business in order to meet the estate
and gift tax burden.
While I look forward to sharing the detailed results of
this survey with the Committee upon its publication, the
evidence we have gathered supports overwhelmingly the
conclusion that the estate and gift tax has a crippling effect
on job growth, job creation and business expansion in Upstate
New York's family-business community, which is one of the most
vital components of the region's economy. I feel almost certain
that these conclusions would not be substantially different if
the survey were conducted in other states. Professor Douglas
Holtz-Eakin, the Chairman of the Economics Department at the
Maxwell School at Syracuse University, has worked with us on
this. According to U.S. News and World Report, the Maxwell
School has been rated as the number one graduate public policy
school in the United States. Professor Holtz-Eakin's analysis
points out that the ultimate cost of this tax is borne by those
who lose their jobs as a result of it.

PENDING FEDERAL ESTATE AND GIFT TAX LEGISLATION

As noted above, The Taxpayer Relief Act of 1997 provided a
narrow class of family businesses with modest relief from the
estate and gift tax. While virtually any form of relief is
welcome, the U.S. Chamber and the other organizations that I
represent feel strongly that any future estate and gift tax
reform legislation should provide relief to all estates,
regardless of the size, financial structure or composition of
the estate's assets.
The U.S. Chamber and the other organizations that I
represent continue to support legislation that provides for
immediate repeal of the estate and gift tax. The case for
immediate repeal is compelling: the estate and gift tax
penalizes savings, results in direct and substantial harm to
family-owned businesses and farms, reduces the rate of job
creation, is complex, costly and inefficient to comply with
(and collect) and does not produce substantial federal revenue.
While outright repeal of the estate and gift tax should thus
remain the ultimate goal, the U.S. Chamber and the other
organizations that I represent realize that current budget
limitations may prevent this Congress from taking that step. If
so, additional interim estate and gift tax relief should be
enacted, and should be geared toward what is the most harmful
aspect of the regime: the outrageously high rates of tax
imposed.
Both family business owners and estate tax practitioners
agree that Congress should avoid any attempts to define what
does, and what does not, constitute a ``family business'' for
purposes of targeting estate and gift tax relief. The
competitive marketplace requires that family businesses
structure their assets and operations in ways that are as
varied as the industries in which they engage. It follows that
conditioning the benefits on the way that a family business may
chose to structure itself simply cannot achieve an equitable
distribution of estate and gift tax relief.
In addition, Congress should avoid merely accelerating the
increase in the estate and gift tax exemption that already is
scheduled to be fully phased-in to the $1 million level by the
year 2006. This would provide additional relief to only those
estates at the lowest end of the taxable range and would not
provide any meaningful relief to the medium and larger-sized
businesses that make more substantial contributions to
employment levels and local economies. For these businesses,
merely accelerating the increase in the exemption level is
insufficient to mitigate the impact of estate and gift tax
rates that can result in more than half of the value of the
family business going directly to the U.S. Treasury.
Currently, the United States has the highest estate and
gift tax rates of any country, followed by France at 40
percent, Spain at 38 percent, Germany at 35 percent, and
Belgium at 30 percent. For estates with a value that equals or
exceeds $3 million, a maximum rate of 55 percent is imposed,
even if the majority of the value of the estate is comprised of
non-liquid assets. With such high rates of tax, it is common
for the estate and gift tax liability of a business or
individual to exceed the monetizable value of the estate's
assets. Thus, even if one were to embrace the dubious notion
that a tax at death is needed to insure progressivity within
the tax code and ``backstop'' the income and capital gains tax
systems, the 55 percent maximum rate is, by any reasonable
definition, confiscatory.
There is simply no legitimate rationale for a maximum
income tax rate of 39.6 percent, a long-term capital gains tax
rate of 20 percent and a maximum estate and gift tax rate of 55
percent, which not surprisingly is the highest stated rate of
tax in the Internal Revenue Code. Only recently has there been
such a marked disparity between the maximum income tax rate and
the maximum estate and gift tax rate.
The U.S. Chamber and the other organizations that I
represent are thus fully supportive of H.R. 8, the bi-partisan
legislation introduced by Representatives Jennifer Dunn (R-WA)
and John Tanner (D-TN) that addresses directly the confiscatory
estate and gift tax rate structure. The Dunn-Tanner legislation
provides for a ``phase-out'' of the estate and gift tax over a
ten-year period, accomplished by a five percentage point,
across-the-board rate reduction in each of the ten intermediate
years. The Dunn-Tanner legislation represents a fiscally
responsible approach to repeal because it mitigates the revenue
impact with a ten-year phase-in period. Moreover, the Dunn-
Tanner legislation provides immediate rate relief over the
interim period without introducing any additional complexity
into the Code.
The U.S. Chamber and the other organizations that I
represent also support S.1128, the bi-partisan legislation
introduced recently by Senators Jon Kyl (R-AZ) and Bob Kerrey
(D-Neb), and co-sponsored by a coalition of Republican and
Democrat members of the Senate Finance Committee. Under the
Kyl-Kerrey bill, estate and gift taxes would be repealed in
their entirety (and immediately) and the ``step-up'' in basis
rules applicable to property acquired from a decedent would
likewise be eliminated. The Kyl-Kerrey bill would thus make
death a non-taxable event, provide for the ``carry-over'' of
tax basis with respect to property received from a decedent,
impose a tax only when the heir decides voluntarily to dispose
of the asset, and provide that the rate of tax imposed on the
subsequent sale of such property by the heir will in no case
exceed the top effective income tax rate of 39.6 percent (and
in most cases, will be the lower applicable capital gains tax
rate of 20 percent). Of course, no estate or gift tax will be
payable in the case of a family-owned business that simply
continues to pass the business property from generation to
generation. It also should be noted that in the context of this
proposal, Section 302 of the Internal Revenue Code should be
modified to allow all such transactions at the 20 percent
capital gains rate so long as the appropriate holding period
requirement is met.
The U.S. Chamber and the other organizations that I
represent urge this Committee to consider seriously proposals
that address the punitive levels of estate and gift tax rates
and provide for an equitable distribution of relief for the
varying types of estates and businesses affected by the tax.

CONCLUSION

In conclusion, the estate and gift tax depletes the estates
of taxpayers who have saved their entire lives, often forcing
successful family businesses to liquidate or take on burdensome
debt to pay the tax. Taxpayers should be motivated to make
financial decisions for business and investment reasons, and
not be punished for individual initiative, hard work, and
capital accumulation. Let us also not forget the thousands of
employees of family-owned businesses who will lose their jobs
as a result of this unfair tax. They bear the heaviest cost of
all. The U.S. Chamber and the other organizations that I
represent believe that the estate and gift tax should be
repealed immediately. However, short of immediate repeal, the
estate and gift tax should be reformed in a manner that
eliminates the well documented negative effects of this tax on
individuals and the owners of family businesses.
Thank you for the allowing me the opportunity to testify
here today.

Chairman Archer. Thank you, Mr. Speranza. The Chair is
going to go slightly out of order because one of our Members,
Mr. Tanner, needs to go to another meeting and he is very, very
interested in this issue. So the Chair recognizes Mr. Tanner
for any brief comments.
Mr. Tanner. Mr. Chairman, thank you very much, and I want
to particularly thank you for this panel. I want to thank you
all and of course thank Ms. Dunn for her interest in this as
well.
What is striking, Mr. Chairman, you all have done a far
better job than I think any of us could do but what is striking
here is two things. One, it has been said that small businesses
are the real economic engines in this country and create the
vast amount of jobs that are created from time to time therein
and also that all of you on this panel are not chief executive
officers of the Fortune 500 or Fortune 100 companies but they
are family-owned businesses and agriculture enterprises which I
believe is the fabric of this Nation that must be maintained
and preserved.
You all have been eloquent in your presentation and I hope
that as we go forward, H.R. 8 can receive a place of high
priority, Mr. Chairman, in your consideration of this entire
matter. Thank you.
Chairman Archer. I share the gentleman's comments that this
panel has done an outstanding job in presentation today. When I
came to the Congress in 1971, one of my goals was to completely
eliminate what we used to call estate tax. We are getting
closer all the time and I am proud of the fact that the new
Majority that came in in 1995 turned the direction of
consideration around. The previous Majority wanted to move
toward a greater taxation under the death tax by reducing the
exclusion from 600,000 to 200,000. Our new Majority said it is
totally wrong and we started moving the balance in the other
direction down the field. Hopefully we will one day achieve the
ultimate goal of complete elimination.
I have a lot of other desired goals. You mentioned the
compliance costs and administrative costs of the death tax, and
we have a similar situation with the income tax, where we have
got the brightest and best minds of this country spending full-
time figuring out how to make end runs around the income tax,
and that is wasted effort.
Mr. Speranza, I compliment you. One of your colleagues sat
at the witness table not too long ago, a gentleman from
Alabama, for whom I have the highest respect, a man named
Harold Apelinski, who makes his living off of advising people
how to reduce their death tax liabilities. He said his goal was
to put himself out of business and that is a truly laudable
position that you have taken because you have a mind that can
produce wealth instead of destroying wealth or trying to
prevent the destruction of wealth. So I do thank you.
I am curious and I do not want to intrude into your
personal financial holdings, but I think it is important to
note that if any one of you has an estate which is likely to be
valued at over $10 million, that the marginal tax will not be
55 percent. It will be 60 percent. So the confiscation goes up
and we should not forget that. Many people don't realize that,
but I know Mr. Speranza does and all you have got to do is look
at the Code and you will find out that that is the case.
I would like to ask Mr. Coyne a question since you
represent the NFIB and as a former small business person
myself, I have great sympathy with what that organization
stands for. Is your presentation which supports the complete
repeal of the death tax, is that the number one tax priority
for tax relief of the NFIB this year?
Mr. Coyne. I believe that is true. I know certainly for our
business that is the case and has been for 10 years.
Chairman Archer. I can understand where it would be for
your business, but I am curious as to whether it is also the
number one priority for tax relief for the NFIB.
Mr. Coyne. The complete elimination of the death tax, yes.
Chairman Archer. Let me also make all of you aware that we
are going to have no money for tax relief in the year 2000.
Under the budget that was adopted by the Congress, there will
be no surplus for tax relief in the year 2000. There will be a
very nominal amount in the projections for the year 2001, but
the projected surpluses wedge out over the 10-year period ahead
of us so that over 10 years we will be able to give slightly
under $800 billion in the way of tax relief and live within the
allowable surpluses. So any bill that would immediately repeal
the death tax is way beyond anything that we can do within the
budget resolution and the scored revenue losses which we have
to live with irrespective of the comparison to the
administrative costs and compliance costs. I am very
sympathetic to that but we have to live with the official
estimates and the estimates are that over a 5-year period,
immediate repeal would lose 170 billion dollars' worth of
revenue. Over 10 years it would be roughly double that. So you
can see the revenue constraints that we have to operate under
and that is just a reality that we all need to be aware of as
we pursue this ultimate goal. But I do compliment each of you
and I wish more Members of the Committee were here to listen to
you.
Ms. Slater, you made, I thought, an extremely compelling
presentation, but I thank each of you for coming to be with us
and I know there are Members here who do wish to inquire. I
know Ms. Dunn wants to say something. So Ms. Dunn, you are
recognized.
Ms. Dunn. Thank you very much, Mr. Chairman, and I
appreciate your allowing six members of the business community
who have had great experience with the onerous burden of the
death tax to come before us. It means a lot for us to be able
to hear their stories and I will just tell you that only in the
United States are we given a certificate at birth and a license
at marriage and a bill at death, and I think those of us here
today would certainly like to see that bill at death removed.
A couple of points and then I have a couple of questions I
would like to direct to the panel. We are looking at a tax that
brings in 1.4 percent of government revenues. Last year that
would have been about $23 billion and you have heard the
panelists talk about the costs of compliance in the private
sector alone being a similar amount, $23 billion. So that is a
total of $46 billion that are being brought out of a
potentially productive market.
The Chairman talked about the total elimination of the
death tax and that it is difficult to do considering lots of
other demands and not as many dollars as we would wish to put
into tax relief. But I do want to say that H.R. 8, which many
of you have mentioned in your testimony, would score at $44
billion over 5 years and it would score at under $200 billion
over 10 years and that is a comparison to the $780 billion we
are looking at for tax relief compared to $200 billion.
As the Chairman says, we have to live within those numbers
and I think it is a tragedy because when you figure how much
death tax really does take out of production and you assume
that you would leave a great deal of that money with your
companies as they move from family to family, I believe the
scoring is way off and I think productivity would be huge and
would offset any of this loss of income. That is my personal
and other people's personal thought about this whole thing.
We are constrained by the scoring of the Federal
Government, which is not a dynamic scoring and therefore does
not take into consideration the behavior of people when they
can keep those dollars and not invest those in compliance or
have them taken by the government that itself spends probably
60 cents out of each dollar that comes from death tax.
We are the highest nation in the world with the exception
of Japan when it comes to rates on inheritance. Japan is the
only nation that supersedes the United States. We are at top
rate 55 percent. As we know, the President in his proposal has
tried to increase that by 5 percent this year. In Japan the
highest marginal rate is 70 percent and certainly exorbitant.
I would also make one more point, and that is that the
unified exemption that we have discussed that stands today at
650,000 is not a true exemption and that families who leave
their property, their business, their farm to their children
actually begin paying after they exempt 650,000 at a 37-percent
rate, not an 18-percent rate and this is a terrible shame and
certainly as we look at what we can do on death tax, I think we
ought to make that unified exemption a true exemption and begin
paying a tax at 18 percent above and beyond that.
I wanted to ask Phyllis Hill Slater a question. Ms. Slater,
you have worked with many, many people, women-owned businesses,
the minority community in your work as head of NAWBO and
involvement in the community and I wanted to ask you if you
would tell us a bit more about the effect of the death tax on
the minority community and on women.
Ms. Slater. Well, it is devastating because of the fact
that this is free enterprise, part of the American dream, to
own your own business, to move up, to be able to leave
something to your family, to obtain wealth that you can pass on
to keep the family strong, and we were told this was--these are
the rules and this is what you do in order to be part of this
great country of ours and now, you know, as soon as someone
dies, they have to sell it, which loses a lot of jobs and also
devastates the family.
When I look back and think about my father who served in
World War II and, by the way, my family has served in every war
that this country has ever been in, but my father did serve in
World War II and he had graduated from Stuyvesant High School
in New York City at the age of 16, so you know he was a smart
guy. And he graduated from CCNY in 1949 after the war
interrupted his education, and he worked very, very hard to
become an engineer and to be a licensed engineer, and there was
only 13 in his class at the time. He worked very hard. It is a
slap in his face to say that now his family, his children, his
grandchildren cannot, cannot live the dream that he worked so
hard to realize.
We know now also that women businessowners are starting
businesses even at a faster rate and one of the things that
women businessowners are bringing to the business culture is a
new way of doing business, changing the way we know business,
more family oriented, bringing great, great practices, best
practices to the business community and they want to pass it on
also to their families. This is also a slap in their face
because we do have to work a little harder and we have to be a
little better in order to compete.
Ms. Dunn. Thank you very much, Mrs. Slater. I would like to
ask unanimous consent to enter into the record an editorial by
Harry C. Alford, Jr. He is the president and chief executive
officer of the National Black Chamber of Commerce and he has
written an op-ed that I think is very revealing that has to do
with the quest for economic empowerment that gets you, quote-
unquote, freedom and authority. Freedom and authority are the
keys to Earthly happiness. Getting rid of the death tax will
start to create a needed legacy and begin a cycle of wealth
building for blacks in this country. He says we cannot begin to
build wealth until we start to recycle our precious dollars. We
cannot recycle our precious dollars until we have businesses
and ventures to invest in. The death tax is in our way.
Mr. Chairman, if I may request unanimous consent to enter
this op-ed into the record, please.
Mr. Herger [presiding]. Without objection.
[The information follows:]

BLACKS SHOULD HELP IN DOING AWAY WITH THE ``DEATH TAX,'' an Editorial
by Harry C. Alford, Jr., President & CEO, National Black Chamber of
Commerce, Inc.

We, as a people, have been freed from physical slavery for
over 134 years and we have yet to begin building wealth. We
cannot begin utilizing all of the advantages of this free
economy until we have gained enough wealth to actively
participate. It's just not civil rights; civil rights can get
you dignity and respect but we need more. It's just not
political empowerment; look at Zimbabwe or South Africa where
we now have enormous political empowerment but, yet, no power
due to lack of Black wealth. Civil rights and political clout
are nice but economic empowerment will get you freedom and
authority. Freedom and authority are the keys to earthly
happiness.
The total net worth of African Americans is only 1.2
percent of the total--versus 14 percent of the population. We
have been stuck at that number since the end of the Civil War
in 1865. Getting rid of the ``death tax'' will start to create
a needed legacy and begin a cycle of wealth building for Blacks
in this country. That would be a great start to breaking the
economic chains that bind us.
What is the death tax? The ``death tax'' is levied against
the government--assessed value of the deceased's estate. The
rates can start at 37 percent and can climb to 55 percent. In
essence, your last remaining parent dies and the estate they
leave to you and your siblings will be reduced by the IRS by an
amount equivalent to 37-55 percent of the total worth.
Thus, the legacy left by your elders or left by you to your
children can be significantly reduced or even wiped out.
An example: The Chicago Daily Defender--the oldest Black--
owned daily newspaper in the United States--was forced into
bankruptcy due to financial burdens imposed by the estate tax.
We all remember what happened when the great Sammy Davis Jr.
died--his wife was in bankruptcy within six months due to the
vicious ``death tax.''
Store owner Leonard L. Harris, a first generation owner of
Chatham Food Center on the South Side of Chicago, can envision
all the work and value he has put into his business
disappearing from his two sons. Says Mr. Harris; ``My focus has
been putting my earnings back in to grow the business. For this
reason, cash resources to pay federal estate taxes, based on
the way valuation is made, would force my family to sell the
store in order to pay the IRS within 9 months of my death. Our
yearly earnings would not cover the payment of such a high tax.
I should know, I started my career as a CPA.''
We cannot begin to build wealth until we start to recycle
our precious dollars. We cannot recycle our precious dollars
until we have businesses and ventures to invest in. The ``death
tax'' is in our way!
Fortunately, we now have an opportunity to get the ``legacy
killer'' out of our lives and future. There are two bills in
the House and Senate as I write this editorial. HR 86 and S 56
will repeal the ``death tax.'' HR 8 and S 38 will phase it out
over a specified period of time. Please keep in mind that this
estate tax only contributes about 1 percent of the total
federal revenue, and of each dollar collected, 65 cents is
spent on collecting the tax. The tax promotes virtually nothing
but financial hardship and a serious insult to the hard work of
our parents.
These bills are making progress on Capitol Hill. However,
we need to provide a needed boost, especially to members of the
Congressional Black Caucus who, many times, aren't where they
should be on financial gain issues. Please call your applicable
congressperson or senator and tell them you support these bills
to end the ``death tax.'' Tell them it is all right for Black
folks to begin building wealth in this country. It is not
against the law and it certainly is more enjoyable than
poverty.
Building wealth will lead to better education, better
health care, safer streets and sustainable communities. Poverty
and the lack of economic empowerment will get you frustration
and hopelessness. The only way to fight poverty is good
government and laws that do not penalize hard work, success and
savings. Let's put to death the ``death tax''!

Ms. Dunn. Thank you.
Mr. Herger. Thank you very much, Ms. Dunn. And thank you,
Ms. Slater, for that very moving testimony. So many of those of
us who are supporting this type of legislation hear that it is
only the ``fat cats,'' the very wealthy that we are helping and
it is very interesting and very informative to hear your
testimony that really we are helping some of the very groups
and minorities that we most want to help in this Nation.
So thank you very much. Mr. Hulshof to inquire.
Mr. Hulshof. Thank you, Mr. Chairman. Mr. Darden, I know
you are pinch hitting now for Mr. Sandmeyer. I assume he had a
plane to catch, had to get home or something of that nature,
but what I wanted to point out and I assume you are also
representing the National Association of Manufacturers?
Mr. Darden. Yes, sir.
Mr. Hulshof. Please communicate to him that certainly he
and his brother are in a distinct minority. By that I mean the
fact that their family business is now in the third generation
and when you consider nine out of ten family businesses don't
make it through a third generation, I think--and while we can't
lay the entirety of the blame at the feet of the death tax, I
think the significant part of it needs to rely on the death
tax. And so please communicate to him just how much of the
minority he is, he and his family.
We are making progress, ladies and gentlemen, and the fact
that you are here, the fact that, as Mr. Tanner pointed out I
think earlier, that today the Americans Against Unfair Family
Taxation announced a campaign to help us raise public awareness
about the impact of death taxes on family-owned businesses and
I look forward to, hoping some of those television sponsored
radio ads will run in my home State of Missouri.
Today as the Chairman pointed out in his opening statement,
the American Council for Capital Formation released its 24-
country survey. Interestingly, just as a quick perusal of it,
that many industrialized countries, including Australia,
Argentina, Canada, India, Mexico, even the People's Republic of
China do not have any death or inheritance tax and I think as
was pointed out by Ms. Dunn, other than the country of Japan,
our highest rate on family-owned businesses is the highest on
the face of the planet. So I think we are making some progress
in raising the profile.
My last count, ladies and gentlemen, is that of the 435
Members in this body and the House of Representatives, 184 have
signed on to or cosponsored some sort of death tax relief,
which is a significant number, and I am hopeful that your
presence here will help us continue that momentum and yet we
still have challenges in front of us.
I note that in today's National Journal of Congress Daily,
it talks about next week's schedule in the Senate and I noticed
that the Treasury Secretary designee Mr. Summers is up for
confirmation hearings and if you weren't aware, and I would
like your comment, perhaps as those hearings will commence
soon, Mr. Summers reportedly stated back in 1997 that those of
you that appear here today and those of us who want to see some
relief from the Federal death tax are, quote, selfish.
I would like to have any one of you who chooses to to
respond to that assertion. Does anybody care to make a comment
to Mr. Summer's comment?
Mr. Speranza. I would like to. I would like to make two
comments as it relates to that. Number one, I firmly believe
that people have a right to understand where their estate goes.
People generally do not understand tax gimmicks such as grits,
grats, cruts, Q-tips, and the like. People work hard all their
lives, such as the people you heard from today. They can't
understand where their money is going and why it is tied up in
the way that it is. I firmly believe that people who work hard
to accumulate wealth ought to be able to understand their
estate plans. I don't think that is being greedy to be able to
know how your assets are going to be handled.
Number two is that the rates are confiscatory. The State of
New York is an example. The law is going to change but if you
were to make a gift today, there is a 21-percent gift tax rate.
So if you add the 55- and the 21-percent New York State tax
rate, you get 76 percent. To oppose the requirement that 76
percent of a gift goes to government, I don't think is greedy.
I would like to make one last point. When you consider how you
score these kinds of bills, and I understand you have to employ
static scoring but logic shouldn't be lost. Whether you are
greedy or not, just think of somebody considering making a gift
at a 76-percent gift tax rate versus ratcheting down these
rates over time or eliminating the estate and gift tax
completely either under a Dunn-Tanner or Kyl-Kerrey approach.
People will not transfer assets at such high tax rates.
However, people will dispose of assets at a 20-percent tax
rate. We see that right now with the capital gains rates in
this country. People are not going to dispose of assets at the
level of 55-, 61-, or 76-percent tax rates.
Mr. Hulshof. I appreciate that comment. I notice my time is
about to expire. At town meetings back in the Ninth
Congressional District of Missouri, the guaranteed applause
line is as follows. The death of a family member should not be
a taxable event. And immediately those in attendance will erupt
in applause. So I appreciate your being here and especially,
Mr. Loop, appreciate your kind words regarding the farm and
ranchers management account that you included in your written
testimony.
I see my time is up so I will yield back. Thank you.
Mr. Loop, did you have a further comment if the Chairman
will indulge you?
Mr. Loop. I would like to comment because I certainly don't
see this as greedy. These people are not wealthy people and
this is particularly true when it comes to farm people.
Farmland has appreciated in value. Most farm people don't have
liquid assets. They don't realize they have an estate tax
problem. Certainly these are not greedy people and they need
relief from estate taxes.
Mr. Hulshof. Thank you. Mr. Chairman, I yield back.
Mr. Herger. Thank you, Mr. Hulshof.
Mr. McInnis will inquire.
Mr. McInnis. Thank you, Mr. Chairman. First of all, to my
colleague, Mr. Hulshof, my response to your question with
regard to Mr. Summers, if I was a Senator I would vote no on
his confirmation based entirely on that particular remark. I
think that is one of the least educated comments I have heard
in my political career.
In regards to the gentleman, Mr. Loop, Mr. Loop, my family,
my wife's side have been ranchers. They realize they have an
estate tax problem. They have lived poor all their life. They
are going to die rich because they have a lot of landholdings.
The fact is there is nothing they can do about it. They can't
afford counsel. People say go buy life insurance. They barely
make enough every year. In fact, 3 out of 4 years they lose
money. And in my particular district, I have a unique district
in that I represent one of the wealthier districts in the
country.
I have got the Rocky Mountains in Colorado. I have got
resorts like Aspen and places like that that are forcing these
prices up. And the only choice that these families have of
course, as you know, is to sell parts of this land and once you
sell the land, you can't sustain the size of the herd you have.
Once you can't sustain the size of the herd, you can't sustain
the family and it goes on down. Unfortunately it also hurts
open space because of course the highest use of that land is to
put in 2-acre lots or 35-acre lots and so on.
I want to mention a couple of things. One, all of you, I
would like you to take a look at my bill. I have got a bill out
there that increases the annual gift exclusion from $10,000 to
$20,000. That has not been changed since the early seventies.
One way that you can over some time do some type of planning is
begin to transfer to the next generation and at $20,000 you can
move some property over a period of time, some substantial
property.
One other thing I might note, I had a good friend--Mr.
Speranza, your comments were excellent. I had a very close
friend of mine who sold an asset that he had, got hit with
capital gains tax, and then unfortunately got terminal cancer
and he died 4 or 5 months later so the effective tax rate on
the estate was somewhere around 72 percent. When I was talking
about the family, I said so all the family got was 28 percent.
The 72-percent tax. So all it left the family was 28 percent.
That was very interesting because the family member said, no,
no, we didn't get 28 percent because in order for us to pay the
72 percent, we had to go to a fire sale. The assets that we had
to sell, we didn't get to sit and sell them at their real
value. We had to move them and we had to move them quickly to
pay the Federal Government. So they figure after the fire sale
discount that their actual--what they got out of that estate
was 21 or--20 or 21 percent.
Now, another thing I might point out is kind of interesting
in this particular family, they lived in a very small town.
Seventy percent of the local Episcopal church, their budget,
their annual budget was provided by this family and a number of
other things, community, all of the money that that family made
was banked in that community, was invested in that community,
and was spent in that community. After that, after the death,
the family could no longer contribute to the episcopal church
more--a few dollars every week but certainly not of the same
kind. It went on down. There is clearly a trickle down effect.
What has happened is that money was removed almost instantly
within the time limit, 3 months, whatever it is, from the local
community there in Colorado to the State and to the Federal
Government.
So I think that--and when you look at the estate tax, I
want to point this out too. I can--and I have got--my studies
are in business and tax and law and so on. In all of my studies
and research, I cannot find one tax that is as unequitable, as
unjustified as the death tax.
So I appreciate all of your comments today, Ms. Slater,
what it does to business in the minority community. This is
nothing but thievery by the Federal Government. So I don't
think I have overstated my position. It is accurate. I feel
very strongly.
Thank you, Mr. Chairman.
Mr. Herger. Thank you, Mr. McInnis. I also represent a
rural, agricultural, small business district and the type of
horror stories that Mr. McInnis is relating is one that each of
us who have lived in this kind area very long can relate to. So
it really emphasizes how crucially important the work we have
before us is.
With that, Mr. McCrery will inquire.
Mr. McCrery. Thank you, Mr. Chairman. Mr. Coyne, you said
that you had spent a lot of time with your tax attorneys, and
so forth, trying to prepare your grandparents' estate and your
parents' estate, I guess. In all of those discussions, have you
talked about the change that the Congress made in the estate
tax law a couple of years ago with respect to closely held
family businesses increasing the exemption in effect to I think
it was $1.3 or $1.5 million per spouse?
Mr. Coyne. Certainly we have, and it was welcomed but my
grandfather did pass away 10 years ago, and although grateful
for all and any relief, we did get the sense that it was in our
situation too little, too late, I guess.
Mr. McCrery. Well, Mr. Sandmeyer commented earlier that
that provision, that liberalization, if you will, of the law
was of little help because the rules were so complex that I
think he said no good tax lawyer would recommend that a family
held business even try to do that because of all of the
conditions attached.
Mr. Darden, is that a fair recap of what he said?
Mr. Darden. Yes. The issue is whether or not the tax
attorney is worried about being hit with a malpractice suit
afterward if it turns out that the family does not qualify at
the later date. The key objection to that provision is that it
is uncertain whether or not--you can't base your business plans
on the knowledge that you are going to qualify for that because
there are so many different factors that may work in there. It
does represent a tax savings to certain small businesses. But
as far as a company or a family that has diverse assets and
they are trying to grow the business, there is the concern that
if you rely on getting that and you buy less insurance because
you are counting on qualifying, then you are leaving the door
open if you don't qualify.
Mr. McCrery. I see Mr. Speranza nodding his head that this
is a problem.
Mr. Speranza. There is no question about it. It is not only
me, but other tax advisors are very reluctant to use it. It is
very complicated, number one.
Number two, people structure their businesses in a
particular way for many, many purposes. To force family
businesses to do things in a certain way to try to save taxes
when there is no guarantee just doesn't work in most cases. It
was a good attempt, but unfortunately it just didn't work.
One additional comment on the suggestion of raising the
$10,000 annual exclusion amount to $20,000, I would
respectfully report that in the tax community we chuckle over
how many decades it is going to be before there is another
change in these exclusion amounts. It was $3,000 for decades.
It has been $10,000 for decades. That is not a way to plan.
What we really need is an overall approach that all of us
have talked about today. With all due respect, we will take
what we can get, but that is not the way to solve the problem,
not in that area, not by raising the exemption. The bottom line
is that businesses, family-owned businesses create jobs and a
significant number of those businesses that create those jobs
are worth more than the lifetime exemption amount. We just need
estate tax relief for this country.
Mr. McCrery. I want to ask you in just a second what kind
of relief, but let me hammer this point. Mr. Coyne, the reason
that I asked you first, you have been in the midst of trying to
plan, and I was just curious if you had discussed this
provision of closely held family businesses. If you haven't
that is OK. If you have and you are knowledgeable on this and
you might be able to use this, tell me. I was the author of the
bill that was included in the omnibus tax bill that made this
change in the estate tax. I thought it was the best thing that
we could do with the limited amount of money that we had to
work with. Now what I am hearing is that I was wrong, that
wasn't the best thing that we can do. I am not a tax lawyer, I
am just a poor country lawyer with no particular knowledge of
the Tax Code, and I admit I probably wasn't the best one to
craft this provision. However, it was with good intent to try
to help family businesses. But if you are telling me now that
it is money wasted, maybe we can recoup that money and repeal
that change and use that money to lower the rates, or whatever
we can do.
So, Mr. Coyne, are you telling me that you don't care if we
repeal that position?
Mr. Coyne. Well, you asked me if I was involved with the
discussions of that. We, of course, hired tax attorneys and our
accountants to discuss that. I was more involved with the day-
to-day operation in trying to figure out--it was basically just
tell us what is the best course to go so we can survive this
because at the time my grandmother was 82 years old and married
for 55 years and I guess the statistics on spouses surviving
after that--fortunately, she is still strong and kicking but at
the time it was really very daunting. I am not familiar with
the intricacies of that.
Mr. McCrery. If you could ask if they would mind if we
repealed that change in the Tax Code and apply that money to
Jennifer Dunn's bill or somebody else's approach. And then Mr.
Speranza, I will give you a chance to answer my question.
If it is no good to do what we did with the family business
and no good to do what we did increasing the gift allowance and
if it is no good increasing the unified credit, what should we
do?
Mr. Speranza. One of two things. Number one, the Dunn-
Tanner approach is excellent. If you repealed the provision you
just talked about, you then have some funds for perhaps the
first 5- or 10- or 15-percent reduction in the estate tax
rates.
Number two, is is important to take death out of the mix as
a taxable event. If you consider the Kyl-Kerrey approach, an
approach that all the organizations I represent support in
principle, that would be an excellent way to proceed as well. A
20-percent tax rate in the view of the organizations I
represent, is going to actually release capital that is now
tied up. It will actually generate additional tax revenue.
People will not make gifts now. They just won't do it. So I
would suggest either Dunn-Tanner or Kyl-Kerrey as the approach
to use.
Mr. McCrery. Thank you.
Mr. Herger. I want to thank the members of this panel for
your taking the time to appear before us and give your
testimony and share with us your personal experiences as well
as all of the members of the other panel.
With that this hearing of the Ways and Means Committee on
reducing the tax burden stands adjourned. Thank you very much.
[Whereupon, at 3:10 p.m., the hearing was adjourned.]
[Submissions for the record follow:]

Statement of Thomas McInerney, President, Aetna Retirement Services,
Hartford, Connecticut

I. INTRODUCTION

We appreciate this opportunity to present our views on ways
to improve the retirement security of Americans. The tax code
can be an important tool in advancing the retirement security
of American workers. The private pension system in this country
is doing a relatively good job at providing retirement benefits
to a large portion of the American workforce. This is in part
due to the tax-preferred treatment accorded contributions to
qualified retirement plans under the tax code.
We support the improvements to these tax code provisions
that are included in H.R. 1102, the comprehensive pension
reform legislation sponsored by Mr. Portman and Mr. Cardin.
Many of these changes have been sorely needed for many years,
and we believe if enacted they will have a beneficial effect on
plans and plan participants, enabling them to better provide a
secure retirement through their employer-sponsored plans.
There continues to be a significant gap in coverage,
however, among workers of smaller businesses. Less than 20
percent of businesses with fewer than 25 employees sponsored a
retirement plan. This means that only 13 percent of these 23
million working Americans has the opportunity to participate in
an employer-sponsored retirement plan. This is despite
Congress's recent efforts, most notably in 1996, to create
plans that small businesses will utilize, for instance, the
SIMPLE IRA and 401(k) plan, which were authored by Mr. Portman
in the House.

II. RETIREMENT PLANS FOR SMALL BUSINESSES

A. Why don't more small businesses offer a retirement plan?

A survey done by the Employee Benefits Research Institute
(EBRI) in 1998 found that small businesses had several reasons
why they decide not to offer a retirement plan. First,
employees often prefer today's wages to tomorrow's benefits.
This is likely to be especially true of lower-income workers.
Second, administrative costs are too high. Third, small
employers are concerned about fiduciary responsibilities and
potential liability. Finally, employers are often uncertain
about their future revenue stream and find it difficult to
commit to sponsoring a plan.
On the other hand, the EBRI survey found that small
businesses might consider starting a retirement plan if certain
things were to occur. The availability of a business tax credit
could make a difference in the small business starting a plan.
Also, reduced administrative requirements, allowing owners to
save more in the plan, or easing of the vesting requirements
were amongst other factors cited by small businesses as
influencing their decision to start a plan.

B. The SIMPLE 401(k)

Congress in 1996 attempted to respond to the needs of small
business by enacting the SIMPLE IRA and the SIMPLE 401(k).
Initial evidence seems to indicate that the SIMPLE IRA has
proven attractive to some small businesses, primarily, we
believe, those with one- or two-employees. One of the
retirement policy concerns with relying on an IRA for
retirement security is that the participant-owner has easier
access to the funds than to the funds in an employer-sponsored
plan (``leakage'').
On the other hand, the SIMPLE 401(k) has not been much
utilized by the small employer community. The small employer
market has not found it attractive thus far, we believe for
several reasons. The SIMPLE 401(k) requires the employer to
make a 100 percent matching contribution up to 3 percent of pay
for those deferring, or a 2 percent contribution for all those
eligible. The marketplace has deemed this requirement too
costly. Moreover, while it is expensive for the owner, the
owner cannot get the full benefit that a regular 401(k) plan
permits because the maximum deferral permitted is $6,000 rather
than $10,000.
Second, small employers continue to be concerned by the
start-up costs and the related administrative costs of the
plan. A full plan document is still required as well as a
summary plan description, spousal notices, loan documents and
annual plan reporting.

III. IMPROVING THE SIMPLE 401(K)

All of these current concerns/issues can be addressed to
expand coverage for employees working in small businesses. We
believe that the SIMPLE 401(k) was the right path for Congress
to take in attempting to provide small businesses with options
for creating retirement plans. Much like the other changes
proposed in H.R. 1102, there are a number of refinements that
we would suggest be made to the current SIMPLE 401(k) to enable
it to have the impact with the small business community that
Congress intended. We hope these can be included with H.R. 1102
as it moves forward in the legislative process.

A. Reducing employer cost

First, Congress should act to address the problem of
employer cost. There are several ways this could be done. Small
businesses have judged the current match requirements to be too
expensive. We would propose a somewhat lower match, but also
some flexibility in the match requirements over a period of
years recognizing some of the financial challenges small
businesses often face. For instance, you could require a match
of 50 percent of the deferral amount up to 4 percent of pay
with an option for a 100 percent match. To provide flexibility,
you could permit no match for the first two plan years or grant
a tax credit to the employer for a match in the first 2 years.
In addition, you could allow an employer to skip a match in one
out of five years after the first five years, provided notice
is given to employees.
In addition, the employer's administrative costs of running
a plan could be reduced. For instance, the plan document should
be simplified to consist of no more than one page, which the
IRS could put on its website and which the accountant for the
small business could easily access. Another simplification
would be to combine the filing of the annual plan return (Form
5500) with the employer's tax return, for instance, using a
one-page schedule.
Employers should not have to worry about setting up another
plan once they begin to outgrow the SIMPLE 401(k) plan, at
least for some reasonable period of growth. We would suggest
that the employer be able to maintain this new SIMPLE 401(k)
plan until its workforce reaches 100, the cut-off for the
current SIMPLE 401(k) plan.

B. Making the plan more valuable

We fully support the change included in H.R. 1102 to raise
the maximum deferral for both forms of 401(k) plans. This
should give owners a better incentive to set up these plans. In
addition, we applaud the catch-up provisions for workers over
50 and would suggest adding a catch-up provision for workers
that have been out of the workforce for some specified period
of time. Finally, we support the provision in the Portman-
Cardin bill permitting business owners to borrow from the plan
under the same terms as their other employees.

C. Balancing the employee's need for security with the
employer's fear of liability

As mentioned above, one of the reasons small businesses do
not set up retirement plans is their fear of ERISA liability as
fiduciary of the plan assets. We suggest the creation of a safe
harbor from ERISA liability along the lines of the current
404(c) safe harbor. To take advantage of this new safe harbor,
a SIMPLE 401(k) sponsor would have to place the plan assets in
an established bank, insurance company, mutual fund or other
entity regulated by the Federal or State government. This
entity must publish an annual internal control audit. All
participants must have toll-free telephone or internet access
to the entity to verify balances independent of their employer.
The plan sponsor would have to meet all existing requirements
for remitting contributions to the entity on a timely basis. If
these and other 404(c) requirements are met, the plan sponsor
would enjoy fiduciary protection.

IV. CONCLUSION

Our experience tells us that there is no single solution
for the pension coverage gap in the small business sector of
our economy. This sector is highly segmented by demographic and
market forces, such as age of the owner and the business, the
type of business, the size of the workforce, the age of the
workforce and other factors. The existing SIMPLE 401(k) should
remain in place for the ``bigger'' small businesses. Creative
thinking on a defined benefit plan for small businesses should
be encouraged as well.
We believe, however, with these changes for businesses of
25 employees or less, the SIMPLE 401(k) could become a popular
tool for providing retirement security for workers in these
particularly small businesses. We urge the Committee to give
consideration to these changes as it contemplates the many
excellent reforms included in the Portman-Cardin legislation
and other pension reform bills.

Statement of America's Community Bankers

Mr. Chairman and Members of the Committee:
America's Community Bankers appreciates this opportunity to
submit testimony for the record of the hearing on retirement
and health security. America's Community Bankers (ACB) is the
national trade association for progressive community bankers
across the nation. ACB members have diverse business strategies
based on consumer financial services, housing finance, small
business lending, and community development, and operate under
several charter types and holding company structures.
ACB members are actively involved in offering prototype
IRAs and qualified plans and recognize the critical need to
increase the current rate of retirement saving. It has been
widely reported that the ``baby-boom'' generation is not saving
out of income at anywhere near the rate needed to provide
adequate retirement income. ACB recognizes that many households
are currently reaping the benefit of stellar returns on equity
holdings in 401(k) and other accounts but these sources do not
represent truly new savings, merely higher, and potentially
temporary though of course welcome, returns on existing
retirement assets. At the same time, despite your best efforts,
Mister Chairman, Congress seems unable to act to eliminate the
looming insolvency of the current Social Security system. ACB
believes that it is imperative that Congress do more to enhance
the attractiveness of individual retirement plans and employer-
sponsored plans. Inducing a higher level of retirement savings
through sound tax policy is one way to eliminate some of the
unavoidable pressure on Social Security. H.R. 1546, the
Retirement Savings Opportunity Act of 1999, introduced by Rep.
Thomas and H.R. 1102, the Comprehensive Retirement Security and
Pension reform Act, introduced by Reps. Portman and Cardin are
excellent vehicles for accomplishing much needed reform of the
pension provisions in the tax code and ACB is strongly
supportive of their enactment.
Under current law in order for an individual to make the
maximum IRA contribution for a year he or she is required to
work through a daunting maze of eligibility and income
limitations that apply to the interaction of traditional IRAs,
Roth IRAs, and spousal IRAs. This interaction does not even
consider the separate eligibility and contribution rules that
apply for the so-called Education IRA, which cause additional
confusion for IRA participants. (The mind-boggling complexity
of the relationships of the various IRA eligibility rules, as
well as the internal complexity of the Roth IRA rules, are set
out in Attachment A, Complexities to Consider in the Roth IRA.)
The confusion caused in the minds of investors by the
inconsistent and complex eligibility rules may be inhibiting
participation, particularly among middle class individuals who
participate in employer plans and who are in the phase-out
ranges of income. This includes plan participants who marry and
lose eligibility to make traditional IRA contributions and plan
participants who quit work and are unaware that they have
become eligible for a spousal IRA.
The income limits on the eligibility of participants in
employer plans was imposed by the Tax Reform Act of 1986. H.R.
1546 would eliminate the eligibility rules and restore
universal eligible for traditional IRAs. In addition, H.R. 1546
would eliminate the income limit (based on ``modified adjusted
gross income'') on eligibility to contribute to a Roth IRA and
would change the $100,000 modified AGI limit on Roth IRA
conversions to $1 million.
It should be noted that the current $2,000 overall limit on
IRA contribution has remained unchanged since 1981. IRAs are
alone among tax-advantaged retirement plans with a contribution
limit that is not indexed for inflation. In fact, if the
original $1,500 IRA contribution limit had been indexed for
inflation since 1974, it would currently be approximately
$5,000. H.R. 1546 and H.R. 1102, in effect, recognize this fact
by increasing the overall IRA contribution limit to $5,000 and
H.R. 1546 would index this amount for future inflation.
H.R. 1546 would permit IRA owners who are 50 years of age
and older to make additional annual IRA contributions of
$3,000. H.R. 1102 would increase the elective deferrals
permitted under 401(k), SEP, Simple Retirement Accounts, and
457 plans permitted to be made by 50 year-olds by $5,000. These
``catch-up'' contributions would create fairer treatment for
middle class IRA participants who are often unable to make the
full IRA contribution in their younger years because of family
obligations.
Both H.R. 1546 and H.R. 1102 would make an incremental
expansion of the Roth IRA concept that, given the popularity of
the Roth IRA, is simply a matter of common sense. Both bills
would permit 401(k) plans to offer an option whereby employees
may treat elective deferrals as after-tax contributions and the
earnings, which will accumulate tax-free, will be tax-free upon
distribution. Providing the Roth IRA option in a 401(k) is
likely to substantially increase the employee's retirement nest
egg, not only because of the inherent advantage of the Roth IRA
concept for younger participants, but because of the discipline
that would be imposed by contributions being made under a
payroll deduction plan.
Another basic idea that should be considered is the
redefinition of participation in a defined benefit plan.
Because of the imposition of vesting periods, an employee who
changes every three years or so might never gain any vested
retirement benefits but be debarred from contributing fully to
a regular IRA account.
In many cases the Tax Reform Act of 1986 imposed limits on
the benefits and compensation that could be taken into account
in funding ERISA benefits. The Omnibus Budget Reconciliation
Act of 1993 reduced limits still further and the Retirement
Protection Act of 1994 made reductions in the rates of cost-of-
living indexing. H.R. 1102 would restore these benefit and
compensation limits and indexing rates schedules that were
reduced. Similar increases in benefits and indexation rates
would be made for other plans. For example, the annual benefit
limit of section 415(b)(1) for defined benefit plans would be
increased from $90,000 to $180,000. The compensation limit
under section 401(a)(17) would be increased from $150,000 to
$235,000. With respect to defined contribution plans, the
dollar amount of the annual addition would be increased from
$30,000 to $45,000 and corresponding 25% limitation would be
eliminated altogether. The limit on elective contributions
under 401(k), SEP, and 403(b) would be increased from $7,000 to
$15,000. In the case of 457 Similar increases would be made for
457 plans, Simple Retirement Plans, and plans maintained by
local governments and tax-exempt organizations.
The dollar limits have become unrealistic over time so that
the increases will benefit primarily middle class employees.
Senior management will still largely rely on nonqualified
deferred compensation plans and incentive stock options. Even
the increase in the section 401(a)(17) limit will benefit all
employees in a defined benefit plan by accelerating the full
funding of the plan. In the case of defined contribution plans,
eliminating the 25% limit will provide middle class workers
with additional flexibility to make catch-up contributions to
offset participation lapses during their younger years or when
they had interrupted employment to raise families.
Several other provisions in H.R. 1102 would encourage
employers to create new retirement plans. For example, the
complex top-heavy rules that often inhibit plan creation by
smaller employees would be modified and simplified. PBGC
premiums would be reduced for new plans of small employers and
phased in for other new single-employer plans. In addition,
small employers will be eligible for a section 38 credit for a
portion of the costs of starting up a retirement plan.
H.R. 1102 will increase pension portability by permitting
rollovers among section 457, 403(b), qualified plans, and IRAs.
The bill would also permit rollovers of employee after-tax
contributions to an IRA. Unaccountably, employee after-tax
contributions are not permitted to be rolled over to another
qualified plan--this shortcoming serves no sound policy purpose
and should be eliminated. In addition, H.R. 1102 would
eliminate two other rules that inhibit portability in the
context of a merge or acquisition. Optional forms of benefit
distribution would no longer be required to be preserved where
plan benefits are being transferred directly to another plan.
The requirement in current Treasury regulations that such
optional benefits be preserved in a transfer of benefits to
another plan inhibited the consolidation of the acquired
employees' benefits after a merger or acquisition. Similarly,
the so-called ``same desk'' rule of section 401(h) would be
eliminated. This rule prevents an employee from rolling over a
section 401(k) plan to a new employer's plan or an IRA, where
the employee continues to perform the same job for the new
employer after an acquisition. The employee is required to
remain in the seller's plan because, as a technical matter, he
or she has not incurred a ``separation from service.''
Although, strictly speaking, the minimum distribution rules
of section may not impact an employer's decision to set up a
retirement plan or an employee's decision to participate or
establish an IRA, they no longer reflect the realities of the
workforce and do not serve a valid policy purpose. (It should
be noted that they do not apply to the Roth IRA.) H.R. 1102
would substantially simplify the minimum distribution rules.
Mr. Chairman the need to encourage retirement saving and
enhance retirement security is critical and you are to be
applauded for holding this hearing to explore ways to achieve
this goal. Enactment of H.R. 1546 and H.R. 1102 would
contribute substantially to achieving it and ACB strongly urges
the Committee to pass them. Once again, Mr. Chairman, ACB is
grateful to you and the other members of the Committee for the
opportunity you have provided to make our views known on this
very important issue. If you have any questions or require
additional information, please contact James E. O'Connor, Tax
Counsel of ACB, at 202-857-3125.

ATTACHMENT A

The Considerable Complexities Of The Roth IRA

Section 408A of the Internal Revenue Act of 1986 (the
Code), which was added by the Taxpayer Relief Act of 1997 \1\
(the 1997 Act) and is effective for tax years beginning after
December 31, 1997, created the Roth IRA, a new individual
retirement plan with great potential to encourage new
retirement savings and take some pressure off Social Security.
Section 408A was amended by the Internal Revenue Service
Restructuring and Reform Act of 1998 \2\ (the 1998 Act) and on
February 3, 1999, final regulations from the Internal Revenue
Service (TD 8816) were published under section 408A. The
potential of the Roth IRA has been constrained in several ways.
The combined annual limit on IRA contributions has remained
stuck at $2,000 since 1981 because of budgetary constraints and
misplaced social fairness concerns. In addition, the
proliferation of individual saving arrangements is confusing. A
more immediate constraint, however, because it reflects, in
many instances, specific judgments and reactive decisions of
Congress and the IRS, is the complexity of the Roth IRA
provisions and the complexity of their interaction with
traditional (deductible) IRA provisions. This complexity makes
the Roth IRA confusing for trustees and participants, has added
significant overhead costs, and may have discouraged
competition among potential plan sponsors.
---------------------------------------------------------------------------
\1\ Public Law 105-34 (111 Stat. 788).
\2\ Public Law 105-206 (112 Stat. 685).
---------------------------------------------------------------------------

Contributions

Contributions may be made to a Roth IRA beginning on
January 1, 1998. Like the traditional IRA, contributions may be
made to a Roth IRA for a particular year until the unextended
due date (i.e., April 15th for calendar year taxpayers) of the
income tax return for that year.\3\ Unlike a traditional IRA,
contributions to a Roth IRA are not deductible,\4\ but the
entire amount of any ``qualified distribution'' will be tax-
free. (See Qualified Distributions, below.) Note that, by
comparison with the permanent exclusion from taxation for Roth
IRA earnings, the tax advantage conferred on nondeductible
contributions to a traditional IRA is limited to the deferral
of taxation of their earnings until distribution. Deductible
contributions cannot be made to a traditional IRA during and
after the year in which an individual (or spouse, in the case
of a spousal IRA) reaches age 70\1/2\, but contributions may be
made to a Roth IRA at any age \5\--to the extent that the
individual has compensation at that age.
---------------------------------------------------------------------------
\3\ See section 219(f)(3) of the Internal Revenue Code.
\4\ See section 408A(c)(1) of the Code.
\5\ See section 408A(c)(4) of the Code.
---------------------------------------------------------------------------
Individuals are permitted to maintain a traditional IRA
(making deductible and/or nondeductible contributions) and a
Roth IRA simultaneously, but the maximum annual combination of
contributions is still limited to the lesser of $2,000 or the
individual's compensation for the year,\6\ excluding rollover
contributions to the Roth IRA. (It should be noted that an
``education IRA'' is not included in the definition of an
``individual retirement plan'' under section 7701(a)(37) and,
thus, contributions to an education IRA do not count against
this annual contribution limit.) The final regulations provide
that, as is permitted for traditional IRAs under section
408(c), an employer or employee association may establish and
even administer a trust set up to hold contributions made to
separate employee accounts, each of which is treated as a
separate Roth IRA.\7\ In fact, it seems apparent that the
regulations are clarifying that section 408(c) is just one of
the traditional IRA provisions applicable to Roth IRAs under
the general overlay rule of section 408A(a). Thus, the employer
intending to create a Roth IRA trust for its employees should
do so by specific reference to the provisions of section 408(c)
in order to avoid taking on ERISA duties and liabilities.
Likewise, a parent or guardian may make contributions to a Roth
IRA on behalf of a minor, provided the minor has compensation
in the amount of the contribution.\8\ As with traditional IRAs,
a 6% penalty on excess contributions applies to the Roth
IRA,\9\ but the penalty can be avoided by distributing the
excess before the extended due date of the return for the year
of contribution.\10\ (See Corrective Distributions, below.
---------------------------------------------------------------------------
\6\ See section 408A(c)(2) of the Code.
\7\ See Treasury regulation section 1.408A-2 A-3.
\8\ See the preamble to the final regulations, General Provisions
and Establishment of Roth IRAs.
\9\ See section 4973(f) of the Code.
\10\ See sections 408A(d)(2)(C) of the Code.
---------------------------------------------------------------------------

Active Participation in an Employer's Retirement Plan

Traditional IRAs

Individuals are permitted to deduct the full $2,000
contribution to a traditional IRA regardless of how high their
adjusted gross income level may be \11\--provided they are not
participants in an employer's retirement plan.\12\ Where an
individual is an ``active participant'' in an employer's
retirement plan, the portion of an IRA contribution that is
deductible will decline from the full $2,000 to zero as his or
her adjusted gross income \13\ increases above a certain dollar
amount.\14\
---------------------------------------------------------------------------
\11\ See section 219(b)(1) of the Code.
\12\ The IRS provides guidance for determining whether an
individual is an active participant in Notice 87-16, 1987-1 CB 446. If
an individual's employer maintains a defined benefit plan, he or she is
treated as an active participant merely on the basis of being eligible
to participate for any part of the plan year ending with or within the
individual's tax year, even where he or she elects not to participate
or ultimately fails to perform the minimum service required to accrue a
benefit. If the employer maintains a defined contribution plan (a money
purchase, profit-sharing, which includes a 401(k), or stock bonus
plan), an individual is an active participant where employer or
employee contributions or forfeitures are allocated to his or her
account for a plan year ending on or within the individual's tax year.
\13\ Three terms applicable to the IRA contribution limits should
be understood: ``compensation''; ``adjusted gross income''; and
``modified adjusted gross income.'' IRA contributions must be made from
compensation and the definition becomes important because Roth IRA
contributions may be made well into an individual's retirement.
(1) Compensation may be defined simply as the amount reported on
the Form W-2 of an employee or the ``earned income'' of a self-employed
individual. The term compensation includes alimony, but it does not
include: (1) gifts; (2) distributions from pension plans (including
401(k) plans and IRAs), commercial annuities, and deferred compensation
arrangements; and (3) Social Security benefits. See section 219(f)(1)
of the Code.
(2) Adjusted gross income, as used to limit contributions by active
participants in employer plans, includes the taxable portion of social
security and railroad retirement and passive activity losses and
credits, but U.S. Savings bond proceeds paid for higher education,
adoption assistance paid by employers, and the foreign income of U.S.
citizens to the extent otherwise excluded are added back. The amount of
any deductible IRA contribution is also added back to AGI. See section
219(g)(3)(A) of the Code.
(3) Modified adjusted gross income, which limits the ability of all
individuals to make Roth IRA contributions, excludes amounts otherwise
included in AGI resulting from the conversion of a traditional IRA to a
Roth IRA. See section 408A(c)(3)(C)(i)(I) of the Code and Treasury
regulation sections 1.408A-3 A-5 and A-6. For taxable years beginning
after 2004, required minimum distributions from IRAs are also not
included in modified adjusted gross income for the purpose of
determining eligibility to convert a traditional IRA to a Roth IRA
(i.e., the $100,000 modified AGI limitation). See section
408A(c)(3)(C)(i)(II) of the Code.
\14\ See section 219(g) of the Code.

---------------------------------------------------------------------------
Roth IRAs

Unlike traditional IRAs, no limitation is imposed on Roth
IRA contributions because the owner is an active participant in
an employer's plan.\15\ The 1998 Act also conferred a benefit
by clarifying that the amount of the Roth IRA contribution that
self-employed individuals are permitted to make for a given
year will not be reduced by any contributions that they make on
their own behalf to SEP IRAs or SIMPLE IRAs,\16\ as well as
corporate or Keogh plans. But individuals are not permitted to
make contributions to a Roth IRA above certain levels of
``modified adjusted gross income'' \17\--regardless of whether
they participate in an employer's plan.
---------------------------------------------------------------------------
\15\ See section 408A(c)(3) of the Code.
\16\ See section 408A(f)(2) of the Code and Treasury regulation
section 1.408A-3 A-3(c)(2).
\17\ See section 408A(c)((3)(A) of the Code.
---------------------------------------------------------------------------

Modified Adjusted Gross Income Limitations on Regular (Annual) Roth IRA
Contributions

The limitations on regular Roth IRA contributions are as
follows:
(1) For a married couple filing a joint return, eligibility
to make regular Roth IRA contributions is phased out between
``modified AGI'' of $150,000 and $160,000 (regardless of
whether or not either spouse is a participant in an employer-
sponsored plan). The statutory calculation of the annual
contribution a joint return filer is permitted to make is
$2,000 (or, if less, compensation) reduced by an amount that
bears the same ratio to $2,000 (or, if less, compensation) that
the excess of modified AGI over $150,000 bears to $10,000.\18\
---------------------------------------------------------------------------
\18\ See sections 408A(c)(3)(A) and (C)(ii)(I) of the Code.
---------------------------------------------------------------------------
(2) For a single individual, eligibility is phased out
between modified AGI of $95,000 and $110,000. The contribution
calculation for the single filer is $2,000 (or, if less,
compensation) reduced by an amount that bears the same ratio to
$2,000 (or, if less, compensation) that the excess of modified
AGI over $95,000 bears to $15,000.\19\
---------------------------------------------------------------------------
\19\ See sections 408A(c)(3)(A) and (C)(ii)(II) of the Code.
---------------------------------------------------------------------------
(3) For a married individual who files a separate return,
eligibility is phased out between modified AGI of $0 and
$10,000. The contribution calculation for the separate filer is
$2,000 (or, if less, compensation) reduced by an amount that
bears the same ratio to $2,000 (or, if less, compensation) that
the excess of modified AGI over $0 bears to $10,000.\20\
---------------------------------------------------------------------------
\20\ See sections 408A(c)(3)(A) and (C)(ii)(III) of the Code.
---------------------------------------------------------------------------

Rounding and De Minimis Rules

The rounding and de minimis rules applicable to traditional
IRAs do apply to Roth IRAs. If the contribution under the
calculation formula is not a multiple of 10, it is rounded to
the next lowest multiple of 10. If the calculation yields a
deductible amount of less than $200, but more than zero, the
owner may deduct a $200 IRA contribution.\21\
---------------------------------------------------------------------------
\21\ See section 408A(c)(3)(A) of the Code.
---------------------------------------------------------------------------

Spousal Roth IRA

As with a traditional IRA, a working spouse may make a Roth
IRA contribution on behalf of a spouse who has insufficient
compensation to make his or her own Roth IRA contribution,
providing they file a joint return.\22\ After the husband or
wife makes a regular contribution of up to $2,000 to his or her
Roth IRA and/or deductible IRA, he or she is then permitted to
contribute to the other spouse's Roth IRA and/or deductible IRA
an additional $2,000 or, if it is less, the amount of both
spouses' combined compensation reduced by the first Roth and/or
traditional IRA contribution.
---------------------------------------------------------------------------
\22\ See section 219(c) of the Code.
---------------------------------------------------------------------------
In other words, the ``excess'' compensation of the higher
paid spouse is used to boost the eligibility of the other
spouse to make a Roth IRA contribution, although the actual
contribution to the spousal Roth IRA may come from the funds of
either spouse. In the most common set of facts where a working
spouse has at least $4,000 of compensation, he or she may
contribute $2,000 to the spousal Roth IRA of a nonworking
spouse, as well as $2,000 to his or her own IRA. The issue of
insufficient compensation will more likely arise for Roth IRA
owners than for owners of traditional IRAs because, as
mentioned, contributions may be made to a Roth IRA after age
70\1/2\.

Interplay of Roth and Traditional IRA Contribution Limits

Taxpayers should be mindful of the interplay of the Roth
IRA and the traditional IRA rules so they may maximize the
benefits of the $2,000 total IRA contribution they are
permitted to make (if only as a nondeductible IRA contribution)
while avoiding the 6% penalty on excess contributions that is
applicable to Roth IRAs, as well as traditional IRAs. The
distinction between AGI and modified AGI should be borne in
mind in those years where additional AGI is created by the
conversion of a traditional IRA to a Roth IRA.
A. In the case of the 1998 return of a single individual:
(1) Where he or she is an active participant with AGI under
$30,000, his or her entire $2,000 contribution may be deducted
as a contribution to a traditional IRA or the entire $2,000 may
be contributed to a Roth IRA.
(2) Where the AGI of an active participant is between
$30,000 and $40,000, the deductibility of a $2,000 IRA
contribution would be gradually eliminated, but he or she could
choose between contributing the remainder, or the full amount,
of the $2,000 to a Roth IRA.\23\
---------------------------------------------------------------------------
\23\ The deductibility of traditional IRA contributions is phased
out for single individuals who are active participants in employer
plans according to the following schedules:

------------------------------------------------------------------------

------------------------------------------------------------------------
1998........................................... $30,000-$40,00
1999........................................... $31,000-$41,00
2000........................................... $32,000-$42,00
2001........................................... $33,000-$43,00
2002........................................... $34,000-$43,00
2003........................................... $40,000-$50,00
2004........................................... $45,000-$55,00
2005 and thereafter............................ $50,000-$60,00
------------------------------------------------------------------------

For example, if a single individual, who participates in an
employer's pension plan, reports $36,000 of AGI on his 1998
return, he could make a deductible IRA contribution of no more
than $800 [$2,000 minus $2,000 ($6,000/$10,000)]. See section
219)(g)(3)(B)(ii) of the Code.
(3) Where the single active participant's modified AGI is
between $95,000 and $110,000, the amount of the $2,000
contribution that can be contributed to a Roth IRA will be
phased down to zero. Nevertheless, within, or above, this
modified AGI range, the single filer may contribute the
remainder of his or her $2,000 contribution to a traditional
IRA, but only as an after-tax (nondeductible) contribution.\24\
---------------------------------------------------------------------------
\24\ See section 408(o) of the Code for the rules on nondeductible
contributions to traditional IRAs.
---------------------------------------------------------------------------
B. Where the single individual is not an active participant
in an employer plan, he or she may contribute the entire $2,000
as a deductible IRA contribution--regardless of how high his or
her AGI may be.\24\ On the other hand, the ability of a single
(or married) individual to make a Roth IRA contribution is not
affected by whether or not he or she is an active participant,
but the ability of a single individual to contribute to a Roth
IRA will still phase out between modified AGI of $95,000 and
$110,000.
---------------------------------------------------------------------------
\24\ See the general rule of section 219(b)(1), as modified by
section 219(g)(1) of the Code.
---------------------------------------------------------------------------
C. With respect to a spouse who joins in a joint return for
1998 and is an active participant:
(1) If joint return AGI is less than $50,000, his or her
$2,000 may be used to make a fully deductible contribution to a
traditional IRA or the full $2,000 may be contributed to a Roth
IRA.
(2) Where joint AGI is between $50,000 and $60,000, the
active participant spouse may still contribute the full $2,000
to a Roth IRA, but within this joint return AGI range the
deductibility of the active spouse's traditional IRA
contribution will be phased out for 1998. The active
participant spouse could split the $2,000 between the portion
that may be deducted as a traditional IRA contribution and a
Roth IRA contribution. The deductibility of traditional IRA
contributions is phased out for married individuals who file
jointly and are active participants in employer plans according
to the following schedules:

------------------------------------------------------------------------

------------------------------------------------------------------------
1998........................................... $50,000-$60,00
1999........................................... $51,000-$61,00
2000........................................... $52,000-$62,00
2001........................................... $53,000-$63,00
2002........................................... $54,000-$64,00
2003........................................... $60,000-$70,00
2004........................................... $65,000-$75,00
2005........................................... $70,000-$80,00
2006........................................... $75,000-$85,00
2007 and thereafter............................ $80,000-$100,00
------------------------------------------------------------------------
Note that the ratio of the statutory formula will change for tax years
after 2006. For example, if a married couple, one of whom participates
in an employer's pension plan, reports $84,000 of AGI on their 2008
joint return, the active participant could make a deductible IRA
contribution of no more than $1,600 [$2,000 minus $2,000 ($4,000/
$20,000)]. See section 219)g)(3)(B)(i) of the Code. The contribution
of the other spouse would not be reduced.

(3) Between joint AGI of $60,000 and joint modified AGI of
$150,000, the active participant spouse could not make a
deductible IRA contribution for 1998, but could still
contribute the full $2,000 to a Roth IRA.
(4) Between $150,000 and $160,000 of joint modified AGI, as
the ability to contribute to a Roth IRA is phased down to zero,
the remainder of the $2,000 contribution may only be used to
make a nondeductible IRA contribution.
D. Where a couple files a joint return and neither spouse
is an active participant, each can make a $2,000 deductible IRA
contribution, no matter how high their AGI is for 1998 or a
subsequent year. Alternatively, all or part of the $2,000 may
be contributed to a Roth IRA--subject to the phase-out of Roth
IRA contributions between joint return modified AGI of $150,000
and $160,000.
E. For tax years beginning after 1997, where a couple files
a joint return and only one spouse is an active participant in
an employer's plan, the deductibility of traditional IRA
contributions made by or on behalf of the spouse who does not
participate in an employer's retirement plan will, for most
couples, no longer be affected by the other spouse's active
participation. The deductibility of the traditional IRA
contribution made by or for the spouse who is not an active
participant will be phased out only as the couple's joint
return AGI increases from $150,000 to $160,000. The statutory
calculation of the deductible contribution is $2,000 reduced by
an amount that bears the same ratio to $2,000 that the excess
of AGI over $150,000 bears to $10,000.\25\ The couple must file
a joint return and the spouse who is an active participant in
the employer's plan will still be subject to a deductibility
phase-out that begins at AGI of $50,000 for 1998.
---------------------------------------------------------------------------
\25\ See section 219)(g)(7) of the Code, as amended by a technical
correction in the 1998 Act.
---------------------------------------------------------------------------
(1) Below $150,000 of joint return AGI, the entire $2,000
maximum contribution made by, or on behalf of, a spouse who is
not an active participant (where the other spouse is) may be
deducted as a traditional IRA contribution or allocated
entirely to a Roth IRA.
(2) IRA deductibility and Roth eligibility phase out
between $150,000 and $160,000 of joint return AGI and modified
AGI, respectively, for the nonparticipant spouse of an active
participant, but he or she should be mindful of the fact that
for a year where a traditional IRA is converted to a Roth IRA,
the amount converted to the Roth will be included in AGI, but
will not be included in modified AGI. Thus, even though AGI for
the year may exceed $160,000 because of the conversion, the
$100,000 modified AGI limit on the ``conversion'' of a
traditional IRA to a Roth IRA (see ``Conversion to a Roth
IRA,'' below) makes it highly likely that both spouses will be
able to make the full $2,000 Roth contribution.
(3) Where the joint return modified AGI of a couple, one of
whom is an active participant and the other is not, is above
$150,000, all or a portion of each spouse's $2,000 total IRA
contribution can only be made as a nondeductible traditional
IRA contribution.
F. In the case of a married individual who files a separate
return:
(1) Regardless of whether the individual or his or her
spouse is an active participant in an employer's plan, a
married individual's permitted Roth IRA contribution phases
down to zero as separate return modified AGI increases from
zero to $10,000. \26\
---------------------------------------------------------------------------
\26\ See section 408A(c)(3)(A)(ii) and (C)(ii)(III) of the Code, as
amended by the 1998 Act.
---------------------------------------------------------------------------
(2) Where the married individual filing a separate return
is an active participant, or where his or her spouse is an
active participant, the ability of either spouse to make a
deductible IRA contribution will phase out between separate
return AGI of zero and $10,000.\27\ Any difference between
$2,000 and the deductible and the Roth IRA contributions that
are permitted may be contributed as a nondeductible IRA
contribution.
---------------------------------------------------------------------------
\27\ See section 219(g)(3)(B)(iii) of the Code.
---------------------------------------------------------------------------
(3) On the other hand, if neither the individual nor his or
her spouse is an active participant, there will be no AGI
limitation on the ability of a married individual filing
separately to make deductible IRA contributions. \28\
---------------------------------------------------------------------------
\28\ See section 219(b)(1) of the Code.
---------------------------------------------------------------------------
The regulations interpret section 408A(c)(2) as providing
that, where the total contributions for a year to a Roth IRA
and a traditional IRA exceed the lesser of $2,000 or
compensation, the excess contribution is deemed to have been
made to the Roth IRA.\29\ It would seem, however, that should
an individual's contributions to a Roth IRA and a traditional
IRA--after age 70\1/2\--exceed the lesser of $2,000 or
compensation, the excess contribution should be deemed to have
been made to the traditional IRA (to which contributions cannot
be made after age 70\1/2\), but the regulations do not address
this situation.\30\
---------------------------------------------------------------------------
\29\ See Treasury regulation section 1.408A-3 A-3(d), Example 2..
\30\ The excess contributed to the traditional IRA cannot be
treated as a nondeductible contribution for purposes of section
408A(c)(2)(B) because under section 408(o) nondeductible contributions
are limited to the amount allowed as a deductible IRA contribution,
which would be zero after age 70\1/2\. Section 408A(c)(2)(A), however,
uses the deductible IRA amount without reference to the age 70\1/2\
limitation.
---------------------------------------------------------------------------

Conversion to a Roth IRA

In addition to making the regular contributions of up to
$2,000, owners may roll over or ``convert'' amounts in other
IRAs to their Roth IRAs. The entire amount converted to a Roth
IRA will be included in gross income, except that nondeductible
contributions to a traditional IRA may be converted to a Roth
IRA tax-free as a return of basis.\31\ The chief benefit
conferred by a valid Roth conversion is that a contribution,
far in excess of the regular contribution limit, can begin
generating tax-free earnings. The 10% premature distribution
penalty will not apply to a valid conversion distribution,
despite the fact that the distribution from the traditional IRA
would fail to qualify for one of the exceptions under section
72(t)(3)(A).\32\
---------------------------------------------------------------------------
\31\ See section 408A(d)(3)(A)(i) of the Code.
\32\ See section 408A(d)(3)(A)(ii) of the Code.
---------------------------------------------------------------------------
When considering a Roth IRA conversion, the distinction
between AGI and ``modified AGI'' must be borne in mind. While
the amount distributed from a traditional IRA in a conversion
transaction is included in gross income and is, thus, included
in the calculation of AGI, it is excluded from the calculation
of a modified AGI amount used to determine eligibility to make
the conversion.\33\ Only those taxpayers whose modified AGI for
the distribution year does not exceed $100,000 will be able to
make a valid Roth IRA conversion.\34\
---------------------------------------------------------------------------
\33\ See section 408A(c)(3)(C)(i) of the Code.
\34\ See section 408A(c)(3)(B)(i) of the Code.
---------------------------------------------------------------------------
It is clear under the statute that a single taxpayer whose
modified AGI exceeds $100,000 is ineligible to make a
conversion. It is not entirely clear, based solely on the
statute, whether the $100,000 modified AGI limit could apply
individually to joint return filers. (It should be noted that a
married individual filing separately is not eligible for a Roth
IRA conversion.\35\) The regulations, however, interpret the
somewhat ambiguous term ``taxpayer's adjusted gross income'' in
the statute as requiring that modified AGI be based on joint
return AGI.\36\ The use of the term ``taxpayer'' arguably gave
the IRS sufficient interpretive flexibility that the $100,000
modified AGI limit could have been applied individually to the
husband and wife who file a joint return. In any case, the
application of such a severe marriage penalty to Roth IRA
conversions is indefensible as a matter of sound tax
policy.\37\ In defense of the IRS interpretation, however, The
term ``taxpayer'' is also used to refer to the husband and wife
filing a joint return in sections 408A(c)(3)(A)(i) and
219(g)(2)(A)(i) of the Code.
---------------------------------------------------------------------------
\35\ See section 408A(c)(3)(B)(ii) of the Code.
\36\ See Treasury regulation section 1.408A-4 A-2(b).
\37\ Nevertheless, a slight bias toward the single return filer
also exists in the $15,000 phase-out period for regular Roth IRA
contributions, as opposed to a $10,000 phase-out for joint return
filers, under section 408A(c)(3)(A)(ii). With respect to traditional
IRAs, the active participant phase-out periods of section
219(g)(2)(A)(ii) will be $10,000 for single filers and $20,000 for
joint return filers for years after 2006.
---------------------------------------------------------------------------
The only exception to the rule that a married individual
who files a separate return is ineligible to convert an IRA to
a Roth IRA applies for a married person who has lived apart
from his or her spouse for the entire year in which the
distribution is made. Such a separated spouse may convert a
Roth IRA, despite filing a separate return, provided the
$100,000 modified AGI limit is not exceeded on the separate
return he or she files.\38\
---------------------------------------------------------------------------
\38\ See section 408A(c)(3)(D) of the Code.
---------------------------------------------------------------------------
A traditional IRA may be converted to a Roth IRA in any
year, but if the conversion is made after December 31, 1998,
the entire amount distributed from the traditional IRA will be
included in the gross income of the year of the conversion. If
the conversion is made before January 1, 1999, a special tax
break is available--the inclusion in gross income will be
spread ratably over four years--25% will be included in 1998
gross income and 25% will be included in each of the next three
years.\39\ The 1998 Act, however, added a provision permitting
an individual to file an election to include the entire amount
converted in 1998 gross income.\40\. The election to forego
four-year spreading must be made on Form 8606 and cannot be
made or changed after the extended due date of the 1998
return.\41\ The final regulations clarify that a Roth IRA owner
who was married at the time of the conversion may continue
spreading the conversion amount over four years, even though he
or she becomes divorced or separated during that period.\42\
(For the applicable rules where the Roth IRA owner dies during
the four-year spread period, see Death of the Owner, below.)
---------------------------------------------------------------------------
\39\ See section 408A(d)(3)(A)(iii) of the Code
\40\ Ibid.
\41\ See Treasury regulation section 1.408A-4 A-10.
\42\ Treasury regulation section 1.408A-4 A-11(c).
---------------------------------------------------------------------------
The actual conversion to a Roth IRA may be structured as a
rollover distribution from the traditional IRA followed by a
contribution to the Roth IRA within the normal 60 day period, a
trustee-to-trustee transfer, or a transfer between a
traditional and a Roth IRA maintained by the same trustee
(which the final regulations clarify includes a simple
redesignation of the same account.\43\) Whatever form the
conversion actually takes, it must qualify as a rollover under
section 408(d)(3), except that, unlike rollovers from one
traditional IRA to another, rollovers to Roth IRAs are not
limited to one per year.\44\ Section 408A(e) provides that
conversion contributions to a Roth IRA may be made only from
another IRA. In other words, no distributions from corporate,
section 401(k), section 403(b), section 457, or Keogh plans may
be converted to Roth IRAs.\45\ In fact, however, it appears
that amounts may be converted to Roth IRAs from corporate and
other qualified pension and profit-sharing plans--it just
requires a two-step process. The amount in the qualified plan
must first be rolled over to a traditional IRA in the normal
way \46\ and then converted to a Roth IRA.
---------------------------------------------------------------------------
\43\ See Treasury regulation section 1.408A-4 A-1(b)(3).
\44\ See section 408A(e) of the Code, which provides that the
annual rollover limitation of section 408(d)(3)(B) does not apply.
\45\ See also section 408A(d)(3)(B) of the Code and Treasury
regulation section 1.408A-4 A-5.
\46\ See sections 402(c)(1) and (8)(B)(i) and (ii) of the Code.
---------------------------------------------------------------------------
Amounts in both SEP \47\ and SIMPLE IRAs \48\ may be rolled
over to Roth IRAs, but distributions to a participant from a
SIMPLE IRA cannot be rolled over to a Roth IRA (as well as a
traditional IRA or a SEP IRA) until he or she has been a
participant for two years.\49\ The 1998 Act added section
408A(f)(1) to the Code which provides that a SEP or SIMPLE IRAs
may not be ``designated'' as a Roth IRA. Although amounts in a
SEP or SIMPLE IRA may be converted, the plan itself cannot be
converted (using the term in a non-technical sense), such that
future contributions under the SEP or SIMPLE IRA agreement can
treated as made directly to a Roth IRA.\50\ This amendment is
evidently intended to remove any uncertainty about whether
contributions could be made to a Roth IRA under the higher SEP
and SIMPLE IRA limits and whether deductible employer
contributions and contributions under salary reduction
arrangements may be made directly to a Roth IRA, with the
result that employer deductions from, and employee reductions
in, income created by the SEP and SIMPLE IRA contributions will
never be recovered by the Treasury.
---------------------------------------------------------------------------
\47\ See section 408(d)(3)(A)(i) of the Code, as made applicable by
the general rule of section 408A(a) of the Code.
\48\ See 408(d)(3)(G) of the Code, as made applicable by the
general rule of section 408A(a) of the Code.
\49\ See sections 408(d)(3)(G) and 72(t)(6) of the Code and
Treasury regulation section 1.408A-4 A-4(a) and (b).
\50\ See Treasury regulation section 1.408A-4 A-4(c).
---------------------------------------------------------------------------
Where a Roth IRA conversion straddles two years--i.e., the
rollover contribution takes place within the 60-day window,\51\
but in the year following the rollover distribution--some
special rules apply. The regulations interpret the requirement
that a husband and wife must file a joint return to be eligible
to make a conversion as requiring that the joint return be
filed for the year that the rollover distribution is paid from
the traditional IRA, but apparently not for the subsequent year
when the conversion contribution is made.\52\ Even though the
rollover contribution occurs in 1999, so long as the rollover
distribution is made within 1998, the regulations provide that
the conversion qualifies for the four-year spread period.\53\
This provision is logical and fair. It is the distribution from
the traditional IRA that creates the tax liability and the
income should be recognized in the year in which the
distribution occurs.
---------------------------------------------------------------------------
\51\ See section 408(d)(3)(A)(i) and (ii) of the Code.
\52\ See Treasury regulation section 1.408A-4 A-2(b).
\53\ See Treasury regulation section 1.408A-4 A-8.
---------------------------------------------------------------------------
The regulations also provide that, where a Roth conversion
is accomplished over two years, the $100,000 modified AGI limit
that determines eligibility to make the conversion is required
to be satisfied for the year of distribution.\54\ This
provisions is not logical--eligibility to make the conversion
should be determined in the year of the conversion--but it is
sensible because eligibility to make the conversion is easier
to determine at the end of the year. Nevertheless, the
inconsistencies in the rules applicable to two-year conversions
create complexities to bog down administrators. (See Reversing
a Roth Conversion and Qualified Distributions, below.)
---------------------------------------------------------------------------
\54\ See Treasury regulation section 1.408A-4 A-2(a).
---------------------------------------------------------------------------
No exception has been created from the withholding
requirements of the Code for conversion amounts included in
gross income. Regardless, it is likely that most individuals
who convert IRAs will not have to file estimated tax returns to
avoid the section 6654(a) penalty for underwithholding, even
those who convert large dollar amounts, because most
individuals receive refunds from their 1040s. Even where the
conversion causes a large increase in 1998 tax liability, a
taxpayer who received a refund in the previous year will be
covered under section 6654(d)(1)(B)(ii), which provides that,
if 100% of last year's tax liability (105% if last year's AGI
exceeded $150,000) is withheld in the current year, the penalty
for underwithholding will not be applied. Taxpayers who sent a
check with last year's return, however, must have 90% of the
current year's tax withheld to avoid the penalty.\55\ Such
taxpayers may have a problem if they made a large conversion
and did not adjust their W-2 withholding or file estimated
returns. It is in 1999, the second year of the four-year spread
period, that most taxpayers will have to remember to factor
into their withholding the tax on 25% of the amount converted.
---------------------------------------------------------------------------
\55\ See section 6654(d)(1)(B)(i) of the Code.
---------------------------------------------------------------------------

Minimum Distribution Rules

Roth IRAs, unlike traditional IRAs under section 408(a)(6),
are not subject to the ``minimum distribution rules.'' \56\ The
minimum distribution rules require distributions to commence by
April 1st of the calendar year following the year in which the
owner attains age 70\1/2\ \57\ and the entire interest in the
plan must be paid over the life or life expectancy of the owner
or the owner and a designated beneficiary.\58\ The annual
distributions must at least equal the quotient obtained by
dividing the individual's account balance by the applicable
life or joint and survivor life expectancy.\59\ Roth IRA owners
and administrators must be aware of the minimum distribution
rule, however, because of the fact that to be valid, a Roth IRA
conversion must satisfy the requirements for a traditional IRA
rollover under section 408(d)(3). Section 408(d)(3)(E) provides
that amounts required to be received as minimum distributions
are not permitted to be rolled over to an IRA.\60\
---------------------------------------------------------------------------
\56\ See section 408A(c)(5)(A)(iii) of the Code.
\57\ See section 401(a)(9)(C)(i)(I) of the Code.
\58\ See section 401(a)(9)(A)(ii) of the Code and proposed Treasury
regulation sections 1.401(a)(9)-1 B-1.
\59\ See proposed Treasury regulation sections 1.401(a)(9)-1 E-1
through E-8 and F-1 through F-4.
\60\ See also section 402(c)(4)(B) of the Code.
---------------------------------------------------------------------------
The regulations make clear that section 408(d)(3)(E)
applies to any Roth IRA conversion with the following
consequences: (1) To the extent that the required minimum
distribution has not been made for the year, the first dollars
distributed (including a trustee-to-trustee transfer) from the
traditional IRA in the conversion will be treated as coming
from the required minimum distribution for that year.\61\ (2)
To the extent that a required minimum distribution is deemed to
have been included in a conversion distribution, it will be
treated as if it were distributed to the owner prior to the
rollover and then contributed as a regular contribution to the
Roth IRA.\62\ An owner who does not understand the impact of
the minimum distribution rules on a Roth IRA conversion may be
liable for having made an excess contribution and, in 1998, for
a failure to pay income tax. In this regard, it should be noted
that, although the required distributions from a traditional
IRA are permitted to begin as late as the April 1st of the
calendar year following the calendar year in which the owner
turns 70\1/2\, such distributions in the subsequent year, as is
made clear in the preamble to the final regulations, are being
made for the year in which the owner turned 70\1/2\.\63\ Thus,
if a conversion distribution is made in the year the
traditional IRA owner turns 70\1/2\, it will be treated as
including the required minimum distribution.
---------------------------------------------------------------------------
\61\ See Treasury regulation section 1.408A-4 A-6(a), which is
consistent with Treasury regulation section 1.402(c)-2 A-7(a).
\62\ See Treasury regulation section 1.408A-4 A-6(c).
\63\ See also section 1.408A-4 A-6(b) of the regulations, which
refers to ``a year for which a minimum distribution is required
(including the calendar year in which the individual attains age 70\1/
2\).''
---------------------------------------------------------------------------
Although up to $2,000 of the minimum distribution that is
inadvertently included in the conversion may qualify as a
regular contribution to the Roth IRA, any excess of the
included minimum distribution amount over $2,000 will be
treated as an excess contribution subject to the 6% annual
excess contribution penalty.\64\ A second penalty trap may be
sprung on 1998 conversions. The amount of any minimum
distribution that is mistakenly converted in 1998 will still
have to be included in gross income for 1998, but it is not
eligible for the four-year spread period because it is not part
of the 1998 conversion. The Roth IRA owner will, thus,
underreport taxable income if he or she applies the four-year
spread period to the minimum distribution amount mistakenly
treated as part of a 1998 conversion.
---------------------------------------------------------------------------
\64\ See section 4973(f) of the Code and proposed Treasury
regulation section 1.401(a)(9)-1 G-1B(a).
---------------------------------------------------------------------------
The impact of this rule is surreptitious and difficult to
justify on a policy basis--the minimum distribution amount
would not escape being included in gross income because it is
included in the conversion. The Congress can be faulted for
creating this trap. Taxpayers may be misled by the language of
section 408A(c)(5) stating that minimum distribution rules
``shall not apply to any Roth IRA.'' The minimum distribution
rules should have been made statutorily inapplicable to
conversions as a simplification measure. The IRS may feel bound
to their interpretation by the overlay rule of section 408A(a),
but more detail about the application of the traditional IRA
rules where gaps exist in the Roth statute would be helpful (on
this issue and in general).
In addition, required minimum distributions are currently
included in modified AGI.\65\ Assuming an IRA owner is even
aware of this treatment, the owner may still fail to separately
account for the minimum distribution as an item of modified AGI
because, based on the misapprehension that the minimum
distribution amount can be included in a rollover, he or she
believes that the rollover eliminated any funds in the
traditional IRA that could be used for a minimum distribution.
Where the inclusion of the minimum distribution causes modified
AGI to exceed $100,000, such a misapprehension could cause an
owner who has attained age 70\1/2\ to make a ``failed
conversion'' \66\--with the consequences that the deferral in
his or her traditional IRA would be lost for nothing and, if
the conversion is made in 1998, that taxable income would also
be understated by an improper use of the four-year spread
period. For taxable years beginning after December 31, 2004,
however, Congress has sensibly eliminated minimum distributions
from modified AGI.\67\
---------------------------------------------------------------------------
\65\ See section 408A(c)(3)(C)(i) of the Code.
\66\ Treasury regulation section 1.408A-8 A-1(b)(4) defines a
``failed conversion as ``a transaction in which an individual
contributes to a Roth IRA an amount transferred or distributed from a
traditional IRA or SIMPLE IRA (including a transfer by redesignation)
in a transaction that does not constitute a conversion under section
1.408A-4 A-1.''
\67\ See section 408A(c)(3)(C)(i)(II) of the Code, as amended by
the 1998 Act.
---------------------------------------------------------------------------
The regulations discuss the consequences of a full or
partial conversion of a traditional IRA that is distributing
substantially equal annual payments for the life or life
expectancy of the owner or for the life or life expectancy of
the owner and a designated beneficiary under section
72(t)(2(iv) of the Code. Not only will the amount of the
conversion distribution will not be a premature distribution
from the traditional IRA subject to the 10% penalty tax of
section 72(t)(3)(A), but the conversion will not modify the
annuity schedule, such that the special penalty under section
72(t)(4)(A) of the Code will apply, nor will the subsequent
annuity payments from the Roth IRA be subject to the 10%
penalty--despite being nonqualified distributions. The
regulations note, however, that, if the 10% penalty is not to
apply, the ``original series of substantially equal periodic
payments'' must continue from the Roth IRA (except for the
owner's death or disability) until five years from the first
payment and until the owner has attained age 59\1/2\.\68\ The
final regulations also clarify that where the conversion
occurred in 1998 and the income inclusion is being spread over
four years, the ``income acceleration rule'' of section
408A(d)(3)(E)(i) will be triggered by the annuity payments
during the spread period. Thus, in addition to the inclusion of
the amount of the annuity payment for each year, a dollar of
the deferred income from the 1998 conversion will be
accelerated into current income for each dollar of annuity
payment made in 1998, 1999, and 2000 up to the amount of the
1998 conversion.\69\ (See Conversion Anti-Abuse Rule, below.)
---------------------------------------------------------------------------
\68\ See Treasury regulation section 1.408A-4 A-12.
\69\ Ibid.
---------------------------------------------------------------------------

Reversing a Roth Conversion

A failed conversion of a traditional IRA to a Roth IRA may
subject the distribution to the 10% premature distribution
penalty \70\ and, to the extent the rollover amount exceeds the
regular contribution permitted to be made to the Roth IRA, it
will be subject to the excess contribution penalty.\71\ After
enactment of the Roth IRA provisions, Congress realized that
taxpayers may not discover, until they are preparing their tax
returns for a year, that they were ineligible to make a Roth
IRA conversion in that year (typically because modified AGI
exceeded $100,000). Section 408A(d)(6) of the Code, added by
the 1998 Act, makes it possible to effectively reverse (or
``recharacterize,'' as the term is used in the regulations
\72\) a Roth IRA conversion by transferring the contribution,
together with its earnings from the Roth IRA, back to a
traditional IRA and, thus, avoid the imposition of penalties.
It is also possible, under the same provision, to
recharacterize a contribution that was initially made to a
traditional IRA, as if it had been made initially to a Roth
IRA.\73\ In either case, the recharacterization must occur by
the extended due date of the tax return for the year of the
failed conversion.\74\
---------------------------------------------------------------------------
\70\ See section 72(t)(3)(A) of the Code.
\71\ See section 4973(f) of the Code.
\72\ See Treasury regulation section 1.408A-5 A-1.
\73\ See section 408A(d)(6) of the Code.
\74\ See section 408A(d)(7) of the Code. Particularly with respect
to 1998 conversions, in order not to lose the benefit of the four-year
spread period by missing the deadline, owners should be mindful of the
distinction between the deadline for conversions--the end of the 1998
calendar year for 1998 conversions--and the recharacterization
deadline--the extended return due date (August 15th for automatic
extensions and October 15th for requested extensions).
---------------------------------------------------------------------------
The recharacterization provision is a means to avoid being
penalized for a contribution or conversion that proves, in
hindsight, to have been a mistake. A recharacterization
transfer is not, however, an alternative to a Roth conversion.
A conversion is necessarily a taxable event because amounts are
being transferred to a Roth IRA that were deducted when they
were contributed previously to the traditional IRA. If
traditional IRAs could be converted to Roth IRAs without these
deductions being brought back into income, the Roth IRA
conversion would amount to the Treasury paying citizens (by
forgiving a tax indebtedness) to save on a tax-free basis.
A recharacterization is not a taxable event because the
contribution made to a Roth (or traditional) IRA--referred to
by the regulations as the ``FIRST IRA''--is withdrawn and
contributed to a traditional (or Roth) IRA--the ``SECOND
IRA''--within the period covered by a single tax return. No
deductions can be taken for the contribution to the FIRST IRA
and no deductions taken in previous years will go unrecovered
by the contribution to the SECOND IRA.
For example, assume a calendar year taxpayer makes a
regular contribution to a traditional IRA on January 1, 1998,
and then recharacterizes the contribution by transferring it
(together with its earnings from the traditional IRA) to a Roth
IRA on August 15, 1999 (filing the return under an automatic
extension). No deduction could be taken on the tax return for
the traditional IRA contribution because it was canceled within
the span of the same tax return. On the other hand, if the
first contribution in 1998 was made to the traditional IRA by
means of a rollover from a qualified plan, the rollover
contribution could not then be transferred from the traditional
IRA to the Roth IRA and labeled a recharacterization. This is
because the recharacterization transfer is not available for
contributions for which deductions have been taken that should
be brought back into income upon being transferred to a Roth
IRA.\75\
---------------------------------------------------------------------------
\75\ See section 408A(d)(6)(B)(ii) of the Code.
---------------------------------------------------------------------------
As a technical matter, the recharacterization provisions
permit all or a portion of a regular or conversion contribution
made during the year to the FIRST IRA to be transferred to the
a SECOND IRA before the extended due date of the return for the
year, with the transaction being treated as if the contribution
to the FIRST IRA had actually been made to the SECOND IRA. (The
transfer to the SECOND IRA is treated as being made on the same
date that the initial contribution was made to the FIRST IRA.)
As mentioned, the earnings on the contribution or portion of
the contribution being transferred from the FIRST IRA to the
SECOND IRA must also be included in the recharacterization
transfer.
The preamble to the final regulations makes clear that an
excess contribution from a prior year, which would otherwise be
treated as a contribution for the current year under section
4973(f) (to the extent that actual contributions for the
current year are less than the contribution limit for the
current year), cannot be recharacterized, unless the extended
due date of the return for the year of the excess contribution
has not passed. Although such excess contributions are
otherwise treated as having been made in the year for which
actual contributions are less than the contribution limit,\76\
according to the preamble, only actual contributions may be
recharacterized and the excess contribution was actually made
in the prior year.
---------------------------------------------------------------------------
\76\ See e.g., proposed Treasury regulation section 1.219(a)-2(d).
---------------------------------------------------------------------------
Where a portion of a contribution is being recharacterized
or where there have been other contributions to the account,
the regulations provide that the amount of earnings that must
also be recharacterized will be determined by reference to a
relatively simple ratio in section 1.408-4(c)(2)(ii) of the
regulations.\77\ The fact that the regulations appear to gloss
over the difficulty of adapting this ratio to a partial
recharacterization of specific securities makes it seem likely
that the ratio is intended to be used on a conceptual basis. In
other words, it makes sense to assume that a trustee will be
able to exercise judgment in allocating earnings in a partial
recharacterization to come up with a sensible result where the
section 1.408-4(c)(2)(ii) regulations would not provide it. It
should be noted that the final regulation, by eliminating the
parenthetical phrase ``(but not below zero)'' from section
1.408-4(c)(2)(iii), as incorporated by reference, make it
possible to recharacterize a portion of an account or a mixed
account where either has declined in value.
---------------------------------------------------------------------------
\77\ See Treasury regulation section 1.408A-5 A-2(c).
---------------------------------------------------------------------------
The form of the recharacterization transfer is explicitly
limited by the statute to a trustee-to-trustee transfer.
(apparently to promote accurate recordkeeping \78\). The final
regulations clarify that where the owner who made the
contribution dies within the time for recharacterizing it, the
executor, administrator, or other person with the
responsibility for filing the decedent's final income tax
return may make the recharacterization election.\79\ The final
regulations also clarify that where there is only one trustee
involved in a recharacterization, an actual transfer from the
FIRST IRA to a newly created SECOND IRA is not required--the
trustee may simply redesignate the FIRST IRA as the SECOND
IRA.\80\
---------------------------------------------------------------------------
\78\ See Treasury regulation section 1.408A-5 A-6(a).
\79\ See Treasury regulation section 1.408A-5 A-6(c).
\80\ See Treasury regulation section 1.408A-5 A-1.
---------------------------------------------------------------------------
The regulations provide that employer contributions and
elective deferrals to SEP and SIMPLE IRAs cannot be
recharacterized as IRA contributions.\81\ This provision is
only being consistent with the rule that contributions for
which deductions were taken cannot be recharacterized--the
deductions would have been taken on the employer's return in
the case of the SEP and the elective employee contributions to
the SIMPLE IRA would not have been included in gross income to
begin with. The proposed (and now the final) regulations
provided that an erroneous rollover contribution from a
traditional IRA to a SIMPLE IRA (which are only permitted to
accept contributions under salary reduction agreements) may be
recharacterized.\82\. In addition, it seemed apparent, based on
the fact that SEP and SIMPLE IRAs are IRAs under section
7701(a)(37) of the Code \83\ and are, thus, covered by the
literal language of section 408A(d)(6) of the Code, that the
conversion of a SEP or SIMPLE IRA could be recharacterized.
Nevertheless, the proposed regulations did not address the
issue. The final regulations, however, do make it explicit that
the conversion of an amount from a SEP or SIMPLE IRA to a Roth
IRA may be recontributed to the same or a different SEP or
SIMPLE IRA.\84\
---------------------------------------------------------------------------
\81\ See Treasury regulation section 1.408A-5 A-5.
\82\ See Treasury regulation section 1.408A-5 A-4.
\83\ See sections 408(k) and (p) of the Code.
\84\ See Treasury regulation section 1.408A-5 A-5.
---------------------------------------------------------------------------
So-called ``conduit IRAs'' represent an exception to the
prohibition on rollovers from IRAs to section 401(a) or 403(a)
qualified plans or section 403(b) annuities. Amounts may be
rolled over from a qualified plan to an IRA and subsequently
back to a qualified plan, provided the only amounts in the
intervening IRA are attributable to rollovers from qualified
plans. The same rule applies to section 403(b) plans.\85\ The
preamble to the regulations clarifies that a conduit IRA that
is converted to a Roth, but then converted back to a
traditional IRA will redeem its status as a conduit IRA because
the effect of the recharacterization is that of a transfer
directly from one conduit IRA to another conduit IRA.
---------------------------------------------------------------------------
\85\ See section 408(d)(3)(A) of the Code.
---------------------------------------------------------------------------
Although individuals should generally elect out of 10%
withholding under section 3405(b) of the Code upon a conversion
to move more money into the Roth IRA, it is also advisable to
do so in anticipation of a possible recharacterization. In the
event of a recharacterization, the 10% withheld on the
conversion is likely to be recoverable only against other taxes
owed on the individual's return. The custodian will be
unwilling to recontribute the 10% withheld to the traditional
IRA if it has been forwarded to the Treasury. If, however, the
custodian is willing to return the 10% withheld, the policy
behind section 408A(d)(6) of the Code supports recontributing
it to the traditional IRA as part of the recharacterization--
even though technically the 10% withheld was not converted.
Nevertheless, whether the 10% is contributed by the custodian
or by the individual from fresh funds, no earnings will have
accrued on the 10% withheld from the time of the conversion to
the recontribution to the traditional IRA.
The regulations provide that the recharacterization must be
made, as mentioned, by the extended due date of the return
``for the taxable year for which the contribution was made to
the FIRST IRA,'' e.g., the Roth conversion. The same provision
of the regulations also provides that where a rollover
contribution to a Roth IRA occurs in the year following the
rollover distribution, the conversion will be treated as
occurring in the year of the rollover distribution.\86\ For
other purposes in the regulations, however, where a rollover
conversion straddles two years, the conversion is deemed to
occur in the year of the rollover contribution.\87\ At least
for 1998 conversions, treating the rollover distribution date
as the conversion date coordinates the recharacterization
provision with the generous one-time exception provided under
the regulations that qualifies rollover distributions that
occur in 1998 for the four-year spread--even though the
rollover contribution to the Roth IRA occurs within the 60-day
window in 1999.\88\
---------------------------------------------------------------------------
\86\ See Treasury regulation section 1.408A-5 A-1(b).
\87\ See, e.g., Treasury regulation section 1.408A-6 A-2 and A-
5(c).
\88\ See Treasury regulation section 1.408A-4 A-8.
---------------------------------------------------------------------------
Admittedly, the bulk of conversions are likely to have
occurred in 1998 to take advantage of the four-year spread and
a minority of the conversions in any year are likely to be two-
year rollovers, but, where two-year conversions do occur
subsequent to 1998, the recharacterization provision could
cause confusion. For example, if a rollover distribution occurs
in 1999 and the rollover contribution occurs 60 days later
during 2000, the owner would be justified in believing that,
because the conversion is treated as occurring in 2000 for
other purposes, he or she has until the extended due date of
the 2000 return to reverse a failed conversion. In fact, the
conversion must be reversed by the extended due date of the
1999 return. It should be recalled that the modified AGI limit
and the joint return requirement apply for the year of the
rollover distribution where the conversion straddles two
years,\89\ but the existence of other provisions that are
consistent with this exception adds to the potential for
confusion. A helpful simplicity would have been created had the
IRS been able to treat two-year conversions consistently.
Treating the year of the rollover distribution as determinative
would not only have been helpful in making the four year-spread
available for 1998 distributions, but it would have eliminated
a trap that has been created in the measurement of the five-
year holding periods for qualified distributions and conversion
contributions (see Qualified Distributions, below).
---------------------------------------------------------------------------
\89\ See Treasury regulation section 1.408A-4 A-2(a) and (b).
---------------------------------------------------------------------------
If, after the initial regular or conversion contribution is
made to a Roth IRA (traditional IRA)--the FIRST IRA--there are
one or more intervening transfers to other Roth IRAs
(traditional IRAs) before the recharacterization or reversal
transfer is made to the traditional IRA (Roth IRA)--the SECOND
IRA--then the intervening transfers will be ignored. The
individual may elect to treat the recharacterization transfer
to the SECOND IRA as occurring on the date that the initial
contribution to the FIRST IRA occurred and all the earnings
from the date of the initial transfer would be credited to the
SECOND IRA.\90\
---------------------------------------------------------------------------
\90\ See Treasury regulation section 1.408A-5 A-7.
---------------------------------------------------------------------------
Recharacterizations, even where limited to one a year, will
create significant complexity for plan trustees. They must
remember for information reporting purposes that the income or
losses of the FIRST IRA will be treated as earned or incurred
in the SECOND IRA, which is the IRA recharacterized as having
received the contribution originally. If the first transfer was
not kept entirely separate, then the earnings must be
apportioned--an exercise for which the IRS has provided minimal
guidance. Where two trustees are involved, the need for
information sharing adds to the complexity.
[Due to the length of the attachment, it is being partially
printed and the full attachment is being retained in the
Committee files. If anyone wants a copy of the statement with
the full attachment, please contact James O'Connor, America's
Community Bankers, 202/857-3100.]

Statement of American Bankers Association

The American Bankers Association (ABA) is pleased to have
an opportunity to submit this statement for the record on
reducing the tax burden including pension reforms, health care
incentives, long-term care incentives, estate and gift tax
relief, and savings incentives.
The ABA brings together all elements of the banking
community to best represent the interests of this rapidly
changing industry. Its membership--which includes community,
regional, and money center banks and holding companies, as well
as savings associations, trust companies, savings banks and
thrifts--makes ABA the largest banking trade association in the
country.
There are several proposals to reduce the tax burden on
individuals and businesses that are of interest to banking
institutions. The most significant proposals are set out more
fully below.

INDIVIDUAL RETIREMENT ACCOUNTS

Inadequate personal savings is one of the most important
long-term issues facing taxpayers in the coming years. Savings
promote capital formation, which is essential for job creation,
opportunity and economic growth. The banking industry fully
supports continued efforts to encourage retirement savings and
to strengthen IRAs. The primary appeal of the IRA concept to
individuals is based upon its tax advantages, which are often
viewed as a supplement to savings, making the IRA an appealing
product for an individual's long-term savings growth.
Individuals concerned about the availability of retirement
funds can appropriately complement social security and other
retirement savings vehicles with IRAs. Also, the tax penalties
that accompany early withdrawals operate as an additional
incentive to save for the long-term.
We commend Representatives Phil Crane (R-IL) [H.R. 1311,
the ``IRA Charitable Rollover Incentive Act of 1999'']; Bill
Thomas (R-CA) [H.R. 1546, ``the Retirement Savings Opportunity
Act of 1999'']; Richard Neal (D-MA) [H.R. 1311, the ``IRA
Charitable Rollover Incentive Act of 1999''] and Jennifer Dunn
(R-WA) [H.R. 1084, the ``Lifetime Tax Relief Act of 1999''] for
introduction of legislation that would enhance IRAs and
encourage retirement savings.
We urge you to include provisions enhancing IRAs in the
next tax legislation enacted.

ESTATE TAX REFORM

The financial services industry has been involved in estate
administration for many years. As a consequence, bankers have
seen many times how families struggle to pay the taxes due when
a death occurs, particularly when such death is unexpected.
Some families encounter more than their fair share of obstacles
when confronted with the required payment of a large death tax
bill after the death of a loved one. The payment of death taxes
with respect to a small business owner or farmer may be
particularly difficult due to a lack of liquid assets in the
estate. Indeed, the death tax will impact more taxpayers in the
future as the value of estates increase as a result the
continued strong growth of the equities market and the increase
in the proportion of senior citizens to the general population.
The ABA strongly supports broad-based estate tax relief in
order to allow small family business owners and family farmers
to keep their businesses in the family. Any proposed tax law
change should not increase complexity nor the time and effort
expended by taxpayers in compliance. In this regard, we urge
you to increase the unified credit or, in the alternative, to
significantly reduce the current estate tax rates. However, we
would oppose any proposal to eliminate both the estate and gift
tax system and eliminate the step-up in basis rules for
inherited property, as provided in certain Senate legislation
(S. 1128, ``the Estate Tax Elimination Act of 1999,''
introduced by Senator Jon Kyl (R-AZ)).
Bank trust departments, which often serve as executors to
estates, are concerned that S. 1128 would place the burden of
establishing the carryover basis on the executor. Determining
the carryover basis would be extremely difficult if not
virtually impossible in that, unlike property transferred in
connection with a divorce or gift, the original owner would not
be available for consultation. Also, records establishing the
original purchase price of inherited property might not be
available.
We urge you to include broad-based death tax relief in the
next tax legislation enacted.

REDUCTION OF INCOME TAX RATES FOR TRUSTS AND ESTATES

The current rate structure complicates the decision-making
process of fiduciaries to trusts and estates such as bank trust
departments. A fiduciary may face possible criticism and
subsequent litigation whenever a decision is made to accumulate
funds within the estate or trust rather than distribute them.
There are many legitimate reasons to accumulate assets within
the estate or trust, such as payment of debts (including estate
and inheritance taxes); provision of future education benefits
to minor children; or care of surviving spouses, orphans,
elderly parents, the mentally or physically disabled, or
accident victims. High income tax rates for trusts and estates
may also have an impact on investment decisions. One of the
factors a prudent fiduciary takes into consideration when
choosing a particular investment portfolio is the income tax
consequence. Due to the compressed tax rates, a fiduciary may
choose to invest trust or estate assets in tax-exempt income
generating investments. This excludes investment choices such
as equity mutual funds. Whatever decision the bank trust
department makes may subject them to potential second-guessing
by beneficiaries.
The ABA supports legislation that would provide that trusts
and estates should be taxed at the same rates as individual
taxpayers.

SHORT-TERM CAPITAL GAINS DISTRIBUTED BY MUTUAL FUNDS

The use of mutual funds as investment options for trust
accounts is increasing every year. When a trust is invested in
a mutual fund, it is not clear how dividends payable out of the
short-term capital gains of a mutual fund are to be treated for
tax purposes. The Internal Revenue Code requires the mutual
fund to classify such sums as ordinary dividends. However, the
short-term capital gains nature of such sums have caused banks
in certain states to allocate them to principal by direction of
the trust instrument or state law. Further questions arise as
to whether this income, when allocated to principal, should be
excluded from distributable net income (DNI) under Internal
Revenue Code Section 643(a)(3) as gains from the sale of
capital assets allocated to principal, and not paid or required
to be distributed to beneficiaries. Another way to treat these
sums is to include them in DNI as ordinary dividend income and
make them potentially taxable to the trust income beneficiary
under the rules of Section 652 for simple trusts and Section
662 for complex trusts.
Due to the lack of certainty in the law and regulations,
the banking industry differs with respect to its handling of
the treatment of such dividends and their includability in DNI.
A similar issue obtains with respect to market value discount
and currency gains, both of which are allocated to principal
but taxable as ordinary income. These items are the result of
bifurcating capital gains between income that is taxed as
capital gain and income that is taxable as ordinary income.
We believe that Section 643 should be modified to
specifically exclude such gains, taxable as ordinary income,
from DNI. Such action would simplify the Code and reduce
confusion.

MODIFICATION OF GENERATION SKIPPING TRANSFER TAX

Under current law, missed allocations of generation
skipping transfer (GST) exemption create significant potential
GST tax liability and no relief is available. The ABA supports
legislation that would allow the IRS to grant relief to
taxpayers who inadvertently fail to allocate GST exemption;
allow validation of certain technically flawed exemption
allocations; allow retroactive allocation of GST exemption in
cases of unnatural order of death; automatically allocate a GST
exemption to certain transfers; and permit division of trusts
to allow taxpayers to maximize the benefit of the exemption
without overly complex planning and drafting.
In this connection, we commend Rep. Jim McCrery (R-LA) for
the introduction of H.R. 2158, the ``Generation-Skipping
Transfer Tax Amendments Act of 1999'' and urge its inclusion in
the next tax legislation enacted.

EMPLOYEE BENEFITS

The American Bankers Association supports long-term savings
for retirement. Providing pension coverage to a greater number
of workers will substantially enhance the retirement security
of American families. The ABA supports initiatives that focus
specifically on the need to make it easier and less expensive
for small businesses to start retirement plans. We also support
increased pension portability. Current law rules should be
modified to facilitate transfer of employee retirement savings
from job to job.
Finally, the overly complex rules governing retirement
plans should be simplified to reduce costs and administrative
barriers that keep employers out of the system, interfere with
business transactions necessary to stay competitive in today's
economic environment, and inhibit the efficient operation of
plans sponsored voluntarily by employers for their employees.
We urge you to include such provisions in the next tax
legislation enacted.

ELIMINATION OF 2% FLOOR ON MISCELLANEOUS ITEMIZED DEDUCTIONS IN
CONNECTION WITH IRREVOCABLE TRUSTS

The ABA supports enactment of legislation that would
Internal Revenue Code Section 67(e) to exclude irrevocable
trusts from the 2% rule calculations. This would aid in
administration of trusts and estates, as well as continue the
efforts to further simplify the Code.

CONCLUSION

We appreciate having this opportunity to present our views
on these issues. We look forward to working with you in the
further development of solutions to our above-mentioned
concerns.

American Federation of State, County and Municipal
Employees (AFSCME) et al.
June 16, 1999

The Honorable Bill Archer
Chairman, House Committee on Ways and Means
United States House of Representatives
Washington, DC 20515

Re: Support for Public Pension Provisions in HR 1102

Dear Mr. Chairman:

The national organizations listed, representing state and local
governments, public employee unions, public retirement systems, and
millions of public employees, retirees, and beneficiaries, support
public pension provisions contained in the bipartisan Comprehensive
Retirement Security and Pension Reform Act (H.R. 1102) sponsored by
Representatives Rob Portman, Ben Cardin, and many other members of
Congress. This proposal would strengthen the retirement savings
programs of public employers and their employees throughout the
country. We are writing to urge your support for this important
legislation.
The Comprehensive Retirement Security and Pension Reform Act would
remove existing barriers between various types of retirement savings
plans so that employees may have a better opportunity to manage and
preserve their retirement savings when they switch jobs. The
legislation would enhance existing portability in public sector defined
benefit plans, and would allow workers to take all their deferred
compensation and defined contribution savings with them when they
change jobs. H.R. 1102 would additionally provide greater clarity,
flexibility and equity to the tax treatment of benefits and
contributions under governmental deferred compensation plans. Finally,
it would simplify the administration of and stimulate increased savings
in retirement plans by restoring benefit and compensation limits that
have not been adjusted for inflation and are generally lower than they
were fifteen years ago; repealing compensation-based limits that
unfairly curtail the retirement savings of relatively non-highly paid
workers; and allowing those approaching retirement to increase their
retirement savings.
All of these provisions would help employees build their retirement
savings, especially those who have worked among various public, non-
profit and private institutions. Our organizations appreciate the
support that you have shown on past public pension issues and are
hopeful you will have similar interest in this comprehensive,
bipartisan legislation. We ask that you please include these proposals
in pending tax legislation before your Committee.
If you have any questions or need additional information,
please contact the following members of our organizations:

Ed Jayne, American Federation of State, County and Municipal Employees
Ned Gans, College and University Personnel Association
Tim Richardson, Fraternal Order of Police
Tom Owens, Government Finance Officers Association
Chris Donnellan, International Brotherhood of Police Oganizations/
National Association of Government Employees
Barry Kasinitz, International Association of Fire Fighters
Michael Lawson, International City/County Management Association
Tina Ott, International Personnel Management Association
Kimberly Nolf, International Union of Police Associations
Neil Bomberg, National Association of Counties
Susan White, National Association of Government Deferred Compensation
Administrators
Bob Scully, National Association of Police Organizations
Jeannine Markoe Raymond, National Association of State Retirement
Administrators
Jennifer Balsam, National Association of Towns and Townships

Ed Braman, National Conference on Public Employee Retirement Systems
Gerri Madrid, National Conference of State Legislatures
Cindie Moore, National Council on Teacher Retirement
David Bryant, National Education Association
Frank Shafroth, National League of Cities
Roger Dahl, National Public Employer Labor Relations Association
Clint Highfill, Service Employees International Union
Larry Jones, United States Conference of Mayors

Statement of AMR Corporation, Fort Worth, Texas

Introduction and Overview

Employer-sponsored defined benefit retirement plans play an
integral role in guaranteeing retirement security. Yet
arbitrary and onerous regulations can encourage certain
employers to abandon such plans. This testimony outlines the
comments of AMR Corporation on one aspect of how the Internal
Revenue Code of 1986 (the ``Code''), as amended, has been
interpreted to impose unfair rules on the sponsors of defined
benefit retirement plans permitting lump sum payments for
retiring employees.
Under the Code, ``qualified'' pension plans must offer a
lifetime stream of monthly payments to plan participants,
commencing upon retirement. Many pension plans permit
participants to receive the value of this lifetime income
stream in a single lump sum payment. In determining the
``present value'' of the lifetime income stream that is being
cashed out, the period over which payments are expected to be
made (the period ending with the assumed date of death) and the
rate at which funds are expected to grow (the assumed interest
rate) are necessary assumptions. The interest rate and
mortality assumptions are therefore critical in calculating the
lump sum value of lifetime benefits.
The Retirement Protection Act of 1994 (the ``RPA'') amended
section 417(e) of the Internal Revenue Code to specify an
interest rate that must be used to convert a pension to a
single lump sum. The RPA also authorizes the Secretary of the
Treasury to prescribe a mortality table for use in calculating
lump sums under section 417(e) of the Code. We perceive no
problem with the current statutory language itself, only with
its implementation by the Internal Revenue Service.
The Internal Revenue Service has prescribed a mortality
table for use by retirement plans. We have no objection to the
table itself. However, we are concerned with the requirement
that the table is to be used together with the mandatory
assumption that half of the participants covered by the plan
are male and half are female.
The requirement that a plan must assume that half its
participants are male and half are female is highly
questionable. The participation in many plans is dominated by
one gender. It is an accepted scientific fact that females, as
a class, have a longer life expectancy than males, as a class.
Prescribing an artificial ``gender mix,'' therefore,
artificially and inaccurately enlarges or contracts the true
average life expectancy of the work force covered by the
pension plan unless the plan's gender mix is actually in
balance. Assumed life expectancy is a major factor in
calculating the amount of a lump sum distribution and in
funding plans, regardless of whether a lump sum distribution
benefit is offered.
These regulations, which appear at Treas. Reg. Section
1.417(e)-1(d)(2) (the regulations) (effective April 3, 1998),
do twist actuarial reality by arbitrarily imposing a mandatory
gender neutral mortality table on pension plans that permit
lump sum payments. A directly relevant revenue ruling, Rev.
Rul. 95-6, 1995-1 C.B. 80, 95 TNT 2-1, contains provisions that
operate in tandem with the regulations. Under these rules,
regardless of whether the participants in a qualified defined
benefit pension plan are 90 percent female or 1 percent female,
all lump sum payments must be calculated using a mortality
table that assumes the plan population is 50 percent female and
50 percent male. The IRS has essentially imposed a requirement
that a pension plan comprised almost entirely of men must
pretend that half its covered participants are women when it
calculates its pension payments. These regulations give
employers of work forces that are gender-imbalanced one more
reason to abandon their defined benefit plans, or not to adopt
them. We anticipate that this issue will raise more concern
when companies with such plans realize that by 2000 all their
lump sum distributions will have to be calculated based on this
arbitrary gender assumption.
The legislative history accompanying the 1993 law mandating
that Treasury create appropriate mortality tables gives no
indication whatsoever that Treasury should issue such an
arbitrary rule. If Treasury and the IRS are unwilling to change
their rules to reflect actuarial reality, we hope that Congress
will amend this law to mandate that Treasury utilize gender
factors reflecting reality in those benefit plans where
participant gender ratios are particularly unbalanced.

The Problem

A lump sum distribution from a qualified defined benefit
pension plan to a participant is designed to be the ``actuarial
equivalent'' of the payments that would otherwise be made
during that participant's lifetime following retirement (or
over the joint lifetime of the participant and the
participant's spouse or other designated annuitant). To fund
this lifetime income, a plan can use assumptions based on the
expected lifetimes of its participants and can recognize, for
example, that the covered participant population is 80 percent
female and 20 percent male. The assumed mortality rates of
participants is obviously a major factor in funding pension
benefits, and it is a universally-accepted and well-documented
fact that females will on average out-live males of the same
age.
In contrast, if lifetime benefits are paid out in a lump
sum, actuarial reality as described above for funding plans is
ignored under current Internal Revenue Service rules. To
determine the amount of lump sum payments, the regulations and
Rev. Rul. 95-6 require plans to use a mortality table that
assumes half the covered participant population is male and
half is female. In the example given above (80 percent female
and 20 percent male), the mandated 50/50 assumption
artificially shortens the expected lifetimes of plan
participants who are female, at least in comparison with the
actual gender factors that can be used in the plan's funding.
Nothing in the statute, which simply requires a ``realistic''
mortality table without reference to gender, mandates this
arbitrary result.
Looking at this result from another perspective, the
greater the gender disparity in favor of males, the more likely
the plan will be underfunded if benefits are regularly paid in
the form of a lump sum. Conversely, the greater the disparity
in favor of females, the more the plan will become overfunded
because expected lifetimes are artificially reduced.

Current Law

The Retirement Protection Act of 1994, enacted as part of
the General Agreement on Trade and Tariffs, amended section
417(e) of the Code, as well as other sections of the Code and
the Employee Retirement Income Security Act of 1974, as
amended. GATT made two significant changes affecting the
calculation of minimum lump sum payments. First, the statute
redefined the applicable interest rate. Second, the legislation
authorized the Treasury Secretary to prescribe a mortality
table for use in calculating the present value of qualified
plan benefits. Nothing in the legislative history of GATT
indicates that Congress intended to preset a particular gender
blend version of GAM 83.
Less than two months after passage of GATT, the Internal
Revenue Service quickly published a mortality table in Rev.
Rul. 95-6 for use under section 417(e). As provided in the
statute, the Service's table uses the current prevailing
commissioner's standard table for group annuities, or the 1983
GAM Table, which is a sex-distinct table (GAM 83). However, the
ruling requires a 50/50 mandatory gender split assumption.
As mentioned above, the Secretary issued final regulations
on both the new interest rate mortality table assumptions, in
April of 1998. The regulations provide specific guidance on how
the interest rate provisions are to be implemented. In
contrast, for the applicable mortality table, the regulations
provide only that the table is to be ``prescribed by the
Commissioner in revenue rulings, notices, or other guidance
published in the Internal Revenue Bulletin.'' Treas. Reg.
Section 1.417(e)-I(d)(2). Treasury's approach of publishing the
table required by the statute in a revenue ruling, instead of
in the regulations, effectively precluded needed public comment
on the 50/50 mandatory gender split that would have otherwise
been required under the Administrative Procedures Act.
The adverse impact of the regulations will be felt
particularly in industries where plans are collectively
bargained. These plans, presumably for historical reasons,
cover work forces that are frequently heavily skewed by gender.
Collectively bargained workforces that are dominated by females
include flight attendants and skilled nurses. Conversely, such
workforces dominated by males consist of, for example, heavy
construction, road building, pilots, long-haul trucking, movers
of household goods, oil and gas, mining, and forestry workers.
Accordingly, this arbitrary regulatory fiat will work to
overfund pensions in industries where rates of female plan
participation are particularly high and will work to underfund
pensions where rates of male participation are high.
Rev. Rul. 95-6 hardly levels the playing field between
annuities and lump sums. Male employees in male-dominated plan
populations will be strongly encouraged to take their benefits
in a lump sum in order to take advantage of the windfall,
possibly exposing their retirement security to the increased
risk of dissipation of their retirement ``nest egg.'' Female
employees in female dominated plans will receive less than they
would if the plan assumptions reflected reality of workforce
participation by gender.

Effect of a 50/50 Mortality Table

The Service's 50/50-gender blend table has an unintended
and inequitable effect on the level of funding and on the
calculation of the present value of lump sum payments. As
previously discussed, the primary focus of GATT was on reducing
underfunding of pension plans. Accordingly, GATT's applicable
mortality table was designed to prevent plan sponsors from
making assumptions that placed plans at risk by minimized
funding obligations. The 50/50 mortality table assumptions
negate that goal by reducing a plan's ability to provide an
accurate and adequate funding level. The 50/50 assumption,
which can be objectively inaccurate, requires plan
administrators to calculate actuarially inaccurate present
values of lump sum payments, at least where plan population by
gender is unbalanced.
For example, if an individual would receive a $1,000 lump
sum payment at retirement based on GAM 83 using gender specific
mortality, the following table presents the adjusted lump sum
amount that would be paid to that individual using the 50/50
blended table:

Discount Rate: 7.0 percent
------------------------------------------------------------------------
Age Male Female
------------------------------------------------------------------------
55................................ 1,042 955
60................................ 1,053 944
65................................ 1,068 929
------------------------------------------------------------------------

This table shows that an age 60 male retiree receives a $53
windfall under the 50/50-blended table and an age 60 female
retiree receives a $56 shortfall.

Proposed Amendment

Congress should rectify this inaccurate treatment by
amending the Code to include a rule addressing use of the
required mortality table for those plans which contain a lump
sum distribution option and which cover populations that are
primarily male or primarily female. For example, the Code could
be amended to include a proposal that would provide an
alternative rule for determining the present value of a
permitted lump sum payment if 80 percent or more of a plan's
covered participant population is comprised of a single gender.
In such cases, the plan would be permitted an election to
utilize Treasury's applicable mortality table with the
assumption that the dominant gender comprises 80 percent, and
the minority gender comprises 20 percent, of the plan's covered
participant population. In order to keep the proposal simple,
the rule could provide that, if in any subsequent plan year the
plan did not satisfy the 80 percent test then, in that and all
successive plan years, the plan sponsor could not make such an
election.

Statement of Associated General Contractors of America

Thank you Chairman Bill Archer for holding a hearing this
morning on the effect of the death (estate) tax on family-owned
construction companies. AGC is pleased to submit testimony
today because elimination of the death tax is our top
legislative priority for the 106th Congress. 94% of AGC members
are closely-held businesses--often family-owned--and planning
for and paying death taxes is an onerous burden our members
will have to face at some point in the life of their company.
You'll notice throughout this testimony that we
consistently refer to the estate tax as the ``death tax.'' We
prefer to call it the ``death tax'' for two reasons: 1) death
of the owner of a company is the event that triggers the tax;
and 2) at a rate of 37% to 55% on all company assets, this tax
kills small businesses and kills jobs!
AGC is the nation's largest and oldest construction trade
organization, founded in 1918. AGC represents more than 33,000
firms, including 7,200 of America's leading general
contractors, and 12,000 specialty-contracting firms. They are
engaged in the construction of the nation's commercial
buildings, shopping centers, factories, warehouses, highways,
bridges, tunnels, airports, waterworks facilities, waste
treatment facilities, dams, water conservation projects,
defense facilities, multi-family housing projects, and site
preparation/utilities installation for housing developments.

EFFECT of DEATH TAXES on CONSTRUCTION COMPANIES

Business continuity--the passing of years of hard work to
the next generation--is a great concern to family-owned
construction companies. Succession planning is long and
difficult. Owners are forced to answer difficult questions
about the future of the company they have often worked all
their life to grow. Who will run the business when I'm gone?
What does my family think should happen? How will ownership be
transferred? These are just a few of the questions a contractor
must address when undertaking succession planning.
As difficult as succession planning can be, it gets even
worse when the owner realizes that up to 55% of his or her
company can be lost to death taxes. When the owner of a
construction company dies, his or her estate is subject to
federal and state death taxes. The total value of the estate
includes the value of the family business along with other
assets such as homes, cash, stocks, and bonds. At a minimum, an
estate over $650,000 (gradually increased to $1 million by
2006) will be subject to a federal death tax rate of 37% and an
estate over $3 million will be taxed at an astronomical federal
rate of 55%. This tax is on top of not only the state death tax
but also the income, business, and capital gains taxes that
have been paid over an individual's lifetime. It is not
surprising, then, that more than 70% of family businesses do
not succeed to the second generation and 87% do not survive to
the third generation.
The construction industry is capital intensive, requiring
large investments in heavy equipment. One single critical
company asset can cost more than the amount ($650,000) of the
unified credit. For instance, a 150-ton crane used in bridge
construction can cost more than $1 million. A scraper can cost
$700,000 and a large bulldozer can cost more than $800,000.
Most family-owned construction firms invest a significant
portion of their after-tax profits in equipment, facilities and
working capital. This is necessary for these firms to increase
their net worth, create jobs and continue to be bonded for
larger projects. Because of these assets, the construction
industry is especially vulnerable to the devastating effect of
the death tax.
Those family-owned construction companies that do survive
after death taxes have spent thousands, sometimes millions, of
dollars to plan for and pay death taxes. Of AGC firms involved
in estate planning, 63% purchase life insurance, 44% have buy/
sell agreements and 29% provide lifetime gifts of stock.
Last year, Richard Forrestel, a CPA and Treasurer for Cold
Spring Construction in Akron, New York, testified succinctly
before this Committee on what death tax planning has cost his
company:

``We spend in excess of $100,000 a year in insurance costs
and accounting fees to ensure that we have the capital to pay
the death tax and transfer our business from one generation to
the next. We have diverted enormous amounts of capital and
management time to this process. We ought to be buying
bulldozers and backhoes built in Peoria, Illinois rather than
wasting capital on intangible life insurance policies.''

In sum, AGC believes that all the resources spent planning
for and paying the death tax should be used more productively
to grow businesses and create jobs.

CONSTRUCTION JOB LOSSES

The death tax not only affects the business owner, but also
his or her employees. While the death tax rate on a company is
37% to 55%, for the worker who loses a job because of death
taxes the rate is in effect an agonizing 100%! AGC's family-
owned firms employ on average 40 persons and have created on
average 12 new jobs each in the last five years. The death tax,
however, can destroy these jobs because firms are often forced
to sell, downsize or liquidate to pay this onerous tax. On
average, 46 workers lose their jobs every time a family-owned
business closes. And every time an owner foregoes the purchase
of new equipment because resources have been diverted to pay
death taxes, the workers who use and build that equipment are
impacted.
Also, remember the effect these family-owned businesses
have on their immediate community. Family-owned businesses not
only offer jobs, but they are a vital part of every community
providing specialized services, supporting local charities, and
returning earnings back to the local economy.

ECONOMIC EFFECTS of the DEATH TAX

A most frustrating aspect of death taxation is that after
all the countless hours and financial resources spent preparing
for and paying the tax, it raises almost no revenue for the
federal government! Annual death tax receipts total
approximately $23 billion, less than 1.4% of total tax revenue.
Furthermore, the Congressional Joint Economic Committee
released a report last year on the death tax that found that
this tax ``raises very little, if any, net revenue for the
federal government.'' The JEC also concluded that the tax
results in losses under the income tax that are roughly the
same size as the death tax revenue.

LEGISLATION SUPPORTED BY AGC

AGC appreciates the efforts made by Congress in lowering
the death tax as part of the Taxpayer Relief Act of 1997.
However, Congress needs to do much more than simply increase
the unified credit to help the growing number of family-owned
businesses facing the death tax. The construction industry
urges Congress to focus on eliminating death tax rates. As
stated earlier, the construction industry is capital intensive
and even the smallest contractors have lifetime assets that
easily exceed the unified credit amount.
In the House, we strongly support H.R. 8, introduced by
Reps. Jennifer Dunn and John Tanner, that calls for gradual
elimination of the death tax by 5% per year over a period of
ten years. We also support H.R. 86, introduced by Rep. Chris
Cox, that calls for full and immediate repeal of this tax. We
urge you to include legislation eliminating the death tax in
any upcoming tax legislation.

SUMMARY

The death tax has become an American nightmare at the end
of the American dream for family-owned construction companies.
Construction company owners work hard to grow their business.
They create jobs for people in their community. They pay
federal and state taxes throughout the life of their company.
But then, when they die, the federal government steps in and
takes over half of their company. It is unthinkable in a time
of surplus that our government imposes a tax that raises so
little revenue while it devastates businesses and kills jobs.
AGC urges you to pass legislation to eliminate this terrible
tax.
Thank you for the opportunity to present testimony this
morning.

Statement of Certified Financial Planner Board of Standards, Denver,
Colorado

The Certified Financial Planner Board of Standards, Inc. is
submitting this testimony to the United States House of
Representatives Committee on Ways and Means for inclusion in
the written record of the June 16, 1999 hearing before the
Committee on Enhancing Retirement and Health Security.
The Certified Financial Planner Board of Standards, Inc.,
known as the CFP Board, is pleased to provide information
concerning Americans' financial futures for the United States
House of Representatives, Committee on Ways and Means. The CFP
Board is the professional regulatory organization for over
34,000 CFP marks holders or licensees. The CFP Board was formed
in 1985 to benefit the public by fostering professional
standards in personal financial planning.
The CFP Board wants the Committee to be aware of a very
serious problem in this country. Americans are not saving
nearly enough for retirement. They are not investing properly,
most of them do not have any kind of financial plan for their
retirement years, they do not understand the differences
between managing money before and after retirement, and they
are very uncomfortable with making the plans for their
financial futures. So far, the solutions Congress has created
have not addressed the situation.
One can not read a paper or magazine, hear the radio, or
watch the television news without seeing something about the
retirement crisis facing this country. A 1997 Consumer
Federation of American and NationsBank survey found only one in
three savers has a comprehensive retirement plan. In many ways,
it is fair to say financially, this is a nation at risk. Many
Americans are finally starting to realize their future is in
their own hands. In a self-directed, defined contribution plan
world, they need to be able to properly plan for their
financial futures since government sources are not nearly going
to cover all of our expenses in retirement.
The CFP Board's September 1998 testimony before the
Department of Labor's ERISA Advisory Council Working Group on
Small Business provided the results of a 1998 survey of CFP
marks licensees. The survey revealed 67% of CFP licensees'
prospective clients consider their employer's retirement plans
as their primary source for funding retirement goals. However,
CFP licensees report only a quarter of their prospective
clients are contributing the maximum amount to their pension
plans. These figures are even more disturbing when we realize
that those seeking financial planning advice are more aware of
the need for retirement than the general population.
The state of Americans' financial planning is not
surprising. Over the past 20 years, this country has undertaken
a massive transfer of financial responsibility from
professional pension plan managers to everyday workers.
Retirement planning has moved away from the old defined benefit
pension plans that required absolutely no input from
participants, provided a guaranteed monthly income for life and
were managed by highly trained professionals. Now, those plans
are largely a variety of self-directed defined contribution
plans, such as the 401(k), that require participants to manage
their own accounts. Essentially, American workers have become
their own pension plan managers.
The problem is that very few American workers have ever had
any education or training in retirement or financial planning.
Securities and Exchange Commission Chairman Arthur Levitt in an
April 1999 speech stated, ``The plain truth is that we are in
the midst of a financial literacy crisis. Too many people don't
know how to determine saving and investment objectives or their
tolerance for risk. Too many people don't know how to choose an
investment, or an investment professional, or where to turn for
help.''
As an educational resource to the American Institute of
Certified Public Accountant's (AICPA) Retirement Security
through Financial Planning Coalition, the CFP Board strongly
believes the retirement education proposals contained in
section 520 of H.R. 1102 (Portman-Cardin) and Section 503 of S.
741 (Graham-Grassley) will encourage American workers to plan
and save for their financial futures. However, a greater
service could be done for American workers if the provisions
went beyond simply retirement and included financial planning.
Financial planning is the process of meeting life goals
through the proper management of personal finances. Life goals
can include buying a home, funding a child's education, passing
along a family business, or planning for the years after
retirement. Financial planning provides direction and meaning
for financial decisions. It allows one to understand how each
financial decision affects other areas of personal finances.
For example, buying a particular investment product might help
pay off a mortgage faster, or it may delay retirement
significantly. By reviewing each financial decision as part of
a whole, one can consider short and long-term effects on life
goals. One can also adapt more easily to life changes and feel
more secure about reaching life goals.
In their 1997 9th Annual Retirement Planning Survey,
Merrill Lynch, Inc. found people with financial plans feel more
confident about their investment skills and ability to achieve
their financial goals. Those with a written plan prepared by a
professional are most confident. Half of people who have
professionally prepared financial plans and 44% of those with
self-prepared plans are ``very confident'' they will realize
their financial goals. Less than a third of the people with no
plans feel this confident, and 20% are not very or not at all
confident they will realize their goals. People who have
financial plans are significantly more likely to have a written
budget and to put money into savings before paying other
expenses (41% of planners put money in savings first then pay
bills while only 14% of people who have no plans did). These
figures demonstrate the urgent need for Americans to have the
opportunities and incentives to develop plans for their
financial futures.
The CFP Board believes if the proposals contained in
section 520 of H.R. 1102 and Section 503 of S. 741 become law,
the nation will be making an investment in the retirement
security of the American worker. These two proposals are a step
though in achieving retirement security through financial
planning. There are many other steps and reaching them all will
require commitment. As Peter Druker said,

``Unless commitment is made, there are only promises and
hopes... but no plans.''

If Congress wants to help Americans reach their financial
goals and not simply make promises to them and raise their
hopes, it must commit to helping them plan for the future.

Statement of Committee To Preserve Private Employee Ownership

Introduction

This statement is submitted on behalf of the Committee to
Preserve Private Employee Ownership (``CPPEO''), which is a
separately funded and chartered committee of the S Corporation
Association. To date, 34 employers have joined CPPEO and more
than 45,000 employees across the country are represented by
CPPEO companies.
CPPEO welcomes the opportunity to submit a statement to the
Ways and Means Committee for the written record regarding the
goal of enhancing Americans' retirement security. CPPEO wishes
to bring to the Committee's attention the proposal in the
Administration's Fiscal Year 2000 Budget that would subject the
income of S corporation ESOPs to the unrelated business income
tax (``UBIT''). This proposal is inconsistent with the goal of
enhancing Americans' retirement savings and cannot be
reconciled with the Administration's own stated goal of
enhancing retirement savings, as reflected in the 17 revenue
proposals included by the Administration in its Fiscal Year
2000 Budget to promote expanded retirement savings, security,
and portability. The Administration's proposal would
effectively repeal key provisions in the Taxpayer Relief Act of
1997 (the ``1997 Act'') \1\ that allowed S corporations to
create ESOPs in order to promote employee stock ownership and
employee retirement savings for S corporation employees. CPPEO
urges the Committee to reject the Administration's S
corporation ESOP proposal and other proposals which would
inhibit the creation or the viability of S corporation ESOPs,
and continue to allow S corporations to have ESOP shareholders
as contemplated in the 1997 Act. Only by retaining the
fundamental policies of the 1997 Act can the Committee continue
to preserve and promote retirement savings for the hundreds of
thousands of S corporation employees in the United States.
---------------------------------------------------------------------------
\1\ P.L. 105-34.
---------------------------------------------------------------------------

Legislative History of S Corporation ESOPs

In the early 1990s, efforts began to enact legislation that
would allow S corporation employees to enjoy the benefits of
employee stock ownership that were already conferred on C
corporation employees. Finally, in 1996, Congress included a
provision in the Small Business Jobs Protection Act of 1996
(the ``1996 Act,'') \2\ that allowed S corporations to have
ESOP shareholders, effective for taxable years beginning after
December 31, 1997. This provision, which was added just prior
to enactment, established Congress' desire to see S corporation
ESOPs established, but did not result in a viable method to
allow S corporation ESOPs to be created or sustained.
---------------------------------------------------------------------------
\2\ P.L. 104-188.
---------------------------------------------------------------------------
Specifically, a 39.6 percent tax (the unrelated business
income tax of Internal Revenue Code section 511,\3\ or
``UBIT'') was imposed on employees' retirement accounts with
respect to the ESOP's share of the income of the sponsoring S
corporation and any gain realized by the ESOP when it sold the
stock of the sponsoring S corporation. The imposition of UBIT
on S corporation ESOPs meant that the same income was being
taxed twice, once to employees' ESOP accounts and a second time
to the employees' distributions from the ESOP. Accordingly,
owning S corporation stock through an ESOP would subject
employees to double tax on their benefits, while individuals
holding S corporation stock directly would be subject to only a
single level of tax.
---------------------------------------------------------------------------
\3\ All ``section'' references are to the Internal Revenue Code of
1986, as amended.
---------------------------------------------------------------------------
The 1996 Act had another defect that made ESOPs an
impractical choice for providing employee retirement benefits
to S corporation employees--the right of ESOP participants to
demand their distributions in the form of employer securities.
By law, S corporations cannot have more than 75 shareholders
and cannot have IRAs or certain other qualified retirement
plans as shareholders. Therefore, S corporations generally
could not adopt ESOPs without taking the risk that the future
actions of an ESOP participant--such as rolling over his or her
stock into an IRA--could nullify the corporation's election of
S corporation status.
Moreover, the 1996 Act did not provide S corporation ESOPs
with the incentives that are provided to encourage C
corporation ESOPs. For example, under section 1042,
shareholders that sell employer stock to a C corporation ESOP
are allowed to defer the recognition of gain from such sale,
while S corporation shareholders cannot do so. In addition,
under section 404(a)(9), C corporations are allowed to make
additional deductible contributions that are used by an ESOP to
repay the principal and interest on loans incurred by the ESOP
to purchase employer stock, though this is also not permissible
for S corporations. C corporations are also allowed deductions
under section 404(k)--deductions for which S corporations are
ineligible--for dividends paid to an ESOP that are used either
to make distributions to participants or to repay loans
incurred by the ESOP to purchase employer stock. In addition,
as a practical matter, S corporation ESOP participants are
unable to use the ``net unrealized appreciation'' exclusion in
section 402(e)(4) because this benefit applies only to the
distributing of employer stock, which S corporations cannot do.
In the 1997 Act, Congress reaffirmed its policy goal of
making viable ESOPs available to the employees of S
corporations and addressed the problems with the ESOP
provisions in the 1996 Act. Recognizing that S and C
corporations are fundamentally different entities, Congress did
not provide S corporation ESOPs with all the advantages and
incentives provided to C corporation ESOPs (such as the
favorable tax treatment for shareholders selling stock to the
ESOP and increased deductions and contribution limits for the
sponsoring employer discussed above), but it did fix the
critical problems. The double tax on S corporation stock held
by an ESOP was eliminated by exempting income attributable to S
corporation stock held by the ESOP from UBIT. Thus, only one
level of tax was to be imposed, and it would be on the ESOP
participant when he or she received a distribution from the
ESOP. S corporation ESOPs also were given the right to
distribute cash to participants in lieu of S corporation stock
in order to avoid the problems of potentially ineligible S
corporation shareholders and the numerical limit on S
corporation shareholders.
While in 1997 it was clear that a key feature of the
legislation was that S corporation ESOPs would not have the
same incentives afforded to C corporation ESOPs, Congress
provided different, but comparable benefits to S corporation
ESOPs.
First, the income of S corporation ESOPs under the 1997 Act
is subject to only a single level of tax. This is a fundamental
characteristic of the taxation of S corporations and their
shareholders. As Assistant Secretary of Treasury Donald Lubick
commented in testimony to this Committee in March of this year,
no one, including the Administration, disputes that only one
level of tax should be imposed on S corporations and their
shareholders.
The second benefit provided to S corporation ESOPs is that
the one level of tax is deferred until benefits are distributed
to ESOP participants. Considerable thought was given in 1997
relating to whether this deferral tax was appropriate. Various
ways of taxing S corporation ESOPs and their participants were
considered in 1997, including ways essentially the same as the
Administration's proposal, and were rejected by Congress as
being too complex, burdensome, and unworkable. In order to
achieve a workable S corporation ESOP tax regime with
incentives that were roughly commensurate with those available
to C corporation ESOPs, Congress determined that the deferral
of the one level of tax, in lieu of the special incentives
afforded to C corporation ESOPs, was appropriate. The
Administration's proposal and others which have followed simply
reject this determination just 18 months after Congress acted.

The Administration's S Corporation ESOP Proposal Would
Undermine Congressional Retirement Savings Policy

The Administration's S corporation ESOP proposal would
undermine the Congressional policy of allowing S corporations
to establish ESOPs for their employees principally because it
will not only end deferral, but also will reinstate double
taxation. The Administration's proposal to allow a deduction to
the ESOP for distributions to participants would effectively
create double taxation.
S corporation ESOPs would be required to pay UBIT for all
the years that they hold S corporation stock, but would not be
allowed any way to recover those taxes until distributions are
made to participants. The rules limiting the timing of
distributions by an ESOP to its employee participants, like the
rules for all qualified retirement plans, are designed to
encourage long-term retirement savings and are intended to
produce the result that distributions to an employee will occur
many years, even decades, after the employee first becomes a
participant in the ESOP. A 2-year carryback and a 20-year
carryforward of excess deductions, as is suggested by the
Administration's proposal, will not ensure that the taxes paid
by the ESOP over many years, even decades, will be recovered.
Thus, there is no assurance that a future deduction will
prevent double taxation of employee benefits. Moreover, it
would encourage ESOP's to make distributions earlier, rather
than later--a practice that is wholly inconsistent with
Congress' intent to create ESOPs as long-term vehicles for
earnings and retirement security. Most telling though, is that
the estimated revenue to be raised by the Administration's
proposal is the same as the revenue cost of the 1997 Act,
demonstrating that the Administration's proposal is simply an
attempt to repeal the provisions of the 1997 Act and is not
aimed at preventing what it claims are unintended uses of
current law.
The Administration's proposed scheme and other similar
proposals for eliminating tax deferral have another substantial
defect. That is, any tax refunds to the ESOP for the tax
deductions allowed to the ESOP cannot be fairly allocated and
paid to the employee participants. Assume, for the sake of
illustration, that employees A and B are the participants in an
S corporation ESOP, each owning an equal number of shares of S
corporation stock through the ESOP. A and B work for the next
20 years and the ESOP pays tax on the income of the S
corporation attributable to their shares of stock. Then A
decides to retire and the ESOP sells the shares of stock in A's
account to the S corporation and pays A the proceeds. The ESOP
receives a deduction for the distribution to A and is able to
reduce its UBIT liability for the year it makes a distribution
to A. In this example, there would be no way the ESOP could use
the full amount of the deduction for the year it makes a
distribution to A, nor would it be able to fully use the excess
amount when it carries the excess deduction back two years.
Thus, the ESOP would not be able to realize the full benefit of
the deduction, which was intended to allow the ESOP to recoup
the taxes it paid over the past 20 years with respect to the
stock in A's account and, presumably, give A that benefit to
offset the second level of taxes A will pay. By the time the
ESOP realizes all the benefits of the deduction, A will have
long ceased to be a participant in the ESOP and those benefits
will be allocated to the remaining participant, B.
In addition, it is not clear how the ESOP could properly
allocate the benefits that it can immediately realize. The
deduction is allowed for distributions to participants. After
the proceeds from the sale of the stock in A's account are
distributed to A, A ceases to be a participant. The ESOP cannot
make any additional allocations or distributions to A. As the
sole remaining participant, B will receive the benefit of those
deductions.
The Administration's proposal also resurrects a problem
under ERISA that the 1997 Act eliminated. The imposition of
UBIT on S corporation ESOPs raises concerns about fiduciary
obligations under ERISA for potential ESOP plan sponsors and
trustees. The potential for double taxation and the inequitable
allocation of benefits among plan participants will make the
establishment of S corporation ESOPs unpalatable to anyone who
would be subject to ERISA. In addition, qualified plan trustees
typically avoid investments that give rise to UBIT because it
obligates the trustee to file a federal income tax return for
the plan's UBIT liability. Under the Administration's proposal,
the establishment of an S corporation ESOP would necessarily
involve making investments that give rise to UBIT liability
because ESOPs are required to invest primarily in employer
securities. By making S corporation stock an unviable
investment for ESOPs, the Administration's proposal and others
like it would prevail against the establishment of many of
these retirement savings programs. This clearly contradicts
Congress' intent.
The Administration's proposal and others attempt to
characterize the treatment of S corporation ESOPs as a
corporate tax shelter. These proposals, however, fail to note
that the beneficiaries of S corporation ESOPs are the
employees, not the S corporation. Moreover, in testimony before
this Committee, Assistant Secretary Lubick made it clear that
the Administration's only concern is that there may be attempts
by some persons to use the S corporation ESOP provisions as a
device to gain tax deferral rather than to provide retirement
savings benefits to employees. Current law was enacted to do
just what it is doing--encouraging employee ownership of S
corporations. Indeed, advocating the repeal of a successful
retirement program--just 18 months after its enactment directly
contradicts the Administration's stated objective of increasing
retirement savings, as reflected in the 17 retirement savings
proposals included in its Fiscal Year 2000 budget.

CPPEO's S Corporation ESOP Anti-Abuse Proposal

CPPEO and other organizations have, in response to a
request from Ways and Means Committee staff, developed an anti-
abuse rule that addresses the issue of potential misuses of S
corporation ESOPs while preserving the ability of S corporation
employees to be owners of their companies through ESOPs and
accrue long-term retirement savings. The joint proposal is
narrowly targeted to penalize only the persons who might
otherwise misuse the ESOP for their own advantage, or the
advantage of members of their families, rather than for the
benefit of S corporation employees. To this end, CPPEO proposes
that such an anti-abuse rule apply to persons who control an S
corporation which has misused its ESOP and who are consequently
responsible for the misuse of the ESOP to defer tax on their
income from the S corporation.\4\ Accordingly, persons who
individually benefit from the deferral of a substantial portion
of the S corporation's income and who collectively have control
of the S corporation would be denied the retirement benefits of
an S corporation ESOP. The penalty for such persons' misuse of
an S corporation ESOP to gain deferral of tax on S corporation
income would be the loss of tax deferral for such persons and
not the disqualification of or tax on, the ESOP.
Disqualification of, or tax on, the ESOP would unfairly harm
the retirement savings of non-controlling S corporation
employees, the intended beneficiaries of the S corporation ESOP
provisions, whose interests in the ESOP reflect the allocation
of retirement benefits in accordance with the requirements that
apply to qualified retirement plans.
---------------------------------------------------------------------------
\4\ To implement this approach, CPPEO urges that Congress enact an
amendment to section 1361 to provide that controlling 20-percent
employee-owners would be taxed currently on S corporation income
attributable to S corporation stock held by them through the ESOP, and
on S corporation income attributable to their holdings of ``synthetic
equity'' (such as options, restricted shares, stock appreciation
rights, or similar instruments) in the S corporation. In this manner,
the benefit of tax deferral on S corporation income attributable to the
use of an ESOP would be denied to the controlling shareholders who
improperly employ the ESOP (alone or in combination with synthetic
equity) to gain such tax deferral for themselves or their families, but
would not be denied to non-controlling employees who participate in the
ESOP.
---------------------------------------------------------------------------
The anti-abuse provision described above preserves the use
of S corporation ESOPs to provide retirement benefits to S
corporation employees as Congress intended, and explicitly
prevents the misuse of S corporation ESOPs by those persons
who, through their control of the S corporation, might
otherwise seek to use an ESOP simply to defer tax on the S
corporation income of themselves and their families rather than
provide retirement savings benefits to their S corporation
employees.

Conclusion

Current law is working to encourage employee ownership of S
corporations and promote employee retirement savings, exactly
as it was intended to work when Congress amended the ESOP rules
for S corporations in the 1997 Act. Accordingly, CPPEO urges
the Committee to reject the Administration's S corporation ESOP
tax proposal because of the great danger it poses to the
retirement security of S corporation owners who do or can now
rely on ESOPs as a major (or only) source of retirement
savings. The tax and retirement policies reflected in the 1997
Act, resolved just a few months ago, should not now be undone.
The targeted anti-abuse legislation supported by CPPEO is the
appropriate response to any concerns that S corporation ESOPs
could be used for unintended purposes.

Statement of J. Michael Keeling, President, ESOP Association

Chair Archer, ranking member Rangel, and members of the
Committee, I am Michael Keeling, President of The ESOP
Association, a national trade association based in Washington,
D.C., with over 2,100 members nationwide, two-thirds of which
are corporate sponsors of Employee Stock Ownership Plans, or
ESOPs, and other members are either providing services to ESOP
company sponsors, considering installing an ESOP, or affiliated
with an educational, or non-profit institution.
We come today because the press release announcement for
today's hearings set forth that the subject matter for review
is ``Enhancing Retirement and Health Security.''
I come with this statement to you on behalf of The ESOP
Association to urge the Committee, at its very first
opportunity, which will hopefully be during your consideration
of a 1999 tax relief bill pursuant to the Congressional FY 2000
budget resolution, to adopt an expansion of the current law
pertaining to the deduction of dividends paid on ESOP stock.
Before describing what the change is that we want, and why
it is good retirement savings, and good employee ownership
policy, permit me to indicate to you the widespread support for
the proposal among members of this Committee, members of the
House, members of the Senate, and private sector employers and
groups that represent those employers.
To note, the proposal we urge you to adopt is Section 510
of H.R. 1102, ``The Comprehensive Retirement Security and
Pension Reform Act of 1999,'' introduced primarily by
Congressmen Portman, and Cardin of your Committee. Although
their list of co-sponsors grows daily, the latest from the
world wide web indicates 23 members of Ways and Means are
sponsors, along with 81 members of the House. Just last
Thursday, June 10th, your colleague and senior member of the
House Committee on Education and the Workforce, Cass Ballenger
introduced H.R. 2124, ``The ESOP Promotion Act of 1999,'' and
Section 2 is the same as Section 510. Your colleagues
Congresswomen Nancy Johnson and Karen Thurman, and Congressmen
Levin and Ramstad joined as original co-sponsors of Mr.
Ballenger's pro-ESOP bill. (The provision we are discussing
will be referred to as Section 510, as a shorthand reference.)
Section 510 is included in Senate bills S.1132, ``The ESOP
Dividend Reinvestment and Participant Security Act,'' by
Senators Breaux and Hatch, and S. 741, ``The Pension Coverage
and Portability Act,'' primarily by Senators Grassley and
Graham of Florida. Both have attracted bi-partisan Senate
support.
But the proposal contained in Section 510 did not crop up
at the last minute for inclusion in these bills promoting
either retirement savings or employee ownership--this proposal
was born in 1997, with the introduction by Breaux and Hatch of
the 1997 ESOP Promotion Act, and was duplicated by Congressman
Ballenger in H.R. 1592, which had 8 members of Ways and Means
as co-sponsors. These two ESOP promotion bills, introduced in
the second quarter of 1997, soon had their provision on
dividend reinvestment included in the 1998 version of the
Portman-Cardin, and Grassley-Gramm.
The history gets even better Chair Archer, because the
Oversight Subcommittee of Ways and Means focused on this
provision at its May 5, 1998, hearings, when Mrs Johnson was
chair of the Subcommittee, as it reviewed our pension laws, and
how to make them more palatable to increasing retirement
savings.
At that hearing, members of the Subcommittee heard
testimony from the private sector, from Mr. Ballenger, and from
trade groups endorsing the expansion of the deduction for
dividends paid on ESOP stock.
In fact, on October 20, 1998, then Chair of the Oversight
Congresswoman Johnson wrote to you an interim report from the
Subcommittee based on its series of hearings and said, among
other things, as an interim recommendation that ``The rules
applicable to the deductibility of the dividends which an
employer pays with respect to ESOP stock should be addressed
and an expansion of the ESOP option should be explored.''
Now, the next few weeks before your final decision on the
provisions of the 1999 tax relief bill for provisions to
enhance retirement savings is the time to make last year's
interim recommendation a permanent pro-savings, pro-employee
ownership recommendation.
Now you should explore the questions, ``What is Section 510
and how will enactment of section 510, as so many have
recommended enhance retirement savings?''
The ESOP Association strongly believes that the answer to
these questions will persuade this Committee to adopt Section
510 as part of a 1999 tax relief bill.
So, let us answer the questions set forth above:
What is Section 510? To answer the question, we first have
to understand current law pertaining to dividends paid on stock
in an ESOP. (Note, an ESOP is a tax-qualified defined
contribution plan that must be primarily invested in employer
securities that may borrow money to acquire employer
securities. In other words, it is an ERISA plan that is akin to
a tax-qualified profit sharing plan. An ESOP must comply with
all the laws, regulations, and regulatory guidance pertaining
to ERISA plans, plus many unique, Congressionally sanctioned
incentives and restrictions to ensure ESOPs are both
``ownership'' plans, and secure ``ERISA'' plans.)
Internal Revenue Code Section 404(k) provides that
dividends paid on ESOP stock are tax deductible if they are
passed through in cash to the employee participants in the
ESOP, or if they are used to pay the debt incurred by the ESOP
in acquiring its employer securities, and the employees receive
stock equal in value to the dividends. This section of the Code
was added to the tax code in 1984, and modified in 1986, and in
1989.
Section 510 provides that if a sponsor of an ESOP pays
dividends on ESOP stock that may be passed through the ESOP in
cash to the employee, and the employee in turn has indicated
that he or she would like the dividends ``reinvested'' in the
sponsor's dividend reinvestment program, the sponsor can still
take the Section 404(k) deduction.
Now, to the second question asked above--Why would Mr.
Portman, Mr. Cardin, Mr. Ballenger, Mrs. Johnson, et al want to
have this proposal considered? Well the reason is simple, but
typical of most of our tax law, we have to be careful to make
the simple explanation understandable.
The IRS has taken the position that when the employee
voluntarily authorizes his or her dividends on his or her ESOP
stock to be reinvested in the ESOP sponsor's dividend
reinvestment program, the value of the dividends is not tax
deductible for the ESOP sponsor.
Let me repeat what I just said--if the employee wants to
reinvest his or her dividends on ESOP stock in more stock to be
held in the ESOP or a co-ordinated 401(k) plan in order to have
more savings, the IRS says, ``No tax deduction.'' Think about
it, the IRS is saying, ``spend the money now, do not save it
for the future,'' or at least that is the impact of the
position.
But the situation in the real world gets even worse in the
view of ESOP advocates, as there is a way for the plan sponsor
to keep its tax deduction and for the employee to save more by
keeping his or her dividends in a 401(k) plan. But this way is
convoluted to a great extent, requiring the creation of some
legal fictions that serve no purpose except to make life more
complex and expensive for the sponsor of the ESOP and 401(k)
plan.
Again, here is the explanation. There is a technique that
the IRS has blessed in several letter rulings back in 1993 and
1994 that is called the 401(k) switchback. Getting a switchback
program set up involves quite a bit of rigmarole, and I am not
going to pretend that what follows is a perfect explanation of
the technique.
In brief, under a suitable program, an ESOP participant is
allowed to make an additional pre-tax deferral to the 401(k)
plan equal to the amount of the ESOP dividends passed through
to her or him. The plan sponsor then pays the ESOP dividends to
the company payroll office, and there is a chain of paper that
has established an agency relationship between the ESOP
participant and the payroll office. (This is done by signing
forms, etc. etc.)
If the ESOP participant elects the additional 401(k)
deferral equal to her or his ESOP dividends, his or her
paycheck would reflect the ESOP dividend amount and the
additional pre-tax deferral to her or his 401(k) account. The
paycheck has gone neither up or down for his or her personal
tax situation.
Now an employee can elect not to make an additional 401(k)
deferral, and thus have his or her dividend paid, and have
personal tax liability on the amount.
As noted the IRS has held that the plan sponsor does not
lose the ESOP dividend deduction in a switchback scheme as
broadly outlined above if the dividends are first paid to the
payroll office, and the employee has entered into a written
agency agreement with the payroll office.
One expert in designing these 401(k) Switchback programs
writes,

``Because the dividend pass-through/401(k) switchback feature
involves a considerable amount of work to implement with regard
to treasury and payroll procedures (including software
programming changes), the company will want to carefully assess
the anticipated value of the program both in terms of the
expected dividend deduction and enhanced employee ownership
values.'' Duncan E. Harwood, Arthur Anderson Consulting, LLP,
``Dividend Pass-Through: Providing Flexibility,'' Proceedings
Book, The 1995 Two Day ESOP Deal, Las Vegas, Nevada, page 158,
The ESOP Association.

In short, Section 510 is to simplify encouraging people to
save their dividends paid on ESOP stock in a manner that
encourages the corporation to pay dividends in an employee
owner arrangement, compared to accomplishing the same thing in
a convoluted way.
Now, lets turn to the third question set forth at the
beginning of this statement. Please remember the answer to this
question would go a long way in determining whether the
Congress will want to make Section 510 law.
The answer to this question should be self-evident. The
current IRS position is anti-savings and anti-simple. To
encourage saving the dividends on ESOPs in a tax-qualified
ERSIA plan in a manner that is simple and easy to understand,
Section 510 should become law.
Otherwise, we can all accept the IRS position that in order
to encourage the savings of the ESOP dividends the plan sponsor
should engage in some mumbo-jumbo involving the payroll office
being an agent for employees who just happen to figure out how
to increase their 401(k) elective deferrals and who tell their
``agent'' to put their dividends in the 401(k) plan.
In conclusion Chair Archer, the ESOP and employee ownership
community, in allegiance of sponsors of 401(k) plans and
dividend reinvestment plans, believe that your focus on
enhancing retirement savings will lead you and your colleagues
to conclude that Congress should enact Section 510.
And, let me pledge that the ESOP community will work with
you, your colleagues, Committee staff, the staff of the Joint
Tax Committee, and Treasury staff, to ensure that any
legislative action on Section 510 meets its intent to be a fair
and reasonable provision of law, both in terms of application
and revenue impact, that promotes savings, and employee
ownership.
Again, I thank you for your leadership in the area of
retirement savings.

Statement of ESOP Coalition, Somerset, New Jersey

This written statement is submitted on behalf of the ESOP
Coalition, an informal organization of more than 30 large and
small corporations doing business in the communications,
banking, oil and gas, utilities, manufacturing, automobile,
retail, and insurance industries. Our work is also supported by
many trade associations, including the Association of Private
Pension and Welfare Plans (APPWP); the ERISA Industry Committee
(ERIC); the ESOP Association; the Financial Executives
Institute (FEI); the National Association of Manufacturers
(NAM); and the U.S. Chamber of Commerce.
The ESOP Coalition commends the Committee and its Chair for
their proactive role in addressing the vital issues now facing
this country in securing important retirement protections for
our workers and retirees. With record numbers of workers on the
verge of retirement, and many young people entering the
workforce and commencing participation in their employer's
retirement programs for the first time, it is more important
than ever before that our nation's employees understand their
own roles and responsibilities in saving for the years when
they no longer will be working and that our laws and policies
encourage this discipline where possible.
One proposal currently before this Congress would
accomplish the worthwhile goal of enhancing retirement security
while at the same time strengthening the very backbone of the
American economy: a worker's commitment to his or her employer.
This provision would further these diverse goals by allowing
employees to retain in the plan dividends paid on employer
stock held in an employee stock ownership plan (an ``ESOP'')
without causing the employer to lose the deduction for these
ESOP dividends.
Current law affirms the importance of fostering employee
ownership in the company by permitting an employer to deduct
the dividends paid on employer stock held in an ESOP. This
deduction is given (under Sec. 404(k) of the Internal Revenue
Code), however, only if the dividends are used to pay off the
loan held by a leveraged ESOP or the dividends are paid in cash
to the ESOP participants. No deduction is generally available
for dividends that the employee would wish to retain in the
ESOP rather than consume immediately. Although one Internal
Revenue Service ``solution'' exists whereby some workers are
able to reinvest some dividends in a 401(k)/ESOP, this approach
is neither practical nor efficient and often is not available
to all participants in the ESOP. In addition, many employees
receive no benefit from this approach because the reinvested
dividends offset the elective deferrals they might otherwise
make to their 401(k) plan rather than being treated--like all
other dividends and interest--as earnings under the plan.
Thus, current law not only discourages the reinvestment of
ESOP dividends, it also deprives employees of an efficient
means of steadily accumulating an ever-growing ownership
interest in the employer and greater retirement income. A
simple change to Sec. 404(k) of the Code would correct this
anomaly by giving employees the additional choice of retaining
their dividends in the ESOP instead of receiving the dividends
in cash.
Many in Congress have recognized the desirability of
amending Sec. 404(k) of the Code to encourage the retention of
dividends in an ESOP. In particular, we applaud Rep. Rob
Portman (R-OH) and Rep. Benjamin Cardin (D-MD) and many other
Members for supporting this provision in H.R. 1102, ``The
Comprehensive Retirement Security and Pension Reform Act of
1999,'' as well as Rep. Cass Ballenger (R-NC) for introducing
the ``ESOP Promotion Act of 1999,'' which also contains this
change. This provision also has been included in comparable
bipartisan pension reform bills in the U.S. Senate.
Employees today appreciate that their retirement years will
be vastly more comfortable if they systematically set aside the
money that will sustain them during their post-working years
and not allow the dissipation of any of their hard-earned
savings through periodic dividend pay-outs. Promotion of the
reinvestment of ESOP dividends is sound tax policy--not only
because it stems the ``leakage'' of retirement savings, but
also because it furthers one of the primary purposes of an
ESOP, encouraging employees to participate more fully in their
employer's growth. Thus, this provision fosters employee
responsibility and productivity while simultaneously building
retirement security.\1\
---------------------------------------------------------------------------
\1\ For a discussion of the evidence supporting the finding that
employee ownership improves the performance of publicly traded
corporations, see ``Unleashing the Power of Employee Ownership,'' a
July 1998 Research Report by Hewitt Associates LLC.
---------------------------------------------------------------------------
The ESOP Coalition commends the Committee and its Chair for
their important work in addressing the issues of retirement
security and urges that this provision to encourage the
reinvestment of ESOP dividends be accorded a top priority in
Congressional efforts to secure comprehensive pension reform.

Statement of Financial Planning Coalition

This Statement is being submitted to the Ways and Means
Committee of the United States House of Representatives by the
Financial Planning Coalition for inclusion in the written
record of the June 16, 1999, hearing before the Committee on
Enhancing Retirement and Health Security. The members of the
Financial Planning Coalition are the American Institute of
Certified Public Accountants, the Consumer Federation of
America, the Institute of Certified Financial Planners, the
International Association for Financial Planning, the
Investment Counsel Association of America, and the Society of
Financial Service Professionals. The Certified Financial
Planner Board of Standards, Inc. is an educational consultant
to the Coalition.\1\
---------------------------------------------------------------------------
\1\ The American Institute of Certified Public Accountants is the
national professional association of CPAs in the United States with
more than 330,000 members in public practice, business and industry,
government and education.
The Consumer Federation of America is a non-profit association of
some 260 pro-consumer groups. It was founded in 1968 to advance the
consumer interest through advocacy and education.
The Institute of Certified Financial Planners is a professional
membership association that exclusively serves Certified Financial
Planner licensees.
The International Association for Financial Planning is the largest
and oldest membership association representing the financial planning
community, with 123 companies as members of the Broker-Dealer Division
and over 17,000 individual members nationwide.
The Investment Counsel Association of America is a national not-
for-profit association that exclusively represents SEC-registered
investment advisors.
The Society of Financial Service Professionals was formerly known
as the American Society of CLU & ChFC. Founded in 1928, it is composed
of 32,000 members who are dedicated to serving the financial needs of
individuals, families, and businesses.
The Certified Financial Planner Board of Standards, Inc. is a non-
profit professional regulatory agency that was founded in 1985. It owns
and sets the standards for using the CFP certification mark and the
marks CFP and Certified Financial Planner.
---------------------------------------------------------------------------

BACKGROUND

The convergence of the growing complexity in the financial
marketplace, and the shifting of a significant portion of
financial and investment decision making from professionals to
the American public has created a significant need for
financial planning services to be more easily accessible.
Financial planning services must include both education and
individual professional assistance to help lead individuals
through the financial marketplace. The use of education and
financial planning assistance will help Americans to
effectively manage their finances in ways that allow them to
provide for their families today and have a secure and
comfortable retirement.

THE CHANGING MARKETPLACE

The financial world that Americans are living in has become
increasingly complex. Because of dramatic changes in the way
pensions are funded, as well as a growing reliance on personal
savings to fund retirement and other major life goals,
individuals increasingly make retirement and financial planning
decisions that were once made for them by professionals. Even
for those who are financially sophisticated, the determination
of how much money must be saved for each individual's varied
future needs, especially for retirement, and how that money
should be invested is difficult. For those who are not
financially sophisticated, the complexity of the decisions that
must be made and the myriad choices that are available make
these decisions truly daunting.
Perhaps the most important change is the sea change in the
type of retirement plans of the American worker in the last 20
years. In 1975, sixty eight percent of pension plans were
defined benefit plans.\1\ These plans defined the amount of the
benefit the worker would receive upon retirement very simply--
the worker would get a check for a specific amount every month
for the rest of his/her life. The worker did not have to make
any decisions regarding the amount of money that must be saved
for retirement or how to invest the money.
---------------------------------------------------------------------------
\1\ Employee Benefit Research Institute Databook on Employee
Benefits, 4th Edition.
---------------------------------------------------------------------------
By 1994, fifty percent of pension payments were made from
defined contribution plans.\2\ These plans generally require
the worker to determine how much to save for retirement and how
to invest the money. Cash balance plans are also becoming very
popular. They give the employee the flexibility of having a
portable pension--one that goes with the worker when there is a
change in employers--but they also often require the worker to
make investment decisions when there is a change in employers.
---------------------------------------------------------------------------
\2\ Id.
---------------------------------------------------------------------------
Also, workers today change jobs much more often than in
previous years, either due to greater opportunities existing in
a tight labor market, or due to layoffs accompanying
consolidation and downsizing. Changing jobs potentially dilutes
a worker's retirement benefits because the worker leaves a
position before benefits have vested and/or because some
pension provisions disfavor leaving early in a career (e.g. the
pension benefit is calculated as a percentage of an employee's
top three years of salary).
Another factor has added to the complexity of managing
investments and retirement funds. The number and type of
investment options has skyrocketed in the last 20 years. Not
only have whole new classes of investments been made available,
such as Roth IRAs and the complex world of derivatives, but
within each type of investment the number of choices has
increased exponentially. For example, in 1983, just 15 years
ago, there were 1,026 mutual funds to choose from. In 1998,
there were 7,314.\3\
---------------------------------------------------------------------------
\3\ 1999 Mutual Fund Fact Book, 39th Ed., pub. By the Investment
Company Institute.
---------------------------------------------------------------------------
Because of these changes, the ability of each American to
retire in comfort increasingly depends on his or her
proficiency in making sound investment decisions. And sound
investment decisions encompass how much to save for various
needs and how to invest the money that is saved. Even for the
relatively sophisticated, making the mathematical calculation
to determine how much we need to save in order to have a
specific income at retirement is not an easy calculation.
Seventy-five percent of American workers do not know how much
money they will need to reach their retirement goals.\4\
---------------------------------------------------------------------------
\4\ Yakoboski and Dickemper, Increased Saving but Little Planning:
Results of 1997 Retirement Confidence Survey, Employee Benefit Research
Institute Brief (Nov. 1997).
---------------------------------------------------------------------------
Yet there is a crisis in savings at the very time that
savings is becoming crucial to the long term well being of the
American public.\5\ The personal savings rate in this country
has fallen to a minus 0.7%.\6\ In a 1998 survey taken by the
Employee Benefit Research Institute, thirty six percent of
those surveyed had no money saved for retirement (a summary of
the survey is attached).\7\ These statistics underscore the
need to educate Americans about the need for retirement
planning.
---------------------------------------------------------------------------
\5\ The SAVER Act (P.L. 105-92 (1997)) (passed unanimously by
Congress) noted that we have a crisis of savings in this country.
\6\ Advisory from the Committee on Ways and Means of the United
States House of Representatives, No. FC-10, June 2, 1999.
\7\ 1998 Retirement Confidence Survey by the Employee Benefit
Research Institute.
---------------------------------------------------------------------------

EFFECT OF FINANCIAL PLANNING

We believe that the cornerstone of retirement income
security is proper financial planning and education (attached
is a copy of a letter sent to all Members of the Ways and Means
Committee by the Coalition). This was a finding of the 1998
National Summit on Retirement Savings that was held in
Washington, D.C. The consensus of the delegates attending the
Summit was that the overall solution to the savings crisis is
education, provided from qualified sources, and made available
to current workers and retirees over an extended period of
time. This Summit was mandated by the SAVERS Act and co-hosted
by the Administration and Congressional leadership. A 1997
survey by the Consumer Federation of America and NationsBank
(now Bank of America) confirms this finding (a copy of the
survey is attached). The survey found that savers with
financial plans report twice as much savings and investment as
do savers with comparable incomes, but without plans.

THE COMPREHENSIVE RETIREMENT SECURITY AND PENSION REFORM ACT--H.R. 1102

The Comprehensive Retirement Security and Pension Reform
Act was introduced this year by Congressmen Rob Portman (R-OH)
and Benjamin Cardin (D-MD) and had a total of 98 co-sponsors on
June 28, 1999. Section 520 of the bill contains an important
first step in making financial planning available to American
workers.
Section 520 of this bill does two things. First, it
clarifies that the provision of retirement planning services by
an employer to employees is a de minimis fringe benefit under
Section 132 of the Internal Revenue Code. This is a
clarification of existing law. It is clear under current law
that it is a de minimis fringe benefit when an employer
provides a seminar to a group of employees to provide
information about the employer's pension plan. However, it
begins to fall into a gray area when the employer adds the
availability of a one-on-one meeting for an employee to discuss
his/her personal situation, especially when the discussion goes
beyond the application of the employer's pension plan and
encompasses other aspects of the employee's financial
situation.
It is critical that this area be clarified. Retirement
planning cannot be done in a vacuum. One of the key questions
to be answered is how much money can and should be saved for
retirement purposes. Included in this determination must be the
consideration of what other assets may be available at
retirement, including from sources such as Social Security and
a spouse's pension. But that is only the first step. The
individual must also determine how much money is currently
available to save for retirement. And this can only be
determined by looking at the employee's entire financial
situation, determining what other needs exist and how much
money can and should be allocated for those needs. Examples of
some other critical financial needs that must be factored into
this calculation are education savings for children and
provision to help care for elderly parents.
The second part of Section 520 would allow the employer to
create an employee benefit plan for its employees regarding
retirement planning that is similar to a ``cafeteria plan.''
This would allow the employer to offer retirement planning or,
in lieu of the planning, additional salary. If the retirement
planning service is chosen, there would be no income imputed to
the employee by reason of taking the service instead of the
salary.
These retirement planning benefits would have to be offered
on a non-discriminatory basis. This would ensure that the rank
and file employee, not just the highly compensated employee,
would have access to the benefit.
Enactment of Section 520 will provide a concrete first step
to help Americans achieve retirement security. This is a first
step because it will only reach a limited number of people. Not
all employers will offer these benefits to their employees.
Large employers will be more likely to offer such benefits than
will small employers. And self-employed individuals,
independent contractors, and part time employees who do not
receive a full range of benefits will not receive these or
other retirement planning services.

CONCLUSION

Financial planning and education has become a critical
element of every American's ability to live and retire in
comfort. Not only do people save more, but they save smarter
when they have the proper education and tools. Unfortunately,
the provision of education and financial planning tools is
trailing the changes in the marketplace that are making them
necessary.
Section 520 of H.R. 1102 is a good starting point in the
move to make financial planning services and education
available to all Americans. If Section 520 is enacted, a
substantial number of Americans will have access to financial
planning services that were previously unavailable. And the
provision of these retirement planning and education services
will prove their worth when they cause a substantial number of
workers begin to save for retirement that have not done so yet,
and cause workers who are saving for retirement to save more
and to invest it more wisely. Section 520 offers a foundation
upon which other efforts to increase American's access to
financial planning services can be built.

May 24, 1999

The Honorable Bill Archer
U.S. House of Representatives
Longworth House Office Bldg.
Washington, DC 20515-0001

Re: RETIREMENT PLANNING IS CRITICAL TO ENSURE THE FUTURE SECURITY OF
THE AMERICAN WORKER

Dear Representative Archer:

We are writing to ask you to support legislative endeavors which
would make retirement planning more available to the American
workforce. A proposal contained in both H.R. 1102 and S.741 would make
it clear that the value of employer provided retirement planning
assistance is not a taxable fringe benefit to an employee.\1\
---------------------------------------------------------------------------
\1\ Sec. 520 and Sec. 503 respectively of H.R. 1102, the
Comprehensive Retirement security and pension Reform Act (the Portman-
Cardin bill) and S. 741, Pension Coverage and Portability Act (the
Grassley-Graham bill).
---------------------------------------------------------------------------
The ability of each American to retire in comfort increasingly
depends on his or her proficiency in making sound investment decisions.
This means that the cornerstone of retirement income security is proper
financial planning and education.\2\ Recent surveys and studies have
underscored the critical need for retirement planning education among
today's workers.
---------------------------------------------------------------------------
\2\ The SAVER Act (P.L. 105-92 (1997)) (passed unanimously by both
houses of Congress) noted that we have a crisis of savings in this
country. A summit was mandated by this law to establish recommendations
to encourage savings. One of the main findings of the 1998 National
Summit on Retirement Savings (co-hosted by the Administration and
Congressional leadership) was that employers must be urged to ``educate
employees about the importance of retirement savings.''
---------------------------------------------------------------------------
Only one in three savers has a comprehensive retirement plan.\3\
---------------------------------------------------------------------------
\3\ 1997 Survey of Consumer Federation of America and NationsBank
(now Bank of America).
---------------------------------------------------------------------------
75% of America's workers do not know how much they will need to
reach their retirement goals.\4\
---------------------------------------------------------------------------
\4\ Yakoboski and Dickemper, Increased Saving but Little Planning:
Results of 1997 Retirement Confidence Survey, Employee Benefit Research
Institute Brief (Nov. 1997). (hereinafter cited as the Yakoboski
study).
---------------------------------------------------------------------------
36% of those surveyed have no money saved for retirement.\5\
---------------------------------------------------------------------------
\5\ 1998 Retirement Confidence Survey by the Employee Benefit
Research Institute. (Hereinafter cited as the Retirement Confidence
Survey).
---------------------------------------------------------------------------
Of all workers, only 39% received employer provided educational
material about retirement planning.\6\
---------------------------------------------------------------------------
\6\ Retirement Confidence Survey.
---------------------------------------------------------------------------
Evidence also exists that retirement education is a key element in
ensuring retirement security for workers:
Savers with financial plans report twice as much savings and
investments as do savers without plans.\7\
---------------------------------------------------------------------------
\7\ 1997 Survey by Consumer Federation of America.
---------------------------------------------------------------------------
81% of workers who received retirement education have money
earmarked for retirement in an account.\8\
---------------------------------------------------------------------------
\8\ Retirement Confidence Survey.
---------------------------------------------------------------------------
These findings are both alarming and encouraging. It means that
many of today's workers will reach and are reaching retirement age with
too little income for retirement. These findings also provide hope. The
studies show that those individuals that receive retirement education
significantly increase their savings and investments. If we are to
encourage national savings, we must encourage education to empower each
American to make the most of his or her investment choices. Retirement
planning services provided by employers to their employees must be
encouraged and promoted but--should not be taxed!

Sincerely,
The American Institute of Certified
Public Accountants
Certified Financial Planner Board of
Standards, Inc. (as an education
consultant to the AICPA)
Consumer Federation of America
Institute of Certified Financial
Planners
Investment Company Institute
Investment Counsel Association of
America
Securities Industry Association

May 24, 1999
The Honorable Xavier Becerra
U.S. House of Representatives
Longworth House Office Bldg.
Washington, DC 20515-0001

Dear Representative Becerra:

Re: RETIREMENT PLANNING IS CRITICAL TO ENSURE THE FUTURE SECURITY OF
THE AMERICAN WORKER

[Additional attachments are being retained in the Committee
files.]

Statement of Food Marketing Institute

Thank you, Chairman Archer, for holding a hearing on
proposals to reduce the tax burden on personal savings. We
particularly wish to focus on the effect of the estate tax on
family-owned businesses. The Food Marketing Institute (FMI)--
Your Neighborhood Supermarkets is pleased to submit testimony
today because elimination of the estate and gift tax is our top
legislative tax priority for the 106th Congress. About 1,000 of
our members are family-owned supermarket companies. In fact,
half of our members are one-store operators. Most of their
money is tied up in assets-costly stores, refrigeration systems
and thousands upon thousands of products. The burden of
planning for and paying estate taxes is a critical issue for
their companies.
The bricks and mortar to build a supermarket can cost $3
million alone, so most grocery store owners, even the smallest
have personal assets taxed at the top marginal rate of 55%.
This tax kills family businesses and affects local jobs. We
also have less than 20 minority-owned grocers, most first-
generation business owners-the first in their families to
accumulate capital--who wonder if their children will be able
to succeed them and participate in the great American economy.
Our members are your constituents. Their customers, who visit
supermarkets on an average of 2.2 times a week, depend on them
not only for food shopping convenience, but also for local
support in charity and community events. They are also
significant employers in their local operating areas.
A small food retailer with one to three stores may have
assets worth about $20 million. Rounding figures a bit, that
creates an estate tax bill of about $10 million. With yearly
profits of a penny on the dollar--the industry average--the
owner has very little cash on hand. While some FMI members buy
life insurance just to prepare for paying the tax, many cannot
afford the premiums necessary to protect all of their assets.
The Food Marketing Institute (FMI) is a nonprofit
association conducting programs in research, education,
industry relations and public affairs on behalf of its 1,500
members including their subsidiaries--food retailers and
wholesalers and their customers in the United States and around
the world. FMI's domestic member companies operate
approximately 21,000 retail food stores with a combined annual
sales volume of $225 billion--more than half of all grocery
store sales in the United States. FMI's retail membership is
composed of large multi-store chains, small regional firms and
independent supermarkets. Its international membership includes
200 members from 60 countries.
FMI's President and CEO Tim Hammonds is the co-chairman of
a unique coalition that was announced yesterday--Americans
Against Unfair Family Taxation. What makes us unique is that we
represent family-owned businesses throughout the United States.
The coalition will give this issue a much higher profile
through a national television and print advertising initiative
and a series of local town meetings designed to inform the
American people. National research already conducted shows that
Americans believe a top 55% tax rate is too high and simply
unfair.

Effect of the Estate Tax when a Supermarket Owner Dies

Supermarket succession, the passing of years of hard work
on to the next generation is a top concern of family-owned
supermarket retailers and wholesalers. Succession planning is
long and difficult. Owners are forced to answer difficult
questions about the future of a company they have worked their
entire lives to create and grow. The transfer of ownership and
the family dynamics are central questions in the decision to
plan for the future of the business. The shocking reality is
when the owner realizes that from 37% up to 55% of his or her
company can be lost to estate and gift taxes. When the owner of
a supermarket dies, the individual's estate is subject to
federal and state death taxes. The tax not only covers the life
savings of the one who passed away, abut also the home, land,
pensions, life insurance, stocks and bonds, annuities, IRAs,
401K plans and the business assets, as well as anything else
that has any economic value. The deceased has already paid
income tax on that money. In addition to income taxes, they
have paid and collected payroll taxes and employment taxes;
many have paid capital gains taxes as well.
Food retailers and wholesalers run capital intensive
businesses, requiring large investments in land, stores or
shopping centers, refrigeration, point-of-sale equipment, large
inventories of products, lighting, transportation, such as
fleets of trucks, etc. One single asset of a company can be
more than the amount of the $650,000 exemption or threshold for
the unified credit. Owners of most family owned grocery stores
plow their after-tax profits back into their stores in
equipment, new consumer services, associates/jobs, remodeling
and new store development. As mentioned earlier, the average
profit of our industry is one penny on the dollar after taxes,
so you can see why the supermarket industry is particularly
vulnerable to the devastating effects of this tax.
Family-owned supermarkets that do survive after the
principal owner's death have already spent thousands, and even
more than $3 to $5 million, according to industry members
surveyed, to simply plan for the eventuality of estate taxes.
Most grocery stores involved in planning purchase life
insurance, have buy/sell agreements or provide lifetime gifts
of stock. FMI strongly believes that the resources spent
planning for and paying the death tax could be used more
productively to grow supermarkets, provide customers with value
and create additional jobs in the economy.
It is hard to imagine a more onerous or unfair tax. When
the owner dies, as much as she or he may have wanted to pass
the business down to the children or cousins, the estate tax
puts them in a deep financial hole. This is even before they
get started. Some try to stay in business by taking out a loan
with the Internal Revenue Service as their silent partner,
skimming off a large portion of the profits every year,
stifling job growth and business expansion. This option is
extremely risky. The supermarket industry has never been more
competitive than it is today. To survive, owners must use all
available capital to upgrade their stores with new services and
invest in technology to stay as efficient as possible. They
need all of their slim profits, along with loans from banks and
other sources, to remain competitive.
All too often, however, the estate tax forces them to close
or sell the store. And the community loses an institution that
may have supported the local economy for years. And the
industry loses another independent operator, historically the
source of greatest innovation in our business. The whole idea
of the self-service supermarket, an American innovation,
started with independent entrepreneurs in the 1930s.

Economic Effects of the Federal Estate Tax

The icing on the cake for FMI members is that after
involved planning, which takes assets away from their business
while they are alive; they are shocked to learn that the tax
raises almost no revenue for the federal government.
The Joint Economic Committee of Congress released a
``dynamic'' report in December 1998, which found that this tax
``raises very little, if any, net revenue for the federal
government.'' The JEC also concluded that the estate tax
results in losses under the income tax that are roughly the
same size as the revenue brought in by the estate tax. Annual
death tax receipts total approximately $23 billion, less than
1.4% of total tax revenue.
FMI believes Congress needs to do much more than simply
increase the unified credit to help the growing number of
family owned businesses facing high estate tax rates upon their
deaths. The supermarket industry urges Congress to focus on
eliminating these high tax rates. As mentioned earlier, raising
the unified credit does little to ameliorate the ravaging
effect of this tax. Closely held supermarkets and their
wholesalers are capital intensive businesses, whose owners
invest profits back into their business, but pay taxes at the
personal rate. Lifetime assets easily exceed the unified credit
amount of $650,000 (under current law, up to $1 million by
2006).
In the House of Representatives, we strongly support the
bipartisan, leadership legislation, H.R. 8, introduced by Reps.
Jennifer Dunn and John Tanner that calls for gradual
elimination of the death tax by 5% per year over a period of 11
years. We also support H.R. 86, introduced by Rep. Chris Cox,
which calls for full and immediate repeal of this tax. Versions
of H.R. 8 have also been introduced in other tax packages,
sponsored by Rep. Sam Johnson and Reps. Jennifer Dunn and Jerry
Weller. We urge Congress to include legislation eliminating the
estate and gift tax in any upcoming tax legislation.

Summary

The federal estate tax has become a huge disincentive to
continuing small family owned businesses. Take for instance,
the two-store operator in the nation's heartland, who has built
his business so he now employs 500 people, with 200 jobs added
in just the last five years. The fair market value of his
business is $10 to $20 million. He has spent between $600,000
and $1 million in succession planning, but he will have to sell
all or part of the business when he dies to satisfy the estate
tax. He believes his business will grow and expects to employ
700 people in his community in the next five years. All would
lose their positions working for this small, but important
market innovator, if he died.
Another supermarket operator has already spent just under
$10 million in estate taxes, and the second generation has
managed to hang on, by taking out a loan. This delayed the
opening of a third store for almost five years and added a
large debt payment. These funds otherwise could have been used
to fund parts of his expansion instead of borrowing and adding
cost to his operations. A few million dollars of the federal
tax payment was deferred and debt taken on to pay back the
federal tax over an allotted time period, so most of his
profits are applied to the federal tax payments.
Supermarket owners pay federal and state taxes throughout
the life of their company. When they die, the federal
government steps in and takes up to half of the worth of the
their company assets. It is unjust for our government to impose
a tax that raises so little revenue while it devastates
businesses and kills jobs. FMI urges you to pass legislation to
eliminate this tax.
Thank you for the opportunity to present testimony this
morning.

Statement of Investment Company Institute

The Investment Company Institute \1\ is pleased to submit
this statement to the House Committee on Ways and Means
regarding retirement savings issues raised at its June 16
hearing. Most importantly, we would like to take this
opportunity to indicate our strong support for many of the
provisions of H.R. 1102, the ``Comprehensive Retirement
Security and Pension Reform Act of 1999'' and H.R. 1546, the
``Retirement Savings Opportunity Act of 1999.'' Both bills
would make the nation's retirement plan system significantly
more responsive to the retirement savings needs of Americans.
Both bills would encourage retirement savings by providing
appropriate tax incentives to employers and individuals; and
both would eliminate many of the unnecessary limitations that
discourage small employers from establishing retirement plans
and individuals from trying to save for retirement. The
Institute commends the sponsors of H.R. 1102 and H.R. 1546 and
other members of this committee for their interest in
retirement savings policy.
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\1\ The Investment Company Institute is the national association of
the American investment company industry. Its membership includes 7,576
open-end investment companies (``mutual funds''), 479 closed-end
investment companies and 8 sponsors of unit investment trusts. Its
mutual fund members have assets of about $5.860 trillion, accounting
for approximately 95% of total industry assets, and have over 73
million individual shareholders.
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Retirement savings are of vital importance to our nation's
future. Although members of the ``Baby Boom'' generation are
rapidly approaching their retirement years, studies strongly
suggest that as a generation, they have not adequately saved
for their retirement.\2\ Additionally, Americans today are
living longer. Taken together, these trends will place an
enormous strain on the Social Security program in the near
future.\3\ In order to ensure that individuals have sufficient
savings to support themselves in their retirement years, much
of this savings will need to come from individual savings and
employer-sponsored plans.
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\2\ For instance, one study concluded that the typical Baby Boomer
household will need to save at a rate 3 times greater than current
savings to meet its financial needs in retirement. Bernheim, Dr.
Douglas B., ``The Merrill Lynch Baby Boom Retirement Index'' (1996).
\3\ Social Security payroll tax revenues are expected to be
exceeded by program expenditures beginning in 2014. By 2034, the Social
Security trust funds will be depleted. 1999 Annual Report of the Board
of Trustees of the Federal Old-Age and Survivors Insurance and
Disability Insurance Trust Funds.
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The Institute and mutual fund industry have long supported
efforts to enhance the ability of individual Americans to save
for retirement in individual-based programs, such as the
Individual Retirement Account or IRA, and employer-sponsored
plans, such as the popular 401(k) plan. In particular, we have
urged that Congress: (1) establish appropriate and effective
retirement savings incentives; (2) enact saving proposals that
reflect workforce trends and saving patterns; (3) reduce
unnecessary and cumbersome regulatory burdens that deter
employers--especially small employers--from offering retirement
plans; and (4) keep the rules simple and easy to understand.
It is our view that together H.R. 1102 and H.R. 1546
achieve these objectives.

I. Establish Appropriate and Effective Incentives to Save for
Retirement

A. Raise Low Caps That Unnecessarily Limit Retirement Savings.

In order to increase retirement savings, Congress must
provide working Americans with the incentive to save and the
means to achieve adequate retirement security. Current tax law,
however, imposes numerous limitations on the amounts that
individuals can save in retirement plans. Indeed, under current
retirement plan caps, many individuals cannot save as much as
they need to. One way to ease these limitations is for Congress
to update the rules governing contribution limits to employer-
sponsored plans and IRAs. Increasing these limits will
facilitate greater retirement savings and help ensure that
Americans will have adequate retirement income.
H.R. 1102 contains several provisions that would address
this issue, which the Institute strongly supports. Section 101
of the bill would increase 401(k) plan and 403(b) arrangement
contribution limits to $15,000 from the current level of
$10,000; government-sponsored 457 plan contribution limits
would increase to $15,000 from the current level of $8,000.
Another important provision of H.R. 1102 would repeal the ``25%
of compensation'' limitation on contributions to defined
contribution plans. These limitations can prevent low and
moderate-income individuals from saving sufficiently for
retirement. (As is noted below, the repeal of these limitations
is also necessary in order to enable many individuals to take
advantage of the ``catch-up'' proposal in the bill.) H.R. 1546
contains similar provisions.
H.R. 1546 also contains an additional proposal that the
Institute urges Congress to enact. Specifically, Section 101 of
H.R. 1546 would increase the annual IRA contribution limit to
$5,000 and permit future adjustments to account for
inflation.\4\ Today's $2,000 contribution limit was set in
1981--almost 20 years ago. If adjusted for inflation, this
limit would be at about $5,000 today. IRAs are a critical
component of the personal savings tier of the nation's three-
tiered approach to retirement savings. But at the current
$2,000 contribution limit IRAs no longer provide sufficient
savings opportunities for many Americans in light of its loss
of real value to inflation over time, longer anticipated life
expectancies and continuing increases in medical costs for our
elderly population. Only the IRA is available to all working
individuals, including those without access to an employer-
sponsored plan. Raising the IRA contribution limit will provide
all individuals with expanded retirement savings opportunities.
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\4\ H.R. 1102 proposes such an increase, but limits its
availability only to individuals able to make a fully deductible
contribution under current income-based eligibility rules. This
targeted approach complicates these rules, which, as we explain below,
already are too confusing. Confusing eligibility rules deter individual
participation in the IRA program.

B. Simplify IRA Eligibility Rules And Bring Back The Universal
---------------------------------------------------------------------------
Deductible IRA.

H.R. 1546 would simplify IRA eligibility criteria. Current
eligibility rules are so complicated that even individuals
eligible to make a deductible IRA contribution are deterred
from doing so. When Congress imposed the current income-based
eligibility criteria in 1986, IRA participation declined
dramatically--even among those who remained eligible for the
program. At the IRA's peak in 1986, contributions totaled
approximately $38 billion and about 29% of all families with a
head of household under age 65 had IRA accounts. Moreover, 75%
of all IRA contributions were from families with annual incomes
less than $50,000.\5\ However, when Congress restricted the
deductibility of IRA contributions in the Tax Reform Act of
1986, the level of IRA contributions fell sharply and never
recovered--to $15 billion in 1987 and $8.4 billion in 1995.\6\
Among families retaining eligibility to fully deduct IRA
contributions, IRA participation declined on average by 40%
between 1986 and 1987, despite the fact that the change in law
did not affect them.\7\ The number of IRA contributors with
income of less than $25,000 dropped by 30% in that one year.\8\
Fund group surveys show that even more than a decade later,
individuals did not understand the eligibility criteria.\9\
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\5\ Venti, Steven F., ``Promoting Savings for Retirement
Security,'' Testimony prepared for the Senate Finance Subcommittee on
Deficits, Debt Management and Long-Term Growth (December 7, 1994).
\6\ Internal Revenue Service, Statistics of Income.
\7\ Venti, supra at note 4.
\8\ Internal Revenue Service, Statistics of Income.
\9\ For example, American Century Investments asked 534 survey
participants, who were self-described ``savers,'' ten general questions
regarding IRAs. One-half of them did not understand the current income
limitation rules or the interplay of other retirement vehicles with IRA
eligibility. Based on survey results, it was concluded that ``changes
in eligibility, contribution levels and tax deductibility have left a
majority of retirement investors confused.'' ``American Century
Discovers IRA Confusion,'' Investor Business Daily (March 17, 1997).
Similarly, even expansive changes in IRA eligibility rules, when
approached in piecemeal fashion, require a threshold public education
effort and often generate confusion. See, e.g., Crenshaw, Albert B.,
``A Taxing Set of New Rules Covers IRA Contributions,'' The Washington
Post (March 16, 1997) (describing 1996 legislation enabling non-working
spouses to contribute $2,000 to an IRA beginning in tax year 1997).
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Based on these data, the Institute recommends the repeal of
the IRA's complex eligibility rules, as proposed in H.R. 1546.
These rules deter lower and moderate income individuals from
participating in the program. A return to a ``universal'' IRA
would result in increased savings by middle and lower-income
Americans.

II. Enact Savings Proposals That Reflect Workforce Trends and Savings
Patterns

A. Make Retirement Account Balances Portable.

On average, individuals change jobs once every five years.
Current rules restrict the ability of workers to roll over
their retirement account from their old employer to their new
employer. For example, an employee in a 401(k) plan who changes
jobs to work for a state or local government may not currently
take his or her 401(k) balance and deposit it into the state or
local government's pension plan. Thus, the Institute strongly
supports Sections 301 and 302 of H.R. 1102, which would enhance
the ability of American workers to take their retirement plan
assets to their new employer when they change jobs by
facilitating the portability of benefits among 401(k) plans,
403(b) arrangements, 457 state and local government plans and
IRAs. This change in the law would make it easier for
individuals to consolidate and manage their retirement savings.
A related proposal in H.R. 1546 would clarify the ability of
individuals to open an IRA ``on-line.'' Such clarification of
the law would facilitate individuals seeking to directly
rollover retirement plan assets in a computer-based environment
and thus encourage the preservation of retirement savings.\10\
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\10\ Increasingly, individuals are able to access plan account
balances on-line. According to one 1998 study, approximately 26 percent
of mid-size companies currently provide Internet access to plan
accounts. This number is expected to increase. Indeed, one mutual fund
complex has reported that more 401(k) plan participants access plan
information on-line than contact the company's phone representatives to
do so.

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B. Allow Individuals To ``Catch-Up'' When Able.

The laws governing pension plans also must be flexible
enough to permit working Americans to make additional
retirement contributions when they can afford to do so.
Individuals, particularly women, may leave the workforce for
extended periods to raise children. In addition, many Americans
are able to save for retirement only after they have purchased
their home, raised children and paid for their own and their
children's college education. Section 201 of H.R. 1102 and
Section 401 of H.R. 1546 would address these concerns by
permitting additional salary reduction ``catch-up''
contributions. The catch-up proposal in H.R. 1102 would permit
individuals at age 50 to save an additional $5,000 annually on
a tax-deferred basis. Similarly, H.R. 1546 would permit the
same individuals to increase their contributions by 50% over
the otherwise permitted amounts. The idea is to let individuals
who may have been unable to save aggressively during their
early working years to ``catch up'' for lost time during their
remaining working years. H.R. 1546 takes the additional step of
exempting the catch-up contributions from nondiscrimination
testing. We believe this is necessary to maximize the
provision's effectiveness. Repeal of the ``25% of
compensation'' limit, which is proposed in both bills, could
further enhance the ability of Americans to ``catch-up'' on
their retirement savings.
The ``catch-up'' is an excellent idea and is a sorely
needed, practical response to the work and savings patterns of
Americans today. We urge Congress to act on this proposal.

III. Expand Retirement Plan Coverage Among Small Employers

A. Eliminate Unnecessary Regulatory Disincentives To Plan
Formation.

The current regulatory structure applied to retirement
plans contains many complicated and overlapping administrative
and testing requirements that serve as a disincentive to
employers, especially small employers, to sponsor retirement
plans for their workers. Easing these burdens will promote
greater retirement plan coverage and result in increased
retirement savings.
Meaningful pension reform legislation must focus on the
need to increase pension plan coverage among small businesses.
Although these businesses employ millions of Americans, less
than 20 percent of them provide a retirement plan for their
employees. By comparison, about 84 percent of employers with
100 or more employees provide pension plans for their
workforce.\11\
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\11\ EBRI Databook on Employee Benefits (4th edition), Employee
Benefit Research Institute (1997).
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Unnecessarily complex and burdensome regulation continues
to deter many small businesses from establishing and
maintaining retirement plans. The ``top-heavy rule'' is one
example of such unnecessary rules.\12\ A 1996 U.S. Chamber of
Commerce survey found that the top-heavy rule is the most
significant regulatory impediment to small businesses
establishing a retirement plan.\13\ The rule imposes
significant compliance costs and is particularly costly to
small employers, which are more likely to be subject to the
rule. It is also unnecessary because other tax code provisions
address the same concerns and provide similar protections.
While the Institute believes the top-heavy rule should be
repealed, Section 104 of H.R. 1102 would make significant
changes to the rule, which would diminish its unfair impact on
small employers.
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\12\ The top-heavy rule is set forth at Section 416 of the Internal
Revenue Code. The top-heavy rule looks at the total pool of assets in a
plan to determine if too high a percentage (more than 60 percent) of
those assets represent benefits for ``key'' employees. If so, the
employer is required to (1) increase the benefits paid to non-key
employees, and (2) accelerate the plan's vesting schedule. Small
businesses are more likely to have individuals with ownership interests
working at the company and in supervisory or officer positions, each of
which are considered ``key'' employees, thereby exacerbating the impact
of the rule.
\13\ Federal Regulation and Its Effect on Business--A Survey of
Business by the U.S. Chamber of Commerce About Federal Labor, Employee
Benefits, Environmental and Natural Resource Regulations, U.S. Chamber
of Commerce, June 25, 1996.
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B. Provide Incentives To Encourage Small Employers To Establish
Plans.

In addition to eliminating rules that deter small
businesses from establishing retirement plans, such employers
also need appropriate tax incentives to encourage plan
formation and address their unique economic concerns. There are
two tax incentives, which are proposed, that we believe would
effectively encourage small employers.
First, Congress should provide a tax benefit that would
reduce the start-up costs associated with establishing a
pension plan. Both H.R. 1102 and H.R. 1546 propose a tax credit
for small employers of up to 50% of the start-up costs of
establishing a plan up to $1,000 for the first credit year and
$500 for each of the second and third year after the plan is
established. This modest tax credit would encourage more small
employers to establish retirement plans by diminishing initial
costs.
Second, Congress should provide assistance to small
employers who would like to contribute to a retirement plan for
their employees in addition to offering them a salary deferral
plan. Because many small employers have cash flow constraints,
they are often reluctant to make a commitment to contribute to
a retirement plan for their employees. H.R. 1546 would grant
small employers a tax credit for 50 percent of their
contributions (up to 3% of employee compensation) to a plan for
non-highly compensated employees during the first 5 years of a
plan's operation. This proposal is effectively designed to
assure it helps those who need assistance the most--smaller
employers and lower-paid individual employees--and would be an
excellent way to help small employers deliver a meaningful
retirement benefits to lower-paid employees.

C. Expand The Effective SIMPLE Plan Program.

The Institute also strongly supports expanding current
retirement plans targeted at small employers. Specifically, the
Institute supports expansion of the SIMPLE plan program, which
was instituted in 1997 and offers small employers a truly
simple, easy-to-administer retirement plan.
The SIMPLE program has been very successful. The Institute
has found a continued pattern of strong small employer interest
in SIMPLE plans over the program's two-year history. Indeed,
new SIMPLE plan formation has continued unabated in the second
year of its availability. Based on Institute estimates, mutual
funds held in SIMPLE IRAs experienced tremendous growth in
1998, increasing from $0.3 billion to $2 billion.
Additionally, information gathered in informal Institute
surveys of its members demonstrates just how popular this
program is. For instance, one firm alone reported almost 10,000
SIMPLE plans and 47,000 SIMPLE accounts as of December 31,
1997. This increased by about 50 percent over the next quarter
to about 14,000 plans and 72,000 accounts. By year-end 1998,
the firm had an estimated 23,000 SIMPLE plans and 219,000
accounts. Thus, over one year the number of SIMPLE plans had
more than doubled and the number of SIMPLE accounts had more
than quadrupled. Other firms for which such data are available
demonstrate similar growth rates. An Employee Benefit Research
Institute study published in October 1998 similarly
demonstrates the effectiveness of the SIMPLE, finding that 12%
of small employers with a defined contribution plan report
having established a SIMPLE plan over a period of less than 2
years. By comparison, only 9% of small employers surveyed
sponsored a SEP, a program that has been available since
1979.\14\
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\14\ Paul Yakoboski and Pamela Ostuw, ``Small Employers and the
Challenge of Sponsoring a Retirement Plan: Results of the 1998 Small
Employer Retirement Survey,'' EBRI Issue Brief No. 202 (Employee
Benefit Research Institute, October 1998).
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Moreover, the SIMPLE plan has been especially popular with
the nation's smallest employers. Institute surveys indicate
that about 90% of those employers establishing SIMPLE plans had
10 or fewer employees. Employers with 25 or fewer employees
constitute nearly the entire market.\15\
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\15\ Institute informal survey results suggest that SIMPLE plan
formation is negligible for employers of more than 25 employees.
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The success of the SIMPLE program is extremely significant,
because the lack of retirement plan coverage in the small
employer population has been stubbornly nonresponsive to
previous policy initiatives and industry efforts. As noted
above, under 20 percent of employers with less than 100
employees provide a retirement plan for their employees, as
compared to about 84 percent of employers with 100 or more
employees.
Despite these successes, Congress can strengthen the SIMPLE
program in two ways, each of which the Institute strongly
supports. First, both H.R. 1102 and H.R. 1546 would raise the
SIMPLE plan contribution limits from $6,000 to $10,000. This
increase would assure that individuals who work for small
employers will have opportunities to accumulate sufficient
retirement savings. (As noted above, other provisions of the
bills would increase the contribution limits for 401(k), 403(b)
and 457 plans.) Second, H.R. 1102 would provide for a salary-
reduction-only SIMPLE plan. We believe that this would make the
program much more effective for employers of 25-100 employees.

IV. Simplify Unnecessarily Complicated Rules

Simplicity is the key to successful retirement savings
programs. This is the lesson of the SIMPLE and IRA programs.
H.R. 1102 recognizes the need to keep the rules simple in the
case of employer-sponsored plans. As we have noted above,
complex and confusing rules diminish retirement plan formation
and significantly reduce individual participation in retirement
savings programs. We strongly support numerous provisions in
H.R. 1102 that would simplify rules. We discuss several of
these provisions below.
First, H.R. 1102 would provide a new automatic contribution
trust nondiscrimination safe harbor. This safe harbor would
simplify plan administration for employers electing to use it,
enabling them to avoid costly, complex and burdensome testing
procedures.\16\ This provision is also an effective way to
increase participation rates in 401(k) plans, especially the
participation rates of non-highly compensated employees.
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\16\ To qualify for the safe harbor, employers would need to make
automatic elective contributions on behalf of at least 70% of non-
highly compensated employees and match non-highly compensated employee
contributions at a rate of 50% of contributions up to 5% or make a 2%
contribution on behalf of each eligible employee.
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Second, the bill also would modify the anticutback rules
under section 411(d)(6) of the Internal Revenue Code in order
to permit plan sponsors to change the forms of distributions
offered in their retirement plans. Specifically, the bill would
permit employers to eliminate forms of distribution in a
defined contribution plan if a single sum payment is available
for the same or greater portion of the account balance as the
form of distribution being eliminated. This proposed
modification of the anticutback rule would make plan
distributions easier to understand, reduce plan administrative
costs and continue to adequately protect plan participants. In
addition, H.R. 1102 would permit account transfers between
defined contribution plans where forms of distributions differ
between the plans; this modification of the anticutback rule
also would simplify plan administration. It also would enhance
benefit portability, which, as noted above, is an important
public policy objective.
Finally, H.R. 1102 contains other provisions that would
simplify currently burdensome rules and which the Institute
supports. These proposals include repeal of the multiple use
test and simplification of the separate line of business rules.

V. Conclusion

Improving incentives to save by increasing contribution
limits to retirement plans and IRAs will provide more
opportunities for Americans to save effectively for retirement.
Similarly, rules that accommodate the work and savings patterns
of today will enable millions of Americans to save toward a
secure future in their retirement years. Additionally,
providing appropriately structured tax incentives, such as
start-up and contribution tax credits for small employers,
would increase plan formation. And finally, simplifying the
rules applicable to employer-sponsored plans and IRAs would
result in a greater number of employer-sponsored plans, a
higher rate of worker coverage and increased individual
savings. The Institute strongly supports the provisions
described above and commends the sponsors of H.R. 1102 and H.R.
1546 for supporting reforms of the pension system that will
increase plan coverage and encourage Americans to save for
their retirement. We encourage members of this Committee and
Congress to enact this legislation this year.

Statement of National Association of Manufacturers

Mr. Chairman, we are pleased to submit the following
statement for the record in support of Section 510 of H.R.
1102, the ``ESOP Dividends May Be Reinvested Without Loss of
Dividend Deduction'' provision. We are submitting this
statement on behalf of the National Association of
Manufacturers--``18 million people who make things in
America''--the nation's largest and oldest multi-industry trade
association. The NAM represents 14,000 members (including
10,000 small and mid-sized companies) and 350 member
associations serving manufacturers and employees in every
industrial sector and all 50 states. Headquartered in
Washington, DC., the NAM also has 11 additional offices across
the country.
The Comprehensive Retirement Security and Pension Reform
Act of 1999 (H.R. 1102), cosponsored by Reps. Rob Portman (R-
OH) and Ben Cardin (D-MD), has attracted over 101 bipartisan
cosponsors to date. The NAM strongly supports this legislation
that would make pensions more secure and cut red tape, thereby
encouraging greater pension coverage. Given the impending
retirement of the baby boom generation, the passage of pension
reform legislation is especially critical.
Among the many provisions of H.R. 1102 is Section 510
(``ESOP Dividends May Be Reinvested Without Loss of Dividend
Deduction''), which would promote two critical and intertwined
goals: to encourage workers to save for retirement and to
promote employee ownership in their companies in which they
work. Under current law, employers are able to deduct dividends
on employer stock held in the employee stock ownership plan
(ESOP), provided the dividends are paid out in cash to
participants. The deduction is also permitted in the case of a
leveraged ESOP, provided the dividends are used to make
payments on a loan that was made for purposes of acquiring
company stock for the ESOP.
While current law encourages employee ownership, it fails
to fulfill another important goal. It prohibits employees from
reinvesting those dividends in the plan. This is especially
unfortunate given the low rate of national savings and the need
for baby boomers, in particular, to prepare for their
retirement. Although it is currently possible for some workers
to reinvest some dividends in the ESOP through an IRS special
letter ruling, the process is cumbersome, and the dividends
count toward the employee's 401(k) limits, diminishing what can
be saved in the plan. Codification of ESOP dividend
reinvestment would solve this problem.
There are approximately 10,000 ESOPs in the United States
with 10 million employee owners. This is almost 10 percent of
the American workforce. Both large and small firms participate.
Of the NAM's membership, over 7 percent of small firms have
ESOPs and in the large firm category the percentage is much
greater. ESOPs promote employee ownership and a stake in
America's future. Legislative means to promote their growth
should be encouraged. Section 510 is an important step in this
regard.
Section 510 has attracted wide support. In addition to the
growing list of bipartisan cosponsors for H.R. 1102, more than
15 members of the Ways and Means Committee have written to the
original cosponsors of H.R. 1102, Reps. Rob Portman and Ben
Cardin, praising the concept of employee stock ownership and
urging a change in the law to permit an employer dividend
deduction so employees can reinvest their dividends and save
for retirement and for other important purposes.
On behalf of the NAM's 14,000 members, we urge your support
for Section 510 as part of H.R. 1102. Taken together, ESOP
dividend reinvestment and the other important provisions of
H.R. 1102 would do much to build retirement security for
America's workers and to encourage continued economic growth
for America's future.

Statement of National Association of Professional Employer
Organizations, Alexandria, Virginia

I. INTRODUCTION

The National Association of Professional Employer
Organizations (NAPEO) appreciates the opportunity to submit
this statement for the record of the Committee's hearing on
retirement and savings issues. NAPEO is the national trade
association of the professional employer organization (PEO)
industry. NAPEO represents nearly 600 member firms from start-
ups to large, publicly traded companies. NAPEO members are
found in all 50 states and employ the vast majority of worksite
employees in PEO arrangements.
We applaud the Committee's interest in these issues and
willingness to look at the tax code for ways to address our
savings problem in this country, particularly our pending
retirement savings crisis. It is our view that only through a
partnership between the government and the private sector can
this crisis be averted.
NAPEO's members would like to participate in that effort
and in fact, we think that we are already doing so. That is
because our members are in the business of expanding coverage
and providing benefits to American workers. The professional
employer organization or ``PEO'' assists mainly workers of
small- and medium-size businesses. While the owners of these
small and med-sized businesses focus on the ``business of their
business'' PEOs assume the responsibilities and liabilities of
the ``business of employment.'' The PEO assumes responsibility
for paying wages and employment taxes generally to all the
workers of its client companies. It maintains employee records,
handles employee complaints, and provides employment
information to workers, such as an employee handbook.
Most significantly, the PEO provides to the workers of its
customers retirement (usually a 401(k) plan), health, dental,
life insurance, dependent care and other benefits, which for
many of these workers is the first opportunity that they have
had to obtain these benefits through their employment.
The average NAPEO member customer is a small business with
just 18 workers and the average wage of these workers is around
$20,000. These are truly small businesses with employees
attempting to provide a working wage for themselves and their
families. Unfortunately, because these workers are employees of
small businesses, they are often left without the option of
needed employee benefits.
A recent Dun & Bradstreet Corporation survey of businesses
with fewer than 25 employees revealed that only 39% offered
health care and just 19% offer retirement savings plans. PEOs,
on the other hand, can provide benefits to these workers on a
more affordable basis because they can aggregate the workers of
all of their customers together into a larger group, thereby
obtaining economies of scale that enable them to set up a
qualified plan and purchase group health and other employee
benefit plans. PEOs have the expertise to operate these plans
in compliance with a rather complex set of requirements imposed
by the tax code and ERISA.
An analyst at Alex. Brown & Sons estimates that 40% of
companies in a PEO co-employment relationship upgrade their
total employee benefits package as a result of the PEO
relationship and further, that 25% of the companies upgrading
their benefits are offering health care and other benefits to
their workers for the first time.
A NAPEO survey of its members revealed that 98% offer
health and dental insurance, 86% offer disability coverage, 80%
offer vision care and 82% offer retirement savings plans.
Moreover, in some cases, workers co-employed by a PEO
obtain the benefits of COBRA rights and the protection of other
employment laws and regulations, only because they are included
in the larger workforce of a PEO. By pooling employees of small
businesses, PEOs bring workers under the protection of federal
laws applicable to large employers such as HIPPA and the Family
and Medical Leave Act. In addition, there is generally a higher
rate of compliance with COBRA and other laws by a professional
employer (PEO) than by its various clients. PEOs employ staff
who are knowledgeable about these laws and regulations, and who
are responsible for addressing employment concerns of worksite
employees.

II. PROBLEMS WITH PRESENT LAW: AN OUTDATED TAX CODE

PEOs have found a need for these types of skills and
benefits in the market place, as small- and medium-sized
businesses have slowly but steadily sought out the services of
PEOs over the past decade. The industry has expanded to meet
this demand. At the state level, NAPEO sought recognition for
PEOs and supported regulation, such as licensing, to ensure
that the industry could grow.
At the Federal level, however, PEOs have been confronted
with a tax code that was written long before the development of
this industry. Therefore, the current rules for who can collect
taxes and provide benefits do not neatly fit a PEO, its
customers and workers. In fact, under some interpretations of
the tax law, PEOs could not do the very things that small
businesses want and need: collect employment taxes and provide
retirement, health and other benefits.
Last year, Congressman Portman (R-OH) and Congressman
Cardin (D-MD) attempted to address this problem by introducing
H.R. 1891, which gained the support of 27 Members of this
Committee. After its introduction, the sponsors and the
industry met with other interested parties, including the
Administration, who raised some specific concerns with the
original bill. As a result, we went back to the drawing board
to try to come up with an approach to our problem that was
narrower, addressing the expressed concerns yet allowing us to
do what we were already doing for small businesses and
workers--providing benefits and collecting taxes.

III. REVISED PROPOSAL: CERTIFIED PEO STATUS

We are pleased to present to the Committee the fruits of
those efforts--a revised proposal that continues to enjoy the
support of our original sponsors, Mr. Portman and Mr.
Cardin, and addresses the concerns raised by the
Administration with the original proposal. This new proposal,
unlike H.R. 1891, applies only to PEOs, not to temporary or
other staffing firms. Thus, the proposal would not affect the
litigation pending in the 9th Circuit, or any similar
litigation. Nor does the proposal make any changes in the
common law tests for who is an employee. In fact, the proposal
specifically states this through the inclusion of a no-
inference rule with respect to employment status.
In brief, what the new proposal does is to provide a safe
harbor for PEOs who elect to meet certain requirements, which
permits a PEO to assume liability for employment taxes with
respect to worksite employees and to offer retirement and other
benefits to such workers. In order to take advantage of this
safe harbor, a PEO must be certified by the IRS. The
certification requirements include a net worth test (if a PEO
wants to have exclusive liability for employment taxes), and
the submission of an annual audit by a CPA.
In order to prevent a customer from obtaining any better
treatment under the tax code's nondiscrimination or other
qualification rules under this proposal, a PEO's qualified plan
would be tested under these rules on a customer-by-customer
basis. A more detailed summary of the proposal is attached as
an appendix.

IV. CONCLUSION: WORKERS GET THE BENEFITS THEY NEED AND DESERVE

Most importantly, this clarification of a PEOs' ability to
offer retirement and health benefits permits the industry to
continue to provide the workers of small and medium businesses
with the benefits that they need and deserve. Current PEO
customers can breathe a sigh of relief that the PEO plans in
which their workers are currently participating will not be
disqualified. PEOs can establish new plans under clear tax code
rules. The market place's creative response to the difficulties
of affording and providing benefits in a small business context
can flourish without the uncertainty imposed by outdated tax
rules. We believe this represents an ideal model of the public-
private partnership that is needed to address the impending
retirement savings crisis as well as the immediate health
problem presented by our country's uninsured workers, and we
urge its support by this Committee.

Overview of Proposed Certified Professional Employer Organization
Legislation

I. Guiding Principles

Difficulties in reaching conclusions regarding the
highly factual determination of an ``employee'' and an
``employer'' should not limit the ability to provide workers
with retirement, health, and other employee benefits.
Clients of the CPEO should generally not get any
significantly better or worse treatment under the
nondiscrimination or other qualification rules than they would
get outside of the CPEO arrangement.
Employment tax administration should not be
significantly affected by the use of a CPEO.

II. General Structure

If certain conditions are satisfied, an entity certified by
the Internal Revenue Service as a Certified Professional
Employer Organization (a ``CPEO'') will be allowed to elect (1)
to take responsibility for employment taxes with respect to
worksite employees and (2) to provide such workers with
employee benefits under a single employer plan sponsored by the
CPEO.

III. No Inference with Respect to Employment Status of Workers

The legislation will expressly state that it does not
override the common law determination of an individual's
employer. The legislation will not affect (and will explicitly
state that it does not affect) the determination of who is a
common law employer under federal tax laws or who is an
employer under other provisions of law (including the
characterization of an arrangement as a MEWA under ERISA), nor
will status as a CPEO (or failure to be a CPEO) be a factor in
determining employment status under current rules.

IV. Certification by IRS

In order to be certified as a CPEO under the legislation,
an entity must demonstrate to the IRS by written application
that it meets (or will meet) certain requirements. Generally,
the requirements for certification will be developed by the IRS
using requirements similar to the requirements for the ERO
(electronic return originator) program and to practice before
the IRS, as described in Circular 230 and will include review
of the experience of the PEO and audit conducted by a certified
public accountant. In addition, in order to be certified, a
CPEO must represent that it (or the client) will maintain a
qualified retirement plan for the benefit of 95% of worksite
employees.
The CPEO must notify the IRS in writing of any change that
affects the continuing accuracy of any representation made in
the initial certification request. In addition, after initial
certification, the CPEO must continue to file copies of its
audited financial statements with the IRS within 180 days after
the close of each fiscal year.
Procedures would be established for suspending or revoking
CPEO status (similar to those under the ERO program). There
would be a right to administrative appeal from an IRS denial,
suspension, or revocation of certification.

V. Operation As a CPEO With Respect to Particular Workers

After certification, a CPEO will be allowed (1) to take
responsibility for employment taxes and (2) to provide employee
benefits with respect to ``worksite employees.'' A worker is a
``worksite employee'' if the worker and at least 85% of the
individuals working at the worksite are subject to written
service contracts that expressly provide that the CPEO will:
Assume responsibility for payment of wages to the
worker, without regard to the receipt or adequacy of payment
from the client for such services;
Assume responsibility for employment taxes with
respect to the worker, without regard to the receipt of
adequacy of payment from the client for such services;
Assume responsibility for any worker benefits that
may be required by the service contract, without regard to the
receipt or adequacy of payment from the client for such
services;
Assume shared responsibility with the client for
firing the worker and recruiting and hiring any new worker; and
Maintain employee records.
For this purpose, a worksite would be defined as a physical
location at which a worker generally performs service or, if
there is no such location, the location from which the worker
receives job assignments. Contiguous locations would be treated
as a single physical location. Noncontiguous locations would
generally be treated as separate worksites, except that each
worksite within a reasonably proximate area would be required
to satisfy the 85% test for the workers at that worksite.
The legislative history will indicate that the 85% rule is
intended to describe the typical, non-abusive PEO arrangement
whereby a business contracts with a PEO to take over
substantially all its workers at a particular worksite, and
that this 85% rule is intended to ensure that the benefits of
the bill are not available in any situation in which a business
uses a PEO arrangement to artificially divide its workforce.

VI. CPEO Employee Benefit Plans

A. CPEO May Sponsor Employee Benefit Plans

The CPEO may provide worksite employees with any type of
retirement plan or welfare benefit plan that the client could
provide. Worksite employees may not, however, be offered a plan
that the client would be prohibited from offering on its own.
For example, government workers may not be offered
participation in section 401(k) plan. Similarly, a CPEO may not
sponsor a plan that it would be prohibited from offering on its
own (e.g., a section 403(b) plan). However, an eligible client
could maintain such plan as discussed below.
In general, employee benefit provisions (in the Internal
Revenue Code and in directly correlative provisions in other
Federal law) that reference the size of the employer or number
of employees will generally be applied based on the size or
number of employees of the CPEO. For example, CPEO workers will
be entitled to COBRA coverage. Similarly, a CPEO welfare
benefit plan will be treated as a single employer plan for
purposes of section 419A(f)(6). Plan reporting requirements are
met at the CPEO level. However, a client which could meet the
size requirements for eligibility for an MSA or a SIMPLE plan
could contribute to such an arrangement maintained by the CPEO.

B. Nondiscrimination testing

The nondiscrimination rules of the Code relating to
employee benefit plans (including sections 401(a)(4),
401(a)(17), 401(a)(26), 401(k), 401(m), 410(b) and 416 and
similar rules applicable to welfare and fringe benefit plans)
will generally be applied on a client-by-client basis.
That portion of the CPEO plan covering worksite employees
with respect to a client will be tested taking into account the
worksite employees at a client location and all other
nonexcludable employees of the client, but worksite employees
would not be included in applying the nondiscrimination rules
to portions of the plan including worksite employees of other
clients, to the portion of the plan including non-worksite
employees, to other plans maintained by the CPEO or to other
plans maintained by members of the CPEO's controlled group.
Consequently, the CPEO workforce (other than worksite
employees) will be treated as a separate employer for testing
purposes (and will be included in applying the
nondiscrimination rules to plans maintained by the CPEO or
members of its controlled group). Thus, for example, in
applying nondiscrimination rules to a plan maintained by the
parent of a CPEO for employees of the parent and for
nonworksite employees of the CPEO, CPEO worksite employees will
not be taken into account.
For purposes of testing a particular client's portion of
the plan under the rules above, general rules applicable to
that client would apply as if the client maintained that
portion of the plan. Thus, if the terms of the benefits
available to the client's worksite employees satisfied the
requirements of the section 401(k) testing safe harbor, then
that client could take advantage of the safe harbor. Similarly,
a client that meets the eligibility criteria for SIMPLE 401(k),
testing would be allowed to utilize that safe harbor to
demonstrate compliance with the applicable nondiscrimination
rules for that client.
Application of qualified plan and welfare benefit plan
rules other than the nondiscrimination rules listed above will
generally be determined as if the client and the CPEO are a
single employer (consistent with the principle that the CPEO
arrangement will not result in better or worse treatment).
Thus, there would be a single annual limit under section 415.
Section 415 will provide that any cutbacks required as a result
of the single annual limit to be made in the client plan.
Deduction limits and funding requirements would apply at the
CPEO level. In determining deduction limits and minimum funding
requirements for the CPEO plan, compensation means compensation
paid to worksite employees by the CPEO. In addition, if the
client portion of a plan is part of a top heavy group, any
required top heavy minimum contribution or benefit will
generally need to be made by the CPEO plan.
The legislation will also contain language giving the IRS
the authority to promulgate rules and regulations that
streamline, to the extent possible, the application of certain
requirements, the exchange of information between the client
and the CPEO, and the reporting and record keeping obligations
of the CPEO with respect to its employee benefit plans.

C. Service Crediting

There will be special ``crediting'' of service for all
benefit purposes. The break in service rules will be applied
with respect to worksite employees using rules generally based
on the Code section 413 tracking rules.
Worksite employees will not generally be entitled to
receive plan distributions of elective deferrals until the
worker leaves the CPEO group. In cases where a client
relationship terminates with a CPEO that sponsors a plan, the
CPEO will be able to ``spin off'' the former client's portion
of the plan to a new or existing plan maintained by the client.
Where the terminated client does not establish or wish to
maintain the client's portion of the CPEO plan, the CPEO plan
may distribute elective deferrals of worksite employees
associated with a terminated client only in a direct rollover
to an IRA designated by the worker. In the event that no such
IRA is so designated before the second anniversary of the
termination of the CPEO/client relationship, the assets
attributable to a client's worksite employees may be
distributed under the general plan terms (and law) that applies
to a distribution upon a separation from service.

D. Plan Qualification

The legislative history will provide that, similar to IRS
practice in multiple employer plans, disqualification of the
entire plan will occur if a nondiscrimination failure occurs
with respect to worksite employees of a client and either that
failure is not corrected under one of the IRS correction
programs or that portion of the plan is not spun off and/or
terminated. Existing government programs for correcting
violations would be available to the plan sponsor for the plan
and, in the case of nondiscrimination failures tested at the
client level, to the client portion of the plan with the fee to
be based on the size of the affected client's portion of the
plan. Moreover, the CPEO plan, as a single employer plan, will
only be required to obtain a single opinion letter and pay a
single user fee.

E. Testing of Plans Maintained by Client

The legislation will treat all worksite employees (who are
not employees of the client) as ``per se'' leased employees of
the client, thus requiring clients to include to include all
worksite employees in plan testing. In accordance with current
leased employee rules, the client will get credit for CPEO plan
contributions or benefits made on behalf of worksite employees.
Consistent with this treatment of worksite employees, the
client would be permitted to cover worksite employees under any
employee benefit plan maintained by the client and compensation
paid by the CPEO to worksite employees would be treated as paid
by the client for purposes of applying applicable qualification
tests. Limits such as section 404 will apply to the client's
plan only to the extent the benefits and contributions, in
aggregation with those under the CPEO's plan, do not exceed the
limits.

F. Transition Issues

The legislation will direct the IRS to accommodate
transfers of assets in existing plans maintained by a CPEO or
CPEO clients into a new plan (or amended plan) meeting the
requirements of the legislation (e.g., client-by-client
nondiscrimination testing) without regard to whether or not
such plans might fail the exclusive benefit rule because
worksite employees might be considered common-law employees of
the client.

VII. Employment Tax Liability

An entity that has been certified as a CPEO must accept
liability for employment taxes with respect to wages it pays to
worksite employees of clients. Such liability will be exclusive
or primary, as provided below. The PEO would generally be
required to provide the IRS on an ongoing basis with a list of
clients for which employment tax liability has been assumed and
a list of the clients for whom it no longer has employment tax
liability.
All reporting and other requirements that apply to an
employer with respect to employment taxes apply to the CPEO for
wage payments made by the CPEO. In addition, the remittance
frequency of employment taxes will be determined with reference
to collections and the liability of the CPEO.
Wages paid by the client during the calendar year prior to
the assumption of employment tax liability would be counted
towards the applicable FICA or FUTA tax wage base for the year
in determining the employment tax liability of the CPEO (and
vice versa). Exceptions to payments as wages or activities as
employment, and thus to the required payment of employment
taxes, are determined with respect to the client.
A CPEO will have exclusive liability for employment taxes
with respect to wage payments made by the CPEO to worksite
employees (including owners of the client who are worksite
employees) if the CPEO meets the net worth requirement. The net
worth requirement is satisfied if the CPEO's net worth (less
good will and other intangibles) as certified by an independent
certified public accountant is, on the last day of the fiscal
quarter preceding the date on which payment is due and on the
last day of the fiscal quarter in which the payment is due, at
least:
$50,000 if the number of worksite employees is fewer than
500
$100,000 if the number of worksite employees is 500 to
1,499
$150,000 if the number of worksite employees is 1,500 to
2,499
$200,000 if the number of worksite employees is 2,500 to
3,999
$250,000 if the number of worksite employees is more than
3,999.
In the alternative, the net worth requirement could be
satisfied through a bond (for employment taxes up to the
applicable net worth amount) similar to an appeal bond filed
with the Tax Court by a taxpayer or by an insurance bond
satisfying similar rules.
Within 60 days after the end of each fiscal quarter, the
CPEO will provide the IRS with an attestation from an
independent certified public accountant that states that the
accountant has found no material reason to question the CPEO's
assertions with respect to the adequacy of federal employment
tax payments for the fiscal quarter. In the event that such
attestation is not provided on a timely basis, the CPEO will
prospectively cease to have exclusive liability with respect to
employment taxes (regardless of the net worth or bonding
requirement). Exclusive liability will not be restored until a
subsequent attestation is filed.
For any tax period for which any of these criteria for
exclusive liability for employment taxes are not satisfied, or
to the extent the client has not made adequate payments to the
CPEO for the payment of wages, taxes, and benefits, the CPEO
will have primary liability and the client will have secondary
liability for employment taxes.

VIII. Effective Date

These provisions will be effective on January 1, 2001 or,
if later, 12 months after the date of enactment. The statute
will direct the IRS to establish the PEO certification program
at least three months prior to the effective date.

Statement of Kenneth B. Allen, Executive Vice President and Chief
Executive Officer, National Newspaper Association, Arlington, Virginia

Thank you for allowing me to submit this testimony on
behalf of the National Newspaper Association in order to
comment briefly on the inherent unfairness of the estate tax.
The National Newspaper Association, established in 1885,
represents nearly 4,000 daily and weekly newspapers nationwide.
America's community papers inform, educate and entertain 170
million readers every week. NNA members are the building blocks
upon which America's communities are founded. More importantly,
our members are primarily family-owned businesses. As part of
the Family Business Estate Tax Coalition, we support the
reduction and elimination of the estate tax rates, specifically
the passage H.R. 8, the Death Tax Elimination Act, as
introduced by Representatives Jennifer Dunn and John Tanner.
NNA believes the confiscatory nature of the estate tax
punishes family-owned businesses and entrepreneurs. In fact,
NNA fully supported the estate tax relief provided by Congress
in the Taxpayer Relief Act of 1997. That legislation raised the
exemption from $600,000 to $1 million by 2005. The law also
created a new $1.3 million exemption from estate taxes for
small business and farms that qualify as ``family-owned.'' We
applaud Congress and the President for that key first step.
However, our goal remains the elimination of the estate tax.
Many community newspapers are forced to sell when the owner
dies since their assets are not liquid. The families need to
sell in order to pay the estate tax. This has a devastating
impact on the entire community. At minimum, someone from
outside the community could purchase the paper. In the worst
cases, the paper is sold and closed. When a newspaper that has
been covering and reporting local news for several generations
is either sold or closes its doors, the sense of community is
lost forever. The newspaper owner's family is not the only one
paying the tax. The reporter who covers local sports, the
restaurant owner who feeds the newspaper staff and the
department store that advertises in the paper all suffer under
the current system. These are two examples of the impact on
community papers:
Everett Bey, Chairman of Feather Publishing
Company, Inc. is facing this very problem. His company prints
and publishes six weekly newspapers including the Feather River
Bulletin, the Indian Valley Record, the Chester Progressive,
the Westwood Pinepress, the Portola Reporter and the Lassen
County Times with staff and offices in each location. When Mr.
Bey's wife passed away two years ago, her shares of the company
were placed in a trust. When Mr. Bey passes, the entire
business will be left to his only daughter and her husband.
Feather Publishing Company, Inc. grosses over $3 million
annually. Based on these revenues, it is entirely possible that
the Mr. Bey's daughter will be forced to sell the business--a
business he has owned for nearly 30 years. Mr. Bey started this
company with seven employees and today he has almost 100. It is
fundamentally wrong to punish Mr. Bey's family for their hard
work and success.
Another community newspaper publisher, Helen
Buffington of the Jackson Herald, the Commerce News, the Banks
County News and the Madison County Journal in Georgia explained
how she and her husband are preparing to transfer the paper to
their children. Starting with a struggling Georgia daily paper,
the Buffingtons built a firm that is now worth more than $2
million. They have been gifting the business to their sons for
several years and have spent tens of thousands of dollars on
legal expenses and insurance premiums in an effort to save
their children from the consequences of the death tax. By
reinvesting their profits back into the company, the
Buffingtons have created a family legacy for their children and
grandchildren. But they fear that when they pass that the IRS
will come looking to collect. (See attached letters)
As you know, Representatives Dunn and Tanner have
introduced H.R. 8, the Death Tax Elimination Act, which would
gradually reduce the estate tax rate by 5 percent a year until
the tax is eliminated in 2010. We would prefer to see a more
rapid phase out, but we support this bill, as it is a good
piece of legislation and has bipartisan support. Sen. Campbell
has introduced a companion bill, S. 38, the Estate and Gift Tax
Rate Reduction Act, which also reduces the estate tax rates by
5 percent each year until they are eliminated.
A study released in 1998 by the Congressional Joint
Economic Committee concluded that the estate tax is a leading
killer of family-owned businesses. Additionally, valuable
resources that could be used to strengthen and expand
businesses, improve working conditions or increase employee's
wages are rather spent in an attempt to avoid paying the tax.
The best way I have heard the death tax described is as a
``virtue'' tax. Unlike a ``sin'' tax, which focuses on vices
such as tobacco products and alcohol, the estate tax punishes
people for their hard work and saving for the future.
Meanwhile, these are qualities many seek to instill in our
communities.
Only 30 percent of family owned businesses survive into the
second generation and only 17 percent survive to a third. This
is something that must change because small businesses are the
backbone of our economy and community papers are the heart and
soul of our communities. It is vital that Congress repeal this
bad policy or our community newspapers, as we know them, will
not survive.
Again, Mr. Chairman, thank you for allowing me the
opportunity to submit this testimony on behalf of the nation's
community papers.

July 10, 1998

Senny Boone
National Newspaper Association
Arlington, VA 22209

Dear Ms. Boone:

My husband and I had a dream--a dream of owning our own community
newspaper.
In 1965, we realized our dream. We purchased a struggling weekly in
North Georgia for $25,000, including the building and equipment. To
raise the 10 percent down payment and have a little operating capital,
we cashed in my insurance policy and sold our home and a small tree
farm we owned.
Today, thanks to a number of factors, our firm includes that
newspaper and three other weeklies, as well as a thriving commercial
printing operation. Our two sons are in the business. And both my
husband and I, in our early 70s but being blessed with good health,
also lend a hand.
The firm is now worth well over $2 million, according to an
appraiser. But what happens when my husband and I die? We want our sons
to have the business and we've been gifting it to them for several
years. We also have spent thousands of dollars to get legal advice and
pay insurance premiums in an effort to see that our sons don't have to
sell the business in order to pay the estate taxes. But we don't know
what will happen.
We have worked hard and taken relatively little out of the firm
over the years in an effort to get it established and to have something
for our children and grandchildren.
But as we understand it, the government could levy a tax of up to
58 percent on it. We don't feel this is fair. We have paid both
corporate and personal taxes over the years on the earnings of this
firm. And it seems totally unfair to then require our descendents to
pay another hefty tax because we have saved and established a strong
business. It would, in fact, be punishing them for our thriftiness and
hard work. This, I believe, discourages people from establishing family
businesses.
The estate tax should be totally abolished.

Sincerely,
Helen Buffington (Mrs. Herman)
Editor Emeritus

NNA
Attn: Government Relations

Re: Estate tax issue

Feather Publishing Co., Inc. is a wholly family-owned printing and
publishing business, located in the Sierra Nevada mountains of Northern
California, in Plumas and Lassen Counties, with headquarters in Quincy,
CA. We publish six weekly newspapers: Feather River Bulletin at Quincy;
Lassen County Times at Susanville; Portola Reporter at Portola; Indian
Valley Record at Greenville; Chester Progressive at Chester-Lake
Alamanor; and the PinePress at Westwood, all with individual offices
and staff at each location.
When my wife died two years ago, her share of the corporate stock
was placed in a trust. When I die, that trust and my stock will all go
to my only daughter and her husband, the latter now serving as
publisher of our publications. Our annual gross is over $3 million. On
this basis, it is entirely possible that they will have to sell the
business in order to pay the estate taxes.
We have owned this business for almost 30 years, buying the
Bulletin and two other small weeklies in 1968, inheriting 3 offices and
7 employees. We now have grown to 6 offices, 97 employees, producing 28
to 36 page standard newspapers, plus 8 or 10 advertising inserts,
weekly for each flag. We also publish a two-county telephone directory
that incorporates phone numbers for three phone companies serving the
area.
Over the years, we have seen the number of independent family-owned
weeklies become smaller and smaller in California. Something has to be
done to relieve the estate tax burden and allow these family-owned
enterprises to continue their independent voices.

Sincerely,
Everett E. Bey
Chairman of the Board
Feather Publishing Co., Inc.

Enhancing Health Security for Responsible Americans by a Private
Citizen in St. Louis, Missouri

Overview:

The passage of the Health Insurance Portability and
Accountability Act is a commendable step in improving access to
health insurance and reducing job lock. While improving access
to insurance, it does nothing to ensure affordable rates, if an
individual must switch to individual insurance, after having
developed a health condition under an individual plan. Further
reform is needed to ensure that responsible citizens who carry
health insurance will be able to retain affordable coverage
over the long term if they should become ill.

This proposal is divided into the following sections:

Problems with the Current System of Health Insurance
The Core Reform Proposal
Cost Issues Related to the Core Proposal
Other Comments about the Core Proposal
Additional Reforms Needed
Cost Issues Related to the Additional Reforms

Problems with the Current System of Health Insurance:

Portability Problems

--The Health Insurance Portability and Accountability Act
(HIPAA) does nothing to ensure affordable rates, if an
individual must switch to individual insurance, after having
developed a health condition. Individuals may be exposed to
extremely high premiums.

Other Problems Concerning Individual Insurance

--If an individual becomes ill under an individual policy,
their rates can be raised or their policy canceled.
--Insurance companies should not be allowed to move
individual policy holders from one internal risk group to
another so that they can increase individual premiums on some
groups of their policy holders due to claims. I have heard from
some insurance agents that this practice may occur under some
policies without the knowledge of policy holders.
--When one insurance company takes over another insurance
company, the individual policy holders need to be protected
from behind the scenes risk class manipulations, and other
detrimental changes to their policy.
--Insurance companies have sometimes deliberately failed to
send a renewal notice to sick policy holders, hoping they would
forget to renew their policy.
--There should be a guarantee that parents can obtain
insurance for a child born with health problems or birth
defects. Or at least, considering the principle that one
ordinarily buys insurance prior to the risk, parents should be
about to buy the insurance for the child during pregnancy
without health considerations.

Problems Concerning Group Insurance

--HIPAA provides protections for employer group policies
and not other types of groups, such as alumni associations,
professional and trade organizations, etc.
--HIPAA does not prevent an insurer from raising the
premium on a group due to claims from its members.
--When an employer self-insures health of its employees,
the employer should be subject to any regulations that would
effect insurance companies offering a similar policy, including
any applicable consumer protections and liability, if the plan
is of HMO style. The ERISA provisions that release employers
and their HMO's from liability can harm the employee.

Problems Concerning Leaving an Employer Group

--The current guaranteed ability for employees to convert
their existing group policy to an individual policy on leaving
the company is often too expensive, and sometimes reduces the
coverages, if the original policy had riders for some of its
coverages.
--A group policy may not always continue its riders when
used under COBRA. Riders such as prescription drug coverage
should continue.
--COBRA places a responsibility on the employer to continue
insurance, but the insurance company is not required to carry
COBRA customers, sometimes leaving an employer to his own
devices to determine how to provide the ex-employee with
insurance. If the employer cannot meet the responsibility, the
ex-employee patient may be unable to use HIPAA to get an
individual policy because he did not do COBRA first. This
places both the employer and patient in an unfair bind.
Insurance companies have delayed the application process of
HIPAA applicants to cause them to run out their 63 day
eligibility period, in order to avoid covering them.

Other Problems

--Coverage disputes with HMO's need to involve an
independent third party in the appeals hearing.
--The problems regarding health insurance stem partly from
the federal income tax code, which encouraged the practice of
associating health insurance with employment. The tax code is
inconsistent in that employer health insurance is tax free,
while individuals who buy their own insurance pay taxes on
income used for this purpose, except if they are self employed,
then there is partial tax deductibility.
--Many insurance companies and agents refuse to send a
sample insurance policy. This makes shopping for all types of
insurance more difficult.

The Core Reform Proposal:

The following provisions would solve what I believe are
some of the worst problems of the health insurance system:
--To make health insurance more portable (e.g. to better
allow transitions to situations of self employment, jobs that
don't offer health insurance, or leaving the workforce), a
person who developed a condition while under a health insurance
policy (group or individual) would be able to move to a new
individual policy and pay the same rate and be underwritten in
the same class or group of policies as a healthy person of the
same age, sex, and smoking status, in addition to avoiding the
delay for coverage of pre-existing condition.
--A person would retain this protection through multiple
policy changes over a lifetime, as the insurance industry
offerings evolve. This protection is important if a person has
individual insurance and loses it or becomes dissatisfied
because the insurance company ceases service in the area, goes
bankrupt, discontinues or changes the product an unsatisfactory
manner, is merged or taken over by another insurance company,
or the individual cannot afford the premium and needs a lower
cost plan whether offered by the original insurer or a
competitor.
--These protections would apply whenever an individual does
not have a break in coverage longer than 63 days since their
prior period of insurance coverage. To prevent this time limit
from being wasted by stonewalling insurance companies, the 63
days should be counted backward from the date of application
for new insurance, and insurance companies must process
applications in a timely manner.
--These insurance protections should apply to allow insured
young adults to transfer from a parent's health insurance plan
to their own insurance, regardless of health and for Senior
Citizens to transfer between Medicare Supplement policies and
HMO's and vice versa.
--For those who have had a gap exceeding 63 days, insurance
companies would be free to use a separate risk group and higher
prices, based on health history, in order to protect the system
from people who wait until they are sick to purchase insurance.
--The use of standard risk class for these insurance
transfers may imply some minimal protection, even if the law to
allow them is later repealed, as any individual policy obtained
by these guidelines would be an ordinary individual policy,
rather than a separate product or risk class, as now created by
HIPAA, which could be priced or discontinued separately.
--Insurance companies would not be allowed to move
individual policy holders from one risk group to another so
that they can increase individual premiums on some persons.
Individual premiums should be based solely on age, sex, smoking
status, geographic location (a broad-brush division of the
state into several areas), and health history (only if
individual has had a gap in coverage of 63 days or longer
immediately prior to the application date). Individual
experience rating should be prohibited, to prevent rate
increases resulting from a decline of health during coverage.
--The guaranteed acceptance into a group policy for a new
employer would be extended to all groups that a person is a
member of for which health insurance is sold (Alumni
associations, professional and trade organizations, etc.). For
example, if an Alumni association offers group health insurance
to graduates of a particular school or university, it would
have to take all graduates of that school and not impose delays
or higher premiums for pre-existing conditions (subject to the
63 day gap rule).
--Insurance companies would not be allowed to raise the
premium on a group policy due to change in health of existing
members.

Cost Issues Related to the Core Proposal:

--The approach of providing total portability only when an
individual has prior coverage is superior to a simple total ban
on health history questions and pre-existing condition
considerations, as it requires a person to have had insurance
to receive the protections, thus protecting the system against
abuse by people waiting to get insurance until they are sick.
--Imposing this protection only in cases where the person
had prior coverage should minimize any resulting increase in
the cost of individual health insurance, as the total cost
borne by the industry in claims should not be strongly impacted
if a chronically ill person moves from one policy to another,
as that person would not move now if he could not get
satisfactory coverage. (It may be necessary to require that the
policies be similar, to prevent a dramatic, abusive upgrade in
coverage at standard prices after a person becomes ill. It
would also be necessary to allow transfer to a slightly better
policy sometimes, to prevent a long term erosion toward
inferior coverage for people who become chronically ill for
decades and go through several insurers.)
--A reinsurance pool could be used by insurance companies
to protect themselves from the risk of a disproportionate
number of transfers of sick persons to their policies, but this
pool should be invisible to the consumer.
--Due to the provision against raising group premiums,
there may be some small increases in the cost of group
insurance for the more healthy groups that would take place
instead of sharp increases in the cost of group insurance for
groups that have one or more unhealthy members. This is a good
thing, as it make insurance do what it was intended to do--
spread the risk.
--The Core Proposal will require no public funds other than
those used to monitor insurance companies and enforce the
rules.

Other Comments about the Core Proposal:

--These protections would help responsible self employed
and small business owners/employees who have maintained health
insurance, as they could obtain individual insurance at an
affordable price.
--The COBRA problems would disappear, as COBRA would fall
into disuse due to the new better options.

Additional Reforms Needed:

The following provisions would make a more complete reform,
but are outside what I consider to the be core proposal:
--For the poor, Medicaid should be considered a qualifying
insurance for purposes of allowing purchase an individual
policy when a period of poverty ends.
--There should be a guarantee that parents can obtain
insurance for a child born with health problems or birth
defects. Or at least, considering the principle that one
ordinarily buys insurance prior to the risk, parents should be
about to buy the insurance for the child during pregnancy
without health considerations.
--One should be able to purchase health insurance in a
standard risk class upon reaching adulthood, regardless of
whether the parents maintained insurance during childhood, e.g.
to not hold the young adult responsible for mistakes of his or
her parents.
--Many insurance companies and agents refuse to send a
sample insurance policy. The text of all insurance policies of
all types should be a part of the public record to aid shoppers
for insurance. The text of policies can be shown on the World
Wide Web (WWW) at minimal cost to the public and/or insurance
companies may be required to make the sample policies available
at their cost.
--The inconsistent tax treatment of health insurance
premiums should be corrected to reduce this unfairness in the
tax code. Regulations regarding the deductibility of health
insurance premiums should not vary depending on whether
premiums are paid by employer, employee, self-employed
individual, or non worker. But it would be dangerous to
implement the tax change without the other reforms, as some
employers would drop insurance, and many sick people would then
have inadequate protection.
--Lifetime policy dollar limits should be prohibited, or at
least required to be indexed for inflation using a health care
index, or perhaps insurance companies should provide a choice
of several indexed dollar limits, much as a policy buyer
chooses a deductible. Perhaps a minimum dollar limit should be
considered.
--When an employer self-insures health of its employees,
the employer should be subject to any regulations that would
effect insurance companies offering a similar policy, including
applicable HMO consumer protections, if the plan is of HMO
style.
--When one insurance company takes over another insurance
company, policyholders of the old company should have the
option of keeping the original terms of their policy.
--Insurance companies should be required to send bills and
renewal notices to all policy holders in a timely manner. They
should provide the option to the policy holder to have their
bills sent by certified mail return receipt requested for an
extra billing fee equal to the additional postage. If a policy
holder chooses this option, then the insurance company shall be
forbidden to cancel the policy for nonpayment of premium for at
least 30 days after the day the bill is sent, or 30 days after
the renewal date, whichever is later, and then only if they
have the card back that the bill was received. This provides
the customer the option to make it the insurance company's
legal obligation to remind them of their premiums via a bill
and to ensure that the bill must be received. If certified mail
billing is not chosen, cancellation should not occur before 30
days after the renewal date.

Cost Issues Related to the Additional Reforms:

--The provisions for children and transition to adulthood
may require public funds or the cost may be spread out in
higher premiums for everyone or higher premiums for child and
young adult policies.
--If sample policies are to be shown on a government
operated web site, there would be some costs for web
development services to create and maintain the site.
--The tax provision may have a cost, or may raise revenue,
depending on whether all premiums are made deductible,
partially deductible, or taxable.

Statement of Hon. Bill Thomas, a Representative in Congress from the
State of California

I hope the Ways and Means Committee will include additional
pension and Individual Retirement Account options in the coming
tax relief bill because we still face a retirement savings
crisis in the very near future. While Congress is concentrating
on Social Security, we cannot afford to ignore the need for
substantial private savings if Americans are to maintain their
lifestyles after retiring.
Measured by almost any standard, the situation is dire.
Pensions and personal savings are forming the other legs of
retirement security, so it would seem reasonable to expect
Americans to put as much aside as possible. That simply is not
happening. During the 1990s, our national savings rate was a
dismal 3.6%. Last year, with the economy doing well, we might
have expected more savings. Instead, the savings rate dropped
to 1/2 of one percent. The savings devices we have available
simply are not doing the job.
I am cosponsoring the Portman-Cardin pension reform bill
and have introduced pension and Individual Retirement Account
expansion legislation of my own, the Retirement Savings Act of
1999 (H.R. 1546), because it is clear that we need to act
immediately. Merrill Lynch has consistently found in its market
research that Americans are saving only a third of the
resources they need to set aside to prepare for their
retirement. Those approaching retirement are also beginning to
see the problem: 60% of those over 50 years old admit they will
not have what they need. Unfortunately, the distribution of
knowledge is limited. Many people are just flat ignoring the
danger and even among those 51 to 61, a third have a grand
total of $10,000 in savings. We need to give people more tools
with which to save as soon as possible.
Initial evidence on the results of our 1997 expansion of
Individual Retirement Accounts shows Americans will respond
favorably to new incentives for saving. Merrill Lynch reports
that its customers increased IRA contributions 80% last year
and that new information about the ``Roth IRA'' even got
customers interested in the traditional IRA. Similarly, we can
expect people to respond favorably to H.R. 1546's proposed
expansion of IRA contribution limits to $5,000 and similar
increases in limits for 401(k) and government plans. Its
creation of new ``back loaded'' tax free savings options for
participants in more traditional savings accounts, and its
provision of opportunities for older workers to make increased
contributions as they approach retirement.
Now is the time for us to act on these expansions.
Including H.R. 1546 in the coming tax bill would be a
productive way for us to cut taxes and help working Americans
prepare for the retirement income needs they will inevitably
face. A summary of key elements of the bill follows.

H.R. 1546

RETIREMENT SAVINGS OPPORTUNITY ACT OF 1999

Increase IRA dollar limit from $2,000 to $5,000 per year.
Limit will be increased in $100 increments to offset inflation.
Increase Other dollar-based benefit limits: 401(k) and
403(b) plan contributions are increased from $10,000 to
$15,000, 457(b) plan contributions from $8,000 to $12,000 and
the SIMPLE plan limit to $10,000.
Increase IRA Income Caps:
Eliminates income limits on deductible IRA
contributions.
Eliminates income limits on Roth IRA
contributions.
Income cap for conversion of traditional IRAs to
Roth IRAs will be raised to $1 million.
Catch Up Contributions: Those over 50 will be able to
contribute an additional amount in excess of annual limits
equal to additional 50% of the annual limit.
Elimination of 25% of Compensation Limitation: Maximum
contribution to a defined contribution plan for an individual
will be $30,000 per year as a result.
Roth 401(k) and Roth 403(b) plans: Gives participants in
these plans an opportunity to contribute to these plans on an
after-tax basis with earnings being tax free on distribution.
IRA Contributions to an Employer Plan: Allows Employers to
establish plans to which employees can make direct
contributions through payroll deductions.
Full funding limit increase: Law preventing contributions
to a pension plan in excess of 150% of current liability amount
of the plan is repealed.
Electronic Signatures for IRA accounts: facilitates
electronic investment by allowing electronic signatures to be
used in funding and controlling Individual Retirement Accounts.

PROVIDING TAX RELIEF TO STRENGTHEN THE FAMILY AND SUSTAIN A STRONG
ECONOMY

----------

WEDNESDAY, JUNE 23, 1999

House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:00 a.m., in
room 1100 Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]

ADVISORY

FROM THE
COMMITTEE
ON WAYS
AND
MEANS

CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE

June 9, 1999

No. FC-11

Archer Announces Second Day in Hearing Series

on Reducing the Tax Burden:

II. Providing Tax Relief to Strengthen the Family

and Sustain a Strong Economy

Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold the second in a
hearing series on reducing the tax burden on individuals and businesses
to review proposals for providing tax relief to strengthen the family
and sustain a strong economy. On June 2, 1999, Chairman Archer
announced that the Committee on Ways and Means would conduct a hearing
series to examine various proposals to provide tax relief (FC-10). On
the first hearing day, scheduled for June 16, 1999, the Committee will
consider tax proposals to enhance retirement and health security. The
second day of the hearing will take place on, Wednesday, June 23, 1999,
in the main Committee hearing room, 1100 Longworth House Office
Building, beginning at 10:00 a.m.

Oral testimony will be from both invited and public witnesses.
Also, any individual or organization not scheduled for an oral
appearance may submit a written statement for consideration by the
Committee or for inclusion in the printed record of the hearing.

BACKGROUND:

Taxes as a percentage of Gross Domestic Product (GDP) continue to
rise, increasing the tax burden on American families and businesses. In
January 1998, the Congressional Budget Office (CBO) reported that taxes
as a percentage of GDP were 19.9 percent. One year later, CBO reported
that taxes as a percentage of GDP had risen to 20.7 percent. CBO also
reports that the Federal budget surplus has materialized sooner than
anticipated because of the sharp increase in revenues relative to GDP.
Individual income taxes are responsible for most of the recent
increase.

Despite these increases in the tax burden and growing budget
surpluses, the Joint Committee on Taxation (JCT) reported in February
that President Clinton's FY 2000 budget represents an $89.7 billion tax
increase over the next 10 years. According to the JCT, the budget
contains 47 tax proposals that lower taxes by $82.1 billion, but it
also contains 75 proposals that raise taxes by $171.8 billion, for a
total tax increase of $89.7 billion.

In announcing the hearing, Chairman Archer stated: ``Taxes are too
high, and American families and businesses deserve relief. When taxes
are the highest they've been since World War II and keep going up, we
should be looking for ways to cut taxes, not raise them even higher. I
am committed to providing meaningful tax relief this year. If we don't
cut taxes now, the politicians in Washington will spend every last
dime--they always have, and they always will.''

FOCUS OF THE HEARING:

The focus of the second hearing day will be on proposals to
strengthen the family and sustain a strong economy. Attention will
first be given to proposals such as marriage penalty relief, education
incentives, and individual alternative minimum tax relief. Attention
will then be focused on proposals including: expiring tax provisions,
investment incentives, corporate alternative minimum tax relief, and
other domestic business tax incentives.

DETAILS FOR SUBMISSIONS OF REQUESTS TO BE HEARD:

Requests to be heard at the hearing must be made by telephone to
Traci Altman or Pete Davila at (202) 225-1721 no later than the close
of business, Tuesday, June 15, 1999. The telephone request should be
followed by a formal written request to A.L. Singleton, Chief of Staff,
Committee on Ways and Means, U.S. House of Representatives, 1102
Longworth House Office Building, Washington, D.C. 20515. The staff of
the Committee will notify by telephone those scheduled to appear as
soon as possible after the filing deadline. Any questions concerning a
scheduled appearance should be directed to the Committee on staff at
(202) 225-1721.

In view of the limited time available to hear witnesses, the
Committee may not be able to accommodate all requests to be heard.

Those persons and organizations not scheduled for an oral
appearance are encouraged to submit written statements for the record
of the hearing. All persons requesting to be heard, whether they are
scheduled for oral testimony or not, will be notified as soon as
possible after the filing deadline.

Failure to do so may result in the witness being denied the
opportunity to testify in person.

WRITTEN STATEMENTS IN LIEU OF PERSONAL APPEARANCE:

Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Wednesday,
July 7, 1999, to A.L. Singleton, Chief of Staff, Committee on Ways and
Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
public at the hearing, they may deliver 200 additional copies for this
purpose to the Committee office, room 1102 Longworth House Office
Building, by close of business the day before the hearing.

FORMATTING REQUIREMENTS:

Note: All Committee advisories and news releases are available on
the World Wide Web at ``http://www.house.gov/ways__means/''.

Chairman Archer. Good morning to everyone on this beautiful
June day.
The Committee will continue its hearings today into how
best to reduce the peacetime record-high tax bite on the
American people. Americans are paying too much in taxes and, as
history has shown, any taxpayer money left in Washington most
surely will be spent. Today's hearing will focus on ways to
help hardworking families and individuals and companies for
which they work.
The marriage tax penalty continues to penalize 21 million
American couples with a higher tax burden for the simple reason
that they are married. At a time when the experts tell us that
children in one-parent families often fare worse than those
with two parents, we should be encouraging marriage, not
penalizing it.
Likewise, we should be looking for ways to strengthen and
improve education. No question, many Americans receive a world-
class education. But for many other Americans, the state of
education is not as good as it could be. I am very interested
in proposals like my Education Savings Account bill which would
give a helping hand to our children, their parents, and their
schools. That bill received bipartisan support in the House and
Senate, but did not receive favor from President Clinton. I
hope President Clinton will reconsider his opposition to this
common sense approach because elected officials and wealthy
Americans should not be the only ones who can afford to send
their children to good schools.
As I said in February, my 1999 tax bill will include a $2.5
billion school construction initiative that makes permanent
changes to tax-exempt bond rules to spur school construction
now and in the future. This plan will make it much easier for
State and local governments to comply with complicated bonding
rules and will help build more public schools all across the
country, from the Spring Branch Independent School District in
Texas to larger school districts in Los Angeles, New York, and
everywhere in between.
Finally, we will explore ways to encourage savings and
investment, which helps families build wealth and keeps our
economy strong. The Congressional Research Service projects
that 83.6 million Americans will own stock in 1999. That is an
all-time high. It is 170 percent more than in 1970. Today
owning stocks is no longer just for Wall Street and high-
rollers. Women are creating investment clubs at an amazing pace
all across the Nation.
Clearly, we are at a crossroads. The old approach of income
redistribution has failed to end poverty or close the widening
income gap. We shouldn't be fixing old problems with old ideas.
Rather, we should work to expand opportunity for all Americans
so they, too, can enjoy our strong economy and now is our
chance, this year.
I now recognize Mr. Rangel for any statement that he might
like to make. Without objection, all Members will be entitled
to insert any written statements in the record.
Mr. Rangel.
Mr. Rangel. Thank you, Mr. Chairman, for this opportunity
to listen to some views that people may have as to how we can
improve our Tax Code and encourage economic growth, as well as
views about strengthening the family. I will be brief since I
intend to testify as a witness myself. I do hope that these
open hearings will continue and that we in the Minority will
have the opportunity to work with those of you in the Majority
so that we can develop a bipartisan tax bill which not only we
can support, but that the President can sign into law.
Thank you.
Chairman Archer. I thank the gentleman. Our lead-off
witness today is a man whose name has been well-known in
history to the people of this country. I might say one that I
have greatly respected all of my life. For the purpose of
introduction, I am going to recognize the gentleman from Ohio,
Mr. Portman.
Mr. Portman. I thank the Chairman very much for allowing me
to briefly introduce a long-time friend and, actually, one of
my most distinguished constituents, Bob Taft. Bob is our new
and very popular Governor of the state of Ohio, but he is not
new to these issues, Mr. Chairman. He has been, as Secretary of
State, up here in Washington giving us guidance, working with
the National Association of the Secretaries of State. Before
that, he was a State representative. Before that he was a
country commissioner. So he brings a wealth of government
experience and knowledge to the task before us today which is
looking at the Federal Unemployment Tax. And I applaud him for
the work he is now doing, picking up for Governor Voinovich and
others, as head of the Coalition for Employment Security
Financing Reform. And we are delighted to have him before the
Ways and Means Committee today.
Chairman Archer. Governor, welcome. We are honored to have
you here and we will be pleased to receive your testimony.

STATEMENT OF HON. ROBERT ``BOB'' A. TAFT, GOVERNOR, STATE OF
OHIO; ON BEHALF OF COALITION FOR EMPLOYMENT SECURITY FINANCING
REFORM

Governor Taft. Thank you very much, Mr. Chairman. I want to
thank you and Congressman Rangel and also my hometown
Congressman Portman for the courtesy you have shown in allowing
me to testify first this morning. I really appreciate that.
Mr. Chairman, Members of the Committee, my name is Bob
Taft, Governor of the state of Ohio. Thank you for the
opportunity to appear in support of the repeal of the temporary
Federal Unemployment Tax surcharge and to urge you to reform
the employment security financing system to provide full
funding for the unemployment insurance and employment services
programs.
Congress enacted the FUTA, Federal Unemployment Tax Act,
surcharge in 1976 to provide funds to reimburse depleted trust
fund accounts that have long since been restored. The Balanced
Budget Act of 1997 extended this surcharge much longer than
necessary to the fiscal year 2007. There is no longer any
justification for the extension of this temporary tax surcharge
at the level of .2 percent.
Not only are employers being overtaxed, but appropriations
from this dedicated source of administrative funds have been
cut. In 1997, 49 of the 53 States and jurisdictions receiving
administrative funding for unemployment insurance and
employment service functions received less from Washington than
the FUTA taxes they collected from employers in their States.
Since 1990, less than $0.58 of every employer FUTA tax $1.00
has been returned in administrative funding to the prepared
states.
A comparison of the taxes paid by employers to
administrative funds provided to the prepared States paints a
compelling picture. From 1993 to 1997, FUTA tax collections
increased from $4.23 billion to $6.45 billion while
administrative funding to the prepared states was cut from
$3.81 billion to $3.36 billion. I have included with the
testimony a graph of this trend to demonstrate the growing
inequity of this system. Although the latest data are available
only through 1997, the trend line has continued in 1998 and
1999, rendering the return of employer taxes to the prepared
States an increasingly smaller percentage with each year.
In our State of Ohio, we receive less than $0.37 on the
$1.00 that we send to Washington. Inadequate funding in recent
years has caused us to close 22 local employment offices,
significantly reduce staff, and use State general revenues to
make up for cuts in Federal funds that are being maintained in
trust, ostensibly to provide the very services that have been
cut through the appropriations process. The differential
between Federal administrative funds provided and actual costs
continues to increase for our State. In 1993, the State deficit
in Federal funding compared to cost was $13.3 million. By 1997,
that deficit had grown to $18.1 million.
We must do a better job of supporting State efforts to
ensure the ability of American families to adjust to the
demands of the work force in the coming century by providing
adequate funding for employment services for those who become
unemployed. It is time for a change. We need a system that
properly funds States for administration and minimizes the tax
burden on the employers who pay for it. We need to ensure
employers that the employment taxes they pay will be used for
the employment services promised when the tax was first
imposed.
A coalition of 28 State and over 90 State and national
employer organizations representing millions of employers have
formed a coalition for reform of employment security financing.
The coalition worked with Representative Clay Shaw to develop
H.R. 3684 in the last session. Ohio Senator Mike DeWine has
introduced a similar bill, S. 462 earlier this year designed to
reform the system.
The proposal has been carefully crafted to address the
Federal/State partnership, appropriate funding levels, and
employer taxes. The proposal includes provisions to repeal the
0.2 percent FUTA surcharge; to transfer responsibility for
collection of the FUTA tax to States; to provide adequate
dedicated funds for administration of the unemployment
insurance program and public employment services; and to
increase the flexibility of the use of funds as part of the
work force development system designed by each State.
It is time to repeal this unnecessary surtax. I urge you to
favorably consider legislation such as that introduced by
Senator DeWine.
Thank you very much, Mr. Chairman.
[The prepared statement follows:]

Statement of Hon. Robert ``Bob'' A. Taft, Governor, State of Ohio; on
behalf of Coalition for Employment Security Financing Reform

Mr. Chairman, members of the committee, my name is Bob
Taft, Governor of Ohio. Thank you for the opportunity to appear
before you today in support of the repeal of the ``temporary''
Federal Unemployment Tax (FUTA) surcharge and urge you to
reform the employment security financing system to provide full
funding for the unemployment insurance and employment service
programs.
Congress enacted the FUTA surcharge in 1976 to provide
funds to reimburse depleted trust fund accounts that have long
since been restored. The Tax Relief Act of 1997 extended this
surcharge much longer than necessary through the year 2007.
There is no justification for the 30 year extension of this
``temporary'' tax surcharge.
Not only are employers being overtaxed, but appropriations
from this dedicated source of administrative funds have been
cut. In 1997, 49 of the 53 states and jurisdictions receiving
administrative funding for unemployment insurance and
employment service functions received less than the FUTA taxes
collected from employers in the states. Since 1990, less than
58 cents of every employer FUTA tax dollar has been returned in
administrative funding for states.
A comparison of the taxes paid by employers to
administrative funds provided to the states paints a compelling
picture. From 1993 to 1997, FUTA tax collections increased from
$4.23 billion to $6.45 billion while administrative funding was
cut from $3.81 billion to $3.36 billion. I have provided a
graph of this trend to demonstrate the inequity of the system.
Although the latest data is only available through 1997, the
trend line has continued in 1998 and 1999, rendering the return
of employer taxes to the states an increasingly smaller
percentage with each year.
In Ohio, we receive less than 37 cents on the dollar.
Inadequate funding in recent years has caused us to close 22
local offices, significantly reduce staff, and use State
general revenue to make up for cuts in federal funds that are
being maintained in trust ostensibly to provide the very
services that have been cut through the appropriations process.
The differential between federal administrative funds
provided and actual costs continues to increase. In 1993 the
state deficit in federal funding compared to cost was $13.3
million. By 1997 the deficit had grown to $18.1 million.
We must do a better job of supporting state efforts to
ensure the ability of American families to adjust to the
demands of the workforce in the coming century by providing
adequate funding for employment services for those who become
unemployed.
It is time for a change! We need a system that properly
funds states for administration and minimizes the tax burden on
the employers who pay for it.
A coalition of 28 states and over 90 state and national
employer organizations representing millions of employers have
formed a coalition for reform of employment security financing.
The coalition worked with Representative Clay Shaw to develop
HR 3684 last session. Senator Mike DeWine introduced a similar
bill, S 462, earlier this year designed to reform the system.
The proposal has been carefully crafted to address the
federal/state partnership, appropriate funding levels, and
employer taxes. The proposal includes provisions to:
Repeal the .2 FUTA surcharge;
Transfer responsibility for collection of the FUTA
tax to the states;
Provide adequate dedicated funds for
administration of the unemployment insurance program and public
employment services; and
Increase the flexibility of the use of funds as
part of the workforce development system designed by each
state.
It is time to repeal this unnecessary tax. I urge you to
favorably consider legislation such as that introduced by
Senator DeWine.

[GRAPHIC] [TIFF OMITTED] T0841.001

[GRAPHIC] [TIFF OMITTED] T0841.002

Chairman Archer. Governor, thank you for taking your time
to appear before us on an issue that I believe is extremely
important. Has the Governors Conference taken a position on
this issue?
Governor Taft. The National Governors Conference has not,
but it is a project that I will be urging them to take on in
our summer conference in St. Louis this year. As I indicated,
we have 28 States signed up. Other States are supportive, and I
believe that we have a good chance of getting NGA support for
the project.
Chairman Archer. Do you know of any Governor who does not
share your views?
Governor Taft. I do not. There may be some, but I have not
had a chance to speak to every Governor on this particular
issue.
Chairman Archer. OK. I only have one last question. As you
are aware, the President has said that the States should use
their unemployment trust funds in order to pay for family
leave. Do you have a position on that?
Governor Taft. We are aware that the President has made
this proposal. We are examining the costs and benefits of this
proposal currently in Ohio. We are also waiting for additional
clarification from the Department of Labor that would assist us
to understand the consequences of the proposal, so we have that
proposal under examination at the present time.
Chairman Archer. So, currently, you do not have a position
established on that proposal.
Governor Taft. That is correct.
Chairman Archer. Thank you, very much, Governor.
Mr. Rangel.
Mr. Rangel. Thank you, Mr. Chairman. And thank you,
Governor. I think our President's position is that the funds
could be used for family leave, not that they should. As a
matter of fact, I think, Governor, that you yourself would like
to use the funds for work force development systems.
Governor Taft. Work force development, yes, sir.
Mr. Rangel. And, clearly, family leave could be
incorporated. Could be, but I think that would be your call.
You would not object if you wanted to use it that way, would
you?
Governor Taft. Well, we are reviewing that whole issue in
Ohio.
Mr. Rangel. Exactly.
Governor Taft. And, you know, we will be in a better
position after we hear more from the Department of Labor about
what is contemplated to take a position on that issue.
Mr. Rangel. Well, I think President Clinton has made it
clear that this is a State issue for Governors to decide and
certainly not the White House.
Governor Taft. Yes, we would feel a lot better about some
of these new proposals if we could get more of our Federal
employer taxes back in Ohio.
Mr. Rangel. Well, tell me, you indicated that you receive
back only less than $0.37 on the $1.00 paid in. That is as it
relates to the FUTA tax?
Governor Taft. Yes.
Mr. Rangel. Do you know what your return is on the Federal
dollar coming back to Ohio, as opposed to the Federal taxes
that are paid?
Governor Taft. Are you referring to total Federal dollars
for all purposes?
Mr. Rangel. Yes. Yes.
Governor Taft. We are under 100 percent, but I don't have
the exact percentage with me this morning.
Mr. Rangel. What other examples of work force development
systems would you think about using the funds for?
Governor Taft. Well, we have a huge challenge, Congressman,
in implementing the Welfare Reform Act. We have made progress,
but we need to do more to help those folks who remain on the
rolls to address their issues through training, through
education, through services, through matching them with jobs in
order to meet the goals that have been established by the
Congress in the Federal Welfare Reform Act.
In addition to that, we now have many of these people who
are working. So, really, they have transferred over from the
welfare system to the unemployment or employment system. We are
very concerned as to what happens to them if they should lose
their employment, that they need services promptly,
expeditiously, effectively, to help them to reenter the work
force and obtain employment once again. So we want to improve
and streamline and use these funds to improve our work force
development and training programs, both for welfare reform and
also to match employees throughout the state to jobs in a very
tight economy.
Mr. Rangel. Well, I certainly support the goals that you
want to achieve and thank you so much for taking the time to
share your views with this Committee.
Governor Taft. Thank you very much, Congressman.
Mr. Rangel. Thank you, Mr. Chairman.
Chairman Archer. Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman. Governor Taft, tell
us again why this 0.2-percent surtax was levied in the first
place.
Governor Taft. It was levied back in 1976 because at that
time the trust funds were depleted. There was much unemployment
and economic hardship at that time. There was extension of
unemployment compensation benefits. But my understanding is
that those funds were replenished in 1987, which is, of course,
12 years ago. And my understanding also is that, currently, the
balances in the unemployment and employment services trust
funds now are in the neighborhood of $20 billion and the
current Federal obligations could be met merely by the interest
on the trust funds that have accumulated over the years.
Mr. McCrery. So this was a dedicated tax, dedicated to a
specific purpose, levied on employers around this country and
that specific purpose was met in 1987.
Governor Taft. That is correct. It cost employers $14.00
per employee.
Mr. McCrery. And so, since then, this tax has been
extended, not for the original purpose, but really just to
provide general revenues to the Federal Government.
Governor Taft. That is exactly right. It is on-budget money
that is used for the Federal deficit.
Mr. McCrery. In Louisiana, we get about 40 percent of the
administrative funds back from the Federal Government. You
stated that less than 58 percent, generally, around the United
States, is returned to the States. So Ohio and Louisiana are
not doing as well as the national average. We need to work on
that.
But it is really, the Federal portion of the unemployment
tax is principally used, is it not, or dedicated, to
administrative expenses of the States in administering this
program.
Governor Taft. That is exactly right. The tax I am
referring to, the FUTA tax, is for administrative purposes.
Mr. McCrery. So its principal purpose is not to pay
benefits, but to pay administrative expenses.
Governor Taft. That is correct. These changes have nothing
to do with and do not alter the payroll tax that States collect
for benefits and forward to the U.S. Treasury, which is in turn
paid out for benefits. This is the administrative side of the
equation.
Mr. McCrery. And you are telling us that even though that
tax is supposedly dedicated to reimbursing the States for
administrative expenses, States are only getting back 58
percent of what they pay in.
Governor Taft. That is exactly right.
Mr. McCrery. How does welfare reform fit with this picture?
Does it make it more difficult on the States in terms of the
administrative expenses of their unemployment program?
Governor Taft. Well, we are trying to modernize our work
force development system in Ohio through the use of computers
and telecommunications and other means to help to place those
recipients who are still on our rolls into jobs. And we have an
opportunity to do so in a tight job market, but the lack of
Federal funding coming back for work force development and
employment service training is making it more difficult for us
to achieve those goals and realize the targets that have been
set for us under Federal welfare reform legislation.
Mr. McCrery. Governor Taft, I agree with you that this is a
tax that should have been repealed a long time ago. I think it
is unfair for the American people and, in this case,
particularly, employers to be told they are going to be taxed
for a specific purpose and then that specific purpose is
satisfied and yet the tax continues to be levied. That is just
not the way we ought to operate, in my view, as representatives
of the people in this country.
Governor Taft. I am very pleased to hear that.
Mr. McCrery. So I appreciate very much your testimony.
Governor Taft. Thank you.
Mr. McCrery. Thank you.
Chairman Archer. Mr. Houghton.
Mr. Houghton. Thank you, Mr. Chairman. Governor, great to
have you here.
Governor Taft. Thank you.
Mr. Houghton. Let me try to understand this in terms of a
taxpayer. There was a tax levied in 1976. It served its
purpose. The purpose is no longer there. Therefore, you want to
repeal that tax. But, at the same time, if I understand it, if
I am a citizen of this country, I will still be paying the same
tax, but it will be levied by the State. Is that right?
Governor Taft. No, no. Regarding the 0.2-percent surcharge,
we propose and Senator DeWine's legislation proposes, should be
completely eliminated. So the employers would no longer have
that burden. That would relieve the employers of the country of
a tax burden of about $1.6 billion per year.
Mr. Houghton. Yes, but does the State pick up that
corresponding part of the tax if it needs it later on?
Governor Taft. No. No, that would not be picked up by the
State. The 0.2-percent surcharge is just a small part of the
total FUTA tax. The total FUTA tax net is about 0.6 percent.
That 0.6 percent tax for administering unemployment
compensation would remain in place unaffected by this.
Mr. Houghton. I see. Thank you very much.
Chairman Archer. Does any other Member wish to be
recognized? Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman. Governor Taft, aren't
State trust fund accounts currently running balances that are
lower as a proportion of covered wages than in earlier periods?
Governor Taft. I am not--could you repeat that question
again? I am not sure that I understand it.
Mr. Coyne. Well, the percentage of the balances in the
trust fund account are lower than the total wages that people
earn that are covered by unemployment insurance. It is a lower
percentage.
Governor Taft. Well, in terms of unemployment compensation
benefits, those are basically in balance. The benefits paid out
and the taxes collected for benefits are basically in balance
and the States have the ability to adjust those under Federal
law to make sure that they do balance. If there is a need for
additional dollars, then the unemployment compensation tax
would be increased in any particular State. So those funds stay
in balance.
What we are referring to here today is the administrative
side of the equation. And all of these trust funds, by the way,
are held in the U.S. Treasury and the States draw down from
them. But in the administrative accounts for unemployment
administration, there is a total balance here in Washington of
in excess of approximately $20 billion.
Mr. Coyne. But if--or more likely when--we have the next
recession, if you were not to have this surcharge, would that
not put an administrative burden on the States that they
wouldn't be able to handle if, as I say, or when, the recession
comes?
Governor Taft. Well, the States will be able to pay their
share. For example, for extended unemployment compensation
benefits that would be paid in a time of recession, the States
pay 50 percent. We are prepared to pay that share. The Federal
Government's share is also 50 percent. And there is a special
fund dedicated in the Federal Government to pay that amount. It
is called the Extended Unemployment Compensation Account.
Currently, in 1999, the balance in that account is $16.9
billion. The last recession in the early nineties cost a total,
in terms of additional costs to the Federal Government, of
about $4 billion. So you have a balance, currently, more than
four times what the last recession cost in terms of providing
extended unemployment compensation benefits to workers who had
lost their jobs.
Mr. Coyne. Well, as I look at it----
Governor Taft. Healthy balance.
Mr. Coyne [continuing]. Yes. As I look at it, the trust
fund is a trust fund that is needed for a rainy day. We are all
experiencing a very vibrant and positive economy in this
country today, but I think that the purpose of this fund has
always been for the rainy day that is sure to come. It is not a
matter of whether it is going to come, it is when it is going
to come.
Thank you.
Governor Taft. Yes, that is correct. But just to reiterate,
the almost $17 billion balance in that particular fund would be
more than ample for virtually any kind of a rainy day that
would be contemplated, based on previous recessions.
Chairman Archer. Mr. Portman.
Mr. Portman. Thank you, Mr. Chairman. And, Governor, again,
thanks for taking the time to be in Washington today to help us
out with this issue. In terms of the rainy day issue, I think
it is probably important to note that the U.S. Department of
Labor has set some standards and, based on the Department of
Labor's own standards, I think those trust funds at the Federal
level exceed the projections of payout through fiscal year
2004.
Governor Taft. In fact, Congressman Portman, I understand,
under current Labor Department projections, the interest alone
on the Federal trust funds is adequate to pay for the
anticipated Federal expenses through fiscal year 2004.
Mr. Portman. Well, I appreciate your raising this issue
with the Membership. I think a lot of Members of Congress
probably aren't as focused on this as you are, heading up this
coalition and now some of the other Governors. I think it would
be helpful if we could hear from you as to the impact on
employers in the state of Ohio and all the other States
represented by this panel today. What is the impact of
continuation of the surcharge tax?
Governor Taft. Well, in the state of Ohio alone, in terms
of the 0.2 percent surcharge, employers are paying $70 million
per year. And across the country, that would translate into
$1.6 billion, just the surcharge portion alone. So we would be
talking about significant savings to employers.
In addition to that, currently the States collect the tax
for benefits and the Federal Government, IRS, collects the tax
for administration. So employers have to deal with two
different entities on basically the same program. This is very
complicated and imposes significant additional administrative
costs on employers across the country. I have seen one estimate
as much as $1 billion of additional administrative expenses.
And what we propose in Senator DeWine's legislation is that the
States would collect both those taxes, which would streamline
the collection of taxes and save some additional administrative
expenses to employers, in addition, of course, to the reduction
they would see from the elimination of the surcharge.
Mr. Portman. Well, again, I encourage you to keep pursuing
that overall reform. I think it is worth noting that the DeWine
legislation and the Shaw legislation from last year goes beyond
repealing the surcharge, which, again, was put in place in 1976
for a problem that was resolved by 1987. And it seems to me
that is inappropriate, given the Department of Labor's own
projections to continue to hoard here in Washington when it
should be going back.
But these reforms go beyond that, as you indicate, to
streamline the system. And I know there is a lot of interest on
this panel in doing that. Even outside this panel, Mr.
Traficant has approached me a number of times. Mr. Collins has
worked on this issue. Mr. McCrery is working on this issue. Mr.
Shaw and others and colleagues from the other side of the
aisle. So I hope it is something that we can work on this year,
in conjunction with the Senate, and begin not just to look at
the surcharge, which is a very important issue--I know that is
the focus of your comments today--but also your other ideas on
how to streamline the system and make it better for employers.
After all, this is much like the Social Security payroll
tax. The employer side comes out of the employees pocket. And
we are talking about an impact on employers, but, ultimately,
it comes out of the worker's paycheck.
Governor Taft. That is right.
Mr. Portman. Again, thank you very much for being willing
to spend the time with us today.
Governor Taft. Thank you, Congressman.
Chairman Archer. Mr. Cardin.
Mr. Cardin. Thank you, Mr. Chairman. Governor, it is a
pleasure to have you here.
Governor Taft. Thank you.
Mr. Cardin. Let me just make one point. I think many of us
are sympathetic to the concerns that you raise about repealing
the 0.2 percent surcharge, but, as has been pointed out, under
our budget rules, that would have to be offset. That that is
revenues that come in under the Unified Budget as an on-budget
revenue source, as you have pointed out. Some of us aren't very
happy about our budget rules, but we have to comply with our
budget rules.
So I am just curious. Have you come forward today with some
suggestions on how we might be able to offset that?
Governor Taft. First of all, I want to congratulate the
Congress on the tremendous progress you have made toward
achieving a balanced budget. I think it is truly remarkable. In
fact, your success creates the opportunity for us to now come
in and say, ``Now that you are balancing your budget, how about
this surtax that you imposed over 20 years ago that we are
still paying? And you are not sending us back enough to
administer our unemployment compensation programs.'' And I
recognize there would be a cost of $1.6 billion which the
Congress would have to find from some source. And I would like
to think it most appropriate for me to leave it to the wisdom
of you and your Members and the Congress to determine how that
might occur.
But we would really earnestly ask you to consider looking
at this particular issue. Because I think we can make the
system both better and more fair.
Mr. Cardin. Well, having served on this Committee for now
close to 10 years, I can assure you we don't have exclusive
wisdom on that. So we will take whatever help we can get on
trying to come up with offsetting revenues.
Let me mention the second point. I also served in the
Maryland legislature for 20 years during a very difficult
period in the eighties when we went into special session
because of unemployment insurance and had a crisis in our State
in order to try to meet the burdens that were on our workers
who were out of work. You point out that there is at least some
balance, a significant balance, in the fund to deal with these
problems. But let me just caution all of us that when we change
these funding sources, to remember that when we go into
recession, it is difficult to raise the revenues necessary to
deal with extended benefits. And extended benefits can be more
costly than the $4 billion that you mentioned.
And if we are going to make a permanent change in repealing
the surcharge, then I think we also must have a safe plan to
deal with workers who are going to be out of work needing
extended benefits, perhaps for an extended period of time. That
was the whole concept of the shared relationship between the
Federal Government and the States. And this surcharge does go
into that fund. It is not just administrative. The moneys go
into the extended benefit program as part of the 0.8 percent
and goes into a loan fund that is available to States if they
need to do that.
So I guess my point is I agree with your testimony. Clearly
the original purpose for which the surcharge was put into
effect, we have accomplished those goals. But we should be
mindful that when you are in recession, it is the most
difficult time to try to find the revenues necessary,
particularly at the state level, to deal with these issues. And
I would invite your comments.
Governor Taft. Yes, I would concur with your comment there,
and we certainly would not propose that you reduce the
balances--the very, really extraordinary balances that exist
now in the different funds that provide that cushion against a
recession. That is very, very important. All we are suggesting
is that it may not be necessary, because of the size of these
surpluses, to continue to add additional money to those
surpluses at the expense of the States.
Mr. Cardin. Well, one of the things that you could do is
have some form of an automatic trigger so that it doesn't
require additional congressional action if the fund balances
drop below a certain amount. There are certain things that we
could do in order to ensure that the extended benefit program
is adequately financed.
Governor Taft. Yes.
Mr. Cardin. Thank you, Mr. Chairman.
Chairman Archer. Mr. Collins.
Mr. Collins. Thank you, Governor, for being here with us
this morning.
Governor Taft. Thank you.
Mr. Collins. The former Governor of Georgia, Governor Zel
Miller, was very supportive of not only repealing the surtax,
but also devolving the tax back to the States, as well as our
former labor commissioner who came up several times on this
particular issue. Where we have always run into opposition here
or problems is from organized labor. And you can understand
their concerns. Which are that they are afraid that if this
tax, the surtax, is repealed and the tax is devolved back to
the States, that it could have some negative impact on
benefits. Do you see any negative impact?
Governor Taft. Absolutely not. This is an entirely separate
funding stream. In fact, it might be possible that, as a result
of this reform, more of the administrative moneys would find
their way into the benefits fund, which would create the
opportunity to possibly even increase benefits if necessary at
a time of recession.
Mr. Collins. Well, I think that is a point that should be
well made by you and other Governors and labor commissioners
across the country who support not only repeal, but devolving
the tax back to the States. As you say, it can help support
your State labor agency itself and the programs there. It also
gives you a lot of flexibility. Mr. Cardin mentioned a special
session in Maryland. We went into legislature in Georgia back
in the late eighties and early nineties. Commissioner Joe
Tanner wore out a pair of shoes walking the halls of the
general assembly encouraging an increase in the tax in Georgia
to build a fund. And he was successful and I voted for that. It
was one of the very few times that I have ever voted for any
type of tax increase at all.
But we did that under the pretense, too, that if we built
this fund, at some point we would be able to give relief to
employees. And I see where here we can give relief to employers
and employers then can also have the funds to better the
benefits of their employees in other ways.
Governor Taft. Exactly.
Mr. Collins. Rather than through a tax that has to be
funneled back through the government which, oftentimes, as you
say, is just totally eaten by administrative costs. So we
appreciate your support.
Governor Taft. Thank you very much.
Mr. Collins. Appreciate you being here. And, hopefully, we
will be successful. As far as the offset, as I have told a lot
of groups that I have spoken to in the last few days, this is a
game of dealer's choice. The dealer happens to be the Chairman
from Texas. I hope this is part of his choice.
Thank you. [Laughter.]
Governor Taft. Thanks very much, Congressman.
Chairman Archer. Governor, I see--let me first recognize
the gentleman from Michigan, Mr. Levin.
Mr. Levin. Thank you, Mr. Chairman. Welcome, Governor.
Governor Taft. Thank you.
Mr. Levin. We have met under--in other ways and I have
enjoyed our relationship.
Governor Taft. Thank you.
Mr. Levin. And I am glad you are here because--for a
variety of reasons--you help open up the discussion of
unemployment compensation maybe beyond your expectation. But it
is useful to do that.
Mr. Cardin and Mr. Coyne raised questions about extended
benefits and I hope you would take a look again, if you would,
at the experience of Ohio and other industrial States. And not
in the recession of the early nineties, but the recession in
the early and mid-eighties. Because you referred to enough
moneys to handle the unemployment in the a recession type of
nineties, but, you know, in the mid-eighties, we were
struggling incessantly here with the issue of extended
benefits. And I don't have, offhand, the amount, but it was far
beyond the amount needed in the recession of the nineties.
We have an extended benefit program that is inadequate and
was grossly so in the eighties. And your State suffered
terribly as a result. And it was two or three times that we had
to struggle to revise the extended benefit formula. So I would
hope, as Governor of a large and important and dynamic State,
you would take another look at the extended benefit program and
tell us whether you think it is adequate. Because the focus
should not only be on the 0.2 percent--and I think there are
problems with the administrative end of it--but also with the
entire system that the 0.8 percent finances.
Because you may be unhappy if there is another recession
with action taken here. I have a chart from the Labor
Department and I don't know all the definitions, but it
diagrams, it spells out how much the States have in their funds
to last for their own programs in the case of a severe
recession. And Ohio is toward the bottom, quite below the state
average in terms of how long the funding would last.
[GRAPHIC] [TIFF OMITTED] T0332.022

Also--and it is not directly related--but the recipiency
rates have been going down in this country. And today the U.S.
average unemployment covering the unemployed is 36 percent--
only 36 percent--of the unemployed are covered by the present
system. My own State of Michigan, that is 48 percent.
Pennsylvania is 53 percent. I am using other industrial States.
And Illinois, if I can pick it out here, is 39 percent. And
Ohio is 31 percent. So the way your unemployment system in your
State is structured, less than a third of the unemployed
receive unemployment compensation.
So I urge that we take this proposal and look at the
extended benefit program, as well as other facets of our
unemployment compensation system. And coming from a State that
has experienced ups and downs maybe beyond the norm or the
average, I would be interested in your sending us your thoughts
about the extended benefit program. You know, one of the
problems is it doesn't click it. As I remember it, Ohio wasn't
even covered by the present law during the severe recession of
the eighties. We had to redo the formula.
Governor Taft. We did provide extended benefits, I know,
but----
Mr. Levin [continuing]. But the original--the formula as it
is presently devised I don't think covers it. So give us the
wisdom of your further inquiry, if you would. And let us look
at the administrative part of this, but also other facets of
the system that are supposed to be financed beyond
administrative.
Governor Taft. We will do that.
Mr. Levin. All right. Thank you.
Governor Taft. Thank you.
Chairman Archer. Does any other Member wish to inquire?
[No response.]
If not, Governor, thank you so much for taking the time to
make your presentation to us.
Governor Taft. Thank you very much, Mr. Chairman. I really
appreciate the opportunity to testify.
Chairman Archer. You are welcome.
Governor Taft. Congressman Rangel, thank you very much.
Chairman Archer. Our next panel is a number of our
colleagues, led by Mr. Rangel. You will come and take seats at
the witness table. If a few more of our Members go down and
join you, then we will not have anybody up here to ask the
questions. Mr. Rangel, welcome to the Ways and Means Committee.
We would be pleased to receive your testimony.

STATEMENT OF HON. CHARLES B. RANGEL, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF NEW YORK

Mr. Rangel. Thank you. The last time that you, Mr.
Chairman, testified as a witness, you made it clear that it may
be your last time. I hope this is not the last time that I have
a chance to testify.
Let me thank you and my other colleagues for being here
this morning as we listen to ideas that Members and others have
as to how we can improve the Tax Code and quality of life for
most Americans. As I said earlier in my opening statement, I
hope we have the same opportunity to share ideas when we are
drafting the tax bill as we have had today to listen to ideas.
Mr. Chairman, as you and I work together to see how much
support we can get in a bipartisan way to repair our Social
Security system, I believe that, if we are able to accomplish
this, it would give a lot of confidence to the House of
Representatives and, hopefully the Senate, that we can tackle
serious problems in a serious way. If there are some people who
believe that Democrats can benefit by the failures of the
Majority, I don't agree with them. I don't think that the
electorate is sophisticated enough just to pick out Republicans
as having failed. We might all get caught in their outrage and
achieve that reputation as well.
And I do believe that with the serious problems that we
face as a nation, there are serious, very serious, differences
in how Republicans and how Democrats approach those problems.
Under our great system, we give the voters an opportunity to
see which direction is most compatible with their beliefs.
Certainly, when we deal with the questions of health care,
the patients bill of rights, gun safety, or housing, there is
enough controversy. But to me, one of the most important issues
on which we are divided is education. When we move into this
next century, our young people have to be prepared better than
ever before to meet the challenges of international trade and
competition. We have an obligation not to say that education is
a local or State issue, but instead to make certain that
American workers are the best trained workers in the entire
world.
It has been reported that some people in the Majority would
want a State to be able to remove itself from the direction of
Federal legislation in providing assistance to kids that come
from poorer communities, that is to allow that State to opt out
of that system and to use the money for whatever purpose it
wishes without any Federal direction. There are others who
believe that the best way to handle the problem of education is
to allow the parent to deposit money into a bank account on
which the parent would receive tax-free benefits and that the
money could be used in any way to assist the child, perhaps for
private education. Of course, if you spend the principal,
perhaps because you are poor and need to eat you have no
interest; you have no benefit. But this is the thinking of some
people.
Others believe that we should use a voucher system. They
say let the parents decide where they want their children to
attend school. After all, wealthy kids go to private schools.
This thinking does not take into account the fact that it is
public schools that 90 percent of our kids attend. It is the
public school system that is the institution that has allowed
so many people like myself even to dream of getting out of
poverty.
And that is the reason, Mr. Chairman, why I am asking for
support for H.R. 1660. This bill would allow local and State
communities to issue bonds. And the bonds would be virtually
cost-free for the communities because the Federal Government
would provide a tax credit equivalent to the interest payments
communities would otherwise be required to pay. The General
Accounting Office has indicated that it would take $112 billion
to repair and to renovate existing public schools. And another
$60 billion during the next decade for upkeep and to build the
new schools that will be necessary to educate our children.
For those who are anxious to support the private school
system, by all means do that and encourage that. But for those
communities that have only the public school system, I am not
here to defend the entire system. However, I hope that we can
identify the communities where that public school system is not
working and demand that the school system go into partnership
with the private sector, with the local and State governments,
to come up with the curricula that are needed to make the
children productive and to make certain that we never are able
to say that education is not a Federal responsibility, even
though we only contribute 7 percent toward the financing of
public education throughout the country.
And we have to keep in mind that in the areas where the
public schools are failing, whether it is in the rural areas or
whether it is in the inner-city areas, all of us lose because
these students are not able to produce, not able to be as
productive, not able to make a contribution toward improving
our economy because of their lack of training. When a kid knows
that there are no opportunities, then the temptations of drugs
and violence and making unwanted babies are there. Take a look
at the prison population that has increased dramatically from
250,000 in 1970 to 1.3 million today, the highest level of any
Nation in the entire world. And in the great city of New York,
we are prepared to spend $84,000 for every kid that gets
arrested as opposed to the $8,000 that we are forced to fight
for to provide a decent public school education.
H.R. 1660 is supported by the teachers, supported by the
superintendents, supported by the mayors and, supported by
businesses and unions alike. I ask you, no matter how you
intend to put together the bill that you may place before this
Committee, to please consider this legislation. It is needed
because we are losing teachers. We are losing students. And,
indeed, we are losing schools, unless we have the resources to
build and to rebuild and to modernize the existing schools that
we have today.
Thank you, Mr. Chairman, and I thank you, my colleagues.
[The prepared statement follows:]

Statement of Hon. Charles B. Rangel, a Representative in Congress from
the State of New York

Colleagues. I am pleased to testify before you today about
the state of the public school system in the United States. It
is becoming increasingly apparent that the most important
challenge facing this country today is the need to improve our
educational system. Investment in public education is the key
to developing young minds and giving all of America's children
a chance to excel.
At the present time, however, some of our young people
attend schools where facilities are crumbling, classrooms are
overcrowded, students are without computer and internet access,
and many teachers are uncertified and under qualified. It is a
shame that the United States maintains a public education
system that subjects some of its students to a poor quality of
education--in effect, dooming them to a future that is bypassed
by the prosperity and promise of the new global economy.
Many children today are attending school in trailers or in
dilapidated school buildings. We cannot expect learning to
occur in those environments. The General Accounting Office
reports that approximately one-third of America's public
schools is in need of extensive repair or replacement. The
report estimates that it will cost $112 billion to repair,
renovate, and modernize our existing schools and another $60
billion over the next decade to build new schools. It is
estimated that in New York City alone more than one-half of the
city's 1,100 school buildings are over half a century old.
Thirty-eight percent of these schools are estimated to be in
need of extensive renovation.
In an effort to help schools meet their capital needs, I
have introduced legislation, H.R. 1660, a bill designed to
provide approximately $24 billion in interest-free funds to
State and local governments for school construction and
modernization projects. I believe this bill is a meaningful
first step in addressing the problem of crowded, dilapidated
and outdated school facilities.
H.R. 1660, The School Construction and Modernization Act of
1999, extends and enhances the education zone proposal that was
enacted on a limited basis in the 1997 Taxpayer Relief Act.
This program is designed to create working partnerships between
public and private entities to improve education and training
opportunities for students in high poverty rural and urban
area.
Some have argued that the Federal government should have no
role in assisting the public school system at the K through 12
level. I disagree strongly. The Federal government historically
has provided financial resources to the public school system.
It has done so in part by providing tax-exempt bond financing
that enables State and local governments to fund capital needs
through low-interest loans. This bill is, in many respects,
very similar to tax-exempt bond financing. The bill provides
special tax benefits to holders of certain State and local
education bonds without requiring any additional layers of
bureaucracy at the Federal or State level. The procedures used
to determine whether bonds are eligible for those special
benefits are substantially the same as the procedures
applicable currently in determining whether a State or local
bond is eligible for tax-exempt bond financing.
I also want to be very clear that H.R. 1660 supports our
public school system. I believe that improving our public
school system should be our highest priority. Approximately 90
percent of the students attending kindergarten through grade 12
attend public schools. If we can find the resources to provide
additional tax incentives, it is imperative that these
incentives focus on improving a public school system that
serves such a large segment of our student population. For this
reason, I have and will continue to oppose legislation, such as
the so-called ``Coverdell'' legislation, that diverts scarce
resources away from our public school system.
The Republicans are promoting a change in the tax-exempt
bond arbitrage rules that they claim is a meaningful response
to the problem of dilapidated and crowded school buildings.
Under current law, a school district issuing construction bonds
can invest the bond proceeds temporarily in higher-yielding
investments and retain the arbitrage profits if the bond
proceeds are used for school construction within two years. The
Republican arbitrage proposal would extend the period during
which those arbitrage profits could be earned for four years.
The Republican proposal does not benefit those districts with
immediate needs to renovate and construct schools. It benefits
only districts that can delay completion of school construction
for more than 2 years. It is inadequate at best. At worst, it
may increase costs for those districts most in need because
more bonds could be issued earlier.
My bill includes a provision that would extend the Davis-
Bacon requirements to construction funded under the new
program. This provision is consistent with the policy that
Federally subsidized construction projects should pay
prevailing wage rates. The bill also includes provisions
designed to ensure that local workers and contractors are able
to participate in the construction projects.
It is becoming increasingly clear to many across the
country that some parts of our current education system are
producing students who come out of high school with a knowledge
base that is incomplete or obsolete. Some schools produce
graduates ill-equipped to compete in an increasingly fast-
paced, knowledge-based, technological world. It is deplorable
that some of our young people are doomed to failure because
they attend resource-poor schools where facilities are
crumbling, classrooms are overcrowded, students are without
computer and internet access, and many teachers are uncertified
and under qualified.
Tragically, the young people who are most likely to be
subjected to an inferior education in this system are those who
attend school in urban and rural areas with high rates of
poverty and those who are of African American and Hispanic
descent. In a country that prides itself on its leadership in
world affairs, the negative effects of race and income continue
to have a pervasive impact on the quality of education and the
life's chances of affected students. These educational
disparities are a national disgrace and must be addressed.
Failing students in poor communities are almost sure to
face high rates of illiteracy, incarceration, joblessness, and
drug abuse. Since 1970, the prison population has increased
from 260,000 to 1.8 million people in 1997 (nearly a 600%
increase). Studies indicate that 70% of inmates lack basic
literacy skills, 49% have not completed high school, more than
70% used illegal drugs one month prior to their arrest, and 40%
in state prisons lived below the poverty level prior to
incarceration. It is important to realize that these
incarcerated individuals are not born criminals. Many are the
products of failed support systems, including schools that have
neglected to provide them with the proper tools to compete and
excel in today's society. It is unacceptable that some of our
children are locked up with no hope for the future in the
richest, most powerful country in the world. This is a waste of
talent and productivity.
Supporting a punitive incarceration policy rather than
front-end investments like education and training is also a
waste of money. Why do we spend $84,000 per year to keep
someone incarcerated but only $9,000 per year to educate him or
her? Wouldn't it make more sense to provide people with the
tools they need to compete before they end up in jail or on the
street? The U.S. must reassess its misplaced priorities and
make a greater investment in its public education system so
that all of America's children can receive a quality education
that enables them to compete in the global economy of the 21st
Century.
Now that the war in Kosovo has ended, it is time to declare
a war much closer to home--one of great significance to
national security and to the economic and social stability of
our nation. America's new ``war'' at home should be a national
initiative to reform failing public schools. Contrary to what
some claim, the answer is not to throw out the entire public
education system when only a few parts are dysfunctional. The
U.S. must focus on turning disadvantaged schools inside out so
that they can be transformed into model schools where students
can learn in a positive and affirming environment. This effort
requires a serious commitment from the federal government with
substantial cooperation from local and state government,
teachers unions, parents, and businesses. Serious school reform
would entail providing better teacher training, more effective
curricula, improved access to new technologies, refurbished or
new facilities, smaller class sizes and innovative partnerships
between schools, businesses and communities.
As a community, we should establish strong expectations for
student performance based on academic literacy, social
competency, civic responsibility, occupational opportunity, and
technical proficiency. Additionally, these expectations should
be aligned with the needs of the U.S. economy so that we can
continue to produce strong economic growth. Investment in
public education is the key to developing young minds and
giving all of America's children a chance to excel.
The President recently embarked on a new initiative to
focus federal resources in those areas of the country that have
been underdeveloped in terms of business opportunities. It is
important to recognize that this ``new markets'' initiative
cannot thrive without also nurturing the underdeveloped human
talent in these distressed areas. We must have new minds for
new markets if we are serious about truly improving the
conditions of poor communities throughout America.
There is no reason why a country possessing the genius and
talent to develop the internet, create innovative computers and
software, and generate enough produce to feed the world, cannot
successfully reform its own public education system. We have
the know-how and expertise, now we need the willpower and
commitment.
Due to a strong economy and budget surpluses, the U.S. now
has a unique opportunity and strong incentive to invest in its
human capital. Public education has helped make the U.S. the
world leader that it is today. It must be our nation's priority
to radically reform poor performing public schools if we are to
guarantee our children's future in the global economy.

Chairman Archer. Thank you, Mr. Rangel.
Our next witness is Congressman Jerry Weller from Illinois.
Mr. Weller, you may proceed.

STATEMENT OF HON. JERRY WELLER, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF ILLINOIS

Mr. Weller. Thank you, Mr. Chairman. And I want to thank
you and this Committee for the opportunity to testify today on
an issue that I believe is really an issue of fairness. And
that is the issue of eliminating the marriage tax penalty which
is imposed on married working couples in 66 different ways by
our current Tax Code.
Earlier this year, Representative McIntosh, Representative
Danner, and I introduced bipartisan legislation, H.R. 6, to
eliminate the marriage tax penalty for the majority of
Americans who suffer it by doubling the standard deduction as
the chart here to my right shows and broadening each tax
bracket for joint filers to twice that of singles. And I am
please to tell you that we now have gained a majority of House
as bipartisan cosponsorship of 230 cosponsors of our
legislation to eliminate the marriage tax penalty.
In the last 30 years, our tax laws have punished married
couples when both spouses work. For no other reason than the
decision to be joined in holy matrimony, more than 21 million
couples a year are penalized an average, according to the
Congressional Budget Office, of $1,400 per year. They pay more
in taxes than they would if they were single and not only is
the marriage penalty unfair, it is wrong that our Tax Code
punishes society's most basic institution. I would also note
that the marriage tax penalty exacts a disproportionate toll
particularly on working women and low-income couples with
children.
Let me give you a couple of examples of how the marriage
tax penalty unfairly affects middle class, working couples in
the district that I represent. In the first example, two
schoolteachers live in the district that I represent. They are
from Joliet, Illinois. Shad Hallohan makes $38,000 a year in
salary. His wife Michelle makes $23,500 a year in salary, both
as teachers. Since they chose to live their lives in holy
matrimony and, of course, file jointly, their combined income
of $61,500 pushes them into a higher tax bracket of 28 percent,
producing a marriage tax penalty of $957 in higher taxes.
Michelle and Shad would have liked to have been here today, but
the couple is about to have their first baby and Michelle's
doctor cautioned against travel. But Michelle did ask me to
relay a message to the Committee today. For their new and
growing family, $957 marriage tax penalty means 3,000 diapers
for their new baby.
I also have a chart here to my right which illustrates how
the marriage tax penalty works and our solution to solve it. To
my right on this chart, of course, I have a machinist who works
at Caterpillar in Joliet and a schoolteacher who works in the
Joliet public schools. They have identical incomes. As single
individuals, after you consider the standard deduction and
exemption, they each, if they file as single and stay single,
pay in the 15-percent tax bracket. But if they choose to marry,
they, on average, with their combined income pushing them into
a higher tax bracket, combined income of $60,500, pay the
average marriage tax penalty of almost $1,400. The marriage tax
penalty--excuse me, the Marriage Tax Elimination Act would
eliminate this marriage tax penalty for this machinist who
works at Caterpillar and this local schoolteacher.
[GRAPHIC] [TIFF OMITTED] T0841.032

On average, America's working couples pay $1,400 more a
year in taxes than individuals with the same incomes. And that
is real money back home in Illinois. $1,400 is 1 year's tuition
at a local community college in Illinois as well as 3 months'
day care at a local day care center. If you think about, over
10 years, the average married working couples suffers a
marriage tax penalty of $1,400 in higher taxes just because
they are married and that is real money. For many people, that
is a new car.
I believe that in the era of Federal budget surpluses which
do not include Social Security revenues, American families
deserve to have their tax burden lowered. We should focus on
Tax Code simplification, beginning with eliminating the
unfairness of the marriage tax penalty.
I would also note that Tax Code simplification is the focus
of legislation that I partnered up with Jennifer Dunn on and we
have introduced on March 11 of this year called the Lifetime
Tax Relief Act. This legislation simplifies the Tax Code by
eliminating the marriage tax penalty, phasing out the death
tax, providing alternative minimum tax relief for middle-class
families and making the R&D tax credit and other extenders
permanent.
This legislation eliminates the marriage tax penalty by
doubling the standard deduction and widening the 15-percent tax
bracket for married couples. I would also point out that our
legislation widens the 15-percent tax bracket by 10 percent,
guaranteeing that a family making under $55,000 will not be
pushed into the 28-percent tax bracket.
I believe the issue of eliminating the marriage tax penalty
can best be framed by asking these questions: Do Americans feel
it is fair that our Tax Code imposes a higher tax on marriage?
Do Americans feel it is fair that the average married working
couple pays almost $1,400 more in taxes than a couple with
almost identical income living together outside of marriage? I
think all Americans agree. The marriage tax penalty is unfair
and today is the day to eliminate it.
Eliminating the marriage tax penalty addresses an important
issue of fairness. I hope we can work together, Mr. Chairman
and Members of this Committee, in a bipartisan way, as we have
demonstrated with the Marriage Tax Elimination Act, to make
elimination of the marriage tax penalty punishing 21 million
married working couples just for being married the number one
priority for family tax relief this year.
Thank you, Mr. Chairman.
[The prepared statement and attachment follows:]

Statement of Hon. Jerry Weller, a Representative in Congress from the
State of Illinois

I want to thank you for holding this hearing on providing
tax relief to families. I appreciate the opportunity to testify
on an issue that is really an issue of fairness, eliminating
the marriage tax penalty imposed on married working couples in
66 different ways by our tax code.
On February 10, 1999, Representatives McIntosh, Danner and
I introduced H.R. 6 to eliminate the marriage tax penalty for
the majority of Americans families who suffer it by doubling
the standard deduction and broadening each tax bracket for
joint filers to twice that of singles. H.R. 6 now enjoys broad
bipartisan support with 230 cosponsors.
Since 1969, our tax laws have punished married couples when
both spouses work. For no other reason than the decision to be
joined in holy matrimony, more than 21 million couples a year
are penalized an average $1,400 per year. They pay more in
taxes than they would if they were single. Not only is the
marriage penalty unfair, it's immoral that our tax code
punishes society's most basic institution. The marriage tax
penalty exacts a disproportionate toll on working women and
lower income couples with children.
Let me give you two examples of how the marriage tax
penalty unfairly affects middle class married working couples
in my district.
In my first example, two school teachers live in my
district in Joliet, Illinois. Shad makes $38,000 a year in
salary. His wife Michelle makes $23,500 a year in salary. If
they would both file their taxes as singles, as individuals,
they would pay 15 percent.
But if they chose to live their lives in holy matrimony,
and now file jointly, their combined income of $61,500 pushes
them into a higher tax bracket of 28 percent, producing a tax
penalty of $957 in higher taxes. Michelle and Shad would have
liked to have been here today but, the couple is about to have
their first baby and Michelle's doctor cautioned against any
travel. Michelle asked me to relay a message to the Committee
today, for their growing family, $957 means 3000 diapers for
their new baby.
Another couple from my district, living in Wilmington,
Illinois, pays an even higher marriage penalty each year.
Calley is a bank teller and earns $21,800. John is an insurance
salesman that earned $51,700. Their marriage tax penalty was
$1,053 last year.
On average, America's married working couples pay $1,400
more a year in taxes than individuals with the same incomes.
That's serious money. $1,400 is a year's tuition at Joliet
Junior College and 3 months of daycare at a Joliet child care
center. Over ten years, average couples pay $14,000 more in
taxes than singles! This can represent the cost of a new car or
a year of college tuition at almost any university in America.
I believe that in an era of federal budget surpluses which
do not include Social Security revenues, American families
deserve to have their tax burden lowered. We should focus on
tax code simplification beginning with eliminating the
unfairness of the marriage tax penalty.
Tax code simplification is the focus of a bill that
Jennifer Dunn and I introduced on March 11, 1999 called the
Lifetime Tax Relief Act. This bill, H.R. 1084, simplifies the
tax code by eliminating the marriage tax penalty, phasing out
the death tax, adjusting the AMT for families, and making the
``extenders'' permanent.
H.R. 1084 eliminates the marriage tax penalty by doubling
the standard deduction and 15% tax bracket for married couples,
as is accomplished in H.R. 6. Additionally, the Lifetime Tax
Relief Act widens the 15% tax bracket by 10%. This guarantees
that a family making under $55,000 will not be pushed into the
28% tax bracket.
I think the issue of the marriage penalty can best be
framed by asking these questions: Do Americans feel its fair
that our tax code imposes a higher tax penalty on marriage? Do
Americans feel its fair that the average married working couple
pays almost $1,400 more in taxes than a couple with almost
identical income living together outside of marriage--is it
right that our tax code provides an incentive to get divorced?
Eliminating the marriage tax penalty addresses a important
issue of fairness--I hope we can work together to eliminate it.
Mr. Chairman, I would again like to thank you for giving me the
opportunity to address the Committee on this important issue
affecting 21 million American families. I would be happy to
answer any questions.
[GRAPHIC] [TIFF OMITTED] T0841.030

Chairman Archer. Thank you, Mr. Weller. You stand out as a
leader in attempting to give relief on this particular area of
the Tax Code.
Mr. Weller. Thank you.
Chairman Archer. We are pleased also to have with us today
Congresswoman Pat Danner. We are delighted to have you here.
Welcome and we will be pleased to receive your testimony.

STATEMENT OF HON. PAT DANNER, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF MISSOURI

Ms. Danner. Thank you, Mr. Chairman. An aspiring Speaker
some years ago asked then-President Franklin Roosevelt for his
suggestions in public speaking and the President said: Be
brief, be sincere, and be seated. So I will try to follow that
admonition.
I thank you all for the opportunity to testify before you
today. I know that my colleague Jerry Weller has discussed in
detail the benefits of eliminating the marriage tax penalty.
And today I would like to inform you of Missouri's experience
and, indeed, leadership on this issue. And I think that the
Congressman seated to my left who is a Member of your Committee
would concur with my remarks, since we are both Missourians,
probably.
When the minister utters the phrase ``for better or
worse,'' although the couple doesn't realize it at the time, he
is uttering a phrase that will have a reflection on their
income tax returns when they file married tax returns. For some
taxpayers, it is for the better. For some taxpayers, it is for
the worse. In my home State of Missouri, fortunately, it is for
the better.
Missouri permits married couples to file jointly or
separately on the same tax form using whichever of the options
imposes the least amount of taxes on their income. Despite this
loss of revenue that Missouri experiences because of our
friendly married couple filing tax laws, Missouri is in the
process of refunding money this year to all who pay income tax.
As a matter of fact, married couples in Missouri will receive
an estimated refund this year of $108 and, as Congressman
Hulshof notes, we have already started receiving those checks.
Mr. Chairman, Missouri, the Show Me State, has shown the
Federal Government there should be and is fairness and equity
in the way our State income tax system addresses the issue of
taxes levied on married couples. Years ago, Missouri's general
assembly gave couples relief from a marriage tax penalty. Today
our State is still able to provide them with a tax refund. The
Congress can and should do no less.
I hope you will agree I have been brief. I have been
sincere. And I am already seated.
[The prepared statement follows:]

Statement of Hon. Pat Danner, a Representative in Congress from the
State of Missouri

Mr. Chairman and Members of the Committee:
Thank you for the opportunity to testify before you today.
I know my colleague, Mr. Weller, has discussed with you in
detail the national benefits of eliminating the marriage tax
penalty. Today, I would like to inform you of Missouri's
experience, and indeed leadership, on this issue.
Mr. Chairman, Missouri--the Show Me State--can show the
Federal Government that there should be, and is, fairness and
equity in the way our state income tax system addresses the
issue of taxes levied upon married couples.
Married taxpayers filing in Missouri have two options. They
may file jointly or separately--using whichever of the options
imposes the least amount of taxes upon their income.
Now is the perfect time for the federal government to
emulate Missouri. The booming economy in Missouri has made more
revenue available--so much so that tax refund checks are
flooding back to our citizens.
Missouri's Governor has stated, ``Our robust economy makes
it possible to offer new, meaningful tax relief this year. And
we can afford to give Missourians this reasonable tax relief
without jeopardizing our investments in education, public
safety and other crucial state services.''
Years ago, Missouri's General Assembly gave couples relief
from a marriage tax penalty, and today our state is still able
to provide them with a tax refund. The Congress can, and
should, do no less!

Chairman Archer. Ms. Danner, you are a superb witness.
Thank you very much. [Laughter.]
Ms. Danner. Mr. Chairman, sometimes I sit on that side of
the witness table and I recognize what we as Members would laud
in those who testify before us.
Chairman Archer. Well, the Chair greatly appreciates your
brevity.
Mr. Hulshof, we are delighted to have you before the
Committee on the other side. And we will be pleased to receive
your testimony.

STATEMENT OF HON. KENNY HULSHOF, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF MISSOURI

Mr. Hulshof. Thank you, Mr. Chairman. What I would like to
do, Mr. Chairman, is really deviate from my prepared remarks as
I expect them to be submitted for the record and really want to
follow up on what the gentleman from New York has said.
First of all, thank you for having this hearing. But I want
to talk a little bit about education, specifically about H.R.
7. Mr. Chairman, the American people, and I think this
Congress, are clearly placing a priority on the education of
our kids and I think the policies, of course, and the Education
Committee will get part of the job done. But I think this
Committee really does have a lot to offer regarding helping
parents be more involved in their education.
Chairman Archer. Would you suspend for a moment?
Mr. Hulshof. Be happy to, Mr. Chairman.
Chairman Archer. The Chair would suggest that perhaps
Congressman McIntosh and Congressman Baird go, vote, and then
come back. We want to continue this through the vote.
Mr. Hulshof.
Mr. Hulshof. Thank you, Mr. Chairman. I think everybody on
this Committee would agree that the best tool that we could
employ would be to bring parents involved into the education
process. We cannot, of course, legislate mandatory attendance
at the parent-teachers meetings. We cannot require parents
through legislative fiat spending time with their kids and
maybe helping them with their homework. We can, however, bring
in the power of the purse and provide some flexibility for
parents to put aside some additional moneys for education and
that is what I want to focus on in the few minutes that I have
got today.
I think that we can build on what this Committee did and
what Congress did and, ultimately, what the President signed
into law back in 1997 when we first enacted the education
savings accounts. The idea that we have, Mr. Chairman, in H.R.
7--and it is regrettable that Senator Coverdell was not able to
be here today. He has been the champion of this legislation in
the other body--but what we would like to do with the education
savings accounts is not pick winners or losers. We want to
commit as many resources as possible to the education system
period.
And, listening to Mr. Weller and thinking about the
marriage tax penalty, if there were some way that we could
eliminate the marriage penalty and, especially as young couples
begin to start a family, they are not thinking about
retirement. Yes, Roth IRAs are a great idea, but when you think
about $1,400 more each year that they pay in income taxes, what
a great solution if they were able to dedicate that $1,400--
instead of paying it to the Federal Government--if they were to
put it into a savings for student account. Just think, as Mr.
Rangel pointed out, that there would not be sufficient moneys
there for these education expenses. Boy, if you were putting
this $1,400 instead of paying in a marriage tax penalty to the
government, if you were putting it into a savings for student
account from the time that the child was their first year of
age. By the time they were ready for first grade, they would
have nearly $8,400 in that account plus probably about $10,000,
including the additional savings from the earnings from
interest.
What we do in this bill, in H.R. 7, is really expand the
education savings account by taking the $500 contribution limit
off, raising that up to $2,000. As you know, Mr. Chairman, the
education savings account was specifically focused on college
education. Let us remove that restraint and allow these
aftertax dollars that buildup on these education accounts be
used for kindergarten all the way through the 12th grade.
If a parent chooses to home-school their kids, they can use
it. If you choose to send your kid to public school, they can
use it. If you choose to have a private education, parents are
making that choice. I would point out for Members of the
Committee, anticipating your question, the Joint Tax Committee
says that 70 percent of the savings to the taxpayers would be,
first of all, families making $75,000 or less and sending their
kids to public education.
So this is a win-win situation. If you have special needs
students, if your child is having a tough time with math, you
can hire a tutor. If your child is having a tough time reading,
you can use this money for Hooked on Phonics. But the decisions
are not made here in Washington; they are made right around the
kitchen table with parents working with teachers for the
betterment of their kids. I think it is a win-win situation. I
would urge this Committee to consider H.R. 7.
Thank you for the time to visit about it today.
[The prepared statement follows:]

Statement of Hon. Kenny Hulshof, a Representative in Congress from the
State of Missouri

Mr. Chairman, let me start by thanking you for holding this
hearing as part of the three part series on reducing the
federal tax burden. In particular, I appreciate the opportunity
to testify today on behalf of my legislation, H.R. 7, the
Education Savings and School Excellence Act.
The American people clearly place a priority on our
children's education. As Members of Congress, we should be
responsive to this worthwhile objective and enact policy that
encourages accountability, quality and makes it easier for
parents to get involved in the process of ensuring that their
children receive an education that will prepare them for the
challenges they will face in the future.
The 106th Congress is off to a good start. Acting in a
bipartisan manner, we passed and the President signed the Ed-
Flex bill, which will give educators at the local level the
ability to use federal resources were they are needed most. In
the future, I would expect the U.S. House to begin its
consideration of a bill to reauthorize the Elementary and
Secondary Education Act (ESEA). I hope the bipartisan spirit
that prevailed during the debate on the Ed-Flex bill carries
over to the consideration of ESEA.
As a member of this committee, I firmly believe that we can
make some common-sense changes to the tax code to help in the
effort of improving education for our children. Some of these
proposals are included in H.R. 7, the Education Savings and
School Excellence Act. I would like take the opportunity to
thank Representative Lipinski, a Democrat from Illinois, for
joining me in this bipartisan effort.
The Taxpayer Relief Act (TRA) of 1997, which this committee
crafted, established Education IRA's. These savings vehicles
were designed to help parents save for a child's college
education. It was wise for us to enact this provision--but we
can do better.
H.R. 7 builds on the Education IRA's included in TRA 97. I
call these expanded Education IRA's Savings for Students
Accounts (SFSA's). Savings for Students Accounts would expand
the current law contribution limit on Education IRA's from $500
annually to $2,000 annually. The money set-aside in a Savings
for Students Account could be used to help pay for both college
and K-12 education expenses. H.R. 7 also modifies the rules
governing existing Education IRA's to give parents the ability
to provide essential education materials and services to
special needs children.
I think that everyone would agree that regardless of the
policies we pass in Washington, the best tool to improve a
child's education is engaged, caring parents. We cannot
legislate involved parents. Congress cannot force a parent to
attend a PTA meeting or to meet regularly with their child's
teachers.
But we can make it easier for parents to make a
contribution to their child's education. For example, under my
bill, if a student is having difficulty in Math class, a parent
could use funds set aside in a Savings for Student Account to
pay for a tutor, buy computer software for the home PC or
enroll the child in after-school classes. This will help
parents and teachers work together as powerful allies in the
effort to improve our children's education.
Let me also briefly mention some of the other provisions in
the Education Savings and School Excellence Act. Prepaid
tuition plans have become an increasingly popular way for
parents to save for a child's college education. H.R. 7 will
make distributions from both public and private prepaid tuition
plans to pay for higher education expenses tax free.
Representatives English, Granger, and Scarborough all deserve
credit for their hard-work on this important issue.
The Education Savings and School Excellence Act also helps
foster continuing education by encouraging employers to cover
an employee's undergraduate studies. This is accomplished by
excluding employer-provided education assistance from an
employee's income for tax purposes. H.R. 7 will also help
provide relief from complicated bond arbitrage regulations to
encourage the construction and rehabilitation of public
schools. Lastly, my bill excludes amounts received from
National Health Service Corps Scholarship Program from income
for tax purposes.
Last month, the Senate Committee on Finance approved S.
1134, the Affordable Education Act of 1999, which is similar to
H.R. 7. The bipartisan efforts of Senator Coverdell, Republican
of Georgia and Senator Torricelli, Democrat of New Jersey, have
helped enhance the visibility of this issue in the U.S. Senate.
It is my hope that this bipartisan spirit of cooperation will
prevail in the U.S. House and that we will be able to give
parents the meaningful tools in H.R. 7 to help educate our
children.
Helping families save for their children's education while
improving public education is a win-win proposal. I look
forward to working with my colleagues on this committee to
improve the quality of education our children receive.

Chairman Archer. Thank you, Mr. Hulshof. Mr. Graham, would
you like to commence? We only have 4 minutes left.
Mr. Graham. I can do this in 2 minutes.
Chairman Archer. All right. That would be great. You may
proceed. We are happy to have you.

STATEMENT OF HON. LINDSEY O. GRAHAM, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF SOUTH CAROLINA

Mr. Graham. Thank you. Thank you, Mr. Chairman. I would
hate to have your job. Every tax plan that has been talked
about and I am probably, I think, a cosponsor of everyone and
eventually we have got to pick and choose, just as we have to
do on spending.
I am here in support of H.R. 1840, the Small Savers Act,
which has already been testified to regarding about the
Committee by Mr. Jefferson, who is a Member of your Committee.
I have got Mr. Clyburn as a cosponsor, Roy Blunt, Alcee
Hastings, Saxby Chambliss, Matt Salmon, Bob Wexler. This is
bipartisan. It is something the Congress needs, I think,
desperately in this area.
What it does, Mr. Chairman, it addresses the lack of
savings in this country. One-third of Americans have no
savings. Another third has less than $3,000. This plan has been
endorsed by the New York Stock Exchange. Senators Coverdell and
Torricelli started this concept in the Senate. It has
bipartisan support there. This bill would pass if we could ever
get it to the floor and vote on it.
What it does is it changes the tax bracket for millions of
Americans by taking the 15-percent bracket and expanding it
$10,000 over 5 years, $5,000 for singles. By 2004, a family of
4 making $72,000 will be in the 15-percent bracket, which is a
break for a lot of Americans. The first $5,000 of capital
gains, long-term capital gains, is tax free. That helps a lot
of Americans in their retirement as they get ready to retire.
The first $500 in dividend and interest income is tax free.
That helps a lot of Americans who are on fixed incomes with
small investments to keep more money in their pocket.
It doubles--not doubles, excuse me, it adds the ability to
deduct from your IRAs $3,000 rather than $2,000. That would be
$6,000 per couple and it will be indexed for inflation by 2009.
It allows Americans to save in the middle-class manner. It has
bipartisan support. It costs $345.7 billion by 2009, which is
half of the non-Social Security surplus. Mr. Chairman, if
Americans had this opportunity, they would have a lot money
when they retire. They would have a lot more control over their
lives. We could do some things with Social Security because the
pressure would be off. This is a plan that allows America to
save better than it has been able to do in the past. I
appreciate your review of it.
[The prepared statement follows:]

Statement of Hon. Lindsey O. Graham, a Representative in Congress from
the State of South Carolina

Dear Mr. Chairman and Members of the Committee,
Thank you for allowing me to testify in support of H.R.
1840, the Small Savers Act I introduced along with Reps.
William Jefferson (D-LA) and Robert Wexler (D-FL).
One-third of Americans have no savings and another one-
third have less than $3,000. With such a low rate of savings,
many people are not equipped to deal with financial trouble or
plan for retirement. This is a problem which must be addressed.
Our legislation, co-sponsored in the Senate by Paul
Coverdell (R-GA) and Robert Torricelli (D-NJ), is the only
bipartisan, across-the-board tax relief plan introduced in the
106th Congress.
The provisions of the bill include:
Returning more middle-income taxpayers to the lowest tax
bracket--The lowest federal tax bracket, 15 percent, will be
expanded by $10,000 over 5 years, $5,000 for singles. By 2004,
a family of four making up to approximately $72,000 will still
be able to file in the lowest tax bracket.
Reduce taxes on long-term investments--The first $5,000 in
long-term capital gains is tax-free.
Encourage savings and investment--The first $500 in
dividend and interest income is tax-free, $250 for singles.
Strengthen retirement planning--The contribution limits on
traditional (deductible) IRA's will be raised from $2,000 to
$3,000 and be indexed for inflation after 2009.
By making some income tax-free, the bill also has the added
bonus of reducing the complexity of the federal tax code and
allowing more individuals to file their taxes using IRS Form
1040EZ, the simplest IRS tax form.
Estimates provided by the Joint Committee on Taxation show
the costs of the bill, $345.7 billion through 2009, to be one-
half the expected non-Social Security surplus. With the
government running a surplus, it's only right that we should
provide the taxpayers with relief.
Every Member of Congress, whether they're Republican or
Democrat, has their own ideas about what a tax bill should look
like. I think if any of the sponsors were given complete
control, they would draw up something different. But in this
business, sometimes you've got to give a little here and there
to get something done.
That's why I think this bill and the fact we've been able
to come together is unique. We're addressing the high taxation
problem in a bipartisan manner. I hope this committee and the
Congress will look favorably on our work.

Chairman Archer. Thank you very much. I think you and I
both probably need to go vote. There are 2 minutes left. We
appreciate your testimony. Well, the Committee will stand in
recess until we have another Member come back to preside.
[Recess.]
Ms. Dunn [presiding]. Please take your seats. The Committee
will resume its hearing.
We would like to hear now from Jim Turner, the Member from
Texas.

STATEMENT OF HON. JIM TURNER, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF TEXAS

Mr. Turner. Thank you, Ms. Dunn. It is a pleasure to appear
before the Committee, and I appreciate very much the
opportunity to testify on an issue that is very important to me
and my district, and I know to you and yours, and the
legislation that I testify about today is of course very
similar to a piece of legislation that you also have
introduced, and so I appreciate this opportunity.
H.R. 1916 is the Reforestation Tax Relief Act of 1999. It
deals with an issue that is very important to many of us. In
fact, there are over 100 members of the Forestry 2000 Task
Force that are heavily dependent upon the forest products
industry in their particular districts. I know in my case that
forestry is the number one industry in my congressional
district.
Back as early as 1980, the Congress recognized that there
needed to be some incentive for landowners to reforest their
lands. It is not only good for the economy but it is good for
the environment, and the Congress passed a tax credit to allow
those who plant pine trees or timber on their lands to receive
a tax credit and to be able to amortize their expenses over a
period of time. Current law provides an amortization period of
7 years and a maximum investment tax credit of 10 percent of a
$10,000 maximum expenditure for amortization purposes.
My bill does a very simple thing: it simply doubles those
numbers. It allows the writeoff of $25,000 in expenses for
reforestation and increases, of course, correspondingly, the
investment tax credit to 10 percent of that amount, and it
shortens the amortization period from 7 years to 3, thus trying
to increase the incentive for private landowners to reforest
their lands.
The charts I have at the right will pretty well tell the
story. If you look at the East Texas area that I represent,
what you see--depicted on the first chart--is the ownership of
forest lands in East Texas. That first chart shows you that the
public lands of the national forest are about 7 percent; it
shows you that the forest products industry, the large timber
companies, own about 32 percent of the land; and small
landowners, which I call the nonindustrial, private landowners,
own about 61 percent. On the next chart, you see what is
happening in terms of reforestation of those forest lands. It
shows you that the forest products industry, the large timber
companies, are doing a pretty good job. They harvest about
73,000 acres of land on average in a year, and they are
replanting about the same amount, about 99 percent. On the
other hand, the small, private landowners, the mom-and-pop
folks who own a little land and hopefully would be encouraged
by this legislation to plant pine trees, are not doing that
currently. Apparently, the current incentive in the law is not
sufficient. They are harvesting 91,000 acres in an average year
and only replanting about 40 percent of that. My bill is
directly aimed to try to encourage those small landowners to
replant their trees.
Now, why is this important? Let us see the next chart. What
you see is that for a number of years in an area like East
Texas--and I suspect you will find this pretty much true all
across the South and the Southeast--that through about 1964 and
1987, in East Texas, we were actually growing more timber than
we were harvesting. That trend reversed in about 1987, and you
see the projections in the outyears. We will harvest more
timber than we plant. That is a very dangerous trend for the
economy of regions like mine because it is essential that the
forest products industry has access to an adequate supply of
timber at a reasonable price if we are going to be competitive
in the international market in producing lumber and paper and
other forest products. If we allow the supply to diminish,
those mills that depend upon that supply will have to pay
higher prices. The law of supply and demand will govern, and
these mills will have to pay higher prices for that raw
product, and our forest products will not be competitive either
in our country or internationally. Therefore, the survival
economically of areas like mine depends upon how good a job we
do in replanting our forest so that we can have the kind of
supply that is necessary.
The next chart shows you the environmental benefits of
reforestation; they are obvious--the absorption of carbon
dioxide and the preservation of wetlands. Reforestation is
essential so that we don't cut trees where we shouldn't be
cutting them.
On the final chart you will see the economic impact of
reforestation. The Texas Forest Service that provided the data
that you see here today has as its goal the reforestation of 1
million acres within 10 years in Texas. That would generate--if
we were successful--new jobs for East Texas. You see the
numbers there--15,000 jobs and an added $3 billion to the
economy.
So, I would urge the Committee to seriously consider this
legislation. I think it is important for the economic and
environmental impacts it will have on many of our districts in
the long term.
[The prepared statement and attachments follow:]

Statement of Hon. Jim Turner, a Representative in Congress from the
State of Texas

Thank you very much, Mr. Chairman, Mr. Rangel (NY), members
of the Committee. Thank you for asking me to come here before
you this morning.
It is truly a pleasure to be able to testify, with my
fellow colleagues, before the House Ways and Means Committee
regarding such an important issue as providing needed and well-
deserved tax relief to Americans. As members of Congress,
American families and businesses are relying on us to deliver
meaningful tax relief. It is my belief that as a result of this
hearing, Congress will be better suited to take the necessary
steps to provide substantial tax relief to millions of
Americans.
As part of this effort, I recently reintroduced H.R. 1916,
the Reforestation Tax Relief Act of 1999, which will provide
expanded and immediate tax incentives to encourage timberland
owners to reforest their lands. Representing over 150,000
private forest landowners in my congressional district, I
realize the importance of maintaining a strong and viable
forestry industry in the United States and am convinced this
legislation is a step in the right direction for our economy
and for our environment.
The economy of the Second District of Texas and many of the
districts represented by the 107 Congressional members of the
Forestry 2000 Task Force are heavily dependent on the long-term
viability of the forestry industry. We must act today to
provide needed tax incentives to landowners to encourage the
replanting of our forests. If we do not act now to promote
reforestation practices, through improved and immediate tax
incentives, we will be unable to maintain a competitive forest
and wood products industry with reasonable timber prices in the
future. In addition, the ecological impact on the quality of
our environment will be severe for many generations to come.
The decision to reforest, particularly after harvesting,
can be a difficult one. Evidence shows that America's larger,
industrial land owners and foresters are doing an acceptable
job of reforesting; however, our smaller, non-industrial forest
owners need added incentives to help in the reforestation
process. Since 1985, the amount of timber harvested in Texas
has exceeded the annual growth rate of reforestation efforts
and future harvests are projected to substantially outpace
annual growth of replanting activities on commercial
timberland. As a matter of fact, in Texas, non-industrial
foresters harvest an estimated 91,000 acres per year but only
replant 36,000 acres per year. For the sake of our nation's
forests, for the sake of our environment, for the sake of our
economy, and for the sake of all Americans, this alarming trend
must be halted.
A shortage of timber in the future will mean that forests
will continue to disappear, our nation's beautiful environment
will ultimately suffer, and we will see higher prices for raw
material, which will in turn make it difficult to survive in an
increasingly competitive market. The expenses are high and the
eventual benefits of reforestation are long term because of the
simple fact trees must grow for many years until mature enough
for harvesting. I believe this legislation is necessary to
overcome the economic reality faced by those involved in this
industry. Reforestation is good for the environment, good for
economy and good for the industry.
H.R. 1916 addresses the concerns I mentioned before by
making simple changes to existing law through increasing the
amount of reforestation expenses that can be amortized from
$10,000 to $25,000 per year, reducing the required amortization
period from 84 to 36 months, and increasing the annual tax
credit from $1,000 to $2,500 for reforestation expenses. With
these changes, forest landowners will be encouraged to operate
in an ecologically sound manner that leads to the expansion of
investment in this vital natural resource. Several House
Members have cosponsored this legislation in a show of
bipartisan support, which translates into potential good news
for the future stability of our forestry-based economy.
Environmentalists agree that reforesting can have numerous
benefits for the environment. By replanting our nation's
forests we will also further protect our wetlands, streamside
and wildlife management zones and critical habitats.
Additionally, the planting and replanting of trees will help
reduce levels of unhealthy carbon dioxide and produce increased
levels of oxygen into the atmosphere. Furthermore,
reforestation will help to address the growing concerns
associated with noise and air pollution. Lastly, by promoting
reforestation tax incentives, landowners will continue to
transform marginal and highly erodible agricultural land, which
is used for livestock and commodity production, into
ecologically beneficial forestland. While I realize the
expenses are high and the eventual benefits of reforestation
may seem years down the road since trees must grow for many
years until mature enough for harvesting, I believe we can all
agree that reforestation is not only good for the economy, but
is good and needed for the environment.
Other states across America can learn from what we are
doing in my home state. The goal of the forestry community in
Texas is to reforest 1 million acres over the next ten years
which will generate more than 15,000 new jobs in the forest-
based economy and an additional $3 billion to the economy
annually. By all working together, we can make sure the economy
and the environment of the 21st Century will be strong and
thriving for future generations.

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Ms. Dunn. Thank you very much, Mr. Turner. You are, in
fact, correct. It also affects my district and I know many
others around this Nation.
We will hear next from the gentleman from Indiana, Mr.
McIntosh.

STATEMENT OF HON. DAVID M. MCINTOSH, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF INDIANA

Mr. McIntosh. Thank you very much, Ms. Dunn, and thank you
for allowing me to have an opportunity to come before the
Committee once again to testify about the Marriage Penalty
Elimination Act that Jerry Weller and Pat Danner and I have
cosponsored this year. The Committee has already heard from
both of them on this, and they explained in great detail the
legislation, which I know this Committee is familiar with. So,
I would ask permission to summarize my remarks and include the
full specs into your record.
Chairman Archer [presiding]. Without objection.
Mr. McIntosh. Thank you, Mr. Chairman.
This bill is widely supported--19 of the 23 Republican
Members of the Committee are in support of it; 230 of our
colleagues are cosponsors, including a number of our colleagues
on the Democratic side of the aisle. It is a bill that
everybody agrees should become law. The task for the Committee
is to decide how best to do that in the context of a
reconciliation bill.
Last year, I brought two of my constituents here--Sharon
Mallory and Darryl Pierce--and I wanted to remind the Committee
about that, because in a way their plight demonstrates the
urgency of passing this legislation. They explained to the
Committee that they work for about $10 an hour at a factory in
Connersville, Indiana. They decided they wanted to get married,
went to H&R Block, and were told that Sharon would have to give
up her $900 tax refund, and they would be penalized about
$2,100 if they got married. This happens to millions of people
across the country. They ended up postponing their marriage. It
broke my heart when I saw their letter. Well, Sharon called our
office last week to ask, ``How is Congress doing on this?'' And
we were able to tell her that the Committee is taking up the
tax bill once again, but, frankly, we hadn't been able to get
anything done last year. Although the Committee did part of it
in its bill and the House passed that, we couldn't get the
Senate to act. And I told her I am optimistic that this year we
will see some work done, and she said, ``Good.'' I asked her if
she had gotten married yet, and they still haven't gotten
married; still are waiting for some action. They can't afford
to, she said, without some action being taken to eliminate this
marriage penalty tax.
And, so I come before you today, and in my remarks I talk
about the harm to children for families that break up, the harm
to working women who pay a disproportionate share of this tax
if they decide to go back into the work force after their
children have been raised, and the harm to minorities who, in a
disproportionate number, are the families in which both the
father and the mother work in order to make enough money to
raise their family.
But let me just close by saying to the Committee, I commend
you moving forward this year on a tax bill. I know that you are
constrained by the reconciliation instructions in the Budget
Act and that you will hear from a lot of people with very good
proposals for changing our Tax Code and that it will be a
struggle to fit all of those into the limited amount of tax
cuts that can be brought forward under those reconciliation
proposals. Having seen the Committee work in the past, I know
you will do the best of squeezing as many good provisions into
those limitations as possible, but let me urge you to go beyond
what you were able to last year with the deductions since there
is more money and, at least, taking a look in a 10-year
perspective, try very hard to eliminate the bracket effects so
that the constituents that Jerry mentioned in his testimony
truly will have their problems solved, and they won't be caught
in those bracket shifts where suddenly they are thrown from a
15-percent marginal tax rate into a 28-percent marginal tax
rate just because they are both working and they are married.
With that, let me say thank you to the Committee for giving
us an opportunity to come and testify, and thank you for taking
up this tax bill once again. It is going to be a difficult
task, but I think it is critical for us in this Congress to
move forward with that.
Thank you.
[The prepared statement follows:]

Statement of Hon. David M. McIntosh, a Representative in Congress from
the State of Indiana

Mr. Chairman and members of the Committee, I welcome the
opportunity to come before you once again to urge this
committee to eliminate the Marriage Penalty, the insidious
quirk in the tax code that actually penalizes people for
getting married. Since 19 of the 23 Republican members of this
committee are cosponsors of the Weller-McIntosh Marriage Tax
Elimination Act, I know many of you share my desire to get rid
of this tax once and for all.
Last year, if you remember, I brought two constituents of
mine, Sharon Mallory and Darryl Pierce, who are victims of the
marriage penalty to share their story before this committee.
Sharon and Darryl could not afford to get married because of
the incredible tax bite that would result from tying the knot.
They still aren't married and contacted my office just this
last Monday to find out if Congress had taken action yet. It
was embarrassing to tell them that Congress has done nothing.
It is time to act. I honestly can't find anyone who supports a
designed government policy which undermines the traditional
institution of the family and discriminates against women and
minorities.
The marriage penalty entered our tax code thirty years ago
and has contributed to the decline of the family. Our nation
has seen a decrease in marriage and increase in divorce.
Divorce is reaching epidemic levels. Twice as many single
parent households exist in America today as when the marriage
penalty came into effect.\1\ The terrible financial strain
caused by the marriage penalty contributes to the decline of
the family. Simply put, the marriage penalty is doing great
harm to our society by frustrating family cohesion.
---------------------------------------------------------------------------
\1\ The Statistical Abstract of the United States, Department of
Commerce, Table No. 146, ``Marriages and Divorces,'' p. 104: 1996.
---------------------------------------------------------------------------
The devastating consequences of divorce on parents and
children are well documented. When parents divorce, they are
likely to die earlier, their general health is worse, and
sadly, many divorced adults, particularly young mothers, are
thrown into poverty.\2\ The effects on children are no less
destructive. The National Fatherhood Initiative has shown that
where divorce occurs, the children are more prone to violence,
illegal drugs, suicide, and
---------------------------------------------------------------------------
\2\ Dr. Wade Horn, The National Fatherhood Initiative, ``Father
Facts 2,'' p.10: 1997.
---------------------------------------------------------------------------
dropping out of school. Over Ninety percent, Ninety
percent!, of children on welfare are from homes with only one
parent.\3\
---------------------------------------------------------------------------
\3\ Ibid.
---------------------------------------------------------------------------
And by the way, don't interpret these facts as an attack on
single mothers. I was raised by a single mom. I know the
sacrifices she made for us. Single moms are heroes born out of
necessity.
Let us simply get rid of the government penalties that help
break up families. Beyond its effects on our core institution
of marriage, its effects on working women and minorities are
particularly devastating.
The marriage penalty could equally be known as ``The Tax on
Working Women.'' When the marriage penalty was proposed,
America was a far different place. Most women were not yet in
the workforce. Today, 75 percent of married couples have two
incomes.\4\ The marriage penalty always hits the second-earner
hardest. Therefore, this tax clearly discriminates against
women who may enter and leave the workforce according to their
needs at home. They sometimes face a marginal tax rate of an
astounding 50%! \5\ Taxing mothers unfairly for simply wanting
to provide for their families is wrong. The Weller-McIntosh
legislation provides much greater freedom for women to work
without having to worry about the taxman.
---------------------------------------------------------------------------
\4\ The Congressional Budget Office, ``For Better of for Worse:
Marriage and the Federal Income Tax,'' (June 1997), Table 10, p.39.
\5\ The Greater Washington Societies of Certified Public
Accountants, Sept. 1997
---------------------------------------------------------------------------
African-Americans are especially hard hit by the marriage
tax. As you may know, the marriage penalty occurs when both
spouses work and make roughly the same income. Black women
historically have entered the workforce in larger numbers than
white women. According to a University of Cincinnati Law School
Study by Dorothy Brown, 73% of married back women are
breadwinners and black women contribute approximately 40% of
their household's income.\6\ Our legislation brings fairness
back into the tax code so that African-American women and
families can keep more of their hard earned money to provide
for their children.
---------------------------------------------------------------------------
\6\ Dorothy Brown, ``The Marriage Bonus/Penalty in Black and
White,'' University of Cincinnati Law Review (Spring 1997), p.5.
---------------------------------------------------------------------------
Who is against our bill? Only someone who believes that big
government is a higher priority than families. I am sick and
tired of hearing that the federal government can't afford the
passage of this bill. Did anyone in Washington ask married
couples if they could afford the $1,400 marriage penalty
imposed on them? The federal government can tighten its belt to
help families. I contend that we have no choice but to pass
this measure because of its hurtful effects on families.
Mr. Chairman, I want to conclude on the subject of
families. At a time when we are witnessing the almost
unthinkable horror of kids killing kids, I think we can all
agree that the need for strong families is greater than ever.
Realistically, Congress cannot do a great deal to build
stronger families. That process starts in our homes, churches,
and communities. However, one thing the Congress can do is
eliminate the marriage penalty.
We have a choice. We can continue down the path of
undermining the family and having more children brought up
without knowing the difference between right and wrong. Or we
can choose a different path: a path based on the firm
conviction that the family must be the foundation of our
society. We can choose a path where families are lifted up--not
punished by government. We can provide a place where young
people like Sharon and Darryl can find happiness and finally be
married.
I realize that official Washington scoffs at the idea of
strengthening families, but the American people have a special
wisdom in these matters. They understand how important this
effort is in light of recent events. The American people will
support eliminating this unfair tax. It is crucial that we
succeed because the future of the family and the future of
America are inseparable.
Thank you, Mr. Chairman.

Chairman Archer. Thank you, Mr. McIntosh, and thank you for
your leadership on this issue. We appreciate your testimony.
Our next witness is Mr. Turner. Have you testified yet?
Mr. Turner. Yes, Mr. Chairman, while you were out.
Chairman Archer. All right. Our next witness is Congressman
Baird. Welcome, and we are pleased to receive your testimony.

STATEMENT OF HON. BRIAN BAIRD, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF WASHINGTON

Mr. Baird. Thank you very much, Mr. Chairman. It is a
pleasure and a privilege to be here to address an extremely
important issue of fairness and equity in the Tax Code. Before
I talk about the particular issue, which is sales tax
deduction, I would like to acknowledge my support of
inheritance tax reform in the bill, offered by my colleague
Congresswoman Dunn and my friend, Mr. Tanner, as well. I think
it is another bill whose time has come, and we need to move
forward on that.
Mr. Chairman, for good intent, I am sure, the 1986 tax
reform bill eliminated the sales tax deduction which was
necessary, perhaps, at the time to help us balance the budget,
but it created an inequity between States, including States
such as yours, mine of Washington, Wyoming, Tennessee, and
Florida; those States that have no income tax but pay only
sales tax. Every year, when it is time to fill out our Federal
tax refund--or, hopefully, refund--our Federal tax return,
residents of States that have income tax are able to deduct the
amount they pay to their State in income tax, but those of us
with only sales tax have to enter a zero on that line. It is my
belief, and, certainly, the belief of many residents of my
State and the other affected States that this is unfair.
What we have proposed to remedy this is H.R. 1433. We have
about 30 cosponsors, and, essentially, it is a very simple
proposal. It would allow residents of States to deduct either
their income tax or their sales tax. We have made it an either/
or choice to reduce the scoring impact, but our goal is to
restore at least a modicum of fairness to people from different
States. Simply put, we don't believe it is the Federal
Government's role to dictate to States whether they should have
an income tax or a sales tax to support their State government,
but that is effectively what the current Federal Code does. So,
by giving a choice, we restore some tax fairness, and we keep
the scoring impact to a minimum.
Like all my colleagues here, I am committed to a balanced
budget, and there has been, indeed, many good proposals put
forward for how we might adjust the Tax Code, but, for myself,
I think the top priority should be restoring fairness across
States.
One other issue I want to briefly address and that is some
tax relief for victims of disasters. Particularly in my
district, there are folks who have lost all of their belongings
to a slow-moving landslide. It has eliminated 130 homes, and
they were unable, completely unable, to buy insurance for this
kind of disaster. As a result, should they be fortunate enough
to have their mortgage forgiven, under current code, that could
be counted as a gift, and they would pay full taxes on a house
that has been completely destroyed. We will be introducing some
legislation to provide tax relief to a very small but important
subset of folks who have lost their possessions and home in a
disaster, and I hope the Committee will look favorably on that.
I would like, if I may, to yield a couple of minutes to my
colleague, Mr. Clement, from Tennessee, to further address the
issue of sales tax deduction.
[The prepared statement follows:]

Statement of Hon. Brian Baird, a Representative in Congress from the
State of Washington

Thank you, Mr. Chairman.
Mr. Chairman and members of the Committee, I'm honored to
be here today for this extremely important hearing, and I truly
appreciate the opportunity to share some specific tax concerns
that have put a strain on constituents in my home state of
Washington.
I'm here primarily to discuss tax fairness in the context
of the federal sales tax deduction; but with the Chairman's
consent, I would like to take just a moment to mention my
strong support for legislation that my colleague from the state
of Washington, Congresswoman Dunn, and the distinguished
gentleman from Tennessee, Mr. Tanner, have introduced to repeal
the estate tax. I also want to take a moment to discuss
measures that I have proposed to provide relief to certain
disaster victims.
Let me initially discuss the difficulties with the estate
tax. In addition to some fundamental problems with the tax that
seriously harm family-owned small businesses and smaller family
farms, I think there are a few rarely-mentioned reasons for its
repeal. One, many of the family-owned small businesses with
more capital assets than covered by the exclusion employ many
people at good family wages, especially within smaller
communities, and often reinvest generously in those
communities. Yet, far too often, the estate tax forces families
to sell such businesses to larger corporate interests with less
involvement in the community and less interest in maintaining a
strong, well-paid local workforce.
Second, in my district, and I know that Congresswoman Dunn
understands this well, we have a lot of family foresters who
have been very good stewards of the land over many years.
However, the estate tax may force the families of many of these
land-owners to sell off all or part of that forest land before
it reaches full maturity. So it is my belief that there are
good labor and environmental reasons to provide additional
estate tax relief.
Now, if I may return to the principle theme of my
testimony, I will explain the rationale for restoring the sales
tax deduction. In principle, Mr. Chairman, I believe that the
federal government must strive to avoid tax policies that favor
residents of some states over others. Unfortunately, I believe
that one egregious failure to adhere to this principle is found
in the manner in which the federal government allows taxpayers
to deduct state and local taxes.
I'm sure, Mr. Chairman and members of the Committee, that
you are well aware of the problem. Simply put, residents of
states without state income taxes now pay a greater percentage
of taxes to the federal government than residents of states
with state income taxes. Solely on account of the system of
taxation their state uses to collect revenues, they pay more
federal tax. That differential treatment of taxpayers is a
profound inequity that the 106th Congress should rectify.
The repeal of the sales tax deduction in 1986, although
well intended, resulted in a significant disparity between
states. By disallowing state sales tax deductions, but
retaining state income tax deductions in the federal code, we
now have a system in which one individual with an income and
financial profile that is identical to another person may pay
higher taxes to the same federal government simply because they
live in different states. As a result, residents of states such
as Texas, Florida, Washington, Tennessee, South Dakota, Nevada,
Alaska, Wyoming, and New Hampshire, pay more in federal taxes
than residents of equal income in other states. In effect,
residents of states without income taxes are underwriting a
disproportionate share of the federal budget.
It's not that Washingtonians pay less in taxes. On the
contrary, we're in the top quarter of states in amount of our
personal income that goes to taxes. The question becomes,
should residents of my state pay hundreds more dollars per year
to the federal treasury for nothing more in return, than those
individuals living across the river in another state. I believe
that they should not.
To remedy this situation, I have proposed legislation,
along with about 30 cosponsors, including several members of
this committee, that will restore the sales tax deduction for
taxpayers in states that do not have an income tax. My measure
would allow taxpayers to deduct either their state income tax
or state sales taxes paid in a given year. By giving a choice
of deducting either sales or income tax, the budgetary scoring
is kept to a minimum, but equity and fairness are restored
across states.
To keep the sales tax deduction simple for taxpayers, under
this legislation the Internal Revenue Service would be directed
to develop standard tables for taxpayers to use in determining
their average sales tax deduction. Such tables, similar to
those used by taxpayers prior to 1986, would include average
calculations, based upon income and household size, for a
taxpayer in a given state. The bill does not restore the
itemized deduction of individual purchases; it only allows
taxpayers to deduct an averaged amount based on income level
and family size.
I, like all of my colleagues in this body, am committed to
maintaining a balanced budget, and I am also committed to the
principle of equal taxation as dictated by the Constitution.
But, as we wrestle with the options for spending projected
budget surpluses in the foreseeable future, I ask my colleagues
to put themselves in the position of more than 50 million
taxpayers who live in sates with no income tax and no means of
deducting sales taxes; and I ask that we prioritize the
restoration of fairness for taxpayers nationwide.
So, as you review the many tax relief proposals before you
today and if, in fact, the committee develops legislation to
provide relief in this Congress, I strongly encourage you to
consider this common-sense proposal, for the simple reason that
it is the right thing to do.
Mr. Chairman, I have one final issue that I would like to
bring to the committee's attention a situation in my district
that warrants significant tax relief.
Since before I was sworn in as a member of this body, I
have been working with a group of constituents from the City of
Kelso, in my Southwest Washington district, to provide
assistance to their disaster-torn community.
This city has literally has been torn apart by slow-moving
landslides that resulted from heavy rainfalls. During the last
14 months, more than 130 homes have been destroyed by those
landslides, and the remainder of the homes in the area may
suffer the same fate in the next 5 to 10 years.
What differentiates this disaster from many others is the
fact that insurance was not readily available for this type of
disaster--in fact, most homeowners policies specifically
exclude mudslides as a covered peril--and now many of these
folks have lost nearly everything they own.
Therefore, Mr. Chairman, I have devised some targeted tax
measures that would assist individuals in this type of
situation, in state or federally-declared disaster areas
resulting from disasters for which insurance is not readily
available. First, my measure would clarify the law to ensure
that any discharge of debt provided to these homeowners would
not be taxable as income. Second, it would establish a tax
credit to help those taxpayers whose homes are destroyed, but
who are required to continue paying mortgage payments on their
destroyed home. Additionally, it would adjust the computation
of the casualty loss deduction by allowing taxpayers to deduct
the fair market value of a home, instead of only the basis in
the home as permitted under current law. Finally, Mr. Chairman,
in those cases where the homeowner is fortunate enough to sell
a home located in such a devastated area, which may or may not
have been irreparably damaged but may be severely devalued,
this legislation allows taxpayers to deduct the full value of
that loss.
Mr. Chairman, I would be happy to include a copy of this
legislation, which I am introducing this week, with my
testimony. I realize that the situation in my state may be
unusual, but as such, the impact of this measure on the federal
government should be limited. However, it's impact in helping
to rebuild the lives of our disaster victims would be enormous.
At this point, Mr. Chairman, I would be happy to answer
questions from members of the committee about any of this
testimony.
Again, I want to thank you, and members of the committee
for graciously granting me this opportunity, and I yield back
the balance of my time.

Chairman Archer. Mr. Clement.
Mr. Clement. Thank you, Mr. Chairman. It is a pleasure to
be here before this distinguished Committee and be associated
with Mr. Baird, who I think so much of, and his legislation
that offers so much to all of us. I also want to agree with him
about the legislation proposed by Ms. Dunn and Mr. Tanner,
which I strongly support on eliminating the inheritance tax.
In 1997, the citizens of Tennessee paid an average of $927
in State and local sales taxes but could not deduct $1 of it
from their Federal income tax returns. So, basically,
Tennesseans are being forced to pay taxes on their taxes, just
like Texas and the other States that do not have an income tax.
My colleagues, this is just not right. In fact, Tennessee
Lieutenant Governor John Wilder is exploring options for filing
a class-action lawsuit against the Federal Government asserting
that the citizens of Tennessee are being discriminated against
simply because they live in a State that has chosen not to
enact a State income tax.
Mr. Chairman, I submit to you that the Federal Government
should treat all taxpayers equally regardless of the system of
taxation their State employs. The Tax Deduction Fairness Act
simply would allow taxpayers to deduct either their State
income tax or State and local sales taxes from their Federal
income tax returns. We have an opportunity to restore fairness
and equity to the Tax Code in this Congress without making the
Tax Code more complex and without abandoning our fiscal
discipline.
In addition, this legislation would return to the States
the decision of how to fund their operations by removing the
incentive toward a State income tax from the Federal Tax Code.
Regardless of your views on income taxes, sales taxes, or some
alternate tax structures, I am sure you would agree that States
should have the right to decide for themselves how they want to
collect their revenues without interference from the Federal
Government.
In closing, I would like to thank Congressman Baird for
introducing this important legislation, and I hope that the
Committee will consider including it if there should be a tax
relief package in this Congress.
Thank you, Mr. Chairman.

Statement of the Honorable Bob Clement, M.C., Tennessee

Thank you, Mr. Chairman. I appreciate the opportunity to
appear before the Committee today to testify about an issue of
fundamental fairness for the citizens of Tennessee as well as
the other seven states that do not have a state income tax. In
1986, the state and local sales tax deduction was eliminated
from the federal tax code in an effort to expand the tax base.
While well-intentioned, the elimination of the sales tax
deduction created a fundamental inequity between states that
have adopted an income tax and those that have not. That's
because, under the current tax code, sales tax paid on the
purchase of goods or services cannot be deducted from an
individual's tax return, while state income tax can be
deducted.
In 1997, the citizens of Tennessee paid an average of $927
in state and local sales taxes but could not deduct one dollar
of it from their federal income tax returns. So basically,
Tennesseans are being forced to pay taxes on their taxes. My
colleagues, this is just not right. In fact, Tennessee
Lieutenant Governor John Wilder is exploring options for filing
a class action lawsuit against the federal government asserting
that the citizens of Tennessee are being discriminated against
simply because they live in a state that has chosen not to
enact a state income tax. Mr. Chairman, I submit to you that
the federal government should treat all taxpayers equally,
regardless of the system of taxation their state employs.
The Tax Deduction Fairness Act simply would allow taxpayers
to deduct either their state income tax or state and local
sales taxes from their federal income tax returns. We have an
opportunity to restore fairness and equity to the tax code in
this Congress without making the tax code more complex and
without abandoning our fiscal discipline.
In addition, this legislation would return to the states
the decision of how to fund their operations by removing the
incentive toward a state income tax from the federal tax code.
Regardless of your views on income taxes, sales taxes or some
alternate tax structures, I'm sure you would agree that states
should have the right to decide for themselves how they want to
collect their revenues without interference from the federal
government.
In closing, I would like to thank Congressman Baird for
introducing this important legislation and I hope that the
Committee will consider including it if there should be a tax
relief package in this Congress. Thank you, Mr. Chairman.

Chairman Archer. Thank you, Mr. Clement.
Our last witness today is Congressman Crowley from New
York. Mr. Crowley, we are glad to have you before the
Committee. You may proceed.

STATEMENT OF HON. JOSEPH CROWLEY, A REPRESENTATIVE IN CONGRESS
FROM THE STATE OF NEW YORK

Mr. Crowley. Thank you, Chairman Archer and Ranking Member
Rangel, for giving me the opportunity to talk about the
overcrowding and structural problems faced by our schools and
the need for the House of Representatives to provide tax-based
relief for those problems. My colleague from New York, Mr.
Rangel, has introduced legislation, H.R. 1660, which I believe
will provide substantial relief to communities across this
country at the least cost to the Federal Government.
Mr. Chairman, I represent the Seventh Congressional
District in New York, which encompasses parts of Queens and the
Bronx. The schools in my district face similar problems to
schools all across this country. The New York City School
District is the largest in the Nation, serving over a million
students, and I represent the Community School District 24, the
most overcrowded school district in the city, which operates at
114 percent over capacity. In total, I represent 3 of the 10
most overcrowded schools in the City of New York. Over the next
10 years, this number will increase, and five of the six school
districts I represent will be operating over capacity. School
District 24, by the year 2007, is predicted to be operating at
168 percent over capacity.
These charts I have brought here show the situation faced
by five school districts located within my congressional
district--you all have copies of these charts. This first chart
illustrates the enrollment versus the capacity of high schools
in Queens--this is enrollment, this is capacity. The second
chart illustrates the enrollment versus the capacity of high
schools in the Bronx. Again, the enrollment on the left,
capacity on the right. The third chart I have shows the
enrollment versus the capacity of elementary schools and
intermediate schools in Queens County. This fourth chart I have
shows that even after an aggressive building and modernization
plan by the City and State of New York, the City of New York
will not have enough seats for its students. In fact, by the
year 2007, Queens County is predicted to comprise 66.3 percent
of the shortage in New York City. And, last, this chart shows
how every single school district in Queens will be operating
over capacity within the next 10 years, not by just a few
students, but between 5,000 and 10,000 students per district
will not have seats in Queens County.
New York City and Queens, in particular, is facing a
rapidly growing school-age population. In Queens, the school
enrollments are increasing by a minimum of 30,000 students
every 5 years. The school system simply cannot handle this
rapid growth. In fact, the schools cannot handle the current
level of student enrollment. The average New York City school
was built 50 years ago--1 in 5 is over 75 years of age--and
these older schools do not meet the needs of the 21st century.
Some, such as P.S. 87 in Middle Village, Queens, still uses
coal to heat its school. Others have converted closets,
bathrooms, and even hallways have been converted into
classrooms.
In this first picture I have here--it is in District 30 of
my district--where you see 50 students and 2 teachers teaching
a regular kindergarten classroom in one room; 50 students in
one room. The second picture I have here is a picture of a
class being taught in the hallway in my district. And the third
picture I have here is a picture of a class being taught in a
closet.
In May, I hosted an education roundtable in my district. I
invited every school principal and superintendent to that
roundtable in my district. We had a great discussion, and the
overwhelming feeling was that we need new schools constructed
and the existing schools to be modernized. I recently sent out
a survey asking school principals regarding their schools. The
survey asked questions about the makeup of the student body,
the school's infrastructure as well as safety concerns and
parental involvement. The majority of these principals were
concerned about the infrastructure. One school, P.S. 11 in
Woodside, Queens, has had to convert their locker rooms, shower
rooms, and supply closets into classrooms. This is in addition
to the temporary classrooms constructed to accommodate the
increased student population. I would also add that P.S. 229,
where I went to grammar school, not only has temporary
classrooms but has built an additional wing, and the
schoolyard, where I grew up and played, no longer exists. The
Renaissance High School in Jackson Heights operates on two
shifts--from 7:50 a.m. until 5 p.m. at night. What happens to
the important extracurricular activities? How about school
sports participation? How about volunteer work by students or
even after-school jobs? A vital part of our students' overall
academic experience is being denied to them, and our students
and our communities are the true losers.
Mr. Chairman, I think you will agree that the schools in
New York City and in many other cities and towns across this
Nation are in a state of crisis. Local communities and States
simply do not have the resources to adequately modernize and
construct enough new schools to meet the growing enrollment
demands.
A commonsense, tax-saving proposal is Representative's
Charles Rangel's H.R. 1660, the Public School Modernization Act
of 1999. H.R. 1660 contains two tax provisions that will help
schools to modernize their buildings and relieve overcrowding
conditions. Using tax credits, Mr. Rangel's bill will provide
approximately $24 billion in interest-free funds for school
modernization projects and new building construction.
Essentially, the bill is tax-exempt bond financing for school
districts. It does not add to the Tax Code or provide for
direct appropriations to States; rather, it would allow State
and local governments to issue qualified school construction
bonds to fund construction or rehabilitation of public schools.
Interest on these qualified bonds would in effect be paid by
the Federal Government through an annual tax credit to the
bondholders on the amount of interest accrued. An additional
benefit of this proposal is that communities whose schools
offer bonds will not have to face increased taxes, thereby
decreasing the tax burden for our less fortunate communities.
Above all, the bonds provide our communities with a flexible
and cost-effective approach to school modernization and
construction.
I understand there are alternatives out there to Mr.
Rangel's bill. However, H.R. 1660 is unique in that it
allocates half of its bond authority base on the existing
Federal Title I grants formula and the other half to the
hundred school districts in the country with the largest number
of low-income students. The alternative uses a 50/50 allocation
that combines Title I and the overall number of K-12 students.
Mr. Rangel's bill will ensure that the neediest communities get
the assistance that they desperately need.
And, Mr. Chairman and Members of the Committee, I thank you
for your time and ask you to call on me if you need any
additional information.
Thank you.
[The prepared statement and attachments follow:]

Statement of Hon. Joseph Crowley, a Representative in Congress from the
State of New York

I want to thank Chairman Archer and Ranking Member Rangel
for giving me to time to talk about to overcrowding and
structural problems faced by our schools and the need for the
House of Representatives to provide tax based relief. My
colleague from New York, Mr. Rangel, has introduced legislation
which I believe will provide substantial relief to communities
across the country at the least cost to the federal government.
Mr. Chairman, I represent the 7th Congressional District of
New York, which encompasses parts of Queens and the Bronx. The
schools in my district face similar problems to schools across
the country. The New York City School District is the largest
in the nation, serving over a million students. I represent
Community School District 24, the most over-crowded school
district in the city, which operates at 114% capacity. In
total, I represent three of the ten most overcrowded schools in
the city of New York. Over the next 10 years, this number will
increase and five of the six school districts I represent will
be operating over capacity. CSD 24 will be operating at 168%
over capacity! These charts I have here show the situation
faced by the five school districts located within my
Congressional District. (See attached charts).
1. This Chart illustrate the enrollments versus the
capacities of high schools in Queens
[GRAPHIC] [TIFF OMITTED] T0841.009

2. This Chart illustrates the enrollments versus the
capacities of high schools in the Bronx
[GRAPHIC] [TIFF OMITTED] T0841.010

3. This Chart shows the enrollments versus the capacities
of elementary and intermediate schools in Queens
[GRAPHIC] [TIFF OMITTED] T0841.011

4. This chart shows that even after an aggressive building
and modernization plan by New York City's Board of Education,
the City of New York will not have enough seats for its
students!
[GRAPHIC] [TIFF OMITTED] T0841.012

5. Lastly, this chart shows how EVERY SINGLE school
district in Queens will be operating over capacity within the
next ten years. Not by just a few students, but between five
and ten thousand students will not have seats!

[GRAPHIC] [TIFF OMITTED] T0841.013

New York City, and Queens in particular, is facing a
rapidly growing school-age population. In Queens, the school
enrollments are increasing by a minimum of 30,000 students
every five years. The school system simply cannot handle this
rapid growth. In fact, the schools cannot handle the current
level of student enrollment. The average New York City school
was built 50 years ago; one in five over 75 years ago; and
these older school do not meet the needs of the 21st century.
Some, such as P.S. 87 in Middle Village, Queens, still use coal
to heat the schools; others have converted closets, bathrooms,
and even hallways into classrooms. See attached photographs.
[GRAPHIC] [TIFF OMITTED] T0841.014

[GRAPHIC] [TIFF OMITTED] T0841.015

[GRAPHIC] [TIFF OMITTED] T0841.016

In May, I hosted an education roundtable in my district. I
invited every school principal and Superintendent. We had a
great discussion and the overwhelming feeling was that we need
new schools constructed and the existing structures modernized.
I recently sent out a survey asking school principal regarding
their schools. The survey asked questions about the make-up of
the student body, the school's infrastructure, as well as
safety concerns and parental involvement. The majority of these
Principals were concerned about their infrastructure. One
school--P.S. 11 in Woodside, Queens, has had to convert their
locker rooms, shower rooms, and supply closets into classrooms.
This is in addition to the temporary classrooms constructed to
accommodate the increased student population. The Renaissance
High School in Jackson Heights operates on two shifts, from
7:50 a.m. until 5:00 p.m. What happens to important extra-
curricular activities? How about sports participation?
Volunteer work by students? Even after school jobs? A vital
part of a students overall academic experience is being denied
to them and our students and our communities are the losers.
Mr. Chairman, I think you will agree that the state of
schools in New York City, and in many other cities and towns
across the nation, is a crisis situation. Local communities and
states simply do not have the resources to adequately modernize
and construct enough new schools to meet the growing enrollment
demands. A commonsense, tax-saving proposal is Representative
Charlie Rangel's H.R. 1660, the Public School Modernization Act
of 1999.
H.R. 1660 contains two tax provisions that will help
schools to modernize their buildings and relieve over-crowded
conditions. Using tax-credits, Mr. Rangel's bill would provide
approximately $24 billion in interest-free funds for school
modernization projects and new building construction.
Essentially, the bill is tax-exempt bond financing for the
school districts. It does not add to the tax code or provide
for a direct appropriation to states. Rather, it would allow
State and Local governments to issue qualified school
construction bonds to fund construction or rehabilitation of
public schools. Interest on these qualified bonds would in
effect be paid by the Federal government through an annual tax
credit to the bondholders on the amount of interest accrued. An
additional benefit of this proposal is that communities whose
schools offer bonds will not have to face increased taxes,
thereby decreasing the tax burden or our less fortunate
communities. Above all, bonds provide our communities with a
flexible and cost-effective approach to school modernization
and construction.
I understand there are alternatives out there to Mr.
Rangel's bill. However, H.R. 1660 is unique in that is
allocates half of its bond authority based on the existing
federal Title I grants formula and the other half to the
hundred school districts with the largest number of low income
students. The alternatives use a fifty-fifty allocation that
combines Title I and the overall number of K-12 students. Mr.
Rangel's bill will ensure that the neediest communities get the
assistance that they desperately need.
Mr. Chairman and members of the committee, I thank you for
your time and ask you to call on me if you need any additional
information.

Chairman Archer. Thank you, Mr. Crowley.
Does any Member of the Committee wish to inquire?
Ms. Dunn.
Ms. Dunn. Thank you very much, Mr. Chairman, and I want to
thank my colleague from Washington State, Mr. Baird, for his
efforts to reinstate the sales tax deduction. Mr. Chairman,
this is a tax that negatively effects you in your State and
those of us in Washington State and apparently Tennessee and
other States, and I really feel that only being able to deduct
a State income tax from Federal taxes is a huge invasion of
States' rights, and I think it is something that we ought to
pay attention to, and, in fact, wondered, when Mr. Foley was
our Speaker, if he might lead us in this direction, and I am
delighted that Mr. Baird has done just that.
I also want to thank Mr. Turner particularly for coming
here today to testify on behalf of his bill, H.R. 1916, which
would allow forest product companies to expense more of their
reforestation expenses. We need to do all we can to help
industries in this business. Lots of these industries have been
lagging lately because of Federal requirements and taxes and
regulations, and I think it is really important that he is
pushing into this area.
I have also included a similar provision in the bill that I
have introduced, which is H.R. 1083, the Reforestation Tax Act,
and this provides a comprehensive approach to increasing the
global competitiveness of today's forest product companies.
H.R. 1083 has the support already, Mr. Chairman--65 Members of
Congress, I am sure, many of whom would want to be on your
bill, and 14 of those are Members of the Ways and Means
Committee, and virtually every forest products company, both
large and small, as well as forestry associations and labor
unions. And so I want to give a lot of credit to Mr. Turner for
recognizing the importance of this issue and helping to advance
this worthy cause.
I would say simply one more thing: Mr. Weller and I have
included in a larger bill the Lifetime Tax Relief Act, the work
that he and Mr. McIntosh have done on the marriage penalty, and
we believe this is critically important to be part of a larger
tax bill. There are many forms that relief could take, but Mr.
Weller and Mr. McIntosh have been the leaders on this issue,
and, as I go home to my district and speak before groups around
this country, that is always the primary tax relief issue that
comes up in the form of questions. So, not to leave out my work
that I have done on death tax relief, and I appreciate your
crediting Mr. Tanner and me with that, because we have worked
very hard on this, and we think fairness dictates that this
sort of relief be given to folks who are paying tax in the
United States.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Rangel.
Mr. Rangel. Mr. Chairman, I want to thank all of the
panelists. I also appreciate the statement given by the
gentleman from Tennessee. Having fought for the deductibility
of State income taxes, I can see the equity issue as it relates
to sales taxes. Mr. Crowley, while you eloquently described the
crisis that exists in New York City schools, we want the
Committee to know that the Conference of Mayors has indicated
that this same crisis exists throughout the United States, in
urban as well as rural areas, and especially in the poorer
communities, which would be targeted for assistance by our
legislation.
The emphasis of the Majority seems to be on the individual
savings accounts where the parents would be able to deposit
$2,000, and if that $2,000 was dedicated in any way toward the
education of the child, the interest on that amount would be
tax free. Could you see how this could possibly alleviate the
crisis about which you testify?
Mr. Crowley. I can't see how that, in and of itself, could
help build schools or modernize the schools, at least in my
district; I can't speak for suburban----
Mr. Rangel. One of the other exciting educational ideas
that they have put forth is substituting Federal funding for
vouchers. Do you see how that would alleviate the
overcrowdedness that exists in the schools about which you were
testifying?
Mr. Crowley. I don't see how vouchers, in and of
themselves, could alleviate the problems we are facing in my
district or in the city of New York, and in terms of--vouchers
will do nothing to modernize the public school system in our
city.
Mr. Rangel. The most creative proposal that they have
recently come up with is to remove all the Federal criteria
that target the funds to help meet educational goals and allow
the Governors to decide how they would want to use the 7
percent of their spending that comes from Federal dollars.
Knowing that you were a member of the State legislature and
knowing the spending formulas that relate to New York City and
the rest of the State, would you believe allowing the Governors
to decide how to use Federal dollars would help you with the
problems that you testify today?
Mr. Crowley. I particularly fear in New York State that
that would not be the case. Having come from there and knowing
that we get shortchanged on an annual basis in New York City,
to leave it in the hands of the legislature and the Governor
would not be a wise thing to do, and I think that is why your
plan, Mr. Rangel, would drive the money where it is mostly
needed, especially as it pertains to Title I programs in the
City of New York and in my district in particular. I know I
fare much better with your bill than I would with any of the
other bills that are proposed.
Mr. Rangel. Thank you, and I thank the panel. Thank you,
Mr. Chairman.
Chairman Archer. Mr. McInnis.
Mr. McInnis. Thank you, Mr. Chairman.
First of all, just to kind of piggyback on the state of the
death tax situation, another way I think an approach that we
could do is a bill I have introduced, which is to take the gift
exemption every year from $10,000 to $20,000. We have never
seen an adjustment since, I think, in the seventies on that
factor, so until we are able to eliminate the death tax of
which I wholly support, and, in fact, I am a cosponsor of the
bill, I think we should look at the gift tax.
My second thing was for Congressman Baird. I agree with
your comments; I am little confused, though. I am not aware of
a disaster or a situation where a home burns or something like
that that the mortgage company forgives the mortgage. I am not
sure they have the authority to forgive the mortgage. Where I
have seen a mortgage written off is where somebody doesn't make
their payments; they just walk off and abandoned the property.
The mortgage company writes the loan off, and the IRS considers
that, then, as a taxable event. So, I am trying to distinguish
between the two. One, I think the disaster--I would agree with
you, if, in fact, that ever occurs--that if it is forgiven,
then I think we should look at that as an exemption, and,
ironically, in my district, we had somebody who was kidnapped--
a bank president. And, believe it or not, the bank gave the
bank president's family the money to pay the kidnappers, and
then the IRS charged that as a gift. They later backed off of
that after publicity, but they initially tried it. So, that
happens, but the written off aspect of it, that, I think, is a
taxable event. So, would you distinguish for me? Does it occur?
Mr. Baird. Let me give you the situation we face. There is
a very slow moving landslide; it has taken out about 130 homes.
The FEMA funds and SPA and HUD are not really well equipped to
deal with a disaster of this sort, and we are trying to help
them out in every way we can through the existing government
agencies. But several of the homeowners are in the following
circumstance: their home, which may have had $150,000, $175,000
of equity, has been destroyed. They now have to find and live
in another home.
There are several problems, and we are going to piece them
together. First problem is this issue of forgiveness. A few of
the lenders have said, basically, ``We don't feel right
continuing to charge you for your mortgage on a home that you
can't live in.'' Quite literally, out of the goodness of their
heart, they are going to forgive the mortgage. They are going
to say, ``You don't owe us any more money.'' That, under
current code, as we understand it, could be constituted as a
gift, and the homeowner would then have to pay taxes on a gift,
which is really, for them, effectively, a valueless gift.
Mr. McInnis. But that in fact is happening? You know of
mortgages being forgiven?
Mr. Baird. We know of several cases where that has
happened.
The other side to this deals more with the casualty loss
provision, which we would also like to address, and let me
briefly raise that. Current casualty loss--these homes are
completely wiped out; they are buried under mud--current
casualty loss calculates your casualty basis from the value of
the house when you purchased it. Many of these homeowners have
owned their homes for 30 years, and obviously the current
equity is quite a bit higher than that. So, we would like to
also propose adjusting the casualty loss. Again, what we are
trying to deal with are disasters of a sort for which you
cannot readily buy insurance, because we don't want to create
the Tax Code as de facto disaster insurance. This is a niche
where people have been hurt and left out, and it is a way to
try to help them out over time.
Mr. McInnis. I think your approach is very reasonable.
Mr. Chairman, I yield back the balance of my time.
Chairman Archer. Mr. English.
Mr. English. Thank you, Mr. Chairman.
Mr. Turner, I am delighted that you are here to testify. I
think the proposal you have brought before us, as with Ms.
Dunn's proposal, is a solid contribution to the debate on how
the Tax Code could be made more environmentally friendly. I
think you have already in your testimony made a strong case on
how this expanded tax credit would help the forestry industry,
including the one we have in western Pennsylvania. Let me ask
you: beyond that advantage, would you care to comment on the
environmental impact of providing this tax credit and the level
of support from conservation groups for what you are proposing?
Mr. Turner. Thank you, Mr. English, for that question. As
you well know, anytime you reforest lands you improve the
quality of the air; there is a very obvious relationship. The
other thing that happens when you encourage reforestation is
you take pressure off areas that you really should not be
harvesting for timber. You are able to preserve wetlands, you
are able to preserve streambeds, and you are able to manage
your land better if you decrease this pressure. And, of course,
in areas like we represent where there is a demand upon the
forest from the forest products industry, anytime we can
provide a greater supply of the raw product, we are not only
going to help the environment but we are also going to lower
the cost of that raw product to those mills and help them to be
more competitive. Therefore, it is kind of a win-win if you
encourage landowners, and, as you know, in my bill, we are
basically targeting the small landowners, the ones that on the
chart I had up a minute ago are not reforesting their lands as
fast as they are harvesting their timber. I think it is a win-
win for everybody.
Mr. English. So, in other words, this would benefit the
little guy. Sometimes tax preferences that are built in aimed
at the forestry industry tend to be mischaracterized as
corporate welfare. This would clearly not be a case of
corporate welfare. This would be aimed at the little guy, and
it would have clear and demonstrable environmental benefits; it
would improve land use, and it would address the large problem
of deforestation.
Mr. Turner. No question about it. In fact, the chart--I
might ask my staff to put it back up--the chart that was
produced by the Texas Forest Service regarding the situation in
Texas is probably very similar to other areas across the
country. What it shows you is that the large industrial
landowners, the timber companies, are doing a great job of
reforesting the lands after they harvest the timber. On the
left side of the chart you can see they are reforesting about
99 percent, but the small landowner on the right side of the
chart is only reforesting 40 percent of the lands that have
been harvested. Under current law you can amortize 10,000
dollars' worth of your expenses, and my bill simply moves that
figure up to $25,000. That amount hasn't changed since 1986, so
inflation alone would justify the increase. Then, of course,
the investment tax credit remains the same at 10 percent.
What it means is that at a cost of $80 to $100 for
replanting timber--replanting seedlings per acre--the average
landowner can probably replant, under our expanded amount of
$25,000, about 250 to 300 acres of land. Clearly, my bill is
aimed at that small landowner and trying to get that number up
on the right side of that chart.
Mr. English. Mr. Turner--you have explained to us the
benefits from the standpoint of the person involved in the
timber industry--may I ask, what would be the overall cost of
your provision, if it were included in a tax bill?
Mr. Turner. The cost estimate on my bill over 5 years is
$112 million, and over 10 years, it is $253 million--a very
modest cost considering the economic benefits and the
environmental benefits that would flow from it.
Mr. English. Ms. Dunn's bill, I think, is broader and would
I believe extend to a broader range of taxpayers, including the
corporate taxpayers. I think your proposal is very interesting,
and we appreciate your taking the time to call our attention to
it.
Thank you. I yield back my time.
Mr. Turner. Thank you, Mr. English.
Chairman Archer. Any other Member wish to inquire? If not,
the Chair is very grateful to all of you for making your
presentations today. We thank you, we excuse you, and we will
go to our next panel.
Mr. Bennett, Dr. Kepple, Mr. Grayson, Dr. Gillespie, Mr.
Baratta, Ms. Zedalis, will you please come to the witness
table?
It's the Chair's intention to continue this hearing
straight through the lunch period. So Members who wish to grab
a bite of lunch need to go and then return as soon as they
wish, but we will not take a break for lunch.
We are happy to have each of you before the Committee
today. And, Mr. Bennett, will you please lead off? The Chair
would reiterate the rules which are for you to keep your oral
testimony within 5 minutes. Your entire written statement,
without objection, will be printed in the record. When you are
recognized, identify yourself for the record and then proceed
with your testimony.
Mr. Bennett.

STATEMENT OF HON. MARSHALL BENNETT, MISSISSIPPI STATE
TREASURER, AND ADMINISTRATOR, MISSISSIPPI PREPAID AFFORDABLE
COLLEGE TUITION PLAN; ON BEHALF OF COLLEGE SAVINGS PLANS
NETWORK

Mr. Bennett. Thank you, Mr. Chairman. Good morning, I am
Marshall Bennett, the State Treasurer of the State of
Mississippi, and I am representing the college savings plans
across America, the national College Savings Plans Network, and
it represents each State that is represented here on the Ways
and Means Committee.
I don't know how many of you read on Sunday before last, an
article in The Washington Post entitled, ``Students Pay Dearly
for Debt.'' It talked about the exploding levels of debt among
college students creating negative effects. Debt diverts the
students' attention from academics, it creates a debt-burdened
class of new graduates who have a difficult time of getting
their life started in their new careers.
Well, Americans have begun to ask for relief. From 1980 to
1995, the U.S. Department of Education loan portfolio went from
$20.2 billion to $11.5 billion. American families have had to
rely on debt to meet the higher cost of higher education for
their kids. As a result, the portion of the household income
needed to pay college tuition has doubled during this same
period. The soccer moms across this country are beginning to
scream for solutions. the States have found a solution and that
is in the Qualified States Savings Plans to encourage families
to save for their children's college tuition rather than to go
into debt. Many States have granted State tax deductions, State
tax exemptions to encourage their citizens to have family
savings.
One common feature of the Qualified State Savings Plans is
that they are all statutorily created. They operate under
prescribed investment policies. The savings funds are dedicated
for higher education. The plans generally include a refund
provision for the beneficiaries who choose not to go to college
or get scholarships. Plans are national in scope and are
portable to any public or private college in the Nation.
I have brought with me, Mr. Chairman, a map of the United
States showing the current State plans. Forty-four States and
the District of Columbia have legislative authority to create
college savings programs. Twenty States operate prepaid plans,
including the Texas Tomorrow Fund. Sixteen States operate
college savings plans, including New York, Mr. Rangel, and
California. Fifteen savings plans and one additional prepaid
plan are expected to open within the next year. Already one
million students have signed up for the tuition plans
representing $5 billion in market value of investments.
Well, Congress has acted too in passing, in 1996, the Small
Business Job Protection Act and creating section 529 of the
Internal Revenue Code. You have recognized tax deferred
treatment, like IRAs, for the college savings plans across the
country. You have recognized the safety, security, stability,
and benefits of these plans by granting this special tax
treatment.
We feel that under current law, however, that even deferred
taxation creates a disincentive to participate in savings
because participants don't understand or are not receptive to
paying taxes on income they have not personally received but
which is used to pay the institutions of higher learning. The
Internal Revenue Service now has created proposed rules
requiring a complex accounting and reporting system and
administrative burdens on the college savings plans across the
country. Currently, any tax withheld from the distribution
reduces the funds available for parents and students to pay for
their college tuition.
What we really need is an exclusion from gross income tax
of the earnings in the college savings plans. This would
motivate families to save for college, encourage college
attendance by providing clear and easily understood uniform tax
treatment. Many of the States offer tax exemption now and tax
deduction.
We have already seen that when a family purchases a
contract or sets up a savings plan, the child is more likely to
attend college. College attendance makes for a better trained
work force which pays more taxes.
The reason that Congress has granted this special tax, 529
status to the States is that you know that the States have
adequate oversight of these plans. The programs are overseen by
the State legislatures, the executive branch, the higher
education authorities. the State programs have strict reporting
requirements. They are subject to administrative procedure
laws, procurement laws, ethics laws, a variety of open meetings
laws, public information sunshine laws, and State audits.
You have before Congress now a number of proposals which
would expand the 529 plan to permit private colleges and
universities to establish qualified tuition proposals. We
generally support proposals which encourage families to save
for their children's higher education. However, as
administrators of current college savings plans, we are
concerned about the proposals to permit private colleges and
universities to establish Qualified Tuition Programs without
oversight and accountability. As these proposals move forward
in Congress, we urge this Committee to ensure that private
plans have effective oversight to maintain financial security.
We recommend that you consider a requirement that private
institutions be subject to the same regulation and oversight as
stringent as the oversight which State programs are subject to.
It is just good basic consumer protection and accountability.
CSPN believes that the Securities and Exchange Commission
regulation, for example, would ensure the contributions are
soundly managed and that disclosure requirements would ensure
that private programs operate soundly. Frankly, ladies and
gentlemen, we are not concerned about the Princetons, the
Northwesterns, the Stanfords, and the Notre Dames. What we are
concerned about are schools like the El Paso Beauty School, the
Chicago Truck Driving School, or the Pineville Bible College.
Some may be good schools and well intended but financially
marginal or even financially distressed or mismanaged. Just
look at the fiasco that has happened with student grants and
student loans at proprietary schools that have gone out of
business creating a national crisis. The last thing that anyone
wants is for even one poorly managed private college or a group
of them to market a savings plan that becomes insolvent or has
financial problems and the students will be left holding an
empty bag.
The financial collapse of a private plan would adversely
reflect on all other college savings plans across the country.
If a private unpaid tuition program fails, the public would
have the difficulty distinguishing between those plans that are
failed and the ones that are soundly managed by State-sponsored
and financially backed plans. All the State plans have State
moral obligations or general obligations behind them.
We urge this Committee to amend the current tax laws to
encourage family savings, eliminate the Federal income tax on
accrued interest, and call for strict oversight and regulation
recognizing that if people want parity in the tax provisions,
you should also require parity in accountability and oversight.
Thank you, Mr. Chairman, for your opportunity granted here
and your strong support of college savings across America.
[The prepared statement follows:]

Statement of Hon. Marshall Bennett, Mississippi State Treasurer, and
Administrator, Mississippi Prepaid Affordable College Tuition Plan; on
behalf of College Savings Plans Network

Introduction

Mr. Chairman and Members of the Committee, I am Marshall
Bennett, the State Treasurer of Mississippi, Administrator of
the Mississippi Prepaid Affordable College Tuition Plan
(``MPACT''), and Chairman of the College Savings Plans Network
(``CSPN''). CSPN was formed in 1991 as an affiliate to the
National Association of State Treasurers. CSPN is a national
association representing the common interests of state-operated
college savings tuition plans. The primary mission of the
Network is to encourage families to save ahead for college. To
accomplish its mission, the College Savings Plans Network
shares information among existing programs, provides
information to other state agencies which are interested in
starting a college savings program, and monitors federal
activities and legislation affecting state programs. CSPN
welcomes the opportunity to discuss sound methods to improve
access to post-secondary education.
A recent headline in the Washington Post read ``Students
Pay Dearly for Debt.'' The article noted that ``exploding''
levels of debt among college students create a number of
negative effects, including the diversion of students'
attention from academics as they look for work to payoff school
loans while in school, and debt levels which force students to
drop out or file for bankruptcy. A longer-term effect is the
creation of a debt-burdened class of new graduates who have a
difficult time getting a start with their careers. The campus
debt explosion is a function of college costs, which have risen
faster than family incomes. Regrettably, debt shapes the
contemporary college experience. While I cannot provide an
answer to why debt levels are so high, I can offer the
experience of the states in addressing this problem. There is a
way to help families and students avoid burdensome debt.
The cost of attending college, whether at a public
institution or a private college, continues to rise steadily.
In order to send their children to college, American families
have increasingly relied upon debt to meet the rising cost of a
higher education. According to the National Commission on the
Cost of Higher Education, between 1976 and 1996, the average
tuition at public 4-year universities increased from $642 to
$3,151 (390 percent) and from $2,881 to $15,581 (440 percent)
at private 4-year universities. In contrast, according to the
U.S. General Accounting Office, median household income rose by
only 82 percent. As a result, the portion of a household's
income needed to pay for college tuition nearly doubled during
the period.
Rising tuition rates force families to resort to loans to
fund their children's college education. From 1980 to 1995, the
U.S. Department of Education's loan portfolio increased from
$2.2 billion to $11.5 billion. Not only are more loans being
taken out, the size of the loans has increased. GAO reports
that, at the undergraduate level, the percentage of post
secondary students who had borrowed by the time they graduated
increased from 41 percent in 1992-93 to 52 percent in 1995-96,
and the average amount of debt per student increased from about
$7,800 to about $9,700 in constant 1995-96 dollars. Students
attending 4-year public institutions showed the largest
increase in the number of borrowers. Sixty percent of seniors
graduating from these schools in 1995-96 borrowed at some point
in their program, up from 42 percent in 1992-93 and about even
with the percentage of borrowers at private 4-year colleges. At
the same time, the value of a college education grew,
increasing the demand for college enrollments. The constantly
rising costs coupled with higher demand create uncertainty for
families who want to send their children to college.

College Tuition Plans Promote Savings

The best answer to rising college costs is to encourage
advance family savings. Student financial aid programs are
facing more and more demands at a time when resources have been
reduced. Over dependence on financial aid has caused the total
annual cost of federal financial aid, originally targeted to
help lower-income families, to rise at an unsustainable rate.
Budgetary constraints force the federal government, as well as
state governments, to reduce direct student financial aid. As
government financial aid is reduced, the responsibility for
funding college falls more directly on families. The well
documented low savings rate in the U.S. also clearly indicates
that additional incentives are required to get families to
start saving for their children's college education.
The states recognized the need to foster saving for
college, which is economically more sound, both for families
and for institutions of higher education. Thus, beginning in
the late 1980s, the states tuition savings programs to
encourage families to save for college. Qualified state tuition
programs (``;QSTPs'') are a convenient method for many families
to fund the high costs of college. The plans encourage early
college savings and promote future access to higher education
for children of middle-class families. The basic premise of
these programs is that they encourage families to purchase
future college tuition at an actuarially determined cost based
on today's prices. Thus, qualified state college tuition plans
act as a catalyst for college savings. Families participating
in the programs save specifically for college where otherwise
they would not set aside money for this purpose. The programs
also raise attention to the need to save for college. As a
result, QSTPs provide a unique psychological benefit because
they guarantee future college costs, providing parents with
permanent assurance about their children's future.

How the College Savings Plan Programs Operate

States have long worked to identify ways to encourage
citizens to attend college. For example, since 1959, New Jersey
has offered college savings bonds to its citizens to encourage
enrollment. As concerns about the affordability of college grew
in the 1980s, states established a variety of college savings
programs to assure access to higher education. Michigan
established the first prepaid college tuition plan in 1986.
Alabama, Florida and Ohio followed between 1988 and 1989. From
1989 to 1997, there was moderate growth in the number of
programs, due principally to uncertainty over the federal tax
treatment of the programs. Federal legislation approved in 1996
and 1997 under the bipartisan leadership of the Committee on
Ways & Means encouraged many more states to set up these plans.
The state-sponsored college tuition programs have achieved
tremendous success. Since enactment of the Small Business Job
Protection Act of 1996 and the Taxpayer Relief Act of 1997, the
number of children participating in the programs has
skyrocketed, and the number of states with programs has nearly
doubled. All of the remaining states are studying the
feasibility of establishing a qualified state tuition program.
The state-sponsored college tuition programs help families save
for the high cost of a college education. As a result, many
more of our children will have the opportunity to gain a higher
education, which benefits the entire nation through a better
educated, more productive workforce.
The states have designed their college tuition programs to
account for the particular circumstances of their higher
education establishment. The programs are intended to promote
access to higher education by providing individuals with a
convenient method to fund the rising cost of post-secondary
education. Each program has unique features intended to
encourage its citizens to participate in the programs. However,
the qualified state tuition programs may be divided into two
general types. Prepaid plans and savings plans.

Prepaid Tuition Plans

The first broad type of plan is the prepaid tuition plan.
These programs are analogous to a defined benefit pension plan.
Under a prepaid tuition program, states enter into contracts
with families, corporations or other entities that purchase
contracts to acquire tuition benefits or waive costs for
designated beneficiaries. Under prepaid plans, contract
purchasers prepay tuition and mandatory fees, and in some
states, room and board expenses, for a set number of academic
periods or course units. Contracts may be for junior college,
community college or for four-year undergraduate programs. A
number of prepaid programs also permit the purchase of
contracts for graduate school expenses. All prepaid programs
permit the use of distributions for out-of-state and private
institutions, although the amount of covered expenses may be
based on in-state tuition.
Under a prepaid plan, the price of a contract is determined
prior to purchase. The contract price depends on the type of
contract purchased, the projected date of the designated
beneficiary's enrollment, the current and projected cost of
tuition, the overall number of years until the beneficiary
enrolls in college, and the assumed rate of return. The
contribution amounts are also capped, in compliance with
section 529 of the Internal Revenue Code. The programs pool all
payments into one large fund and invest it with the goal of
achieving a rate of return that is higher than the rate of
tuition increases anticipated at the participating colleges.
Various refund provisions may apply if the beneficiary
cannot use the benefits due to death or disability; chooses to
not go to college; or attends an out-of-state college or
proprietary college. The programs generally do not guarantee
that the beneficiary will be accepted for enrollment at one of
the participating colleges. However, under many plans, new
beneficiaries may be named in place of the original one.
Finally, in the case the fund becomes actuarially unsound, most
states have built an escape clause into their plans that would
allow them to end the program and issue refunds to the
participants.
States offer a variety of payment plans, including lump-sum
payments and installment plans. Once a unit of tuition is
purchased, the tuition rate is locked in. When a child is ready
to go to college, the state transfers directly to the
institution an amount equal to the cost of tuition at the time
of enrollment. Many states guarantee that the contributions to
the plans will cover future tuition costs.

Savings Plans or Savings Trusts

The second type of plan is referred to as the savings plan
or savings trust, analogous to a defined contribution pension
plan. Under these plans, families enter into participation
agreements where they pledge to make cash contributions to an
account for the beneficiary. Generally, these agreements
require a minimum contribution amount, the purpose of which is
to encourage participants to save on a regular basis, which is
generally a more effective way to save for higher education
expenses. Contributions to the savings plans are also capped,
in order prevent their use as an abusive tax shelter.
Under savings programs, the state invests the funds to
equal the anticipated future costs of tuition when the child
goes to college. The state may directly manage the funds or may
employ outside investment managers or brokers. Either way, the
investments are subject to strict guidelines designed to ensure
that the funds keep pace with anticipated tuition inflation.
Under these plans, states do not guarantee the tuition nor a
rate of return, but offer incentives, including state tax
incentives, for saving. Fund investments may vary, based on the
age of the designated beneficiary. The funds contributed on
behalf of a younger beneficiary may be weighted more toward
equities, while funds for a student nearing college enrollment
are normally weighted toward fixed income investments. Most
states allow these plans to be used for tuition or room and
board expenses, in-state or nationally.

Common Features

Although each state's QSTP is unique, taking into account
the needs and circumstances of the state, there are several
features common to prepaid and savings plans:
The plans are statutorily created;
The plans are administered by the state and/or
governed by a Board appointed by the state and comprised of
state officials and others;
State personnel operate the plans, which are
governed by strict financial and program accountability
requirements;
The plans are limited to prescribed investment
policies and standards;
The savings provided by the plans are dedicated to
the provision of higher education, with prescribed limitations
governing the return of savings or prepayments only in the
event of such circumstances as death, permanent disability; or
the failure of the beneficiary to meet entrance requirements;
and
The plans generally include a refund provision for
beneficiaries who choose not to matriculate.

A Current Profile of the State Plans

Forty-four states and the District of Columbia have
authority to operate and manage college tuition programs.
Currently, nineteen states operate prepaid plans and 16 a
savings plan. Fourteen new savings plans and one additional
prepaid plan are expected to begin operation within the next
year. Every remaining state, except Georgia, which operates the
lottery funded HOPE scholarship program, has legislation
pending or is actively studying the establishment of a college
tuition plan. Currently, there are nearly one million signed
college tuition contracts. The estimated fair market value of
these contracts is over $5 billion. The exact totals for the
number of contracts and participants are not available because
several of the programs are just now completing their peak
spring open enrollment periods. However, the numbers of
participants and contracts are expected to show healthy growth
this year. These figures reflect the strong support by state
residents who are diligently saving for the college education
of their children or grandchildren.

Current Federal Tax Treatment

The Small Business Job Protection Act of 1996 clarified the
tax treatment of contributions made to state college savings
programs. Prior to the 1996 law change, the treatment of
distributions from QSTPs was not clear. The Internal Revenue
Service considered implementing rules which would have treated
the prepaid contracts as a form of contingent debt instrument
because, like bonds, they mature at a certain future date. The
IRS proposed to tax participants in prepaid programs annually
on ``phantom'' income earned on prepaid accounts. However,
because the beneficiaries in most cases are children, the
earnings would generally not be large enough to result in a tax
liability. Moreover, the inconvenience to participants and the
costly paperwork involved in annual income reporting would have
substantially reduced the popularity of the plans. Indeed, the
uncertainty with the law was the principal reason for the slow
growth in the number of plans, as well as the slow growth in
the number of plan participants.
Working closely with the College Savings Plans Network and
the National Association of State Treasurers, the 104th
Congress passed section 529 of the Internal Revenue Code. The
new section clarified the federal tax treatment of qualified
state tuition plans and outlined the qualifications required to
establish the tax-exempt status of the state agencies which
administer the programs. Section 529 also clarified the tax-
deferred status of earnings, and set the policies and
procedures related to the refund of the account if the
beneficiary dies before distribution of the funds.
Under the 1996 Act, the federal income tax obligation on
contributions to a qualified state college tuition plan is
deferred until the contributions are redeemed. Upon redemption,
the applicable tax is levied on the student who benefits from
the plan, not the contributor. The federal income tax is due on
the difference between the current value of the contributions
and their original cost. As a result, the accrued interest
income is taxed at the beneficiary's rate. The annual increase
in value is not subject to annual capital gains tax.
Further, in the Taxpayer Relief Act of 1997, Congress said
that deferred tax treatment applied not only to amounts used
for tuition, but also funds used on room and board. The 1997
Act also clarified the estate and gift tax treatment of the
programs. Under the provision, a contribution to a qualified
state tuition program is a completed gift eligible for the
annual gift tax exclusion and the annual generation-skipping
transfer exclusion. A special rule applies to gifts in excess
of the annual exclusion, under which a contributor may elect to
take the contribution into account ratably over five years. The
College Savings Plans Network strongly supported these changes
because they make participation in the plans more attractive to
families.

Proposals to Clarify the Current Tax Treatment of Qualified State
College Tuition Plans

The College Savings Plans Network believes additional
legislation is necessary to increase the attractiveness and
marketability of the plans. Congress is currently considering a
number of proposals to provide an exclusion from gross income
for distributions from qualified state tuition programs.\1\ The
proposals properly focus on increasing the attractiveness of
college tuition plans. Under current law, the taxation of
distributions creates a disincentive to participate in the
plans because potential participants may not understand or be
receptive to paying taxes on income they had not personally
received, but which is used to pay qualified education
expenses. Program sponsors are concerned that this disincentive
hinders maximizing participation in the programs. Program
sponsors are also concerned that requirements to notify
taxpayers of the tax on certain distributions may create costly
administrative burdens for the plans.
---------------------------------------------------------------------------
\1\ H.R. 588; S. 387; H.R. 58, the College Savings Protection Act;
H.R. 7, Education Savings and School Excellence Act of 1999; S. 13 and
H.R. 254, Collegiate Learning and Student Savings Act; S. 1054, Savings
for Scholars Act; H.R. 464, Higher Education Affordability and
Availability Act; S. 14, Education Savings Account and School
Excellence Act of 1999; S. 277, Educational Opportunities and
Excellence Act of 1999; S. 1013, Child Savings Account Act; S. 1134,
Affordable Education Act of 1999; H.R. 892, Renewing America's Schools
Act; H.R. 1084, Lifetime Tax Relief Act of 1999.
---------------------------------------------------------------------------
The College Savings Plans Network believes that
establishing an exclusion from gross income for distributions
from the qualified state tuition programs is essential to
encouraging savings and college attendance. An exclusion from
gross income would recognize that contributions to the programs
cannot be used for any purpose other than higher education. Any
tax withheld from the distribution would reduce funds available
to pay college expenses, increasing the cost to attend college.
The public policy of this proposal is to enable and motivate
families to save for college by providing clear and easily
understood tax treatment of the qualified state tuition plans.
The basic transaction of the qualified state tuition
programs is the purchase of a service to be provided in the
future. After entering into a prepaid tuition contract or
establishing a savings plan account, families have no control
over the assets contributed to the plan. Contributions are
transferred directly to the college or university when the
child attends school. Thus, the accounts are not liquid and
cannot be use for non-education purposes without incurring a
federal tax penalty and penalties or charges issued by the
state. The student will have to find other means of generating
funds to pay the tax.
Congress should make the programs tax-free in order to
encourage savings and college attendance. When a family
purchases a contract or sets up a saving plan, the child is
more likely to actually enroll in college. By encouraging
savings, Congress benefits the national economy. College
attendance makes for a better-trained workforce, which pays
more taxes.

Oversight of the College Savings Plans

The state-sponsored college tuition programs are secured by
the moral or political obligation of the states. To back this
obligation, the state programs are subject to multiple levels
of oversight. These oversight mechanisms protect the financial
integrity of the programs, ensuring that the contributions to
the programs are soundly invested and that the actuarial goals
of the plans are met. Safe financial operation of the programs
means that when a beneficiary enrolls in college, the program
can pay out the proper amount of tuition.
The plans are administered by state entities, variously
called boards, authorities, or trusts. Executive committees or
trustees, subject to specific qualification requirements, are
responsible for the overall direction of the programs. They
generally are comprised of officials from the state
legislature, executive branch, higher education authority, or
from financial institutions and the public. Many of the
programs also have public advisory committees. The executive
entities are responsible for operation of the funds and for
oversight of the strict investment policies governing the
contributions to the funds.
By statute or regulation, the operating authorities are
required to follow prudent investment practices to maximize the
total return on investment and to ensure that the investments
meet the future obligations of the funds. Generally, these
investment guidelines state that the investment profile seeks
to maximize return consistent with the security of principal,
and subject the investments to generally accepted prudency
rules. In addition, many of the funds are required to follow
detailed asset allocation rules to ensure diversity of
investment and liquidity of the funds.
All of the programs are subject to financial and actuarial
audit and reporting requirements. Audits may be conducted
internally, by legislative oversight committees, or by external
auditors. National accounting firms audit many programs. By
law, the reports are required to include a detailed statement
of the financial condition and rates of return of the programs.
Most of the reports also discuss any risks associated with the
program. These reports generally are required to be distributed
to the state legislature, the governor and other executive
branch officials, and to program participants. All states make
some form of the reports available to the public, and many post
this information on Internet websites.
In most states, the qualified tuition program is subject to
administrative procedure laws, procurement laws, ethics and
financial disclosure rules, and a variety of open meeting and
public disclosure statutes. The purpose of all of these rules
is to ensure that the public has information to make an
informed judgement on the financial condition of the program
and to ensure that the programs are operated in the soundest
financial manner possible. As public trusts, the states demand
the highest degree of financial integrity of the programs.
Strict oversight provides assurance that when a child enrolls
in college, the funds saved for their education are available
to pay for school.
A number of bills have been introduced that would expand
Section 529 to permit private colleges and universities to
establish qualified tuition programs. The College Savings Plans
Network supports all proposals designed to encourage families
to save for their children's higher education, because making
it easier for families to save for college is in the long-term
interest of the nation. However, as the administrators of the
state-sponsored college savings plans, we are concerned about
proposals to expand Section 529 to permit private colleges and
universities to establish qualified tuition programs. As these
proposals move forward in the legislative process, we urge the
Committee to ensure that there is effective oversight and
financial security of the private institution programs.
In allowing private institutions to establish qualified
tuition programs, the Committee should consider a requirement
that the private institutions be subject to regulation and
oversight as rigorous as the oversight to which the state
programs are subject. A multi-state private prepaid tuition
plan, qualified under Section 529, should be subject to strict
oversight and reporting requirements. CSPN believes Securities
and Exchange Commission registration requirements, for example,
would ensure that contributions held in common and invested by
a private entity would be soundly managed, and would permit
prospective participants to determine the financial soundness
of such plans. The last thing anyone wants is for even one
poorly managed private college to market a savings plan that
becomes insolvent or has financial problems. This may result in
parents and students left holding an empty bag and would
adversely reflect on all the other college savings plans. If a
private prepaid tuition program failed, the public would have
difficulty distinguishing between the failed plan and the
soundly managed state sponsored plans.

Conclusion

The College Savings Plans Network believes promoting
greater access to higher education and encouraging savings over
debt is sound public policy. The existing state sponsored
college tuition programs promote savings and reduce the need
for financial aid and subsidized student loans. As a result,
the limited amounts of financial aid can be focused to directly
benefit lower income students. Moreover, these programs enable
more young Americans to go to college and secure higher paying
positions, providing a better-educated workforce.
CSPN urges the Committee to amend current tax law to help
encourage families to plan, prepare, and save, rather than rely
on student loans or financial aid to educate their children.
CSPN supports proposals to establish an exclusion from gross
income for distributions from a qualified tuition program.
Eliminating all federal income taxes on the accrued interest
earned through the state programs would create an additional
incentive for college savings. An exclusion from gross income
for distributions from the qualified state tuition programs
encourages innovation by the states, which can tailor the
programs to meet the needs of its citizens while taking into
account its unique mix of higher education institutions. CSPN
commends the Committee on Ways & Means' leadership on these
proposals and urges the Committee to include these provisions
in the Fiscal Year 2000 Budget Reconciliation bill or any other
tax legislation to be considered by the Committee in 1999.
The state tuition savings programs are subject to strict
oversight and regulation in order to ensure that the programs
are operated in a sound financial manner. CSPN urges the
Committee to recognize the need for an equal level of oversight
to ensure that private institution qualified tuition programs
also operate in a manner, which guarantees that when a
beneficiary enrolls in college, sufficient funds are available
to cover the costs of tuition. The failure of a private
institution program would reflect negatively on the successful
state tuition programs.
Thank you again, Mr. Chairman, for your strong support of
the state college tuition programs and the hundreds of
thousands of families who participate in them. We look forward
to working with you on legislation to promote advance savings
for college. I would be pleased to answer any questions.

Mrs. Johnson of Connecticut [presiding]. Thank you, Mr.
Bennett.
Dr. Kepple.

STATEMENT OF THOMAS KEPPLE, JR., Ph.D., PRESIDENT, JUNIATA
COLLEGE, HUNTINGTON, PENNSYLVANIA; AND CHAIRMAN, TUITION PLAN
CONSORTIUM

Mr. Kepple. Thank you, Madame Chairwoman. I am Tom Kepple,
president of Juniata College, a liberal arts college located in
central Pennsylvania. I am also the chair of the Tuition Plan
Consortium, a group of 127, and growing, independent colleges
and universities from across the Nation.
Our consortium has a found a way to do exactly what
Congress has challenged higher education to do. That is, to
significantly lower the cost of college education without
sacrificing the quality of our programs which are the envy of
the world. Our program is to build upon the highly successful
prepaid tuition plans now operating in 20 States that Mr.
Bennett has recently described. Plans that allow parents and
grandparents to guarantee the future cost of in-State public
colleges and universities. Our program captures all the
positive aspects of these plans and adds three important new
benefits.
First, the tuition plan represents the first truly
nationwide prepayment tuition program. Our members represent
the greatest geographic and mission diversity of any plan in
existence. We already have members in 35 States and the
District of Columbia. And we plan to add, perhaps triple in
size over the next several years.
Let me illustrate the geographic diversity by the map you
will see to my right. You will note that there are colleges all
across the United States, and let me briefly mention just a few
of these to indicate our diversity. And by the way, there are
no truck driving schools among our group. In Texas, Rice,
Austin College, Trinity University, SMU, TCU. In New York,
Barnard, Ithaca, the University of Rochester. In Pennsylvania,
Westminster, Grove City, Juniata College, Swarthmore. In
Maryland, Goucher. In Washington, the University of Puget
Sound. In Minnesota, St. Olaf. In Illinois, the University of
Chicago: In Indiana Notre Dame, the University of the South in
Tennessee, Eckerd College in Florida, Princeton University in
New Jersey, and Birmingham Southern College in Alabama.
This diversity is a major benefit to families who
understandably cannot be sure what college their children will
ultimately attend.
Second, our plan guarantees the future cost of tuition at
private colleges and universities across the Nation, something
that individual State programs logically cannot do.
Third, and most importantly, the Consortium will offer to
sell guaranteed future tuition to families at below today's
tuition rates. We actually will be reducing the cost of
college, thus making it more affordable for more families.
In Juniata's case, we are considering a discount as
significant as 50 percent below today's tuition rates. For
example, full tuition this year at Juniata College is $18,000.
A parent or grandparent could purchase a full year of education
18 years from now for about $9,000 for a newborn child. Of
course, this discount would be less for older children and
member colleges will establish their own discount rates.
How can we guarantee a future tuition at a discount? The
member institutions of Tuition Plan have years of experience in
managing their own individual endowments. By applying this
experience and employing sound investment safeguards, we expect
to earn a rate of return in excess of tuition inflation. In
fact, over 18 years, we expect to earn enough in our
investments to cover the increases in tuition and offer a
discount to grandparents.
You may be surprised to learn that nationally 48 percent of
students attending private colleges have family incomes under
$50,000. Nearly identical to the 49 percent attending public
colleges. As you would expect, these families are especially
concerned about being able to afford the cost of a college
education. Prepaid tuition programs are designed for these
middle income American families who seek to guarantee the
future tuition and protection against investment risks. In our
plan, investment risk is shifted from families to Consortium
members.
Not only would we be required to comply with the safeguards
and rules under 529, and not only is it to the public's
interest that we are required, but it is also very much in our
interest to provide effective oversight and financial security
for prepayments since tuition plan members will bear the
ultimate risks.
We know that this plan is interesting to American families.
I have already had to return a $31,000 check from a grandparent
who wished to begin the tuition prepayment program for his
grandchildren. That is something that college presidents don't
like to do.
Now we need your help. As you know, section 529 covers only
plans established by States, thus omitting the opportunity for
groups of private colleges and universities develop a tax
advantage plan. Congress has already identified that section
529 is not consistent with other Federal higher education
policies that do not distinguish between public and private
institutions. Last year, a provision to rectify the situation
was included in both the Chairman's bill and your alternative,
Mr. Rangel. More than 80 Members of Congress, representing a
bipartisan coalition, have supported this legislation.
I sincerely hope that all your effort and this broad base
of support will lead to passage of this important measure,
legislation that is endorsed by the statement, by the American
Council for Education on this issue.
Mr. Chairman, Mr. Rangel, Members of the Committee, on
behalf of the 127 member institutions of the Tuition Plan
Consortium and the entire higher education community, I thank
you for support and look forward to working with you to make
this tremendous opportunity a reality for the benefit of
millions of American families.
Thank you.
[The prepared statement and attachments follow:]

Statement of Thomas Kepple, Jr., Ph.D., President, Juniata College,
Huntington, Pennsylvania; and Chairman, Tuition Plan Consortium

Mr. Chairman, Representative Rangel, distinguished members
of the Committee, I am the president of Juniata College, a
small independent college in Huntington, Pennsylvania with
1,200 undergraduate students. We are one of 108 independent
colleges and universities in Pennsylvania. Together,
independent institutions graduate over half of all students who
attend four-year colleges in the state.
I also serve as Chairman of Tuition Plan Consortium, a non-
profit consortium comprised of a growing group of independent
colleges and universities from across the country. By the time
of our planned program launch, we hope to include several
hundred institutions. Ours is a diverse membership including
institutions such as Rice University, a major research
university in Houston, Texas, and Ithaca College, a small
liberal arts college in upstate New York. Working together to
help American families, we are developing a nationwide prepaid
tuition plan that encourages parents, grandparents, and other
family members to save now for the future college expenses of
younger children.
Education is a top concern for American families. Recently,
fifty eight percent of Americans surveyed by the American
Council on Education (ACE) agreed that ``a college degree is so
important that, regardless of how much it costs, I am going to
make sure that my children go to college.'' But when asked what
they worry about most, many say they do not know how they will
pay for their children's education. The tax bill this committee
passed last year expanded the tax treatment for qualified
state-sponsored tuition plans to include prepaid tuition
programs established and maintained by non-profit, private
colleges and universities. We thank you for your past support
and urge that once again Congress act to help independent
higher education respond to the public's anxiety over how to
provide for the cost of their children's college.
Today, for many middle income families, paying for higher
education means going into debt. In fact, families incurred
more college-related debt during the 1990s than the previous
three decades combined. In the last ten years, the number of
students with student loans increased by 87%. The cost of not
saving for college when children are younger and then having to
rely upon loans, increases a family's burden enormously.
Families must pay interest on their loans rather than having
interest work for them. Congress helped borrowers in the last
tax bill by restoring the tax deductibility of interest on
student loans for the first 60 months of payments. We applaud
your initiative, and we urge Congress to increase incentives
for families to save as well as to borrow.
State governments have developed programs designed to help
families pay for college. The response to long-established
prepaid state tuition plans in Texas, Pennsylvania and other
states indicates clearly that families respond to incentives
encouraging them to save for college, especially when they can
defer taxes. To date, nearly 700,000 students have prepaid
tuition benefits under 21 state plans. These families lock in
the cost of tuition at public colleges, and therefore no longer
need to worry about future tuition increases.
Since Congress enacted Section 529 of the tax code in 1996
authorizing tuition prepayment programs, the number of state
plans has increased sharply. The state-sponsored programs have
helped families save for college, but they leave several
important needs unmet. Fewer than half of the states currently
offer prepaid tuition plans that protect families against
tuition inflation. Colleges such as Juniata draw students
widely from other states, which makes it difficult for families
to take full advantage of state tuition plans; and tuition
benefits in state plans generally are not extended to private
colleges and universities. For these reasons, many private
institutions want to offer prepaid tuition plans which address
more fully the needs of families who wish to have their
children attend private colleges and universities.
Many families prefer to send their children to independent
colleges because of smaller class sizes, particular academic
programs, religious affiliations, and other reasons.
Nationally, nearly 20 percent of college-bound students attend
an out-of-state institution. In some states, particularly those
in the New England region, the percentage of students traveling
out of state to attend college is as high as 67 percent. A
nationwide plan is also important for families that move from
one state to another while their children are young. Each year
more than six million individuals in America move from one
state to another. A national prepaid tuition plan gives these
families the alternative of securing prepaid tuition regardless
of a change in residence or attendance at an out-of-state
college or university.
Prepaid tuition programs are designed for middle-income
Americans. Our research indicates that higher income families
may be less likely to participate in prepaid tuition plans.
Higher income families have the resources to absorb the risk of
aggressive investments and often wish to maintain control of
their assets rather than purchase guaranteed tuition. The
experience of existing state plans supports this and indicates
that these plans appeal most highly to middle income families
looking for an easy and secure way to save for college. Seventy
one percent of families participating in the Florida Prepaid
College Program have an income under $50,000. Families with
annual incomes of less than $35,000 have purchased sixty two
percent of contracts sold through the Pennsylvania Tuition
Account Program. And, the average monthly contribution to a
family's college savings account during 1995 in Kentucky was
$43.
Nationally, forty eight percent of the dependent students
attending private, not-for-profit colleges have family incomes
under $50,000, nearly identical to the forty nine percent
attending public colleges. In our case, at Juniata College, the
majority of our students come from families with incomes under
$63,000. As you might expect, these families of modest means
are especially concerned with being able to afford the cost of
a college education. They are most likely to purchase tuition
plans that offer a guarantee of future tuition and protection
against tuition inflation. In addition, in the case of Tuition
Plan, participating colleges intend to offer families future
tuition benefits at a price less than today's cost. Finally, we
believe the benefits of tax deferral are essential to creating
sufficient value for a program to meet family needs.
Including prepaid tuition plans established and maintained
by non-profit, independent colleges and universities in Section
529 would be consistent with other federal higher education
policies that do not distinguish between public and private
institutions. Specifically, students receiving Pell and other
grants, direct student loans, federally guaranteed student
loans, and other forms of federal financial aid are permitted
to attend any accredited institution. Also, families may claim
HOPE and Lifetime Learning tax credits whether their children
attend public or private college. And finally, regardless of
their alma mater's affiliation, all student loan beneficiaries
are able to deduct the interest expenses associated with their
student loans from their taxable income. Ensuring a level
playing field within Section 529 would be consistent with this
important precedent set through existing federal, higher
education programs. All families would get equal tax treatment
regardless of their choice of a public or private college. By
encouraging all families to save for college through qualified
tuition plans Congress would help increase national savings and
would provide private colleges an incentive to keep a close
watch on long-term costs.
A bipartisan group of more than 80 Members of Congress are
supporting legislation to enhance qualified tuition plans under
Section 529. Mr. Chairman, Mr. Rangel, members of the
Committee, private colleges have found a way to do exactly what
Congress asked of the higher education community: to reduce the
cost of a college degree without sacrificing the quality of
instruction that remains the envy of the world. On behalf of
the future students at our nation's private colleges, I thank
you for your support. I look forward to working with you to
make this valuable opportunity a reality to the benefit of
millions of American families.

[GRAPHIC] [TIFF OMITTED] T0841.017

Mrs. Johnson of Connecticut. Thank you very much, Dr.
Kepple.
Mr. Grayson.

STATEMENT OF JERRY GRAYSON, REGIONAL DIRECTOR, DETWILER
FOUNDATION COMPUTERS FOR SCHOOLS PROGRAM

Mr. Grayson. Thank you, Madam Chair, Mr. Rangel, Honorable
Committee Members, I appreciate this opportunity to speak to
you on the New Millennium Classrooms Act, which is coming
before you in this legislative session.
My name is Jerry Grayson. I am regional director with the
Computers for Schools Program. What we do is solicit computer
donations from businesses, from institutions, from individuals,
and from organizations. We have those machines refurbished. And
then we place them in schools.
Two years ago, Congress passed the 21st century Classrooms
Act as part of the Taxpayer Relief Act of 1997. That Act
provided businesses with a tax deduction for computer donations
if the machines were 2 years old or less. This was seen as a
way to increase and enhance the level of technology available
in schools. This Act was pushed through with the guidance of
Chairman Archer and the support and sponsorship of Congressman
Randy ``Duke'' Cunningham. We appreciate their support and
their championing of this cause.
Unfortunately, the act has not lived up to the promise and
intent that Congress had when it passed the Act. We found from
businesses that the 2-year window of opportunity was a bit too
short for their business cycle and that the tax deduction did
not offset what essentially was penalization of them for
donations of machines of that age.
The New Millennium Classrooms Act is an attempt to address
these issues. It opens that window from 2 to 3 years for the
age of equipment donated. And as opposed to the deduction, it
allows for a tax credit of 30 percent for machines that are 3
years old or less. That credit is increased to 50 percent when
the equipment is designated for schools in empowerment zones,
enterprise zones, and on Indian reservations. There is a third
element to this, the Act broadens the base with which we can
draw these machines, thus making newer machines available in a
higher quantity.
I believe the New Millennium Classrooms Act has the
potential to have a significant impact on the level of
technology available in our schools and especially in schools
in empowerment zones, enterprise zones, and on Indian
reservations. And these are the schools most in need of
equipment upgrading. Increasingly, we are seeing what you might
call a digital divide, that is, students in poorer schools
having less technology available to them as they go through
their computer instruction. What we now see is an average of 24
to 1, students-to-computer ratio in the average classroom of
multimedia computers. But that ratio jumps to 32 students per
computer when you look at schools in economically disadvantaged
areas. These are the very students who by and large receive
less positive feedback. They come from a less nurturing
environment for the most part and computers help them the most.
Computers are patient. They are persistent. They offer
immediate reward for correct responses. These are the students
who really need these machines. The New Millennium Classrooms
Act has the potential to have a significant effect on these
students' lives.
Let me just close with a couple of anecdotes here about our
program and the kind of impact New Millennium can have within a
program like ours. We work with one school in northern
Maryland, in north Harford County, North Harford High School.
They were undergoing a project in class with a database and
unfortunately before a donation of our machines, they had five,
six, eight students standing around one machine trying to take
part in the project. Because we donated to them, they were able
to put each student at a terminal. Test scores went up as a
result of it.
In New Jersey, our program works through a Welfare-to-Work
Workforce Development Project and the machines we put in are
refurbished by former welfare recipients who are now learning a
viable skill. Computer repair skills are the skills of the
future.
Finally, in Hawaii, we were able to give machines to a
rural school in the big island where students were not in the
position to take some college prep courses because of their
isolation. Now through distance learning, using our machines,
they can take college prep courses from a professor at the
University of Hawaii in Honolulu.
Thank you, Madam Chair, Mr. Rangel, Chairman Archer,
Congressman Portman and Congressman Becerra for your support,
for your time, and we appreciate your patience and your
consideration of this important legislation. Thank you.
[The prepared statement follows:]

Statement of Jerry Grayson, Regional Director, Detwiler Foundation
Computers for Schools Program

Mr. Chairman, Honorable Committee Members, Staff and
Guests:
Thank you for the privilege of addressing you on what I
consider legislation important to the country's future.
My name is Jerry Grayson. I am regional director for the
Detwiler Foundation Computers for Schools program. That means I
develop our computer donation program in states and communities
across the country.
The Detwiler Foundation began in 1991 when John, Carolyn
and Diana Detwiler recognized the opportunity to put business
computers being retired to use in schools--places where the
level of technology continues to lag significantly behind the
business standard. Computers for Schools started in California
and, beginning in 1997, has been branching out to partner with
organizations across the country. Unofficially, we are the
nation's single most productive source of donated computers to
schools. We have facilitated donations of more than 56,000
computers in 27 states.
The 21st Century Classrooms Act, part of the Tax Relief Act
of 1997, was an attempt to enhance those donations with more
and newer technology. It provides businesses with an enhanced
tax deduction for donation of equipment two years old or less.
We are among the many students, parents, teachers and friends
of education most grateful to Congressman Randy ``Duke''
Cunningham for his sponsorship of this far-sighted legislation
and his championing of better technology in our schools.
Unfortunately, the promise of the Act has not been
fulfilled. We at Computers for Schools have received more than
a thousand calls regarding the Act and have worked with dozens
of companies eager to put it to use. Most could not for two
primary reasons: the two-year provision did not fit their
equipment use cycle and the deduction enhancement did not
provide significant incentive. In general, a business buys a
computer with a three-year life cycle in mind. Asking business
owners to donate equipment before that cycle is complete
essentially asks them to take a loss on their equipment
investment. Many in a position to donate--those with
accelerated equipment use patterns--still found that the
deduction provisions in the Act did not adequately compensate
them for the loss of revenue they could receive by getting a
fair market price for the machines.
Before us today is the New Millennium Classrooms Act, which
builds on the foundation laid by Congressman Cunningham's
initial work. It is our opinion at Computers for Schools that
the New Millennium legislation will take us closer to
accomplishing the intent behind the 21st Century Classrooms
Act. Several elements of the bill are key in this regard; it
expands the window through which donations can be made from two
years to three and it provides for a more straight-forward tax
credit for eligible donations. Additionally, this credit--30
percent for donations for unspecified direction--will rise to
50 percent when the donation is designated for enterprise or
empowerment zone schools. This legislation also helps us expand
the group of eligible donors and thus raises the potential for
the significant donations intended.
I would like to repeat something I said in opening my
testimony; this is important legislation. Through the breadth
and depth of our experience at Computers for Schools we have
seen the kind of difference computer donations can make in our
schools. But perhaps that is best illustrated by the experience
of students who have been the recipients of donated computers.
Ladies and gentlemen of the committee, the legislation you
are considering has the power to alter lives. I don't have to
tell you we live in a world increasingly dependent on
technology. Our children must be prepared for that world as
thoroughly as is within our power. This is about life options--
the ability and capability of students to make positive choices
about who they are, what they can do and who they will become.
When we have the opportunity to provide them the resources
needed to make those positive choices, and we don't, we have
stifled their futures.
The New Millennium Classrooms Act helps open those options.
The case for computer-aided teaching and its positive impact on
academic achievement grows stronger every day. Just last week
in testimony before the Joint Economic Committee, Secretary of
Education Richard Riley emphasized the importance of technology
in education. He noted that with an expectation of 70 percent
growth in computer and technology-related jobs in the next six
years, students who can use technology effectively will be in
the best position to build rewarding careers and productive
lives.
With this trend as a backdrop, consider that children from
lower income areas and many disadvantaged minority children--
children less likely to have computers at home--are
unfortunately also less likely to have computers in their
schools. For example, schools with 81percent or more
economically disadvantaged students, as defined by federal
education Title I eligibility, have one multimedia computer for
every 32 students while a school with less than 20 percent
economically disadvantaged students will have a multimedia
computer for every 22 students. Schools with 90 percent or more
minority students have one multimedia system for every 30
students. Additionally, just over 50 percent of the schools
with 70 percent or more poor students have Internet access
compared to nearly 80 percent of schools which have less than
11 percent lower income students.
Now consider that the very students with the least
technology available to them are the ones who can be helped
most by its use. This was borne out by a recent City University
of New York study that noted dramatic increases in test scores
for disadvantaged students once computer-aided instruction was
introduced or increased in their curricula. Computers are
patient, persistent and operate with total equanimity. These
characteristics have special relevance for disadvantaged youth
growing up in tough, often less-than-nurturing surroundings.
These are also the very youth helped most by this legislation
because of its incentive clause to encourage equipment
donations where they are needed most--to enterprise and
empowerment zones. The New Millennium Classrooms Act is an act
of empowerment.
Even outside the target zones delineated in the bill, our
schools stand in dire need of technology upgrading. Depending
on which figures you look at, students-per-computer ratio
across the country can be as low as ten or eleven to one.
That's about ten students for each computer. But that ratio
includes millions of woefully substandard machines; 386's,
286's, Apple IIe's, even old 8086's and Commodore 64's. The
best that can be said about these systems is that they're a
step above typewriters, but even that statement is suspect.
Getting serious, up-to-date education software installed on any
of these or, in many cases Internet access, is out of the
question.
While that ten-to-one ratio of students per computer may
sound promising, it needs to be put in another context.
Statistics by the Educational Testing Service show a much lower
students per computer ratio of 24 students to one multimedia
computer. Multimedia computers are the type that provide
adequate access to the Internet and to the kind of software
that teachers find useful as teaching tools. Keep in mind that
the students-per-multimedia computer ratio increases to 32 to
one for lower income school districts, and the Department of
Education recommends that the optimal ratio of students per
computer is five to one.
The New Millennium Classrooms Act would spur the donation
of nothing older than Pentium II generation technology. This
raises the bar in our schools where the average machine today
is the 486SX processor, circa 1990. If enacted, New Millennium
accepts nothing built prior to 1997 and keeps that standard
moving forward with the calendar.
In addition to its direct impact on teaching and learning,
this bill provides other benefits to help us better prepare for
the next century.
The Rand Institute estimates it will cost about $15 billion
to provide U.S. schools with the technology necessary to
educate our children for the future. The New Millennium
Classrooms Act helps us stretch the funds available, providing
more opportunities for other critical technology needs such as
teacher training and curricular software.
As we approach a preferable level of technology in our
schools, this bill lets us do so in a cost-effective manner--
easing pressure on federal and state budgets. I want to be
clear; we do not advocate this legislation as a replacement to
state and federal technology expenditures. This is, however, a
way to limit the inflation of that spending. Many of you have
already noted that a time of better budget health is also a
time to be more mindful of spending. From a cost-benefit
perspective, New Millennium helps keep the pulse of spending
more even and secures more for less in the process.
New Millennium also triggers more business interest and
involvement in our communities and our schools. I am not here
to discuss the extent and nature of that involvement--that is
for local schools and communities to decide. But the Act gives
businesses another tool through which they can contribute to
their communities. In the process those businesses are not
penalized financially and, when they concentrate their giving
on empowerment and enterprise zones, they may--I emphasize
may--they may see a slight benefit. The Act also encourages the
most environmentally sensitive of recycling options re-use.
This Act also has Welfare to Work and workforce development
implications. In our work, Computers for Schools is partnered
with numerous refurbishing facilities where trainees are the
chronically underemployed or unemployed. To give one example,
our donations in New Jersey, which go through four state
community colleges, are refurbished and outfitted for schools
by former welfare recipients. They are learning skills that can
move them so far ahead it turns welfare checks into distant
specks in their rear-view mirrors.
Other trainees through our program include inmates at
correctional facilities, students in vocational and technical
schools and those in high schools and even middle schools. For
all of them, the equation is the same; exposure to the latest
technology only enhances their training, making them more ready
for key certifications such as A+ and MCSE or Microsoft
Certified Systems Engineer. These skills are in high demand.
They can make the transition from welfare to work, or crime to
work, permanent. But it doesn't happen without the opportunity.
As we see it at Computers for Schools, opportunity is what
the New Millennium Classrooms Act is all about. First and
foremost, it opens a world of opportunity to students and
teachers in the classroom. It gives local, state and federal
budget makers the opportunity to extend their tight dollars.
For business, it's an opportunity to contribute to students and
communities without being penalized in the process. And we have
just noted how this legislation can help trainees.
In every case we are talking about the impact this Act can
have on people's lives. Our children face a daunting world of
constant change. It's the least we can do to give them all the
positive tools at our disposal to help them meet that change.
The New Millennium Classrooms Act does that.
Thank you.

Mrs. Johnson of Connecticut. Thank you, Mr. Grayson.
Dr. Gillespie.

STATEMENT OF CHRISTINA GILLESPIE, M.D., RECENT GRADUATE, TUFTS
UNIVERSITY SCHOOL OF MEDICINE; AND RECIPIENT, NATIONAL HEALTH
SERVICE CORPS SCHOLARSHIP

Dr. Gillespie. Good afternoon. Thank you for the
opportunity to testify. I am Christina Gillespie, a recent
medical school graduate and a recipient of the National Health
Service Corps Scholarship. This morning, I would like to
address the taxation of the National Health Service
Scholarship. I will be sharing the ways in which the taxes
affected me personally and the potential long-term consequences
of the tax on the health of our Nation's most needy
communities.
I started medical school with a clear professional goal.
Having worked extensively with the homeless during my
undergraduate years, I knew I wanted to be a primary care
physician working in a community with limited access to health
care. As you probably know, completing a medical education is
no small feat. But I was surprised to find that the biggest
barriers were financial. My first year of medical school would
cost me $45,000. For even a middle-class or an upper-class
family, the cost is prohibitive. I, like many of classmates,
turned to loan programs to finance my education. My projected
debt at graduation was $200,000, and I was told by my financial
aid counselor that a career in primary care was an unrealistic
goal because I would not be able to afford my loan payments.
And a career in primary care working with underserved
populations? Get real.
It is no exaggeration to say that the National Health
Service Corps Scholarship Program was a dream come true. The
National Health Service would pay for my tuition and fees,
books, and provide me with a monthly stipend. In return for
each year of funding, I would spend 1 year working in what is
known as a Health Professional Shortage Area, or a medically
underserved community. The program was a way to meet my
personal and professional goals without being crippled by
$200,000 of interest-accumulating debt.
In the summer of 1997, half way through my medical
training, I received notice that I would be taxed on the full
amount of my scholarship. I had always been taxed on my stipend
payments, but now I would also need to pay taxes on my tuition
and fees, about $45,000 a year, as if it were income. The
reason for the new taxation was that section 117FE of the
Internal Revenue Code had been misinterpreted. The IRS had
taken the position that the scholarship amount was compensation
for future services. This position is erroneous. I am not and
never will be an employee of the National Health Service. While
in medical school, I was a full-time student receiving a
scholarship. While in residency training, I will be employed by
my residency program. And when I begin my National Health
Service commitment, I will be employed by the clinic in which I
am working.
I would like to share with you some numbers to make this
issue more concrete. Before the taxation, I was receiving $915
a month in stipend payments. After the tax went into effect, I
received only $254 a month. This was not nearly enough to cover
the cost of rent, food, utilities, and transportation. I had
only a few months forewarning and scrambled to borrow
additional money in loans. To add insult to injury, I had to
borrow even more money to pay State taxes, which were not
automatically withheld. My service commitment, of course,
remains unchanged despite my additional loan burden.
The National Health Service Corps Scholarship Program is an
innovative way to encourage health care providers to work in
areas which otherwise would have no access to care.
Unfortunately, the new tax has made the program less attractive
to students. It would certainly be a shame to see some of our
Nation's most dedicated health care professionals lose their
enthusiasm for underserved communities simply because of an
unfair tax.
Hopefully, I have impressed upon you the importance of
reversing the National Health Service tax. This is an issue
about access to higher education for low- and middle-income
families. This is an issue about unfair taxation. And, finally,
this is an issue about providing quality health care to
America's most needy communities.
Please support H.R. 1414, a bill which seeks to reverse the
taxation of the National Health Service Corps Scholarship.
Thank you for your attention.
[The prepared statement follows:]

Statement of Christina Gillespie, M.D., Recent Graduate, Tufts
University School of Medicine; and Recipient, National Health Service
Corps Scholarship

Good Morning. Thank you for inviting me to speak before you
today. I am Christina Gillespie, a recent graduate of Tufts
University School of Medicine, and a recipient of the National
Health Service Corps Scholarship. This morning I would like to
address the taxation of the NHSC Scholarship. I will be sharing
the ways in which the tax has affected me personally, and the
potential long-term consequences of the tax on the health of
our nation's most needy communities.
I started medical school with a clear professional goal.
Having worked extensively with the homeless during my
undergraduate years, I knew I wanted to be a primary care
physician working in a community with limited access to health
care. Four years later, my commitment is unwavering.
As you probably know, completing a medical education is no
small feat. But I was surprised to find that the biggest
barriers were financial. My first year of medical school would
cost me $45,000 (that was in 1995, today a year of education at
my medical school is approximately $52,000). For even middle
class and upper-middle class families, the cost is prohibitive.
I, like many of my classmates, turned to loan programs to
finance my education. My projected debt at graduation was
$200,000, and I was told by my financial aid counselor that a
career in primary care was an unrealistic goal, because I would
not be able to afford my loan payments. And a career in primary
care, working with under-served populations? Get real.
It is no exaggeration to say that the National Health
Service Corps Scholarship program was a dream come true. The
NHSC would pay for my tuition and fees, books, and provide me
with a monthly stipend. In return for each year of funding, I
would spend 1 year working in what is known as a Health
Professional Shortage Area--a medically under-served community.
I would also commit to specializing in a primary care field.
This program was a way to meet my personal and professional
goals of providing health care for the nation's most needy
populations, without being crippled by $200,000 of interest-
accumulating debt.
In the summer of 1997, half way through my medical
training, I received notice that I would be taxed on the FULL
amount of my scholarship. I had always been taxed on my stipend
payments, but now I would also need to pay taxes on my tuition
and fees, about $45,000 a year, as if it were income. The
reason for the new taxation was that section 117 (c) of the
Internal Revenue Code had been misinterpreted. The IRS had
taken the position that the scholarship amount was compensation
for future services. This position is erroneous. I am not, and
never will be an employee of the NHSC. While in medical school,
I was a full time student receiving a scholarship, not an
employee. While in residency training, I will be employed by my
residency program. And when I begin my National Health Service
commitment, I will be employed by the clinic in which I am
working.
I would like to share with you some numbers, to make this
issue more concrete. Before the taxation, I was receiving
$915.00 per month in stipend payments. After the taxation went
into effect, $661.00 was withheld monthly, and I received only
$254.00 per month. As a medical student, I was used to living
on a small budget, but two hundred and fifty dollars was not
nearly enough to cover the cost of rent, food, utilities, and
transportation. I had only a few months forewarning, and
scrambled to borrow additional money in loans. To add insult to
injury, I had to borrow even more money to pay state taxes,
which were not automatically withheld. My service commitment
remains unchanged, despite my additional loan burden. I will be
working as a family practitioner, and will take a position with
less compensation than I might earn in a more wealthy
community.
The National Health Service Corps scholarship program is an
innovative way to encourage health care providers to work in
areas which otherwise would have no access to care.
Unfortunately, the new tax has made the program less attractive
to health professional students. It would certainly be a shame
to see some of our nation's most dedicated health care
professionals lose their enthusiasm for under-served
communities simply because of an unfair tax.
Hopefully I have impressed upon you the importance of
reversing the NHSC tax. This is an issue about access to higher
education for lower and middle-income families. This is an
issue about unfair taxation. And finally, this is an issue
about providing quality health care to America's most needy
rural and inner city communities.
Please support H.R. 1414, a bill which seeks reverse the
taxation of the NHSC scholarship. Thank you for your attention.
I would be happy to answer any questions at this time.

Mrs. Johnson of Connecticut. Thank you very much, Dr.
Gillespie.
Mr. Baratta.

STATEMENT OF JEFFREY A. BARATTA, INVESTMENT BANKER, STONE &
YOUNGBERG LLC; AND MEMBER, CALIFORNIA-FEDERAL SCHOOL
INFRASTRUCTURE COALITION

Mr. Baratta. Yes, good afternoon, Madam Chair and Mr.
Rangel. Thank you very much for this opportunity. I look
forward to hopefully providing some information that can help
here.
My name is Jeff Baratta and I am an investment banker with
Stone & Youngberg, a broker-dealer in California. I am also a
member of the California-Federal School Infrastructure
Coalition. I first would like to thank Chairman Archer for his
comments on such a national pressing need as school facilities
earlier this morning. I would also like to thank Chairman
Rangel for his development of the tax credit bond issue through
the QZAB bond program just several years ago. And also to you,
Madam Chair, for your authoring of H.R. 1760.
My purpose for being here today is to discuss with you the
expansive facility needs within the State of California for
school construction and also to discuss with you the
enhancements made, as outlined in H.R. 1660, that clearly will
help the tax credit bond program. the State of California is
currently in need of $20 billion in funds for school
facilities, new construction and for modernization projects
over the next 5 years.
In November 1998, the State passed a statewide bond measure
totaling $60.2 billion for K-12 education. Just to give you an
idea of how quickly that is going to be spent, a 600-student
elementary school will cost approximately $7.75 million. A
1,000-student middle school will cost $13.75 million. And a
2,000-student high school will cost approximately $36 million.
Now there are many, many school districts in the State of
California that will need more than just one of those schools a
year. So the money will go quickly.
There is a process in the State of California where
statewide construction dollars can be combined with local
general obligation bond debt to help build and rehab school
facilities. The issue surrounding that is that the local school
district must first get a two-thirds super majority vote to get
the bond passed. Since 1986, there have been 711 school
districts that have attempted this type of election. Only 378
of those districts have passed for a 53 percent passage rate.
On top of the 330 school districts that failed over that time
period, there were many other school districts that didn't even
bother to take the expense of the election and try it out
because they had no hope. And, quite frankly, they had no hope
because the tax rates on the local GO bonds were too high and
the voters would just say no.
The Qualified School Construction Bond Program, outlined in
H.R. 1660 can help reduce the local GO bond tax rates by 25 to
30 percent thereby allowing more funds to go directly to the
school district and get more of those facility needs taken care
of.
This truly is a three-pronged approach to facility funding.
We need local dollars out of the general obligation bonds. We
need State dollars through the statewide bond program, and we
need Federal dollars through the tax credit bond program.
The tax credit bond program, through the Qualified School
Construction Bond, H.R. 1660, has truly been enhanced and it
has been done in six different ways that I would like to touch
on. The move from annual tax credit allocations to quarterly
allocations will actually help the end investor match up the
credit against when their tax liabilities are due. The ability
to carry over the unused tax credits into the next year will
help the end investor again focus on the fact that they can use
those tax credits in any year and not put a penalty cost
against the security itself because they may not be able to use
the tax credit in 1 year or the next.
The ability to strip the security, the principal portion of
the security, away from the tax credit portion is a very large
piece as well. You then get two securities and you can market
them to two different buyers. The increase investor base into
the retail funds, the new construction component and the
elimination of the private contribution will also help in the
pricing. If the price goes up, the yield goes down and
effectively what you want to do is move the investment moneys
from the investment community over into the schools and the
school sites to meet their facility needs.
In today's world, school construction financing is a very
expensive way to meet the need, so the country needs
participation on all three levels. They need the local, State,
and Federal Government to provide those needs. I truly believe
that H.R. 1660 can accomplish the goals of enhancing the
marketability of the bonds and increasing the ease of use for
schools.
Madam Chair, you authored H.R. 1760 and it encompasses the
same tax credit mechanisms as H.R. 1660. There are many other
proposals on the table today, but none like H.R. 1660 and 1760
that will provide the most resources in the most efficient and
timely fashion. Schools can receive approximately $25 billion
with a calculated cost of $3.1 billion. The need is now and
this is an incredible opportunity to leverage the most dollars
for the least cost.
I thank you for this opportunity and would request a letter
be entered into the record from the Cal-Fed Coalition to the
California delegation.
Mrs. Johnson of Connecticut. So ordered, Mr. Baratta.
[The information follows:]

Cal-Fed School Infrastructure Coalition
Sacramento, CA 95814
June 8, 1999

The Honorable Randy Cunningham
US House of Representatives
2238 Rayburn House Ofc. Bldg. Washington, D.C. 20515

Dear Representative Cunningham:

Cal-Fed School Infrastructure Coalition is writing to ask your
support and co-sponsorship for two important bills addressing the need
to assist local communities in the rebuilding of California's schools.
These bills are HR 1660, The Public School Modernization Act introduced
by Congressman Charles Rangel (D) of New York and HR 1760 introduced by
Congresswoman Nancy Johnson (R) of Connecticut.
The Cal-Fed School Infrastructure Coalition is a coalition of local
school districts, architects, financial firms, developers and school
suppliers working to support federal tax and other incentives to help
California and local communities address the pressing need to renovate,
modernize and build schools. The school facilities problem in
California has reached critical proportions and necessitates
partnerships among local, state and federal governments.
California's school facility needs for 1995-96 through 2005-2006
are:
Growth (including $3 billion for land costs and backlog) $15.0
billion
Modernization $10.0 billion
Deferred Maintenance $5.0 billion
HR 1660 would allocate $3.029 billion in school bonds to
California, while HR 1760 would allocate $2.927 billion in school
constructions bonds to our state.
The national need for repair and renovation of schools, estimated
by the Government Accounting Office (GAO) in 1996 to exceed $112
billion requires federal partnerships with states and local
communities. Today, the cost of projected repairs, renovations and
technology additions surpasses the GAO 1996 estimate. In addition, more
than $70 billion will be needed to build new schools to meet record
enrollments.
The School Modernization Act of 1999 (HR 1660) will provide $22
billion in zero interest bonds for the construction and renovation of
public school facilities at a five-year cost of $3.7 billion.
Representative Rangel's bill also will expand the Qualified Zone
Academy Bonds (QZAB) program.
Established in the Taxpayer Relief Act of 1997, QZABs provide the
equivalent of zero interest bonds for a variety of activities including
school renovation and repair. Underway in a number of states, QZABs are
financing innovative school renovations to support new education
programs.
The America's Better Classroom's Act (HR 1760) also will provide
federal assistance to states and local communities through tax credits
to underwrite $25 billion in school modernization bonds.
The major difference between these two bills is the allocation of
the bonds. HR 1660 allocates $25 billion to the States, half ($12.5
billion) based on the existing Title I formula, and the other half
($12.5 billion) to the 100 school districts with the largest number of
low-income students. HR 1760 bases the allocation on Title I and the
school aged population and allocates all the bonds directly to the
States for allocation to local communities.
A federal investment of $3.1 billion will generate $25 billion in
school construction bonds. Under both HR 1660 and HR 1760 the federal
government provides a tax credit in lieu of interest and the
responsibility for the bond principal will be at the state and local
level. All decision-making prerogatives related to the actual school
renovation and construction remains a local community decision.
We look forward to working with the members of the California
delegation to enact bipartisan provisions to help local communities
build the schools their children will need to succeed in the 21st
century.
We hope you can join as a cosponsor on HR 1660 and HR 1760 to
assist communities in California build and modernize their schools.

Sincerely yours,
Mike Vail
President

MV/ad
California Cosponsors to HR 1660
(Rangel bill)
5 MATSUI (D-CA)

6 WOOLSEY (D-CA)

8 PELOSI (D-CA)

13 STARK (D-CA)

16 LOFGREN (D-CA)

17 FARR (D-CA)

24 SHERMAN (D-CA)

29 WAXMAN (D-CA)

30 BECERRA (D-CA)

31 MARTINEZ (D-CA)

32 DIXON (D-CA)

33 ROYBAL-ALLARD (D-CA)

35 WATERS (D-CA)

37 MILLENDER-MCDONALD (D-CA)

42 BROWN, GEORGE (D-CA)

46 SANCHEZ (D-CA)

50 FILNER (D-CA)

California Cosponsors to HR 1760
(Johnson bill)

38 HORN (R-CA)

Mr. Baratta. Thank you.
[The prepared statement follows:]

Statement of Jeffrey A. Baratta, Investment Banker, Stone & Youngberg
LLC; and Member, California-Federal School Infrastructure Coalition

Mr. Chairman and Members of the Ways and Means Committee:
I appreciate the opportunity to address you on this very
important issue of new financing techniques for school
construction. Mr. Chairman we greatly appreciate your attention
and support on this pressing national issue of school
facilities. It is important to thank Mr. Rangel as well for his
role in developing the Qualified Zone Academy Bond (QZAB)
program and the concept of using federal tax-credits to help
school facility needs.
I am here today to provide testimony to the expansive
facility needs of school districts and the enhanced market
viability of the Qualified School Construction Bond (QSCB)
program, school modernization bonds, as outlined in H.R. 1660.
As we are all painfully aware, school facility needs
increase every day as our school age population continues to
grow. In the State of California alone school facility needs
top $20 billion for the next five years. For example the cost
of one 600 student elementary school is $7.75 million. A 1,000
student middle school will cost $13.75 million and a 2,000
student high school will cost $36 million. Student enrollment
is increasing at such a rapid rate that many communities will
have to build more than one elementary school, more than one
middle school and more than one high school per year.
In November 1998, California voters approved a $6.2 billion
state-wide bond measure for K-12 education. Although this will
help many schools it is woefully short of meeting the current
needs.
Through a two-thirds majority vote election, school
districts throughout California can avail themselves to locally
secured general obligation bonds. From 1986 through the present
time, 711 school districts have attempted local general
obligation bond elections. Of that number approximately 53% or
378 school districts have been successful. On top of the 333
unsuccessful campaigns there are many more districts that knew
they did not have a chance and therefore did not spend the
money to try an election. Local communities are constantly
struggling to balance local tax rates with the need to
modernize existing schools and to build new schools to meet
rapidly rising enrollments.
One of the main reasons school districts lose elections is
that the tax rates are more than the voters are willing to pay.
H.R. 1660 will provide some relief to those districts that have
been unsuccessful and also to those districts who have been
unable to try an election. Zero interest bonds through the QSCB
program can reduce the tax-rate associated with the repayment
of the bonds. This federal program will give school districts
another option to fund school facilities.
H.R. 1660 is another piece of the puzzle named ``School
District Capital Funding.'' Through the proper financing
structure, local districts can be helped in their overall
attempt to receive local general obligation bond approval. The
zero-interest tax-credit program will allow school districts to
lower tax rate estimates and ultimately get approval from their
local voters.
Districts will start to be able to meet the growing school
facility need through the combination of local general
obligation bond financing, California construction dollars,
from the recently approved state-wide bond measure, and federal
tax-credit bonds.
Mr. Rangel has done an excellent job, through H.R. 1660 of
combining the most pressing needs of school districts and the
requirements of the traditional tax-exempt bond markets.
The current QZAB program has been used in certain
situations and has been very successful for those districts
able to participate. As with any new program, interest starts
slowly and then builds. Every day more and more districts are
looking to the QZAB program for help.
H.R. 1660 has taken the primary aspects of the tax-credit
bonds in the QZAB program and increased their ease of use for
schools.
H.R. 1660 provides six distinct enhancements that will
greatly increase the marketability and trading value of the
QSCB program to the bond market. These enhancements will
immediately create new capital funding strategies for schools
to meet their increasing facility needs.
The six market enhancements are as follows:
Quarterly tax-credit payments versus annual tax-
credit payments.
The ability to carry-over unused tax-credits from
year to year.
The ability to strip the principal and tax-credit
components apart and make two separate securities.
The increased investor base (i.e. retail investor
funds)
The addition of new construction to the list of
possible uses of the proceeds.
The elimination of private contributions.
Mr. Chairman, let me please take a few moments to discuss
the price and yield relationship within the bond market. In the
bond market prices and yields move in an inverse relationship
to each other. As prices for a security increase the yield on
that security decreases. Therefore, a security worth $100 (par
amount) that sells above the par amount, (at a premium) will
provide greater proceeds to the issuer and a lower yield to the
investor. So, if a security sells at a price below par (at a
discount) the issuer receives less proceeds and the investor
receives a higher yield.
The following is an expanded discussion of the above listed
enhancements:

Quarterly Tax-credits

The move from annual tax-credit payments in the QZAB
program to quarterly tax-credit payments in the QSCB program
allows the investors to match up their tax liability, which is
due quarterly, with the earned tax-credit. Waiting for one full
year to realize any return from the investment is difficult and
therefore costly in the pricing of the investment. This is one
reason why a discount is attached to the QZAB program.

Tax-credit Carry-over

Allowing unused tax-credits to carry-over into the
following year is a great enhancement. In the QZAB program an
increased discount was associated with the loss of tax-credits
when the investor could not use them. Therefore, investors were
calculating a total return based on approximately 80% usage of
the tax-credits. Having the ability to transfer credits into
the following year when the investors tax liability comes back
eliminates the need to attach a higher discount to the
security.

Stripability of the Security

The ability to strip the principal component of the
security from the tax-credit component will lower the discount
of the overall security. This stripping mechanism allows for
the capturing of the two distinctly different credits. The
principal component will carry the credit of the issuing
agency, while the tax-credit component will carry the credit of
the United States government. This difference means a higher
price is paid for the tax-credits (which means a lower yield),
while a somewhat lower price will be paid for the principal
maturity (which means a higher yield). The two separate prices
will be better than that of the single priced security. Another
reason for this situation is that investors differ as to their
end requirements. To a tax-credit investor the need to receive
principal re-payment is far less than the current need to
receive a quarterly tax-credit or benefit. To an investor
looking for no current income a single principal maturity in
the future fits perfectly. Because of these differences school
districts through their financial team can market the
securities to the absolute best buyers thereby receiving the
most proceeds for their projects.

Increased Investor Base

Any time you can increase the competition (willing buyers),
you can typically decrease the costs associated with selling
the product. The decreased yield, which translates into a
higher price for the security will provide more proceeds to
schools and further help the capital funding requirements.

New Construction Component

This enhancement is a major change for school districts.
New construction is a very important piece for growing school
districts. With many school districts building at least one
school per year and sometimes even more, including new
construction as an authorized use is paramount. The bonds will
benefit in the market because of the increased presence. As the
securities become more prevalent in the market place the
liquidity problems will decrease and a secondary market will
appear.

Private Contribution Elimination

By eliminating the private contribution component the small
suburban and rural school districts can participate. Sometimes
it is difficult to get businesses to look to these smaller
districts when a larger district is located in the same
geographic area. Small school districts are squeezed further
with lower fiscal resources. A zero interest loan program, such
as the QSCB program, can help those districts meet their
facility needs.

Other Issues

Two other issues are important to discuss. The first issue
is that H.R. 1660 will utilize a different tax-credit
calculation than what is currently in place for the QZAB
program. This new rate will capture the volatility of the
market by fluctuating on a daily basis, until the pricing day
of the bonds. This is different than the old QZAB rate which is
calculated monthly based on a prior month's market.
The second issue deals with the size of the program. A
multi-billion dollar bonding program will cause the market to
take notice. With a $25 billion program the liquidity issue
associated with the QZAB program should effectively be removed.
Investors will no longer be faced with an illiquid or non-
tradable security. These two issues will greatly help the bonds
be priced closer to their original par value.
It is important to remember that school district capital
needs are greater than the resources that can be provided from
one or two government entities, such as the local governments
or the state governments or even the federal governments. In
today's world building schools is so expensive participation by
local, state and federal governments is the only way we will
develop the resources to build and modernize the schools our
country needs to serve all our children in the future. H.R.
1660 will augment local and state resources to help provide
needed capital facilities to school districts throughout the
Nation. The changes, as discussed above, will enhance the
market viability of the tax-credit bonds. This will in turn
provide greater proceeds to construct and modernize more
schools.
Congresswoman Nancy Johnson has recently authored H.R.
1760. This bill encompasses the same mechanisms for facility
funding as the QSCB program, as defined in H.R. 1660. There are
many other proposals on the table today as well. All of the
proposals can be viewed as beneficial to schools, but in what
magnitude and how quickly? H.R. 1660 and H.R. 1760 provide the
most resources in the most efficient and timely fashion. H.R.
1660 has been calculated as providing $25 billion for school
facilities at a cost of $3.1 billion over the next five years.
The need is now and this is an incredible way to leverage the
most dollars for the least cost.
It is time for the Federal government to partner with local
agencies to help provide facilities for our children. Both H.R.
1660 and H.R. 1760 can help provide for this national facility
need. I urge your support and thank you for your time and
consideration.

Mrs. Johnson of Connecticut. Thank you for your testimony.
Ms. Zedalis.

STATEMENT OF LEWIS H. SPENCE, DEPUTY CHANCELLOR FOR OPERATIONS,
NEW YORK CITY BOARD OF EDUCATION; AS PRESENTED BY PATRICIA
ZEDALIS, CHIEF EXECUTIVE, DIVISION OF SCHOOL FACILITIES, NEW
YORK CITY BOARD OF EDUCATION

Ms. Zedalis. Thank you, Madam Chair, Mr. Rangel, and
Members of the Committee. Please convey my thanks also to
Chairman Archer for giving me the opportunity to address you
today on the issue of how the Federal Government can play a
meaningful and positive role in rebuilding America's schools.
My name is Patricia Zedalis and I am head of School Facilities
for the New York City Board of Education, the largest public
school system in the country with 1.1 million school children
and over 11,000 individual school buildings.
I especially want to thank Congressman Charles Rangel for
his leadership on this issue. Congressman Rangel initiated
congressional activity in this area when he authored the
Qualified Zone Academy Bond legislation in 1997. He followed
through on his commitment to improve our Nation's schools by
introducing H.R. 1660, the Public School Modernization Act of
1999, which is before this Committee.
I also want to thank Congressman Joe Crowley for his
efforts to focus attention on this very important issue in this
session of Congress.
Finally, I want to commend Congresswoman Nancy Johnson for
her efforts to bring the issue of school construction to the
attention of her colleagues on this Committee. It is the New
York City Board of Education's sincere hope that the consensus
that exists between Representatives Rangel and Johnson on the
need to address this issue will lead to a bipartisan bill that
is passed by the 106th Congress. Congresswoman Johnson's bill
is substantively identical to Congressman Rangel's proposal, as
both proposals provide the same form and level of tax credits
to pay the interest on State and local school construction
bonds. However, the Board prefers Congressman Rangel's
legislation because its allocation formula is more targeted at
high-need communities and New York City is certainly a high-
need community.
Across America, urban, rural, and high-growth suburban
school districts all face difficult school modernization
problems. The one thing they hold in common is the struggle to
find the resources to modernize their existing school
facilities and to build new schools for rapidly rising student
enrollment. The need has been well-established by the General
Accounting Office.
Just to give you an idea of New York City's needs, we have
had explosive enrollment growth in the nineties, which has
begun to taper off. Our enrollment growth was in excess of
20,000 a year. One of the largest other school systems in the
New York is Yonkers. It only has around 22,000 students. So we
replicated the school district of Yonkers every year for most
of the nineties.
School facility problems negatively impact the safety and
learning of school children everywhere. The average school
building in America is 50 years old. These buildings were not
designed to meet the demands of current and future technology.
The GAO also reports that 38 percent of urban school districts,
29 percent of suburban, and 30 percent of rural school
districts have at least one building needing extensive repair
or total replacement. In New York City, we have 280 schools
that require complete exterior modernization and many of those
schools also need complete interior modernization. The issues
of school replacement and extensive repair affect over 14
million students nationwide. I am here today to ask you to make
an investment in these 14 million children. That investment
begins with the fundamental right of every child to a safe and
adequate learning environment that supports achievement at the
most challenging levels. Where students learn what really
matters.
In 1993, New York City took the lead in our State by
setting rigorous graduation standards that were eventually
adopted statewide. This year's eighth graders will be the first
high school class required to take an all-regions curriculum
developed by the New York State Board of Regents. We are asking
these students to take 3 years of science, 2 of those years in
laboratory sciences, though there are not adequate facilities
to support their learning. Without significant investment in
the physical infrastructure of the New York City public
schools, we are setting these children up to fail. At the
moment, we have over $100 million in our current capital plan
to take care of upgrading science labs. That will only handle
approximately 50 schools. We have 200 high schools in New York
City.
We as adults lack credibility when we tell children that we
have high expectations for their achievement and that literacy,
math, and science are paramount while at the same time we shunt
them into outdated and overcrowded classrooms with meager
laboratories and decrepit laboratories. The environment in
which we place our children speaks volumes about what we really
expect from them. It is the children in our schools who face
the real building and capacity issues everyday. It is our
students who must cope with leaking roofs, peeling plaster, and
overcrowded classrooms. The lack of adequate facilities takes
its greatest toll on instruction and hampers our ability to
effectively implement early intervention strategies, such as
reducing class size and critical grades, which is an extremely
important initiative in New York City and we are definitely
constrained in achieving our goals of class-size reduction
unless we can provide new facilities.
In addition, school districts must be able to provide
adequate air conditioned space for its most at-risk students
who will attend summer school classes in an effort to perform
at grade level and ultimately acquire the tools needed to lead
our Nation into the 21st century.
This is not a call for massive federalization of school
construction, which is and should remain a primary
responsibility of States and localities. However, it is
recognition that the infrastructure needs of public schools
have out-paced the ability of State and local governments to
meet these demands by themselves. New York, like many
localities, is doing its part in school construction. The City
is addressing the board's school infrastructure needs with a $7
billion capital plan over the next 5 years. As you just heard,
California has a $60.2 billion statewide program. Our capital
plan's main goals are to expand our program to bring our
existing facilities to a state of good repair, increase program
accessibility, upgrade or provide new speciality spaces, and to
increase capacity to relieve overcrowding, provide universal
pre-K, and class-size reduction. This $7 billion doesn't
achieve everything that we need to do in terms of technology
and modernizing our existing buildings. It just gets us further
along.
We need partners at the Federal level to meet all of our
pressing needs. The idea of the Federal Government assisting
localities and addressing their critical needs is not a novel
concept. You have acted decisively in many other areas,
transportation being one of them because it is considered
important to the national economy. I am sure that no one here
questions the importance of schools to our economic
competitiveness in the 21st century. We believe that schools
deserve the same attention that many other areas such as
transportation receive.
As Congress considers the broad range of school
construction proposals that have been introduced in this
Congress, New York City hopes that Congress will ultimately
enact legislation that addresses the magnitude of the
nationwide need for construction assistance. H.R. 1660 does
that.
First and foremost, Congress must pass legislation that
offers substantial and immediate assistance to local schools.
Given the $200 billion in construction needs nationwide, the
Board strongly supports H.R. 1660. H.R. 1660 will provide
meaningful support----
Mrs. Johnson of Connecticut. Ms. Zedalis, could you
conclude your remarks since the red light has been on for a
while now?
Ms. Zedalis. Yes, thank you very much. H.R. 1660 will
provide $1.8 billion to New York City schools. The $1.8 billion
will help us to begin to start working on the interior of our
buildings. It will help us to provide much needed new seats.
Our current plan provides 32,000 with a need of over 75,000
seats.
[The prepared statement follows:]

Statement of Lewis H. Spence, Deputy Chancellor for Operations, New
York City Board of Education; as presented by Patricia Zedalis, Chief
Executive, Division of School Facilities, New York City Board of
Education

Mr. Chairman and Members of the Committee:
Thank you Chairman Archer for the opportunity to address
the issue of how the federal government can play a meaningful
and positive role in rebuilding America's schools.
I especially want to thank Congressman Charles Rangel for
his leadership on this issue. Congressman Rangel initiated
congressional activity in this area when he authored the
Qualified Zone Academy Bonds program in 1997. He followed-
through on his commitment to improving our nation's schools by
introducing H.R. 1660, the School Infrastructure Modernization
Act of 1999. As the committee is aware, this legislation would
provide tax credits to pay the interest on nearly $25 billion
in state and local bonds over the next two years to build and
modernize up to 6,000 public schools.
I also want to thank Congressman Joe Crowley for his
efforts to focus attention on the need for school construction
legislation in this session of Congress. While he is not a
member of the Ways and Means Committee, he has been a strong
advocate in Washington for the needs of New York City's public
schools and we are grateful for his work in this area.
Finally, I want to commend Congresswoman Nancy Johnson for
her efforts to bring the issue of school construction to the
attention of her colleagues on the Ways and Means Committee. It
is the New York City Board of Education's sincere hope that the
consensus that exists between Representatives Rangel and
Johnson on the need to address this issue will lead to a
bipartisan bill that is passed by the 106th Congress.
Congresswoman Johnson's bill is substantively identical to
Congressman Rangel's proposal as both proposals provide the
same form and level of tax credits to pay the interest on state
and local school construction bonds. However, the Board prefers
Congressman Rangel's legislation because its allocation formula
is more targeted at high-need communities.
Across America, urban, rural, and high-growth suburban
school districts all face different and difficult school
modernization problems. Yet, the one thing that they hold in
common is the struggle to find the resources to modernize
existing school facilities and to build new schools for rapidly
rising student enrollments. The national need for repair and
renovation of schools, estimated by the Government Accounting
Office in 1996 to exceed $112 billion, requires federal
partnerships with states and local communities. Today, the cost
of projected repairs, renovations and technology additions
surpasses the GAO 1996 estimate. In addition, more than $70
billion will be needed to build new schools to meet record
enrollments.
School facility problems negatively impact the safety and
learning of school children everywhere. The average school
building in America is 50 years old. These buildings were not
designed to meet the demands of current and future technology.
The GAO also reports that 38% of urban schools, 29% of suburban
schools, and 30% of rural schools have at least one building
needing extensive repair or total replacement. This affects
over 14 million students throughout the nation.
I am here today to ask Congress to make an investment in
these 14 million children. That investment begins with the
fundamental right of every child to a safe and adequate
learning environment that supports achievement at the most
challenging levels.
In 1993, New York City took the lead in our state by
setting rigorous graduation standards that were eventually
adopted statewide. This year's eighth graders will be the first
high school class required to take an all-Regents curriculum
developed by the New York State Board of Regents. Students will
need four years of English, three years of math and three years
of science to graduate. They will have to pass five Regents
exams, including a Regents exam in Lab Science. We are asking
these students to take three years of science, two of those
years in laboratory sciences, though there are not adequate
facilities to support their learning. Without significant
investment in the physical infrastructure of the New York City
public schools, we are setting these children up to fail.
We as adults lack credibility when we tell children that we
have high expectations for their achievement and that literacy,
math and science are paramount while at the same time we shunt
them into outdated and overcrowded classrooms with meager
libraries and decrepit laboratories. The environment in which
we place our children speaks volumes about what we really
expect from them. It is the children in our schools who face
the real building and capacity issues every day. It is our
students who must cope with leaking roofs, peeling plaster and
overcrowded classrooms. The lack of adequate facilities takes
its greatest toll on instruction and hampers our ability to
effectively implement early intervention strategies such as
reducing class size in critical grades. In addition, school
districts must be able to provide adequate, air-conditioned
space for its most at-risk students who will attend summer
school classes in an effort to perform at grade-level and
ultimately acquire the tools needed to lead our nation into the
21st century.
This is not a call for massive federalization of school
construction, which is, and undoubtedly will remain, a primary
responsibility of states and localities. However, it is
recognition that infrastructure needs of public schools have
outpaced the ability of state and local governments to meet
these demands by themselves. New York City, like many
localities, is doing its part on school construction. The City
is addressing the Board's school infrastructure needs; $7
billion has been committed to our five-year capital plan, which
will:
Expand our program to bring our existing
facilities to a state of good repair;
Increase program accessibility to achieve
compliance with the Americans with Disabilities Act;
Upgrade or provide new specialty spaces, such as
science laboratories, to meet expanded graduation requirements;
and
Increase capacity to relieve existing overcrowding
and accommodate enrollment growth, and reduce class size in
pre-kindergarten and early grades.
Of course, much more needs to be done, and New York City
and other school systems around the nation cannot do it alone.
We need partners at the federal level to meet all these
pressing needs.
The idea of the federal government assisting localities
address their critical needs is not a novel concept. Last year,
Congress acted decisively to provide federal support to our
state and local communities as a partner in building America's
roads, highways, and transit system. In 1998 Congress
authorized spending of $250 billion for these purposes. I do
not question the wisdom of these investments, given their
importance to our national economy. However, I do question the
rationale of those who claim that we cannot afford to invest
ten cents for every highway dollar on schools given their
relationship to our economic competitiveness in the 21st
century marketplace.
As Congress considers the broad range of school
construction proposals that have been introduced in the 106th
Congress, the New York City Board of Education hopes that
Congress will ultimately enact legislation that addresses the
magnitude of the nationwide need for construction assistance.
First and foremost, Congress must pass legislation that
offers substantial and immediate assistance to local schools.
Given the $200 billion in construction needs nationwide, the
Board strongly supports H.R. 1660, which was authored by
Congressman Rangel earlier this year and is awaiting
consideration by this committee.
H.R. 1660 will provide meaningful support to local
communities by providing a tax credit to the holder of the
school modernization bonds in lieu of interest paid by the
school district. This financing scheme wisely maximizes a
relatively small federal investment of $3.1 billion by
leveraging $25 billion in local school construction and
modernization. Local communities, such as New York City, would
benefit from the savings and by the investment in the public
school infrastructure. We would also benefit from the bill's
flexibility since it involves no federal interference in local
school decisions. The design and selection of the construction
and modernization projects will be totally within the
discretion of state and local public school officials, a
concept that has always enjoyed bipartisan support.
We appreciate Chairman Archer's interest in assisting local
schools through changes in the current arbitrage requirements,
and do not argue that it could be of some benefit to certain
schools with less-immediate capital needs. However, the
proposal to extend the rebate period from two to four years
would be of little value to New York City's public schools. New
York City's practice is to issue general obligation bonds to
reimburse cash flow expended on capital projects. Bond
proceeds, therefore, do not earn any interest that would be
subject to increase from the proposed legislation.
From New York City's perspective, H.R. 1660 offers the most
meaningful form of federal assistance because the interest-free
subsidy really adds up. We estimate that the school
modernization bond program contained in this legislation will
allow New York City to issue $1.8 billion in bonds and save up
to $890 million in interest payments. With $1.8 billion in
additional funds, New York City would expand its program to
upgrade many of its 1,100 buildings, particularly to undertake
critical work on interior systems; not investing in these
buildings means we will lose capacity. With these additional
funds we would also dedicate a portion for adding new seats.
Under our five-year plan we project that we will add over
32,000 new seats in our classrooms, but our total need is
actually in excess of 75,000 seats. We could also begin the
rebuilding of our physical education facilities, such as
gymnasiums, because education doesn't just occur in the
traditional classroom setting. Clearly, this is a significant
incentive for us to improve our school infrastructure that can
really make a difference in our ability to improve learning
spaces for our children.
As we approach the new millennium, America must invest the
resources needed to improve school facilities and to provide
our students with greater numbers of well-equipped classrooms
to accommodate smaller class sizes and to enhance learning
environments. We must send a message to our children that they
matter to us, that they deserve state of the art schools, that
they are an integral part of the health of our communities.
Unfortunately, many of our nation's children live in poor urban
and rural neighborhoods, isolated from the economic, cultural
and civic life of America. Yet they are as bright, full of
potential, and precious to our future as the most privileged
children growing up in affluence. We need these and all
children to succeed if our nation is to thrive economically and
socially in the next century. Therefore, I respectfully request
the committee to approve H.R. 1660 and bring it to the House
floor for full debate and consideration.
Thank you Mr. Chairman and members of the Committee for
your time and consideration of the New York City Board of
Education's views on school construction.

Mrs. Johnson of Connecticut. Thank you.
Ms. Zedalis. Thank you.
Mrs. Johnson of Connecticut. I certainly appreciate your
point about the needs of the cities, but I have been
increasingly impressed with the needs of the rural areas. They
have a very, very small tax base to shoulder any of these
costs, as you all pointed out, school construction costs have
absolutely zoomed. If we are going to provide modern, high-tech
environments, they are much more costly. If you do not help
rural communities in the same way, then you will have, in a
sense, the kids from the country backward. Any agricultural
enterprise now, I mean Dearing, in my part of the country,
requires very sophisticated computer knowledge and attritional
knowledge. And not to have those kids have classrooms that are
sophisticated is really a disadvantage to them. So that is why
my bill is different in that it takes half of the money and
allocates on the basis of student population. I don't think we
can afford to, as important as it is to rebuild the inner-city
schools, I don't think we can afford to disadvantage the rural
schools.
Dr. Gillespie, I wanted you to go through in a little more
detail, but not long because other people have questions too,
why your stipend of $915 a month was reduced to $254 a month
just by the IRS making the decision that your stipend was
taxable? Now they did not make a similar decision in regard to
all other stipends. And one of the reasons I think this has to
be addressed legislatively is that it wasn't fair to single out
one program and treat it differently than other programs. But I
don't understand why the stipend would have been quite so
dramatically impacted, less than 25 percent remaining. Could
you go through your calculation there a little more precisely?
Dr. Gillespie. Yes, the decrease in the stipend was so
dramatic because the tuition at my medical college was so high.
So because the tuition was being considered income, the tuition
is about $35,000 a year and all of that was being considered
income in addition to my stipend payment. So when taxes were
withheld from the monthly stipend only $254 was left.
Mrs. Johnson of Connecticut. So they withheld FICA taxes
for the first time?
Dr. Gillespie. What?
Mrs. Johnson of Connecticut. Did they withhold FICA taxes
for the first time from the $35,000 portion?
Dr. Gillespie. Actually, FICA taxes were not withheld. They
withheld Federal Income taxes.
Mrs. Johnson of Connecticut. And then also income taxes?
Dr. Gillespie. Right. They were withheld as income, as if
it were income.
Mrs. Johnson of Connecticut. I think the thing that is hard
for people to see is that this money had no FICA tax on it
either so that is 15 percent between FICA and Medicare and then
income taxes over and above that. Fifteen percent for FICA and
Medicare taxes. And then over and above that the income tax.
Otherwise, you couldn't account for such a heavy load.
Dr. Gillespie. Income taxes accounted for the entire
withholding.
Mrs. Johnson of Connecticut. Yes, Social Security taxes.
OK, thank you.
Mr. Rangel.
Mr. Rangel. Madam Chairwoman, you will be pleased to know
that our bills really are compatible when it comes to allowing
the rural areas to participate in the bond issues. The major
difference is that mine concentrates more of its benefits on
areas of need than yours does. I think that is very important
because of the diversity in formulas that we have in our major
States. The amazing thing is that we never have a problem with
the budget for construction of prisons. I just never understand
why that budget is so easy to enact and an adequate education
budget is not.
But I want to thank the supporters of this approach,
including Mrs. Johnson because Mrs. Johnson is a breath of
fresh air when it comes to innovative ideas. The Majority
thinking on her side of the aisle is that we should remove all
requirements by States and local governments for Federal aid.
There is an article in today's New York Times which states that
Governors should be able to determine what they want to do with
the money rather than to have it earmarked toward improving
education. The Chairman has said he believes that the approach
of Senator Coverdell, which would allow individual savings
accounts to accumulate tax-free interest earnings if the
accounts are dedicated for the child's education. Also, more
and more Republicans talk about vouchers. Many parents prefer
to send their children to private schools, but I am impressed
that more and more people recognize the fact that the education
of our children in the public school system is a national issue
that cannot be ignored. And I really want to thank you for your
support.
Last week, Madam Chairwoman, the Conference of Mayors voted
their overwhelming support for this approach. I am anxious to
work with you and Chairman Archer to make our bills even more
compatible so that we do not cause damage to our budget as we
encourage people, local and State governments, to invest in
education.
I want to thank the entire panel. Dr. Gillespie, I will be
working with the Chairwoman to see what remedy we can have for
the problems that you had to endure personally and, of course,
Mr. Grayson--where is your foundation located, Mr. Grayson?
Mr. Grayson. We are in La Jolla, California, but we, as I
noted, serve the entire country. We operate in 27 States at
this time.
Mr. Rangel. Well, I wish you would send some additional
information as to what you do and where you do it because----
Mr. Grayson. I have got some with me and you are welcome to
it.
Mr. Rangel. I appreciate the fact that it is targeted to
the areas where it is most needed. I want to thank the entire
panel.
I yield back the balance of my time.
Mrs. Johnson of Connecticut.
Mr. English.
Mr. English. Thank you, Madam Chair. Mr. Bennett, welcome.
I appreciate your coming here to offer such eloquent testimony
for Qualified State Tuition Plans, which have been in the case
of Pennsylvania very successful. It is my privilege to work
with your counterpart and colleague, Barbara Hafer, in
Pennsylvania on expanding the tax breaks. I notice here
specifically you encourage the Committee to consider the
exclusion from gross income for distributions from Qualified
Tuition programs and also eliminate all Federal income taxes on
accrued interest. I wonder, knowing as you undoubtedly do, that
there was an attempt by this Committee to write a much broader
tax break for these plans and that in 1997 when we did our tax
bill, we were faced with a violent reaction, that's the best
way I can describe it, from the Treasury, which opposed the
extent of the tax break we had written and charged that we were
creating an opportunity for tax breaks for the rich and
specifically abuses by high-income taxpayers.
Mr. Bennett, can you put us at ease on this? Are these
programs the sorts of programs that are utilized by plutocrats.
I mean is Bill Gates' kid going to be in this program?
Mr. Bennett. Well, of course, the programs are open to all
citizens regardless of income. We find from the results of the
million students that are enrolled in it now, the great
majority, over 55 percent are in the middle-income bracket,
family income between $20,000 and $70,000.
Mr. English. And you don't see any way that high-income
taxpayers could somehow structure this to be a special tax
break or exclusion for income?
Mr. Bennett. No, because if they use it for anything other
than higher educational expenses, then it is taxable.
Mr. English. That is wonderful. That puts me at ease.
Now can you tell me how many qualified State tuition plans
currently allow participation by private colleges or allow a
break that is comparable to that for State institutions be
extended over to private colleges?
Mr. Bennett. All plans, all prepaid plans of the 20 allow
for public or private institutions to participate. A student
can choose wherever they want to go and the tuition will be
paid to that institution. The savings plan States obviously
have a program where the proceeds that are earned while it is
in the invested plan can be spent anywhere. And, of course,
those are market-driven and it very well could produce enough
income to pay for any private institution's tuition, no matter
what the cost.
Mr. English. I have not seen a formal study on this, Mr.
Bennett, but my impression is that the tax break allowable for
a private institution in some of the State programs, and I
applaud them for including private schools, the break for
private institutions is really not as great as the one for
public institutions. And that is where I would like to bring
Dr. Kepple in. Welcome and thank you very much for representing
our smaller institutions in Pennsylvania, which I have a number
of within my congressional district.
Mr. Kepple. Yes, you do, sir.
Mr. English. Mr. Bennett in his testimony makes the point
that there needs to be some sort of regulatory regime for
private prepaid tuition plans if we end up creating a tax
incentive for those. Would you care to comment on what you
think would be appropriate. And I take it you don't really
object to that?
Mr. Kepple. We do not object at all. We believe that is an
appropriate move, and we certainly support the 529 section and
would follow those basic rules.
Mr. English. Well, I think that is outstanding. As both of
you gentlemen know, I have legislation in currently that you
have referenced in your testimony that would allow for a level
tax playingfield for both kinds of institutions. I hope both
kinds of programs ultimately are available and flourish because
I think it is a great way for middle-class families to save. I
am running out of time, but I want to thank both of you for
highlighting these points before our Committee and providing
eloquent testimony.
Mr. Kepple. Thank you.
Mr. English. Thank you, gentlemen.
Chairman Archer [presiding]. Mr. Hulshof.
Mr. Hulshof. Thank you, Mr. Chairman. I am constrained to
make a quick comment to my friend from New York, and I don't
know if this puts me in the open-minded Republican category or
some other characterization that he chooses to make. There are
some of us, most of us, who do not believe that there is a one-
size-fits-all regarding education. If we are truly sincere
about helping our kids learn and get a world-class education,
we should look at a variety of things. The gentleman from New
York talked about vouchers. And, clearly, low-income
scholarships allowing parents make those choices is one facet.
I spent some time this morning talking about the Savings for
Student Accounts, which really does provide the flexibility and
puts it in the hands of the parents because I don't believe any
American student should be discriminated against because he or
she goes to a public school or private school or is home-
schooled. So I make that remark.
I also applaud Mr. English, your efforts, which you talked
about. What we tried to do in H.R. 7 was take many of these
free-standing bills and roll them into one. For instance, Dr.
Gillespie, you will be happy to know that we do in H.R. 7, you
talk about 1414, which is a free-standing bill, we incorporate
that idea in this comprehensive Education Savings and School
Excellence Act because we have heard the stories of people just
like you. So we want to make sure that not only the National
Health Corps Scholarship program but the F. Edward Abare Armed
Forces Health Profession Scholarship and Financial Assistance
Program, which is a mouthful, also gets the same treatment. So
that is in H.R. 7.
Mr. Baratta, let me ask you a question and to preface the
question, let me tell you that I posed this same identical
question to the former Secretary of the Treasury, Mr. Rubin,
and if it is any consolation to you, he didn't have the answer
for me that day either. So having said that, especially
regarding the Qualified Zone Academy Bond Program, do you have
any idea how many school districts across the country have
utilized QZABs to help provide additional construction?
Mr. Baratta. Yes, sir, I can answer that with the knowledge
that I have today. There may be a couple out there that I am
not aware of. The State of California had two school districts
combined for a $12 million issue. And the Chicago public
schools did one also, I believe it was $14 million. In the
State of Oklahoma, there were 10 rural school districts that
participated in the program. I have contacts with Milwaukee
public schools and some others in Kansas City. And I believe
Texas is moving along as well.
Mr. Hulshof. So as far as those here today who have taken
advantage, I think you speak correctly, so let me first commend
you for having the answer that the Secretary did not. Can you
tell me, since you have the information, let me go one step
further and ask you specifically those, the QZABs used, I think
for the Fresno and Clovis school districts in your home State
of California, what percent of par those issues sold for?
Mr. Baratta. The Fresno-Clovis transaction actually sold at
a $91 price, which means 91 cents on the dollar came to the
school district.
Mr. Hulshof. OK. Let me move on and really continue the
questioning that Mr. English asked. And, again, we incorporated
his idea, Mr. Bennett and Dr. Kepple, of the Qualified Tuition
programs, and, Mr. Bennett, let me ask you the reverse question
that Phil asked Dr. Kepple regarding being willing to embrace
oversight. With that caveat--and I read your testimony--would
you be supportive of allowing private prepaid tuition plans
were the private institutions to have some similar type of
oversight that you have?
Mr. Bennett. Well, I think we support any effort to broaden
the accessibility across the country. The difference is that
the IRS regulation under 529 is really not enough oversight as
far as the investment portfolio is concerned, as far as the
financial stability. It penalizes the participant and protects
the Federal Government in the Treasury from tax fraud, but it
doesn't protect the consumer from purchasing a plan that is
mismanaged, whereas SEC regulation would require filings and
disclosure and management requirements and criteria before they
could even sell the plans to the public.
Mr. Hulshof. I appreciate that. Thank you, each of you, for
your presence and testimony today.
Chairman Archer. Mr. Hayworth.
Mr. Hayworth. Thank you, Mr. Chairman. I thank the
witnesses for taking time to come and visit with us today. I
apologize for the fact that I was not able to be here earlier.
I had another markup so I couldn't hear all of your comments.
Mr. Baratta, specifically to you, I am interested in your
assessment of H.R. 1660. And I am concerned about provisions
that incorporate Davis-Bacon into this legislation, into the
whole question of school construction. Won't inclusion of
Davis-Bacon needlessly increase the cost of school construction
under this bill?
Mr. Baratta. Only being able to respond to the California
issue, the answer to that is, no, it won't. We have a
prevailing wage in the State of California for schools
currently and that will not affect us in any way.
Mr. Hayworth. What is interesting, you mentioned prevailing
wages in the State of California because, as you do in your
profession, I wonder if you may have done an independent
analysis of the impact of expanding Davis-Bacon requirements on
this bill, that is, its impact on project cost and small
business and also minority contractors and women? Has anyone
done that type of analysis within California?
Mr. Baratta. None that I have seen.
Mr. Hayworth. OK. So really we don't really have empirical
data to show us that it doesn't adversely impact those
contractors and those folks?
Mr. Baratta. None that I can provide you today, yes.
Mr. Hayworth. Well, I hope that at the Federal level such
an analysis I think would be helpful, especially when we are
trying to assess just what transpires with wages. You mentioned
California specifically and our concerns at the Federal level,
this would be the first Federal tax bill that would incorporate
Davis-Bacon in such a manner. And as we prepare, I guess the
question would be why should we make such a drastic change in
policy at a time when the Department of Labor has admitted it
is not capable of accurately surveying wages for purposes of
issuing the required wage determinations under the act?
Mr. Baratta. I will have to beg off on that question, sir,
not necessarily being in that area.
Mr. Hayworth. OK, sir, well, again, if anyone on the panel
would care to address it? I just believe we have some real
concerns if the idea is to, in fact, improve school facilities
and I welcome State initiatives and, indeed, at the national
level, just 2 weeks ago, my Education Land Grant Act was passed
unanimously on the floor of the House of Representatives that
will help rural areas in terms of land costs and free up a
great deal of government-controlled, federally controlled land
for rural school districts. Its impact will be great, but
before we take such a drastic step in terms of federalizing, if
you will, school construction, I am very concerned about school
construction costs, and I think that if we include Davis-Bacon,
we are looking at an inflation in costs in terms of
construction by 5 to 38 percent. So those would be my concerns.
Again, I thank all of you for taking time, and I yield back
the balance of my time.
Chairman Archer. The Chair would like to inquire briefly,
and I apologize that I did not get to listen to the testimony
of each one of you, but I do thank each of you for coming. The
Members on the Committee on both sides of the aisle have a
strong desire to do everything we can to improve the
educational structure of the country. You have that same
desire, perhaps in different ways, but the same desire. After
we have done appropriate within the Tax Code, the Tax Code
cannot solve the problems. When we talk about the debt that our
young people have today to go to college, it is a matter of
great, great concern. But the Tax Code cannot solve all of that
problem.
As I look at the numbers, the cost of a public, 4-year
college education in the last 10 years has more than doubled,
more than doubled. What are we going to do to restrain the
cost? We are terribly concerned about health care costs
outstripping the rate of inflation, and we feel that we just
cannot continue on that path. What are we going to do about
education? Are they receiving twice the education today in
their colleges as we did 10 years ago? I don't think so. Does
anyone have a suggestion as to what we do about lowering cost
so that young people can afford education and do not have so
much debt?
Mr. Kepple. Mr. Chairman.
Chairman Archer. Dr. Kepple.
Mr. Kepple. Mr. Chairman, I think we mentioned some of
these things while you were out, but under our private prepaid
program, we expect to actually reduce the cost of higher
education, and we are doing it by investing those funds,
prepaid early and giving a discount to parents and grandparents
who have prepaid those funds. So, indeed, we hope to in fact
reduce the costs over time of our programs. But at the same
time not reduce the quality that, in fact, is the envy of the
world. It is a very important part of this formula.
Mr. Bennett. Mr. Chairman, what happens in the qualified
plans is that the tuition is locked in at today's price so no
matter how high the tuition cost increases at the colleges, the
investments cover that increase. So that to the American family
who is paying for college, they are only paying at 1999 prices
when their kid may not even go to college until 2010. The other
thing you are seeing some of the State legislatures do, such as
in Virginia and in our State, is they have put a moratorium for
2 years or 3 years on the increase in tuition at the public
universities in the State, which give families an opportunity
to at least plan for the next 2 to 3 years on the inflation
factor of college costs.
Chairman Archer. I think the prepaid tuition program is a
wonderful program that so many colleges have gone into, which
guarantees to young couples their children will be able to go
to school at the fixed price at whatever time they decide to
fund it. But that is only one side of the ledger. That has
nothing to do with the cost of the education. Ultimately that
cost must be recovered. If it is not recovered from the prepaid
tuition parents, it will be recovered somewhere else. I don't
know whether any of you get into that, but I just wonder what,
if any, efforts are underway in the colleges today to restrain
the costs?
Mr. Kepple. Mr. Chairman, I can't speak for every college
and university in the country but I have been at three
different institutions over the last 25 years, and I can't tell
you of a board meeting at any of those institutions where this
topic was not discussed with our board. It is an issue that we
all try to grapple with at every meeting and seek different
ways, innovative ways we hope, to reduce the cost. We are
seeing I think a reduction in the increase in tuition certainly
at most private institutions, and I suspect also at public
institutions as well. So the cost inflation rate that you have
seen in the last several years is in fact being reduced, but we
have not solved the problem.
Chairman Archer. OK. Thank you very much. You are excused
and we will get to our next panel.
Mr. Baroody, Mr. Capps, Mr. Bloomfield, Mr. McCants, Mr.
Greenberg, and Mr. Leonard, if you will come to the witness
table.
Welcome, gentlemen. You are encouraged to keep your oral
testimony within 5 minutes and, without objection, your entire
written statement will be inserted in the record. And after
identifying yourself, each of you may proceed.
Mr. Baroody, will you lead off, please?

STATEMENT OF MICHAEL E. BAROODY, SENIOR VICE PRESIDENT, POLICY,
COMMUNICATIONS AND PUBLIC AFFAIRS, NATIONAL ASSOCIATION OF
MANUFACTURERS

Mr. Baroody. Yes, sir, and thank you very much. I would
like to thank the Chairman and the Members of the Committee for
giving us the opportunity to testify and for holding these very
important hearings. My name is Michael Baroody, and I am here
to testify on behalf of the National Association of
Manufacturers, our 14,000 members, large, medium, and small,
and our 350 member associations, and especially the 18 million
people who make things in America. And I am here to testify in
favor of progrowth and----
Chairman Archer. Mr. Baroody, will you suspend for a
moment?
Mr. Baroody. Yes, sir.
Chairman Archer. The Chair encourages all of our guests and
staff to take seats. If they wish to converse, to do so outside
the Committee room.
Now, Mr. Baroody.
Mr. Baroody. Thank you, Mr. Chairman. I am here to testify
in favor of progrowth and proworker tax relief.
America's economy has expanded impressively over the past
18 years, with only one relatively mild downturn in that entire
period. At the NAM, we are proud of the disproportionately
large contribution American manufacturers have made to that
expansion. Coupled with fiscal restraint in recent years, our
booming economy has filled Federal coffers beyond expectations
and yielded the first Federal budget surplus in a generation.
Throughout the past decade, the NAM has been an advocate
for growth, I would say for ``more growth.'' And against the
widespread common wisdom in the early nineties that growth
rates of 2 percent or so were the best we could expect, the NAM
insisted we could do better with growth rates of 3 percent or
more. Over the past 3 years, this economy has averaged
noninflationary growth of about 4 percent, and we believe it
has proven us right.
The fiscal 2000 budget resolution approved by Congress with
its projections for a 10-year budget surplus of almost $800
billion, not including Social Security revenues, rests on the
assumption of continued growth. We strongly agree the surplus
should be returned to taxpayers through tax relief, but believe
just as strongly that a substantial portion of the total tax
cut should take the form of an insurance policy for continued
growth. Last December, the NAM announced our advocacy for
across-the-board reductions in tax rates for just that reason.
We thought such tax rates balanced between individuals and
corporations would give us a balanced growth stimulus. We
thought then and think now that it would be the best insurance
policy for growth. But if such a broad-based tax cut seems for
the time out of reach, we nonetheless continue to believe that
growth-oriented tax cuts should be included in the package for
the sake of maintaining our expansion and realizing Congress's
current revenue projections.
As the Chairman knows, because the NAM has carried on a
much-appreciated dialog with him over the years, we believe
that the Federal Tax Code is the single largest current
obstacle to economic growth. It needs to be reformed and
replaced with a Progrowth Code, but until it is, we believe
that certain provisions, such as repeal of the corporate AMT
and the estate tax, a permanent extension of the R&D tax
credit, and simplification of international tax provisions are
essential pro-growth incentives that need to be incorporated
into an otherwise Antigrowth Code.
I would say also that such progrowth provisions should
account in our view for about a third of the total tax cut.
This was the proportion that went to businesses in the tax cuts
of the sixties and the currently unsettled state of the world
economy we think justifies a similar portion now. That would
translate into a 10-year total of about $250 billion, more than
enough to accommodate the four provisions I have mentioned.
And, importantly, to ensure the prospects for continued
expansion.
The NAM believes that additional relief from the corporate
alternative minimum tax, the AMT, is a critical component of
ensuring long-term sustained economic growth in the United
States. And we note, Mr. Hayworth, the work you have been doing
to put together a bill that would improve the implementation.
And we, on behalf of the NAM and the coalition we represent,
express our gratitude to you for that. Despite the relief that
was enacted in 1997, many of our member companies, particularly
those in distressed industries, continue to be burdened by the
unfair AMT. The NAM believes that the best solution is repeal.
Short of repeal, we strongly support legislative changes to
allow corporate taxpayers to use AMT credits more quickly, Mr.
Hayworth, than they can under current law. It is also important
to ensure that companies that have paid the AMT are not further
penalized by losing any of the value of these credits. These
credits represent assets on the books of AMT companies. We also
support eliminating arbitrary limits on net operating losses
and foreign tax credits under the AMT.
Also, a permanent extension of the R&D tax credit would
provide an effective economic stimulus. Increased productivity,
new product development, and process improvements are direct
results of technological advancements that occur from R&D
activities. Two-thirds of the growth in manufacturing is
attributable to productivity improvements from technological
advance derived primarily from U.S.-based R&D. The
manufacturing sector performs 77 percent of all private
industrial R&D in the United States and the R&D tax credit is a
key factor in promoting that. The tax credit has been
particularly effective in spurring incremental R&D that
probably would not have been conducted without additional funds
provided by this incentive. Also, the R&D tax credit is a job
creator. More than three-quarters of the credit dollars are
used for the salaries of American workers performing R&D in the
United States.
The temporary tax credit is scheduled to expire a week from
today on June 30. Its history of lapses and temporary
extensions stymies planning for R&D activities and exacerbates
tax compliance difficulties. We strongly urge enactment of a
permanent R&D tax credit, including a modest increase in the
alternative incremental research credit, as proposed in the
bill introduced by Committee Members Nancy Johnson and Bob
Matsui.
Another powerful and effective progrowth tax policy would
be elimination of the death tax imposed on a business when an
owner dies. The estate tax burden is the leading reason why
more than two-thirds of family-owned businesses are sold or
liquidated by heirs. Eliminating this burden would allow small
business owners to invest more money in expanding their
companies and hiring additional workers. They could make long-
range plans based on rational business issues and not tax
policy concerns. Simplification of the current international
tax regime would also provide an effective economic stimulus by
reducing compliance burdens and helping to level the
playingfield between U.S.-based companies and their foreign
competitors.
The NAM believes the international tax rules are overly
complex, arbitrary, and, in many cases, unfair. We will provide
more expansive comments on international tax issues in
conjunction with this Committee's hearing scheduled for next
week, June 30.
There are also, finally, a number of more targeted tax cuts
supported by the NAM that would have a positive impact on
growth and our economy. They certainly include education
incentives, such as a permanent exclusion for employer-provided
tuition assistance and an expansion of this benefit to cover
graduate education, as well as additional incentives for
training, lifelong learning, and school donations.
We also support tax rate relief for small businesses
operating as S corporations and additional capital gains tax
relief for individuals. In addition, capital gains tax relief
for corporations is important. Lowering the capital gains tax
rate reduces the cost of capital and promotes U.S. economic
growth and job creation. Legislators began the job in 1977 by
lowering the top rate on individual capital gains from 28
percent to 20 percent, we hope that efforts will continue by
enacting similar reductions in capital gains tax rates for
corporations.
Clearly, the robust economic growth experienced by the
United States during most of the past decade has benefited
businesses and workers alike. We believe it is critical to
continue this growth and welcome the opportunity to work with
this Committee to develop progrowth tax policies.
Thank you for this opportunity.
[The prepared statement follows:]

Statement of Michael E. Baroody, Senior Vice President, Policy,
Communications and Public Affairs, National Association of
Manufacturers

Chairman Archer, members of the Committee, my name is
Michael Baroody. I am here to testify on behalf of the National
Association of Manufacturers; our 14,000 member companies,
large, medium and small; our 350 member associations; and the
18 million people who make things in America.
And I am here to testify in favor of pro-growth and pro-
worker tax relief.
America's economy has expanded impressively over the past
18 years, with only one relatively mild downturn in the entire
period. At the NAM, we are proud of the disproportionately
large contribution American manufacturers have made to that
expansion. Coupled with the fiscal restraint of recent years,
our booming economy has filled federal coffers beyond
expectations and yielded the first federal budget surplus in a
generation. This made possible a budget resolution, passed by
Congress earlier this year, which provides for $778 billion in
tax cuts over the next ten years.
Throughout the past decade, the NAM has been an advocate
for growth. Against the widespread common wisdom of the early
'90s that growth rates of 2 percent to 2.5 percent were all we
could expect and all we should strive for--and that growth
rates in excess of that would reignite inflation--the NAM
insisted we could and should do better, with growth rates of 3
percent or more. Regardless of whether we were in a new
economy, we said, the old formulas and the old certainties
needed a new look. Over the past three years, this economy has
averaged non-inflationary growth of about 4 percent. We believe
we've been proven right.
The budget resolution I cited--with its projections for a
10-year budget surplus of almost $800 billion, not including
Social Security revenues--rests on the assumption of continued
growth. We strongly agree that the surplus should be returned
to taxpayers through tax relief--but we believe just as
strongly that a substantial portion of the total tax cut should
take the form of an insurance policy for continued growth.
Without continuing growth, of course, the entire tax-relief
plan will be frustrated.
Last December, the NAM announced our advocacy of across-
the-board reductions in tax rates. We called for rate cuts that
were balanced between individuals and businesses. In that way,
both the growth stimulus and the tax relief would also be
balanced--in NAM's terms--between our 14,000 manufacturing
member companies and the 18 million people who make things in
America, between America's working families and the companies
they work for, between the supply side and the demand side. We
thought then, and think now, that this would be the best
insurance policy for growth. But if such a broad-based tax cut
seems for the time out of reach, we nonetheless continue to
believe that growth-oriented tax cuts should be included in the
package, for the sake of maintaining our expansion and
realizing Congress' current revenue projections.
As you also know, Mr. Chairman, because the NAM has carried
on a much-appreciated dialogue with you over the years, we
believe that the federal tax code is the single largest current
obstacle to economic growth. It needs to be reformed and
replaced with a pro-growth code. Until it is, we believe that
certain provisions--such as repeal of the corporate AMT and the
estate tax, a permanent extension of the R&D tax credit and
simplification of international tax provisions--are essential
pro-growth incentives that need to be incorporated into an
otherwise anti-growth tax code.
As a final point of preface, Mr. Chairman, we believe that
such pro-growth provisions should account for about a third of
the total tax cut. This was the proportion that went to
businesses in the tax cuts of the '60s and the currently
unsettled state of the world economy justifies a similar
portion now. That would translate into a 10-year total of about
$250 billion--more than enough to accommodate the four
provisions I have mentioned and, importantly, to ensure the
prospects for continued expansion.

Corporate AMT

The NAM believes that additional relief from the corporate
alternative minimum tax (AMT) is a critical component of
ensuring long-term sustained economic growth in the United
States. AMT relief enacted in 1997 significantly reduced the
cost of capital for AMT payers by conforming AMT depreciation
lives with regular tax lives for property placed in service
after 1998. Nonetheless, the AMT, sometimes known as the anti-
manufacturing tax, remains an impediment to economic growth and
job creation in the United States, particularly in the capital-
intensive manufacturing sector of the economy.
The NAM strongly opposed enactment of the corporate AMT in
1986, arguing that the AMT would have a negative impact on U.S.
manufacturing. Unfortunately, this proved to be true. During
the early 1990's, many companies, particularly in the
manufacturing sector, reported large losses to their
shareholders and were forced to reduce employment. At the same
time, because of the way the AMT works, these companies were
forced to make large AMT payments to the federal government.
Mr. Chairman, the NAM welcomed your proposal in 1995 to
repeal the corporate AMT and worked vigorously for enactment of
this proposal. Although this effort was not successful, our
members appreciated your leadership in advancing the more
limited depreciation reforms enacted in 1997.
Despite the changes enacted in 1997, many of our member
companies, particularly those in distressed industries,
continue to be burdened by the unfair AMT. In order to improve
this situation, the NAM strongly supports legislative changes
to allow corporate taxpayers to use AMT credits more quickly
than they can under current law. It also is important to ensure
that companies that have paid the AMT are not further penalized
by losing any of the value of these credits. These credits
represent assets on the books of AMT companies. The NAM also
supports eliminating arbitrary limits on net operating losses
and foreign tax credits under the AMT.

A Permanent R&D Tax Credit

A permanent extension of the research and experimentation
tax credit, commonly referred to as the R&D tax credit, also
would provide an effective economic stimulus. The contribution
of research and development to economic growth cannot be
overstated. Increased productivity, new product development and
process improvements are direct results of technological
advances that occur from R&D activities. In fact, two-thirds of
the growth in manufacturing is attributable to productivity
improvements from technological advances derived primarily from
U.S.-based R&D. According to the National Science Foundation,
the manufacturing sector performs 77 percent of all private
industrial R&D in the United States. The R&D tax credit is a
key factor in promoting increased research spending by
manufacturers.
The tax credit has been particularly effective in spurring
incremental R&D that probably would not have been conducted
without additional funds provided by this incentive. A number
of small businesses, which account for $20 billion or 14
percent of total industrial R&D spending in 1996, also benefit
from the credit. Moreover, many smaller companies that do not
conduct enough R&D to benefit from the credit experience a
``spillover benefit'' when R&D performed by another company
generates additional business for them and gives them access to
new technology to improve their productivity.
The R&D tax credit is also a job creator and an investment
in our greatest asset: people. More than 75 percent of the
credit dollars are used for the salaries of American workers
performing U.S.-based R&D. These trained and skilled workers
performing R&D enjoy greater economic security and higher
wages. Without these workers, we would not have the innovative
ideas that are the genesis of many R&D activities.
The temporary tax credit is scheduled to expire, once
again, a week from today on June 30. A history of lapses and
temporary extensions of the credit, since its initial enactment
in 1981, stymies business planning for R&D activities and
exacerbates tax-compliance difficulties. The NAM strongly urges
enactment of a permanent R&D tax credit, including a modest
increase in the alternative incremental research credit (AIRC)
rates, as proposed in the bill (H.R. 835) introduced by
committee members Nancy Johnson (R-CT-6) and Bob Matsui (D-CA-
5). In addition to extending the credit permanently, the AIRC
rate increase will provide greater parity for those companies
that do not qualify for the regular credit.
The Johnson/Matsui bill enjoys wide bipartisan support. The
bill's 143 cosponsors include half of the Ways and Means
Committee members. A companion bill in the Senate (S. 680), has
43 cosponsors, including half of the Senate Finance Committee
members.

Death Tax Repeal

Another powerful and effective pro-growth tax policy is
elimination of the death tax imposed on a business when an
owner dies. The estate tax burden is the leading reason why
more than two-thirds of family-owned businesses are sold or
liquidated by heirs. Under the current system, closely held
businesses devote significant resources to costly and
complicated planning to minimize the estate tax, diverting
major financial resources from hiring and business expansion.
In short, federal estate taxes take a toll on economic growth
and job creation. Eliminating this burden would allow small
business owners to invest more money in expanding their
companies and hiring additional workers. They could make long-
range plans based on rational business issues and not tax
policy concerns.
Just last week, an NAM member and small business owner, Ron
Sandmeyer Jr. from Sandmeyer Steel Company in Philadelphia,
appeared before this committee to discuss the difficulties his
company faces today as it prepares for the transition to a new
generation of ownership and ask you to eliminate the estate tax
burden. His testimony reflects the concerns and problems faced
by many of our 10,000 small and medium manufacturers in trying
to plan for and pay this onerous tax.

International Tax Simplification

Simplification of the current international tax regime
would also provide an effective economic stimulus by reducing
compliance burdens and helping to level the playing field
between U.S.-based companies and their foreign competitors.
The NAM believes that the international tax rules in the
federal tax code are overly complex, arbitrary, and, in many
cases, unfair. U.S. companies are facing increased competition
from counterparts in other countries that have the distinct
advantage of a more rational tax policy. Furthermore, U.S.
trade and tax policies are at odds. Trade is essential to
expand our markets, but our current tax system penalizes
foreign source income by taxing it even more severely than
domestic source income, and by requiring enormous amounts of
additional recordkeeping.
The NAM will provide more expansive comments on
international tax issues in conjunction with the committee
hearing scheduled for June 30.

Conclusion

Clearly the robust economic growth experienced by the
United States during most of the past decade has benefitted
businesses and workers alike. The NAM believes that it is
critical to continue this growth and welcomes the opportunity
to work with this committee to develop progrowth tax policies.
Undoubtedly, the current tax system represents a major drag on
the economy and should be replaced with a simpler and fairer
system that encourages work, investment and entrepreneurial
activity. Pending reform, there are a number of tax cut
proposals that fit within the current budgetary constraints and
that will stimulate job creation and economic growth. These
pro-growth tax incentives include corporate AMT repeal, a
permanent R&D tax credit, elimination of the death tax and
international tax simplification.
There also are a number of more targeted tax cuts,
supported by the NAM, which would have a positive impact on our
economy. Those proposals include education incentives such as a
permanent exclusion for employer-provided tuition assistance
and an expansion of this benefit to cover graduate education,
as well as additional incentives for training, lifelong
learning and school donations. The NAM also supports tax-rate
relief for small businesses operating as S-corporations and
capital gains tax cuts for individuals and corporations.
We applaud you, Mr. Chairman, for holding these hearings
and for your commitment to meaningful tax relief for American
families and businesses. Our members agree with you, Mr.
Chairman, that if the surplus is not returned to taxpayers
through tax cuts, it will likely go towards more government
spending.

Chairman Archer. Thank you.
Mr. Capps.

STATEMENT OF R. RANDALL CAPPS, CORPORATE TAX DIRECTOR AND
GENERAL TAX COUNSEL, ELECTRONIC DATA SYSTEMS CORPORATION; ON
BEHALF OF R&D CREDIT COALITION

Mr. Capps. Good afternoon, Mr. Chairman and Members of the
Committee. My name is Randy Capps. I am corporate tax director
for Electronic Data Systems. I would like to thank you for this
opportunity to speak to you about the research and
experimentation tax credit.
I am here on behalf of my company, EDS, and the R&D Credit
Coalition. EDS has been a leader in the global information
technology services industry for more than 35 years. Our
140,000 employees deliver management consulting, electronic
business solutions, and systems and technology services to
improve the performance of more than 9,000 businesses and
government clients in approximately 50 countries.
The R&D Credit Coalition is comprised of 53 trade and
professional organizations and approximately 1,000 companies of
all sizes who rely on the credit to reduce the cost of high-
risk research. The Coalition supports a permanent extension of
the credit and a 1-percent increase in the rates of the
alternative incremental research credit, as called for in H.R.
835. Introduced by Congresswoman Nancy Johnson and Congressman
Robert Matsui, the bill currently has 143 cosponsors. An
identical bill, S. 680, has 43 cosponsors in the Senate.
The first point I would like to address with the Committee
is why the credit is so important. It is important because it
offsets the tendency to under invest in R&D. The single biggest
factor driving productivity growth is innovation. However,
companies cannot capture fully the rewards of their innovations
because they can't control the indirect benefits of their
technology on the economy. As a result, the rate of return to
society from innovation is twice that which accrues to the
individual company.
The credit is important because it helps U.S. business
remain competitive in a world marketplace. And, unfortunately,
our Nation's private sector investment in R&D, as a percentage
of GDP, is far below many of our major foreign competitors.
Foreign governments are competing aggressively for research
investments by offering substantial tax and other financial
incentives. Companies that do research in the United States are
at a disadvantage when competing with foreign-based
multinationals who have lower research costs.
The credit is also important because R&D spending is very
responsive to the incentive it provides. Economic studies of
the credit have found that a $1 reduction in the aftertax price
of R&D stimulates approximately $1 of additional private R&D
spending in the short-run and about $2 of additional R&D in the
long-run.
The credit is important because research and development is
about jobs and people. Investment in R&D is ultimately an
investment in people, their education, their jobs, their
economic security, and their standard of living. Dollars spent
on R&D are primarily spent on salaries for engineers,
researchers, and technicians. At EDS, over 90 percent of the
expenses qualifying for the R&D credit go to salaries for
employees directly involved in research.
The second point I would like to address with the Committee
is that the credit should be permanent to have the maximum
incentive value. Research projects cannot be turned off and on
like a light switch. If the credit is to achieve its maximum
return in increased R&D activity, the practice of extending the
credit for short periods and allowing it to lapse must be
eliminated and the credit must be made permanent. Only then
will the full potential of its incentive be felt across all the
sectors of our economy.
The final point I would like to address with the Committee
is that the alternative credit rate should be increased. In
1996, the elective alternative incremental research credit was
added, making it available to R&D intensive industries which
could not qualify for the credit under the regular criteria.
The alternative credit adds flexibility to address changes in
business models and R&D spending patterns.
In addition to making the credit permanent, H.R. 835
provides for a modest increase in the alternative credit rates
to bring the incentive effect more in line with that provided
by the traditional credit. It is important to note that the
increase in the alternative credit rates is low cost, does not
affect the structure of the current credit, and is the only
change endorsed by the Coalition.
In conclusion, making the R&D credit permanent promotes the
long-term economic interests of the United States. It will
encourage investments that lead to innovative products and
processes that contribute to economic growth, increased
productivity, new and better U.S. jobs, and higher standards of
living for all Americans.
Thank you.
[The prepared statement follows:]

Statement of R. Randall Capps, Corporate Tax Director and General Tax
Counsel, Electronic Data Systems Corporation; on behalf of R&D Credit
Coalition

Good morning. Mr. Chairman and members of the committee, my
name is Randy Capps, and I am Corporate Tax Director for
Electronic Data Systems. I would like to thank you for the
opportunity to speak with you about the research and
experimentation tax credit and to thank you and all the members
of the committee who have supported the credit over the years.
I am here this morning on behalf of my company and the R&D
Credit Coalition. EDS has been a leader in the global
information technology services industry for more than 35
years. Our 140,000 employees deliver management consulting,
electronic business solutions, and systems and technology
expertise to improve the performance of more than 9,000
business and government clients in approximately 50 countries.
EDS reported revenues of $16.9 billion in 1998.
The R&D Credit Coalition is comprised of 53 trade and
professional organizations and approximately 1,000 companies of
all sizes who rely on the credit to reduce the cost of high
risk research. The coalition supports a permanent extension of
the credit and a one percentage point increase in the rates of
the alternative incremental research credit as called for in
H.R. 835. Introduced by Congresswoman Nancy Johnson and
Congressman Robert Matsui, this bill currently has 143
cosponsors. An identical bill, S. 680, has 43 cosponsors on the
Senate side.
The companies in the Coalition represent a broad range of
industries including the information technology, electronics,
chemicals, pharmaceuticals, biotechnology, automotive, and
manufacturing industries. We are united by our conviction that
extending the credit is critical to our companies, our economy,
and an enhanced quality of life for all Americans.
My own industry, information technology services, was born
out of basic research and is driven by the applied research of
hundreds of innovative corporations. This corporate R&D
produces a growing range of products and services that are
generating productivity increases throughout the economy. The
technological revolution that is occurring in my industry is
replicated in other industries that participate in the
coalition. These industries are reinventing themselves and in
the process are creating a broad range of high-paid, high-
skilled jobs in the United States.
Last week, the Joint Economic Committee held a high tech
summit that included three days of hearings and a hands on
demonstration of products and services made possible by
corporate R&D. Sixteen companies, including EDS, were part of
the R&D exhibit. EDS showcased our Interactive Billing Services
which are part of a suite of electronic business applications
developed by EDS. The cost of this development was reduced by
the credit. We believe the end result will be productivity
increases and substantial cost savings for EDS' customers and
for our customers' customers.
R&D is the primary source of technological innovation.
According to the U.S. Office of Technology Policy,
technological innovation has accounted for up to half of U.S.
economic growth during the past five decades.

I. R&D CREDIT LEGISLATIVE HISTORY

The R&D credit was enacted in 1981 to provide an incentive
for companies to increase their U.S. R&D activities. As
originally passed, the R&D credit was to expire at the end of
1985. Recognizing the importance and effectiveness of the
provisions, Congress decided to extend it. In fact, since 1981
the credit has been extended nine times. In addition, the
credit's focus has been sharpened by limiting both qualifying
activities and eligible expenditures. With each extension, the
Congress indicated its strong bipartisan support for the R&D
credit. Most recently, the Congress approved a one year
extension of the credit, until June 30, 1999.
In 1996, the elective Alternative Incremental Research
Credit (``;AIRC'') was added to the credit, increasing its
flexibility and making the credit available to R&D intensive
industries which could not qualify for the credit under the
regular criteria. The AIRC adds flexibility to the credit to
address changes in business models and R&D spending patterns
which are a normal part of a company's life cycle. The sponsors
of H.R. 835 and S. 680 recognize the importance of the AIRC.
Their legislation, in addition to making the credit permanent,
provides for a modest increase in the AIRC rates that will
bring the AIRC's incentive effect more into line with the
incentive provided by the regular credit to other research-
intensive companies.
According to the conference report of the Tax Reform Act of
1986, the R&D credit was originally limited to a five-year term
in order ``to enable the Congress to evaluate the operation of
the credit.'' It is understandable that the Congress in 1981
would want to adopt this new credit on a trial basis. The
credit has long since proven over the seventeen years of its
existence to be an excellent, highly leveraged investment of
government resources to provide an effective incentive for
companies to increase their U.S.-based R&D.
The historical pattern of temporarily extending the credit
reduces the incentive effect of the credit. The U.S. research
community needs a stable, consistent R&D credit in order to
maximize its incentive value and its contribution to the
nation's economic growth and sustain the basis for ongoing
technology competitiveness in the global arena.

II. WHY DO WE NEED AN R&D CREDIT?

A. The credit offsets the tendency for under investment in R&D

The single biggest factor driving productivity growth is
innovation. As stated by the Office of Technology Assessment in 1995:
``Much of the growth in national productivity ultimately derives from
research and development conducted in private industry.'' Sixty-six to
eighty percent of productivity growth since the Great Depression is
attributable to innovation. In an industrialized society, R&D is the
primary means by which technological innovation is generated.
Companies cannot capture fully the rewards of their innovations
because they cannot control the indirect benefits of their technology
on the economy. As a result, the rate of return to society from
innovation is twice that which accrues to the individual company. This
situation is aggravated by the high risk associated with R&D
expenditures. As many as eighty percent of such projects are believed
to be economic failures.
Therefore, economists and technicians who have studied the issue
are nearly unanimous that the government should intervene to increase
R&D investment. The most recent study, conducted by the Tax Policy
Economics Group of Coopers & Lybrand, concluded that ``absent the R&D
credit, the marketplace, which normally dictates the correct allocation
of resources among different economic activities, would fail to capture
the extensive spillover benefits of R&D spending that raise
productivity, lower prices, and improve international trade for all
sectors of the economy.'' Stimulating private sector R&D is
particularly critical in light of the decline in government funded R&D
over the years. Direct government R&D funding has declined from 57% to
36% of total R&D spending in the U.S. from 1970 to 1994. Over this same
period, the private sector has become the dominant source of R&D
funding, increasing from 40% to 60%.

B. The credit helps U.S. business remain competitive in a world
marketplace

The R&D credit has played a significant role in placing American
businesses ahead of their international competition in developing and
marketing new products. It has assisted in the development of new and
innovative products; providing technological advancement, more and
better U.S. jobs, and increased domestic productivity and economic
growth. This is increasingly true in our knowledge and information-
driven world marketplace.
Research and development must meet the pace of competition. In many
instances, the life cycle of new products is continually shrinking. As
a result, the pressure of getting new products to market is intense.
Without robust R&D incentives encouraging these efforts, the ability to
compete in world markets is diminished.
Continued private sector R&D is critical to the technological
innovation and productivity advances that will maintain U.S. leadership
in the world marketplace. Since 1981, when the credit was first
adopted, there have been dramatic gains in R&D spending. Unfortunately,
our nation's private sector investment in R&D (as a percentage of GDP)
lags far below many of our major foreign competitors. For example, U.S.
firms spend (as a percentage of GDP) only one-third as much as their
German counterparts on R&D, and only about two-thirds as much as
Japanese firms. This trend must not be allowed to continue if our
nation is to remain competitive in the world marketplace.
Moreover, we can no longer assume that American companies will
automatically choose to site their R&D functions in the United States.
Foreign governments are competing aggressively for U.S. research
investments by offering substantial tax and other financial incentives.
Even without these tax incentives, the cost of performing R&D in many
foreign jurisdictions is lower than the cost to perform equivalent R&D
in the U.S.
An OECD survey of sixteen member countries found that thirteen
offer R&D tax incentives. Of the sixteen OECD nations surveyed, twelve
provide a R&D tax credit or allow a deduction for more than 100% of R&D
expenses. Six OECD nations provide accelerated depreciation for R&D
capital. According to the OECD survey, the U.S. R&D tax credit as a
percentage of industry-funded R&D was third lowest among nine countries
analyzed.
Making the U.S. R&D tax credit permanent, however, would markedly
improve U.S. competitiveness in world markets. The 1998 Coopers &
Lybrand study found that, with a permanent credit, annual exports of
goods manufactured here would increase by more than $6 billion, and
imports of good manufactured elsewhere would decrease by nearly $3
billion. Congress and the Administration must make a strong and
permanent commitment to attracting and retaining R&D investment in the
United States. The best way to do that is to permanently extend the R&D
credit.

C. The credit provides a targeted incentive for additional R&D
investment, increasing the amount of capital available for innovative
and risky ventures

The R&D credit reduces the cost of capital for businesses that
increase their R&D spending, thus increasing capital available for
risky research ventures.
Products resulting from R&D must be evaluated for their financial
viability. Market factors are providing increasing incentives for
controlling the costs of business, including R&D. Based on the cost of
R&D, the threshold for acceptable risk either rises or falls. When the
cost of R&D is reduced, the private sector is likely to perform more of
it. In most situations, the greater the scope of R&D activities, or
risk, the greater the potential for return to investors, employees and
society at large.
The R&D credit is a vital tool to keep U.S. industry competitive
because it frees-up capital to invest in leading edge technology and
innovation. It makes available additional financial resources to
companies seeking to accelerate research efforts. It lowers the
economic risk to companies seeking to initiate new research, which will
potentially lead to enhanced productivity and overall economic growth.

D. Private industrial R&D spending is very responsive to the R&D
credit, making the credit a cost effective tool to encourage economic
growth

Economic studies of the credit, including the Coopers & Lybrand
1998 study, the KPMG Peat Marwick 1994 study, and the article by B.
Hall entitled: ``R&D Tax Policy in the 1980s: Success or Failure?'' Tax
Policy and the Economy (1993), have found that a one-dollar reduction
in the after-tax price of R&D stimulates approximately one dollar of
additional private R&D spending in the short-run, and about two dollars
of additional R&D in the long run. The Coopers & Lybrand study predicts
that a permanent R&D credit would lead U.S. companies to spend $41
billion more (1998 dollars) on R&D for the period 1998-2010 than they
would in the absence of the credit. This increase in private U.S. R&D
spending, the 1998 study found, would produce substantial and tangible
benefits to the U.S. economy.
Coopers & Lybrand estimated that this permanent extension would
create nearly $58 billion of economic growth over the same 1998-2010
period, including $33 billion of additional domestic consumption and
$12 billion of additional business investment. These benefits, the 1998
study found, stemmed from substantial productivity increases that could
add more than $13 billion per year of increased productive capacity to
the U.S. economy. Enacting a permanent R&D credit would lead U.S.
companies to perform significantly more R&D, substantially increase
U.S. workers' productivity, and dramatically grow the domestic economy.

E. Research and Development is About Jobs and People

Investment in R&D is ultimately an investment in people, their
education, their jobs, their economic security, and their standard of
living. Dollars spent on R&D are primarily spent on salaries for
engineers, researchers and technicians.
When R&D results in new products and services, the incentives that
support R&D translate into salaries of employees in manufacturing,
administration and sales. Successful R&D also means salaries to people
in the distribution channels who bring new products to customers and
service providers and developers of complementary products. Finally,
customers benefit from advances in technology that improve their
productivity and ability to compete. By making other industries more
competitive, research within one industry contributes to preserving and
creating jobs across the entire economy.
At EDS more than 90 percent of expenses qualifying for the R&D
credit go to salaries for employees directly involved in research.
These are high-skill, high-wage jobs that employ U.S. workers.
Investment in R&D, in people working to develop new ideas, is one of
the most effective strategies for U.S. economic growth and competitive
vitality. Indeed, the 1998 Coopers & Lybrand study shows improved
worker productivity throughout the economy with the resulting wage
gains going to hi-tech and low-tech workers alike. U.S. workers'
personal income over the 1998-2010 period, the 1998 study predicts,
would increase by more than $61 billion if the credit were permanently
extended.

F. The R&D credit is a market driven incentive

The R&D credit is a meaningful, market-driven tool to encourage
private sector investment in research and development expenditures. Any
taxpayer that increases their R&D spending and meets the technical
requirements provided in the law can qualify for the credit. Instead of
relying on government-directed and controlled R&D spending, businesses
of all sizes, and in all industries, can determine what types of
products and technology to invest in so that they can ensure their
competitiveness in the world marketplace.

III. THE R&D CREDIT SHOULD BE MADE PERMANENT TO HAVE MAXIMUM INCENTIVE
EFFECT

As the Joint Committee on Taxation points out in the
Description of Revenue Provisions in the President's Fiscal
Year 2000 Budget Proposal (JCS-1-99), ``If a taxpayer considers
an incremental research project, the lack of certainty
regarding the availability of future credits increases the
financial risk of the expenditure.'' Research projects cannot
be turned off and on like a light switch. If corporate managers
are going to take the benefits of the R&D credit into account
in planning future research projects, they need to know that
the credit will be available to their companies for the years
in which the research is to be performed. Research projects
have long horizons and extended gestation periods. Furthermore,
firms generally face longer lags in adjusting their R&D
investments compared, for example, to adjusting their
investments in physical capital.
In order to increase their R&D efforts, businesses must
search for, hire, and train scientists, engineers and support
staff. They must often invest in new physical plants and
equipment. There is little doubt that a portion of the
incentive effect of the credit has been lost over the past
seventeen years as a result of the constant uncertainty over
the continued availability of the credit.
If the credit is to provide its maximum potential for
increased R&D activity, the practice of periodically extending
the credit for short periods and then allowing it to lapse,
must be eliminated, and the credit must be made permanent. Only
then will the full potential of its incentive effect be felt
across all the sectors of our economy. No one has said this
more forcefully than Federal Reserve Chairman Alan Greenspan
who testified at last week's high technology summit. Chairman
Greenspan was emphatic in his conclusion that, if there is a
credit, it should be permanent.

IV. CONCLUSION

Making the R&D credit permanent promotes the long-term
economic interests of the United States. It will eliminate the
uncertainty over the credit's future and enable businesses to
make better long-term decisions regarding investments in
research. Private sector R&D leads to innovative products and
processes that contribute to economic growth, increased
productivity, new and better U.S. jobs, and higher standards of
living for all Americans. By creating an environment favorable
to private sector R&D investment, a permanent credit will make
it easier for U.S. companies to compete effectively in the
global economy and help to ensure the growth of high-skill jobs
in the United States.
EDS strongly supports the permanent extension of the R&D
credit and increasing the AIRC rates by 1 percentage point. The
credit expires on June 30, 1999. I urge you to provide a
seamless and permanent extension as soon as possible.

Chairman Archer. Thank you.
Mr. Bloomfield.

STATEMENT OF MARK BLOOMFIELD, PRESIDENT, AMERICAN COUNCIL FOR
CAPITAL FORMATION

Mr. Bloomfield. Mr. Chairman, thank you for the opportunity
to be here today. For the record, I am Mark Bloomfield,
president of the American Council for Capital Formation, and I
am accompanied by Dr. Margo Thorning, our senior vice president
and chief economist.
Mr. Chairman, the subject of today's hearing is tax relief
to strengthen the family and sustain a strong economy. A strong
economy is necessary to strengthen the family and I will
therefore focus my remarks on tax policy to promote
competitiveness, growth, and retirement security.
The American Council proposes that if Congress decides to
enact a multi-year tax cut, a substantial portion should be
dedicated to savings and investment initiatives. We offer as a
model two well thought out initiatives enacted since World War
II that moved this country toward a tax system suitable for the
first post-war period. One was proposed by a Democratic
president, the other by a Republican. In our view, the striking
characteristic of the Kennedy-Johnson tax cuts of the sixties
and the Reagan tax cuts of the eighties is that they were not
confined to tax cuts and taxes on consumption, but provided
liberal reductions in tax rates on growth-producing savings and
investment. Both plans fueled economic growth in succeeding
years.
As with the past generations, a major responsibility of
today's generation is to lay a strong economic basis for the
future.
The question then before all of us is which tax cuts are
most effective in enhancing competitiveness, increasing
economic growth, and promoting retirement savings? To try to
answer that question in anticipation of today's hearing on a
1999 tax bill, the American Council for Capital Formation
commissioned five new studies:
One, an analysis of the macroeconomic impact of the 1997
capital tax cuts;
Two, an international survey of death taxes in 24
countries;
Three, an analysis of the impact of the death tax on
investment, entrepreneurship, and employment;
Four, an international comparison of the taxation of
savings in 24 countries; and
Five, an analysis of pension reform.
We summarized the results of these studies in our written
testimony, but would be pleased to discuss them with you in the
question period which will follow. Our new studies confirm and
our recommended tax cuts address the deleterious impact of the
current U.S. Tax Code on savings and investment. Economists
agree that the U.S. tax system is strongly biased in favor of
consumption and against savings and investment, thus raising
capital costs. Indeed, the United States taxes both savings and
investment, including U.S. corporate investment and foreign
source income, as well as capital gains, dividends, and
interest much more harshly than do most of our competitors.
This impairs U.S. competitiveness in the world markets.
Also, take note that experts predict that today's Federal
budget surpluses may be relatively short-lived. The long-term
prosperity of the United States remains threatened by the
prospect of looming budget deficits arising from the need to
fund the retirement of the baby boom generation in the next
century.
Remember, the U.S. savings rate continues to compare
unfavorably with those of other countries, as well as with our
own past experience. Thus, the American Council for Capital
Formation recommends a menu of tax options for you to consider
that taken either together or singularly could enhance
competitiveness, increase economic growth, and promote
retirement security. We have organized this menu into tax cuts
for individuals and tax cuts for business. Economically sound
tax cuts for individuals include increasing the deductible IRA
contribution limit or raising the income level; repealing the
death tax; providing a tax-free rollover for reinvested
savings; reducing the capital gains tax and providing an annual
exclusion for capital gains; increasing pension affordability;
establishing personal retirement accounts; providing a
deduction for dividends and interest.
Sound tax cuts for business include phasing in expensing
for plant and equipment outlays, providing more favorable tax
treatment for investment to promote environmental goals,
providing relief from the corporate AMT, reforming the foreign
tax provisions of the U.S. Tax Code, reducing the corporate
capital gains tax, and liberalizing employer-sponsored pension
plans.
In conclusion, persistently low U.S. savings rates and
investment that in recent decades has lagged behind our
industrial competitors, despite continued economic growth and
low unemployment, provide real challenges to our country. It is
in that context that we strongly urge this Committee to
dedicate a significant amount of any multiyear tax cut for
competitiveness, growth, and retirement security.
Thank you.
[The prepared statement follows:]

Statement of Mark Bloomfield, President, American Council for Capital
Formation

Introduction

My name is Mark Bloomfield. I am president of the American
Council for Capital Formation and I am accompanied by Dr. Margo
Thorning, the ACCF's senior vice president and chief economist.
The ACCF represents a broad cross-section of the American
business community, including the manufacturing and financial
sectors, Fortune 500 companies and smaller firms, investors,
and associations from all sectors of the economy. Our
distinguished board of directors includes cabinet members of
prior Republican and Democratic administrations, former members
of Congress, and well-known business leaders. Our affiliated
public policy think tank, the ACCF Center for Policy Research,
includes on its board leading mainstream scholars from
America's most prestigious universities, as well as prominent
public finance experts from the private sector.
Mr. Chairman, we commend you for this timely hearing on tax
relief to strengthen families and sustain a strong economy as
we prepare to enter the next millennium. The question then
becomes which taxes should be cut. For example, some experts
are calling for using the surplus to promote social goals such
as relief of the ``marriage penalty'' that often results in
married couples paying more federal tax than two single people
with the same income levels. Other experts support using the
budget surplus to reduce death taxes, capital gains, or
marginal income tax rates.
The central theme of the ACCF's testimony is that if the
Congress does indeed approve a tax cut, any such cut should
enhance competitiveness, increase economic growth, and promote
retirement saving.
We would also like to use the opportunity of this hearing
to showcase several new research projects that our Center for
Policy Research commissioned especially in anticipation of the
Ways and Means Committee hearings on this year's tax bill.
Specifically, our Center's new research focuses on:
An analysis by David Wyss, chief economist, DRI,
on the macroeconomic impact of the 1997 capital gains tax cuts;
A new international survey by Arthur Andersen LLP
comparing ``death'' taxes in 24 major industrial and developing
countries, including most of the United States' major trading
partners;
An analysis by Professor Douglas Holtz-Eakin,
chairman of the Department of Economics at Syracuse University,
which analyzes the impact of the current estate tax on capital
accumulation, saving, capital costs, investment, and
employment, especially employment in the small business sector;
A comparison by Arthur Andersen LLP of the tax
treatment of retirement savings, insurance products, social
security, and mutual funds in 24 major industrial and
developing countries.
An analysis of pension reform by Dr. Sylvester
Schieber, director of Watson Wyatt Worldwide Research and
Information Center and a member of the Social Security Advisory
Council.
For our part, if Congress decides to consider a major
multi-year tax cut, we offer as a model two well-thought-out
tax initiatives enacted since World War II that moved this
country toward a tax system suitable for the post-war period.
We have the opportunity today to emulate the Kennedy-Johnson
tax cuts of the 1960s and the Reagan tax cuts of the early
1980s and, in so doing, put in place a tax system appropriate
for the challenges of the new century.
In our view, the striking characteristic of the Kennedy-
Johnson and Reagan plans for tax cuts today is that they were
not confined to cuts in taxes on consumption but provided
liberal reductions in tax rates on growth-producing saving and
investment. To be sure, these earlier tax plans included badly
needed cuts in marginal income tax rates, but in addition both
included sharp reductions in capital gains tax rates. Moreover,
the first Kennedy tax cuts (1961-1962) liberalized some
business depreciation rates and, of primary importance, created
for the first time a tax credit for business investment in
equipment. The Reagan tax plan included similar components and
also liberalized Individual Retirement Accounts (IRAs).
Both plans fueled economic growth in succeeding years. The
Kennedy-Johnson initiative opened the way for the golden
economic era of the 1960s, with 4 percent productivity growth
until economic overheating set in as a result of sharp
increases in deficit spending. Similarly, the Reagan tax cut
set the stage for strong economic performance in succeeding
years and laid the base for growth in the U.S. economy in the
1990s. One may quarrel about the financing of the Reagan tax
cuts and whether there was sufficient balance in the form of
spending cuts. Our point is that the tax cuts recognized the
essentiality of stronger individual saving and lower business
capital costs for investment to foster economic growth.
As with past generations, a major responsibility of today's
generation is to lay a strong economic base for future
generations. To do so, we should follow the wisdom of these
earlier, brilliantly conceived tax plans and ensure that a
significant proportion of any tax cut is dedicated to saving
and investment initiatives. If we are genuinely concerned about
our children, grandchildren, and generations beyond, we should
have the discipline to deny a reasonable amount of consumption
to ourselves today in order to enhance prospects for growth in
the future and to provide retirement security for all. It is in
that context that we strongly urge the Congress to dedicate a
significant amount of any multi-year tax cut for
competitiveness, growth, and retirement security.
In advocating this position we do not at all deny the
merits of other tax proposals currently advanced. The marriage
tax penalty should be corrected over time, and marginal tax
rates are far too high and should be reduced. Indeed, lower
marginal tax rates will foster economic growth but with less
leverage than more direct tax cuts on individual saving and
productive business investment. To this end, our testimony
suggests a menu of a dozen direct tax cuts to promote pro-
growth saving and investment (including investments to reduce
pollution and increase energy efficiency in order to address
the potential threat of global warming and other environmental
concerns).
In essence, the U.S. tax code treats saving (including
retirement saving) and investment very harshly. Since saving is
essential to investment and growth, this harsh taxation of
saving in the United States works against higher living
standards for coming generations and may also impair the
economic strength that underlies our world leadership position.
In addition, our tax code hits saving and investment harder
than those of many of our international competitors. The
foreign-source income of U.S. multinationals is also subject to
higher taxes than that of many of our competitors. All of these
facts are of increasing concern as globalization continues.
Tax reform can be carried out through a broad-based
restructuring in which consumption, rather than income, becomes
the tax base, or it can be accomplished through incremental
changes to the current income tax base which reduce the tax
burden on various types of saving and on investment. Either
type of tax restructuring would enhance U.S. productivity and
economic growth and could promote the achievement of
environmental goals. Tax reductions, we want to stress, should
not come at the expense of fiscal responsibility or reforming
social security.
As a predicate to our tax cut proposal to promote
competitiveness, economic growth, and retirement security, we
would like to set out the intellectual framework for such a
plan by first discussing the impact of the current U.S. tax
code on saving and investment.

IMPACT OF THE U.S. TAX CODE ON SAVING AND INVESTMENT

Taxation of U.S. Business Investment

Economists are in broad agreement that the cost of capital
for investment is significantly affected by tax policy. The
``user cost of capital'' is the pretax rate of return on a new
investment that is required to cover the purchase price of the
asset, the market rate of interest, inflation, risk, economic
depreciation, and taxes. This capital cost concept is often
called the ``hurdle rate'' because it measures the return an
investment must yield before a firm would be willing to start a
new capital project. Stanford University Professor John Shoven,
an internationally renowned public finance scholar, estimates
that in the United States about one-third of the cost of
capital is due to taxes. In other words, hurdle rates are 50
percent higher than they otherwise would be due to the tax
liability on the income produced by the investment. Quite
clearly, therefore, the higher the tax on new investment, the
less investment that will take place.
Several measures show that the United States taxes new
investment more heavily than most of our international
competitors. For example, according to a study by the centrist
Progressive Policy Institute (the research arm of the
Democratic Leadership Council), the marginal tax rate on
domestic U.S. corporate investment is 37.5 percent, exceeding
that of every country in the survey except Canada (see Figure
1). The tax rate calculations include the major features of
each country's tax code, including individual and corporate
income tax rates, depreciation allowances, and whether the
corporate and individual tax systems are integrated.
Tax rates on foreign-source investment, which are
indicators of how much encouragement domestic firms are given
to enhance their economic viability by expanding operations
abroad, again show the United States falling behind. The U.S.
tax rate is 43.4 percent versus an average of 36.7 percent in
the other G-7 countries (see Figure 2).
Prior to the 1986 Tax Reform Act (TRA), the United States
had one of the best capital cost recovery systems in the world.
For example, the present value of the deductions for investing
in machinery to produce computer chips and in modern and
competitive continuous casting equipment for steel production
were close to 100 percent under the strongly pro-investment tax
regime in effect from 1981 to 1985, according to a study by
Arthur Andersen LLP (see Table 1). In contrast, under current
law the present value of the capital cost recovery allowance
for that same investment today for computer chips is only 85
percent and for continuous casting equipment is only 81
percent.
The Arthur Andersen study also shows that the United States
lags behind many of our major competitors in capital cost
recovery for equipment that is technologically innovative, is
crucial to U.S. economic strength, or helps prevent pollution.
Capital cost recovery provisions for pollution-control
equipment are much less favorable now than prior to TRA's
passage. For example, the present value of cost recovery
allowances for wastewater treatment facilities used in pulp and
paper production was approximately 100 percent prior to TRA
'86. Under TRA '86, the present value for wastewater treatment
facilities dropped to 81 percent. Allowances for scrubbers used
in the production of electricity were 90 percent prior to TRA
'86; the present value fell to 55 percent after TRA '86. As is
true in the case of productive equipment, both the loss of the
investment tax credit and lengthening of depreciable lives in
TRA raised effective tax rates.
While the Taxpayer Relief Act of 1997 substantially
improved cost recovery allowances for corporate alternative
minimum taxpayers (AMT), those firms are still disadvantaged
relative to firms paying the regular corporate income tax (see
Table 1). The AMT limits or delays the benefit of tax code
provisions that are based on investment in plant, equipment,
research and development, mining, energy exploration and
production, pollution abatement, and many others. Companies
that have been subject to the AMT since its enactment have
accumulated numerous AMT credits. These credits reflect cash
that is not available for new productivity-improving
investment.

Taxation of U.S. Multinational Firms

A tax reduction plan should also focus on the need of U.S.
multinational companies (especially in the industrial and
financial sectors) to be competitive and gain market share,
both at home and abroad. Such a tax cut could enhance the
ability of U.S. firms to compete in global markets by reducing
the competitive disadvantages that they face. For example, as a
1997 study sponsored by the ACCF Center for Policy Research
showed, U.S. financial service firms face much higher tax rates
on foreign-source income than do their international
competitors when operating in a third country such as Taiwan
(see Figure 3). A 12-country analysis shows that U.S. insurance
firms are taxed at a rate of 35 percent on income earned abroad
compared to 14.3 percent for French-, Swiss-, or Belgian-owned
firms. As a consequence of their more favorable tax codes,
foreign financial service firms can offer products at lower
prices than can U.S. firms, thereby giving them a competitive
advantage in world markets.

Capital Gains Taxation

The ACCF's first new 1999 study, which is on capital gains
taxation, was prepared by Dr. David Wyss, chief economist of
Standard & Poor's DRI and a top public finance expert, finds
that the Taxpayer Relief Act of 1997, which reduced the long-
term individual capital gains tax rate from a top rate of 28.0
percent to 20.0 percent has had several favorable impacts on
the U.S. economy in the intervening two years. First, the net
cost of capital for new investment fell by about 3 percent;
other things being equal, this will raise business investment
by 1.5 percent per year. Over a 10-year period, the capital
stock will rise by 1.2 percent and productivity will increase
by 0.4 percent relative to the baseline forecast. Second, a
significant share of the increase in stock prices since 1997
(about 25 percent) is due to lower taxes on individual capital
gains realizations. Third, Dr. Wyss's analysis shows that when
a dynamic rather than a static analysis is used, the stronger
growth of the economy adds to total federal tax revenues in the
long run. Finally, Dr. Wyss rebuts several new studies which
attempt to debunk the importance of lower capital gains tax
rates in encouraging start-ups and venture capital.
In spite of the 1997 tax reductions whose favorable
economic impacts are documented by Dr. Wyss's new analysis,
U.S. capital gains tax rates, which affect the cost of capital
and therefore investment and economic growth, are still high
compared to those of other countries. In fact, most industrial
and developing countries tax individual and corporate capital
gains more lightly than does the United States, according to a
1998 survey of 24 industrialized and developing countries that
the ACCF commissioned from Arthur Andersen LLP.
Both short- and long-term capital gains on equities are
taxed at higher rates in the United States than in most of the
other 23 countries surveyed. Short-term gains are taxed at 39.6
percent in the United States compared to an average of 19.4
percent for the sample as a whole. Long-term gains face a tax
rate of 20 percent in the United States versus an average of
15.9 percent for all the countries in the survey. Thus, U.S.
individual taxpayers face tax rates on long-term gains that are
26 percent higher than those paid by the average investor in
other countries. In addition, the United States is one of only
five countries surveyed with a holding period requirement in
order for the investment to qualify as a capital asset.
Similarly, short- and long-term corporate capital gains tax
rates are higher in the United States than in most other
industrial and developing countries surveyed. Both short- and
long-term gains are taxed at a maximum rate of 35 percent in
the United States, compared to an average of 22.8 percent for
short-term gains and 19.6 percent for long-term gains in the
sample as a whole. In other words, U.S. corporations face long-
term capital gains tax rates almost 80 percent higher than
those of all but two of the other countries surveyed (Germany
[45 percent] and Australia [36 percent], and only four of the
24 countries surveyed impose a holding period in order to be
eligible for preferential corporate capital gains tax rates.

Taxation of Interest and Dividends

Interest and dividends received by individuals also are
taxed more heavily in the United States than in many other
countries, according to the 1998 Arthur Andersen survey of 24
countries. High tax rates on dividends and interest received
raise the cost of capital for new investment and slow U.S.
economic growth. The top marginal income tax rate is 39.6
percent in the United States compared to an average of 32.4
percent in the countries surveyed as a whole. Nearly 40 percent
of the countries surveyed tax interest income at a lower rate
than ordinary income; for example, Italy taxes ordinary income
at a top rate of 46 percent while its top tax rate on interest
income is only 27 percent.
In several countries surveyed, small savers receive special
encouragement in the form of lower taxes or exemptions on a
portion of the interest they receive. For example, in Germany,
the first $6,786 of interest income for married couples filing
a joint return ($3,393 for singles) is exempt from tax; in
Japan, interest on saving up to $26,805 is exempt from tax for
individuals older than 65; in the Netherlands, the first $987
of interest income for married couples ($494 for singles) is
exempt from tax; and in Taiwan, the first $8,273 of interest
received from local financial institutions is exempt from tax.
Similarly, dividend income is also taxed more heavily in
the United States than in the other countries surveyed; the
U.S. tax rate is 60.4 percent (combined corporate and
individual tax on dividend income) compared to an average of
51.1 percent in the surveyed countries as a whole. Of the
countries surveyed, 62.5 percent offset the double taxation of
corporate income (the income is taxed at the corporate level
and again when distributed in the form of dividends) by
providing either a lower tax rate on dividend income received
by a shareholder or by providing a corporation with a credit
for taxes paid on dividends distributed to their shareholders.
In the case of dividends received, small savers receive
preferential treatment in about one-fourth of the countries
surveyed. In France, for example, the first $2,661 of dividends
on French shares received by a married couple is exempt from
tax ($1,330 for singles); in the Netherlands, the first $987 of
dividend income for married couples ($494 for singles) is
exempt from tax; and in Taiwan, the first $8,273 of dividends
from local companies is exempt from tax.

Death and the U.S. Tax Code

Many top academic scholars and policy experts conclude that
the estate tax should be repealed or reduced because it adds to
the already heavy U.S. tax burden on saving and investment. For
example, analysis by MIT's Professor James Poterba shows that
the U.S. estate tax can raise the cost of capital by as much as
3 percent. The estate tax also makes it harder for family
businesses, including farms, to survive the deaths of their
founders. The ACCF's second new study, which was compiled by
Arthur Andersen LLP, surveys 24 industrialized and developing
countries and shows that the top U.S. federal marginal death
tax rate is higher than that of all other countries surveyed
except for Japan (see Figure 4). Death tax rates imposed on
estates inherited by spouses and children average only 21.6
percent for the 24 countries in the study, compared to 55
percent in the United States. (Tax rates are often higher on
assets inherited by more distant relatives or by non-
relatives). Seven countries Argentina, Australia, Canada,
China, India, Indonesia, and Mexico have no death or
inheritance taxes. The average marginal top tax rate in the 17
countries with a death tax is only 30.5 percent, which is
slightly more than one-half of the U.S. top federal estate tax
rate. Not only are U.S. death tax rates higher than those in
most of the industrialized and developing world, but the value
of the estate where the top tax rate applies is lower. The
average value of the estate where the top tax rate applies is
over $4 million compared to only $3 million in the United
States.
The third new ACCF-sponsored study, prepared by Professor
Douglas Holtz-Eakin, chairman of the Department of Economics at
Syracuse University, analyzes the impact of the current death
tax on capital accumulation, saving, capital costs, investment,
and employment.
First, using a sample of data collected by the Public
Policy Institute of New York State in May, 1999, Professor
Holtz-Eakin notes that there is a negative relationship between
anticipated death tax liability and growth in employment,
particularly for growing firms. His analysis suggests that at
least 15,000 jobs will be lost in New York State over the next
five years due to the effect of the estate tax on small firms.
Second, the death tax reduces U.S. annual investment by sole
proprietors in the range of 2 to 10 percent or almost $45
billion in 1996. Third, the death tax hits hard at
entrepreneurs; of the total number of people liable for the
estate tax, 48 percent are entrepreneurs. Professor Holtz-Eakin
states that the death tax should not be viewed as hitting all
savers equally. Instead, the tax hits especially hard at
entrepreneurs who are trying to put money into their business.
For these individuals, their saving is their investment.
Professor Holtz-Eakin concludes that his study suggests
that the estate tax is shifted--forward in time to the business
operation and onto factors of production (capital and labor).
Since most incidence studies suggest that labor supply bears
the incidence of labor taxes and that slower capital
accumulation hurts productivity and real wages, this suggests
that the estate tax on the ``rich and dead'' small business
owners and entrepreneurs may be in part paid by their far-from-
rich and very alive employees.

The U.S. Tax Code and Retirement Security

Experts predict that today's federal budget surpluses may
be relatively short-lived phenomena. The long-term prosperity
of the United States remains threatened by the prospect of
looming budget deficits arising from the need to fund the
retirement of the baby boom generation in the next century. In
addition, the U.S. saving rate continues to compare unfavorably
with that of other nations, as well as with our own past
experience; U.S. net domestic saving has averaged only 4.8
percent of GDP since 1991 compared to 9.3 percent over the
1960-1980 period (see Table 2). Though the U.S. economy is
currently performing better than the economies of most other
developed nations, in the long run low U.S. saving and
investment rates will inevitably result in a growth rate short
of this country's true potential.
The ACCF's fourth new study is a survey of the tax
treatment of retirement savings, insurance products, social
security, and mutual funds in 24 major industrial and
developing countries, including most of the United States'
major trading partners. The survey (also compiled for the ACCF
by Arthur Andersen LLP) shows that the United States lags
behind its competitors in that it offers fewer and less
generous tax-favored saving and insurance products than many
other countries. For example:
Life insurance premiums are deductible in 42
percent of the surveyed countries but not for U.S. taxpayers;
for many individuals life insurance is a form of saving;
Thirty-three percent of the sampled countries
allow deductions for contributions to mutual funds for
retirement purposes while the United States does not;
More than half of the countries surveyed allow a
mutual fund investment pool to retain earnings without current
tax, a provision which increases the fund's assets; the United
States does not;
Thirty percent of the countries with social
security systems allow individuals to choose increased benefits
by increasing their contributions during their working years;
and
Canada, for example, provides a generally
available deduction of up to $9,500 (indexed) yearly for
contributions to a private retirement account, compared to a
maximum deductible IRA contribution of $2,000 for qualified
taxpayers in the United States.
The ACCF's study demonstrates that many countries have gone
further than the United States to encourage their citizens to
save and provide for their own retirement and insurance needs.

Reform of the Private Pension System

The ACCF's fifth new study, ``Improving the Retirement
Security System in the United States Through Mechanisms for
Added Savings,'' by Dr. Sylvester Schieber and his colleagues,
Richard Joss and Marjorie M. Kulah of Watson Wyatt Worldwide, a
prominent pension consulting firm, contends that the U.S.
private pension system should be expanded and reformed,
particularly for small employers who are responsible for much
of the growth in employment in recent years. Pension policy
experts contend that long-service, high-income employees of
large firms benefit most from the current system. The public
interest would be better served, they argue, if pension rules
were simpler and easier to administer. For example, complicated
and costly rules to prevent ``discrimination'' discourage
employers, especially small ones, from offering pension plans.
Dr. Schieber concludes that all of the elements of the
retirement system need to be shored up in order to anticipate
the claims the baby boomers will make beginning next decade. In
the case of employer sponsored pension plans, most of the
policy initiatives undertaken during the last two decades have
led to restricted saving through these plans. The long-term
implication of this result is that plan sponsors are either
going to face higher contribution costs in the future than if
they had been allowed to contribute to their plans at
historical rates, or they will curtail benefits.
The potential curtailing of benefits from employer-
sponsored plans is a direct threat to the retirement security
of today's workers. First, Dr. Schieber states it is imperative
that employers begin to more effectively communicate to workers
the importance and necessity of saving for retirement.
Employers should be encouraged to expand existing
communications efforts. Second, in the case of employer-
sponsored plans, Dr. Schieber advocates further simplification
of the multiple funding and contribution limits to which these
plans are subject. The funding biases that have skewed plan
sponsors toward defined contribution plans should be
eliminated. The inconsistencies in public policy that result
from a given level of funding resulting in tax penalties for
overfunding, on the one hand, and government penalties for
underfunding, on the other, should be resolved. Although Dr.
Schieber is a strong advocate of employer-sponsored plans and
their expanded availability, he recognizes that not everyone
has an opportunity to participate in such a plan. For such
workers, the playing field should be leveled so they can
effectively save on their own through tax-preferred retirement
plans.

A TAX MENU FOR COMPETITIVENESS, GROWTH, AND RETIREMENT SECURITY

Those who favor a truly level playing field to encourage
saving and investment by individuals and businesses, stimulate
economic growth, and create new and better jobs, believe
savings (including capital gains) should not be taxed at all.
This view was held by top economists in the past and is held by
many mainstream economists today. The fact is however that an
income tax hits saving more than once--first when income is
earned, and again when interest and dividends on the investment
financed by saving are received, or when capital gains from the
investment are realized. The playing field is tilted away from
saving and investment because the individual or company that
saves and invests pays more taxes over time than if all income
were consumed and no saving took place. Taxes on income that is
saved raise the capital cost of new productive investment for
both individuals and corporations, thus dampening such
investment. As a result, future growth in output and living
standards is impaired.
While fundamental reform of the U.S. federal tax code
continues to interest policymakers, the public, and the
business community, the key question is whether a totally new
system would be worth the inevitable disruption, cost, and
confusion the switch would create. Several recent analyses by
academic scholars and government policy experts including
University of California Professor Alan Auerbach, Boston
University Professor Laurence Kotlikoff, the Joint Committee on
Taxation, and the Congressional Budget Office conclude that
substituting a broad-based consumption tax for the current
federal income tax would have a positive impact on economic
growth and living standards. A consumption tax exempts all
saving and investment from tax; all income saved is tax-free
and all investment is written off, or ``expensed,'' in the
first year. As a result, the cost of capital for new investment
would fall by about 30 percent.
If, instead of fundamental tax reform, political reality
requires an incremental approach to tax reform, the ACCF
recommends a menu cut of tax options that, taken either
together or singly, could enhance competitiveness, increase
economic growth, and promote retirement security. We have
organized the menu into tax cuts for individuals and tax cuts
for business.

Tax Cuts for Individuals

Increase the deductible IRA contribution and/or raise the
income limit. This step would make IRAs more accessible to middle and
upper-middle income individuals and families. Many academic analyses by
top public finance scholars indicate that IRAs do produce new saving
that would not otherwise take place. An increase in the $2,000
deductible contribution for each employed person to $4,000 and/or
raising the income ceiling for deductible contributions to $120,000 for
married couples, for example, would tend to raise the personal saving
rate.
Repeal the federal estate (death) tax. Many public finance
scholars support its elimination because it is a tax on capital and
thus reduces the funds available for productive private investment,
especially in family-run businesses. The ACCF's two new analyses on the
death tax indicate that the death tax is higher in the United States
than elsewhere and that the entrepreneurial sector and small businesses
are particularly hard hit by the tax.
Provide a tax-free ``rollover'' for reinvested mutual
funds, interest, dividends, and capital gains. Allowing individual
savers to make tax-free investments from the proceeds from transactions
of this type would significantly increase the mobility of capital and
would be a powerful incentive to save.
Reduce the individual capital gains tax rate and provide
an exclusion. A significant reduction from the current maximum tax rate
of 20 percent would reduce the cost of capital, stimulate investment,
and encourage the entrepreneurial activity that is a major source of
U.S. economic growth. In addition, an annual exclusion of $5,000, for
example, would help encourage saving and reduce the complexity of the
tax code by allowing middle income investors to realize a relatively
modest amount of capital gains without paying tax.
Increase pension portability and access to tax-preferred
saving plans. These reforms would make it more attractive for workers
to take part of their compensation in the form of a ``nest egg'' for
retirement than under current law. For example, easing rollover rules
to allow employees to transfer between different types of plans and
easing benefit transfer rules between qualified plans so employees can
move benefits to their new employers' plans would not only increase
retirement security but also help productivity growth through not
hindering workers from changing jobs among firms and industries.
Greater access to and higher ceiling on tax preferred saving accounts
such as IRAs would also increase retirement security.
Establish personal retirement accounts. Both the Clinton
Administration and members of Congress have proposed using part of the
budget surplus to fund personal retirement accounts. Chairman Bill
Archer (R-TX) and Rep. Clay Shaw (R-FL) have introduced a proposal that
both reforms social security and allows for the creation of individual
accounts and the purchase of individual annuities for workers.
Provide a deduction for dividends and interest received by
individuals. Exempting, for example, the first $2,000 of dividends and
interest received by married taxpayers ($1,000 for singles) is an
approach used in many other countries.

Tax Cuts for Business

Comprehensive tax reform, to shift the federal tax base
from income to consumption and thus permit the expensing of all
investment, would have the strongest impact on capital costs
and economic growth. However, more modest tax cuts on
investment would also stimulate capital formation and growth.
Phase in expensing for plant and equipment
outlays. Scholars agree that expensing is the most efficient
way of reducing the cost of capital for new investment. In the
period 1981-1985, the United States had one of the best tax
treatments for new investment in the world. In today's global
economy, U.S. firms need tax parity with foreign firms in order
to compete effectively.
Provide more favorable tax treatment for
investment to promote environmental goals. Tax credits or other
provisions for environmental expenditures required to meet
federal, state, and local standards or to enhance energy
efficiency would ease the compliance costs facing U.S.
industry. In addition, such tax measures would make it easier
for capital-intensive manufacturing firms to continue operating
their U.S. facilities.
Provide relief from the corporate AMT. Eliminating
the myriad of investment-based AMT preference items is
essential. Additionally, providing for accelerated use of AMT
credits will help alleviate the competitive disadvantage faced
by commodity-based industries that are suffering low world
prices. It will allow and ensure the long-term growth and
competitiveness of basic U.S. industry. Relief efforts must
take care not to diminish the value of the credits that have
accrued in the past.
Reform the foreign tax provisions of the U.S. tax
code. Moving to a consumption tax in which all foreign-source
income is exempt from tax (a ``territorial'' tax) would have a
strong positive impact on the international competitiveness of
U.S. firms. However, such a fundamental shift in tax policy is
not now ``on the table.'' Still, firms' ability to compete
abroad could be enhanced through a variety of reforms to U.S.
foreign tax provisions. U.S. industrial and financial service
firms face higher taxes on their foreign-source income than do
their international competitors (see Figures 2 and 3). Reducing
the tax burden on the foreign-source income of U.S. firms would
be beneficial by allowing them to be more competitive in
foreign markets. For example, making permanent the one-year
provision that reforms Subpart F of the Internal Revenue Code
for financial service firms such as securities firms, insurance
companies, banks, and finance companies would be an important
step. As a matter of sound tax policy, U.S.-based financial
service firms should be able to defer U.S. tax on the active
income of their foreign subsidiaries until those earnings are
returned to the U.S. parent company.
It is equally important not to impose stringent new tax
policies that make U.S. industrial and financial firms less
competitive. For example, proposed changes that tighten the
foreign tax credit and deferral would put U.S. firms at a
further disadvantage.
Reduce the corporate capital gains tax rate. A
corporate capital gains tax cut would reduce capital costs and
increase investment. Sound tax policy as well as economic
considerations argue for a reduction in the U.S. maximum
corporate capital gains rate of 35 percent, which is now the
same as the top regular corporate tax rate. This would
reinstate the historical U.S. treatment of corporate capital
gains; an alternative corporate capital gains tax was part of
the Internal Revenue Code from 1942 until its repeal by the Tax
Reform Act of 1986. Reducing corporate capital gains tax rates
would also help move the U.S. tax code toward a consumption tax
base by lightening the burden on income from investment.
Liberalize employer-sponsored pension plans.
Improvements to employer-sponsored pension plans would increase
saving and enhance retirement security. Small employers are
often unable to provide pensions for their employees because of
the cost and complexity of the system. A tax credit for
businesses establishing new plans would be especially helpful
to small employers. Creating a simplified defined benefit plan
for small employers would promote the retirement security of
small-firm employees.

CONCLUSION

Persistently low U.S. saving rates, and investment that in
recent decades has lagged behind our industrial competitors
despite continued economic growth and low unemployment,
underline the need for pro-growth tax policies as a substantial
part of any tax bill approved by this Committee. Given the
projected budget surplus and the desire of many in Congress to
enact a major tax cut for Americans, there is clearly an
opportunity to move the U.S. tax system in a pro-growth
direction.
We therefore urge Congress to give the most careful
consideration to the pro-growth tax provisions discussed here.

Table 1.--International Comparison of the Present Value of Equipment Used to Make Selected Manufacturing Products and Pollution Control Equipment
[As a percent of cost]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Telephone Wastewater Wastewater
Continuous Engine Treatment Treatment Scrubbers
Computer Switching Factory Crank- Casting for for Pulp Used in
Chips Robots shafts for Steel Blocks Chemical and Paper Electricity
Equipment Production Production Equipment Plants
--------------------------------------------------------------------------------------------------------------------------------------------------------
United States:
1985 Law............................................... 100.1 100.1 100.1 100.1 100.1 100.1 100.1 100.1 89.7
MACRS \1\.............................................. 85.2 85.2 80.8 80.8 80.8 80.8 85.2 80.8 54.5
DAMT \2\............................................... 83.0 83.0 77.9 77.9 77.9 77.9 83.0 78.0 54.5
Brazil................................................... 75.7 74.8 74.7 74.7 88.3 74.7 74.7 74.7 79.4
Canada................................................... 76.9 75.9 74.0 73.8 74.2 73.6 85.3 85.3 85.3
Germany.................................................. 83.6 83.0 82.7 83.9 82.2 83.9 71.8 69.7 68.9
Japan.................................................... 87.1 86.2 83.4 83.9 81.4 83.7 84.6 83.7 82.4
Korea.................................................... 88.7 84.3 82.6 80.1 77.7 79.6 95.2 93.9 92.2
Singapore................................................ 91.7 91.7 91.7 91.7 91.7 91.7 91.7 91.7 91.7
Taiwan................................................... 83.9 78.0 79.0 64.3 63.5 63.7 147.0 147.0 147.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Notes: 1. MACRS = Modified Accelerated Cost Recovery System (current law) for regular taxpayers.
2. AMT = Alternative minimum tax (current law, Taxpayer Relief Act of 1997).

Source: Stephen R. Corrick and Gerald M. Godshaw, ``AMT Depreciation: How Bad is Bad?'' in Economic Effects of the Corporate Alternative Minimum Tax
(Washington, D.C.: American Council for Capital Formation Center for Policy Research, September 1991). Updated by Arthur Andersen LLP, Office of
Federal Tax Services, Washington, D.C., January 1998.

Table 2. Flow of U.S. Net Saving and Investment
Percent of GDP in current dollars; national income accounts basis
------------------------------------------------------------------------
Average Average Average 1991-
1960-1980 1981-1985 1999***
------------------------------------------------------------------------
Net private domestic saving......... 8.1% 8.0% 5.4%
State and local government surpluses 2.1% 1.9% 1.5%
Subtotal of private and state saving 10.2% 9.9% 6.9%
Less: Federal budget deficit.... -0.8% -3.8% -2.1%
Net domestic saving available for 9.3% 6.1% 4.8%
private investment.................
Net inflow of foreign saving*....... -0.4% 1.2% 1.4%
Net private domestic investment..... 8.9% 7.4% 6.2%
Gross private domestic investment... 16.0% 16.9% 14.3%
Nonresidential fixed investment..... 10.4% 12.2% 9.9%
Producers' durable equipment........ 6.6% 7.4% 7.1%
Information processing, related 1.6% 3.1% 3.2%
equipment, computers, and
peripheral equipment...............
Industrial equipment................ 1.9% 1.8% 1.6%
Producers' durable equipment less 5.2% 5.0% 4.7%
info processing and related
equipment..........................
Personal saving..................... 5.4% 5.8% 2.5%
Net business saving**............... 2.7% 2.2% 2.9%
------------------------------------------------------------------------
*In the 1960-1980 period, the United States sent more capital abroad
than it received; thus net inflow was negative during this period.
**Net business saving = gross private saving - personal saving -
corporate and noncorporate capital consumption allowance.
***Preliminary estimates for first quarter of 1999.
Source: Department of Commerce Bureau of Economic Analysis, National
Income Accounts. Update prepared by American Council for Capital
Formation Center for Policy Research, June 1999.

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Chairman Archer. Thank you, Mr. Bloomfield.
Mr. McCants.

STATEMENT OF LARRY MCCANTS, PRESIDENT, CHAIRMAN AND CHIEF
EXECUTIVE OFFICER, FIRST NATIONAL BANK, GOODLAND, KANSAS; ON
BEHALF OF AMERICAN BANKERS ASSOCIATION

Mr. McCants. I would like to commend this Committee and the
Chairman for holding hearings to focus attention on domestic
tax incentives. As a community banker--first of all, my name is
Larry McCants. I am from the First National Bank in Goodland,
Kansas, and I am representing the American Bankers Association.
And as a community banker, I must point out many of the
proposals will help level the playingfield between small
taxpaying community banks and tax-exempt credit unions and the
farm credit system. I have submitted my full written statement
for inclusion in the record and will limit my comments today to
that portion pertaining to subchapter S banking.
In order to survive this intensely competitive financial
service market, community bankers, such as myself, continue to
look for ways to improve efficiencies. Nonbank competitors,
such as the farm credit system lenders and the credit unions,
enjoy significant tax advantages which make it even more
difficult for community banks to compete in their local
markets. Therefore, proposals such as improvement and expansion
of the subchapter S tax laws for banking institutions are of
particular interest to community banks.
The American Bankers Association would like to commend
Representatives Scott McInnis, Jim McCrery, and J.D. Hayworth
for introducing H.R. 1994, which would further remove
unreasonable burdens placed on S corporations.
Our bank, which is an employee-owned bank through our ESOP
elected subchapter S status in January 1998. Although over
1,200 FDIC-insured banking institutions and savings
institutions have elected subchapter S status. It is important
to note that potential tax burdens and strict eligibility
standards continue to exist. We strongly urge you to remove
many of the competitive barriers and unreasonable burdens
placed on S corporation banking institutions in the next tax
bill.
We consider the following legislative proposals most
significant to community banking:
Number one, tax relief for S corporation banking
institutions should include a provision to clarify that
interest in dividends on investments held by a bank should not
be considered passive investment income. An S election will
terminate if, for 3 consecutive years, 25 percent or more of
the gross receipts consist of passive investment income. For
bank regulatory purposes, a bank must maintain certain types of
investments for liquidity. Banks must pledge securities to
secure municipal deposits. At certain times of the year, banks
may be required to hold excess securities and double pledge for
the same deposits as deposits are transferring between
municipalities. Bonds issued under H.R. 1660 would be
considered passive investment.
The IRS requires an ambiguous and controversial reasonable
liquidity needs standard to be met. As a former bank examiner,
I can't define ``reasonable liquidity,'' and I can't imagine an
IRS agent attempting to make that determination because each
bank is different based on its own role in the community. It is
unnecessary and inappropriate to impose this limitation on
subchapter S banks.
National banking laws and several State statutes also
require directors of banks to own certain percentages of bank
stock. Legislation is needed to ensure that director qualifying
shares will not be considered a second class of stock.
Number three, the proposal to raise current shareholder
limit from 75 shareholders to 150 would significantly enhance
and promote a healthy small business and banking environment.
The current 75-shareholder limit restricts participation in S
corporations by local community investors and restricts the
ability to raise capital.
I personally had to ask several of my shareholders to sell
their shares back to the bank, to our bank holding company in
order to qualify for subchapter S treatment.
Number four, S corporation tax relief should expand the
category of permitted shareholders to include family limited
partnerships and IRAs to assist in retirement and estate tax
planning.
And, number five, finally, tax relief is sorely needed to
require the Treasury to modify existing regulations to allow
bad debt deductions to offset built-in gains income.
I appreciate this opportunity to present the ABA's views,
and I would be pleased to answer any questions that you may
have later.
And, Congresswoman Johnson, I would specifically like to
thank you for your assistance in trying to keep taxes imposed
ESOPs.
Thank you.
[The prepared statement follows:]

Statement of Larry McCants, President, Chairman and Chief Executive
Officer, First National Bank, Goodland, Kansas; on behalf of American
Bankers Association

Mr. Chairman and members of the Committee, I am Larry
McCants, Chairman, President and CEO of First National Bank,
Goodland, Kansas. I am pleased to appear before you today to
present the views of the American Bankers Association (ABA) on
providing tax relief to strengthen the family and sustain a
strong economy.
The ABA brings together all elements of the banking
community to best represent the interests of this rapidly
changing industry. Its membership--which includes community,
regional, and money center banks and holding companies, as well
as savings associations, trust companies, and savings banks--
makes ABA the largest banking trade association in the country.
At the outset, I would like to commend you for holding this
hearing to focus attention on domestic business tax incentives.
There are a number of proposals currently of interest to
banking institutions. As a community banker, I must point out
that any proposals that help to level the playing field between
small, tax paying community banks and ever expanding tax-exempt
credit unions are particularly attractive. Banking institutions
play a variety of important roles in many of the proposals
being discussed in this series of hearings.
My comments today will address a few of the more direct
domestic tax proposals with particular emphasis on Subchapter S
banking.

Subchapter S

In order to survive in this intensely competitive financial
services market, community bankers, such as myself, must
continually look for ways to improve efficiencies, operations
and tax savings. Non-bank competitors, such as farm credit
system lending institutions and credit unions, continue to
enjoy significant tax advantages, which makes it even more
difficult for banks to compete in their local communities.
Therefore, tax relief measures, such as the improvement and
expansion of the subchapter S tax laws for banking
institutions, is of particular interest to the community
banking industry.
The ABA would like to commend Representatives Scott McInnis
(R-CO), Jim McCrery (R-LA) and J.D. Hayworth (R-AZ) for
introducing legislation that would help subchapter S banking
institutions to compete with tax-exempt and ever expanding
credit unions. H.R. 1994, the Subchapter S Reform Act of 1999,
would further remove unreasonable burdens placed on S
corporations, consistent with congressional intent. We would
also like to commend Representative Marge Roukema (R-NJ) for
introducing legislation that would improve and expand the
subchapter S banking industry.
As you are aware, the Small Business Job Protection Act of
1996 permitted eligible banks, for the first time, to become S
corporations beginning in January 1997. My bank, First National
Bank of Goodland, Kansas, was one of the first banking
institutions to elect subchapter S status in 1997.
The subchapter S tax laws provide a method of taxation for
eligible corporations that reduces burdens associated with the
imposition of corporate-level taxes. Under the subchapter S
regime, shareholders are taxed in a manner that is similar to
the taxation of a partnership. Shareholders are taxed on the
earnings of the corporation, whether or not such earnings are
distributed. Data recently released by the FDIC shows that over
1,200 FDIC-insured banking and savings institutions have
elected subchapter S status. This number represents over 10% of
the banking industry--primarily community banks seeking to
survive in an extremely competitive financial services
environment. It is important to note that potential tax burdens
and strict eligibility standards continue to exist, thus
preventing many banking institutions from taking advantage of
this unique tax status. We strongly urge you to include
provisions to remove many of the competitive barriers and
unreasonable burdens placed on S Corporation banking
institutions in the next tax package you enact.

Increase Shareholder Limit From 75 To 150

The ABA supports raising the subchapter S shareholder limit
to 150. The Small Business Job Protection Act of 1996 increased
the number of eligible subchapter S shareholders from 35 to 75.
Many small businesses and banks with 75 or more shareholders
are unable to take advantage of subchapter S tax benefits.
Raising the shareholder limit to 150 would not only help expand
subchapter S to many otherwise eligible small businesses, but
would help community banks compete on a level playing field
with non-bank competitors. Such a change would significantly
enhance and promote a healthy and competitive small business
and banking environment.

Allow Individual Retirement Account Shareholders

The ABA supports the expansion of eligible subchapter S
shareholders to include individual retirement accounts (IRAs).
Under the current tax laws, IRAs are not permissible subchapter
S shareholders. The Small Business Job Protection Act of 1996
permitted qualified plans (including ESOPs) and certain tax-
exempt entities to become eligible S corporation shareholders.
Consistent with Congress' policy of expanding S Corporation
ownership to certain tax advantaged plans or entities, IRAs
(including Roth IRAs) should be eligible subchapter S
shareholders.

Allow Family Limited Partnership Shareholders

The ABA supports allowing limited family partnerships to
become eligible subchapter S shareholders. Family limited
partnerships are commonly utilized by community bank
shareholders. This arrangement is utilized primarily to
generate valuation discounts (for estate and gift tax purposes)
on the transfer of a limited interest in the partnership. Under
current law, partnerships, including limited partnerships, are
impermissible subchapter S shareholders. Allowing a specific
type of family limited partnership as an eligible subchapter S
shareholder would greatly benefit family-owned community banks
wishing to convert to subchapter S status.

Exclude Bank Investment Securities From The Passive Income Rules

The ABA supports the proposal to clarify that interest and
dividends on investments held by a bank shall not be considered
passive investment income. Under current law, an S election
will terminate if, for three consecutive years, 25% or more of
the gross receipts of an S corporation consists of passive
investment income. Further, a corporate-level tax (currently
35%) is imposed on an S corporation on any such excess passive
investment income. For bank regulatory purposes, a bank must
maintain certain types of investment assets for liquidity and
other purposes. Though the IRS addressed subchapter S bank
passive income issues in previous regulatory guidance (Notice
97-5) and excluded certain bank assets from the passive income
limitations, we believe that it did not go far enough. An
ambiguous and controversial ``reasonable liquidity needs''
standard will be applied by the IRS in determining whether
assets not specifically listed are exempt from the passive
income tax rules. Such a standard not only undermines a banking
regulator's authority to examine and enforce safety and
soundness laws, but is unnecessary given the limited amount of
investment assets banks are permitted to hold under existing
statutes. This provision would exclude bank investment
securities from the subchapter S passive income limitations.

Treatment Of Director Qualifying Stock

The ABA supports the proposal clarifying that qualifying
bank director stock shall not be treated as a second class of
stock. Under the national banking laws and several state
statutes, a director of a national bank is generally required
to own a certain percentage of stock in the bank. The OCC
allows such stock to be preferred and held through various
plans, such as IRAs. Under the subchapter S laws, any stock
that confers different economic rights than stock issued to
other shareholders is considered an impermissible second class
of stock. This provision would ensure that stock that is
required to be owned by bank directors will not be considered a
second class of stock for subchapter S eligibility purposes.

Bad Debt Chargeoffs To Offset Loan Loss Reserve Recapture

The ABA supports the proposal requiring Treasury to modify
existing regulations to allow bad debt deductions to offset
built-in gains income during the entire 4-year bad debt reserve
recapture period. Under a subchapter S regime, a bank must use
the specific chargeoff method of accounting for bad debts.
Banks that switch from the reserve method of accounting for bad
debts to the specific chargeoff method must take the reserve
into income over 4 years (section 481 adjustment). The amount
taken into income is treated as an item of built-in gain and
subject to a corporate-level built-in gain tax under section
1374 of the Code. A bank's bad debt reserve recapture built-in
gain can only be offset by built-in losses realized in the same
tax year. Treasury regulations currently only allow bad debt
chargeoff deductions to offset built-in gain income in the
first year of an S election.

Include Banks In Three-Year Rule Under Section 1363(b)(4)

The ABA supports the proposal to modify the applicability
of the 3-year rule under section 1363(b)(4). Under section
1363(b)(4), corporate preference items under section 291
(including special bank disallowance or cutback items) apply
only during the first three years of an S corporation that
converted from a C corporation. The tax laws do not specify
whether this three-year rule applies to banks that are treated
as QSubs. The Small Business Job Protection Act of 1996
permitted S Corporations to hold QSub subsidiaries. Under the
subchapter S tax laws, QSubs are disregarded for tax purposes
and treated as a division of the parent. Most subchapter S
banks operate in a holding company structure and elect QSub
status for their bank subsidiaries. A technical reading of the
statute excludes QSubs because it only refers to S corporations
(or any predecessor) that was a C corporation.

Capital Gains

The American Bankers Association supports the enactment of
legislation to reduce the tax rate on capital gains. We believe
that capital gains tax relief is necessary in order to increase
capital formation, stimulate saving and investment, raise real
wages for U.S. workers and boost economic growth in the U.S.
A reduction in capital gains tax rates would encourage
domestic investment, particularly venture capital investments
by financial institutions, by lowering the excessively high
cost of capital. A broad based reduction would benefit a wide
variety of income groups and economic sectors, including
retirees, middle income families, large and small investors,
businesses, farmers, and entrepreneurs. The banking industry
continues to promote savings and investment. Reducing the
capital gains tax rate would ``unlock'' capital assets, lower
interest rates and spur the economy, resulting in raising
federal revenues.

Low-Income Housing Tax Credit

The ABA supports the proposal to raise the $1.25 per capita
cap to $1.75 per capita. This dollar value has not been
increased since it was first set in the 1986 Act. Since that
time the Consumer Price Index for All Items has increased by
50%. That is, $1.25 in 1986 dollars is worth only $.63 today.
Adjustment for inflation would yield an amount slightly in
excess of $1.75. Raising the cap would assist in the
development of much needed affordable rental housing in all
areas of the country.

Educational Assistance

The ABA supports the permanent extension of tax incentives
for employer provided education. The banking and financial
services industries are experiencing dramatic technological
changes. This provision will assist in the retraining of
employees to better face global competition. Employer provided
educational assistance is a central component of the modern
compensation package and is used to recruit and retain vital
employees.

Research And Experimentation Tax Credit

The ABA supports the permanent extension of the tax credit
for research and experimentation. The banking industry is
actively involved in the research and development of new
intellectual products and services in order to compete in an
increasingly sophisticated and global marketplace. The proposal
would extend sorely needed tax relief in this area.

Qualified Zone Academy Bonds

The ABA supports the proposals to authorize the issuance of
additional qualified zone academy bonds and school
modernization bonds and to modify the tax credit bond program.
The proposed changes would facilitate the usage of such bonds
by financial institutions in impacted areas.

CONCLUSION

The ABA appreciates having this opportunity to present our
views on providing tax relief to strengthen the family and
sustain a strong economy. We look forward to working with you
in the future on these most important matters.

Chairman Archer. Thank you, Mr. McCants.
Mr. Greenberg.

STATEMENT OF ARTHUR GREENBERG, COUNSEL, EQUITY GROUP
INVESTMENTS, CHICAGO, ILLINOIS, ON BEHALF OF NATIONAL REALTY
COMMITTEE, NATIONAL ASSOCIATION OF REAL ESTATE INVESTMENT
TRUSTS, NATIONAL ASSOCIATION OF REALTORS, NATIONAL ASSOCIATION
OF INDUSTRIAL AND OFFICE PROPERTIES, INTERNATIONAL COUNCIL OF
SHOPPING CENTERS, NATIONAL MULTI-HOUSING COUNCIL/NATIONAL
APARTMENT ASSOCIATION, AND BUILDING OWNERS AND MANAGERS
ASSOCIATION INTERNATIONAL

Mr. Greenberg. Thank you, Mr. Chairman. Mr. Chairman,
Members of the Committee, my name is Arthur Greenberg. I am
associated with Equity Group Investments, a real estate
investment company headquartered in Chicago, Illinois. I also
serve on the Tax Policy Committees of the National Realty
Committee and the National Association of Real Estate
Investment Trusts. I am also testifying today on behalf of the
National Association of Realtors, the National Association of
Industrial and Office Properties, the International Council of
Shopping Centers, the National Multi-Housing Association, the
National Apartment Association, and the Building Owners and
Managers Association International.
Real estate is a critically important sector of our
economy, generating almost 20 percent of the nation's gross
domestic product and accounting for nearly nine million jobs.
The aggregate value of the Nation's real estate stock, land,
buildings, and improvements is over $20 trillion. Economic
growth and real estate go hand-in-hand. Clearly, real estate
should be included in any consideration of tax relief
legislation designed to sustain economic growth.
The real estate industry is not here seeking tax incentives
today. Rather, we are seeking tax changes that reflect the
economics of today's real estate transactions and treat real
estate fairly relative to other investments.
Our written statements present a number of tax changes we
support, but because of the time, let me highlight three of
them in this presentation.
The first is H.R. 844, legislation to provide a 10-year
depreciation class life for leasehold improvements, sponsored
by Mr. Shaw and 34 other Members of the Committee. Leasehold
improvements are the build-outs an owner does in order to
customize leased space for a business tenant. Most leases, and
the improvements made pursuant to them, typically last less
than 10 years. Writing off the cost of these improvements over
39 years, while the rental income is received over the lease
term, increases the cost to the owner providing these
improvements. The result is the amount and quality of the
improvements will be compromised.
Who would benefit as a result of H.R. 844? Certainly, the
tenant, who would receive the most efficient and modern space
available for his business, as all businesses rely on their
business space to be productive and competitive. In addition,
small business would benefit because their space needs to
evolve extremely rapidly and almost 80 percent of building
owners are small businesses themselves. In addition, H.R. 844
would also aid community revitalization by removing a tax
impediment to improving and revitalizing the buildings that
make up that community.
The second issue I want to highlight is H.R. 1616, the REIT
Modernization Act, sponsored by Representatives Thomas and
Cardin and cosponsored by over two-thirds of the Committee's
Members. This bill would modernize the REIT rules to allow
REITs to remain competitive by permitting a REIT to establish a
fully taxable service subsidiary. The real estate industry has
been evolving rapidly into a consumer-oriented service
business. The current REIT rules make it difficult for REITs to
compete with others in the marketplace by limiting a REIT's
ability to provide leading edge services to its tenants and use
its expertise to serve as third parties. H.R. 1616 allows REITs
the ability to respond to the evolving needs of their tenants
and importantly, the bill contains a number of rules designed
to ensure that the income generated by the service subsidiary
is taxed at the level before being passed on to the REIT.
The third issue I would like to address is the capital
gains and the treatment of recaptured depreciation. Low capital
gains rates are important to unlocking investments and allowing
capital to flow more freely and productively. Therefore, a
further rate reduction would be welcome. However, to be
meaningful to real estate, the depreciation recapture must be
lowered as well. We support H.R. 2054, Mr. English's bill
proposing to reduce the recapture rate to the capital gains
rate, the same treatment that applied prior to the 1997 Tax
Act. At a minimum, we believe the 25 percent depreciation
recapture rate should be reduced proportionately with any
reduction in the capital gains rate. Otherwise, real estate
would be much further disadvantaged relative to other
investment assets such as stock.
In the case of real estate, sales proceeds over the
adjusted tax bases of the property in most cases is a result of
appreciation in the property, not overly generous depreciation
deductions. Several factors contribute to appreciation and the
overall value of the property. These include inflation, land
values, road and other transportation improvements, the
economy, and local market conditions.
In conclusion, Mr. Chairman, we believe that these tax
items: reforming depreciation for leasehold improvements,
modernizing the REIT operating rules, and lowering both the
capital gains and depreciation recapture rates together with
the other items in our written statement will help sustain the
economy, promote competitiveness, and create jobs. In
particular, I want to point out one of the other items which we
support is the provision in Mrs. Johnson's bill, H.R. 2020,
allowing the deductibility of brownfield cleanup expenses. This
would help community revitalization and in-fill development
across the country.
Thank you for your time. I will be pleased to answer any
questions you may have.
[The prepared statement follows:]

Statement of Arthur Greenburg, Counsel, Equity Group Investments,
Chicago, Illinois; on behalf of National Realty Committee, National
Association of Real Estate Investment Trusts, National Association of
Realtors, National Association of Industrial and Office Properties,
International Council of Shopping Centers, National Multihousing
Council/National Apartment Association, and Building Owners and
Managers Association International

Chairman Archer and Members of the Committee, the above
mentioned real estate organizations \1\ appreciate the
opportunity to testify before the Committee on Ways and Means
regarding tax relief to strengthen the family and sustain a
strong economy. We applaud the Committee's effort to enact
broad-based tax relief and look forward to working with you Mr.
Chairman and with all the committee members on upcoming tax
legislation.
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\1\ National Realty Committee (NRC) serves as Real Estate's
Roundtable in Washington for national policy issues vital to commercial
and income producing real estate. NRC Members are America's leading
real estate owners, advisors, builders, investors, lenders and
managers. NRC offices are located at 1420 New York Avenue, NW suite
1100, Washington DC 20005, 202-639-8400.Contact: Stephen M. Renna.
National Association of Real Estate Investment Trusts (NAREIT) is
the national trade association of the REIT industry. NAREIT's members
are public and private REITs, and professionals with an interest in the
REIT and the real estate investment industries. NAREIT is located at
1875 Eye Street, NW Suite 600, Washington, D.C. 20006, 202-739-9400.
Contact: Tony Edwards.
National Association of Realtors (NAR) is comprised of brokers,
agents, property managers, counselors and others involved in all
aspects of the real estate industry. About three-fourths of NAR's
730,000 members are involved in residential real estate. NAR is located
at 700 11th Street, NW, Washington, DC 20001, 202-383-1000. Contact:
Linda Goold.
National Association of Industrial and Office Properties (NAIOP) is
provides developers and owners of industrial, office and related
commercial properties with effective support to create, protect and
enhance property values. Through chapters nationwide, NAIOP facilities
communication, networking and provides a forum for continuing education
and promotes effective grassroots public policy related to real estate
development. NAIOP is headquartered at Woodland Park, 2201 Cooperative
Way, Herndon, VA 20171, 703-904-7100. Contact: Mele Williams.
International Council of Shopping Centers (ICSC) is the trade
association of the shopping center industry. Its 32,000 members in 60
countries represent owners, developers, retailers, lenders and all
others having a professional interest in the shopping center industry.
ICSC's Washington office is located at 1033 North Fairfax Street, Suite
404, Alexandria, VA 22314, 703-549-7404. Contact: Wayne Mehlman.
The National Multi Housing Council (NMHC) and National Apartment
Association (NAA) represent the majority of the nation's firms
participating in the multifamily rental housing industry. NMHC and
NAA's combined memberships are engaged in all aspects of the
development and operation of apartment communities, including
ownership, construction, finance, and management. NMHC and NAA operate
jointly a federal legislative program. NMHC is headquartered at 1850 M
Street, NW, Suite 540, Washington, DC 20036, 202-659-3381. NAA is
located at 201 North Union Street, Alexandria, VA 22314, 703-518-6141.
Contact: James Arbury.
Building Owners and Managers Association International (BOMA) is a
federation of 85 United States, 10 Canadian and 5 international
associations representing over 6 billion square feet of North American
office space. BOMA's purpose is to represent the interests of the
commercial real estate industry on policy matters, and to collect,
analyze and disseminate information. BOMA is headquartered at 1201 New
York Avenue, NW, Suite 300, Washington, DC 20005, 202-408-2662.
Contact: Gerald Lederer.
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Real estate taxation is comprehensive and complicated.
There are many changes that should or could be made to this
broad area of taxation. However, we have chosen to focus our
testimony on the following limited number of initiatives that
we believe have broad consensus throughout the industry and are
important to sustaining a strong national economy:
H.R. 844, legislation to provide a 10 year
depreciation class life for leasehold improvements.
H.R. 1616, the REIT Modernization Act.
A reduction in the depreciation recapture tax rate
that is at least proportionate to any reduction in the capital
gains tax rate.
Deductibility of brownfield cleanup expenses as
provided in H.R. 2020.
Modification to the closely held REIT rules only
to the extent necessary to address clearly identified and
substantiated tax avoidance transactions.
Modification to the ``at-risk'' rules to allow
publicly traded real estate debt to come under the ``qualified
nonrecourse financing'' exception.

BACKGROUND

Real Estate and the U.S. Economy

Millions of Americans share in the ownership of the nation's real
estate--those who own homes, those who own buildings in which they
operate their businesses and those who invest directly or indirectly in
real estate. Commercial and residential real estate assets constitute
almost half of the nation's domestic investment. No tangible capital
asset is more important to the U.S. economy than real estate.
Real estate represents about 20 percent of America's gross domestic
product and accounts for nearly 9 million jobs. About $293 billion in
federal state and local tax revenues is generated annually by real
estate and almost 70 percent of all tax revenues raised by local
governments come from real property taxes. Unquestionably, real estate
is a direct, vital and major contributor to the nation's economy.
The impact of real estate on the nation's economic health and
welfare is further complemented by the role it plays in providing the
space in which Americans live, work, shop, recreate, learn, worship and
heal. Real estate enhances our quality of life and is vital to the
nation's productivity.

State of the Real Estate Industry

Today's real estate markets, as a whole, are in overall good
health. Interest rates and inflation are low and availability of
capital and credit is good. Furthermore, housing demand for multi-
family and single homes is good and work and shopping space, in most
regions, is at a high level of occupancy.
However, the current healthy status of real estate can be affected
quickly and dramatically as demonstrated by the financial crisis that
erupted last summer in Japan and Russia. The international credit
crisis brought about by the faltering economies of these countries led
to a near shut-down of the commercial mortgage-backed security (CMBS)
market as anxious investors stood on the sidelines forcing yield
spreads to widen to the point that no debt placements were being made.
This occurred despite the underlying fundamentals of real estate
investment remaining strong. Clearly, this was a financial crisis, not
a real estate crisis, but real estate was nonetheless seriously
affected. Fortunately, investor worries have eased and the credit
markets are returning to normal. Nevertheless, some residual effects
remain; particularly among public real estate investment trusts (REITs)
whose stock prices plunged by double-digit amounts and have yet to
fully recover.
Interest rates similarly can affect the course of the real estate
industry. The anticipated increase in interest rates in response to
inflation concerns will have a direct impact on all real estate from
coast to coast as the cost of buying or owning a home, apartment
building, office buildings, shopping center or warehouse will increase.
Real estate also is affected by its tax treatment. The turmoil in
the industry created by the tax changes of the Tax Reform Act of 1986
is evidence of this. Real estate tax laws should bear a rational
relationship to the economics of the real estate transaction. In cases
where certain social results are clear, such as homeownership and
affordable low-income housing, tax laws should help bring about such
results. They also should not unduly restrict the ability of investment
real estate owners to respond to changing economic and market
conditions--an ability critical to the competitiveness of any
investment asset.

SUMMARY OF PROPOSED REAL ESTATE TAX CHANGES

We urge the committee to include the following tax
proposals in the broad-based tax relief legislation soon to be
considered. We want to be clear that these are not all the real
estate tax proposals supported by the above-mentioned real
estate organizations. However, they do reflect those proposals
of the highest priority and those that have the broad,
collective support of the real estate industry.
Ten Year Depreciation for Leasehold Improvements (H.R. 844,
S. 879)
As a function of doing business, most owners of office,
retail and other commercial rental real estate must routinely
reconfigure, change or somehow improve their rental space to
suit the needs of new or existing tenants. H.R. 844, introduced
by Representative Shaw with 91 bipartisan cosponsors including
32 Members of the Committee, would reduce the depreciable
recovery period for leasehold improvements from the current 39
years to 10 years. This would more closely align the expenses
incurred to construct these improvements with the income they
generate during the lease term.
Enacting H.R. 844 would help make buildings more modern and
efficient for business tenants and help businesses stay
competitive. Small businesses particularly would benefit by
H.R. 844 since their rapid growth rate often results in rapidly
changing space needs. Further, an overwhelming percentage of
building owners (80 percent) are small businesses. The bill
also would help maintain the vitality of buildings and
buildings are a main contributor to the overall vitality of
neighborhoods and communities. By helping maintain and improve
existing space, H.R. 844 would ease pressure to develop new
buildings which is contributing to the ``sprawl'' problems in
many communities across the country.
Current leasehold improvement depreciation rules clearly do
not make economic sense. The owner receives taxable income
produced by leasehold improvements over the life of the lease
(i.e. 10 years) yet can only recover his costs for building
those improvements over 39 years--nearly a rate four times
slower. This mismatch of income and expenses causes the owner
to incur an artificially high tax cost on these improvements.
For example, a building owner who makes a $100,000
leasehold improvement for a 10-year, $1 million lease would be
able to recover his entire investment by the end of that lease
at a rate of $10,000 a year. Under current law, this $100,000
improvement is recovered at a rate of $2,564 per year over 39
years. By reducing this cost recovery period, the expense of
making these improvements would fall more into line with the
economics of a commercial lease transaction, and more property
owners would be able to adapt their buildings to fit the
demanding needs of today's modern business tenant. Small
business should find this bill particularly helpful. Small
businesses turn over their rental space more frequently than
larger businesses and over 80 percent of building owners who
provide space to small businesses are small businesses
themselves.
Also, the longer an existing building remains viable for
tenants who need modern, efficient commercial space, the less
pressure on property owners to develop greenfields in outlying
suburban areas and the less growth impact on communities. This
is particularly significant in light of the fact that Americans
are increasingly concerned about preserving open space, natural
resources and a sense of neighborhood. Current 39 year
leasehold depreciation is an impediment to reinvesting in
existing properties and communities and therefore contributes
to the development of new properties and what is commonly known
as ``sprawl.'' This legislation would remove that tax
impediment and help to level the tax playing field for new
development and redevelopment.
Additionally, a recently issued Congressional Research
Service (CRS) report entitled ``Depreciation and the Taxation
of Real Estate'' by Jane G. Gravelle lends support to the
merits of, and justification for, H.R. 844. The report
concludes that depreciation of nonresidential structures is
more restrictive today than at any time since 1953, while
depreciation on residential structures is more restrictive than
it has been since 1971. It also finds that the tax burden on
structures is higher than that on equipment. In fact, in order
to equalize the effective tax rates between equipment and
office and apartment structures, a depreciation life of 20
years would be required. In the case of factory buildings, a
life of 17 years would be required.
Finally, S. 879 is the companion bill to H.R. 844.
Introduced by Senators Conrad, Mack Nickles, Robb and Baucus,
it currently has 12 bipartisan cosponsors. We believe the
broad, bipartisan cosponsorship and support for H.R. 844 and S.
879 justifies their inclusion in the respective tax bills
drafted by this Committee and the Senate Finance Committee.

REIT Modernization Act (H.R. 1616, S. 1057)

Based in part on the rationale for mutual funds, Congress
created REITs in 1960 to allow people of all means to invest
easily and effectively in income-producing real estate. A REIT
is essentially a corporation or business trust combining the
capital of many investors to own, operate, and/or finance
income-producing real estate, such as apartments, shopping
centers, offices and warehouses. Like a mutual fund, a REIT may
deduct all dividends paid to its shareholders provided that its
assets are primarily composed of real estate held for the long
term, its income is mainly derived from real estate, and it
distributes most of its taxable income to shareholders. In
addition to benefiting investors, the lower debt levels
associated with REITs have had a positive effect on the
economy.
Subsequent positive changes made by Congress over the
almost 40 years since the enactment of the original REIT rules
have helped to make the REIT industry a vibrant part of today's
publicly traded real estate market. However, the real estate
industry rapidly has been evolving into a customer-oriented
service business. The current rules governing the REIT industry
make it difficult for REITs to compete with others in the
marketplace by limiting a REIT's ability to provide leading
edge services to its tenants and to use its expertise to serve
third parties.
Building on a similar proposal contained in the
Administration's budget package, H.R. 1616, co-sponsored by
over two-thirds of the members of the Ways and Means Committee,
would modernize the REIT rules to allow REITs to remain
competitive by satisfying customer demand. H.R. 1616 would
permit a REIT to own up to 100% of a taxable REIT subsidiary
(``TRS'') that could provide ``non-customary'' services to its
tenants and to provide services to third parties, thus enabling
REITs to be in a better position to attract and retain top-
quality tenants, maintain better quality control over the
services rendered to their tenants, and produce greater
customer loyalty. The TRS would be fully subject to a
corporate-level tax as well as to a number of rules designed to
prevent any inappropriate shifting of income between the parent
REIT and the subsidiary company. H.R. 1616 also would modernize
several other important rules applicable to REITs, such as
reducing a REIT's distribution requirement to 90%.
Given the breadth of the support for REIT modernization and
the legislation's importance to the continuing competitiveness
of the publicly traded real estate industry, we encourage you
to include H.R. 1616 in the Chairman's mark.

Capital Gains Rate Reduction and Depreciation Recapture

In the context of the current tax debate, a number of
policymakers in Congress have expressed interest in reducing
capital gains taxes in order to sustain economic growth and
generate additional revenues. Lowering the capital gains rates
would further ``unlock'' assets and allow capital to flow more
freely and productively. Historically, the real estate industry
has favored low capital gains rates and would welcome further
rate reduction. However, further capital gains rate reduction
raises the important issue of depreciation recapture. If
Congress chooses to enact a capital gains rate cut in 1999, we
believe the appropriate action to take is to reduce the
depreciation recapture rate to the same rate as the capital
gains rate. At a minimum, the depreciation recapture rate
should be reduced proportionately.
In 1997, Congress revamped the capital gains regime
applicable to real estate that had been in place since 1963.
From 1963 until the 1997 changes, when an income-producing
property was sold, the aggregate of previously allowed
depreciation deductions was taken back into income (or
``recaptured''). If the owner had used the straight-line method
of depreciation for recovering the costs of the property, then
the recapture amount was taxed at capital gains rates. (During
any periods between 1963 and 1986 when accelerated depreciation
had been an allowable method, the accelerated method resulted
in ordinary income treatment for depreciation recapture amount.
Since 1986, however, accelerated depreciation has not been an
allowable method for real estate.) Another way of describing
this treatment was that the gain above adjusted basis was
treated as a capital gain.
In 1997, Congress overturned this long-standing regime.
Since 1997, the gain above the adjusted basis of real property
has been broken into two elements. All previously allowed
depreciation allowances (even straight-line) are taxed at 25%
(representing neither ordinary income nor capital gains). Only
the gain above the original purchase price (plus improvements)
is taxed at capital gains rates of 20%. Thus, since 1997, the
effective rate of tax on any sale of income-producing real
estate has been higher than the 20% capital gains rate
applicable to sales of most other capital assets.
Taxing recapture amounts at rates higher than capital gains
rates implies that depreciation allowances have been taken in
amounts in excess of economic depreciation, or that the
depreciation allowance has been overstated. We disagree. The
``gain'' on the sale of real estate often is due to extrinsic
factors--not excessive tax depreciation. The building itself
does, in fact, depreciate over time like any other wasting
asset. Real estate is very capital and maintenance intensive as
the building shell and interior components constantly
deteriorate and wear out requiring their upgrading or
replacement.
Gains in real estate often are attributable to inflation,
appreciation in the value of the land, road and other
transportation improvements and the marketplace and economy in
general. Applying a recapture rate to this appreciation higher
than the capital gain rate is inappropriate because the
appreciation is capital gain. Such treatment would discriminate
against real estate relative to other assets and put real
estate at an even greater competitive disadvantage for
investment dollars
The recent CRS study on depreciation by Jane Gravelle cited
above supports this position. The study shows that the cost
recovery period for real estate is unduly long. It concludes
that, in order to be treated on a par with investment in
equipment, the cost recovery period for real estate should be
reduced to 20 years. The 1997 depreciation recapture changes
exacerbated the disparity in tax treatment between real estate
and other assets. Another reduction in the capital gains rate
without, at a minimum, the proportionate reduction in the
recapture rate, would make this disparity even more pronounced.
We urge Congress, therefore, to be mindful of the recapture
implications created by further capital gains rate reduction.
We believe revisiting the capital gains issue presents an
opportunity to redress the inappropriate recapture treatment
imposed in 1997. At a minimum, Congress should act to ensure
that that real estate is not further disadvantaged relative to
other assets by making reductions in capital gains and
depreciation recapture rates proportionate.

Deductibility of Brownfield Cleanup Expenses

Brownfield properties, once the source of jobs and tax
revenue for hundreds of communities across the U.S., are often
stigmatized by a legacy of environmental contamination and
cleanup liability. Encouraging investors to purchase and
remediate an estimated 400,000 mildly polluted yet potentially
renewable industrial sites not only makes good economic and
business sense, it makes for good neighborhoods. Yet, only a
handful of these troubled properties have been restored. Why?
One reason is the lack of clear federal guidelines to relieve
innocent parties from the prospect of unlimited legal liability
for cleaning up contamination that they had no role in
creating. Another reason is a federal tax system that creates
economic disincentives for businesses that might otherwise
consider rehabilitating brownfields.
Unless a brownfields site is located in a federally
targeted empowerment zone, the costs of cleaning up
contaminants must be capitalized and added to the cost of the
land rather than deducted in the year they are incurred.
Capitalized costs can only be recovered when the property is
sold. Long term holding of real estate results in minimal, if
any, effective recovery of these costs. Depending on the extent
and type of contamination, these costs can be substantial.
The 1997 Taxpayer Relief Act provided immediate expensing
of brownfield cleanup costs in empowerment zones and other high
poverty targeted areas. This tax treatment should be extended
to non-targeted areas as well. Therefore, we support the urban
revitalization provision in H.R. 2020, introduced by
Representative Nancy Johnson (CT), which would allow the
expensing of brownfield cleanup costs. Other Members of the
Committee, such as Mr. Weller and Mr. Neal also have supported
improved tax treatment of brownfield cleanup expenses. If full
deductibility cannot be provided, then, at a minimum, a rapid
amortization period such as 60 months should be provided.
Requiring that these costs be capitalized to the basis of the
land is a disincentive to acquisition and redevelopment.
Removing this tax impediment would allow for more infill
development and revitalization of existing properties. This
would contribute to revitalization of existing communities and
help ease the pressure to build new properties on greenfields.

Modifications to Closely-held REIT Rules

We understand that the Committee is reviewing a Clinton
Administration proposal to modify the closely held REIT rules
in light of recent high profile tax avoidance transactions that
involved closely held REITs.
The capitalization of real estate through REITs that has
occurred in the 1990s has been an important factor in the
recovery of the real estate industry which itself is making a
significant contribution to the strength of the overall
economy. We are concerned with the impact the Administration's
closely held proposal could have on capital flows to real
estate and the potential resulting negative effect on asset
values and jobs. We believe the Administration's proposed
prohibition on all closely held REITs is overly broad and
unnecessary to prevent improper tax avoidance.
The highly visible ``step-down'' preferred and liquidating
REIT transactions do not represent all, or even most, uses of
the closely held REIT. In fact, most of the uses of closely
held REITs that we are aware of are quite legitimate and play
an important role in the capitalization of real estate by
domestic and foreign capital sources.
Legitimate uses of closely held REITs include, for example,
REITs owning other REITs (which the Administration's proposal
properly acknowledges) and incubator REITs. Incubator REITs are
closely held REITs that serve as precursors to publicly held
REITs. Incubator REITs that have developed into publicly held
REITs have created jobs and resulted in additional revenue to
Treasury through taxes paid on dividends.
Domestic and foreign partnerships, mutual funds, pension or
profit-sharing trusts or other pass-through entities also
should not be counted as one entity in determining whether any
``person'' owns 50 percent or more of the vote or value of a
REIT. Partnerships, mutual funds and other pass-through
entities are usually ignored for tax purposes and, therefore,
the owners of these entities, be they partners, shareholders or
beneficiaries, should be considered the ``persons'' owning a
REIT.
Also, joint ventures between private and public REITs
recently have taken on heightened importance. In present market
conditions, depressed stock prices hamper the ability of many
public REITs to go back to the stock market to raise equity
capital. Many of these same REITs want to limit borrowings
under their lines of credit to maintain, or improve, their
investment grade ratings. They, therefore, are relying on
privately structured joint ventures with closely held REITs to
raise equity in order to complete new transactions and to grow.
In many cases, a third party investor owns a majority share
of the closely held REIT. Although the Administration's
proposal would allow a REIT to own another REIT, such ownership
effectively would be limited to REITs that meet the ownership
requirements of the proposal. This would have a material
adverse impact on the ability of public REITs to tap into the
much needed alternative source of capital provided by joint
ventures with closely held private REITs.
Therefore, as you review the closely held REIT rules, we
recommend that you refrain from enacting broad-based
prohibitions such as that proposed by the Administration. We
further recommend that, at a minimum, the legitimate uses of
closely held REITs be allowed to continue under any
modification of the closely held REIT rules.

Modify the ``At-Risk'' Rules to Treat Publicly Traded Debt as
Qualified Nonrecourse Financing

The ``at-risk'' rules of Section 465 were extended to real
estate in the 1986 Tax Reform Act in a broad effort to curb
real estate tax shelters. Congress recognized at the time,
however, that real estate traditionally used nonrecourse
financing and, therefore, allowed ``qualified nonrecourse
financing'' to receive at-risk treatment.
Qualified nonrecourse financing is nonrecourse financing
provided by a person in the business of lending (i.e. banks,
insurance companies, pension funds) that is secured by the real
property. This exception was adequate for the type of real
estate lending that existed in 1986--property specific
financing from traditional lending institutions.
Since 1986, however, real estate financing has undergone
significant changes. The most significant being the use of
publicly traded debt to finance real estate. This is general
obligation debt provided by the public through investment banks
typically to real estate investment trusts. It is essentially
the same as a corporate bond issued by any publicly traded
corporation.
Currently, publicly traded debt does not meet the technical
requirements of the qualified nonrecourse financing because the
lender--in this case the public--is not in the business of
lending. Furthermore, the debt is a general obligation of the
company and is not secured by a specific property interest as
is a typical mortgage loan.
The failure of the at-risk rules to be updated as real
estate financing has evolved is creating unfair potential tax
liabilities for many real estate owners and serious compliance
headaches. The Internal Revenue Service has recognized this and
issued private letter rulings that alleviate some of the
concerns created by the outdated at-risk rules. However, these
rulings are limited in their usefulness and only apply to the
taxpayer applying for the ruling.
Logic dictates that a technical statutory modification is
needed to update the at-risk rules so they are relevant to
modern real estate financing transactions. We have been working
on such a modification with Members of the Ways and Means
Committee and staff of the Joint Committee on Taxation. Mr.
Foley has submitted draft language to Chairman Archer and
requested that this language be included in his mark. We urge
you to adopt this narrowly targeted and appropriate
modification to the at-risk rules.

CONCLUSION

Again, we thank you Mr. Archer and Members of the Committee
for this opportunity to testify. We reiterate that real estate
is a major contributor to our economy and the sustained and
healthy growth rate experienced by it since the early 1990s.
The aggregate value of the nation's real estate stock --land,
buildings and other fixed improvements--is over $20 trillion.
The importance of maintaining and growing this value cannot be
understated. We believe the tax proposals outlined in this
testimony are needed to for the health and welfare of the real
estate industry and the economy. They are reasonable, carefully
thought-through and necessary. We urge you to enact them today.
Whatever revenue costs to the Treasury that may be associated
with them, (and some, in fact, should raise revenues), will be
offset by the economic and social benefits they would help
bring about. We look forward to working with the Chairman and
Members of the Committee on these issues as the broad-based tax
relief effort progresses.

Chairman Archer. Thank you, Mr. Greenberg.
Mr. Leonard.

STATEMENT OF CHARLES H. LEONARD, SENIOR VICE PRESIDENT, CHIEF
FINANCIAL OFFICER AND TREASURER, TEXAS EASTERN PRODUCTS
PIPELINE COMPANY; ON BEHALF OF COALITION OF PUBLICLY TRADED
PARTNERSHIPS

Mr. Leonard. Good afternoon, Mr. Chairman and Members of
the Committee. I am pleased and honored to have been invited to
testify before you. My name is Charles H. Leonard, and I am the
senior vice president and chief financial officer and treasurer
of Texas Eastern Products Pipeline Co., the general partner of
TEPPCO Partners, L.P., a publicly traded partnership based in
Houston. TEPPCO is one of the largest pipeline common carriers
of refined petroleum products and LPGs in the United States and
is also engaged in the gathering, transportation, storage, and
marketing of crude oil, and the transportation of natural gas
liquids.
The Coalition of Publicly Traded Partnerships, on whose
behalf I am speaking today, is a trade association representing
publicly traded partnerships, or PTPs, and their general
partners. The legislative issue on which I will testify is of
critical importance not only to TEPPCO, but to all publicly
traded partnerships.
I am here to ask your help in remedying a provision in the
Tax Code which unfairly, unintentionally, and for no good
policy purpose discriminates against PTPs with regard to
investment by mutual funds. Legislation to address this
situation, H.R. 607, has been introduced by Representative Bill
Thomas and is cosponsored by 12 Committee Members.
As their name suggests, PTPs, also known as master limited
partnerships or MLPs, are limited partnerships which are traded
on public exchanges. The interests in a PTP are referred to as
units, the investors are unitholders. Most PTPs are structured
so that unitholders receive quarterly cash distributions which
generally provide them with a very good yield on their
investment.
On the financial markets, PTPs are seen as investments
which provide steady income through the quarterly distributions
and some measure of growth. This makes them an attractive
investment option for retirees in particular or for anyone
wishing to receive a steady income stream.
The Coalition currently knows of 56 PTP issues that are
trading on the exchanges or over the counter. Of these, about
half are in energy-related industries. The rest are in real
estate investment and homebuilding, mortgage securities,
timber, investment management, and various other industries.
PTPs have operations in just about every State in the country
and unit holders in every State.
Our problem is that the Tax Code prevents us from
attracting mutual funds as investors. Under the Regulated
Investment Co., or RIC, rules of the Code, mutual funds must
receive 90 percent of their gross income from specified
sources. Income from a partnership, even one that is publicly
traded, does not qualify. Neither the quarterly distributions,
nor the partnership income allocated to the mutual fund fall
into one of the approved categories.
Thus, a mutual fund cannot invest in a PTP unless it is
certain that the resulting income, together with all other
nonqualifying sources, will not exceed 10 percent of its gross
income. Faced with the burden of monitoring percentages, and
loss of their special tax status if they exceed the 10-percent
limit, most mutual funds choose not to take the risk.
Mutual funds are an increasingly important segment of the
capital markets. Moreover, a growing number of individual
investors, and most of our public unit holders are individuals,
are investing through mutual funds rather than buying
securities directly. This means that a company that is not
bought by mutual funds is at a huge disadvantage. The
disadvantage is compounded by the fact that if mutual funds
aren't buying your securities, most analysts don't bother to
follow them.
Analysts that do follow PTPs have found some excellent
investments to recommend to their clients. For example, a
recent analysis issued by an analyst at A.G. Edwards and Co.
found several energy-related PTPs to be appropriate investments
for both conservative and aggressive income investors.
Unfortunately, such analysts are few and far between. We
believe that if there were more activity in our units by mutual
funds, it would increase interest among other investors.
We also believe that our units are seriously undervalued
because of this problem and that resolving it could increase
the value by anywhere from 5 to 10 percent. This could have a
significant effect on capital formation and market value in
those industries, particularly energy-related industries, where
PTP use is concentrated.
The RIC rules were written before such a thing as a
publicly traded partnership existed. As we understand it, the
rules reflect two concerns. First, mutual funds should not be
active participants in a company's business, as a partner in a
smaller partnership might be. Second, because they were
illiquid, sometimes risky, and often structured to generate tax
losses, nontraded partnerships were considered inappropriate
for mutual funds.
Neither of these concerns applies in the case of PTPs. PTPs
are liquid by definition, are safe, and fully SEC regulated,
and are structured to generate income. The mutual fund would be
only one of tens of thousands of unitholders contributing
capital, not a participant in managing the business.
In short, there is no reason to treat PTP units differently
from any other publicly traded security, and it is highly
unfair to place them at this disadvantage in attracting mutual
fund investment.
H.R. 607 would resolve this issue by simply making income
derived from a PTP a qualifying income source for mutual funds.
This will allow the decision on mutual fund investment in PTPs
to be made the same way it is made for other publicly traded
securities: by a mutual fund manager who evaluates each PTP's
current performance and outlook for the future.
This legislation will make it easier for PTPs to raise the
capital they need to grow, expand their operations, and create
new jobs. It will also increase the value of the units held by
the PTP investors who live in your States. I urge you to make
the Tax Code more fair and rational by including H.R. 607 in
the tax bill that you will write in July.
[The prepared statement follows:]

Statement of Charles H. Leonard, Senior Vice President, Chief Financial
Officer and Treasurer, Texas Eastern Products Pipeline Company; on
behalf of Coalition of Publicly Traded Partnerships

I am pleased and honored to have been invited to testify
before this Committee. My name is Charles H. Leonard, and I am
the Senior Vice President, Chief Financial Officer and
Treasurer of Texas Eastern Products Pipeline Company, the
general partner of TEPPCO Partners, L.P., a publicly traded
partnership based in Houston. TEPPCO is one of the largest
pipeline common carriers of refined petroleum products and LPGs
in the United States and is also engaged in the gathering,
transportation, storage and marketing of crude oil, and the
transportation of natural gas liquids.
The Coalition of Publicly Traded Partnerships, on whose
behalf I am speaking today, is a trade association representing
PTPs and their general partners. The legislative issue on which
I will testify is of critical importance not only to TEPPCO,
but to all publicly traded partnerships.
I am here to ask your help in remedying a provision in the
tax code which unfairly, unintentionally, and for no good
policy purpose that we can discern, discriminates against
investment in publicly traded partnerships with regard to
investment by mutual funds. For those of you who are not
familiar with PTPs, I would like to briefly explain this
business entity, and then discuss the problem.

Publicly Traded Partnerships

As their name suggests, publicly traded partnerships (PTPs)
are limited partnerships which are traded on public exchanges.
They are also commonly known as ``master limited partnerships''
or MLPs. The interests in a PTP are called ``units'' and the
investors are referred to as ``unitholders.''
Most PTPs are structured so that unitholders receive
quarterly cash distributions, which generally provide them with
a very good yield on their investment.
On the financial markets, PTPs are seen as investments
which provide a steady income through the quarterly
distributions and some measure of growth, although usually less
than that of corporate investments. For this reason, they are
often compared with bonds or utility stocks in market analyses.
This makes them a very attractive investment option for
retirees in particular, or for anyone wishing to receive a
steady income stream.
Since the PTP rules of section 7704 of the Code were
enacted in 1987, only those partnerships receiving 90 percent
of their income from specific sources can be publicly traded
and still be taxed as partnerships. These sources include
interest, dividends, real estate rental income and gain from
the sale of real estate, and income from a broad range of
natural resource activities.
In addition, there are several PTPs not meeting the gross
income test which were already in existence when the 1987 rules
were passed. They received a 10-year grandfather period at that
time, and now, under rules enacted in 1997, may continue to be
taxed as partnerships if they elect to pay a 3.5% gross income
tax.
The Coalition currently knows of 56 PTP issues that are
trading on the New York and American Stock Exchanges, NASDAQ,
or over-the-counter. Of these, 25 are in energy related
industries--oil and gas exploration, processing, pipeline
transportation of various petroleum products, propane
distribution, and so on. Ten are in real estate investment or
homebuilding, 7 invest in mortgage securities, 3 are timber
companies, and one produces and markets agricultural chemicals.
Three are ``grandfathered'' PTPs in the advisory business, and
the rest are scattered among various industries. There may be
other PTPs of which we are unaware because they are very thinly
traded or are still in formation.
These PTPs collectively have operations in just about every
state in the country and unitholders in every state. TEPPCO,
for example, currently has operations in 24 states, including
the following states represented by the Members of this
Committee: Texas, our home state, Louisiana, New York,
Illinois, Pennsylvania, Ohio, Colorado, Oklahoma, Missouri, and
Kentucky. Other PTPs in the Coalition have a presence in many
of these state--particularly Texas, which is the home of a
number of the energy-related PTPs--as well as a strong presence
in California and operations in Upper Midwest states like
Minnesota, Wisconsin, Nebraska, Iowa and the Dakotas. A list of
currently trading PTPs and the location of their headquarters
is attached to this testimony.
A 1998 study by Pricewaterhouse Coopers estimated that as
of 1996, PTPs collectively owned about $27 billion in net
assets. Based on an examination of SEC filings, the Coalition
believes that PTPs had roughly $20 billion in market capital at
the end of 1997. While we are a small part of the overall
market, we are not an insignificant one.

Regulated Investment Company Rules

The problem which we need your help in resolving is that
the tax code prevents us from attracting mutual funds as
investors. Under the Regulated Investment Company (RIC) rules
in section 851 of the tax code, mutual funds must receive 90
percent of their gross income from specified sources. Income
received from a partnership, even one that is publicly traded,
does not qualify. The quarterly distributions, while resembling
dividends, are not in fact dividends for tax purposes; and the
partnership income allocated to the mutual fund only rarely
will fall into one of the section 851 categories.
Thus, a mutual fund cannot invest in a PTP or other
partnership unless it is certain that the income it receives
from that partnership, together with all other nonqualifying
income sources, will not exceed 10 percent of its gross income.
Faced with the burden of monitoring percentages, and the dire
consequences of exceeding the 10 percent limit--loss of their
special tax status--most mutual funds choose not to take the
risk.
Mutual funds, as we all know, are an increasingly important
segment of the capital markets. Moreover, a growing number of
individual investors--which is where most of our public
unitholders come from--are investing through mutual funds
rather than buying securities directly. This means that a
company that is not being bought by mutual funds is at a huge
disadvantage. The disadvantage is compounded by the fact that
if mutual funds aren't buying your securities, most analysts
don't bother to follow them.
Those few analysts who have chosen to follow the PTP market
have found some excellent investments to recommend to their
clients. For example a recent analysis issued by an analyst in
A.G. Edwards & Company's St. Louis office found several energy
related PTPs to be appropriate investments for both
conservative and aggressive income investors. Unfortunately,
such analysts are few and far between; there are not nearly
enough to generate the type of ``buzz'' on Wall Street that
helps sell securities. We believe that if there were more
activity in our units by mutual funds, it would increase
interest among other investors.
As a result of this situation, we believe our that our
units are seriously undervalued, and that if this impediment to
mutual fund investment were removed, their value would increase
by anywhere from 5% to 10%. The 1998 Pricewaterhouse Coopers
study agreed, and predicted that investors would realize
substantially greater capital gains from their PTP units if
this provision were enacted. It is our strong belief,
therefore, that this measure could have a significant effect on
capital formation and market value in those industries,
particularly natural resource industries, where PTP use is
concentrated.
Before changing the way the RIC rules work for PTPs, it
makes sense to examine the policy behind these rules and
whether that policy is applicable in the case of PTPs. It is
our understanding that there are two essential policy reasons
behind the current rules. First, because of the flow-through
nature of a partnership, an investor in a partnership is
technically considered to be engaging in the partnership's
business. The writers of the RIC rules did not want RICs to be
actively engaged in businesses, but only passive investors;
hence they set the rules up so that a partnership investment
would qualify only if it was generating income characteristic
of a passive investment.
This makes sense in the case of smaller, nontraded
partnerships, where the RIC might indeed be in a position to
influence the partnership's business dealings. In a PTP,
however, the RIC is in the same position it would be as a
corporate shareholder, one of tens of thousands of investors
who contribute capital to the enterprise but have no role to
play in the company's management.
Also, at the time the RIC rules were written there were no
traded partnerships. PTPs did not come into existence until the
early 1980s, when computer technology made it possible to track
complex partnership tax attributes for large numbers of
investors. Before that, a partnership investment was highly
illiquid, required a sizeable investment, and was often quite
risky. As this Committee knows, many nontraded partnerships in
earlier days were set up for the specific purpose of generating
losses. For all these reasons, they were not a suitable
investment for a mutual fund.
PTP units, however, are safe and potentially attractive
investments for mutual funds. By definition, they are publicly
traded and hence are liquid; and they can be obtained in small
investment increments. Moreover, being fully regulated by the
SEC, PTP units are no more risky than any other traded
security. They have always been structured for the purpose of
generating income, not loss, for their investors.
In short, there is no reason to treat PTP units differently
from any other security that is traded on the public markets,
and it is highly unfair to place them at this disadvantage in
attracting mutual fund investment.

Legislative Solution

Representative Bill Thomas, with the cosponsorship of
twelve members of this Committee, has introduced H.R. 607,
which would resolve this issue by simply making income derived
from a publicly traded partnership a qualifying income source
for mutual funds. This will allow the decision on whether and
how much a mutual fund invests in PTP units to be made in the
same way it is made for other publicly traded securities: by a
mutual fund manager who evaluates each PTP's current
performance and outlook for the future.
PTPs are an important vehicle for capital formation,
particularly in the energy and natural resources industries.
This legislation will make it easier for PTPs which may
currently operate in your states to raise the capital they need
to grow, expand their operations, and create new jobs. And by
eliminating an application of the Code which has no policy
justification and which results in an undervaluation of PTP
units, this provision will increase the value of the units held
by the PTP investors who live in your states. I urge you to
make the tax code more fair and rational by including the
Thomas bill in the tax legislation that you will write in July.

COALITION OF PUBLICLY TRADED PARTNERSHIPS PUBLICLY TRADED PARTNERSHIPS
Partnerships trading as of June 22, 1999
------------------------------------------------------------------------
Exchange/Symbol Principal Offices
------------------------------------------------------------------------
REAL ESTATE--Income Properties
and Homebuilders
American Real Estate Partners. NYSE/ACP.......... Mt. Kisco, New
York
Carey Diversified LLC......... NYSE/CDC.......... New York, New York
Hallwood Realty Partners...... AMEX/HRY.......... Dallas, Texas
Heartland Partners............ AMEX/HTL.......... Chicago, Illinois
Interstate General Company, AMEX/IGC.......... Chantilly,
L.P.. Virginia
National Realty L.P........... AMEX/NLP.......... Dallas, Texas
New England Realty Associates, NASDAQ/NEWRZ...... Boston,
L.P.. Massachusetts
Newhall Land and Farming NYSE/NHL.......... Valencia,
Company. California
Royal Palm Beach Colony, L.P.. OTC/RPAMZ......... Hollywood, Florida
Teeco Properties, L.P......... OTC/3TPLPZ........ New York, New York
REAL ESTATE--Mortgage Loan
America First Apartment NASDAQ/APROZ...... Omaha, Nebraska
Investors.
America First Tax Exempt NASDAQ/AFTXZ...... Omaha, Nebraska
Mortgage Fund.
American Insured Mortgage AMEX/AII.......... Rockville, MD
Investors 85.
American Insured Mortgage AMEX/AIJ.......... Rockville, MD
Investors 86.
American Insured Mortgage AMEX/AIK.......... Rockville, MD
Investors 88.
Municipal Mortgage & Equity, NYSE/MMA.......... Baltimore, MD
LLC.
Oxford Tax-Exempt Fund II, AMEX//OTF......... Bethesda, MD
L.P..
NATURAL RESOURCE--Oil and Gas,
Energy Processing &
Distribution
Amerigas...................... NYSE/APU.......... King of Prussia,
Pennsylvania
Buckeye Partners, L.P......... NYSE/BPL.......... Emmaus,
Pennsylvania
Cornerstone Propane Partners, NYSE/CNO.......... Watsonville,
L.P.. California
Dorchester Hugoton Ltd........ NASDAQ/DHULZ...... Garland, Texas
Enterprise Products Partners, NYSE/EPD.......... Houston, Texas
L.P..
EOTT Energy Partners.......... NYSE/EOT.......... Houston, Texas
Ferrellgas Parters, L.P....... NYSE/GEL.......... Houston, Texas
Hallwood Energy Partners.... AMEX/HEP.......... Dallas, Texas
Hallwood Energy Partners, AMEX/HEPCWI....... Dallas, Texas
Class C.
Heritage Propane Partners, NYSE/HPG.......... Tulsa, Oklahoma
L.P..
Kaneb Pipe Line Partners--Sr. NYSE/KPP.......... Dallas, Texas
Preferred.
Kaneb Pipe Line Partners-- NYSE/KPU.......... Dallas, Texas
Preferred.
Kinder Morgan Energy Partners, NYSE/ENP.......... Houston, Texas
L.P..
Lakehead Pipe Line Partners... NYSE/LHP.......... Duluth, Minnesota
Leviathan Gas Pipeline Ptrs., NYSE/LEV.......... Houston, Texas
L.P..
National Propane Partners, NYSE/NPL.......... Cedar Rapids, Iowa
L.P..
Northern Border Partners, L.P. NYSE/NBP.......... Omaha, Nebraska
Plains All American Pipeline, NYSE/PAA.......... Dallas, Texas
L.P..
Pride Companies, L.P.......... NYSE/PRF.......... Abilene, Texas
Star Gas Partners, L.P........ NYSE/SGU.......... Stamford,
Connecticut
Suburban Propane.............. NYSE/SPH.......... Whippany, New
Jersey
Sun Energy Partners, L.P...... NYSE/SLP.......... Dallas, Texas
TEPPCO Partners, L.P.......... NYSE/TPP.......... Houston, Texas
Unimar Company, L.P........... AMEX/UMR.......... Houston, Texas
NATURAL RESOURCE--Timber and
Minerals
Crown Pacific, L.P............ NYSE/CRO.......... Portland, Oregon
Pope Resources................ NASDAQ/POPEZ;..... Poulsbo,
PSE/PRP........... Washington
Terra Nitrogen, L.P........... NYSE/TNH.......... Sioux City, Iowa
U.S. Timberlands Company, L.P. NASDAQ/TIMBZ...... Klamath Falls,
Oregon
INVESTMENT ADVISORS
Alliance Capital Management, ANYSE/AC.......... New York, New York
L.P..
NVest, L.P.................... NYSE/NEW.......... Boston,
(formerly New England......... Massachusetts
Investment Companies).........
PIMCO Advisors Holdings, L.P.. NYSE/PA........... Newport Beach,
California
MISCELLANEOUS
Airlease, Ltd................. NYSE/FLY.......... San Francisco,
California
Borden Chemicals & Plastics NYSE/BCU.......... Geismar, Louisiana
L.P..
Boston Celtics L.P............ NYSE/BOS.......... Boston,
Massachusetts
Cedar Fair, L.P............... NYSE/FUN.......... Sandusky, Ohio
Equus Gaming Company.......... NASDAQ/EQUUS...... Hato Rey, Puerto
Rico
FFP Partners, L.P............. AMEX/FFP.......... Fort Worth, Texas
Mauna Loa Macadamia Partners, NYSE/NUT.......... Honolulu, Hawaii
L.P..
------------------------------------------------------------------------

Mrs. Johnson of Connecticut [presiding]. I thank the panel
for your testimony on a range of issues of importance across
the country.
Mr. Capps, I wanted to have you address briefly, because I
do have some other questions in my time, I did want to have you
address why the AIRC is important, why extension of just the
old R&D tax credit doesn't meet our needs? And then if you
would also speak to the broader question of why the market--
some people will say to me, ``Well, the market rewards R&D. If
you have better products out there, you win in the market,'' so
why does government need to recognize R&D costs at all and then
why do we need that addition that we, frankly, have worked so
hard on?
Mr. Capps. Well, first addressing the AIRC or the
alternative credit. It is extremely important to all members of
the Coalition, including companies like EDS, who have
historically used the traditional credit. Back in 1994,
companies were coming from different directions as far as their
approach to the credit. And Members of this Committee had
suggested that the business community try to tie together and
come up with a unified front and proposal for a structure for
the credit. We deliberated and worked amongst ourselves for
over a year and ultimately came up with a design, the
traditional credit, which did in fact work well for most
companies. But then also the incremental credit, which picked
up other companies that were doing substantial amounts of
research, were research-intensive but the historical base
period that we used in the traditional credit wasn't a good
measure or reasonable basis, a good basis to use to measure
them on a go-forward basis.
So we came up with this compromise structure. We think it
works well. As a business community, we are coming forward with
a structure for the credit that includes both the traditional
and the alternative credit. And the alternative credit is
essentially the glue that helps hold our Coalition together. So
it is very important to us.
As far as your question regarding the free market and why
isn't it an adequate incentive for research and development in
the private sector, much of the research that is done is
compelled for competitive reasons by the free market. What the
R&D credit is focusing on are those activities, those research
projects that are on the margin, where a company is evaluating
whether or not to go forward with a project, it will look at
the benefits that it is going to realize from that research.
Well, the benefits that flow to the economy and society at
large can greatly exceed that benefit that the company is
getting. So with the credit and the added capital that it
provides the companies, they can pick up those marginal
activities which end up providing a significant benefit to the
economy as a whole.
Kind of driving home that point, I just saw something in
The Washington Post this morning talking about my industry, the
information technology industry, and it says that,
``Information technology industries are having a huge impact on
the economy, contributing more than one-third of U.S. economic
growth between 1995 and 1998, even though they account for just
8 percent of the Gross Domestic Product.'' And that is
reflecting this concept that the benefits that flow to the
economy greatly exceed what the individual companies get. And
that is out of a Commerce Department study that they just came
out with.
Mrs. Johnson of Connecticut. I appreciate that because we
actually in other areas invest a tremendous amount of public
money, in health research, in much of our defense research
flows over into the private sector and our national lab
research capability goes over to the private sector only when
it is economic for a company to be able to pick up the
additional research necessary to translate the basic research
into product. But you are right, if there is a one-to-one
relationship between research and product, if it were always
that easy, we wouldn't need to help. And many, many companies
do that kind of research and don't take the credit because it
is fairly inexpensive and it is very fast-moving and it is hard
to document. So there is a lot of R&D that goes on that the
government doesn't have any role in.
The kinds of R&D projects that go on that the government
has a legitimate interest in are those that are higher risk,
may not lead exactly to products, and do take a much longer
term investment. And I know you made the point in your
testimony that permanency is important because the bigger, more
significant projects that are going to lead to generations of
products in the future are the very kind of projects that need
the credit and that are disadvantaged by these very short-term
extensions that we have enjoyed or suffered in the past.
Mr. Capps. At EDS, we have undertaken research projects
that have spanned 10, 12 years.
Mrs. Johnson of Connecticut. Thank you. I just want to ask
Mr. Greenberg, if I may, Mr. Greenberg, thank you for your
testimony and being specific about a number of bills that have
been introduced by Committee Members and their impact on a
number of markets that you are associated with, the number of
industries that you are associated with. It is also true that
29 of the 39 Members of this Committee are cosponsors of my
bill and Mr. Rangel's interest in raising the cap on the low-
income housing tax credit to expand the availability of high-
quality, well-managed, affordable units. The credits currently
are in tremendous demand, the demand far exceeds the
availability of the credits. And I just wondered what you
thought about that bill since it isn't one of the ones you
mentioned?
Mr. Greenberg. Well, it isn't one of the ones we mentioned,
but some of our members definitely have an interest in that.
And we do support the fact that if low-income housing credits
will increase the production and the construction of low-income
housing for people, that it is a good thing and we would
support that. It wasn't one of the main topics because it
didn't encompass most of our members.
Mrs. Johnson of Connecticut. Well, your focus on broader
things like build-out costs and brownfields and REIT
modernization do take a slightly different approach to this.
But certainly the low-income housing tax credit has proved its
power in the affordable housing range.
Mr. Greenberg. But we do support that because if it does
create low-income housing, if it does help produce more
construction of low-income housing, we do support that, yes.
Mrs. Johnson of Connecticut. Thank you.
Mr. Levin.
Mr. Levin. Thank you. Welcome. Mr. Baroody, in your
testimony, you referred toward the end to section 127.
Mr. Baroody. Yes, sir.
Mr. Levin. And might I kind of make a pitch? We have had an
uphill battle on this, as you know, especially including
graduate education. And I think there are a lot of
misconceptions about what kind of graduate education was really
being abetted by 127. It wasn't doctors and lawyers, it was
primarily people who, for example, wanted to increase their
engineering proficiencies. I don't know what the odds are for
making progress this time around. We almost did so last time in
this Committee. And I just want to express my hope that
everybody who is interested in this will help to focus
attention on it.
Mr. Baroody. The pitch is taken, Mr. Levin. And our members
are very serious about the continuing and the predictably
growing need for higher level skills across the board of our
membership. So we are very serious about this, and would look
forward to working with you on it.
Mr. Levin. OK, because I think within manufacturing, there
is really a revolution within the workplace and connected with
it, this distinction between rust belt and high-tech and all
that is really very, I think, misinformed, if I might say so.
Let me ask you, Mr. Capps, there was a question about the
R&D tax credit, but I want to emphasize the issue of permanency
because it is pretty clear there will be an extension. I would
doubt that there won't be an extension. There always has been
except there was one gap. So, briefly, if you would, make the
strong case for its permanent extension.
Mr. Capps. With the on-and-off nature of the credit, it
makes it difficult for companies, especially like EDS that have
undertaken long-term research projects that can span a decade,
to take the credit into account in the out years. Economically,
I cannot tell my management at EDS and the people who are
undertaking our research, that we are going to have a credit
for sure next year. I gambled on the year when we had the
lapse, and I said, ``Oh, don't worry, they will extend it
retroactively. They have been doing that consistently.'' And I
got stung on that. All the economists that have studied it, we
have got a number of reports we can cite to you, have found
that the simple act of having it permanent as opposed to just
these annual extensions effectively turbocharges it, and we get
a huge incremental benefit going forward from the standpoint of
jobs, from the standpoint of exports increasing, and imports
decreasing. It is like turbocharging it effectively. And I know
at EDS, we would avail ourselves of it even more in our
economic analyses and modeling, just like we used to do with
the investment tax credit. Every time before we purchased
equipment or undertook a long-range capital investment plan, we
modeled in the ITC, having a reasonable expectation that it was
going to be around.
Mr. Levin. OK. Mr. Bloomfield, you mentioned some studies.
Why don't you make sure we get them, if you would, just send
them to us. I want to ask you a question though, if I might
skip to the leaseholder improvement provision. When a lessee
makes the improvements, not the lessor, but the lessee, what is
the rule in terms of the amortization?
Mr. Greenberg. They get to amortize it out over the period
of their lease.
Mr. Levin. Over the period of their lease. So one of the
arguments is that there is a major differential in treatment
depending on who makes the leasehold improvements?
Mr. Greenberg. That's true. In fact, there is a
disincentive for the landlord to make an improvement, and more
of an incentive for him to have the tenant make it.
Mr. Levin. OK, thank you. Thank you, Mr. Chairman.
Chairman Archer [presiding]. Mr. English.
Mr. English. Thank you, Mr. Chairman. Mr. Greenberg, in
your testimony you mentioned that REITs are at a competitive
disadvantage in today's marketplace. Can you give us some
examples on why REITs aren't competitive currently?
Mr. Greenberg. Yes, the rules currently state that if a
REIT renders services to its tenants that aren't customary and
usual and for the convenience of the tenants, that it will
taint all the rental income they get from that tenant and make
it bad income. If a REIT has more than 5 percent of their gross
income as bad income, they lose their REIT status. Now, the
REITs have to wait while their competitors are offering these
services to their tenants until enough of the competitors are
doing it where it becomes customary and usual. And then the
REIT has to wait on top of that until the IRS finally agrees
that they then see that it is customary and usual.
To give you a couple of examples, I got the first ruling
that said that cable TV was customary and usual for apartment
buildings. It took us over 2 years to get the IRS to agree that
it was customary and usual--that cable TV was customary and
usual.
I just got a ruling on high-speed Internet for office
buildings, that high-speed Internet was a form of
communications for office tenants. It took over 16 months to
get that. While the competitors of the REITs are out making
deals and offering these services to their tenants, the REITs
had to sit around and wait until they can get these private
letter rulings.
Mr. English. That's interesting. Mr. Greenberg, I want to
thank you for mentioning in your testimony my legislation to
reduce the depreciation recapture rate, which a number of my
colleagues have signed on to. I noticed that there was a recent
CRS report on real estate depreciation that concluded that real
estate depreciation is less favorable today than at any time
since 1953. It went on to conclude that the recovery period for
commercial real estate would have to be reduced to 20 years to
provide real estate the same effective tax rate as equipment.
Would you agree that this supports your position, that ``sale
proceeds above the adjusted bases'' are not ``the result of
overly generous depreciation, but are in fact a gain?''
Mr. Greenberg. Yes, definitely I would. And to elaborate a
little bit more on that, it was 20 years, the report said 20
years for office and residential and 17 years for industrial
properties. So it was even lower to make them equivalent to the
depreciation tax effect for equipment. Today we are using 39-
year-life depreciation. So the depreciation recapture we are
talking about, we are really taxing part of the appreciation,
not the depreciation.
Mr. English. Thank you, Mr. Greenberg. Mr. Bloomfield, I am
curious about the details of your study on the impact of the
reduction, the last reduction in 1997 of the capital gains tax.
Can you elaborate on your findings and also how they might
impact on the assumptions that underlay our revenue estimates
about capital gains tax cuts?
Mr. Bloomfield. Well, let me begin by indicating that DRI
did an analysis of the 1997 capital gains tax cut. And, as you
know, there are five revenue implications of reducing the
capital gains tax cut. The first is the arithmetic one when you
lower the rate. And David Wyss, the chief economist for DRI,
looked at that, which is a revenue loss. The second is the
unlocking that takes place, which is a revenue gain. The third,
and perhaps the most important part of David Wyss' analysis, is
that it had a significant impact on the value of the assets. So
if the value of the asset went up, you obviously got more
revenue when you sold that asset. The fourth is some small,
minor revenue loss, reclassification of ordinary income into
capital gains to take advantage of the lower rate. And the
final one is the impact on the growth of the economy.
And the preliminary report, which is in our testimony,
indicates that both in the short-term and in the long-run, if
you take into account those five revenue implications, that the
1997 capital gains tax cut was a revenue gainer. It definitely
was not a revenue loss. If you look at the impact of the 1997
capital gains tax cut in terms of its overall economic impact,
whether it be on the impact of the cost of capital, whether it
be impact on investment, whether it be impact on GNP, all of
those are also positive. So a capital gains tax cut is one of
those few tax cuts which really is a free lunch, particularly
because of its impact on revenue.
Now, the next question I assume is, can we generate revenue
with additional capital gains cuts? Senator Lott and others in
the Senate have suggested reducing the capital gains tax cut to
generate revenue. Obviously, a lot of it depends what revenue
implications you take into account. And, as you know, both the
Joint Committee and the CBO take into account some of those
revenue effects. But as many people on this Committee,
including the Chairman know, you can craft a capital gains tax
cut which could raise revenue in the budget window that you are
looking at if it is carefully crafted.
Mr. English. Thank you, Mr. Bloomfield. That is testimony
that really turns a lot of conventional notions on their head
here and it is welcome for that reason.
Mr. Chairman, I thank you for the opportunity.
Chairman Archer. Mr. Hulshof.
Mr. Hulshof. Mr. Chairman, may I begin by asking how many
of you are appearing here personally for the first time to give
testimony, just by a show of hands. So a few rookies and a few
veterans. For those of you appearing for the first time, it is
incumbent upon us at this moment to single out those provisions
that we have authored or that we have cosponsored and to talk
about them. And so since that is a requirement, let me take
this moment then. Mr. Bloomfield, and especially thank you for
your kind comments, I know you didn't mention them
specifically, but Mr. Neal and I have the small savers
provision, and I think it is seriously worth pointing out that
many of the other industrialized countries really do encourage
savings and thrift. For instance, you talk about Germany
providing some nearly $7,000 exclusion from taxable income,
interest that is derived and married couples, and other
countries, even more than that. And I know regarding the small
savers provision that Mr. Neal and I have introduced, much more
modest than that. And so I appreciate the fact that you have
included that.
And now let me get to really a more serious policy question
and maybe as a preface. In the days leading up to this
Committee marking up the Taxpayer Relief Act of 1997, there was
a witness sitting where you were, and I don't recall who asked
him the question, but the question was posed if the witness had
to choose whether he would embrace a capital gains cut or death
tax relief, which one would he suggest the Committee accept and
which one would he let go by the wayside. And I think the
response was something like that, that that is like asking a
pedestrian whether they would like to be hit by a bus or by a
car. This question, if you could just put the policy, the
theoretical, economics aside, there is some discussion among
Members about addressing the corporate capital gains rate. And,
as you have pointed out, there is no distinction between long-
term gains or short-term gains, although you also note that in
other countries that there is for instance a different rate
perhaps for short-term gains as opposed to a different rate for
a long-term gain. Is that a good idea? Why is it a good idea or
not a good idea if we were to maybe create a two-tier approach
of dealing with corporate capital gains or would you think that
that is akin to being that dubious pedestrian that I mentioned?
Mr. Bloomfield. You are talking about a sliding scale for
corporate capital gains?
Mr. Hulshof. I'm saying if we had, yes, a short-term gain
or a long-term gain, similar as we do for individuals?
Mr. Bloomfield. Well, let me first respond with two points.
Number one, Mr. English, with regard to the impact of the 1997
capital gains tax cut, in my testimony, I have laid out the
details of David Wyss's report.
Number two, with regard to Mr. Neal and Mr. Hulshof, it is
true that there are incentives for small savers around the
world, and what I would like to do is introduce into the record
an analysis that Arthur Andersen did on that issue.
But getting back to the poor witness in my seat who had to
choose among various tax cuts, I suggested a menu, which I said
singularly and together could move the country forward because
they would reduce the bias in the Tax Code against saving and
investment. There are political and policy questions to
address. There are economists like Stanford Professor John
Shoven who have tried to rank the different tax cuts, but that
is hard to do. I cannot be in a situation of saying that one
tax cut, a capital gains cut versus elimination of the death
tax would have a greater impact. It would depend on how the cut
is structured.
For example, let's get to the issue you raised, that of
capital gains cuts for corporations and individuals. We tax
both individual and corporate capital gains much higher than
the rest of the world. We have always had a differential
between ordinary income and capital gains. We no longer have
that on the corporate side. That causes all sorts of
distortions. If you look internationally, corporate capital
gains, both short- and long-term capital gains, are much lower
in the rest of the world. Other countries do tax short-term
corporate capital gains differently than long-term capital
gains. In the United States, we tax both short- and long-term
corporate capital gains at a 35-percent rate.
I would encourage you to strongly consider a corporate
capital gains tax cut. There are ways to address it depending
on holding periods, and so forth, to deal with the revenue
effect.
Chairman Archer. Does any other Member wish to inquire?
Mr. Neal.
Mr. Neal. Thank you, Mr. Chairman. Mr. Bloomfield, is that
Arthur Andersen report sympathetic to Mr. Hulshof's bill and my
bill?
Mr. Bloomfield. It most certainly is.
Mr. Neal. All right, you can submit it for the record.
[Laughter.]
Mr. Bloomfield. Mr. Neal, I could read it here. It is
several pages. You pick your country, and I will tell you what
the----
[The information follows:]

American Council for Capital Formation

Center for Policy Research

Special Report

Small Saver Incentives: An International Comparison of the Taxation of
Interest, Dividends, and Capital Gains

Many countries tax the interest, dividends, and capital
gains income received by individuals more lightly than does the
United States, according to a recent survey of twenty-four
industrialized and developing countries that the ACCF Center
for Policy Research commissioned from Arthur Andersen LLP. High
tax rates on dividends and capital gains increase the bias
against saving and investment, raise the cost of capital for
new investment, and slow U.S. economic growth. The Center study
also shows that many countries provide tax incentives for small
savers by exempting some portion of the income from tax.

Interest Income

Interest received by individuals is taxed at a higher rate
in the United States than in many other countries; the marginal
tax rate is 39.6 percent in the United States compared to an
average of 32.4 in the countries surveyed as a whole (see
comparison table, p. 3, and accompanying notes, p. 5). Nearly
40 percent of the countries surveyed tax interest income at a
lower rate than ordinary income; for example, Italy taxes
ordinary income at a top rate of 46 percent while its top tax
rate on interest income is only 27 percent.
In several countries surveyed, small savers receive special
encouragement in the form of lower taxes or exemptions on a
portion of the interest they received:
Australia: The first $1,951 of interest is taxed
at a rate of 33.5 percent (instead of the 48.5 percent rate on
ordinary income).
Belgium: The first $1,484 of interest on bank
saving accounts is exempt from tax.
Chile: The first $1,100 of interest income is
exempt from tax.
Germany: The first $6,786 of interest income for
married couples filing a joint return ($3,393 for singles) is
exempt from tax.
Japan: Interest on saving up to $26,805 is exempt
from tax for individuals older than 65.
Netherlands: The first $987 of interest income for
married couples ($494 for singles) is exempt from tax.
Taiwan: The first $8,273 of interest received from
local financial institutions is exempt from tax.
United Kingdom: Interest income received by savers
in the 23 percent income tax bracket is taxed at a rate of 20
percent.

Dividend Income

Dividend income is also taxed more heavily in the United
States than in the other countries surveyed; the U.S. tax rate
is 60.4 percent (combined corporate and individual tax on
dividend income) compared to an average of 51.1 percent in the
surveyed countries as a whole (see comparison table, p. 3, and
accompanying notes, pp. 5-6). Of the countries surveyed, 62.5
percent offset the double taxation of corporate income (the
income is taxed at the corporate level and again when
distributed in the form of dividends) by providing either a
lower tax rate on dividend income received by a shareholder or
by providing a corporation with a credit for taxes paid on
dividends distributed to their shareholders.
In addition, small shareholders receive preferential
treatment in about one-fourth of the countries surveyed:
Australia: The first $1,951 of dividends is taxed
at a rate of 33.5 percent (instead of the 48.5 percent rate on
ordinary income).
Chile: Taxpayers may exclude the first 50 percent
of dividends received up to $33,000 annually; above this
threshold, 20 percent of dividends received are excluded from
tax.
France: The first $2,661 of dividends on French
shares received by a married couple is exempt from tax ($1,330
for singles).
Japan: Dividends of less than $350 from each
individual corporation are taxed at a top rate of 20 percent
instead of 50 percent. In addition, shareholders with non-
dividend income of less than $70,000 get a 10 percent tax
credit on dividends received; those with non-dividend income
greater than $70,000 get a tax credit on dividends ranging from
5 percent to 10 percent.
Netherlands: The first $987 of dividend income for
married couples ($494 for singles) is exempt from tax.
Taiwan: The first $8,273 of dividends from local
companies is exempt from tax.

Capital Gains Tax Rates

Both short- and long-term capital gains on equities are taxed at
higher rates in the United States than in most of the other twenty-
three countries surveyed. Short-term gains are taxed at ordinary income
rates as high as 39.6 percent in the United States compared to an
average of 19.4 percent for the sample as a whole (see comparison
table, p. 4, and accompanying notes, p. 6). Long-term gains face a tax
rate of 20 percent in the United States versus an average of 15.9 for
all the countries surveyed. Thus, U.S. individual taxpayers face tax
rates on long-term gains that are 26 percent higher than those paid by
the average investor in other countries. In addition, the United States
is one of only five countries surveyed with a holding period
requirement in order for the investment to qualify as a capital asset.
Several countries provide incentives for small savers to invest in
capital assets:
Canada: Provides an exclusion for the sale of shares of
Canadian-owned small businesses, subject to a lifetime limit.
Chile: Provides an annual capital gains exclusion of
$6,600.
Denmark: Exempts capital gains from the sale of publicly
listed shares valued at less than $16,000 if held three or more years.
France: Exempts capital gains if gross proceeds are less
than a threshold amount ($8,315 in 1998).
United Kingdom: Excludes up to $11,225 per year of net
gains.

Conclusions

The Center's study demonstrates that many countries tax the
interest, dividends, and capital gains received by individual
taxpayers at lower rates than does the United States. A
substantial number of countries also provide special tax
incentives to encourage small savers. Perhaps not
coincidentally, almost all the countries surveyed have higher
saving rates than the United States. More favorable tax
treatment for U.S. savers, especially small savers, could
encourage individuals to provide more for their own retirement
as well as help to provide the funds necessary for investment
and economic growth.
[GRAPHIC] [TIFF OMITTED] T0841.028

[GRAPHIC] [TIFF OMITTED] T0841.029

Notes

Interest Income

Argentina--Interest from certain saving accounts and
certificates of deposit receives preferential treatment.
Australia--The first A$3,000 (US $1,951) of investment
income from any source (including interest, dividends, and
other business income of individuals) is subject to tax at 33.5
percent instead of 48.5 percent.
Belgium--Exemption up to BF 55,000 (US $1,484) for interest
on bank saving accounts (``spaarboekje'').
Chile--Interest income up to US $1,100 annually is exempt
from tax.
China--Interest income earned on a deposit placed in China
banks, or on a bond or debt issued by China, is exempt from
tax.
France--A withholding tax of approximately 30 percent may
be requested.
Germany--With respect to net interest income, single
individuals can claim an allowance of DM 6,100 (US $3,393) per
year, and married persons filing a joint income tax return can
claim an allowance of DM 12,200 (US $6,786) per year.
India--Interest income from certain specified securities
(typically government securities) could be exempt.
Italy--Interest income earned on bonds whose duration is
longer than 18 months is taxed at 12.5 percent.
Japan--Interest on saving up to %3.5 million (US $26,805)
is exempt from tax for individuals older than 65.
Korea--Various rate reductions are available for interest
income.
Mexico--Mexican-source interest is withheld at 1.7 percent
of the principal.
Netherlands--An exclusion of NLG 1,000 (US $494) (NLG 2,000
[US $987] if individual is married) is available for interest
income. The exclusion will be reduced by tax-deductible
interest paid on personal loans.
Poland--The interest income of individuals earned on loans
and bonds is not aggregated with other sources of income and is
subject to a flat 20 percent income tax.
For individuals, interest income earned on State Treasury
securities, local government bonds, and personal bank accounts
is generally exempt.
Singapore--Interest income received from savings with the
POS Bank in Singapore, or foreign source interest income that
is not remitted to Singapore, is exempt.
Sweden--An individual may deduct certain interest expenses
to offset interest income.
Taiwan--Individual residents may exclude interest income
from deposits in local financial institutions and dividends
from local companies from taxable income up to NT$270,000 (US
$8,273) per year.
U. Kingdom--A U.K. individual whose marginal tax rate is 23
percent pays tax at a rate of 20 percent on savings income
including interest.
United States--Interest earned on qualified municipal bonds
is tax exempt.

Dividend Income

Argentina--Dividends are exempt from tax.
Australia--The corporation keeps account of the amount of
tax it has paid. At the time a dividend is paid, the
corporation ``franks'' the dividend by notionally attaching to
it the amount of Australian tax the corporation has paid on the
profits from which the dividend is paid. Dividends are deemed
to have been paid from the taxed profits first. The shareholder
is assessed on both the cash dividend and the imputed tax
(i.e., the dividend is ``grossed up''). The imputed tax is then
allowed as a credit against the shareholder's tax. Any excess
credit cannot be refunded.
Belgium--Dividends are subject to reduced rates of tax, 25
percent for dividends on bearer shares and 15 percent for
dividends on nominative shares.
Brazil--Dividends are exempt from tax.
Canada--Individual shareholder is taxable on 125 percent of
the dividend received, and claims a credit equal to 13.33
percent of the total taxable dividend amount.
Chile--The 15 percent tax paid at the company level may be
credited against the tax on the shareholder's taxable dividend
(i.e., cash dividend plus the tax credit).
Under a special regime, individuals may exclude 50 percent
of dividends received up to US $33,000 annually. Above this
threshold, 20 percent of dividends received are excluded.
China--Dividends from A shares listed in Shenzhen and
Shanghai Stock Exchanges are currently exempt from tax.
France--The shareholder credit equals 33.33 percent of the
grossed-up dividend.
For dividends on French shares, a single individual may
take a special deduction up to Fr 8,000 (US $1,330), and
married persons may deduct up to Fr 16,000 (US $2,661).
Germany--A corporate income tax credit on dividends is
granted to shareholders in the amount of 43 percent of the net
dividend. In addition, the corporation receives a refund of
income tax, reducing the corporate rate from 45 percent to 30
percent.
Hong Kong--Dividends from a corporation which is chargeable
to tax are not included in the taxable income of any other
person chargeable to tax.
India--The corporation paying the dividend pays an
additional tax equal to 10 percent of the dividend distributed
to the shareholders. The shareholders are not subject to any
additional tax on the dividend received.
Italy--The credit is 58.73 percent of the dividends
provided that the distributing company has paid an equal amount
of taxes on the earnings distributed. The tax credit is offset
against personal income tax computed on the dividend grossed up
by the amount of the tax credit.
Dividends subject to a withholding tax as a definitive tax
are excluded from the taxable income. Individuals are allowed
to opt for the definitive withholding at 12.5 percent. In such
cases no tax credit is granted and the total tax burden on
corporate earnings is 49.5 percent.
Japan--Dividends of less than $350 from each individual
corporation are taxed at a top rate of 20 percent instead of 50
percent. In addition, shareholders with non-dividend income of
less than $70,000 get a 10 percent tax credit on dividends
received; those with non-dividend income greater than $70,000
get a tax credit on dividends ranging from 5 percent to 10
percent.
Korea--The shareholder credit is 19 percent.
Mexico--Dividends are exempt from tax.
Netherlands--An individual may exclude NLG 1,000 (US $494)
for dividends received from a Dutch resident company (NLG 2,000
[US $987] for married individuals).
Poland--Dividends distributed to individuals are subject to
a definitive 20 percent withholding tax.
Singapore--The dividend is subject to normal individual
income tax with a credit equal to the 26 percent corporate tax
paid with respect to the earnings distributed.
Dividend income from shares held outside Singapore and not
remitted to Singapore is exempt from tax.
Taiwan--The shareholder credit equals the amount of the
dividend (net of corporate tax) multiplied by 33.33 percent.
An individual may exclude interest received from a
financial institution and dividends from local companies up to
NT$270,000 (US $8,273) per year.
U. Kingdom--At present, 25 percent of the cash dividend is
available as a credit. From April 1999, 11.1 will be available.
The taxable amount of the dividend is the cash dividend plus
the credit.
After March 1999, the combined rate on corporate earnings
will be 47.5 percent.

Capital Gains Income

Canada--Exclusion applies only to sale of shares of
Canadian-owned small businesses, subject to a lifetime limit.
Chile--Original cost is adjusted by internal inflation.
Annual limit for capital gains exclusion is approximately US
$6,600.
Denmark--Gains on publicly listed shares held three or more
years are tax exempt if taxpayer owns less than US $16,000 of
the company's shares.
France--Capital gains realized by individuals are not taxed
if gross proceeds are less than a threshold amount (for 1998,
Fr 50,000 [US $8,315]).
U. Kingdom--Sliding scale of rates applies to one to ten
years of ownership through an exclusion that rises gradually to
75 percent for assets held ten or more years. Thus, assets held
ten or more years face a top marginal rate of 10 percent.
An individual may exclude up to #6,800 (US $11,225) per
year of net capital gains.
United States--Shares held 12 months or more are taxed at a
rate lower than that on ordinary income under the IRS
Restructuring and Reform Act of 1998.

Mr. Neal. I was going to encourage you to save it if it
wasn't supportive of our view.
Mr. Greenberg, I have a question on H.R. 844, the leasehold
depreciation bill. I represent an old New England city and, as
you know, old New England cities all look alike now. In your
testimony, you make reference to how this bill would help small
business and I would like you to speak to that after you speak
to how the bill would help old cities in their revitalization
processes. Our manufacturing base is fairly stable in this
economy, but at one time the hand-tool industry was highly
dominant and now it is but a fraction of what it once was.
Mr. Greenberg. Well, the issue has to do with the
disincentive for the landlord to make the improvements by
virtue of the fact that he has to depreciate over 39 years and
the rental stream is for a shorter period. As a result of that,
the landlord is not willing to make the kind of improvements
that someone else who is building a new building might already
put in in the beginning, in the early period. And, therefore,
you will find urban sprawl. You will find people moving out and
going to more modern buildings, higher tech buildings, and so
forth, rather than the landlord updating his. So that will
create growth away from the inner city as opposed to trying to
keep it in the inner city.
And regarding the small business person, the small business
person is usually the person who is starting out and he doesn't
have the capital to lay out to make his improvements, so you
really want the landlord to make the improvements. And the
small business person pays for the improvements by paying an
increased rent over that period of time. And that is in effect
having the landlord finance his improvements for him. The
incentive would be if the landlord were able to write that off
over the period he is receiving the income on it. In most other
areas, we try to match income and expenses, but this one we
don't.
And, as I said before, we have given an incentive for the
tenant to make improvements because he can write it off over
the period of his lease. The landlord must write it off over 39
years. So H.R. 844 would help small business because the
landlord has as much of an incentive or he is not de-
incentivized to make those tenant improvements for the small
business. And, as you know, small businesses hope to grow and
increase. Their size space needs change. The configuration of
their office space changes, and they need all of these kinds of
services.
Mr. Neal. I think that given the debate that is about to be
undertaken on the whole notion of suburban growth, urban
sprawl, and a host of other issues that come together, I think
there really is an extraordinary opportunity here for old
cities as more and more suburbanites resist any sort of growth
and put up signs essentially that say, ``No more growth.'' And
I think that how it is done, hopefully in a tasteful manner,
can really bring many of these old cities back to life. And I
think as perspective entrepreneurs look at old cities now, they
look at them in a different light than they did just 10 years
ago. So I think that the suggestion you made is right on
target.
Mr. Greenberg. Yes, I think there are two areas. I think
both the tenant improvement one and the brownfields one
should----
Mr. Neal. Brownfields, yes.
Mr. Greenberg. The two of them together should increase the
ability to keep people back in the cities and to encourage
construction within the cities.
Mr. Neal. Thank you very much. Thank you, Mr. Chairman.
Chairman Archer.
Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman. And I will direct my
question to Mr. Greenberg, who represents the community who I
have the privilege of representing and glad to see you here.
You just, with my friend, Mr. Neal, you touched on an issue, of
course, which is of great concern in the Chicago region and
that is the issue of brownfields. And it is estimated that
there is at least 2,000 brownfields in the Chicago metropolitan
area. And 2 years ago, as part of the Balanced Budget Act, we
had a limited provision which provided a tax incentive for the
clean up of brownfields, encouraging private investors and I
have seen that work in the 10th Ward in Chicago down in Hegwich
with what is the largest brownfield in the State now is being
rejuvenated as a result of that tax incentive.
But do you have a feel, since this tax incentive was
targeted solely to Federal empowerment zones and to low-income
census tracks and to neighboring census tracks, what percent of
the brownfields in the Chicago metropolitan area benefit from
that targeted brownfield incentive?
Mr. Greenberg. I don't know. I believe it is a pretty small
percentage. One of our members is someone who develops or
redevelops industrial buildings. And he is extremely interested
in this, especially in the Chicago area because there are a lot
of areas that are not targeted empowerment zones.
And I don't look at it as a tax incentive, the ability to
write off brownfields expenses. I look at it as correcting a
disincentive because what is happening is if you were to repair
or fix any kind of a problem, you get to write that off. You
get to expense it as you fix the problem. The problem with
brownfields is you bought a piece of property, you inherited a
piece of property that has contamination. If you spend the
money to fix it up, that gets capitalized into the cost of the
land. You never recognize the benefit of what you paid for
until you ultimately sell that project. Well, that is a
disincentive. You are not giving the people incentive to
correct the problem. And I think that cities like Chicago,
would benefit tremendously by being able to have people not be
disincentivized from repairing contamination.
Mr. Weller. I know 2 years ago, I worked closely with Mayor
Daley on this issue, and we had some success. And I am
constantly reminded by a lot of other community leaders in
Illinois, of course, that there are a lot of middle-class and
rural communities in the suburbs as well as rural areas that
are denied this tax incentive because of the way it was
targeted. And I believe it is a fairness issue to these other
communities because a brownfield could be that gas station on
that strategic quarter in town that everyone wonders why nobody
buys it and puts it to work or it could be an industrial park
in a rural area that is just sitting there and it both has an
environmental initiative to clean up the environment and
preserve open space because it is estimated that greenfield
industrial parks consume about three to four times as much land
as the old traditional, old-fashioned brownfield industrial
parks.
So my hope is as we work over the next few years that we
can find a way to expand that brownfields, lack of a better
word, tax incentive to encourage private investors to clean up
these old brownfields, put them back to work, revitalize those
old communities and also help clean up our environment.
Mr. Greenberg. We hope so too.
Mr. Weller. So thank you. I am glad you are here. I
appreciate it.
Mr. Greenberg. Thank you.
Chairman Archer. Mr. Hayworth.
Mr. Hayworth. Thank you, Mr. Chairman. To the witnesses,
thank you all for coming. And to my colleague from Missouri,
thank you for delineating those who are newcomers to testify,
as well as those who are grizzled but not cynical veterans of
the entire process. My friend from the ``Show Me State'' really
had more of a ``tell me'' approach when he talked about
different legislation. And in that spirit, taking his cue, Mr.
Baroody, thank you for your comments about the bill I am
preparing to introduce today as a matter of fact with the
cosponsorship of eight Members of this Committee.
You know, Mr. Chairman and colleagues, it is interesting
that ofttimes we are awash in a sea of acronyms. In Washington,
DC, in general, especially with reference to tax policies and
just a casual observation, the letters I am about to use, you
just invert a little bit and they become a major issue for
America's bankers. We can get to that in a second. But in this
case, I am not speaking of ATMs, but of the AMT, the
alternative minimum tax. Mr. Baroody, why is the AMT referred
to as an antimanufacturing tax?
Mr. Baroody. Mr. Hayworth, because it operates with effect
all too often among manufacturers generally, and our members
specifically. Clearly, any company that has to make large
investments in plant and equipment, and that is the
manufacturing community, are especially affected by the AMT.
And inherently the AMT is designed to have that effect when a
company is doing relatively poorly in terms of profits. That is
where the AMT inherently triggers in. So it has the effect of
focusing specifically on capital intensive companies when they
are in the worst situation financially.
Mr. Bloomfield. Mr. Hayworth, can I also comment on that?
Mr. Hayworth. Indeed, please do.
Mr. Bloomfield. First of all, let me not be dilatory and
also not avoiding congratulating and thanking you for your
leadership on the AMT. To put some numbers on that, if you
could please look at table 1 of our testimony, there is a
comparison of the taxation of equipment. Table 1 compares the
present value of certain types of equipment in the United
States under the 1985 lax law, MACRS, and the AMT with present
values for the same equipment in several other countries. And
whether you are looking at computer chips or telephone
switching equipment, crankshafts, or pollution control
equipment, you can see what the AMT does in reducing the value
of that important investment.
I could say one other thing. I don't know what the rules of
the Committee are in terms of studies appearing, but do CRS
studies automatically become part of the Committee's record?
Because there is one that is troublesome and that is Jane
Gravelle's study of ``Capital Gains Taxes, Innovation, and
Growth'' in January 28, 1999, that indicated that capital gains
tax cuts do not have much of an impact on entrepreneurship and
venture capital. And we have asked David Wyss of DRI to respond
to that. And if I could at some point, I would like his
analysis to be put in the record to rebuttal Ms. Gravelle's
piece.
Mr. Hayworth. I thank you for that observation, Mr.
Bloomfield. And we will check with the Chairman vis-a-vis the
rules of the Committee and the House to see if that report can,
in fact, be included.
I mentioned earlier the bankers. Mr. McCants, thank you for
coming out from Goodland to this challenging land right here
around the Nation's capital. And I just wanted to thank you as
well for mentioning the legislation of Mr. McInnis and I am
pleased to cosponsor that along with my friend from Louisiana.
Your testimony says that the IRS reasonable liquidity needs
standards undermine a regulator's authority to examine and
enforce safety and soundness laws. Could you please explain or
elaborate what you mean by that statement?
Mr. McCants. Well, from a regulatory standpoint, we need
certain amounts of investments that are very liquid. And that
liquidity comes from our bond portfolio, for the most part.
And, consequently, such as in our particular case, we are just
a small $250 million bank. But in December we may be borrowing
$30 million or $40 million in funds from the Federal home loan
bank in upstream correspondence. And then, in turn, in January,
we may be selling $10 million or $20 million in funds because
we are an agricultural bank and those farmers are not going to
be paying taxes by selling grain in December when they sell it
in January and defer those gains.
So, consequently, we see big shifts in liquidity and we
have to be prepared for that. So we maintain large bond
balances in our bank portfolio to help prepare for liquidity
needs and seasonal runoffs of deposits. Well, by really
overstating our balance sheet and our income from the bond
portfolio, we are doing ourself a disservice and we could
jeopardize our S corporation status by doing it.
And then, consequently, the other side of the coin is some
of our municipalities are depositing huge government payments
in January and we have to have bonds to pledge for our county
as the funds are going to the school district and,
consequently, we have got to pledge to both entities at the
same time. So we have to have a very liquid bond portfolio to
generate that kind of pledging ability.
So, in doing that, yes, we are overstating the income from
our bond portfolio or the necessary. It is good business? No,
probably isn't. Is it good for our municipalities? Yes, it is
very good because they don't have to go outside our area.
Mr. Hayworth. Thank you, sir, very much. Thank you, Mr.
Chairman.
Chairman Archer. The Chair will conclude the inquiry with
this panel for about 5 minutes and then the Committee will
stand in recess to vote. When we come back, we will hear from
our last panel today.
Gentlemen, thank you for your input. You speak to a great
degree on items in the Tax Code that will affect job creation
and productivity which, in the Chair's opinion, is the
essential ingredient to improve the lot of workers in the next
century, all American workers. If we do not create better jobs
and higher productivity, then we are not going to be able to
see an improvement in the standard of living. Having said that,
in the opinion of each of you, what is the single biggest thing
that we can do in the Tax Code to bring that about: more job
creation, higher productivity? Mr. Baroody.
Mr. Baroody. You ask for a single----
Chairman Archer. One thing, now, only. [Laughter.]
Mr. Baroody. Yes, sir. The discussion may have gone on when
you were out about whether we want to be hit by a bus or a car.
I won't try to hide behind that. As you heard--first, it is
exactly what the Chairman intends, a very difficult question.
What we have testified today and historically support are tax
provisions which see to the continued growth of the economy.
That was the thrust of my testimony.
That was why, last December, we called for across-the-
board, evenly balanced, and fair approaches. I would be hard-
pressed, Mr. Chairman, right now, to answer your question on
its own terms. And I regret that.
Clearly the R&D tax credit, in terms of bang for the buck,
if I could put it that way, is hugely important. But the
operation of the AMT, right now, functions, as Mr. Hayworth's
question suggests, as an antimanufacturing tax.
Chairman Archer. Well, that was three things.
Mr. Baroody. Yes, sir.
Chairman Archer. You know, I have got to prioritize.
Mr. Baroody. I understand.
Chairman Archer. I am asking each of you to prioritize. I
am not saying that that is the only thing that you would want.
But I would like to know what you feel is the number one
priority. Mr. Capps.
Mr. Capps. Mr. Chairman, I think it all centers around
technology. Federal Reserve Chairman Alan Greenspan----
Chairman Archer. OK. We have got a limited amount of time.
What in the Tax Code would you change that would have the
biggest impact on job creation and productivity?
Mr. Capps. I would make a permanent extension of the
research tax credit. It is job-oriented, technology-oriented.
It is going to give growth and productivity increases to the
economy and keep driving it.
Chairman Archer. OK. All right. Mr. Bloomfield.
Mr. Bloomfield. Replacing the income tax with a consumption
tax. And if you won't do that----
Chairman Archer. That is the right answer. OK. [Laughter.]
Mr. Bloomfield. Then I had better stop. If you won't do
that, people smarter than me, like Professor John Shoven, said
probably reducing the cost of capital for expensing for
investment.
Chairman Archer. Reducing the cost of----
Mr. Bloomfield [continuing]. The cost of capital by
expensing investment.
Chairman Archer. OK. All right. Mr. McCants.
Mr. McCants. I would have to agree with Mr. Bloomfield. I
think whatever we can do to reduce the cost of capital is
essential.
Chairman Archer. I agree with that, but what in the Tax
Code would you change that would have the biggest impact on
that?
Mr. McCants. I think by being able to accelerate the
expensing of items.
Chairman Archer. Accelerate expensing. All right. Mr.
Greenberg.
Mr. Greenberg. I agree because you need something to
encourage the entrepreneurship in this country to create the
jobs and I think that would be one of the ways to do that.
Chairman Archer. Mr. Leonard.
Mr. Leonard. Encourage equity investment in American
industry.
Chairman Archer. All right. But what change in the Tax Code
would you make to do that?
Mr. Leonard. Specifically in the case of my testimony is to
allow publicly traded partnerships to be treated as investments
by mutual funds. This would allow more equity to flow into such
partnerships.
Chairman Archer. All right. In your opinion, that would do
more for job creation and productivity than any other single
change in the Tax Code?
Mr. Leonard. I think in certain areas, yes.
Chairman Archer. OK. Several of you mentioned the R&E
credit and there is good bipartisan support for extension of
it. I have always been curious, though. How much of that credit
goes to industries who would do the research any how without
the credit? What percent of the credit, in your opinion or your
knowledge by any data that you have, is going to industries
that would otherwise, because of competitive pressures, do the
very same thing?
Mr. Capps. I don't think it is a function of what
industries is it going to; on the margin it makes a difference
to all industries. In the United States now, we are all under
competitive pressure and the market is driving us to do
research. And much of our research is market-driven. But what
is being incentivized is, across-the-board, those projects on
the margin that wouldn't have gotten done otherwise. The credit
is providing the capital and the incentive to go that extra
step and pick up those projects. So it is not industry-
specific. It is across-the-board, I think.
Chairman Archer. Well, that is my last question. I only
have one brief statement to make before you are excused. As I
listen to witnesses who come forward with different types of
suggestions for improvements in the Income Tax Code, whether it
be your panel or any other panel, it is generally on the basis
of fairness and equity that the proposals are made. Every time
that we adopt a proposal, we create within the Tax Code other
areas of inequity and unfairness. When we do something to
create more equity in one case, we have less equity in another
case.
I am more and more convinced that Mr. Bloomfield is right.
The only way to solve these problems is to have a true level
playingfield by abolishing the income tax, completely and
totally, and getting the IRS completely and totally out of
running our lives one way or another. Go to a specific tax
which has no grey areas, which is a consumption tax, a spending
tax, a sales tax. Whatever you want to call it. Then you have
specificity. You have no opportunity for the IRS to say, oh,
but this is right. Or that is wrong. Or anything else.
So I simply say we will keep working to try to fix the
income tax, but we will never get there. Thank you very much.
We will stand in recess until the votes are over.
[Recess.]
Chairman Archer. The Committee will come to order. My
apologies for keeping all of you people waiting. I know my
former colleagues understand that when the votes are called
over there, there is not much you can do about it. We are glad
to have all of you before us. The rules, of course, are that we
would like for you to try to keep your oral testimony within 5
minutes and your entire written statements, without objection,
will be printed in the record. At least two of you are no
strangers at all to this Committee room and we are delighted to
see you back before us again. Henson Moore, would you like to
lead off?

STATEMENT OF HON. W. HENSON MOORE, PRESIDENT AND CHIEF
EXECUTIVE OFFICER, AMERICAN FOREST AND PAPER ASSOCIATION; AND
FORMER MEMBER OF CONGRESS

Mr. Moore. Thank you, Mr. Chairman. My name is Henson
Moore. I am the president of the American Forest and Paper
Association, which is the national trade organization
representing the forest products industry.
We are the biggest in the world. Nobody makes more lumber,
building materials, or paper products than the United States,
currently. In 1992, Fortune Magazine said that our industry was
one of the two or three heavy industries the United States had
left that was competitive worldwide. Unfortunately, since
1992--and it may have even begun before that--that
competitiveness is slipping away.
We did a study last year, a study of all of the factors
that are important to our industry and compared them with the
countries with whom we compete in our industry. And,
unfortunately, on every one of those factors, and taxes is one
of them, we came out as being either the worst off or almost
the worst off. And those factors are having a telling effect on
us being able to compete.
In the field of taxes, we asked Pricewaterhouse to compare
the effective tax rate of our industry, both as a manufacturer,
which would affect industries besides just us, and on forestry
operations, which is just us; to take a look at those and
compare it with five sample countries with whom we compete that
are major competitors of ours: Brazil, Canada, Finland,
Indonesia, and Japan.
And as a result of that study by Pricewaterhouse, it came
back a bit worse than we thought, that, overall, generally, the
effective tax rate on our industry in the United States, as a
corporation, is 55 percent. And the only country higher than
that--and just slightly higher than that--is Canada. The rest
of the countries with whom we compete had effective tax rates
substantially lower.
In the case of manufacturing, we were at about something
like 62 percent. Canada was at about 70 percent. And forestry
operations, overall, we were at 55 percent and Canada was at
about 60 percent. Some countries like Indonesia is minus 2
percent. They pay you to plant trees and take care of forests
there. And just plain reforestation expenses, the cost of
planting trees after you cut them and taking care of that until
they get to a point you can harvest them, the United States has
the distinction of having the highest tax rate of all of the
countries studied at 63 percent.
Basically, Mr. Chairman, the biggest cost in our industry
is fiber, the tree. The tree in the United States now costs
more and is going up substantially. And then the tax bit on us
providing or maintaining or reforesting and providing that
source of fiber is too high for us to be competitive. We need
to move on all of these factors we studied: costs of
environmental compliance, transportation costs, international
trade barriers and tariff barriers to our products. There are a
number of factors we looked at, but taxes is one of the key
ones.
And if we don't address that, our industry is not going to
remain--in fact, it isn't today--as competitive as it was. And
we don't think it is today as competitive as it should be. We
may not even be competitive, period. And we saw changes last
year for the first time, swings in reduction in our exports and
increases in imports.
And so, basically, Mr. Chairman, we would like to call your
attention to a bill that one of the Members of the Committee
has sponsored, Representative Dunn, the Reforestation Tax Act,
along with a number of cosponsors from the Committee and about
65 in the House. It has been introduced in the Senate,
yesterday, by Senators Mikulski and Breaux with 13 senators
cosponsoring it so far there.
It basically does two things. It cuts the capital gains tax
rate for corporations and individuals in owning forest and it
raises the cap that is on now for a tax credit for
reforestation and shortens the amortization period on the
balance. And those two things, according to Pricewaterhouse, if
this Committee were to pass those two things on the forestation
cost side of the tax study, it would put us about in the middle
of the pack of the countries with whom we compete. We are now
at the bottom of the pack or the top of the pack, however you
look at it. Top of taxes, but it would move us to about the
middle of the pack.
And so the bill would, in fact, have a dramatic effect on
that part of our lack of competitiveness. The remaining part on
taxes, just the tax rate and the tax bite on a manufacturing
concern in the United States, that wouldn't really be affected
by this and that is something that would have to wait for a
later day when this Committee has a bill before it that affects
all manufacturing in that regard. And so, Mr. Chairman, we
would urge the Committee to seriously considering including in
its bill, the Reforestation Tax Act.
[The prepared statement follows. Attachments are being
retained in the Committee files.]

Statement of Hon. W. Henson Moore, President and Chief Executive
Officer, American Forest & Paper Association; and Former Member of
Congress

My name is Henson Moore. I am President & CEO of the
American Forest & Paper Association. AF&PA represents more than
240 member companies and related associations that engage in or
represent the manufacturers of pulp, paper, paperboard and wood
products. America's forest and paper industry ranges from
state-of-the-art paper mills to small, family-owned saw mills
and some 9 million individual woodlot owners.
The U.S. forest products industry is vitally important to
the nation's economy. We employ 1.5 million people, and rank
among the top ten manufacturing employers in 46 states. Our
industry has annual sales exceeding $230 billion, and accounts
for about seven percent of U.S. manufacturing shipments.
The U.S. forest products industry has many important
assets, including a productive work force, technological know-
how, and an abundant renewable domestic fiber base. Yet we are
facing severe global competitive challenges. In 1992, Fortune
magazine listed this industry as one of the most competitive
U.S. industries. That assessment increasingly no longer
applies.
There is currently not a level playing field between us and
our competitors around the world. Our taxes are higher than
those of competing nations, and there are unfair trade barriers
to the exporting of our products to other markets. The cost of
compliance with our nation's environmental laws is higher, and
transportation costs are greater than anywhere else around the
globe. Additionally, increased restrictions on fiber are
limiting access to the lifeblood of our industry. If we cannot
successfully address these challenges, the public demand for
forest products will increasingly be filled by other nations
who do not adhere to our high standards. The cost to the global
environment and to our economy will be significant.
As a result, our industry has done an intensive self-
examination to determine what is causing that shift in our
international competitiveness, and my written testimony
includes AF&PA's white paper on that analysis. To summarize
however, the US forest products industry critically looked at
all of the key factors--forestry practices here and overseas,
environmental practices here and abroad, access to fiber,
tariff and non-tariff barriers to our exports, labor, taxes,
and transportation costs--to determine where we could improve
our international competitiveness. Some findings we expected--
others we didn't. Basically, we are not as competitive as we
need to be on any of these factors.
Some key factors are beyond our industry's direct
control, such as exchange rates and the build up of overseas
capacity.
Some factors are subject to the whims of
international negotiations, such as the tariff reductions
proposed in the APEC tariff initiative and now the ATL
initiative, which we hope to see bear fruit in the WTO
Ministerial in Seattle in November. Tariffs in the US on paper
and wood products imports have been basically non-existent
since the 1980's, while our major trading partners continue to
hide behind tariff walls on these same products. We continue to
fight for tariff elimination--through GATT, through APEC, and
now maybe the WTO--but the window for meaningful change is
becoming more narrow all the time.
At home, other competitive factors can be improved
by industry initiatives, such as the Sustainable Forestry
Initiative. In the SFI, AF&PA members are voluntarily taking
steps to show the rest of the world what can be accomplished
through our industry's self initiated program to support
sustainable forestry practices on lands AF&PA members manage
and actively promote such practices on other forestlands.
However, today we would like to focus on one of the major
domestic factors--that of taxes. As part of our industry
analysis, we asked PriceWaterhouseCoopers to do a study that
compared the effective tax burdens on investments in paper
manufacturing and forestry and timber in the United States and
our top 5 competitors: Brazil, Canada, Finland, Indonesia, and
Japan.
And the results? The US has the second highest effective
tax rate on all forestry operations among its major
competitors--55%--while reforestation costs in the US were
subject to the highest effective tax rate of all countries
studied--63%.
These results probably were not intended and were the
result of years of tax policy changes without an analysis of
the accumulated effect on competitiveness. But the problems we
now face can and must be addressed through positive
Congressional action. Congress can act now to remove certain
tax disincentives in current law that would go a long way to
insure the future competitiveness of this industry.
The changes the forest products industry recommends are
embodied in the Reforestation Tax Act, HR 1083, introduced by
Rep. Jennifer Dunn, a member of this committee, and supported
by 64 additional co-sponsors in the House, including 14 members
of this committee. An identical bill, S.1240, has also been
introduced in the Senate by Senators Murkowski and Breaux with
15 co-sponsors.
HR 1083 would essentially do two things:

1. MITIGATE THE COMPETITIVE DISADVANTAGE OF INVESTING IN THE FOREST
PRODUCTS INDUSTRY.

The Reforestation Tax Act recognizes the unique nature of
timber and the overwhelming risks that accompany investment in
this essential natural asset, and attempts to place the
industry on a more competitive footing with our competitors. In
short, it would reduce the capital gains paid on timber for
both individuals and corporations and expand the current
reforestation credit. Because it often takes decades for a tree
to grow to a marketable size, it is important that we look
carefully at the long-term return on investment and the
treatment of the costs associated with owning and planting of
timber.
The bill would provide a sliding scale reduction in the
amount of taxable gain based on the number of years the asset
is held (3% per year). The maximum reduction allowed would be
50 percent. Thus, if the taxpayer held the timber for 17 years,
the effective tax rate for corporate holdings would be 17.5%
and the rate for most individuals would be 10%.
AND
2. ENCOURAGE REPLANTING BY LIFTING THE EXISTING CAP ON THE
REFORESTATION TAX CREDIT AND AMORTIZATION PROVISIONS OF THE TAX
CODE.
Currently, the first $10,000 of reforestation expenses are
eligible for a 10 percent tax credit and can be amortized over
7 years. No additional expenses are eligible for either the
credit or the deduction, meaning that most reforestation
expenses are not recoverable until the timber is harvested. The
legislation removes the $10,000 cap and allows all
reforestation expenses to qualify for the tax credit and to be
amortized over a 5-year period. This change in the law will
provide a strong incentive for increased reforestation by
eliminating the arbitrary cap on such expenses.
These tax changes will provide a strong incentive for
landowners of all sizes to not only plant and grow trees, but
also to reforest their land after harvest. This is key to
maintaining a long-term sustainable supply of fiber and to
keeping land in a forested state. The Dunn bill does not affect
the manufacturing tax competitive inequities--that will have to
wait for another day. But it does address the reforestation
element and goes a long way to solving that part of the
problem. We believe it moves us from the most taxed to about
the middle of the pack. That will start us down the path back
towards being competitive.
HR 1083, the Reforestation Tax Act, has united this
industry and is endorsed by all elements of the forest products
industry--small growers, organized labor, large and medium
sized forest and paper companies, and regional forestry
associations across the country. I would like to submit for the
record letters of support for the Dunn bill which express the
backing of 98 industry CEOs, the Carpenters Union, and 28
regional and state forestry associations. I might add these
include a resolution of support for HR 1083 from the Texas
Forestry Association. The Reforestation Tax Act recognizes the
unique nature of timber and the overwhelming risks that
accompany investment in this essential natural asset, and
attempts to place the industry on a more even footing with our
competitors.
HR 1083 would reduce capital gains taxes paid on timber for
both individuals and corporations and expand the current
reforestation credit. Because it often takes decades for a
timber grower to recoup his or her investment, it is important
that we look carefully at the long-term return on investment
and the treatment of the costs associated with owning and
planting of timber.
It is our strong belief that this bill represents not only
fair tax policy, but also promotes good trade and environmental
policy, and will help keep the industry competitive as we enter
the next century.
As you begin the process of putting together a tax bill
next month, we urge you to include HR 1083 in the Chairman's
mark. It is a bipartisan bill which is in the best interest of
the environment, the economy, and both corporate and private
landowners who are some of the best environmental stewards in
this country.
Thank you, Mr. Chairman, for this opportunity to testify,
and I would be happy to answer any questions.

Chairman Archer. Thank you, Mr. Moore.
Mr. Andrews.

STATEMENT OF HON. MICHAEL A. ANDREWS, TRUSTEE, NATIONAL TRUST
FOR HISTORIC PRESERVATION; A FORMER MEMBER OF CONGRESS

Mr. Andrews. Thank you very much.
Chairman Archer. Welcome. We would be pleased to receive
your testimony.
Mr. Andrews. I am delighted to have a chance to be here. I
am Michael Andrews, and I am here on behalf of the National
Trust for Historic Preservation. I serve on the board of
trustees and I am here because president Richard Moe could not
be here this afternoon. But I am delighted to have an
opportunity to talk with you about H.R. 1172, the ``Historic
Home Ownership Assistance Act.''
It is a bill that the National Trust believes can be a
powerful tool to encourage revitalization of our inner-city
communities and save precious historic structures. Let me say
at the onset that there are 19 Members of this Committee that
are cosponsors of the bill and some 130 bipartisan members of
the House. Congressman Clay Shaw and John Lewis are the two
leading cosponsors of this really, truly important legislation.
Briefly, let me tell you a little bit about the National
Trust. There are over 275,000 members in the Trust. It was
chartered in 1949 by the Congress to preserve our Nation's
historic structures and heritage. There is nothing more
important than recognizing what needs to be done in our
country's inner cities and historic neighborhoods to maintain
the sense of community and save those structures. This bill
really augments and complements the Federal rehabilitation tax
credit that has been so successful for commercial uses.
For instance, the Federal rehabilitation tax credit, just
in the last year, has leveraged some $2 billion in private
investment in restoring commercial structures for business use;
structures, in many cases, that would have been razed or not
used at all have been put back into active use and most of
them--most, not all, but most of them--find themselves in
inner-city areas. And in the last 20 years, since Federal
rehabilitation tax credit was initiated, $20 billion in private
investment has gone into saving those kinds of structures.
In our city of Houston, for instance, the famed Rice Hotel
would likely not have been restored without the use of that
important tax credit. And what this legislation (H.R. 1172/S.
664) does is focus on families and home ownership. It is very
tightly drawn to say that a young family or a couple that wants
to live in a historic neighborhood, to live in a historic
structure, can receive a 20 percent tax credit to help them
restore that structure. There is a maximum allowable credit of
$40,000 on any given structure. The developers themselves could
rehabilitate the properties, but they have to pass on the tax
credit to the homeowners. Homeowners have to live in the
property itself for 5 years to qualify for the tax credit.
We think these historic areas, much like the way the
commercial tax credit works in empowerment zones, should have
added incentives for poor families to encourage them to restore
structures. In Houston, for instance, again, the fourth ward,
Freedmanstown, where 15 years ago there were well over 400
structures on the National Register for historic sites is a
good example. And today there are less than 200. They are being
destroyed almost daily. Those are primarily homes for single
families. They are not businesses; they are not tall buildings,
as you know, Mr. Chairman. They are homes.
And the way this tax credit is structured is that a young
family or family that wants to restore a historic house and use
that credit, can get a tax credit against the interest rate
that they pay. They can turn it into their mortgage company, if
they don't have enough revenue to itemize their taxes. So it is
tightly drawn not to simply reward a wealthy family in
particular in a wealthy neighborhood, but to try to focus the
credit where it is needed the most, in our country's inner
cities and older suburbs.
This is an important bill. It is modest, relatively modest
in its cost. The revenue estimate is about $678 million over 5
years. It is something that I hope the Chairman will consider
in the context of the tax bill as a very important way to
encourage home ownership in our country's inner cities.
[The prepared statement follows:]

Statement of Hon. Michael A. Andrews, Trustee, National Trust for
Historic Preservation; a Former Member of Congress

H.R. 1172, The Historic Homeownership Assistance Act

I am pleased to have this opportunity to present to the
U.S. House of Representatives Committee on Ways and Means the
views of the National Trust for Historic Preservation on H.R.
1172, the Historic Homeownership Assistance Act, which would
provide a 20 percent income tax credit based on expenditures
related to the certified rehabilitation of an owner-occupied
home in a historic district. The National Trust strongly
supports passage of this legislation, and asks the Committee to
include the provisions of this bill in any tax package it
advances. The National Trust for Historic Preservation,
chartered by Congress in 1949, is a nonprofit organization with
more than 275,000 members. As the leader of the national
historic preservation movement, the Trust is committed to
saving America's diverse historic environments and to
preserving and revitalizing the livability of communities
nationally.
I want to begin my testimony by commending Congressmen E.
Clay Shaw and John Lewis for championing the Historic
Homeownership Assistance Act, which is critical to preserving
historic districts and stabilizing older neighborhoods around
the country. The legislation has 130 cosponsors in the House
from both sides of the aisle, including 19 members of the Ways
and Means Committee. The Historic Homeownership Assistance Act
accomplishes the goals of historic preservation, homeownership
and community revitalization.

I. The Need for a Historic Homeowner Tax Credit

America's historic resources are at risk. In the decades
since World War II, in tragic counterpoint to the growth of the
sprawling new suburbs, we have witnessed the progressive
erosion and loss of older neighborhoods and communities all
across the country. As new development pushes relentlessly into
the countryside, it erodes the prospects for preserving (or
restoring) the economic vitality of our older cities, towns,
and suburbs.
Protecting the Irreplaceable: Historic buildings cannot be
saved unless they have users. They will not have users unless
the areas in which they are located have an economic pulse.
I believe that all Americans are committed at heart to the
preservation of our heritage. As preservationists, we have
developed tools to save the individual treasured building from
the wrecker's ball. We do not always succeed, but we are not
without the means to show the way and make the case for
preservation.
What we lack are the tools to address the problems of
blight and abandonment that threaten entire older neighborhoods
and communities. In the decade from 1980 to 1990, Chicago lost
41,000 housing units to abandonment, Philadelphia 10,000 and
St. Louis 7,000. Smaller communities suffered the same fate,
and the trend continues. Some of these houses were
architectural gems; many were ordinary houses. But taken
together they constituted the physical fabric of a way of life
which is now gone.
The historic homeowners tax credit would complement the
existing historic rehabilitation tax credit for commercial
historic properties. The commercial tax credit has generated
approximately $20 billion in private reinvestment in historic
commercial properties across the country over the past 20
years. This tax credit leveraged more than $2 billion in
private investment last year alone. Unlike the commercial
credit however, only existing and prospective homeowners would
benefit from the new tax credit.
H.R. 1172 is designed to work in a broad range of contexts;
each community is likely to find its own applications. From
small towns in New England and the midwest to large and small
cities on the east and west coasts, as well as older
neighborhoods everywhere, homeowners will be attracted by the
appearance of a different era, but the convenience of living in
older, established neighborhoods.
Clearly, this is no time for massive government programs
which might or might not be successful in helping to preserve
these resources. What is needed is a carefully targeted
incentive to revitalize these communities which will involve a
minimum of government involvement and a maximum of individual
initiative, one that is modest in cost and limited in scope but
that can spark broad private activity. We believe H.R. 1172 is
a fair, feasible and cost-effective answer for revitalizing
older communities, encouraging homeownership, and protecting
historic homes.

II. Eligible Structures

The universe of buildings eligible for the tax credit is a
limited one. Only buildings that are listed in the National
Register of Historic Places, are contributing buildings in
National Register Historic Districts or in nationally-certified
state or local districts, or are individually listed on a
nationally-certified state or local register would qualify. The
National Park Service has estimated that slightly in excess of
one million buildings nationwide presently fall in those
categories.
To insure that their historic character is preserved,
buildings receiving the credit would have to be rehabilitated
in accordance with the Secretary of the Interior's Standards
for Rehabilitation. However, the bill provides that
certification of compliance may be performed by states or even
localities under cooperative agreements entered into with the
Secretary of the Interior. In addition, the bill authorizes the
states to charge processing fees, the proceeds of which would
be used to fund the costs of processing the applications for
certification.

III. Costs and Benefits

Because of the constraints on eligibility that I have
described, the revenue implications of H.R. 1172 would be
modest. Nevertheless I believe it can make a real difference in
communities all across the county--from decaying small towns to
threatened big-city neighborhoods. By providing an incentive
for Americans at all income levels to invest in the
rehabilitation of deteriorated buildings and become home owners
in older neighborhoods and communities, it can provide the
following benefits:
saving invaluable historic resources, which would
otherwise be lost through decay, abandonment and demolition.
stabilizing and rescuing endangered communities
through the infusion of new home owners, who will make a
commitment to the enhancement of community life through their
purchase of a home.
providing cities and towns with the chance to
strengthen their tax bases by attracting middle-income and more
affluent residents.
creating jobs and stimulating economic activity in
areas where economic opportunities are scant.

IV. Major Provisions of H.R. 1172

Rate of Credit:

The credit, which would equal 20% of qualified
rehabilitation expenditures, would be available to homeowners
in condominiums and cooperatives as well as single-family
homes. It could be used by the do-it-yourself rehabber, or
someone who purchases a home rehabilitated by a developer. In
the latter case, the credit would accrue not to the developer,
but to the purchaser of the home.

Maximum Credit, Minimum Expenditures

The maximum credit allowable would be $40,000 for each
principal residence, subject to Alternative Minimum Tax
provisions. As with the current credit, rehabilitation must be
substantial--the greater of $5,000 or the adjusted basis of an
eligible building, with an exception for buildings in census
tracts targeted as distressed for Mortgage Revenue Bond
purposes under I.R.C. Section 143(j)(1) and Enterprise and
Empowerment Zones, where the minimum would be $5,000. At least
five percent of the qualified rehabilitation expenditures would
have to be spent on the exterior of the building.

V. Homeownership and Historic Preservation

Central to the American dream is the desire to own one's
own home. But home ownership is more than just a personal goal;
by giving residents a true stake in their community, it
promotes the qualities of neighborliness needed to heal and
revive threatened and decaying residential areas.
The existing Federal tax credit for historic rehabilitation
is not available to homeowners, but applies only to commercial
property or other property held for the production of income.
H.R. 1172 fills that gap. Moreover, because the tax credit that
H.R. 1172 would create is limited to persons who occupy the
building for which the tax credit is claimed as their personal
residence, there are no tax shelters, no ``passive losses'' and
no syndications. This provision is in contrast the to the
existing rehabilitation tax credit for commercial historic
properties. The historic homeowners tax credit only acts is an
incentive purely for homeowners and homebuyers.

VI. Opportunities for Low and Moderate Income Home Buyers

There is a widespread misperception that historic districts
are places where only upper-income families live. While it is
true that some of the better known districts on the National
Register have been rehabilitated by or for affluent people, it
is equally true that the older housing stock in the United
States tends far more to be occupied by families with more
modest incomes. Indeed, according to an analysis of 1990 census
data, 29% of the 8,700 National Register historic districts lie
within or contain tracts with poverty rates greater than 20%.
This legislation has been drafted to provide homeownership
opportunities in rehabilitated historic buildings to Americans
with a broad spectrum of income levels. For those who do not
have sufficient income to be able to use a tax credit, the bill
creates a Historic Rehabilitation Mortgage Credit Certificate
that can be used to reduce the interest rate on their mortgage
loan.
Rehabilitation would have to be substantial. As I stated
earlier, the bill would follow existing law by requiring a
minimum investment in qualified rehabilitation expenditures
equal to the greater of $5,000 or the adjusted tax basis of the
building. However, an exception would be made for economically
distressed census tracts where the minimum investment required
would be $5,000. Taxpayers at all income levels would be
permitted to use the credit, but the amount of credit available
to a homeowner would be limited to $40,000.
Consider, as an example, a hypothetical home rehabilitated
by a developer which qualifies for the credit. Assume that the
home has a selling price of $150,000 and contains $100,000 in
qualified rehabilitation expenditures. The credit on this home
is $20,000 (20% of $100,000). This would more than cover a down
payment of 10% on the home. In this case the credit would have
the effect of reimbursing the home purchaser for the down
payment. Although this example involves a developer, the credit
could also be used by an individual homeowner to help defray
the cost of rehabilitating his current or newly-purchased
residence.

VII. Illustrations

As I stated earlier, the Historic Homeownership Assistance
Act benefits families with a broad spectrum of incomes. Allow
me to provide two examples:
Barrington Historic District in Barrington, Illinois, is a
historic commuter suburb of Chicago consisting of Victorian
country homes. Barrington is a much-desired place to live.
While Barrington's popularity has encouraged investment in the
historic district, it has also invited problems. Some homes
have been destroyed or converted drastically through
speculation, while others have been boarded up while owners
hold out for property values to increase. The Historic
Homeownership Assistance Act would spur further revitalization,
and help prevent Barrington's popularity from ruining the very
qualities that make the town so special--and strengthen the
sense of community of Barrington.
Mount Morris Park Historic District in Harlem consists of
19th Century townhouses, originally bought by prosperous white
middle-class households. Today, Mount Morris is a growing
neighborhood, with an economically diverse African-American
population. One district homeowner, Josephine Jones, has spent
the last decade reconverting her 1880s townhouse from a
boarding house to a single-family home. Because she is a
retiree, she has limited tax liability. Ms. Jones wants to
complete her rehabilitation at a cost of $200,000. With the
Historic Homeownership Assistance Act, Ms. Jones could receive
a Mortgage Credit Certificate for $40,000 (20 percent of
qualified rehabilitation expenditures). She could transfer the
certificate to the mortgage lender in exchange for a reduced
interest rate on her home mortgage loan. A local bank, more
likely to grant her a loan with the backing of the certificate,
could reduce its own federal income tax by $40,000.

VIII. Conclusion

When preservation begins in a community, good things
follow. H.R. 1172 is not a cure-all for ailing communities.
Change for the better, if it is to come, will be incremental.
It will result from decisions made by individual Americans, one
family at a time. But H.R. 1172 can be a spark that ignites
those private decisions to the benefit of our families, our
communities, and our heritage as Americans. On behalf of the
275,000 members of the National Trust for Historic
Preservation, I strongly urge the prompt enactment of this
legislation.

Chairman Archer. Thank you, Mr. Andrews.
Our next witness is Mr. Wolyn. Welcome. You may proceed.

STATEMENT OF MICHAEL A. WOLYN, EXECUTIVE DIRECTOR, NATIONAL
ALLIANCE OF SALES REPRESENTATIVES ASSOCIATIONS, ATLANTA,
GEORGIA

Mr. Wolyn. Mr. Chairman, Members of the Ways and Means
Committee, my name is Michael Wolyn. I am executive director of
the National Alliance of Sales Representatives Associations or
NASRA. And, on behalf of the 10,000 members of NASRA, I want to
thank you for the opportunity to speak to you today and discuss
a tax relief issue of great concern to that membership.
The issue that we would like to address impacts every sales
representative and other independent businessowner who must
travel to sell for a living. The issue I would like to address
is the tax limiting the tax deduction for meals. Current tax
law allows the deduction of a business meal at half its value,
not 100 percent, as a legitimate business deduction, but 50
percent. Many of our member groups have asked legitimate
questions. If the meal is a true business meal or a true
business-related expense, why isn't it fully deductible?
Most of our members do not have formal offices. Most work
out of home offices. When a rep is working his or her
territory, they are technically on the road. Many are out 150
to 170 nights a year. One of the methods of dealing with their
customers, the small and large retailers they service, is to
get them out of their store, out of their stock room or to get
them into an area where a relationship can be developed. And,
more often than not, that relationship is developed in a local
coffee shop or a bagel shop.
I have got an example for you. One of the gentlemen you may
well know, Bob Lantour out of Houston, Texas, who,
unfortunately, can't be here because his roof blew off last
week in a storm, indicates to me by letter that he was out 137
nights last year and had 411 meals. Now I posed the question:
411 meals? And he says, yes, I sometimes eat five times a day.
Well, before I became executive director of this body, I
was a traveling sales representative. I traveled the 13 western
States based out of San Francisco, California. And I was out
more than 200 nights a year and, quite literally, had more than
5 meals a day. I would build my business around meals. I would
have coffee in the morning. Breakfast, if you will. Coffee and
danish. I would have a mid-morning break where I would take a
retailer out of a store.
My best story, I think, that I can relate when I was
drafting the testimony, speaking to some of the folks up here.
I used to be a manufacturer out of Hong Kong and this one
particular story, I flew in from Hong Kong to New York in
advance of a market week, had to go, got in at 5 in the
morning, went to the New York Athletic Club from there to Chock
Full O'Nuts, if you have ever been to Chock Full O'Nuts on
Broadway. Didn't go to have coffee, went to have a business
meeting. On that particular day, according to my record, I had
seven meals. None of which, by the way, for sustenance. All of
which were for relationship building.
And my point, simply, is this. That this is a, for people
that do not have a marketing budget or promotional budget, this
is, in fact, their marketing and promotion budget. I know this
conduct, business may seem strange--five meals a day--but the
average ticket is not enormous. We are looking at meals--the
National Restaurant Association suggest that the average meal
is about $11.00 a meal. Dinner is about $22.00.
To date, two bills have been introduced on this issue that
meet the stated goal of helping small business. H.R. 1195,
which was introduced by Congressman McCrery--we appreciate that
and thank you very much--has been cosponsored by
Representatives Tanner, Foley, Farr, Ramstad, Dunn, Weller,
Jefferson, and Shaw. In the Senate, the companion language has
been introduced by Senator Breaux. Identical language is also
included in H.R. 2087, a bill that has been introduced by
Congressman Talent, Chairman of the Committee on Small
Business.
Both bills target the increased meal deduction to small
business with less than $5 million in gross sales. The proposed
legislation would increase the meal deduction limitation to 80
percent by 5 percent increments over the next 6 years and we
would appreciate your consideration for this bill.
[The prepared statement follows:]

Statement of Michael A. Wolyn, Executive Director, National Alliance of
Sales Representatives Associations, Atlanta, Georgia

Mr. Chairman, members of the Ways and Means Committee, my
name is Michael A. Wolyn, Executive Director of the National
Alliance of Sales Representatives Associations, or NASRA. On
behalf of the 10,000 members of NASRA I want to thank you for
the opportunity to speak before you today to discuss a Tax
Relief issue of great concern to NASRA members.
NASRA is a coalition of sales representative organizations
founded by the Bureau of Wholesales Sales Representatives and
the International Home Furnishings Representatives Association.
NASRA represents the interests of more than 10,000 independent
wholesale sales representatives in the apparel, home
furnishings, gift, western, ski/outdoor, and footwear
industries. A full list of NASRA member groups is included in
this statement.
NASRA is comprised solely of national sales representative
associations. These associations are generally made up of local
chapters, which conduct regional trade shows in their
respective industries. These trade shows bring together
hundreds of representatives and thousands of retailers, making
them a significant contributor to the local economies.
NASRA's sole objective is the advocacy of the legislative
interests of its member organizations. On the federal level,
NASRA promotes economic and tax policies that level the playing
field on which sales representatives compete. At the state
level NASRA has achieved a remarkable record of successfully
advocating state laws protecting sales representatives right to
collect earned commissions.
The typical NASRA member is a self-employed business owner.
NASRA members represent the lines of multiple manufacturers and
participate in regional trade shows in cities throughout the
US, often comprising a territory of up to seven states.
Usually paid exclusively by commission, these sales
representatives pay all business expenses out-of-pocket and are
not reimbursed by their principals. They typically drive 30,000
business miles per year and spend approximately 150 nights per
year in hotels. While compensation levels vary, the average
member grosses between $80,000 and $100,000 per year, and
expends approximately $30,000 per year in business-related
expenses.
At the outset I would like to compliment the members of
this Committee. In recent years the Ways and Means Committee
has proposed changes in several areas of the tax law that are
of great benefit to the sales representative community.
Legislation clarifying the home office deduction rules and
making permanent and increasing the health insurance deduction
for self-employed business owners are of substantial benefit to
sales representatives, and they are grateful to you for these
tax rule changes.
Today, I wanted to address a provision that impacts every
sales representative and other independent business owners who
must travel to sell for a living. The issue I would like to
address is the tax rule limiting the tax deduction for meals.
It is an issue that several members of this committee have
become concerned over and it is one that we hope Congress can
redress this year.

BACKGROUND

As a part of the Tax Reform Act of 1986 Congress determined
that the meal deduction should be reduced from 100 percent to
80 percent. The General Explanation of the Tax Reform Act of
1986 prepared by the Joint Committee on Taxation, stated the
following rationale for limiting the meal deduction.
``The Congress believes that prior law, by not focusing
sufficiently on the personal-consumption element of deductible
meal and entertainment expenses, unfairly permitted taxpayers
who could arrange business settings for personal consumption to
receive, in effect, a Federal tax subsidy for such consumption
that was not available to other taxpayers.
The taxpayers who benefit from deductibility tend to have
relatively high incomes, and in some cases the consumption may
bear only a loose relationship to business necessity.''
In 1993 Congress further limited the deduction by reducing
it from 80 percent to 50 percent. The rationale by congress for
further reducing the meal deduction limits presumed a bias that
the person using the meal deduction was a wealthy corporate
executive and that the meal was incidental to the business
purpose at best.
The substantiation rules, while slightly revised, provided
no increased reliability to Congress that the meal deduction
incurred was a valid tax deductible business expense. For
purposes of comparison, large companies weren't asked to
relinquish any portion of their advertising budgets nor a
portion of their office rents that applied to lavish conference
rooms for client meetings.

HOW SALES REPRESENTATIVES USE MEALS IN THEIR BUSINESS

An independent sales representative like any other
salesperson must go out and meet the person they are selling
to. To do that they must go to the customer's location in small
towns and on country roads. On average sales representatives
travel 30,000 miles per year and spend an average of 150 days
and nights on the road.
Having taken the time to go to the customer's business,
they seek to find an opportunity to build a relationship with
the buyer. They must then find a way to meet one on one with
the buyer, away from distractions like CNN, other calls,
employee questions, etc.
This is normally done in a moderately priced local
restaurant where both individuals can have a quiet focused
discussion on products and prices. On the road this restaurant
is the sales rep's conference room. On the road this is the
rep's advertising budget. On the road this is the way business
is done.

ADVERTISING & CONFERENCE ROOMS

Most sales representatives work out of their homes.
Therefore they lack a formal conference room for client
meetings. Yet they are expected to have a place to meet with a
prospective client. In addition sales representatives do not
have large advertising budgets with which to create goodwill
and name recognition. Advertising of this nature is not cost
effective and misses most of the real target market.
The conference room for the rep on the road is the local
restaurant, the advertising budget is the time that a rep can
get a buyer to spend one on one time with him or her to view
the products that they represent.

CURRENT RESEARCH ON WHO USES MEAL DEDUCTIONS

In 1998 a study on the use of the business meal deduction
confirmed several facts widely understood by sales
representatives who are major users of the meal deduction as a
way of doing business.
The research done for the National Restaurant Association
revealed that:
One fifth of business meal users are self-employed.
Over two thirds of the business meal spenders have incomes
of less than $60,000 and 37 percent have incomes below $40,000.
Low to moderately priced table service restaurants are the
most popular types for business meals, with the average check
equaling less than $20, and occur throughout the US, with 50
percent occurring in small towns and rural areas.
The average check size was $11.60 for lunch and $22.52 for
dinner. These facts illustrate that the primary user of the
business meal who is putting out the cost of the meal from his
or her own pocket, are not tax abusers but business people
expending business capital for a business purpose.
Clearly, the rationale that limiting the meal deduction
would only harm large companies for whom a meal as
entertainment was merely incidental to any business purpose, is
inaccurate. In reality, the limitation inadvertently harms many
small businesses, and especially the independent sales
representative.
Restricting the meal deduction is also discriminatory
against those small business owners for whom the meal is both
advertising and conference room facility. It is especially
interesting to note that an employer can reimburse an employee
for a meal permitting the employee to entertain, yet a self-
employed business owner is limited to a 50 percent deduction
for entertainment. This creates an imbalance between the
independent sales representative and the employed sales
representative.
It does seem that the rules are stacked in favor of the
large company to keep small business owners at a competitive
disadvantage.

LEGISLATIVE PROPOSALS

To date two bills have been introduced on this issue that
meet their stated goal of helping small business. HR 1195, was
introduced by Congressman McCrery, and has been cosponsored by
Representatives Tanner, Foley, Farr, Ramstad, Dunn, Weller,
Jefferson, Johnson, and Shaw of the Ways and Means Committee.
In the Senate, companion language has been introduced by
Senator Breaux.
Identical language is also included in HR 2087, a bill that
has been introduced by Congressman Talent, Chairman of the
Committee on Small Business. Both bills target the increased
meal deduction to small businesses with less than $5 million in
gross sales. The proposed legislation would increase the meal
deduction limitation to 80 percent by 5 percent increments over
the next six years.
Similar legislation has been enacted on behalf of employees
are limited to the number of hours they may work by federal
rules such as truckers and airline pilots. This proposal
mirrors the same concept.

ECONOMIC IMPACT

This hearing is focused on tax relief to sustain a strong
economy, and information that supports a positive economic
effect from a tax benefit is important. The National Restaurant
Association has estimated the economic benefit of moving the 50
percent meal deduction to 80 percent. Based on data produced by
the Bureau of Economic Analysis, they estimate that this change
would produce between $4.2 and $5.2 billion in economic impact
across the country.
We do know that for a sales representative the meal
deduction is a cost of doing business, not a tax dodge. It is
as much a cost of doing business as buying a computer or a car
for travel to meet with customers.

CONCLUSION

Once again, I appreciate the opportunity to appear before
you today. We strongly believe that enacting the proposal HR
1195, would be positive tax relief that would benefit many
independent sales representatives, and many other small
business owners.
We believe that restoring this provision would address a
competitive disadvantage that they have had to deal with since
1986. We encourage the members of this committee to include
such language in any tax relief legislation enacted this year.

APPENDIX

NASRA MEMBERSHIP

Bureau of Wholesale Sales Representatives
International Home Furnishings Representatives Association
National Golf Sales Agents
Ski & Outdoor Sales Representatives Association
Western Winter Sports Sales Representatives Associations
New England Ski Sales Representatives Association
Eastern Ski Sales Representatives Association
Mid West Ski Sales Representatives Association
Southeast Winter Sports Association
Western Shoe Association
Boot & Shoe Travelers of New York
National Association of Selling Agents
Professional Representatives Organization
Independent Sales Association

Chairman Archer. Mr. Wolyn, thank you. As I listen to the
kind of life that you have led and the amount of sustenance
that you have taken in every day, I wonder why you are not 300
pounds. [Laughter.]
Mr. Wolyn. Thank you, Mr. Chairman.
Chairman Archer. Mr. Nemtzow.

STATEMENT OF DAVID NEMTZOW, PRESIDENT, ALLIANCE TO SAVE ENERGY;
ON BEHALF OF COALITION FOR ENERGY-EFFICIENT HOMES

Mr. Nemtzow. Thank you, Mr. Chairman. I am David Nemtzow,
and I am president of the Alliance to Save Energy. Thank you
very much for the opportunity to testify today.
I am testifying today on behalf of the Coalition for
Energy-Efficient Homes. This is an ad hoc coalition that we
have created for one single purpose: to support Congressman
Thomas on H.R. 1358, the Energy Affordable Home Act. If it
pleases the Chairman, I would like to include for the record
the more than 50 companies that are members of our coalition,
many of whom are represented here today. And if the Chairman
would indulge me, my colleagues are right behind me,
representing the National Association of Home Builders;
representing the Nation's leading insulation manufacturers;
Owens Corning Window Manufacturers; and the Alliance to Save
Energy. And it is a very broad coalition designed to help this
one bill.
[The information follows:]

Alliance Associates, 1998

3M
AlliedSignal
American Gas Association
American Gas Cooling Center
Andersen Corporation
Anonymous
Armstrong International
AT&T
Battelle/PNNL
Bear Stearns and Company
Brookhaven National Laboratory
California Energy Commission
Cardinal IG
CertainTeed Corporation
City of Austin/Austin Energy
Dewey Ballantine
Dow Chemical
Edison Electric Institute
E-Mon
Energy Performance Services
Enron Corporation
Fannie Mae Foundation
Florida Solar Energy Center
Gas Research Institute
Geothermal Heat Pump Consortium
Hagler Bailly, Inc.
Honeywell
IBM
Intercontinental Energy Corporation
Iowa Energy Center
Johns Manville
Johnson Controls
Lawrence Berkeley National Laboratory
Libbey-Owens-Ford
Lithonia Lighting
Los Angeles Department of Water & Power
MagneTek
National Insulation Association
National Renewable Energy Laboratory
New England Electric System
New York State Energy Research & Development Authority
Nexus Energy Software
North American Insulation
Manufacturers Association
Northern States Power Company
Oak Ridge National Laboratory/
Lockheed Martin Corporation
Ontario Power Generation
OSRAM SYLVANIA
Owens Corning
Polyisocyanurate Insulation
Manufacturers Association
Public Service Company of New Mexico
Sempra Energy
Sensor Switch
Society of the Plastics Industry
Polyurethane Division
Solar Energy Industries Association
Southern California Edison
Spirax Sarco
Swagelok
Tennessee Valley Authority
Texas A&M University
Energy Systems Laboratory
Thermo Electron
Washington Gas
Watt Stopper
Whirlpool Corporation
Xenergy

Mr. Nemtzow. Let me just say that the Alliance to Save
Energy was founded in 1977 on a bipartisan basis by Senator
Chuck Percy and Senator Hubert Humphrey. And they invited their
colleagues in the Congress and in business to work together to
promote energy efficiency. And today we are chaired by Senator
Jeff Bingaman and Jim Jeffords on the Senate side and by your
colleagues John Porter and Ed Markey and continue our tradition
of bipartisan support for energy efficiency.
We are here today to testify in the strongest support for
Congressman Thomas' bill, the Energy Efficient Affordable Home
Act, H.R. 1358. It is also cosponsored by several Members of
this Committee and I want to thank Mr. Herger and Mr. English
for their cosponsorship. Mr. Rangel also is a cosponsor as well
as several other Members. And I would also like to acknowledge
Mr. Matsui who, on behalf of the administration, is introducing
a similar bill, somewhat different from ours, but with similar
goals. And what these Members of Congress have in common is a
commitment to work to provide energy efficient homes for
America's families.
I know you have heard a lot of witnesses today and I know
you are tired and I very much appreciate your attention. So I
will try to sweeten the deal for you by saying, of all the
witnesses you hear today, I may be the only one who will
promise you and can deliver to you--are you ready--affordable
housing for American families, cleaner air quality, lower risk
from foreign oil, and an opportunity to cut bills nationwide
and stimulate the economy. So I know you have heard a lot of
witnesses. Let me tell me how we are going to do that and why
you can be confident in that.
H.R. 1358 would provide a tax credit for new and existing
homes that significantly upgrade their energy efficiency. For
new homes that met these tight standards--and these standards,
Mr. Chairman, are 30 percent beyond what is known in my
business as the IECC, the International Energy Conservation
Code. And the IECC code is already quite stringent. So 30
percent beyond that is really a tough standard. Only about 1
percent to 2 percent of the homes in the country this year even
come close today. And it would provide a $2,000 credit for
homes that can meet that new tough standard. It would be around
for 5 years and then sunset after 5 years. And we have built in
provisions to make sure that this credit is verifiable and that
this Committee can be confident that you are getting your
money's worth.
Why are we doing this? The reason is quite simple. By
making homes more energy efficient, we are doing several
things. One is we are making housing more affordable for
American families. Energy is the second largest cost of housing
in this country. After the rent or the mortgage, energy is
number two. It is ahead of security. It is ahead of insurance.
It is ahead of landscaping. And so by lowering energy bills and
by lowering utility bills through more insulation or better
windows or a better furnace, we are lowering Americans' utility
bills and making their homes more affordable for them for years
to come.
Number two, we are improving the air quality. Why do I say
that? Because homes pollute. We don't notice it the way we
notice it with cars, but when homes use energy and they burn
that energy, whether it is at a power plant or in the basement
in the fuel oil tank, there is pollution that is created. In
fact, the average home in America produces twice the pollution
of the average car. If we cut that, we will be able to lower
the pollution, whether it is climate pollution or local urban
pollution.
I don't have to tell you, Mr. Chairman, about our dangerous
dependence on foreign oil. Do you know a lot of our oil imports
are for home heating oil? We can cut that.
And, finally, the reason this bill is so important and why
we thank Congressman Thomas and his colleagues for their
leadership, is that homebuilders are trying to do the right job
for America. They are trying to build good homes at a good
price. But the reality is that homebuilders don't pay the
utility bills. They build the house. They want it to be a good
quality house. But they don't pay the bills. It is the home
buyer who pays the bills. So by providing this modest tax
credit that is verifiable, you are bridging the split
incentive. You are letting the homebuilders focus on what they
are good at, building a good quality home that is affordable,
because of the credit. And you are helping American families,
especially those middle income families make their homes more
affordable for years to come.
I think you will find it is a winner for American families.
It is a winner for this Committee. Thank you again for the
opportunity to testify on behalf of the coalition.
[The prepared statement follows:]

Statement of David Nemtzow, President, Alliance to Save Energy; on
behalf of Coalition for Energy-Efficient Homes

Mr. Chairman and Members of the Committee, thank you for
the opportunity to testify before you today on behalf of the 50
member organizations of the Coalition for Energy-Efficient
Homes regarding H.R. 1358, sponsored by Rep. Bill Thomas, the
Energy Efficient Home Act of 1999.
My name is David Nemtzow. I am President of the Alliance to
Save Energy, a bi-partisan, non-profit coalition of business,
government, environmental, and consumer leaders dedicated to
improving the efficiency with which our economy uses energy.
Senators Charles Percy and Hubert Humphrey founded the Alliance
in 1977; it is currently chaired by Senators Jeff Bingaman and
James Jeffords, as well as your colleagues, Representatives
John Porter and Ed Markey.
Seventy companies and organizations currently belong to the
Alliance to Save Energy. If it pleases the Chairman I would
like to include for the record a complete list of the
Alliance's Board of Directors and Associate members, which
includes the nation's leading energy efficiency firms, electric
and gas utilities, and other companies providing cost savings
and pollution reduction to the marketplace.
I am pleased to be testifying today on behalf of the
Coalition for Energy-Efficient Homes, a group of companies,
trade associations, and non-profit groups united in the goal of
seeking incentives for the construction of homes that are
better for the environment, more affordable, and more
comfortable. This broad collection of members is composed of
energy-efficiency advocates, home builders, electric utilities,
and building products manufacturers. Prominent members of the
Coalition include the National Association of Home Builders,
the North American Insulation Manufacturers Association, the
Andersen Windows Corporation, Cardinal IG, the Polyisocyanurate
Insulation Manufacturers Association, and the Edison Electric
Institute. I would also like to include for the record a list
of the current members of this group.
The Alliance to Save Energy has a long history of
researching and evaluating federal energy efficiency efforts.
We also have a long history of supporting and participating in
efforts to promote energy efficiency that rely not on mandatory
federal regulations, but on partnerships between government and
business and between the federal and State governments.

I. INTRODUCTION

Today's Testimony

Mr. Chairman, I am here today to address the need for promoting
energy-efficiency in residential construction and existing homes. The
Coalition for Energy Efficient Homes strongly supports H.R. 1358, the
Energy-Efficient Affordable Home Act of 1999, sponsored by your
colleague, Rep. Bill Thomas. We believe that this legislation will
provide a sound plan for substantially increasing the energy-efficiency
and affordability of American homes by providing tax credits to home
builders for constructing highly-efficient homes, and to home owners
for upgrading the efficiency of their existing houses.
In addition, I will elaborate on the continuing need for increasing
energy-efficiency in the U.S. and, Mr. Chairman, the forceful role that
energy-efficiency has already played in bolstering our economy and
protecting our environment.

Tax Credits: A Mechanism for Change

For as long as the current tax system has been in place in the
U.S., policy-makers have used tax credits to promote activities deemed
desirable for the public good. Whether investment tax credits or the
earned income credit, Congress has extensively used this mechanism to
provide financial incentives for public goals. We support the extension
of this practice to fortify the energy-efficiency of our nation by
enlisting home builders and homeowners in active participation.

II. THE ENERGY-EFFICIENT AFFORDABLE HOME ACT OF 1999

Mr. Chairman, we have nothing but strong praise today for
Rep. Thomas, and his foresight and concern in offering H.R.
1358. We have taken up the banner for his legislation and are
building strong support for it. The Energy Efficient Affordable
Home Act currently has 24 cosponsors, including several members
of the Committee, such as Congressmen Rangel, Ramstad, Herger,
English, Cardin, and Weller.
However, Mr. Chairman, Mr. Thomas' bill is not the only
proposal circulating which would provide tax credits for highly
efficient homes. Last year, Rep. Matsui worked with President
Clinton to offer a credit for efficient new homes and we
understand that an updated version is soon to be introduced. As
we will explain later, we differ with the qualification level
in last year's Matsui bill. However, the Coalition for Energy
Efficient Homes still strongly commends both Congressman Matsui
and President Clinton for their fine efforts to address and
raise attention for this issue.

Why Do We Need Tax Credits for Energy Efficient Homes?

Mr. Chairman, tax credits for energy-efficient homes will
address several key areas of concern for Americans. Frankly,
Mr. Chairman, increasing the energy-efficiency of the economy
is an ongoing process for the nation, desirable for its
significant benefits to the economy, the environment, national
security and our competitiveness internationally. Increased
energy-efficiency has already resulted in a windfall for the
U.S. economy, which I will discuss in more detail later. As
well as providing a macro-economic boon, energy efficiency is a
decentralized way for average Americans to gain better
financial control of their lives.
H.R. 1358 Improves Home Affordability--This tax credit
would make houses more affordable for average American
families. In many homes, energy is the second largest component
of the total cost of housing, so cutting energy and utility
bills can make homes dramatically more affordable for
Americans, especially for moderate and low-income households.
While some mortgage lenders and underwriters have programs that
make loans based on the lower energy costs of efficient homes,
the reality is that home buyers and home builders alike need a
break up front to lower the first cost of efficient housing.
Home-ownership for all who desire it has long been a public
policy goal in the U.S. and this legislation would further that
goal.
H.R. 1358 Improves Environmental Quality--Mr. Chairman,
investments in energy-efficiency provide a no-regrets strategy
for reducing emissions which carries huge ancillary benefits to
Americans, regardless of what one thinks of climate change.
Frankly, energy-efficiency has been noted in a number of
studies as a potentially key solution to the problem. Although
the Alliance to Save Energy does not endorse any specific
targets or timetables for emissions reductions, we believe that
if reducing carbon emissions is a national goal, investment in
energy-efficiency provides a non-regulatory, decentralized,
cost-effective way to do that. In addition, the Alliance
believes if a scientific and political consensus for action
should develop down the road, early investment in energy-
efficiency provides a cost-effective insurance policy that can
help make sure that we are still in a position to affect the
problem when we decide to act.

H.R. 1358 Increases National Security--Mr. Chairman, we went to
war in large part over oil in 1991 and we bombed Iraq again
last year. Aside from transportation, our largest household use
of oil is for home heating. Increasing the energy-efficiency of
new and existing homes may be the best way to reduce our more
than 50 percent dependence on foreign oil supplies, next to
raising automobile fuel economy standards--a politically
difficult alternative. This legislation, by lowering our per
capita national consumption of home heating oil will help in
the battle to maintain our lifestyle while reducing our
vulnerability to oil supply fluctuation.
H.R. 1358 Increases Consumer Awareness--Focus groups
conducted by the Alliance to Save Energy revealed that a large
number of Americans are unaware of either the scope or the
effect of energy use in the home. In fact, many of the people
we spoke with were shocked to learn that their home generates
twice as much air pollution as their car on a yearly basis. Yet
our studies and other research shows that the vast majority of
Americans consider themselves environmentalists and want to do
the right thing. H.R. 1358 will provide needed incentives for
homeowners to become better educated about their energy
situation and enable them to act in the most economically wise
and environmentally sound manner. Currently the options for
buying energy-efficient homes are limited, as I will now
discuss.

Tax Credits for Energy-Efficiency: A Checkered Past?

As you know, we are not the first group to advocate tax
credits for improving energy-efficiency in homes. Credits for
energy-efficient equipment spawned by the energy crises of the
1970s gave a broad credit for items that might loosely be
construed to reduce energy-use in homes. Those credits have
been regarded by many observers as having cost the Treasury far
too much for the actual energy-efficiency gains achieved. In
fact, Mr. Chairman, you could basically enclose your hardware
store bills with your tax return and that credit for nearly any
home improvement that could broadly be construed as improving
efficiency.
H.R. 1358 represents a generation of progress from those
initial attempts at providing incentives for home energy-
efficiency. This bill offers a credit for very specific
measures of achievement. It draws from the work of scores of
experts over the past 20 years who have painstakingly
determined what constitutes an energy-efficient home. Back in
1980, there was no such consensus. We have the ability to act
decisively today to make our homes more affordable, less
polluting, and more comfortable--and document it in a precise
and reliable fashion.
Mr. Chairman, even the greatest ideas often take time to be
reconsidered, debated and improved. The plan for providing tax
credits for energy-efficient homes is no exception. As we
speak, we are wrapping up several months of hard work to try
and improve the mechanisms in H.R. 1358, and working with Rep.
Thomas to incorporate those changes. The input of
environmentalists, home builders, home energy raters, state
officials and others has been critical to what we believe will
reduce revenue-impact, reduce the possibility of free riders
and fraud, and ultimately broaden the support for this bill.
Where applicable, the changes we will be recommending to Rep.
Thomas will be noted.

Major Provisions of H.R. 1358:

New Homes Tax Credit--Mr. Chairman, 1.5 million homes are
built each year. The Alliance to Save Energy estimates that
less than 2 percent of those are built to a what we would call
a high level of energy-efficiency, achievable with technology
available at your local Home Depot. We now measure energy-
efficiency levels against the International Energy Conservation
Code (IECC) of 1998. The IECC is a model, consensus code
developed by the private sector to employ existing, off-the-
shelf technology to produce a reasonably energy-efficient home.
The IECC corrects for climatic differences throughout the
country.
H.R. 1358 provides that between the years 2000 and 2004, a
tax credit of $2000 may be claimed by a home builder for
construction of an energy-efficient home that exceeds the 1998
IECC by 30 percent or more. Mr. Chairman, moving 30 percent
beyond that code constitutes a highly efficient house. In
addition, Mr. Chairman, the Alliance estimates that the average
increased cost of reaching this level of efficiency in a home
costs $3000, so that a 5-year federal incentive would leverage
significant additional resources. The Alliance estimates that
these measures will save the owner of an average new home
approximately $250 per year.

Builder Credit Vs. Buyer Credit: The Chicken Versus the Egg

While my political instincts see merit in providing a tax
credit to home buyers, I am strongly supportive of a builder
credit. Unless highly-efficient houses are built in greater
numbers than they are today, a tax credit for these homes will
be highly underutilized. Without offering an incentive for
construction, rather than sale of the house, there simply won't
be enough houses available for people to buy, to have any
effect on our housing stock.
It brings me back to my earlier question of why highly
energy-efficient homes aren't being built. Frankly, many if not
all home builders are attentive to at least two things: keeping
homes affordable and responding to customer demand. As an
energy-efficiency advocate, it pains me to say this, but most
consumers do not yet pay as much attention as they should to
the energy-efficiency of a new home. While these concerns are
essential for how comfortable their house will be and how much
it will cost to live in on a year-to-year basis, a buyer's eye
is often more swayed by the jacuzzi tub or Corian countertops
than by the insulation level in the walls.
Giving the builder a tax credit gets their attention, gives
them a chance to upgrade their building practices, and to use
advanced energy-efficiency as a sales tool, addressing three of
the biggest obstacles to improving the energy-efficiency of our
nation's housing stock in a significant way. While a credit for
the buyer might be more attractive politically, it simply won't
do the job as well. With the builder credit, the typical tract
builder putting up a development of 100 townhouses will be
motivated to build higher efficiency into them up front--
meaning more homebuyers, and more moderate-income families--
will get the real benefit of the credit, which is lower energy
bills.

How is a House Certified as Energy Efficient?

This is one area almost certain to be markedly affected by
changes to the bill. Those changes will provide two paths to
the builder for certifying his homes for qualification for the
credit.
First, we recommend that there be a prescriptive path that
sets out very specific values for a number of areas of the
home, such as windows, wall insulation, foundation insulation,
and other areas of the building envelope. The second suggested
path is a performance option that would allow an accredited
home energy rater to come in and certify the house for annual
energy performance 30 percent beyond the IECC. Bringing in a
professional to assess the home allows a builder to exploit
particularly effective efficiency measures without having to
follow a prescriptive path in every area of the house. We
believe that a combination of the two options gives the builder
the maximum flexibility while assuring that qualifying homes
will reach the required efficiency level.

Why Not 50 percent Above IECC ... or More?

Last year's proposal by Rep. Matsui contained a very
similar credit as H.R. 1358 does, only it required that
qualifying homes be 50 percent beyond the model code. We have
three major differences with a 50 percent approach. First, we
believe that a 50 percent improvement is not achievable by the
average builder. Second, requiring houses to be 50 percent
beyond the IECC will severely limit the number of builders that
become interested in qualifying, because the cost of that extra
20 percent will further outstrip the size of the credit. Third,
the awarding of the credit to the home buyer will fail to
provide the incentive to builders needed to result in the
construction of a significant number of energy-efficient homes.
I believe that part of the reason the Administration
program went with a 50 percent standard is that they were
restricted by the revenue allocations for the various parts of
their Climate Change Technology Initiative. If we were to
devise a package with a cap of $3.5 billion over 5 years--as
the Administration package has done--energy-efficient homes
would play a larger role in it than the $450 million allocated
to it in that program.

What Does it Cost?

The short answer to this one, Mr. Chairman, is we don't yet
know. Rep. Thomas made a request for scoring by the Joint
Committee on Taxation, but has not yet returned its estimates.
In addition, information has been submitted to JCT reflecting
amendments we hope to see in H.R. 1358.

Existing Homes Tax Credit

While making new homes more energy-efficient is essential
for the future, the lion's share of energy use and energy waste
in the residential sector remains in existing homes. The 1.5
million homes built each year pale in comparison to the 100
million that already stand--many millions of which were built
before energy-efficiency became a major consideration in
housing construction.
The current bill allows a homeowner to claim a tax credit
for 20 percent of the cost of improving the energy-efficiency
of their home by 30 percent from a baseline level, up to a
$2000 limit over the 5 years. We have been working with
Coalition members, other stakeholders, and Rep. Thomas to
better-define the details of the existing home provision to
limit revenue-impact, free ridership and the potential for
fraud.

III. ENERGY-EFFICIENCY: A CONTINUING NATIONAL PRIORITY

In order to fully make the argument for H.R. 1358, Mr.
Chairman, the Alliance would like to comment on how energy-
efficiency has delivered over the past 25 years for the
American public. That background, illustrates why improving the
energy-efficiency of our economy is a more urgent priority than
ever before.

A Bipartisan Political Tradition

From the days of our first national nightmare of gas lines
and soaring fuel prices, energy-efficiency has had champions in
Congress from both sides of the aisle. Sen. Charles Percy, who
founded the Alliance to Save Energy in 1977, recognized the
need to promote energy-efficiency to address a glaring hole in
our nation's economic security. He recruited Sen. Hubert
Humphrey for this endeavor in the final days of his life to
demonstrate that the need to pursue greater energy-efficiency
in the economy obliterated party lines. In addition, he knew
that a partnership between business, government,
environmentalists, and consumer advocates would not only result
in benefits for each sector, it would help avoid the need for
coercive regulation when our problems reach crisis level.
That maxim is no less true today, even though oil supplies
and prices have eased. Our fossil fuel economy is now believed
by many to have put new stresses on our environment. Energy-
efficiency has been repeatedly cited as a key solution to slow
the loading of carbon and other greenhouse gases into the
atmosphere. Fortunately, we now have a quarter-century track
record of showing how energy-efficiency reduces emissions of
criteria air pollutants as well as carbon.
Support of action by the federal government to promote
energy-efficiency has also been historically bipartisan. Though
the establishment of the Department of Energy and energy-
efficiency programs is most often associated with the Carter
Administration, key advancements in federal efforts were made
under the Reagan and Bush Administrations. While funding was
cut severely from Carter-era levels, President Ronald Reagan
signed the National Appliance Efficiency and Conservation Act
(NAECA) the law requiring DOE to set energy-efficiency
standards for appliances and other equipment. That program has
led to tens of billions of dollars in savings for the American
people and significant carbon emissions reductions. The Bush
Administration, in the context of its support for the Rio
Treaty, began to significantly expand funding for DOE energy-
efficiency and renewable energy efforts and created the Green
Lights and Energy Star programs at EPA. In addition, President
Bush signed the Energy Policy Act of 1992, which expanded the
scope and magnitude of energy-efficiency efforts.
The House and Senate caucuses devoted to promoting
renewable energy and energy-efficiency continue that tradition
of bipartisanship. Currently, the House Renewable Energy Caucus
features 65 Republicans and 84 Democrats, while the newer
Senate version counts 10 Republicans and 14 Democrats. Such
support from all parts of the political spectrum is what has
made clean energy a driving force in the American economy.
Mr. Chairman, of the current cosponsors of this
legislation, 11 are Republicans and 13 are Democrats. Rep.
Thomas's plan to bolster our nation's energy-efficiency through
housing follows this long bipartisan tradition of support for
doing more with less.

An Economic Workhorse for the U.S.

Energy efficiency makes money and puts people to work. The
economic gains from energy efficiency come in two forms. The
greatest benefit comes from displaced costs--money that
households and businesses can spend elsewhere because they no
longer have to spend it on energy. That spending includes
additional investment and hiring additional workers. Direct
economic benefits come from growth in industries that generate
energy-efficient products and services. Companies that sell
insulation or efficient windows domestically and/or for export
employ Americans in high-skill service and manufacturing jobs.
Secondary economic benefits come from businesses and consumers
re-spending these newfound energy savings in sectors of the
economy which are more labor-intensive than energy supply.

Energy-Efficiency Must Be Measured as an Energy Source

The U.S. economy has become significantly more energy-
efficient over the past quarter-century. But we often fail to
realize the actual contribution of energy efficiency to our GDP
and national well being.
Mr. Chairman, it isn't easy to compare the contribution of
energy-efficiency to the environment and the economy with more
traditional energy sources such as oil and coal. It requires
the observer to regard saved or unused energy as created energy
in the same way that oil comes out of the well and coal comes
out of the mine. In addition, I think that any economist would
tell you that energy-efficiency measures have increased the
supply of energy and thus helped to lower the price. Energy not
used is just as salable and usable when conserved as when
produced. Upgrades in energy-efficiency made to home
appliances, industrial equipment, building systems, or car and
truck fleets serve as an energy source that increases our
overall supply of electricity, coal, oil, and natural gas.

Energy-Efficiency, our Number 2 Energy Source

Alliance research shows that, for 1997, the most recent
year for which we have complete data, energy-efficiency was the
second leading source of energy for U.S. consumption, and if we
consider only domestic energy sources, it's number one. Mr.
Chairman, it would have been number one if we declined to count
oil imports, now more than half of this nation's oil
consumption. Our analysis of 1997 energy consumption shows that
energy efficiency provided the nation with 29.5 quadrillion
Btus (quads), approximately 25 percent of U.S. energy
consumption. While energy-efficiency trails our mammoth oil
consumption (36.3 quads), it significantly outstrips the
contribution of natural gas (22.5 quads), coal (21.0 quads),
nuclear (6.7 quads) and hydro (3.8 quads). (See attached
chart.)
Mr. Chairman, the contribution of energy-efficiency to our
nation's overall supply is now so great that we cannot regard
it as an esoteric externality anymore. It is a commodity just
like oil and gas, and deserves a the same consideration. We
must promote and support it in the same way we do the coal belt
and the oil patch, which enjoy a variety of tax breaks and
subsidies based on their use of fuel.
These figures show energy-efficiency for what it is--an
unparalleled driver of environmentally sound economic growth.
Mr. Chairman these economic snapshots of efficiency show an
energy industry that spans the economy and the populace. But it
is not an energy industry that looks like what we have known in
the past. However, all the functions of traditional energy
industries are represented. But with energy-efficiency, the
miners are businesses trying to cut their costs. The roughnecks
are homeowners trying to keep their families warmer in the
winter. The geologists are mechanical engineers working to get
more out of less. Energy-efficiency is highly dispersed
throughout the economy. And because of its diffuse nature,
energy-efficiency doesn't carry the political clout of the
coal-mining regions, or of the oil and gas-producing regions.
There is no ``energy-efficiency patch.''
By the same token there is not a defined energy-efficiency
industry. Whirlpool makes highly efficient appliances but they
sell washing machines and refrigerators, not energy efficiency.
Honeywell sells controls that regulate building systems that
can save a company millions of dollars a year, not energy
efficiency. Johns-Manville and Owens-Corning sell fiberglass
insulation which can make a house warmer, more comfortable, and
more economical to live in, but they sell insulation, not
energy-efficiency. Likewise, Andersen Corporation sells highly-
efficient windows, but their first concern is marketing those
products, not the energy-efficiency they carry with them.
So when we have to make tough choices about what we do with
federal dollars, we must think about energy-efficiency as what
it is--an energy source that is essential for the economic
health of our nation--and one that is paying off like a gusher
for the American people. And yes, Mr. Chairman, that energy is
produced cleanly, displacing both conventional air pollutants
as well as ones believed by many to be causing a warming of the
Earth's climate. It enhances our national security, as I have
spoken of earlier. Energy-efficiency cuts costs for businesses
and consumers, and it increases our international
competitiveness--all the things we have traditionally talked
about.
The tough choices on our environment and economy--such as
whether to establish tax credits for efficient homes--must be
made with a clear eye on the contribution to the environment,
the economy, national security, and international
competitiveness delivered in the past and promised for the
future by energy-efficiency.

III. CONCLUSION

Mr. Chairman, H.R. 1358 and the improvements to it that I
have discussed here set out a prudent, accountable path to
significantly upgrade the energy-efficiency of our nation's
housing stock. It does this not just by subsidizing efficient
construction, but by teaching more home builders to construct
more efficient houses, and more consumers about the value of
owning them. Once a builder is acquainted with energy-efficient
building practices he or she will more likely realize that they
are not difficult, that significant strides that can be made
with off-the-shelf technology, and that energy-efficiency is
helpful as a marketing tool. Homeowners will realize a
difference in dollar savings attainable by making relatively
inexpensive improvements to their home.

A Time For Action

Mr. Chairman, as I have shown, energy-efficiency has
provided a massive source of clean, affordable energy to our
economy, and has significantly reduced air pollution in this
country. One guarantee for the future is that as our population
rises, our housing stock will grow with it. Providing
incentives to improve the energy-efficiency of the our homes
will have help save American families millions of dollars on
heating and cooling bills and reduce air pollution
significantly, while allowing more families to own homes.
We believe these are highly laudable goals, Mr. Chairman,
and on behalf of the Coalition for Energy Efficient Homes, I
urge that you include H.R. 1358 in any tax bill reported by the
Ways and Means Committee this summer.
Thank you for your consideration and the opportunity to
speak before you. I would be happy to take any questions that
you or other Committee members might have at this time.

Chairman Archer. Thank you.
Mr. Wallace, welcome. You may proceed.

STATEMENT OF ERIC P. WALLACE, CERTIFIED PUBLIC ACCOUNTANT,
PITTSBURGH, PENNSYLVANIA; ON BEHALF OF ASSOCIATED BUILDERS AND
CONTRACTORS, INC., ROSSLYN, VIRGINIA

Mr. Wallace. Thank you, Mr. Chairman. Good afternoon, Mr.
Chairman and Members of the Committee. My name is Eric Wallace.
I am a CPA and I speak today on behalf of the Association of
Builders and Contractors.
ABC is a national trade association representing more than
20,000 contractors, subcontractors, material suppliers, and
related firms from across the country, including all
specialties, in the construction industry. We would like to
thank Chairman Archer and the Committee Members for conducting
this hearing on providing the tax relief to strengthen the
family and sustain a strong economy.
I am a practicing CPA with over 20 years of experience
serving contractors and service providers from across the
country in the fields of taxation, accounting, auditing, and
consulting. I recently researched and authored an article
titled ``The IRS and the Cash Basis Contractor'' that appeared
in several publications. My extensive experience dealing with
this issue enables me to provide you specific expertise and
insight concerning the need for legislation to clarify that
small business taxpayers are allowed to use the cash method of
accounting without limitation.
The IRS is currently targeting nearly all contractors and
service providers who report their taxable income on the cash
method of accounting. One of the most onerous changes that a
contractor or service provider can face is an IRS initiated
change in its tax accounting method from the cash to the
accrual method. Such IRS proposed audit changes typically
subject the taxpayer to over $100,000 due with a significant
portion of this consisting of mandatory assessed interest and
penalties.
The difference between the cash method and the accrual
method of accounting is not that the cash method necessarily
results in a greater income. The only difference is one of
timing of the reporting of income and expenses. For example, if
a cash basis contractor collects their money early and doesn't
pay their vendors, they could actually be reporting their
income earlier. It is a matter of timing, not of collection
based upon revenue.
But now more than ever, the IRS is pushing the cash audit
position on a national level. The IRS spelled out its position
on the cash basis when, in 1987, it released its Construction
Audit Technique Guide as part of its market segment
specialization program. In their Audit Technique Guide, it
stated that IRS examiners should generally conclude that a
contractor or service provider should be changed from the cash
method of accounting when their material costs as a percentage
of their gross receipts is 15 percent or more. There are not
that many contractors that would be able to fulfill that
criterion. And, depending on the facts and circumstances, the
method when it is less than 15 percent. This position is not
based upon any specific Tax Code, but is the result of several
court cases that are successfully litigated by the Service.
This push is based upon a certain logic flow. The Service
logic flow is generally summarized as follows: materials are
merchandise. If the cost of merchandise is over 15 percent of
gross revenues, it is a significant income-producing factor. If
it is a significant income-producing factor, they have to use
inventories. And if they have to use inventories, they are
required to use an accrual method of accounting. The result of
this push would leave few if any contractors able to stay on
the cash accounting method.
One of the IRS authors of the Audit Technique Guide stated
to me that the only type of cash contractor that the IRS is
permitting to stay on the cash method is an asphalt contractor
who does not maintain their own asphalt plant. All other
contractors are fair game. The Service denies that there is a
national coordinated effort to focus on the construction
contractors and service providers. And they believe that they
are merely enforcing the laws as they interpret them.
I, however, do believe there is a national effort, based
upon the calls that I have received from across the country and
advising other CPAs and advising construction contractors. For
example, the IRS audited a carpet installer from Michigan doing
slightly more than $1 million in revenue with materials and
supply costing equal to 12 percent of the revenue. The only IRS
audit adjustment was to change him from cash to the accrual,
resulting in penalties of almost over $100,000.
The Service believes that, based upon a selective series of
court decisions and their interpretation of regulations and
congressional intent, their position to change all contractors
and service providers from cash to accrual is justified. But
that is in conflict with congressional intent on the cash
method, referring back to the 1986 congressional
documentations: Quote, ``The Committee recognizes that the cash
method generally is a simpler method of accounting and that
simplicity justifies its continued use by certain taxpayers for
certain types of activities. Small businesses should continue
to use the cash method of accounting in order to avoid the
higher cost of compliance, which would result if they are
forced to switch from the cash method.''
The IRS specialist who wrote the Audit Technique Guide
stated to me that the only hope for cash basis contractors is a
congressional solution. ABC applauds H.R. 2273, introduced by
Mr. English along with the Small Business Committee Chairman
Jim Talent, which would provide a much needed congressional
solution. The English-Talent legislation would stop the IRS'
universal push against cash basis contractors and service
providers and enable those small businesses to utilize the
simple cash method without fear of IRS reprisal. ABC, along
with a broad-based coalition of other construction groups and
other organizations, endorses this legislation. We strongly
urge the Committee to include this common-sense legislation as
it draft its legislation this year.
In addition, the ABC would just like to comment on several
other issues, such as Mr. English's introduction of a bill to
repeal the look-back method, H.R. 2347; the indexing of
thresholds for construction contractors including the section
460 threshold requiring recognization of the percentage of
completion method; AMT relief, as we have discussed; and,
certainly, estate tax relief. Again, I would like to thank
Chairman Archer and the Committee Members for allowing ABC to
present their concerns regarding these important issues and I
do welcome the questions you may have.
[The prepared statement follows:]

Statement of Eric P. Wallace, Certified Public Accountant, Pittsburgh,
Pennsylvania; on behalf of Associated Builders and Contractors, Inc.,
Rosslyn, Virginia

Good afternoon, Mr. Chairman and members of the Committee.
My name is Eric P. Wallace, CPA, and I speak today on behalf of
Associated Builders and Contractors, Inc. ABC is a national
trade association representing more than 20,000 contractors,
subcontractors, material suppliers and related firms from
across the country including all specialties in the
construction industry. We would like to thank Chairman Archer
and the Committee members for conducting this hearing on
``Providing Tax Relief to Strengthen the Family and Sustain a
Strong Economy.''
I am a practicing CPA with over 20 years of experience
serving contractors and service providers from across the
country in the fields of taxation, accounting, auditing, and
consulting. I recently researched and authored an article
titled ``The IRS and Cash Basis Contractors'' that appeared in
publications of the Construction Financial Management
Association as well as ABC. My extensive experience dealing
with this issue enables me to provide to you specific expertise
and insight concerning the need for legislation to clarify that
small business taxpayers are allowed to use the cash method of
accounting without limitation.
Later in this statement, ABC would like to weigh in on some
additional key issues affecting its members, the construction
industry and the economy as a whole. The complexity and cost of
these tax burdens are taking a devastating toll on
contractors--particularly small contractors--and their
employees. Lifting the weight of these outdated and burdensome
requirements will allow contractors to devote their time, money
and resources towards productivity, growth and providing new
jobs.

CASH BASIS METHOD OF ACCOUNTING

The IRS is targeting just about all contractors and service
providers who report their taxable income on the cash basis of
accounting. One of the most onerous audit adjustments a
contractor or service provider can face is an IRS initiated
change in its tax accounting method from the cash to the
accrual method. Such IRS proposed audit changes typically
subject the taxpayer to over $100,000 due to the IRS with a
significant portion of this consisting of mandatory assessed
interest and penalties.
The difference between the cash method and the accrual
method is not that the accrual method necessarily results in a
greater taxable income. The only difference is one of timing of
the reporting of income and expense. As an example, if a cash
basis contractor or service provider collects its billings in
advance and delays the payment of its payables, it will report
income sooner under the cash method than it would under the
accrual method.
Now, more than ever, the IRS is pushing their cash audit
change position on a national level. The IRS spelled out its
position on the cash basis when, in late 1997, it released its
``Construction Audit Technique Guide'' (ATG) as part of its
Market Segment Specialization Program. In this ATG, it stated
that IRS examiners should generally conclude that a contractor
or service provider should be changed from the cash basis of
accounting when their material cost, as a percentage of their
gross receipts, is 15% or more, and depending on the facts and
circumstances, can be changed when the ratio is less than 15%.
This position is not based on any specific code section but is
the result of several court cases successfully litigated by the
Service.
This push is based upon a certain logic flow. The Service
foundation logic is generally summarized as follows: materials
are merchandise; if the cost of merchandise is over 15% of
gross receipts, it is a significant income producing factor; if
material is a significant income producing factor, the
contractor or service provider must use inventories; if the
taxpayer is required to use inventories, it is required to use
an accrual method of accounting.
The result of this national push by the Service would leave
few, if any, contractors or service providers remaining on the
cash basis of accounting. One of the IRS authors of the ATG
stated to me that the only type of cash basis contractor that
the Service is permitting to stay on the cash basis is an
asphalt contractor who does not produce their own asphalt in a
plant. (This is based upon the Galedridge Construction, Inc. v.
Commissioner, T.C. Memo 1997-240 court case, though the IRS has
still not agreed to the Galedridge decision.) All other
contractors or service providers are ``fair game.''
The Service denies that there is a national coordinated
effort to focus on construction contractors and service
providers and that they are merely enforcing the law as they
interpret it. I, however, do believe that there is a national
effort based upon the calls that I have received from
contractors, service providers, and other practicing CPAs from
across the country. For example, the IRS audited a carpet
installer from Michigan doing $1.2 million in revenue with
material and supplies equaling 12% of his revenue. The only
audit issue was to change him from the cash method to the
accrual method. The cost to him of such a change was almost
$100,000. The IRS auditor had used as support the newly
released IRS ATG. I advised an underground utility pipeline
contractor from Pennsylvania to voluntarily change from the
cash method to the accrual method because, if audited by the
IRS, it would face over $100,000 in interest and penalties. A
window installer from Texas, with about 20% of revenues for
materials as a cost of revenue, would be forced out of business
if the IRS proposed a change from the cash method and assessed
the mandatory interest and penalties.
The Service believes, based upon a selective series of
court decisions and their interpretation of regulations and
congressional intent, that their position to change all
contractors and service providers from the cash method of
accounting to the accrual method is justified. This is in
conflict with congressional intent on the use of the cash
method. ``The committee recognizes that the cash method
generally is a simpler method of accounting and that simplicity
justifies its continue use by certain types of taxpayers and
for certain types of activities. Small businesses should be
allowed to continue to use the cash method of accounting in
order to avoid the higher cost of compliance which will result
if they are forced to switch from the cash method.'' [House
Report 99-426, at 605-606 (1985), 1986-3 C.B. (Vol.2) 1, 605-
606.]
A head IRS Construction Industry Specialist stated to me
that, based upon the current IRS approach and court cases, cash
basis contractors and most service providers will not be able
to maintain their cash reporting position or have it supported
in court. Their only hope is a congressional solution.
ABC applauds legislation introduced by Ways and Means
member Phil English along with Small Business Committee
Chairman Jim Talent, which would provide this much-needed
congressional solution. Mr. Talent included an identical
provision in the Small Employer Tax Relief Act (H.R. 2087). The
current ATG states that ``Reg 1.446-1 (a)(4)(i) and 1.471-1
provide that the use of an inventory accounting method is
required in every case in which the sale of merchandise is an
income producing factor. The fact that the use of an inventory
accounting method may result in inventory balances that are
zero or minimal is irrelevant.'' It is clear that the Service
position is inappropriate. The English-Talent legislation would
stop the Service's universal push against cash basis
contractors and service providers and enable these small
businesses to utilize the simpler cash method without fear of
severe IRS reprisal. ABC, along with a broad-based coalition of
construction and other organizations from across the small
business spectrum, endorses this legislation. We strongly urge
the Committee to include this common sense legislation as it
drafts its tax legislation this year.

LOOK-BACK METHOD

The construction industry has fallen under a provision in
the Tax Reform Act of 1986 aimed to target major defense and
aerospace contractors. The law requires ``percentage of
completion'' and look-back accounting methods for contracts
lasting more than one tax year. Contractors must estimate their
costs and revenues and, upon completion of the contract, ``look
back'' and substitute the actual costs and revenues for those
estimated at the conclusion of the prior tax years.
Construction contractors face look-back calculations can number
in the thousands and can take between 15 to 30 hours to
complete for each project. Construction contractors pay
thousands of dollars each year just to comply with look-back
requirements without any justification or need to do so.
Because the majority of construction contracts are
completed within one or two years and success in the industry
is dependent on financial accuracy, look-back has no effect on
``catching'' underreported revenues or gains. Instead,
approximately 75% of the industry's look-back calculations
result in zero dollars being remitted to the IRS, and 25% are
owed money by the IRS. Look-back accounting is an unnecessary
requirement and an onerous burden on construction contractors
(as well as the IRS) with virtually no gain to the Treasury.
The current de minimis rules, including those recently
implemented as part of 1997 Taxpayer Relief Act, are not
sufficient relief. ABC strongly supports repeal of look-back
for commercial construction contractors.

INDEXING OF THRESHOLDS

Several key thresholds in the tax code affect contractors'
tax liability. These include the $10 million threshold under
section 460(e) and the $5 million threshold under section 448.
Since 1986 these amounts have not been adjusted for inflation.
This has had the effect of forcing contractors to use more
complex accounting methods.
ABC believes that these thresholds should be indexed for
inflation in the same manner as other items are treated in the
tax code. An example would be how the amount of the personal
exemption increases each year or the mileage rate increments
annually.

ALTERNATIVE MINIMUM TAX (AMT)

The corporate AMT was enacted in 1986 to end a perceived
abuse that corporations were reporting earnings to
shareholders, yet not paying any federal income tax in that
year by taking legitimate deductions and credits. The actual
operation of the AMT has imposed a severe penalty on companies
whose businesses require large capital investments to modernize
and remain competitive. The AMT penalizes investment,
particularly by imposing a considerably slower depreciation
rate. It doubles compliance costs, forcing corporations to keep
two separate deduction records and engage in complex
calculations. The AMT also adds complexity for small
contractors by requiring use of the percentage of completion
method for long term contracts.
AMT proponents see it as a significant revenue source and
argue that it ensures all corporations reporting income pay at
a base tax. However, the AMT treats corporations with generally
the same long-term economic incomes very differently. The AMT
penalizes capital intensive firms with relatively low profit
margins for their products. These firms are being denied the
benefit of accelerated depreciation which is afforded to their
non-AMT competitors.
ABC supports repeal or a significant reduction in the
adverse effects of the AMT. ABC advocates allowing S-
corporations similar treatment to C-corporations regarding
small company exemptions. Additionally, ABC favors allowing the
AMT credit to be carried back, as contractors can be unfairly
penalized due to depreciation and other unique timing
preferences;

ESTATE TAX RELIEF

Federal estate [death] tax rates have increased
significantly since their implementation in the early 1900s.
They are so high now that families must often sell their
businesses in order to pay the taxes. This in turn creates
disruption for the employees, customers, and suppliers and the
community. Death taxes not only jeopardize the survival of
family-owned construction companies, they also divert critical
funds that could be invested in the business to grow and
provide more jobs.
Construction companies are frequently family owned and do
not have the liquid assets to withstand an assault from the IRS
upon the unfortunate death of the owner. Therefore, the
construction industry is particularly hard hit by the estate
tax burden. ABC is supportive of legislation that will relieve
the estate tax burden on businesses. Specific measures ABC
supports include rate relief, increasing and simplifying the
exemption for closely held businesses, and indexing the unified
credit and closely held business exclusion for inflation.
Ultimately, ABC members would like to see death taxes
eliminated. ABC strongly supports H.R. 8, the Estate and Gift
Tax Rate Reduction Act.

CAPITAL GAINS CUTS AND SIMPLIFICATION

The 1986 Tax Reform Act constituted the largest capital
gains tax hike in more than 50 years. Real Estate and
Construction were devastated, and have only in the last few
years recovered. Increasing the exclusion for capital gains
would unlock hundreds of billions of dollars of unrealized
capital gains, thus promoting more efficient allocation of
capital and increasing capital formation, economic growth and
job creation. Opponents claim a capital gains relief will be a
tax cut for the rich. In fact, a cut in the capital gains tax
would actually increase taxes paid by the wealthy and benefit
poor and working-class Americans most. It would expand economic
opportunities for the working-class by encouraging capital
formation, new business creation, and investment in capital-
starved inner cities. It would lead to the creation of more
than half a million new jobs and increased wages by the year
2000.
ABC supports reducing or eliminating the capital gains tax
burden on businesses and individuals.

INDEPENDENT CONTRACTOR SIMPLIFICATION

Currently, the Internal Revenue Service relies on a 20-
factor test to be classified as an independent contractor. It
is often criticized as too subjective, arbitrary, inconsistent,
and burdensome. Considering the fact that back-tax assessments
imposed on businesses with reclassified employees are often
large and potentially bankrupting, ABC believes that the test
for classification should be clear and simple.
The construction industry faces unique problems due to its
fluctuating work demand and seasonal forces which affect
employment levels. Many in the industry can not afford nor have
the need to maintain specialized trade craftsmen as full-time,
long-term employees, which may be needed several times
throughout the year but not enough to warrant full-time or even
part-time employment. Independent contractors are often the
perfect answer to a pressing demand for the special skills and
know-how often required for short term projects.
Independent contractors are an important sector of the
economy--there is no better way to become established as a
small business than to begin as an independent contractor. Many
ABC members started their own businesses by working as
independent contractors. Independent contractor relationships
can be advantageous for all involved. The arrangement allows
the independent contractor to have the freedom to choose his or
her work schedule, a business owner the flexibility to adjust
staff demands with business activity, and the consumer the
opportunity to benefit from a reasonably priced, quality
product. ABC believes that companies should be able to make
sound economic decisions about the classification of
individuals as employees or independent contractors, without
fear of misclassification or penalty from the IRS. ABC opposes
H.R. 1525.

SCHOOL CONSTRUCTION TAX CREDITS

ABC would like to express its strong opposition to tax
proposals before the Committee that would limit flexibility and
competition for small contractors by expanding Davis-Bacon
requirements to school construction tax credits.
Representatives Charles Rangel (H.R. 1660) and Nancy Johnson
(H.R. 1760) have introduced bills which would allow states and
localities to issue special bonds for school improvements and
construction. The federal government would effectively pay the
interest via a tax credit to the bond holder.
H.R. 1660 and H.R. 1760 include an unprecedented expansion
of the Davis-Bacon Act into the area of school construction tax
credits for purchasers of qualified school modernization bonds,
by amending the General Education Provisions Act. As a result,
this is a wholly new application of the federal Davis-Bacon Act
to tax credits, without any justification for such an expansion
into these state and local efforts. Davis-Bacon has been shown
to increases public construction costs by anywhere from 5 to 38
percent above what the project would have cost in the private
sector. The unnecessary costs will be directly passed on to the
customers--the American taxpayers in these school districts--
who have to pay for the inefficiencies and waste in federal
programs. Furthermore, the application of Davis-Bacon makes no
sense because the burdensome requirements of the Act operate as
a disincentive to contractors and corporations to get involved
in school construction, undercutting the very purpose of the
bill which is supposed to be to create tax incentives to
attract capital.
In contrast, Chairman Archer's school construction proposal
would make it easier for state and local governments issuing
public school construction bonds to comply with the arbitrage
rebate rules, by extending the time for issuers to spend bond
proceeds from two to four years. It would preserve local
control of education funds and help scarce tax dollars go
farther.
Congress and the Administration should not be hampering
efforts to leverage capital into school construction by
imposing outdated and wasteful Davis-Bacon Act requirements
that act as an unfunded mandate on local school districts.
Adding federal Davis-Bacon requirements to local school
construction tax credits would hurt those who fund, provide,
and receive public education by forcing school districts to pay
more for providing less. The inflated construction costs from
Davis-Bacon will further limit already scarce dollars which
could be better spent on real efforts to help education, such
as additional schools, more repairs and facility improvements,
schoolbooks, computers, and other educational services that
actually improve classroom learning and benefit school
children.

CONCLUSION

As stated earlier, these onerous tax provisions are having
a dramatic negative effect on contractors, their employees and
the economy as a whole. Much needed legislative changes to
these outdated and burdensome requirements will allow small
companies to devote their time, money and resources towards
productivity, growth and providing new jobs. We would like to
thank Chairman Archer and the Committee members for allowing
ABC to present its concerns regarding these important issues,
and I welcome any questions the Committee may have.

Chairman Archer. Thank you, Mr. Wallace.
Our remaining witnesses come in tandem. Ms. McMullin, I
believe you share your time and testimony with Mr. Henderson.
We are happy to have you before the Committee. Welcome. You may
proceed.

STATEMENT OF RUTH R. MCMULLIN, CHAIRPERSON, EAGLE-PICHER
PERSONAL INJURY SETTLEMENT TRUST, CINCINNATI, OHIO

Ms. McMullin. Mr. Chairman, thank you very much. My name is
Ruth McMullin and I am here as a trustee, as chairperson of the
Eagle-Picher Personal Injury Settlement Trust to testify on
behalf and in support of H.R. 580, which has been introduced by
Congressman Crane and is cosponsored by Congressman Rangel and
several other Members of this Committee.
The Eagle-Picher Trust is a settlement fund under section
468(b). Like other settlement trusts, it was established to pay
claims of persons who were deemed by a court to have been
injured. Typically, these trusts are substantially underfunded.
They can pay claims at nowhere near their full value. The trust
that I chair is responsible for making payments to people with
asbestos-related illnesses, past, present, and well into the
next century.
Now section 468(b) governs how settlement funds are taxed.
Currently, settlement funds pay taxes on both capital gains and
ordinary income tax at the very highest ordinary income tax
rate. Now in 1986, when the tax rules for settlement funds were
established, there was no difference in the rate of taxation
between ordinary income and capital gains and so there was no
need to specify different rates on those two types of income
for settlement funds. But now, however, things have changed and
settlement funds still pay ordinary income tax rates on their
capital gains. As a result, our beneficiaries are subjected to
higher taxes on capital gains than any other beneficiaries of
any other taxable trust or, for that matter, any other
individual taxpayer.
H.R. 580 remedies this inequity. It is a very simple bill,
one that provides capital gains earned by settlement funds to
be taxed at capital gain rates like all other taxable trusts.
Simple or not, this bill is extremely important to the
beneficiaries of long-term settlement funds such as the Eagle-
Picher Trust.
As trustees, we are obligated to pay claimants several
decades into the future. Today, asbestos trusts make payments
to approximately 500,000 people and our actuaries estimate that
approximately another 500,000 people will become ill and make
claims that we will have to meet over the next few decades.
Now, without capital gains relief, trustees of these funds
cannot prudently invest in equities. trustees of these funds
need to be able to avail themselves of the long-term growth
potential which investment in equities would permit. If H.R.
580 is passed, it will, first, allow us the higher rates of
return available from equities. And, second, equally
importantly, it will allow us to invest in ways such as to
reduce investment risk through critically important
diversification, particularly important because our trusts will
last for so many years. Now, even with this bill, our assets
will fall far short of the amount needed to permit payment in
full of the claims of our beneficiaries. Nonetheless, it will
make a huge difference in the lives of our beneficiaries and
their families, the vast majority of whom are working people,
sick and who have very limited financial resources.
Mr. Chairman and Members of the Committee, I want to thank
you again for the opportunity to testify on behalf of the
beneficiaries of my trust and other settlement funds. With your
permission, I am pleased now to introduce Mr. Roosevelt
Henderson, who is one of those beneficiaries. He can tell you,
firsthand, exactly how important this bill is to him, to his
family, to others like him, and to their families. Thank you
very much.
[The prepared statement follows:]

Joint Statement of Ruth R. McMullin, Chairperson, Eagle-Picher,
Personal Injury Settlement Trust, Cincinnati, Ohio; and Roosevelt
Henderson, Texas City, Texas; on behalf of Eagle-Picher Personal Injury
Settlement Trust

Mr. Chairman and members of the Committee, my name is Ruth
McMullin, and I am Chairperson of the Eagle-Picher Personal
Injury Settlement Trust.
Thank you very much for the opportunity to testify in
support of H.R. 580, which has been introduced by Congressman
Crane and is cosponsored by Congressman Rangel and several
other members of this Committee. H.R. 580 is a very simple
bill. Due to a technical flaw in current law, capital gains
earned by settlement funds are presently taxed at the highest
ordinary income tax rate rather than at the rates normally
applicable to capital gains. That flaw, which appears to be a
drafting oversight, unfairly penalizes the hundreds of
thousands of families who depend on settlement funds to help
pay their medical and living expenses. H.R. 580 would correct
that flaw by providing that capital gains earned by settlement
funds would be taxed at a capital gains rate, as is the case
with all other taxable trusts.
By way of background, settlement funds are trusts which are
used in connection with the settlement of certain tort claims.
The settlement fund which I chair, and others like it, have
been established in accordance with section 468B of the
Internal Revenue Code. Section 468B, which was enacted as part
of the Tax Reform Act of 1986, controls the tax treatment of
qualified payments to funds used in the extinguishment of tort
liabilities as well as the taxation of income earned by those
funds. Section 468B(d)(2) defines a designated settlement fund
as any fund (1) which is established pursuant to a court order,
(2) which extinguishes completely the taxpayer's tort liability
with respect to a class of claimants, as determined by the
court, (3) which is managed and controlled by persons unrelated
to the to the taxpayer, (4) in which the taxpayer does not have
a beneficial interest in the income or corpus, and (5) to which
no amount may be transferred other than ``qualified payments.''
Because section 468B does not cross-reference to the
capital gains rates of section 1(h) of the Internal Revenue
Code, settlement funds are taxed at the highest ordinary income
tax rate of 39.6% on both ordinary and capital gains income
earned before such earnings are distributed to claimants. The
capital gains earned by all other taxable trusts are taxed at
capital gains rates, typically 20%. Despite an exhaustive
search of the legislative history, we have not found any
explanation of this anomaly. In fact, we have not found any
evidence that Congress even was aware that section 468B created
this problem. In view of the fact that there was no difference
between capital gains and ordinary income rates at the time
section 468B was enacted, the failure to cross-reference to the
capital gains rates of section 1(h) in section 468B appears to
be a drafting oversight. Indeed, Congress traditionally has
allowed capital gains earned by a trust to be taxed at capital
gains rates where a differential between the rates exists. For
example, in ``The Small Business Job Protection Act of 1996,''
Congress specifically provided that capital gains earned by
``electing small business trusts'' be taxed at capital gains
rates.
H.R. 580 simply would amend section 468B by adding a cross-
reference to section 1(h), thus ensuring that capital gains
earned by settlement trusts would be taxed at capital gains
rates. Doing so is consistent with sound tax policy and simple
fairness. The burden of taxing a settlement fund's capital
gains at the highest ordinary income rate falls upon the
claimants of the fund, thus reducing the amounts that they
would otherwise be able to recover. Moreover, capital gains
income should be taxed at the same rate, whether generated by a
settlement fund, an electing small business trust, or an
individual.
Passage of H.R. 580 is particularly important to the
beneficiaries of settlement funds such as the Eagle-Picher
Personal Injury Settlement Trust, which will be obligated to
pay claims several decades into the future. Certain settlement
funds, such as those established to pay, for example,
securities fraud claims, distribute all their assets to a
clearly defined group of claimants over a relatively short
period of time, typically a matter of months. Those settlement
funds almost never invest in equities, and thus do not realize
capital gains. Other settlement funds, most notably those
established to pay individuals afflicted by asbestos-related
illnesses, must manage their assets to maximize payments to a
very large, undefined group of claimants over the course of
many years. Asbestos settlement funds currently make payments
to approximately 500,000 persons, and actuaries estimate that
approximately 500,000 additional claimants will be identified
in the coming years. Furthermore, those payments will need to
continue until about the year 2030.
Unfortunately, the asbestos settlement funds have enough
funds to pay only a small fraction of the amount of the claims
against them. Therefore, it is imperative that we be able to
invest the assets of the trusts in a way to maximize the return
for our beneficiaries. In general, the best long term returns
are achieved by investing in equities. Yet investment advisers
have stated that settlement funds cannot responsibly invest
more than a very modest part of our portfolios in equities
given the current taxation of capital gains, and as
fiduciaries, trustees of the settlement funds must be attentive
to their advice. Changing the capital gains rate on settlement
funds would change the investment advisers' asset allocation
models to permit greater investments in equities. As a
consequence, passage of H.R. 580 would permit settlement trusts
to earn a higher return on their investments. In fact, we
project that that greatest benefit to settlement fund claimants
would result not from tax savings, but from the reallocation of
a portion of the portfolios from relatively low-yielding
assets, such as tax-free municipal bonds, into higher-yielding
equities. Unfortunately, those investment gains still would
fall far short of the amounts needed to permit full payment of
the claims of our beneficiaries. Nonetheless, the additional
investment income would make a very real difference in the
lives of our beneficiaries and their families, the vast
majority of whom are working people with very limited financial
resources.
Mr. Chairman and members of the Committee, thank you again
for the opportunity to testify. I am now pleased to have you
hear from Mr. Roosevelt Henderson, who can explain this issue
to you further.

Chairman Archer. Mr. Henderson, we are happy to have you
before the Committee. I am particularly happy to have another
Texan sitting out there. We welcome you and we will be glad to
hear your testimony.

STATEMENT OF ROOSEVELT HENDERSON, TEXAS CITY, TEXAS; ON BEHALF
OF EAGLE-PICHER PERSONAL INJURY SETTLEMENT TRUST, CINCINNATI,
OHIO

Mr. Henderson. Mr. Chairman and the rest of the Members of
the Committee, I am Roosevelt Henderson from Texas City. I
would like to thank the Members of the Committee for allowing
me this opportunity to come before you and talk about H.R. 580.
This H.R. 580 would allow us to have more money to pay our
bills, for medical expenses, which these settlements are coming
from. And we would like to take this opportunity to ask the
Chairman and the Committee to rely on passing this bill, H.R.
580. And we want to thank you again, Mr. Chairman. Thank you
for the job you have done in Texas and we want to continue to
thank you.
We just want to be put on the playingfield with everybody
else. Everybody else is paying 20 percent taxes and we are
paying 39.6 percent. And we would just like to be put on the
same playingfield with everybody else. And thank you.
[The prepared statement follows:]

Statement of Roosevelt Henderson, Texas City, Texas; on behalf of
Eagle-Picher Personal Injury Settlement Trust, Cincinnati, Ohio

Mr. Chairman and members of the Committee, my name is
Roosevelt Henderson and I live in Texas City, Texas. I am here
to testify on behalf of approximately one million families of
disabled persons who are, or will be, dependent on settlement
funds to meet their medical and living expenses. On behalf of
those families, I strongly urge the Committee to support H.R.
580.
For many years, I put installation in industrial plants,
businesses, and homes in the Texas City area. Because of my
exposure to asbestos, I developed severe breathing problems and
was forced to retire. I am a former president of the Texas City
chapter of the NAACP and I try to remain active in civic
affairs to the extent my health permits. However, most of my
time and energies are spent at home, where I care for my wife,
who is in poor health.
Mr. Chairman, I am grateful that you have called this
hearing to discuss tax relief for America's families. I can
tell you first hand, we need it. I am also grateful for your
leadership in seeking capital gains tax cuts. You are right
when you say that capital gains tax relief is important to all
Americans, no matter what their income levels. My wife and I do
not have much, but we would certainly benefit if settlement
funds paid the same lower taxes on capital gains as everyone
else. Right now, settlement funds set up to pay asbestos-
related claims do not have enough money to pay the full value
of the claims due to people like me. Ending the unfair tax
treatment of capital gains earned by settlement funds would
make a very real difference for my wife and me.
Finally, I personally want to thank Mr. Crane and Mr.
Rangel for sponsoring H.R. 580 and for arranging for me to
speak here today. They are both fine public servants, and I
know I speak on behalf of all the families that would be helped
by H.R. 580 in expressing our deep gratitude.
Mr. Chairman, thank you for the chance to speak with you
today.

Chairman Archer. Thank you, Mr. Henderson. The Chairman
would like to put everybody on the same playingfield with a
zero tax on income, but we will get into that at another time.
We are very fortunate today, Mr. Henderson. We have got
another Texan at the other end of the table down there
appearing with you, Mr. Andrews. I am pleased to hear the
testimony of every one of you. I thank you for coming.
I now will find out if any Members wish to inquire.
Yes, Mr. English.
Mr. English. Thank you, Mr. Chairman. Mr. Moore, we heard
testimony at the beginning of this day from Representative
Turner and comments from Representative Dunn, who have both
offered different approaches to a reforestation credit. I
wondered if I could get your comments, given that
Representative Turner's credit seems to be narrower.
Representative Dunn's seems to apply to a much broader range of
taxpayers. My understanding is that your preference would be
that there be no limit on this credit and that it form the
basis of a very strong tax policy aimed at encouraging
reforestation. Could you give us your thoughts on the relative
benefits of those two approaches?
Mr. Moore. Yes, Congressman, I would be happy to try. They
are similar in the extent that both bills deal with the
reforestation tax credit. Jennifer Dunn's bill also deals with
corporate capital gains rates on forest products--on trees,
rather, which Congressman Turner's bill does not. Congressman
Turner's bill also stops--I think it raises the cap from
$10,000 where it presently is to $25,000. Ms. Dunn's bill takes
it off entirely.
What the effect of that is simply you are targeting the tax
effect to some very small landowners in the Turner bill
concept, and that's all well and good. The problem exists
across the entire panoply of growing trees in the United
States, and so you are missing the much bigger target. In terms
of moving the needle of the industry being competitive, his
bill moves it a notch; Ms. Dunn's bill moves it halfway.
And, so, for example, in the United States today, corporate
landowners own probably about 17 percent of the forest land of
the country, but they produce 45 percent of the wood. That is
intensive silvaculture going on, which brings on expenses.
Congressman Turner's bill would completely miss that and would
go at small landowners who basically aren't producing that much
wood but own half the forest land in the country and who are
very important to the process. Congresswoman Dunn's bill
affects both. It doesn't just affect just the small; it covers
both. It lowers the capital gains rate on everybody. It raises
the cap or takes the cap on reforestation expenses for
everybody.
And, so you have correctly characterized it. Her bill is
much broader, affects the entire industry, does a great deal
more. Our initial indication is, as I said, would put us at
about the middle of the pack of the country's with whom we
compete in taxation on forestry operations.
Mr. English. Thank you, sir.
Mr. Wallace, I am delighted to see another western
Pennsylvanian here, and I wondered if I could pursue a line of
questioning on your testimony?
First of all--because I think most people really still have
trouble getting their arms around the real differences between
cash and accrual. In your view, what does the average
contractor spend as a percentage of revenue on material or
merchandise costs?
Mr. Wallace. I would say, at a minimum, 30 to 50 percent;
some contractors more, but I would say in order to achieve the
IRS numbers of 15 percent or less, there are very few, if any,
contractors are going to meet that number.
Mr. English. So, in other words, this mandate would be
applied to almost all contractors.
Mr. Wallace. That is exactly right, almost all contractors.
Mr. English. If the IRS continues this push to change all
contractors with material costs in excess of 15 percent from
the cash method, what effect would this have on the
construction industry?
Mr. Wallace. It is going to have a tremendous negative
effect on the construction industry. It is going to reduce
production, the creation of jobs, it is going to require a lot
of compliance and paperwork, and it is going to require them to
report their taxes earlier than collecting the funds.
Mr. English. And if Congress legislates the use of the cash
method for small contractors of service providers, are you at
all concerned about the transition end or implementation of
such a law?
Mr. Wallace. I am concerned, and I would like to see a
congressional comment or intent to say to the IRS, ``Let us
just not enforce this for 1999 and beyond, but don't pick on
those contractors for the prior years that they are still
currently auditing, and so forth.''
Mr. English. And, Mr. Wallace, finally, if the IRS requires
a contractor's service provider to report their income on the
accrual method, would this mean that they would pay tax on
retainages that have not been collected, and doesn't the
retainage amount typically equal 10 percent of the contract and
in the majority of times exceed the contractors profit on the
Federal contract?
Mr. Wallace. The answer is yes to both of your questions.
It will require them to report their income earlier, and it is
going to require them to pay taxes in a greater amount than
their final profit on the job.
Mr. English. Thank you, Mr. Wallace, for your testimony. It
is most helpful in making the case for Congress intervening in
this issue. Thank you for your time.
Mr. Wallace. Thank you for your help and the Chairman's
help.
Chairman Archer.
Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman.
First, just a comment for Mr. Wolyn. I appreciate your
coming before the Committee today and underscoring the fact
that business meals are in fact a legitimate business expense,
particularly for small business people who have to use that as
a means to market their products.
But my questions are for Mr. Moore, a fellow Louisianan;
not because he is a fellow Louisianan, but----
Chairman Archer. If the gentleman will yield, I intended to
say that he was an almost Texan. [Laughter.]
Mr. McCrery. That is right--but because I share Mr. Moore's
concern about our domestic timber industry, forest products
industry. Louisiana, of course, has a very large stake in that
industry. Mr. Moore, would you say that our domestic forest
products industry is distressed right now?
Mr. Moore. Yes, Congressman, it is. I will give you some
examples. We are, by every economist agreement, the second most
capital intensive industry in the United States, yet we have
earned the cost of capital once in the last decade--1995. We
were ranked last year by Fortune magazine--the same magazine
that said in 1992 we were competitive--ranked the 26 industries
in the United States in terms of profitability. We were 25th,
the very bottom. Our imports have gone down dramatically--our
exports, rather, and imports to the United States in our area
are going up dramatically. The last factor--there are no new
mills being built in our industry in the United States; they
are being built in developing countries. And, so, basically, we
can try to provide some additional data, but I think those
indicators pretty well indicate this is an industry that is
losing its competitive edge and is starting to downsize. We
lost 10,000 jobs last year. We used to employ 1.5 million; last
year, we lost 10,000, and we see that trend continuing.
Mr. McCrery. And you pointed out in your testimony several
reasons why you think our domestic industry is at a competitive
disadvantage in the tax treatment, and I agree with that. When
you look at just the growing trees, for example, why should we
treat an investment in trees any different from any other
investment? Is it more risky? Are you less likely--is it easier
to put your money into some safer investment? Can you expand on
that?
Mr. Moore. I think the ultimate optimist is somebody who
puts money in the ground in trees. Farmers are thought to be
real optimists, but their crops are generally annual. In this
business, you put your money in the ground, and you are lucky
if you can start harvesting or getting anything back. Depending
on the species and the part of the country you are in, the
soonest is about 15 to 17 years, and you really get your
investment back in about 40 years. Meanwhile, you have the risk
of forest fires, the risk of storms, the risk of insect
infestation, and there is even theft, and all of this makes
this a very risky proposition, one that our companies are
beginning to measure whether it is worth putting the money into
it or would they do better putting the money someplace else?
And individuals who are not in our business but just might own
100 acres of land or 50 acres of land are important to us,
because they do provide about half of the fiber that our
industry consumes. They are sitting there 50-years-old
thinking, ``I am going to put $200 an acre into reforesting an
acre in land and wait 40 years to recover it?'' And, so, yes,
it is a pretty risky business, and it is one that Congress has
recognized. Even the 1986 Tax Act recognized this industry's
investment was very different from that of others.
Mr. McCrery. And it is a problem not only for individuals
but also for corporations. You said that even some corporations
are beginning to question whether they should put their
stockholders' money into some other investment, because the
return is not enough to justify the risk. Is that right?
Mr. Moore. Exactly. We have seen some companies develop
housing developments and golf courses out of the forest lands.
I think if you want to see the country stay forested, there
needs to be incentives, at least on par with other competing
countries, to put the trees in the ground. Otherwise, I think
we are going to see a decline in that.
Mr. McCrery. Well, besides the obvious advantage of a
vibrant forest products industry--1.5 million jobs in this
country--is there an environmental advantage to keeping a
healthy forest, healthy trees, in this country?
Mr. Moore. Well, judging by the folks who get upset when we
cut them even when we plant them, I would say that, yes, there
must be some advantage to keeping trees in the ground.
Certainly, it is important for wildlife; it is important to the
aesthetics--all of us like the thought of there being forest
there that we might someday take a walk in or hunt or fish in.
And, so, yes, we think there very definitely is that. If there
is something to global warming, then, obviously, carbon
sequestration is very important, and so these things addressed
in the Dunn bill will promote, hopefully, and begin to take
some of the incentives out of reforestation; take some of the
disincentives out of reforestation.
Mr. McCrery. Thank you, Mr. Moore. Thank you, Mr. Chairman.
Chairman Archer. Mr. Shaw.
Mr. Shaw. I would like to follow up just a little bit on
the previous line of questioning with regard to Henson and the
planting of the trees. Also, there is not only just the
environmental considerations that you have talked about, there
is also the question of erosion. As a matter of fact, there are
erosion programs whereby the Federal Government actually pays
people to plant trees to stop the erosion, so it is good for
clean water, as well.
And I would like to add to the answer that you gave with
regard to why would you distinguish this from, perhaps, other
investments? And another reason is what we are doing is if you
are farmer and buy fertilizer and whatever you buy, you get to
write that off; you don't have to wait until that crop comes
in, and this is just recognizing the tree farmer as a farmer,
and that is exactly what they are. They just have to wait
longer for their investment to come back, but I think just from
the standpoint of just not only competitiveness and the
environment, I think it is just a question of basic fairness,
not requiring the capitalization.
Do we have any figures or do we have any estimates as to
what it would be to go back to the old law like it used to be,
just simply saying when you cut your timber and replant it, you
get to write it off? Do we have any figures on that?
Mr. Moore. Congressman, we don't. We can try to get those
for you. I think you could probably get them quicker from the
Joint Committee than we can. We do have figures, obviously,
that we have seen on the Dunn bill, but, no, I don't know what
the revenue loss would be for that.
Mr. Shaw. I think maybe the Committee ought to take a look
at that to see what would be the effect rather than going
through the--writing it off over a period of several years and
then getting a tax credit. I mean, it is just a quick writeoff.
Just go back to existing law what it was a number of years ago.
In fact, since I have been in this Congress, I think that has
been changed.
Historic preservation, and it is nice to see you back here
before this Committee, Mr. Andrews and I know you have been
very active in this area. This is a piece of legislation that
really gives you a two-for. You get not only historic
preservation, but you also get housing, and I can tell you
having renovated two townhouses on Capitol Hill, it is a little
costly, and I think that there is certainly a national interest
in preserving many of these older homes around the country, and
I think the statistics that you gave us as to how they are
disappearing is really quite startling, and I would hope that
that would be included in the bill that finally comes out of
this Committee and maybe even the Chairman's part.
Mr. McCrery. Will the gentleman yield?
Mr. Shaw. Yes, I would be glad to yield.
Mr. McCrery. If I am not mistaken--Mr. Andrews, correct me
if I am wrong--but you are here totally on a voluntary basis,
is that right? [Laughter.]
Mr. Andrews. Yes, I am. Yes, this is something that I feel
very strongly about. You know, there are a lot of things that
need to be done for our country's cities and our
neighborhoods--fighting crime, better schools, better
infrastructure. This is one important step, though, that can
make a significant difference in encouraging families to
rehabilitate historic structures and preserve our culture and
our heritage. If you look at every successful city, those
cities have done a good job of preserving their history and
their culture and their heritage. They have not allowed their
neighborhoods to be decimated and razed, and this is a very
modest cost bill, but it will have far-reaching impacts on
historic neighborhoods.
Mr. McCrery. Mr. Chairman, let me clarify, I didn't mean to
imply that any of the others were here--were compelled to be
here; I mean that Mr. Andrews is not being paid by the
association he is representing; he is here just as a volunteer
on behalf of that cause. So, thanks.
Chairman Archer. The gentleman might want to quit while he
is ahead. [Laughter.]
Mr. Shaw. Thank you. I yield back, Mr. Chairman.
Chairman Archer. Mr. Moore, one of the things I have noted
over the years is a misunderstanding about forestry and proper
management of trees. Is it not true that with proper forest
management and selective cutting, in contrast to clear cutting,
there are environment benefits? You reduce the amount of
greenhouse gases that come from the decaying of older trees
that are not cut prior to the time that they go into decline.
Mr. Moore. Yes, Mr. Chairman. Also, you would help prevent
insect infestation. Anything old tends to get weaker; it tends
to get sicker; it tends to do less for the environment, and it
consumes less carbon.
Chairman Archer. Furthermore, don't you open up the forest
for the growth of younger trees so that they can produce their
beneficial effect on the environment?
Mr. Moore. Yes, that is a raging debate now in the Kyoto
Protocol discussions of these very points you are making. The
science of silvaculture and the foresters would say,
``Absolutely, you are correct on these points.'' That is
disputed by some who are not trained in forestry.
Chairman Archer. Thank you. Any other inquiry?
The Chair thanks all of you for your presentations today,
we appreciate all of your input, and you are excused.
There being no further testimony before the Committee, the
Committee will stand adjourned.
[Whereupon, at 3:43 p.m., the hearing was adjourned.]
[Submissions for the record follow:]

Statement of America's Community Bankers

Mr. Chairman and Members of the Committee:
America's Community Bankers appreciates this opportunity to
submit testimony for the record of the hearing on ways to
strengthen the family and sustain a strong economy. America's
Community Bankers (ACB) is the national trade association for
progressive community bankers across the nation. ACB members
have diverse business strategies based on consumer financial
services, housing finance, small business lending, and
community development, and operate under several charter types
and holding company structures.

Introduction

Our testimony will focus on a single legislative proposal
that is uniquely suited to both strengthening the family and
helping to sustain a strong economy. This is a proposal to
increase the per capita limit on the low-income housing tax
credit (LIHTC) from $1.25 to $1.75. It was introduced in the
House this year by Representatives Nancy Johnson and Charles
Rangel as H.R. 175 and introduced in the Senate this year by
Senators Connie Mack and Bob Graham as S. 1017, as well as
advocated in the Administration's fiscal year 2000 budget
proposal. As an important part of the thrift industry's
commitment to housing, ACB's member institutions have been
participants, as direct lenders and, through subsidiaries and
affiliates, as investors, in many low-income housing projects
that were viable only because of the LIHTC. The per capita
ceiling on the annual allocation of the LIHTC has not been
increased since the credit was created by the Tax Reform Act of
1986. Many member institutions have communicated to ACB that
there are shortages of affordable rental housing in their
communities and that, if the supply of LIHTCs were increased,
such housing could be more efficiently produced to address this
shortage.
Experts in the field have commented on the unique ability
of the LIHTC to strengthen the family and create private sector
jobs that strengthen the economy. For example, Joseph Lynch,
the Commissioner of the New York State Division of Housing and
Community Renewal testified on May 27, 1999, at the IRS public
hearing on proposed regulations intended to enhance the
compliance monitoring of LIHTC projects (REG 114664-97) that:

``It is important to note that the housing credit not only
develops and preserves decent housing, it also stimulates
business activity, creating private sector jobs and generating
tax revenues. Based on information provided by the National
Association of Home Builders, my staff estimates that the
housing credit assisted development of those 30,840 units that
I talked about has created more than 31, 765 jobs and generated
more than a billion dollars in wages and more than half a
billion dollars in combined federal, state, and local tax
revenues and fees, the bottom line is that the housing credit
is a very wise investment, a wise investment for the federal
government, for the states, for private investors, and for low-
income families and other citizens who live in decent, safe,
and affordable housing made possible by the credit.''

Background

The LIHTC was created in 1986, and made permanent in 1993,
to replace a variety of housing subsidies, the efficiency of
which had been called into question. Under Section 42 of the
Internal Revenue Code, a comprehensive regime of allocation and
oversight was created, requiring the involvement of both the
IRS and state and local housing authorities, to assure that the
LIHTC is targeted to increase the available rental units for
low-income citizens. This statutory scheme has been revised in
several subsequent tax acts to eliminate potential abuses.
Nevertheless, the Code does impose the judgment of federal
bureaucrats over that of state housing agencies in making
credit allocations. Section 42 requires the housing credit
allocation agencies to develop qualified allocation plans to
target their tax credits to proposed housing projects that meet
their ``housing priorities'' and that include selection
criteria that are ``appropriate to local conditions.'' In
addition the Code requires the agencies to ``give preference''
to projects ``serving the lowest-income tenants'' and projects
``obligated to serve qualified tenants for the longest
periods.'' Because the Code does not define these terms or set
forth the procedures for implementing the program's
requirements, it gives the allocating agencies the flexibility
to respond to their particular needs.
Every year since 1987, each state has been allocated a
total amount of LIHTCs equal to $1.25 per resident. The annual
per capita limit may be increased by a reallocation of the
unused credits previously allocated to other states, as well as
the state's unused LIHTC allocations from prior years. The
annual allocation must be awarded within two years or returned
for reallocation to other states. State and local housing
authorities are authorized by state law or decree to award the
state's allocation of LIHTCs to developers who apply by
submitting proposals to develop qualified low-income housing
projects.
A ``qualified low-income project'' under Section 42(g) of
the Code is one that satisfies the following conditions. (1) It
must reserve at least 20 percent of its available units for
households earning no more than 50 percent of the area's median
gross income, adjusted for family size, or at least 40 percent
of the units must be reserved for households earning no more
than 60 percent of the area's median gross income, adjusted for
family size. (2) The rents (including utility charges) must be
restricted for tenants in the low-income units to 30 percent of
an imputed rental income limitation based on the number of
bedrooms in the unit. (3) During a compliance period, the
project must meet habitability standards and operate under the
above rent and income restrictions. The compliance period is 15
years for all projects placed in service before 1990.
Amendments in 1989 extended the period for which credit project
are required to serve low-income households to 30 years, but
included an exception that, in some instances, could permit a
sale that would result in the project's conversion to market
rental rates after 15 years.
Putting together a qualifying proposal is, however, only
the first step for a developer seeking an LIHTC award. The
state or local housing agency is required to select from among
all of the qualifying projects by means of a LIHTC allocation
plan satisfying the requirements of Section 42(m). The
allocation plan must set forth housing priorities appropriate
to local conditions and preference must be given to projects
that will serve the lowest-income tenants and will serve
qualified tenants for the longest time.
Section 42 effectively requires state and local housing
agencies to create a bidding process among developers to ensure
that the LIHTCs are allocated to meet housing needs
efficiently. To this end the Code imposes a general limitation
on the maximum LIHTC award that can be made to any one project.
Under Section 42(b) the maximum award to any one project is
limited to nine percent of the ``qualified basis'' (in general,
development costs, excluding the cost of land, syndication,
marketing, obtaining permanent financing, and rent reserves) of
a newly constructed building. Qualified basis may be adjusted
by up to 30 percent for projects in a qualified census tract or
``difficult development area.'' For federally subsidized
projects and substantial rehabilitations of existing buildings,
the maximum annual credit is reduced to four percent. The nine
and four percent annual credits are payable over 10 years. In
1987, the first year of the LIHTC, the 10-year stream of these
credits was equivalent to a present value of 70 percent and 30
percent, respectively, of qualified basis. Since 1987, the
Treasury has applied a statutory discount rate to the nominal
annual credit percentages to maintain the 70 and 30 percent
rates.
The LIHTC has to be taken over 10 years, but the period
that the project must be in compliance with the habitability
and rent and income restrictions is 15 years. This creates an
additional complication. The portion of the LIHTC that should
theoretically be taken in years 11 through 15 is actually taken
pro rata during the first 10 years. Where there is
noncompliance with the project's low-income units during years
11 through 15, the related portion of the LIHTC that was, in
effect, paid in advance will be recaptured.
Where federally subsidized loans are used to finance new
construction or substantial rehabilitation, the developer may
elect to qualify for the 70 percent present value of the credit
by reducing the qualified basis of the property. Where federal
subsidies are subsequently obtained during the 15-year
compliance period, the qualified basis must then be adjusted.
On the other hand, certain federal subsidies do not affect the
LIHTC amount, such as the Affordable Housing Program of the
Federal Home Loan Banks, Community Development Block Grants,
and HOME Investment Partnership Act funds.
The LIHTCs awarded to developers are, typically, offered to
syndicators of limited partnerships. Because of the required
rent restrictions on the project, the syndications attract
investors who are more interested in the LIHTCs and other
deductions the project will generate than the unlikely prospect
of rental profit. The partners, who may be individuals or
corporations, in essence, provide the equity for the project,
while the developer's financial stake may be limited to
providing the debt financing.
The LIHTC is limited, however, in its tax shelter potential
for the individual investor. Individuals are limited by the
passive loss rules to offsetting no more than $25,000 of active
income (wages and business profits) with credits and losses
from rental real estate activities. For an individual in the
28% bracket, for example, the benefit from the LIHTC would be
limited to $7,000. It should also be borne in mind that such
credits are unavailable against the alternative minimum tax
liability of individuals and corporations.

No Abuses Found by GAO

Three years ago the Chairs of the Ways and Means Committee
and its Subcommittee on Oversight requested the GAO to study
the LIHTC program and, specifically, to evaluate: whether the
LIHTC was being used to meet state priority housing needs;
whether the costs were reasonable; and whether adequate
oversight was being performed. The resulting GAO report, which
took more than a year to compile, amounted to, in the measured
terms of such reports, a validation of the program. (The report
was careful ``o emphasize that GAO has never taken a position
on whether the tax credit should be retained or repealed.'' See
Tax Credits: Opportunities to Improve Oversight of the Low-
Income Housing Program (GAO/GGD/RCED-97-55, March 28, 1997, p.
52).
Among the GAO findings were the following:
1. Although renters in credit properties are permitted by
the Code to earn up to 60% of the local area's median income,
the actual renters earn on average 37% of the local median and
more than three-fourths meet HUD's definition of ``very low
income''--i.e., their incomes were below 50% of the local
median income. (To verify tenant income, GAO selected a random
sample of at least one tenant in each of the randomly sampled
projects and reviewed IRS tax return data on those tenants.
2. The average monthly rent of about $453 per apartment in
a credit property is below market--as much as 23% below the
maximum rent set by the Code and 25% below HUD's national Fair
Market Rent.
3. About 26% of the properties were intended to serve
primarily the elderly and about 5% were intended to serve
people with special needs. About 53% of the properties were in
rural areas, 36% were in urban areas, and the remainder were in
suburban areas.
4. States are giving preference in awarding credit to
projects dedicated to providing low-income housing for more
than the 30-year compliance period required for properties
placed in service after 1989. Two-thirds of the projects
studied by the GAO had extended use commitments to low-income
tenants longer than 30 years or had waived the option to
convert to market rate after the fifteenth year.
5. Development costs for credit properties are reasonable.
The average cost of developing credit properties was about
$60,000 per unit and about two-thirds of these units cost less
than or the same as the average noncredit unit.
6. Section 42 requires the states to consider the
``reasonableness'' of project development costs, but does not
specify a national standard of reasonableness. The states have
adopted a number of practices to directly control costs and to
manage competition in ways that will promote cost control. The
National Council of State Housing Agencies has provided ``best
practice'' guidance on cost control. Of the 54 allocating
agencies surveyed by the GAO, 48 have established guidelines
for controlling overall project construction costs. The
remaining agencies reported that they rely on competition in
the application process or on their staff's expertise to
control development costs.

Proposed IRS Compliance Regulations

While the GAO could find no actual abuses or fraud in the
LIHTC program, it did determine that the procedures that some
states use to review and implement project proposals needed to
be improved. The report recommended changes in the appropriate
IRS regulations with respect to existing state agency
compliance procedures used to ensure the eligibility of
projects for the credit. The GAO also recommended that the IRS
regulations be amended to establish clear requirements to
ensure independent verification of the developer's information
on sources and uses of funds submitted to a state agency. The
assurance of reliable and complete cost and financing
information will enable state agencies to avoid providing more
(or fewer) credits than are actually authorized.
In response to the GAO recommendation the IRS issued
proposed regulations under section 42(m)(1)(B)(iii) of the Code
that substantially toughened the compliance monitoring
currently required of the state agencies administering the
LIHTC. Under the proposed regulations state agencies will be
required to conduct an on-site inspection of every one of their
LIHTC projects at least once every three years, including a
review of the compliance records of 20% of the project's
tenants. The agencies will be required to conduct an on-site
inspection of each new project by the end of the year following
the year it is placed in service, including a review of the
compliance documents for 100% of the tenants. In addition, the
proposed regulations would shift to the state agencies the
responsibility for conducting all health, safety, and building
code inspections of LIHTC projects and would require such
inspections at least once every three years.
The proposed regulations also require that, under section
42(m)(2)(A) of the Code, the developer must obtain a CPA's
audit opinion on the accuracy of the financial statements and
certifications provided by the developer to the state agency,
including the costs that may qualify for inclusion in eligible
basis under section 42(d) and the amount of the LIHTC. At the
hearing on the proposed regulations held on May 27, 1999, The
three, out of the four, speakers who represented state agencies
and developers stated that these new requirements were too
burdensome.

The Necessity for Expanding the LIHTC

The GAO, after a detailed examination, found no evidence
that fraud or abuse is occurring in the LIHTC program and did
find substantial evidence that the program is working as
Congress intended to provide the genuinely needy with decent
affordable housing. The IRS, at the recommendation of the GAO,
has issued stringent proposed regulations that are intended to
assure compliance with the congressional purpose expressed in
the LIHTC statute. Whether or not these proposed regulations
would impose compliance burdens on state agencies and
developers that are too onerous, Congress should at least be
assured that the IRS is diligently working to eliminate any
potential for fraud of abuse in the LIHTC.
The only problem with the LIHTC is its insufficiency to
meet the urgent need that currently exists for affordable
housing. The only increase in the total amount of LIHTCs since
1987 has been through population growth, which has been only
five percent nationwide over the 10-year period (floor
statement of Senator Alphonse D'Amato, October 3, 1997). Had
the $1.25 per capita limit been indexed for inflation since the
inception of the LIHTC, as is commonly done in other Code
provisions, it would be comparable to the $1.75 limit the
Administration is proposing. According to the Joint Committee
on Taxation, the Consumer Price Index measurement of cumulative
inflation between 1986 and the third quarter of 1998 was
approximately 49.5 percent. Using this index to adjust the per
capita limit, it would now be approximately $1.87. The GDP
price deflator for residential fixed investment indicates 39.9
percent price inflation, which would have increased the per
capita limit to approximately $1.75. (See Joint Committee on
Taxation, Description of Revenue Provisions Contained in the
President's Fiscal Year 2000 Budget Proposal (JCS-1-99),
February 22, 1999)
More affordable low-income housing is urgently needed.
``Despite the success of the Housing Credit in meeting
affordable rental housing needs, the apartments it helps
finance can barely keep pace with the nearly 100,000 low cost
apartments which were demolished, abandoned, or converted to
market use each year. Demand for Housing Credits currently
outstrips supply by more than three to one nationwide.
Increasing the cap as I propose would allow states to finance
approximately 27,000 more critically needed low-income
apartments each year using the Housing Credit, helping to meet
this growing need.'' (floor statement of Representative Nancy
Johnson, January 6, 1999).
``And, as Adam Smith would have predicted, this incentive
does the job. Since 1987, state agencies have allocated over $3
billion in Housing Credits to help finance nearly one million
apartments for low income families, including 70,000 apartments
in 1997. In my own state of Florida, the Credit is responsible
for helping finance over 52,000 apartments for low income
families, including 3,300 apartments in 1997. The demand for
Housing Credits nationwide currently outstrips supply by more
than three to one'' (floor statement of Senator Connie Mack,
May 12, 1999).
``In the state of Florida, for example, the LIHTC has used
more than $187 million in tax credits to produce approximately
42,000 affordable rental units valued at over $2.2 billion. Tax
credit dollars are leveraged at an average of $12 to $1.
Nevertheless, in 1996, nationwide demand for the housing credit
greatly outpaced supply by a ratio of nearly 3 to 1. In
Florida, credits are distributed based upon a competitive
application process and many worthwhile projects are denied due
to a lack of tax credit authority'' (floor statement of Senator
Bob Graham, October 3, 1997).
``In 1996, states received applications requesting more
than $1.2 billion in housing credits-- far surpassing the $365
million in credit authority available to allocate that year. In
New York, the New York Division of Housing and Community
Renewal received applications requesting more than $104 million
in housing credits in 1996--nearly four times the $29 million
in credit authority it already had available'' (floor statement
of Senator Alphonse D'Amato, October 3, 1997). ``The Housing
Credit is the primary federal-state tool for producing
affordable rental housing all across the country. Since it was
established, state agencies have allocated over $3 billion in
Housing Credits to help finance nearly one million homes for
low income families, including 70,000 apartments in 1997. In my
own state of Connecticut, the Credit is responsible for helping
finance over 7,000 apartments for low income families,
including 650 apartments in 1997'' (floor statement of
Representative Nancy Johnson, January 6, 1999).

Conclusion

Based on the foregoing, it is clear that it is time to
increase the LIHTC. Increasing the availability of the LIHTC is
one of the top legislative priorities of ACB. Our members have
been in the forefront of those who have been using the LIHTC to
profitably increase the housing stock of their communities and,
by their use of the LIHTC, our members are proving that it is
possible to do well by doing good in their communities. ACB
appreciates very much this opportunity to testify for the
record of this important hearing and commends you, Mister
Chairman, and the members of the Subcommittee for holding it.
If you have any questions or if ACB can be of further
assistance, please do not hesitate to call James O'Connor, at
202-857-3125.

Joint Statement of American Association of Colleges of Osteopathic
Medicine, Chevy Chase, MD; and Association of American Medical Colleges

The Association of American Medical Colleges (AAMC) and the
American Association of Colleges of Osteopathic Medicine
(AACOM) are pleased to have this opportunity to comment on
reducing the tax burden on individuals through increased
education incentives.
We believe that there is a compelling public interest in
exempting payments for tuition and education-related expenses
under the National Health Service Corps (NHSC) Scholarship
Program from gross income for tax calculation purposes. The
NHSC Scholarship Program provides highly educated health care
professionals to federally-designated health professional
shortage areas, often in rural or inner city locations. By
levying a tax on the tuition and fees portion of NHSC
scholarships, participation in the program is jeopardized,
threatening the ability of under-served health communities to
secure needed medical providers.
The NHSC Scholarship Program was established more than 20
years ago to provide health professions students with funding
to cover tuition and education related expenses, as well as a
monthly stipend for living expenses, in exchange for a
commitment to provide primary health care services in a
federally-designated health professional shortage area (HPSA).
During this time, the NHSC Scholarship Program has produced
over 23,000 doctors, physician assistants, nurse midwives and
other health care professionals. The program attracts a
culturally diverse applicant pool--over 40 percent of
recipients are minorities--who are more sensitive to the health
care issues in underserved areas, but at the same time also are
more sensitive to incurring debt. Because the imposition of tax
on the scholarship drastically reduces the amount of the
monthly stipend, students may be forced to find additional
funding sources or look at other scholarship options, reducing
the ability to fulfill the national priority of increasing
access to health care in medically underserved areas.
On August 29, 1997, the NHSC sent notification to health
professions schools and students of their intention, based on
the result of a new Internal Revenue Service (IRS)
interpretation, to begin withholding federal income tax on the
entire amount of scholarships awarded to NHSC scholarship
recipients. According to the IRS, taxation of the entire
scholarship amount is required to comply with a change in the
tax code, specifically a 1986 amendment to 26 USC 117 (c).
In 1994, the NHSC sought clarification of the 1986
amendment to section 117 (c) from the IRS. The IRS
interpretation concluded that NHSC scholarships are awarded as
payment for substantial future services and therefore are not
excludable from gross income under section 117 (c). The IRS
distinguishes NHSC scholarships from other award programs
administered by the Department of Health and Human Services
such as Scholarships for Students with Exceptional Financial
Need (EFN), Financial Assistance for Disadvantaged Health
Professions Students (FADHPS), and Mental Health Clinical
Traineeship (MHCT). The IRS concluded that these programs ``do
not impose the same substantial quid pro quo service
requirements on the participants as are imposed upon NHSC
participants'' and therefore are not subject to the same
federal taxation.
Prior to 1986, NHSC scholarship recipients were required to
pay federal tax only on the stipend portion of the scholarship.
Tuition and related expenses were excluded from gross income.
Although an unintended effect of the Tax Reform Act of 1986 was
to levy tax on NHSC scholarships, the provision went unnoticed
and unenforced until the NHSC's 1994 inquiry. To comply with
the 1997 IRS interpretation, the NHSC began withholding the
entire tax obligation from the stipend part of the scholarship,
beginning December 1, 1997. Many NHSC scholarship recipients
encountered drastic reductions in the amount of their monthly
stipends as a result of the IRS interpretation.
A reduced stipend is likely to cause these students to seek
supplemental financial assistance to meet their living expenses
and creates a disincentive for students to participate in the
program. The high cost of medical school tuition means that
students could face thousands of dollars in tax payments on
their scholarships. In addition, NHSC analysis shows that
students in their second, third and fourth years of study are
impacted to even greater degrees. In a worst case scenario, the
NHSC estimates that a fourth year student at a high-cost
institution would not only forfeit the entire stipend in
federal tax payments, but additionally owe nearly $300.
Bipartisan legislation aimed at exempting NHSC scholarship
payments from income for tax purposes was recently introduced
in both chambers of Congress. Representatives Nancy Johnson (R-
Conn.) and Karen Thurman (D-Fla.) introduced H.R. 1414 on April
14, 1999, and Senator Jim Jeffords (R-Vt.) introduced S. 288 on
January 21, 1999. This version also exempts scholarships
granted under the F. Edward Hebert Armed Forces Health
Professions Scholarship and Financial Assistance Program. The
proposal is also part of Senate Finance Committee Chairman
William Roth's (R-Del.) education tax break package which was
approved by his committee on May 19, 1999. The section related
to NHSC and Armed Forces scholarship exemptions was costed at
only $8 million over the next 10 years. This is a minimal price
to pay to increase access to high quality health care in
underserved areas.
There also is no opposition to this proposal. The current
congressional proposals include significant support from both
sides of the aisle, and similar language was approved by both
chambers in the 105th Congress before being vetoed by the
president for unrelated reasons. However, the Administration
included a similar proposal in the FY 2000 budget request as
part of a larger administration proposal to expand education
initiatives. In the Analytical Perspectives volume of the FY
2000 Budget Proposal, the Administration proposes to amend
current law to provide that ``any amounts received by an
individual under the NHSC Scholarship Program or the Armed
Forces Health Professions Scholarship and Financial Assistance
Program are `qualified scholarships' excludable from income,
without regard to the recipient's future service obligation.''
In conclusion, the AAMC and AACOM believe that taxing
tuition and education related expenses under the NHSC
Scholarship Program creates a disincentive to participation in
a program that serves a compelling national public policy
interest. As you compose legislation aimed at reducing the tax
burden on individuals, we urge you to include a provision
exempting these important scholarships from gross income for
tax purposes.
The AAMC represents the nation's 125 accredited medical
schools, some 400 major teaching hospitals and health systems,
86 professional and scientific societies representing 87,000
faculty members, and the nation's medical students and
residents.
AACOM represents the 19 accredited colleges of osteopathic
medicine in the United States as well as all osteopathic
medical students and osteopathic interns and residents.

American Association of Engineering Societies
Washington, DC 20036-3690
June 14, 1999

The Honorable William Archer
Chairman
Ways and Means Committee
U.S. House of Representatives
Washington, DC 20515

Dear Mr. Chairman:

The Engineers Public Policy Council of the American Association of
Engineering Societies strongly supports HR 1682, the Private Sector
Research and Development Investment Act of 1999 that was introduced by
Representatives Wilson and Ford. This legislation would make the
federal Research and Experimentation Tax Credit permanent and expand
the basic research credit component. Enclosed is a copy of our position
statement, which we would appreciate being placed in the record of your
committee's June 23rd hearing.
Federal policy should foster investment in research, both public
and private, in order to ensure our nation's ability to compete in the
market place of the 21st Century. Making the credit permanent should be
a top priority for Congress to enable private industry to create long-
term research plans that will benefit all of society.
The R&E tax credit provides a vital incentive for private companies
to increase their R&D spending in the U.S. The credit is both a good
investment in U.S. productivity and job growth, as well as a critical
compliment to direct federal support for R&D. Investment in engineering
and science research is the lifeblood of technological innovation,
which drives U.S. economic growth, environmental progress, and national
security. Private firms fund almost two-thirds of the nation's
engineering and science research.
AAES notes that only HR 1682 seeks to address the gross under-
utilization of the basic research credit. The enhancements proposed by
this legislation will spur private industry to undertake more basic
research programs, many at our nation's research universities. The
results will not only include great advances in our body of knowledge,
but also the training of the next generation of researchers.
If you have any questions, please feel free to contact Pete Leon,
AAES Director of Public Policy at (202) 296-2237.

Sincerely,
Dr. Theodore T. Saito
1999 EPPC Chair

American Association of Engineering Societies Recommendations

Make the R&E Credit Permanent

The R&E credit should be made a permanent part of the tax
code. While the temporary nature of the credit was originally
justified as a way to review the performance of the law, 17
years has been a more than adequate review period. A recent
study by Coopers and Lybrand claimed that a permanent credit
would stimulate $41 billion in additional R&D by 2010. While
current budget constraints are cited as the principal barrier
to permanence, we urge Congress to give more weight to the
expected long-term gains to society of a permanent credit than
is given to short-term revenue loss.

Reform the ``Basic Research Credit'' to Promote Collaborative Research

Studies by the Office of Technology Assessment (OTA),
Congressional Research Service (CRS), and others conclude that
the current ``Basic Research Credit'' is ineffective. We
believe this is due to its narrow definition of research and
its incremental nature. According to OTA, basic research
payments to universities and other qualified organizations
represented only 0.4 percent of total qualified research in
1992.
The definition of research under this provision should be
expanded to include all long-term, high-risk collaborative
research. While one of the strengths of the R&E credit is that
it leaves decisions on what research areas to fund to the
private sector, a robust incentive for long-term collaborative
research would increase the credit's spillover benefits to
society. Such a credit should foster basic and long-term
precompetitive research, which industry has cut back on, and
promote company-to-company, company-to-university, and company-
to-federal laboratory partnerships. It should also include
expenditures for collaborative research involving nonprofit
research centers.
Further, because this type of research does not represent a
major portion of a typical company's R&D budget, an incremental
design--as is currently used under the Basic Research Credit--
is not likely to affect decisions on R&D strategies and, thus,
not provide a sufficient incentive. By contrast, a 20% flat
credit would be much simpler and would likely create the needed
incentive for firm's to pursue more long-term research through
joint ventures with universities, laboratories, nonprofit
centers, and industry-wide consortia. Such research allows
firms to share costs, hedge risks, and broaden their
technological competence. It can also speed the rate of
technology diffusion across firms and produce multiple societal
benefits.

Adjust the Base Period

To be fair and effective, the base amount realistically has
to account for changes in a firm's research intensity over
time. The current 1984-88 period is both discriminatory and
outdated. While some firms do very well with this base period,
many others reap little or no benefit because their sales have
grown faster (or fallen more slowly) than their qualified
research expenses since the base period. The current 1984-88
base simply is not a reasonable benchmark for many companies
given their current business conditions. One proposal worth
considering is to permit companies to use any 4-year period
within the previous 10 years, which would better match their
current business environment while retaining the incremental
nature of the credit.

Repeal the 50% Rule

The 50% rule reduces the value of the credit to firms that
have substantially increased their R&D spending over their base
period. This rule is particularly troublesome for small firms,
which produce the lion's share of new jobs in the U.S. Under
the 50% rule, many high-tech start up firms often see the
effective rate of the R&E tax credit cut in half.

American Association of Engineering Societies

The Federal R&E Tax Credit

June 16, 1998

Summary Recommendations

Make the R&D Tax Credit Permanent
Reform the ``Basic Research Credit'' to Promote
Collaborative Research
Adjust the Base Period
Repeal the 50% Rule

Introduction

Investment in science and engineering research is the
lifeblood of technological innovation, which drives U.S.
economic growth, environmental progress, and national security.
Almost two-thirds of the nation's science and engineering
research is funded by private firms. The federal share of total
U.S. R&D investment has decreased steadily and currently
represents 31% of total R&D spending, down from 57% in 1970.
The increasing role of the private sector in funding U.S.
science and engineering R&D is likely to continue. Moreover,
considering that private firms typically underinvest in R&D
when responding solely to the marketplace and that real R&D
growth in many manufacturing industries has declined, federal
policies--both direct and indirect--that induce additional
private R&D investment are essential. Currently, the Research
and Experimentation (R&E) tax credit is the centerpiece of the
federal government's indirect support for R&D.
The American Association of Engineering Societies (AAES)
believes that the R&E tax credit provides an important, market-
driven incentive for companies to increase their R&D spending
in the U.S. The credit is both a good investment in U.S.
productivity and job growth and a critical complement to direct
federal subsidies for R&D.

How the R&E Credit Works

In 1981, Congress created the R&E tax credit to encourage
business to increase their R&D spending in the U.S. Under
section 41 of the Internal Revenue Code, a firm can claim a 20%
tax credit on the amount by which its qualified research
expenditures (QREs) exceed a base level. Such an incremental
design, in principle, minimizes the likelihood of providing a
tax subsidy to a firm for R&D that would have taken place in
the absence of the credit.
The base amount is determined by multiplying a firm's
``fixed base percentage'' (the ratio of its combined QREs from
1984-88 to its combined gross income in that period) by its
average gross income in the preceding 4 tax years.
QREs generally include salaries and wages, supplies, and
65% of the total amount paid for contract research. Basic
research payments to universities and other scientific research
organizations are also treated as QREs. The primary
expenditures that do not qualify are property, plant, and
equipment costs as well as depreciation on R&D capital goods.
Qualified research, while not well defined under section 41,
must be technological in nature and relate to the development
of new or improved business components. Generally, roughly 50
percent of industry R&D expenditures qualify for the tax
credit.

Importance to Engineers and Scientists

Because almost 70% of R&E tax credit dollars claimed are
investments in the salaries of U.S. research employees, the
credit benefits engineers and scientists directly by fostering
high-skilled, high-paying jobs in the U.S. In addition to the
direct benefit on jobs and wages of engineers and scientists,
most studies show that the credit stimulates substantial
amounts of additional science and engineering research, which
improves productivity across virtually all industries and,
thus, our economic strength and standard of living.
At a time when U.S. companies are looking increasingly to
moving development of products for foreign markets offshore,
the R&E tax credit encourages companies to keep a greater
portion of R&D, and the related jobs, in the U.S.
Studies have shown that the credit benefits companies of
all sizes and all sectors of the economy. Industries that
particularly benefit include: electrical and electronic
equipment, communications, chemicals and allied products,
biotechnology, machinery, motor vehicles and equipment,
instruments and related products, and business services.

Effectiveness of the R&E Credit

The U.S. General Accounting Office, Bureau of Labor
Statistics, the National Bureau of Economic Research, and many
private researchers agree that the R&E tax credit stimulates
substantial amounts of additional R&D. Exactly how much
spending is stimulated per dollar of revenue lost (the ``bang-
per-buck'' ratio) varies. Many recent studies, however, support
the conclusion that for each dollar lost in tax revenue, the
credit stimulates a dollar of new R&D spending in the short
run, and as much as two dollars in the long run. This implies
long-run gains in productivity, wages, and GDP.
While this ratio is a useful barometer, more important is
the net benefit the credit produces for society. Determining
what type of research is stimulated by the credit is difficult,
however, as is measuring the social rate of return on R&D. R&D
investment, in general, provides substantial returns to
society. In fact, economists estimate that half of U.S.
economic productivity since WWII is attributable to technical
progress driven by science and engineering research. And past
studies suggest that the median social rate of return on R&D in
general exceeds twice the median private rate of return
Most studies have shown that the structure of the R&E
credit can also have a significant impact on its effectiveness.
When Congress decided in 1990, for example, that taxpayers
claiming the credit must forego the deductibility of those
qualifying research expenses under a separate section of the
tax code (Section 174), it essentially lowered the maximum
effective rate of the regular credit from the statutory level
of 20% to 13%. In addition, since the base amount can never be
less than 50% of current year's QREs, the marginal rate of the
credit is frequently capped at 6.5%. This ``50% rule''
particularly impacts small firms.
Perhaps the most important hindrance to the credit's
effectiveness is its temporary status. The continuing short-
term approach to stimulating long-term research is a more
costly and much less efficient policy than a permanent credit.
Many firms overlook the R&E credit when setting their research
budgets because they cannot be certain of its future
availability as they plan long-term research projects. Repeated
on-again, off-again extensions dampen the very incentive value
the credit was enacted to promote. This is particularly the
case for companies with longer planning horizons, such as
biotechnology firms. Allowing gaps in coverage to occur, as
happened in 1996, reduces the incentive even further.

Statement of Jaime Steve, Legislative Director, American Wind Energy
Association

The American Wind Energy Association,\1\ or AWEA,
respectfully submits this written testimony in support of a
five-year extension of the existing 1.5 cent per kilowatt-hour
production tax credit (PTC) for electricity produced using wind
energy resources. An immediate extension of this provision is
crucial if we are to see significant growth in the domestic
wind energy industry. We are grateful for the opportunity to
participate in the deliberations of the House Ways and Means
Committee as it considers this important issue.
---------------------------------------------------------------------------
\1\ The American Wind Energy Association, or AWEA, was formed in
1974 and has nearly 700 members from 48 states. AWEA represents
virtually every facet of the wind energy industry, including turbine
manufacturers, project developers, utilities, academicians, and
interested individuals.
---------------------------------------------------------------------------
The Energy Policy Act of 1992 (EPAct) enacted the PTC as
Section 45 of the Internal Revenue Code. The credit is phased
out if the price of wind generated electricity is sufficiently
high. In report language accompanying EPAct (H. Rpt. 102-474,
Part 6, p. 42), the Ways and Means Committee stated, ``The
Credit is intended to enhance the development of technology to
utilize the specified renewable energy sources and to promote
competition between renewable energy sources and conventional
energy sources.''
Since its inception, the PTC has supported wind energy
development and production. In the 1980's, electricity
generated with wind could cost as much as 25 cents per
kilowatt-hour. Since then wind energy has reduced its cost by a
remarkable 80% to the current levelized cost of between 4 and 5
cents per kilowatt-hour.
The 1.5 cent per kilowatt-hour credit enables the industry
to compete with other generating sources being sold at 3 cents
per kilowatt-hour. The extension of the credit will enable the
industry to continue to develop and improve its technology to
drive costs down even further and provide Americans with
significantly more clean, emissions-free electricity
generation. Indeed, experts predict the cost of wind equipment
alone can be reduced by another 40% from current levels, with
an appropriate commitment of resources to research and
development and from manufacturing economies of scale.
Current PTC Provision: The Production Tax Credit (PTC)
provides a 1.5 cent per kilowatt-hour credit (adjusted for
inflation) for electricity produced from a facility placed in
service between December 31, 1993 and June 30, 1999 for the
first ten years of the facility's existence. The credit is only
available if the wind energy equipment is located in the United
State and electricity is sold to an unrelated party. Under
current law, the tax credit qualification date would expire on
June 30, 1999. A five-year extension would create a new sunset
date of June 30, 2004.
Status: A five-year extension of this provision--through
June 30, 2004--was introduced in the House (H.R. 750) by Rep.
Bill Thomas (R-CA). H.R. 750 has been cosponsored by 26 Ways
and Means Committee members, including Reps. Jim Nussle (R-IA),
Jennifer Dunn (R-WA), Robert Matsui (D-CA), Jim McDermott (D-
WA), John Lewis (D-GA) and Karen Thurman (D-FL). At present,
H.R. 750 has 124 co-sponsors. A similar bill (S. 414) has been
introduced in the Senate by Senators Chuck Grassley (R-IA) and
James M. Jeffords (R-VT) joined by 10 members of the Senate
Finance Committee, including Sens. Frank Murkowski (R-AK), Kent
Conrad (D-ND) and Bob Kerrey (D-NE). At present, S. 414 has 25
co-sponsors. A five-year extension of the wind tax credit is
also contained within the Clinton Administration's FY 2000
budget proposal.
Contributions of Wind Power: Wind is a clean, renewable
energy source which helps to protect public health, secure a
cleaner environment, enhance America's national security
through increased energy independence, and reduce pollution. In
fact, reducing air pollutants in the United States will
necessitate the promotion of clean, environmentally-friendly
sources of renewable energy such as wind energy. Further,
renewable energy technologies such as wind power should play an
important role in a deregulated electrical generation market.
With the proper set up policies in place, wind power alone
has the potential to generate power to provide the electric
energy needs of as many as 10 million homes by the end of the
next decade. The extension of the PTC will not only assure the
continued availability of wind power as a clean energy option,
but it also will help the wind energy industry secure its
position in the restructured electricity market as a fully
competitive, renewable source of electricity.
Significant Economic Growth Potential of Wind Power: The
global wind energy market has been growing at a remarkable rate
over the last several years and is the world's fastest growing
energy technology. The growth of the market offers significant
export opportunities for U.S. wind turbine and component
manufacturers.
The World Energy Council has estimated that new wind
capacity worldwide will amount to $150 billion to $400 billion
worth of new business over the next twenty years. Experts
estimate that as many as 157,000 new jobs could be created if
U.S. wind energy equipment manufacturers are able to capture
just 25% of the global wind equipment market over the next ten
years. Only by supporting its domestic wind energy production
through the extension of the PTC can the U.S. hope to develop
the technology and capability to effectively compete in this
rapidly growing international market.
Finally, we must stress that the immediate extension of the
PTC is critical to the continued development of the wind energy
industry. Since the PTC is a production credit available only
for energy actually produced from wind facilities, the credit
is conditioned on permitting, financing and construction of the
facilities. The financing and permitting requirements for a new
wind facility often require two to three years of lead time.
With the credit due to expire on June 30, 1999, wind energy
developers and investors are reluctant to commit to new
projects without the assurance of the continued availability of
the PTC.
The American Wind Energy Association appreciates the
opportunity to submit written testimony on this matter. We
stand ready to assist the Committee in any way regarding the
five-year extension of the wind energy Production Tax Credit.

Thank you.
Jaime C. Steve
Legislative Director
American Wind Energy Association
Washington, DC 20001

Statement of AMT Coalition for Economic Growth

The AMT Coalition for Economic Growth is a broad-based
coalition formed to advocate relief from the corporate
Alternative Minimum Tax (AMT). The coalition is comprised of
companies and associations representing the following
manufacturing-related industries: automotive, builders and
contractors, chemicals, energy, information technology, mining,
paper, printing, steel, transportation and utilities.
Mr. Chairman, the Coalition commends you and this committee
for recognizing the negative impact the corporate AMT has had
on job creation, economic growth and workers in many basic
manufacturing industries. In 1997, this committee approved
meaningful reform of the AMT by partially eliminating the
depreciation adjustment under the AMT. We share your view,
however, that more relief is needed.

The Problems:

Numerous adjustments, preferences and limitations under the
AMT continue to hinder investments in important areas such as
equipment, research and development, mining, energy exploration
and production, pollution abatement and many others. Over the
past 13 years, many companies have accumulated numerous AMT
credit carryforwards. Due to current law limitations, they have
not been able to fully recover these credits in a timely
manner. Still others are hampered by arbitrary limitations such
as the 90 percent limitation on net operating losses and
foreign tax credits. This latter limitation results in a
portion of an AMT payer's foreign earnings being taxed twice.
Even with the 1997 reforms, investments in plant and
equipment are penalized by the difference between the 150
percent declining balance method allowed under the AMT and the
200 percent declining balance method of the regular tax. This
depreciation method gap continues to place companies at a
competitive disadvantage against their foreign competitors.
Other accounting method differences under the current AMT that
are discriminatory are the treatment of long-term contracts and
LIFO inventory rules.
These problems are not unique to large businesses. Many
small and medium size businesses continue to face the bite of
the AMT as well. Subchapter S corporations cannot take
advantage of the small business provisions enacted in the 1997
legislation. Still others continue to be subject to AMT because
they are growing quickly, but their revenue stream has not yet
caught up to their investment levels, or they face limitations
on the use of work-opportunity tax credits. And most businesses
continue to face the onerous recordkeeping burden of
calculating their taxes using two different sets of rules to
determine whether their alternative minimum tax liability
exceeds their regular tax liability.

Suggestions for Relief:

In 1995, this committee and the U.S. House of
Representatives approved legislation to phase-out the corporate
AMT. Unfortunately that legislation was not enacted. The
Coalition strongly supported the 1995 proposal. We believe it
should serve as a model for future legislative action on AMT.
A critical element of the 1995 House passed phase-out was
the preservation of the value of AMT credits, even after full
repeal of AMT. The bill accomplished this by allowing companies
to use AMT credits to offset up to 90 percent of their regular
tax liability. AMT credits are carried as assets on a company's
books, because they represent ``pre-paid'' taxes. The cash
value of these credits is already being diminished due to the
long period of time that may pass before the credits can be
fully recovered. The Coalition firmly believes that any AMT
reform efforts that would further restrict the use or reduce
the value of these credits would penalize the very companies
that have suffered the most detriment from the system.
If the Committee chooses not to repeal the corporate AMT,
the Coalition would strongly urge the adoption of a proposal to
allow faster utilization of AMT credits. The Coalition has
united in its efforts to support this approach because the
relief is broad-based and focused most directly on companies
that have suffered the greatest harm. Specifically, a company
with long-term, unused AMT credits, should be allowed to reduce
its tentative minimum tax by a maximum of 50 percent using such
credits. Long-term AMT credits would be defined as credits that
are more than three years old. The credit portion to be allowed
would be the lesser of: (1) the aggregate amount of the
taxpayer's AMT credits that are more than three years old; or
(2) 50 percent of the taxpayer's tentative minimum tax. Under
this proposal a taxpayer would be required to use its oldest
AMT credits first. The proposal would operate as an addition to
the present-law ability of a corporation to use AMT credits to
reduce its regular tax.
In addition, for taxpayers with AMT net operating losses
(NOLs) in the current and two previous years, AMT NOLs could be
carried back up to 10 years to offset AMT paid in previous
years. This provision would help the most troubled firms,
especially those in commodity-based industries.
The Coalition advocates this proposal because many
companies continue to be penalized by the AMT in ways
unintended by Congress; the AMT credit is a case in point. The
original intent of the AMT credit was to provide a taxpayer
which paid alternative minimum tax in any year, an alternative
minimum tax credit in future years. This rule was intended to
insure that companies did not, over time, pay more under the
AMT than was owed under the regular income tax. Under current
law, AMT credits may be used to reduce regular tax but not the
alternative minimum tax.
In practice, the corporate alternative minimum tax
continues to impose a significant long-term tax burden on
capital intensive and commodity based industries. Given the
high rate of tax in relation to profit margins for these
industries, the alternative minimum tax operates to lock many
U.S. firms into the AMT, burdening them with unused (and
potentially unusable) AMT credits. The AMT adversely affects
the profitability and cash flow necessary for American
companies to invest and remain competitive in the world market.
Many of the companies with significant long-term AMT credits
have also felt the double whammy of depressed world-wide
commodity prices due to the global financial crisis of the
previous two years.
While some reform has occurred in the calculation of
depreciation, no changes have been enacted to the numerous
other investment-based adjustments and preferences, or to the
arbitrary limitations on the use of foreign tax credits and
net-operating losses. Furthermore, after years of paying the
AMT, many companies have significant unused alternative minimum
tax credits that cannot be used due to current law limitations.
This proposed change would provide greater financial certainty
that AMT credits could be recovered in a timely manner.
Mr. Chairman and Committee members, you are commended for
having this hearing on reducing the tax burden to sustain our
strong economy. The Coalition believes that AMT relief is a
critical component of a growth oriented tax policy and urges
it's inclusion in the Ways and Means Committee tax bill later
this year.

Joint Statement of Hon. Robert Coble, Mayor, Columbia, South Carolina;
and Hon. Stephen Creech, Mayor, Sumter, South Carolina

Chairman Archer and members of the Committee, thank you for
this opportunity to submit testimony on the important tax
legislation that you will consider this year. After years of
surpluses and mounting debt, you must now tackle the pleasant
question of how to work with a surplus. The recent predictions
by the Congressional Budget Office and the Office of Management
and Budget that the federal government will run a large non-
Social Securitysurplus in the coming decade present you with
many opportunities.
We appreciate the desire to use some of this surplus to
give the American people a measure of tax relief. However, the
previous decade's tremendous economic growth that led to these
surplus forecasts also presents us with an historic opportunity
to invest in our nation's most troubled neighborhoods. Although
a decade of economic prosperity has led to investments in
central city neighborhoods that would have seemed impossible
ten years ago, the good times have yet to reach our distressed
communities. For these reasons, we urge you to include full
funding for the second round of Empowerment Zones, Enterprise
Communities and Strategic Planning Communities.
This second round of Empowerment Zones were authorized by
the Taxpayer Relief Act of 1997 (PL 105-34). The second round
designations were awarded earlier this year. Thanks to the
commitment and hard work of our citizens, Columbia and Sumter
were awarded with one of these designations. As you can
imagine, preparing an Empowerment Zone application requires a
tremendous amount of time and resources. When we decided to
embark on the application process, we were relying on the good
faith of Congress and the Administration to provide the same
level of funding given to the first round of Empowerment Zones.
In his FY 2000 budget request, President Clinton requested full
funding of $100 million over ten years for each of the 15
second round urban Empowerment Zones and $40 million over ten
years for each of the five second round rural Empowerment
Zones. Bipartisan legislation (HR 2170) mirroring that request
has been introduced. We urge you to include that bill in any
tax legislation produced by your Committee.
We are very excited about our plans for the Sumter-Columbia
Empowerment Zone. That excitement is shared by broad segments
of our community, including the business community. We are
amazed at the broad support our Empowerment Zone enjoys and are
confident that this will translate into success. For the first
time our most distressed neighborhoods are looking at a
brighter future. It would be a shame if this hope and
excitement were dashed because of a lack of funding--funding we
were counting on when we embarked on these ambitious plans.
In addition to funding for the second round of Empowerment
Zones, there are a number of issues before this Committee that
are an important part of our economic development plan. These
include enhancement of the Low-Income Housing Tax Credit (HR
175, which enjoys overwhelming bipartisan support in this
Congress and the support of our entire delegation), the
extension of the Work Opportunity Tax Credit, the extension of
the Welfare-to-Work Tax Credit, creation of a Commercial
Revitalization Tax Credit, and the enhancement of industrial
development bonds.
The surplus combined with our strong economy gives Congress
an opportunity to make a difference in some of our nations'
most distressed urban neighborhoods. We urge you to seize this
opportunity. Thank you for your attention to our views on these
important matters.

Statement of Construction Financial Management Association, Princeton,
New Jersey

Mr. Chairman and Members of the Committee:
The Construction Financial Management Association (CFMA) is
pleased to comment on various tax issues of importance to our
members and to the construction industry. CFMA was established
in 1981 and represents more than 6,500 financial managers in
the construction industry. Our members are employed by 2,500
construction companies across the U.S. More than one-third of
these companies have gross annual revenues ranging from $25-99
million.
As the Committee considers a tax package later this summer,
CFMA supports the Committee's efforts to eliminate the estate
and gift tax and provide tax relief for individuals and
businesses. Additionally, CFMA encourages the Committee to
include, in a tax-reduction package, proposals that would
clarify and simplify the rules governing worker classification,
clarify the use of the cash basis method of accounting for
small businesses and provide relief from costly and time-
consuming look-back calculations.
The cost and complexity of our Nation's tax law is imposing
an onerous burden on construction companies at a time when
Congress should be encouraging these companies to devote their
resources to increasing productivity, promoting growth and
encouraging job creation.

ESTATE TAX RELIEF

The Federal estate tax was first enacted in 1916 and was
imposed primarily to finance our nation's involvement in World
War I. The tax has evolved since then, and today, the estate,
gift and generation-skipping transfer taxes form a unified
transfer tax system. The estate and gift tax share a unified
progressive rate schedule and an applicable ``unified credit''
that shelters a portion of the value of a decedent's estate.
The unified credit, which, for 1999, effectively exempts the
first $650,000 of a deceased taxpayer's estate and any gifts
made during the current year from taxation will incrementally
increase up to $1 million in year 2006. This exemption amount,
however, will not be indexed for inflation after 2006.
Additionally, a change to the law in 1997 resulted in a
limited exclusion for certain ``family-owned business
interests,'' from the taxable portion of an estate provided
that such interests comprise more than 50 percent of a
decedent's estate. This exclusion may be taken only to the
extent that the exclusion, plus the amount effectively exempted
under the unified credit does not exceed $1.3 million

Impact of the Estate Tax on the Construction Industry

Construction companies are generally family-owned
enterprises and often do not have the liquid assets to pay
taxes owed on an estate upon the death of the owner. Thus, the
construction industry is particularly hard hit by the estate
tax system. The burden imposed by the estate and gift tax is a
leading reason why many family-owned construction companies are
forced to sell or liquidate the business when there is a death
in the family.
Under the current system, closely-held construction
businesses devote significant resources to costly and
complicated planning to minimize the estate tax. This effort
diverts financial resources from hiring and business expansion.
Additionally, planning for the estate tax is not a one-time
event. The threat and uncertainty of the estate tax is a
constant burden for small businesses, which must make costly
and time-consuming decisions today if they hope to survive when
the business is passed on to the next generation. There is no
simple solution in estate planning. Business owners do not know
when the tax will have to be paid and it is difficult to
ascertain how much tax will be owed. Funds spent on attorney
fees and insurance policies would be better spent if they were
invested in new resources or on hiring and training new
workers. This diversion of valuable human and financial capital
achieves no economic benefit.

Eliminate the Estate and Gift Tax System

CFMA supports eliminating this confiscatory tax and
encourages the Committee to support the efforts of House Ways
and Means Committee Members Jennifer Dunn (R-WA) and John
Tanner (D-TN), who have introduced H.R. 8, the Death Tax
Elimination Act. H.R. 8 would phase out the highest current
estate tax rate of 55 percent by five percentage points each
year until it is completely eliminated in 2010.
Entrepreneurs and other visionary business leaders should
be allowed to make financial decisions for business and
investment reasons and not be punished for initiative, hard
work and capital accumulation.

WORKER CLASSIFICATION

Classification of workers as either employees or
independent contractors has been a perennial problem for all
parties involved in this issue and CFMA supports efforts to
clarify and simplify the myriad of rules, factors and
circumstances that dictate current law.
The construction industry faces unique worker
classification problems due to its fluctuating work demand and
seasonal forces which affect employment levels. Many in the
industry can not afford nor have the need to maintain
specialized trade craftsmen as full-time, long-term employees.
Such workers may be needed several times throughout the year
but not enough to warrant full-time or even part-time
employment. Independent contractors are often the best solution
to a pressing demand for the special skills and expertise often
required for short-term projects.
Congress adopted section 530 of the Revenue Act of 1978 in
recognition that 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 provide Congress time to produce a permanent
solution to the complexity of the independent contractor issue
that would eliminate this source of controversy. Although
Congress has made some progress on the issue, it has also
learned the lesson learned earlier by business and the IRS:
this issue eludes simple solutions.

Importance of Section 530 to the Construction Industry

Construction projects frequently involve an amalgamation of
independent economic entities that come together under unique
and complex legal arrangements for a specific job and then
disperse. These entities are a combination of corporations,
partnerships and sole proprietors who associate as general
contractors, first and second-tier subcontractors, material and
equipment suppliers and other vendors.
Within the construction industry, the general/subcontractor
and subcontractor/sub-subcontractor relationships have always
been the norm for doing business. Additionally, specialty trade
contractors are hired on a project-by-project basis for short
durations under varying contractual arrangements to complete
certain assignments. 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.
The construction industry has always relied upon the
existence of a contractor-subcontractor relationship to carry
out construction projects. The industry must continue to rely
on these relationships because:
the requirements of each particular project differ
so dramatically as to the scope of work to be performed, the
degree of skills needed, the number of disciplines to be
engaged, and the human resources to be allocated;
general contractors cannot afford to hire the
number and variety of trade specialists they need as full-time
or even part-time employees; and
construction work, by its very nature, is
cyclical, unpredictable, intermittent and non-repetitive.
Removal of the section 530 ``safe-harbor'' would threaten
the long-standing industry practice of subcontracting and would
threaten the ordinary way of doing business for smaller
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, 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 long-
standing industry practice for an owner to contract directly
with a general contractor who will manage a project and enter
into contracts with trade specialists and other independent
contractors. However, it is also common industry practice for
an owner to contract directly with a general contractor and
with the trade specialists and other independent contractors.
In both cases, under industry practice, the general contractors
and the subcontractors are independent contractors.
If section 530 protection were removed, however, it is all
but certain that some IRS agents will decide that owners who
contract directly with subcontractors are employers under the
common law ``20 factor'' test. Consequently, owners, general
contractors, and subcontractors will be left in a situation
where they can no longer feel confident when they have issued a
contract or work order that the IRS will view the arrangement
similarly.
In addition, it is important to note that many construction
contracts are acquired on a competitive bid basis. By removing
section 530 protection, contractors would have to either
increase the price for this contingency or else assume that any
changes would impact their bid profit. This situation simply
adds risk to an already very risk-laden business.
CFMA contends that the majority of construction contractors
use legitimate independent contractors for legitimate economic
reasons. CFMA also recognizes that there are abuses in the
system, but does not believe that these abuses are so
widespread that the entire working structure of the industry
needs to be dismantled. CFMA supports legislative initiatives
that would simplify and clarify the law regarding worker
classification. One of these approaches that merits review by
the Committee was introduced in the Senate by Small Business
Committee Chairman Christopher Bond (R-MO). S. 344 would
provide a general safe harbor and protection against
retroactive reclassification of an independent contractor in
certain circumstances. The bill is designed to provide
certainty for businesses that enter into independent-contractor
relationships and minimize the risk of significant tax bills
for back taxes, interest, and penalties if a worker is
misclassified.

CASH BASIS METHOD OF ACCOUNTING

Currently, businesses are required to use the accrual
method of accounting for income tax reporting if they are
involved in merchandise sales and maintain an inventory. There
is an exception that allows small businesses with less than $5
million in annual revenues to use the cash basis method of
accounting. Cash basis accounting simply allows a business to
recognize only those revenues it has actually received.
Unfortunately, the IRS has increasingly sought to challenge
the use of cash basis accounting, forcing small construction
companies to switch accounting methods, often at significant
cost. One of the most difficult and onerous tax adjustments a
construction contractor can face is an IRS imposed change in
accounting methods. The cost involved with switching accounting
methods, coupled with the mandatory interest and penalties that
are often assessed by the IRS can severely impact the bottom
line for these small businesses.
CFMA supports legislation introduced by House Small
Business Committee Chairman James Talent (R-MO) and Ways and
Means Committee Member Phil English (R-PA), that would clarify
the use of cash accounting by small businesses. H.R. 2273 would
provide that small business taxpayers with average annual gross
receipts of $5 million or less for the prior three years would
be entitled to use the cash method of accounting without
limitation. Specifically, the legislation would provide that
small business taxpayers shall not be required to use the
accrual method of accounting because they sell merchandise or
have inventory.
This clarification would greatly benefit small construction
companies who currently use cash basis accounting and are
concerned that the IRS could arbitrarily force them to change
accounting methods.

LOOK-BACK METHOD OF ACCOUNTING

The Tax Reform Act of 1986 included a provision that
continues to unfairly impact the construction industry.
Congress intended for the provision to target large defense and
aerospace contractors by requiring ``percentage of completion''
and look-back accounting methods for contracts lasting more
than one tax year. Under current law, contractors must estimate
their costs and revenues and, upon completion of the contract,
``look-back'' and substitute the actual costs and revenues for
those estimated at the conclusion of the prior tax years.
Unfortunately, construction companies can face look-back
calculations numbering in the thousands, which results in a
significant financial as well as manpower costs to comply with
the law. Construction contractors spend thousands of dollars in
accounting fees each year complying with look-back
requirements. In an industry dependent on financial accuracy,
look-back has little effect on ``catching'' underreported
revenues or gains. Construction contractors, by their very
nature, are optimistic people. Owners' estimates of profits to
be realized on any given project tend to be high, not low.
Therefore, approximately 75 percent of the industry's look-back
calculations result in refunds, not revenues!
CFMA strongly supports legislation (H.R. 2347) introduced
by Committee Member Phil English (R-PA) that would repeal the
look-back method for commercial construction contractors. The
look-back method of accounting imposes costly and time-
consuming reporting requirements on construction companies that
result in virtually no additional revenue for the Treasury.

CONCLUSION

CFMA appreciates the opportunity to present to the
Committee its views on tax issues that significantly impact the
construction industry. The current estate and gift tax is one
of the most onerous burdens facing family-owned construction
companies, many of which must be sold, downsized or liquidated
just to pay this ``death'' tax. Accounting for only one percent
of annual revenues for Treasury, this tax is not worth the
devastation is causes family-owned construction companies.
Worker classification continues to be a perennial problem
for the construction industry and any efforts to simplify and
clarify current law is supported by CFMA. Other changes
beneficial to the construction industry include clarification
of the use of the cash basis method of accounting for small
businesses and relief from costly and difficult look-back
calculations.
CFMA supports the Committee's efforts to relieve the
excessive tax burden on small businesses and to preserve the
accumulated savings of productive and hard-working citizens.

Statement of Hon. Paul D. Coverdell, a United States Senator from the
State of Georgia

Chairman Archer and the other Members of the Committee. I
would like to thank you very much for inviting me to appear
before this Committee hearing to present my views on providing
millions of hard-working American families the tax relief they
deserve and need.
Today Congress confronts a dilemma most Americans never
anticipated, a Federal budget surplus approaching one trillion
dollars. This historic surplus affords us the rare opportunity
to create the foundations of a permanent prosperity for
generations of Americans.
In particular, I believe that we have an obligation to use
the current Federal surplus to accomplish three important
objections. First, we must ensure that we stop Washington's
traditional urge to spend money from the Social Security Trust
Fund on new federal programs. In that regard, we must make
protecting Social Security our number one priority.
Second, because the current Federal surplus is the product
of the prosperity created by the American people and their
hardwork, we should make every effort to return as much of the
non-Social Security surplus to the American people. We must
stop the arrogance of Washington that refuses to relinquish its
grip on the pursestrings and the pocketbooks of the American
people.
And lastly, we must use part of the Federal surplus to give
parents, families and communities the power and the resources
they need to provide our nation's children with the world's
best and most successful education opportunities.

Broad Tax Relief for Working Americans and Great Incentives to Save

Although the economy is strong, there are troubling signs.
Personal bankruptcies and consumer debt are at record levels.
The personal savings rate is at Depression-era lows and has
actually fallen into the negative. Consumer prices jumped in
April by 0.7 percent, the largest monthly gain in nearly nine
years according to the Labor Department.
In the Senate, I have joined a bi-partisan group of
colleagues to offer a substantial tax relief plan that returns
the prosperity surplus to the American people as well as
expands the options and incentives that families have to save
for the future.
The plan I introduced, the Small Savers Act, is based on
three principles to address these concerns. First, any tax cut
should provide broad-based rate relief. Second, tax cuts should
be targeted at savings and investment.
And third, that anything we do should simplify the code.
An unnoticed and un-wanted side effect of the soaring
economy has been that middle class workers are forced into tax
brackets never intended for them. Small Savers expands the 15%
tax bracket by $10,000 over five years ($5,000 for singles)
returning 7 million taxpayers to the lowest bracket. But,
because more income will be taxed at a lower rate, 35 million
taxpayers will gain tax relief.
To reverse the dangerous personal savings trend in this
country, Small Savers would exempt the first $500 in a family's
dividend and interest income from taxation. This would
essentially make a $10,000 savings account tax-free. The Joint
Economic Committee reports such a change would eliminate all
taxes on savings for 30 million Americans.
Small Savers would do more than just take the government
out of the business of taxing a family's savings. The plan also
excludes the first $5,000 in long-term capital gains from
taxation. The Federal Reserve Board's 1995 Survey of Consumer
Finance reported that 75% of stockholders have incomes less
than $75,000. The stock market is no longer simply a place
where the wealthy get wealthier, but where lower and middle
class families can build a secure retirement. By excluding
capital gains, rather than reducing the rate, we can eliminate
capital gains taxes for 10 million people.
The final aspect of Small Savers aimed at encouraging
retirement security is a modest increase in the contribution
limit for a deductible IRA from $2,000 to $3,000. Although we
have taken steps previously to increase the availability of
IRAs, the limit on contributions has remained at $2,000 since
1981. Had we been indexing the limit for inflation, individuals
would be able to contribute nearly $5,000 a year to their
retirement.
All too often small businesses cannot afford to establish
pension plans for their employees. For their employees and the
self-employed, the ability to contribute to an IRA is often the
only means of retirement savings available. It is simply unfair
to restrict them to an annual contribution of $2,000.
Lastly, Small Savers would simplify tax filing for millions
of Americans. It is estimated that it takes the 67 million
Americans with dividend and interest income over an hour just
to fill out their Schedule B form for such income. Small Savers
would eliminate that requirement for 7 million Americans. The
Schedule D form for capital gains is even worse. An estimated
22 million Americans had capital gains or losses last year. For
them, filling out the 54-line Schedule D took, on average,
nearly 7 hours. Small Savers would eliminate this arduous
requirement for 10 million Americans. Overall, Small Savers
would return nearly 74 million man-hours formerly used to fill
out tax forms into productive activities.
With a revenue impact of estimate $134.7 billion over 5
years and $345.7 billion over ten years, Small Savers will not
interfere with seeking and meeting other tax relief goals--
whether they be education tax relief, health tax relief,
marriage penalty relief, business tax relief, etc. In the end,
I believe that if the Federal government collects too much in
taxes, it owes it to taxpayers to return some of their hard-
earned dollars.
In short, Small Savers recognizes the problems of an unfair
tax burden... lack of savings and investment and a tax code
that is too complicated. It is the first step to restoring
fundamental fairness to the millions of hard working, middle
class families who deserve tax relief.

Educating Our Nation's Children--Providing New Choices for America's
Families

Educating our children is among the most important issue that we
face as public servants. In that regard, I would like to wish the
Committee well as it considers a number of very important tax measures
designed to assist families and communities in their efforts to provide
our children the quality education that they deserve.
Needless to say, the education of our nation's children is one of
the most sacred and important issues that we as public servants can
address. For much of the past century, America's place as a leading
industrial and intellectual force in the world has been established by
the pre-eminence of our nation's education system. Simply put, our
schools were the best in the world, and as a result Americans started
the Industrial Revolution, ushered in the Nuclear Age, and paved the
Super Information Highway.
Unfortunately, just as the world economy and marketplace have
become more competitive and interdependent, we have lost significant
ground to other nations in the educational achievements of our
children. For example, the results of the most recent International
Math and Science Study reveal that U.S. seniors have lost their
competitive edge over their counterparts in Western Europe in math and
science. In physics, U.S. 12th graders seniors finished last behind 20
other countries, including Latvia and the Czech Republic. The
Organization for Economic Cooperation and Development reported on
November 13, 1998, that, even though the United States dedicates one of
the largest shares of GDP to education, it has fallen behind other
economic powers in high school graduation rates.
With these recent reports showing an alarming lack of academic
achievement among an increasing number of American students, the
Congress and the Administration must work together to develop a new
path toward improving our nation's schools and ensuring that each and
every child receives a first-class education.
During the State of the Union, however, the President outlined a
litany of new programs that are very similar to a number of federal
programs already on the books.
While these proposals may make for good newspaper copy, there are
already more than 800 federal education programs spread across 39
federal agencies. New programs are not the answer. If new federal
education programs were the answer to educational excellence, our
schools would still be among the world's best.
I believe there is a better way to improve the quality of education
our children receive.
Education Savings Accounts are a major step in a bi-partisan reform
effort. Here's how they work: a parent, relative, friend, business,
union, charitable organization--anyone--could contribute up to $2000 in
an account which could be withdrawn tax-free if used for a child's K-12
education expenses.
Right now, the law allows parents to contribute up to $500 per year
for a child's college education. We increase that amount to $2000 per
year and allow for tax-free withdrawals for K-12 educational expenses,
as well.
With education savings account, 14 million families (over 20
million kids) will take advantage of ESAs, generating $12 billion in
education savings that might otherwise not exist.
You would think such a modest reform--which builds on a law signed
by President Clinton--would be embraced by everyone. Not opponents of
reform, however, who see allowing families to keep their own money as a
great threat.
Those who oppose this bill, stand in the way on new opportunities
for millions of children and their families. Just consider how many
people benefit from our plan:
14 million families--20 million children--from benefiting
from education savings accounts;
$12 billion in savings from being pumped into K-12
education;
1 million college students in state pre-paid tuition plans
from receiving tax relief;
1 million workers from receiving education assistance
through their employers.
Hundreds of local school districts from using more of
their local money to build and repair new schools.
Those of us--Republicans and Democrats--who believe parents should
have the ability to invest in their kids' futures believe we represent
the most important special interest--children. And, in the end, we will
prevail.
We have a great challenge before us. For too long, our children
have been victimized by failing schools, growing bureaucracies and
politicians who ignore their needs. During the 106th Congress, we can
do better to help our children succeed. We must put aside our partisan
differences, and join in a bipartisan effort to change a culture and
system that for too long has let our kids down. I pledge to undertake
that effort, I can only hope that my colleagues on the other side of
the aisle will do so too.

Statement of Richard P. Walker, Managing Director, CSW Renewable
Energy, Central & South West Corporation, Dallas, Texas

Mr. Chairman and other distinguished members of the
committee, my name is Richard Walker. I am Managing Director of
CSW Renewable Energy, a subsidiary of Central & South West
Corporation of Dallas, Texas. I want to thank you for providing
me with this opportunity to testify on the importance of
extending the wind energy production tax credit (PTC) until the
year 2004.
Central and South West Corporation (CSW) has been active in
the research and development of wind energy for six years, and
was named as the American Wind Energy Association's Utility of
the Year in 1996. CSW owns and operates the first wind farm
built as part of the U. S. Department of Energy's Turbine
Verification Program in which state-of-the-art, U.S.-
manufactured wind turbine technology is being tested. In
addition, a 75 megawatt wind farm is currently being built near
the west Texas community of McCamey in order to serve the
customers of three CSW subsidiaries--West Texas Utilities
Company, Central Power and Light Company, and Southwestern
Electric Power Company.
CSW is an investor-owned electric utility holding company
based in Dallas, Texas. CSW owns and operates four electric
utilities in the United States: Central Power and Light
Company, Public Service Company of Oklahoma, Southwestern
Electric Power Company, and West Texas Utilities Company. These
companies serve 1.7 million customers in an area covering
152,000 square miles of Texas, Oklahoma, Louisiana, and
Arkansas.
CSW also owns a regional electricity company in the United
Kingdom, SEEBOARD plc, which serves 2 million customers in
Southeast England. CSW engages in international energy,
telecommunications and energy services businesses through
nonutility subsidiaries including CSW Energy, CSW
International, C3 Communications, EnerShop, and CSW Energy
Services. CSW is currently in the process of seeking regulatory
approval for a merger with American Electric Power Company,
based in Columbus, Ohio, and expects the merger to be completed
sometime in the 4th quarter of 1999.
I want to commend Representative Bill Thomas, and all of
the cosponsors of H.R. 750, for their leadership in supporting
legislation to extend the wind energy PTC until the year 2004.
H.R. 750 has broad, bipartisan support. H.R. 750 was introduced
with sixty (60) original cosponsors, including 19 members of
this committee. H.R. 750 is currently supported by 123
cosponsors, including 26 (two-thirds) of the members of this
committee. The Senate companion bill, S. 414, has similar
broad, bipartisan support, including a majority (11) of the
members of the Senate Finance Committee. Additionally, a five-
year extension of the PTC was included in the President's
FY2000 Budget.
I hope the committee will include a five-year extension of
the wind energy PTC in the tax bill the committee intends to
mark-up next month. As the committee knows, the current PTC
will expire next week, June 30, 1999.

I. BACKGROUND OF THE WIND ENERGY PTC

The wind energy PTC, enacted as part of the Energy Policy
Act of 1992, provides an inflation-adjusted 1.5 cents/kilowatt-
hour credit for electricity produced with wind equipment for
the first ten years of a project's life. The credit is
available only if the wind energy equipment is located in the
United States and electricity is generated and sold. The credit
applies to electricity produced by a qualified wind energy
facility placed in service after December 3, 1993, and before
June 30, 1999. The current credit expires next week, June 30,
1999.

II. WHY DO WE NEED A WIND ENERGY PTC?

A. The Wind Energy PTC is Helping to Drive Costs Down, Making Wind
Energy

A Viable and Efficient Source of Renewable Power

The efficiency of wind generated electric energy has increased
dramatically since the early to mid-1980s. The machine technology of
the 1980's was in its early stages and the cost of wind energy during
this time period exceeded 25 cents/kilowatt-hour. Since that time,
however, the wind industry has succeeded in reducing wind energy
production costs by a remarkable 80% to the current cost of about 4.5
cents/kilowatt-hour. The 1.5 cents/kilowatt-hour credit enables the
industry to compete with other generating sources currently being sold
in the range of 2.5 to 3.0 cents/kilowatt-hour.
The industry expects that its costs will continue to decline as
wind turbine technology and manufacturing economies of scale increase
in efficiency. Through further machine development and manufacturing
efficiencies, the wind energy industry anticipates the cost of wind
energy will be further reduced to 3 cents/kilowatt-hour or lower by the
year 2004, which will enable it to fully compete on its own in the
marketplace.
The most significant factor contributing to the dramatic reduction
in U.S. wind energy production costs over the years--since the early
1980s--has been the dramatic improvement in machine efficiency. Since
the 1980's, the industry has developed three generations of new and
improved machines, with each generation of design improving upon its
predecessor. As a result, reduced costs of production of new wind
turbines, blade designs, computer controls, and extended machine
component life have been achieved. Proven machine technology has
evolved from the 50-kilowatt machines of the 1980's to the 750-kilowatt
machines of today that have the capacity to satisfy the energy demands
of as many as 150 to 200 homes annually. Moreover, four new 1,650-
kilowatt class machines have recently been installed in Texas that are
expected to further improve the technology's efficiency and reduce wind
power costs.
The wind industry anticipates that wind energy production costs
will continue to decline in the future, and is confident that the next
two generations of wind turbine design--estimated to be available by
the year 2004 --will sufficiently lower costs in order to enable the
industry to compete in the United States on its own merits with fossil-
fueled generation. The five-year extension of the wind energy PTC will
bridge the commercialization gap for the industry until it can compete
on its own by the year 2004.

B. Wind Power will Play an Important Role in a Deregulated Electrical
Market

The electrical generation market is going through significant
changes as a result of efforts to restructure the industry at both the
Federal and State levels. Renewable energy sources such as wind power
are certain to play an important role in a deregulated electrical
generation market. In Texas, for example, just last week, June 18,
1999, Governor George W. Bush signed into law restructuring legislation
that provides for the addition of 2,000 megawatts of renewable energy
generating capacity in Texas by the year 2009. Wind power will play a
significant role over the next decade in enabling Texas to meet this
new goal and the extension of the wind energy PTC will help in this
effort by ensuring that Texans receive the lowest cost renewable energy
possible.

C. Wind Power Contributes to the Reduction of Greenhouse Emissions

Wind-generated electricity is an environmentally friendly form of
renewable energy that produces no greenhouse gas emissions. Several
polls, surveys, and focus groups of our customers have made it clear
that the use of environmentally friendly sources of electrical
generation is very important to them. Renewable energy sources such as
wind power are particularly helpful in reducing greenhouse gas
emissions. Significant reductions of greenhouse gas emissions in the
United States can only be achieved through the combined use of many
new, energy-efficient technologies, including those used for the
production of renewable energy. The extension of the wind energy PTC
will assure the continued availability of wind power as a clean,
renewable energy source.

D. Wind Power has Significant Economic Growth Potential, Provides a
Supplemental Income Source for Farmers, and Creates New Jobs in Local
Economies

1. Domestic--Wind energy has the potential to play a meaningful
role in meeting the growing electricity demand in the United States.
With the appropriate commitment of resources to wind energy projects,
it is estimated that wind power could generate power to as many as 10
million homes by the end of the next decade. There currently are a
number of wind power projects operating across the country. These
projects are currently generating 1,761 megawatts of wind power in the
following states: Texas, New York, Minnesota, Iowa, California, Hawaii
and Vermont.
There also are a number of new wind projects currently under
development in the United States. These new projects will generate 670
megawatts of wind power in the following states: Texas, Colorado,
Minnesota, Iowa, Wyoming and California.
The domestic wind energy market has significant potential for
future growth because, as the sophistication of wind energy technology
continues to improve, new geographic regions in the United States
become suitable for wind energy production. The top twenty states for
future wind energy potential, as measured by annual energy potential in
the billions of kWhs in environment and land use exclusions for wind
class sites of 3 and higher, include:

1. North Dakota.................................. 1,210
2. Texas......................................... 1,190
3. Kansas........................................ 1,070
4. South Dakota.................................. 1,030
5. Montana....................................... 1,020
6. Nebraska...................................... 868
7. Wyoming....................................... 747
8. Oklahoma...................................... 725
9. Minnesota..................................... 657
10. Iowa.......................................... 551
11. Colorado...................................... 481
12. New Mexico.................................... 435
13. Idaho......................................... 73
14. Michigan...................................... 65
15. New York...................................... 62
16. Illinois...................................... 61
17. California.................................... 59
18. Wisconsin..................................... 58
19. Maine......................................... 56
20. Missouri \1\.................................. 52

Source: An Assessment of the Available Windy Land Area and Wind Energy
Potential in the Contiguous United States, Pacific Northwest
Laboratory, 1991.

Sixteen states, including CSW's home state of Texas, have greater
wind energy potential than California where, to date, the majority of
wind development has taken place.
The increasing sophistication of wind energy technology has enabled
the industry to open up new regions of the country to wind energy
production. In addition to the recent growth of wind power in Texas,
another area of the country that has been opened up to wind power
production in the last few years is the Farm Belt. Since wind power
projects and farming are totally compatible --a wind power plant can
operate on land that is being farmed with little or no displacement of
crops or livestock--wind power projects are now being sited on land in
the Farm Belt that is also being used for crop and livestock
production. The lease payments paid by wind project developers to
landowners is a valuable source of steady, additional income for
farmers. For example, a new wind plant soon to go on line in Clear
Lake, Iowa will pay rent to fourteen different landowners who will be
supplementing their income by leasing their land for the operation of
the new wind plant without disrupting their farming operations. This is
a win-win situation for farmers and consumers.
Electricity production from renewable resources takes advantage of
local resources rather than those that may be imported. In addition to
the lease payments discussed above, this results in several economic
development opportunities such as increasing tax bases for counties,
construction jobs, on-going operation and maintenance jobs, and
manufacturing opportunities. The wind farms recently completed or
currently being constructed in the U.S. have provided manufacturing
opportunities in Champagne, Illinois, Tehachapi, California,
Gainesville, Texas, Shreveport, Louisiana, Tulsa, Oklahoma, and El
Paso, Texas, just to name a few.
2. International--The global wind energy market has been growing at
a remarkable rate over the last several years and is the world's
fastest growing energy technology. The growth of the market offers
significant export opportunities for United States wind turbine and
component manufacturers. The World Energy Council has estimated that
new wind capacity worldwide will amount to $150 to $400 billion worth
of new business over the next twenty years. Experts estimate that as
many as 157,000 new jobs could be created if United States wind energy
equipment manufacturers are able to capture just 25% of the global wind
equipment market over the next ten years. Only by supporting its
domestic wind energy production through the extension of the wind
energy PTC can the United States hope to develop the technology and
capability to effectively compete in this rapidly growing international
market.

E. The Immediate Extension of the Wind Energy PTC is Critical

Since the wind energy PTC is a production credit available
only for energy actually produced from new facilities, the
credit is inextricably tied to the financing and development of
new facilities. The financing and permitting requirements for a
new wind facility often require up to two to three or more
years of lead-time. With the credit due to expire next week,
wind energy developers and investors are unable to move ahead
with new projects. The immediate extension of the wind energy
PTC is therefore critical to the continued development and
evolution of the wind energy market. In addition, the five-year
extension is also necessary to give wind industry manufacturers
the confidence to invest in additional production facilities
within the U.S.

III. CONCLUSION

Extending the wind energy PTC for an additional five years
is critical for a number of reasons. The credit enables wind-
generated energy to compete with fossil fuel-generated power,
thus promoting the development of an industry that has the
potential to efficiently meet the electricity demands of
millions of homes across the United States. If the wind energy
PTC is extended, wind energy is certain to be an important form
of renewable energy in a deregulated electrical market, and is
an environmentally-friendly energy source that can aid in the
reduction of greenhouse gas emissions. The economic
opportunities of the wind energy market are significant, both
domestically and internationally. As such, we urge the
committee to extend the wind energy PTC until the year 2004 so
that the industry can continue to develop this important
renewable energy resource.
Thank you for providing me with this opportunity to present
CSW's views on the extension of the wind energy PTC.

Statement of Kenneth C. Karas, Chairman and Chief Executive Officer,
Enron Wind Corp., Tehachapi, California

My name is Ken Karas, and I am the Chairman and Chief
Executive Officer of Enron Wind Corp., a subsidiary of Enron
Renewable Energy Corporation. Enron Wind Corp., the largest
U.S. manufacturer and developer in the wind energy industry,
offers a fully integrated range of services including wind
assessment, project siting, engineering, project finance,
turbine production, construction, and operation and maintenance
of wind energy facilities. Enron Wind Corp. completed 300
megawatts of installed capacity in 1999. Over the last nineteen
months, the company has installed 667 wind turbines for a total
installed capacity of 500.25 megawatts. Most recently, we
finished construction of a new 16.5 megawatt facility in
California producing electricity to be sold into the green
market. Other recent projects include development of new wind
facilities in Minnesota and Iowa totaling approximately 239
megawatts. As a committed member of the wind energy industry,
Enron Wind Corp. strongly endorses the broadly supported
proposal to extend the Wind Energy Production Tax Credit
(``PTC'') for five years.
The current Wind Energy PTC, first enacted under the Energy
Policy Act of 1992, provides a 1.5-cent-per-kilowatt-hour tax
credit, adjusted for inflation after 1992, for electricity
produced from wind or ``closed-loop'' biomass. The credit is
available for wind energy production facilities placed in
service prior to July 1, 1999, and applies to wind energy
produced for the first ten years after the facilities are
brought on line. However, the current credit is scheduled to
expire as of June 30, 1999. The loss of the Wind Energy PTC
would be a critical blow to the future of wind power in the
United States at a pivotal time in its development as viable
large scale energy technology.
A five year extension of the placed-in-service date for the
Wind Energy PTC has been introduced in legislation in both the
House and Senate as well as being included in the
Administration's FY 2000 budget proposal. These proposals would
extend the availability of the credit to facilities placed in
service through June 30, 2004. H.R. 750, introduced by
Representative Bill Thomas (R-CA), has been cosponsored by 26
members of the Ways and Means Committee and has 129 cosponsors
in the House of Representatives. Companion legislation in the
Senate, S. 414, introduced by Senators Charles Grassley (R-IA)
and James M. Jeffords (R-VT) currently has 10 cosponsors on the
Senate Finance Committee and 25 cosponsors in the Senate. A
recent revenue estimate prepared by the Joint Committee on
Taxation concludes that the legislation would have a modest
revenue impact of $1 million in FY 1999, $5 million in FY 2000,
and only $76 million over five years.
Wind energy has made phenomenal advances in the last
fifteen years achieving improvements in reliability,
efficiency, and cost per kilowatt hour. Energy Secretary Bill
Richardson recently remarked, ``We think that wind technology
has the most potential of any renewable energy technology right
now.'' This enhanced potential is driven by improved
technologies, the vast amount of untapped wind resources in the
United States, and an interest in green generation sources by
consumers. Nonetheless, the cost of energy continues to be a
key concern both to consumers and to utilities choosing to
develop wind energy projects. Extension of the Wind Energy PTC
now is essential to provide parity with fossil fuel
technologies, and to achieve the economies of scale necessary
to deliver energy to consumers at cost effective rates. As most
wind energy projects require a minimum of two years to develop,
extension of the Wind Energy PTC for five years is critical now
to ensure the availability of long-term, low-cost financing for
wind energy projects. Despite these difficulties, close to 900
megawatts will have been installed in the last year prior to
the June 30, 1999 date for expiration of the credit.
Extension of the Wind Energy PTC is a targeted investment
in renewable energy that will provide significant returns to
the country, including:
Continuing to Reduce the Cost of Wind Power:
Dramatic advances have been made in the cost of wind power with
some current projects currently based upon a cost of below 5
cents per kilowatt hour. Stimulating investment through the
Wind Energy PTC will continue to bring these costs down as wind
energy begins to achieve economies of scale, allowing the
industry to compete head-to-head with other conventional
generating sources;
Achieving Reduced CO2 Emissions: The Department of
Energy has cited wind power as one of the emerging electricity
supply technologies needed to reduce the emissions of carbon
dioxide (CO2) caused by burning fossil fuels; and
Creating Jobs, Tax and Export Revenues: A healthy
domestic wind energy industry creates the momentum to continue
developing wind energy technologies for export abroad into the
booming world market for renewable power, which in turn creates
more jobs at home. Wind projects provide federal, state and
local tax revenues that over time exceed the cost of the tax
credits provided by the PTC.
We at Enron Wind Corp. are excited to be at the forefront
of one of the most promising renewable energy technologies
available, and believe that the Wind Energy PTC represents a
sound investment in the American economy, renewable energy and
our environment. I urge your support for this important and
cost-effective initiative.

Statement of Hon. Elton Gallegly, a Representative in Congress from the
State of California

Mr. Chairman, I appreciate this opportunity to testify on
how to find ways to provide tax relief to strengthen the family
and sustain a strong economy by sharing with you two bills I
have introduced this Congress.
The first would modify or expand investment incentives for
the American family. As the committee is aware, the U.S.
savings rate fell into negative territory in September of last
year and now we are at the lowest levels ever recorded. This
means that, collectively, individuals not only did not save
anything but actually raided their savings to pay current
spending. The last time this occurred was in 1938, during the
Great Depression.
The American family is actually saving less, and this will
mean that there will be less money available in the retirement
years for the working parents of today. We must provide
incentives to the families now to prevent creating an
exorbitant baby-boom tax on the families of tomorrow. To
counter this alarming trend in negative family savings, I have
introduced H.R. 1322-a bill which will provide investment
incentives to encourage long-term savings by increasing the
amount that may be contributed to individual retirement plans.
H.R. 1322 is simple and straightforward. The measure will
raise the maximum annual contribution limit to traditional or
Roth IRAs from $2,000 to $5,000. The amount taxpayers can
deduct would remain at $2,000 but would be annually indexed to
inflation.
The IRA is the most inspired investment incentive device to
promote long term savings Washington has ever created. However,
Mutual Funds magazine has reported that the IRA is receding in
importance at the very moment it should be rapidly expanding.
Merely to offset inflation since IRAs were introduced, annual
IRA contribution limits would have to be raised to more that
$5,000.
We ought to encourage long term investment and empower
these individuals who desire to use IRAs to supplement their
retirement. This legislation will make the IRA an even more
effective way for American families to save.
In addition, providing a high quality education to our
children is my highest priority. An educated populace is key to
economic prosperity. To accomplish this goal, I have introduced
H.R. 638, the Teacher Investment and Enhancement (TIE) Act.
While it is important to know how to teach, it is equally
if not more important to know what you are teaching. However,
many teachers are teaching ``out-of-field'' and, therefore, are
not sufficiently knowledgeable in their subject area. Offering
more education opportunities for our teachers is an investment
in our children and one we cannot afford not to take. The TIE
Act addresses this problem by providing secondary teachers the
incentives to return to college to take courses in the classes
they teach. This will be accomplished by doubling the current
Lifetime Learning Tax Credit for tuition expenses for the
continuing education of secondary teachers in their fields of
teaching. This increase would allow such teachers to receive up
to a $4,000 tax break for college tuition costs.
I look forward to working with the committee on both of
these measures. I am hopeful the committee will include these
proposals in any tax relief bill that is brought up for
consideration.

Statement of Hon. Scott L. King, Mayor, Gary, Indiana

Chairman Archer, Ranking Member Rangel and Members of the
Committee, I appreciate the opportunity to submit the following
testimony as you hear and review the written statements of
members of the public on how our government can most
effectively reduce the tax burden on hardworking Americans and
businesses.
Mr. Chairman the cities of Gary, Hammond, and East Chicago,
Indiana are the proud recipients of a second round Empowerment
Zone designation. I write today on behalf of the citizens of
our three cities to ask that this Committee honor the work that
we are doing, in partnership with 20 private sector businesses
to bring long term economic revitalization to the Calumet
region. As you begin crafting a tax package I ask that you
include grant funding for the second round of Empowerment
Zones, Enterprise, and Strategic Planning Communities.
The Calumet Area Empowerment Zone is home to approximately
48,889 residents, 40% of which live at or below the poverty
line. In three of the neighborhoods included in the Zone, the
percentage of individuals over the age of twenty-five that lack
a high school diploma range from 25% in the Brunswick
neighborhood to 45% in the Central/Mission neighborhood, and
44% in the Emerson community. The 1998 unemployment rates for
the three cities range from 3.6% in Hammond, 6% in East Chicago
to 7.1% in Gary, all three significantly above the state rate
of 2.8%.
Mr. Chairman I urge you to consider these demographics in
light of even more staggering economic trends for the Northwest
Indiana region as a whole. Historically the region's economy
has been centered primarily around heavy industry, steel in
particular. Over the last three decades we have witnessed
severe slumps in the region's economy due primarily to the
downsizing of steel and related service industries. The
downsizing of the steel industry resulted in marked reductions
in the civilian workforce, population declines ranging from 20%
in Hammond to 40% and 41% in Gary and East Chicago
respectively, and a 42.7% reduction in the total number of
manufacturing jobs region-wide.
Despite these alarming statistics, our region's leaders,
citizens and businesses have come together to address our
shared challenges and concerns. The future of our entire region
rests on our ability to create jobs, foster economic
opportunity, and attract new business investment to the Calumet
region. The tax incentives provided to Empowerment Zones,
Enterprise Communities, and our private sector partners under
the Taxpayer Relief Act of 1997 will go a long way toward
helping us achieve this end. These incentives will not only
ease the burden of financing our revitalization plans by
providing tax-exempt bonding authority, but will also provide
much needed incentives for businesses to invest in distressed
communities across this nation.
On the contrary, Mr. Chairman, the tax incentives provided
under the '97 tax bill are simply not enough on there own, to
allow us to do the kind of work that must be done to truly
rebuild and stabilize our region's economy. I ask that you and
the Members of this Committee, maintain your commitment to the
distressed communities across this nation that received second
round Empowerment Zone and Enterprise Community designations. I
urge you to provide the $1.7 billion in mandatory funding that
we desperately need to fully implement our revitalization
plans, which we are confident will yield tremendous economic
growth and opportunity for the Northwest Indiana region and
other communities throughout the nation.
Mr. Chairman and Members of the Committee thank you again
for your time and favorable consideration.

Statement of the Higher Education Community

Mr. Chairman and Members of the Committee, we greatly
appreciate your holding this hearing in anticipation of the
reconciliation tax bill expected next month. We particularly
appreciate your dedicating time during this hearing for
consideration of education-related tax issues.
The higher education associations listed below have
identified the following tax items as priorities for the higher
education community:

Remove current restrictions on claiming the student loan interest
deduction.

We are supportive of various bipartisan proposals to
eliminate the 60-month limit on claiming the student loan
interest deduction. Current law places several restrictions on
claiming this deduction. Students who need to borrow to finance
their education should not be restricted on claiming a tax
deduction for interest on their borrowing.
We feel current restrictions should be lifted to allow more
students and former students to qualify for this deduction that
limit its use and greatly complicate the administration of this
benefit. In addition to repealing the 60-month limit, which
would allow the interest to remain deductible as long as the
loan is outstanding, we also support an increase in the amount
of interest allowable for the deduction. Under current law, the
deduction cannot exceed $1,500 in 1999, $2,000 in 2000, $2,500
in 2001 and beyond. Finally, the income threshold for the
phase-out of this deduction needs to be increased. Currently,
taxpayers with incomes of $40,000 for single taxpayers and
$60,000 for joint returns are phased-out of eligibility for
this deduction. Certainly, students who financed their
education through student-loans and subsequently graduate with
high amounts of debt should not lose eligibility for this
deduction based on an arbitrary income threshold that renders
the deduction practically useless.

Enactment of Charitable IRA Rollover legislation that would provide new
incentives for donors to give funds held in various retirement
accounts, such as 403(b), 401(k), and Keogh plans, directly to
charities.

Under current law, an individual taxpayer may withdraw
funds from an Individual Retirement Account (IRA) without
penalty after age 59\1/2\, and must commence withdrawals by the
April 1st following the year in which he or she attains age
70\1/2\. IRA withdrawals are fully taxable as income to the
individual in the years they occur. A donor who withdraws IRA
funds for transfer to a charity will be subject to tax on the
entire withdrawal, offset to varying degrees by the charitable
deduction.
Legislation recently introduced by Representatives Phil
Crane and Richard Neal, H.R. 1311, would allow a donor to
rollover IRA funds to a charity with favorable tax treatment,
as either an outright gift or a life-income gift such as a
charitable remainder trust, gift annuity or contribution to a
pooled income fund. If the IRA funds are rolled over as an
outright gift to the charity, the donor will not be subject to
income tax at the time of withdrawal and transfer. If the IRA
funds are rolled over as a life-income gift, the donor will be
subject to taxes on subsequent income payments received for the
gift. In either case, the donor would receive a charitable
deduction only to the extent that the gift has ``basis'' as a
result of after-tax contributions to the IRA.
Higher education and charitable organizations strongly
support this proposal, which has the potential to unlock
substantial new sources of funding for the charitable community
from donors who hold billions of dollars in IRA and other
retirement accounts.

Permanent extension of Section 127, employer-provided education
assistance, for both graduate and undergraduate course work.

For many Americans attempting to balance work, family, and
economic priorities, Section 127 is the only feasible and
affordable way that they can further their education and
thereby improve their skills and remain competitive in today's
job market. Section 127 is a purely private-sector initiative,
and represents an important tool for encouraging employer
investment in their workers' continuing education. Like any
other employer benefit, it is purely voluntary, and is provided
by many employers because they see value and a return on an
investment in their employees' education. Section 127 is of
special importance to women and minorities, as well as those at
the bottom of the career ladder who need better skills to
advance
Section 127 provides more appropriate tax treatment for
this educational benefit than the new Lifetime Learning tax
credit. The credit, equal to 20 percent of the first $5,000,
does not fully offset the tax liability that arises if the
benefit is considered taxable income. In addition, the credit
is not sensitive to family size--the maximum tuition that may
be counted towards the credit is $5,000, whether the taxpayer
is single, married, or married with children in college. As a
result, parents with a child in college who are continuing
their own education at the same time will receive no benefit
from the new Lifetime Learning tax credit, and will also be
liable for additional taxes if any educational benefit they
receive is not covered by Section 127.
The on-again, off-again status of Section 127 has prevented
workers who need the educational assistance most from fully
participating in the program. Some workers have postponed
registering for classes because of uncertainty about whether
the benefits would be taxable, while others have scaled back
their education plans. We strongly support the permanent
extension of this expiring provision for both graduate and
undergraduate education.

Tax relief for college savings and prepaid tuition plans.

In addition to supporting equal tax treatment for all types
of plans, we are very supportive of expanding the tax relief to
include tax free distributions from these plans. Section 529 of
the IRC should be expanded to ensure fair tax treatment to all
college savings and pre-paid tuition plans. In addition, to
further encourage these as savings options for families, tax
free distributions would be highly desirable. We appreciate and
support the numerous bills Members of both the House and Senate
have introduced to achieve such tax relief for these plans.

An increase in the annual contribution limit to Education IRAs.

Education IRAs (also known as Education Savings Accounts,
or ``ESAs'') were created as part of the Taxpayer Relief Act of
1997 to provide a new savings option for families trying to
plan ahead for future education expenses. ESAs were intended to
appeal to the many individuals who are comfortable with
traditional IRAs as a saving option. Unfortunately, the current
$500 annual contribution limit is simply too low to enable
families to build sufficient savings for higher education
expenses. For this reason, ESAs have proved to be ineffective
in their current form. We appreciate the wide support for
increasing the contribution amount and hope appropriate
language will be included in tax legislation at your next
opportunity.

Amend the Internal Revenue Code of 1986 to repeal or substantially
modify the information-reporting requirement relating to the Hope
Scholarship and Lifetime Learning Credits.

We urge you to address the costly reporting requirements
related to the Hope Scholarship and Lifetime Learning Credits.
While we believe that repealing the requirements is in the best
interest of both institutions and the IRS, significant
modifications of the reporting requirements are another option
to consider. IRS/Treasury temporarily reduced the reporting
requirements in tax years 1998 and 1999 and may do so again for
tax year 2000.
Making the current minimal reporting requirements
permanent-and thus avoiding the pending requirement for schools
to annually obtain the taxpayer SSN, name and address for
dependent students-would be one such significant modification
that falls short of repeal. We also urge you to modify the
reporting requirements to limit the universe on whom tax
reports must be sent. This would reduce institutional reporting
by allowing schools to report on only those students who
request such reporting and provide the school with adequate
information to file such a report.

Research and Development Tax Credit

The higher education community perceives the objectives of
the credit as twofold: first, to encourage sustained support
from the private sector for the conduct of basic research by
colleges and universities and, second, to involve colleges and
universities to a greater extent in research oriented to
practical applications. The credit also fosters the interaction
between industry and the talents and skills available at
colleges and universities.
Permanent extension of the R&D credit will contribute to
increased research and development and higher annualized rates
of return; and it will stimulate economic growth, improve
productivity, and benefit the entire economy. The credit is
also central to the continuation and expansion of partnerships
between industry and universities, which will speed progress
toward important scientific discoveries.
Thank you Mr. Chairman and Members of the Committee for
allowing us the opportunity to submit this testimony for the
record. We greatly appreciate your holding this hearing and
focusing a portion of it on education-related tax provisions.
We hope you will find our comments and recommendations useful
as you continue building the next reconciliation package. We
feel very strongly that inclusion of these items in upcoming
tax legislation would present a well-rounded and much needed
higher education tax relief package.
On behalf of:

Accrediting Association of Bible Colleges
American Association of Community Colleges
American Association of Dental Schools
American Association of Presidents of Independent Colleges
American Association of State Colleges and Universities
American Council on Education
Association of Advanced Rabbinical and Talmudic Schools
Association of American Universities
Association of Community College Trustees
Association of Governing Boards of Universities and Colleges
Association of Jesuit Colleges and Universities
Coalition of Higher Education Assistance Organizations
Council for Advancement and Support of Education
Council for Christian Colleges & Universities
Council of Graduate Schools
Council of Independent Colleges
National Association for Equal Opportunity in Higher Education
National Association of College and University Business Officers
National Association of Independent Colleges and Universities
National Association of Schools and Colleges of the United Methodist
Church
National Association of Student Financial Aid Administrators
North American Division of Seventh-Day Adventists
The Mennonite Board of Education

Joint Statement of IRA Charitable Rollover Working Group

Mr. Chairman and Members of the Committee, this written
statement is submitted to the House Ways and Means Committee on
behalf of the IRA Charitable Rollover Working Group, a
coalition of nonprofit associations nationwide that was formed
specifically in order to promote passage of the IRA Charitable
Rollover Incentive Act (H.R. 1311, S. 1086). Passage of this
legislation is also supported by two broad-based coalitions of
charitable organizations throughout the nation--Charitable
Accord, which is focused mainly on charitable giving issues,
and Independent Sector, which addresses a wider range of
charitable issues. Attached is a list of the members of the
Working Group. In addition, Charitable Accord has a list of 200
members, and Independent Sector a list of 41 members, that
endorse the enactment of H.R. 1311/S. 1086 into law. These
endorsees represent the interests of service and religious
groups, museums and arts groups, colleges and universities,
private and community foundations, and other charitable
organizations across the country.
Although charitable giving has increased in recent years,
charitable organizations still face the continued challenge of
meeting the needs of the people they serve. Over the past two
decades, government funding for programs that serve social
needs have been significantly reduced. According to a recent
study prepared for Independent Sector, under the President's FY
1998-2002 budget proposal, inflation-adjusted federal spending
for FY 2002 in budget functions of concern to nonprofits would
decline 3% below FY 1995 levels. Moreover, if entitlement-
driven spending for income security is excluded from the
calculation, inflation-adjusted spending for the remaining
categories of concern to nonprofits would decline 9% below FY
1995 levels. Among those services that will suffer the largest
declines in the federal share of their funding from 1996 to
2002 are: services to the elderly (from 17% to 9%); nursing
homes for the elderly (from 42% to 30%); housing, community
development and other community services (from 50% to 31%);
home healthcare (from 39% to 27%); and food services (from 46%
to 36%). Consequently, the charitable sector, which is expected
to fill this gap, must constantly seek additional resources,
for example, through charitable gifts, or cut back on programs
as social needs continue to grow.
Excess IRA assets represent a very large, untapped source
of potential support for the nation's charities. According to
Joint Tax Committee staff, there is currently more than $1
trillion in IRA accounts and $5 trillion in defined
contribution accounts, which can be rolled into IRA accounts.
In addition, economists estimate that more than $10 trillion in
wealth will be transferred to the so-called baby-boomer
generation from their parents. One result of this large
generational transfer is that, for many individuals, IRA assets
accumulated under favorable market conditions will be less
necessary for their retirement and, at least in part, available
for charitable giving. However, current law presents serious
tax disincentives to such gifts.
Under current law, IRA withdrawals are fully taxable as
ordinary income to the individual in the years they occur. A
donor who withdraws IRA assets for transfer to a charity is
subject to tax on the entire amount, offset to varying extents
by the charitable deduction. Although charitable organizations
frequently receive inquiries from potential donors about giving
IRA assets during their lifetimes, the tax consequences are so
significant a deterrent that such gifts are rarely made.
The following are selected examples from an informal survey
that was designed to solicit anecdotal information about how
current tax law inhibits donors interested in making charitable
gifts from the rollover of IRA assets. A growing number of
individuals report that they have satisfactory arrangements in
place for their retirement income, and that they want to give a
portion of their IRA assets to charity. In virtually all
examples collected, when the potential donors were informed
that they must pay ordinary income tax on any IRA assets they
give to charity, they chose not to make such gifts.
A national disease association with headquarters
in Illinois has had two inquiries this year about gifts of
approximately $1 million each from IRA assets. The first was
from a widow with other assets, who considered establishing a
charitable remainder trust that would not only ``do some good
for society'' but also provide her with annual income to care
for her disabled child. The second was from a highly successful
businessman nearing retirement, who wanted to set up a
charitable remainder unitrust. Because of the tax consequences,
neither individual has made the proposed gift.
A 71 year old male donor with a $1.3 million IRA
wishes to make a life-income gift to a major public university
in Texas. He would like to receive annual income payments that
would help ensure the care of his wife, who is in the early
stages of Alzheimers. Given the tax consequences of such a gift
under current, the donor has not been willing to move forward.
The husband of a hospital volunteer at a medical
center in Tennessee would like to establish a charitable trust
to benefit cancer research, which was responsible for the
recent death of his wife. He wants to use retirement plan
assets of $1.8 million to establish this cancer research fund,
to provide himself with annual payments for retirement income,
and to reduce the tax burden on his heirs, which would be
greater for IRA assets than other appreciated securities. He
has been advised against such a gift because of tax
disincentives under current law.
A successful entrepreneur, who is a board member
of an Arizona foundation, proposed to make a life-income gift
of up to $.5 million from excess qualified pension plan
proceeds. This gift, in addition to providing retirement income
for himself and his wife, would assist in financing two
community hospitals, a children's dental clinic, a food bank,
an adult day healthcare center, long-term and rehabilitative
care facilities, and a host of other medical and social
services. However, upon investigation, he concluded that the
tax consequences were too unfavorable.
A major university in Pennsylvania has recently
received about 24 calls per year concerning gifts from IRA
assets. Typical cases are in the $100,000 range, but one
inquiry was regarding a $700,000 gift. To date, all except one
of these donors have decided against making such a gift.
In Maryland, an elderly couple, who had a lifetime
commitment to volunteerism and a history of charitable giving
to a hospital foundation, a community-based housing group, and
a welfare-to-work training organization, inquired about
establishing a charitable remainder trust from IRA assets. They
wanted to benefit their philanthropic interests, but provide
some additional income for whomever was the survivor. However,
concern about the high level of taxation on assets withdrawn
from their IRA prevented them from proceeding with the
proposal.
One major university in California has received at
least 12 inquiries in the past year, and another received four
inquiries, about making outright gifts or establishing
charitable trusts by assigning IRA or other qualified pension
assets. However, upon learning about the tax treatment of those
actions, no prospect has actually made a gift.
A major social welfare provider in Illinois was
approached by a contributor who wanted to donate outright his
total IRA assets of $650,000. Given the unfavorable income tax
consequences under current law, he did not make he gift.
A research university in New York has had six
inquiries in the past two years about gifts in the $1.5 to $3.0
million range from IRA assets. Given the unfavorable tax
consequence under current law, none of these gifts has
materialized.
A community foundation in California received an
inquiry from a donor, wishing to use IRA assets to establish a
$.5 million scholarship fund. However, when the tax
implications were reviewed, the donor declined to create this
fund.
In contrast, given passage of the IRA Charitable Rollover
Incentive Act (H.R. 1311), if IRA assets were rolled over to
charity as an outright gift, they would be removed from the
donor's tax calculation of ordinary income. In addition, if IRA
assets were rolled over as a life-income gift, the annual
income payments from the gift would still be subject to
taxation. In both cases, the donor would not receive a
charitable deduction unless after-tax dollars had been
contributed to the IRA.
The following example will illustrate the different tax
consequences under current law and H.R. 1311. Mr. Smith, age
60, has accumulated approximately $1,000,000 in his IRA and
other tax-favored retirement plans. While he believes he will
only need about $750,000 for retirement, he plans to leave his
IRA intact for another 10 years rather than pay tax on
withdrawal of assets.
If legislation is enacted allowing charitable IRA rollovers
with favorable tax treatment, Mr. Smith can transfer IRA assets
he will not need for retirement to the charity as an outright
gift or a life-income gift. Either way, these gifts will not be
subject to tax upon withdrawal and transfer of his IRA assets
to the charity. His gift would be tax-deductible only to the
extent he had previously funded his IRA with after-tax dollars.
If Mr. Smith prefers a life-income gift, for example, he
can transfer $250,000 to a 7% charitable remainder annuity
trust, from which he will receive $17,500 in annual taxable
income (a 7% return on the $250,000) for life. Over the first
10 years, Mr. Smith (assuming a 39.6% tax bracket) may pay
income taxes totaling as high as $69,300 on income totaling
$175,000.
By contrast, under current law, Mr. Smith could owe an
initial tax of approximately $79,600 on the $250,000
withdrawal, even after taking into account the charitable
deduction he may receive for contributing the net proceeds to
the trust. Mr. Smith may then contribute only $170,400 to the
trust, from which he will receive $11,900 in annual taxable
income (a 7% return on the $170,400) for life. Over the first
10 years, Mr. Smith may pay income taxes totaling as high as
$47,124 on the income totaling $119,000.
This proposed legislation is good public policy. Since
other qualified retirement plans can now be rolled over tax-
free into IRAs, this proposal would unlock substantial new
resources for the support of charitable organizations and their
public-service missions. In addition, this proposal would
realign tax treatment on IRA assets to match current tax laws
that apply to other assets donated to charity. Finally, to the
extent that donors transfer IRA assets into life-income
gifts soon after age 59--, rather than waiting until the
required distributions at age 70--, this proposal would
generate new tax revenues, partially offsetting revenue losses.
Implementation of H.R. 1311 will involve lost revenue,
which was estimated by the Joint Tax Committee staff at $1.4
billion in the first five years. However, the revenue loss
would be partially offset by life-income gifts (e.g.,
charitable remainder trusts or charitable gift annuities) that
would accelerate revenue to the degree that individuals, before
age 70--when withdrawals must begin, roll IRA funds into such
gifts, which will generate taxes on the annual income payments.
Attached are three charts illustrating that, in many cases, the
tax revenue created by an IRA rollover to a life-income gift
may exceed the tax revenue lost because of the tax exclusion
permitted by the legislation. The illustrations reflect single
and dual income recipients at ages 60, 70, and 80 together with
their respective single and joint life expectancies. Current
calculations show the federal income tax revenue ``lost'' and
``found'' under these three life-income arrangements.
Although IRA assets were originally intended as a
supplement to retirement income, withdrawal is now allowed in
order to assist in financing a home or a college education. It
is equally, perhaps more, appropriate for public policy to
allow financially successful individuals, who have reached a
point where IRA and other tax-deferred retirement assets are
not needed for retirement, to use those assets not to benefit
personally, but to support charities that better the lives of
others. Moreover, in the case of life-income gifts, a portion
of the IRA assets would be retained as retirement income for
the donor and his or her spouse alone, with the remainder
passing to charity upon the death of the participants.
Furthermore, since an IRA may now pass to charity at death by a
direct or life-income gift, the proposal parallels the current
tax code.
Some may incorrectly characterize H.R. 1311 as a tax break
for the wealthy. The plain fact is that many middle-class
Americans, including teachers, nurses, sales persons, retired
military, and librarians, frequently express their desire to
make gifts using IRA assets. Many retirement plans have
multiplied well beyond anticipated needs and expectations as a
result of favorable investment markets and moderate inflation.
These donors want the removal of a tax disincentive, not a tax
break, in order to complete their charitable objectives.
Indeed, upper-bracket taxpayers can best afford, and are most
likely to make, this type of wealth transfer to charity.
However, if this proposal were passed into law, although the
government would give up a tax worth 39.6% of the value of the
asset, the donor would give up 100% of the asset. The
government would not collect tax on the transfer of the asset
to charity because the transfer does not financially benefit
the donor. Thus, there is no income on which to levy a tax.
Rather, this untaxed asset transfer will increase private
support for public services that the government would otherwise
be called upon to provide. Therefore, it is good public policy
to create incentives that encourage individuals, including
upper-bracket taxpayers, to support philanthropy through gifts
of IRA assets.
The future of the charitable sector and of the public
services it provides depends upon expanding financial resources
to meet increasing social needs. The existing billions of
dollars in IRA assets constitute a significant, untapped
resource for charitable purposes. This proposal would allow
individuals, who have assets in excess of requirements for
their retirement, to make penalty-free donations of IRA assets
to support the charitable sector and its public-service
mission. For these reasons, we urge the passage of H. R. 1311.

IRA Charitable Rollover Working Group

American Arts Alliance
American Association of Museums
American Bar Association
American Council on Education
American Heart Association
American Hospital Association
American Institute for Cancer Research
American Red Cross
Association for Healthcare Philanthropy
Association of American Universities
Association of Art Museum Directors
Association of Jesuit Colleges and Universities
Baptist Joint Committee
CARE, Inc
Catholic Health Association
Charitable Accord
Council for the Advancement and Support of Education
Council on Foundations
Council of Jewish Federations
Goodwill Industries International
Independent Sector
National Association of Independent Colleges and Universities
National Association of Independent Schools
National Committee on Planned Giving
National Health Council
National Multiple Sclerosis Society
National Society of Fund Raising Executives
The Salvation Army
United Way of America
[GRAPHIC] [TIFF OMITTED] T0841.022

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[GRAPHIC] [TIFF OMITTED] T0841.024

Statement of Maria J. Jerardi, Third Year Student, Georgetown
University School of Medicine; and Recipient, National Health Service
Corps Scholarship

I am writing to you with my concerns about the impact of
the new Internal Revenue Service (IRS) taxation policy on
myself as well as on other National Health Service Corps (NHSC)
scholarship recipients nationwide. I am appealing to you now
for your assistance in changing this policy through support of
H.R. 1414 and H.R. 324. While I acknowledge the importance of
civic responsibility, which includes paying taxes, I believe
that there are several issues that distinguish the case of NHSC
scholarship recipients.
First, I completely agree with the tax liability of the
monthly stipend NHSC Scholars receive to cover their living
expenses ($915.00 per month), however it is generally the case
that support received as a scholarship and used for tuition,
books, and mandatory fees is tax-deductible. The recent
decision by the IRS to require NHSC Scholars to pay taxes on
the entire value of the scholarship has had several negative
ramifications. It results in financial hardship for the
recipients and undermines the purpose of the program while
serving only to transfer funds from one federal agency to
another.
It should be emphasized that I am currently a medical
student and will soon be a resident and then a practicing
physician. As a resident I will be employed by the hospital
affiliated with my residency program and as a clinician I will
work for a private, non-profit clinic. Consequently the
argument by the IRS that NHSC scholars are receiving payment in
advance, to support their education, in exchange for future
services rendered makes no sense. I will not be employed by the
NHSC or the Department of Health and Human Services during
either my residency or the four year clinic placement which
will immediately follow my residency. Clearly section 117 (c)
of the Internal Revenue Code was not intended to penalize NHSC
scholars and the current policy has resulted from a
misinterpretation of this regulation by the IRS.
Due to the expense of attending a private medical school
such as Georgetown University where tuition is over $26,000.00
per year, this new tax provision results in a significant
reduction in the proportion of expenses covered by a NHSC
scholarship. Currently, the monthly stipend of $915.00 per
month which used to be reduced to approximately $800.00 per
month after federal withholding has been reduced to $380.00 per
month for Georgetown students due to increased tax liability.
This amount covers less than a third of the budgeted monthly
living expenses of a Georgetown medical student (estimated by
the financial aid office to be approximately $1200.00 per
month). Consequently, this scholarship which is supposed to be
sufficient to cover the normal expenses of a medical student
(tuition, books, supplies, fees, and living expenses) is no
longer meeting this goal. Consequently, I was forced to take
out approximately $11,500.00 in loans to cover living expenses
for the 1998-99 school year. Additionally, as a Maryland state
resident, I have incurred an additional state income tax
liability requiring me to borrow an additional $6,600 in the
middle of the past academic year to cover the cost of my state
taxes.
The necessity of this type of lending is somewhat
nonsensical, considering that the money I am now borrowing
through federally-subsidized loan programs (from the Department
of Education) is being used indirectly to pay taxes to a
government agency (the Internal Revenue Service) on a
scholarship I received from another government agency (the
Department of Health and Human Services). Additionally, the
necessity of these loans is undermining the whole purpose of
the NHSC program. The NHSC strives to encourage health
professions students to practice in medically-underserved rural
and urban areas (MUAs) in the U.S. These are areas which are in
great need of physicians and other health professionals in
order to provide the access to health care deserved by all
communities in our country.
The NHSC requires a year in an underserved area for each
year of support received. However, the NHSC also encourages
scholarship recipients to continue to serve in medically-
underserved communities after the completion of the commitment
required by the scholarship. The organization does this by
striving to recruit those individuals who will continue to
serve in such areas despite the challenges posed to one's work
and lifestyle by work in rural or urban health professional
shortage areas (HPSAs). One of the major drawbacks of working
in such a region is the lower level of compensation offered by
many of the federally-funded clinics in these communities. By
removing the debt burden experienced by many medical students,
this scholarship once enabled recipients to select positions
after completion of their commitment somewhat independent of
financial considerations. Now, with the prospect of having to
borrow over $65,000 (if I am forced to continue my current
level of borrowing to cover losses of stipend income to both
state and federal tax liability) during my medical education in
addition to the debt burden incurred by undergraduate and
graduate school, I know that my ability to take future
positions (following my scholarship commitment) in regions of
the country that critically need my services will be limited by
salary considerations. I may have to find a job which provides
a sufficient salary to cover the much higher monthly payments
required by my much increased level of indebtedness.
At the time I applied for an NHSC scholarship, these
current tax issues were not apparent. I chose to attend
Georgetown because of the superior clinical training I believe
it provides. However, this decision was made with the
expectation of receiving an NHSC scholarship. Now with this
recent tax ruling by the IRS, my financial situation has
changed dramatically. Had I known before of the debt burden
that I would be forced to incur even with the NHSC scholarship,
I would have made the choice to attend a less-expensive school
and not participate in the NHSC program.
As the United States continues to deal with its apparent
surplus of physicians, despite the fact that many rural
counties in the midwest and southeast are without any physician
services, the NHSC program can serve a valuable role. With
increasing financial constraints on government spending, the
maximization of cost-effectiveness of federal programs is
vital. Why not allow NHSC scholarship recipients to receive the
benefits which are supposed to be provided through this
program? By allowing these students to pursue an education in
the health professions with little or no debt burden, the
program stands a much better chance of making a long-term
impact on the physician maldistribution problem in our country
and maximizing the program's cost-effectiveness. Without debt
burden, the clinicians this program trains will stay in areas
of critical need longer, thereby making a bigger contribution
to the ultimate goals of the NHSC.
I thank you for your concern about the impact of these tax
changes on my program of study and on my future as a community-
oriented physician. More importantly I appreciate your concern
for those communities in our country without adequate access to
health care who will truly be most affected by these tax
changes. For all of these reasons I ask you to please support
the quick passage of H.R. 1414, a bill which seeks to reverse
the taxation of the NHSC scholarship.

Sincerely,
Maria J. Jerardi

Joint Statement of Victor Ashe, Mayor, City of Knoxville, Tennessee

As Mayor of the City of Knoxville, I am pleased to have the
opportunity to communicate to this Committee a sense of the
community support for the federal Empowerment Zone (EZ)
initiative.

Background

In 1994, hundreds of members of our community, spurred by
the promise of the new Empowerment Zone/Enterprise Community
(EZ/EC) program, came together to develop a strategic plan for
the most distressed areas of our city. Residents and other
stakeholders from throughout the community joined together to
conduct an introspective evaluation of the strengths and
problems of the city, and to develop strategies and
relationships to tap those strengths and attack those problems.
Citizens, local government, private businesses, and nonprofit
organizations worked together to define and plan for the
revitalization of an area that traditionally had been seen as
past its prime at best, and not worth saving at worst.
That planning formed the basis for Knoxville's Round I
application for EZ/EC designation. Although Knoxville was not
selected as an EZ or an EC in 1994, the relationships formed
during that planning process continued to grow and flourish.
The planning process set in motion a new way of looking at
Knoxville's central city and its potential as an investment
opportunity. It laid the groundwork for more inclusive and open
local planning. Best of all, it forged a plan backed by the
commitment of residents, local government, and philanthropic
organizations. It empowered the community to see what is
possible in Knoxville, and it created some of the tools
necessary to make that vision a reality.
The community could have seen all of the hard work on the
Round I application as fruitless when Knoxville was not chosen
as an Empowerment Zone, but that is not what happened. The
city, with its public and private partnerships stayed committed
to implementing as much of the 1994 EZ plan as possible without
the federal EZ funding.
When the opportunity for Round II EZ designation became
available in 1998, again the residents and other stakeholders
in Knoxville's central city joined together to develop a plan.
The 1998 effort built upon and expanded the 1994 planning
process, incorporating the most promising ideas from that
earlier effort. The result of the 1998 planning process was a
plan with broad-based community support, a plan that promises
genuine empowerment combined with new economic prosperity for
our most challenged neighborhoods.

The Importance of the Empowerment Zone to Knoxville

Knoxville's Empowerment Zone is not just a few isolated
patches of poverty--it encompasses more than 20% of the total
geographic area of the City and houses almost 30% of
Knoxville's population.
Our Empowerment Zone faces the challenges common to many
older urban areas. The Zone suffers from workforce
obsolescence, a paucity of community capital, and weak civic
attachment. Brownfields dot the Zone's industrial landscape.
Virtually every Zone neighborhood faces blighted dilapidated
housing and overgrown vacant lots. The majority of Zone
residents need to develop new job skills, because the ones that
once supported them have become unmarketable in the information
age. Other residents have become dependent upon public
assistance programs that will no longer sustain them and must
engage in education and training that will challenge them to
become contributors to our social and economic fabric.

The Importance of the Empowerment Zone to the Region

Knoxville's EZ carries tremendous significance as the
historic, geographic, and economic heart of Southern
Appalachia. The revitalization of the Zone and its
reintegration into the economic and social fabric of East
Tennessee are essential to the long-term vitality and commerce
of the entire Southern Appalachian region, an area with more
than six million residents and 86,000 square miles.

Empowerment Zone as Investment Opportunity

We here in Knoxville view our Empowerment Zone as an
investment opportunity. It does have more than its share of
competitive disadvantages, but these problems are neither too
deeply rooted nor too overwhelming to solve. Since 1993, the
community has been steadily assembling the resources needed for
a renaissance in the Heart of Knoxville. Other investors have
begun to see the possibilities of the Zone, but these
investments need augmentation to sustain them. With the help of
the federal government, the assets of this Zone can and will be
developed into competitive advantages that will yield economic
and social returns far greater than any initial investment.
Our successful shepherding of investment in our EZ will
require us to adhere to some basic tenets of business practice.
We will:
Build on the competitive advantages and eliminate
the competitive disadvantages of the Zone.
Target resources to maximize neighborhood
improvements.
Increase the economic value of doing business in
the Zone.
Provide flexible, accountable, effective
management of the Zone.
Mobilize the private sector.

Use of Federal Investment in Empowerment Zone

Federal funding appropriated for the Empowerment Zone
initiative will result in highly visible programs that achieve
broad goals of economic opportunity and improved quality of
life. Some examples of projects in Knoxville that need
Empowerment Zone funding to become a reality:
Redevelopment of Brownfields: A public/private
partnership led by the City of Knoxville will pilot and then
replicate a model for redeveloping contaminated or
underutilized commercial and industrial sites within our Zone.
This initiative will lead to the creation of 1,800 new jobs and
will leverage an anticipated $98 million in private investment
over the period of designation.
Empowerment Bank: The City and its partners will
establish an institution to provide comprehensive services for
small businesses in the Empowerment Zone. It will be set up in
one location and provide a wide-range of capital and technical
assistance under one roof. This initiative will leverage more
than $2 million in private lending and create at least 50 jobs
per year.
Workforce Competitiveness: This initiative will
provide Zone residents with training and match them with job
opportunities in the Zone and the region. This initiative would
build on current capabilities and would be one way of targeting
our resources to achieve maximum results.
Housing Affordability and Choice: Using the EZ
funds to leverage a private pool of lending, this initiative
would allow us to focus on mixed income financing with two
components: a fund of private financing that can be used for
purposes where it is normally difficult to obtain a loan; and
subsidy funds that encourage existing residents to improve
their homes, enable households that could not otherwise afford
it to purchase, construct, or purchase/rehabilitate a home in
the Zone. This effort would result in the construction of 1,000
new housing units and the rehabilitation of 500 additional
homes over the period of designation.
Preservation-based Housing Rehabilitation: Through
this program, endangered historic homes will be acquired,
stabilized, and marketed to low-and middle-income home buyers
and other investors. This program will not only help to
preserve our heritage and the historic character of our older
neighborhoods, it will also attract new investment into the
area. Empowerment Zone funding for this initiative can leverage
$200,000 from the National Trust for Historic Preservation,
$100,000 from local sources, and additional private investment
in renovation and restoration.

Empowerment Zone Funding as a Means to Spur Other Investment

What all of the examples above illustrate is the concept of
leverage: using federal funds as seed money to attract other
investment. With the commitments already in place, a federal
investment of $100 million in the Knoxville Empowerment Zone
will leverage more than $550 million in additional private and
public funding. In addition, the projects described above will
attract private investment not yet committed to the Zone will
in excess of $100 million. Over the ten year designation, I
would expect that an investment of $100 million in federal EZ
funding would result in $1 billion in total new investment in
Knoxville's Empowerment Zone. This is a rate of return that any
investor could be proud of.

Why your support for this legislation is so important

Healthy cities have long been the foundations of our
national economic life. The Empowerment Zone initiative offers
a means of achieving revitalization for the most distressed
parts of American cities. If we can work together to reverse
the declines affecting these areas--redeveloping contaminated,
underutilized industrial sites; attracting businesses to expand
and hire Zone residents; fighting crime and lack of civic
attachment; promoting community pride; preserving our heritage;
improving our housing opportunities--we can help to ensure the
long term health of our national economy.
Like all of the Round II Empowerment Zones, Knoxville has
assembled a large group of committed partners. Residents,
businesses, financial institutions, philanthropic
organizations, nonprofit organizations, educational
institutions, and governmental entities have all come together
to support Knoxville's EZ initiative. This broad-based group
has carefully developed a plan that can bring lasting health
and vitality back to an area that has suffered significant
disinvestment. They have pledged their time, energy, and
financial resources to making the plan become a reality. But
they cannot do it without support from the federal government.
You can provide the seed money and tax incentives that leverage
tremendous amounts of private funding. You can provide the
resources that will bring new partners to the table. With $100
million in EZ funding, we can leverage a $1 billion
revitalization effort. Without your support, the promise
offered by our EZ plan cannot become a reality.
Thank you for your consideration of this very important
issue.

Respectfully submitted,
Victor Ashe

2308 Rayburn House Office Building
Washington, DC 20515-0505
July 2, 1999

The Honorable Bill Archer
Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, D.C. 20510

Dear Mr. Chairman,

I am writing to bring your attention to an issue related to the
Hope Scholarship and Lifetime Learning tax credits affecting colleges
and universities in a manner unintended by Congress. Provisions of the
Taxpayer Relief Act of 1997 require colleges to file an information
return with the IRS, supplying a copy to the student or to the taxpayer
who claims the student as a dependent, for all students for whom
tuition and fees were received in the tax year. This requirement is
imposed without regard to whether the students will be eligible for the
tax credits or will choose to take advantage of them.
The IRS issued interim guidelines for colleges and universities to
follow for the 1998 and 1999 tax years and is in the process of
drafting regulations that will increase the amount of data those
institutions are required to supply. This reporting standard has
created a problem for all postsecondary institutions. In my state of
California it is particularly burdensome for the California Community
College system because the number of reports that must be filed far
exceed the number of students who will utilize the tax credits.
I have received correspondence from the Chancellor of the
California Community Colleges in support of changes to these IRS
requirements and in support of HR 1389, the Higher Education Reporting
Relief Act introduced by Congressman Manzullo. I request that this
letter be included as part of the Committee's hearing record for June
23, 1999 on ``Providing Tax Relief to Strengthen The Family and Sustain
a Strong Economy.''
In addition, I am cosponsoring HR 1389 with Mr. Manzullo, and I
hope that the Ways and Means Committee will give full consideration to
this measure in this session of Congress.
Thank you for your consideration on this important matter.

Sincerely,
ROBERT T. MATSUI
Member of Congress

STATE OF CALIFORNIA
CALIFORNIA COMMUNITY COLLEGES
CHANCELLOR'S OFFICE
Sacramento, CA 95814-3607
June 21, 1999

The Honorable Donald Manzullo
United States House of Representatives
Cannon House Office Building
Washington, D.C. 20515

Dear Congressman Manzullo:

I am writing to thank you for your continuing efforts to repeal
provisions of the Taxpayer Relief Act of 1997 (TRA) that require
institutions of higher education to devote significant resources to
providing data to the Internal Revenue Service in a manner that is
inconsistent with serving student needs. The California Community
Colleges are strong supporters of H.R. 1389, the Higher Education
Reporting Relief Act, and I am anxious to do whatever I can to help you
and Congressman Matsui secure passage of this legislation in the 106th
Congress.
The California Community Colleges are eager to assist all students
who can qualify for the higher education tax benefits to take advantage
of them. However, current law requires the colleges to file an
information return with the IRS, supplying a copy to the student or to
the taxpayer who claims the student as a dependent, for all students
from whom tuition and fees were received in the tax year. This
requirement is imposed without regard to whether the students will be
eligible for the tax credits or will choose to take advantage of them.
This reporting standard has created a problem for all postsecondary
institutions, but nowhere is the inefficiency of the statutory approach
more clear than in the California Community Colleges system, where
colleges are required to report on more than 2 million students but,
because of our uniquely low enrollment fees, only one-third of those
students are likely to claim the tax credits. My office has estimated
that the annual accounting, system programming, printing, mailing, and
student services support costs to comply with these requirements is
likely to average $108,000 for each of the 106 California Community
Colleges. Thus the colleges in our system are expected to spend more
than $11 million per year in order to provide less than $51 million in
student tax benefits.
I am attaching a table that displays our calculation of tax credit
utilization and reporting costs. Based on consultation with management
information systems staff in my office, I also want to briefly outline
where we see the major data processing costs arising and delineate our
concerns about the usefulness of the data we will provide so that you
will better understand the problems that institutions like ours are
facing and the weaknesses in the current statutory reporting approach.
Detailed Issues:

Identifying Students in Their First Two Years of Postsecondary
Education

Institutions are required to indicate those students who,
as of the beginning of the taxable year, have not completed the
first two years of postsecondary education at an eligible
educational institution. Colleges cannot accurately determine
who those students are because a student may have taken units
at other colleges, may have taken advanced placement courses in
high school, may be concurrently enrolled in more than one
college, may have changed majors, and may have even completed a
degree at another institution before enrolling at a community
college. Unless a student's prior units are applicable to their
current educational objective, colleges do not record their
postsecondary history. Therefore, community colleges are likely
to report all enrolled students in this category, since we do
not provide programs that extend beyond the first two years of
postsecondary education. This calls into question the validity
of the assumptions about Hope tax credit eligibility the IRS
can make from the data.

Excluding Certain Types of Students

The statute excludes from eligibility students who have
been ``convicted of a federal or state felony offense for the
possession or distribution of a controlled substance as of the
end of the taxable year for which the credit is claimed.''
Colleges do not have access to this kind of law enforcement
information and will report students to the IRS who may fall
into this category.

Identifying Students who are Enrolled in an Eligible Degree or
Certificate Program

The California Community Colleges do not enroll students
into specific programs, but rather provide the opportunity for
students to fulfill a variety of educational objectives. From
an information systems perspective, the determination as to
whether or not a student is enrolled in a degree or certificate
program is not made until the student has completed the
program. While financial aid and counseling offices monitor
students' progress toward a specific goal within an eligible
program for the 15 percent of students who receive federal
Title IV student financial aid, there is no mechanism to make
an accurate determination about enrollment in a specific
program for the general student population.

Exclusion of Fees for Certain Courses

The statute and IRS guidelines provide that ``qualified
tuition and related expenses'' does not include expenses that
relate to any course of instruction that involves sports,
games, or hobbies unless the course is part of the student's
degree program or, in the case of the Lifetime Learning tax
credit, the student is enrolled in the course to acquire or
improve job skills. Colleges have no mechanism to make this
determination on a student-by-student basis and are likely to
report all instructional fees as ``qualified tuition and
related expenses.'' Thus, the IRS will not have reliable data
on which to determine tax credit eligibility.

Reconciling the Academic Year and the Tax Year

Virtually all college record-keeping is on a term and
academic year basis. Extensive programming is required to
conform student fee and financial aid data to a calendar year/
tax year reporting schema. Accomplishing this is complicated by
the fact that a student may pay fees in one calendar year for a
term that begins in the next calendar year and then, because
enrollment fees are charged on a per-unit basis, receive a
refund of some or all of their fees in the next calendar year
if their enrollment plans change. Taxpayers in 1999 and
subsequent years will be required to report refunds of amounts
claimed as ``qualified tuition and related expenses'' in a
prior tax year; they may also report any reduction of
previously reported educational assistance. Under current
statute, colleges can be required to annually report both types
of prior-year adjustments, necessitating additional expansion
of institutional recordkeeping. Because the reporting timeframe
required by the IRS occurs in the middle of the adjustment
period for the typical fall term (January and February),
adjustments after the tax year will be the norm rather than an
exception.

Aggregating ``Qualified Tuition and Related Expenses''

The IRS Restructuring and Reform Act of 1998 (H.R. 2676)
responded to college concerns about their ability to report net
out-of-pocket expenses as required in the original statue by
defining ``qualified tuition and related expenses'' as a
distinct element and limiting institutional responsibility for
reporting educational assistance that offsets tax credit
eligibility to grants processed through the institution.
However, reporting ``qualified tuition and related expenses''
in a single record for each student remains problematic because
community colleges frequently maintain separate components,
such as extension campuses, noncredit programs, community
service courses, contract education, and others, that are not
unified into a single database or information system. Bringing
those together and reporting a single student record to the IRS
requires extensive systems development and programming.
Although the H.R. 2676 Conferees authorized the Treasury to
exempt colleges from filing information returns for non-degree
students enrolled exclusively in non-credit courses, and IRS
interim guidelines did not require the reporting of any fee
information for 1998, institutions are not free to exclude
community service and other non-core enrollments from their TRA
databases because a credit-enrolled student who is also taking
a non-credit community service class is entitled to include the
community service course fees as part of ``qualified tuition
and related expenses.''

Matching Taxpayers and Students

The statutory requirement that colleges provide information
returns to taxpayers who are not students but are eligible to
claim a Hope or Lifetime Learning tax credit for a dependent
student assumes that colleges posses information that is not
collected. If students are required to provide eligible
taxpayer information to colleges as a condition for the 1098-T
to be sent to the taxpayer, it will involve creation of a
database that colleges need for no other purpose and will
increase programming and mailing costs. If colleges are
required to assertively collect eligible taxpayer information
from all students in order to comply with the letter of current
statute, those costs will be magnified. This is a clear example
of burden that should appropriately be placed on the Treasury
being diverted to colleges and universities.

Interim Guidelines and Incremental Implementation Adds to Total Costs

Colleges are grateful for Congressional efforts and the
Treasury Secretary's willingness to delay full implementation
of the TRA reporting requirements, and appreciate the intent
that issues of institutional cost and burden be taken into
consideration as final regulations are drafted. However,
colleges have been put in the position of having to
simultaneously comply with IRS interim requirements that are
inconsistent with the statute; anticipate, as institutional
systems are developed, future IRS requirements based on the
statute; and be responsive to students and parents seeking
information needed in the preparation of their tax returns.
These functions are not complementary. For example, interim IRS
guidelines relieved colleges of the statutory responsibility to
include financial information on the 1998 1098-T forms provided
to students, but required them to send the forms to virtually
all students, including hundreds of thousands of students in
our system with no or minimal tax credit eligibility. Because
colleges were required to include a college telephone number
for taxpayers to seek additional information, colleges had to
have available for students, parents, and professional tax
preparers the financial information that IRS did not require.
Furthermore, college personnel had to respond to inquiries from
ineligible taxpayers who assumed the tax credit was available
to them because they received the 1098-T form.
I have heard it suggested that full implementation of the
statutory reporting requirements should simply be delayed for
another year, but that provides a solution for no one. From our
perspective, colleges and universities will continue to be in
an untenable position until their responsibilities under the
TRA are clearly defined. And from what I understand to be the
Treasury's perspective, while the extensive institutional
reporting requirements in the TRA were designed to prevent
widespread taxpayer fraud, information received by the IRS
under the interim reporting procedures does little more than
confirm a taxfiler's college enrollment. If enrollment
verification is sufficient to meet the Treasury's needs, there
are much simpler and less costly ways to achieve that objective
than what is currently required.
Repeal of the TRA institutional reporting requirements
would allow colleges to focus their efforts on providing
information about the tax credits to students and parents and
assisting those that can benefit from them to obtain the
information necessary to claim them. The California Community
Colleges, operating on the lowest margin of revenues per
student of any public institutions of higher education in the
nation, simply cannot afford to expend resources that do not
contribute to the educational programs and services needed by
our students without there being consequences for student
access and program quality. The resources we are now forced to
divert to serving the needs of the IRS represent resources that
are denied to our students. Passage of the Higher Education
Reporting Relief Act will result in better service to those
students and families who will actually benefit from the higher
education tax credits and enable colleges to focus their
efforts on fulfilling their educational missions. Please be
assured that I will make every effort to help you gain its
passage.
If my office can be of any assistance to you as this legislation
advances, please do not hesitate to contact me directly or contact
Linda Michalowski, Director of Federal Relations, at (916) 327-0186.
You can also feel free to call on Bob Canavan at our Federal Liaison
Office at (202) 462-5911.

Sincerely,
Thomas J. Nussbaum
Chancellor
cc: The Honorable Robert Matsui
Board of Governors President Schrimp
Vice Chancellor Walters

Statement of National Association of Home Builders

On behalf of the 197,000 member firms of the National
Association of Home Builders (NAHB), we would like to express
our support for Chairman Archer (R-TX) convening a hearing on
proposals that would reduce the tax burden on individuals and
businesses. NAHB appreciates the Chairman's willingness to
listen to the concerns of individuals, businesses and
organizations such as ours on the tax proposals that reduce the
burden on our members the most.

Increase the annual state authority for the Low Income Housing Tax
Credit

NAHB's top tax policy priority for the 106th Congress is to
increase the annual state authority for the Low Income Housing Tax
Credit (LIHTC) to $1.75 per capita. The current LIHTC cap of $1.25 per
capita has not been adjusted since the program's inception in 1986,
while inflation has eroded the credits' purchasing power by
approximately 45%. As a result, twelve million American households
eligible for this program are not benefiting and are still paying too
much of their income for rent or living in substandard housing.
Therefore, the need for an increase in the credit is critical.
NAHB therefore, endorses H.R. 175, introduced by the Chair of the
House Ways and Means Subcommittee on Human Resources, Representative
Nancy Johnson (R-CT) along with Ranking Member Charles Rangel (D-NY).
H.R. 175 or ``The Affordable Housing Opportunity Act of 1999,'' will
increase the annual authority for the Low Income Housing Tax Credit
program from $1.25 per capita to $1.75 per capita and index the amount
for inflation. The bill currently has 324 cosponsors including 74% (29
of the 39 members) of the Ways and Means Committee. Additionally, an
identical bill in the Senate, S. 1017, was introduced by Senators
Connie Mack (R-FL) and Bob Graham (D-FL) and has 61 cosponsors
including 60% of the Finance Committee.
Created by Congress in 1986 and made permanent in 1993, the Low
Income Housing Tax Credit is the nation's primary tool for building
affordable rental housing. It is responsible for having produced 95% of
all units and over 900,000 homes. The LIHTC has also been a cornerstone
of revitalization in low-income communities and contributes to economic
growth, generating approximately 70,000 jobs, $2.3 billion in wages and
$1.2 billion in federal, state and local taxes annually.

Reforms to the Low Income Housing Tax Credit Program

Rep. Nancy Johnson is planning to introduce another bill
that will increase the LIHTC to $1.75 per capita and reform the
program. NAHB would like to include a reform in this bill that
would level the playing field between non-profits and for
profit developers of low income housing credit projects.
NAHB would like to minimize the taxpaying status of the
sponsor as a factor in determining LIHTC allocations without
eliminating the 10% set aside for nonprofit organizations. In
1997, 24 states had more than 30% of their LIHTC allocations go
to non-tax paying entities, 10 states had more than 50% go to
non-profits, 7 of which allocated over 70% of their credits to
non-profit sponsors. These numbers show that most non-profit
sponsors can compete head-to-head with taxpaying developers
without preferential treatment. As a result, Rep. Nancy Johnson
proposes to eliminate the additional selection criteria
preference for non-profits in Section 42(m)(1)(C) of the Code
without eliminating the current 10% set-aside for non-profit
developers. NAHB has agreed with this concept and fully
supports Rep. Nancy Johnson's efforts.
Another programmatic reform that NAHB would like to see
included in this year's tax package is a provision to provide
finality for the amount of tax credits issued by the state
agencies. The LIHTC program provides to each state a limited
amount of tax credits that are used to finance, in part, the
building of affordable housing. Developers of Section 42
affordable housing must submit to an underwriting process by
the state allocating agency at three different times in order
to be awarded housing tax credits. The three determinations
include an assessment of all the sources of financing and the
total development costs for the project. This assessment of
sources and uses results in a calculation by the state as to
the minimum amount of credits necessary to fill the ``funding
gap'' to make the project financially viable. Once the state
agency issues the final amount of tax credits, in the form of
an 8609 determination, the developer then sells those credits
to investors at a discount which raises the necessary equity
funds to build the project.
The continued success of the program is dependent upon the
certainty, stability and finality of the tax credit allocations
by the state. However, the certainty, and therefore viability,
of the LIHTC has been threatened by the IRS, which has begun
auditing LIHTC projects and recalculating the amount of credits
awarded by the state causing instability for the affordable
housing credit industry.
Recently, the IRS released a new LIHTC Audit Guide which
makes it clear that the IRS will not treat allocations of the
tax credits by state agencies as final. In its 1989 amendments
to the housing credit program, Congress imposed on state
agencies the burden of determining the appropriate amount of
credit. Over the last two years, the IRS has begun second
guessing state allocations by auditing projects and
reevaluating the amount of credits awarded by the state
agencies. This has resulted in the retroactive recalculation of
what costs are included and excluded in the ``formula'' used to
determine the appropriate amount of tax credits that can be
claimed by an applicant.
This retroactive recalculation and ultimate recapture of
tax credits by the IRS is unfair and contravenes congressional
intent. The states received the affordable housing units for
the tax credits issued and the IRS is coming in to reclaim the
tax credits after the public benefit intended by Congress has
been bestowed by the private sector. There are no assertions by
the IRS that the housing has not been occupied by qualified low
income residents or that the costs in dispute have not or
should not have been incurred. It is simply an after the fact
calculation of which costs were included in the ``eligible
basis.''
The LIHTC program must have a certain and predictable base
for making the calculation of the amount of tax credits that
any project may need. The ``eligible basis'' concept in Section
42 involves many factual determinations and potential disputes
over whether a cost associated with a project is either
``eligible'' or ``ineligible'' for inclusion in the calculation
of the basis. The largest area of dispute with the IRS has been
professional and developer fees. The IRS is taking a position
that certain portions of the developer and professional fees
should not be considered eligible for tax credit equity
financing. This has not been the practice in the affordable
housing industry and if true, would not produce enough credit
equity funds to finance the building of most projects. By
excluding portions of developer and professional fees, the IRS
is creating instability and uncertainty about credit
allocations. When allocations are uncertain, it threatens the
continued viability of the program and must be addressed now in
order to prevent the capital markets from fleeing the industry.

Impact of the New IRS Audit Guide

The result of some IRS audits has been a recapture of tax
credits which does not increase funds for affordable LIHTC
housing. A recapture by the IRS does not return the funds to
the states for reallocation. Therefore, no increased affordable
housing results and the recaptured credits are lost from the
housing program completely.
When the formula for tax credit allocations is uncertain,
the allocations are unstable. Without the reliability of
allocations, the ability to plan for the development of housing
with private financing is restrained. The success of the LIHTC
program depends on leveraging private corporate funds to
produce affordable housing that reaches a policy goal set by
Congress. Private capital and capital markets, however, are
very sensitive to risks and potential risks. Therefore, the
possibility that an IRS audit will result in the recapture of
tax credits may have a negative influence on the capital
markets and cause potential investors to flee the market based
on the perception of the high risk of recapture.
In addition to a slow down or reduction in capital flows to
LIHTC projects, the prices paid for credits may decline to
compensate for the increased risk of recapture and loss of
credits to the investor. When the discount paid by investors
increases and the price for credits declines, there will be
fewer housing units or lesser quality units built for the same
revenue offset to the Treasury.

The Solution

The housing credit industry needs a legislative solution
that defines what is in, or out of, eligible basis for purposes
of calculating the 8609 tax credit allocation. As a result,
NAHB would like to work with Congress to develop a legislative
proposal that does the following three things: 1) increases
certainty for determining eligible basis and hence tax credit
allocations, 2) protects existing tax credit allocations and 3)
provides finality for future tax credit allocations.
NAHB believes that as a part of the solution Congress
should provide legislative finality in the area that has the
largest potential for tax credit recalculation and recapture
and limit the amount of retroactive recaptures. Thus, NAHB
would like Congress to clarify that reasonable fees for
development, architectural and other services are included in a
building's adjusted basis, without regard to whether a portion
of the services involved might be attributable to aspects of
the development process which are not includable in basis. In
doing so, Congress would recognize that these types of services
performed in the course of a project's development are, in
themselves, critical to the production of qualified low-income
housing projects, and therefore, that the reasonable fees for
such services are properly chargeable to capital accounts and
includable in eligible basis. Although a particular element of
a developer's, contractor's or architect's services, for
example, may involve an aspect of the development process which
is not, itself, includable in depreciable basis (e.g.,
landscaping or obtaining financing) does not make the
particular services less important to the project or less
appropriate for treatment as capitalized costs. Congress must
clarify that it expects that, in determining the reasonableness
of fees, the Treasury Department will be guided by the policies
and determinations of the housing credit agency with authority
over the building(s) at issue.
Additionally, NAHB would like Congress to make final the
state agencies determination that a building was developed in a
timely manner in accordance with the requirements of the Code.
The purpose of the 10% test and the two year in-service rule of
Code section 42(h)(1)(E) is to assure that projects receiving
carryover allocations of tax credit authority are ready to
proceed and will be placed in service in a timely fashion. Once
a project is actually placed in service, these objectives have
been achieved. Congress should make it clear that after a
housing credit agency determines that a building has been
placed in service, the allocation to that building may not be
challenged, absent fraud, on the technical ground of a
deficiency in the carryover allocation. Adoption of this
solution will provide greater certainty to investors, thereby
increasing the efficiency of the tax credit, and will reduce
legal fees and other transactional costs.
NAHB would like to work with Congress in formulating a
legislative solution to resolve these issues and ensure the
continued success and viability of the LIHTC program.NAHB would
like to work with Congress in formulating a legislative
solution to resolve these issues and ensure the continued
success and viability of the LIHTC program.

Private Activity Bond Increase

NAHB also supports H.R. 864, introduced by Representative
Amo Houghton Jr. (R-NY), Chair of the House Ways and Means
Subcommittee on Oversight. H.R. 864 will increase the private
activity bond cap to $75 per resident or $255 million, if
greater, and index it for inflation by the year 2000. Senators
John Breaux (D-LA) and Orrin Hatch (R-UT) introduced S. 459 an
identical bill in the Senate.
Currently the Internal Revenue Code limits the amount of
tax-exempt private activity bonds that each state may issue to
$50 per resident of the state, or $150 million if greater. This
cap is severely restricting the ability of states and
localities to meet pressing housing, economic development, and
other investment needs of the citizens and communities.
Although last year the private activity bond cap was
increased, it does not begin to take effect until 2003. The
1998 Omnibus Appropriations Bill, H.R. 4328, increased the
state private activity bond cap to $55 per capita or $165
million starting in 2003 with a phased in increase to $75 per
capita or $225 million annually by 2007 for each state. This
increase is too slow to keep up with the growing need for
private activity bonds.
The demand for private activity bonds far exceeds the
supply in most states, leaving many individuals without an
opportunity to achieve the American dream of home ownership.
One example is the overwhelming demand in almost every state
for Mortgage Revenue Bonds (MRBs), issued primarily by state
housing finance agencies (HFAs) to finance modestly-priced,
first time homes for lower income families. According to the
National Council of State Housing Agencies (NCSHA), in 1996,
state HFAs issued almost $7.5 billion in MRBs for nearly
100,000 mortgages. The NCSHA estimates that in 1996, State HFAs
could have used an additional $2 billion in bond cap authority.
Unfortunately, this causes home ownership to remain out of
reach for thousands of other families many of which could be
better served by the MRB program.

Energy Efficiency Homes Tax Credit

Another NAHB tax policy priority is H.R. 1358, ``the Energy
Efficiency Affordable Home Act of 1999'' which was introduced
by Congressman Bill Thomas (R-CA), a member of the House Ways
and Means Committee. This bill provides a flat $2000 tax credit
for the purchase of any new energy efficient home that exceeds
the 1998 International Energy Conservation Code (IECC) by 30%.
It also offers a credit of 20% for the cost of an upgrade
project, up to $2000, for a homeowner who upgrades the energy
efficiency of his or her home by 30%. NAHB supports this bill
because it encourages voluntary energy efficiency, provides for
a cleaner environment, lower utility costs and reduced carbon
emissions and pollution.
The Clinton Administration is also interested in this issue
and has proposed its own tax credit proposal; however, the
amount of the credit is tiered to reflect the energy efficiency
level achieved over the IECC. Also, the administration's
proposal does very little to address existing home energy
efficiency. Last year, Representative Robert Matsui (D-CA)
introduced the administration's proposal.

Contributions in Aid of Construction

Finally, Congress should also include a change in this
year's tax bill that would treat Contributions in Aid of
Construction (CIAC) as non-taxable contributions to capital.
The taxation of CIAC creates an unnecessary and unfair burden
on economic growth. It requires utilities to pay taxes on the
contributions of land and utility infrastructure from the
builders which raises the ultimate price of the utility to the
customer.
Prior to 1986, CIAC were considered non-taxable events.
However, the Tax Reform Act of 1986 changed the treatment of
CIAC by making those capital contributions taxable income to
the utility. The result of the CIAC tax has been the increased
cost of new development for both private and public facilities
by more than 50 percent. CIAC taxes tax-exempt entities such as
municipal governments, school districts, charitable
institutions and even the federal government.
In many states, the utility is required to assess the CIAC
tax on the capital contribution at the time of the contribution
or payment. The result is that when a new customer pays the
cost or contributes property to connect to the utility system,
that cost to the customer must be ``grossed up'' to cover the
utility's tax liability. The amount of the gross up varies with
federal and state tax rates, but it can increase the cost by
over 50 percent. In other states, the utility may pass CIAC tax
onto its other customers in higher utility bills. In both
cases, the CIAC tax unnecessarily and improperly increases the
cost of extending utility services to new customers on the
system. In many cases, the tax is high enough to stop the
transaction entirely.
In 1996, Congress reversed the requirement that taxes be
paid on CIAC for regulated public utilities providing water and
sewage disposal services. NAHB would urge Congress to grant an
equal tax exclusion for all CIAC including electric energy and
gas distribution.

Independent Contractor Issue

We also want to bring to your attention our opposition to
Congressman Kleczka and Houghton's bill, H.R. 1525, the
``Independent Contractor Clarification Act.'' NAHB is opposed
to this bill for several reasons. First, this bill will turn
back the clock 20 years and undermine the current law regarding
whether an individual is an independent contractor or an
employee. This bill begins with the statutory presumption that
an individual is an employee unless the parties can prove
otherwise. Current law is neutral and does not, in theory,
present a preference either way although, in practice, there is
a bias against independent contractors. By creating a statutory
preference towards employees, Congress would ignore a national
policy that places the utmost importance and value on
independent contractors and the small businesses that utilize
their services.
Secondly, the bill provides a three-prong test to determine
employment status that does not simplify the test but only
complicates it further. The test consists of three elements:
the service recipient must lack control, make their services
available to others and have entrepreneurial risk. Neither
``control'' nor ``entrepreneurial risk'' is defined in the
bill. Although the bill repeals the common law test, the new
test would be even more subjective than current law, and would
create even greater uncertainty and confusion because the new
test lacks clear definition and guidance.
Thirdly, the bill repeals Section 530, a safe harbor
provision that allows small businesses and the independent
contractors they may engage to rely on ``long standing industry
practice'' as a guide to the appropriate classification of
individuals. H.R. 1525 repeals Section 530 and replaces it with
a narrower safe harbor, reliance on substantial authority.
There have been few favorable IRS rulings over the years that
might constitute substantial authority. What makes this repeal
so damaging is that it will return us to an era when the IRS
had the tools, the authority and power to stifle the
entrepreneurial spirit or independent contractors and small
businesses and was subject to the mercy of the enforcers.
What NAHB and other small businesses are looking for is
clarity and surety regarding the classification of the service
provider and protection against retroactive reclassification. A
bill S. 344, the ``Independent Contractor Simplification and
Relief Act of 1999'' sponsored by Senator Kit Bond does achieve
that goal. Please consider other avenues to address worker
classification because H.R. 1525 is not the answer.
NAHB appreciates your attention to issues of concern to our
members and look forward to changes in the tax code that
include the priorities mentioned in this testimony.

Statement of Steven A. Wechsler, National Association of Real Estate
Investment Trusts

As requested in Press Release No. FC-11 (June 9, 1999), the
National Association of Real Estate Investment Trusts
(``NAREIT'') respectfully submits these comments in connection
with the Committee on Ways and Means' review of tax relief
proposals to sustain a strong economy. NAREIT thanks the
Chairman and the Committee for the opportunity to share its
views on several important issues affecting REITs and publicly
traded real estate companies.
NAREIT's comments address (1) H.R. 1616, the Real Estate
Investment Trust Modernization Act of 1999; (2) the
Administration proposals to modify the treatment of closely
held real estate investment trusts ('REITs'') and amend section
1374 \1\ to treat an ``S'' election by a large C corporation as
a taxable liquidation of that C corporation; (3) H.R. 844; and
(4) at risk rules applying to nonsecured public debt. We
appreciate the opportunity to present these comments.
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\1\ For purposes of this Statement, ``section'' refers to the
Internal Revenue Code of 1986, as amended.
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NAREIT is the national trade association for REITs and
publicly traded real estate companies. Members are REITs and
publicly traded businesses that own, operate and finance
income-producing real estate, as well as those firms and
individuals who advise, study and service these businesses.
REITs are companies whose income and assets are mainly
connected to income-producing real estate. By law, REITs
regularly distribute most of their taxable income to
shareholders as dividends. NAREIT represents over 200 REITs and
publicly traded real estate companies, as well as over 1,600
industry professionals who provide a range of legal,
investment, financial and accounting-related services to these
companies.

Executive Summary

REIT Modernization Act. Congress created REITs in 1960 to
make investment in income producing real estate easily and
readily available to investors from all walks of life, yet
current law prevents REITs from providing needed and emerging
services to their tenants, putting them at a competitive
disadvantage in the real estate marketplace. In addition,
current law requires REITs to use indirect and inefficient
methods in order to provide services to third parties. The
Administration's Fiscal Year 2000 Proposed Budget contains a
proposal to address these issues by authorizing REITs to own
and operate taxable REIT subsidiaries. Because it is a better
solution to the competitive limitations facing REITs today,
NAREIT strongly supports H.R. 1616, the Real Estate Investment
Trust Modernization Act of 1999 co-sponsored by Messrs. Thomas,
Cardin and 31 other members of the House of Representatives.
H.R. 1616 would incorporate the principles of the
Administration's Fiscal Year 2000 proposal to allow a REIT to
own stock in taxable REIT subsidiaries, with four significant
exceptions. First, H.R. 1616 would require taxable REIT
subsidiaries to fit within the current, unified 25% asset test,
rather than the complex and cumbersome 5% and 15% assets tests
under the Administration proposal. Second, H.R. 1616 would
limit interest deductions on debt between a REIT and its
taxable subsidiary in accordance with the current earnings
stripping rules of section 163(j), whereas the Administration
would eliminate even a reasonable amount of intra-party
interest deductions. Third, H.R. 1616 would prohibit a taxable
REIT subsidiary from operating or managing hotels, while
allowing a subsidiary to lease a hotel from its affiliated REIT
so long as (a) the rents are set at market levels, (b) the
rents are not tied to net profits, and (c) the hotel is
operated or managed by an independent contractor. Fourth, H.R.
1616 would not apply the new rules on taxable REIT subsidiaries
to current arrangements so long as a new trade or business is
not engaged in and substantial new property is not acquired,
unless the REIT affirmatively elects taxable REIT subsidiary
status for its existing third party subsidiaries. Conversely,
the Administration proposal would apply to current arrangements
after an undefined period of time. H.R. 1616 also would make
other beneficial and modernizing changes to the REIT tax rules,
such as restoring the distribution requirement to 90% from 95%.
Closely Held REITs. The Administration proposes to prevent
any entity from owning 50% or more of the vote or value of a
REIT's stock. NAREIT supports the Administration's intention to
craft a new ownership test intended to correspond to a REIT's
primary mission: to make investment in income-producing real
estate accessible to ordinary investors. However, we believe
that the Administration's proposal is too broad, and therefore
should be narrowed to prevent only non-REIT C corporations from
owning 50% or more of a REIT's stock (by vote or value). In
addition, the new rules should not apply to so-called
``incubator REITs'' that have proven to be a viable method by
which small investors can access publicly traded real estate
investments.
Built-in Gain Tax. The Administration proposes to deny S
corporations, mutual funds and REITs worth more than $5 million
from using the 10-year deferral rule under section 1374.
Congress has rejected the Administration's call for a change in
the section 1374 rules for three straight budgets. NAREIT
recommends that Congress again reject this proposal. We also
ask Congress to conduct oversight of the IRS to ensure that it
does not do administratively what it has not been able to
achieve by legislation.
Tenant Improvements. NAREIT strongly supports H.R. 844,
which would change the depreciation period of certain tenant
improvements to 10 years to better approximate their true
economic lives.
At Risk Rules. NAREIT urges Congress to update the
qualified nonrecourse financing rules to include publicly
traded debt.

Background on REITs

A REIT is a corporation or business trust combining the
capital of many investors to own, operate or finance income-
producing real estate, such as apartments, shopping centers,
offices and warehouses. REITs must comply with a number of
requirements, some of which are discussed in detail in this
statement, but the most fundamental of these are as follows:
(1) REITs must pay at least 95% of their taxable income to
shareholders; (2) most of a REIT's assets must be real estate;
(3) REITs must derive most of their income from real estate
held for the long term; and (4) REITs must be widely held.
In exchange for satisfying these requirements, REITs (like
mutual funds) benefit from a dividends paid deduction so that
most, if not all, of a REIT's earnings are taxed only at the
shareholder level. On the other hand, REITs pay the price of
not having retained earnings available to meet their business
needs. Instead, capital for growth and significant capital
expenditures largely comes from new money raised in the
investment marketplace from investors who have confidence in
the REIT's future prospects and business plan.
Congress created the REIT structure in 1960 to make
investments in large-scale, significant income-producing real
estate accessible to investors from all walks of life. Based in
part on the rationale for mutual funds, Congress decided that
the only way for the average investor to access investments in
larger-scale commercial properties was through pooling
arrangements. In much the same ways as shareholders benefit by
owning a portfolio of securities in a mutual fund, the
shareholders of REITs can unite their capital into a single
economic pursuit geared to the production of income through
commercial real estate ownership. REITs offer distinct
advantages for smaller investors: greater diversification
through investing in a portfolio of properties rather than a
single building and expert management by experienced real
estate professionals.
Despite the purpose of the REIT structure, the industry
experienced very little growth for over 30 years mainly for two
reasons. First, at the beginning REITs were seriously
constrained by policy limitations. REITs were mandated to be
passive portfolios of real estate. REITs were permitted only to
own real estate, not to operate or manage it. This meant that
REITs needed to use third party independent contractors, whose
economic interests might diverge from those of the REIT's
owners, to operate and manage the properties. This was an
arrangement the investment marketplace did not accept readily
or warmly.
Second, during these years the real estate investment
landscape was colored by tax shelter-oriented characteristics.
Through the use of high debt levels, which created artificial
bases for depreciation, interest and depreciation deductions
significantly reduced taxable income--in many cases leading to
so-called ``paper losses'' used to shelter a taxpayer's other
income. Since a REIT is geared specifically to create
``taxable'' income on a regular basis and a REIT, unlike a
partnership, is not permitted to pass ``losses'' through to its
owners, the REIT industry could not compete effectively for
capital against tax shelters.
In the Tax Reform Act of 1986 (the ``1986 Act''), Congress
changed the real estate investment landscape. On the one hand,
by limiting the deductibility of interest, lengthening
depreciation periods and restricting the use of ``passive
losses,'' the 1986 Act drastically reduced the potential for
real estate investment to generate tax shelter opportunities.
This meant, going forward, that real estate investment needed
to be on a more economic and income-oriented footing.
On the other hand, as part of the 1986 Act, Congress
modified a significant policy constraint that had been imposed
on REITs at the beginning. The Act permitted REITs not merely
to own, but also to operate and manage most types of income
producing commercial properties by providing ``customary''
services associated with real estate ownership. Finally, for
most types of real estate (other than hotels, health care
facilities and some other activities that consist of a higher
degree of personal services), the economic interests of the
REIT's shareholders could be merged with those of the REIT's
operators and managers.
Despite Congress' actions in 1986, significant REIT growth
did not begin until 1992. One reason was the real estate
recession in the early 1990s. Until the late 1980s banks and
insurance companies kept up real estate lending at a
significant pace. Foreign investment, particularly from Japan,
also helped buoy the marketplace. But by 1990 the combined
impact of the Savings and Loan crisis, the 1986 Act,
overbuilding during the 1980s by non-REITs and regulatory
pressures on bank and insurance lenders, led to a nationwide
depression in the real estate economy. During the early 1990s
commercial property values dropped between 30 and 50%. Credit
and capital for commercial real estate became largely
unavailable. As a result of this capital crunch, many borrowers
defaulted on loans, resulting in losses by financial
institutions and expense to the federal government.
Against this backdrop, starting in 1992, many private real
estate companies realized that the best and most efficient way
to access capital was from the public marketplace utilizing
REITs. At the same time, many investors decided that it was a
good time to invest in commercial real estate--assuming
recovering real estate markets were just over the horizon. They
were right.
Since 1992, the REIT industry has attained impressive
growth as new publicly traded REITs infused much needed equity
capital into the over-leveraged real estate industry. Today
there are over 200 publicly traded REITs with an equity market
capitalization exceeding $150 billion. These REITs are owned
primarily by individuals, with 49% of REIT shares owned
directly by individual investors and 37% owned by mutual funds,
which are owned mostly by individuals. But REITs certainly do
not just benefit investors.
The lower debt levels associated with REITs compared to
real estate investment overall have had a positive effect
throughout the economy. Average debt levels for REITs are 40-
50% of market capitalization, compared to leverage of 75% and
often higher used when real estate is privately owned. The
higher equity capital cushions REITs from the negative effects
of fluctuations in the real estate market that have
traditionally occurred. The ability of REITs better to
withstand market downturns should have a stabilizing effect on
the real estate industry and its lenders, resulting in fewer
future bankruptcies and work-outs. Consequently, the general
economy will benefit from reduced real estate losses by
federally insured financial institutions.
Consistent with the policy underlying the REIT rules, many
believe that, over time, the U.S. commercial real estate
economy will move toward more and more ownership by REITs and
publicly traded real estate companies. Yet, future growth may
be significantly limited by the inability of REITs under
current law to be able to provide more services to their
tenants than they are currently allowed to perform. Although
the 1986 Act largely married REIT management to REIT assets and
the Taxpayer Relief Act of 1997 included additional helpful
REIT reforms, REITs still must operate under limitations that
increasingly will make them non-competitive in the emerging,
customer-oriented real estate marketplace. NAREIT looks forward
to working with Congress and the Administration further to
modernize and improve the REIT rules so that REITs can continue
to offer investors from all walks of life opportunities for
rewarding investments in income-producing real estate.

I. REIT MODERNIZATION ACT OF 1999

A. Taxable REIT Subsidiaries

As part of the asset diversification tests applied to
REITs, a REIT may not own more than 10% of the outstanding
voting securities of a non-REIT corporation pursuant to section
856 (c)(5)(B).\2\ The Administration's Fiscal Year 1999 Budget
proposed to amend section 856(c)(5)(B) to prohibit REITs from
holding stock possessing more than 10% of the vote or value of
all classes of stock of a non-REIT corporation.\3\ The
Administration's Fiscal Year 2000 Budget proposed an exception
to this vote or value rule for taxable REIT subsidiaries.
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\2\ The shares of a wholly-owned ``qualified REIT subsidiary''
(``QRS'') of the REIT are ignored for this test.
\3\ Since it is a disregarded entity for tax purposes, a qualified
REIT subsidiary would be excepted from the requirement that a REIT not
own more than 10% of the vote or value of another corporation.
---------------------------------------------------------------------------
1. Background and Current Law. The activities of REITs are
strictly limited by a number of requirements that are designed
to ensure that REITs serve as a vehicle for public investment
in real estate. First, a REIT must comply with several income
tests. At least 75% of the REIT's gross income must be derived
from real estate, such as rents from real property, mortgage
interest and gains from sales of real property (not including
dealer sales). In addition, at least 95% of a REIT's gross
income must come from the above real estate sources, dividends,
interest and sales of securities.
Second, a REIT must satisfy several asset tests. On the
last day of each quarter, at least 75% of a REIT's assets must
be real estate assets, cash and government securities. Real
estate assets include interests in real property and mortgages
on real property. As mentioned above, the asset diversification
rules require that a REIT not own more than 10% of the
outstanding voting securities of an issuer (other than a
qualified REIT subsidiary under section 856(i)). In addition,
no more than 5% of a REIT's assets can be represented by
securities of a single issuer (other than a qualified REIT
subsidiary).
REITs have been so successful in operating their properties
and providing permissible services to their tenants that they
have been asked to provide these services to non-tenants,
utilizing expertise and capabilities associated with the REIT's
real estate activities. In addition, mortgage REITs are
presented with substantial opportunities to service the
mortgages that they securitize. The asset and income tests,
however, restrict how and to what extent REITs can engage in
these activities. A REIT can earn only up to 5% of its income
from sources other than rents, mortgage interest, capital
gains, dividends and interest. However, many REITs have had the
opportunity to maximize shareholder value by earning more than
5% from third party services.
Starting in 1988, the Internal Revenue Service (``IRS'')
issued private letter rulings to REITs approving a structure to
facilitate a REIT providing a limited amount of services to
third parties.\4\ These rulings sanctioned or permitted a
structure under which a REIT owns no more than 10% of the
voting stock and up to 99% of the value of a non-REIT
corporation through nonvoting stock. Usually, managers or
shareholders of the REIT own the voting stock of the ``Third
Party Subsidiary'' (``TPS,'' also known as a ``Preferred Stock
Subsidiary''). The TPS typically either provides to unrelated
parties services already being delivered to a REIT's tenants,
such as landscaping and managing a shopping mall in which the
REIT owns a joint venture interest, or engages in other real
estate activities, such as development, which the REIT cannot
undertake to the same extent. A TPS of a mortgage REIT
typically services a pool of securitized mortgages and sells
mortgages as part of the securitization process that has the
effect of lowering homeowners' interest rates.
---------------------------------------------------------------------------
\4\ PLRs 8825112, 9340056, 9428033, 9431005, 9436025 9440026. See
also PLRs 9507007, 9510030, 9640007, 9733011, 9734011, 9801012,
9808011, 9835013.
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The REIT receives dividends from the TPS that are treated
as qualifying income under the 95% income test, but not the 75%
income test.\5\ Accordingly, a REIT continues to be principally
devoted to real estate operations. While the IRS has approved
using the TPS for services to third parties and ``customary''
services to tenants the REIT could otherwise provide, the IRS
has not permitted the use of these subsidiaries to provide
impermissible, non-customary real estate services to REIT
tenants.\6\
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\5\ The REIT does not qualify for a dividends received deduction
with respect to TPS dividends. I.R.C. Sec. 857(b)(2)(A).
\6\ But see PLR 9804022. In addition, the IRS has been flexible in
allowing a TPS to engage in an ``independent line of business'' in
which it provides a service to the public and a minority of the users
are REIT tenants. See, e.g., PLRs 9627017, 9734011, 9835013.
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2. Administration Proposal. In 1998, the Administration
proposed changing the asset diversification tests to prevent a
REIT from owning securities in a C corporation that represent
10% of either the corporation's vote or its value. The proposal
would have applied with respect to stock acquired on or after
the date of first committee action. In addition, to the extent
that a REIT's ownership of TPS stock would have been
grandfathered by virtue of the effective date, the grandfather
status would have terminated if the TPS engaged in a new trade
or business or acquired substantial new assets on or after the
date of first committee action.
In its Fiscal Year 2000 Budget, the Administration again
proposed to base the 10% asset test on either vote or value.
However, it also proposes an exception for two types of taxable
REIT subsidiaries (``TRS''). A qualified business subsidiary
(``QBS'') would be the successor to the current TPS and could
engage in the same activities as can a TPS today. A REIT could
not own more than 15% of its assets in QBSs. The second type of
TRS would be a qualified independent contractor subsidiary
(``QIKS''), which could provide non-customary services to the
affiliated REIT's tenants. A REIT could not own more than 5% of
its assets in QIKSs as part of its 15% TRS allocation.
Under the Administration's proposal, a TRS could not deduct
any interest payments to its affiliated REIT, and 100% excise
tax penalties would be imposed to the extent that any pricing
between a TRS and either its affiliated REIT or that REIT's
tenants was not set on an arms'-length basis. The new TRS rules
would apply to all existing TPSs after a time period to be
determined by Congress.
3. Statement in Support of H.R. 1616. The REIT industry has
grown significantly during the 1990s, from an equity market
capitalization under $10 billion to over $150 billion. The TPS
structure is used extensively by today's REITs and has been a
small, but important, part of recent industry growth. These
subsidiaries help ensure that the small investors who own REITs
are able to maximize the return on their capital by taking full
economic advantage of core business competencies developed by
REITs in owning and operating the REIT's real estate or
mortgages. The Administration appropriately recognized that it
makes sense to allow a REIT to utilize these core competencies
through taxable subsidiaries so long as the REIT remains
focused on real estate and the subsidiary's operations are
appropriately subject to a corporate level tax.
In addition, the Administration's proposal recognizes that
the REIT rules need to be modernized to permit REITs to remain
competitive. By virtue of the ``customary'' standard in
defining permissible REIT rental activities, REITs must wait
until their competitors have established new levels of service
before providing that service to their customers. This ``lag
effect'' assures that REITs are never leaders in their markets,
but only followers, to the detriment of their shareholders.
Under the Administration proposal, the REIT could render such
services to its tenants through a subsidiary that is subject to
corporate tax.
The Administration's TRS proposal is a serious and very
significant step in the right direction, but NAREIT requests
Congress instead to enact H.R. 1616. This bill parallels the
Administration's subsidiary proposal, but improves and
clarifies this concept in four major ways.
First, H.R. 1616 would require taxable REIT subsidiaries to
fit within the current, unified 25% asset test, rather than the
unnecessarily complex and cumbersome 5% and 15% assets tests
under the Administration proposal described above. Requiring
two types of TRSs would cause severe complexity and
administrative burdens, such as allocating costs between a QBS
and a QIKS without incurring a 100% excise tax. Further, the
Code should encourage, rather than prohibit, the same TRS
providing the same service to its affiliated REIT's tenants and
to third parties to make it easier to ensure that the pricing
of those services is set at market rates. Moreover, the 5% and
15% limits are unnecessarily restrictive given the fact that
the subsidiary is subject to a corporate level tax on all of
its activities. H.R. 1616 adopts the better approach of
treating TRS stock as an asset that must fit within the current
25% basket of non-real estate assets a REIT that can own, along
with other non-real estate assets such as personal property.
Second, H.R. 1616 would limit interest deductions on debt
between a REIT and its taxable REIT subsidiary in accordance
with the current earnings stripping rules of section 163(j),
whereas the Administration would eliminate even a reasonable
amount of intra-party interest deductions. Congress confronted
very similar earnings stripping concerns in the 1980s with
respect to foreign organizations and their U.S. subsidiaries
and resolved those concerns by enacting section 163(j). This
section permits interest deductions on objective, modest
amounts of related party debt. Section 163(j) is easily
implemented, and guidance has been provided by final
regulations. H.R. 1616 would adopt even stricter rules for
REITs and their subsidiaries by limiting the interest
deductions to market rates, or else suffer a 100% excise tax.
Clearly, REITs should not be forced to comply with an absolute
denial of legitimate interest deductions when foreign
organizations in similar circumstances are not so limited.
Third, the Administration's proposal does not address
whether REITs could use a TRS to own or operate hotels or
health care facilities. H.R. 1616 would prohibit a taxable REIT
subsidiary from operating or managing hotels and health care
facilities, while allowing a subsidiary to lease a hotel from
its affiliated REIT so long as (a) the rents are set at market
levels, (b) the rents are not tied to net profits, and (c) the
hotel is operated or managed by an independent contractor.
Fourth, H.R. 1616 would not apply the new rules on
subsidiaries to current arrangements so long as a new trade or
business is not engaged in and substantial new property is not
acquired, unless the REIT affirmatively elects, on a timely
basis, taxable REIT subsidiary status for such TPS. Conversely,
the Administration proposal would become effective after an
undefined period of time. REITs have planned their operations
based on IRS rulings starting in 1988 that have sanctioned or
permitted TPSs and should not be penalized for following
established policy. H.R. 1616 would adopt the approach to an
effective date contained in last year's Administration's budget
proposals that acknowledged the IRS' earlier acquiescence to
the TPS structure.

Other Provisions in H.R. 1616

NAREIT strongly endorses the other important modernization
provisions contained in H.R. 1616: (1) restoration of the
distribution requirement to the 90% level that applied to REITs
from 1960 to 1980 (and that has at all times applied to mutual
funds); (2) providing more flexibility for a REIT to hire an
independent contractor to operate nursing homes, etc. without a
lease for up to six years when the REIT takes back a health
care property at the end of a lease and cannot re-lease it; (3)
in the case of a publicly traded corporation being tested as an
independent contractor, H.R. 1616 only would examine
shareholders owning more than 5% of the corporation's stock;
and (4) to prevent some traps for the unwary, H.R. 1616 would
make some technical changes about how a company computes pre-
REIT earnings and profits that it must distribute to its
shareholders after electing REIT status or having a C
corporation merge into it.

II. OTHER ADMINISTRATION PROPOSALS AFFECTING REITS

A. Closely Held REITS

The Administration's Fiscal Year 2000 Budget proposes to
add a new rule, creating a limit of less than 50% on the vote
or value of stock any entity could own in any REIT.
1. Background and Current Law. As discussed above, Congress
created REITs to make real estate investments easily and
economically accessible to the small investor. To carry out
this purpose, Congress mandated two rules to ensure that REITs
are widely held. First, five or fewer individuals cannot own
more than 50% of a REIT's stock.\7\ In applying this test, most
entities owning REIT stock are ``looked through'' to determine
the ultimate ownership of the stock by individuals. Second, at
least 100 persons (including corporations and partnerships)
must be REIT shareholders. Both tests do not apply during a
REIT's first taxable year, and the ``five or fewer'' test only
applies in the last half of each subsequent taxable year of the
REIT.
---------------------------------------------------------------------------
\7\ I.R.C. Sec. 856(h)(1). There is no apparent reason why the
proposed ownership test similarly should not be aimed at limiting more
than 50% stock ownership, rather than 50% or more as now proposed.
---------------------------------------------------------------------------
The Administration appears to be concerned about non-REITs
establishing ``captive REITs'' and REITs doing ``step-down
preferred'' transactions for various tax planning purposes,
which the Administration finds abusive, such as the
``liquidating REIT'' structure curtailed by the 1998 budget
legislation.\8\ The Administration proposes changing the ``five
or fewer'' test by imposing an additional requirement. The
proposed new rule would prevent any ``person'' (i.e., a
corporation, partnership or trust, including a pension or
profit sharing trust) from owning stock of a REIT possessing
50% or more of the total combined voting power of all classes
of voting stock or 50% or more of the total value of shares of
all classes of stock. Certain existing REIT attribution rules
would apply in determining such ownership, and the proposal
would be effective for entities electing REIT status for
taxable years beginning on or after the date of first committee
action.
---------------------------------------------------------------------------
\8\ NAREIT supported the Administration's and Congress' move to
limit the tax benefits of liquidating REITs.
---------------------------------------------------------------------------
Statement Providing Limited Support for Administration
Proposal on Closely Held REITs. NAREIT generally shares the
Administration's views and concerns. We believe that the REIT
structure is meant to be widely held and that it should not be
used for abusive tax avoidance purposes. Therefore, NAREIT
fully supports the intent of the proposal. But we are concerned
that the Administration proposal casts too broad a net,
prohibiting legitimate, temporary use of ``closely held'' REITs
and fails to recognize that ownership by another pass-through
entity is widely held. A limited number of exceptions are in
order to allow certain ``entities'' to own a majority of a
REIT's stock. For instance, NAREIT certainly agrees with the
Administration's decision to exclude a REIT's ownership of
another REIT's stock from the proposed new ownership limit.\9\
NAREIT would like to work with Congress and the Administration
to ensure that any action to curb abuses does not disallow
transactions necessary to foster the future REIT marketplace
and to recognize the widely held nature of certain non-REIT
entities.
---------------------------------------------------------------------------
\9\ If the proposed test remains applicable to all persons owning
more than 50% of a REIT's stock, then Congress should apply the
exception for a REIT owning another REIT's stock by examining both
direct and indirect ownership so as not to preclude an UPREIT owning
more than 50% of another REIT's stock.
---------------------------------------------------------------------------
First, an exception should be allowed to enable a REIT's
organizers to have a single large investor for a temporary
period, such as in preparation for a public offering of the
REIT's shares. Such an ``incubator REIT'' sometimes is majority
owned by its sponsor to allow the REIT to accumulate a track
record that will facilitate its going public. The
Administration proposal would prohibit this important approach
which, in turn, could curb the emergence of new publicly traded
REITs in which small investors may invest.
Second, there is no reason why a partnership, mutual fund,
pension or profit-sharing trust or other pass-through entity
should be counted as one entity in determining whether any
``person'' owns 50% of the vote or value of a REIT. A
partnership, mutual fund or other pass-through entity is
usually ignored for tax purposes. The partners in a partnership
and the shareholders of a mutual fund or other pass-through
entity should be considered the ``persons'' owning a REIT for
purposes of any limits on investor ownership. Similarly, the
Code already has rules preventing a ``pension held'' REIT from
being used to avoid the unrelated business income tax rules,
and therefore the new ownership test should not apply to
pension or profit-sharing plans. Instead, NAREIT suggests that
the new ownership test apply only to non-REIT C corporations
that own more than 50% of a REIT's stock.\10\
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\10\ As under the current ``five or fewer'' test, any new ownership
test should not apply to a REIT's first taxable year or the first half
of subsequent taxable years. See I.R.C. Sec. Sec. 542(a)(2) and
856(h)(2).
---------------------------------------------------------------------------

III. SECTION 1374

The Administration's Fiscal Year 2000 Budget proposes to
amend section 1374 to treat an ``S'' election by a C
corporation valued at $5 million or more as a taxable
liquidation of that C corporation followed by a distribution to
its shareholders. This proposal also was included in the
Administration's Fiscal Year 1997, 1998 and 1999 proposed
budgets.

A. Background and Current Law

Prior to its repeal as part of the Tax Reform Act of 1986,
the holding in a court case named General Utilities permitted a
C corporation to elect S corporation, REIT or mutual fund
status (or transfer assets to an S corporation, REIT or mutual
fund in a carryover basis transaction) without incurring a
corporate-level tax. With the repeal of the General Utilities
doctrine in 1986, such transactions arguably would have been
immediately subject to tax but for Congress' enactment of
section 1374. Under section 1374, a C corporation making an S
corporation election pays any tax that otherwise would have
been due on the ``built-in gain'' of the C corporation's assets
only if and when those assets are sold or otherwise disposed of
during a 10-year ``recognition period.'' The application of the
tax upon the disposition of the assets, as opposed to the
election of S status, works to distinguish legitimate
conversions to S status from those made for purposes of tax
avoidance.
In Notice 88-19, 1988-1 C.B. 486 (the ``Notice''), the IRS
announced that it intended to issue regulations under section
337(d)(1) that in part would address the avoidance of the
repeal of General Utilities through the use of REITs and
regulated investment companies (``RICs,'' i.e. mutual funds).
In addition, the IRS noted that those regulations would enable
the REIT or RIC to be subject to rules similar to the
principles of section 1374. Thus, a C corporation can elect
REIT status and incur a corporate-level tax only if the REIT
sells assets in a recognition event during the 10-year
``recognition period.''
In a release issued February 18, 1998, the Treasury
Department announced that it intends to revise Notice 88-19 to
conform to the Administration's proposed amendment to limit
section 1374 to corporations worth less than $5 million, with
an effective date similar to the statutory proposal. This
proposal would result in a double layer of tax: once to the
shareholders of the C corporation in a deemed liquidation and
again to the C corporation itself upon such deemed liquidation.
Because of the Treasury Department's intent to extend the
proposed amendment of section 1374 to REITs, these comments
address the proposed amendment as if it applied to both S
corporations and REITs.

B. Statement in Support of the Current Application of Section
1374 to REITs

As stated above, the Administration proposal would limit
the use of the 10-year election to REITs valued at $5 million
or less. NAREIT believes that this proposal would contravene
Congress' original intent regarding the formation of REITs,
would be both inappropriate and unnecessary in light of the
statutory requirements governing REITs, would impede the
recapitalization of commercial real estate, likely would result
in lower tax revenues, and ignores the basic distinction
between REITs and partnerships.
A fundamental reason for a continuation of the current
rules regarding a C corporation's decision to elect REIT status
is that the primary rationale for the creation of REITs was to
permit small investors to make investments in real estate
without incurring an entity level tax, and thereby placing
those persons in a comparable position to larger investors.
H.R. Rep. No. 2020, 86th Cong., 2d. Sess. 3-4 (1960).
By placing a toll charge on a C corporation's REIT
election, the proposed amendment would directly contravene this
Congressional intent, as C corporations with low tax bases in
assets (and therefore a potential for a large built-in gains
tax) would be practically precluded from making a REIT
election. As previously noted, the purpose of the 10-year
election is to allow C corporations to make S corporation and
REIT elections when those elections are supported by non-tax
business reasons (e.g., access to the public capital markets),
while protecting the Treasury from the use of such entities for
tax avoidance.
Additionally, REITs, unlike S corporations, have several
characteristics that support a continuation of the current
section 1374 principles. First, there are statutory
requirements that make REITs long-term holders of real estate.
The 100% prohibited transactions tax on REITs complements the
10-year election mechanism.
Second, while S corporations may have no more than 75
shareholders, a REIT faces no statutory limit on the number of
shareholders it may have and is required to have at least 100
shareholders. In fact, some REITs have hundreds of thousands of
beneficial shareholders. NAREIT believes that the large number
of shareholders in a REIT and management's fiduciary
responsibility to each of those shareholders preclude the use
of a REIT as a vehicle primarily to circumvent the repeal of
General Utilities. Any attempt to benefit a small number of
investors in a C corporation through the conversion of that
corporation to a REIT is impeded by the REIT widely-held
ownership requirements.
The consequence of the Administration proposal would be to
preclude C corporations in the business of managing and
operating income-producing real estate from accessing the
substantial capital markets' infrastructure, comprised of
investment banking specialists, analysts, and investors, that
has been established for REITs. In addition, other C
corporations that are not primarily in the business of
operating commercial real estate would be precluded from
recognizing the value of those assets by placing them in a
professionally managed REIT. In both such scenarios, the
hundreds of thousands of shareholders owning REIT stock would
be denied the opportunity to become owners of quality
commercial real estate assets.
Furthermore, the $5 million dollar threshold that would
limit the use of the current principles of section 1374 is
unreasonable for REITs. While many S corporations are small or
engaged in businesses that require minimal capitalization,
REITs as owners of commercial real estate have significant
capital requirements. As previously mentioned, it was Congress'
recognition of the significant capital required to acquire and
operate commercial real estate that led to the creation of the
REIT as a vehicle for small investors to become owners of such
properties. The capital intensive nature of REITs makes the $5
million threshold essentially meaningless for REITs.
It should be noted that this proposed amendment is unlikely
to raise any substantial revenue with respect to REITs, and may
in fact result in a loss of revenues. Due to the high cost that
would be associated with making a REIT election if this
amendment were to be enacted, it is unlikely that any C
corporations would make the election and incur the associated
double level of tax without the benefit of any cash to pay the
taxes. In addition, by remaining C corporations, those entities
would not be subject to the REIT requirement that they make
taxable distributions of 95% of their income each tax year.
Moreover, the Administration justifies its de facto repeal
of section 1374 by stating that ``[t]he tax treatment of the
conversion of a C corporation to an S corporation generally
should be consistent with the treatment of its [sic] conversion
of a C corporation to a partnership.'' Regardless of whether
this stated reason for change is justifiable for S
corporations, in any event it should not apply to REITs because
of the material differences between REITs and partnerships.
Unlike partnerships, REITs cannot (and have never been able
to) pass through losses to their investors. Further, REITs can
and do pay corporate level income and excise taxes. Simply put,
REITs are C corporations. Thus, REITs are not susceptible to
the tax avoidance concerns raised by the 1986 repeal of the
General Utilities doctrine.
We note that on March 9, 1999, the Treasury Department and
the IRS released their 1999 Business Plan, in which it listed a
project for ``[r]egulations regarding conversion of C
corporation to to [sic] RIC or REIT status.'' On February 22,
1996, the Treasury Department issued a release stating that
``the IRS intends to revise Notice 88-19 to conform to the
proposed amendment to section 1374, with an effective date
similar to the statutory proposal.'' We urge the Congress to
use its oversight authority to be certain that the Treasury
Department does not by-pass Congress and enact the ``built-in
gain'' tax on REITs and RICs administratively. Any such action
would directly contravene Congress' repeated rejection of any
statutory change in this area.
C. Summary

The 10-year recognition period of section 1374 currently
requires a REIT to pay a corporate-level tax on assets acquired
from a C corporation with a built-in gain, if those assets are
disposed of within a 10-year period. Combined with the
statutory requirements that a REIT be widely held and a long-
term holder of assets, current law assures that the REIT is not
a vehicle for tax avoidance. The proposal's two level tax would
frustrate Congress' intent to allow the REIT to permit small
investors to benefit from the capital-intensive real estate
industry in a tax efficient manner.
Accordingly, NAREIT believes that tax policy considerations
are better served if the Administration's section 1374 proposal
is not enacted. Further, the Administration should not
contravene the Congress' clear intent in this area by
attempting to impose this double level tax on REITs and RICs by
administrative means.

IV. TENANT IMPROVEMENTS

As an essential part of meeting customer demands, landlords
routinely construct improvements to leased space to conform to
a tenant's requirements. The average lease term (and therefore
the usefulness of the ``build out'' for the tenant) ranges from
five to ten years. However, since the Tax Reform Act of 1986,
landlords must depreciate these ``tenant improvements'' over
the tax life of the entire building: 39 years.
H.R. 844 and S. 879 would ameliorate this disconnect
between the tenant improvement's economic life and its tax
write-off period. For the purposes of simplicity, under H.R.
844 and S. 879 a lessor would depreciate its tenant
improvements over ten years.
NAREIT joins the other national real estate trade
associations in strongly urging the Committee to incorporate
H.R. 844 in its mark-up of tax legislation this year. H.R. 844
would remove disincentives currently in place that discourage
landlords from updating buildings, and would more closely
conform the tax Code to economic realties.

V. AT RISK RULES

In 1986, Congress extended the at risk rules for the first
time to real estate. However, it created an exception for
``qualified nonrecourse financing,'' since it recognized that
loans made by an unrelated party in the lending business would
not be used to create the ``tax shelters'' targeted by the
underlying rules.
Congress modernized the REIT rules in the 1986 Act, and the
REIT industry has blossomed from less than $10 billion in
equity market capitalization to about $150 billion today. As
REITs have matured into full-fledged public companies, they
have used the financing techniques long traditional to public
companies. More than two thirds of the publicly traded REITs
now have investment grade rating from the credit agencies and
routinely issue nonsecured corporate debt. The use of such debt
benefits the economy because the rating agencies require a
conservative level of debt.
However, as with the rest of the real estate sector, REITs
routinely use partnerships to own and operate real estate
holdings. Under the current at risk rules, a REIT's partners
are penalized by the REIT's use of unsecured debt because the
money is lent by the public markets rather than an entity
engaged in the business of lending money.
Even though the Internal Revenue Service has issued some
private letter rulings that provide some limited relief in
these situations, NAREIT strongly recommends that Congress
update the at risk rules to include a publicly traded debt as
being eligible as qualified nonrecourse financing. Such debt
should include a debt instrument which either is traded on an
established securities market or is readily tradable on a
secondary market (or the substantial equivalent thereof).
NAREIT thanks the Committee for the opportunity to comment
on these important proposals.

The National Coalition for Public Education
Washington, DC 20005-4905
June 22, 1999

Members of the House Ways and Means Committee
Washington, D.C. 20515

Dear Committee member:

It is expected that your June 23rd hearing on Tax Reduction
Proposals will address many tax-related issues including those related
to education incentives. We understand that the committee could
consider education tax subsidies as part of an education-related tax
package. The following members of the National Coalition for Public
Education urge you NOT to support education savings accounts or any
similar measure designed to create a tax subsidy for K-12 private and
religious schools' tuition, homeschooling and other education expenses.
The National Coalition for Public Education opposes funneling scarce
tax revenues to private and religious schools through such mechanisms
as K-12 education tax subsidies, tax credits and education savings
accounts.
NCPE's opposition to education tax subsidies was bolstered by a
recent analysis conducted by the Joint Committee on Taxation on a
Senate tax subsidy proposal. It found that the benefit to students in
public school would be $5 a year for a program which would cost
taxpayers more than $2.6 billion over the next ten years. However, the
IRA accounts would only exist for a few years because the accounts'
benefits expire in 2003. These education tax accounts are designed to
help wealthy families pay for private school tuition. Families unable
to save, including most families earning less than $55,000 a year,
would not benefit at all. Higher income families who already send their
children to private schools would gain most of the benefits. For all
children the tax benefits would be minimal. According to the Joint
Committee on Taxation's analysis of a similar proposal debated last
year, families with students in private schools would receive a benefit
of $37 annually.
The federal government should be focusing its efforts and public
funds towards our nation's public schools where 90% of America's
children are educated. Real investments are needed, such as tax credits
to subsidize $25 billion of public school construction bonds, which
would make a real difference in our childrens' education. Tax subsidies
do nothing to raise academic standards for all children, provide safe
learning environments, increase teacher quality or increase parent
involvement in schools.
The undersigned groups urge you to oppose the inclusion of
education tax subsidies in any future tax bill. This proposal is merely
a scheme to use public money to offset the cost of private and
religious schools for wealthy families.

Sincerely,

American Association of Educational Service Agencies

American Association of School Administrators

American Association of University Women

American Civil Liberties Union

American Federation of State, County and Municipal Employees (AFSCME)

American Federation of Teachers

American Humanist Association

American Jewish Committee

American Jewish Congress

Americans for Religious Liberty

Americans United for Separation of Church and State

Council of Chief State School Officers

Council of the Great City Schools

Mexican American Legal Defense and Education Fund

National Association of Elementary School Principals

National Association of School Psychologists

National Association of State Boards of Education

National Association of State Directors of Special Education

National Council of Jewish Women

National Education Association

National PTA

National Rural Education Association

National School Bards Association

New York City Board of Education

People for the American Way

Service Employees International Union AFL-CIO

Union of American Hebrew Congregations

Unitarian Universalist Association

United Auto Workers International Union

Women of Reform Judaism

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National Conference of State Legislatures
June 10, 1999

Representative Bill Archer, Chair
House Ways and Means Committee
1102 Longworth House Office Bldg.
Washington, DC 20510

Re: FY 2000 Tax Legislation

Dear Chairman Archer:
We write on behalf of the National Conference of State Legislatures
(NCSL) to urge you to include tax items of critical importance to state
legislatures in your Chairman's mark of reconciliation legislation.
Efforts by the Congress and the administration over the last
several years, including passage of the 1997 balanced budget agreement,
have produced federal budget surpluses that are expected to continue
well into the future. These past budget decisions have prompted
discussion of possible tax changes among members of Congress and the
administration.
We are concerned that federal tax relief not come at the expense of
federal support for vital state-federal programs and partnerships. NCSL
continues to support the objectives of the bipartisan budget agreement,
yet we are well aware that the agreement places steep constraints on
the construction of the thirteen appropriations bills for FY 2000. In
the past, states shared disproportionately in federal efforts to reduce
the deficit with major cuts to state-federal programs and partnerships.
On the tax side, numerous tax changes made for deficit reduction
purposes eliminated or significantly reduced preferential tax treatment
in areas of importance to state and local governments.
As you prepare your mark, NCSL trusts that you will give major
consideration to our tax priorities which we believe strengthen the
intergovernmental partnership as well as advance our shared goals of
simplification, ensuring fairness and encouraging work and savings.
NCSL asks that you include the following provisions in your mark of
tax legislation:
1) Pension Portability and Simplification: Proposals forwarded by
Representatives Rob Portman and Benjamin Cardin, Senators Charles
Grassley and Bob Graham and the President would make significant
strides to increase the national savings rate, encourage retirement
savings, simplify pension administration, and increase compensation
limits reduced in the 1980s for deficit reduction purposes.
Specifically, NCSL urges your inclusion of provisions that would:
Enhance existing portability in public sector defined
benefit plans, as well as allow portability between all retirement
plans when employees change employment.
Provide much needed clarity, flexibility and equity to the
tax treatment of benefits and contributions under governmental 457
deferred compensation plans.
Restore benefit and compensation limits that have not been
adjusted for inflation and are generally lower than they were fifteen
years ago.
Repeal compensation-based limits that unfairly curtail the
retirement savings of relatively non-highly paid workers.
Allow those approaching retirement to increase their
retirement savings and further enhance their retirement security
through catch-up provisions.
2) Pubic School Construction and Modernization: NCSL supports
efforts by the Congress and the administration to increase support for
school construction and modernization. We urge you to include in your
mark tax provisions for school construction that conform to existing
state constitutional and regulatory requirements in order to maximize
the impact of these provisions. Further, we urge inclusion of
provisions supported in both the House and Senate that would treat
qualified public educational facility bonds as exempt facility bonds
and provide additional increases in the arbitrage rebate exception for
governmental bonds used to finance education facilities. Current
arbitrage rules essentially tax interest income on these bonds at a
rate of 100% and thereby limit the states' ability to leverage
infrastructure funds for school construction and modernization.
3) Private Activity Bond Volume Cap: Volume caps have unduly
restricted the use of bonds for projects that have increasingly become
governmental responsibilities. The Omnibus Reconciliation Act of 1998
included a partial, phased-in increase of the bond cap. NCSL supports
H.R. 864 and S. 459, which would accelerate the increase of the volume
cap and provide for an inflationary adjustment of the cap.
4) Low-Income Housing Tax Credit: NCSL has long supported this
important tax credit. H.R. 175 and S. 1017 provide an increase in the
tax credit to $1.75 per capita and provide for an inflationary
adjustment in the credit.
While the President's budget proposal includes recommendations
that, if adopted, will have a significant and positive impact on the
delivery of specific services, we strongly disagree with several of the
President's recommendations for tax offsets. We urge you not to include
these offsets in your mark:
1) State Bank Exam Fees: We are hopeful that these fees, rejected
by the Congress in the past, are not taken as an offset for federal
priorities. The Administration's proposal would constitute a double tax
on state-chartered banks for exams conducted by state banking
departments and which are used by both the Federal Deposit Insurance
Corporation and the Federal Reserve Board. The proposed fee would
create an inequity in our nation's dual banking system as national
chartered banks would not be assessed this double charge.
2) Leasing to State and Local Government: The President's proposal
would limit the ``tax benefits for lessors of tax-exempt use property''
The Administration contends that in certain cross-border transactions
involving tax-exempt entities, lessors have inappropriately applied
certain tax benefits. Since introduction of the proposal in February,
the Treasury has exercised its authority to shut down these cross-
border transactions through the issuance of Revenue Ruling 99-14 and
Final Section 467 Regulations. The application of the Administration's
proposal to tax-exempt state and local governments which lease
equipment such as 911 emergency systems, school busses, police
vehicles, computers and other high cost technology, would severely
increase the cost of these leases for state and local government
entities and likely eliminate leasing as a cost effective equipment
acquisition option for state and local governments.
As lawmakers, we understand the magnitude of the challenge that
balancing the federal budget and determining how best to preserve or
use the federal surplus presents. We know the decisions that must be
made to address the challenge are difficult. As well, we understand
that many exceptional tax relief proposals may be more difficult to
implement in FY 2000. We would urge you to consider phasing in these
proposals, as additional funds become available. State and local
governments have much at stake in the method of financing the federal
budget as federal and state tax systems are inextricably linked. We
stand willing to help at all stages of the process.
We look forward to cooperating with you as the reconciliation
process moves forward. If we can provide additional information, please
contact Gerri Madrid (202-624-8670) or Michael Bird (202-624-8686).

Sincerely,
Representative Daniel T. Blue, Jr.
Senior Majority Leader, North Carolina House Representatives
President, National Conference of State Legislatures

Representative Paul S. Mannweiler
Minority Leader, Indiana House of Representatives
President Elect, National Conference of State Legislatures

Statement of the National Council of Farmer Cooperatives

The National Council of Farmer Cooperatives (NCFC) supports
and is working for the inclusion of H.R. 1914 into the upcoming
tax bill. H.R. 1914 allows a farmer cooperative to bypass the
dividend allocation rule, a regulatory rule that negatively
impacts the amount of the patronage dividend deduction taken by
a cooperative.
As cooperatives look to the 21st Century, it is important
for the industry to have the appropriate tools so it can
continue to give value to its farmer owners. In today's world,
businesses need to be adequately capitalized if they hope to
remain competitive. Farmer cooperatives have a difficult time
raising capital. The reason is that they generally have only
two sources of capital--their farmer owners and borrowing from
a lending institution. Farmer cooperatives do not raise capital
from financial markets by issuing voting common stock because
members hold this stock.
However, farmer cooperatives are allowed to issue a class
of non-voting preferred stock that can be used to raise equity
from sources other than its farmer owners. When issuing a
dividend bearing class of nonvoting preferred stock on which a
dividend payment is made, a cooperative must comply with the
``dividend allocation rule,'' which has an adverse tax affect
on the cooperative and has been one reason why farmer
cooperatives must heavily rely on debt financing.
What is the dividend allocation rule? The dividend
allocation rule applies when a cooperative pays a dividend on
its capital stock or other proprietary capital interests (a
``Capital Stock Dividend''). The rule causes a portion of the
capital stock dividend to be allocated to the patronage
operation and reduces the amount of the patronage dividend
deduction, thereby creating additional taxable income for the
cooperative.
This rule has a long history going back to the 1920s, and
currently is interpreted under Treasury Regulation Sec. 1.1388-
1(a)(1). It has evolved over the years to go beyond the
particular situations in which it was developed to become a
general rule that has a devastating effect on the industry's
ability to raise equity capital. The prohibition established by
the rule is one of the main reasons why cooperatives are
heavily dependent on debt capital for their financing today.

H.R. 1914:

NCFC has been working with Representative Bill Thomas in
attempting to change this regulation. Congressman Thomas has
introduced H.R. 1914, a bill that, if enacted, would repeal the
``dividend allocation rule.''
H.R. 1914 adds the following sentence to Sec. 1388 and
effectively changes the regulation:
(a) IN GENERAL-Subsection (a) of section 1388 of the
Internal Revenue Code of 1986 (relating to patronage dividend
defined) is amended by adding at the end the following: `For
purposes of paragraph (3), net earnings shall not be reduced by
amounts paid during the year as dividends on capital stock or
other proprietary capital interests of the organization to the
extent that the articles of incorporation or bylaws of such
organization or other contract with patrons provide that such
dividends are in addition to amounts otherwise payable to
patrons which are derived from business done with or for
patrons during the taxable year.'
The language of H.R. 1914 is straightforward. It reverses
the language of the regulation if agreed to by the patrons of
the farmer cooperative. The effect of the language would allow
a farmer cooperative to pay a ``capital stock dividend''
without first reducing the patronage earnings of the
cooperative's patrons.
H.R. 1914 allows cooperatives and their members to bypass
the rule by agreeing in the articles, bylaws, or other contract
that a Capital Stock Dividend would first be paid from
nonpatronage and accumulated earnings of the cooperative before
patronage dividends would be reduced. This would allow the
cooperative, for example, to create a class of nonvoting
preferred stock and pay dividends on this stock exclusively
from nonpatronage earnings. The cooperative would not reduce
the amount of its patronage dividend deduction by any portion
of the Capital Stock Dividend.
The benefits of this legislation for cooperatives could be
substantial. Among other things, a cooperative could more
easily:
(1) raise capital from outside investors without
having the farmer members who patronize the cooperative lose
control;
(2) create a class of nonvoting preferred stock
that could be traded on capital markets, thereby providing
liquidity to the cooperative's interests;
(3) create a preferred stock program for
management and employees that would improve incentive programs;
(4) repurchase a departing member's interests for
dividend paying stock, rather than debt; and
(5) increase the amount of patronage earnings paid
to the farmer owners.
For these reasons, NCFC supports and is working for the
inclusion of H.R. 1914 into the upcoming tax bill, and we look
forward to working with the Ways & Means Committee on this
issue.
NCFC is a nationwide association of cooperative businesses
owned and controlled by farmers. Its membership includes nearly
70 major farmer marketing, supply and credit cooperatives, plus
the state councils of cooperatives in 31 states. NCFC's
members, in turn, represent nearly 4,000 local cooperatives,
with a combined membership that includes approximately 1.6
million farmers in the United States. NCFC members handle
almost every type of agricultural commodity produced in the
United States.
Farmer cooperatives are self-help organizations that were
formed, and operate today, to meet the needs of farmers for
reliable and fairly-priced sources of farm supplies
(fertilizer, seed, feed, petroleum products, herbicides and
pesticides), services and credit, and to provide farmers
assistance in effectively marketing the commodities that they
produce. Some cooperatives focus on serving a single function--
providing farm supplies to members (referred to as ``supply
cooperatives''), or helping members market a particular kind of
crop (referred to as ``marketing cooperatives''). Others
perform several different functions for their members. Whatever
their function, farmer cooperatives are an extension of the
farming operations of their members. Their importance to
agriculture is demonstrated by the fact that most American
farmers are affiliated with one or more cooperative.

Statement of National Education Association

Mr. Chairman and Members of the Committee:
On behalf of the 2.4 million members of the National
Education Association (NEA), we thank you for the opportunity
to submit our views on education-related tax proposals.
As you move forward to consider a comprehensive tax
package, we urge you to include meaningful proposals to
strengthen public education by addressing the critical needs of
students and schools. NEA strongly supports inclusion in any
tax package of tax credits to subsidize interest paid on school
construction and modernization bonds. We believe such tax
credits offer the best tax-related avenue for improving public
education. In addition, NEA supports proposals to extend and
expand tax exemptions for employer-provided educational
assistance (Sec. 127) and to remove time limits on deductions
for student loan interest payments. NEA strongly opposes
proposals to permit tax-free withdrawals from education IRAs
for K-12 private, religious, and home-school education
expenses.

Tax Credits for School Modernization

Public school construction and modernization is a top NEA
priority. We urge Congress to provide significant federal
assistance for school construction and modernization as part of
any tax package.
NEA members routinely express concern about the state of
school buildings and facilities. Stories of leaking roofs,
holes in walls, and overcrowded schools forced to hold classes
held in temporary trailers are commonplace. The disrepair of
our public schools is a nationwide problem that demands
nationwide attention.
The average school building in America is nearly 50 years
old. Schools are in worse shape than any other part of the
nation's infrastructure, according to a 1998 American Society
of Civil Engineers study. Almost 60 percent of our nation's
public schools report at least one building feature--such as
roofs, exterior walls, windows, plumbing, heating/ventilation,
electrical power, and lighting--in need of extensive repair,
overhaul, or replacement. Every day 14 million children attend
schools in inadequate buildings. The problem affects urban,
suburban, and rural areas. A 1995 study by the General
Accounting Office (GAO) found that 38 percent of urban school
districts, 29 percent of suburban school districts, and 30
percent of rural school districts have at least one building
needing extensive repair or total replacement. Yet, while
Congress just last year provided $216 billion for roads,
bridges, and mass transit, to-date virtually no federal funds
have been made available to improve school buildings.
Overcrowded classrooms and structurally unfit school
buildings impair student achievement, diminish student
discipline, and compromise student safety. A 1996 study by the
Virginia Polytechnic Institute and State University found an
11-point difference in academic achievement between students in
substandard classrooms and demographically similar children in
a first-class learning environment. Similarly, a 1995 study of
North Dakota high schools found a positive correlation between
school condition and both student achievement and student
behavior. A 1995 study of overcrowded schools in New York City
found students in such schools scored significantly lower on
both mathematics and reading exams than did similar students in
underutilized schools.
Ensuring all of our nation's students access to safe,
modern schools that are not overcrowded will require a
significant federal investment. Although school construction
is, and will remain, primarily a state and local
responsibility, states and school districts cannot meet the
current urgent needs without federal assistance. In 1995, GAO
estimated that just repairing existing school facilities would
cost $112 billion. Wiring and equipping schools for technology
will require billions more. In addition, building new
facilities to meet the demands of surging enrollments could
cost as much as $73 billion. States and localities simply
cannot finance this magnitude of repair and construction
without federal assistance.
NEA strongly supports the Public School Modernization Act
(H.R. 1660), sponsored by Representatives Charles Rangel with
150 bipartisan cosponsors, and the America's Better Classrooms
Act (H.R. 1760), sponsored by Representative Nancy Johnson with
17 bipartisan cosponsors. These critical bills recognize the
urgent need for federal school modernization assistance by
providing tax credits to subsidize interest paid on $25 billion
in school construction bonds.
``Zero-interest school modernization bonds'' offer a
sensible, flexible, cost-effective approach for modern schools
and better learning:
Tax credits for school modernization bonds would
create an effective local/state/federal partnership. The
federal government would provide the necessary resources but
leave decisions about which schools to build or repair to
states and localities.
Tax credits would create no additional
bureaucracy. Existing government departments would implement
the program.
Zero-interest modernization bonds are fiscally
sound. Three billion dollars in federal tax credits would
generate $25 billion in bonds, with every dollar going for
repair or construction.
The tax credits would free up local monies
normally spent on bond interest for additional investments in
teaching and learning. As an example, the state of Connecticut
paid over $100 million in interest on school debt in 1997-98.
The interest on a typical 30-year tax-exempt bond almost equals
the amount borrowed. Even on 15-year bonds the interest totals
about 35 percent of the amount borrowed. Thus, the tax credits
for bond interest would result in substantial savings for local
districts. Such fiscal relief for school districts would help
relieve pressure on property taxes, and thus make it easier to
convince local voters to pass school bond referenda.
In addition to the $25 billion in zero-interest school
modernization bonds, NEA supports the School Construction Act
of 1999 (H.R. 996), sponsored by Representative Bob Etheridge,
which would provide $7 billion in bonds to states with high
enrollment growth. States and localities will need to build
some 6,000 new schools to serve additional students in the next
decade. H.R. 996 would help meet some of this need by targeting
additional resources to areas with the greatest projected
growth.
NEA recognizes that some Members of Congress--including
Chairman Archer--seek to address school modernization needs
through ``arbitrage relief'' proposals. Such proposals would
allow school districts to retain earnings on bond proceeds for
an additional two years, instead of rebating the funds to the
federal government.
While NEA commends the Chairman's interest in addressing
the school modernization issue, we believe that arbitrage
relief will not provide the type of meaningful assistance
necessary to meet nationwide school modernization needs. While
arbitrage relief might benefit some schools, it would fall well
short of the need and would fail to leverage new investments
for construction. Under an arbitrage relief plan, school
districts would have to delay construction for at least two
years to receive any benefit. Thus, areas with the most urgent
needs would not be helped. In addition, arbitrage relief would
provide little, if any, assistance for rural areas, as many
rural schools are already exempt from arbitrage requirements.
Even for those schools that can stretch out construction for
two additional years, arbitrage profits would only amount to
$10 on average for each $1000 of bond principal.
The American public overwhelmingly supports a significant
federal investment in school buildings. Americans' support for
a federal investment in public school repair, renovation, and
modernization transcends partisanship and geography. As
demonstrated by a 1998 survey conducted by Republican pollster
Frank Luntz, Republicans, Independents, and Democrats, in
cities, suburbs, and rural areas want safe, modern school
facilities. NEA believes that zero-interest school
modernization bonds offer the best approach to ensuring all our
students such safe, modern schools.

Private School Education Tax Subsidies

NEA strongly opposes proposals to permit tax-free
withdrawals from education IRAs for K-12 private, religious,
and home-school education expenses. We believe these proposals,
such as Representative Hulshof's Education Savings and School
Excellence Act of 1999 (H.R. 7), represent bad tax and
education policy.
Education tax subsidies would disproportionately benefit
private school students. Although families with children in
private school represent only 7 percent of families eligible
for the education IRA, they would receive more than half (52%)
the tax benefits. Such subsidies would also disproportionately
benefit wealthier families. Almost 70 percent of the benefits
would go to the wealthiest 20 percent of families. In addition,
although the cost to taxpayers would be over $2.6 billion, the
average tax benefit to families with children in public schools
would only be $5. For families with children in private school,
the average tax break would be $37. The majority of working
families earning less than $50,000 would get an annual tax cut
of only $2.50. Such a small benefit would not create any
incentive for families to increase savings.
Despite rhetoric to the contrary, tax subsidies do not
offer parents ``school choice.'' Private schools retain the
freedom to deny admission to anyone they choose--especially
children with costly special needs such as a learning or
physical disability or limited-English proficiency. Tax
subsidies also do not give choices to working families who
cannot afford to pay or save for their child's private school
tuition.
Unlike tax credits for school modernization bonds, proposed
tax subsidies for education IRAs fail to address the real
problems confronting our nation's schools. They merely use the
tax system to subsidize private school tuition and costs, while
doing nothing to raise academic standards for all children,
reduce class sizes, provide safe learning environments, improve
teacher quality, or increase parent involvement in schools.
Education tax subsidies divert attention away from a real
debate on how to improve public schools and offer instead only
a minor benefit to those who least need it. We urge you to
reject such tax subsidy proposals in favor of proposals, such
as tax credits for school modernization bonds, which will make
a real difference for the majority of students and schools.

Additional Education-Related Tax Proposals

In addition to tax credits for school modernization bonds,
NEA supports several tax proposals to assist college students
in meeting educational expenses. We support the Employee
Educational Assistance Act of 1999 (H.R. 323)--sponsored by
Rep. Levin, and 125 bipartisan cosponsors, which would
permanently extend the tax exclusion for employer-provided
educational assistance and restore the exclusion for graduate
level educational assistance. This proposal would benefit not
only students seeking to continue their education but
employers, who will benefit substantially from sending
employees to school to acquire additional skills. Extending and
expanding the exclusion for employer-provided educational
assistance could also have a significant impact on teacher
quality, as more teachers would be able to take graduate
courses to enhance their skills and learn new technologies
without facing tax consequences for the employer-provided
assistance.
NEA also supports repealing the limit on the number of
months during which interest paid on a college student loan is
deductible. This proposal will help students facing
overwhelming student loan debt and will eliminate complexity
and administrative burdens for borrowers and financial
institutions. Many teachers will benefit from this proposal.
Lowering the tax burden for teachers--who often face large
student loan debts but receive low salaries compared to other
professions--will be of great assistance. Removal of the time
restriction on student loan deductibility was proposed in the
President's budget and is the cornerstone of legislation
sponsored by Representatives Hulshof and English (H.R. 2141).
Both extending and expanding the exclusion for employer-
provided educational assistance and eliminating the 60-month
limit on deducting student loan interest enjoy broad bipartisan
support. Both proposals offer practical solutions to helping
students meet the rising costs of education. NEA urges
inclusion of both proposals in the final tax package.

Conclusion

NEA believes that a tax package offers an important
opportunity to make real strides toward improving public
education. We urge you to reject efforts to divert public funds
for the benefit of a small number of students in private
schools and instead to craft an education tax package providing
real benefits to the majority of students in public schools.
We thank you for the opportunity to offer our views and
hope we can now move forward to address the critical needs of
our public schools.

Statement of Kristine S. Arnold, MS-II, University of Health Sciences,
College of Osteopathic Medicine; on behalf of National Rural Health
Association

My name is Kristine Arnold, and I am representing the
National Rural Health Association (NRHA). I want to thank the
Chairman, and the members of the House Ways and Means Committee
for allowing me the opportunity to submit written testimony
regarding the Committee's hearing on reducing the tax burden on
individuals and families.
The NRHA is a national nonprofit membership organization
that provides leadership on rural health issues. Through
discussion and exploration, the NRHA works to create a clear
national understanding of rural health care, its needs, and
effective ways to meet them. The association's mission is to
improve the health of rural Americans and to provide leadership
on rural health issues through advocacy, communication,
education and research. As you are well aware, rural areas are
unique. They differ from urban communities in their geography,
population mix and density, economics, lifestyle, values and
social organization. Rural people and communities require
programs that respond to their individual characteristics and
needs.
The membership of the NRHA is a diverse collection of
individuals and organizations, all of whom share the common
bond of an interest in rural health. Individual members come
from all disciplines and include hospital and rural health
clinic administrators, physicians, nurses, dentists, non-
physician providers, health planners, researchers and
educators, state offices of rural health and policy-makers.
Organization and supporting members include hospitals,
community and migrant health centers, state health departments
and university programs.
I would like to share with you the NRHA's support for a
change in the tax code that would exclude from federal income
and FICA taxation tuition and other educational related
expenses for National Health Service Corps (NHSC) scholars.
The NHSC is helping to improve our nation's health, one
community at a time. NHSC primary care providers represent many
disciplines, including allopathic and osteopathic physicians,
nurse practitioners, certified nurse-midwives, physician
assistants, dentists, dental hygienists, clinical social
workers, psychiatric nurse specialists, and marriage and family
therapists. Over the past 25 years, more than 20,000 NHSC
clinicians have spent all or part of their careers going where
others choose not to go, serving the poorest, the least
healthy, and the most isolated of our fellow Americans. There
are currently 2,821 primary medical health professionals
shortage areas (HPSAs). Today, 4.6 million people who would
otherwise lack access are receiving high-quality primary care
from over 2,400 dedicated NHSC professionals.
I am currently an NHSC scholar and second year medical
student at the University of Health Sciences, College of
Osteopathic Medicine in Kansas City, Missouri. Beginning
December 1997, the Internal Revenue Service (IRS) began
withholding taxes on NHSC scholarships to comply with a 1986
change in the tax code. This move by the IRS has been
devastating to NHSC scholars because it places us in a higher
tax bracket, and drastically reduces our living stipends. The
monthly stipend for an NHSC scholar is currently $935. Each
month $547 of that $935 is withheld from my stipend, leaving me
with $388 to pay for my living expenses. (This number varies
from school to school depending on the cost of tuition and
fees). As a result I have been forced to take out a loan to pay
for the majority of my living expenses. In April, I filed my
federal and state income taxes and found that my reported
income was in excess of $40,000; consequently I owed more than
$5,000 in additional taxes. Again, I had to turn to a loan from
the federal government to pay for the tax.
One of the major incentives for participating in the NHSC
scholarship program is the opportunity to graduate from medical
school without debt. In return, NHSC scholars agree to serve in
a federally designated HPSA for a number of years. Serving in
one of these areas might otherwise prove to be financially
impossible considering that the average debt for medical school
graduates in the United States is currently $80,000. The burden
the taxation of NHSC scholarships places on potential NHSC
scholars may be a significant deterrent to interested and
motivated students and clinicians who might otherwise be
recruited to live and work in those areas most desperate for
health professionals.
The taxation of National Health Service Corps scholarships
by the IRS is in direct conflict with the mission of the
program. In order to resolve this problem, Congress must
provide the IRS with the legislative authority required to
continue to exclude from gross income any amounts received
under the tuition and related expenses portion of the NHSC
scholarship. This provision would make the NHSC Scholarship
Program comparable to the Veteran's Administration (VA)
Scholarship program.
Last year, the House of Representatives included a
provision to remedy this issue in a broader education bill that
was later passed by the Congress, but vetoed by President
Clinton for reasons other than this provision. Currently,
legislation has been introduced in both the House and the
Senate (H.R. 1344 and S. 980) that would exclude tuition and
related expenses under the NHSC scholarships from taxation. The
NHSC tax provision is supported by the Senate Rural Health
Caucus, the House Rural Health Care Coalition, and the
Department of Health and Human Services. In addition, a number
of outside organizations support passage of this provision
including the National Organization of State Offices of Rural
Health, the American Psychological Association, the National
Association of Community Health Centers, and the American
Medical Student Association.
In closing the NRHA encourages the Committee members to
include this important provision in an omnibus tax reform
measure or other legislative vehicle considered by the Congress
this year. Enactment of this provision would enable the NHSC to
carry out its continuing mission of bringing health care to 47
million underserved Americans.

Statement of David Goldstein, Energy Program Co-director, Natural
Resources Defense Council, San Francisco, California

Mr. Chairman and Members of the Committee:
The Natural Resources Defense Council appreciates the
opportunity to provide written testimony following the hearing
of 23 June, 1999. We will comment concerning two pieces of
legislation before your Committee, H.R. 1358, sponsored by
Representative Bill Thomas, and H.R. 2380, sponsored by
Representative Robert Matsui.
The Natural Resources Defense Council is a national
environmental organization with over 400,000 members and
contributors. NRDC has promoted energy efficiency at the state,
regional, national and international levels for 25 years, and
has pioneered the development of market transformation programs
to promote efficiency through overcoming market barriers.
NRDC's analysis, summarized below, concludes that the
Thomas Bill, while well intentioned, fails to meet most of this
criteria for effective market transformation. NRDC therefore
opposes this legislation. The Matsui Bill does satisfy the
criteria and we urge the Committee to support it.
Improving energy efficiency is a policy that has broad
support from stakeholders in the environmental movement, the
utility industry, citizens' groups, private companies, business
organizations, states and cities, and others. Over 5% of the
nation's GDP is spent on energy, but this could be reduced by
half or more at a net profit. Increasing energy efficiency
provides new business opportunities, improves the
competitiveness of the American economy, provides increased
numbers of jobs, and saves money for consumers, while at the
same time providing cleaner water, cleaner air, and less
pressure on limited energy resources.
Even though energy efficiency is cheaper than continuing to
pay bills for energy supply, many of the technologies that
would provide these savings are not widely available in the
marketplace. In part, this market failure occurs because many
consumers do not make the fundamental decisions concerning
their own energy efficiency. Members of Congress and their
staffs, along with much of the business world, work in office
spaces where they do not pay their own utility bills. An
investment in energy efficiency would not make sense for them,
no matter how quick the payback, because someone else is paying
the energy bills. Consumers who rent their houses have the same
problems, as do those citizens who purchase energy-using
products such as refrigerators or washing machines on the used
market. Few new homeowners are able to make important energy
efficiency decisions that will affect their energy bills.
Because of these and other persistent market barriers, many
of the most promising technologies are not even offered to the
consumer.
But, many state energy offices and utilities working with
businesses, builders, and homeowners, have learned how to
overcome these barriers during the past 25 years through a
number of programs and policies.
One important new policy is market transformation. By
offering targeted incentives for high levels of energy
efficiency and maintaining them for a long enough time to make
new product introduction worthwhile, market transformation can
bring forth new products that would not otherwise be available.
Once sold and mass produced, the price comes down, and these
products can succeed with reduced or even eliminated policy
intervention.
Tax credits provide an opportunity to extend these state-
level successes while reducing the tax burden of individual
households or businesses. But, as we learned in the 1970's,
carelessly drawn up tax credits can simply contribute to
inefficiency in the tax system: by paying for behavior that was
going to happen anyway, with little effect once they have
expired. In contrast to market transformation, where a small
amount of ``seeding'' with federal money leads to large and
continuing benefits, poorly structured tax credits leave no
lasting effect and are wasteful of taxpayer's money.
What are the criteria that market transforming tax credits
should meet?
The tax credits must be enforceable and workable:
it must be simple to determine compliance with the credit and
simple to apply for the credit and verify that the application
is correct.
The tax credit should make economic sense: the
value of the credit should be commensurate with the cost of the
technology it is attempting to bring forth and with the
benefits to the consumer from the technology.
The tax credits should introduce technologies that
would not otherwise be purchased in significant numbers, or
create new infrastructure that would not otherwise be there.
The tax credits should be competitively fair: they
should not favor one fuel or another (for technologies using
utility-supplied fuels), or one technology approach over
another, when both would be equally effective in protecting the
environment and saving money for consumers.
They should be based on programs that have a track
record of working and learn from the experience of programs
that have failed.
They should minimize free ridership: people who
qualify for the tax credit without doing anything different.

The Thomas Bill

While superficially the Thomas Bill appears to meet several
of the criteria for market transformation, the structure and
actual language is fatally flawed in a number of different
ways:
The bill is not workable in its current form.
For new homes complying by prescriptive methods,
the legislation allows builders to self-certify. No oversight
procedure is establish to see whether this self-certification
works.
If builders say they installed something different
than what they are really installing, there is no obvious way
to check this. The IRS does not know much about energy
efficiency technologies, and does not have the staff expertise
to review building plan documents, particularly since no
standardized format for submitting results to the IRS is
provided for in the legislation.
Even if new buildings are designed in a way that
qualifies with the criteria for the tax credit, there is no
mechanism for assuring that houses are constructed to meet
these plans.
Since the tax credit goes to the builder and not
to the home buyer, the buyer is not assured a means by which to
know whether or not his or her home qualified for the tax
credit. If the consumer's utility bills are no lower than those
of his neighbors, he would not realize that anything is amiss.
For new homes complying using the performance
approach, a number of different options are offered for how to
do the calculations. Experience at the state level has shown
clearly that builders will ``shop around'' for the method that
gives them the most credit for the least amount of work.
Builders and their consultants have been very creative in
applying the rules for how to perform performance calculations.
Energy savings of 30% in theory could be 10% or even smaller in
practice.
For existing buildings, contractors can self-
certify to the taxpayer both the cost of the improvement
attributable to energy efficiency and the extent of compliance
with the prescriptive regulations. The temptations to ``fudge''
should be self-evident.
For existing houses, the legislation is unclear on
what actual criteria the contractor has to meet. In many
climates, it is quite possible that very little physical
improvements have to be made in order to qualify for the tax
credit. The concern is that home repairs made for other
purposes will be construed by the contractor to have been made
for the purposes of energy efficiency.
The legislation does not provide for regulatory
oversight of the programs; even if we know after the first year
that qualifying houses are being built that hardly save any
energy, there is no regulatory mechanism for changing things to
fix the problems.
In summary, the lack of firm rules opens the door
to waste and abuse. Fraud would be unnecessary because the
taxpayer can abuse the system as much as he or she wants
without breaking any explicit rules.
The value of tax credit is excessive compared to
the amount of energy saved. The value of energy savings for
reducing heating and cooling costs by 30% would be about $150
per year. A $2,000 tax credit would take over 15 years to pay
back, even on a societal cost basis. This is excessive,
particularly considering the fact that in many regions, the
cost of meeting the criteria for this bill as intended is less
than $700 (and the cost for meeting the requirements as written
will, of course, be substantially less because the results will
be less.
The Thomas proposal is not fuel neutral. It will
cause many homes to switch from gas to electricity in order to
qualify more easily for the tax credit. In some cases,
depending on how the rules are made or interpreted, the shift
could be in the reverse direction. In any event, it does not
enhance, but rather restricts competition between fuel
suppliers.
There may be significant problems with free
ridership, particularly in regions of the country where strong
energy codes are already being enforced, such as Oregon,
California, and Florida.
The legislation could undercut the emerging Home
Energy Rating Systems (HERS) industry by allowing less
qualified new entrants to make certifications on the same basis
as existing, legitimate organizations.

The Matsui Bill

The Matsui Bill does a good job of building on the
successes of state programs and avoiding the mistakes of
earlier failed programs. This bill covers a number of different
technologies; our comments are not intended to be
comprehensive.
For new housing, the Matsui Bill offers a tiered approach
with increasing tax credits for increasing savings. This is an
approach that has been used successfully by utility programs.
The lower tier, which is equivalent in savings to the
Thomas Bill, provides a relatively easily achievable target
with commensurately less reward. The highest tier provides an
ambitious target with a more substantial financial incentive.
The builder gets to choose which level of incentive he or she
is aiming for. The housing section of the Matsui Bill has the
following attributes:
The implementation of the tax credits program is
simple and effective; it builds on the experience of over a
million houses in complying with similarly structured state
energy efficiency building codes:
Compliance is determined by experts certified by
private sector firms. The Department of Energy is given
authority to regulate the quality assurance and training
programs of these firms based on a private sector model cited
in the legislation.
As in the Thomas Bill, a simple prescriptive path
is offered for compliance. The Department of Energy is charged
with developing this path. Because it is determined by
regulation, mid-course corrections can be made to make the path
more usable or to solve problems that occur in the field.
A more flexible performance-based approach is
allowed based on oversight by the Department of Energy. This
oversight follows the successful experience of implementing
performance-based approaches in a simple-to-enforce fashion in
California and Florida. By relying on these states' software-
based approach, all of the complexity is taken away from both
the users (the home energy raters) and the government auditors.
The complexity is all ``hidden'' in the software. Software
eligible to determine compliance must be certified by the
Secretary of Energy.
Since the certifications must be prepared by a
third party, and given to the homeowner (taxpayer), there is a
clear record that the house is supposed to be energy efficient
and concerning what measures the builder took to make it energy
efficiency. This establishes responsibility based on the
consumer's self interest in assuring that energy efficiency
measures are real.
The highest level of tax credit, $2,000, is paid
for savings of 50%. These savings may be in the neighborhood of
$300/year or greater, so the tax credit is not out of
proportion with the level of financial benefits that are being
achieved.
The higher tiers are easiest to meet using new
construction methods for leak-free ducts and tightly
constructed houses. To verify these results, a new home
diagnostics industry will need to be created. The tax credits
legislation can cause this industry to come into existence.
Once it is there, the high economic attractiveness of these
measures make it likely that they will continue to be used even
after the tax credit expires.
The legislation explicitly calls for fuel
neutrality, so that there is no incentive to switch from gas or
oil to electricity, or in the reverse direction. The
performance-based approach provides the maximum level of
competition between different technologies.
The Matsui Bill also provides tiered tax credits for more
efficient heating, cooling, and water heating equipment. These
tax credits are similar to programs that have worked with
extremely high effectiveness in bringing forth more efficient
refrigerators, air conditioners, and water heaters, based on
utility rebates. The tax credit programs are likely to be more
effective than the utility programs because the manufacturers
who are required to make the investments to bring forth these
advanced technologies can be assured of several years' worth of
tax credit, as opposed to utility programs that can only be
committed to one year at a time.
The Matsui Bill does not cover existing homes as the Thomas
Bill does. NRDC believes that this is unfortunate, since a
higher level of energy savings can be achieved in existing
houses than in new houses. We believe that existing houses that
meet the component requirements established for new houses--for
example, the insulation levels in the ceiling, or the windows,
or the walls--should qualify for a pro-rata fraction of the tax
credit for new homes. This should not be a major budgetary
impact, because it is difficult to meet these advanced levels
designed for new houses in existing homes.
The Matsui Bill also provides tax credits for energy-saving
renewable technologies, such as solar water heating systems.
While this is a good idea, the implementation in the bill is
flawed. The legislation, as it stands, pays for a fraction of
the expenditures on the device, rather than the results
achieved by the device. As is the case in the housing and
equipment sections of the Matsui bill, it is better to pay for
achieving performance goals than for spending money.
The Matsui Bill also provides incentives for energy
efficient new automobiles. This section is structured
imperfectly because it tends to ``pick winners'' among
technologies and focuses only on improvements in the drive
train, as opposed to all of the other areas of the car where
fuel economy improvements can be made. Nevertheless, this bill
would encourage technology advancement for the purpose of fuel
economy in automobiles adding export value to fuel-efficient
U.S. vehicles.
Fuel consumption in cars causes multiple problems in the
United States, including the nation's highest level of
dependence on imported fuels. The seriousness of this problem
commends support of even imperfect approaches towards solving
this immense economic and geopolitical as well as environmental
problem.

Summary and Conclusions

NRDC believes that tax credits have an important role to
play in a diversified portfolio of policies to improve energy
efficiency in an economically justified way. The Thomas Bill,
while well intended, is so structurally flawed that NRDC
opposes this bill. The Matsui Bill is both structurally and
technically more workable and worthy of enactment. Although
NRDC has suggestions for improvements to the bill, we support
it and urge the committee to include it in its markup.

Statement of Hon. Paul D. Fraim, Mayor, City of Norfolk

Chairman Archer and Members of the Committee, I am Paul
Fraim, Mayor of the City of Norfolk, Virginia. I appreciate the
opportunity to submit my comments in writing to you on an issue
of importance not only to our community but to the many other
communities participating in Round II of the Empowerment Zone/
Enterprise Community (EZ/EC) program.
I am writing to urge you to include HR 2170, cosponsored by
Reps. Rangel and Foley which completes the funding for the
Round II EZECs in any tax bill which passes your committee this
year. This program has been crucial to our local community in
strengthening families and enabling more of our citizens to
participate in the benefits of a strong economy.

Background:

The Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66)
authorized 11 Empowerment Zones (EZs) and 94 Enterprise
Communities (ECs) to receive tax relief benefits and federal
funding of $100 million for each urban EZ, $40 million for each
rural EC, and $3 million for each EC to implement local plans.
Four years later, in 1997, 20 new Empowerment Zones were
authorized as part of the tax reconciliation package in the
Balanced Budget Act (15 Round II urban and 5 Round II rural
EZs). These were selected and announced in January 1999. Unlike
the first round, this second round of 20 new EZs were not
authorized to benefit from the employer wage tax credit.
In his budget for FY99 President Clinton proposed to fund
the 20 new EZs at virtually the same level as the first round
of EZ/ECs, requiring such funding to be mandatory and flowing
through the Title XX Social Services Block Grant (SSBG). In the
absence of a tax bill last year, $60 million in appropriations
were provided to start up the program: $3 million each for the
15 new urban EZs, $2 million each for the 5 new rural EZs, and
$250,000 for each of 20 new rural ECs.
This year the President's Budget for FY 2000 contained
about $1.7 billion (over nine years) to fully fund the EZs and
ECs and to provide $3 million each for 15 new Strategic
Planning Communities (SPCs). Funding for the program is
contained in HR 2170.

Norfolk, Virginia:

Norfolk was fortunate to have been chosen to be an
Enterprise Community during the first round of EZ/EC
designations. The central focus of our program has been to
enable substantial numbers of our citizens, who would not
otherwise have had the means to do so, to achieve economic
self-sufficiency in our community. Working in concert with and
through our existing neighborhood centers and with the help of
the City's business leaders and a number of existing training
organizations, we have been able to offer our citizens
services ranging from basic job readiness training and even
specialized training using existing and new programs, to job
placement, and on-the-job support.
Our job placement rate is about 60% with another 16%
pursuing additional training or educational opportunities.
Nearly 900 individuals have been employed over the last four
years, with a retention rate of 75%, above the norm for average
employees. The word is spreading that a better life is
available and demand for training exceeds supply. The cost per
person trained and employed is only $3,654--substantially lower
than most employment training programs.
Chartered first as a town in 1682, Norfolk is one of the
nation's older cities which means aging public schools and
infrastructure, and little undeveloped land to attract new
business. Our inability to grow and our age are exacerbated by
the fact that almost 50% of our land is tax exempt, in large
part due to being home to the world's largest naval base and
the second largest commercial--but tax exempt--port on the East
Coast. We are ranked first among Virginia's 140 cities and
counties for ``fiscal stress,'' a well accepted state measure
of imbalance between fiscal requirements and tax resources.
Despite all this, Norfolk is a city that is aggressively
and creatively working to solve our problems, to make Norfolk a
great place to live, work and visit. Hardly a day passes that
we don't encounter a visitor who remembers Norfolk as it was
twenty years ago and cannot believe how positively we have
changed. We have revitalized our waterfront and in the last ten
years increased our tax base ten-fold.
Meeting these significant challenges has not been easy. The
City is in a constant financial struggle to meet the needs of
our constituents within the resources available while
maintaining our AA bond rating. For these reasons, the EZ/EC
program is vital to Norfolk and to those who live here.
In addition to the tax incentives and federal funds
provided in the program, federal EZ/EC designation triggers
state tax benefits and grants which supplement federal support.
By requiring the state zone to conform with the federal zone,
we have been also been able to expand the number of eligible
businesses from 600 to 1700.

EZEC Funding Is Necessary to Complement Tax Incentives:

Other communities may have had a different experience but,
for Norfolk, the expanded use of tax-exempt private activity
bonds for our EC has not been of significant value in
attracting new business to Norfolk. We have been told the bonds
are too restrictive and complicated, especially for small
businesses. Incentives for businesses to locate in ECs or EZs
need to be attractive enough to realistically enable the
community to compete with other regions of the country and
adjacent jurisdictions.
Tax incentives for businesses to hire EZ/EC residents are
beneficial but, unfortunately, the new
EZs do not receive the Employer Wage Credit which was
available to the first round of EZs.
Conceptually, the Work Opportunities Tax Credit (WOTC)
should provide similar advantages but in Norfolk it is not used
extensively. Employers tell us it is too burdensome and overly
bureaucratic.
Because most of our effort has been devoted to job
readiness training and placement for our citizens, it has been
the federal funding that has made the big difference in our
community. This view is shared by other mayors and local
government leaders who competed successfully for an EZ and EC
designation.
Norfolk was instrumental in organizing the ``EZ/EC Round II
Coalition'' (Attachment) which meets regularly to share
information on progress to convince Congress that it has an
obligation to complete the process already undertaken regarding
this program. All of us invested a great deal to compete for
the new EZ and EC designations in good faith with the
understanding that the plans for our local communities would be
funded by the Congress that authorized Round II of this
program.
Finally, Mr. Chairman and Members, your desire to reduce
the tax burden on families and keep the economy strong can be
realized in part by completing the funding for the EZ/EC
communities--communities which represent populations that have
not benefitted from the strength of the current economy as much
as all of us would like.
Thank you for your consideration of our request.
Attachment

EZ/EC II COALITION Members

Empowerment Zones--

Thomas M. Menino, Mayor--Boston, MA

Michael Parolli, Mayor--Bridgeton, NJ

Anthony Campanella, Mayor--Vineland, NJ

Roxanne Qualls, Mayor--Cincinnati, OH

Robert D. Coble, Mayor--Columbia, SC

Stephen M. Creech, Mayor--Sumter, SC

Gregory S. Lashutka, Mayor--Columbus, OH

Carlos M. Ramirez, Mayor--El Paso, TX

Scott King, Mayor--Gary, IN

Robert A. Pastrick, Mayor--East Chicago, IN

Jean Dean, Mayor--Huntington, WV

Robert A. Cleary, Mayor--Ironton, OH

Victor Ashe, Mayor--Knoxville, TN

Joe Carollo, Mayor--Miami, FL

Sharon Sayles Belton, Mayor--Minneapolis, MN

John DeStefano, Jr., Mayor--New Haven, CT

Paul D. Fraim, Mayor--Norfolk, VA

James W. Holley III, Mayor--Portsmouth, VA

Miguel A. Pulido, Mayor--Santa Ana, CA

Clarence Harmon, Mayor--St. Louis, MO

Gordon Bush, Mayor--East St. Louis, IL

Richard Borer, Mayor--West Haven, CT

Kim Steffield--Cordele, GA

Irvin Rustad--Fargo, ND

Herb Wounded Head--Pine Ridge, SD

John Thurman--Riverside County, CA

Lisa Thurston--Ullin, IL

Strategic Planning Communities--

Rick Mystrom, Mayor--Anchorage, AK

Richard Arrington, Jr., Mayor--Birmingham, AL

Peter Clavelle, Mayor--Burlington, VT Clyde M. Rabideau, Jr., Mayor--
Plattsburgh, NY

Joseph P. Riley, Jr., Mayor--Charleston, SC

R. Keith Summey, Mayor--North Charleston, SC

Hardy Johnson, Jr., Mayor--Jackson, MS

Kay Barnes, Mayor--Kansas City, MO

Carol S. Marinovich, Mayor--Kansas City, KS

David L. Armstrong, Mayor--Louisville, KY

Jan Laverty Jones, Mayor--Las Vegas, NV

Michael Montandon, Mayor--North Las Vegas, NV

Jim Dailey, Mayor--Little Rock, AR

Patrick Henry Hays, Mayor--North Little Rock, AR

Marc Morial, Mayor--New Orleans, LA

Rudolph Giuliani, Mayor--New York/Brooklyn, NY

Sharpe James, Mayor--Newark, NJ

Chris Bollwage, Mayor--Elizabeth, NJ

Vincent A. Cianci, Jr., Mayor--Providence, RI

Howard W. Peak, Mayor--San Antonio, TX

Brian Ebersole, Mayor--Tacoma/Lakewood, WA

Rural Enterprise Communities

Timothy Gilmartin, Mayor--Metlakatla Indian

Larry Rodgers--Four Corners

Zak Gonzalez--Orange Cove, Huron, Parlier, and Tule River Tribal
Council

Barbara Cacchione--Empowerment Alliance of SW Florida

Karen M. Holt--Molokai

Lanny McIntosh--Austin

Sharla Krenzel--Wichita County

Charlotte Mathis--Bowling Green

John C. Bott--Lewiston

Tim Wolverton--Clare County

Melissa Buckles-Fort Peck Assiniboine and Sioux Tribe

John Strand--Deming

Billie J. Floyd--Tri-County Indian Nations

Debra Hanna--Fayette

Joe Vuknic--Allendale County ALIVE

Tom Mottern--Clinch-Powell

Leodoro Martinez--Middle Rio Grande

Martin Wold--Tri-County Rural

Gale Kruger--Northwoods Niijii

Ben Newhouse--Upper Kanawha Valley

Statement of Hon. Bill Thomas, a Representative in Congress from the
State of California

Mr. Chairman, I appreciate having an opportunity to comment
on provisions I believe should be included in the coming tax
bill.
With respect to expiring provisions, I urge the inclusion
of my bill to extend the Production Tax Credit (PTC) for wind
power for an additional 5 years, H.R. 750. The bill has
tremendous support in the House. One hundred and twenty-four
members of the House, including 27 members of the Committee on
Ways and Means, are cosponsors.
Wind offers one technology we can use to reduce climate-
changing emissions. The America Wind Energy Association has
estimated that under an extension of the PTC, working in
conjunction with a set of policies aimed at further reducing
costs, wind energy can achieve 30,000 megawatts of generating
capacity in our country by 2010. Doing so would reduce
CO2 emissions by up to 100 million metric tons,
about 18% of the reduction that the electric industry must
achieve to reduce emissions back to 1990 emissions levels.
We should also give the embattled oil industry some help by
including a five year carry back treatment to net operating
losses resulting from the production of oil and gas as proposed
in H.R. 423. Congress already extended a five year carry back
to farmers and President Clinton has offered such a provision
to the steel industry. My bill, which is supported by the
Independent Producers Association of America and the California
Independent Producers Association, aids the domestic oil
industry in the same fashion.
The recent increase in crude oil prices hardly means that
H.R. 423 is no longer needed. Prices of late have risen on
speculation that OPEC will maintain price discipline, hardly
something on which we can count. H.R. 423 can serve as an
insurance policy against further loss of jobs and production,
both of which are valuable in this economy.
H.R. 607 will remove barriers to mutual fund investment in
publicly-traded partnerships (PTPs). PTP shares are subject to
federal regulations on reporting data to the market. The shares
are openly traded on public exchanges. In spite of these
similarities to stocks and bonds, PTP shares are avoided by
mutual funds managers because of outdated Internal Revenue Code
standards.
Under the Code, mutual funds can lose their pass-through
status if more than 10% of their income comes from investments
which are not listed in the statute. As PTP shares are not
among the listed investments, fund managers avoid PTP shares
due to the risk of earning too much income from them. H.R. 607
provides a simple solution to this anomaly by including PTP
shares in the list of assets generating income a mutual fund
can count to its legal requirements.
H.R. 1713 resolves long-standing problems for companies
trying to manage risk with respect to vital supplies and
working capital. Increasingly, businesses are relying on
hedging and financial derivatives to manage their exposure to
the risk of input price changes and capital costs.
For taxpayers, the lack of clarity means continued
uncertainty as to whether or not instruments will be treated as
capital assets for tax purposes. Unless gain and loss are
treated the same way, taxpayers' ability to manage risk will
remain limited by the tax code.
H.R. 1713 resolves the issue by defining hedge transactions
as those in which risk is being managed. The language of the
bill has been developed with Treasury and the resulting bill
will actually raise federal revenue.
I also strongly recommend the inclusion of H.R. 1616, the
Real Estate Investment Trust Modification Act of 1999, in the
coming bill. This bill, which Congressman Cardin and I
coauthored, will resolve outstanding problems in the tax
treatment of Real Estate Investment Trusts (REITs). H.R. 1616
incorporates the Administration's REIT proposals but goes
beyond them to make critical improvements in three areas of the
law: services, the treatment of hotels, and handling bankrupt
or foreclosed health care properties.
The bill allows REITs to offer tenants services through
Taxable REIT Subsidiaries. These subsidiaries will pay tax on
income they earn. Severe penalties will apply to excessive
changes used to shift subsidiary income back to the parent
company, reducing the risk of ``earnings stripping'' schemes.
The creation of these subsidiaries is vital to modernizing the
role of REITs in offering resources to their tenants.
Services are an increasingly important part of the real
estate trade. While corporations and partnerships can offer
potential tenants internet connections and other services, a
REIT can only offer such services after the IRS deems them
``customary'' in the trade. Until services are deemed
customary, the income they generate puts a REIT at risk of
losing its pass-through status. Today's law therefore makes
REITs inherently less competitive than other rentors in the
market.
The bill also corrects an anomaly in the treatment of hotel
REITs. Today, the law forces a REIT to have an independent
third party lease the REITs' properties to a hotel operator.
This rule diverts rental profits from the REIT shareholders to
a third party. The bill's TRS requirement allows hotel REITs to
use Taxable REIT Subsidiaries to conduct these activities.
The final significant adjustment is in the treatment of
health care properties subject to foreclosure proceedings or
abandoned by lessees. Present law requires a REIT to find a new
tenant within an unreasonably short period of time. Failure to
meet this requirement means income from the property cannot be
treated as rental income of the sort needed to remain a REIT.
H.R. 1616 gives REITs in this difficult position up to two
years in which to find a new tenants.
For additional environmental benefits in reducing
greenhouse gases, I urge the inclusion of H.R. 1358 in the
coming tax bill. H.R. 1358 creates tax incentives to raise the
energy efficiency of both new and existing homes. In the case
of new homes, 30% more efficient than model code standards, a
builder would receive a $2,000 credit. Homeowners would get a
$2,000 credits for making improvements to existing housing
stock.
Incentives to improve homes are a good way to achieve
voluntary greenhouse gas reductions. The average home today is
responsible for about 12 tons of carbon dioxide in the
atmosphere. H.R. 1358 gives builders and homeowners a
substantial incentive to cut those emissions without forcing
them to take prescribed steps.
The Alliance to Save Energy has estimated the new home
credit in H.R. 1358 would reduce the carbon dioxide emissions
by up to 200,000 tons per year, nearly seven times the
reduction expected from the Administration's proposal in this
year's budget. Further, H.R. 1358 provides incentives to
improve older homes as well. While older housing is far less
efficient in its use of energy and substantial gains could be
made there, the Administration's budget ignores this vital
area.
Finally, I have introduced H.R. 1914 to correct a flaw in
the ``dividend allocation'' rule applicable to farmer
cooperatives. Generally, a cooperative can deduct dividends
paid to farmers which are based on cooperative earnings from
business done for those farmer patrons. Earnings from other
``nonpatronage sources'' are taxed when received by the coop as
well as in the farmers' hands. Over the years, a ``dividend
allocation rule'' has developed out of Treasury and court
decisions that now creates problems for coops using sales of
stock to raise capital.
Coops are increasingly interested in raising funds through
stock sales because many are reaching the limits of raising
capital through debt. If dividends are paid on stock, the
allocation rule taxes some income three times because the rule
makes the coop reduce its dividends paid deduction based on the
amount paid out on stock.
H.R. 1914 puts an end to the third level of tax by
allocating dividends paid on stock to nonpatronage sources of
income and retained earnings first. Adoption of this rule will
allow farmer cooperatives to continue serving agriculture in
today's sophisticated markets.

Statement of U.S. Securities Markets Coalition

This statement is submitted by the U.S. Securities Markets
Coalition. The members of the Coalition are The American Stock
Exchange, The Boston Stock Exchange, The Chicago Board Options
Exchange, The Chicago Stock Exchange, The Cincinnati Stock
Exchange, The NASDAQ Stock Market, The National Securities
Clearing Corporation, The Options Clearing Corporation, The
Pacific Stock Exchange, and The Philadelphia Stock Exchange.
The statement sets forth two recommendations for improving the
accuracy and fairness of the ``tax straddle'' rules. The
proposals, which are relatively modest, will result in more
equitable treatment of investors seeking to hedge risk
associated with appreciated securities by tailoring the tax
straddle rules to more precisely implement their underlying
purposes. The statement also urges the Committee to proceed
cautiously in considering certain aspects of the
Administration's proposal to repeal the special rules for stock
under section 1092(d)(3).

OVERVIEW

The significant increases in the value of equity securities
in recent years have led many investors to seek to hedge their
appreciated stock positions against possible declines in value.
While the options exchanges provide an efficient means for
investors to hedge such risks,\1\ certain aspects of the ``loss
deferral'' rule of section 1092, relating to tax straddles,
impose what amounts to a tax penalty on legitimate hedges of
appreciated stock with options and other financial instruments.
---------------------------------------------------------------------------
\1\ Trading volume on the options exchanges has increased
significantly in recent years. For example, the total volume on the
options exchanges has increased from 295,000,000 contracts in 1996 to
406,000,000 contracts in 1998, with each contact representing an option
on 100 shares of stock.
---------------------------------------------------------------------------
The Administration has previously recognized the
``punitive'' nature of the loss deferral rule,\2\ and in 1997
and 1998 the Administration proposed legislation to make
certain aspects of the rule more equitable.\3\ In both
instances, the Administration's proposal was coupled with
certain proposals to expand and clarify the tax straddle rules
of section 1092 and to clarify the treatment of ordinary
business hedges. Although the Administration's Year 2000 Budget
includes these latter proposals, the Administration
inexplicably did not renew its prior proposal to ameliorate the
harsh effects of the loss deferral rule.
---------------------------------------------------------------------------
\2\ See ``Report on Tax Simplification Proposals,'' U.S. Treasury
Department (April 16, 1997) (``[T]he loss deferral provision under the
straddle rules is punitive and sometimes results in a total
disallowance of losses.''); ``General Explanations of the
Administration's Revenue Proposals,'' U.S. Treasury Department
(February 1998) at pp. 52-53 (``[T]he loss deferral provision under the
straddle rules can be punitive and sometimes results in a total
disallowance of losses.'').
\3\ See id.
---------------------------------------------------------------------------
The Coalition urges the Committee to improve the fairness
and accuracy of the loss deferral rule in order that taxpayers
who enter into legitimate hedges of appreciated stock positions
will not receive inappropriately harsh tax treatment.
Specifically, the Coalition recommends that section 1092 be
amended to provide that (i) gain that has economically accrued
before a straddle is created will not be taken into account for
purposes of applying the loss deferral rule, and (ii) losses
that have been deferred under the rule will be ``freed up'' on
a proportionate basis as gains on offsetting positions are
recognized.
The Coalition also recommends that the Committee exercise
considerable caution in evaluating the Administration's
proposal to eliminate the special treatment of stock under the
tax straddle rules. If the proposal is broadly implemented, it
will have significant consequences that need to be carefully
examined.

Discussion

1. The ``loss deferral'' rule and its origins. Under Code
section 1092(a)(1), a recognized loss with respect to a
position in a straddle is taken into account only to the extent
that it exceeds unrecognized gain with respect to one or more
positions that were offsetting positions with respect to the
position from which the loss arose. This rule (the ``loss
deferral'' rule) is applied at the end of the year in which the
loss is recognized. Any loss that is deferred under this rule
is treated as sustained in the following year, when the loss is
again subjected to the same rule (i.e., it is to be taken into
account only to the extent it exceeds the unrecognized gain in
positions that were offsetting positions).
The loss deferral rule was enacted in 1981 along with the
other ``anti-straddle rules'' of section 1092. The specific
transactions that Congress had in mind were straddles in
commodities and commodities futures, which had become widely
touted as transactions that could be used to create artificial
losses to defer tax on unrelated gains.\4\ For example, a
taxpayer seeking to shelter a capital gain would simultaneously
enter into both long and short futures contracts with different
delivery months in the following year. Whichever way the price
of the underlying asset moved, the value of one contract would
go up while the value of the other contract would go down. The
taxpayer would then close out the loss contract and replace it
with a similar contract with a slightly different delivery
month. The taxpayer would use the loss to offset unrelated
capital gain. In the following year, the taxpayer would close
out both of the remaining contracts, in effect deferring gain
from one year to the next.\5\ The loss deferral rule prevents
this result by denying the taxpayer the ability to claim the
loss on the straddle position to the extent there is
unrecognized gain in the offsetting position at year-end.
---------------------------------------------------------------------------
\4\ See S. Rep. No. 97-144, 97th Cong. 1st Sess. 145-146 (1981).
\5\ See S. Rep. No. 97-144, supra, at 146. For a more detailed
description of a classic commodities straddle, see Rev. Rul. 77-185,
1977-1 C.B. 48 (describing a straddle transaction in silver futures
contracts).
---------------------------------------------------------------------------
As part of the 1981 anti-straddle legislation, Congress
also adopted section 1256, which marks all regulated futures
contracts to market at year-end. This mark-to-market regime,
which treats all regulated futures contracts (and certain other
contracts) as sold at the end of the year, prevents taxpayers
from using straddles consisting solely of these contracts to
create artificial losses.
In 1984, the straddle provisions, including the loss
deferral rule, were extended to cover (i) straddles consisting
of options on stock, (ii) straddles consisting of stock and an
option (or options) with respect to substantially identical
stock or securities, and (iii) under regulations, straddles
consisting of stock and positions with respect to substantially
similar or related property (other than stock). See Code
Sec. 1092(d)(3).
2. Gain that arises before a straddle is created should not
be taken into account under the loss deferral rule.--A loss on
a position that was part of a straddle is deferred to the
extent of any unrecognized gain remaining with respect to a
position that was offsetting to the loss position. Current law
does not distinguish between unrecognized gain that arose
during the period of the straddle and unrecognized gain that
arose before the straddle was entered into.
The failure to make this distinction is understandable in
light of the types of transactions that Congress had in mind
when the straddle provisions were adopted in 1981. These
transactions typically entailed simultaneously entering into
long and short commodities futures contracts. When both
``legs'' of a straddle are entered into at the same time, there
can be no preexisting gain associated with either position, and
any loss from a position is properly viewed as ``artificial''
to the extent that the taxpayer has economic gain on an
offsetting position. As the Treasury Department has previously
explained, straddle transactions are ``transactions having
multiple components in which the same market movement
simultaneously produces a loss and a gain.'' \6\
---------------------------------------------------------------------------
\6\ See Statement of John E. Chapoton, Assistant Secretary of the
Treasury Department for Tax Policy, Before the Ways and Means Committee
on November 2, 1983 at page 21.
---------------------------------------------------------------------------
The enactment of section 1092 (as well as section 1256) put
a stop to the types of transactions Congress was concerned
about in 1981. In today's world, the straddle rules most
commonly operate with respect to transactions in which a
taxpayer has held a position (such as stock) for some period of
time before entering into another position (such as an option
on the stock) to hedge some of the risk associated with the
first position. If the taxpayer hedges appreciated stock, say,
by purchasing a put option on that stock, any loss with respect
to the put option will generally be deferred under the loss
deferral rule without regard to whether the stock increases in
value during the time the put option is outstanding.
Example:
Assume that an investor bought 1,000 shares of Amazon.com at
$5 a share and that it is currently trading at $150 a share.
The investor buys a put option on all 1,000 shares with an
exercise price of $140 a share, for which the investor pays
$5,000. The put protects the investor if the stock price drops
below $140. On the put's expiration date, Amazon.com is trading
at $145, so the put expires unexercised. The taxpayer has a
loss of $5,000 on the put (as well as an economic loss on
Amazon.com during the period of the straddle).
Under current law, the taxpayer cannot claim the $5,000 loss
on the put because he continues to hold the Amazon.com stock
with unrecognized gain that is greater than the amount of that
loss. This is true even though (i) all of the gain accrued
economically before the straddle was entered into, and (ii) the
value of Amazon.com actually declined during the period of the
straddle.

There is no policy rationale to support the result under
current law. The loss on the put in the example is a real
economic loss (as opposed to the ``artificial losses'' that
Congress sought to preclude by enacting section 1092). The gain
that current law takes into account all arose before the
straddle was entered into and cannot properly be viewed as
offsetting the loss on the put.
The Coalition recommends that the loss deferral rule of
section 1092(a)(1) be amended so that gain accruing before the
straddle is entered into is not taken into account in
determining the amount of any loss to be deferred as a result
of the straddle transaction. This change will both reduce the
unfairness inherent in present law and more precisely implement
the original purpose of the straddle rules, which was to
prevent taxpayers from creating economically offsetting gains
and losses through straddle transactions and using the losses
to defer tax on unrelated gains.
As a corollary of this change, any economic loss on a
position that arises before a straddle transition is entered
into would also be disregarded in determining the amount of
unrecognized gain on that position for purposes of applying the
loss deferral rule. This change will prevent taxpayers from
exploiting the lack of precision in the current rules by
entering into straddles with respect to positions with ``built-
in losses.'' \7\
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\7\ A taxpayer who holds a depreciated stock or security may be
able to generate artificial losses through straddle transactions and
avoid application of the loss deferral rule. Assume a taxpayer holds
stock with a basis of $10,00 and a value of $8,000. The taxpayer enters
into a straddle transaction that results in a $2,000 loss on the
offsetting position and a $2,000 increase in the value of the stock
during the straddle. Because there is no overall gain in the stock, the
loss deferral rule will not defer the deduction of the $2,000 loss
(even though it was economically offset by $2,000 of gain on the stock
during the time the straddle was in place).
---------------------------------------------------------------------------
The Coalition's proposal can be readily implemented by
limiting the amount of loss subject to the loss deferral rule
to the amount of unrecognized gain in the retained offsetting
position(s) that arose after the time the straddle was created.
Because application of the straddle rules is limited to
positions with respect to actively traded personal property, it
should generally not be difficult to determine the market value
of the position at the time the straddle is created (i.e., when
the offsetting position is entered into). Current law already
depends on determining the market value of the position as of
the end of the year.
The application of the Coalition's proposal can be
illustrated by the following example.
Example:

Investor X holds 1,000 shares of stock with a basis of
$10,000 ($10 per share) and a value of $60,000 ($60 per share).
X buys a put option with an exercise price of $60 on all 1,000
shares, paying a premium of $7,000. At the expiration of the
put, the stock is trading at $62 per share, and the put expires
worthless. X continues to hold the stock, which is trading at
$62 at year-end.

Under current law, X cannot deduct any portion of the
$7,000 loss on the put because the unrecognized gain in the
stock exceeds that amount. This is true even though the $7,000
loss on the put was offset by only a $2,000 gain in the stock
during the period the straddle was in place. Under the
proposal, X would be allowed to deduct $5,000, which represents
the real economic loss to X during the time the straddle is in
place. The remaining $2,000 of loss, which was offset by gain
on the stock, would be deferred as under current law. The only
additional change would be that the unrecognized gain taken
into account at year-end would be limited to the excess over
$60 per share (the value of the stock at the time the straddle
was entered into).\8\
---------------------------------------------------------------------------
\8\ The Coalition's proposal to segregate gain (or loss) that
arises before a straddle is created for purposes of the loss deferral
rule is consistent with approaches taken by Congress in other areas.
For example, under Code section 475(b)(3), if a securities dealer holds
property for investment and then converts it to dealer property, the
property becomes subject to the mark-to-market rules of that section
However, only gains and losses arising after the date of conversion are
marked to market. Any unrealized gain or loss existing at the date of
conversion remains suspended until the property is sold.
Another analogous provision is former section 851(g), which
provided that gains and losses of regulated investment companies during
the period of any ``designated hedging transaction'' would be netted
for purposes of the ``short-short test'' of former section 851(b)(3).
Thus, any gain or loss arising before such a hedging transaction was
entered into was segregated from the calculation of the net gain or
loss during the period the hedging transaction was in place.
---------------------------------------------------------------------------
In light of the substantial appreciation of equities over
the last several years, and the desire of investors to hedge
risks associated with their appreciated investments, this is an
appropriate time for the Committee to correct an obvious
inequity in the straddle rules. The loss deferral rule of
current law is unnecessarily crude and imprecise. The Coalition
urges the Committee to report legislation that will make the
loss deferral rule both more equitable and more accurate in
light of its intended purpose.
3. Permit deferred losses to be deducted proportionately as
offsetting gains are recognized.--Under current law, a loss on
a position that was part of a straddle apparently has to be
deferred to the extent of any unrecognized gain with respect to
one or more positions that were offsetting to the loss
position. See Code Sec. 1092(a)(1)(A). This rule applies even
if the taxpayer has recognized a substantial portion of the
gain associated with such offsetting positions.
Example:

Investor B buys 1,000 shares of Selectron at $50 share and
buys a put option on all 1,000 shares with a strike price of
$45 at a cost of $2,000. Assume that the stock goes up to $70
per share and the puts expire worthless. B then sells 900
shares of the stock, thereby recognizing $18,000 of gain
($63,000 of proceeds less basis of $45,000). Under current law
it appears that B cannot deduct any portion of the $2,000 loss
on the puts because he still has $2,000 of unrecognized gain in
his 100 remaining shares of stock. This is true even though B
sold--and recognized gain on--90% of the stock position that
was offsetting to the puts.

This aspect of current law is unnecessarily harsh and
should be corrected. Section 1092 should be amended to provide
that a taxpayer is permitted to deduct a portion of any loss
from a position that was part of a straddle to the extent that
he or she has recognized a similar portion of gain associated
with offsetting positions in the straddle. Thus, in the above
example, B would be permitted to deduct 90% of his loss on the
puts ($1,800) because he recognized the gain associated with
90% of his stock position.
This proposal is consistent with the hedge timing rules of
Treasury Regulation section 1.446-4. It appropriately matches
the timing of the loss on the hedging position to the timing of
the gain on the hedged position. As with the proposal set forth
above, it would both improve the accuracy of the tax straddle
rules and ameliorate unnecessarily harsh consequences under
current law.
4. The Administration's proposal to eliminate the special
rules for stock.--The Administration's Year 2000 Budget
includes a proposal to repeal the special rules for stock under
section 1092(d)(3). These rules generally limit application of
the straddle rules, in the case of stock, to (i) straddles
consisting of stock and options with respect to substantially
identical stock or securities, and (ii) to the extent provided
by regulations, straddles consisting of stock and positions
with respect to substantially similar or related property
(other than stock).
In 1995 Treasury exercised its regulatory authority to
apply the straddle rules to straddles consisting of stock and
positions with respect to substantially similar or related
property (other than stock). See Treas. Reg. Sec. 1.1092(d)-2.
This regulation provides guidance on the meaning of the phrase
``substantially similar or related property'' by cross-
referencing Treas. Reg. Sec. 1.246-5, which was adopted at the
same time and which provides guidance on the meaning of the
same phrase for purposes of section 246(c). The IRS has also
issued a proposed regulation that would amend Treas. Reg.
Sec. 1.1092(d)-2 to make clear that the regulation applies to a
straddle consisting of stock and an equity swap.
It is our understanding that Treasury's main reason for
making the legislative proposal to eliminate the special rules
for stock is to eliminate any uncertainty regarding its
authority under current law to apply the straddle rules to
stock offset by an equity swap. However, the proposal, as
stated, would have much broader consequences, some of which are
difficult to gauge.
There are two areas that we believe need careful study if
the special rules for stock are to be repealed. First, long
stock and short stock positions (i.e., short sales), which have
long been governed by section 1233, would become straddles
subject to section 1092. At a minimum, the proposed change
would appear to make the rules of section 1233 redundant as
applied to publicly traded stock. Whether there may also be
some unintended consequences is a subject that should be
carefully studied.
Perhaps of greater importance, and creating greater
uncertainty, would be the elimination of the ``substantially
similar or related property'' standard (which is part of the
special rules for stock in section 1092(d)(3)). As noted above,
Treasury has issued guidance on the meaning of that standard
under section 246(c) and has incorporated that guidance by
reference for purposes of section 1092(d). While that guidance
is not without its problems, it does provide a body of law that
taxpayers (and the government) can refer to and rely upon.
Simply eliminating that standard under section 1092 would raise
substantial uncertainties as to the potential scope of the
application of the straddle rules to stock. Unless there is
some compelling reason to eliminate this standard, the
Coalition would urge the Committee not to do so. At the very
least, careful study must be given to the types of transactions
that could conceivably cause stock to be part of a straddle if
the standard is eliminated.