[House Hearing, 107 Congress] [From the U.S. Government Publishing Office] PROMOTING INTERNET ENTREPRENEURSHIP: SHOULD THE GOVERNMENT TAKE ANY ACTION? ======================================================================= HEARING before the SUBCOMMITTEE ON REGULATORY REFORM AND PAPERWORK REDUCTION of the COMMITTEE ON SMALL BUSINESS HOUSE OF REPRESENTATIVES ONE HUNDRED SEVENTH CONGRESS FIRST SESSION __________ WASHINGTON, DC, APRIL 3, 2001 __________ Serial No. 107-3 __________ Printed for the use of the Committee on Small Business U.S. GOVERNMENT PRINTING OFFICE 72-118 WASHINGTON : 2001 COMMITTEE ON SMALL BUSINESS DONALD MANZULLO, Illinois, Chairman LARRY COMBEST, Texas NYDIA M. VELAZQUEZ, New York JOEL HEFLEY, Colorado JUANITA MILLENDER-McDONALD, ROSCOE G. BARTLETT, Maryland California FRANK A. LoBIONDO, New Jersey DANNY K. DAVIS, Illinois SUE W. KELLY, New York WILLIAM PASCRELL, New Jersey STEVEN J. CHABOT, Ohio DONNA M. CHRISTIAN-CHRISTENSEN, PHIL ENGLISH, Pennsylvania Virgin Islands PATRICK J. TOOMEY, Pennsylvania ROBERT A. BRADY, Pennsylvania JIM DeMINT, South Carolina TOM UDALL, New Mexico JOHN THUNE, South Dakota STEPHANIE TUBBS JONES, Ohio MIKE PENCE, Indiana CHARLES A. GONZALEZ, Texas MIKE FERGUSON, New Jersey DAVID D. PHELPS, Illinois DARRELL E. ISSA, California GRACE F. NAPOLITANO, California SAM GRAVES, Missouri BRIAN BAIRD, Washington EDWARD L. SCHROCK, Virginia MARK UDALL, Colorado FELIX J. GRUCCI, Jr., New York JAMES P. LANGEVIN, Rhode Island TODD W. AKIN, Missouri MIKE ROSS, Arizona SHELLY MORRE CAPITO, West Virginia BRAD CARSON, Oklahoma ANIBAL ACEVEDO-VILA, Puerto Rico Phil Eskeland, Deputy Staff Director Michael Day, Minority Staff Director ------ SUBCOMMITTEE ON REGULATORY REFORM AND OVERSIGHT MIKE PENCE, Indiana, Chairman LARRY COMBEST, Texas ROBERT BRADY, Pennsylvania SUE KELLY, New York BILL PASCRELL, Jr., New Jersey SAM GRAVES, Missouri CHARLES GONZALEZ, Texas ROSCOE BARTLETT, Maryland DAVID D. PHELPS, Illinois TODD AKIN, Missouri JAMES P. LANGEVIN, Rhode Island PAT TOOMEY, Pennsylvania ANIBAL ACEVEDO-VILA, Puerto Rico Meredith Matty, Professional Staff Member C O N T E N T S ---------- Page Hearing held on October 19, 1999................................. 1 WITNESSES Clark, Joseph A., CEO, LocalWeb4U................................ 3 Mellinger, Doug, Chairman, National Commission on Entrepreneurship............................................... 5 Engel, Josh, General Counsel, Bigstep.com........................ 7 Hughs, Ragan, Co-Owner, Capital Baby Rental...................... 8 Draluck, Jonathan D., Vice President Business Affairs & General Counsel, iBasis, Inc........................................... 10 McCord, Rob, President & CEO, Eastern Technology Council......... 12 APPENDIX Opening statements: Pence, Hon. Mike............................................. 22 Brady, Hon. Robert........................................... 25 Prepared statements: Clark, Joseph A.............................................. 26 Mellinger, Doug.............................................. 31 Engel, Josh.................................................. 40 Hughs, Reagan................................................ 44 Draluck, Jonathan D.......................................... 50 McCord, Rob.................................................. 56 PROMOTING INTERNET ENTREPRENEURSHIP: SHOULD THE GOVERNMENT TAKE ANY ACTION? ---------- TUESDAY, APRIL 3, 2001. House of Representatives, Subcommittee on Regulatory Reform and Oversight, Committee on Small Business, Washington, DC. The subcommittee met, pursuant to call, 2:11 p.m. in Room 311 Cannon House Office Building, Hon. Mike Pence, [chairman of the subcommittee] presiding. Chairman Pence. The hearing of the Subcommittee on Regulatory Reform and Oversight of the Committee on Small Business will come to order. Our hearing today is about the meteoric rise of Internet- based economy and whether current federal government policies help or hinder small businesses that seek to utilize the Internet as a business strategy. Today's hearing will be the first in a series of hearings that this subcommittee will hold to examine the impact of federal regulatory policies on the ability of small businesses to deploy new technologies, develop new markets and generate economic growth. The expansion of commerce on the Internet is simply staggering, with numbers that are difficult to comprehend. Internet traffic in 1996, a mere five years ago, but in Internet time almost a generation ago, was doubling every 100 days. Even analysts could not comprehend the growth in usage of the Internet. For example, in 1998, one report estimated that retail transactions on the Internet would reach 7 billion by the year 2000. Most analysts now believe that the estimate was reached in 1998. Just this past Christmas, retail sales of goods on the Internet reached $8.7 billion and the Bureau of the Census estimates that Internet business to consumer retail transactions hit the $20 billion mark in 2000. The use of the Internet by consumers to purchase goods pales in comparisons to estimates of business to business transactions on the Internet. Some analysts predict the value of global transactions on the Internet will exceed $6 trillion. The growth in commerce and use of the Internet demonstrates that it is the new central business district, the new Main Street, if you will, and the new shopping mall. And just as small businesses play a vital role in the central business districts, on our Main Streets and in the shopping malls, they also play a key role in the development of commerce on the Internet. Rather than hire a real estate agent and construction contractor to build a new store, Capital Baby Rentals decided to expand on the new American Main Street and sought the help of another business, Bigstep.com. However, the Internet is not just the new American business district. Digital convergence enables the Internet to be the next newspaper, the next telephone network and cable system. In my district, LocalWeb4U provides information that individuals currently receive from their local newspapers, broadcast stations and telephone directories. However, because of the ubiquity of the Internet, LocalWeb4U can provide that information not just for Anderson, Indiana but for communities throughout the United States. But we also have iBasis, a company that provides voice over Internet Protocol telephony. In other words, it uses the Internet to provide telephone service and, unlike the telephone company, its customers are not limited by geographic location. No one can doubt that an Internet-based economy provides significant opportunities for new small businesses, as well as new ways to expand existing small businesses. In fact, three of the businesses testifying here today simply would not exist and did not exist prior to 1995 without the ubiquitous availability of the Internet and the desire of Americans to log on. Before Congress takes further action to promote expansion of commerce on the Internet or hinder its unbridled growth, it behooves us to understand this new stream of commerce, the problems they face and whether they currently perceive government policies to help or hinder their operation and growth. The panelists here today will explain how businesses is done on the Internet, how they as small businesses discovered unserved or under served niches to expand their businesses and how this new technology will continue to open new opportunities for the pioneering small businesses. Finally, the panelists will highlight any issues of concern about existing federal policies or changes in federal policies that may help or hinder their businesses. Congress will then have the information it needs to rationally make decisions and ensure federal legislative and regulatory policies are partners in helping small businesses take advantage of this new stream of commerce and not act as a dam to its potential. Before turning to the ranking member, the distinguished gentleman from Pennsylvania, I would like to take a few moments to mention the superb work done by my predecessor, the gentlewoman from New York, Sue Kelly, who chaired this subcommittee in the last Congress. She demonstrated leadership in this subcommittee in doing oversight of the regulatory problems facing small businesses and she persevered in finally getting the Truth in Regulating Act passed. Her understanding of the regulatory problems faced by small businesses is second to none in this Congress and, as the new chairman of this subcommittee, I hope to follow in her footsteps. The ranking member not being in attendance, we will recognize our first speaker for the afternoon who is with a company known as LocalWeb4U and his name is Joe Clark, who is recognized for five minutes. [Mr. Pence's statement may be found in appendix.] STATEMENT OF JOSEPH CLARK, CHIEF EXECUTIVE OFFICER, LOCAL WEB4U, ANDERSON, IN Mr. Clark. Thank you, Mr. Chairman. It is a huge honor to be able to be here and I greatly appreciate you extending us that privilege. LocalWeb4U was founded on the belief that people need to be heard and to be found, especially on the Internet. LocalWeb4U was established to give individuals, businesses, non-profit organizations the ability to state their opinion, give dates for events, even brag about their children's accomplishments within a local community. The sad news is economies of scale have reduced local content providers such as newspapers and radio stations for two-thirds of America so that their voices cannot be heard, the Internet having a virtually unlimited amount of space. It lets you get out into every community of every size without the cost of raw goods and capital expenditure matter. LocalWeb4U was blessed to create a concept in November of 1999, the peak of the Internet days. It incorporated two days before the largest Nasdaq record reporting in terms of the market. We came to market in a wonderful time and were placed to deal with this economy. As a certified financial planner, I have looked at my clients who often talk about their new 201(k) versus the 401(k) and they literally feel that they have been cut in half. As a result, LocalWeb4U has had the trials and tribulations and had to tick through periods of time of slow capital infusion. As all good businesses should, we have listened to the market and we have been forced to go more from a conceptual build up period of time to an immediate let-us-produce-net- revenue type of company. We have changed with the times and I am proud today to tell you that we are here intact and with a strong vision. There is much talk about the new economy versus the old economy. And, in my opinion, I think you need to understand that the whole world is really changing with new innovations and new technologies. There is no company that really has a stronghold, whether they are an old company or a new company, on this marketplace. Not Oldsmobile, not Sunbeam, not even Yahoo!. As an example, there were 200 companies in 1920 that produced automobiles, 23 alone in Anderson, Indiana, my hometown. In 1930, we were down to three, Studebaker barely holding on. During this phase of the economy, the same one that we are in today, there is a mighty shake-out and a race for leadership. This change in corporate profitability and survivability during these economic times forces us to address the taxation of our business economy for one simple reason. The largest barrier to entry for our business was not a failing business model, it was not a mistake in assumptions, but it was a lack of capital. The best way to get capital is to inspire investment. I believe it is imperative that we create a method so that investors do not pay taxes on growth. As long as the money that they have stays in the market for the development of companies, whether they be new companies or old companies trying to re- tool to stay alive in this great economy. We must give intra- stage investors support in the investment process, not obstacles that they need to overcome. And I realize to some of the people in this room that a 20 percent tax does not seem like a lot of money, but let me remind the committee that a 25 percent reduction in the stock market is titled as a crash. Mr. Chairman, the only way for people to get money out of one company and to invest in another company is to go through their own little economic crash. I think people forget that regardless of which party you represent, people are scared to death of taxes. That is represented by the fact that 70 percent of all money in qualified plans, in IRAs, stays in the plan until age 70 and a half when the government forces them to pull it out. People cannot bear the loss of their net worth on paper. They cannot bear their own little economic crash. I dare to wonder how many people would have left the money in some of these high flying Internet stocks last year with several hundred return in one year and not diversified if they had not been trapped by the psychology of the tax code. If people take money out of the market to spend on themselves, if we must tax them, tax them then, but do not stop investors from supporting companies that have the ability to do what it is they need to do. I think it would be much easier for Congress, it would be much easier for American citizens, if our tax basis was taxed only when all the money left the market. We would not have to deal with the 3 billion shares trading every day and people trying to determine what basis was and it would spur investment based on the company's merits of that day. Do not punish investors and make them stay with their original decision if the market offers a better opportunity. I do not feel it is the government's place to make sure my business works and survives, but I do look at it this way: I feel it is my best interests to protect my customers, the people that provide my living and buy my product. Investors are one of the IRS's best customers because even if they get it wrong once or twice, they end up staying with it and truly enhance government revenues. Entrepreneurs live and die by the willingness of investors to bet on their success. Do your best as legislators to encourage investment, to encourage new innovation and to encourage willing compliance to the tax code. Thank you for this wonderful opportunity. May you be filled with wisdom and God's inspiration to lead our country into the best economic time in history. Thank you. [Mr. Clark's statement may be found in appendix.] Chairman Pence. Thank you, Mr. Clark. An excellent presentation. The next witness to testify is Mr. Douglas Mellinger, who is chairman of the National Commission on Entrepreneurship in Washington, D.C. Mr. Mellinger, you are recognized for five minutes. STATEMENT OF DOUGLAS MELLINGER, CHAIRMAN, NATIONAL COMMISSION ON ENTREPRENEURSHIP, WASHINGTON, DC Mr. Mellinger. Thank you, Mr. Chairman. Thank you for inviting me to testify today. As you said, I am chairman of the National Commission on Entrepreneurship, an organization whose charter is to help government policymakers at the federal, state and local level better understand the needs and interests of entrepreneurs and to elucidate a set of public policies that support a strong entrepreneurial economy. Over the past few years, we have brought together some of America's top entrepreneurs as commissioners and have gone out across the country to talk to thousands of entrepreneurs and policymakers. We have learned from our research and interviews the opportunities and issues that face entrepreneurs related to infrastructure needs and policy implications. My testimony today reflects some of the highlights of the work that we have done. While the media likes to write ``dotcom, dotgone,'' the fact is that Internet technologies are revolutionizing how we communicate and transact business. We will look back 20 years from now and realize that we are just now beginning to see the radical change that this technology will have on everybody's lives, both personally and professionally. Let me give a little bit of my background. I started my first entrepreneurial activities in my early teens before I knew there was such a word as entrepreneur. My first real company was started in college at Syracuse University, which was where I learned the meaning of the word entrepreneur and realized how critical people such as myself were to the economy and to the communities in which we operated. When I was 25, I started my first technology firm, which I had started with $12,000 in 1989, and built its sales to $85 million in 1998 with about 800 employees. When I started PRT, the venture capital industry was tiny as compared to today. Banks did not want to provide funding and the SBA was of little use due to its focus on small business rather than on entrepreneurship. I was creating a software services business which had as its main assets intellectual capital ratherthan a manufacturing or retail business with hard assets. We struggled with financing and growth of the business for many years and were fortunate six years later to attract venture capital to fuel our growth. Today, I am a partner in Interactive Capital, which helps early stage companies and Internet-enabled companies get founded, funded and go through the issues of hiring management teams and accelerating their sales. My two partners and I have been involved with more than 40 companies in our careers and have raised more than $400 million in investment capital to fuel these companies. I live all the issues that you are looking at today, including investment and regulatory infrastructure, labor, globalization, and hope that through my personal experiences and my commission I can give some insight. Some entrepreneurs think that the government should just get out of the way, but I think it is very naive and reactionary since they often feel they are all alone with the world on their shoulders. I believe that the government plays a crucial role and can be a positive player or it can be a hindrance, depending on the actions it takes. I hope that you and your fellow policymakers take the time to understand entrepreneurship, as well as small business, and what the differences are. Before enacting legislation take a moment to understand the impact on entrepreneurs and their companies. I will focus on a couple of the areas today. The first is human capital. In my experiences are in talking to my colleagues, I know that finding the right employee is the most difficult task. For many Internet entrepreneurs, finding talented engineers is an overriding concern. We also see that finding strong management teams and entry level employees is just as hard. Today, it is a little bit easier than it was three to six months ago, but certainly my belief is that over the next big of years we are going to have as strong an issue in finding people as we have in the past. There are couple of the areas that I think need to focus on. The first and foremost is that we are not graduating enough science and engineering graduates in the United States today. The K-12 education system is certainly a problem. We need computer literate employees with strong analytical abilities and competencies in the three Rs. We also need employees who understand the free enterprise system. More universities should be offering entrepreneurship programs. And, most importantly, from a technology standpoint, one of our limitations today is getting the engineering talent and for that, we are looking overseas more and more. Investment capital is a second major issue. Today, the venture capitalists, the large ones, have become very large and there is a gap which I think needs to be addressed between the angel capital at the small end and the large venture capitalists. Another area of focus is the communications infrastructure. There is not enough broadband access across this country and the costs are sometimes prohibitive. Regulations, as we look at both H1B filings, business formation, compliance, capital raising and others is a big issue. Intellectual property, being able to protect the ideas that we have is critical. And, finally, as we look at Internet taxation, the impact of lifting the moratorium has to be studied. Finally, a couple of specific recommendations that I have. First, devise incentives that will encourage more students, especially women and minorities, to major in science and engineering. Secondly, explore changing our immigration system to take into account the education and training of our immigrants, rather than focusing primarily on family relationships. And we should also be looking at the student visas and allowing graduates to stay in. Finally, explore options such as enhancing the effectiveness of Section 1202 of the IRS code providing preferential capital gains treatment for individual investments in emerging start-up companies, relaxing the restrictions on the Investment Company Act to allow formation of more professionally managed funds, and, finally, allowing a small portion of 401(k) funds to be invested in venture funds targeted to the capital gap. Thank you very much. [Mr. Mellinger's statement may be found in appendix.] Chairman Pence. Thank you, Mr. Mellinger. The chair now recognizes Mr. Joshua Engel, who is general counsel for BigStep.Com and comes to us from San Francisco, California. STATEMENT OF JOSHUA ENGEL, GENERAL COUNSEL, BIGSTEP.COM, SAN FRANCISCO, CA Mr. Engel. Good afternoon. First of all, thank you very much for inviting BigStep to testify today on behalf of our customers. Our customers are small businesses from around the country. We at BigStep recognize, as I am sure all the members of this committee do as well, that small businesses are a critical piece of the business ecosystem. They are the nucleus of virtually all corporate geneses. They fill local and specialized places around the globe and often fill critical gaps in rural communities through their focus on services. In fact, this coveted role in our national fabric is recognized by reputation. Fully 85 percent of all Americans recognize small businesses as a positive influence on American life. We also share that belief. In July of 1998, BigStep was founded with a simple premise. We wanted to help level the playing field for small businesses using the Internet. We wanted to give them power and tools to compete with the big boys on line: websites, e-mail, marketing tools and e-commerce tools. Today, nearly three years later, we are succeeding. With over 300,000 members, BigStep is helping small businesses do on line what they do best off line: build businesses based on unique products and services, building meaningful, personal relationships with customers and providing enhanced value. While we are proud to serve the small businesses, we cannot support them alone in their success. As the power of the Internet and broadband access and universally acceptable e- commerce becomes a reality, these businesses that fuel our economy will need greater advocates. There are two particular areas of concern where we believe small businesses can benefit from your support. First, is taxes. We have already heard mention of that day. By their very nature, small businesses are challenged with juggling several duties, making time their most precious commodity. The complexity of small business taxation, particularly for home- based businesses, is challenging enough. What we hear over and over again from our 300,000 members is that on-line commerce tax management is a huge challenge. Just handling sales taxes today over the Internet is extraordinarily complex. If the tax moratorium were lifted and electronic commerce were conceptually opened and new taxation at all levels of government, small businesses will spend an enormous amount of time trying to figure out how much tax they owe and to whom do they pay it. This is time that would be much better spent running their small businesses. As you mentioned in your opening statement, access to technology is also an incredibly important issue. Most analysts agree that an internet presence and tools to communicate with customers via the Internet are critical to business success. One very interesting fact is this. The research firm IDC has found that businesses without any kind of Internet presence average--and this is small businesses up to 100--average 1.74 million in total revenue per year. That number increases to 2.07 million for small businesses with some kind of Internet presence and that number jumps to 2.15 million per year for small businesses with at least a home page. So I think the message there is clear that the Internet can work for small businesses. Indeed, every member of Congress has both e-mail and a website and nearly 100 percent of the Fortune 1000 have websites and they have broadband access. As recently as last month, the research firm IDB found that over 20 million small businesses do not even have websites. This disparity in access and deployment often has as much to do with a lack of time and resources as it does to access to the offering. However, access that is affected by regulatory controls does have a real impact on small business capabilities. In particular, broadband access is a crucial hurdle for small business success on line. As I mentioned earlier, time is the most precious resource to a small business. Using applications like BigStep, with transaction tools and other e- business management services, these things become incredibly valuable when used over broadband connections. With high speed lines, small businesses can truly compete with the large corporations who have had this access for years and continue to provide over 50 percent of Americans their jobs. Finally, small businesses need a friend. They do not have organizations like the ITAA as a support system. If we are indeed moving toward an economic slowdown, we need to show small businesses that we understand their integral role in today's economy. We need to help them flourish and not be stifled by the perplexity involved with more taxation or lack of access to technology. Thank you very much. [Mr. Engel's statement may be found in appendix.] Chairman Pence. Thank you, Mr. Engel. The chair recognizes Ragan Hughs, who is co-owner of Capital Baby Rental in Falls Church, Virginia, for five minutes. STATEMENT OF RAGAN HUGHS, CO-OWNER, CAPITAL BABY RENTAL, FALLS CHURCH, VA Ms. Hughs. Thank you very much, Mr. Chairman. I would like to express my gratitude for being invited to speak. I am not a large company, I am actually a small business owner, so I am speaking to you from the people would be most directly affected by action of the committee. Mr. Engel told you about the two areas of concern to the small business market. As a small business owner doing business both on and off the Internet, the issues of equal access to the Internet and to new Internet technologies as well as the moratorium on Internet taxation are extremely important to me and my businesses. As you said, I am a co-owner of Capital Baby Rental, which is a baby equipment rental company meeting the needs of business and leisure travelers to the Washington, D.C. area. My experience with Capital Baby Rental demonstrates the importance of equal access to the Internet and to new Internet technology. The company itself is a brick and mortar business. We make physical deliveries and pickups of our equipment at the customer's location. However, the Internet is extremely important to the success of our business. Approximately 80 percent of our customers come to us via our website. Since most people making a trip use the Internet in some form or fashion for research and planning, our Internet presence is absolutely critical to us to reach international and domestic consumers traveling to the D.C. area with small children before they absolutely arrive to get them in that planning stage. To use traditional methods of advertising to reach potential customers would be absolutely outrageously expensive and completely prohibitive. Using the Internet, however, we have been able to expand our reach considerably for very little cost. Using services like BigStep which are free to the Internet consumer, it is amazing what you can do. Having an informational website where a potential customer can learn about Capital Baby Rentals, who we are, what we do, what services we provide, what costs are going to be incurred, has become a major part of our marketing plan. Without our website, we would be limited to serving the needs of local residents and last minute travelers and true success just would not be possible. I also operate ThePartyBug.com which I wholly own, which is a party supplies company that is solely an Internet-based business. ThePartyBug.com markets, promotes and sells all of its products on line. The most important issue to us without question is the issue of Internet taxation, the state imposition and collection of sales and use taxes on e-commerce transactions. Currently, when an on-line sale takes place, we collect sales tax when the items are being shipped to the state in which we have a physical location. Therefore, we are taxed exactly the same, no different, no more, no less, than a brick and mortar store. If a small business owner were operating on the Internet also had to collect and report sales tax for several other states and localities, it would make it almost impossible for them to do business. Should the moratorium be lifted, the confusion that would ensue would be outrageous. By nature, Internet transactions actually take place in several different locations. For example, a web business' physical location may be in D.C., but the site is hosted in California, the traffic from that site is routed to several different servers in several different states, the consumer is located in Nebraska. Which state has the right to impose its taxes? Are several or, even worse, all of these states, going to be permitted to impose sales taxes on this one transaction? If this is the case, e-commerce will soon become a thing of the past. Merchants who either cannot or will not keep up with the different regulations will close their Internet businesses. Further, consumers who do not want to pay the excessive taxes would most likely choose to shop only at brick and mortar stores. I feel that the current e-commerce taxation is much more than sufficient. The Internet has opened up several doors for up and coming entrepreneurs like myself and as we move to the next phase of the Internet age, I would like to hold onto the hope that the World Wide Web will continue to make business easier, not more complicated. Thank you very much. Chairman Pence. The chair also will recognize Jonathan Draluck, who is Vice President for Legal Affairs of iBasis and comes to us today from Burlington, Massachusetts, recognized for five minutes. Thank you. STATEMENT OF JONATHAN DRALUCK, VICE PRESIDENT FOR LEGAL AFFAIRS, iBASIS, BURLINGTON, MA Mr. Draluck. Thank you, Mr. Chairman, for the invitation to address the issue that this subcommittee has correctly identified as critical to the success of Internet-based businesses, that is, an environment free from legal barriers. My name is Jonathan Draluck. I represent iBasis. It is a company that has succeeded in large part due to Congress' resolve to keep businesses that provide Internet-based services as free as possible from burdensome regulatory oversight. Please allow me to share with you briefly what iBasis is and what we hope to become. Our core business is wholesale Internet telephone service. We carry the long haul portion of international telephone calls over the public Internet. We provide this service to over 100 telephone carriers around the world, including nearly all of the big U.S. long distance carriers that you are familiar with. We began our operations in a basement in suburban Boston three years ago. We now carry millions of ordinary phone traffic minutes every day, using more than 426 Internet telephony facilities in 46 countries. And, today, if you dial an international long distance call using your regular long distance carrier, the odds are up to one and three that for any of 15 countries you may be trying to reach, including China and Russia, that your call is being carried by iBasis. Our global network operates using Internet protocols which, like the Internet itself, are more efficient, versatile and scalable than the transport offered by traditional networks. Because of this, we are uniquely well suited to provide innovative web-based voice applications over our network. For instance, our Speech Solutions business based in Northern Virginia developed speech-driven applications that are available to anyone with a phone. Some of you may have already used a speech-recognition application such as that employed by major U.S. airlines. The service enables customers to dial in to a number and using spoken command make a flight reservation without ever using a touch tone. Think of speaking into your mobile phone anywhere in the world and having the answer you seek spoken back to you, but never speaking to a person. That is the potential of the iBasis network. The Internet's open protocols offer a lot more. We take for granted the use of the Internet. We all log on and surf, but if you think about it, there are only 300 million PCs in the world, that as compared with 2 billion telephones. So the idea is to leverage the phone and leverage the power of the Internet. For instance, unified communications which we offer lets you hear and respond with your voice to your e-mail or your voice mail from any phone. We also see a world in which ordinary Internet content is accessible over the phone with what we call Global Spoken Web. It is a worldwide infrastructure of interconnected voice enabled websites that respond to spoken requests. Finally, we offer our global IP voice infrastructure as an incubator for other small developers for new applications we can barely imagine now. In this way, we hope to bridge the digital divide by becoming an Internet access device and developing applications for it that are navigated by human voice. A key driver in these kinds of applications is deregulation. On the U.S. front, therefore, iBasis urges the U.S. Government to maintain its current hands-off policy to regulating the Internet. In other words, let us keep the status quo and I will tell you the three issues that we are following. First is international settlement regimes, which historically have maintained a balance of payments for terminating international telephone traffic between any two countries. The international settlement regime is rapidly becoming a relic of the monopoly era on competitive routes, though some countries that continue to have monopolies are persisting in imposing some form of settlements on international Internet traffic. So iBasis encourages Congress to send a signal that it opposes such efforts by some foreign regulators. The absence of such charges has resulted in dramatic increase in international long distance traffic and a commensurate decrease in rates and has benefitted consumers worldwide. Second, unlike in the U.S., where Internet services are not subject to licensing or tariffing requirements, some foreign governments erect obstacles to market entry. We attempt and are often successful in negotiating with the regulatory organ in these countries, but in some cases, countries impose all sorts of obstacles that prove insurmountable. There are also significant delays and obstacles in getting local telephone numbering resources and international codes for signalling and set up. The U.S. Government and in particular Departments of State and Commerce have been an enormous source of support. They have carried our torch and that of others at the ITU, which is an international organization laden with monopolist regulators who still do not see the benefits of competition, innovation and technological change. We are concerned about access charges for the same reason in this country because it requires higher communication services costs for consumers and it is a subsidy that is a relic of the traditional telephone network era. We are hoping to deliver the new, more dynamic flexible and efficient voice services of the 21st century all over the world. We are giving a voice to the Internet, but we need this committee's voice to speak together with ours to help maintain the deregulatory momentum that preserves our invaluable freedom to innovate. Thank you very much for your time and for your efforts on behalf of small business. [Mr. Draluck's statement may be found in appendix.] Chairman Pence. Thank you, Mr. Draluck. The chair as our last witness recognizes Mr. Robert McCord, President and CEO of Eastern Technology Council, and I do so on behalf of the ranking minority member, who was detained but who I know would want you to feel very welcome as a fellow citizen of Philadelphia. I bring greetings on behalf of the Honorable Robert Brady and welcome Mr. McCord of Eastern Technology Counsel in Philadelphia for five minutes of testimony. STATEMENT OF ROBERT McCORD, PRESIDENT AND CHIEF EXECUTIVE OFFICER, EASTERN TECHNOLOGY COUNCIL Mr. McCord. Thanks so much. It is a real pleasure to get to be here and an honor to meet you and spend time with you. With the chair's permission, of course, I would like to submit my written testimony as my official testimony and just speak extemporaneously and be open for questions. As you noted, I have the pleasure of serving as president and CEO of the Eastern Technology Council which has 1300 member companies, dues paying member companies, many of which are venture capital firms and many of which are technology oriented leaders nationally. I am also joined today by my colleague Donna Gentile O'Donnell, who is a strong civil, political and business leader in her own right and is the managing director of our Philadelphia office. I am out in the suburbs in what is called the Route 202 Corridor, recently labeled as one of the three hot new areas nationally to develop tech companies. And Donna, in addition to heading up all of our city-based activities and a close colleague and a close friend of your colleague, she also heads up all of our bio-pharma activities and one of the things that I would very much like to emphasize is that much of the Internet-oriented wealth creation that will flow into America over the next few years will have to do with the convergence of biotechnology, the pharmaceutical industry and the IT industry. Indeed, if Donna is successful in the development of various projects related to the human genome project and also specifically in recruiting the Wellcome Trust, the largest single funder of human genome research in the world to have some sort of an operations in North American, specifically in the United States, that single project is likely to mint more Internet-oriented wealth creation than any 50 publicly traded Internet companies are today. That is a matter of scale. And then, of course, you also are able to create real human progress in a lot of these cases, thanks to leadership from the pharmaceutical sector. So I hope you will recognize that convergence and invite your direct questions to Donna or to me and, of course, we are informally available to you because we are a hop, skip and a jump away. We can commute down here by train. Informally, I would just want to highlight for you, first of all, I would want to associate us with the remarks made across the table here. I believe that Ms. Hughs made a terrific point, that there is serious peril out there if we do over- regulate, over-tax, complicate the lives of a lot of these really inspiring early stage company entrepreneurs like her. There is a real hazard here. It is not the go-go, late 1990s any more. It is harder to get these companies started and funded and it is very important that we not hurt these companies, indeed, that we look for ways to help them. Furthermore, Mr. Mellinger's remarks were a great sort of laundry list of specific actions that I hope this subcommittee will embrace and we would be eager to help. And in terms of the spirit of things going on, I think you have a reputation as somebody who is likely to emerge as a young leader in Congress, I would hope to highlight for you that in terms of the new, new economy, it is a time for reconsideration, it is a time for activism, and it is also time for immigration. In terms of reconsideration, in general, the era of hype is out. Hype is out and margins and profitability are in. Part of what that creates, candidly, is opportunity for leaders from regions like yours and mine. Companies with many more mature companies and lower cost factors. Companies that do have bricks and not just clicks to offer because you are going to get much more mature business leaders looking to use the Internet to lower costs or increase revenues and if it does not do one of those two things, they are not interested in it. It is not the Internet for its own sake. The era of sort of 24-year-old with little more than an ego, a business plan and a tricycle being heavily funded is going away. And that will create tons of opportunities for low- cost platforms that show open affection for these early stage entrepreneurs especially if they bolt into more mature companies. Secondly, I mentioned activism by intent. While we want to be very careful about regulation and preserving an era of deregulation, and I had the great honor of working for a variety of members of Congress who were avid about deregulation, including of the aviation industry and the trucking industry and so on, I was honored to get to work a bit for Bob Walker in a bipartisan setting when I was staff director of the Congressional Clearinghouse on the Future and Bob Walker, a conservative Republican, was very good at highlighting the need to have real activism at the federal level on behalf of science and technology, that this is one of those areas where you have a massive, if you will, externality, an external good is created. And with funds drying up for what we call pre-product, pre- revenue companies, having federal and local governments take a look at ways to play here with relatively small but very meaningful amounts of money could be huge. In Pennsylvania, we have the Ben Franklin Partnership that was created by Governor Thornburg. There are tons of other examples. And, finally, on immigration, we do hope that you will help us get more aggressive on the H1B visas. It is one reason that I was hoping to speak with our great leader from Philadelphia because in particular leaders who are close to labor I believe should be brought to think more creatively about this. We have had tens upon tens of millions immigrate from Central Europe, Eastern Europe, Ireland, Great Britain in the 19th and 20th century to be an aggressive importer of brilliant, talented, skilled labor. It could make a big difference in the early 21st century. Chairman Pence. Thank you, Mr. McCord. [Mr. McCord's statement may be found in appendix.] Chairman Pence. I want to thank the panel for a very exceptional and informative presentation. I will recognize him in a moment, but I do want to acknowledge the presence of my colleague and a genuine young leader in the U.S. Congress, Mr. Toomey from Pennsylvania, who I will recognize in a moment to participate in questions. We appreciate you being here. Also a subcommittee chairman on the Small Business Committee. A few questions, if I may. There have been several common denominator themes that I have heard from the witnesses and I want to get a sense from each of you about the role and the threat of Internet taxation. I think Ms. Hughs raised that issue in the most practical way. But before that, Mr. Clark, you in your presentation talked about creating incentives to investment. You as not only a constituent of mine, but a successful entrepreneur, attracting investment capital. Others have talked about attracting investment capital. As this committee moves foreword and makes an effort particularly to promote incentives for investment, I wondered if you might give more detail to the idea that you introduced of having a similar profusion in the new technologies area that we have that allows people to roll over their capital gains on the sale of a house toward the purchase of a new home. Is that what you were referring to? And briefly describe how we would do that in Internet investment. Mr. Clark. Very similar. And it is not--I do not think you should necessarily have to limit it just to the Internet side. And he mentioned the 1232. Section 1045 of the tax code is there that allows you if you have a qualified business interest stock, it has to be a qualified interest, which means you had to currently have purchased it at the very beginning stages, something that momsand pops and certainly those of us in Indiana are rarely eligible to participate because of other securities rules and regulations, rarely do we ever get to see them. We need to figure out a way to allow the average American investor the opportunity to help build companies, whether they are old companies that are trying to re-tool to become part of this new economy as they watch the manufacturing jobs leave, or whether it is new companies that are coming along, where people want to invest. We need to give them ways to encourage it and when you look in a market and you realize you are going to lose 25 percent of your wealth when you count estate taxes, it is very difficult to sell, to go from one company to another. And I believe that there are--very similar to the stock exchange on section 1031 as we transfer property there is no limitation there to the amount of money that you can have little or big. And it would be a very easy process. As a financial planner, the most trying time I see all year long in my client's face is not just having to pay Uncle Sam on April 15th, but it is sitting down with years and years of tax returns and trying to figure out really what their tax basis is. They try to be honest. They try to do the right thing. Many of them are in my church. And it is a challenging day. I have to believe with trading 3 billion shares of stock every single day on the United States markets that it is tedious and expensive for the IRS. Senator John Breaux from Louisiana pointed out that 90 percent of the money that comes from federal estate tax is used to operate the system. I have never heard the percentage quoted for capital gains tax, but I have to believe it is a very expensive process for the IRS to really mandate and watch. If we could figure out how to let people put money in, they would have to keep track of it one time, and allow them to go and invest in companies big and small that are right for that time and right for that economy and have the merits and deserving of the investment without regard to taxation, I think you would see a lot of the littler investors able to help promote companies like my own. Chairman Pence. Mr. Mellinger, you talked about devising incentives during your testimony. What specific incentives would you like to see this committee promote to encourage investment capital in high technology? Mr. Mellinger. Well, there are a couple of things I think that could be looked at. One, from a standpoint of individuals investing, is the change in ERISA regulations, specifically the prudent man rule, which enabled public pension funds to invest a portion of their money in risk capital. And really the result of that, which I do not think was the main intention at the time that the legislation was enacted, was what we know of today as the venture capital industry. While it was a small, small industry before that, the amount of public pension funds that came into the venture industry was enormous. As we look at it today, one of the biggest pools of money is out there is the 401(k) fund. A lot of people would love to be able to invest in private companies but do not have the ability to today, I think looking at enabling some small portion of 401(k) assets to be allocated towards riskier investments is something that would be a very interesting area and create a whole new class of capital that could come in to the market. And I would hope that that would be looking at more than the capital gap. Because right now, one of the biggest problems we face as we help young companies is the first couple hundred thousand dollars that might be invested in a company while funds coming from the angels, friends, families, and people like that is great, but it is harder today than ever to raise these funds because of what has happened in the public market. So, as Joe said, we should be able to give people more incentives around this capital gains issue and be able to, as we talked about, to provide the Section 1202 preferential capital gains treatment for individual investments. We very much support looking at both these ideas. The last issue I would raise, and I do not have a specific recommendation on how to do it, but we should support the people that have organized loosely--some more officially, but into these angel networks. I think we need to encourage people to invest. The biggest thing that we have found with the National Commission that has been troublesome is looking at a map of the United States and seeing where all the venture capital has been invested and then taking that next step which is where all the angel capital has been invested. And then very much match each other, more then two-thirds of all venture capital that has gone into five states in the United States. Investments are not being shared equally across this country. What has happened is that successful companies that have cashed out through either selling the companies or IPOs, and have become angel investors. Lo and behold, they are right in the areas where those first companies started. And so we see more concentration happening over time, not something that is spreading out. And I think that the more we can do to encourage people across the country to invest and build companies the better. Chairman Pence. Mr. Engel, you talked about the mission of your company was to level the playing field for small businesses and I commend you for that. In the public policy realm, are there specific instances where in the high tech area you think we in Congress and on this committee could pursue that goal? Mr. Engel. Absolutely. In fact, I will stick to the two points that I raised in my statement. The first is anything you can do to keep the tax system as simple as possible for small businesses like Ragan the better. Again, if the moratorium is lifted in October, who knows what may come out of that as local and state jurisdictions from around the country start to say, hey, I want a piece of the pie, too? And the second is an overall point of increasing just access to technology, broadband especially, the services such as BigStep but there are a ton of others out there that can help a small business actually level the playing field and really that was our mission. Big businesses have money, they have staff and they a lot of time have technical expertise. They will have a whole IT department just to get themselves up on the web. Ragan does that all herself. So a broadband access helps her do those things and to get on the web and really establish her Internet presence in order to help her business. So I will stick with those two and anything that this committee can do, that would be great. Chairman Pence. Thank you. Ms. Hughs, you focused on Internet taxation at a very practical level. If the moratorium was lifted, do you believe that the Capital Baby Rental could survive? Would you have the capability of complying with the wide range of taxes or would you see that as a threat to your business survival? Ms. Hughs. Well, I think that was what was interesting about me being selected to come before you today. Since I have two different businesses that do totally different things with the Internet, a business like Capital Baby Rentals is not going to be affected by the taxation moratorium unless there are new taxes that are going to be imposed on Internet access because we are not actually selling anything on the Internet; it is just an informational site where peoplecan find out and then call us, fax us, e-mail us to set up a reservation. The transaction does not occur over the Internet. But for businesses like ThePartyBug, it would just devastate it. It is very difficult for a small business owner who is wearing a million and fifty different hats to be an expert in everything. We do not have a general counsel and an IT department and we have to do all these things by ourselves, so that is a barrier right there. And if more tax regulations were imposed upon us, it would just be completely prohibitive to most small business owners doing business on the Internet to continue doing that. In addition to the fact that I just basically do not think it is fair. I hear brick and mortar saying, oh, well, you guys get so many breaks, but it is actually not true. For instance, I am in D.C. and if somebody has to have something shipped to the District, I collect the sales tax on that and then I report that to the District of Columbia. So I am not doing any different than the Gap down the street, so I do not feel that we should have to be double taxed or consumers should have to be penalized because they want to purchase something over the Internet when it is a huge convenience, saves time, allows access to things that people with disabilities and what not cannot access going to regular stores sometimes. So I do not think that that would be very good at all. Chairman Pence. Mr. Draluck, your business is very fascinating to me and represents one of those new uses of the Internet in terms of communications technology. The international settlement regimes that are in place now, do you believe that they need to be modified, set aside? I understand from your testimony that they are a barrier, but what do you see that this Congress and this committee should do to address that somewhat antiquated means of distributing resources in the telephone business? Mr. Draluck. It is a prime example of a system of subsidies that really affects innovation and development in every telecom sector, both locally and internationally. On the one hand, a pitch about taking one's small business international which iBasis has done, and that is that the kind of forward thinking discussion that is taking place here today does not occur in many of the countries that iBasis serves and, as a result, we are faced with all sorts of obstacles. The settlements in particular, many countries that have signed the WTO have simply dropped settlement charges. Many lesser developed countries that might have one monopoly carrier see settlement charges as an enormous source of revenue because when calls are terminated into the country they collect. Now, one way that iBasis has worked to get around this actually to work with monopolist carriers. That allows regulators in the distant countries to get a taste of what technological innovation can bring to consumers in that country and understand--or let us say begin to understand how the competitive force operates. So our strong position is that this committee and Congress overall recognize that these kinds of issues over which you are grappling are issues in their infancy overseas and the FCC has taken a big stand to disallow carriers in this country from paying settlement charges over a certain amount and that rate is constantly coming down and it is almost a fiction that they are strangled, but being disallowed to pay those fees because there is a balance of payments, it forces other countries to reduce the collection. So if we can get the message internationally that that kind of subsidy that is not market driven will not lead to development, then that would be quite an important message and we are grateful for that. Chairman Pence. I am going to come back to Mr. McCord before I close, but I do want to acknowledge and recognize for any questions he might have the gentleman from Pennsylvania, my colleague, Mr. Toomey. Mr. Toomey. Thank you, Chairman. I would like to start by saluting you for having this hearing. I for one think that the development and, probably more precisely, the deployment of new technologies, to put it very broadly, has been the great driving force behind the growth in productivity and the boom in our economy over recent years. And I think it is not a coincidence that as a general matter the technology sectors, if you will, of our economy have tended to be the least regulated and the most successful and innovative at the same time. I think there is a good reason for that. I have just really one area that I would like to discuss a little bit in particular with Mr. Clark, if I could. In your testimony, you pointed out a couple of things. One is the well known fact that the capital gains tax has a tendency to lock investments in in ways that are not necessarily rational for the investor otherwise, not as productive for the economy as they could be if investors were not locked in, and you point out that that kind of mentality that is a creation of the tax code could in fact contribute to things like excessive share prices when there is a run up and perhaps contributed to the speculative bubble that we saw recently. But you make an interesting point also, and I think you are talking about a capital gains tax, although perhaps you would broaden that to include other multiple layers of taxation on savings like the double taxation of dividend income, for instance, but you make the point that the capital gains tax in particular hinders the capital formation for new companies and I think that is an important observation. And while for new companies and for some others there might be a strong case to be made for allowing people to roll into other investments, I prefer abolition of the capital gains tax all together. Mr. Clark. Amen. Mr. Toomey. It is just simply an irrational tax. But could you explain a little bit more how you would foresee a greater opportunity to build capital in new companies, in start-up, in inherently more risky ventures in the absence of a capital gains tax, if you believe that would be the case? Mr. Clark. Sure. I think there are two things that we have to understand and one is that we have left an economy, what we call the extension of maturity phase, where there is no question that the companies that have strong loyalty, the GMs, the Fords, the Chryslers, they are not going out of business and so you can tax at will and it is not a matter of somebody pulling their money out of GM to go to another company or not. When you go back to the entrepreneurial phase or the shake- out, you have people literally trapped. I mean, literally. Psychologically, they are trapped when they look at seeing how much of their wealth is going to leave if they go into another company. I think it would be very, very simple to develop a method, if you will, to say, okay, this is the amount of money that we have that we have put in, whether it be on a monthly basis or whether it be in lump sums, over a period of time, this is the amount of money that we have invested in the United States stock market in these particular type of companies. And I do not believe even though we are here for the Internet today, I do not think it is just Internet. I think it is about companies that are really trying to use new technologies and new innovations that are really trying to drive our country to the next level, that are trying to take our economy where it has to be. And you figure out how to define what those companies are andlabel them as such and they can go freely from one company's investment to another without having to have any regard to a capital gains tax until they take the money out to go spend, to buy a Harley-Davidson or do something else that fuels the economy. Mr. Toomey. Mr. McCord, I would be happy to hear your thoughts on this, but I wanted to just respond briefly. My reservation about creating a category of investments is that we then bias investors in favor of those at the exclusion of others and I question--well, I do not question, I doubt strongly whether the government has the wisdom to know which ones the economy---- Mr. Clark. I agree. I have the same problem with the government investing the Social Security money that way because we are picking out some companies versus others. Mr. Toomey. Right. Mr. Clark. And so I agree. I am with you. Abolish the capital gains tax all together. I am telling you, the next level of my company, to get to the next step, I need $1.4 million and if you change the capital gains rules, I can have it in two days. And if you do not, I get to go back home and go through the same struggle that I did to raise the first million and a half. Mr. Toomey. Thanks. Mr. McCord? Did you have something? Mr. McCord. Yes. First of all, it is a great honor finally to meet you in person. Even though you served your share of time at the Evil Empire of Harvard Business school, if I remember correctly. Mr. Toomey. Undergrad. Mr. McCord. Oh, okay. Well, then we have that in common. I am a Wharton partisan. I did want to be responsive on this and also echo the 401(k) idea which I think is a brilliant one and I had not heard before. Having staff members of Congress, you know, you always do kind of mine for the gold of actual new ideas. Just trying to be responsive a little bit here, I think a blended average of what the two of you are talking about, without pretending that I am an expert in the Byzantine ways of the tax code, might be the most productive. Otherwise, you run into a watch out what you wish for, you may get it. If you eliminate the inheritance tax and then you have a bunch of--you know, you are self-made, you made a lot of money, now you are a public servant. Your kids did not make a lot of money, they inherit it tax-free because you paid taxes on it. Okay. Now, they put it in the stock market. Now, they have a smart dad, he went to Harvard, et cetera, they get 11 percent a year on it. They may never in their lives pay a dollar in taxes if there is no capital gains tax cut. Now, I just want you to ponder that for a second. Conversely, the next time we are trying to float a bond for Lehigh Valley to have fat pipes so that the less affluent can get the same level of service as Alargco, we have no tax tool whatsoever because tax-free is meaningless if we have no capital gains. Conversely, if you have patient treatment where you say if all you are doing is moving your money from one field to another but keeping it in the equity markets, you are not out there buying SUVs or, you know, third homes or whatever. That is a big deal. And I do think in general we have problems with the capital gains tax cut. To your point, I mean, you have probably read about Safeguard and some of those fiascos. A lot of that stuff, a lot of the margin purchasing that was done, was done specifically to avoid capital gains tax cuts because they figured their cost of capital was 7 percent instead of 40 percent. So I understand these are challenging problems, but in a hierarchy, at the same moment that you are going after the inheritance tax, I would say something that you might want more promptly to put on your to do list to allow on a voluntary basis the small fry who are with 401(k) plans to allow them the freedom to put up to 1 percent of their 401(k), because the vast majority of people moving towards retirement are not part of these SURS, PSRS, CALPERS. We are speaking in code, but these are the largest pension fund funders because they are state-run pension funds. If you allowed the average 401(k) for the average risk affectionate true entrepreneur to say, hey, heck, I will put 1 percent into private equity funds, you would really turbo charge a lot of the venture money out there and I think have a big net benefit in a very timely fashion because there is a fright--I mean, all respect to angel groups aside, those tend to be a long run for a short throw. You get 20 rich guys sitting around Lehigh, they get together because they want to get together with other rich guys, they kick tires for a few weeks and then they squawk to put 10 grand into a company. A 401(k), now, that is a real turbo charger. So just trying to parse this out and give you a flavor for what you might want to put on your to do list, I wanted to be responsive in real time to your thought. Mr. Toomey. Thank you. I will yield the balance of my time, Mr. Chairman. Chairman Pence. Thank you, Mr. Toomey. Thank you again for participating in the hearing as a leader in the Congress on economic issues and as a subcommittee chairman. You have greatly enhanced the value of this hearing. I know we and the witnesses appreciate your participation. Let me just close, if I may, by thanking each one of you. I can expect that testifying before a congressional hearing is a harrowing experience. Many of you traveled far distances to be here and may well have enjoyed a sleepless night last night thinking about your presentation. Let me say that you were none worse for the wear today, that each of your presentations were not only eloquent and well executed, but, as I hope you could tell from my questions and Mr. Toomey's questions, quite well informative and very helpful to us as we begin this process of really using this subcommittee as a driving force for small business entrepreneurism and policies in Congress that will promote that. Let me close by saying as someone who built my own small business starting in my basement of my home and working in the communications area that I am a bit envious of each one of you. Now sitting in the stolid chambers of Congress, I some days pine for the rugged world of entrepreneurism and I hope each one of you know that this chair admires you as the new Edisons, the new Fords, and as genuine pioneers in an economy that our children and grand children will know nothing different than. Each one of you are the first ones into the wilderness, really paving a way for what I think is the real key to the United States of America remaining the dominant force on the world economic scene. So I congratulate you for your courage. I congratulate you for your testimony and I thank you for being here today. With that, this hearing is adjourned. 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