U.S. GOVERNMENT PRINTING OFFICE

67–831 WASHINGTON : 2001

THE IMPACT OF THE COMPLEXITY OF THE TAX

CODE ON SMALL BUSINESS: WHAT CAN BE

DONE ABOUT IT?

HEARING

BEFORE THE

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

OF THE

COMMITTEE ON SMALL BUSINESS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

WASHINGTON, DC, SEPTEMBER 7, 2000

Serial No. 106–70

Printed for the use of the Committee on Small Business

(

For sale by the U.S. Government Printing Office

Superintendent of Documents, Congressional Sales Office, Washington, DC 20402

(II)

COMMITTEE ON SMALL BUSINESS

JAMES M. TALENT, Missouri, Chairman

LARRY COMBEST, Texas

JOEL HEFLEY, Colorado

DONALD A. MANZULLO, Illinois

ROSCOE G. BARTLETT, Maryland

FRANK A. LOBIONDO, New Jersey

SUE W. KELLY, New York

STEVEN J. CHABOT, Ohio

PHIL ENGLISH, Pennsylvania

DAVID M. MCINTOSH, Indiana

RICK HILL, Montana

JOSEPH R. PITTS, Pennsylvania

JOHN E. SWEENEY, New York

PATRICK J. TOOMEY, Pennsylvania

JIM DEMINT, South Carolina

EDWARD PEASE, Indiana

JOHN THUNE, South Dakota

MARY BONO, California

NYDIA M. VELAZQUEZ, New York

JUANITA MILLENDER-MCDONALD,

California

DANNY K. DAVIS, Illinois

CAROLYN MCCARTHY, New York

BILL PASCRELL, New Jersey

RUBEN HINOJOSA, Texas

DONNA MC CHRISTENSEN, Virgin Islands

ROBERT A. BRADY, Pennsylvania

TOM UDALL, New Mexico

DENNIS MOORE, Kansas

STEPHANIE TUBBS JONES, Ohio

CHARLES A. GONZALEZ, Texas

DAVID D. PHELPS, Illinois

GRACE F. NAPOLITANO, California

BRIAN BAIRD, Washington

MARK UDALL, Colorado

SHELLEY BERKLEY, Nevada

HARRY KATRICHIS, Chief Counsel

MICHAEL DAY, Minority Staff Director

SUBCOMMITTEE ON TAX, FINANCE, AND EXPORTS

DONALD A. MANZULLO, Illinois, Chairman

STEVEN J. CHABOT, Ohio

PHIL ENGLISH, Pennsylvania

PATRICK J. TOOMEY, Pennsylvania

CAROLYN MCCARTHY, New York

RUBEN HINOJOSA, Texas

CHARLES A. GONZALEZ, Texas

GRACE F. NAPOLITANO, California

PHILIP ESKELAND, Senior Professional Staff Member

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C O N T E N T S

Page

Hearing held on September 7, 2000 ....................................................................... 1

WITNESSES

Sununu, John E., a Representative in Congress from the State of New Hampshire ....................................................................................................................... 2

Davidoff, Martin, Martin Davidoff & Associates ................................................... 4

Tauzin, W.J. ‘‘Billy’’, a Representative in Congress from the State of Louisiana ..................................................................................................................... 6

Oveson, W. Val, National Taxpayer Advocate, Internal Revenue Service .......... 9

Olson, Pamela, Chair, Tax Section of the American Bar Association ................. 11

Lifson, David, Chair, Tax Executive Committee, American Institute of Certified Public Accountants ..................................................................................... 13

Moody, Scott, Economist, Tax Foundation ............................................................ 15

McCraken, Todd, President, National Small Business United ............................ 17

APPENDIX

Opening statements:

Manzullo, Hon. Donald A ................................................................................. 23

Prepared statements:

Sununu, John E ................................................................................................ 25

Davidoff, Martin ............................................................................................... 29

Tauzin, W.J. ‘‘Billy’’ .......................................................................................... 42

Oveson, W. Val ................................................................................................. 53

Olson, Pamela ................................................................................................... 60

Lifson, David ..................................................................................................... 80

Moody, Scott ...................................................................................................... 99

McCraken, Todd ............................................................................................... 103

Additional material:

‘‘Tax Complexity Factbook’’, April 2000, Joint Economic Committee Staff

Report ............................................................................................................ 115

Letter to Mr. Manzullo from Edward Mezner, Certified Public Accountant .................................................................................................................. 136

Letter to Mr. Manzullo from Donald Benning, Millikin Benning Kleckler . 143

Letter to Mr. Manzullo from Henry Fleming, Certified Public Accountant 145

Letter to Mr. Manzullo from Richard Lamm, Lindgren, Callihan, Van

Osdol & Co., LTD .......................................................................................... 148

Letter to Mr. Manzullo from Glenn Miller, CPA & CVA .............................. 154

Letter to Mr. Manzullo from Leland Freberg, CPA ....................................... 155

FY 1999 National Taxpayer Advocate’s Annual Report to Congress ........... 157

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THE IMPACT OF THE COMPLEXITY OF THE

TAX CODE ON SMALL BUSINESS: WHAT CAN

BE DONE ABOUT IT?

THURSDAY, SEPTEMBER 7, 2000

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON TAX, FINANCE AND EXPORTS,

COMMITTEE ON SMALL BUSINESS,

Washington, DC.

The Subcommittee met, pursuant to call, at 10:05 a.m., in room

2360, Rayburn House Office Building, Hon. Donald A. Manzullo

(chairman of the Subcommittee) presiding.

Chairman MANZULLO. We are going to get started in an a little

unusual manner. We are waiting for two Members of Congress to

come who constitute the first panel. They are on their way. I would

like to take half of the second panel and get started with their testimony. We are going to have a tyranny of the bells today with voting going on, etc.

Martin Davidoff is here. Martin, why don’t you take the seat on

the end here? Who else is here from our second panel? Okay. Why

don’t you come on up, and let’s get half of the second panel. Leave

two chairs on the end for the Members of Congress, and as soon

as they come in, if you don’t mind, we will interrupt your testimony

in order to accommodate them so they can get on with their other

duties.

Mr. Tauzin has been a little busy, if you know from watching C– SPAN. When I was going to bed last night, he was still grilling

Firestone.

I want to immediately get into the testimony. I will not do much

in the way of introductions, except that I am going to start with

Martin Davidoff of Martin Davidoff & Associates from Dayton, New

Jersey, who is here on behalf of the National Federation of Independent Businesses.

We have the 5-minute rule here. When it turns yellow, you have

1 minute. When it turns red, the gravel comes down.

[Mr. Manzullo’s opening statement may be found in the appendix.]

Chairman MANZULLO. Mr. Davidoff.

Mr. DAVIDOFF. Thank you, Mr. Chairman, Members and their

staff which have been most helpful. First of all, I would like my

written statement entered into the record.

Chairman MANZULLO. Without objection, all written statements

will be admitted.

Martin, I will interrupt.

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Mr. Sununu, do you want to come up? And we will start with

you.

Mr. Davidoff, we will be back to you shortly.

Mr. DAVIDOFF. Thank you.

Chairman MANZULLO. It is my pleasure to introduce to you Congressman John Sununu from the great State of New Hampshire.

And, Congressman Sununu, we are on the 5-minute rule that I enforce, so if I get somebody who can operate this timer. Please start.

STATEMENT OF HON. JOHN E. SUNUNU, A REPRESENTATIVE

IN CONGRESS FROM THE STATE OF NEW HAMPSHIRE

Mr. SUNUNU. Thank you, Mr. Chairman. I am familiar with the

5-minute rule, and I will do my best to comply. And I apologize for

arriving a little bit late and hope that the panelists and in particular Mr. Davidoff won’t hold it against me in any way.

It is a pleasure to be here. I am pleased that you are holding this

hearing today on the complexity of our Tax Code and in particular

its effect on small business. For anyone that has traveled around

the country and spent a little bit of time with small business owners and entrepreneurs, the Tax Code is probably the first thing

that comes up, even, in most cases, before regulation, because it is

something they deal with year in and year out. And it is not just

once a year when they pay their taxes. It is every day, as I will

describe, and it is a source of endless frustration for entrepreneurs.

In a previous part of my career, I worked as chief financial officer and director of operations for a small electronics firm of about

30 employees and dealt with the financial issues for the owner of

a firm that was a Sub-Chapter S corporation, and dealt with a lot

of these issues on a personal level. So in many cases I speak from

anecdotal, but really personal experience as well.

The complexity of the Tax Code and its impact on small business,

I think, is felt in three particular areas. There is the outright cost

of the complexity, the cost of doing your returns every year, paying

someone to prepare your returns and submitting them.

Of course, there is also the opportunity cost, the time that is lost,

lost not just from business operations, but from time from the family as well, because so many small businesses are family-owned,

and so many entrepreneurs and managers put in such an extraordinary amount of their personal time in their companies.

The third cost of the complexity of our Code is in what I just call

distrust. The complexity breeds distrust. It breeds uncertainty as

to whether or not the same system applies to both larger and

smaller corporations. I think that undermines public confidence in

the way we tax and raise revenues for the Federal Government.

We can solve this problem. We can do better. And I am here to

testify on behalf of tax reform, fundamental tax reform, and the

implementation of a flat tax, an issue that I have worked very hard

on with the Majority Leader Dick Armey. He has taken a strong

leadership role on the objective of scrapping the current Code and

replacing it with a system that is simple, honest and fair and that

addresses each of these costs that I mentioned.

First a few words about the exact complexity of the system and

its effect on small businesses. First, the estate taxes. An inordinate

amount of time at the small business level and at the family busiVerDate 11-MAY-2000 10:27 Feb 28, 2001 Jkt 070376 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 E:\HEARINGS\67831 pfrm02 PsN: 67831
3

ness level is taken in preparing, avoiding, understanding our complex estate taxes, trying to maintain the small business flavor, and

that means keeping the small business in a family. An entrepreneur often has worked hours, years managing a business. He

has had his family members involved. They want to keep it in the

family, but the estate tax burden can be crushing, and the complexity of the estate taxes can be overwhelming on a yearly basis.

Depreciation schedules. We have called on small businesses to

depreciate equipment, sometimes, for example, computers, over 5

or 7 years, which doesn’t make any sense in and of itself in that

we ask small businesses to keep separate books for depreciation for

an income-reporting basis and for IRS purposes. Keeping multiple

books doesn’t serve any real useful purpose, and, of course, the

time and effort required to keep on top of the depreciations rules

can be very burdensome for a business that only has 10 or 15 or

20 employees.

Capital gains taxes. Small businesses spend an enormous

amount of time dealing with the complexities of employee stock

ownership plans, the Sub-Chapter S filings and the impact of potential sales of stocks on their capital gains liability.

And finally retirement savings, IRAs and 401(k)s for employees,

but also retirement savings plans that are necessary to avoid the

crushing burden of estate taxes.

All of these complexities have the impact of raising the cost of

running a small business, taking up an inordinate amount of management time and, of course, undermining confidence in the way

we fund government.

How can a flat tax solve this problem? I believe that a flat tax

would have enormous benefits for both individuals and corporations, but in particular for small businesses because now small

business is going to be able to take a look at its revenues for the

years, deduct all of its legitimate expenses, cost of goods, wages,

salaries, all capital equipment and investment and then pay a simple, honest, fair rate. The same system applies to corporations

large and small. It is understandable. You don’t have to keep two

sets of books. You don’t have to go through the complexity of estate

tax planning. In fact, there would be no estate taxes, no capital

gains taxes, no inheritance taxes, no taxes on Social Security benefits, and no depreciation schedules.

All of those add to the burden of running a small business. They

would be eliminated. And by having the same system for everyone,

we restore public confidence in the way that we finance government. I think it would make an enormous difference for the small

business community in time, in money, and in confidence, and it

would create the right set of incentives for entrepreneurs to invest

in their employees, invest in their firms and create economic opportunity. And that ultimately should be our goal here, not to try to

distort the market, but to create an environment where entrepreneurs can do the job of creating economic opportunity.

Thank you, Mr. Chairman.

Chairman MANZULLO. Thank you, Congressman Sununu.

[Mr. Sununu’s statement may be found in the appendix.]

Chairman MANZULLO. If you would like to join us on the panel,

you are welcome to.

4

Mr. SUNUNU. I have a commitment, Mr. Chairman. I would like

to thank you for having the hearing and thank the panelists for

being here. My experience in this regard, as I said, working for 4

years in a small business setting, but my guess is the panelists

have far more depth of experience with the kinds of frustrations I

have touched on in my testimony.

Chairman MANZULLO. Thank you very much. I appreciate it.

Martin, we will start with you again, knowing full well that if

Mr. Tauzin comes in, which he probably will after six words of your

testimony, we will have to interrupt you again. If you are almost

through, we will make sure we finish up.

STATEMENT OF E. MARTIN DAVIDOFF, E. MARTIN DAVIDOFF &

ASSOCIATES, DAYTON, NJ, ON BEHALF OF THE NATIONAL

FEDERATION OF INDEPENDENT BUSINESS

Mr. DAVIDOFF. Thank you. Thank you very much. I am here representing 600,000 small businesspersons on behalf of the NFIB. I

come before you with a unique perspective, one of an attorney, a

CPA, a small business owner myself, having participated in two

White House conferences, and an advisor to hundreds of small

businesses. So I see this day in and day out.

Every time Congress attempts to deal with simplification and

simplifying the Tax Code, we get something called ‘‘complification’’. We get a morass of tax law that is even more complex. Just take

a look at what has happened in the last couple of years.

In 1996, Steve Forbes is talking about the flat tax and simplification, and everybody was gung-ho, yes, let’s do it. Then in 1997,

1998 and 1999, you added infinitely more complexity. Just a couple

of examples, we changed the safe harbor for estimated taxes for

high-income taxpayers three times. If you look at page 5 of my testimony, you will see a table that shows public laws and the percentages that were changed time in and time out. One of the bills

was just to change it from 105 to 106 percent for 2 of the 4 or 5

years that are in the table. It is really crazy the way Congress goes

about it. Instead of changing the tax rates, they add complexity to

the tax law because they don’t want to tell the American people the

correct tax rates.

Other things that have been done, you added a child credit, but

then from $110,000 to $130,000 you are phasing out that credit.

You added complicated learning credits and retirement alternatives, each with its own phaseout limitations.

And that takes us to really the most complex problem for all taxpayers, not just for small business, and that is the phaseout. It

started with Congressman Claude Pepper in phasing out 3 percent

of your itemized deductions to the extent that your income exceeded a base and in phasing out exemptions. They are bad ideas. Why

are they bad ideas? Because what happens here is you have

changed the tax law to look not at taxable income, but you are

looking at adjusted gross income. For example, with the phaseout

of exemptions, if I am making $200,000 a year adjusted gross income, and I am a family of four, you are adding 3.3 percent to my

36 percent tax rate. My real tax rate is 39.3 percent, even though

the stated original rate is 36 percent. And after I am phased out,

the tax rate comes back. So what have you done?

5

We have all argued should there be a flat tax, or should there

be a progressive income tax like we have? What you have done

with phaseouts is you have given us a regressive tax. The tax rate

is lower for people who get beyond the thresholds. And when you

have thresholds of $110,000 for learning credits and $74,000 for

double E bonds, and all these phaseins and phaseouts at different

levels, all you are doing is you are imposing a higher tax rate.

And I say to you bring back taxable income. Congress defined

taxable income as the basis on which you are going to set one’s

ability to pay. I will throw out the following example: If you have

two families—one with 10 exemptions, 10 children, and one with

zero children. Let’s say they are making $300,000, so they have

fully phased out their exemptions. Are you telling me that the family with 10 children is in a position to pay the same tax as the family with no children? Clearly not.

On every level you look at this, regression of taxation, or fairness, phaseouts don’t work. They are a terrible idea. Get rid of

them, please.

Let’s go to a couple of specific examples about small business.

First of all, we have meals and entertainment expenses. It is a

complexity issue. If somebody comes down to Washington on business, and they stay in a hotel they turn in their bill back to the

comptroller back in the office, and the comptroller says, okay, I will

classify that as travel. That is what it used to be. But now they

have to look at that bill and segregate out the meals, because

meals are only 50-percent deductible. And they have to put that in

a different account called meals and entertainment. But then if I

have a picnic for all my employees, I have to put it in another account because picnics for employes comes into one of the 10 exceptions under Section 274 that say you can deduct 100 percent.

Chairman MANZULLO. Just eat outside every time.

Mr. DAVIDOFF. Eat outside every time. Well, you have to pay for

your employees every time. That is the bottom line.

So basically what we have here is we have a situation with meals

and entertainment that adds much complexity. And people talk

about the three-martini lunch. You have plenty of provisions in section 274 that prevent abuse.

I see that my time is almost up, so let me just wrap up with two

concepts. One other concept is a tax trap. Congress has come forward and said, we are going to let everyone deduct $20,000 with

certain exceptions for capital improvements. So Joe Taxpayer files

his tax return, and he says, I know about that $20,000 rule. I have

purchased a $3,000 computer for my business. It is classified as office supplies, and those who work with real taxpayers know that

happens. The fax machine, everything ends up in office supplies.

He deducts it on the return. It is $3,000. He is perfectly entitled

to it under the law. However the law says you have to make an

election. He didn’t make the election, and there are approximately

a dozen court cases that basically take that deduction away for failure to make the election. In my materials there are citations of a

couple of those cases. And a very simple change that you can make

that would probably be practically revenue-neutral that would just

say if somebody takes a deduction, let’s deem it to be an election.

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My time is up. I just wanted to say I would like to thank the

Chairman for taking his time to fix the installment sales problem

for accrual-based taxpayers and to say that for cash-basis taxpayers that we ask that we index for inflation the $5 million

threshold of 1986 and increase that to apply to businesses of similar size back then, which today would be businesses of $6 and $7

million. Thank you very much.

Chairman MANZULLO. Thank you, Mr. Davidoff. I appreciate it.

[Mr. Davidoff’s statement may be found in the appendix.]

Chairman MANZULLO. Good timing. Congressman Billy Tauzin.

What time did you finish last night?

Mr. TAUZIN. I think I have been called and recalled. We finished

about 11 o’clock.

Chairman MANZULLO. Well, you are up.

Mr. TAUZIN. Thank you, sir.

Chairman MANZULLO. And we have the 5-minute rule here.

STATEMENT OF HON. W.J. ‘‘BILLY’’ TAUZIN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF LOUISIANA

Mr. TAUZIN. I will hit it really quickly for you.

In a nutshell we have an outdated, outmoded Tax Code, and

Americans know it; 7 million words of instructions from Washington, D.C., that nobody can understand anymore. And if you try

to get information on what it means, even from the IRS, you get

wrong answers all too often. It is a mess. More importantly, it is

a set of instructions on how to live your life from Washington, D.C.;

if you think about it, 7 million words about how you should earn,

spend, save, what you ought to do with your money. There are government preferences built all over it. We set them. We change

them every now and then.

In fact, since Ronald Reagan left town and simplified the Code— do you remember—from 14 different rates down to a couple, we are

back up to five effective rates, over 5,000 changes later. Many of

those changes we put in thinking we are doing a good thing for

America. But we ‘‘complexed’’ that Code up, and we literally give

instructions through it about how to live your life.

When you look at the instructions, you ought to think about

what instructions we are getting. Think about it. The power to tax

is the power to discourage or destroy. So look at what the Code

tells you. What does it discourage? Look at what it taxes. It discourages you from earning income. It taxes incomes. It taxes savings; therefore, that must be bad. It taxes investments. It taxes

gifts to your kids in life. It taxes gifts to your family in death. And

worst of all, it even taxes you for buying an American product and

rewards you for buying a foreign product. You haven’t thought

about that one. Think about it.

Dr. Dale Jorgenson at Harvard University, who is the dean of

the economics department, did a paper on the subject, and his

paper says in effect that the income tax adds on average 25 percent

to the cost of every product and service made in America. That is

on average. The price of bread, for example, is 35 percent. The reason that is true is every person in the manufacturing process, from

the farmer all the way to the retailer, has to pay taxes. The employer pays taxes. You pay taxes on the business. You pay taxes

7

on compliance costs. You have to hire accountants and lawyers. All

that adds up to the point where by the time we buy a loaf of bread,

instead of it costing $1.30, it costs $2. That is a fact, according to

Harvard School of Economics, not necessarily a bastion of conservative thought.

What does that tell us? That tells us the income tax code is really pernicious. It taxes your income when you earn it, and then if

you dare buy anything that was made in America, made with your

own hands in some cases, you get taxed again with a hidden tax

of 25 percent or so. If you buy a foreign product, on the other hand,

very often those products—they are burdened with some income

taxes overseas, but they are not burdened by the other taxes that

are assessed overseas, the VAT taxes. The VAT tax, the value

added taxes, are rebated back to the manufacturer before products

are shipped into this country. An American product burdened with

our income tax goes over there and pays the VAT tax again. It gets

taxed twice. Their product comes in and escapes the second tax. So

we have a tax system in a global free trade economy that in effect

tells American workers it is better to buy foreign goods. We will tax

you twice if you buy an American good.

If I am an American worker, and my government is penalizing

me for buying my own products, I should be hopping mad. I would

want to get rid of that system. I would want a border adjustable

tax system that is fair, decent, taxes me only once, and rewards me

for doing the right things instead of punishing me for doing the

right things.

So we built one. We have offered you a bill to replace the income

tax code with a simple, fair, national retail sales tax. It is automatically border-adjustable. Here is how it works.

You get rid of income taxes, gift taxes, inheritance taxes, corporate taxes, individual taxes. All the income taxes are gone in our

plan. We get rid of the gift and inheritance taxes so you don’t have

all this double taxation on income. We simply say, when you buy

something at retail, not when you buy it for business purposes to

make a product or to help your business along, but when you buy

it at retail, you pay a retail tax. Whether it is a foreign product

or a domestic product, you pay the same tax.

And we figured out a rate equivalent to the amount of money we

needed to collect if we repealed all those other taxes. We did it very

simply. We took those taxes and divided it into the amount of consumption in this country, and you come up with a number. It is

12.9 percent. We came up with a 15 percent rate, and I will tell

you why. That extra 2 percent we put into and the extra 1/10 is

all factored in for tax compliance problems as well as to cover the

cost of something important in our plan.

You have probably often heard that retail taxes are bad because

they are regressive. They tax poor people more than rich people. In

a sense that is correct because poor people who have to spend all

of their income to survive obviously would pay a bigger proportion

of their income in taxes than a rich person who doesn’t have to

spend all his income. So we provide a total protection for income

earned under poverty.

The way we do it is we also repeal the payroll tax, the 71⁄2 percent you pay and your employer pays into the system on income

8

earned under poverty. The 2 percent of sales tax pays for that and

goes back into Social Security and Medicare Trust Funds to cover

that loss for the Treasury.

So we have got a plan that protects income at the bottom, that

provides cheaper American products. According to the Harvard

study, if you got rid of income taxes, products in America would

cost 25 percent less than they do today or in cost of production. In

a competitive marketplace you get cheaper prices. You have cheaper prices. You have more dollars to buy them with, and you are no

longer penalized when you buy an American product.

The Harvard study says our exports would jump 29 percent. That

would get rid of the trade deficit. That is 19,000 American jobs lost

for every billion of that trade deficit, and we are over 300 billion

today. Multiply that out; 6 million jobs or better. We get rid of the

trade deficit. Our exports climb 29 percent on average yearly because now we are competitive overseas. We are not double-taxing

our products. They get taxed once when they go overseas. They

don’t get taxed over here, just like their products only get taxed

once when they come to America under our plan.

Thirdly, according to the Harvard study there would be an 80

percent shift of investment back into America. Why wouldn’t you

want to build your plant here and your manufacturing here if you

didn’t have to pay income taxes here, and there would simply be

a retail consumption tax in its place? Why wouldn’t you want to

build closer to your markets instead of building somewhere else in

the word? And the Harvard study confirms that.

Here is the bottom line. We have presented you with an alternative that instead of punishing you for earning income, it rewards

you. No income taxes. Instead of punishing you for saving, it rewards you. No taxes on savings interest earned. Instead of punishing you for investing, no capital gains taxes. No investment

taxes. No need for Washington to incentivize you to invest anymore, to tell you how to spend your money or save it. No gift taxes,

so you can give things to charities and your kids and anyone you

want to without fear of double taxation. No inheritance taxes; you

can pass your businesses on without the death tax. And all of a

sudden no penalty for buying American products. Equalized border

taxation in a global free trade marketplace. We get rid of the trade

deficit.

We got a simple taxation system now instead of this complex one,

and the States administer it. They collect the commission for doing

it under our plan, as well as the retailers who collect the tax while

they are collecting the State sales taxes in 45 States of America

that have such systems. For the five that don’t, we would put a

system in. If they would not want to do it, they would have the

right to put it in for us and collect the commission.

It is a simple plan, much simpler than this complex Code. Hard

to get to. It takes some courage to make that kind of change, but

if we had the courage, Americans would love us for it.

Thank you, Mr. Chairman.

[Mr. Tauzin’s statement may be found in the appendix.]

Chairman MANZULLO. Well spoken. Can you stay here for a

while, Congressman Tauzin?

Mr. TAUZIN. Sure.

9

Chairman MANZULLO. What happened to Scott?

Mr. TAUZIN. You have to talk to Dr. Evil about that.

Chairman MANZULLO. Scott, do you want to come up here and

sit to Billy Tauzin’s right? I know he might get offended with anybody sitting to his right, but that is okay. Is that okay? There we

are. Thank you.

Mr. TAUZIN. Hello, Scott.

Chairman MANZULLO. Let’s go with Mr. Oveson, and then we

will go back to Ms. Olson.

STATEMENT OF W. VAL OVESON, NATIONAL TAXPAYER ADVOCATE, DEPARTMENT OF THE TREASURY, INTERNAL REVENUE SERVICE

Mr. OVESON. Thank you very much, Mr. Chairman and distinguished members of the Committee.

Chairman MANZULLO. Would you pull the mike up closer?

Mr. OVESON. I appreciate being invited to be here today and

speak with you. Again, I view my role as a national taxpayer advocate as working within the existing Code and will not get to other

suggestions and ideas as has been talked about, but there is certainly a lot that can be done within the existing Code to simplify

and make things better for small business.

There is both legal and administrative complexity in the Tax

Code, and during the last 2 years that I have been the taxpayer

advocate, I have mentioned in my annual report that complexity of

the Code was the number one problem facing taxpayers. Based on

the cases that we handle each year and input from practitioners

and stakeholder groups, we have identified several areas of the law

that are a particular burden and adds costs to small business. I

will mention them today and put them in my written testimony.

The first issue is penalty administration. A lot has been done

with penalty administration. The Joint Committee on Taxation has

produced a report on that, but the number of penalties is staggering, and they have increased from 10 to over 100 in the last 7

or 8 years. And this is particularly true for small business. In the

Taxpayer Advocate Service we see a large number of cases where

taxpayers can’t reasonably expect to pay off their liabilities because

of one reason or another. Over time the amount of penalties that

has been assessed and the interest that has accrued has been an

insurmountable obstacle for the taxpayer.

One suggestion that we have made in the annual report is to

completely repeal the failure to pay penalty. In my experience, few

taxpayers are aware of the failure to pay penalty, so it really isn’t

an effective motivator to comply with it if they don’t know about

it. In fact, when a taxpayer is in financial trouble or hasn’t filed

returns for many years, the failure to pay penalty actually becomes

a barrier to compliance rather than an enhancer.

The next issue I want to mention is capitalization and depreciation. That has been mentioned this morning in a couple of different

ways. The depreciation section of the Internal Revenue Code has

been altered many times over the last few years, and it just gets

more and more complicated. Depreciation and capitalization are

consistently among the most litigated issues that we see in the sysVerDate 11-MAY-2000 10:27 Feb 28, 2001 Jkt 070376 PO 00000 Frm 00013 Fmt 6633 Sfmt 6602 E:\HEARINGS\67831 pfrm02 PsN: 67831
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tem. I believe it is time to revise the depreciation rules or replace

them with a simple or more consistent system.

One bold proposal that I have made the last 2 years in my annual report is to allow the section 179 expense deduction for all

capital assets purchased. In some ways this is a back door to some

of the other proposals. I acknowledge that. But a more modest approach would be a system that would mix the section 179 deduction

with other depreciation rules. It is important that we have a simple

set of rules.

I want to add that this suggestion is a major policy change, and

the impact would be substantial. That analysis is beyond the scope

of my office.

The third problem area is the employer/independent contractor

dilemma. It has long been a thorn in the side of small businesses

and even valiant attempts to solve this problem have fallen short.

Small businesses have to weigh the common law requirements or

the section 530 safe harbor rules to determine whether individuals

who work for them are treated as independent contractors or employees. If the employer makes the wrong decision, they face potentially huge delinquent employment tax liabilities and just lots and

lots of problems. The inequality in this area also creates distinct

competitive advantages for some businesses that are not complying

as compared with those that are, and I urge you to address this

issue again.

You have asked me to highlight some of the areas that we can

play a role in helping resolve complex problems with the small

business owners. I give you three.

First, we can advocate changes in the law, as I am doing right

now, and procedures and regulations. We have met with business

groups and their practitioners to get their input. And this testimony and my annual report to Congress serve as examples of how

we can gather information and make meaningful recommendations

for change to the existing statutes.

Second, we can advocate for educational programs. For example,

all new businesses should be invited to attend a local training session where their tax obligations can be thoroughly and completely

explained and discussed.

And third, the primary service that we offer to individuals is to

help them with their individual account issues. Business owners

who encounter problems should contact their local taxpayer advocate. And while we can’t guarantee a favorable result, we can guarantee a fresh look at the problem.

Mr. Chairman, thank you for inviting me here today. I am passionate about reducing the complexity in the tax law, and I think

my recommendations here, and others that I have made over the

last 2 years, show that. I applaud you for your efforts and wish you

well in making a better system for the small business owners of the

country. Thank you, sir.

[Mr. Oveson’s statement may be found in the appendix.]

Chairman MANZULLO. We appreciate your distinguished service

to the taxpayers—I was going to say to the government, but it is

to the taxpayers—in trying to simplify this code, and we wish you

well in the private sector. Please stay in contact with us. UndoubtVerDate 11-MAY-2000 10:27 Feb 28, 2001 Jkt 070376 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 E:\HEARINGS\67831 pfrm02 PsN: 67831
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edly you will be back as a private sector witness. I appreciate that

again.

Pamela Olson.

STATEMENT OF PAMELA OLSON, CHAIR, TAX SECTION,

AMERICAN BAR ASSOCIATION, WASHINGTON, DC

Ms. OLSON. Thank you, Mr. Chairman.

My name is Pam Olson, and I appear before you today in my capacity as Chair of the ABA Section of Taxation to present testimony on behalf of the Section of Taxation. This testimony has not

been approved by the House of Delegates or the Board of Governors

of the ABA and accordingly should not be construed as representing the policy of the ABA.

The Section appreciates the opportunity to appear before the

Subcommittee today to discuss the critically important topic of tax

simplification. On behalf of the Section, I want to thank the Chairman and the members of this Subcommittee for their focus on

eliminating complexity in the Internal Revenue Code. I also want

to compliment Val Oveson on his work over the years. We will miss

him very much when he returns to Utah.

Over a year ago the Section of Taxation testified before the

House Ways and Means Oversight Subcommittee and the Senate

Finance Committee on simplification of the Internal Revenue Code.

On February 25th of this year, the Section of Taxation together

with the AICPA Tax Division and Tax Executives Institute released identical simplification proposals.

Although tax law complexity adversely effects all taxpayers, it

has a particularly adverse effect on small businesses because they

are ill-equipped to deal with the complexity. For that reason our

previous testimony has included a number of recommendations important to the small business community.

In recent years the tax law has become more and more complex

as Congress and various administrations have sought to address

difficult issues, target various tax incentives, and raise revenue

without explicit rate increases. As the complexity of the tax law

has increased, so has the complexity of the regulations that the

IRS and Treasury have issued to interpret it. Moreover, the sheer

volume of the tax law changes has made learning and understanding these new provisions difficult for taxpayers, tax practitioners, and IRS personnel alike.

The volume of changes, especially recent changes, that affect average taxpayers has created the impression of instability and unmanageable tax complexity. This takes a tremendous toll on taxpayer confidence. Our tax system relies heavily on the willingness

of the average taxpayer to voluntarily comply with his or her tax

obligations. The willingness and ability to keep up with the pace

and complexity of changes is now under serious stress.

We want to point out that simplification necessitates hard

choices and a willingness to embrace proposals that are often dull

and without passionate political constituencies. Simplification also

requires that easy, politically popular proposals be avoided if they

would add significantly to complexity in the Code. Simplification or

just preventing greater complexity may not garner political capital

or headlines, but it is crucial.

12

In our view the tax law is replete with provisions, the complexity

of which far exceed the perceived abuse to which the provision was

directed or the benefit that was deemed gained by its addition.

Furthermore, the tax law contains many provisions that at the

time of enactment may well have been desirable, but with the passage of time or, more importantly, the enactment of other changes

have truly become dead wood. Despite the lack of utility of these

provisions whether in a relative or absolute sense, analysis of their

effect may nevertheless be required either in the preparation of a

tax return or in simply planning business affairs.

The elimination of these provisions would greatly simplify the

law, but, again, the work necessary to do so will be dull and unlikely to garner political headlines. Nevertheless in our view it is

essential.

Our written statement includes—and this is lengthy—several examples of provisions that when analyzed do not justify their continuation in the law. These are but a few examples, not an extensive analysis, of all the complexity that could be addressed in the

tax law.

I would like to briefly mention a few areas of particular importance to small business. The first is an area of which this Committee is well aware: Accounting methods. You have already addressed this year the problems caused by the repeal of the installment method of accounting for accrual-method taxpayers. You are

also aware of our proposal to expand the use of the cash method

of accounting for small businesses that satisfy the $5 million gross

receipts test included in section 448, even when the purchase, production or sale of merchandise is an income-producing factor. In

addition, we have proposed permitting those same small businesses

to elect not to maintain inventories and to deduct materials and

supplies as purchased rather than capitalizing them as materials

and supplies under the regulations.

There are other significant accounting issues that have been alluded to this morning, whether an expense must be capitalized or

may be deducted, the depreciation rules, the uniform capitalization

rules. Another area is the rules governing pension plans. The tax

rules in this area contain numerous traps for the unwary. Among

the rules that are badly needed to be simplified are the minimum

distribution rules and the top heavy rules.

A related area requiring attention is another that has been mentioned this morning, and that is the test for determining whether

a worker is an employee or independent contractor. This determination is based on a 20-factor common law test. The factors are

subjective, given to varying interpretations, and there is precious

little guidance on how or whether to weigh them. The current complex and highly uncertain determination should be replaced with

an objective test that applies for Federal income tax purposes and

for retirement plan purposes as well.

Another area requiring simplification is the multiple rules limiting the ability of a taxpayer to use losses. These include sections

465, 469, 704(d) and 1366(d).

The fifth area is the international tax rules. Although the complexity of the international rules has generally been the problem of

large business, the growth of global business opportunities is exposVerDate 11-MAY-2000 10:27 Feb 28, 2001 Jkt 070376 PO 00000 Frm 00016 Fmt 6633 Sfmt 6602 E:\HEARINGS\67831 pfrm02 PsN: 67831
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ing an increasing number of small businesses to the complexity of

these rules.

Finally, let me point out the importance of addressing some individual provisions that often affect small business owners. These include the individual AMT, which no longer serves the purpose for

which it was enacted, the rules for calculating estimated income

taxes that Marty mentioned, the 2 percent floor on miscellaneous

itemized deductions, the capital gains regime, and the estate tax

and special rules within the estate tax.

We appreciate your attention and interest in these matters, and

we will be pleased to work with the Committee and its staff on

these important issues as well as other tax issues of significance

to small business. Thank you.

Chairman MANZULLO. Thank you very much.

[Ms. Olson’s statement may be found in the appendix.]

Chairman MANZULLO. Congressman Tauzin was nodding his

head with an ‘‘I told you so’’ in his eye, with all these different

types of taxes.

David Lifson.

STATEMENT OF DAVID A. LIFSON, CHAIR, TAX EXECUTIVE

COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC

ACCOUNTANTS, NEW YORK, NY

Mr. LIFSON. Thank you, Mr. Chairman and members of this distinguished Committee. I am David Lifson, the chairman of the Tax

Executive Committee of the American Institute of Certified Public

Accountants, and I come before you representing more than

330,000 members, who in turn represent countless millions of small

business taxpayers, many of whom work daily with small business

units that are responsible to comply with the tax provisions that

you enact.

I would like to mention with respect to the competing alternate

proposals for tax systems, the AICPA has published a book ‘‘Flat

Taxes, A Guide To The Debate’’ that analyzes four of the more popular, brand new ideas to revamp the Internal Revenue Code. I

would suggest that each of these ideas sound like a very efficient

and good idea until you analyze the details, and as they say, the

devil is in the details. Those same details are horribly weighing

down our tax system right now, and I think the analysis has to be

made of the competing details, as opposed to the competing concepts of equity and fairness, and just and appropriate tax systems

to fund our society.

The fourth alternative to the four competing tax systems is the

alternative that we came here today to speak of, and that is the

alternative of fixing the Code, we have rather than adopt a brand

new, untested system. We don’t take a position whether the solution is the fifth or any one of the first four, but offer you an analysis of each.

Our tax laws are certainly too complicated. There appears to be

very broad agreement on that level here. The current outcry for tax

simplification is not new. In fact, the AICPA has warned Congress

for more than a decade that the tax law is growing so dense that

it threatens to undermine voluntary compliance. Small businesses

14

in particular need an advocate such as the AICPA to collect and

voice their concerns about the burdens that are imposed on them.

As you know, we are not alone in our deep concerns about the

ill effects of complexity in our tax system. Last year we were

pleased to join with the American Bar Association’s Section of Taxation and the Tax Executives Institute in a bipartisan effort to

work toward the common goal of suggesting ways to make our current tax system simpler and more rational for a broad range of

business and individual taxpayers.

In collaboration with our professional colleagues, we developed

an initial big-picture package of tax simplification recommendations that was submitted to Congress in February of this year. You

need to know that there are a growing number of taxpayers who

perceive the law to be unfair, that complexity impedes the continuing efforts of the Internal Revenue Service to administer and

enforce the law, that the cost of compliance for taxpayers is increasing disproportionately with everyone’s income, and that complexity interferes with economic decisionmaking.

The worst part of all of this is that the end result is erosion of

voluntary compliance, and we have the voluntary compliance system that is the envy of the rest of the world. Now, by and large

our citizens obey the law, but it is only human to disobey a law

if you do not or cannot understand the rules. The dynamic American economy is changing and moving rapidly against an unnecessarily cumbersome and in some areas, an absolutely outdated income tax system.

There are various types of simplification. You can simplify calculations. You can simplify the filing burden. But most importantly, you can reduce the chance of having a dispute between the

IRS and the taxpayer.

Now, the first two types of simplification are sometimes the easiest to identify and fix, although the repairs involve some very hard

choices. Computers help, forms help, technology will help. But this

is not just about math. The last type of problem, adding certainty

to the law and thereby reducing the likelihood of a dispute, is the

most difficult to effectuate, yet, in my view, the most important.

Clarifying law that is hard to understand must be a priority if we

are to achieve a simpler system that is based on anything like our

current Internal Revenue Code.

Now, the AICPA, in their blueprint for Tax Simplification issued

back in 1992, identified four elements to consider in creating a simpler tax system. That blueprint was largely adopted as part of your

1997 legislative action. But starting to consider simplification falls

way short of delivering less complex tax rules. The blueprint, the

related complexity index and our written remarks submitted for

the record go into greater detail, and I hope you will review both.

The bottom line is there has been much talk about simplification,

but simplification still has a difficult time finding its way into enacted legislation. Nevertheless, the basic principles outlined above

still apply and should be used in today’s tax legislation environment. We need to look at worker classification, capitalization

versus expensing, installment sales of business, and safe harbors;

especially safe harbors from the most complex rules, and particuVerDate 11-MAY-2000 10:27 Feb 28, 2001 Jkt 070376 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 E:\HEARINGS\67831 pfrm02 PsN: 67831
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larly when those rules were designed for large corporations. Many

of the other witnesses have discussed these items.

I thank you for your time. We recognize that a tax system that

is simple for all taxpayers may never be designed, but we do believe a simpler system is attainable.

Thank you for the opportunity to voice our concerns.

Chairman MANZULLO. Thank you very much.

[Mr. Lifson’s statement may be found in the appendix.]

Chairman MANZULLO. Scott Moody. Do you want to pull that

mike close to your face?

STATEMENT OF SCOTT MOODY, ECONOMIST, TAX

FOUNDATION, WASHINGTON, DC

Mr. MOODY. Thank you, Mr. Chairman and members of the Committee. My name is Scott Moody, and I am an economist with the

Tax Foundation.

It is an honor for me to be here before your Committee today on

behalf of the Tax Foundation to discuss tax complexity on small

businesses.

The Tax Foundation is a nonprofit, nonpartisan educational organization that has been monitoring fiscal policy at all levels of government since 1937. The Tax Foundation is neither a trade association nor a lobbying organization. As such we do not take a position

on specific legislative proposals.

Our goal is to explain precisely and as clearly as possible the current state of fiscal policy in light of established tax principles. According to these principles a good tax system should be as simple

as possible, not be retroactive, be neutral in regards to economic

activities and, of course, be stable.

All of the studies that the Tax Foundation has ever undertaken

on tax complexity demonstrate that there are economies of scale

when it comes to tax compliance. For instance, in 1996, small corporations, those with less than a million dollars in assets, spent at

least 27 times more on compliance as a percent of assets than the

largest U.S. corporations or those with more than 10 billion in assets.

This is especially important to consider because most smaller corporations, 90 percent in fact, have assets of less than $1 million.

While some tax simplification for small business has occurred

since 1996, most notably the Taxpayer Relief Act of 1997, we believe our results remain illustrative of the magnitude of the tax

burden faced by small businesses. For instance, two important

measures of the tax complexity, the size of the Tax Code and the

instability of the Tax Code, have been continuing to increase. The

number of words in the Tax Code, for example, have been steadily

increasing. We have looked back in time, and since 1955, there

were slightly more than 400,000 words that we estimate in the Internal Revenue Code. Today there are more than 1.6 million, and

that is up by 200,000 words only 5 years ago.

In addition, the number of sections in the Internal Revenue Code

have been climbing even faster than the word count. In 1954, there

were 103 sections in the Tax Code. Today there are 725. That is

an increase of over 600 percent.

16

In addition to the complexity associated with the sheer size of

the Tax Code, small businesses must also contend with the instability of the Tax Code itself. In other words, it is not just a matter

of learning the Tax Code a single time, rather it is an ongoing process of keeping up to date with the latest legislative changes, regulatory changes, and Tax Court rulings.

In terms of legislative changes, the Tax Foundation research has

estimated that on average every section of the Internal Revenue

Code is amended once every 4 years. This is a direct result of the

32 significant Federal tax enactments that have taken place since

1954, or approximately one every 1.4 years. However, this legislative instability does not take into account the fact that when tax

law changes, so do regulations. As a general rule, surges in proposed IRS regulations occur within the first 3 years after significant tax legislation has been enacted.

So you can see between the changes in legislation and regulation,

the Tax Code is almost always in a state of constant fluctuation.

Such instability also spills over into the tax courts, and since it

typically takes a taxpayer’s dispute 3 years to appear on court

dockets, small businesses are at an inherent disadvantage.

If small business owners cannot accurately predict the consequence of a particular economic activity either because of the size

or instability in the Tax Code, then the tax policy is handicapping

the growth of small businesses and the U.S. economy in general.

The benefits of reducing tax complexity would dramatically benefit

small businesses since they currently bear a disproportionate

amount of the burden. This could be done in a comprehensive revision of the Tax Code guided by established tax principles. In addition, such tax reform would diminish the need for future corrective

tax legislation and thereby increase the stability of the Tax Code

and regulations.

Thank you very much.

Chairman MANZULLO. Well, thank you. I appreciate it very

much.

[Mr. Moody’s statement may be found in the appendix.]

Chairman MANZULLO. Congressman Tauzin, I know you have an

11 o’clock Subcommittee hearing, so if you have to leave us you are

excused. If you want to stick around that would be fine, too.

Mr. TAUZIN. Thank you. I have to leave. I really enjoyed the

presentations, and let me say big kudos to Scott. That was excellent.

I want to say one more thing. I don’t know—certainly not in this

session of Congress, but there are growing cries for tax reform. And

Dick Armey and I went on a tax debate around the country. We

did 40 cities in the last several years. I have never touched a hotter

political button. Americans are so ready for us to do major reform,

not just little fixes, not just minor reforms, but major reforms that

really simplify matters.

And I agree with the accountants. I have been close with the accountants for many years. We have worked closely together. There

are a lot of good plans out there. I don’t have any pride of authorship. I think we have a good one, and I will defend it with anyone,

but if someone has a better one, bring it on. Americans are ready

for this, and small businesses in particular, and people generally

17

who have less resources, the small business community than the

big business community, are indeed the ones most impacted.

Let me urge you to keep up your good work. Count on me to help

you any way I can.

Chairman MANZULLO. Thank you very much. I appreciate that.

Todd McCracken.

STATEMENT OF TODD McCRACKEN, PRESIDENT, NATIONAL

SMALL BUSINESS UNITED, WASHINGTON, DC

Mr. MCCRACKEN. Thank you, Mr. Chairman. It is a pleasure to

be here today. Again, my name is Todd McCracken. I am president

of National Small Business United. We are the Nation’s oldest

small business advocacy organization. I appreciate the opportunity

to be here today and to make a few comments about the problems

that small businesses have with the complexity of the Tax Code.

I would like to take time to discuss a tax proposal that we have

endorsed that I believe could really revolutionize the existing tax

system.

Mr. Chairman, the NSBU was founded when the income tax was

only 23 years old, with only two pages in forms and several pages

of instructions. While we have not grown at the exponential rate

of the income tax laws, we do now represent 65,000 small businesses nationwide.

We have given a great deal of thought and attention to the problem of simplification and agree with every one of the areas that

were mentioned here this morning as important areas that need to

be simplified for small business, but as you can see, when you put

up those—and what we have heard this morning are for the most

part broad areas, and within each of those broad areas are enormous numbers of issues that need to be addressed to simplify the

Code for small business.

It is a monumental chore that we are faced with to truly simplify

the system for small businesses, and the reason this is the case is

because we insist on continuing to tax income, which means we

have to define income, which means we have to do it in an equitable way.

We are faced with so many political agendas in trying to do that,

and there are so many political advantages to simplifying the current system that we have grown unfortunately cynical and skeptical that this system can really be fixed and simplified for small

business. And to the extent that it can be, and we are prepared to

work with anybody on any of these proposals to truly get some additional simplification in the Code, we are also unfortunately of the

belief that any simplification that we do see is likely to be temporary, just given the lessons that we have seen since 1986 and

even before that the forces that work on this Code continued to

make it more complex and continued to make it more unwieldy for

smaller businesses.

Most entrepreneurs, that is unless they make a career of selling

tax shelters, correctly see the current system we have as punishing

each step toward the American dream. Every step of a business’s

life faces significant tax obstacles. At the start-up level the savings

are taxed and start-up costs are not deductible. Capital investments are made from after-tax dollars and then taxed multiple

18

times when the income is earned and when the underlying asset

that generates that income is sold. They are taxed when growing

because the government takes an increasing share of income as

more money is made. They are taxed on exporting because U.S.

taxes raise the price of our goods relative to foreign goods. They are

taxed when they add jobs because of our extraordinarily high payroll taxes, increased costs of hiring.

Family businesses are discouraged because they are taxed when

they are sold. And finally the owner gets to meet the undertaker

and the IRS on the same day as the government effects a leveraged

buyout of the business.

In February of this year, a national survey conducted by American Express confirmed what NSBU already knew. A survey

showed that 74 percent of entrepreneurs consider tax reform a top

priority, but since the majority of Americans share our common

dislike for our present system, it is unfortunately easier to demagogue the current system than to reach consensus on what a new

and more ideal system should look like.

NSBU leads entrepreneurial organizations not only by defining

the principles on which tax reform should be based, but lending our

full support for a specific proposal, the FairTax national sales tax

plan. The FairTax, we believe, is an enlightened policy. The

FairTax abolishes all Federal income, FICA, estate and capital

gains taxes, and so it allows small businesses to prosper as never

before in this country by instituting a 23 percent tax on all enduse goods and services. The FairTax would sweep away the burdens of the current tax system and create a new dawn of American

entrepreneurship and economic growth.

The FairTax would allow small businesses to begin with savings

put aside with pre-tax dollars. It would allow them to grow unfettered by the income tax, and without an eye on the capital gains

tax. It would allow them to hire without discouragement from the

payroll tax. It would allow them to export unfettered by punitive

American taxes on our exports. It would allow them to make capital investments, unfettered by hidden costs in the capital assets.

It would not penalize good years and bad by implementing the best

of income averaging, a zero rate of tax. It would discontinue the

charade of taxing income multiple times. But most importantly, it

would repeal the self-employment taxes that are the most despised

by entrepreneurs.

The FairTax would tax Americans on income, but only at the

point that they consume that income, not when they invest and

save. Small business owners would have greater access to capital,

the lifeblood of a free economy. Small business owners would be

able to pass their businesses on to their children.

I would like to make one final point about this kind of system

that I think gets on the point that other people made, and then I

will end.

As the complexity disappears, we would reinstate the novel concept that Americans have the right to understand the law to which

they are subject. Moreover, they will immediately see and understand the tax rates and any changes that occur.

The current complexity of the Code leaves most Americans, rightly or wrongly, feeling that they bear an unfair share of the tax burVerDate 11-MAY-2000 10:27 Feb 28, 2001 Jkt 070376 PO 00000 Frm 00022 Fmt 6633 Sfmt 6602 E:\HEARINGS\67831 pfrm02 PsN: 67831
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den. The poor believe that advantages must lie with those who are

well off. The wealthy see the high marginal rates and limited deductions and feel singled out by the tax system. The middle class

assume that credits for the poor and loopholes for the wealthy

mean they alone bear the country’s tax burden.

While there are fallacies and accuracies in each group’s assumption, the unfortunate side effect is a polarization of the country and

a universal feeling of victimization. It should be clear to any observer that this feeling leads to tax avoidance and cheating on an

unprecedented scale.

If we can remove these hard feelings about the Tax Code, we can

markedly improve compliance and give a boost to the national comity at the same time.

There are all kinds of other reasons that Mr. Tauzin got into for

moving to this kind of system, but I appreciate the opportunity to

be here and look forward to talking some more about this topic.

Thank you.

Chairman MANZULLO. Thank you very much.

[Mr. McCracken’s statement may be found in the appendix.]

Chairman MANZULLO. I have a few questions.

Scott, do you want to scoot around there so you can share the

mike there with Mr. McCracken?

First of all, we want to thank you for coming. We did get the testimony in prior to the bells going off.

And, Mr. Oveson, this question is to you. We have a constituent

who has a petition for a private letter ruling pending before the

IRS for 6 years. And I have a phone conference call with Mr.

Rossotti today between noon and 12:30, I have found him to be extremely helpful in going right to the top on helping to move some

things. It involves approval of some pension plans. I just don’t want

to get into great detail. But I am willing to go to the floor next

week if we don’t get action from the IRS and mention specifically

the people within the IRS who refuse to answer a Congressman’s

phone call. That will take full use of the liability immunity under

the Constitution in order to move these bureaucrats off center so

they can do their specific jobs.

That may sound like a threat, and it certainly is. But unfortunately sometimes the only way to get something done around this

city is to threaten to expose people by name, and then all of the

sudden something miraculously gets done.

But notwithstanding that, we have found Mr. Rossotti to be extremely helpful. Some of you may have dealt with him. He is the

first—and forgive me, Pam, because I am an attorney also—nontax lawyer to take over the IRS. He is a systems person. He understands analysis. He understands the concepts you are talking about

in terms of predictability and ability for small businesses to thrive.

So I have a lot of respect for him.

Val, let me ask you this question: In terms of your office, what

type of independence do you have from IRS? Tell us how you are

set up legally.

Mr. OVESON. I am not independent from the IRS. There were

various proposals that——

Chairman MANZULLO. Legally.

20

Mr. OVESON [continuing]. That came up that would have had me,

the taxpayer advocate, be independent, but I report to Commissioner Rossotti, whom you have appropriately praised. I feel the

same way about him. I report to him. He does my evaluations. I

am not independent from the IRS. The independence that is talked

about is with the individual taxpayer advocates out in the field of

which the law requires there be at least one per State.

Chairman MANZULLO. Explain how that works.

Mr. OVESON. They are independent from the district directors,

from the regional commissioners in the current system, from the

unit commissioners in the future system.

Chairman MANZULLO. How are they paid?

Mr. OVESON. They are IRS employees.

Chairman MANZULLO. Through IRS, but they have true legal

independence in terms of their thoughts?

Mr. OVESON. Well, they report up to me rather than to the other

parts of IRS, so they are independent in the same way that appeals

is independent from the other portions of the IRS. But this issue

is one that I deal with and answer daily around the country with

the perception or misperception that we are independent from the

IRS, which we are not. We are independent within the IRS and not

independent from the IRS. Does that help?

Chairman MANZULLO. That does. We have a similar situation

with Jerry Glover in SBA, who heads the Office of Advocacy. He

ends up going head to head with other government agencies. We

appreciate that.

I have a question for Pam Olson, and for any of you who may

want to answer too. Everyone agrees the present system is anywhere from bankrupt or corrupt to unfair. Where do you start?

Where do you start without getting somebody else’s feathers up?

Can there be a consensus of 10 points upon which everybody

agrees, or even one point in this whole process of reforming?

Pam, do you want to start with that?

Ms. OLSON. Well, yes, that is a question you could probably

spend a couple of days talking about. I guess I would say there are

two sources—there are millions of sources—but two sources of complexity we need to address.

One of them comes from the IRS, and I actually share your admiration of Commissioner Rossotti. And long before a non-tax lawyer

was appointed to the Commissioner’s job, I suggested to people that

I thought it was an appropriate thing to do because I don’t think

that all tax lawyers have the predisposition needed to run an organization the size of the Internal Revenue Service. And I think

bringing somebody into the IRS from the outside business community was a very smart thing to do. Lawyers have too much of a

tendency to dot every I and cross every T and not enough sense

that what we are doing here is running a very large business institution. It has got to be run like a business institution.

For the same reason I applauded bringing in Val Oveson from

outside the IRS, somebody with a different mindset about how

things have to get done and what you have to do to run the system.

That attitude on the part of Mr. Rossotti and Mr. Oveson needs to

spill over into the Chief Counsel’s Office and needs to permeate

down through the Agency so that there is an appreciation for the

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fact that we need to make decisions; we need to have those decisions whenever possible have prospective effect, not retroactive effect, so that people can plan; and the answers need to be clear, simple and administrable. We can’t spend our time splitting hairs forever, because if we do, we end up with a law that is so complex

that nobody can comply with it.

Chairman MANZULLO. We have 5 minutes. It gives everybody

here about a minute.

Martin.

Mr. DAVIDOFF. I agree with Pam. Also, the constituency of the

ABA and the AICPA have come forth with proposals that I think

very few people could disagree with, and you can start with that

as a means. Also I think Mr. Oveson in his annual report has

talked about phaseouts and getting rid of that, which I have talked

about today. I don’t think anybody really disagrees with that, other

than people who want to trick the American public on what the tax

rate is.

I want to comment on the reason why Mr. Oveson and everyone

else thinks the National Taxpayer Advocate is independent even

though they are not is the way that Mr. Oveson has run that office

and Mr. Rossotti has given him the freedom to run the office, and

I think they have done a magnificent job.

But there are plenty of proposals on the table today; I mean, section 179 traps, and a lot of other things. If you dedicated yourself

to spending the next 2 years to doing that and avoiding things like

changing estimated tax, safe harbors and consulting us before you

do things like you did last year with the installment sales, we

wouldn’t do this. The problem is Congress too often says, I need

revenue, and refuses to go back to the American public and say, I

need to increase the rate. Well, now you have an opportunity. You

have a surplus. So instead of saying we are going to give a 10 percent across-the-board tax cut, say we are going to start fixing some

of these things, because we have the revenue, and now we can

undo some of these things and make them more fair.

Chairman MANZULLO. I appreciate that.

David.

Mr. LIFSON. We all know that simplification is complex. And in

the words of a former IRS Commissioner who happened to be a tax

attorney, but a very insightful one, I think one of the keys is the

appropriate balance of rough justice. And the difficulty with simplification is enacting a single act of simplification which often

leads to a rough justice where there are winners and losers in that

particular thought or in that particular change.

If you actually were on a mission to create simplification and you

took 10, 20 or 30 simplification ideas, it would blur the winners

and losers because so many people would be affected by multiple

changes that by the time you were all done, you would wind up

with a system that, I am sure, you could find one person in some

small town somewhere got cheated; but in the end of the game, you

will have your rough justice system and the advantages of understanding, and, in our view, the increase in the tax compliance rate

would more than pay for the revenue losses from averaging down

or simplifying the law so a few people paid a little bit less tax.

22

Chairman MANZULLO. Does anybody else want to respond to the

same question? We will conclude here.

Mr. MCCRACKEN. I think the most important thing to be done—

obviously, a lot of these things that have already happened have

to be addressed or need to be addressed. I agree with something

somebody else said earlier, and that is the foremost thing is to stop

making it more complex. And probably the smartest way to do that

is, yes, we have a surplus now, and most of the talk is not how do

we raise taxes, but how to find some consensus on lowering them.

I guess my admonition would be avoid highly targeted, phased-in

strange things in the Tax Code. If you are going to change the tax

system, change it.

Mr. DAVIDOFF. Here, here.

Mr. MCCRACKEN. And stay away from ‘‘targeted’’ tax cuts—targeting always sounds nice because we will help the people that

really need the help, but it usually ends up meaning we are adding

enormous complexity to the Tax Code.

Chairman MANZULLO. Scott or Val, do you want to add anything

to that?

Mr. OVESON. I just want to reemphasize that every change or

every deduction credit or line you add to the Code geometrically

complicates the Code.

Chairman MANZULLO. Scott, did you want to have the last word

on that?

Mr. MOODY. One thing I wanted to mention is the instability.

There is a trade-off. Every time you make these small changes, you

are increasing the instability, and instability is a huge component

of tax complexity. It is hard to measure, but it is something that

is there.

Chairman MANZULLO. I want to thank you very much. Our goal

was to conclude the hearing before the votes started, and we accomplished that. This is extremely significant in terms of the small

businesses that we represent. My brother has a small restaurant

with 13 tables, and he literally just pulls his hair out because he

doesn’t know what to do. He does not know what is expected of him

with the complexities of the tax code.

What bothers me, and it did not come up here, is the social consequence of a complex Tax Code which is to push small businesses

out of business and make way for larger chain stores. I am not saying there is anything wrong with that, but people ask what happened to the corner drug store? What happened to the corner grocery store? What happened to this? The corners are gone now because the trucks have to make right turns, and along with them

the businesses are gone. But so often they are gone because they

just can’t keep up with all the regulations and all the taxation, and

they end up selling out.

Our Ranking Minority Member Mrs. McCarthy is having emergency dental surgery. Otherwise she would have been here. She is

always at these meetings, and we miss her. If she wanted to submit some statement to the record, we will do that.

And this Subcommittee is adjourned. Thank you.

[Whereupon, at 11:14 a.m., the Subcommittee was adjourned.]

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