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

                  PRESIDENT'S FISCAL YEAR 2001 BUDGET

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

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                               __________

                            FEBRUARY 9, 2000

                               __________

                             Serial 106-96

                               __________

         Printed for the use of the Committee on Ways and Means

                               __________

                   U.S. GOVERNMENT PRINTING OFFICE
67-025                     WASHINGTON : 2001

_______________________________________________________________________
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402

                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

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

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

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

                            C O N T E N T S

                               __________

                                                                   Page

Advisory of February 2, 2000, announcing the hearing.............     2

                               WITNESSES

U.S. Department of the Treasury, Hon. Lawrence H. Summers, 
  Secretary, accompanied by Sylvia Mathews, Deputy Director, 
  Office of Management and Budget................................     8

                       SUBMISSIONS FOR THE RECORD

Air Courier Conference of America International, Falls Church, 
  VA, statement..................................................    74
Alliance of Tracking Stock Shareholders, statement...............    75
American Association for Homecare, Alexandria, VA, statement.....    78
American Bankers Association, statement..........................    81
American Petroleum Institute, statement..........................    84
American Society of Association Executives, Michael S. Olson, 
  statement......................................................    90
Benson, David, Ernst & Young LLP, Global Competitiveness 
  Coalition 2000, joint statement................................   124
Boom, Rev. Vada Ba, Bethesda, MD, letter.........................    95
Center for a Sustainable Economy, statement and attachment.......    97
Clark/Bardes, Dallas, TX, statement..............................   102
Coalition for the Fair Taxation of Business Transactions, 
  statement......................................................   106
Coalition of Service Industries, statement.......................   112
Committee on Annuity Insurers, statement and attachment..........   115
Council on Foundations, Dorothy S. Ridings, statement............   119
Equipment Leasing Association, Arlington, VA, statement..........   121
Garrett-Nelson, LaBrenda:
    Washington Counsel, P.C., statement..........................   166
    Global Competitiveness Coalition 2000, joint statement.......   124
Gasper, Gary, Washington Counsel, P.C., statement................   166
Giordano, Nicholas, Washington Counsel, P.C., statement..........   166
Global Competitiveness Coalition 2000, David Benson, Ernst & 
  Young LLP, and LaBrenda Garrett-Nelson, Washington Counsel, 
  P.C., joint statement..........................................   124
Home Care Coalition, statement...................................   126
Independent Sector, statement....................................   129
Leasing Coalition, PricewaterhouseCoopers LLP, statement.........   130
National Association of Real Estate Investment Trusts, statement.   140
Olson, Michael S., American Society of Association Executives, 
  statement......................................................    90
Pierce, Benjamin R., Vanguard Charitable Endowment Program, 
  Southeastern, PA, letter.......................................   166
PricewaterCoopers LLP:
    Leasing Coalition, statement.................................   130
    Statement and attachments....................................   144
Real Estate Roundtable, statement................................   159
Ridings, Dorothy S., Council on Foundations, statement...........   119
Vanguard Charitable Endowment Program, Southeastern, PA, Benjamin 
  R. Pierce, letter..............................................   166
Washington Counsel P.C:
    Global Competitiveness Coalition 2000, joint statment........   124
    LaBrenda Garrett-Nelson, Gary Gasper, Nicholas Giordano, and 
      Mark Weinberger, statement.................................   166
Weinberger, Mark, Washington Counsel, P.C., statement............   166

 
                  PRESIDENT'S FISCAL YEAR 2001 BUDGET

                              ----------                              

                      WEDNESDAY, FEBRUARY 9, 2000

                          House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:09 a.m., in 
room 1100, Longworth House Office Building, Hon. Bill Archer 
(Chairman of the Committee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

                                                CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE

February 2, 2000

FC-17

                      Archer Announces Hearing on

                the President's Fiscal Year 2001 Budget

    Congressman Bill Archer (R-TX), Chairman of the Committee on Ways 
and Means, today announced that the Committee will hold a hearing on 
President Clinton's fiscal year 2001 budget proposals within the 
jurisdiction of the Committee. The hearing will take place on 
Wednesday, February 9, 2000, in the main Committee hearing room, 1100 
Longworth House Office Building, beginning at 10:00 a.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from Secretary of the Treasury 
Lawrence H. Summers. However, any individual or organization not 
scheduled for an oral appearance may submit a written statement for 
consideration by the Committee and for inclusion in the printed record 
of the hearing.
      

BACKGROUND:

      
    On January 27, 2000, President Clinton delivered his State of the 
Union address. In it, he outlined numerous budget and tax proposals. 
Among them was a proposal to set aside Social Security surpluses for 
debt reduction, and a proposal to offer prescription drug coverage to 
Medicare beneficiaries. Among the tax items was a proposal to reduce 
the marriage tax penalty by increasing the standard deduction for two-
income couples filing jointly, a proposal for tax incentives for 
retirement, and a proposal for relief from the alternative minimum tax. 
Among other things, the President proposed a number of new tax credits 
for a wide variety of purposes. His budget is expected to include 
various other tax, fee, and revenue increases.
      
    The details of these proposals are expected to be released on 
February 7, 2000, when the President is scheduled to submit his fiscal 
year 2001 budget to the Congress.
      
    In announcing the hearing, Chairman Archer stated: I look forward 
to receiving the President's budget proposals. The President has 
already announced many of his ideas and it's appropriate we now review 
them in complete detail. I'm sure they will raise important questions 
for thoughtful discussion.''
      

FOCUS OF THE HEARING:

      
    The Committee will receive testimony on the President's fiscal year 
2001 budget proposals from Secretary Summers. The Secretary is expected 
to discuss the details of the President's proposals which are within 
the Committee's jurisdiction.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect 5.1 format, with their name, address, and 
hearing date noted on a label, by the close of business, Wednesday, 
February 23, 2000, to A.L. Singleton, Chief of Staff, Committee on Ways 
and Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Committee office, room 1102 Longworth House Office 
Building, by close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1 
format, typed in single space and may not exceed a total of 10 pages 
including attachments. Witnesses are advised that the Committee will 
rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.
      

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

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

                                

    Chairman Archer. Welcome, Mr. Secretary. We are happy to 
have you before the committee.
    Before I begin my prepared statement, I am going to discuss 
a recent concern that is disturbing to me and I believe to all 
members of the committee on both sides of the aisle. I refer to 
the steady stream of news reports about computer hackers 
disabling major Internet web sites and accessing consumer 
credit information.
    Obviously, our committee is concerned because your Treasury 
Department computer systems must guard some of the most 
sensitive records of the American people--the IRS records, the 
tax records of all our citizens. I know the IRS and the 
Treasury have world-class computer security measures in place, 
and I am sure this is a top priority for you and Commissioner 
Rossotti. I commit publicly to you that you have the full 
support of this committee to help protect the privacy of the 
American people.
    Of course, this committee oversees other agencies that 
protect similar information like Social Security wage 
information, Medicare health records, and a host of other 
personal records. We will focus on those areas as well. But we 
must do everything we can to apprehend Internet hijackers and 
put an end to this cyber terrorism.
    Perhaps you would like to comment briefly before I make my 
statement relative to the budget, which is before us today.
    Mr. Summers. Mr. Chairman, we share your concern and I will 
be speaking with Commissioner Rossotti about this question of 
integrity of our systems. Frankly, privacy at the IRS has been 
a top priority for us for a number of years. We have taken 
steps, working with this committee, with respect to employees 
who have made unauthorized use of the systems and issues of 
that kind.
    I might just say, Mr. Chairman, financial privacy generally 
is something that is a very, very important issue for us. There 
is both the question of what is illegal hacking and also the 
question of what is absolutely legal in terms of the widespread 
dissemination of information. As the President made clear in 
the State of the Union Address, this is something on which we 
will be suggesting legislation to the Congress this year to 
further protect financial privacy. We welcome your interest in 
this area.
    Chairman Archer. It is important that we work together. 
This is something that knows no party lines and something that 
we need to cooperate fully on.
    Having said that, I would like to turn to the President's 
budget request.
    After saying in 1998 that we should ``save Social Security 
first,'' and saying in 1999 that we ``should save Social 
Security now'', the President appears to have abandoned his 
pledge in this budget request. He apparently told reporters 
just last week that while he would like to save Social 
Security--in his words--he can't. It is a little disappointing 
when the most powerful elected official in the free world says, 
``I can't.''
    More disappointing and confusing, perhaps, is that the 
President has changed his mind again on the idea that the 
Federal Government should invest Social Security funds in 
private financial markets. We went through that with the 
original request and it was negated powerfully by Mr. 
Greenspan, who sat in exactly the chair where you are, after it 
was proposed. And the President then left it out of his October 
Social Security proposal.
    Now in the budget it is back in again. I am eager to know 
why when there is massive concern on the part of people across 
the country on a bipartisan basis of having the Federal 
Government own corporations in this country.
    I would also like to know why it is necessary to keep 
raising taxes on the American people at a time when the tax 
rate is at a peacetime high, we not only have balanced the 
budget, we are paying down the debt, we are protecting every 
dime of the Social Security surplus, and our fiscal house--I 
think we both would agree--is on a solid foundation. Last year, 
the President signed a tax relief bill that was funded largely 
out of the non-Social Security surplus. Why does the White 
House believe that we should push for tax hikes?
    There are plenty of other items we need to discuss like 
helping low-income seniors with the high cost of prescription 
drugs, making health care more affordable and accessible, 
continuing with the success of welfare reform, and creating 
better jobs and growth here at home by opening markets 
overseas.
    These are some of the things I look forward to hearing your 
thoughts on.
    With that, I yield to Mr. Rangel for any opening statement 
he might like to make.
    Without objection, each member will be permitted to enter 
any written statements into the record.
    Mr. Rangel?
    Mr. Rangel. Thank you so much, Mr. Chairman.
    Welcome again, Mr. Secretary. On behalf of the full 
committee, we welcome Sylvia Matthews, the new Deputy OMB 
Director. When you first started saying that you were 
disturbed, Mr. Chairman, I took a deep breath because I did not 
know where you were going to go with that. I was hoping you 
were disturbed because there were reports that we were not 
working closely together in a bipartisan way in order to do the 
best for the Congress and the country.
    There are many things I have problems with in the 
President's budget. But I do hope and truly believe that it 
would be helpful to both Democrats and Republicans if we can 
get something done in this session because I am not convinced 
that the voters are just going to blame the majority party. 
They just might not be that sophisticated and take it out on 
us, too.
    So if we are concerned about Social Security, Medicare, 
prescription drug benefits, patient bill of rights, and 
education initiatives, it would seem to me that there was a 
time when the President met with the House and Senate leaders 
and that some of these things could be worked out--not to adopt 
what the President's creative imagination would present to us--
but to select from those things that just made sense, whether 
you are Republican or Democrat, to see whether or not we could 
work together on it.
    This type of thinking was shattered when I found out that 
the Republican--shall I say, leadership--decided that the 
marriage penalty relief would be the first thing coming out of 
the Ways and Means Committee. I know how important it is for 
the majority to get this thing done before Valentine's Day 
because it is important that we send a message to the voters 
for Valentine's Day that we love them and we want to give them 
relief.
    But how we can do this before we have a budget, I do not 
know. And I know that you have abandoned the 792 tax cut bill, 
and you have accepted the George W. Bush $1.3 trillion tax cut 
bill. And I understand that instead of bringing it all to us at 
once, since we cannot digest it any more than the American 
people can, that we will be getting it in little slices. But at 
some point, it adds up.
    I think the first slice we get is the $182 billion marriage 
tax penalty that benefits mostly people who do not have a 
penalty. That does not bother me because I am just as 
political, perhaps, as you are. But what bothers me is that 
this is an opportunity to tell Mr. Summers and Ms. Matthews to 
take a message back to the President that there are some things 
that we want to get done, that we are going to select those 
things, and we hope we work together because the majority does 
not have enough votes to override the President.
    So clearly, if we cannot override the President, we are 
going to have to work with the President. As unfortunate as it 
may seem sometimes, you may even have to work with me--the 
Democrats. But if we are going to get anything done, we have to 
stop taking shots at each other and suggest in a more positive 
way how we can get something--no matter how small it may appear 
to be--done.
    I really think that the President has laid out for the 
Nation a blueprint of exciting ideas, some of which we may not 
be able to do. We may not be able to do it because we have 
other priorities. Maybe we may not be able to because we won't 
agree that it is the best way to do it. But out of two hours of 
suggestions, many of which we were able to get the majority 
party to give support at least in applauding, I would like to 
believe that out of that meeting with the President--or 
subsequent meetings--we can agree to do something.
    And I do hope that the President is receptive to that. 
First, it is important to the American people and the Congress. 
Also, because both Chairman Archer and President Clinton will 
not be returning. I would like to be a part of leaving some 
type of legacy in being able to say that they have done 
something that the country and the Congress will treasure.
    I think we can do that and still have enough differences to 
have a knock-down, drag-out fight in November to see which 
team--the Democratic team or the Republican team--the American 
people would want. I am convinced that there is not that much 
difference between what we would want, it is just how we get 
there.
    I welcome you coming. I certainly will be working with you. 
Of course, if we can't work together, there is another way to 
do it, but I prefer to do it in a bipartisan way.
    Thank you, Mr. Chairman.
    [The opening statements of Mr. Matsui and Mr. Ramstad 
follow:]

Opening Statement of Hon. Robert T. Matsui, a Representative in 
Congress from the State of California
[GRAPHIC] [TIFF OMITTED] T7025.001

      

                                

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

    Mr. Chairman, thank you for calling this important hearing 
today to review the President's fiscal year 2001 budget 
proposal.
    The budget proposal before us today is a mixed bag--not as 
good or bad as many of my colleagues will claim. There are 
elements worth considering, as well as elements worth 
disregarding.
    I applaud the President's proposal to pay off the public 
debt by 2013 because we must quit mortgaging the futures of our 
children and grandchildren. However, I do not support the 
President's excessive spending, at twice the rate of inflation. 
As Chairman Greenspan has warned, Congress and the President 
must keep federal government spending in check so we don't see 
the return of soaring interest rates.
    I am disappointed the President provides such little tax 
relief, and at the same time, imposes significant tax hikes. 
With a non-Social Security surplus of $2 trillion, Congress 
should save Social Security, pay down the debt and provide 
responsible tax relief.
    As a Member of the Health Subcommittee, I am very concerned 
that the President once again proposed to spend Medicare 
dollars on new programs while, at the same time, cutting a 
number of payments for current beneficiaries. In the BBA of 
1997, we set out to save the Medicare system $115 billion, but 
the Administration's implementation of it has almost doubled 
that figure. In response, we restored $16 billion in funding in 
1999 after providers predicted dire situations. Now the 
President would take another $70 billion out of the system. It 
certainly makes me wonder--is he not hearing the cries from 
providers that every Member of Congress is hearing?
    Instead of cutting payments and raising taxes through fees 
to pay for new spending, Congress and the President should 
modernize Medicare to reflect the advancements in our health 
care system, including a targeted prescription drug proposal to 
cover low-income seniors without displacing the coverage that 
65% of our seniors already enjoy. I hope the President will 
work with us on this important issue this year!
    In addition, I am concerned about the President's return to 
the idea of having the federal government invest Social 
Security money directly into private financial markets--a 
concept respected experts like Alan Greenspan and Rep. Bill 
Frenzel have strongly recommended against.
    Mr. Chairman, thanks again for calling this hearing. I look 
forward to learning more of the details of the President's 
proposal from Secretary Summers.
      

                                

    Chairman Archer. Mr. Summers, welcome again. We are happy 
to have you before the committee. We will be pleased to hear 
your verbal presentation. Without objection, your entire 
written statement will be printed in the record.

    STATEMENT OF HON. LAWRENCE H. SUMMERS, SECRETARY, U.S. 
  DEPARTMENT OF THE TREASURY; ACCOMPANIED BY SYLVIA MATHEWS, 
        DEPUTY DIRECTOR, OFFICE OF MANAGEMENT AND BUDGET

    Mr. Summers. Thank you very much, Mr. Chairman, Congressman 
Rangel. It is a pleasure for Ms. Matthews and I to be here to 
discuss the President's fiscal year 2001 budget at a remarkable 
moment in our Nation's economic history.
    It was reported yesterday that productivity had grown at a 
five percent annual rate in the third and fourth quarters of 
last year, a performance that is nearly unprecedented, and 
performance that suggests that we live in a moment of great 
possibility.
    The President's top priority in formulating this budget was 
to preserve our progress and to build our future. Above all, 
preserving our progress means maintaining budget surpluses and 
continuing to pay down the debt at a rapid rate. It is the pay-
down of debt that makes room for the investments that allow us 
to take advantage of the opportunities of this moment in 
information technology, in biotechnology, in productivity 
creating machinery and equipment.
    The President's budget has five primary objectives. Let me 
summarize them in turn.
    First, debt reduction. This is a budget that provides for 
the elimination of the national debt by 2013 and steady 
reductions in its magnitude in the meantime. Debt reduction is 
tantamount to a tax cut in two important respects. Because it 
removes the burden on taxpayers of interest payments and 
ensures that principal payments will not need to be made on 
newly issued debt in the future, and because--as we have seen--
reducing Federal debt and expected Federal debt reduces 
pressure on interest rates, allowing them to decline. Each 
percentage point reduction in the interest rate over 10 years 
results in an approximately $250 billion tax cut in the form of 
lower mortgage costs for American families.
    And budgeting for debt reduction has another important 
benefit. It increases the resilience of our economy with 
respect to the shocks and uncertainties that will happen with 
respect to any forecast. Reloading the fiscal cannon gives us a 
chance to respond to any future problems that may arise. 
Creating valuable fiscal space allows us to address challenges 
of an aging society.
    The second objective of the President's budget is to meet 
the needs of an aging society. Paying down debt will ultimately 
eliminate the nearly $200 billion in interest costs that are 
contained in this year's budget. The question naturally arises 
of what is the best use of the fiscal space that is thereby 
created. Here the President's budget gives a clear answer: 
support for Social Security, funding of our existing obligation 
to Social Security beneficiaries.
    Mr. Chairman, the President's budget does provide for a 
portion of those transfers to be invested in equities. That 
reflects judgments that we discussed at some length when I 
testified before this committee in early November about the 
importance of allowing Social Security beneficiaries to take 
advantage of the return the private market can provide and the 
miracle of compound interest that we discussed. But it is our 
judgment that this is best done within the context of a defined 
benefit framework that does not transfer risk to Social 
Security beneficiaries and one that conserves and minimizes 
administrative costs.
    The budget also calls for the modernization of the Medicare 
program in three important respects. First, by providing 
seniors with prescription drug coverage. If Medicare were 
enacted today, it would surely include a prescription drug 
benefit. Second, by providing a choice-based approach involving 
competition, but an approach that encourages the selection of 
lower-cost care alternatives, provides financial incentives for 
seniors to choose those alternatives, but avoid--and this is 
crucial--financial coercion that could interfere with existing 
relationships between seniors and their caregivers.
    And reflecting the rising size of the aging population, the 
age of the aged population as life expectancy increases, the 
President's budget also proposes to fortify the Medicare Trust 
Fund with the savings from debt pay-down and allot several 
hundred billion dollars for that purpose.
    Third, the President's budget establishes a framework in 
which it is possible to provide significant targeted tax cuts 
and it proposes some $350 billion in tax cuts over 10 years in 
a number of crucial areas. These include the promotion of 
savings through a new program of retirement security accounts 
that works with the grain of the existing employer-provided 
pension system and private financial institution-provided IRA 
system, but works to provide extra incentives to motivate 75 
million Americans who do not have a pension or 401(k) to save.
    Expansion of educational opportunity by allowing the 
deduction of as much as $10,000 in higher education costs for 
middle-income families. Steps to make health care more 
affordable by tripling the long-term care credit and helping 
those who have lost jobs to maintain continuity in their 
insurance in a number of ways. Support for working families, 
including crucially a reduction in marginal tax rates under the 
earned income tax credit programs and targeted and appropriate 
marriage penalty relief. Tax simplification through the 
alternative minimum tax and increases in standard deduction.
    There are also measures contained in the President's budget 
to address the environmental concerns, to address the digital 
divide, and to support philanthropy.
    Let me highlight one area of the President's tax offsets, 
and that is the area of corporate tax shelters.
    In my judgment, there is ample room for reason and debate 
about a variety of tax subsidies of various kinds that are 
contained in the budget. But it seems to me that we all ought 
to be able to agree that transactions that are devoid of 
economic substance and are marketed in secret ought to be 
curbed, revenue considerations apart, in support of the 
maintenance of the integrity of the system. And yet it has 
become increasingly clear to thoughtful observers of our tax 
system that these transactions are increasing and are becoming 
increasingly pervasive and a source of pressure on honest 
taxpayers.
    It would be my hope that wherever we come down on the broad 
range of business subsidies, that we and the Congress can work 
together to address this problem of abusive shelters, which it 
seems to me is becoming a very serious problem in the same way 
that the individual tax shelter problem became a very serious 
problem in the 1980s, before legislative action was taken.
    Fourth, spending targeted on key priorities. Let me 
highlight one aspect of the President's budget. It is built 
around a current services baseline. That baseline starts from a 
Government that is smaller today in terms of public employees, 
smaller today in terms of total spending as a share of GNP, 
smaller today in terms of discretionary spending as a share of 
GNP, and smaller today in terms of domestic discretionary 
spending as a share of GNP than at any time since the 1960s. 
And it shrinks the Government steadily over 10 years by each of 
those measures. With this budget, the Government as a share of 
GNP will be smaller than at any time since the middle of 
President Eisenhower's term.
    This is a conservative, prudent fiscal assumption in which 
all of our initiatives are financed by changes in the pattern 
of Government spending. To budget for a lower rate of growth 
than this would be to count on slower growth in discretionary 
spending than we had between 1981 and 1993 or slower growth in 
discretionary spending than we have had since 1993. It would, 
it seems to me, take a great risk of relying on cuts that 
ultimately would not come, thereby putting our fiscal progress, 
our debt reduction--which is so crucial to the maintenance of 
prosperity--at substantial risk.
    Within this restricted current services envelope, the 
President's budget includes a number of initiatives: health 
care initiatives to substantially expand coverage, education to 
reduce class sizes to enable a million more children to 
participate in HeadStart by 2002 and to repair the Nation's 
classrooms, and law enforcement where among other things we are 
proposing the largest ever expansion in our efforts to 
prosecute firearms violations involving 300 more agents, 200 
more inspectors, and 1,000 more prosecutors.
    Let me finally highlight an area that I know is of great 
concern to you, Mr. Chairman, and that is our international 
engagement. At a moment of such economic strength for our 
country, we must always remember that as Chairman Greenspan 
once testified, we cannot forever be an oasis of prosperity in 
a troubled world. That is why it is crucial that we find a way 
to move together to support an open global trading system, 
including the passage of the Permanent Normal Trading Relations 
Bill that is essential for China's entry into the WTO, and the 
African Growth and Opportunity Act and the Enhanced CBI.
    In our judgment, it is also particularly important in this 
year that we do our part to include support for the poorest 
countries, including continued funding of the highly indebted 
poor countries, and debt relief initiatives. I would highlight 
something that is of particular concern to me. Our proposed 
measures include a tax credit to accelerate development and 
delivery of vaccines for infectious diseases such as AIDS, 
malaria, and tuberculosis that kill more than a million people 
each year.
    To conclude, we are at a special moment in our national 
economy. But above all, it is not a moment for complacency. We 
cannot assume that without proper choices we will always enjoy 
this good fortune. Indeed even with the proper choices, we may 
not always enjoy this good fortune. That is why it is crucial 
that we act responsibly this year to continue paying down debt, 
prepare for the liabilities of an aging society, to prudently 
assure that we can continue to fund core Government, and then 
provide tax benefits to American families to meet some of their 
most important needs. We can do all of that working together.
    [The prepared statement follows.]

Statement of Hon. Lawrence H. Summers, Secretary, U.S. Department of 
the Treasury

    Mr. Chairman, Mr. Rangel, Members of the Committee, it is a 
pleasure to speak with you today about the President's FY 2001 
budget. Let me start by thanking this Committee for your hard 
work in helping bring about the enviable position in which we 
now find ourselves.
    At the outset of this Administration, the President 
established a three-pronged economic strategy based on strong 
fiscal discipline, investing in people, and engaging in the 
international economy. Partly as a consequence of that strategy 
we have achieved the first back-to-back unified budget 
surpluses in more than 40 years.
    It is no coincidence that this month the US economy also 
achieved the longest expansion on record. This historic 
accomplishment is a tribute to the hard work and 
entrepreneurial qualities of our workers, businesses and 
farmers. But without the budget agreements of 1993 and 1997 
between the President and Congress, the economic expansion 
would not have been as impressive or as enduring.
    Last year's surplus of $124 billion was the largest in our 
history. Even using conservative assumptions, the budget will 
move still further into the black this year. By the end of 
September, we expect that Federal debt held by the public will 
be $2.4 trillion less than was projected for that date in 1992. 
This represents scarce national savings that have been freed up 
for private sector investment in the productive economy: in 
American businesses, workers and homes.
    In 1992, the Federal budget posted a record deficit of $290 
billion--almost 5 percent of our gross domestic product. Since 
then we have achieved not only a unified budget surplus--
comprising both the operating budget and the Social Security 
budget--but also a small surplus in our on-budget account. In 
other words, for the first time since 1960, all of last year's 
Social Security surplus was used to improve the government's 
balance sheet.
    This dramatic improvement in our fiscal situation reflects 
some hard choices. Federal spending has fallen below 19 percent 
of GDP, a sharp drop from the 22 percent level that prevailed 
when the Administration came into office. And we have reduced 
the Federal civilian payroll by more than one-sixth in that 
period, a reduction of 377,000 full-time equivalent employees.
    As a result of this discipline, we are now in a position to 
eliminate the debt held by the public by 2013, on a net basis. 
Paying down the remaining $3.6 trillion of Federal debt will 
help to intensify the remarkably positive interaction that we 
have witnessed between the budget and the economy over the last 
several years, whereby what was once a vicious cycle of more 
debt, higher interest rates, a weaker economy and still more 
debt has been replaced with
    A virtuous circle of declining debt, lower interest rates, 
and a stronger economy, in turn producing still less debt, 
further downward pressure on interest rates, and stronger 
growth.
    As a result, unemployment is at its lowest rate in 30 
years, more than 20 million new jobs have been created, 
productivity growth has increased even this far into the 
expansion, home ownership rates are at an all-time high, and 
real wages are rising across the board including for those at 
the bottom of the income ladder.
    At the same time, our fiscal position also provides us with 
a rare opportunity to focus on crucial national priorities. Let 
me set out the five basic objectives of this budget before 
discussing each item in turn.
     Reducing Federal debt to safeguard our economic 
expansion.
     Meeting the needs of an aging society by laying 
the foundations for the secure retirement of the baby boom 
generation.
     Providing new incentives through the tax system to 
strengthen our communities and encourage people to work and 
save more.
     Pursuing well-targeted initiatives that invest in 
health, education and other national priorities.
     Redoubling our commitment to opening markets and 
sustaining American leadership in order to bolster 
international economic opportunities for America and strengthen 
our national security in an uncertain world.

OVERVIEW OF THE FY2001 BUDGET

          I. Safeguarding Our Economy by Reducing Federal Debt

    For decades, Treasury's discussions with its Borrowing 
Advisory Committee centered on how we could finance growing 
budget deficits and whether the market would have the capacity 
to absorb the huge volumes of government debt that we needed to 
sell. In this new era of rising projected budget surpluses, our 
discussions now focus on how we can maintain liquidity in the 
market while reducing the volume of debt outstanding.
    According to OMB and Treasury projections, this challenge 
will become even more apparent in the years ahead. Until now, 
debt reduction has been accomplished solely by retiring 
Treasury securities when they fall due. But from now on, we 
will have another tool available to help us manage the process 
of reducing the debt held by the public--namely, the ability to 
buy debt back from the public that has not yet matured. Using 
this tool, we can both reduce debt and bolster liquidity in our 
key ``benchmark'' issues. In the April to June quarter of this 
year, we expect that Treasury's net borrowing will result in a 
record pay down of $152 billion worth of bonds. This puts us on 
track to pay down more debt this year than in 1998 and 1999 
combined.
    As I have explained, under the President's proposals we 
will eliminate the debt held by the public by 2013 on a net 
basis. This will generate substantial further gains for the 
American economy. Reducing Federal debt functions like a tax 
cut in two respects. First, it removes the burden of interest 
and principal payments from the American taxpayer. Second, it 
maintains downward pressure on interest rates, and thereby 
helps reduce payments on home mortgages, car loans and other 
forms of consumer credit. We estimate that a 1 percentage point 
reduction in interest rates results in roughly a $250 billion 
reduction in mortgage interest expense over a decade.
    Debt reduction also creates fiscal space, widening the 
range of choices available to us, and giving us greater 
capacity to respond to unforeseen problems. Today, the Federal 
Government is spending more than $200 billion a year on 
interest payments that would be eliminated under our proposals. 
The President proposes that resources not paid in interest be 
used to help ease the burden of the Social Security and 
Medicare costs that will arise once the baby-boom generation 
begins to retire.

               II. Meeting the Needs of an Aging Society

    As we create more fiscal space through continued fiscal 
discipline, we face a fundamental choice about how best to 
utilize that space. In this context, it is a vital objective of 
this budget to improve our ability to shoulder this country's 
obligations to its seniors.
    Let me focus on two central elements: strengthening Social 
Security and modernizing Medicare.

1. Extending the solvency of Social Security to 2050 and beyond

    It is a central tenet of our strategy that we will use all 
of the surpluses from Social Security to improve the 
government's net financial position. Compared to an alternative 
scenario, in which we merely balance the unified budget, the 
President's framework generates an increasing amount of savings 
on interest that would otherwise be paid to holders of the 
debt. Beginning in 2011, we propose to transfer these interest 
savings into the Social Security trust funds. These transfers 
would extend the solvency of the trust funds until 2050.
    At the core of the President's proposal is a high level of 
fiscal discipline. In the Administration's framework, every 
dollar added to the trust funds is ``backed'' by a dollar's 
worth of pay down of the debt held by the public, and hence a 
dollar's worth of contribution to national savings. These are 
serious steps, and constitute important preparation for the 
retirement of the baby boom generation.
    In line with private sector practice, we also propose to 
invest a sensible and measured proportion of the trust funds in 
the equity market with the safeguard that such investment be 
limited to 15 percent of the value of the trust funds. This 
would further extend the solvency of the trust funds to 2054.

2. Modernizing Medicare

    Since Medicare was launched 35 years ago, accessible and 
affordable health care has dramatically improved the lives of 
Americans over the age of 65. But there is now a very broad 
consensus that it is time to reform Medicare to meet the 
challenges of the new century.

By extending competition

    The President put forward a detailed Medicare reform 
proposal last year, and he remains committed to enacting 
comprehensive reform in this Congress. A key element of this 
proposal is the move to full price and quality competition 
between traditional fee-for-service Medicare and managed-care 
plans.
    By letting consumers realize most of the cost savings from 
choosing more efficient health plans, genuine competition will 
give all health plans a strong incentive to deliver the most 
value for money. At the same time, our proposal would ensure 
that seniors who move to lower-cost plans do so out of choice 
and not because of financial coercion. We look forward to 
working with the Members of this Committee to achieve these 
important objectives.

By providing coverage for prescription drugs

    A second central element of Medicare reform is a voluntary 
prescription drug benefit that is affordable to all Medicare 
beneficiaries. Drug treatment has become an increasingly 
important part of modern health care, and no one would design a 
Medicare program today that excluded prescription drug 
coverage. Yet, roughly 3 out of 5 Medicare beneficiaries do not 
have dependable drug coverage today, and a majority of the 
uninsured have incomes greater than 150 percent of poverty. The 
Administration's proposal would provide a 50 percent subsidy 
for all seniors who choose to purchase the new Medicare drug 
benefit, with additional subsidies for lower-income seniors. 
The budget also includes a reserve fund of $35 billion for 2006 
through 2010 to be used to design protections for beneficiaries 
with extremely high drug spending.

And by extending the solvency of Medicare

    A third aspect of responsible Medicare reform is the 
addition of new resources into the Hospital Trust Fund. In the 
coming decades we expect to see a doubling in the number of 
Medicare beneficiaries, and continued advances in the ability 
of modern medicine to improve the length and quality of 
seniors' lives. We cannot meet the rising future demands on 
Medicare through our structural reforms alone. But by enacting 
the combination of reforms and transfers in the President's 
budget, the projected solvency of the Medicare program could be 
extended to 2025.

           III. Using Tax Cuts to Strengthen Our Communities

    The President's budget creates room for prudent and 
targeted tax cuts totaling $250 billion on a net basis over the 
next decade and $350 billion on a gross basis. These tax 
initiatives would advance a broad range of national priorities, 
including: reducing poverty and stimulating the creation of 
small businesses in our deprived communities; strengthening 
incentives to work and to save; and making it easier for 
families to care for chronically ill relatives. The proposals 
would also close unfair tax loopholes and eliminate tax 
shelters.
    Let me highlight briefly some of the most important tax cut 
proposals in the President's budget.

Retirement Savings

    Almost one in five elderly Americans has no income other 
than Social Security; two-thirds rely on Social Security for 
half or more of their income. Half of all working Americans 
have no pension coverage at all through their current job. It 
is very clear that steps need to be taken to help Americans 
take greater responsibility for their own financial security in 
retirement, and new incentives should be targeted to moderate 
and lower-income working families.
    The President proposes to address this situation by 
creating a new, broad-based savings account, Retirement Savings 
Accounts. These accounts would give 76 million lower-and 
middle-income Americans the opportunity to build wealth and 
save for their retirement.
    Under our plan, individuals could choose whether to 
participate, on a strictly voluntary basis, either through a 
retirement plan sponsored by their employer, or through a 
special stand-alone account at a financial institution. The 
employer or the financial institution would match each 
individual's contribution and then recover the cost of the 
match from the Federal government in the form of a tax credit.
    Individuals could contribute up to $1,000 per year. Low-
income individuals would qualify for a two-for-one match on the 
first $100 contributed, and a dollar-for-dollar match on 
additional contributions. Higher income participants could 
qualify for a 20-percent match, in addition to the tax 
incentives that apply to pension or IRA contributions. A person 
who participated in this savings program for his or her entire 
career could accumulate well over two hundred thousand dollars 
for his or her retirement.
    In addition, the President proposes to make small employers 
eligible for new tax credits to help them set up or improve 
their retirement plans. Related proposals include measures to 
increase pension security and portability, and to improve 
disclosure to workers. Overall, the cost of these initiatives 
to expand retirement savings would total $77 billion over ten 
years.

Helping Working Families

    The Earned Income Tax Credit has proved one of the most 
effective means of rewarding work and lifting people out of 
poverty. In 1998 alone, the EITC raised the income of 4.3 
million working people above the poverty level. But many 
families still remain in poverty. The President proposes to 
help more families work their way out of poverty by increasing 
the Earned Income Tax Credit for the larger families that are 
most apt to be poor and relieving the marriage penalty under 
the EITC. The increases in the EITC would total $24 billion 
over the next ten years.
    Under the budget plan we would also reduce the marriage tax 
penalty, strengthen work incentives, and cut taxes for the 70 
percent of families who claim the standard deduction. To 
address the marriage penalty in a targeted way, the President 
proposes to make the standard deduction for two-earner married 
couples twice the standard deduction for singles. In 2005, when 
it is fully phased in, this proposal would raise the standard 
deduction for two-earner married couples by $2,150. Starting in 
2005, the proposal would also simplify and reduce taxes for 
middle income taxpayers by increasing the standard deduction 
for single-earner married couples by $500 and for singles by 
$250. The proposal would make the child and dependent care tax 
credit refundable and raise the maximum credit rate to 50 
percent.

Revitalizing our Communities.

    By expanding the New Markets tax credit the budget would 
help spur $15 billion in new investment for businesses in inner 
cities and poor rural areas. The budget also proposes to extend 
and expand incentives for businesses to invest in empowerment 
zones.

Health

    Last year the President proposed a tax credit that 
compensated families for the cost of looking after chronically 
ill relatives. But at $1,000, the credit was insufficient 
compensation for the rising burden that these families face. 
The President's FY2001 proposal triples the credit to $3,000. 
We also propose to provide tax credits for workers between jobs 
who purchase COBRA coverage from their old employers.

Education

    The budget proposes to save taxpayers $30 billion over ten 
years through the College Opportunity Tax Cut. When fully 
phased in, this new tax incentive would give families the 
option of taking a tax deduction or claiming a 28 percent 
credit for up to $10,000 of higher education costs. This would 
provide up to $2,800 in tax relief to millions of families who 
are now struggling to afford the costs of post-secondary 
education. We also put forward a tax credit to help state and 
local governments build and renovate their schools.

Tax Simplification and Fairness

    Although the Alternative Minimum Tax was originally 
intended to ensure that high-income taxpayers could not use tax 
breaks to avoid income tax altogether, we recognize that it is 
increasingly eating into the take-home pay of middle-income 
taxpayers, especially those with large families. We propose to 
redress this problem by allowing taxpayers to deduct all of 
their exemptions for dependents against AMT. By 2010 when it is 
fully phased-in, this change would halve the number of 
taxpayers affected by the AMT.

Corporate Shelters and Tax Havens

    The proliferation of corporate tax shelters presents a 
growing and unacceptable level of abusive tax avoidance that 
reduces government receipts and consequently raises the tax 
burden on compliant taxpayers. Corporate tax shelters breed 
disrespect for the tax system--both by those who participate in 
the tax shelter market and by those who perceive unfairness. A 
perception that well-advised corporations can and do avoid 
their legal tax liabilities by engaging in these tax-engineered 
transactions may cause a ``race to the bottom.''
    The President's FY 2001 Budget again contains a 
comprehensive approach to addressing this problem. This 
approach is intended to change the dynamics on both the supply 
and demand side of this ``market,'' making it a less attractive 
one for all participants--``merchants'' of abusive tax 
shelters, their customers, and those who facilitate these tax-
engineered transactions. The main elements of the legislation 
include: requirements aimed at substantially improving the 
disclosure of corporate tax shelter activities; provisions to 
raise the penalty where there is substantial understatement of 
tax owed; and the codification of the economic substance 
doctrine. Enactment of corporate tax shelter legislation, 
combined with the efforts of the restructured IRS, will go a 
long way towards deterring abusive transactions before they 
occur, and uncover and stop these transactions when they do 
take place.
    Another area that raises similar concerns is the growing 
use of tax havens. These jurisdictions, through strict bank 
secrecy and other means, facilitate tax avoidance and evasion. 
Curbing this harmful tax competition should help businesses to 
compete on a level playing field and encourage investment 
growth and jobs. Our budget includes several provisions 
intended to reduce the attractiveness of tax havens and to 
increase access to information about activities in tax havens.

Other Provisions

    There are a number of other important proposals that I 
would like to mention. These include: incentives to increase 
philanthropic donations; tax credits aimed at bridging the 
``digital divide'' by encouraging investment in technology in 
deprived communities, and measures to help reduce pollution and 
emissions of greenhouse gases.

    IV. Investing in Health, Education and Other National Priorities

    The spending proposals in the President's budget are based 
on two fundamental principles.
    The first principle is that we use realistic projections of 
the level of spending needed to maintain core government 
functions. To meet this requirement, we begin with a ``current 
services'' baseline under which discretionary spending is held 
constant on an inflation-adjusted basis.
    Our budget policy would maintain defense spending at this 
baseline and reduce non-defense discretionary spending slightly 
below it, meaning that existing domestic programs would need to 
be trimmed by more than enough to finance new initiatives. In 
1999, non-defense discretionary spending was a smaller share of 
GDP than at any point in at least 40 years; under our policy, 
it would represent a yet smaller share over the coming decade. 
Moreover, total outlays as a proportion of GDP would decline in 
2001 and they would continue to decline on this basis for the 
rest of the decade.
    The second fundamental principle of the President's 
spending proposals is to focus on critical national priorities, 
including health care, education, law enforcement, and 
technology. By focusing our initiatives in these and other key 
areas, we can meet people's needs in a fiscally disciplined 
way.
    Let me briefly summarize our proposals in these four areas.

Health Care

    The President has proposed a bold initiative to reverse the 
disturbing increase in the number of Americans without health 
insurance. Through the combination of targeted spending 
proposals and tax incentives, we can expand health coverage to 
millions of uninsured Americans.
    A central part of this initiative is an expansion of the 
State Children's Health Insurance Program, known as S-CHIP, 
which was introduced two years ago with broad bipartisan 
support. In the FY2001 budget we would build on the success of 
this program by extending it to cover the parents of eligible 
children, most of whom are uninsured. Another important element 
of this initiative is providing a Medicare buy-in option for 
people close to the Medicare eligibility age. This year, to 
make this option more affordable, our budget includes a tax 
credit to offset some of the premium.

Education

    Education is another key priority in the President's 
budget, as has been true since the beginning of this 
Administration. For next year we are proposing an additional $1 
billion for the Head Start program and almost $150 million for 
Early Head Start, which would put us within reach of serving 
one million children by 2002. We are also proposing sufficient 
funding to take us almost halfway to the President's goal of 
hiring 100,000 new teachers in order to reduce class sizes.

Law Enforcement

    Turning to law enforcement, the budget includes significant 
new resources to enforce our nation's gun laws. Last Friday we 
released a report from the Bureau of Alcohol, Tobacco and 
Firearms showing that 1 percent of gun dealers account for well 
over half of all crime guns traced last year. The information 
from gun tracing will help us target our enforcement efforts, 
but we also need more agents and inspectors at the ATF and more 
prosecutors -and our budget will provide them.
    At the same time we are requesting funds that would pay for 
recruiting and training of 50,000 new police officers, and 
funds that would strengthen the National Money Laundering 
Strategy. Money laundering is a growing international problem, 
and we need this budget allocation to strengthen U.S. 
leadership in fighting this problem.

Technology and the Environment

    Another important national priority must be investment in 
the science and technology that will spur economic growth and 
improve people's lives in the 21st century. The President's 
budget includes a nearly $3 billion increase in crucial 
investments, including a $1 billion increase in funding for 
biomedical research for the National Institutes of Health and a 
rise in funding for the National Science Foundation that is 
double the previous largest increase. These investments will 
enable Americans to continue to lead the world in many areas of 
science and technology, including biomedical research, nano-
technology, and clean energy.
    The budget also contains $42 billion for high-priority 
environmental and natural resource programs, an increase of $4 
billion over last year's enacted level. This includes $1.4 
billion in discretionary funding for the Land's Legacy 
initiative to expand and protect our open spaces, an additional 
$1.3 billion to support farm conservation, and an additional 
$770 million to help combat global climate change.

                  V. American Leadership in the World

    As we enter this new century, it is crucial that we 
continue to learn the lessons of the last one by working to 
build an ever-widening circle of more prosperous and more open 
international economies. This enables us to enjoy the benefits 
of peace and the spread of our core values. And we benefit more 
directly in the millions of high-paying jobs that exports 
create and the competition and innovation that openness to 
imports can promote. In short, globalization is not a zero sum 
game but a ``win-win proposition'' for America and its trading 
partners.
    Let me outline several areas where we can strengthen this 
process while also enhancing our national security.

China

    One of the President's top priorities this year is to seek 
Congressional approval for the agreement we negotiated to bring 
China into the World Trade Organization, by passing Permanent 
Normal Trading Relations with China as soon as possible. I 
firmly believe that China's entry into the WTO, under the terms 
of the trade agreement that we reached last November, is in our 
economic and national security interest.
     First, this is a good deal for American workers, 
farmers and businesses since the concessions all run one way, 
in our favor.
     Second, by integrating China into the rules-based 
world trading system, we will help promote reform within China 
and reduce the security threat that an isolated China can pose 
to America and the rest of the world.
    Mr. Chairman, we will need your support to prevail, and 
look forward to working with you on this issue in the weeks and 
months ahead. We also look forward to working with you to 
implement the Caribbean Basin, African Trade, and Balkans Trade 
Initiatives.

Multilateral Development Banks

    Obtaining adequate funding for U.S. participation in the 
MDBs remains a Treasury priority. Every dollar we contribute to 
the multilateral development banks leverages more than $45 in 
official lending to countries where more than three-quarters of 
the world's people live. These programs are the most effective 
tools we have for investing in the markets of tomorrow. This 
budget's request for $1.35 billion is $40 million less than we 
requested last year, yet it would fully cover our annual 
obligations to the MDBs as well as paying down some of our 
arrears to a global system that we were instrumental in 
creating.

Highly Indebted Poor Countries Initiative

    I would like to thank Congress for your efforts in the 
FY2000 budget to provide broader, deeper and faster debt relief 
to the world's poorest and most heavily indebted nations. As a 
result, progress has been made. Writing off debts owed by 
countries that will never be able to repay them is sound 
financial accounting. It is also a moral imperative at a time 
when a new generation of African leaders is trying to open up 
their economies.
    The President is asking for an additional $210 million this 
year and $600 million over the next three years to support 
multilateral and bilateral debt relief for countries under the 
Highly Indebted Poor Countries initiative. In doing so he is 
asking Congress to finish the enormously important work we 
began last fall.

Vaccines

    The budget also contains requests that would help fulfill 
the President's Millennium Initiative for vaccines. By 
allocating $50 million to the Global Alliance for Vaccines and 
Immunization, we could save many children's lives and at the 
same time help protect the health of American citizens. The 
President has also proposed a new tax credit that would help 
stimulate development of vaccines for malaria, HIV-AIDS and 
tuberculosis.

                         VI. Concluding Remarks

    I began my remarks today by focusing on the link between 
fiscal discipline and the performance of our economy over the 
last seven years. Having worked hard to help bring us to the 
remarkable economic moment that we are now enjoying, the 
Members of this Committee know well the value to our economy 
and our country of further paying down the national debt held 
by the public. If we can act to reduce the debts we bequeath to 
our children, while continuing to fund our obligations to 
seniors and pursuing the vital purpose of making the economy 
work for all our people and communities, then we can maximize 
the extraordinary opportunities with which we are now 
presented. I look forward to working together with this 
Committee and others in Congress to turn these high-class 
challenges into even higher-class solutions. Thank you. I would 
now be happy to respond to any questions that you might have.
      

                                

    Chairman Archer. Mr. Secretary, thank you for your succinct 
presentation.
    Does Ms. Matthews wish to make a statement?
    Ms. Matthews. No, thank you, Mr. Chairman.
    Chairman Archer. We are happy to have you with us.
    This problem that you mentioned toward the end of your 
presentation is a very serious one. If FSC, which is one of our 
few tools to help exports, is negated by the Europeans, then it 
will fall very heavily on the good jobs that have been created 
for exports. I am glad you mentioned it, because we need to 
work together in every possible way to find some relief from 
this.
    I am constrained to say that there is one easy answer, and 
that is to abolish the income tax and go to a consumption tax. 
I wish that I could have intrigued the President to join me in 
pushing for that, but apparently that will be for a later day. 
That in one fell swoop would take care of the problem, not only 
the disadvantage, but give us a fair advantage under the world 
trading rules.
    I think ultimately we must come to it, because otherwise we 
are going to see--as we heard testimony from witnesses last 
year--more and more American corporations being merged to 
become foreign corporations. We saw it with Chrysler. Our tax 
code single-handedly forced Chrysler to become a German 
corporation at the end of the merger. That testimony is in the 
record from a Chrysler executive.
    Bankers Trust is now Deutsche Bank because of our tax code. 
Amoco is now BP because of our tax code. And we will see more 
and more and more of that if we do not get serious about 
eliminating the massive negative impact of the way that we tax 
foreign source income. This FSC part is only one small part of 
that entire problem. I will work very, very aggressively with 
you in trying to find an answer to it.
    Mr. Secretary, there are so many things that I would like 
to ask about. I am going to limit it to a couple and then the 
other members, of course, will want to have their turn in the 
questioning.
    You provide significant increases in spending, but you do 
not talk about how we can eliminate wasteful spending. We just 
found out that the Defense Department's records are so bad that 
we cannot even have an audit to determine missing billions of 
dollars. The same is true of the Department of Education where 
billions of dollars have been unlocated.
    It seems to me that we should start talking about 
eliminating wasteful spending before we start talking about 
increases in spending.
    Let me go on to the debt. I am looking at the figures in 
your budget relative to the aggregate debt of this country. If 
I read them correctly, they go up every year from 2000 through 
2013, necessitating an increase in the debt ceiling. Yet you 
say that you are going to pay off the debt. Obviously, you are 
not paying off the debt if we have to have an increase in the 
debt ceiling. It is almost like a shell game. You are 
transferring debt being held from one group to that being held 
for another group, but the aggregate is going up. And, that is 
still money that future taxpayers are going to have to pay off. 
Those debt service charges continue to go up. They are going to 
have to be paid.
    I think we ought to be very forthright with the American 
people, both the Republicans and Democrats because we both get 
involved in this. Neither party is not paying off the debt. The 
debt is going up. And debt service charges, depending on what 
interest rates are, are going up, too. That is a very serious 
factor for this country.
    Then finally I would ask you to comment on why you believe 
that you need to have $14 billion of extra revenue coming into 
the Federal Government at a time when the tax take is the 
highest in peacetime. Your budget, integrating all the revenue 
items and all the tax reduction items, is a net $14 billion by 
your numbers. It may be different by CBO and Joint Committee--
we haven't had time to get those numbers yet. But by your 
numbers, it is an increase of $14 billion that will be taken 
into the Federal Treasury on a net basis.
    For the life of me, I cannot understand why the 
productivity and the people of this country are going to have 
to put more money into the Treasury at a time when revenues are 
skyrocketing. I would be happy to have your comments on that.
    Mr. Summers. Mr. Chairman, I am glad you have given me the 
opportunity to address three important issues.
    First, with respect to Government waste, we have over the 
years taken management to the Government very seriously. That 
is why the civilian labor force in the Government is one-sixth 
smaller than it was in 1993. Treasury, for example, has reduced 
its work force by 10 percent, even though there are a lot more 
tax returns and a lot more people crossing the border than 
there were. We think that represents real progress, although 
there is a lot more to do.
    You are absolutely right in raising the concern about funds 
that cannot be fully accounted for. When these programs began 
taking on the task for the first time of accounting for all 
Federal assets as a result of legislation we worked together 
with Congress on in the mid-1990s, there was far more in the 
way of unaccounted for assets. Year after year we have improved 
the quality of financial controls. That is a crucial task for 
us all to continue.
    But let's recognize that we are making progress in 
improving our financial control. We are making progress in 
shrinking Government. We are making progress in shrinking 
civilian Government for the first time in a very, very long 
time.
    Chairman Archer. Mr. Secretary, very quickly--yes, so much 
more to do and so little time.
    Mr. Summers. There is a great deal to do. The establishment 
of a fully satisfactory set of controls is not something that 
is going to happen this year. It may not be something that 
happens in the next several years. But we are getting much 
better controls on these expenditures, and we are doing much 
more with much less for the first time in a long time.
    With respect to the debt, it is the convention of 
economists, of financial analysts--almost all experts that look 
at these issues--to focus on the issue of publicly-held debt. 
They focus on the publicly-held debt because that represents 
the obligation of the Government to its citizens and to net out 
the intra-governmental debt much as in looking at the financial 
position of my family, one would net out any debt obligation 
between me and my wife. It was the publicly-held debt figures 
to which I was speaking. It is that which reflects pressure on 
credit markets and the unified deficit. I would argue very 
strongly that experts of both parties would agree that it is 
the publicly-held debt and the net interest flow of the Federal 
Government that is relevant for analyzing the Government's 
fiscal position.
    The third issue is an important one, and that is the 
question with respect to the gross versus the net tax cut. As I 
indicated, the President's budget has $350 billion in gross tax 
cuts. It has $100 billion in tax offsets, such as the tax on 
corporate shelters that I referred to in my testimony.
    It also includes a number of other measures that generate 
revenues for the Federal Government. Some of those are measures 
such as user fees, which do generate receipts but which we do 
not think of as a tax. A large part of those represent tobacco 
policy, which we feel is the best way of stopping a fraction of 
the 3,000 kids who start to smoke each day, a thousand of whom 
will die, from starting to smoke. We think that is an 
appropriate public health investment in our country's future. 
It is a judgment on which one can disagree, but the motivation 
for it is very clearly not generation of revenue, it is the 
protection of the public health.
    Chairman Archer. Mr. Secretary, again I compliment you on 
the succinctness of your responses, which the committee 
appreciates.
    A tax is a tax is a tax. A tax on cigarettes means that 
those people who use cigarettes are going to have less money to 
spend on other things. It is highly aggressive. It hits very, 
very hard the lowest income people. It has not been proved to 
be a deterrent, but it is a tax and it is raising more money 
out of the economy.
    User fees--and you tried to reclassify certain things from 
a tax to a user fee--but a user fee technically is only 
something which is voluntary. If you want to use a service, 
then you pay a fee. That is the technical definition of whether 
it is a fee or a tax. I would say that what you are calling 
fees will not pass muster in most cases under that definition.
    But in any event, you are raising--by your own figures--$14 
billion more out of the economy net than is currently being 
raised today, at a time when revenues are burgeoning already. 
We just have a disagreement about whether that is an 
appropriate thing to do.
    Mr. Summers. I think we may.
    Let me just emphasize that a large share of the tobacco 
policy represents a penalty on tobacco companies if they are 
not sufficiently successful in reducing the incidence of youth 
smoking. So it seems to me that a fine for failing to achieve a 
public health objective as a policy--one could argue both 
sides--it does not seem to me best to think of it as a tax.
    And of course, nobody has to pay any of this who chooses 
not to smoke. So by your voluntary criterion--which I am not 
sure I would agree with--but by that criterion, one could 
distinguish the tax.
    I would like to bring up one other point. It is sometimes 
suggested that taxes are at some kind of high level at this 
point. I would hasten to observe that if you look at the tax 
burden on a family with half the median income, the median 
income, or twice the median income, it is lower than it has 
been at any time in the last two decades. It is true that taxes 
relative to GNP are at a high level. That is a reflection of 
two things. It is a reflection of the fact that income is at a 
high level relative to GNP because of the strength of the stock 
market and all of that, and it is a reflection of the fact 
that--something we are working to try to address--the income 
gains over the last two decades have gone heavily to those who 
are in higher tax brackets and heavily in the form of profits 
that are particularly heavily taxed.
    Those two considerations account for the tax to GNP ratio 
having risen. But I think we do need to be clear to anyone who 
is listening to this hearing that if you measure the tax burden 
on a family with the given median income, that tax burden at 
the Federal level for either income taxes or income plus 
payroll taxes has fallen over the last two decades.
    Chairman Archer. No matter how you spin it, Mr. Secretary, 
the take out of our economy is at the highest percentage of GDP 
than at any time in peacetime history. that money is coming out 
of the productive private sector into the Government. And the 
danger is that will perhaps be a magnet to pull up the total 
spending level which may become entrenched at the highest level 
of GDP in history and which then would be difficult to maintain 
if you have a change in the economy.
    I would love to discuss this more with you. You are the 
economist and I am not.
    Mr. Rangel?
    Mr. Rangel. Thank you, Mr. Chairman.
    I find intriguing that the cigarette tax is not a tax but a 
penalty because I have been wrestling with the Republican 
marriage penalty tax relief. They are giving the relief to 
people who have no penalty and indeed have a bonus. So it would 
be good if we could have a course between the White House and 
the Congress in what worries me.
    But I like the word penalty instead of taxes. [Laughter.]
    Mr. Rangel. Let's see what we are up against.
    When the President met with the congressional leaders, were 
you present?
    Mr. Summers. Yes.
    Mr. Rangel. It has not been shared with us in the minority, 
but do you have some guideline as to where the Republican 
leadership is taking us with the tax bill?
    Mr. Summers. I think it is best to let the Republican 
leadership state their own intentions. I would rather not be 
put in a position of trying to characterize or predict their 
judgments. I am happy to speak for the Administration.
    Mr. Rangel. Was this a secret meeting you had? This was a 
meeting to determine if we could cooperate--I thought--between 
the Congress and the Executive Branch. I assume they wanted to 
work with the President.
    Mr. Summers. I think there is a sense that we would like to 
work together. We in the Administration would certainly like 
very much to work together with the Congress, both houses and 
both parties, to try to accomplish the key things I have been 
talking about: paying down the debt, helping health, helping--
    Mr. Rangel. No, it is clear where the Administration is 
coming from. But we do not have a budget from the Republicans, 
so we do not have a blueprint to work with. I assume that 
nothing was given to you to share with us.
    Social Security--we don't have a bill in the House. Was 
that discussed with the President to see whether we could work 
together on that? It doesn't bother me that they don't talk 
with me, but did they talk with the President about a bill on 
Social Security?
    Mr. Summers. Certainly there is no specific private 
proposal of which I am aware.
    Mr. Rangel. I would hate to see this year go by without us 
really dealing with the question of education initiatives. It 
is so important that our country be prepared to keep up with 
the advancements in technology. I know many of my Republican 
friends would want to support some initiatives there.
    Certainly the earned income tax credit provisions is just 
the equitable thing to do with so many people becoming 
instantly wealthy. This would give an opportunity to pull hard-
working people out of poverty.
    The Speaker has said that he shares the new market 
initiatives working with the private sector. Have people talked 
with you about how we have to work this thing together, 
especially the tax portion of it?
    Mr. Summers. My hope would be, Mr. Rangel, that coming out 
of this hearing we could move toward trying to establish a 
framework for the budget this year into which some of the 
crucial tax components could fit. In addition to the earned 
income tax credit, school construction, and the digital divide 
you have mentioned, I would highlight the alternative minimum 
tax and the retirement savings questions as areas where I very 
much hope that we can work together.
    Mr. Rangel. It is clear that many objections are going to 
be raised from the points of view of you, the President, and 
the Administration. I am trying desperately to find out if you 
got a sense of any areas in which the majority can work in 
positive ways with the President, or are we just talking about 
your hopes and the President's hopes?
    Mr. Summers. I think it is best for me not to hold myself 
out as a spokesman for the majority, Congressman Rangel. 
Certainly I think we have all seen and welcomed statements 
indicating a desire--such as the one the chairman expressed 
today--to work together on a range of issues. My hope would be 
that this would prove to be possible.
    Mr. Rangel. Now that you have all these hopes on the table, 
there is a bill coming to the Floor tomorrow, a marriage tax 
penalty bill.
    Did the Republicans discuss this with the President? It was 
included in his State of the Union, and while it is a 
dramatically different approach, did they reach out to you to 
try to work something out on this issue?
    Mr. Summers. No, I have communicated my view in a letter to 
both you and Chairman Archer with respect to that proposal.
    Mr. Rangel. What is your view in respect to this proposal?
    Mr. Summers. I have written indicating that the President 
believes that it is important to address marriage penalty 
issues, but it should done in the right way, in the right 
framework, at the right time and expressing the judgment that I 
and the President's other senior advisors would not be able to 
recommend that he sign the current legislation because of an 
absence of an overall framework for a tax cut of this 
magnitude.
    Mr. Rangel. I have been used as an interpreter for White 
House language, and I have been telling my friends that you not 
recommending that the President sign means veto, but I 
understand that you cannot say that.
    If you are going to veto the bill, and they are still going 
to push the bill, then it seems to me that your hopes for 
cooperation in taxes are not well founded.
    Mr. Summers. I am an optimist. I think there are real 
opportunities this year. It seems to me that there is a great 
deal of consensus on the idea of paying down debt. I have been 
encouraged by the number of people who have shared the view 
that we need to provide that prescription drug benefit, by a 
number of people who recognize that choice in Medicare is 
possible without financial coercion, and who see that really in 
the tax area the priority is helping middle class families at 
crucial points in their lives and particularly helping those 
who have been left behind. I think there are an increasing 
number of voices who are recognizing that.
    My hope would be that it would be possible to work together 
to do things that will strengthen our national economy because 
it won't always be this strong. This is a moment when we have a 
real opportunity to work together.
    Mr. Rangel. Your inspiring presentation has given me now 
hope. So I am going to hope that the majority would put the 
Archer-Shaw Social Security concept into some type of 
legislative language so that we could get the Administration to 
look at it. I am going to hope that the death penalty 
provisions and the tax cuts that have been placed on the 
patient bill of rights and that the Republican retirement 
savings incentives and the tax cuts that are on the minimum 
wage bill and the exciting education saving accounts and the 
community renewal and the repeal of the Social Security earning 
test--I am only up to $1.4 trillion, but this is still part of 
an overall concept the Republicans have put together in small 
parts.
    We only have the first slice of this trillion dollar 
package for tomorrow. But if you have hope, I am going to have 
hope that one day the majority would come to us with the rest 
of these very important issues to see whether we can work 
together with you and the President. But if that doesn't 
happen, you might want to pick out the most important things, 
like the vaccine and the trade bills, and then maybe we will 
operate on plan two.
    But I am going to have hope, too.
    Mr. Chairman, I hope you were nearly as inspired as I was 
by the Secretary's eternal desire and hope that you and I work 
more closely together.
    Chairman Archer. I am always inspired by your comments, Mr. 
Rangel. [Laughter.]
    Chairman Archer. Mr. Crane?
    Mr. Crane. Fist I would like to remind Mr. Rangel that 
Congress makes policy. The function of the White House is to 
administer policy.
    Let me touch on one other thing that is a major concern 
because it can have a profound impact on our ability to remain 
competitive in world markets.
    Our chairman talked about how his consumption tax would 
eliminate that disadvantage that potentially we are confronted 
with. I pushed for a flat tax for 30 years that would eliminate 
any tax on business whatsoever on the grounds that they don't 
pay taxes in the first place. That is a cost like plant, 
equipment, and labor. You have to pass them through and get a 
fair return. Either one of those approaches would eliminate 
that problem that we are facing.
    One other issue you touched on, Mr. Secretary, is the 
tobacco tax. Are we contemplating taxing sugar, too?
    Mr. Summers. I am not aware of any proposals the President 
has put forward.
    Mr. Crane. Because excessive consumption of sugar puts on 
all that fat, and that is injurious to your health. Shouldn't 
we punish people for going down that path?
    Mr. Summers. That is not something--let me emphasize the 
thrust of the President's policy in the tobacco area. It is 
focused on kids. It is focused on people below what we normally 
take to be the age of consent, who become addicted before 
reaching the age of 18. I don't remember the precise figure, 
but it is something like three-fourths of smokers have become 
addicted before the age of 18.
    So it becomes a rather different kind of context than a 
number of other issues.
    Mr. Crane. If you will yield, Mr. Secretary, putting that 
huge tax on a pack of cigarettes--that is going to discourage 
that teenage from going to the market because he can't lay his 
hands on all that money. Is that it?
    Mr. Summers. Let me just say that there is an extensive 
body of evidence that on another occasion, if the committee is 
prepared to take this issue up seriously I would be pleased to 
come present to the committee documenting the price 
responsiveness of cigarette demand, particularly among young 
people to the level of prices. That evidence comes from cross-
State comparisons. That evidence comes from inter-temporal 
comparisons. That evidence comes from international 
comparisons. It is corroborated by the work of Nobel Prize 
winners like Gary Becker.
    There are a number of aspects to the tobacco question that 
one can debate, but the proposition of price elasticity in 
response to the tax I think is one of the better established 
facts in empirical microeconomics.
    Mr. Crane. I hope it doesn't encourage any young kid who 
has a breakdown in terms of moral standards to engage in 
increased theft and stealing to finance that bad habit.
    Now let me turn to another subject that is of major concern 
to me, and it has to do with trade. Given the failed outcome at 
Seattle, how have our objectives changed for achieving further 
trade liberalization, and what is the Administration's strategy 
for achieving those objectives?
    Mr. Summers. Congressman Crane, we are engaged in quite 
active consultation with a number of countries around the world 
to try to establish a basis for consensus that would allow a 
new round of WTO to move forward. Crucial issues include 
agriculture, the treatment of services, the definition of what 
kind of rules will apply to investment--if that is going to be 
a subject that is going to be treated--and of course, what 
kinds of discussions are going to take place with respect to 
issues of environment and labor.
    The President spoke in considerable detail to the U.S. 
position in his address in Davos and made what I think is the 
central point, which is that there is no alternative to a free 
trade open market approach, but that for such an approach to be 
sustainable and successful, it is essential that it be 
complimented by efforts to address the other consequences of 
global integration. Much has taken place as interstate commerce 
increased in the United States in the first part of this 
century.
    I would say that in terms of starting the round, in terms 
of moving ahead with trade, the most important decision that 
will be made in the United States will be the decision as to 
whether Congress gives impetus to the global trading system by 
passing China's entry into the WTO and by passing the Africa 
and CBI initiatives. My hope would be that it would be possible 
for us to give in to that system through those two pieces of 
legislation.
    Mr. Crane. I have one quick question. Many foreign 
delegations and others expressed concern over the President's 
remarks regarding labor standards and trade sanctions in 
Seattle. With those comments still echoing in the minds of 
delegates, how can we take the next steps to create an 
atmosphere of cooperation?
    Mr. Summers. We have been speaking to countries all over 
the world. I had a chance to discuss these questions on my 
visit to India and Indonesia. I think there is an increasing 
recognition that it is absolutely unacceptable for labor and 
environment to be used as cloaks for protection. But at the 
same time, if we are all coming together in a smaller world, we 
have to find approaches to address what everyone agrees is a 
real problem.
    Children who are working in mills rather than being in 
schools, and environmental problems that cross international 
borders--we are going to have to work to find a formula. I 
think there is now considerable agreement on ends, and the 
question and issue really goes to means.
    Chairman Archer. The gentleman's time has expired.
    Mr. Thomas?
    Mr. Thomas. Thank you, Mr. Chairman.
    Welcome, Mr. Secretary.
    I was pleased to see in the written testimony you provided, 
on pages four and five, that you focused on modernizing 
Medicare. However, in the first paragraph you say, ``But there 
is now a very broad consensus that it is time to reform 
Medicare.'' So my assumption is that modernizing is also 
reform. I would not want to get into a semantic squabble about 
what is going on.
    I am also pleased because in that first paragraph, in 
talking about the President's interest in extending 
competition--that was one of the core interests of the Medicare 
Commission--I was pleased that the President chose you and your 
Department to put together a competitive market structure for 
future service.
    I think the majority is ready to sit down and talk about 
competitive models both for fee for service and for managed 
care. Some of the President's proposals we think are forward-
looking and positive. Obviously there are some items that have 
been presented to both Democratic and Republican Congresses and 
simply have not been accepted. But the core of working together 
is there.
    Should I read anything at all into the fact that the White 
House chose the Treasury Department to put together a 
competitive model on Medicare rather than using the Health Care 
Finance Administration, which is currently charged with the 
responsibility of running the old-fashioned structure of 
Medicare?
    Mr. Summers. Let me just say, Congressman Thomas, that I 
appreciate the kind words about the Treasury Department, but I 
would hasten to point out--as is the case with virtually all of 
the proposals that the Administration puts forward that reflect 
the hard work of an interagency process overseen by a 
principle--
    Mr. Thomas. I understand that, but I have a short period of 
time, and my question would be: Was there any discussion, or 
are you at liberty to be able to tell us?
    In looking at the models the Treasury Department put 
together, from my perspective it was not inconceivable that you 
could have simply then added a little frosting on top of that 
nice cake you baked for competition saying we should use a new 
entity to oversee the competitive model.
    We, of course, on the Commission would have called it the 
Medicare Board. You can call it anything you want as long as 
Treasury is the one that proposes the structure.
    Is that an area you think we could work toward modernizing 
and reforming Medicare?
    Mr. Summers. The Administration has real concerns about 
making sure that there is full political accountability with 
respect to any mechanism that is established for overseeing 
competition. But we very much want to be in discussion with the 
Congress to find the right approach to choice.
    Mr. Thomas. I appreciate that.
    So if I have the Thesaurus that the gentleman from New York 
has where you won't say ``veto'', you didn't say ``no''. So my 
assumption is that is an area in which we can work, and I 
appreciate that response.
    One of the concerns in terms of reform in the next 
paragraph on prescription drugs--it is still a kind of stand-
alone proposal which isn't integrated. Frankly, prescription 
drugs as part of the tool chest for medicine today really does 
tend to integrate the use of drugs with other more traditional 
medical practices. I would hope that we have the ability to 
move forward on looking at perhaps an integrated prescription 
drug program along with more traditional Medicare.
    I also noticed that the President changed the proposal from 
last year because I know there was major criticism along the 
fact that it wasn't a very good structure you proposed because 
you had to have a certain level to get your money back at the 
front end, and then at the $2,000.00 amount people were paying 
100 cents on the dollar. I wish I could have seen some 
structure to this $35 billion proposal, but I assume that is 
going to come out.
    Last question. I assume you folks did not recommend a veto 
to the about $16 billion adjustment to Medicare called the 
Balanced Budget Refinement Act. The President signed the bill. 
So my assumption was that where we placed the money--especially 
for hospitals, outpatient, for skilled nursing facilities, and 
for home health care--that all of us were concerned that 
seniors were going to be denied services because the original 
package in 1997 did not have as finely crafted tools that we 
would have liked to adjust the marketplace.
    CBO is now telling us--and I am anxious to see what OMB's 
numbers are--that from just the last baseline estimate to 
today's revision we are going to be getting about $62 billion 
over five years of ongoing Medicare savings. In light of those 
numbers, why would the Administration recommend cutting 
Medicare by an additional $70 billion over 10 years when you 
just voted last year to put $16 billion back in?
    Mr. Summers. Congressman Thomas, we will be getting new 
information on the long-run baseline when the actuaries prepare 
their report on Medicare in April or May. The Administration 
certainly did hear the same voices the Congress heard in 
passing the Balanced Budget Refinement Act last year. Our 
proposals do contemplate certain economies that we believe are 
still possible within the Medicare program, but does so in a 
rather more limited--
    Mr. Thomas. I am sorry. Did I read the budget wrong? There 
isn't $70 billion of reduced payments which are extenders for 
the BBA? Did the budget not contain that?
    Mr. Summers. I indicated that it does, but I indicated that 
those proposals were scaled back from the proposals that had 
been contained in last year's budget and--
    Mr. Thomas. So instead of $109 billion in cuts, you scaled 
them back to $70 billion in cuts. That still doesn't answer the 
question of why you voted to put money in last year and you are 
still on a track of--albeit reduced cuts--$70 billion over 10 
years of cutting back on Medicare when we are trying to get it 
right.
    I guess my response to you would be, I would love to sit 
down and work on the competitive model. I think we can save 
some money over projection and that we ought to take any 
surplus that we are now getting from Medicare and reinvest it 
so that we can create a better Medicare, but not go back to the 
old-fashioned cutting of Medicare, which to a very great extent 
is what the President's program offers. If we can make savings, 
then we don't have to make that massive transfer in the 
President's program to argue that we can get to 2025. We know 
we are going to make it to the teens, and there can be some 
mid-course corrections so that if Medicare is saving money, we 
can reinvest it to build a better Medicare, include 
prescription drugs, and more importantly take care of low-
income seniors.
    I really don't understand why the President offered $70 
billion of Medicare cuts over 10 years.
    Mr. Summers. Could I turn that to Ms. Mathews?
    Chairman Archer. Ms. Mathews, as quickly as possible, 
please. The gentleman has exceeded his time.
    Ms. Mathews. I will be brief.
    Our proposals get back to something the chairman raised in 
his first presentation about waste, fraud, and abuse and 
assuring that we make appropriate payments. We believe that the 
proposals this year are not extenders as we did last year, 
simply taking a policy and extending it, but instead we are 
looking at areas such as competition and other places where we 
believe there are inappropriate or double payments or those 
sorts of things.
    Mr. Thomas. So last year you were cutting back on potential 
benefits, this year you have tweaked it a little bit and the 
$70 billion in reductions are not in fact squeezing Medicare 
under extenders? You are saying that there are no BBA extender 
positions in the President's budget?
    Ms. Mathews. In the policy last year--
    Mr. Thomas. The question was, Are there no Medicare 
extenders in the President's budget which would cut Medicare?
    Ms. Mathews. In the President's budget there are some of 
the things that were included in last year's package.
    Mr. Thomas. And that is why this year's is less than last 
year's because you are simply cutting from the $100 billion 
plus to the $70 billion?
    Chairman Archer. The chairman is constrained to transfer 
further discussion of this into the hearings of the Health 
Subcommittee, which will I am sure be voluminous this year.
    Mr. Thomas. Mr. Chairman, I would love to have the 
Secretary there, but they never send him.
    Chairman Archer. Maybe you can get Ms. Matthews to come.
    Mr. Matsui?
    Mr. Matsui. Thank you very much, Mr. Chairman.
    I would like to make three observations and then ask one 
question, Secretary Summers.
    First of all, I want to thank you and Ms. Matthews for 
being here.
    I appreciate very much the fact that you mentioned the 
three trade bills, the CBI, the African Trade Bill, and China's 
entry into the WTO. I think the fact that you mention this in a 
budget hearing shows the commitment of the Administration to 
pass all three of these this year, obviously with the 
cooperation of the House and Senate.
    Secondly, I would like to discuss briefly the comment the 
chairman made with respect to the President's resolve in terms 
of Social Security. He said that the President can't deal with 
this issue this year.
    The President certainly is willing and wants to complete 
Social Security and have a reformed package across his desk 
this year. The problem is that it is in our hands--Congress--at 
this time. The President came up with a proposal in the form of 
the Bradley-Rangel Bill last year. The Administration in its 
budget package has come up with a proposal. It gives a 50-year 
life to Social Security. Now the issue is, How does the 
Congress deal with it?
    We can continue to keep pressing the President, but he has 
a proposal and now it is really up to us.
    Lastly--and I don't need a response on this right now in 
terms of my comments--Mr. Rossotti is doing a very good job in 
terms of management of the IRS, but there is a concern, 
according to press reports, about enforcement and collections. 
I really hope that you in the Treasury Department will really 
get into this issue. I know Mr. Rosetti is trying to address 
it. But nevertheless, I am afraid that if we allow this process 
to continue on for an indefinite future, we could find 
ourselves as we were in the early 1980s where collections were 
down and morale was down and obviously we had a huge 
underground economy--tax reform somewhat brought it back.
    But I know the direction. We don't want abuse, but on the 
other hand, we want to make sure that the principal focus of 
the IRS is collecting taxes that are legitimate.
    The last thing I want to ask you a little bit about is 
FISC. I think the chairman raised that issue.
    We did have DISC, as you know. That was declared 
ineffective or inappropriate by the GATT in the early 1980s, 
and then we came up with the DISH. We appealed the loss we had 
and I understand the decision should be sometime in the next 
few months. Under the WTO's ruling, we have to come up with a 
final approach to this issue by October 1st of this year.
    This is obviously a major incentive for U.S. corporations 
to export. If we lose this opportunity by the third quarter of 
this year, it could have a significant impact on our 
competitiveness.
    It is being appealed now. Is there any effort by the 
Administration to try to come up with a compromise on it with 
the Europeans who filed the initial action? Is there any effort 
to perhaps take a look at some alternatives? I don't want to 
concede a loss yet, but at least we need to have something in 
place if in fact we are not successful.
    Mr. Summers. On FSC, let me say that this is a very 
important issue. I have asked Deputy Secretary Eizenstat to 
take the lead in the Department and for the Administration on 
this issue.
    The case was appealed on January 19th and January 20th. Our 
people felt that they received a fair hearing and a number of 
aspects were explored. We don't yet know the decision.
    Clearly what would be best, from our point of view, would 
be a decision that upheld the U.S. position. We are working 
very hard in an advocacy context for such a decision. In the 
event that such a decision is not forthcoming, I think it will 
be important to work as a matter of urgency to craft a solution 
that preserves the incentive and does so in a way that is WTO-
legal. We will be pleased to work with members of this 
committee and Senate Finance Committee to achieve that 
objective in as expeditious and effective a way as possible.
    I might just mention if I could, Congressman Matsui, with 
respect to your very thoughtful question on compliance, that 
this is something that Commissioner Rossotti and I have talked 
a great deal about. I think it is our feeling that perhaps the 
greatest threat in that area to the integrity of the system is 
around the corporate tax shelter issue. And the essence of that 
issue is, frankly, a tendency to play with what some refer to 
as the audit lottery, carrying out these transactions and just 
sort of hoping that nobody notices.
    The commissioner has taken a number of administrative steps 
to increase enforcement in this area, but it is our feeling 
that containing the abuse problem--and again, this is a 
separate issue from what everyone thinks about--containing the 
abuse problem will require certain legislative remedies. It 
would be our hope--regardless of what happens on the larger tax 
picture but just in terms of maintaining the integrity of our 
system--that is something that we all could discuss this year.
    Mr. Matsui. Let me say this--I know my time has expired and 
you do not need to respond to it--but I think it is important 
to deal with obvious tax shelters. It is about $23 billion to 
$30 billion over five years. But the larger issue in my comment 
to you was the potential for people to say that they do not 
have to comply any longer because it is a voluntary system. We 
don't have to comply any longer because the Service isn't going 
to check up on us and enforce the laws anyway.
    If you recall, back in the early 1980s, we were talking 
about a potential loss. In an underground economy, it went from 
$100 billion to $200 billion a year. I am talking about a much 
larger issue that I think deals with the whole process of the 
Service and what it stands for.
    Mr. Summers. You are raising a very crucial issue. I see 
Congressman Portman sitting who has been enormously thoughtful 
as a member of the Commission on these issues.
    The judgment that we have come to--and it is really heavily 
Commissioner Rossotti's judgment--is that just as business has 
moved past the idea that there is a trade-off between quality 
and cost, and have come to recognize that pursuing the highest 
quality is often the way of pursuing the way of the lowest 
cost.
    And thinking of this in terms of a pendulum that swings 
between customer service and enforcement is not the right way. 
We are working very hard. I think it would be a serious mistake 
for anyone to rely on the IRS' lack of enforcement capacity in 
the years ahead. I think we are going to be providing better 
service to the vast majority of honest taxpayers--more 
appropriate service for the small minority of dishonest 
taxpayers.
    But this is an absolutely critical priority for us. If you 
look to Commissioner Rossotti's exemplary report on his first 
two years and his strategy for the IRS going forward, I think 
you will find that it is responsive to the kinds of concerns 
you are addressing, which are enormously important.
    Chairman Archer. Well stated, Mr. Secretary.
    The gentleman's time has expired.
    Mr. Shaw?
    Mr. Shaw. Thank you, Mr. Chairman.
    Mr. Secretary, a few minutes ago you described yourself as 
an optimist. I have been an optimist, particularly on Social 
Security. The other day I saw a report that said that optimists 
live longer, which made me more optimistic. But I will say that 
I am losing my optimism when it comes to the question as to 
whether this President or this Congress is going to be able to 
work together to solve the problem of Social Security.
    I also have to express profound disappointment that in a 
12-page statement that you have provided us here in the Ways 
and Means Committee, only a half-page is devoted to Social 
Security, which consumes a very large percentage of the budget 
over which you preside. And this hearing is about the national 
budget.
    But my optimism is further diminished into pessimism when I 
read what is contained in that actually less than a half-page, 
that the Administration is suggesting two things with regard to 
Social Security reform. One is accumulating more Federal debt 
within the trust fund--which you and I both know, as we have 
discussed in the past, will be a call upon our kids and 
grandkids to pay off. This is not a real economic asset. 
Chairman Greenspan has testified to that. As a doctor in 
economics, you are well aware of that. So this really does 
nothing to help our the further generations, even though we may 
not run out of Treasury bills until 2050 something under the 
President's plan.
    As those Treasury bills are paid off, that is going to call 
upon the taxpayers, and we get closer to a situation where we 
are going to have two workers supporting each retiree when 
Social Security originally had 40 some workers supporting each 
retiree. What an awful thing to leave to our kids and our 
grandkids, that for them to pay for their parents' pensions, 
there will only be two of them paying into the system to take 
care of them. This is a terrible legacy.
    And I am also very, very disappointed by the fact that the 
President has proposed in his budget that we use the Social 
Security trust fund to buy into the corporate sector of this 
country. That is classic privatization of the Social Security 
trust fund. The American people don't want it. Poll after poll 
say that they don't want it. I don't think there is anyone on 
either side of the aisle supporting privatization of Social 
Security. I don't think the President has any takers with this.
    So you have not only given us something that is dead on 
arrival, this thing died months ago. This thing died years ago 
when the President first brought it up and pulled back from it. 
Now it has gone nowhere.
    I would also like to say to my good friend Charlie Rangel--
he is talking about reaching across the aisle on January 5th in 
a letter--I asked him to comment on the Archer-Shaw plan. We 
have been reaching out. We reached out to the leadership on the 
Democrat side in the Congress--Mr. Gephardt and the other 
Democrat leadership--and we have been met with nothing but a 
wall of silence.
    In order to solve the problem of Social Security in this 
country, it has to be done in a bipartisan fashion. And you 
can't do it in a bipartisan fashion unless we are willing to 
reach out across the aisle and work with each other. There is 
no question in my mind but that we are being stonewalled as a 
political motivation.
    I am not talking about people necessarily on this 
committee, but I am very concerned that we are getting 
absolutely no leadership from the White House on this and we 
are getting no leadership from the Democratic leadership with 
regard to saving Social Security. It is time that we move 
together.
    The President has put out as part of his budget and plan--
he has had it sitting out there for several years there--the 
question of USA accounts. Those are private accounts that are 
set up for American workers. Why can't we bring that into the 
Social Security system so that it leaves the Social Security 
system totally alone, as Mr. Archer and I do in our plan? We 
don't touch it. It stays exactly as it is, but we take funds 
and set up individual retirement accounts.
    Don't take it out of Social Security. It is totally 
separate and apart that is out there for the retirement of 
tomorrow's seniors that will be used to save the system so that 
they won't get absolutely lambasted by a system that our 
generation refused to fix.
    Would you care to comment on that?
    Mr. Summers. You have raised a number of very important 
issues in your comments, Congressman Shaw. Let me just first 
say that I did have an opportunity to testify before the 
committee in early November on Social Security, as you know. At 
that time I had a rather lengthy and detailed statement 
defending the Administration's perspective and presenting the 
Administration's perspective. I also provided rather extensive 
comments on the individual accounts approach. So we certainly 
have done our part in reaching out and seeking to consult to 
find a common solution.
    Mr. Shaw. I have to interrupt here.
    I delivered to you a letter personally to be delivered to 
the President just asking him to meet with Mr. Archer and me or 
someone on this side in order to try to map out this private 
ground.
    This was done months ago. This letter was sent to you and 
you assured me that you were going to deliver it to the 
President's desk, and I am sure you did. I have heard nothing.
    Mr. Archer and I have sent letters to the President. We 
have heard nothing. The President told us over a year ago at 
the White House Summit on Social Security that he was going to 
be sending us a plan that would save Social Security for all 
time. We are still waiting.
    What is wrong?
    Mr. Summers. Congressman Shaw, from my perspective, looking 
at this as an economist, we have a defined benefit pension plan 
that works well for beneficiaries, that is at this point under-
funded. That is the actuarial deficit.
    It seems to me that the responsible course for the trustees 
of a defined benefit pension plan that is under-funded in the 
private sector context would be to look and see if it was an 
extremely profitable year so that larger contributions could be 
made and--
    Mr. Shaw. Mr. Archer and I have introduced a plan that also 
continues it as a defined benefit pension plan with the 
possibility of increases in the amounts people are relying on 
in retirement.
    Mr. Summers. And I think we have recognized that the 
proposal you have put forward is a valuable contribution to the 
debate. We have expressed concerns about the magnitude of 
future budgetary commitments that are implicit in a proposal of 
the kind that you and Mr. Archer have put forward. There are 
concerns about what it could mean over the longer term for the 
ultimate coalition and progressivity that Social Security 
depends on. There are certain concerns about administrative 
costs and the fraction that would be used up in administrative 
costs within a proposal of that kind.
    But we are very much prepared to discuss--if there is 
formal legislation embodying it--we in the Administration and 
the Treasury Department would certainly be prepared to provide 
commentary with respect to that formal legislation and our 
concerns regarding it.
    But I would urge you, Congressman Shaw, to take seriously 
the plan that the President has put forward as something that 
we can feasibly accomplish this year. I think it is not 
accurate to suggest that it is simply placing I.O.U.s in the 
trust fund because every penny that is contributed to the 
Social Security trust fund in the President's plan represents a 
direct allocation of interest saving that has resulted from 
debt pay-down. Therefore, we are taking resources and 
transferring them from one use--a sterile payment of interest--
to another use--the meeting of an existing obligation for 
Social Security. I think that is fiscally responsible.
    I think it is responsible, as the trustee of a large 
pension plan, to look at the way its assets are managed, and to 
be very reluctant to see those assets managed in a way that 
earns a lower return than almost any other defined benefit plan 
in the country.
    That is why we introduced the discussion of equities. If 
others prepared to rule that opportunity out, I think that is 
an unfortunate reduction in the scope for us to compromise and 
find common solutions. We very much would like to see this get 
done, but it does depend on a willingness to take each other's 
proposals seriously. I think the Administration has put forth a 
very constructive foundation for anything that is going to 
happen in the Social Security area by extending the life span 
of the Social Security trust fund out past the life span of the 
baby boom generation, and doing so in a fully paid-for way 
based on debt reduction.
    I think it should also be supplemented by investment policy 
changes, but that is an issue that can be separated in either 
direction from the issue of debt pay-down.
    Mr. Shaw. I know my time is long past, but I would like to 
say that the American people do not want us to privatize the 
Social Security trust fund, and Republicans are not going to 
privatize the Social Security trust fund. But we are very 
anxious to talk to the President or talk to you to try to 
hammer out a program. You know our telephone numbers, the 
President has our telephone numbers, and we are waiting for the 
phone to ring.
    Mr. Summers. Congressman Shaw, you have used the phrase 
``privatize the Social Security trust fund''--I would certainly 
agree that it would be a very poor idea to privatize Social 
Security.
    Mr. Shaw. But that is what you do by buying corporate 
equities out of the trust fund. That is what your statement 
said. I did not make that up. You can read it back into the 
record, if you want to, but that is what it says.
    Mr. Summers. Let me say that I don't think of the Federal 
Employee Retirement Fund as being privatized. I don't think of 
the Pension Benefit Guarantee Corporation as being privatized. 
I don't think of the California Public Employees Retirement 
System being privatized, even though each of those entities do, 
as is the best practice for defined benefit pension plans, 
invest in equities.
    Chairman Archer. The gentleman's time has expired, but 
since my name has been mentioned a couple of times, I feel 
compelled to very briefly make a couple of comments.
    The American people do not view the Social Security trust 
fund in the same way they do the other pension plans you 
mentioned, Mr. Secretary. It is a very sacred fund to the 
American people.
    And the American people do not trust the Federal Government 
to invest that sacred money in private corporations for two 
reasons: number one is risk, and number two is their view that 
the Federal Government should not have the potential to control 
any private corporations in this country and thereby be in a 
position to set policy. Those are the concerns Mr. Greenspan 
has and those are the concerns of 80 percent of the American 
people.
    Very quickly, the President's so-called plan in your budget 
is not really a plan, Mr. Secretary. It is simply a 
placeholder. It simply makes a promise that in the years ahead, 
when there is a shortfall in the fund, that the Treasury will 
write a check to the trust fund from general revenues. That has 
never happened in the history of the trust fund. That sacred 
trust fund has been set apart from the general treasury.
    I am surprised that AARP has just not gone up the wall 
about this because year after year after year it has opposed 
infusion of general treasury funds into the Social Security 
trust fund. There is no immediate reform in the President's so-
called plan--no restructuring, no reform--other than the small 
part of the fund that would be invested in the private sector 
to gain added earnings. You might call that a reform, but that 
is a reform that is dead on arrival with the American people.
    So there really is no reform. It is a placeholder.
    Finally let me say, as you know, Congress has never been 
able to handle a significant reform of Social Security. It has 
happened either from presidential leadership, as it did with 
President Carter in the late 1970s, or it has happened through 
the creation of a bipartisan commission as in the early 1980's. 
No other major reform of Social Security has ever occurred 
simply from within the Congress.
    I have tried as hard as I know how. I have tried to get Mr. 
Rangel to come over and say, What can we do to join together on 
a plan? I have talked to minority leader Gephardt. Nothing has 
happened because Congress cannot develop this within its 
structure. It just has never been able to do so.
    But the White House opposed the Social Security Reform 
commission that we created in this committee, which had strong 
bipartisan support and was passed by the House of 
Representatives because the President said that he had his own 
plan. He called for a national dialogue culminating in a White 
House conference which would launch a bipartisan effort. I had 
high hopes after that conference, as I walked across the street 
from the Blair House to the White House with the President.
    I don't believe that I am at liberty now to repeat the 
private commitments that he made to me, but they are very 
different from what has come out publicly. And I am not trying 
to create controversy between me and the Congress and the White 
House, but I will simply say that this will not happen without 
aggressive, direct Presidential leadership.
    As a result of the Administration's flip-flop on this issue 
we will not find the solution to Social Security this year. I 
am terribly, terribly saddened about that. And I apologize to 
the committee for resuming on the time of the committee.
    Mrs. Johnson?
    Mrs. Johnson. Thank you, Mr. Chairman.
    Mr. Summers, I have a rather specific question, but I 
certainly do want to put on the record a couple of other 
things.
    First of all, at the beginning of this hearing it looked 
like this committee had been acting in a very partisan fashion. 
I want the record to note that the subcommittees are for the 
most part running in a totally bipartisan fashion, and it is 
because of the response--when the chairman of the Ways and 
Means Committee calls the President and doesn't even get a call 
back, there really is a problem. And I'm proud to say that most 
of the legislation that actually comes out of this committee 
comes out as a result of bipartisan action.
    There is a lot of ground for bipartisan tax action in this 
Congress. If you look at the package we proposed to go with the 
minimum wage bill, much of those details are already in your 
budget. And unless you are just going to on principle oppose a 
tax package being coupled with a minimum wage bill, there is 
plenty of ground for agreement--the low income housing tax 
credit, the pensions reforms, the expensing for small business, 
lots of things. And if philosophically we believe that those 
provisions should help offset the cost to small businesses of 
increasing the minimum wage so people don't have to get fired 
and jobs can be protected, I really don't think that is such a 
bad rationale. I hope it won't be a rationale that will mean 
that you will a priori decide not to support tax changes as 
part of the minimum wage bill.
    If you look at the health access bill, I have heard the 
President many times support our proposal to let people deduct 
the cost of their health insurance premiums. Everybody else 
gets to deduct the cost of their health insurance premiums 
except individuals who pay their own health insurance. So in 
fairness, just plain fairness, there are things we need to do 
this session. And I will end up with the fairness issue on the 
marriage penalty bill.
    But before I do, I do want to mention that I am very 
disappointed that your Medicare proposal does not propose any 
new money back into Medicare. We all know that particularly in 
the area of hospitals we only deferred certain problems for one 
year. I have never seen the hospital system, from our 
sophisticated medical centers on which the quality of American 
health care depends and the world depends right down to our 
little rural facilities, under such crushing distress.
    I urge you to give specific directives to HCFA that they 
can make proposals to increase spending in that area, that they 
are not in the budget but you are going to support them. I 
don't want to go through what we went through last time with 
your people sitting over there knowing how serious the problems 
were, saying we must address the problems, but not being able 
to make specific proposals because you had cut Medicare in your 
budget, you cut it again when you brought the tax package up to 
try to avoid the 1 percent across the board, and so their hands 
are tied. Untie their hands. We have got to do something again 
this year for hospitals. So on Medicare, this is not enough.
    On retirement security, I hear you about that and I am 
pleased there are some pension proposals in here. But your big 
money is for matching. At least those people already have a 
pension plan. Fifty percent of working people in America work 
for employers who provide no pension plan. You have some 
proposals that will help that. But let's get our money out 
there so that everyone can have an income stream that will 
compliment Social Security. And that is why I do not understand 
why you would take $8 billion more out of the insurance 
industry that will increase the cost of the kinds of retirement 
products that are the only option people have to really create 
a retirement economic security; that is, Social Security and a 
complimentary privately saved income stream.
    So on retirement security, I think there is common ground 
but I think there are some backhanded hits in your budget. And 
the irony is that those provisions have already been rejected 
by this committee and House on many occasions, by Democrats as 
well as Republicans.
    Lastly, let me get to the marriage penalty bill that we are 
going to vote on tomorrow. I am very pleased that in your bill 
you do provide for stay at home moms. Now those can be 
described as people already benefitting from the marriage 
bonus. That's true. But they are also the little families in 
America making the greatest sacrifice to live on a single 
income.
    You provide a total of $1,000 new deductibility. Can you 
tell me how does that compare to the new deductibility we 
provide for stay at home moms? Because if we care about 
families and children, we have got to do something about the 
bias in the system against those who are making the really 
tough choice of staying home and taking care of their children. 
And in addition to the provisions specifically for 
deductibility, then I want to ask a question about 
refundability.
    Mr. Summers. Let me respond if I could to five points in 
what you raised. First, with respect to stay at home moms, our 
proposal does, as you say, directly benefit them. We believe it 
does so in a more targeted, progressive, and less costly way 
than the alternative that the committee is considering.
    Mrs. Johnson. But why is it less costly? Because it 
provides $1,000 and we provide how much?
    Mr. Summers. Because it is more targeted to be progressive.
    Mrs. Johnson. No, no, it is not more targeted to be 
progressive. I am talking specifically about the stay at home 
provision which would be the same for every stay at home, as my 
understanding of your proposal from your write-up in the 
summary pages. In other words, you are not going to provide a 
stay at home deduction for a mom whose husband makes more than 
a certain income.
    Mr. Summers. Excuse me, Congressman Johnson, I thought you 
were speaking about the marriage penalty. I think I now 
understand that you are speaking about the child and dependent 
care.
    Mrs. Johnson. They have the effect that we get from a very 
simple mechanism in our marriage penalty of helping stay at 
home moms or stay at home dads, whatever the case may be. You 
do it through other programs but the impact is the same. Do you 
limit that to very low income families?
    Mr. Summers. We have certain limits, I don't remember what 
the limit is, but you receive the full benefit up to an income 
of $59,000 in our proposal and after that it phases down. My 
impression is that the limits are somewhat higher in your 
proposal.
    Mrs. Johnson. But you take no consideration for the number 
of children, because $59,000, if you have three or four 
children, is really still pretty tough sledding.
    Mr. Summers. This is something we are happy to work with 
the Congress on. I think that is a crucial point. In our EITC 
proposals the question of multiple child families is something 
we very explicitly pick up on because there is a real problem 
with the way our tax system and our AMT proposal treats 
families with multiple children.
    Mrs. Johnson. Now in the EITC area, have you been able to 
lower the fraud rate below 20 percent which are most recent 
figures? Do you have any more recent figures on error and fraud 
in the EITC?
    Mr. Summers. We do not have more recent figures. But we 
have taken a number of steps, including the allocation of a 
specific enforcement budget for the EITC, including 
simplification measures to conform the earned income 
definitions which we expect will significantly reduce the rate 
of error, including an outreach effort to tax preparers in this 
area, and including a requirement that the EITC beneficiaries 
give their Social Security numbers.
    Mrs. Johnson. I would just say that having chaired the 
committee that oversaw that for a number of years, we worked 
hard to eliminate the amount of fraud there is. If there were 
an appropriated program that had a 20 percent fraud rate around 
here, it would not be there long. And for us to expand a tax 
program that has a 20 percent fraud rate when there are very 
direct and simple ways to help people, stay at home moms and 
make families stronger seems to me questionable. But I am very 
pleased that you do recognize the need to provide better 
support to stay at home moms. I hope your colleagues on this 
committee will work with us on that provision in our marriage 
penalty bill.
    Thank you, Mr. Chairman.
    Chairman Archer. Mr. Houghton?
    Mr. Houghton. Thank you, Mr. Chairman.
    Mr. Secretary, good to see you.
    Mr. Summers. Good to see you.
    Mr. Houghton. I have two questions. One has to do with 
complexity, the other has to do with the Customs issue in terms 
of ACE.
    On complexity, we have had, and I happen to be on the 
oversight committee, we have had Val Oveson, who is sort of the 
taxpayer advocate from the IRS, come up here and he says the 
number one issue really with taxpayers is tax complexity. I 
totally agree with him. You take a look at the Treasury 
introductions to the budget, I have a report here from 1995 and 
it is that thick, and the one this year is that thick. 
Proposals of just geometrically increased. This is not just the 
fault of the Administration. As a matter of fact, it is the 
fault of Congress also. We complexify this whole thing. It is 
bothersome.
    Now you have attended this in a certain way in terms of 
your report. In terms of tax simplification, you say you 
propose to redress a particular problem with the AMT by 
allowing taxpayers to deduct all their exemptions for 
dependents against the AMT. You know, that is a good idea but 
it really does not get at the complexity because I am making 
out my tax form and I have to still go through all the 
arithmetic before I come to the point to where maybe I will 
have an exemption here.
    It is a very important issue. I think, frankly, from a 
personal standpoint, it is even more important than tax 
reduction, the tax complexity issue. I do not see really either 
of us getting at this. And I would appreciate any comments you 
have.
    The second issue is in terms of the customs. We have had 
the head of the Customs Service up here quite a few times. He 
has talked about this automated commercial system, ACE, and you 
know about this. It is really important. The problem is one of 
money and where does it come from and where does it go. It is 
going to cost another $200 million and you feel that is a good 
idea, but at the same time, it should be paid for by user fees.
    The business community sort of feels that they have given 
at the office. In other words, they pay in user fees almost $1 
billion and a whole bunch to the Customs Service, about $900 
million. And so then to sort of lay on another $200 million 
doesn't really seem to me to make an awful lot of sense.
    So those are two issues, the tax complexity, which is 
really a huge megaissue, and the other thing specifically in 
terms of helping our Customs Service.
    Mr. Summers. Let me say, Congressman, I agree with what you 
said about the seriousness of the tax complexity issue and it 
is something that we are very focused on. I think we have done 
some things that are constructive; the AMT is constructive, 
raising the standard deduction and reducing the number of 
itemizers is constructive, expensing for small business is 
constructive. But I think there is a lot more that can be done.
    I would say that I think this is a largest problem for a 
small minority of relatively fortunate taxpayers. Some 30 
million Americans are able to file their taxes by pushing 
buttons on a telephone in less than seven minutes. The 
increased emphasis on the use of software to do this is making 
many of things that used to be very computationally burdensome 
much less burdensome. So you are getting a kind of 
simplification in that way.
    But I think this is a crucial issue and it is one that we 
need to be in a position to work together on. I would be sorry 
though if that were to be seen as a reason not to extend 
existing mechanisms. We have tried to work in our budget by 
achieving some of the social objectives by working with 
existing mechanisms--expanding EITC, expanding the child and 
dependent care credit. It seems to me those things provide 
important benefits to families without creating increased 
complexity. But I think it is a fair concern.
    With respect to--
    Mr. Houghton. Can I just interrupt a minute. I really think 
that we are probably equally to blame with the Administration. 
But in something like this you need leadership and it really 
ought to come from the White House. So last year, you know, 
there were 28 different tax credits, this year there were 18 or 
20. It just seems to roll on and roll on and roll on. So the 
only thing I ask you is if you could really think in terms of 
what does the White House do to lead all of us, because that is 
where the direction must come from on this.
    Mr. Summers. We will carefully consider it. I would also 
say that I think if you probe what people don't like about 
complexity, some of it is the hassle of filling out their own 
returns, and some of it is the sense that out of all that 
complexity somebody else is getting an unfair break. The reason 
I have put such emphasis in my remarks today on the corporate 
shelters is that, I think, is an important thing that is 
stimulating anger or even outrage with respect to the code and 
that if we do not address it will do so even more in the 
future.
    With respect to ACE, I think we all have a common position 
that this is very important to get done if we are going to have 
the efficient flow of goods across our borders. I should say 
that we in the Department have learned a lot from the painful 
TSM experience at the IRS, the computer program at the IRS. I 
think we have this under control so that those kinds of 
mistakes will not be repeated.
    Budget realities being what they are, this program is not 
it seems to me likely to be fully funded without a contribution 
of the business community. We have reconfigured the proposal 
that is in this year's budget relative to the proposal that was 
in last year's budget so as to make very tangible that the 
contribution the business community is making is going right to 
the things that will benefit them. But as important as this 
issue is, I do not think I could responsibly propose measures 
that would reduce the number of people who were monitoring 
narcotics on incoming flights or agents who were doing that 
kind of work protecting our borders against drug incursions in 
order to invest more heavily in this computer system.
    So my hope would be that we could work with the affected 
people in the private sector to find a solution. We were very 
mindful in the design of this year's proposal, frankly, that, 
as you put it, the private sector had given at the office and 
we had to find a proposal in which what they were being asked 
to do was commensurate with some benefit they were going to 
receive. That is what we tried to do. We are obviously happy to 
work with members of this committee and the affected trade 
associations to try to find a solution to this problem.
    Mr. Houghton. I think that is really important because the 
Customs Service clearly is important. This is very, very 
important for the Customs Service. And you want to have people 
working with it rather than bucking it all the time. And I 
think the private sector has really made an enormous 
contribution already for that.
    Thanks very much, Mr. Chairman.
    Chairman Archer. Mr. Coyne?
    Mr. Coyne. Thank you, Mr. Chairman.
    Welcome, Mr. Secretary. As a result of last year, the 
Administration came around to signing legislation relative to 
rectifying the 1997 Balanced Budget Act inequities relative to 
hospitals. I wonder if you or Ms. Mathews could explain in the 
proposal this year are we doing more to try and rectify the 
problem that was created as a result of the 1997 Balanced 
Budget Act relative to reimbursement for hospitals.
    Ms. Mathews. We do not have a specific extension or 
additional proposal to the BBRA that we passed last year. What 
we did, in trying to do our efficiency proposals, is ensure 
that we take steps that are consistent with what we did last 
year in terms of increasing competition, as we discussed 
earlier. For example, in some of our proposals there are 
distinctions made for rural hospitals that build upon some of 
the concepts that were discussed as part of what passed and was 
signed last year.
    Mr. Coyne. Well, can hospitals look with any encouragement 
to additional help in this proposed budget, help from what 
occurred in the 1997 situation?
    Ms. Mathews. We do not currently have a proposal, as I 
said, that extends in the same way that the BBRA did last year. 
There are proposals such as GME hospitals where we have doubled 
the funding on the discretionary side from $40 to $80 million. 
There are specific proposals like that. But I think you are 
referring in a particular area, and we do not have those.
    Mr. Coyne. On another subject, I wonder if the Secretary or 
yourself could tell us a little bit about who is going to 
benefit from the proposal in the proposed budget about the 
Earned Income Tax Credit and extending the benefits. What grade 
of income level in the country is going to benefit from 
expansion of the EITC?
    Mr. Summers. I think most of the benefits will go to those 
with incomes between, say, $10,000 and $30,000, and the groups 
will principally be those with more than two children, married 
couples who will avoid the marriage penalty, and those who are 
making special efforts to save who will benefit from the 
conformity of the earnings definition.
    Let me say that the EITC has probably been more successful 
than any other social program we have had in moving people from 
poverty to work. I would also say, at this point, when more 
than at any time in the last 35 years, our economy's issue is 
jobs looking for people as well as people looking for jobs. 
Doing everything we can to stimulate work incentives and 
improve the supply of labor is crucial if we are going to be 
able to keep growing at these rates without running into a 
bottleneck.
    Mr. Coyne. We have a responsibility in Congress to do 
everything we can to ensure the solvency of the Social Security 
program and the Medicare program. But in a time like this when 
the economy is so strong, it seems that it is time to invest in 
public infrastructure, to have a growth in the future of 
workmanship for workers to become more productive in the 
economy. And along those lines, what is this budget going to do 
to invest in trying to make workers more productive and also to 
help the public infrastructure of the country?
    Mr. Summers. Let me comment on some components of that and 
then I will turn to Ms. Mathews if I could. I think probably 
among the most important infrastructure investments we can make 
as a country are in satisfactory schools. It is wrong that with 
all the prosperity that we have children in America beginning 
the school day at 4:00 because their schools work in three 
shifts. Other children in America are going to school in 
closets. Other children in America have the lunch period begin 
at 9:45 in the morning because the school facility is so 
constricted. The restroom facilities in some of our schools are 
an embarrassment.
    If we want kids to take learning seriously, it seems to me 
we ought to take seriously the kind of facilities that we 
provide them. That's why one of our priorities in the tax area 
is the school construction proposal. That is why we are also 
proposing measures for repair and modernization of schools in 
the discretionary budget.
    More generally, it stands to reason, and statistics confirm 
what common sense suggests, that when there are fewer kids per 
teacher the kids learn more. When there is more emphasis on 
quality, more learning takes place. So we are focused very much 
on improvement in education. This year's budget includes the 
most robust improvements in education budget that we have had 
in a number of years. I think that is an important step.
    Ms. Mathews could probably add something on the worker 
training side.
    Ms. Mathews. On the worker training side, we are continuing 
our youth formula grants which include the Summer Jobs 
programs. There are a number of specific programs, such as the 
Head Start increase of $1 billion which is starting at the very 
beginning of the educational process. Additionally, our After 
School monies which we have put in before are proposed again. 
There is a smaller schools initiative with regard to 
infrastructure issues that relates to our building of schools 
and our modernizing of schools. Another part of that is 
addressing the digital divide. As part of our school 
modernization plan on the tax side, we want to modernize and 
create an ability for those schools to wire and get the 
computers in. Some of the schools don't have the ability to do 
that. So those are some infrastructure as well as some 
programmatic things we do in the area of education.
    Mr. Coyne. Thank you.
    Chairman Archer. Mr. Herger?
    Mr. Herger. Thank you, Mr. Chairman.
    Mr. Secretary, it is good to have you with us. I would like 
to ask you a question concerning a provision that I understand 
was recommended by the Treasury, was put in the President's 
budget at the end of the budget cycle this last year and which 
the Congress passed. I think it was done inadvertently. It had 
to do with the installment sales method for the accrual method 
of selling small businesses. The way it used to be, people with 
small businesses maybe worth $100,000 who would be retiring and 
would be selling these small businesses. If they sold it over 
ten years there would be $10,000 per year that maybe they would 
receive in payments and the capital gains then would be on that 
$10,000 say per year. What this has done is that now these 
small businesses have to pay all of the taxes up front, which 
on $100,000 the 20 percent capital gain would be $20,000.
    What is happening is that these businesses are not able to 
sell for as much. The buyers of these small businesses who many 
times are unable to obtain credit from the banks, their only 
way of getting into small businesses is through this method, 
are unable to buy. Again, I feel that we are hearing as Members 
of Congress from literally hundreds of small business people 
throughout our districts, and it is not just my district, I'm 
sure every congressional district in the Nation is hearing 
this.
    My question is, were the end results of this anticipated by 
Treasury and by the Administration at the time that it was 
proposed? And if it was not, I understand that Chairman Archer 
did send a letter to the President requesting that this 
correction be made in the President's budget. My question would 
be, was it anticipated? And if it was, why was this not 
included in the President's budget?
    Mr. Summers. Thank you for raising that issue, Mr. Herger, 
which touches on what is a very real concern for us as well. My 
colleagues in the tax policy area at the Treasury and in the 
IRS have had a series of meetings with the NFIB and other 
representatives of the affected parties. I think it is clear 
that these provisions have impacted in a way that was much more 
broad than was originally intended. We expect in the very near 
future to provide regulatory guidance that I think will, at 
least in a large part and perhaps completely, clear up what 
have been very legitimate concerns. We are working in tandem 
with the groups that represent many of the small businesses 
because this is a serious problem. I would be happy to ask my 
colleagues to provide you or your staff with a more detailed 
briefing on what is involved.
    Mr. Herger. Very good. I appreciate that, and that will 
help us very much because these businesses that are selling 
right now are being very dramatically affected. I am authoring 
legislation along with Mr. Tanner from this committee and Mr. 
Matsui. It is bipartisan legislation. We have some 21 members 
just of Ways and Means who are on legislation to correct this. 
Of course, this will take some time. But if you could work on 
this in the meantime to help these businesses that are being 
affected right now, that would be very helpful.
    I would gather by what you are saying--well, let me just 
state. We would really appreciate your support as well, not 
only in correcting it now but in changing the legislation, 
repealing what I believe was inadvertent certainly by the 
Congress and I believe, by what you are saying, by the 
Administration.
    Mr. Summers. Let me suggest that those who are more 
knowledgeable than I about the technical details take this up. 
You have my commitment to address in a regulatory way the 
overly broadness of the past legislation. Whether we are in 
precise agreement on any specific proposal or not is something 
that I can say until I have had a chance to review it. But I 
think we will be able to act and act very quickly, frankly, on 
a shorter timeframe than would be possible legislatively to 
address this concern in large part. And I very much appreciate 
your having raised it.
    Mr. Herger. Mr. Summers, thank you very much.
    [An additional statement by Mr. Herger was subsequently 
received.]

Statement of Mr. Herger to Secretary Summers

    Rep. Herger: ``Mr. Secretary, since 1992 no taxpayer has 
ever been able to claim one penny of tax credits under section 
45 for biomass power production because the code section was 
drafted too narrowly.
    Biomass power provides important waste removal and rural 
employment benefits to rural communities such as my district in 
Northern California and around the country. Unfortunately, many 
of the plants are shutting down or running at reduced capacity.
    I have introduced legislation to fix section 45, and I am 
pleased to know that the President is aware of this problem and 
has adopted my solution of providing a tax credit for existing 
facilities.
    I applaud the Administration for stepping up to bat on this 
issue and look forward to working with you to fix section 45 
this year.''
      

                                

    Chairman Archer. Mr. Secretary, obviously, it is going to 
take some significant additional time to let all members have 
an opportunity to inquire. My guess is that you may need a wee 
bit of relief at this point.
    So the Chair is going to recess the committee. Hopefully, 
everybody can grab a bite of lunch and return at a quarter to 
one.
    Mr. Shaw. Mr. Chairman, could I read something into the 
record very quickly because there was a question as to the 
definition of ``privatize`` or ``privatization`` a moment ago.
    Chairman Archer. Without objection, so ordered.
    Mr. Shaw. In the American Heritage Dictionary, ``privatize/
privatizing'' is described as ``To change in industry or 
business, for example, from government or public ownership or 
control to private enterprise.'' And the American Academy of 
Actuaries describes ``privatization'' as ``The broad concept of 
investing funds in the private sector which, in turn, implies 
accumulating substantial advanced funding is known as 
privatization.''
    Thank you, Mr. Chairman.
    Chairman Archer. Mr. Secretary, if you can accommodate 
another five minutes, Mr. Levin is going to have to go to 
another meeting and would like to get his five minutes of 
questioning. I will leave it up to you. If you can handle 
another five minutes--
    Mr. Summers. I would be delighted to.
    Chairman Archer. The Chair will recognize Mr. Levin.
    Mr. Summers. I will remain with Mr. Levin as long as Mr. 
Levin wishes.
    Mr. Levin. I will take my five minutes. I think the 
Chairman will grant another five minutes on the other side. 
Thank you, Mr. Chairman.
    Mr. Secretary, Mr. Crane raised the trade issue, and I am 
glad he did. And in response, reflecting your own views and 
that of the President as he articulated at Davos so well, you 
talked about the need for expanded trade and also for an 
expanded perspective of trade in this new era. And in terms of 
a new perspective to incorporate considerations of the 
environment and labor, you referred to child labor. But I trust 
that when you refer to labor you are talking about, as the 
President did, issues of core labor standards, not universal 
minimum wages, but core labor standards as articulated by the 
ILO.
    Let me also say a word about the reference to waiting for a 
call from the President on Social Security. I just hope the 
Republican majority would look back at how they handled the 
marriage penalty. As I understand it, when there was the 
meeting of the leadership with the President there wasn't even 
a reference to this first step in their tax program. I think 
that if we are going to get off on the right foot in terms of 
bipartisanship, there needs to be a willingness on the part of 
the majority to raise issues like the marriage penalty and try 
to work them out before they are simply sprung on the minority.
    One other quick comment, and this relates to Mr. Shaw's 
reference to privatization. However one thinks about investment 
of equities by the Government, a small portion, I do not think 
it is fair to refer to that as privatization, and you mentioned 
that.
    Let me now close by just talking about the share of income 
that people today pay in Federal income tax. You discussed this 
earlier but I think the record should be clear. I have from the 
Treasury Department a chart that talks about the Federal income 
and FICA tax rates and it uses the median income for a four-
person family. As I read the chart, it shows that average 
combined tax rate--we are now talking about for the median 
income--is less today than it was in 1979. Is that correct? Do 
I read that chart correctly?
    Mr. Summers. Yes.
    Mr. Levin. The projected rate for 1999 is 15.11 percent 
compared to 16.97 percent twenty years ago. That is reflected 
in the CBO chart that compares the effective tax rate, this is 
the Federal tax rate, projected 1999 compared to 1981. I just 
want to read the figures. For the lowest quintile, 4.6 percent 
compared to 8 percent in 1981; the second quintile, 13.7 
percent compared to 15 percent; the middle quintile, 18.9 
percent versus 19.5 percent; the fourth quintile, 22.2 percent 
compared to 22.9 percent. The only increase is for the highest 
quintile. The retort is, of course, that takes money out of 
private investment.
    So if you would comment quickly on what really has happened 
in terms of the Federal tax rate and the fact that the highest 
income category is paying a higher tax rate but whether that 
has had a negative impact in terms of growth in this country.
    Mr. Summers. Let me make these comments if I could, 
Congressman Levin. First, from the mid-1990s on we have had 
what some would call the greatest, and it is certainly one of 
two or three greatest, economic expansions in the history of 
our country, driven by productivity growth, driven by capital 
formation and investment. We have had record levels of 
investment as a share of GNP, record levels of investment in 
absolute terms, and record levels of growth in investment 
during this period.
    And so it seems to me difficult to argue that we have seen 
new or serious impediments to the capital formation process 
from anything we have done with tax policy. Indeed, I would 
argue that the budget surpluses have been major sources of 
strength for investment.
    The tax rates for the same family, configured in the same 
way for something like 90 percent of American families have 
come down and are lower now than they were at any time in the 
last twenty years. As I indicated earlier, the statistic is 
frequently cited that a ratio of taxes to GNP has gone up. That 
is a reflection of two things. It is a reflection of the fact 
that income relative to GDP has gone up because there is more 
foreign income, because there is more capital gains than there 
once was. And so, in some sense, GDP is not really the right 
denominator for looking at taxes. And the other factor that it 
represents is that a larger share of income represents 
corporate profits which are taxed at the corporate level and 
represents income to higher income people that is taxed at a 
higher rate.
    So, and this is the crucial point, the changes in the taxes 
to GNP ratio do not reflect tax increase policies. They reflect 
instead changes in the pattern of who is receiving the income. 
A universally agreed technique for measuring the impact of 
policies is to look at taxpayers configured in a given 
situation and seeing what happens to their tax burden. And by 
that standard, for the vast, vast majority of Americans taxes 
have declined since the late 1970s, taxes have declined since 
the early and mid-1990s.
    Mr. Levin. Federal taxes.
    Mr. Summers. Federal taxes.
    Mr. Levin. Thank you. And thank you, Mr. Chairman, for your 
indulgence.
    Chairman Archer. Your welcome, Mr. Levin.
    I must say I can't just let that stand because, as usual, 
when you deal with statistics there are any numbers of ways to 
receive them, present them, analyze them, and ultimately reach 
conclusions.
    Mr. Secretary, what you did not mention is that as we sit 
here today America has the lowest private savings rate in all 
of its history--in all of its history. It is negative. What you 
did not allude to is that a great part of the investment on 
which we are presently building our economy is foreign 
investment, the savings of foreigners who save far in excess of 
what we do in this country. And the great danger to the stock 
market, the cloud that hangs over the stock market is that if 
these foreigners begin to have more confidence in their own 
domestic economies than in ours, there could be an outflow of 
this investment capital and we would be in very big trouble. So 
we do need to be concerned about that, and I think you probably 
share that concern. I am not saying it is imminent but it is a 
cloud hanging over the economy.
    Now, if we are not to care about what percent of GDP the 
Federal Government is taking, that all that we care about is 
what median families are paying in taxes, then we can increase 
taxes on everything that does not relate to median families and 
it would not affect anybody. Now, as an economist, you know 
that is not true. The embedded cost of the income tax 
represents roughly 20 percent in the price of the products on 
average in this country, according to the very, very 
comprehensive study done at Harvard by one of your colleagues. 
And so if you keep taxing everything else and you say, ``Oh, 
but the median family's taxes have not gone up,'' you are 
ignoring this reduction from the economy that must be paid for 
by the median families in the price of their products which is 
hidden from them.
    And so on the thesis that Mr. Levin and you are exchanging, 
we could take 50 percent of the GDP provided that the median 
family did not show any increase in taxes. That clearly would 
not be wise. And so the percent that we are taking out of the 
economy, particularly at a time when this goes in the other 
direction, which it will at some point sometime, I don't know 
when, it may be ten, fifteen, twenty years from now, will leave 
us at this bigger demand at the Federal level. You and I may 
disagree, but I think this is something to be concerned about.
    Mr. Summers. Mr. Chairman, let me clarify very explicitly 
my position. You are, of course, correct that if you raised 
taxes on some people but not the median person and you looked 
only at the median person, that would be a misleading 
statistic. That is why I was careful to cite those with half 
the median income, those with the median income, those with 
twice the median income.
    But I suspect you could agree that if the stock market goes 
up and more individuals realize capital gains and nothing else 
changes, it would be quite misleading to describe that 
situation as a tax increase on the American people. And yet the 
statistic that is frequently cited comparing taxes to GNP 
suggests a tax increase when that has taken place.
    If the distribution of income changes and no tax law is 
changed so that more income is received by those in the 28 
percent bracket relative to those in the 15 percent bracket, 
then more taxes will be collected and compared to GNP. But 
again, it would be hard to see that as having been a 
legislative tax increase. We would be happy to do more 
comprehensive analysis, but what I can assure you that analysis 
will show is that the increase in the tax ratio to GNP that is 
of concern to you, and is something we do need to investigate, 
we will find that it is not a consequence of tax law policy 
changes but is instead a consequence of the two factors that I 
have been citing--an increase in income that is not reflected 
in GDP, such as capital gains, and a change in the composition 
of income towards those who have higher tax rates. And it would 
surprise me if one took the view that a stock market increase 
constituted a tax increase, and yet that is the logic of the 
comparison of taxes to GNP.
    With respect to savings, I can only agree with you. I think 
we can take common satisfaction that whereas our country's 
national savings rate had reached its historic low ever in 
1992, as a consequence of the progress we have made in 
increasing public savings, that national savings rate has more 
than doubled over the last seven years. I think we have made 
great progress in the public area and I think we can all agree 
on the importance of working to increase private savings.
    I was particularly encouraged by Congresswoman Johnson's 
suggestion that we stress the needs of the 70 to 75 million 
Americans who do not have any kind of pension plan. I think if 
we can agree on that as a primary objective rather than raising 
the limits for those who are already most fortunate, I think if 
we can agree on the 70 million, as Mrs. Johnson suggested, then 
I think we would be in a very strong position to work out an 
approach that I believe would be the most effective approach 
and provide the greatest incremental benefit in encouraging 
personal and private savings.
    Chairman Archer. Mr. Secretary, we will continue this 
comprehensive economic discussion at a seminar somewhere. For 
the time being, the committee will be recessed now until 1:00.
    [Whereupon, the committee recessed, to reconvene at 1:01 
p.m., the same day.]
    Chairman Archer. The committee will come to order.
    Mr. Secretary, I know that you have a lot of demands upon 
your time. I inquire as to how long you can comfortably stay 
with us?
    Mr. Summers. The discomfort level would start rising 
geometrically after 2:00.
    Chairman Archer. Well, we will see if we can expedite the 
inquiry so that we can release you, as it were, at 2:00.
    Mr. Summers. Thank you.
    Chairman Archer. Next on the list is Mr. Nussle.
    Mr. Nussle. Pass.
    Chairman Archer. He passes.
    Is Ms. Dunn here?
    [No response.]
    Chairman Archer. Mr. Collins?
    [No response.]
    Chairman Archer. Mr. Portman?
    Mr. Portman. Thank you, Mr. Chairman.
    Thanks to you, Mr. Secretary, for being willing to be 
patient and stay for the second round. I have lots of questions 
and what I would like to start with, if I could, is picking up 
where we left off a moment ago on the pension issue.
    You mentioned in your dialogue with the Chairman the 
importance of increasing the private savings rate in this 
country. In my view, nothing would be more important with 
regard to the tax code and what we could do this year than 
encouraging people to save more for their own retirement. We 
have a crisis I believe among baby-boomers not saving enough. 
We also have a Social Security crisis which we have talked a 
lot about today. And the solvency of Social Security and the 
backstop that private retirement savings can offer is another 
reason to move forward. And finally, we have half the 
workforce, about 75 million Americans who have no pension 
coverage today, which I think is something this Congress and 
the Administration ought to focus on because it is 
unacceptable.
    We have a proposal, as you know, to allow all Americans to 
save more for their own retirement. In this budget, you have 
again picked up some of the so-called Portman-Cardin 
provisions. I know Mr. Cardin, who is here with us now, is also 
interested in talking about some of the differences between 
your proposals and ours. But I want to start by focusing on the 
fact that there are a lot of similarities, and we appreciate 
the movement that you have made toward the Portman-Cardin 
proposal in the area now called the Retirement Savings Account, 
which was the USA Account. I think the RSA proposal that you 
have is an improvement from the USA Account. It, frankly, takes 
away some of what I viewed to be a counterproductive proposal 
that could compete with the private side.
    I do have some questions about how RSAs would work. If I 
could just quickly go through some of those questions and, to 
the extent you have answers today, it would be very helpful I 
think for our further understanding. If you don't, we are happy 
to have you follow up in writing through the appropriate 
person.
    First, how would they work in terms of the employee and the 
employer? One of the concerns that I have is if it is based on 
a matching basis from the Government, does the employer have to 
know what the employee's adjustable gross income is to make 
that calculation, and how would that work?
    Second, and I think this is in relation to that in terms of 
the practicality, if there is a tax credit provided as the 
match, what is the timing of that? Is it practical for an 
employer or a financial institution, because, as you know, 
financial institutions can also be involved in this, to provide 
that match before the tax credit is available? I see a timing 
issue there.
    If you could briefly address those practical issues, and 
then let me just go ahead and put on the table one other issue 
because it is really of question of how it would work. When 
there is no tax liability, for instance, a governmental entity, 
a nonprofit, a hospital where you don't have the ability to 
take advantage of that tax credit, how would this work?
    Mr. Summers. Let me first say that our objective is to find 
common ground with you and Congressman Cardin and the others 
who are working in this area. And towards that end, the 
President's budget contains a number of new proposals, new for 
us, that incorporate many of the elements that you have been 
working on. My hope would be that we could forge a common 
approach that would meld all our priorities. My understanding 
is that my staff has already begun meeting with your staff and 
Congressman Cardin's towards that objective.
    With respect to the questions that you raised, we would 
envision a procedure that benchmarked the size of the accounts 
towards last year's AGI. So there would be no recordkeeping 
burden on employers but a relatively simple certification by 
the individual.
    The time value of money issues with respect to the credit 
is something that I think we would have to work on. Once the 
program was started and there was a regular flow of new 
accounts at the financial institution or new pensions and a 
regular flow of estimated tax payments, I would expect that 
they could be dovetailed very closely. But there are some 
start-up issues and those are things that we would be happy to 
work with you to find the best way to address.
    With respect to nonprofits, this is something that is of 
concern to us. Our expectation would be that nonprofits would 
contract with some kind of financial institution that was for 
profit who was involved in the benefits who would be able to 
make use of the credits and would pass on the benefits to the 
employees of the nonprofit.
    But those are very important issues. I have given you what 
our preliminary thoughts are but these would be things we would 
be very happy to work with you and other Members of Congress 
on.
    Mr. Portman. I appreciate that. I do think there is an 
opportunity to make progress here. I have been disappointed, as 
you know, with Treasury's inability to accept some of our very 
modest increases in limits. You mentioned earlier in your 
dialogue with the Chairman you were concerned about raising 
limits. All we do in our legislation is take the limits that 
somebody can put into a 401(k), for instance, back to where 
they were in the early 1980s. In the aggregate, it is not even 
keeping up with inflation, as you know.
    It is not just about allowing people who are bumping up 
against the limits now to be able to save more for their own 
retirement, which I think is a good idea. It is about allowing 
small businesses, most of whom offer no pension at all today, 
to offer pensions to workers who are low or middle income 
workers. We have to understand how those decisions are made. 
They are made by business owners, they are made by managers who 
will have an incentive to set up a plan if they can see some 
benefit to it.
    I would hope that we can take the blinders off, talk about 
the crisis that is at hand, which is half of America's workers 
not having a pension, get the politics aside, get out of the 
rich-poor debate, and really begin to help all Americans save 
more for their own retirement.
    Mr. Summers. I would agree with that general orientation. 
And to the extent that raising limits can be constructive in 
raising the number of employers who are covered by pensions, we 
will be particularly enthusiastic.
    I think we all agree that 75 million people without 
pensions represents a major problem in our country. There will 
undoubtedly be a combination of approaches that will be most 
effective. We obviously feel that we have suggested some 
constructive ideas, we have incorporated some of your ideas 
which we think are particularly constructive, and we are 
certainly prepared to work in a spirit of compromise to try to 
find the best way forward in this.
    Mr. Portman. Thank you, Chairman. I have lots of other 
questions but I will be following up later.
    Mr. McCrery [presiding]. Thank you.
    Mr. Hulshof?
    Mr. Hulshof. Thanks, Mr. Chairman.
    Mr. Secretary, thank you for bearing with us. I have some 
technical questions regarding qualified zone academy bonds and 
the new proposal on qualified school modernization bonds that I 
will probably need to follow up in writing because my time will 
not permit, and I would appreciate Treasury, as it has done in 
the past, responding to those questions.
    What I do want to do, Mr. Secretary, is to make some 
comments, and maybe there will be some time at conclusion that 
you can respond to any of these points or none of these points 
as you so deem. What I would like to highlight are what I 
believe are some inconsistencies from what I have been hearing 
through the questions that you have sat through this morning.
    Earlier, you said that we are ``in a remarkable moment in 
our Nation's economic history.'' And I don't disagree with 
that. What I find troubling, however, is an insistence, as we 
look at the President's budget, on raising taxes and user fees 
especially in an era of surplus. That to me seems to be 
somewhat inconsistent.
    You were quick to point out that the amount of Government 
spending as a percentage of GDP has gone down. And yet when the 
Chairman pointed out that the tax take on the American worker 
in this country continues to be at the highest percentage of 
GDP, you were quick to explain that away. I find that somewhat 
inconsistent. I find that troubling.
    Talking about waste, fraud, and abuse, Ms. Mathews made an 
excellent point to Mr. Thomas' question about Medicare. We 
always invoke the mantra, we want to eliminate waste, fraud, 
and abuse. And yet, Mr. Secretary, you mentioned as far as 
expanding the Earned Income Tax Credit, and I think we all 
share your opinion that this has been a useful program as far 
as the income supplement to working Americans, we have got an 
over 20 percent error and fraud rate with the Earned Income 
Tax. So, in other words, for every five dollars that are being 
paid out in income supplements one of those dollars is not 
deserved under the law. And yet we are continuing to talk about 
this very wasteful program. We have had hearings on that and 
representatives of your office have talked about that. I find 
that extremely troubling.
    I want to focus just another comment on something that I 
think in principle we agree on, and something you talked about, 
corporate tax shelters. I notice my colleague from Texas was 
nodding very vigorously in the affirmative. I know this is an 
issue he finds very important. You talked about closing 
corporate transactions that are void of substance. We agree 
with you.
    But what I find inconsistent, Treasury came to us in 1997, 
and maybe even before but I got here in 1997, but I remember we 
had hearings on the President's budget proposals back in 1997 
and Treasury asked us for some additional authority to crack 
down on corporate shelters. Specifically, we passed a provision 
that would require registration of corporate tax shelters. Two 
and a half years later we still are waiting for regulations and 
rules to come from Treasury on something we passed two and a 
half years ago. And I find that inconsistent.
    When we talk about tax cuts or tax fairness, we have heard 
every excuse imaginable, not from you, Mr. Secretary, but from 
those who oppose tax cuts. We have heard back in 1997 with the 
Taxpayer Relief that it was inconsistent to give tax cuts at a 
time when we had deficit spending. When we had the 1999 tax 
bill that we debated we heard from some on the other side that 
this is not the time, it would overheat the economy, as the 
Minority Leader said on the floor. And then there were the 
others who said we can't cut taxes because the economy is too 
fragile. When we had the extenders package, and I certainly 
appreciate the fact the President signed that RND credit and 
these extenders, but the thought was we can't do that because 
it is not paid for. Now we are hearing from the other side that 
we don't have this budget document in place.
    And I follow along with what Ms. Johnson said in her 
comments, Mr. Secretary, and that is there are so many areas of 
agreement, whether it is the Portman-Cardin pension plan, 
whether it is the marriage penalty, whether it is the long-term 
dependent care, you have a credit, we had a deduction. The 
point is that I find that our substance doesn't match our 
rhetoric. And even here today in this hearing, there are so 
many things that I think there is agreement on, and yet when 
the rubber meets the road we aren't actually putting into 
practice what we profess regarding those changes.
    My time is running short, but one quick point. I know that 
there are some school bond proposal, going to the technical 
question, school bond proposals that would invoke Davis-Bacon 
prevailing wage requirements on school districts that utilize 
these tax credit bonds. If you can give me a yes or no answer 
on this, in the Treasury's ``green book'' it is silent on this 
issue. Where is the Administration on Davis-Bacon. And if that 
is something where you need to respond in writing, that would 
be fine. I have got some other questions I will submit in 
writing regarding the school construction bond proposal.
    With that, if you have any comments, my time has expired 
and so I would yield.
    Mr. Summers. I will respond in writing on the school 
construction question.
    I would stress in response to a number of your points, 
Congressman Hulshof, that we believe that debt reduction, which 
removes the obligation to pay principal and pay interest, takes 
pressure off interest rates and holds down their costs is 
probably the most effective form of tax relief that we can 
provide. And we believe that we need to not do anything that 
puts that at risk in terms of unrealistic budgeting.
    Mr. Hulshof. If the Chairman would indulge me on that 
point. Just as you say we are trying to put pressure on 
interest rates, the Fed does not agree. Mr. Greenspan and the 
Federal Reserve are doing just the opposite as far as pushing 
interest rates up to try to curtail so-called inflation. Not to 
put you at odds with the Chairman.
    Mr. Summers. Congressman Hulshof, I of course cannot 
comment on Federal Reserve policy. What I can say is that 
every, and I use that word every advisedly, serious 
professional economist who has looked at these issues would 
agree that an environment of paying down debt will be an 
environment of lower interest rates, whatever else happens, 
than an environment without paying down debt. That is the 
operative principle and the reason why debt reduction is such 
an important and effective form of tax cut.
    The President's budget contains $350 billion in tax cuts 
for American families. We are prepared to legislate those any 
time we are sure that they are in the context of a program that 
is paying down debt and assuring our ability to strengthen 
Social Security and Medicare.
    With respect to tax shelters, the regulations you described 
I expect will be announced within the next month. But, frankly, 
as we have drafted them, we have realized that the legislative 
authorities were in some ways insufficient and would permit tax 
shelters to still be marketed in stealth to those who play the 
audit lottery. That is why we will be coming back and asking 
for new legislation.
    With respect to the EITC, there are real compliance 
problems. We have addressed them in the ways I mentioned--more 
budgeting, Social Security numbers, conforming definitions, tax 
preparer's initiative. But I think it is quite a misleading 
suggestion about the compliance statistics to suggest that one 
dollar out of every five dollars is somehow fraudulently 
wasted. The 20 percent figure refers to returns in which there 
is some kind of error. The error is often not of large 
magnitude. The error is in most cases not fraudulent. In many 
cases the error comes from anomalies that the President's 
proposing to simplify this year, such as the distinction 
between earned income for EITC purposes and earned income for 
other purposes.
    With respect to the taxes over GDP figure, we will just 
have to agree to disagree. I don't see how it can be said that 
more capital gains from a stronger economy constitutes a tax 
increase even though it does raise tax revenues. And every 
evaluation of the situation of the typical working family, or 
the working family that is at half the typical income, or 
family at twice the typical income does say that they are 
paying less taxes today than at any point in the last twenty 
years.
    Finally, with respect to the question of the revenue offset 
measures that you raised, it seems to me that just as you take 
the position that even in a time of surplus we need to 
eliminate any wasteful spending, it is also appropriate to take 
the position that if there are tax measures that constitute 
distortionary subsidies or inappropriate measurement of income, 
that is something we should also be looking at for fairness and 
integrity of the tax system regardless of what the overall 
budget surplus is. And it is from that perspective that the 
President has put forward his offset proposals.
    Chairman Archer. The gentleman's time has expired.
    The Chair observes that there are nine members who have not 
yet inquired. The Chair will attempt to conclude the hearing at 
2:00, so the Chair will be constrained to strictly invoke the 
five minute rule so that every member will have their full five 
minutes.
    Mr. Cardin?
    Mr. Cardin. Thank you, Mr. Chairman, for calling on me, 
even under the new interpretation of our five minute rule.
    Let me thank Mr. Summers for his testimony and for laying 
out I think a very comprehensive budget that we can follow. 
Just in response to some of my colleagues' points about why we 
are so concerned about voting tomorrow on a tax bill without 
having a budget is that the Administration has laid out a very 
clear agenda; five objectives that you spelled out, Mr. 
Secretary, at the beginning of your comments--reducing the 
debt, dealing with Social Security and Medicare to protect 
those programs, targeted tax cuts, and our international 
commitments, and some of our new spending priorities. Most of 
that is within the jurisdiction of this committee.
    It was interesting to hear comments about Social Security. 
Well, your budget provides that we can preserve Social 
Security. I question the Republicans and their tax proposals, 
that will exceed $1 trillion dollars over ten years, whether 
they can do that and still pay down the debt and deal with 
Social Security. You have given us a blueprint that we can deal 
with Social Security. I question whether the Republican budget 
allows us to really modernize Medicare to include prescription 
drugs for our seniors, which we need to do.
    I was interested in Mr. Thomas' comments about competition. 
I can tell you what the Medicare Plus choice has done in my 
State, a rather urban State, where now 14 of our 24 
jurisdictions do not have any Medicare Plus choice. No option 
but the fee-for-service as a result of changes we made. So I am 
not so sure there is the interest in the private sector that 
some of my colleagues believe in ensuring our seniors.
    I do want to emphasize though a point that was made by Mr. 
Levin on trade because I do hope that we can develop a broader 
consensus in this Congress on expanding international 
opportunities. Mr. Secretary, our concern about labor and 
environment is not for protectionist policies to protect 
American markets, but that we should be a leader in 
establishing international core standards in these areas. Where 
it is right for us to be a leader in the world, as we were on 
financial services, as we were on intellectual property rights, 
we should be with labor and environment. I think if you do 
that, you are going to find a broader consensus in this 
Congress on both sides of the aisle on the trade agenda.
    But let me in the few minutes I have just underscore the 
point that Mr. Portman made on the private retirement and 
savings and the Chairman made right before our break. The 
economic figures are very encouraging for this Nation but we 
still need to save more. You understand that, we understand 
that. And what the Portman-Cardin bill attempts to do is make 
it easier for Americans to be able to save for their retirement 
by eliminating some of the complexity and making it easier.
    I really do appreciate your comment about finding common 
ground. I applaud the President's RSA proposal because you put 
some money on the table. We weren't quite that bold. We didn't 
spend quite as much on most of our proposals as you are putting 
on the table. That is good because we should be willing to have 
targeted tax relief for people who are willing to put money 
away for their retirement, particularly lower wage workers. We 
agree with you, we want to get to that 70 million who do not 
have private retirement. We also want to get the low wage 
workers, small businesses, and the decisionmakers to have 
pension plans so those 70 million can get pension plans.
    Just one last point on this, and then I invite your 
response. We are not suggesting increasing the caps. We are 
suggesting that we go back and bring the caps where they used 
to be. We have had such a regression in the ability of 
Americans to put money away for private retirement because we 
are so concerned that some people might put more away than 
others that we find that people aren't putting anything away.
    So, our objectives are to deal with the 70 million, but it 
is also to deal with the low savings rates, to put more money 
into private retirement plans so we can have less pressure in 
the future on Social Security. Social Security is supposed to 
be just one leg of a three-legged stool. So I really do 
appreciate your comments, and your proposal, on common ground 
on the pension issues. But I invite you to work with us so that 
we can bring out legislation in this Congress to deal with that 
issue. And I invite your comments.
    Mr. Summers. I think I agree with everything you said, 
Congressman Cardin, and I look forward very much to working 
with you and Congressman Portman and other members of this 
committee to address what I think is a macro economic problem 
for our country in terms of too low a personal savings rate, 
and what is a personal problem for a large number of 
individuals in terms of their preparation for retirement. I 
think this is an issue which ought to, and I think does, reach 
across party lines, reach across generational lines, and it is 
one that I would hope that as we pay down the debt and 
strengthen Social Security and Medicare this year we could also 
work on.
    Mr. Cardin. Thank you, Mr. Secretary.
    Chairman Archer. The gentleman's time has expired.
    Mr. McInnis?
    Mr. McInnis. Thank you, Mr. Chairman.
    Mr. Secretary, I will have a number of questions here I 
would like your response to in writing since I am limited to 
five minutes.
    Let me kind of put it in context because I think you and I 
come from opposing ends in regard to the estate tax. I always 
think of your quote when you were talking about estate tax, 
that the advocation of the repeal of the estate tax is ``about 
as bad as it gets.'' That is when you were the Deputy 
Secretary. And then you went on to say that, ``When it comes to 
the estate tax there is no other case other selfishness.'' As 
you know, my district is geographically larger than the State 
of Florida, comprised primarily of farms and ranches. Needless 
to say, we take strong issue with that position. Further on, I 
would like you to confirm in writing so I am sure of the 
accuracy of the quote, but the Washington Post on April 22, 
1997, says, ``You have to raise revenue somewhere and the 
ability to pay seems like a good way to do it.''
    So I expected that the Administration was going to continue 
in its opposition to relief on the estate tax. Although I would 
be curious as to the upper income level of members of the 
cabinet or in the Administration. My guess is that most of them 
have taken steps to hire tax accountants to be sure that they 
are not hit with this estate taxation, unlike the middle class 
for whom they are advocating no repeal of the estate tax. But 
what I did not expect from the Administration in the budget, 
and what I would like confirmation on in the letter, is in fact 
an estate tax increase.
    I knew you weren't going to give us any kind of relief out 
there with the estate tax. I didn't expect an increase. I would 
like just to confirm that my numbers or the proposals are 
correct. They restore the phase-out of the unifying credit for 
large estates. The Administration proposes a $1.1 billion 
increase in that element of the estate state. They propose a 
$214 million increase in required consistent valuation for 
estate and income tax purposes; $55 million increase in the 
estate tax for basis allocation for part sale/part gift 
transactions; a $1.054 billion increase in conformed treatment 
of surviving spouses in community property States; $18 million 
include the QTIP trust assets and surviving spouses estates; $6 
billion in eliminate nonbusiness valuation discounts in the 
estate tax; eliminate gift taxation exemption for personal 
residents trusts, $408 million; limit use of the CRUMY powers, 
$208 million.
    So the proposal in this new budget on an increase in the 
estate taxation is $9 billion. I would like some comment in 
writing on that.
    The second issue is last year we had 28 members of this 
committee, Democrat and Republican, sign a letter that I had 
drafted opposing what we call tracking stock. The 
Administration appeared to somewhat backtrack but, kind of like 
the estate tax, they didn't give it up. And lo and behold, as I 
look at the new budget, you are back again but this time with a 
different mask. Now I understand that under the tracking stock, 
instead of taxing the issuing corporation, you are now going to 
tax the stockholder. So you are still back on the tracking 
stock. Apparently the Administration is still taking the 
position, and I stand to be corrected I would hope when you 
answer these questions, but you are still at the position 
apparently that the tracking stock is an income and should be 
taxed.
    Both of those issues are issues that I think are important.
    The other thing, and I will conclude with these comments, I 
believe early in your remarks you said the drop in the interest 
rate of mortgages is an administrative way of a tax cut for 
families. Now I kind of think the Administration in this 
economy takes credit for rain. I want to tell you, this is the 
market's benefit to the families. This is not a tax cut to the 
families out there of America that the Administration and the 
Congress have decided to cut your mortgage rates. That is a 
result of market functions, not a result of a tax cut.
    I think it is somewhat of a misappropriation of the term 
tax cut when you talk about interest factors, interest rates 
being lowered out there and you all of a sudden now put that in 
the classification of a tax cut. When I talk to middle America 
out there, when I talk to the average person and I say ``If the 
interest rate on your car, the financing of your car drops from 
10 percent to 9 percent, is it a tax cut?'' They don't see it 
as a tax cut. I think there is confusion with the words.
    Thank you, Mr. Chairman.
    Chairman Archer. Unfortunately, Mr. Secretary, your answers 
will have to be submitted in writing because the gentleman's 
time has expired.
    Ms. Thurman. Mr. Chairman, I think some of the rest of us 
members would like to have those answers as well. So if we 
could have--
    Chairman Archer. Perhaps the gentlelady will provide time 
within her five minutes. I have got to be able to release the 
Secretary and still let everybody have their five minutes.
    Mr. Summers. Mr. Chairman, I would be prepared to stay till 
2:03 in order to take three minutes to respond to the 
gentleman's thoughtful question.
    Chairman Archer. Mr. Secretary, whatever you want.
    Mr. Summers. Let me just say with respect to interest 
rates, I think the words I used were tantamount to a tax cut to 
take the pressure off credit markets and allow interest rates 
to fall. I don't believe for a moment that we would have 
anything like the interest rate environment we do if we had not 
made progress in creating budget surpluses.
    With respect to tracking stock, I would simply say to you 
that I think it is appropriate for us to conform tax rules for 
corporations to all forms of corporate distributions in some 
level playing field way. That is the thrust of our corporate 
tracking stock regulation.
    With respect to the estate tax, I have made clear both in 
writing and in public comments immediately after the remarks 
you quoted that I had what might be referred to as a learning 
experience with respect to those observations and that they 
were not a fair statement with respect to the motives of those 
who advocated estate tax repeal and have worked very hard in 
connection with the 1997 legislation to provide tax relief to 
farmers and to small businesses and to be part of a program to 
generally raise the limits on the estate tax.
    With respect to the set of provisions that you identified, 
to say that estate tax burdens are a legitimate concern for 
many small businesses and farmers is not to say that we 
shouldn't be responsive to loop holes that arise in estate tax 
that in many cases were not intended. The references to QTIP 
trusts, to the CRUMY powers, to certain valuation discounts, to 
residential trusts, these are responses to various systems that 
have been designed over time to avoid the intent of the estate 
tax as it was legislated. I think it is much better for us to 
debate what the appropriate level of that tax is and make 
decisions explicitly rather than to allow loop holes to be 
expanded. The legislation is not directed at increasing the tax 
but only at responding loop hole concerns that have arisen.
    Chairman Archer. Now Mr. Becerra.
    Mr. Becerra. Thank you, Mr. Chairman.
    Mr. Secretary, thank you very much for being here and for 
being so patient with your time. Let me also compliment you and 
certainly the President and Vice President on the proposal that 
you have put before us in your budget to try to address Social 
Security, Medicare, and certainly of course to pay down the 
debt. I would also congratulate you on what you did with the 
EITC. I think it is great that we are looking at more ways to 
make work pay for working families that otherwise would fall in 
the poverty limits of what we have defined as poverty. And by 
the way, I think we should acknowledge Chairman Archer as well 
because he also had a similar proposal on EITC.
    You mentioned a number of things, you answered a number of 
questions on a number of subjects. Let me just touch on a 
couple. First, FSC. I hope that Treasury will take with as much 
seriousness the issue of FSC and what happens with the WTO on 
that issue as the USTR is taking it. I think if we don't treat 
that as a very high priority, we could find ourselves at a 
great disadvantage, competitively speaking, with our European 
counterparts. I think the last thing we want to see is a loss 
of jobs in this country because we are not able to export on 
competitive terms with our European colleagues.
    The digital divide. I am glad you spoke a little bit about 
that. I am very pleased to see the President's proposal to help 
households acquire computers and help young people and adults 
get connected. I am fortunate to work with Mr. Portman on a 
bill that we call the New Millennium Classroom Act which does 
something very similar. It tries to provide a tax deduction for 
companies or individuals that contribute computers to 
classrooms and to senior citizen centers to help child and 
seniors get connected. So I hope you will take a close look at 
that bill that we have.
    I am not sure if it was mentioned, but because so much of 
your budget talks about working families, I hope that we can 
count on you to work with us on an issue that is affecting a 
number of States more and more dramatically every year, and 
that is the whole issue of runaway productions in the 
entertainment industry. We are seeing more and more countries 
offer tax credits to companies that would leave the United 
States to do their productions abroad, places like Canada, 
Australia, England. And as a result, they are getting tax 
credits of up to 40 percent on the production costs, 
principally in labor. It has become very difficult for a number 
of companies in the U.S. to stay here and for us to compete to 
keep those companies here.
    I hope that you will take a close look at the opportunities 
to try to help those industries. And by the way, we are not 
talking about helping the movie star who makes $5 million to 
$20 million with a movie, or the producer, or the writer, or 
the director who is making megabucks. We are talking for the 
most part about the folks behind the camera, the stagehands in 
productions, the boom individuals who operate all of the 
equipment, we are talking about the caterers who provide the 
lunch to those who are actors who make working man's wage. So 
if you could do us a favor and take a close look at that. That 
is becoming more and more an important issue.
    And finally, if I can focus the remainder of my time on an 
issue that I hope you will take a close look at dealing with 
Customs. Customs right now has an automation problem. It has a 
computer system that works to track product that is imported 
into this country that uses 1980s technology. As a result, we 
have already experienced on occasions brown-outs, delays in the 
ability to move a lot of this product. And with our in and out 
system of production these days where it is time sensitive to 
be able to bring in what you need to produce your product, a 
lot of companies in this country would suffer greatly if we 
found not just a brown-out but a black-out where products that 
are supposed to be coming in to help manufacturing here in 
America would not reach their location.
    I have a letter that I will leave with you rather than 
getting into detail since we are constrained on time. But you 
are probably familiar with the new system that Customs is 
trying to implement, the ACE system that would replace the ACS 
system that is in place right now. The problem becomes that at 
this stage the Administration has proposed only to fund the 
modernization through a new fee. I think most of us have seen 
that hasn't worked. I would hope that you all would think 
seriously about other options to try to do that. I know that at 
some point there was an exploration of the possibility of 
earmarking some of the merchandise fee that is used right now 
and collected from importers to offset the cost of that 
modernization or perhaps using a straight appropriation to do 
that.
    Somehow or another we have to get this resolved because if 
we don't get that new computer system in place I think we are 
going to find that we are all going to be hurt. Certainly, 
American business will suffer, consumers will suffer, and our 
competitiveness will suffer. I don't know if you have any 
comment on the whole issue with Customs and automation, but I 
would welcome an answer.
    Mr. Summers. I will take one minute to respond to your four 
points, if I could. I've got a clock in front of me.
    On FSC, I agree. We are absolutely committed. Deputy 
Secretary Eizenstat is leading the effort.
    On computer donations, we share the objective with respect 
to the digital divide but we have some concerns about the form 
of your proposal in terms of encouraging overly old computer 
donations rather than ours which is focused on newer equipment. 
But I am sure we could work something out.
    Mr. Becerra. We could work on that.
    Mr. Summers. On runaway production in the entertainment 
area, this points up the generally important issue of tax 
competition which we are pursuing very actively through the 
OECD because this is an issue that arises in a number of 
contexts.
    On ACE, we agree with you on its importance. We have 
reconfigured the proposal in this year's budget to much more 
clearly link the benefits to the business community to their 
contribution. And I hope we can move forward with it because 
you are absolutely right that it is essential.
    Mr. Becerra. Thank you very much.
    Chairman, thank you very much.
    Chairman Archer. Mr. Lewis?
    Mr. Lewis. Thank you, Mr. Chairman.
    Mr. Secretary, over the next ten years, the Federal 
Government is going to be taking in about $24 trillion in money 
from the taxpayers' pockets in this country, with a sizeable 
projected surplus. Do you think that the American people are 
not paying enough to take care of the needs of the Federal 
Government?
    Mr. Summers. I think there is room to meet the needs of the 
Federal Government and to provide for appropriate tax relief. 
Although I think we have had a real accomplishment in the last 
seven years in reducing the number of Federal employees by a 
sixth and bringing Government, by a wide variety of measures, 
down to its smallest size since the 1960s, and that we have 
enjoyed the first decade in which we have been significantly 
cutting discretionary spending, which I think represents a real 
achievement for our country, we have got to be very 
disciplined.
    Mr. Lewis. Do you think $170 billion in net tax relief over 
ten years is a significant amount of tax relief? That is 
basically seven-tenths of 1 percent. That is not a lot of tax 
relief. And let me say this, you have increased taxes by $181 
billion, $69 billion of which comes out of families in 
Kentucky, tobacco farmers that are struggling. They just had a 
45 percent cut in their quota, last year 30 percent. They are 
dying out there on those family farms. Their income has been 
cut in half.
    Is it the President's desire to totally tax legal tobacco 
out of existence and the family farmer?
    Mr. Summers. With respect to the tax cuts, $170 billion is 
a lot of money where I come from.
    Mr. Lewis. Out of $24 trillion?
    Mr. Summers. But $350 billion in gross tax cuts is even 
more.
    With respect to tobacco, the core of the President's 
proposal is a youth penalty that would fall on companies whose 
products are sold to young people below the age of consent. I'm 
sure that if there were proposals to ensure that those 
penalties were borne by the companies rather than passed on to 
consumers, if there were an approach along those lines, I am 
sure that is something we would be prepared to join in working 
on.
    Mr. Lewis. Let me ask you this. One of the major causes of 
death with teenagers today is automobile accidents. Are we 
going to make automobile manufacturers responsible for 
decisions made in the family home? One of the biggest causes of 
cancer today is exposure, over exposure to the sun. Are we 
going to make those manufacturers of swimwear responsible for 
kids getting out on the beach and being over-exposed to the 
sun? Are we going to have lookback provisions for every company 
in this country for decisions that should be made in the home 
and the responsibility should be there? Where will this all 
end? Are we going to always have lookback provisions? Where is 
the responsibility here?
    Mr. Summers. I think that is a fair and important question. 
Let me just emphasize that whatever we do, it is very important 
that we protect the interests of tobacco farmers who are not 
the people who are responsible for all of this.
    That said, we have had effective public health policies 
around automobile accidents that have reduced the number of 
fatalities per mile by 50 percent over the last 35 years. We 
have had effective policies in the other areas that you cited 
that have reduced fatalities very substantially. We, frankly, 
have not had similar effectiveness with respect to tobacco even 
though tobacco is a far, far greater cause of death than either 
of the examples you cited.
    This is the best strategy as judged by all the public 
health authorities to rely on price to achieve the same kinds 
of benefits the Government has achieved with respect to most of 
the other sources of--
    Mr. Lewis. Let me interrupt just for a second. My time is 
short here. When I said legal tobacco, there is a law of 
diminishing returns here. The reason that the tobacco farmers 
have been cut by 45 percent is because they can't afford to 
stay in business any longer. Underground tobacco products are 
already being sold. Our kids are going to be exposed to illegal 
tobacco where they are going to be buying it at cheaper prices 
because you are going to force the legal people out of 
business.
    Mr. Summers. Congressman Lewis, that is something we would 
be happy to discuss with you. I think the Bureau of Alcohol, 
Tobacco, and Firearms and others who have looked at this issue 
can make a compelling case that youth penalties in the range 
that we are considering can quite comfortably be administered. 
But the concern you are raising, if it did lead to smuggling or 
illegal use, obviously is a very serious one but it is one that 
we have given a lot of thought to and that I believe can be 
controlled.
    Chairman Archer. The gentleman's time has expired.
    Ms. Dunn?
    Ms. Dunn. Thank you very much, Mr. Chairman.
    Welcome, Secretary Summers. I enjoyed your presentation. It 
did clarify where the Administration stands from different 
points of view and it will be useful as we compare your 
proposals to those that we intend to propose as we put together 
our budget document.
    I did want to move back to asking you some questions about 
the death tax. In some areas that I do a lot of work, the 
minority community and women business owners, where we see 
women starting businesses at twice the rate of men, and they 
are small businesses but they are businesses that are being 
built and that these women would like to provide as a legacy to 
their children when they finish their life.
    The 1993 budget agreement increased the rates of 
inheritance tax up to 53 and 55 percent. That puts us at the 
second highest inheritance tax rate of the whole world. Japan 
is the only country that is ahead of us. That concerned me when 
it happened then. But now as I have done work in the 
entrepreneurial community, I have learned that many minority 
groups, particularly black enterprises, see that it takes about 
three generations to create a business that provides a legacy, 
that provides them standing in the community so that they can 
continue to do well in their lives. And for them the death tax 
becomes a true enemy.
    I know that you agree with me that we need to encourage 
entrepreneurial women and minority women to get into the 
business market to become more independent. I wanted to ask 
you, when Congressman Tanner's bill, my bill, the death tax 
repeal that phases out death tax in ten years, when it is 
supported by groups like the National Association of Women 
Business Owners, the Black Chamber of Commerce, the National 
Indian Business Council, the National Congress of American 
Indians, the United States Hispanic Chamber of Commerce, the 
Hispanic Business Round Table, the United States-Pan-Asian 
American Chamber of Commerce, and the Texas Conference of Black 
Mayors, why doesn't the Administration want to help by 
repealing the death tax? In fact, why do they stand in the way 
of that repeal even to the extent of increasing it as they do 
in this budget? And I would like to know from you the answer to 
that question. I think it would be very useful to those of us 
who believe that this onerous tax should go away. I know that 
the Administration's position is in opposition to positions you 
took, for example, when you were teaching at Harvard 
University.
    So I ask your comments.
    Mr. Summers. Let me say first, just with respect to your 
last comment, the Administration's position is consistent with 
positions that I took as an academic. I did write something 
that summarized the conclusions of another researcher, who took 
a position favoring the estate tax.
    I think you have very powerfully stated what is a very 
important concern, which is the proper treatment of small 
businesses, and it should not be the way things work, that the 
estate tax is a force for liquidation of small businesses.
    We have proposed--and supported in 1997, and at other 
points--a variety of proposals that are designed to provide 
relief from what can be a liquidity problem, an enormous 
problem, for small businesses at the most threatening moment in 
the business' experience, when the founder or the owner passes 
away. That is a very real and large concern to us.
    With respect to the full-scale elimination of the estate 
taxes that some have proposed, we would share the view of many 
tax experts that the estate tax provides a very important 
backstop to the income tax. If the estate tax were completely 
removed, you would see a very substantial erosion not just of 
the estate tax revenue, but also of the income tax revenue, as 
income was put into various forms where it accumulated tax-free 
and there was never any taxation with respect to the income 
that had been earned.
    So we think it would be dangerous to our fiscal integrity 
to, full-scale, repeal the estate tax.
    We would also have a concern about the very large volume of 
philanthropic contributions to the Nation's universities, to 
the Nation's religious institutions, to the nongovernmental 
organizations and social organizations that do so much of the 
Nation's work, that would not be there but for the 
deductibility that takes place under the estate tax.
    So we would be pleased to work on proposals to address the 
specific inequities with respect to small businesses to the 
extent that they can be identified, but we do not believe that 
it would be prudent to eliminate a tax that does, after all, as 
real as the issues are, only impact about seven-tenths of a 
percent of all American estates.
    Chairman Archer. The gentlelady's time has expired.
    Ms. Thurman?
    Ms. Thurman. Thank you very much, Mr. Chairman.
    Mr. Secretary, thank you very much for being here today and 
spending all of this time with us.
    First I would like to say something to our colleagues that 
I think is important because we have talked about this abuse 
and fraud issues. You know, that is really some part of our 
responsibility as well. We have governmental operations to 
overlook, these kinds of issues. I served on that committee; we 
had some 300 reports on Defense spending that we should have 
been looking at, but we did a lot of other investigations 
instead. And I think we have to take some responsibility; and 
then, in those findings, how we're putting them into 
legislative proposals.
    We, in fact, should take some credit for that because we 
did that under the EITC. We did that in 1995. We did it again 
in 1997 under the leadership here. So I think we should be 
careful of how we address some of these issues.
    Mr. Secretary, I would suggest, though, for some of us in 
the idea of this Medicare issue and the idea that some things 
are just cutting across the board on hospitals, I just met with 
my hospitals this last week and one of the things that they 
told me was because of the uninsured rate going up, of people 
not having insurance, has created a real problem for them 
because of indigent health care.
    So in your proposals--I mean, you may want to reiterate all 
of the new steps that you are taking to bring people into 
insurance, because I think this is very important in the fact 
that we really are helping the health care system. So if you 
could just give us kind of a little run-down, a little bit 
more, on that.
    Another issue, though, in all due respect to my colleagues, 
if I remember correctly under the Social Security proposal that 
was given--in fact, for many of us--I can't speak for the 
President not returning the phone call, but many of us sat for 
almost an entire day with the Chairman and others, trying to 
learn the intricacies of Social Security. You all weren't 
invited; some outside folks came in and gave us that. But in 
that proposal, if I remember correctly, it was done so that 60 
percent of the surpluses were going to be put into equities as 
well, or some sort of investment. And I understand the 
difference between the private account and the 15 percent, but 
I don't think you can just say out there, ``Oh, you guys are 
doing this, but you're not doing this.'' That's just wrong.
    Thirdly, I would like to ask--and I am particularly 
interested in this proposal, which is on the sustainable or 
renewable energies issue; I am co-chair of that--and in looking 
at the issues that we've been talking about over the last 
couple of months, how this economy has grown with technological 
innovations--what in this budget, because your comment at the 
beginning was, ``You know, we have to make some choices here.'' 
In this budget, where do you see and what do you see as choices 
that we've made that will sustain this economy?
    Mr. Summers. I think the most important--
    Ms. Thurman. Wait, one last thing. Prescription drugs, as 
well. If we have a prescription benefit, which you've proposed, 
or which has been proposed, let me tell you the dollars that 
we're going to save in Medicare by not hospitalizing people, 
because they can have their medicines and stay on their 
medicines and not cut them in half to choose between food and 
medicine. They will stay on them and we will save money there.
    Mr. Summers. I share your last point. I think there is a 
general issue in all of the scoring exercises that we do that I 
think that, probably appropriately, we're very conservative 
about taking account of the various feedback effects. Just as 
the Chairman has expressed concern at some points that we don't 
take account of all the behavioral effects of tax policies, and 
that raises certain questions, I think similar kinds of 
questions can be raised with respect to the economies that come 
from prescription drugs.
    All things considered, I think in the formal scoring 
processes it's best to be conservative, but there certainly is 
the effect that you described.
    With respect to promoting the recovery in a broad sense, 
the most important thing we're going to do to promote the 
recovery is have a large-scale pay-down of debt.
    In the sense of sustainable development, in the 
environmental sense, the most important provisions are the 
increases in research and development at the Department of 
Energy. And of particular importance to me, the tax credits for 
more miles to the gallon automobiles, greater use of biomass, 
and other kinds of carbon-conserving policies. We've had a 
great achievement in that while we've had this remarkable 
growth in the economy, we've actually had record low growth in 
carbon emissions in recent years. That's a tribute to the move 
to the information technology type economy, and that's 
something that I think that we need to build on.
    I think Ms. Mathews can say something about the question 
you raised with respect to Medicare.
    Ms. Mathews. I think it's absolutely true in that we will 
be helping our hospitals by ensuring that their indigent care 
numbers go down.
    I would just point to a couple things quickly. One is 
family care, which is the expansion of something that was 
passed in 1997 on a bipartisan basis, which was the CHIP 
proposal. We've proposed expanding it to cover the parents of 
those children. In addition, also getting more information so 
that children that are not yet covered, are. That's two 
examples.
    Chairman Archer. The gentlelady's time has expired.
    Mr. McCrery?
    Mr. McCrery. Thank you, Mr. Chairman.
    Mr. Secretary, welcome, and thank you for staying so long.
    You made the point earlier that spending by the Federal 
Government is at, probably, a 40-year low, or close to it. I 
think if you go back to find a year in which spending as a 
proportion of our national income was lower, you would have to 
go back to 1966, if I'm not mistaken. And I think that is good, 
I agree with you that it's good that we have restrained 
spending to the extent that we have. We have made progress in 
shrinking Government at the Federal level.
    But I would want to make a point that we could have done 
better had the Clinton Administration not fought the Republican 
Congress every year since we've been in control, for more 
spending. And here you are, back again this year, asking for 
more spending.
    I think President Clinton deserves some of the credit for 
restraining spending, but I am reminded of Secretary Shalala 
coming and sitting right where you are, back in 1995, promoting 
welfare reform, which was great; we were all for welfare 
reform, but her welfare reform program--that is, the Clinton 
Administration's welfare reform program--actually would have 
spent more money than we were then currently spending on 
welfare; whereas, as you know, the welfare reform program that 
was ultimately adopted by the Congress and finally signed by 
the President, after two vetoes, actually reduced spending on 
welfare by some $60 billion over five years.
    Here we go again. At a time when we have surpluses, when 
the Federal Government is taking in more money than we need to 
finance Government, as pointed out by Chairman Archer, tax 
revenues, unlike spending, are at an all-time high for 
peacetime. Over 20 percent of our gross domestic product is 
coming into the Federal Government in the form of revenues, and 
instead of coming in and saying, ``Let's have a tax cut, let's 
let the people who have created this strong economy to keep 
doing the good things they're doing,'' you all are coming in 
asking us to increase taxes.
    Your budget proposal, as it is designed, would continue the 
surpluses, you're right. But if the tax increases and the fee 
increases that you have asked for don't materialize, then 
you've got a problem with your budget; it doesn't work, the 
numbers don't work. And I think it's safe to say this Congress 
is not in a mood to raise taxes.
    I would like for you to explain to us any contingency plans 
that you have for scaling back the spending increases that you 
all have proposed, just in case we don't adopt the tax 
increases that you've proposed.
    Mr. Summers. Let me respond, if I could, in three ways to 
what you've said.
    First, with respect to the question of credit allocation, I 
think the news is good enough that we can all take credit for 
what's happened, although I would note that spending has 
increased and Federal employment has increased, but far less 
than it did in either the legislation between 1981 and 1993, or 
in the Executive Branch's proposals between 1981 and 1993.
    With respect to the level of taxes, I would just 
respectfully have to disagree. I honestly don't see how it's 
possible to argue that higher stock prices and more capital 
gains taxes, coupled with more of the income going to those in 
high brackets, constitutes a tax increase. And if one looks at 
standardized families, one does, once again, see that taxes are 
lower than they've been in 20 years.
    Mr. McCrery. Well, Mr. Secretary, though, if you compare--I 
like your figure on spending, and I congratulate the 
Administration and the Congress for working together to get 
spending down to 18.7 percent of GDP this year. But if you're 
going to compare apples to apples, you have to say that the 
Federal Government is taking in over 20 percent of GDP in the 
form of revenues, and that's an all-time high for peacetime.
    So as an economist, don't you have any concerns that we are 
taking an ever-higher proportion of our national income into 
Washington to redistribute?
    Mr. Summers. As an economist I have analyzed that figure 
very, very closely, and the increase does not derive from any 
legislative change. It derives from higher stock prices and 
more capital gains, with a constant tax law, and it derives 
from a change in the income distribution towards those who are 
more highly taxed.
    When one looks at the tax law as a measure, one finds that 
it is taking less relative to income than at any time in the 
last 20 years.
    With respect to the question of tax cuts, the 
Administration's budget, of course, does propose net tax cuts 
over the next 10 years, and quite significant gross tax cuts.
    You spoke of new spending, but those calculations are done 
relative to one of the first two CBO baselines, which would 
require either a scaling-back of the defense buildup, or cuts 
on the order of 20 to 25 percent in a number of key areas of 
Government expenditure. I'm not sure just what is envisioned by 
those who invoke that baseline.
    Our judgment is that it's better to use a current services 
baseline, because just as we learned in the 1980s that it was 
important to avoid overly-optimistic economic forecasts, we 
believe that unrealistically-optimistic forecasts about future 
spending could put us in a situation where we were back in 
deficit. These forecasts are volatile and we can't always rely 
on the kind of good news that is reflected in this year's 
forecast.
    Chairman Archer. The gentleman's time has expired.
    Mr. Secretary, unfortunately, if we're going to get to the 
other three members who have not enquired, assuming we stay 
strictly within the five-minute rule, we're looking at another 
15 minutes. Can you handle that?
    Mr. Summers. Yes.
    Chairman Archer. Without objection, I would insert in the 
record at this point a compilation of the figures in your 
budget, based on your estimates, which show that there is a $14 
billion net tax and user fee increase, over and above what you 
give in the way of tax relief.
    [The material follows:]

                      Administration's FY01 Budget
      Tax and User Fee Increase of $14,730 Million Over Five Years
 
                                                      Fiscal Years 2001-
                                                       2005 (Millions of
                     Tax Relief                            Dollars)
 
 
Claimed gross tax relief including refundable                  -101,749
 credits (AP, p. 88)
  Less three tax increases
      (1) Accelerated vesting for qualified plans                  -550
       (AP, p. 87...................................
      (2) Electricity restructuring (AP, p. 88).....               -105
      (3) Levy tariff on certain textiles (AP, p.                  -676
       88)..........................................
  Less other provisions affecting receipts
      (1) Replace harbor maintenance tax (AP, p. 90)             -3,197
      (2) Roll back Federal retirement contributions             -1,206
       (AP, p. 90)..................................
                                                                    -36
      (3) Provide Government-wide buyout (AP, p. 90)             +5,999
  Plus refundable credits (actually increased                  -101,520
   spending) (AP, p. 88)
                                                     -------------------
        Actual gross tax relief:
 
        Tax and User Fee Increases                              +47,151
Claimed tax increases (p. 90)                                      +550
  Plus three tax increases                                         +105
      (1) Accelerated vesting for qualified plans                  +676
       (AP, p. 87)..................................
      (2) Electricity restructuring (AP, p. 88).....
      (3) Levy tariff on certain textiles (AP, p.                +2,466
       88)..........................................
  Plus other provision affecting receipts (AP, p.                +3,823
   90)
      (1) Environmental tax (AP, p. 90).............             +6,667
      (2) Superfund excise taxes (AP, p. 90)........            +31,194
      (3) Airport user taxes (AP, p. 90)............               +431
      (4) Tobacco taxes (AP, p. 90).................             +3,752
      (5) Recover state bank supervision (AP, p. 90)                +49
      (6) Maintain federal reserve surplus (AP, p.                 +218
       90)..........................................
      (7) Premiums for United Mine Workers (AP, p.                  +25
       90)..........................................
      (8) Abandoned mine reclamation fees (AP, p.               +19,143
       90)..........................................
      (9) Corp of Army Engineer fees (AP, p. 90)....
  Plus other user fees not included above (AP, pp.             +116,250
   98-99)
                                                     -------------------
        Actual gross tax and user fee increase:                  +14,73
                                                     ===================
 
        Actual net tax and user fee increase:
 
 

       

                                

    Chairman Archer. These are your figures, Mr. Secretary, and 
they are right here in black and white.
    Mr. Summers. I would hope that you would permit me to 
insert a response to that analysis in the record.
    Chairman Archer. Absolutely.
    Chairman Archer. Mr. Ramstad?
    Mr. Ramstad. Thank you, Mr. Chairman.
    Mr. Secretary, thank you for your indulgence. It's good to 
see you again.
    I have a question concerning one of the items in the 
revenue-raising portion of the Administration's budget, and I 
refer to the proposal affecting employee stock ownership plans, 
the so-called ``ESOPs,'' that are for S-corporation employees.
    First, I must say that I am relieved that this year's 
proposal doesn't go as far as last year's proposal, which would 
have effectively killed this effective retirement savings 
program for thousands of S-corp employees. As you know, a 
strong bipartisan majority--in fact, 23 members of this 
committee; I see Ms. Thurman shaking her head affirmatively--a 
strong bipartisan majority of this committee went on record as 
opposed to that approach.
    So this year's proposal certainly moves in a better 
direction, and we're happy to see that, Mr. Secretary. It seems 
that it's an attempt to preserve broad-based employee 
ownership, but I think there's a problem--and we certainly 
differ on what constitutes ``broad-based.'' Quite candidly, we 
believe that the ``highly-compensated employee test,'' so-
called in the Administration's proposal, is unworkable.
    The legislation that 23 of us, Democrats and Republicans 
alike, on this committee have introduced, H.R. 3082, uses a 
control test to determine whether an ESOP is truly benefitting 
rank and file employees.
    The important question here, I think, Mr. Secretary, can I 
interpret the Administration's new proposal as an offer to work 
with us, to work with Congress, on preventing possible misuses 
of the 1997 law, which everyone agrees we should do? But at the 
same time, preserving employee ownership opportunities for rank 
and file workers of S-corporations?
    Mr. Summers. If I understood you right, Congressman, you're 
asking for my agreement on the dual principles, that we want to 
preserve the ESOP as an important tool, and at the same time we 
want to avoid any shelter opportunities created by the 1997 
legislation, and we want to do those two things in the most 
effective and reasonable way possible.
    We are absolutely prepared to work with you and members of 
this committee toward those two objectives, and that is 
precisely the motivation behind our proposals.
    Mr. Ramstad. Well, I certainly appreciate that movement and 
that willingness to work together in a collaborative way, 
because the last thing we want to do is kill ESOPs for S-
corporation employees. I mean, that makes absolutely no sense 
at all when we're trying to improve and increase savings 
programs and retirement programs. They're doing it right, and 
for us--for the Administration, for anybody--to try to put a 
damper on this sort of employee stock ownership plan is, I 
think, counterproductive to any good public policy.
    Mr. Summers. I agree.
    Mr. Ramstad. I am glad to hear that you do agree.
    Let me also just ask you parenthetically, could you provide 
us with a definition of the term ``highly-compensated 
employee'' that you are using in this year's proposal?
    Mr. Summers. Not off the top of my head, but wait just one 
second.
    I have just been provided with an answer that you may or 
may not find helpful.
    We define ``highly-compensated employee'' for this purpose 
in a way that parallels the definition of ``highly-compensated 
employee'' in other areas of the pension law. [Laughter.]
    It may be better for us to pursue some parts of this in 
writing because it would be difficult to underestimate my 
degree of knowledge of these details. [Laughter.]
    Mr. Ramstad. Let me use the remaining minute. I want to 
focus on the President's prescription drug proposal.
    We all agree that for many low-income seniors, prescription 
drugs are a crisis, the lack of accessibility, for the 35 
percent that aren't covered under Medicare. Why not, instead of 
spending $76 billion, as the President's budget does, why not 
target prescription drug coverage to low-income seniors? Why 
displace the coverage that a majority of enrollees have? Why 
not target the 35 percent of low-income seniors? And I ask that 
in good faith; I'm not trying to politicize this issue. In my 
judgment, this is the last issue that we should politicize. I 
really don't understand why we don't simply target the 35 
percent of those Medicare beneficiaries without prescription 
drug coverage.
    Mr. Summers. That's something we've--
    Chairman Archer. Mr. Secretary, you have one minute. It 
just expired. [Laughter.]
    Chairman Archer. Go ahead.
    Mr. Summers. Thank you, Mr. Chairman.
    Three reasons. First, more than half of those without 
prescription drugs have incomes above 150 percent of the 
poverty line.
    Second, many of those with some coverage have completely 
inadequate coverage that is important to build on, and our 
proposal contains incentives for the preservation of that 
coverage, and wraps a better form of coverage around that base 
coverage.
    Third, the strength of Medicare has traditionally been its 
universality. Everybody pays in and everyone receives the 
benefits. To carve out certain portions of Medicare benefits 
and make them only available to some individuals, it seems to 
us, would weaken the program.
    For those three reasons, we favored a universal approach.
    A fourth reason is to avoid various kinds of adverse 
selection effects.
    Mr. Ramstad. Thank you.
    Thank you, Mr. Chairman.
    Chairman Archer. The gentleman's time has expired.
    Mr. Ramstad. Let me just say I hope we can work together, 
and I hope the Administration doesn't persist with an all-or-
nothing approach to this, because it's too--
    Chairman Archer. The gentleman's time has expired.
    Mr. Doggett?
    Mr. Doggett. Thank you, Mr. Secretary, for your leadership 
on so many issues.
    Let me say first that I really applaud the initiative that 
you've taken on tax havens, these international tax havens that 
have been used to provide tax shelters, and I'm already working 
on some legislation in this area and I look forward to 
cooperating with you.
    Second, with reference to tobacco, do I understand that 
your recommendation basically is to use the tax code to address 
the problem of youth smoking and the leading cause of 
preventable death in America today in much the same way we used 
the tax code to encourage research and development, or 
accomplish some other reasonable social objective?
    Mr. Summers. It could be put that way, Congressman Doggett. 
I think I would prefer to think of it as not using the tax 
code, but simply working to create a youth penalty in an 
overall tobacco program that would reduce youth smoking, and 
some of which would be administered through the tax system.
    I think we've made much greater progress, frankly, with 
respect to most other forms of public health problems than we 
have with respect to tobacco, and I think the price sensitivity 
is very clear. And that's why we're going with this approach.
    Mr. Doggett. We certainly have in some other areas, as you 
have noted. There is a smuggling problem, and I do have some 
legislation on that, that I think we need to work together on. 
But it just seems to me that your tobacco area that you're 
working on here deserves the title ``death tax'' much more than 
the misapplication of that term to the alleged inheritance tax 
plight of the Steve Forbes family.
    Let me say as a third area that I am concerned about that 
you have addressed, and I am pleased to see you do it, is 
something similar to the approach that I have advocated through 
H.R. 2255 on addressing corporate tax shelters.
    During last year, when this Congress largely ignored the 
problem of abusive corporate tax shelters and never got around 
to even having a hearing on it until Members were packing in 
the middle of November to leave town, I noted recently that 
period was described by a top official at the Internal Revenue 
Service in the Wall Street Journal as one in which there was 
``almost a product of the week, or a product of the day, that 
these tax hustlers were promoting.''
    Let me just ask you if you would characterize the problem 
of abusive shelter tax evasion as having grown much worse 
during 1999.
    Mr. Summers. You know, it's the nature of this problem that 
it is very difficult to track, because it takes multiple years 
until one can fully analyze corporate returns, and those who 
engage in these transactions don't take out advertisements 
indicating that they have engaged in these transactions. So any 
evidence has to be inherently circumstantial.
    But from the conversations that we've had with a range of 
practitioners, I think both Commissioner Rossotti and I have 
come away with a sense that there is more and more pressure to 
engage in these transactions, and in part it takes the form of 
a kind of competitive pressure, where Chief Tax Officers of 
corporations are told by their CFOs, you know, ``The other CFOs 
are engaging in that transaction; why won't you?'' And then 
increasingly, law firms are giving opinions in support of 
transactions that they would have been unwilling to give 
several years before, because of the competitive pressure.
    So it is our sense that this is a problem that is of 
growing significance.
    Mr. Doggett. I believe you refer to that as a ``race to the 
bottom'' in your written testimony.
    You know, at our last and only hearing on this in November, 
Mr. Kies, who has been a real head cheerleader for these 
abusive tax shelters, indicated he had no familiarity with the 
BOSS transaction marketed by his company. I was so pleased to 
see Treasury move forward to deal with the BOSS problem. My 
question to you would be, why is it that legislation is 
necessary? Why can't you just go and solve these problems 
administratively?
    Mr. Summers. Let me say we have had, I think, a number of 
successes in dealing with these problems administratively, and 
I am proud of the work which my colleagues have done which I 
think has saved the Treasury over the last three years 
literally tens of billions of dollars as a consequence of their 
alertness.
    But I don't think we can rely for the integrity of our tax 
system on an approach based on Treasury staff picking up 
rumors, going and investigating, finding out about 
transactions, and closing them. It seems to me that the people 
and the companies that engage in these transactions know that 
these are transactions of a somewhat questionable nature, and 
it seems to me appropriate that they be expected to flag these 
transactions so that they can be clearly considered. And if 
they are within the law, no one should pay more taxes than the 
law requires them to pay, but they should flag these 
transactions rather than being encouraged to carry them out by 
stealth.
    It seems to me that where we have situations--not where 
people make an honest error, or a controversial judgment is 
ruled against them--but where there are transactions that are 
devoid of economic substance, if we want to deter those types 
of transactions, some increases in penalties seem to us to be 
appropriate in those cases.
    It also seems to me appropriate that as part of a 
simplification that a number of people have espoused here, that 
rather than encouraging reliance on a common law approach where 
everybody reads a lot of different court cases to seek to 
understand what the definition of ``economic substance'' is, it 
seems to me appropriate to codify what is meant by ``economic 
substance'' and for this to be an area in which policy is set 
by the Congress rather than by the Judiciary.
    And so for all of these reasons, it seems to me appropriate 
to legislate in this area, although you have my assurance that 
the Department and the IRS will do what we can within our 
authorities, but we want to be very careful not to overstep our 
authorities. That's why we're looking to Congress for what we 
regard as very much necessary legislation.
    Chairman Archer. The gentleman's time has expired.
    The last member to enquire, you will be happy to hear, Mr. 
Secretary, is Mr. English.
    Mr. English. And thank you, Mr. Chairman. Hopefully, as in 
the Bible, the last shall be first.
    I thank you for the opportunity to enquire, Mr. Secretary. 
There are some things in your budget that I really don't care 
for. Probably at the head of that list is the $70 billion in 
unitemized Medicare cuts, and I understand why they're in 
there.
    I do think you deserve credit for having included a number 
of tax changes that could be positive. I would specifically 
reference the end of the Section 415 restrictions on 
multiemployer defined benefit plans, which unnecessarily 
restricts the pension rights of many workers in this country. 
You have proposed the elimination of the 60-month limit on 
student loan interest deduction; that makes a great deal of 
sense. You have proposed to extend the exclusion for employer-
provided education assistance to graduate education, and I've 
come to recognize how important that is.
    Mr. Secretary, I am interested in your comments on earned 
income tax credit, because I think the modest proposal you put 
forward probably does not increase fraud and is probably worth 
doing for the working poor, but that's something that I want an 
opportunity to examine.
    If I might, because my time is limited, I would appreciate 
your written response on a number of points.
    One, you proposed modifying the Section 179 expensing 
provision for small business, which is a very important 
provision, all out of proportion to its size. You propose 
putting the additional limit on it, liberalizing it elsewhere, 
applying it only to firms with $10 million in gross receipts.
    If you would, I am interested in that proposal and I would 
like your further justification of it.
    [The information was not available at the time of 
printing.]
    Mr. English. I would like for you to outline for me in 
writing, in proposing your exemption of severance pay from 
income tax, which seems to be a solid proposal going in the 
direction of income stabilization. Why do you apply it only to 
the first $2,000, if it's for some reason other than simply 
limiting the revenue loss?
    [The information was not available at the time of 
printing.]
    Mr. English. I would look forward to your justification of 
your proposal to tax the gains from the sale of a principal 
residence if it is a residence that has been obtained through a 
``like kind'' exchange within the prior five years. I don't 
understand the abuse you're trying to address here, if there is 
one. In my view, I don't want to see us move back in the 
direction of taxing the capital gains on residences for 
taxpayers; that exclusion is one of the best things we've been 
able to do in recent years, and I would like you to justify, if 
you would, why you have again proposed to moving to monthly 
payments of UC taxes for small employers. I don't see that does 
anything positive in terms of regulation or recordkeeping 
except impose an enormous paperwork burden on many small 
employers.
    [The information was not available at the time of 
printing.]
    Mr. English. If you could get back to me in writing on 
those, I would like you to comment now--while, as I have noted, 
I support some of the things the Administration has proposed in 
the area of education tax policy, I am disappointed that you 
have not proposed any additional tax break for college savings. 
That seems to me to be something that we ought to be 
encouraging. We ought to be taking college savings out from aid 
calculations.
    I wonder if you can comment on why the Administration 
didn't pursue this area, and how your proposed college 
opportunity tax cut would interact with the Hope Scholarship, 
with a phase-out starting at $50,000 in some cases. That, to 
me, seems to be an extremely low threshold. I look forward to 
your comments.
    [The information was not available at the time of 
printing.]
    Mr. Summers. We will get back to you in writing on the 
multiple concerns you raised.
    With respect to education, the so-called RSAs, Retirement 
Savings Accounts, despite their name, would be available for 
college education and would involve withdrawals for college 
education. We've had some concerns about how some of the 
Education Savings Account proposals could be turned into an 
estate planning technique, frankly, and that's why we prefer 
our Retirement Savings Account approach.
    With respect to the college opportunity deduction, my 
understanding is that it would have a substantially higher 
income limit than you suggested, somewhat closer to $100,000--
    Mr. English. That's for joint filers, though. I think for 
single income filings it starts at $50,000 to $60,000, is that 
not correct?
    Mr. Summers. It is, as you suggest, lower for single 
filers.
    We also have the existing IRAs and the existing approach to 
qualified State tuition plans. Those provide additional 
incentives for saving.
    With respect to your question about college financial aid 
formulas, speaking personally I have very considerable sympathy 
for your view, although in the reauthorization legislation a 
year or two ago it wasn't possible to make that change in the 
higher education area.
    My sense is that we now have, particularly if we have the 
RSAs, the IRAs, the qualified State tuition plans, very 
substantial inducements to save for tuition, but that it is 
important also to provide direct assistance as college 
educations become economically more important, particularly for 
the third and fourth years. Only about a third of Americans who 
begin college actually graduate, and that points up the 
importance of support in the third and fourth years.
    Mr. English. Thank you, Mr. Chairman.
    Chairman Archer. The gentleman's time has expired.
    Ms. Mathews, thank you for your patience and for appearing 
with the Secretary today.
    Mr. Secretary, thank you very much. We appreciate your 
responses. We appreciate the succinctness with which you 
deliver them, and we appreciate your patience for spending so 
much time with us today.
    There being no further business before the committee, the 
committee will stand adjourned.
    [The following questions submitted by Chairman Archer, and 
Secretary Summer's reponses, are as follow:]

                           Debt Buyback Plan

1.) How has Treasury's announcement to buy back up to $30 
billion of outstanding debt affected the bond market?

    The Treasury's announcement that it expects to purchase up 
to $30 billion in debt this year has had a positive effect on 
the bond market. In a period of budget surplus such as we now 
enjoy, debt buybacks allow us to maintain larger, more liquid 
issuance of securities while simultaneously preventing an 
unjustified increase in the average maturity of the national 
debt. In conjunction with Treasury's announced policy of re-
openings for 5, 10 and 30-year notes and bonds, buybacks will 
help to preserve the liquidity that is the hallmark of the US 
Government securities market.

2.) What is the estimated cost of the debt buyback plan in FY 
2001?

    Debt buybacks allow us to enhance the liquidity of 
Treasury's benchmark securities, which promotes overall market 
liquidity and should reduce the government's interest costs 
over time. The budget treatment (in accordance with CBO and 
OMB) for any price premium is as a ``means of financing.'' This 
is the section of the budget that includes funds used for debt 
reduction (or borrowed to finance deficits), seigniorage on 
coins, changes in Treasury cash balances, and other items that, 
like debt buybacks, do not represent a true cost to the Federal 
government.

3.) Other countries that implemented debt buyback plans have 
abandoned the policy because it created unintended effects. 
Have you taken the experience of other countries into account 
in announcing this policy, and how do you plan to avoid the 
unintended effects that other countries experienced?

    The Treasury Department is aware that other countries have 
conducted, and still conduct, debt buyback operations somewhat 
similar to our own. Canada, for instance, conducts regular debt 
buybacks and Sweden recently announced its own buyback program. 
However, those countries that have stopped buybacks appear to 
have done so for budgetary reasons as opposed to any adverse 
effects related to the buyback programs themselves.

                            Social Security

1.) The President's legislative proposal submitted last fall 
dropped the idea of government investing in the stock market, 
which he had proposed in two prior versions of his plan. Why 
was government investing dropped from the President's bill, 
which was introduced by Mr. Gephardt and Mr. Rangel, among 
others? Why was the provision revived in the most recent plan?

    The President believes that part of the new Social Security 
solvency transfers should be invested for higher returns, and 
he has held this belief consistently ever since he put forward 
his first framework for Social Security reform in the 1999 
State of the Union address. The President omitted this proposal 
from the legislation he submitted in October because it was 
late in the Congressional session and he was looking for 
agreement on a starting point for Social Security reform. The 
President recognized that implementing a plan that included 
investing the solvency transfers in equities is a complex 
process that requires substantial discussion. So, in the 
interest of a bipartisan agreement, he put forward a plan he 
thought could attract support from a wide spectrum of opinion 
in the Congress in a very short amount of time. This year, with 
the benefit of a full Congressional year before him, the 
President returned to a full specification of the package he 
believes should be put in place to shore up Social Security for 
the long term.

2.) Why does the President's plan wait until 2011 to transfer 
``interest savings'' to the Social Security Trust Funds? Why 
aren't the interest savings transferred this year to gain 
compounded returns immediately?

    First, the policy begins in Fiscal Year 2001, with the 
reduction in publicly held debt from the Social Security 
surpluses and the associated interest savings. It is these 
interest savings that are credited to the Social Security Trust 
Fund, starting in 2011.
    Second, the problems facing Medicare are more immediate 
than those facing Social Security. At the time the President 
put forward his budget the Hospital Insurance (Medicare Part A) 
Trust Fund was projected to be exhausted in 2015, compared with 
2034 for the Social Security Trust Fund. Even now, it is still 
projected to be insolvent 12 years earlier, in 2025, compared 
to 2037 for Social Security. Therefore, the President has 
proposed using $299 billion of the on-budget surpluses over the 
next ten years to strengthen Medicare.
    Third, on-budget resources are limited. Within these 
limits, the President put forward a framework that keeps the 
on-budget account in balance or surplus; preserves core 
government functions at realistic levels; extends Social 
Security solvency and Medicare solvency; provides a long-
overdue Medicare prescription drug benefit and extends health 
insurance to millions of currently uninsured Americans; pays 
down the national debt by 2013; and provides tax cuts that are 
affordable, targeted, and progressive.

3.) How does the President's plan seek to protect the Trust 
Fund investments from political interference? What firewalls 
are in place?

    The President has emphasized that the Administration and 
Congress must work together to put mechanisms in place that 
ensure that any investments are made independently and without 
political interference.
    The President has proposed that equity investment be 
implemented in a manner that:
     Is independent and non-political;
     Uses the most effective private sector management 
services;
     Invests with a broad-based, neutral approach; and
     Minimizes administrative costs.
    One approach that would satisfy these principles would be 
to establish an independent Social Security investment board. 
This board would, in turn, engage private money managers in a 
competitive process for the right to manage a portion of the 
Trust Fund's equity investment. These managers would each be 
instructed to invest their pool of money ``passively''--that 
is, according to a broad-based index of equity prices that 
reflects the movement of all or a very substantial portion of 
the equity market. Overall investment of the Trust Fund in 
equities would be strictly limited--to no more than 15 percent 
of the total value of the Trust Fund. We anticipate that total 
Trust Fund holdings would average about 3 percent of the 
overall market over the next 30 years.
    We are confident that these protections will result in an 
investment structure that is maximally effective in 
strengthening the financial standing of the system. The Federal 
government's Thrift Savings Plan is a good example of how we 
expect the equity investment to be managed.

4.) Why hasn't the President submitted a plan that saves Social 
Security for 75 years--his stated goal in the State of the 
Union address in 1998?

    The President has consistently stated that achieving full 
75-year solvency would require a bipartisan effort. He has also 
consistently believed that he could best move that effort 
forward by working with the Congress to jointly develop a 
bipartisan plan, rather than by unilaterally putting forward a 
plan of his own. That said, the President clearly has taken the 
first step. He submitted a budget that, under the assumptions 
underlying last year's Trustees' Report, would extend the 
solvency of the Social Security Trust Fund from 2034 to 2054. 
With the President's reforms, the 75-year actuarial deficit 
would have been reduced by more than half, from 2.07 percent of 
taxable payroll to 0.80 percent. (Under the assumptions of the 
2000 Trustees' Report, the President's proposal would extend 
solvency from 2037 to 2058, and reduce the 75-year actuarial 
deficit from 1.89 percent of taxable payroll to 0.67 percent.) 
The President encourages Congress to work with him in a 
bipartisan fashion to close the rest of the 75-year solvency 
gap through sensible reforms to the Social Security system.

5.) The latest plan has a ``safeguard'' mechanism to ensure 
that the general revenue transfers do not exceed the size of 
the on-budget surplus in any given year. Since the plan relies 
on annual transfers from 2011 through 2050, is OMB projecting 
that we will have sizeable on-budget surpluses every year for 
the next 50 years to make this plan work? If the surpluses do 
not materialize, what will happen to Social Security's 
solvency? Do you have an alternate plan for Social Security in 
case these surpluses do not materialize over the next 50 years?

    OMB is indeed currently projecting that, under current 
policy, the on-budget account would remain in balance past 
2050. This projection was developed under conservative economic 
assumptions--in fact, slightly more conservative than either 
CBO's or the Blue Chip consensus. Many respected private 
forecasters have more optimistic projections. For seven years 
in a row, throughout the Clinton Administration, both economic 
and budget results have been better than predicted.
    Our policy of paying down the debt and securing the future 
of Social Security and Medicare is the best insurance against 
adverse developments in the future. Eliminating the publicly 
held debt by 2013 frees up the 13 percent of Federal spending 
now going to interest payments. And we believe the benefits of 
debt reduction should be earmarked to meeting our existing 
commitments to Social Security and Medicare, not to create new 
obligations.
    The ``safeguard'' referred to in the FY 2001 Budget places 
annual dollar-specified limits on the maximum amount of the 
general revenue transfers to the Social Security Trust Fund. 
The general revenue transfers in the President's budget are 
based on the amount of interest savings from using the Social 
Security surpluses to reduce publicly held debt, up to these 
limits. If the actual on-budget surpluses turn out to be 
smaller than projected, the transfers to the Trust Fund would 
still occur. Even in that event, we would still be better off 
having used the resources to improve the net financial position 
of the government than to have paid for new spending or new tax 
cuts. Even with adoption of the President's proposal, the Trust 
Fund would be exhausted in 2058, and the 75-year actuarial 
deficit would be 0.67 percent of taxable payroll, under the 
assumption underlying the 2000 Trustees' Report. A bipartisan 
effort will still be needed to close the remainder of the 75-
year gap.

6.) The President's plan extends Social Security's solvency 
through 2054, according to Social Security's actuaries. Does 
this mean that the President's plan ensures that taxes will not 
need to be raised and benefits will not be reduced before 2054?

    First, the 2054 figure is a projection, based on economic 
and demographic assumptions. Actual performance of the Social 
Security Trust Fund could be better or worse than projected, 
which could result in the need for additional measures to 
secure Social Security's solvency even to 2054.
    Second, the fact that OMB is projecting on-budget surpluses 
past 2050 means that it will be possible to implement the 
President's Social Security plan while paying full benefit and 
not increasing taxes. In fact, OMB's projections are based on 
the President's policy, which cuts taxes below the baseline 
with targeted tax cuts totaling $256 billion from 2001-10.
    [Whereupon, at 2:27 p.m., the hearing was adjourned, to 
reconvene at the call of the Chair.]
    [Submissions for the record follow:]

Statement of the Air Courier Conference of America International, Falls 
Church, VA

    This statement is submitted by the Air Courier Conference 
of America (``ACCA'') in conjunction with the House Ways and 
Means Committee's February 9 hearing on President Clinton's 
proposed budget for fiscal year 2001. ACCA is the trade 
association representing the air express industry. Its members 
include large firms with global delivery networks, such as DHL 
Worldwide Express, Federal Express, TNT U.S.A. and United 
Parcel Service, as well as smaller businesses with strong 
regional delivery networks, such as Global Mail, Midnite 
Express and World Distribution Services. Together, our members 
employ approximately 510,000 American workers. Worldwide, ACCA 
members have operations in over 200 countries; move more than 
25 million packages each day; employ more than 800,000 people; 
operate 1,200 aircraft; and earn revenues in excess of $50 
billion.
    ACCA would like to comment on one aspect of the President's 
proposed budget as it relates to the U.S. Customs Service. This 
is a critical area of interest to our industry because Customs 
administrations play a vital role in ensuring expeditious 
movement of goods across borders and consequently are critical 
to our industry's ability to deliver express international 
service. To give a sense of the size of our industry in U.S. 
trade--and as a customer of U.S. Customs--the express industry 
accounts for roughly 25 percent of all Customs formal and 
informal entries. In addition, express operators enter more 
than 10 million other manifest entries on low-value shipments, 
plus millions of clearances on letters and documents. In short, 
the flow of international commerce carried by express operators 
has become a significant portion of the total entering the 
United States, and American business has incorporated express 
service as an integral part of regular business operations. 
Express operators and these American businesses are highly 
dependent upon an efficient and effective Customs Service.
    For the U.S. Customs Service to be efficient and effective, 
it must have modern, fully functional automation systems. 
Unfortunately, as the Ways and Means Committee knows, the 
current Customs automation system--the Automated Commercial 
System, or ACS--is antiquated and in desperate need of 
replacement. ACCA is extremely concerned about the pending 
obsolescence of ACS because the express industry operates in a 
virtual seven-day, 24-hour mode and thus relies on automation 
more than any other mode of transportation. We have invested 
tens of millions of dollars in automated systems designed to 
expedite shipment and delivery of goods within an express 
timeframe. An interruption in Customs' automation programs 
would devastate our ability to meet our express delivery 
deadlines and would harm a significant portion of the U.S. 
economy.
    ACCA is extremely concerned that the Clinton Administration 
budget for FY2001 once again fails to acknowledge the critical 
importance to the U.S. economy of maintaining and improving an 
automated Customs environment. The budget proposes a new user 
fee to pay for Customs' automation programs, with the 
expectation that this would generate $210 million in the next 
fiscal year. First, this proposal fails to acknowledge the true 
cost for Customs to maintain its existing system, ACS, and 
develop a next-generation automation regime. The actual cost of 
this effort is probably close to $400 million annually. Second, 
the Clinton budget proposal fails to acknowledge the fact that 
the trading community has been and continues to pay an enormous 
annual stipend in the form of the merchandise processing fee 
(MPF) that should be directed to U.S. Customs' operations, 
including automation programs. MPF revenues total about $900 
million annually and would be more than enough to pay for 
Customs automation programs. However, the MPF revenues have not 
been channeled to U.S. Customs; instead, they have gone to the 
general revenue fund of the U.S. Treasury.
    With respect to user fees for Customs services, the express 
industry has a unique perspective because we pay for dedicated 
Customs resources at our facilities; this is a revenue source 
distinct from the MPF paid on entry. In order to obtain 
inspectional services whenever needed at our hub and express 
consignment facilities, the express industry agreed about 12 
years ago to pay ``reimbursables'' to Customs. These fees are 
supposed to cover the costs to Customs of providing inspectors 
when needed. However, in recent years the cost of reimbursables 
has escalated well beyond the understood intent of the law and 
regulations, to the extent that reimbursables have become a 
serious burden on the express industry. Reimbursable charges 
cost the industry more than $20 million last year--and the 
bills are mounting rapidly. On top of that, the express 
industry generated in excess of $75 million in MPF revenues in 
1999. Since the MPF collected already exceeds the cost of 
services provided by Customs for express operations, the 
reimbursables system represents a hidden tax that is borne by 
the express industry and that is ultimately paid by U.S. 
importers. Yet, notwithstanding the significant user fees we 
already pay to U.S. Customs, we are facing a situation where we 
may not be able to provide express international service 
because of possible breakdowns in Customs' automation systems.
    ACCA commends the Ways and Means Committee for opposing 
past Clinton Administration proposals to impose user fees on 
the trading community to pay for Customs automation, and we 
urge Congress to deny once again the Clinton Administration's 
request for a user fee for FY2001. However, we also urge 
Congress to recognize the critical need for new Customs 
automation systems and to acknowledge the fact that the trading 
community has already been paying for such a service without 
receiving any return on its investment. If Customs automation 
programs are allowed to founder for an additional year without 
any appropriated monies, the consequences could be dire for the 
entire U.S. economy. Therefore, ACCA urges Congress, as part of 
its FY2001 budgetary process, to appropriate MPF monies 
specifically for the development of a next-generation Customs 
automation program.
      

                                

Statement of the Alliance of Tracking Stock Stakeholders

I. Position Statement

    The Administration's proposal to impose a tax on certain 
distributions or exchanges of tracking stock (Tracking Stock) 
is unsound tax policy which, if enacted, will harm 
shareholders. It will also restrain new business and technology 
investment and development, cost jobs, cause severe harm to 
companies with Tracking Stock presently outstanding, and reduce 
business expansion.
    In 1999, a substantial majority of the members of the House 
Ways and Means Committee (28 of 39 members) opposed a proposal 
by the Administration to impose a tax on corporations that 
issue tracking stock. The Committee should reject the current 
Administration proposal because it is even more onerous than 
last year's proposal for a number of reasons:
     It imposes a tax on shareholders upon the receipt 
of Tracking Stock in a distribution or recapitalization, even 
though the shareholder's overall investment in the corporation 
remains the same before and after the receipt of the Tracking 
Stock.
     The shareholder does not receive any cash with 
which to pay the taxes imposed and could be forced to liquidate 
part of his/her investment.

     The proposal gives the Treasury Department the 
authority to treat Tracking Stock as non-stock or as stock of 
another entity ``as appropriate for other purposes,'' thus 
granting the Treasury unlimited authority to impose a tax on 
corporations that issue Tracking Stock.

     The new Treasury Department authority could 
preclude companies with Tracking Stock from being able to 
engage in ordinary nontaxable corporate recapitalizations 
(e.g., stock for stock exchanges) and distributions, thus 
limiting their ability to compete with companies with 
traditional equity structures.

    Therefore, this proposal should be rejected.

     The issuance of Tracking Stock is motivated by 
compelling business needs. It provides a market-efficient 
source of capital, particularly to corporations attempting to 
grow lines of business that would not be valued appropriately 
by the equity markets without Tracking Stock.
     The proposal, if enacted, would eliminate a 
valuable source of capital to new businesses, deter the use of 
Tracking Stock, and possibly also force companies with over 
$500 billion of equity securities outstanding or pending to 
recapitalize at a considerable cost to them and to their 
shareholders.
     If Treasury becomes aware of inappropriate uses of 
Tracking Stock, it should resolve the issues administratively 
(through Treasury regulations and pronouncements) in a targeted 
way that avoids adverse consequences to business-driven 
Tracking Stock issuers. In abusive situations, Treasury has 
authority under current law to do this.
     The revenue estimates are unrealistic. The 
proposal would economically eliminate the use of Tracking Stock 
and provide little if any revenue to the Treasury.

II. Definition of Tracking Stock

    Tracking Stock is a type of equity security issued by some 
companies to track the performance or value of one or more 
separate businesses of the issuing corporation. The holder of 
Tracking Stock has the right to share in the earnings or value 
of less than all of the corporate issuer's earnings or assets 
while retaining voting rights, liquidation rights and other 
risks of the issuing corporation as a whole. The Tracking Stock 
instrument has developed largely in response to the dual 
economies arising from the equity market's preference for 
``pure-play'' securities (i.e., pure, single line of business 
companies) and the debt market's preference for diversified 
corporate balance sheets.

III. Business Considerations

    Since General Motors first used it as an acquisition 
currency in September 1984, to acquire Electronic Data Systems 
Corporation (EDS), Tracking Stock has found wide receptivity by 
shareholders in North America.
    To date, a total of 23 public companies have issued 33 
separate Tracking Stocks for a variety of business reasons 
including:
     Acquisitions
     Growth of start-up businesses
     Source of equity capital
     Creation of stock-based employee incentive 
programs
     Continuation of economies of scale for 
administrative costs
     Retention of operating synergies
     Maintenance of consolidated credit and existing 
borrowing arrangements
     Valuation enhancement
     Increasing shareholder knowledge, and
     Broadening of the investor base

    Numerous real-life examples demonstrate the beneficial 
impact the issuance of Tracking Stock has had on the U.S. 
economy:
     USX Corporation raised sufficient capital, through 
its U.S. Steel Tracking Stock, to modernize its steel 
operations and transform U.S. Steel from a company that 
generated billions of dollars in losses throughout most of the 
80's into a more efficient steel company. It is the largest 
employer in the domestic steel industry, with high paying jobs, 
generating taxable income rather than losses and paying 
substantial income and payroll taxes to federal, state and 
local governments.
     Genzyme Corporation, a biotechnology company 
founded in 1981, develops innovative products and services to 
prevent, diagnose, and treat serious and life-threatening 
diseases. It initiated its use of Tracking Stock in 1994 when 
it founded a new program to develop tissue repair technologies. 
More recently, it adopted a new Tracking Stock to fund 
molecular oncology research, including cancer vaccine clinical 
trials in breast, ovarian and skin cancer.
     Perkin-Elmer (now PE Corporation), a high 
technology company, chose Tracking Stock for several business 
reasons including: facilitating new business and technology 
development; recruiting and retaining key employees; exposing 
and facilitating appropriate valuation for new technology 
opportunities; and providing flexibility for raising future 
capital and optimizing further development and expansion of 
each of its businesses.
    The economic benefits of Tracking Stock to these and other 
companies will be substantially eliminated if a tax is imposed 
on shareholders or issuers.

    IV. Financial Market Impact of the Administration's Budget 
Proposal to Tax Tracking Stock

     Should the Tracking Stock proposal be enacted, 
many future uses of Tracking Stock would be deterred and 
companies currently capitalized with Tracking Stock--and their 
shareholders--would be severely impacted. The imposition of tax 
upon the issuance or exchange of equity to shareholders would 
effectively shut down a Tracking Stock company's ability to 
access the equity capital markets.
     The new Treasury Department authority could 
preclude companies with Tracking Stock from being able to 
engage in ordinary non-taxable corporate recapitalizations 
(e.g., stock for stock exchanges) or distributions, thus 
limiting their ability to compete with companies with 
traditional stock structures.
     The proposal would seriously reduce the ability of 
Tracking Stock companies to raise capital through the debt 
markets. It would undermine their credit worthiness in the 
marketplace by hampering their ability to continue to use 
Tracking Stock to raise equity to strengthen their balance 
sheets and build their businesses in a cost efficient manner.
     High-technology companies in particular would lose 
a medium used to attract and retain key personnel.
     As a result of these consequences, investors would 
see Tracking Stock as an inefficient capital structure and 
equity valuations would suffer.
     Ultimately, as a result of this Tracking Stock 
proposal, over $500 billion of equity securities currently 
outstanding or pending could need to be restructured at great 
cost and under intense market pressure, causing a loss of 
shareholder investment and competitive vulnerability.

V. Tax Policy Considerations

    Treasury states that the use of Tracking Stock is outside 
the contemplation of subchapter C and other sections of the 
Internal Revenue Code. Treasury also states that receipt of 
Tracking Stock by a shareholder in a distribution or exchange 
for other stock of the issuing corporation is a recognition 
event, as the shareholder has altered its interest in the 
issuing corporation. Both of these statements are wrong.
     Tracking Stock is consistent with subchapter C of 
the Internal Revenue Code because the tracked business remains 
in the same corporation and the Tracking Stock represents 
equity in that same corporation.
     Tracking Stock does not reduce a corporation's tax 
liability compared to its tax liability prior to the issuance 
of Tracking Stock. Thus, revenues to the U.S. Treasury are the 
same before and after the initial transaction. If the tracked 
business is successful, however, it will generate taxable 
income, create jobs, and pay additional taxes to federal, state 
and local governments. Likewise, increased equity valuations 
generate additional capital gains for individuals.
     Tracking Stock is not used to circumvent the 
requirements of section 355 of the Internal Revenue Code, 
including the Morris Trust provisions in section 355(e).
     Unlike Morris Trust transactions, corporations do 
not use Tracking Stock to dispose of businesses tax-free. 
Tracking Stock is a vehicle used for building and maintaining 
business assets within a single corporation.
     Tracking Stock does not result in a sale of the 
tracked business. Subsequent to adopting Tracking Stock, a 
corporation will recognize gain on any future disposition of 
the tracked assets, unless all of the provisions of Section 355 
are satisfied.
     A shareholder receiving Tracking Stock has not 
altered his/her overall investment in the issuing corporation.
     The shareholder continues to own an equity 
interest in the same corporation, continues to have voting 
rights in the same corporation, and continues to participate in 
the growth of the same corporation.
     Although dividends paid to the shareholder on 
Tracking Stock may be based on the performance of a division or 
subsidiary, and not on the entire issuing corporation, the 
dividends are still subject to limitations at the corporate 
level.
     It is inappropriate to tax a shareholder at the 
time he/she receives Tracking Stock in a distribution or 
exchange for other stock of the issuing corporation, as the 
shareholder has received no cash to use to pay the tax. The 
shareholder may be required to liquidate a portion of his/her 
holdings to pay the tax. The proper time for taxation is when 
the shareholder disposes of the Tracking Stock.
     Corporations do not issue Tracking Stock for tax 
reasons. The fiduciary responsibilities incumbent on the 
directors of a corporation with Tracking Stock (i.e., to 
multiple shareholder interests) far outweigh any conceivable 
tax motivation.
     Legislation is unnecessary. In abusive situations, 
Treasury has authority to address transactions it perceives as 
inappropriate under current law, through regulations and 
pronouncements, in a way that avoids adverse consequences to 
business-motivated Tracking Stock issuers.
     A statutory attack is unnecessary and 
inappropriate because:
     It harms shareholders by reducing the market value 
of their shares and by imposing a tax upon a distribution or 
exchange of Tracking Stock.
     It harms employees and customers. Unless a 
replacement source of capital is found, businesses will scale 
back operations, adversely impacting employees, customers, and 
the communities in which the companies operate.
     It harms corporations, impairing their equity and 
adversely impacting their ability to raise capital.
     It adds more complexity to the Internal Revenue 
Code.
     Tracking Stock transactions undertaken to-date 
have been driven by business considerations. The complexities 
associated with the issuance of Tracking Stock should prevent 
it from becoming a tax motivated vehicle. Tracking Stock is 
only appropriate for those companies for which the business 
advantages outweigh the complexities. These complexities 
include:
     The fiduciary responsibilities of the Board of 
Directors to shareholders of all classes of common stock, which 
may create conflicts.
     Each Tracking Stock business has continued 
exposure to the liabilities of the consolidated entity.
     The Administration's published revenue estimates 
for the proposal are unrealistic. Taxing Tracking Stock at 
issuance or upon receipt by shareholders would make it non-
competitive relative to other sources of capital. Thus, the 
legislation would generate little or no revenue.

VI. Conclusion
    Last year, the Administration proposed to tax corporations 
when they issued Tracking Stock to their shareholders. This 
year, the Administration proposes instead to tax shareholders 
when corporations issue Tracking Stock to them. The same tax 
considerations that mandated rejection of last year's proposal 
also require rejection of this year's proposal. Indeed, this 
new proposal is even more onerous as it attempts to impose tax 
on shareholders who have sold nothing and have received no cash 
with which to pay the tax.
    Issuance of Tracking Stock is motivated by compelling 
business needs. Treasury's Tracking Stock proposal will disrupt 
financial markets and cause severe harm to companies with 
Tracking Stock since it will not only restrict access to 
capital in the future, but also require massive financial re-
engineering for some companies. Individual investors, and 
possibly entire communities in which Tracking Stock companies 
operate, will be adversely affected as a result of the 
competitive pressures this tax would impose.

    Alliance of Tracking Stock Stakeholders
    The Alliance is an informal group of companies that 
currently utilize or are considering using Tracking Stock. 
Members of the Alliance include companies such as Cendant 
Corporation, Circuit City, Comdisco Inc., General Motors, 
Genzyme Corporation, PE Corporation, Quantum Corporation, 
Staples Inc., The Walt Disney Company, USX Corporation, and 
others. These companies share a common concern for the value of 
shareholder investment in tracking stocks, as well as their 
continued ability to meet various business objectives through 
the issuance of tracking stock. For further information, 
contact Scott Salmon, Manager, Governmental Affairs, USX 
Corporation, 202-783-6797.
      

                                

Statement of American Association for Homecare, Alexandria, VA

    The American Association for Homecare is pleased to submit 
the following statement to the House Ways and Means Committee. 
The American Association for Homecare is a new national 
association resulting from the merger of the Home Care Section 
of the Health Industry Distributors Association, the Home 
Health Services and Staffing Association and the National 
Association for Medical Equipment Services. The American 
Association for Homecare is the only association representing 
home care providers of all types: home health agencies and home 
medical equipment providers, be they not-for-profit, 
proprietary, facility-based, freestanding or governmentally 
owned.

                     What is a Home Health Agency?

    Home Health Agencies provide skilled nursing care, therapy 
and home health aide services to individuals recovering from 
acute illnesses and living with chronic health care conditions. 
Health care services in the home setting provide a continuum of 
care for individuals who no longer require hospital or nursing 
home care, or seek to avoid hospital or nursing home admission. 
The range of home care services includes skilled nursing; 
respiratory, occupational, speech, and physical therapy; 
intravenous drug therapy; enteral feedings; hospice care; 
emotional, physical, and medical care; assistance in the 
activities of daily living; skilled assessments; and 
educational services.

                        What is an HME Provider?

    Home medical equipment (HME) providers supply medically 
necessary equipment and allied services that help beneficiaries 
meet their therapeutic goals. Pursuant to the physician's 
prescription, HME providers deliver medical equipment and 
supplies to a consumer's home, set it up, maintain it, educate 
and train the consumer and caregiver in its use, provide access 
to trained therapists, monitor patient compliance with a 
treatment regimen, and assemble and submit the considerable 
paperwork needed for third party reimbursement. HME providers 
also coordinate with physicians and other home care providers 
(e.g., home health agencies and family caregivers) as an 
integral piece of the home care delivery team. Specialized home 
infusion providers manage complex intravenous services in the 
home.

                      Home Care is Just Beginning

    Over the last two decades, advances in medical technologies 
and changes in Medicare's payment structure have spurred a 
considerable growth in the use of home care. As in every other 
aspect of modern medicine, home health care has benefited from 
an explosion of new and emerging technologies. From the use of 
space-age materials to make wheelchairs and mobility aids 
lighter, to the application of micro-chip computer technology 
in implantable devices used to dispense critical medication, 
technology makes it possible for the care received in the home 
to equal or exceed that received in a hospital, at a fraction 
of the cost. Today, it is common for a Medicare beneficiary to 
undergo chemotherapy in the comfortable surroundings of his or 
her own home, a fete that was inconceivable just a few years 
ago. In the future, advances in tele-medicine and similar 
technologies will make it possible to further reduce health 
care costs and improve the quality of health care provided in 
the home. None of these advances could have been envisioned at 
Medicare's inception in 1965.
    Recent changes to Medicare's payment system have also 
spurred a growth in home health utilization. In the late 
1980's, the Health Care Financing Administration's (HCFA's) 
rigid definition of the coverage criteria for home health 
services was struck down by a United States District court, 
making it possible for more beneficiaries to access home health 
services. At roughly the same time, Medicare instituted a 
prospective payment system for hospital inpatient care, which 
reimbursed hospitals according to the patient's diagnosis 
regardless of the number of days spent in the institution.
    Together, these changes have resulted in a situation where 
more Medicare-eligible beneficiaries are arriving home 
``quicker and sicker'' than ever before. In turn, these 
beneficiaries require increasingly complex health services. All 
indicators show that as the 'baby-boomers' continue to age, 
this trend will continue. The American Association for Homecare 
believes that the increased utilization of home health care 
prompted by these changes should be seen as a rational response 
to the changing needs of Medicare beneficiaries and the 
increased ability of home health providers to meet these needs.

                        Home Care is Economical

    Importantly, home care is not only patient-preferred, it is 
also cost effective. Numerous studies \1\ have shown that home 
care providers are a cost-efficient component of the healthcare 
delivery system, as they help keep beneficiaries out of costly 
inpatient programs. One study, conducted by an independent 
research organization, particularly demonstrates these savings. 
This study, The Cost Effectiveness of Home Health Care, 
examines the highly successful In-Home/CHOICE program 
instituted by the State of Indiana in 1985. Indiana provides 
100% of the funding for this program, which covers the costs of 
home health care for qualified residents in need of long term 
care in order to prevent institutionalizations.
---------------------------------------------------------------------------
    \1\ For recent studies, please see:
     Styring, William & Duesterberg, Thomas, The Cost 
Effectiveness of Home Health Care: A Case Study on Indiana's In-Home/
CHOICE Program, (Vol. 1, No. 11), November 1997, (Hudson Institute, 
Indianapolis, IN).
     Mann, Williams C. et al, ``Effectiveness of Assistive 
Technology and Environmental Interventions in Maintaining Independence 
and Reducing Home Care Costs for the Frail Elderly,'' Archives of 
Family Medicine, May/June 1999 (Vol. 8, pp. 210-217).
---------------------------------------------------------------------------
    The authors of the Study note that the coming crisis in 
health care funding for America's rapidly growing elderly 
population could be alleviated by home health care programs 
such as Indiana's. By avoiding institutionalized care, Indiana 
was able to reduce inpatient caseload costs by 50% or more, 
while allowing patients to receive care in the comfort of their 
own homes. The cost savings associated with this increased 
reliance on home care were considerable. The study states that 
home care for the elderly in Indiana can be provided for one 
half the cost of skilled nursing facility care. Similar care 
for the disabled costs 1.5 times more in a skilled facility 
than in the home. In addition, the quality control and 
screening procedures used in the Indiana program have 
successfully avoided problems with fraud and abuse. The Hudson 
Institute Study concludes that ``Properly crafted and 
administered, home health care can play a critical role in 
helping society meet the looming health care needs of the 'Baby 
Boom' generation.''

                 Resist the Rush to Competitive Bidding

    The President's budget proposal includes a provision that 
would expand and strengthen Medicare's competitive bidding 
authority. The American Association for Homecare urges the 
Committee to withhold support for competitive bidding for 
Medicare Part B durable medical equipment, prosthetics, 
orthotics and supplies (DMEPOS) until the results of the 
current demonstration project can be fully evaluated.
    As the Committee is aware, the first demonstration project 
testing competitive bidding for DMEPOS services has just begun 
in Polk County, Florida. This project is a necessary first step 
to determine whether Medicare can effectively administer a 
competitive bidding program, whether it will achieve savings, 
and whether it will maintain access to quality HME services. 
Currently, very little is known about the administration or 
long-term impacts of such a complicated change to the DMEPOS 
benefit. The demonstration project will not be completed until 
the end of 2002.
    Our concerns about the undue rush to implement national 
competitive bidding are bolstered by the fact that competitive 
bidding for HME services has been tried and rejected in the 
Ohio, Montana, and South Dakota state Medicaid programs. These 
states cited increased administrative costs and serious 
management problems as reasons for dropping competitive 
bidding. Each state also experienced an actual reduction in 
competition among providers (and, consequently, higher bid 
prices) and reduced access to provider support services.

                     The Polk County Demonstration

    The American Association for Homecare is particularly 
concerned that HCFA's current competitive bidding plan 
threatens access to important health services. Home medical 
equipment (HME) such as oxygen equipment cannot be drop-shipped 
to patients; the therapeutic support services offered by HME 
providers are as crucial to positive health outcomes as the 
equipment itself. We are concerned that the 'winning' bidders 
in Polk County will face budget pressures that lead them to 
eliminate these important therapeutic services, which are not 
separately reimbursed by Medicare (e.g., preventative 
maintenance, patient education, 24-hour on call service, the 
professional care of respiratory therapists, and the furnishing 
of supplies). If these services are eliminated, beneficiaries 
will be much more likely to experience negative health 
outcomes.
    Importantly, beneficiaries in the demonstration area have 
lost their ability to choose their own HME provider. These 
beneficiaries are not granted the option to ``opt out'' of the 
demonstration; they are forced to use the ``winning'' bidders 
if they want Medicare to continue to cover their HME needs. A 
beneficiary who is dissatisfied with the quality of products or 
the level of the services provided to him/her through the 
bidding program will have very limited alternatives. Medicare's 
winning bidders, therefore, are not being subject to the market 
forces of consumerism.
    Although the demonstration is only months old, a number of 
problems have already emerged. In fact, the parent company of 
one winning bidder has filed for Chapter 11 protection and some 
beneficiaries have expressed confusion about the availability 
of providers. HCFA has not yet examined the impact of the 
demonstration on beneficiary satisfaction or health outcomes. 
The American Association for Homecare urges the Committee to 
examine carefully the results of this demonstration and the 
suitability of the demonstration design before expanding the 
demonstration to other areas.

          Eliminate Additional Cuts to the Home Health Benefit

    The American Association for Homecare urges the Committee 
to maintain Medicare beneficiaries' access to home health 
agency services by eliminating the additional 15% payment cut 
scheduled to be implemented on October 1, 2001. Home health 
reimbursements have already been reduced by much larger amounts 
than originally forecasted, and the most frail elderly are 
experiencing problems with access to home health care. The 
addition 15% reduction will only exacerbate these problems.
    The Balanced Budget Act of 1997 (BBA, P.L. 105-33) was 
originally scored to reduce the home health benefit by 
approximately $16.1 billion over five years. However, the 
actual impact of the BBA was much more dramatic. In March 1999, 
the Congressional Budget Office (CBO) revised their estimate to 
a reduction of more than $48 billion over five years, more than 
twice the intended amount. In January 2000, HCFA announced that 
home health services had a rate of growth of -4%, less than any 
other health care sector. Unfortunately, reductions such as 
this have an inevitable impact on the availability of the home 
health benefit. The most significant concern has been lack of 
access for eligible Medicare beneficiaries to the home health 
benefit.
    The George Washington University's Center for Health 
Services Research & Policy has released two studies reviewing 
the impact of BBA 97 on home health patients and providers. The 
studies provide the following points:
    1. The number of Medicare home health patients has declined 
by 50% from 1994 levels and by 21% as a percentage of all 
patients in 1998 alone.
    2. Patients who were most likely to lose access to covered 
services under the interim payment system included those 
suffering from complex diabetes, congestive heart failure, 
chronic obstructive pulmonary disease, multiple sclerosis, skin 
ulcers, arthritis, and mental illness.
    3. 68 percent of hospital discharge planners surveyed 
report increased difficulty in initially obtaining home health 
services for Medicare beneficiaries.
    4. 56 percent of respondents report increases in the number 
of beneficiaries requiring substitute placements, primarily in 
skilled nursing facilities, in lieu of home health services.
    The American Association for Homecare urges this Committee 
to avoid further disruptions in access to home health care by 
permanently eliminating the scheduled additional 15% reduction.

                 Home Health Prospective Payment System

    The American Association for Homecare strongly supports the 
implementation of the prospective payment system for home 
health agencies. The BBA mandated HCFA develop a PPS to be 
implemented in October 1999. HCFA requested a further delay 
until October 2000 and Congress granted that request.
    During the development of PPS, the home health industry is 
being reimbursed under an interim payment system (IPS). The 
interim payment system was implemented for cost reporting 
periods beginning on October 1997. IPS changed the way home 
health agencies were reimbursed by setting new limits and 
removing the old cost-based incentives. As stated above, the 
IPS imposed significant losses on home health agencies and 
resulted in reductions more than double the 1997 baseline 
developed by the CBO.
    Home health agencies were unable to receive from HCFA 
definitive information on what their reimbursement would be 
under IPS until a year or more into the new system. The home 
health agencies were then required to reimburse HCFA for 
overpayments made during the first year. The inability of home 
health agencies to access the accurate reimbursement 
information needed to plan appropriately for the care of 
beneficiaries negatively impacted home health patients and 
providers alike.
    It is crucial for HCFA and Congress to work with home 
health providers as the new reimbursement system is implemented 
to ensure access to care for beneficiaries while providing 
needed information to home health providers and fiscal 
intermediaries.

                               Conclusion

    Home health care continues to evolve and expand to meet the 
increasingly complex needs of today's Medicare beneficiaries. 
By capitalizing on technical innovation, home care providers 
can conduct increasingly complex medical and therapeutic 
regimens in the comfort of beneficiary's own homes. In 
addition, recent studies have shown that an expanded home care 
benefit would reduce Medicare expenditures by avoiding costly 
institutionalizations. We urge the Committee to recognize the 
many benefits of home care by strengthening Medicare's 
commitment to the home health benefit.
      

                                

Statement of American Bankers Association

    The American Bankers Association (ABA) is pleased to have 
an opportunity to submit this statement for the record on 
certain of the revenue provisions of the Administration's 
fiscal year 2001 budget.
    The American Bankers Association brings together all 
categories of banking institutions to best represent the 
interests of the rapidly changing industry. Its membership--
which includes community, regional and money center banks and 
holding companies, as well as savings associations, trust 
companies and savings banks--makes ABA the largest banking 
trade association in the country.
    The Administration's Fiscal Year 2001 budget proposal 
contains a number of provisions of interest to banking 
institutions. Although we would welcome certain of those 
provisions, we are once again deeply concerned with a number of 
the Administration's revenue raising measures. Many of the 
subject revenue provisions are, in fact, thinly disguised tax 
increases rather than ``loophole closers.'' As a package, they 
would inhibit job creation and inequitably penalize business. 
The package may also lead to the reduction of employee and 
retiree benefits provided by employers.
    Our views on the most troubling provisions are set out 
below.

REVENUE INCREASE MEASURES

Modify the Corporate-Owned Life Insurance Rules

    The ABA strongly opposes the Administration's proposal to 
modify the corporate-owned life insurance rules (COLI). We urge 
you not to enact any further restrictions on the availability 
of corporate owned life insurance arrangements. We believe that 
the Administration's proposal will have unintended consequences 
that are inconsistent with other congressional policies, which 
encourage businesses to act in a prudent manner in meeting 
their liabilities to employees. Corporate-owned life insurance 
as a funding source has a long history in tax law as a 
respected tool. The Health Insurance Portability Act of 1996 
eliminated deductions for interest paid on indebtedness with 
respect to policies covering officers, employees, or 
financially interested individuals. However, that legislation 
allowed deductions with respect to indebtedness on COLI 
covering up to 20 ``key persons'' (defined generally as an 
officer or a 20-percent owner of the policy owner). The 
Taxpayer Relief Act of 1997 applied a pro rata formula to 
disallow the deduction of a portion of a taxpayer's total 
interest expense with respect to COLI. That legislation 
provided a broad exception for policies covering 20-percent 
owners, officers, directors, or employees. Accordingly, 
Congress has effectively ratified continued use of COLI, 
pursuant to the requirements of those rules. In this 
connection, taxpayers have, in good faith, made long term 
business decisions based on existing tax law. They should be 
protected from the retroactive effects of legislation that 
would result in substantial tax and non-tax penalties.
    Moreover, federal banking regulators recognize that 
corporate-owned life insurance serves a necessary and useful 
business purpose. Bank regulatory guidelines confirm that 
purchasing life insurance for the purpose of recovering or 
offsetting the costs of employee benefit plans is an 
appropriate purpose that is incidental to banking.
    The subject provision would effectively eliminate the use 
of corporate-owned life insurance used to offset escalating 
employee and retiree benefit liabilities (such as health 
insurance, survivor benefits, etc.). It would also penalize 
companies by imposing a retroactive tax on those that have 
purchased such insurance. Cutbacks in such programs may lead to 
the reduction of benefits provided by employers. We urge you 
to, once again, reject this revenue proposal.
    However, should any legislative change in this area be 
contemplated, we would urge that the following principles 
apply. Any proposal should:
     Be prospective and should not put businesses that 
made decisions based on existing law in a disadvantaged 
position.
     Only apply to contracts entered into after the 
date of enactment. Any premiums paid after the date of 
enactment with respect to contracts written prior to the date 
of enactment should be grandfathered.
     Continue to allow tax-free exchanges of insurance 
contracts.
     Create a ``safe harbor'' exception to general 
interest disallowance for COLI to protect a certain level of 
COLI.

Increased Information Reporting/Substantial Understatement 
Penalties

    The ABA strongly opposes the Administration's proposal to 
increase penalties for failure to file information returns. The 
Administration reasons that the current penalty provisions may 
not be sufficient to encourage timely and accurate reporting. 
We disagree. The banking industry prepares and files a 
significant number of information returns annually in good 
faith for the sole benefit of the Internal Revenue Service 
(IRS). The suggestion that the Administration's proposal closes 
``corporate loopholes'' presumes that corporations are 
noncompliant, a conclusion for which there is no substantiating 
evidence. Further, there is no evidence available to support 
the assertion that the current penalty structure is inadequate. 
Certainly, the proposed penalty increase is unnecessary and 
would not represent sound tax policy. We urge you to, once 
again, reject this revenue proposal.
    The ABA also opposes the Administration's proposals to 
modify the substantial understatement penalty. The proposed 
increases would be overly broad and could penalize innocent 
mistakes and inadvertent errors. The establishment of an 
inflexible standard could effectively discourage legitimate 
business tax planning. We urge you to reject this revenue 
proposal.

Require Current Accrual of Market Discount

    The ABA opposes the Administration's proposal to require 
current accrual of market discount by accrual method taxpayers. 
This proposal would not only increase administrative complexity 
but would raise taxes on business unnecessarily. We urge you to 
reject the Administration's proposal.
    Subject Investment Income of Trade Associations to Tax

The ABA opposes the Administration's

    proposal to tax the net investment income of trade 
associations. The proposal would impose a tax on all passive 
income such as interest, dividends, capital gains, rents and 
royalties. It would not only impact national organizations but 
smaller state and local associations as well. Dues payments 
generally represent a relatively small portion of an 
association's income. Associations maintain surpluses to 
protect against financial crises and to provide quality service 
to their members at an affordable cost. Indeed, investment 
income is used to further the exempt purposes of the 
organization.
    The Administration's proposal would impose an overly broad, 
and ill conceived tax on well managed trade associations that 
would directly inhibit their ability to continue to provide 
services vital to their exempt purposes. We urge you to reject 
the Administration's proposal.

Environmental Taxes

    The ABA opposes the proposal to reinstate the Superfund 
environmental and excise taxes. We believe the burden of 
payment of the taxes will fall on current owners of certain 
properties (who may in many instances be financial 
institutions) rather than the owners at the time the damage 
occurred. It would, thus, impose a retroactive tax on innocent 
third parties. In any event, such taxes would be better 
considered as part of overall program reform legislation. We 
urge you to reject the Administration's proposal.

Other Issues

    The Administration's proposal contains a number of other 
provisions to which we object as being harmful to banking 
institutions, as listed below:
     Prohibit deferral on swap fund contributions
     Modify treatment of ESOPs as S corporation 
shareholders
     Modify the treatment of closely held REITs
     Disallow interest on debt allocable to tax-exempt 
obligations
     Impose excise tax on purchase of structured 
settlements
     Penalty increases with respect to corporate tax 
shelters
     Treat certain foreign-source interest and 
dividends equivalents as U.S.-effectively connected income
     Recapture overall foreign losses when controlled 
foreign corporation stock is disposed
     Treat receipt of tracking stock as property
     Recover state bank exam fees

TAX INCENTIVE PROPOSALS

Expand Exclusion for Employer Provided Educational Assistance 
to Include Graduate Education

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

Retirement Savings Accounts

    The ABA fully supports efforts to expand the availability 
of retirement savings. We are particularly pleased that the 
concept of tax-advantaged retirement savings has garnered long-
standing bi-partisan support and that the Administration's plan 
contains many significant proposals to encourage savings.
Low-income Housing Tax Credit

    The ABA supports the proposal to raise the low-income 
housing tax credit cap from $1.25 per capita to $1.75 per 
capita. This dollar value has not been increased since it was 
first set in the 1986 Act. Raising the cap would assist in the 
development of much needed affordable rental housing in all 
areas of the country.

Qualified Zone Academy Bonds

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

Other Issues

    The Administration's proposal contains a number of other 
provisions that we support, as listed below:
     Increase limit on charitable donations of 
appreciated property
     Make Brownfields remediation expensing permanent
     Simplify the foreign tax credit limits for 10/50 
company dividends

                               CONCLUSION

    The ABA appreciates having this opportunity to present our 
views on the revenue provisions contained in the President's 
fiscal year 2001 budget proposal. We look forward to working 
with you in the future on these most important matters.
      

                                

Statement of American Petroleum Institute

Introduction

    These comments are submitted by the American Petroleum 
Institute (API) for inclusion in the written record of the 
February 9, 2000 Ways and Means hearing on the tax provisions 
in the Administration's FY 2001 budget proposal. API represents 
approximately 400 companies involved in all aspects of the oil 
and gas industry, including exploration, production, 
transportation, refining, and marketing.
    The U.S. oil and gas industry continues to be a leader in 
exploring for and developing oil and gas reserves around the 
world. However, this leadership position is being threatened 
due to the diminishing advantages enjoyed by the domestic 
industry in the areas of U.S. technology and investment 
capital. At the same time, the continuing depletion of U.S. 
petroleum reserves and federal and state government policies 
restricting reserve replacement domestically have forced U.S. 
petroleum companies to look increasingly overseas to replace 
their petroleum reserves.
    A recent API study demonstrates that despite the fact that 
production outside the United States by U.S. companies 
increased by 300,000 barrels per day over the period from 1987 
to 1996, that was not enough to offset the decline in U.S. 
production by those firms. Therefore, total global production 
by U.S. oil and gas companies actually declined during that 
period. As evidenced by recent events, ceding greater control 
over petroleum product supplies to OPEC can have a profound 
effect on the prices paid by U.S. oil and gas consumers.
    A major factor behind the decline in the U.S. oil and gas 
industry's global competitive position is U.S. international 
tax policy. One of the provisions in President Clinton's budget 
proposal is aimed directly at the foreign source income of U.S. 
petroleum companies. The U.S. tax regime already imposes a 
substantial economic burden on U.S. multinational companies by 
exposing them to double taxation, that is, the payment of tax 
on foreign source income to both the host country and the 
United States. In addition, the complexity of the U.S. tax 
rules imposes significant compliance costs. As a result, U.S. 
companies are forced to forego foreign investment altogether 
based on projected after-tax rates of return, or they are 
preempted in bids for overseas investments by global 
competition. Congress can help to stem further losses in the 
global competitive position of the U.S. oil and gas industry by 
rejecting the Administration's proposal to increase taxes on 
their foreign source income, and the proposals to reinstate the 
Superfund taxes and the Oil Spill tax.

Administration Proposals

    Our testimony will address the following proposals:
     modify rules relating to foreign oil and gas 
extraction income;
     reinstate excise taxes and the corporate 
environmental tax deposited in the Hazardous Substance 
Superfund Trust Fund;
     reinstate the oil spill excise tax;
     corporate tax shelters;
     Harbor Maintenance Tax Converted to User Fee; and
     tax investment income of trade associations

RULES RELATING TO FOREIGN OIL AND GAS EXTRACTION INCOME

President Clinton's budget proposal includes the following 
provisions:
     In situations where taxpayers are subject to a 
foreign income tax and also receive an economic benefit from 
the foreign country, taxpayers would be able to claim a credit 
for such taxes under Code Section 901 only if the country has a 
``generally applicable income tax'' that has ``substantial 
application'' to all types of taxpayers, and then only up to 
the level of taxation that would be imposed under the generally 
applicable income tax.
     Effective for taxable years beginning after 
enactment, new rules would be provided for all foreign oil and 
gas income (FOGI). FOGI would be trapped in a new separate FOGI 
basket under Code Section 904(d). FOGI would be defined to 
include both foreign oil and gas extraction income (FOGEI) and 
foreign oil related income (FORI).
     Despite these changes, U.S. treaty obligations 
that allow a credit for taxes paid or accrued on FOGI would 
continue to take precedence over this legislation (e.g., the 
so-called ``per country'' limitation situations.)
    This proposal, aimed directly at the foreign operations of 
U.S. petroleum companies, seriously threatens the ability of 
those companies to remain competitive on a global scale, and 
API strongly opposes the proposal.
    If U.S. oil and gas concerns are to stay in business, they 
must look overseas to replace their diminishing reserves, since 
the opportunity for domestic reserve replacement has been 
restricted by both federal and state government policy. The 
opening of Russia to foreign capital, the competition for 
investment by the countries bordering the Caspian Sea, the 
privatization of energy in portions of Latin America, Asia, and 
Africa--all offer the potential for unprecedented opportunity 
in meeting the challenges of supplying fuel to a rapidly 
growing world economy. In each of these frontiers, U.S. 
companies are poised to participate actively. However, if U.S. 
companies can not economically compete, foreign resources will 
instead be produced by foreign competitors, with little or no 
benefit to the U.S. economy, U.S. companies, or American 
workers.
    With non-OPEC development being cut back, and OPEC market 
share and influence once again rising, a key concern of federal 
policy should be that of maintaining the global supply 
diversity that has been the keystone of improved energy 
security for the past two decades. The principal tool for 
promotion of that diversity is active participation by U.S. 
firms in the development of these new frontiers. Therefore, 
federal policy should be geared to enhancing the 
competitiveness of U.S. firms operating abroad, not reducing it 
with new tax burdens.
    The foreign tax credit (FTC) principle of avoiding double 
taxation represents the foundation of U.S. taxation of foreign 
source income. The Administration's budget proposal would 
destroy this foundation on a selective basis for foreign oil 
and gas income only, in direct conflict with long established 
tax policy and with U.S. trade policy of global integration, 
embraced by both Democratic and Republican Administrations.

The FTC Is Intended To Prevent Double Taxation

    Since the beginning of Federal income taxation, the U.S. 
has taxed the worldwide income of U.S. citizens and residents, 
including U.S. corporations. To avoid double taxation, the FTC 
was introduced in 1918. Although the U.S. cedes primary taxing 
jurisdiction for foreign income to the source country, the FTC 
is intended to prevent the same income from being taxed twice, 
once by the U.S. and once by the source country. The FTC is 
designed to allow a dollar for dollar offset against U.S. 
income taxes for taxes paid to foreign taxing jurisdictions. 
Under this regime, the foreign income of foreign subsidiaries 
is not immediately subject to U.S. taxation. Instead, the 
underlying earnings become subject to U.S. tax only when the 
U.S. shareholder receives a dividend (except for certain 
``passive'' or ``Subpart F'' income). Any foreign taxes paid by 
the subsidiary on such earnings is deemed to have been paid by 
any U.S. shareholders owning at least 10% of the subsidiary, 
and can be claimed as FTCs against the U.S. tax on the foreign 
dividend income (the so-called ``indirect foreign tax 
credit'').

Basic Rules of the FTC

    The FTC is intended to offset only U.S. tax on foreign 
source income. Thus, an overall limitation on currently usable 
FTCs is computed by multiplying the tentative U.S. tax on 
worldwide income by the ratio of foreign source income to 
worldwide taxable income. The excess FTCs can be carried back 
two years and carried forward five years, to be claimed as 
credits in those years within the same respective overall 
limitations.
    The overall limitation is computed separately for not less 
than nine ``separate limitation categories.'' Under present 
law, foreign oil and gas income falls into the general 
limitation category. Thus, for purposes of computing the 
overall limitation, FOGI is treated like any other foreign 
active business income. Separate special limitations still 
apply, however, for income: (1) whose foreign source can be 
easily changed; (2) which typically bears little or no foreign 
tax; or (3) which often bears a rate of foreign tax that is 
abnormally high or in excess of rates of other types of income. 
In these cases, a separate limitation is designed to prevent 
the use of foreign taxes imposed on one category to reduce U.S. 
tax on other categories of income.

FTC Limitations For Oil And Gas Income

    Congress and the Treasury have already imposed significant 
limitations on the use of foreign tax credits attributable to 
foreign oil and gas operations. In response to the development 
of high tax rate regimes by OPEC, taxes on foreign oil and gas 
income have become the subject of special limitations. For 
example, each year the amount of taxes on FOGEI may not exceed 
35 percent (the U.S. corporate tax rate) of such income. Any 
excess may be carried over like excess FTCs under the overall 
limitation. FOGEI is income derived from the extraction of oil 
and gas, or from the sale or exchange of assets used in 
extraction activities.
    In addition, the IRS has regulatory authority to determine 
that a foreign tax on FORI is not ``creditable'' to the extent 
that the foreign law imposing the tax is structured, or in fact 
operates, so that the tax that is generally imposed is 
materially greater than the amount of tax on income that is 
neither FORI nor FOGEI. FORI is foreign source income from (1) 
processing oil and gas into primary products, (2) transporting 
oil and gas or their primary products, (3) distributing or 
selling such, or (4) disposing of assets used in the foregoing 
activities. Otherwise, the overall limitation (with its special 
categories discussed above) applies to FOGEI and FORI. Thus, as 
active business income, FOGEI and FORI would fall into the 
general limitation category.

The Dual Capacity Taxpayer ``Safe Harbor'' Rule

    As distinguished from the rule in the U.S. and some 
Canadian provinces, mineral rights in other countries vest in 
the foreign sovereign, which then grants exploitation rights in 
various forms. This can be done either directly or through a 
state owned enterprise (e.g., a license or a production sharing 
contract). Because the taxing sovereign is also the grantor of 
mineral rights, the high tax rates imposed on oil and gas 
profits have often been questioned as representing, in part, 
payment for the grant of ``a specific economic benefit'' from 
mineral exploitation rights. Thus, the dual nature of these 
payments to the sovereign has resulted in such taxpayers being 
referred to as ``dual capacity taxpayers.''
    To help resolve controversies surrounding the nature of tax 
payments by dual capacity taxpayers, the Treasury Department in 
1983 finalized the ``dual capacity taxpayer rules'' of the FTC 
regulations. Under the facts and circumstances method of these 
regulations, the taxpayer must establish the amount of the 
intended tax payment that otherwise qualifies as an income tax 
payment and is not paid in return for a specific economic 
benefit. Any remainder is a deductible rather than creditable 
payment (and in the case of oil and gas producers, is 
considered a royalty). The regulations also include a safe 
harbor election (see Treas. Reg. 1.901-2A(e)(1)), whereby a 
formula is used to determine the tax portion of the payment to 
the foreign sovereign, which is basically the amount that the 
dual capacity taxpayer would pay under the foreign country's 
general income tax. Where there is no generally applicable 
income tax, the safe harbor rule of the regulation allows the 
use of the U.S. tax rate in a ``splitting'' computation (i.e., 
the U.S. tax rate is considered the country's generally 
applicable income tax rate).

The Proposal Disallows FTCs Of Dual Capacity Taxpayers Where

The Host Country Has No Generally Applicable Income Tax

    If a host country had an income tax on FOGI (i.e., FOGEI or 
FORI), but no generally applicable income tax, the proposal 
would disallow any FTCs on FOGI. This would result in 
inequitable and destructive double taxation of dual capacity 
taxpayers, contrary to the global trade policy advocated by the 
U.S.
    The additional U.S. tax on foreign investment in the 
petroleum industry would not only eliminate many new projects; 
it could also change the economics of past investments. In some 
cases, this would not only reduce the rate of return, but also 
preclude a return of the investment itself, leaving the U.S. 
business with an unexpected ``legislated'' loss. In addition, 
because of the uncertainties of the provision, it would also 
introduce more complexity and potential for litigation into the 
already muddled world of the FTC.
    The unfairness of the provision becomes even more apparent 
if one considers the situation in which a U.S. based oil 
company and a U.S. based company other than an oil company are 
subject to an income tax in a country without a generally 
applicable income tax. Under the proposal, only the U.S. oil 
company would receive no foreign tax credit, while the other 
taxpayer would be entitled to the full tax credit for the very 
same tax.
    The proposal's concerns with the tax versus royalty 
distinction were resolved by Congress and the Treasury long ago 
with the special tax credit limitation on FOGEI enacted in 1975 
and the Splitting Regulations of 1983. These were then later 
reinforced in the 1986 Act by the fragmentation of foreign 
source income into a host of categories or baskets. The earlier 
resolution of the tax versus royalty dilemma recognized that 
(1) if payments to a foreign sovereign meet the criteria of an 
income tax, they should not be denied complete creditability 
against U.S. income tax on the underlying income; and (2) 
creditability of the perceived excessive tax payment is better 
controlled by reference to the U.S. tax burden, rather than 
being dependent on the foreign sovereign's fiscal choices.

The Proposal Limits FTCs To The Amount That Would

 Be Paid Under The Generally Applicable Income Tax

    By elevating the regulatory safe harbor to the exclusive 
statutory rule, the proposal eliminates a dual capacity 
taxpayer's right to show, based on facts and circumstances, 
which portion of its income tax payment to the foreign 
government was not made in exchange for the conferral of 
specific economic benefits and, therefore, qualifies as a 
creditable tax. Moreover, by eliminating the ``fall back'' to 
the U.S. tax rate in the safe harbor computation where the host 
country has no generally applicable income tax, the proposal 
denies the creditability of true income taxes paid by dual 
capacity taxpayers under a ``scheduler'' type of business 
income tax regime (i.e., regimes that tax only certain 
categories of income, according to particular ``schedules''), 
merely because the foreign sovereign's fiscal policy does not 
include all types of business income.
    For emerging economies in lesser developed countries that 
may not be ready for an income tax, as well as for post-
industrial nations that may turn to a transaction tax, it is 
not realistic to always demand the existence of a generally 
applicable income tax. Even if the political willingness exists 
to have a generally applicable income tax, such may not be 
possible because the ability to design and administer a 
generally applicable income tax depends on the structure of the 
host country's economy. The available tax regimes are defined 
by the country's economic maturity, business structure and 
accounting sophistication. The most difficult problems arise in 
the field of business taxation. Oftentimes, the absence of 
reliable accounting books will only allow a primitive 
presumptive measure of profits. Under such circumstances the 
effective administration of a general income tax is impossible. 
All this is exacerbated by phenomena typical of less developed 
economies: a high degree of self-employment, the small size of 
establishments, and low taxpayer compliance and enforcement. In 
such situations, the income tax will have to be limited to 
mature businesses, along with the oil and gas extraction 
business.

The Proposal Increases The Risk Of Double Taxation

    Adoption of the Administration's proposals would further 
tilt the playing field against overseas oil and gas operations 
by U.S. business, and increase the risk of double taxation of 
FOGI. This will severely hinder U.S. oil companies in their 
competition with foreign oil and gas concerns in the global oil 
and gas exploration, production, refining, and marketing arena, 
where the home countries of their foreign competition do not 
tax FOGI. This occurs where these countries either exempt 
foreign source income or have a foreign tax credit regime that 
truly prevents double taxation.
    To illustrate, assume foreign country X offers licenses for 
oil and gas exploitation and also has an 85 percent tax on oil 
and gas extraction income. In competitive bidding, the license 
will be granted to the bidder that assumes exploration and 
development obligations most favorable to country X. Country X 
has no generally applicable income tax. Unless a U.S. company 
is assured that it will not be taxed again on its after-tax 
profit from country X, it very likely will not be able to 
compete with another foreign oil company for such a license 
because of the different after-tax returns.
    Because of the 35 percent additional U.S. tax, the U.S. 
company's after-tax return will be more than one-third less 
than its foreign competitor's. Stated differently, if the 
foreign competitor is able to match the U.S. company's 
proficiency and effectiveness, the foreign company's return 
will be more than 50 percent greater than the U.S. company's 
return. This would surely harm the U.S. company in any 
competitive bidding. Only the continuing existence of the FTC, 
despite its many existing limitations, assures that there will 
be no further tilting of the playing field against U.S. 
companies' efforts in the global petroleum business.

Separate Limitation Category For FOGI

    To install a separate FTC limitation category for FOGI 
would single out the active business income of oil companies 
and separate it from the general limitation category or basket. 
There is no legitimate reason to carve out FOGI from the 
general limitation category or basket. The source of FOGEI and 
FORI is difficult to manipulate. The source of FOGI was 
determined by nature millions of years ago. FORI is generally 
derived from the country where the processing or marketing of 
oil occurs which presupposes substantial investment in 
nonmovable assets. Moreover, Treasury has issued detailed 
regulations addressing this sourcing issue. Finally, unless any 
FORI is earned in the extraction or consumption country, it is 
very likely taxed currently, before distribution, as Subpart F 
income even though it is definitely not passive income.

The FTC Proposals Are Bad Tax Policy

    Reduction of U.S. participation in foreign oil and gas 
development because of misguided tax provisions will adversely 
affect U.S. employment, and any additional tax burden may 
hinder U.S. companies in competition with foreign concerns. 
Although the host country resource will be developed, it will 
be done by foreign competition, with the adverse ripple effect 
of U.S. job losses and the loss of continuing evolution of U.S. 
technology. By contrast, foreign oil and gas development by 
U.S. companies increases utilization of U.S. supplies of 
hardware and technology. The loss of any major foreign project 
by a U.S. company will mean less employment in the U.S. by 
suppliers, and by the U.S. parent, in addition to fewer U.S. 
expatriates at foreign locations. Many of the jobs that support 
overseas operations of U.S. companies are located here in the 
United States--an estimated 350,000 according to a 1998 
analysis by Charles River Associates, a Cambridge, 
Massachusetts-based consulting firm. That figure consists of: 
60,000 in jobs directly dependent on international operations 
of U.S. oil and gas companies; over 140,000 employed by U.S. 
suppliers to the oil and gas industry's foreign operations; 
and, an additional 150,000 employed in the United States 
supporting the 200,000 individuals who work directly for the 
oil companies and their suppliers.
    Thus, the questions to be answered are: (1) Does the United 
States--for energy security and international trade reasons 
among others--want a U.S.-based petroleum industry that is 
competitive in the global quest for oil and gas reserves? (2) 
If the answer is ``yes,'' why would the U.S. government adopt a 
tax policy that is punitive in nature and lessens the 
competitiveness of the U.S. petroleum industry? The U.S. tax 
system already makes it extremely difficult for U.S. 
multinationals to compete against foreign-based entities. This 
is in direct contrast to the tax systems of our foreign-based 
competitors, which actually encourage those companies to be 
more competitive in winning foreign projects. What we need from 
Congress are improvements in our system that allow U.S. 
companies to compete more effectively, not further impediments 
that make it even more difficult and in some cases impossible 
to succeed in today's global oil and gas business environment. 
These improvements should include, among others, the repeal of 
the plethora of separate FTC baskets, the extension of the 
carryback/carryover period for foreign tax credits, and the 
repeal of section 907.
    The Administration's FY 1999 and FY 2000 budgets included 
these same proposals which would have reduced the efficacy of 
the FTC for U.S. oil companies. Congress considered these 
proposals at that time and rightfully rejected them. They 
should be rejected this year as well.
REINSTATMENT OF EXPIRED SUPERFUND TAXES

    The Administration's proposal would reinstate the Superfund 
excise taxes on petroleum and certain chemicals through 
September 30, 2010 and the Corporate Environmental Income Tax 
through December 31, 2010. API strongly opposes this proposal.
    It is generally agreed that the CERCLA program, otherwise 
known as Superfund, has matured to the point that most of the 
sites on the National Priorities List (NPL) are in some phase 
of cleanup. Problems, however, remain in the structure of the 
current program. The program should undergo comprehensive 
legislative reform and should sunset at the completion of 
cleanups of the CERCLA sites currently on the NPL. Issues that 
the reform legislation should address include liability, remedy 
selection, and natural resource damage assessments. A 
restructured and improved Superfund program can and should be 
funded through general revenues.
    Superfund sites are a broad societal problem. Revenues 
raised to remediate these sites should be broadly based rather 
than unfairly burdening a few specific industries. EPA has 
found wastes from all types of businesses and government 
agencies at hazardous waste sites. The entire economy benefited 
in the pre-1980 era from the lower cost of handling waste 
attributable to standards that were acceptable at the time. To 
place responsibility for the additional costs resulting from 
retroactive Superfund cleanup standards on the shoulders of a 
very few industries when previous economic benefits were widely 
shared is patently unfair.
    The petroleum industry is estimated to be responsible for 
less than 10 percent of the contamination at Superfund sites 
but has historically paid over 50 percent of the Superfund 
taxes. This inequity should be rectified. Congress should 
substantially reform the program and fund the program through 
general revenues or other broad-based funding sources.

REINSTATMENT OF OIL SPILL EXCISE TAX

    The Administration proposes reinstating the five cents per 
barrel excise tax on domestic and imported crude oil dedicated 
to the Oil Spill Liability Trust Fund through September 30, 
2010, and increasing the trust fund limitation (the ``cap'') 
from $1 billion to $5 billion. API strongly opposes the 
proposal.
    Collection of the Oil Spill Excise Tax was suspended for 
several months during 1994 because the Fund had exceeded its 
cap of $1 billion. It was subsequently allowed to expire 
December 31, 1994, because Congress determined that there was 
no need for additional taxes. Since that time, the balance in 
the Fund has remained above $1 billion, despite the fact that 
no additional taxes have been collected. Clearly, the 
legislated purposes for the Fund are being accomplished without 
any need for additional revenues. Congress should reject this 
proposal.

CORPORATE TAX SHELTERS

    In a sweeping attack on corporate tax planning, the 
Administration has proposed fifteen provisions purported to 
deal with corporate tax shelters. These proposals are overly 
broad and would bring within their scope many corporate 
transactions that are clearly permitted under existing law. 
Moreover, their ambiguity would leave taxpayers uncertain as to 
the tax consequences of their activities and would lead to 
increased controversy and litigation. Business taxpayers must 
be able to rely on the tax code and existing income tax 
regulations in order to carry on their business activities. 
Treasury's proposed rules could cost the economy more in lost 
business activity than they would produce in taxing previously 
``sheltered'' income.

HARBOR MAINTENANCE EXCISE TAX CONVERTED TO COST-BASED USER FEE

    The Administration's budget contains a placeholder for 
revenue from a new Harbor Services User Fee and Harbor Services 
Fund. This fee would raise $1.7 billion in new taxes, more than 
three times what is needed for harbor maintenance dredging. 
Despite the intense and uniform opposition from ports, 
shippers, carriers, labor and many Members of Congress, the 
Administration has provided few details about how the new user 
fee would be structured and has not sought stakeholder input 
since September 1998.
    API strongly supports the use of such funds for channel 
maintenance and dredge disposal. We object to the 
Administration's proposal to use these funds for port 
construction and other services. The Administration should 
earmark these funds to address the growing demand for harbor 
maintenance and dredging. Furthermore, the Administration's 
proposal would force commercial shipping interests to bear the 
entire cost of the Army Corps of Engineers' harbor maintenance 
and dredging program rather than spreading the costs among all 
beneficiaries. We urge Congress to pass H.R. 3566 and create an 
off-budget trust fund for the Harbor Services Fund. Finally, 
API urges Congress to take the lead in seeking stakeholder 
input and developing a fair and equitable means of generating 
the needed revenue.

SUBJECT INVESTMENT INCOME OF TRADE ASSOCIATIONS TO TAX

    The Administration's proposal would subject to tax the net 
investment income in excess of $10,000 of trade associations 
and other organizations described in section 501(c)(6). API 
opposes this provision that is estimated to increase taxes on 
trade associations and other similar not-for-profit 
organizations by $1.5 billion. We agree with the Tax Council 
and other groups that subjecting trade association investment 
income to the unrelated business income tax (UBIT) conflicts 
with the current-law purpose of imposing UBIT on associations 
and other tax-exempt organizations to prevent such 
organizations from competing unfairly against for-profit 
businesses. The Administration's proposal mischaracterizes the 
benefit that trade association members receive from such 
earnings. Without such earnings, members of these associations 
would have to pay larger tax-deductible dues. There is no tax 
abuse. Congress should reject this proposal.
      

                                

Statement of Michael S. Olson, American Society of Association 
Executives

    Mr. Chairman, my name is Michael S. Olson, CAE, President 
and Chief Executive Officer of the American Society of 
Association Executives (ASAE). ASAE is an individual membership 
society made up of 25,200 association executives and suppliers. 
Its members manage more than 11,000 leading trade associations, 
individual membership societies, and other voluntary membership 
organizations across the United States and in 48 countries 
around the globe.
    I am here to testify in strong opposition to the budget 
proposal that has again been submitted to Congress by the 
Clinton Administration that would tax the net investment income 
of Section 501(c)(6) associations to the extent the income 
exceeds $10,000 annually. Income that would be subject to 
taxation, however, is not as narrow as would be expected from 
the characterization in the proposal of ``investment income'' 
but includes all ``passive'' income such as rent, royalties, 
interest, dividends, and capital gains. This provision, which 
is estimated by the Treasury Department to raise approximately 
$1.55 billion dollars over five years, would radically change 
the way revenue of these tax-exempt organizations is treated 
under federal tax law. In addition, if enacted this proposal 
would jeopardize the very financial stability of many Section 
501(c)(6) organizations.
    This proposal is identical to the provision included last 
year in the President's FY2000 budget. At that time, the 
proposed change was meet by broad and unified opposition from 
the professional society and trade association community that 
it targeted. It also created serious concern among charities 
and other Section 501(c) organizations who were alarmed with 
the dangerous precedent the provision, if enacted, would set in 
altering the fundamental tax treatment of tax-exempt 
organizations that has existed for nearly a century.
    Last year, this proposal was received by Congress with 
broad, bipartisan opposition. In the House of Representatives, 
twenty-eight members of the House Ways and Means Committee sent 
a bipartisan letter to the chairman and ranking member of the 
committee, voicing strong opposition to the proposed tax on 
investment income. In the Senate, thirty-five Senators of both 
political parties sent a similar letter to the chairman and 
ranking member of the Senate Finance Committee. In addition, 
the entire Senate passed a resolution in opposition to this 
ill-conceived legislation. We are therefore troubled that the 
Administration has chosen to resurrect this measure given the 
broad-based opposition from Congress to the original proposal.
    America's trade, professional and philanthropic 
associations are an integral part of our society. They allocate 
one of every four dollars they spend to member education and 
training and public information activities, according to a new 
study commissioned by the Foundation of the American Society of 
Association Executives. ASAE member organizations devote more 
than 173 million volunteer hours each year, time valued at more 
than $2 billion, to charitable and community service projects. 
95 percent of ASAE member organizations offer education 
programs for members, making that service the single most 
common association function. ASAE member associations are the 
primary source of health insurance for more than eight million 
Americans, while close to one million people participate in 
retirement savings programs offered through associations.
    Association members spend more than $1.1 billion annually 
complying with association-set standards, which safeguard 
consumers and provide other valuable benefits. Those same 
associations fuel America's prosperity by pumping billions of 
dollars into the economy and creating hundreds of thousands of 
jobs. Were it not for associations, other institutions, 
including the government, would face added burdens in the areas 
of product performance and safety standards, continuing 
education, public information, professional standards, ethics, 
research and statistics, political education, and community 
service. The work of associations is woven through the fabric 
of American society, and the public has come to depend on the 
social and economic benefits that associations afford.
    The Administration has suggested that their proposal would 
only affect a small percentage of associations, that it is 
targeted to larger organizations, that the proposal targets 
``lobbying organizations,'' and that it somehow provides 
additional tax benefits to those who pay dues to associations. 
All of these assertions are misleading, ill-informed and 
incorrect.
    Based on information from ASAE's 1997 Operating Ratio 
Report, this proposal will tax most associations with annual 
operating budgets as low as $200,000, hardly organizations of 
considerable size. In fact, the bulk of the organizations 
affected would include associations at the state and local 
level, many of whom perform little if any lobbying functions. 
Furthermore, existing law, as outlined below, already 
eliminates any tax preference, benefit, or subsidy for the 
lobbying activities of these organizations, and can even unduly 
penalize their lobbying.
    The primary argument the Administration has used to support 
its proposal is that association members prepay their dues in 
order to enjoy a tax-free return on investment. This flawed 
argument fails to recognize (1) the existing outright ban on 
associations paying dividends to their members; and (2) the 
fact that association members do not tolerate any amount of 
excessive dues.
    In many ways, this proposal attacks the basic tax-exempt 
status of associations, and runs counter to the demonstrated 
commitment of Congress to furthering the purposes of tax-exempt 
organizations. These exempt purposes, such as training, 
standard-setting, and providing statistical data and community 
services, are supported in large part by the income that the 
Administration's proposal would tax and thereby diminish. If 
Congress enacts this proposal, it will alter in a fundamental 
way the tax policy that has governed the tax-exempt community 
for nearly a century, and will set a dangerous precedent for 
further changes in tax law for all tax-exempt organizations.
    I would now like to review more completely the existing tax 
law governing this area, and to specifically address some of 
the arguments that have been made in support of the 
Administration's proposal. I believe that a careful 
consideration of the issues involved will make the Committee 
conclude that this proposal is both ill-advised and ill-
conceived, and should be rejected.

I. Taxation of Section 501(c)(6) Organizations Under Current 
Law.

    Section 501(c)(6) organizations are referred to in the tax 
law as ``business leagues'' and ``chambers of commerce.'' Today 
they are typically known as trade associations, individual 
membership societies, and other voluntary membership 
organizations. These organizations are international, national, 
state, and local groups that include not only major industry 
trade associations but also small town merchants' associations 
or the local Better Business Bureau. Currently, the tax law 
provides that Section 501(c)(6) organizations are exempt from 
federal taxation on income earned in the performance of their 
exempt purposes. Associations engage primarily in education, 
communications, self-regulation, research, and public and 
governmental information and advocacy. Income received from 
members in the form of dues, fees, and contributions is tax-
exempt, as are most other forms of organizational income such 
as convention registrations and publication sales. However, 
Section 501(c)(6) groups and many other kinds of exempt 
organizations are subject to federal corporate income tax on 
revenues from business activities unrelated to their exempt 
purposes (``unrelated business income tax'' or ``UBIT''). UBIT 
is applicable to income that is earned as a result of a 
regularly-carried-on trade or business that is not 
substantially related to the organizations' tax-exempt 
purposes. Section 501(c)(6) organizations are also subject to 
specific taxes on any income they spend on lobbying activities.
    The UBIT rules were designed to prevent tax-exempt 
organizations from gaining an unfair advantage over competing, 
for-profit enterprises in business activities unrelated to 
those for which tax-exempt status was granted. Congress 
recognized, however, that Section 501(c)(6) tax-exempt 
organizations were not competing with for-profit entities or 
being unfairly advantaged by the receipt of tax-exempt income 
from certain ``passive'' sources: rents, royalties, interest, 
dividends, and capital gains. Tax-exempt organizations use this 
``passive'' income to further their tax-exempt purposes and to 
help maintain modest reserve funds--to save for necessary 
capital expenditures and to even out economic swings. Indeed, 
the legislative history regarding UBIT recognizes that 
``passive'' income is a proper source of revenue for 
charitable, educational, scientific, and religious 
organizations [Section 501(c)(3) organizations], issue advocacy 
organizations [Section 501(c)(4) organizations], and labor 
unions and agricultural organizations [Section 501(c)(5) 
organizations], as well as trade associations, individual 
membership societies, and other voluntary membership 
organizations [Section 501(c)(6) organizations].
    Therefore, Congress drafted the tax code to expressly 
provide that UBIT for most tax-exempt organizations does not 
extend to ``passive'' income. As a result, exempt organizations 
such as associations are not taxed on rents, royalties, 
dividends, interest, or gains and losses from the sale of 
property. The proposal to tax ``net investment income'' of 
Section 501(c)(6) organizations would allow the IRS to impose a 
tax on all such previously untaxed sources of ``passive'' 
income. Contrary to its denomination, the scope of the tax is 
clearly much broader than just ``investment income.''

II. Taxation of Section 501(c)(6) Organizations Under the 
Administration Budget Proposal: Treating Professional 
Associations Like Social Clubs.

    Under the Administration's proposal, Section 501(c)(6) 
organizations would be taxed on all ``passive'' income in 
excess of $10,000. This proposed tax would not be imposed on 
exempt income that is set aside to be used exclusively for 
charitable and educational purposes. Funds set aside in this 
manner by Section 501(c)(6) organizations could be taxed, 
however, if those funds are ultimately used for these purposes. 
In addition, the proposal would tax gains realized from the 
sale of property used in the performance of an exempt function 
unless the funds are reinvested in replacement property.
    Essentially, the budget proposal would bring Section 
501(c)(6) organizations under the same unrelated business 
income rules that apply to Section 501(c)(7) social clubs, 
Section 501(c)(9) voluntary employees' beneficiary 
associations, and Section 501(c)(20) group legal services 
plans. These organizations receive less favorable tax treatment 
due to Congress' belief that they have fundamentally different, 
and less publicly beneficial purposes than other tax-exempt 
organizations. The Clinton Administration proposes to equate 
trade associations, individual membership societies, and other 
such voluntary membership organizations with country clubs, 
yacht clubs, and health clubs.
    Social clubs, for example, are organized under Section 
501(c)(7) for the pleasure and recreation of their individual 
members. As case law and legislative history demonstrate, 
social clubs were granted tax exemption not to provide an 
affirmative tax benefit to the organizations, but to ensure 
that their members are not disadvantaged by their decision to 
join together to pursue recreational opportunities. Receiving 
income from non-members or other outside sources is therefore a 
benefit to the individual members not contemplated by this type 
of exemption.
    With regard to associations exempt under Section 501(c)(6), 
however, Congress intended to provide specific tax benefits to 
these organizations to encourage their tax-exempt activities 
and public purposes. These groups are organized and operated to 
promote common business and professional interests, for example 
by developing training material, providing volunteer services 
to the public, or setting and enforcing safety or ethical 
standards. In fact, the tax code prohibits Section 501(c)(6) 
organizations from directing their activities at improving the 
business conditions of only their individual members. They must 
enhance entire ``lines of commerce;'' to do otherwise 
jeopardizes the organizations' exempt status. Social clubs have 
therefore long been recognized by Congress as completely 
different from professional associations, engaged in different 
activities that merit a different exempt status.
    Social clubs have always been taxed differently from 
associations. This reflects their different functions. 
Associations are organized to further the interests of whole 
industries, professions, and other fields of endeavor. 
``Passive'' income received by an association is reinvested in 
tax-exempt activities of benefit to the public, rather than in 
recreational/social activities for a limited number of people. 
Applying the tax rules for social clubs to associations imposes 
unreasonable and unwarranted penalties on those organizations. 
For example, under the Administration's proposal, these 
organizations would be taxed on all investment income unless it 
is set aside for charitable purposes. Income that is used to 
further other legitimate organizational activities of value to 
the industry, the profession, and the public would therefore be 
taxed. In addition, the proposal would tax these organizations 
on all gains received from the sale of property unless those 
gains are reinvested in replacement property. This tax on gains 
would apply to real estate, equipment, and other tangible 
property. It would also apply, however, to such vastly diverse 
assets as software, educational material developed to assist an 
industry or profession, certification and professional 
standards manuals, and other forms of intellectual property 
which further exempt purposes.
    It is important to note that the Administration's proposal 
targets only Section 501(c)(6) organizations. No other 
categories of tax-exempt organizations would be taxed in this 
proposal. The Administration's proposal inappropriately seeks 
to impose the tax scheme designed for Section 501(c)(7) social 
and recreational clubs only on Section 501(c)(6) associations. 
Congress has recognized that organizations exempt in these 
different categories serve different purposes and long ago 
fashioned a tax exemption scheme to reflect these differences. 
The Administration's proposal runs counter to common sense and 
would discourage or prevent Section 501(c)(6) organizations 
from providing services, including public services, consistent 
with the purposes for which these associations were granted 
exemption.

III. Taxation of Association Lobbying Activities.

    Last year, the Administration's proposal was characterized 
by the former Secretary of the Treasury Robert Ruben as a tax 
on ``lobbying organizations,'' suggesting that associations 
somehow now enjoy a favored tax status for their lobbying 
activities. This characterization was and still is incorrect. 
Many associations do not conduct any lobbying activity. 
Moreover, the lobbying activities of associations have no tax 
preferences, advantages, or subsidies whatsoever, and these 
expenditures are are fully taxed by virtue of the Omnibus 
Budget Reconciliation Act of 1993. That law imposed a tax on 
all lobbying activities of trade and professional associations, 
either in the form of a flat 35% tax on all funds that the 
organization spends on lobbying activities, or as a pass-
through of non-deductibility to individual association members.
    Indeed, not only is there no tax benefit or tax exemption 
for associations' lobbying activities, either for the members 
or for the entities themselves, but the 1993 law provides a tax 
penalty on any funds used to lobby. Lobbying tax penalties can 
arise in essentially three ways:
    1. Proxy Tax. The ``proxy'' tax, an alternative to 
informing association members of dues non-deductibility because 
of association lobbying, is set at a flat 35% level. This is 
the highest level of federal income tax for corporations, paid 
only by corporations with net incomes over $18.33 million. 
Associations are denied the ``progressivity'' of the income tax 
schedule. Therefore, even though no associations ever achieve 
nearly that level of income, they must pay the proxy tax as if 
they did.
    2. Allocation Rule. Under the ``allocation rule,'' all 
lobbying expenses are allocated to dues income to determine the 
percentage of members' dues that are non-deductible. Most 
associations pay for their lobbying expenses using many sources 
of income. Increasingly, associations have far more non-dues 
income than dues income. The allocation rule, however, requires 
association members to pay a tax on all association income used 
to conduct lobbying activities, regardless of the percentage of 
lobbying actually paid from their dues. Indeed, under the 
``allocation rule,'' a business can pay more tax if it joins an 
association that lobbies for a particular government policy 
than if the business had undertaken the lobbying itself.
    3. Estimation Rule. The ``estimation rule'' requires that 
associations estimate in advance how much dues income and 
lobbying expense they anticipate. The estimation forms the 
basis for the notice of dues non-deductibility, which must be 
given at the time of dues billing or collection. If the actual 
expense proves to be different from the estimates, the 
association or its members are subject to very high penalties. 
There is no way to ensure freedom from the penalty for 
underestimating short of ceasing to spend money on lobbying the 
moment the association reaches its estimate. There is no way to 
avoid the penalty for overestimating at all.
    Associations are therefore already subject to more than tax 
neutrality and absence of exemption or subsidy for lobbying 
activities. The Administration's proposal would not change any 
provision with respect to lobbying activities of these 
associations, although it would certainly weaken the financial 
resources of associations and reduce their ability to advocate 
for industries, professions, and the public. Indeed, the 
Administration's characterization of the proposal as one that 
addresses ``lobbying organizations'' is tantamount to an 
Administration decision to further weaken and suppress the 
ability of tax-exempt organizations to lobby at all.

IV. Taxation of Member Dues.

    The Administration's proposal has also been justified by 
its proponents as eliminating a double tax advantage claimed to 
be enjoyed by dues-paying association members. According to the 
Administration, association members already receive an 
immediate deduction for dues or similar payments to Section 
501(c)(6) organizations. At the same time, members avoid paying 
taxes on investment income by having the association invest 
dues surplus for them tax-free.

    This argument is flawed for a variety of reasons:

    The argument implies that members voluntarily pay higher 
dues than necessary as an investment strategy. While in some 
circumstances members of tax-exempt associations can deduct 
their membership dues like any other business expense, members 
receive no other tax break for dues payments. As discussed 
above, they are in fact denied a deduction for any amount of 
dues their association allocates to lobbying expenses.
    The argument implies that associations overcharge their 
members for dues, thereby creating a significant surplus of 
dues income. In fact, dues payments usually represent only a 
portion of an association's income; and dues are virtually 
always determined by a board or committee consisting of 
members, who would hardly tolerate excessively high dues. 
Finally, associations tend to maintain only modest surpluses to 
protect against financial crises, expending the rest on 
programs and services. Again, associations are member-governed; 
members would typically make certain that their associations do 
not accumulate a surplus beyond the minimum that is necessary 
and prudent for the management of their associations.
    The argument assumes that Section 501(c)(6) organizations 
somehow pay dividends to their members. Tax-exempt 
organizations do not pay dividends or returns in any form to 
their members, let alone for payment of dues. Indeed, an 
organization's exempt status may be revoked if any portion of 
its earnings are directed to individuals.
    In other words, the Administration suggests that 
association members are voluntarily paying higher than 
necessary dues, solely to avoid paying tax on their own 
investment income resulting when not all dues revenues are 
expended immediately. This is the same as suggesting that 
individuals donate to charities in hopes that the charities 
will earn investment income on un-spent donations. It is an 
argument that defies common sense and completely misunderstands 
the structure and operation of tax-exempt organizations.

V. Expenditures Attributed to Investment and Other ``Passive'' 
Income Would Generally Qualify As Deductible Expenses If 
Incurred by Members of the Association.

    The investment income and other ``passive'' income of 
associations is used to further the exempt purpose of the 
organizations. Most if not all of these expenditures for 
association programs and activities, which are made on behalf 
of the association's members, would be deductible if carried on 
directly by the members. This is because these expenses would 
otherwise be regarded as ordinary and necessary business 
expenses under Section 162(a) of the tax code or as a 
charitable contribution. Therefore, it is inappropriate to 
essentially deny this deduction by imposing the UBIT tax on 
this income. Under the Administration's proposal, this would in 
fact be the indirect result of subjecting the ``passive'' 
income of Section 501(c)(6) organizations to taxation.

VI. The Administration's Proposed Tax Would Reach All Forms of 
``Passive'' Income and Jeopardize Tax-Exempt Programs.

    Trade associations, individual membership societies, and 
other similar voluntary membership organizations typically 
receive only a portion of their income from membership dues, 
fees, and similar charges. In many such organizations, 
particularly professional societies, there are natural limits 
or ``glass ceilings'' on the amounts of dues that can be 
charged to members. As a result, these Section 501(c)(6) tax-
exempt organizations have increasingly sought additional 
sources of income to enable them to continue their often broad 
programs of exempt activities on behalf of businesses, 
professions, and the public. One of those additional sources 
has been ``passive'' income--rents, royalties, dividends, 
interest, and capital gains--that may be earned from a variety 
of sources.
    Section 501(c)(6) organizations rely heavily on ``passive'' 
income to support their exempt activities. The proposal would 
adversely affect virtually all associations, since most 
organizations from time to time receive some amount of rents, 
royalties, interest, dividends, or capital gains. These 
associations use ``passive'' income to further a host of 
beneficial activities, which would be threatened by imposition 
of the Clinton Administration's ``investment'' tax. For 
example, Section 501(c)(6) tax-exempt associations are 
responsible for:
    Drafting and disseminating educational materials.
    Establishing skills development seminars and programs.
    Creating training and safety manuals for various 
professions.
    Producing books, magazines, newsletters, and other 
publications.
    Increasing public awareness, knowledge, and confidence in 
an industry's or a profession's practices.
    Conducting and sponsoring industry research and surveys.
    Compiling statistical data for industries and professions, 
which is often requested or relied upon by government.
    Providing professionals and businesses with new technical 
and scientific information.
    Developing and enforcing professional safety and health 
standards.
    Developing and enforcing ethical standards for industry 
practice.
    Operating accreditation, certification, and other 
credentialing programs.
    Organizing and implementing volunteer programs.
    The Administration's proposal imposes a broad-based, 
pervasive, and detrimental penalty on virtually all 
associations of any kind or size. A tax on the ``investment 
income'' of Section 501(c)(6) organization does not address any 
issue of income used for lobbying activities; all such 
activities by these organizations is already free of tax 
exemption or subsidy of any kind (indeed, it can be subject to 
offsetting ``penalty'' taxation). There is no double or special 
tax benefit to those who pay dues to associations. Instead, the 
Administration's proposal taxes significant sources of funding 
that associations use now for highly desirable services to 
entire industries, professions, and the public. Treating 
Section 501(c)(6) organization in the same manner as social 
clubs ignores the special, quasi-public purposes and functions 
of associations, and threatens the ability of such 
organizations to continue to provide publicly beneficial 
services in the future. In summary, this proposal is a threat, 
albeit ill-conceived, to the ongoing viability of thousands of 
America's membership organizations, and should be rejected by 
this Committee.
    Thank you for this opportunity to submit this testimony. 
ASAE would be happy to supplement this testimony with answers 
to any questions you may have.
      

                                

                                    Bethesda, MD 20824-0776
                                                  February 18, 2000

Chairman, Committee on Ways and Means
U.S. House of Representatives
Longworth House Office Building
Washington, DC 20515
Reform of Certain Private Foundation Rules

    Dear Mr. Chairman

    Relevant web sites have invited public commentary on changes 
proposed by the Treasury Department to certain of the federal tax laws 
affecting charities and charitable foundations. The comments submitted 
herein are personal to the undersigned and do not represent the 
comments of my religious society, the Society of Jesus, or the church 
where I am now in residence. The undersigned is a graduate of the 
University of Bombay (B. Sci. 1940), Woodstock Theological Seminary 
(S.J.D., 1952), and New York University (LLM, Tax, 1966).
    Tax reduction is certainly to be applauded, especially with respect 
to amounts that might otherwise not reach the charitable mainstream. A 
review of the excise tax based on investment income, suggests that it 
was drafted with minute attention to various details, yet, based upon 
an equally careful reading of Treasury Department regulations, the law 
omitted certain matters found to be so important that the Treasury 
Department took upon itself the task of amending the statute via 
regulations.
    It would seem prudent that if the excise tax based on investment 
income is being analyzed anew for changes which have the net effect of 
reducing total tax collections, the Congress should address matters 
which were originally omitted from the legislation but now covered, but 
not necessarily governed by, applicable regulations. Congress has the 
opportunity to decide whether the same public policy considerations 
which inhered in writing ameliorative regulations benefiting 
foundations should be confirmed by statutory changes aimed primarily at 
rate reductions.
    It was not a particularly difficult task to read the statute, and 
applicable Treasury Department regulations, and find at least one half 
dozen gaps between the statutory language and provisions in the 
applicable regulations. It is the suggestion of the undersigned that, 
because there is no statutory authority supporting ameliorative 
regulations cited below, that these matters be addressed by Congress so 
that their beneficence is confirmed by statutory support.
    The statute says plainly that gross investment income includes 
interest, rents, royalties, etc. The law also specifically provides 
that gains and losses are includable in income respecting property 
``used for'' the production of interest, rents, etc. Nevertheless, 
applicable regulation specifically exempt from the capital gains tax 
property which is so used but which is also used for a charitable or 
educational function by the foundation. The statute does not contain 
any such allowance as that granted by the regulation. It would seem 
that the statute should do so to protect the property of foundations 
which they have chosen to place within the charitable mainstream and, 
which at the same time, produces some of the income so designated.
    It is worth re-examining whether or not interest earned from loans 
by a private foundation to a public charity which allow the borrower to 
better conduct its public function should be subject to the excise tax 
at all. Certainly, if a private foundation holds a municipality's 
indebtedness, the law specifically precludes taxation of such interest 
income (but not necessary any capital gain). From a tax policy 
standpoint, encouraging private foundations to lend monies to 
religious, scientific and charitable institutions for enhancement of 
their proper purposes by excluding the interest revenues would quite 
likely reduce borrowing costs of such public institutions for obvious 
reasons including the ancillary consideration that it increases 
competitors in the marketplace for such institutional indebtedness. 
Creating such a modest incentive for foundations to lend (tax free) 
monies to public institutions is also beneficial because such 
institutions would then avoid the tortuous processes now extant to 
qualify their debt for municipal status allowed by other Code 
provisions.
    If a parishioner of mine, God forbid, is obligated by a court 
decree to pay alimony or child support and transfers property to 
satisfy any such obligation, there is irrefutable judicial authority 
which supports the income taxation of the transferor based upon the 
gain inherent in his transfer of property to satisfy his obligation. 
There is no significant difference between an ordinary debt and the 
annual mandatory pay out of private foundations (now fixed at 5%). Case 
law would deem a distribution of appreciated property by a foundation 
to satisfy this pay out obligation as a sale or exchange. The statute 
specifically provides that ``net investment income shall be determined 
under the principles of subtitle A.'' Despite the specific language of 
the cited Code provision, Internal Revenue regulations specifically 
provide that a distribution of appreciated property, treated as a 
qualifying distribution, is not a ``sale'' or other disposition, i.e., 
not a taxable event. While this certainly is a salutary regulation and 
helpful to the private foundation community, it is nowhere to be found 
within the statute and directly contradicts the literal rule, meaning 
that the Treasury Department set itself above Congressional draftsmen 
in addressing the problem it discovered. To allow such regulation to 
continue without statutory support and in contradiction of law, does 
not promote the integrity of statutory authority nor does it conform 
Treasury behavior to expected norms. It is my suggestion that this 
particular provision, upon review and analysis, be added by law to 
preserve some foundation principal and make the statutory language more 
principled.
    Apart from these regulatory flaws notated above, though helpful as 
they are, there are other statutory considerations addressed by 
Treasury Department regulations which also amend the law but to the 
detriment of the private foundation community. Again, the regulations 
have chosen to ignore language expressly written by Congress and seek 
revenue protecting regulations which are incongruous to the relief 
described above. It almost seems as if there were two complete sets of 
draftsmen for these regulations, those who favored reducing the 
exposure and liability of private foundations and those which favored 
their taxation. Whichever group was involved, it is time for Congress 
to reevaluate whether or not all these particular omissions (as 
corrected by regulations) should be confirmed or repealed in that they 
run counter to the present philosophy exhibited by the President's tax 
plan to reduce the tax burden on private foundations.
    The specific statutory language precludes ``capital loss 
carryovers'' in connection with the computation of net capital gain 
income. Based upon a careful reading of the rules governing capital 
gain taxation, there is a plain distinction between a carryover, 
provided for by existing law, and a carryback, not now provided for by 
the excise tax on investment income. Despite the absence of the term 
``carryback'' in the statute, the applicable regulations have 
nevertheless chosen to insert that word and that principle to dilute 
the effect of the Congressional omission by expressly providing that a 
current year's capital loss may not be used to reduce taxable gains 
realized in a prior taxable year. It is suggested that this policy 
question be resolved in favor of foundations and the policy of tax 
relief evidenced by the tax reduction proposal expanded to allow the 
use of net capitol losses in prior or future taxable years. It is 
therefore suggested that the ``no carry forward'' barrier for losses be 
amended to grant such minor relief for the future. One has to merely 
open the pages of the many ``bear'' journals to see some see the stock 
market as quite unstable. Denying the full utilization of net capital 
losses acts as a hindrance to prudent financial investments by 
foundation managers and their professional advisors.
    The statute specifically provides that the tax on capital gains 
applies only with respect to property ``used for'' the production of 
interest, dividends, royalties, etc. Despite this express provision 
limiting the type of property whose capital gain is subject to tax, it 
appears from the tax literature, and text writers, that the government 
asserts the right to tax property which yields none of these forms of 
investment income. The authority for such assertion of liability arises 
from regulations which authorize the taxation of capital gains which 
arise solely through appreciation although the property is not or was 
not actually so used.
    Real estate is commonly acquired for investment purposes, though 
not income producing via rents or royalties, and often held solely for 
its appreciation potential. It seems that with sharp change in 
investment philosophy for charities, viz, moving towards a total return 
portfolio, no longer balanced between ``income'' and capital 
appreciation, a revised tax statute should assure the foundation 
community that capital gains from property which yielded, during the 
taxable year, no interest, no dividends, no rents or no royalties, are 
exempt from capital gains tax when such are realized.
    One last provision should be addressed because it again runs 
completely counter to the statement in the statute that the 
``principles of subtitle A'' are to be followed in determining 
liability respecting the excise tax on investment income. The rules 
governing the income taxation of trusts, which make charitable 
distributions, are very clear. If a trust has a governing instrument 
which provides for a distribution to a charitable organization, or for 
charitable purposes, the trust is entitled to an income tax charitable 
deduction for the amount paid for that purpose. The income tax rules 
governing such payments specifically preclude the inclusion of any such 
amounts in the income of the donee charity and also remove from the 
donee charity the onus of the characterization of the amount so 
distributed. Thus, if a decedent, in year 2000, upon death created and 
funded a charitable lead trust, the amounts distributed by the 
charitable lead trust, to a private foundation, would be deductible by 
the charitable lead trust in the computation of its taxable income. 
Under the provisions of existing law, because the trust claimed and was 
entitled to claim a charitable deduction, the includability and 
characterization rules, otherwise invoked by a trust distribution, are 
specifically barred from application by law (sec. 663(a)). Nonetheless, 
Treasury Department regulations would treat the annuity amount received 
by a private foundation, in for example, 2005, as subject to the 4940 
tax. This regulation purports to distinguish between trusts making 
charitable distributions which were funded before 1969 and those funded 
after 1969, which appears to be a highly arbitrary determination 
(unless some law occurred at that time which authorized such a 
distinction). But even if such a law did so provide, there is nothing 
within sec. 4940 which cross references to the trust taxation 
provisions so as to preclude the application of sec. 663(a) to a 
charitable lead trust distribution. But Treasury Department regulations 
demand that the amounts which are received by a private foundation from 
a post 1969 charitable lead trust be included in the computation of tax 
liability under Sec. 4940. Again, this is yet another example of these 
regulations, taken in sum, violating basic legal precept that 
interpretative regulations should follow closely the statutory text. 
Regulations, according to the esteemed Carl Lewellyn, are an agency's 
performance of ``interstitial rites'' and not a revision of principles 
Congress chose (or forgot) to enact. Regulations do not represent an 
opportunity of the Treasury Department to alter congressional policies 
or congressional language which was omitted by law, whatever the reason 
for the omission. These Treasury regulations -cited above -are contrary 
to principle, embodied in the Code, and need to be taken into account 
in your consideration of rate reduction.

    Yours in Christ,
                                               Rev. VBB, SJ
      

                                

Statement of Center for a Sustainable Economy

    Embargoed until 9:00 a.m. Thursday, February 3.
    Contact: Andrew Hoerner, 202-234-9665, [email protected]
    Organization: Center for a Sustainable Economy
    Full Text: The full text of the study can be downloaded 
from http://www.sustainableeconomy.org/resources.html
    Context: Next week the President will release a new package 
of tax incentives for clean energy as part of his climate plan. 
These credits have been controversial--embraced by Al Gore, and 
attacked by, e.g., the Cato Institute, as uneconomic. This 
study finds that the economic benefits of such credits outweigh 
the cost by more than five times--even ignoring the 
environmental benefits.

Study Finds Economic and Environmental Benefits from Tax Incentives for 
Energy Efficiency and Renewable Energy

    In a ground-breaking approach to measuring the costs and 
benefits of technology investments, the Center for a 
Sustainable Economy (CSE) released a study today showing net 
economic gains in addition to the environmental benefits 
expected from the President's proposed tax credits for energy 
efficiency. The U.S., long recognized as world leader in 
innovation and industry, has fallen behind its competitors in 
the areas of energy efficiency and renewable energy. ``This 
study shows that measures to protect the climate can also 
benefit the economy,'' says study author J. Andrew Hoerner. 
``We found the tax credits would have non-environmental 
economic benefits that pay for the credits five times over.'' 
The U.S. has been lagging behind Europe and Japan in the 
deployment of many clean energy technologies. The 
Administration's proposed tax incentives would help reverse 
this trend by making it easier for Americans to invest in 
efficient homes, vehicles, building equipment, and renewable 
energy, such as wind and biomass.
    The Climate Change Technology Initiative included tax 
incentives with an estimated revenue cost of $6.4 billion.\1\ 
The purpose of these incentives was to promote a range of 
energy efficiency and renewable energy technologies, including 
high-mileage vehicles, energy-efficient buildings and homes, 
cogeneration (combined heat and power) facilities, and solar, 
wind and biomass energy. In order to evaluate the economic 
costs and benefits of the credits, CSE estimated the price and 
quantity of each technology produced with and without the 
credit, based on a detailed survey of over 80 experts in the 
six technologies from industry, academia, NGOs and government. 
``This methodology is a way to represent the consensus of the 
best thinking from experts on these technologies,'' said 
Hoerner.
---------------------------------------------------------------------------
    \1\ Estimate by U.S. Joint Committee on Taxation of 
Administration's FY2000 proposals (released in February 1999). CSE's 
estimate of the cost is $5.7 billion.
---------------------------------------------------------------------------
    The study, Assessing Tax Incentives for Clean Energy: A 
Survey of Experts Approach, by J. Andrew Hoerner and Avery 
Gilbert, has the potential to breach the stalemate that has 
long characterized debate over federal incentives for clean 
energy technologies. By assessing the long-term market 
transformation effect of the tax credits (as part of a larger 
clean energy policy), the study found that an expenditure of 
$5.7 billion on the tax incentives would:
     Cause reductions in the price of the technologies 
receiving the credits that are greater then the cost of the 
credit to the government;
     Have non-environmental economic benefits that 
exceed the cost of the credits (The present value of the non-
environmental economic benefits will be roughly five times the 
cost of the credit over the 2000-2018 period. In addition, 
consumer savings from reduced energy bills would amount to $74 
billion between 2000-2018);
     Cut local air pollution emissions to a degree that 
would save Americans two times as much in health care costs as 
the U.S. government would spend on the credits.
     Result in 116 million metric tons of carbon 
emissions reductions between 2000-2018. Although the carbon 
dioxide emission reductions from the credits in 2012 are still 
small (3 to 4 percent of the emission reductions that would be 
required under the Kyoto Protocol), the equipment installed as 
a result of the credits will continue to produce emissions 
savings over lives ranging up to 60 years. When these lifetime 
reductions are considered, carbon savings are achieved at 
approximately $11/ton. This compares favorably with the cost of 
achieving emission reductions through international trading as 
estimated by the Council of Economic Advisors.
    It has often been claimed that most of the benefits from 
credits such as these go to people who would have purchased the 
equipment anyway. This study confirms that, during the period 
of the credit, the direct benefits go primarily to the 
taxpayers who would have purchased the equipment or energy in 
any case. The study nonetheless finds that the benefits to 
those who actually take the credit are greater than the cost of 
the credit and that the benefits to society at large in the 
form of lower prices for clean energy technologies and 
improvements in related technologies, as well as local 
environmental benefits, are also greater than the cost to the 
government of the credits.

Center for a Sustainable Economy is a non-profit non-partisan 
research and policy organization that promotes innovative 
market-based approaches to achieving a sustainable economy--one 
that integrates long-term economic prosperity, environmental 
quality and social fairness.
      

                                

Assessing Tax Incentives for Clean Energy Technologies:

--A Survey of Experts Approach--

    Abstract

    Some analysts regard tax incentives for environmentally 
beneficial technologies as necessary to jumpstart new clean 
technologies; others see them as wasteful subsidies to the 
benefited industries. The magnitude of public benefits from a 
particular tax incentive provision depends on the nature of the 
market, the impact of the provision on the process of 
technological change, and the value of the environmental harm 
averted. Whether public benefits are greater or less than the 
revenue cost of a given tax subsidy is an empirical question 
that must be decided on a case-by-case basis.
    This paper uses a survey-of-experts (single-round Delphi 
Analysis) approach to estimating the impact of the tax 
incentive portion of the Climate Change Technology Initiative 
(CCTI) proposed by the Administration as part of the fiscal 
2000 budget. Based on the responses of a panel of 81 experts 
(at least ten per technology) drawn roughly equally from 
industry, government, academia and the non governmental 
organization (NGO) community, we provide mean forecasts for 
quantity and price of each of the technologies covered by the 
CCTI tax incentives with and without the tax package. These 
price and quantity estimates are then used to calculate the 
increase in consumer surplus in the market for that technology. 
We also asked the panel to estimate any spillover benefits from 
credit-induced technological progress on the efficiency of 
products not receiving the credit.
    To be effective the tax credits cannot be enacted alone. 
Instead they must be part of a larger policy effort to 
stimulate the targeted technologies. Because this is true we 
did not attempt to estimate the impact of the credit absent 
additional policies that help counter other types of barriers 
to the penetration of the technologies. Instead, we assumed 
that a host of measures and policies to facilitate the market 
penetration of the technologies would be introduced and then 
asked our panel of experts what the additional penetration 
might be with a tax credit.
    We conclude first that the credits are likely to have a 
revenue cost about 13 percent less than estimated by the 
Congress's Joint Committee on Taxation (JCT). This modest 
change disguises much greater disagreement on a provision-by-
provision basis, with our estimates of the cost of the solar 
and the wind and biomass credits being more than double JCT's 
estimates, with all other provisions costing significantly 
less. Four of the six proposed credits would provide non-
environmental economic benefits to the public more than 
sufficient to offset the cost of the credits: the credits for 
fuel-efficient vehicles, energy-efficient homes, energy-
efficient building equipment, and combined heat and power 
systems. The credits for wind and biomass power and for rooftop 
solar systems have estimated non-environmental economic 
benefits to consumers comparable to their revenue cost.
    Based on the expert forecasts of the quantity of each 
technology adopted we then estimated the energy savings 
attributable to each credit for each fuel type. The 
environmental value of these fuel savings were then monetized 
based on the high, medium and low estimates from a literature 
search and assessment by Viscusi, et al. (1994). These are 
local U.S. environmental benefits and do not include any 
benefit from reductions in impacts on the global climate. We 
conclude that, based on non-environmental benefits and local 
environmental benefits alone, the benefit/cost ratio is greater 
than one for all six credits, ranging from 1.5 to 1 (solar) to 
75 to 1 (vehicles). These estimates use market-rate 
discounting. If lower social discount rates are used, the 
benefit is even higher.
    However, it should be observed that in every case the 
precise level of public benefit is highly uncertain. Moreover, 
most of the benefits from accelerated technology development 
accrue from the continued use of that technology after the 
credits expire. In some cases, especially the vehicles credit, 
other energy policies need to be adjusted to prevent the 
effectiveness of the credit benefits from being undermined. 
Finally, the value of the local environmental benefit from the 
electricity oriented technologies (CHP, wind and biomass, PV's, 
and some heating and cooling equipment) is greatly reduced if 
the technologies are presumed to displace new natural gas fired 
generating plants rather than the average fuel mix.
    In addition, we estimate the CCTI tax incentive package 
would reduce carbon emissions by 116 million metric tons over 
the forecast period 2000-2018. Estimates of the value of this 
reduction are provided on a credit-by-credit basis for a range 
of alternative carbon emission damage values. The cost of 
credit-induced carbon savings averages eleven dollars per ton 
of carbon saved over the lifetime of the equipment, a value 
that compares favorably with the cost of abatement through 
international trading as estimated by the President's Council 
of Economic Advisors.
    The following table summarizes the present value of the 
costs and benefits of the CCTI tax incentives. It assumes that 
a package of low-cost technology promotion measures is enacted 
along with the CCTI incentives.

                                                           Value of Non-environmental and Environmental Benefits from the Tax Credits,
                                                                                   2000-2018 (millions 1999$)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     Non-Environmental Costs and                                        Environmental Benefits
----------------------------------------------------------------              Benefits              --------------------------------------------------------------------------------------------
                                                                ------------------------------------ Local Environmental Benefits                     Climate Related Benefits
                                                                                                    --------------------------------------------------------------------------------------------
                                                                               Consumer                                 Local       $5/ton     $5/ton    20$/ton    0$/ton   100$/ton   100$/ton
                                                                 Expenditure   Surplus    Spillover      Local      Environmental   Direct   spillover   Direct   Spillover   Direct   Spillover
                                                                              Spillover  Benefits**  Environmental     Benefits     Carbon     Carbon    Carbon     Carbon    Carbon     Carbon
                                                                                                        Benefit      (Spillover)    Benefit   Benefit    Benefit   Benefit    Benefit   Benefit
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Vehicles.......................................................      1,181      20,197     67,232           550            517          43         40       172        161       859        807
Homes..........................................................         35         115        728         33/7*        0.05/0*     0.8/.6*   0.0/0.0*      3/2*      0.02/    17/14*   0.1/0.0*
                                                                                                                                                                     0.01*
Building.......................................................        108         146        N/A        190/18            N/A         6/5        N/A     24/19        N/A    120/96        N/A
Eqpmt..........................................................
CHP............................................................        208       4,674        N/A      5,016/46            N/A       92/58        N/A   366/229        N/A     1831/        N/A
                                                                                                                                                                                1144
Solar..........................................................        358         406        N/A         132/8            N/A         9/7        N/A     38/30        N/A   189/151        N/A
Wind &.........................................................      3,718       2,014      5,962      5,800/53            N/A      106/66        N/A   422/264        N/A     2112/        N/A
Biomass........................................................                                                                                                                 1320
Total..........................................................      5,608      27,552     73,921    11,721/682            517     256/180         40    1,025/        161    5,127/       807
                                                                                                                                                            716                3,584
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
*The second figure in each cell is the value of benefit when we assume that electricity savings displaces emissions only from natural gas combustion rather than the forecast average fuel mix.
** Only the economic value of the spillover benefits from hybrid vehicles, energy efficient homes, and biomass are included in this table Spillovers from wind and solar technologies are not
  included because of the difficulty distinguishing social benefits from mere redistribution of income.

      

                                

Statement of Clark/Bardes, Dallas, TX

Introduction

    Clark/Bardes appreciates the opportunity to present this 
statement to the House Ways and Means Committee for the record 
of its hearing on the Administration's FY 2001 budget 
proposals. Our statement focuses specifically on a proposal 
that would increase taxes on companies purchasing insurance 
covering the lives of their employees.
    Clark/Bardes is a publicly traded company headquartered in 
Dallas, Texas, and with offices around the country. We design, 
market, and administer insurance-based employee benefit 
financing programs. Our clients, which include a broad range of 
businesses, use insurance products as assets to offset the 
liabilities of employee benefits and to supplement and secure 
benefits for key executives.
    Clark/Bardes strongly opposes the Administration's proposed 
tax increase on ``corporate-owned life insurance'' (``COLI''). 
The same proposal also was floated by the Administration in its 
FY 1999 and 2000 budget submissions and wisely was rejected by 
Congress. Perhaps in recognition of the fact that Congress has 
found no coherent tax policy justification for such a change, 
the Administration has branded COLI as a ``corporate tax 
shelter''--an egregious characterization intended to build 
visceral support for the proposal. Regardless of the 
Administration's rhetoric, the reasons for rejecting the COLI 
tax increase remain the same:
     Employer-owned life insurance remains an effective 
means for businesses to finance their growing retiree health 
and benefit obligations.
     The Administration's proposal shares none of the 
same tax policy concerns that drove Congressional action on 
COLI in 1996 and 1997 legislation.
     The current-law tax treatment of COLI was 
sanctioned explicitly by Congress in the 1996 and 1997 
legislation.
     The Administration's proposal is a thinly 
disguised attempt to tax the ``inside buildup'' on insurance 
policies--i.e., a tax on a long-standing means of savings.
     The Administration's proposal represents yet 
another move by the Administration--along a slippery slope--to 
deny deductions for ordinary and necessary business expenses.

Use of Employer-Owned Life Insurance

    Before turning to the Administration's proposal, Clark/
Bardes believes it is important to provide background 
information on employer-owned life insurance--a business 
practice that does not appear to be well understood.
    Many employers, large and small, provide health and other 
benefits to their retired employees. While ERISA rules 
generally make ``dedicated'' funding impossible, employers 
often seek to establish a method of financing these 
obligations. This allows them not only to secure a source of 
funds for these payments but also to offset the impact of 
financial accounting rules that require employers to include 
the present value of the projected future retiree benefits in 
their annual financial statements.
    Life insurance provides an effective means for businesses 
to finance their retiree benefits. Consultants, like Clark/
Bardes, and life insurance companies work with employers to 
develop programs to enable the employers to predict retiree 
health benefit needs and match them with proceeds payable under 
the life insurance programs.
    A simplified example may help to illustrate. ABC Company 
guarantees its employees a generous health benefits package 
upon retirement. Like all employers, ABC Company is required to 
book a liability on its balance sheet for benefits costs 
related to the eventual retirement of its employees, and needs 
to find ways to fund these obligations. As a solution, ABC 
Company takes out a series of life insurance policies on its 
employees. It pays level insurance premiums to the insurance 
carrier each year. The cash value on the life insurance policy 
accumulates on a tax-deferred basis and can be identified as a 
specific source of funds to meet benefit liabilities. In the 
event that the contract is surrendered, ABC Company pays tax on 
any gain in the policy. In the event that covered employees 
die, ABC Company receives the death benefit and uses these 
funds to offset the cost of benefits payments to its retired 
employees. Actuaries are able to match closely the amount of 
insurance necessary to fund ABC Company's liabilities.
    The Administration's COLI proposal effectively would take 
away an employer's ability to finance retiree benefit programs 
using life insurance, and thus could force businesses to 
severely limit or discontinue these programs. It is ironic that 
the President's proposal would hamstring a legitimate means of 
funding post-retirement benefits when a major focus of Congress 
is to encourage private sector solutions to provide for the 
needs of our retirees.

The Administration's COLI Proposal

    The Administration's proposal to tax employer-owned life 
insurance should be viewed in light of the basic tax rules 
governing life insurance and interest expense and recent 
changes made by Congress to the tax treatment of COLI.
    Since 1913, amounts paid due to the death of an insured 
person have been excluded from Federal gross income. The 
present-law provision providing this exclusion is section 101 
of the Internal Revenue Code of 1986, as amended (the 
``Code''). Amounts paid upon the surrender of a life insurance 
policy are taxable to the extent the amount received exceeds 
the aggregate amount of premiums or other consideration paid 
for the policy, pursuant to section 72(e) of the Code.
    Section 163 of the Code generally allows deductions for 
interest paid on genuine indebtedness. However, sections 
264(a)(2) and (a)(3) of the Code, enacted in 1964, prohibit 
deductions if the interest is paid pursuant to (i) a single 
premium life insurance contract, or (ii) a plan of purchase 
that contemplates the systematic direct or indirect borrowing 
of part or all of the increases in the cash value of such 
contract, unless the requirements of an applicable exception to 
the disallowance rule are satisfied. One of the exceptions to 
this interest disallowance provision, known as the ``four-out-
of-seven'' rule, is satisfied if no part of four of the annual 
premiums due during a seven-year period (beginning with the 
date the first premium on the contract is paid) is paid by 
means of indebtedness.
    The Tax Reform Act of 1986 (the ``1986 Act'') amended 
section 264 of the Code to limit generally deductions for 
interest paid or accrued on debt with respect to COLI policies 
covering the life of any officer, employee, or individual who 
is financially interested in the taxpayer. Specifically, it 
denied deductions for interest to the extent that borrowing 
levels on corporate-owned policies exceeded $50,000 of cash 
surrender value per insured officer, employee, or financially 
interested individual.
    Congress in the Health Insurance Portability and 
Accountability Act of 1996 (the ``1996 Act'') eliminated 
deductions for interest paid on loans taken against the tax-
free earnings under the life insurance contract. Specifically, 
the 1996 Act denied a deduction for interest paid or accrued on 
any indebtedness with respect to any life insurance policies 
covering an officer, employee, or financially interested 
individual of the policy owner. The 1996 Act provided a phase-
out rule for indebtedness on existing COLI contracts, 
permitting continued interest deductions in declining 
percentages through 1998. After 1998, no deductions were 
permitted.
    The 1996 Act provided an exception for certain COLI 
contracts. Specifically, the Act continued to allow deductions 
with respect to indebtedness on COLI covering up to 20 ``key 
persons,'' \1\ defined generally as an officer or a 20-percent 
owner of the policy owner, subject to the $50,000 indebtedness 
limit, and further subject to a restriction that the rate of 
interest paid on the policies cannot exceed the Moody's 
Corporate Bond Yield Average-Monthly Corporates for each month 
interest is paid or accrued. Other than this one exception, 
there is no longer any ability for a corporation to deduct 
interest on a life insurance policy covering its officers, 
directors, employees, or 20-percent owners.
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    \1\ For many companies, the effective key person limit under this 
rule is five employees. See section 264(b)(3).
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    The Taxpayer Relief Act of 1997 (the ``1997 Act'') added 
section 264(f) to the Code. This provision generally disallows 
a deduction for the portion of a taxpayer's total interest 
expense that is allocated pro rata to the excess of the cash 
surrender value of the taxpayer's life insurance policies over 
the amounts of any loans with respect to the policies, 
effective for policies issued after June 8, 1997. However, 
section 264(f)(4) provides a broad exception for policies 
covering 20-percent owners, officers, directors, or employees 
of the owner of the policy. Thus, the interest deduction 
disallowance provision in the 1997 Act generally affected only 
COLI programs covering the lives of non-employees.
    The COLI proposal in the Administration's FY 2001 budget, 
submitted on February 7, 2000, would extend the section 264(f) 
interest deduction disallowance to COLI programs covering the 
lives of employees. \2\ The proposal therefore would apply a 
proportionate interest expense disallowance based on all COLI 
cash surrender values. The exact amount of the interest 
disallowance would depend on the ratio of the average cash 
values of the taxpayer's non-leveraged life insurance policies 
to the average adjusted bases of all other assets.
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    \2\ By eliminating the section 264(f)(4) exception that currently 
exempts COLI programs covering the lives of employees, officers, and 
directors.

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Lack of Tax Policy Justification

    The Treasury Department, in its ``Green Book'' explanation 
of the revenue proposals in the Administration's FY 2001 
budget, implies that the COLI measures taken by Congress in 
1996 and 1997 were incomplete in accomplishing their intended 
goals. A closer inspection of the tax policy considerations 
that gave rise to the 1996 and 1997 changes would suggest 
otherwise.
    The 1996 Act changes to the tax treatment of COLI focused 
on leveraged COLI transactions (i.e., transactions involving 
borrowings against the value of the life insurance policies), 
which Congress believed represented an inappropriate and 
unintended application of the tax rules. The ``Blue Book'' 
explanation of the 1996 Act, prepared by the staff of the Joint 
Committee on Taxation, states that leveraged COLI programs 
``could be viewed as the economic equivalent of a tax-free 
savings account owned by the company into which it pays itself 
tax-deductible interest.'' \3\ The Blue Book further states:
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    \3\ Joint Committee on Taxation, General Explanation of Tax 
Legislation Enacted in the 104th Congress (JCS-12-96), December 18, 
1996, p. 363.
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    . . .Congress felt that it is not appropriate to permit a 
deduction for interest that is funding the increase in value of 
an asset of which the taxpayer is the ultimate beneficiary as 
recipient of the proceeds upon the insured person's death. 
Interest paid by the taxpayer on a loan under a life insurance 
policy can be viewed as funding the inside buildup of the 
policy. The taxpayer is indirectly paying the interest to 
itself, through the increase in value of the policy of which 
the taxpayer is the beneficiary.\4\
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    \4\ Id, at 364.
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    The 1997 Act COLI provision grew out of concerns over plans 
by a particular taxpayer, Fannie Mae, to acquire corporate-
owned life insurance on the lives of its mortgage holders. The 
1997 Act changes, therefore, specifically targeted COLI 
programs developed with respect to non-employees. Both the 
House Ways and Means Committee Report and the Senate Finance 
Committee Report on the 1997 Act discuss an example involving a 
Fannie Mae-type fact pattern:
    If a mortgage lender can . . . buy a cash value life 
insurance policy on the lives of mortgage borrowers, the lender 
may be able to deduct premiums or interest on debt with respect 
to such a contract, if no other deduction disallowance rule or 
principle of tax law applies to limit the deductions. The 
premiums or interest could be deductible even after the 
individual's mortgage loan is sold to another lender or to a 
mortgage pool. If the loan were sold to a second lender, the 
second lender might also be able to buy a cash value life 
insurance contract on the life of the borrower, and to deduct 
premiums or interest with respect to that contract.\5\
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    \5\ H.R. Rep. No. 105-148, 105th Cong., 1st Sess. p. 501; S. Rep. 
No. 105-33, 105th Cong., 1st Sess., p. 186.
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    The COLI proposal in the Administration's FY 2001 budget 
lacks any similarly compelling tax policy justification. Unlike 
the 1996 Act provision targeting leveraged COLI programs, the 
Administration's proposal would apply where there is no link 
between loan interest and the COLI program.\6\ And unlike the 
1997 Act provision targeting the use of COLI with respect to 
non-employees, this proposal does not involve a newly conceived 
use of COLI.
---------------------------------------------------------------------------
    \6\ Current law is quite specific that interest deductions 
resulting from both direct and indirect borrowing, i.e., using the 
policy as collateral, are disallowed. Sec. 264(a)(3).
---------------------------------------------------------------------------
    In explaining the rationale underlying the proposal, the 
Treasury Department argues that the ``inside buildup'' on life 
insurance policies in COLI programs gives rise to ``tax 
arbitrage benefits'' for leveraged businesses.\7\ Treasury 
argues that businesses use inside buildup on COLI policies to 
fund deductible interest payments, thus jumping to the 
conclusion that COLI considerations govern decisions regarding 
when businesses incur debt. This view is clearly erroneous. 
Businesses incur debt for business reasons, such as business 
expansion.
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    \7\ General Explanation of the Administration's Fiscal Year 2001 
Revenue Proposals, Department of the Treasury, February 2000, p.137.

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COLI is Not a ``Tax Shelter''

    Clark/Bardes strongly objects to the Administration's 
characterization of non-leveraged COLI as a ``corporate tax 
shelter.'' The penalty provisions of the Internal Revenue Code 
define a tax shelter as any entity, plan, or arrangement with 
respect to which tax avoidance or evasion is a significant 
purpose.\8\ A separate proposal in the Administration's FY 2001 
budget proposes a new definition of ``corporate tax shelter'' 
under section 6662 that would apply to ``attempts to obtain a 
tax benefit'' in a ``tax-avoidance transaction,'' defined as 
any transaction in which the reasonably expected pre-tax profit 
is insignificant relative to the reasonably expected net tax 
benefits.\9\
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    \8\ Section 6662(d)(2)(C)(iii).
    \9\ As a separate matter, Clark/Bardes believes the 
Administration's proposed new definition of ``corporate tax shelter'' 
is unnecessary, ill-advised, and could be broadly applied by IRS agents 
to attack many legitimate business transactions.
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    It is difficult to see how traditional COLI programs might 
reasonably be viewed as meeting any of these ``corporate tax 
shelter'' definitions. As discussed above, the Administration's 
proposal would deny interest deductions on borrowings totally 
unrelated to COLI, for example, where a company owning life 
insurance policies on the lives of employees borrows money to 
construct a new manufacturing plant, or conversely, where a 
company that borrowed ten years ago to construct a plant now 
considers purchasing life insurance to help finance retiree 
benefits. It is difficult to see how these disparate actions 
could be collapsed and viewed as a tax-avoidance transaction. 
Does Treasury seriously suggest that a company holding life 
insurance that decides to borrow to fund construction of a new 
plant is motivated by tax considerations? The Treasury proposal 
would completely disregard the obvious business purpose 
underlying such a decision.
    Under a broader view, a ``tax shelter'' might be thought of 
as an arrangement involving an unintended application of the 
tax laws. It is impossible to argue that current COLI programs 
are unintended. Few other areas of the tax law have received as 
thorough scrutiny in recent years. In the 1996 Act, Congress 
explicitly allowed COLI programs to continue so long as they 
were not leveraged. In the 1997 Act, Congress carefully crafted 
a specific exception (designed to preserve longstanding use of 
unleveraged COLI) to the pro rata interest expense disallowance 
provisions for COLI programs covering employees. In other 
words, current COLI programs involve an intended application of 
the tax law.

Attack on ``Inside Buildup,'' Savings

    The Administration's COLI proposal, at its core, is not 
about ``tax shelters'' at all. Rather, it is a thinly veiled 
attack on the very heart of traditional permanent life 
insurance--that is, the ``inside buildup'' of credits (or cash 
value) within these policies that permits policyholders to pay 
level premiums over the lives of covered individuals. Although 
couched as a limitation on interest expense deductions, the 
proposal generally would have the same effect as a direct tax 
on inside buildup. Thus, the proposal would reverse the 
fundamental tax treatment of level-premium life insurance that 
has been in place since 1913.
    Congress in the past has rejected proposals to alter the 
tax treatment of inside buildup, and for good reason. The 
investment element inherent in permanent life insurance is a 
significant form of savings. Congress and the Administration in 
recent years have worked together in the opposite direction, 
considering new incentives for savings and long-term investment 
and removing obvious obstacles. It is odd that the 
Administration at this time would propose making it more 
difficult to save and invest through life insurance.

Inappropriate Limitation on Business Deductions

    In some respects, Treasury's proposed denial of deductions 
for interest expenses for companies owning life insurance is 
not surprising. This proposal comes on the heels of other 
Clinton Administration proposals to chip away at deductions for 
expenses that long have been treated as ordinary and necessary 
costs of doing business. Another recent example is the 
provision in the Administration's FY 2001 budget that would 
deny deductions for damages paid by companies to plaintiffs 
groups.
    But the proposal is troubling nonetheless, as illustrated 
by a simple example. The XYX company in 1998 borrows funds to 
build a new manufacturing facility. The XYZ company in 1998 and 
1999 is able to deduct interest paid on these borrowings. In 
2000, the XYZ company, responding to concerns over mounting 
future retiree health obligations, purchases insurance on the 
lives of its employees. IRS agents tell the XYZ company that it 
has just entered into a ``corporate tax shelter.'' Suddenly, 
the XYZ company finds that a portion of the interest on the 
1998 loan is no longer viewed by the government as an ordinary 
and necessary business expense. XYZ therefore is taxed, 
retroactively, on its 1998 borrowing.
    The proposal becomes even more troubling when one considers 
the logical extensions of the Administration's rationale, which 
seems to be to deny interest deductions when a taxpayer at the 
same time enjoys the benefits of tax deferral. Might the IRS, 
using the same reasoning, someday seek to deny home mortgage 
interest deductions for individuals who also own life 
insurance? Might the government deny deductions for medical 
expenses for individuals that enjoy tax-preferred accumulations 
of earnings in 401(k) accounts or IRAs?

Conclusion

    Clark/Bardes respectfully urges the Committee on Ways and 
Means to reject the Administration's misguided COLI proposal, 
as it did in 1998 and 1999. As discussed above, the 
Administration once again has failed to articulate a clear or 
compelling tax policy concern over the current-law rules, and 
has sought to couch COLI, altogether inappropriately, as a 
``tax shelter.'' If enacted, the Administration's proposal 
would represent a significant departure from current law and 
longstanding tax policy regarding the treatment of life 
insurance. It would have a significantly adverse impact on the 
ability of businesses to solve a variety of needs including the 
ability to finance meaningful retiree health benefits. It also 
would provide a disincentive for savings and long-term 
investment and would represent yet another attack on deductions 
for ordinary and necessary business expenses.
      

                                

Statement of the Coalition for the Fair Taxation of Business 
Transactions \1\

    The Coalition for the Fair Taxation of Business 
Transactions (the ``Coalition'') is composed of U.S. companies 
representing a broad cross-section of industries. The Coalition 
is opposed to the broad-based ``corporate tax shelter'' 
provisions proposed by the Administration in their FY2001 
budget because they believe that the proposals, if enacted, 
would have a far-reaching effect that unnecessarily harms 
legitimate business transactions. To the extent that abuses 
exist, current administrative remedies are available and 
sufficient to curtail overly aggressive tax shelter activity. 
In addition, IRS has been very successful in attacking tax 
shelters through the courts, which themselves have issued 
criteria for assessing potential tax shelters that should prove 
to be effective deterrents to abuse. Finally, if Congress feels 
compelled to legislate in this area, they should narrowly limit 
the category of transactions classified as corporate tax 
shelters so as not to penalize legitimate business 
transactions. This would necessitate recognizing the business 
purpose of the transaction.
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    \1\ This testimony was prepared by Arthur Andersen on behalf of the 
Coalition for the Fair Taxation of Business Transactions.
---------------------------------------------------------------------------
    This paper contains the Coalition's specific concerns with 
the President's FY2001 corporate tax shelter proposals. The 
Coalition has previously submitted testimony to the House Ways 
and Means and Senate Finance Committees with respect to the 
proposals contained in the Administration's FY2000 Budget, 
Treasury's White Paper and the Joint Committee Study.

I. Introduction

    The Administration's FY2001 Budget, submitted to Congress 
on February 7, 2000, contains several proposals concerning the 
definition of and the penalties for corporate tax shelters. 
These recommendations fall into two general categories: those 
that affect corporate taxpayers that engage in tax shelter 
activity and those that affect other parties, such as tax 
shelter promoters and tax advisers.
     Last year, on July 1, 1999, the Department of Treasury 
issued its much-publicized ``White Paper'' \2\ on corporate tax 
shelters. Treasury's White Paper analyzes corporate tax shelter 
activity and proposes recommendations for modifying the 
Administration's corporate tax shelter proposals originally 
proposed in February 1999 as part of the FY2002 Budget. Many of 
Treasury's White Paper modifications have been incorporated in 
the Administration's FY2001 budget and are an improvement over 
the recommendations in the FY2000 budget. However, the 
substance of the Administration's underlying proposals remains 
problematic. The recommendations continue to characterize too 
broad a classification of activities as tax shelters. To this 
end, Treasury has proposed a set of recommendations that, 
instead of narrowly stopping abusive shelter schemes, will hit 
legitimate transactions, impose penalties on unsuspecting 
taxpayers, require burdensome disclosures and generally allow 
IRS agents to call into question virtually any transaction 
undertaken by a corporate taxpayer, regardless of the purpose, 
if it reduces the corporation's taxes.
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    \2\ Department of the Treasury, The Problem of Corporate Tax 
Shelters: Discussion, Analysis and Legislative Proposals, July 1999.
---------------------------------------------------------------------------
     Furthermore, we believe the IRS currently has the 
necessary tools to challenge abusive transactions and 
additional statutory changes are unwarranted. The IRS has the 
authority to issue administrative pronouncements (notices, 
rulings, or other announcements) to address perceived abusive 
transactions. In fact, the number of announcements the IRS has 
issued in the past few years addressing perceived tax shelter 
activity has been substantial. In addition, Treasury and the 
IRS have a wide range of general anti-abuse provisions already 
available to combat the perceived proliferation of corporate 
tax shelters. For example, if a taxpayer's method of accounting 
does not clearly reflect income, section 446(b) of the Code 
authorizes the IRS to disregard the taxpayer's method of 
accounting and to compute the taxpayer's income under a method 
of accounting it believes more clearly reflects income. Under 
section 482 of the Code, the IRS can allocate, distribute, or 
apportion income, deductions, credits and allowances between 
controlled taxpayers to prevent evasion of taxes or to 
accurately reflect their taxable income.
    Moreover, the IRS has recently announced the formation of a 
working group to identify and target corporate tax shelter 
activity. This group should enable the IRS to identify tax 
shelter activity more quickly and should be a deterrent to 
abusive tax shelter activity particularly given IRS' stated 
intent to impose penalties more often. This working group 
should provide a formidable resource when coupled with existing 
IRS authority to issue administrative pronouncements and 
general anti-abuse authority available to IRS and Treasury.
    Finally, as evidenced by recent court rulings, the IRS can 
and does challenge abusive transactions in the courts. The 
primary reason why it is so difficult to draft a broad-based 
tax shelter rule is because it is extremely difficult to 
provide a mechanism to evaluate a corporation's business 
purpose in a statutory framework. This is because evaluation of 
business purpose is a subjective evaluation.\3\ However, the 
courts can and routinely do effectively make this evaluation, 
which has resulted in several recent successful challenges of 
tax shelters by the IRS. Thus, we believe that the 
Administration's corporate tax shelter proposals are not 
warranted.\4\
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    \3\ As the Tax Court stated in the recent decision of Saba 
Partnership, et. al. v. Commissioner, T.C. Memo 1999-359, ``(a)n 
evaluation of the economic substance of the. . .2transactions requires: 
(1) A subjective inquiry whether the. . .carried out the transaction 
for a valid business purpose other that to obtain tax benefits; and (2) 
an objective inquiry whether the. . . transactions had practical 
economic effects other than the creation of tax benefits.'' at 111.
    \4\ See also Compaq Computer Corporation and Subsidiaries v. 
Commissioner of Internal Revenue, 113 T.C. No. 17 (Sept. 21, 1999); ACM 
Partnership v. Commissioner, 73 T.C.M. 2189 (1997), aff'd in part, 
rev'd in part, 157 F.3d 231 (3d Cir. 1998), cert. denied, 119 S.Ct 1251 
(1999); ASA Investerings v. Commissioner, 76 TCM 325 (1998); Laidlaw 
Transportation Inc., et al. V. Commissioner, T.C. Memo. 1998-232; The 
Limited Inc. v. Commissioner 113 T.C. No. 13 (1999); IES Industries 
Inc. v United States 84 AFTR2d Par. 99-5373 (1999); and United Parcel 
Service of America v. Commissioner 78 TCM 262 (1999).

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II. Tax Shelter Definition

     Central to the approach taken by the Administration is an 
enhanced definition of corporate tax shelter.\5\
---------------------------------------------------------------------------
    \5\ Under current law, a tax shelter is any entity, investment, 
plan, or arrangement with a significant purpose of avoiding or evading 
Federal income taxes. Section 6662(a)(2)(c)(iii).
---------------------------------------------------------------------------
     The definition of tax shelter is key to the penalty 
regimes contained in the proposals. In the Administration's 
budget, once a transaction is characterized as a tax shelter, 
the taxpayer can be subject to an increased substantial 
understatement penalty (40 percent), unless certain disclosure 
requirements are met. In addition, same test would be applied 
to disallow tax benefits from transactions that would be deemed 
to lack economic substance.
     The Administration's FY2001 Budget proposal would modify 
the existing tax shelter definition \6\ to provide that a 
corporate tax shelter would be any entity, plan, or arrangement 
in which a corporation obtained a ``tax benefit'' in a ``tax 
avoidance transaction.'' The proposal defines a ``tax benefit'' 
as a reduction, exclusion, avoidance or deferral of tax (or an 
increase in a refund) unless the benefit was ``clearly 
contemplated'' by the applicable Code provision. The proposal 
defines a ``tax avoidance transaction'' as any transaction in 
which the reasonably expected pre-tax profit (determined on a 
present value basis, after taking into account foreign taxes as 
expenses and transaction costs) of the transaction is 
insignificant relative to the reasonably expected net tax 
benefits (i.e., tax benefits in excess of the tax liability 
arising from the transaction, determined on a present value 
basis) of such transaction. Additionally, a financing 
transaction would be considered a tax avoidance transaction if 
the present value of the tax benefits of the taxpayer to whom 
the financing is provided are significantly in excess of the 
present value of the pre-tax profit or return of the person 
providing the financing.
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    \6\ For transactions entered into before August 6, 1997, a ``tax 
shelter'' is defined as a partnership or other entity, an investment 
plan or arrangement, or any other plan or arrangement if the principal 
purpose of the partnership, entity, plan, or arrangement is the 
avoidance or evasion of Federal income tax. The Taxpayer Relief Act of 
1997 amended section 6662(d)(2)(C)(ii) to provide a new definition of 
tax shelter for purposes of the substantial understatement penalty. 
Under this new definition of tax shelter, the tax avoidance purpose of 
an entity or arrangement need not be its principal purpose. Now a tax 
shelter is any entity, investment, plan, or arrangement with a 
significant purpose of avoiding or evading Federal income taxes. The 
new definition of tax shelter is effective for transactions entered 
into after August 5, 1997.
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     One need look no further than the proposed new definition 
of corporate tax shelter to find the genesis of the problems 
with the Administration's budget proposals. The Administration 
has proposed an objective standard for determining what is a 
corporate tax shelter in order to avoid an overdelegation of 
authority to the IRS. Nonetheless, the definition remains too 
broad. The new definition does not adequately deal with the 
numerous day-to-day business transactions that do not lend 
themselves to a pre-tax profit comparison that are not 
financing transactions.
     The Administration excludes tax benefits that are 
``clearly contemplated'' from consideration as tax shelters, 
but this standard is too vague to provide much relief from the 
broad application of the definition. In determining the 
application of the ``clearly contemplated'' exception, 
Congressional purpose, administrative interpretations, and 
interaction of the provision with other provisions are to be 
taken into account. This standard would provide an IRS agent 
with extraordinary leeway in making a determination that a 
transaction did not meet the clearly contemplated standard, 
which will inevitably result in increased confrontations 
between taxpayers and revenue agents and a backlog of 
litigation in the Tax Court.
     Thus, the Administration's proposed tax shelter definition 
would apply to a broad category of legitimate business 
transactions, which do not confer a direct profit stream. For 
example, a corporation may need to structure its affairs to 
conform to regulatory requirements or may reorganize its 
structure to gain access to certain foreign markets. A company 
may also restructure or reorganize to gain economies of scale. 
These transactions are motivated by business concerns, even 
though they do not directly produce a pre-tax economic return 
by themselves. If these legitimate transactions are done in a 
tax efficient manner, they apparently will be characterized 
automatically as a tax shelter because they do not produce a 
direct economic return. In addition, it is unclear as to what 
type of transaction will be affected by the proposal to deal 
with financing transactions other than a ``stepped-down 
preferred transaction,'' which has already been addressed in 
recent Treasury guidance.\7\
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    \7\ Notice 97-21, 1997-1 C.B. 651 and Prop. Treas. Reg. section 
1.7701(l).
---------------------------------------------------------------------------
     Although the Administration claims that their tax shelter 
definition is rooted in case law, citing ACM Partnership \8\, 
Compaq Computer \9\, and Winn-Dixie \10\, the Administration's 
test fails to include as essential part of the analysis that is 
common to all of these cases--whether despite the fact that 
there is little or no direct economic effect of the 
transaction, there is a valid business purpose. For example, 
the circuit court in ACM Partnership appeal states, ``(T)he 
inquiry into whether the taxpayer's transactions had sufficient 
economic substance to be respected for tax purposes turns on 
both the 'economic substance of the transaction' and the 
'subjective business motivation' behind them. However, these 
distinct aspects of the economic sham inquiry do not constitute 
discrete prongs of a 'rigid two-step analysis,' but rather 
represent related factors both of which inform the analysis of 
whether the transaction had sufficient substance, apart from 
its tax consequences, to be respected for tax purposes.'' \11\ 
Evaluating business purpose on a facts and circumstances basis 
is central to judicial application of the economic substance 
doctrine.
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    \8\ ACM Partnership v. Commissioner, 73 T.C.M. 2189 (1997), aff'd 
in part, rev'd in part, 157 F.3d 231 (3d Cir. 1998), cert. denied, 119 
S.Ct 1251 (1999).
    \9\ Compaq Computer Corporation and Subsidiaries v. Commissioner of 
Internal Revenue, 113 T.C. No. 17 (Sept. 21, 1999).
    \10\ Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. No. 21 
(1999).
    \11\ ACM at 247.

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III. Modified Substantial Understatement Penalty

    The Administration's budget proposal would increase the 
substantial understatement penalty from 20 percent to 40 
percent with respect to any item attributable to a corporate 
tax shelter.\12\ A corporation can reduce the 40 percent 
penalty to 20 percent by fulfilling specific disclosure 
requirements. Specifically, a taxpayer would be required to 
disclose a tax shelter transaction to the IRS National Office 
by filing a statement with the tax return describing the 
transaction. If the taxpayer meets a strengthened reasonable 
cause standard the penalty can be reduced from 20% to 0, even 
if the transaction ultimately is deemed to be a corporate tax 
shelter. The reasonable cause exception would be modified and 
strengthened by requiring that the taxpayer have a ``strong 
chance of sustaining its tax position'' (rather than ``more 
likely than not'').
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    \12\ Generally, Section 6662(a) of the Internal Revenue Code 
imposes a 20 percent penalty on the portion of an underpayment of tax 
attributable to a substantial understatement of income tax.
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     We commend the Administration for some of the improvements 
they have made to their FY2000 Budget Proposal. For example, in 
response to criticisms that the Coalition and others have made, 
they no longer propose eliminating the reasonable cause 
exception to the substantial understatement penalty. They also 
have eliminated the proposal to require that a tax shelter 
disclosure be made both 30 days after the transaction is 
completed, as well as with the tax return. Nonetheless, we 
remain concerned that the proposed 40 percent penalty is too 
harsh given the uncertainty that will result from the vague 
definition of ``corporate tax shelter'' in the Administration's 
proposal.
     Revenue agents, who have no downside, can threaten to 
propose adjustments based on alleged corporate tax shelter 
transactions to extract unreasonable concessions by the 
corporate taxpayer on other issues. Incidents of ``rogue'' 
revenue agents abusing their authority in efforts to extort 
unfair concessions and settlements are not limited to 
individual taxpayers. In fact, the higher rate of corporate tax 
audits makes this a particularly worrisome proposal. The use of 
the increased substantial understatement penalty to obtain 
concessions from corporate taxpayers is inconsistent with the 
goals expressed in the IRS Restructuring and Reform Act of 
1998.
     Furthermore, the proposed strengthened reasonable cause 
standard is too high a standard to satisfy and is unclear in 
its application. The only current standard in the Code that is 
similar to the ``strong chance of sustaining its tax position'' 
is the burden placed on IRS by Sec. 7454(a) and Tax Court Rule 
142(b) in a civil fraud case of proving by ``clear and 
convincing evidence'' the taxpayer's intent to evade his taxes. 
To place such a similar burden on a corporate taxpayer to avoid 
the accuracy penalty attributable to a tax shelter is 
unwarranted because it places this heavy burden on the 
taxpayer, not the IRS who is seeking to impose the penalty.
     If it were true that taxpayers are either ignoring or 
circumventing the requirements of regulation section 1.6664-4, 
codifying the requirements therein would significantly 
strengthen the reasonable cause standard and should satisfy the 
administration's stated concerns.

IV. Increased Corporate Disclosure Requirements

     Under current law, unlike the rules for non-tax shelter 
understatement items, disclosure of a corporate tax shelter 
item does not provide a basis for avoiding the substantial 
understatement penalty. To increase disclosure, the 
Administration recommends that the substantial understatement 
penalty be reduced if the proposed disclosure requirements are 
met. The Administration would require that transactions meeting 
certain characteristics be disclosed, whether or not they meet 
the definition of corporate tax shelter. A $100,000 penalty 
would be applied to each failure to satisfy the disclosure 
requirements.
     Corporate taxpayers would be required to disclose 
transactions that result in a significant tax benefit and have 
some combination of the following characteristics 
(``filters''): (1) a book/tax difference in excess of a certain 
amount; (2) a rescission, unwind or provision insuring tax 
benefits; (3) involvement of tax-indifferent parties; (4) 
advisor fees in excess of a certain amount or contingent fees; 
(5) confidentiality agreement; (6) offering of the transaction 
to multiple corporations (if known); and a difference between 
the form of the transaction and how it is reported. The 
disclosure must be filed with the IRS National Office by the 
unextended due date of the tax return and again with each 
income tax return that the transaction affects. The disclosure 
would be a ``short form'' filed with the National Office and 
would require taxpayers to provide a description of the filters 
that apply to the transaction, as well as other information. A 
$100,000 penalty for each failure to disclose would apply. The 
disclosure form must be signed by a corporate officer who would 
be made personally liable for misstatements on the form. The 
officer could be subject to penalties for fraud or gross 
negligence and would be accorded due process rights.
     While this enhanced notice requirement is intended to keep 
IRS current on the latest tax planning activities of corporate 
taxpayers, it is burdensome and a trap for the unwary corporate 
taxpayer. Although we believe that the Administration proposed 
the use of the ``filters'' to limit the number of transactions 
that must be disclosed, the use of these filters may have the 
opposite effect because several of the filters can occur with 
some frequency in routine business transactions. For example, 
non-deductible goodwill can create a book/tax difference, which 
is a common occurrence and does not indicate the presence of a 
tax shelter. Moreover, with the recently enacted 2-year 
limitation on NOL carrybacks, characterizing a taxpayer with a 
3-year NOL carryforward as a tax indifferent party could 
classify many business combinations as tax shelters subject to 
disclosure and possible penalties.
     The inequity and burden of this requirement is only 
further compounded with the significant $100,000 monetary 
penalty. Surely the breadth of the proposed ``filters'' and the 
vagueness of the tax shelter definition will cause taxpayers, 
including unsophisticated small and medium sized businesses, to 
be subject to this very large penalty. As noted above, the wide 
scope of business transactions subject to disclosure under this 
proposal would be astonishing. If filters are to be used to 
narrow the number of transactions that must be disclosed, a 
better approach would be to require that a transaction have at 
least three of the filter characteristics to trigger the 
disclosure requirements. However, we believe that disclosure 
made on schedule M-1 \13\ of the corporate tax return, 
reconciling discrepancies between how income and losses are 
reported for tax and book purposes, should provide the IRS with 
the information they need without imposing an unnecessary 
additional burden on taxpayers.
---------------------------------------------------------------------------
    \13\ Adequate disclosure must meet the requirements of Rev. Proc. 
98-62, 1998-52 I.R.B. 23 (12/28/98).
---------------------------------------------------------------------------
     Furthermore, the proposal to hold a corporate officer 
personally liable for the disclosures, with possible penalties, 
does not serve a logical propose. According to Treasury 
officials, one of the purposes of having a corporate officer 
attest to this information is to have the person most in 
control of the facts sign the disclosure. In most cases, the 
person most in control of the facts is the tax director. If the 
tax director is a corporate officer, he generally is already 
signing the tax return under penalties of perjury that to the 
best of his knowledge and belief, the return is true, correct 
and complete. We do not believe it is appropriate or necessary 
to require the attestation of an additional corporate officer 
who does not otherwise have control of the facts in the 
situation.
     Even more troublesome is the possibility that a 
transaction that the taxpayer reasonably believes is not a tax 
shelter, and therefore does not disclose, is later classified 
as a corporate tax shelter. Under the proposed regime, that 
taxpayer would be subject to a significant penalty. First, the 
tax benefits would be denied. Second, a 40 percent penalty 
would apply. Finally, a $100,000 failure to disclose penalty 
would be imposed. Thus, in addition to the substantial power 
granted to IRS field agents, the higher standards for 
reasonable cause and the significantly increased monetary 
penalties create substantial risk for both routine business 
transactions and legitimate corporate tax planning. Overall, 
the regime Treasury has proposed is overly burdensome, 
complicated and vague in its practical application.

V. Codification of the Economic Substance Doctrine

     The Administration's proposal attempts to codify and 
clarify the judicial economic substance doctrine. Under the 
proposal, tax benefits would be disallowed from any transaction 
in which the reasonably expected pre-tax profit (determined on 
a present value basis, after taking into account foreign taxes 
as expenses and transaction costs) of the taxpayer from the 
transaction is insignificant relative to the reasonably 
expected net tax benefits (i.e., tax benefits in excess of the 
tax liability arising from the transaction, determined on a 
present value basis) of the taxpayer from such transaction. 
With respect to financing transactions, tax benefits would be 
disallowed if the present value of the tax benefits of the 
taxpayer to whom the financing is provided are significantly in 
excess of the present value of the pre-tax profit or return of 
the person providing the financing.
     The proposal would not apply to disallow any claimed loss 
or deduction of a taxpayer that had economically been incurred 
by the taxpayer before the transaction was entered into. The 
proposal would apply to any transaction entered into in 
connection with a trade or business or activity engaged in for 
profit or for the production of income, whether or not by a 
corporation.
     As noted above, this proposal would provide IRS agents 
with extraordinary power to classify business transactions as 
tax shelters. Taxpayers that enter into transactions that have 
legitimate business purposes, even though under the 
mathematical test of the proposal no pre-tax profit is 
quantifiable, would be denied tax benefits and subject to harsh 
penalties. The judicially applied economic substance doctrine 
looks to both the economic consequences and an analysis of the 
intended purposes behind the transaction. This business purpose 
analysis is an important means of determining whether a 
transaction has no purpose other than the avoidance of tax or 
serves a non-tax business purpose. The proposal is clearly 
lacking this critical element of the doctrine developed over 
the years by the courts.

VI. Administrative Safeguards

     Identifying and defining corporate tax shelters is a 
nearly impossible task. As evidenced by the various iterations 
of tax shelter definition, all of which are extremely broad and 
lack a business purpose exception, both taxpayers and IRS 
agents are bound to disagree about which transactions are or 
are not tax shelters. Thus, especially in light of the proposed 
enhanced penalty regimes, taxpayers should be afforded remedies 
to protect against the potential abuse of power by IRS agents 
under these stricter yet ambiguous tax shelter definitions.
     The budget proposals of the Administration do not provide 
any safeguards or protections against IRS agents using the new 
penalties as leverage to extract other concessions or otherwise 
abusing their power as a result of these new higher and 
stricter penalties.
     In its White Paper, Treasury suggested modifying the 
Administration's FY2000 budget proposal to allow any corporate 
tax shelter issue raised by an examining agent to be 
automatically referred to the National Office of the IRS for 
further processing or resolution. This review would facilitate 
consistent treatment among various taxpayers and protect 
taxpayers from aggressive IRS field agents. It is extremely 
unfortunate that the revised FY2001 budget proposals provide no 
such relief.
     Treasury's White Paper also suggested allowing a taxpayer 
to get an expedited ruling on whether a contemplated 
transaction is a tax shelter. Again, given the ambiguity in the 
definition of tax shelter and the harsh penalty associated with 
characterization as a tax shelter, an expedited ruling process 
could be helpful.
     The proposed overly broad definition of corporate tax 
shelter will give examining agents an unwarranted and 
unrestrained opportunity to hold corporate taxpayers hostage 
during the examination process. Revenue agents, who have no 
downside, can threaten to propose adjustments based on alleged 
corporate tax shelter transactions to extract unreasonable 
concessions by the corporate taxpayer on other issues. 
Incidents of ``rogue'' revenue agents abusing their authority 
in efforts to extort unfair concessions and settlements are not 
limited to individual taxpayers. In fact, the higher rate of 
corporate tax audits makes this a particularly worrisome 
proposal.
     Under the proposal to codify the economic substance 
doctrine, revenue agents could disallow any deduction, credit, 
exclusion, or other allowance obtained by a corporate taxpayer 
based on the determination that a transaction falls within the 
vague definition of a ``tax avoidance transaction.'' This 
authority could be used to deny a corporate taxpayer a tax 
benefit provided by the Code merely because the IRS believes 
that the transaction yielded too much tax savings, regardless 
of a corporate taxpayer's legitimate business purpose for 
entering into the transaction. Again, this is giving an IRS 
agent too much discretion and is inconsistent with the IRS 
Restructuring and Reform Act. At least, the Treasury's White 
Paper recognized and made accommodations along these lines by 
proposing National Office review of a tax shelter 
characterization, as well as an expected ruling process. An 
additional safeguard might be to allow taxpayers to obtain an 
early referral to Appeals on an item that is characterized by 
an agent as a tax shelter.

VII. Promoters, Tax Advisors and Standards of Practice

     In addition to tougher requirements for corporate 
taxpayers, the proposals increase the penalties and sanctions 
on third parties associated with corporate tax shelters. Among 
other reasons, the Administration blames promoters for the 
recent increase in corporate tax shelter activity. Currently, 
there are a number of Code provisions that impose promoter 
penalties. In addition, there are ethical standards to guide 
tax advisors that practice before the IRS. In general, to 
curtail the proliferation of tax shelter activity and increase 
the risk to promoters, the proposals increase and expand 
current penalties as well as impose additional penalties.
     The Administration's FY 2001 Budget proposes to impose 
additional penalties on other parties involved in corporate tax 
shelter transactions. The proposal would impose a 25-percent 
excise tax on fees received in connection with the purchase and 
implementation of a corporate tax shelter (including 
underwriting and other fees) and the rendering of certain tax 
advice related to a corporate tax shelter. Only persons who 
perform services in furtherance of the corporate tax shelter 
would be subject to the proposal. The proposal would not apply 
to expenses incurred with respect to representing the taxpayer 
before the IRS or a court. For example, an adviser that 
cautions not to enter into the transaction would not be subject 
to the penalty excise tax. In addition, due process procedures 
would be provided for parties subject to the excise tax. Again, 
we believe the Administration heeded some of the concerns that 
the Coalition and others expressed with their FY2000 Budget 
Proposals. It is appropriate that this excise tax be imposed 
only on the fees associated with furtherance of a corporate tax 
shelter and that procedures for due process be provided.
     Finally, any income received by a tax-indifferent person 
with respect to a corporate tax shelter would be taxable to 
such person. To ensure that a tax is paid, all corporate 
participants would be made jointly and severally liable for the 
tax. A tax-indifferent person would be defined as a foreign 
person, a Native American tribal organization, a tax-exempt 
organization, or a domestic corporation with a loss or credit 
carryforward that is more than three years old.
     These proposals rely on the same vague and faulty 
definition of ``tax avoidance transaction'' as the previously 
discussed proposals. The proposal to impose an excise tax on 
fees received in connection with a tax shelter raises numerous 
administrative issues. The determination that a transaction 
falls within the new definition of corporate tax shelters may 
not be made until years after the payment or the receipt of 
fees, which raises questions concerning the statute of 
limitations and IRS' assessment authority against the ``shelter 
provider.''

VIII. Conclusion

     Notwithstanding the attempts to address criticisms of the 
Administration's budget proposals on corporate tax shelters, 
the fundamental problem still remains; the proposals are so 
broad in their application that they will still impact 
legitimate business transactions. This is primarily because the 
proposals focus on the tax result and completely ignore 
business purpose. For example, business restructurings designed 
to reduce business costs would be characterized as tax shelters 
if structured in a tax efficient manner.
     The disclosure requirements in the proposals are also too 
burdensome. Given the broad application of the disclosure 
requirements, taxpayers will have difficulty in identifying 
transactions that must be disclosed. Even an inadvertent 
failure to disclose will prevent taxpayers from being able to 
reduce or eliminate the 40 percent understatement penalty. In 
addition, attestation should not be required, other than the 
attestation required by a corporate officer in signing a tax 
return. Again, because of the breadth of the tax shelter 
definition in the proposals, attestation would be required for 
numerous transactions. It would be extremely burdensome to 
provide a briefing on all of these transactions to a corporate 
officer who is not the tax director that is sufficient to make 
this individual comfortable in attesting to the facts of these 
transactions under penalties of perjury.
     A regime that narrowly targets abusive transactions and 
encourages disclosure without significant burdens would prove 
more effective in curtailing unwanted activity and promoting 
voluntary compliance. In addition, administrative safeguards 
are needed to protect against the potential abuse of power by 
IRS agents. The Administration's proposal does not strike this 
essential balance.
     We continue to believe that the best way of addressing the 
corporate tax shelter issue is through the court system because 
in applying the judicial economic substance doctrine the court 
will examine whether any business purpose existed.\14\
---------------------------------------------------------------------------
    \14\ As noted previously, the IRS has successfully litigated many 
cases in this area, including most notably Compaq Computer Corporation 
and Subsidiaries v. Commissioner of Internal Revenue, 113 T.C. No. 17 
(Sept. 21, 1999); ACM Partnership v. Commissioner, 73 T.C.M. 2189 
(1997), aff'd in part, rev'd in part, 157 F.3d 231 (3d Cir. 1998), 
cert. denied, 119 S.Ct 1251 (1999) and ASA Investerings v. 
Commissioner, 76 TCM 325 (1998).
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Statement of the Coalition of Service Industries \1\

    The Coalition of Service Industries, which represents a 
broad range of financial institutions, including both large and 
small institutions, strongly opposes the Administration's 
proposal to increase penalties for failure to file correct 
information returns.
---------------------------------------------------------------------------
    \1\ The Coalition of Service Industries (CSI) was established in 
1982 to create greater awareness of the major role services industries 
play in our national economy; promote the expansion of business 
opportunities abroad for US service companies; and encourage US 
leadership in attaining a fair and competitive global marketplace. CSI 
represents a broad array of US service industries including the 
financial, telecommunications, professional, travel, transportation, 
information and information technology sectors.
---------------------------------------------------------------------------
    The proposed penalties are unwarranted and place an undue 
burden on already compliant taxpayers. It seems clear that 
most, if not all, of the revenue estimated to be raised from 
this proposal would stem from the imposition of higher 
penalties due to inadvertent errors rather than from enhanced 
compliance. The financial services community devotes an 
extraordinary amount of resources to comply with current 
information reporting and withholding rules and is not 
compensated by the U.S. government for these resources. The 
proposed penalties are particularly inappropriate in that (i) 
there is no evidence of significant current non-compliance and 
(ii) the proposed penalties would be imposed upon financial 
institutions while such institutions were acting as integral 
parts of the U.S. government's system of withholding taxes and 
obtaining taxpayer information.

The Proposal

    As included in the President's fiscal year 2001 budget, the 
proposal generally would increase the penalty for failure to 
file correct information returns on or before August 1 
following the prescribed filing date from $50 for each return 
to the greater of $50 or 5 percent of the amount required to be 
reported.\2\ The increased penalties would not apply if the 
aggregate amount that is timely and correctly reported for a 
calendar year is at least 97 percent of the aggregate amount 
required to be reported for the calendar year. If the safe 
harbor applies, the present-law penalty of $50 for each return 
would continue to apply.
---------------------------------------------------------------------------
    \2\ A similar proposal was included in President Clinton's fiscal 
year 1998, 1999 and 2000 budgets.

---------------------------------------------------------------------------
Current Penalties are Sufficient

    We believe the current penalty regime already provides 
ample incentives for filers to comply with information 
reporting requirements. In addition to penalties for 
inadvertent errors or omissions,\3\ severe sanctions are 
imposed for intentional reporting failures. In general, the 
current penalty structure is as follows:
---------------------------------------------------------------------------
    \3\ It is important to note that many of these errors occur as a 
result of incorrect information provided by the return recipients such 
as incorrect taxpayer identification numbers (TINs).
---------------------------------------------------------------------------
     The combined standard penalty for failing to file 
correct information returns and payee statements is $100 per 
failure, with a penalty cap of $350,000 per year.
     Significantly higher penalties--generally 20 
percent of the amount required to be reported (for information 
returns and payee statements), with no penalty caps--may be 
assessed in cases of intentional disregard.\4\
---------------------------------------------------------------------------
    \4\ The standard penalty for failing to file correct information 
returns is $50 per failure, subject to a $250,000 cap. Where a failure 
is due to intentional disregard, the penalty is the greater of $100 or 
10 percent of the amount required to be reported, with no cap on the 
amount of the penalty.
---------------------------------------------------------------------------
     Payors also may face liabilities for failure to 
apply 31 percent backup withholding when, for example, a payee 
has not provided its taxpayer identification number (TIN).
    There is no evidence that the financial services community 
has failed to comply with the current information reporting 
rules and, as noted above, there are ample incentives for 
compliance already in place.\5\ It seems, therefore, that most 
of the revenue raised by the proposal would result from higher 
penalty assessments for inadvertent errors, rather than from 
increased compliance with information reporting requirements. 
Thus, as a matter of tax compliance, there appears to be no 
justifiable policy reason to substantially increase these 
penalties.
---------------------------------------------------------------------------
    \5\ Also note that, in addition to the domestic and foreign 
information reporting and penalty regimes that are currently in place, 
for payments to foreign persons, an expanded reporting regime with the 
concomitant penalties is effective for payments made after December 31, 
1999. See TD 8734, published in the Federal Register on October 14, 
1997. The payor community is being required to dedicate extensive 
manpower and monetary resources to put these new requirements into 
practice. Accordingly, these already compliant and overburdened 
taxpayers should not have to contend with new punitive and unnecessary 
penalties.

---------------------------------------------------------------------------
Penalties Should Not Be Imposed to Raise Revenue

    Any reliance on a penalty provision to raise revenue would 
represent a significant change in Congress' current policy on 
penalties. A 1989 IRS Task Force on Civil Penalties concluded 
that penalties ``should exist for the purpose of encouraging 
voluntary compliance and not for other purposes, such as 
raising of revenue.'' \6\ Congress endorsed the IRS Task 
Force's conclusions by specifically enumerating them in the 
Conference Report to the Omnibus Budget Reconciliation Act of 
1989.\7\ There is no justification for Congress to abandon its 
present policy on penalties, which is based on fairness, 
particularly in light of the high compliance rate among 
information return filers.
---------------------------------------------------------------------------
    \6\ Statement of former IRS Commissioner Gibbs before the House 
Subcommittee on Oversight (February 21, 1989, page 5).
    \7\ OBRA 1989 Conference Report at page 661.

---------------------------------------------------------------------------
Safe Harbor Not Sufficient

    Under the proposal, utilization of a 97 percent substantial 
compliance ``safe harbor'' is not sufficient to ensure that the 
higher proposed penalties apply only to relatively few filers. 
Although some information reporting rules are straightforward 
(e.g., interest paid on deposits), the requirements for certain 
new financial products, as well as new information reporting 
requirements,\8\ are often unclear, and inadvertent reporting 
errors for complex transactions may occur. Any reporting 
``errors'' resulting from such ambiguities could easily lead to 
a filer not satisfying the 97 percent safe harbor.
---------------------------------------------------------------------------
    \8\ For example, Form 1099-C, discharge of indebtedness reporting, 
or Form 1042-S, reporting for bank deposit interest paid to certain 
Canadian residents.

---------------------------------------------------------------------------
Application of Penalty Cap to Each Payor Entity Inequitable

    We view the proposal as unduly harsh and unnecessary. The 
current-law $250,000 penalty cap for information returns is 
intended to protect the filing community from excessive 
penalties. However, while the $250,000 cap would continue to 
apply under the proposal, a filer would reach the penalty cap 
much faster than under current law. For institutions that file 
information returns for many different payor entities, the 
protection offered by the proposed penalty cap is substantially 
limited, as the $250,000 cap applies separately to each payor.
    In situations involving affiliated companies, multiple 
nominees and families of mutual funds, the protection afforded 
by the penalty cap is largely illusory because it applies 
separately to each legal entity. At the very least, any further 
consideration of the proposal should apply the penalty cap 
provisions on an aggregate basis. The following examples 
illustrate why aggregation in the application of the penalty 
cap provisions is critical.

EXAMPLE I--Paying Agents

     A bank may act as paying agent for numerous issuers of 
stocks and bonds. In this capacity, a bank may file information 
returns as the issuers' agent but the issuers, and not the 
bank, generally are identified as the payors. Banks may use a 
limited number of information reporting systems (frequently 
just one overall system) to generate information returns on 
behalf of various issuers. If an error in programming the 
information reporting system causes erroneous amounts to be 
reported, potentially all of the information returns 
subsequently generated by that system could be affected. Thus, 
a single error could, under the proposal, subject each issuer 
for whom the bank filed information returns, to information 
reporting penalties because the penalties would be assessed on 
a taxpayer-by-taxpayer basis. In this instance, the penalty 
would be imposed on each issuer. However, the bank as paying 
agent may be required to indemnify the issuers for resulting 
penalties.
     Recommendation: For the purposes of applying the penalty 
cap, the paying agent (not the issuer) should be treated as the 
payor.

EXAMPLE II--Retirement Plans

     ABC Corporation, which services retirement plans, 
approaches the February 28th deadline for filing with the 
Internal Revenue Service the appropriate information returns 
(i.e., Forms 1099-R). ABC Corporation services 500 retirement 
plans and each plan must file over 1,000 Forms 1099-R. A 
systems operator, unaware of the penalties for filing late 
Forms 1099, attempts to contact the internal Corporate Tax 
Department to inform them that an extension of time to file is 
necessary to complete the preparation and filing of the 
magnetic media for the retirement plans. The systems operator 
is unable to reach the Corporate Tax Department by the February 
28th filing deadline and files the information returns the 
following week. This failure, under the proposal, could lead to 
substantial late filing penalties for each retirement plan that 
ABC Corporation services (in this example, up to $75,000 for 
each plan).\9\
---------------------------------------------------------------------------
    \9\ If the corrected returns were filed after August 1, the 
penalties would be capped at $250,000 per plan.
---------------------------------------------------------------------------
     Recommendation: Retirement plan servicers (not each 
retirement plan) should be treated as the payor for purposes of 
applying the penalty cap.

EXAMPLE III--Related Companies

     A bank or broker dealer generally is a member of an 
affiliated group of companies, which offer different products 
and services. Each company that is a member of the group is 
treated as a separate payor for information reporting and 
penalty purposes. Information returns for all or most of the 
members of the group may be generated from a single information 
reporting system. One error (e.g., a systems programming error) 
could cause information returns generated from the system to 
contain errors on all subsequent information returns generated 
by the system. Under the proposal, the penalty cap would apply 
to each affiliated company for which the system(s) produces 
information returns.
     Recommendation: Each affiliated group \10\ should be 
treated as a single payor for purposes of applying the penalty 
cap.
---------------------------------------------------------------------------
    \10\ A definition of ``affiliated group'' which may be used for 
this purpose may be found in Section 267(f) or, alternatively, Section 
1563(a).
---------------------------------------------------------------------------
    While these examples highlight the need to apply the type 
of penalty proposed by the Treasury on an aggregated basis, 
they also illustrate the indiscriminate and unnecessary nature 
of the proposal.

                               CONCLUSION

    The Coalition of Service Industries represents the 
preparers of a significant portion of the information returns 
that would be impacted by the proposal to increase penalties 
for failure to file correct information returns. In light of 
the current reporting burdens imposed on our industries and the 
significant level of industry compliance, we believe it is 
highly inappropriate to raise penalties.
    Congress has considered and rejected this proposal on three 
previous occasions, and we hope it will continue to reject this 
unwarranted penalty increase. Thank you for your consideration 
of our views.
      

                                

Statement of the Committee of Annuity Insurers

    The Committee of Annuity Insurers is composed of forty-one 
life insurance companies that issue annuity contracts, 
representing approximately two-thirds of the annuity business 
in the United States. The Committee of Annuity Insurers was 
formed in 1982 to address Federal legislative and regulatory 
issues affecting the annuity industry and to participate in the 
development of Federal tax policy regarding annuities. A list 
of the member companies is attached at the end of this 
statement. We thank you for the opportunity to submit this 
statement for the record.
    The Administration's proposals relating to the taxation of 
life insurance companies and their products are largely a 
rehash of last year's discredited budget proposals, which 
Congress rejected. All of these proposals remain fundamentally 
flawed and should be rejected again. The focus of this 
statement, however, is the Administration's proposal to 
increase retroactively the so-called ``DAC tax'' imposed under 
IRC section 848 and, in particular, the increase proposed with 
respect to annuity contracts used for retirement savings 
outside of pension plans (``non-qualified annuities''). 
Increasing the DAC tax continues to be bad tax policy, and 
doing so retroactively would make a bad situation far worse.
    As was the case last year, the Administration's proposed 
increase in the DAC would have a substantial, adverse effect on 
private retirement savings in America. The Administration 
continues to show that it does not understand the important 
role that annuities and life insurance play in assuring 
Americans that they will have adequate resources during 
retirement and adequate protection for their families.
    Annuities are widely owned by Americans. At the end of 
1997, there were approximately 38 million individual annuity 
contracts outstanding, nearly three times the approximately 13 
million contracts outstanding just 11 years before. The 
premiums paid into individual annuities--amounts saved by 
individual Americans for their retirement--grew from 
approximately $34 billion in 1987 to $90 billion in 1997, an 
average annual increase of greater than 10 percent.
    Owners of non-qualified annuities are predominantly middle-
income Americans saving for retirement. The reasons for this 
are obvious. Annuities have unique characteristics that make 
them particularly well-suited to accumulate retirement savings 
and provide retirement income. Annuities allow individuals to 
protect themselves against the risk of outliving their savings 
by guaranteeing income payments that will continue as long as 
the owner lives. Deferred annuities also guarantee a death 
benefit if the owner dies before annuity payments begin.
    The tax rules established for annuities have been 
successful in increasing retirement savings. Eighty-six percent 
of owners of non-qualified annuities surveyed by The Gallup 
Organization in 1999 reported that they have saved more money 
than they would have if the tax advantages of an annuity 
contract had not been available. Nearly all (93%) reported that 
they try not to withdraw any money from their annuity before 
they retire because they would have to pay tax on the money 
withdrawn.
    As discussed below, the proposal contained in the 
Administration's FY 2001 budget to increase the DAC tax is in 
substance a tax on owners of non-qualified annuity contracts 
and cash value life insurance. It would make these products 
more expensive and less attractive to retirement savers. It 
would also lower the benefits payable to savers and families. 
As discussed below, the DAC tax is already fundamentally flawed 
and increasing its rate would simply be an expansion of bad tax 
policy. The fact that the Administration proposes to increase 
the DAC tax retroactively suggests that the proposal is simply 
a device to raise a targeted amount of revenue from the 
insurance industry.

1. The Administration's DAC proposal is in substance a tax on 
the owners of annuities and life insurance.

    The Administration's proposal to increase the DAC tax is an 
attempt to increase indirectly the taxes of annuity and life 
insurance contract owners. Two years ago, the Administration's 
proposed direct tax increases on such owners were met with 
massive, bipartisan opposition. Last year and again this year, 
the Administration seeks to increase indirectly the taxes on 
annuity and life insurance contract owners. We urge this 
Committee to reject once again the Administration's back door 
tax increase on annuity and life insurance contract owners.
    IRC section 848 denies life insurance companies a current 
deduction for a portion of their ordinary and necessary 
business expenses equal to a percentage of the net premiums 
paid each year by the owners of certain types of contracts. 
These amounts instead must be capitalized and then amortized 
over 120 months. The amounts that currently must be capitalized 
are 1.75 percent of non-qualified annuity premiums, 2.05 
percent of group life insurance premiums, and 7.70 percent of 
other life insurance premiums (including noncancellable or 
guaranteed renewable accident and health insurance). Under the 
Administration's proposal, these categories of contracts would 
be modified and the percentages would be dramatically 
increased. Specifically, the rate for annuity contracts would 
more than double to 4.8 percent, while the rate for individual 
cash value life insurance would increase by a third to 10.3 
percent.
    The DAC tax under section 848 is directly based on the 
amount of premiums paid by the owners of the contracts. Thus, 
as individuals increase their annuity savings (by paying more 
premiums), a company's taxes increase--the higher the savings, 
the higher the tax. It is clear that since the enactment of DAC 
in 1990, the DAC tax has been passed through to the individual 
owners of annuities and life insurance. Some contracts impose 
an express charge for the cost of the DAC tax, for example, 
while other contracts necessarily pay lower dividends or less 
interest to the policyholder. Still other contracts impose 
higher general expense charges to cover the DAC tax. (See The 
Wall Street Journal, December 10, 1990, ``Life Insurers to Pass 
Along Tax Increase.'')
    According to the Treasury Department, the increased 
capitalization percentages proposed in the Administration's FY 
2001 budget will result in increased taxes of $8.29 billion for 
the period 2001 -2005 and $11.82 billion for the period 2001 
-2010. A large portion of this tax increase will come from 
middle-income Americans who are purchasing annuities to save 
for retirement and cash value life insurance to protect their 
families. According to a Gallup survey conducted in 1999, most 
owners of non-qualified annuities have moderate annual 
household incomes. About three-quarters (71%) have total annual 
household incomes under $75,000. Eight in ten owners of non-
qualified annuities state that they plan to use their annuity 
savings for retirement income (81%) or to avoid being a 
financial burden on their children (82%).
    The Administration's proposal will discourage private 
retirement savings and the purchase of life insurance. Congress 
in recent years has become ever more focused on the declining 
savings rate in America and on ways to encourage savings and 
retirement savings in particular. As described above, Americans 
have been saving more and more in annuities, which are the only 
non-pension retirement investments that can provide the owner 
with a guarantee of an income that will last as long as the 
owner lives. Life insurance contracts can uniquely protect 
families against the risk of loss of income. Increasing the 
cost of annuities and cash value life insurance and reducing 
the benefits will inevitably reduce private savings and the 
purchase of life insurance protection.

2. Contrary to the Administration's claims, an increase in the 
DAC tax is not necessary to reflect the income of life 
insurance companies accurately.

    The Administration claims that the proposed increase in the 
DAC tax is necessary to accurately reflect the economic income 
of life insurance companies. In particular, the Administration 
asserts that ``life insurance companies generally capitalize 
only a fraction of their actual policy acquisition costs.'' The 
Administration is wrong. As explained below, life insurance 
companies already more than adequately capitalize the expenses 
they incur in connection with issuing annuity and life 
insurance contracts. The Administration's proposal would 
further distort life insurance company income simply to raise 
revenue.
    The current tax rules applicable to life insurance 
companies capitalize policy selling expenses not only through 
the section 848 DAC tax, but also by requiring (in IRC section 
807) reserves for life insurance and annuity contracts to be 
based on a ``preliminary term'' or equivalent method. It is a 
matter of historical record that preliminary term reserve 
methods were developed because of the inter-relationship of 
policy selling expenses and reserves. Since the early 1900's, 
when preliminary term reserve methods began to be accepted by 
state insurance regulators, the relationship between policy 
reserves and a life insurance company's policy selling expenses 
has been widely recognized. See, e.g., K. Black, Jr. and H. 
Skipper, Jr, Life Insurance 565 -69(12th ed. 1994); McGill's 
Life Insurance 401 -408 (edited by E. Graves and L. Hayes, 
1994).
    Under a preliminary term reserve method, the reserve 
established in the year the policy is issued is reduced (from a 
higher, ``net level'' basis) to provide funds to pay the 
expenses (such as commissions) the life insurer incurs in 
issuing the contract. The amount of this reduction is known as 
the ``expense allowance,'' i.e., the amount of the premium that 
may be used to pay expenses instead of being allocated to the 
reserve. Of course, the life insurance company's liability for 
the benefits promised to the policyholder remains the same even 
if a lower, preliminary term reserve is established. As a 
result, the amount added to the reserve in subsequent years is 
increased to take account of the reduction in the first year.
    In measuring a life insurance company's income, reducing 
the first year reserve deduction by the expense allowance is 
economically equivalent to computing a higher, net level 
reserve and capitalizing, rather than currently deducting, that 
portion of policy selling expenses. Likewise, increasing the 
reserve in subsequent years is equivalent to amortizing those 
policy selling expenses over the subsequent years. Thus, under 
the current income tax rules applicable to life insurance 
companies, policy selling expenses are capitalized both under 
the section 848 DAC tax and through the required use of 
preliminary term reserves. The Administration's FY 2001 budget 
proposal ignores this combined effect.
    This relationship between policy selling expenses and 
preliminary term reserves has been recognized by Congress. In 
accordance with the treatment mandated by the state regulators 
for purposes of the NAIC annual statement, life insurance 
companies have always deducted their policy selling expenses in 
the year incurred in computing their Federal income taxes. 
Until 1984, life insurance companies also computed their tax 
reserves based on the reserve computed and held on the annual 
statement. However, under the Life Insurance Company Income Tax 
Act of 1959 (the ``1959 Act''), if a company computed its 
annual statement reserves on a preliminary term method, the 
reserves could be recomputed on the higher, net level method 
for tax purposes. Because companies were allowed to compute 
reserves on the net level method and to deduct policy selling 
expenses as incurred, life insurance companies under the 1959 
Act typically incurred a substantial tax loss in the year a 
policy was issued.
    When Congress was considering revisions to the tax 
treatment of life insurance companies in 1983, concern was 
expressed about the losses incurred in the first policy year as 
a result of the interplay of the net level reserve method and 
the current deduction of first year expenses. In particular, 
there was concern that a mismatching of income and deductions 
was occurring. As a consequence, as those who participated in 
the development of the Deficit Reduction Act of 1984 (the 
``1984 Act'') know, Congress at that time considered requiring 
life insurance companies to capitalize and amortize policy 
selling expenses.
    Congress chose not to change directly the tax treatment of 
policy selling expenses, however. Rather, recognizing that the 
effect of the use of preliminary term reserve methods is 
economically identical to capitalizing (and amortizing over the 
premium paying period) the expense allowance by which the first 
year reserve is reduced, Congress decided to alter the 
treatment of selling expenses indirectly by requiring companies 
to use preliminary term methods, rather than the net level 
method, in computing life insurance reserves. See, e.g., Jt. 
Comm. on Taxation, General Explanation of the Tax Reform Act of 
1986, at p. 595 (relating to amendments to section 832(b)(7)) 
(Under the 1984 Act, life insurance reserves ``are calculated . 
. . in a manner intended to reduce the mismeasurement of income 
resulting from the mismatching of income and expenses.'').
    In summary, life insurance companies are already 
overcapitalizing policy selling expenses for income tax 
purposes because of the combination of the current DAC tax and 
the mandated use of preliminary term reserves. In these 
circumstances, increasing the DAC capitalization percentages 
will not result in a clearer reflection of the income of life 
insurance companies. To the contrary, increasing the 
percentages as the Administration proposes would further 
distort life insurance company income simply to raise revenue.

3. Contrary to the Administration's suggestion, an increase in 
the DAC tax is inconsistent with GAAP accounting.

    The Administration's explanation of the DAC proposal 
suggests that increases in the DAC percentages are consistent 
with generally accepted accounting principles (GAAP). The 
Administration states that ``[l]ife insurance companies 
generally capitalize only a fraction of their actual policy 
acquisition costs. . . . In contrast, when preparing their 
financial statements using generally accepted accounting 
principles (GAAP), life companies generally capitalize their 
actual policy acquisition costs, including but not limited to 
commissions.'' See Treasury Department, General Explanation of 
the Administration's Fiscal Year 2001 Revenue Proposals 170-71 
(February, 2000). This explanation is disingenuous. The 
Administration fails to disclose that, while GAAP accounting 
does require actual acquisition costs to be capitalized, GAAP 
accounting does not mandate the use of preliminary term 
reserves. In fact, no system of insurance accounting ``doubles 
up'' on capitalization by requiring a combination of 
capitalization of actual policy acquisition costs combined with 
the use of preliminary term reserves. Thus, far from promoting 
consistency with GAAP accounting, the Administration's proposal 
to increase the DAC tax would exacerbate the distortion that 
already exists under current law.
    Apart from the foregoing, the Administration's reference to 
GAAP accounting is misplaced. In 1990 when the DAC tax was 
first enacted, Congress expressly considered and rejected GAAP 
as a basis for accounting for life insurance company policy 
selling expenses. Instead, Congress chose a proxy approach of 
amortizing a percentage of premiums over an arbitrary 10 year 
period, rather than capitalizing actual selling expenses and 
amortizing them over the actual life of the contracts. In 
short, when Congress enacted the DAC tax in 1990, it knew that 
the proxy percentages did not capitalize the same amount of 
acquisition expenses as does GAAP accounting. However, as 
discussed above, the combination of the current DAC percentages 
with the mandated use of preliminary term reserves already 
results in two different capitalization mechanisms. If GAAP 
accounting is the appropriate model for taxing life insurance 
companies, as the Administration suggests, then the DAC tax 
should be repealed, not increased.

4. The Administration's proposal to increase the DAC tax 
retroactively is punitive and suggests that the Administration 
is simply seeking to raise a targeted amount revenue from the 
insurance industry

    Last year, the Administration's proposal to increase the 
DAC tax was strongly criticized and rejected by Congress. Not 
only is the Administration resurrecting this discredited 
proposal, but now it seeks to apply the tax increase 
retroactively to 1990 under the guise of a ``change in 
accounting method.'' Retroactive tax increases are bad tax 
policy and violate basic notions of fairness. Moreover, in this 
case a retroactive increase in the DAC tax would have a severe 
punitive effect on insurers, which priced their products based 
on the law in place when those products were sold.
    The Administration offers no explanation for why the 
proposed increase in the DAC tax should be treated as a change 
in accounting method. When the DAC tax was first enacted in 
1990, Congress specifically stated that the DAC tax was not a 
change in accounting method. The proposal to treat the proposed 
increase in the DAC capitalization percentages as a change in 
accounting method, and thus apply the DAC tax increase 
retroactively, suggests that the Administration's true motive 
is simply to raise a targeted amount of revenue from the life 
insurance industry. The retroactive DAC proposal was contrived 
to achieve this overriding goal. Singling the insurance 
industry out for a tax increase of this magnitude ($11.82 
billion over 10 years) is entirely inappropriate. The insurance 
industry has and continues to pay more than its fair share of 
corporate income taxes.

    In conclusion, the Committee of Annuity Insurers urges the 
Committee to reject the Administration's proposal to increase 
the section 848 DAC tax. The proposal is a disguised tax on the 
owners of annuities and life insurance contracts. Furthermore, 
the proposal lacks any sound policy basis and further distorts 
the income of life insurance companies.

The Committee of Annuity Insurers Washington, D.C. 20004

    Aetna Inc., Hartford, CT
    Allmerica Financial Company, Worcester, MA
    Allstate Life Insurance Company, Northbrook, IL
    American General Corporation, Houston, TX
    American International Group, Inc., Wilmington, DE
    American Investors Life Insurance Company, Inc., Topeka, KS
    American Skandia Life Assurance Corporation, Shelton, CT
    Conseco, Inc., Carmel, IN
    COVA Financial Services Life Insurance Co., Oakbrook 
Terrace, IL
    Equitable Life Assurance Society of the United States, New 
York, NY
    Equitable of Iowa Companies, DesMoines, IA
    F & G Life Insurance, Baltimore, MD
    Fidelity Investments Life Insurance Company, Boston, MA
    GE Financial Assurance, Richmond, VA
    Great American Life Insurance Co., Cincinnati, OH
    Hartford Life Insurance Company, Hartford, CT
    IDS Life Insurance Company, Minneapolis, MN
    Integrity Life Insurance Company, Louisville, KY
    Jackson National Life Insurance Company, Lansing, Ml
    Keyport Life Insurance Company, Boston, MA
    Life Insurance Company of the Southwest, Dallas, TX
    Lincoln Financial Group, Fort Wayne, IN
    ManuLife Financial, Boston, MA
    Merrill Lynch Life Insurance Company, Princeton, NJ
    Metropolitan Life Insurance Company, New York, NY
    Minnesota Life, St. Paul, MN
    Mutual of Omaha Companies, Omaha, NE
    Nationwide Life Insurance Companies, Columbus, OH
    New York Life Insurance Company, New York, NY
    Ohio National Financial Services, Cincinnati, OH
    Pacific Life Insurance Company, Newport Beach, CA
    Phoenix Home Mutual Life Insurance Company, Hartford, CT
    Principal Financial Group, Des Moines, IA
    Protective Life Insurance Company, Birmingham, AL
    ReliaStar Financial Corp., Minneapolis, MN
    Security First Group, Los Angeles, CA
    SunAmerica, Inc., Los Angeles, CA
    Sun Life of Canada, Wellesley Hills, MA
    Teachers Insurance & Annuity Association of America--
College Retirement
    Equities Fund (TIAA-CREF), New York, NY
    Travelers Insurance Companies, Hartford, CT
    Zurich Kemper Life Insurance Companies, Chicago, IL
      

                                

Statement of Dorthy S. Ridings, Council on Foundations

    On behalf of the Council on Foundations, thank you for this 
opportunity to submit comments on the President's fiscal year 
2001 budget proposals. The Council on Foundations is a 
membership organization representing the collective interests 
of more than 1,900 community, family, independent and company 
foundations as well as corporate giving programs. For more than 
40 years, the Council has taken a keen interest in how federal 
tax laws support and promote philanthropy. President Clinton's 
proposed budget for fiscal year 2001 contains several proposals 
to encourage philanthropy. While we generally support them all, 
the Council wishes to comment on two that are of particular 
interest to its members: the proposal to clarify the public 
charity status of donor-advised funds and the proposal to 
simplify the annual tax on private foundation investment income 
imposed by section 4940. We look forward to working with the 
Committee to make technical improvements to these two much-
needed changes that will ensure their objectives are truly 
accomplished.

Donor-Advised Funds

    The first proposal would clarify the public charity status 
of organizations offering donor-advised funds. Specifically, it 
would provide that any organization that operates one or more 
donor-advised funds as its primary activity could qualify as a 
public charity only if it met three requirements: (1) the 
organization is free from any material restriction on its 
authority to manage and make distributions from the fund; (2) 
distributions from the donor-advised funds go only to public 
charities, private operating foundations or governmental 
entities; and (3) annual distributions equal or exceed 5% of 
the aggregate fair market value of the assets the organization 
holds in donor-advised funds.
    From the time community foundations were formed, more than 
85 years ago, donors have made recommendations regarding the 
charitable projects or organizations that they consider worthy 
of support. Donor-advised funds offer a valuable way for a 
community foundation to establish a relationship with a donor 
and to encourage that person to take a continuing interest in 
the community's needs.
    Recent developments, including the formation of new 
charities that make extensive use of donor-advised funds, have 
persuaded the Council of the need for clear and consistent 
rules for donor-advised funds, wherever they may be maintained. 
We are pleased that the President also recognizes this need. 
However, we believe that his specific recommendations raise 
several critical issues that, unless resolved, will interfere 
with legitimate and long-standing charitable activities carried 
on by community foundations and other public charities with 
donor-advised funds. Because these issues are vital to the 
interests of community foundations, Congress should not act 
until there has been adequate time to review the President's 
suggestions, and to understand their implications for the wide 
range of charities that have donor-advised funds.
    The Council on Foundations would be happy to work with the 
members of the Committee and with staff in defining these 
issues and finding appropriate solutions to them.
     1. Definition of donor-advised fund. There is a need to 
clarify this definition so that both community foundations and 
the Internal Revenue Service can easily determine which funds 
are ``donor-advised.''
     2. Permissible donees. Many community foundations operate 
programs that make grants and award scholarships to individuals 
for charitable purposes. Many community foundations also make 
grants for exclusively charitable purposes to both U.S. and 
foreign organizations that are not recognized as exempt under 
section 501(c)(3) of the Internal Revenue Code. Frequently 
these programs are begun at the recommendation of individuals 
and businesses that have created donor-advised funds, as in the 
case of the many community foundations that offer local 
businesses the ability to create a donor-advised fund to 
provide educational scholarships for employees and their 
families. Community foundations should retain the ability to 
make distributions to individuals, to domestic non-charities, 
and to foreign organizations as long as they can demonstrate 
that distributions are used for exclusively charitable 
purposes.
     3. Sanctions. The primary sanction in the President's 
budget proposal is loss of public charity status, either for 
the organization as a whole or for its donor-advised funds. The 
Council believes that a graduated set of penalties, analogous 
to those imposed on private foundations, would provide the 
Internal Revenue Service with a more flexible compliance tool, 
while protecting community foundations from the inadvertent 
loss of public charity status. Sanctions also should be 
appropriately distributed between the exempt organization and 
the donor/advisor, depending on which was in the best position 
to prevent the offence from occurring.
     4. Preventing abuse. Community foundations want to be sure 
that donor-advised funds are used exclusively for bona fide 
philanthropy, not as a mechanism to get tax benefits without 
achieving charitable results. A limited rule that treats donor/
advisors as disqualified persons with respect to distributions 
from their funds may help accomplish the goal of preventing 
distributions that confer an improper benefit on such 
individuals. There also may be some benefit in a five percent 
distribution requirement, although it, too, should be tailored 
to prevent real abuse.
    The Council looks forward to working with the Committee and 
its staff to address these concerns. We are optimistic that the 
proposal can be revised successfully, and that once enacted, it 
will encourage significant philanthropic activity.

Reforming the Section 4940 Tax

    The second proposal would reform the annual tax on private 
foundation investment income, replacing the current two-tier 
tax structure with a single rate. The Council on Foundations 
welcomes this change as a much-needed simplification, and we 
express our thanks to the Department of Treasury for 
recognizing that the current system is badly in need of 
adjustment. The current two-tier system actually has the 
unintended effect of penalizing foundations that make the extra 
effort to increase their annual grantmaking significantly in a 
given year. Such a decision forces the foundation to choose 
between two negative options: 1) Increase its long-term 
spending percentage (thus endangering its ability to maintain 
the real value of its assets), or 2) return to its normal 
spending percentage and be required to pay a higher level of 
tax (two percent) for the next five years. Lowering the 
effective private foundation investment income tax will 
automatically cause an overall increase in foundation grants 
and other charitable distributions. Because foundations are 
given credit toward their payout for taxes paid under section 
4940, reducing the tax automatically requires foundations to 
distribute more dollars to meet charitable needs.
    While we strongly support amending the code to adopt a 
single, flat-percentage excise tax, we urge serious 
consideration of a lower rate, preferably 1.0 percent. Even 
though we recognize that a flat excise tax of 1.0 percent will 
result in a higher revenue loss to Treasury, we have learned 
from many of our members that a 1.25 percent flat tax will be a 
tax increase to them. Small and mid-sized foundations, in 
particular, usually can qualify for the 1.0 percent rate under 
the current system. To do so, these foundations must slightly 
increase their charitable spending each year. Ironically, with 
a flat, 1.25 percent rate, those foundations that have been 
slowly increasing their spending levels will be hit with a tax 
increase.
    Again, we thank you for the opportunity to present our 
views. We look forward to working with the Committee in 
accordance with these comments to seek enactment of these 
proposals.
      

                                

Statement of the Equipment Leasing Association, Arlington, VA

INTRODUCTION

    The Equipment Leasing Association, (ELA) is submitting this 
statement for the record to express our concerns regarding the 
proposed ``corporate tax shelter proposals'' included in the 
Clinton Administration's proposed FY 2001 Budget. ELA has over 
850 member companies throughout the United States who provide 
financing for all types of businesses in all types of markets. 
Large ticket leasing includes the financing of transportation 
equipment such as aircraft, rail cars and vessels. Middle 
market lessors finance high-tech equipment including main frame 
computers and PC networks, telecommunications equipment and 
medical equipment such as MRIs (magnetic resonance imaging) and 
CT (computed tomography) systems. Lessors in the small ticket 
arena provide financing for equipment essential to virtually 
all businesses such as phone systems, pagers, copiers, scanners 
and fax machines.

WHAT TYPE OF COMPANY LEASES?WHAT TYPE OF COMPANY LEASES?

    More companies, particularly small businesses, acquire new, 
state of the art equipment through leasing than through any 
other type of financing. In a survey of the winners of the 
Small Business Administration's State Small Business Contest 
last May, ELA found that 85% of small businesses lease 
equipment and that 89% of these companies plan to lease again. 
Companies that lease tend to be smaller, growth-oriented and 
focused on productivity--these are companies long on ideas, but 
often, short on capital.

WHY COMPANIES LEASEWHY COMPANIES LEASE

    Companies choose lease financing for several reasons:
    *Leasing permits 100% financing;
    *Leasing permits a close matching of rental payments to the 
revenue produced by the use of the equipment;
    *Leasing allows companies to keep their debt lines open for 
working capital rather than tying it up in capital 
expenditures;
    *Companies that lease know that they make money by using 
the equipment, not owning it;
    *Leasing allows a company to focus on its core business--
they don't have to worry about maintenance, upgrading or asset 
disposition;
    *Leasing minimizes concerns about the technological 
obsolescence of the company's equipment;
    *Leasing shifts asset management risk to the lessor, away 
from the user.
    Leasing by commercial enterprises increases productivity 
and stimulates economic growth. While the federal and state tax 
codes provide various incentives to invest in new equipment, 
many companies find they are not in a financial position to 
utilize the incentives. However, through leasing, the intended 
incentives to invest can be passed through to the company using 
the equipment in the form of lower rental payments because the 
leasing company utilizes the intended investment incentives. 
The use of leasing in this manner has long been intended by 
Congress.
LEASING CREATES JOBSLEASING CREATES JOBS

    It is estimated that each increase of $1 billion in 
equipment investment creates approximately 30,000 jobs (Brimmer 
Report). In 1999 alone, the equipment leasing industry financed 
over $200 billion in equipment acquisition and it is 
anticipated that equipment lessors will finance over $230 
billion in new equipment acquisition in 2000.

STATE AND LOCAL GOVERNMENTS LEASE TOO

    It is not only commercial enterprises that lease equipment. 
Tax-exempt entities such as states, cities, counties and other 
subdivisions around the U.S. often lease various types of 
equipment in an effort to keep taxpayer costs down. Equipment 
leased by local governments includes 911 emergency phone 
systems, computers, school buses and police vehicles. Tax-
exempt hospitals often lease their emergency vehicles and high-
cost, sophisticated diagnostic medical equipment, in an effort 
to keep health care costs down.
    Lessors also lease equipment to other tax-exempt entities 
such as foreign corporate enterprises or individuals. Examples 
include automobile fleet leasing, leases of tractors and 
trailers, and leases of aircraft (both commercial and 
corporate). Further, many domestic lessees have the right to 
sublease assets into foreign markets in times when the 
equipment may be surplus. Very often, these subleases are to 
entities in foreign markets which have the need for the asset.

THE ADMINISTRATION'S ``CORPORATE TAX SHELTER'' PROPOSALS 
REPRESENT A SIGNIFICANT CHANGE IN U.S. TAX

    An analysis of the Administration's sweeping and vague 
corporate tax shelter proposals raises the concern that leasing 
transactions which conform to long standing tax policy and 
Congressional intent could be negatively impacted by the 
Administration's proposals. If this is the case, these 
proposals represent a significant change in longstanding U.S. 
leasing tax policy, overturning longstanding I.R.S ruling 
polices set forth in Revenue Procedures 75-21 and 75-78, as 
well as established judicial precedent. Without a clear 
exclusion of leasing transactions that meet the standards of 
current law from the sweeping new corporate tax shelter 
proposals, ELA must oppose these proposals and urges Congress 
to reject them.
    ELA has long supported two fundamental principles of 
federal tax policy. First, the form of financing chosen to 
facilitate the acquisition of assets, whether loans or leases, 
should be respected as long as economically valid. Second, is 
the principle that the tax treatment of an owner of an asset 
should not differ whether the asset is used directly by the 
owner or leased to another end-user. Again, in their current 
form, the Administration's proposals appear to violate these 
two principles and have already had a chilling effect on 
equipment acquisition in certain markets. Therefore, ELA 
opposes them and urges Congress to reject them.

ADMINISTRATION'S ANTI-LEASING SERVICE CONTRACT PROPOSAL

    The service contract rules set forth in Section 7701(e) of 
the Code were enacted as part of the original Pickle 
legislation in 1984. These rules set forth explicit statutory 
standards based on clear economic distinctions for 
distinguishing leases from so-called service contracts. A lease 
of equipment is in fact different than a service contract and 
Congress clearly intended that an agreement that qualifies as a 
service contract would not be treated as a lease for purposes 
of the Pickle legislation or for any other tax purpose. The 
Administration's proposal would repeal this clear distinction 
and expand the scope of an already discriminatory statute that 
inhibits U.S. global competitiveness and no longer furthers a 
legitimate policy objective. Further, the proposed legislation 
overlooks significant business purposes that give rise to use 
of service contracts. Service contracts involve a tradeoff 
between rights and risks. Relative to a lessor, the service 
provider enjoys more control over the asset used to generate 
such services, but also assumes additional performance and 
operational risk with respect to such asset. The parties' 
preferences as to the division of rights and risks with respect 
to property determine the form of contractual arrangement they 
choose. The service contract arrangement has long been 
commercially recognized, particularly within certain industries 
including the utilities and shipping industries. Congress 
should reject the Administration's most recent misguided 
assault on leasing as it did in both 1998 and 1999. (See the 
enclosed 1999 letter signed by 26 members of the House Ways and 
Means Committee to Chairman Archer and Ranking Member Rangel.)
    Clearly, the Administration's proposal goes far beyond what 
is necessary to prevent perceived abusive transactions as it 
encroaches upon non-abusive transactions that are permitted 
under current law. In fact, in light of the 1986 depreciation 
rules providing for straight-line depreciation over the class-
life of foreign use property (which were intended to replicate 
economic depreciation), we believe that the Pickle depreciation 
rules, insofar as they relate to foreign lessees, are no longer 
necessary or appropriate and do not reflect sound tax policy. 
Consequently, we urge Congress to reject this proposal and 
encourage the Treasury Department to support a depreciation 
rule which does not discriminate between property owned by a 
U.S. taxpayer that is used outside the U.S. and property owned 
by a U.S. taxpayer that is leased to a foreign person. In both 
cases the income is fully taxable.
    In applying the Pickle rules, Treasury regulations adopted 
in 1996 (Treas. Reg. Section 1.168 (i)-2 (b) (1)) provide that 
the lease term will be deemed to include certain periods beyond 
the original duration of the lease. Under these regulations the 
lease term includes both the actual lease term and any period 
of time during which the lessee (or a related person) (i) 
agreed that it would or could be obligated to make a payment of 
rent or a payment in the nature of rent or (ii) assumed or 
retained any risk of loss with respect to the property 
(including, for example, holding a note secured by the 
property). Clearly, these regulations extend beyond the reach 
of the statute and should be overturned.

ADMINSTRATION'S PROPOSAL CONFLICTS WITH U.S. TRADE POLICY

    If enacted, this proposal will have a devastating impact on 
U.S. companies currently involved in selling assets to foreign 
entities where lease financing has been a significant feature 
of the marketplace, for example, manufacturers of aircraft and 
aircraft engines. As such, the proposal is contrary to long-
established policies of promoting U.S. exports and is in direct 
conflict with the Congressional objective of developing a U.S. 
trade policy which will provide U.S. companies with the ability 
to compete on a level playing field with their foreign 
competitors. If enacted, this legislation will severely inhibit 
the ability of U.S. exporters and financial institutions to 
compete effectively on a global scale. If U.S. companies are 
not able to compete on cross-border leases, tax revenues 
currently going to the U.S. Treasury will be lost to foreign 
Treasuries, as all leases, including cross-border leases, 
generate more taxable income than deductions over the life of 
the lease agreement.

HISTORY OF THE ``PICKLE'' RULES 

    As part of the Deficit Reduction Act of 1984, Congress 
amended the Code to limit the depreciation available for 
property leased to a tax-exempt entity to straight line 
depreciation over the longer of the property's class life or 
125% of the lease term. These provisions, referred to as the 
Tax-Exempt Entity Leasing Rules or the ``Pickle'' rules, were 
enacted in response to a series of leasing and similar 
transactions which passed a significant portion of the economic 
benefit of the Accelerated Cost Recovery System (ACRS) 
depreciation deductions through to various U.S. federal, state 
and local governmental entities and tax-exempt organizations.
    At that time, Congress was concerned that investment 
incentives, such as depreciation under ACRS, were being turned 
into unintended benefits for tax-exempt entities. These 
restrictions were extended to foreign persons not subject to 
U.S. tax on their operations as Congress concluded that it 
would be inappropriate to subsidize foreign persons that were 
not U.S. taxpayers by permitting accelerated depreciation for 
property leased to them.
    However, as part of the Tax Reform Act of 1986, Congress 
limited depreciation on foreign use property to the straight-
line method over an asset's class life. Thus, after 1986, 
property used predominantly outside the United States by an 
U.S. taxpayer was not entitled to accelerated depreciation. 
Consequently, the changes in generally applicable depreciation 
rules enacted in 1986 rendered the Pickle rules unnecessary in 
order to achieve the 1984 policy objective of not passing 
accelerated depreciation through to foreign persons not subject 
to U.S. income tax. Nevertheless, the Pickle rules were not 
amended in 1986 or subsequently.

THE PICKLE RULES ARE DISCRIMINATORY AND ANTI-COMPETITIVE AND 
SHOULD BE CONFORMED TO THE TAX ACT OF 1986 TO MAKE THE U.S. 
LEASING INDUSTRY GLOBALLY COMPETITIVE

    The Pickle rules discriminate against property owned by a 
U.S. taxpayer which is used in its leasing business outside the 
United States, as compared to the same property owned by a U.S. 
taxpayer, and used in a non-leasing business outside the U.S. 
For example, a U.S. owner of an item of equipment operated 
outside the U.S. would be entitled to straight-line 
depreciation over the asset's class life, even though the 
benefit of that depreciation would be reflected in the price of 
the goods or services provided to non-U.S. taxpayers. By 
contrast, a U.S. lessor of the same item of equipment if leased 
to a foreign entity would be limited by Pickle depreciation to 
straight-line depreciation over the longer of the property's 
class life or 125% of the lease term.
    If U.S. companies are to compete effectively in a global 
marketplace, Congress should enact a depreciation rule which 
does not discriminate between property owned by a U.S. taxpayer 
which is used outside the United States, and property owned by 
a U.S. taxpayer and leased to a foreign person. In both cases, 
the income is fully taxable. This policy can be accomplished by 
simply conforming the 1984 Pickle rules to the Tax Reform Act 
of 1986.

PROPOSAL TO ``DISALLOW INTEREST ON DEBT ALLOCABLE TO TAX-EXEMPT 
OBLIGATIONS'' WILL INCREASE STATES' AND MUNICIPALITIES' COST OF 
CAPITAL

    ELA also opposes the Administration's proposal to 
``disallow interest on debt allocable to tax-exempt 
obligations,'' as the elimination of the 2% de minimis rule 
will impair the ability of state and local governments to raise 
capital. While non-financial corporations may not account for a 
large percentage of total municipal securities outstanding, 
these corporate buyers do play a vital role in three important 
market segments: 1) short term municipal investments, 2) state 
and local government housing and student loan bonds, and 3) 
municipal leasing transactions.

CONCLUSION

    Congress, the Treasury Department and the courts have long 
recognized that companies financing the acquisition of 
equipment through a loan are the recipients of various tax 
incentives. These same bodies also have long recognized that 
equipment acquired through leasing involves the transfer of tax 
benefits from the user of the equipment to the owner-lessor. As 
a direct result of these sound tax policies, American citizens 
are the beneficiaries of the most modern and productive economy 
in the world. While equipment lessors would undoubtedly be 
negatively impacted by the proposed changes discussed above, 
the ultimate impact will be to drive up the cost of capital 
equipment acquisitions for all businesses, particularly small 
businesses.
    For over three decades, ELA members have provided lessees 
with various financing options within the spirit and intent of 
U.S. tax policy. In 1999 alone, the equipment leasing industry 
invested in excess of $200 billion in productive assets. 
However, the uncertainty caused by the Administration's 
proposals has already slowed down the market. To minimize 
further market disruptions and maintain strong economic growth 
while Congress deliberates the FY 2001 budget, we urge the 
respective Chairmen of the House Ways and Means and Senate 
Finance Committees to publicly state that the effective date 
for any tax code amendments restricting the use of incentives 
will be the date of enactment.
      

                                

Statement of David Benson, Ernst & Young LLP, and LaBrenda Garrett-
Nelson, Washington Counsel, P.C., Global Competitiveness Coalition 2000

    The Global Competitiveness Coalition (the ``Coalition'') is 
a group of about 30 U.S.--based multinational business 
enterprises representing a broad cross section of American 
businesses.

Introduction

    The proposed hybrid branch regulations that were issued 
pursuant to Notice 98-35 in July of last year provided for a 
six-year-plus ``moratorium'' on the application of rules that 
would restrict the ability to use hybrid branch arrangements to 
reduce foreign tax without triggering subpart F inclusions. The 
Coalition believes the Ways and Means Committee should reject 
the proposal relating to ``identified tax havens,'' to the 
extent the proposal has the potential to alter Treasury's 
agreement to allow the Congress an opportunity to deal with 
hybrid branch arrangements during the ``moratorium'' on the 
finalization of hybrid branch regulations.

Summary of the Administration's ``Identified Tax Haven'' proposal

    The Administration's proposal would require the reporting 
of payments to, and restrict tax benefits for income flowing 
through, ``Identified Tax Havens.''
    Under the proposed reporting requirement, all payments 
(including money and tangible and intangible property) to 
entities (including corporations, partnerships and disregarded 
entities, branches, trusts and estates), accounts or 
individuals resident or located in Identified Tax Havens would 
be reported on the taxpayer's annual income tax return. 
Jurisdictions would be considered tax havens and included on 
the list of Identified Tax Havens to be published by the 
Secretary of the Treasury based on certain criteria, including, 
but not limited to, whether a jurisdiction (1) imposes no or 
nominal taxation, either generally or on specific classes of 
capital income, and (2) has strict confidentiality rules and 
practices, and/or has ineffective information exchange 
practices. The proposal would not apply to payments if: (1) the 
Identified Tax Haven has in force with the U.S. an agreement 
providing for the exchange of tax information that is effective 
for both criminal tax and civil tax administration purposes, 
(2) the payee certifies to the payor that, through a legally 
effective confidentiality waiver or otherwise, information 
about the payment would be available to the IRS upon request, 
or (3) the payment is less than $10,000 (subject to an anti-
abuse rule requiring related payments to be aggregated). A 
penalty of 20 percent of the amount of the payment would be 
imposed on payors who fail to report.
    The proposal affecting tax benefits would deny foreign tax 
credits (FTCs) for taxes paid to Identified Tax Havens and 
would apply the FTC limitation rules separately to income 
earned in or through an Identified Tax Haven. The proposal also 
would reduce by a factor (similar to the international boycott 
factor) a taxpayer's (1) otherwise allowable FTC or foreign 
sales corporation benefit attributable to income from an 
Identified Tax Haven, and (2) the income, attributable to an 
Identified Tax Haven, that is otherwise eligible for deferral. 
This reduction of tax benefits would be based on a fraction, 
the numerator of which is the sum of the taxpayer's income and 
gains from an Identified Tax Haven, and the denominator of 
which is the taxpayer's total non-U.S. income and gains. The 
proposal would be effective for taxable years beginning after 
the date of enactment.
    Although the proposal is generally effective for payments 
made after the date of enactment, because the proposal is 
limited to jurisdictions to be included on a published list; 
the proposal would only apply to taxable years beginning after 
the publication of the list.

Unresolved Issues Regarding the Identification of Tax Havens

    At a Treasury briefing on February 7, 2000, the Acting 
Assistant Secretary for Tax Policy (Jon Talisman) acknowledged 
that this proposal was based on work done with the OECD. 
Indeed, elements of the proposal can be traced to the 
recommendations included in the OECD's 1998 report entitled 
``Harmful Tax Competition: An Emerging Global Issue.'' For 
example, one of the OECD recommendations is to deny a tax 
benefit to ``foreign source income that has benefited from tax 
practices deemed as constituting harmful tax competition;'' and 
another recommendation encourages OECD countries to ``undertake 
programs to intensify exchange of relevant information 
concerning transactions in tax havens.'' It is unclear whether 
Treasury intends to build on the on-going work being done by 
the OECD ``Forum on Harmful Tax Practices'' to compile a list 
of tax havens, nor is it clear whether this proposal is 
intended to reach preferential tax regimes that may be 
available to particular activities in countries that are not 
generally viewed as tax havens.

The Concern About Hybrid Branch Arrangements

    As currently described, the Administration's proposal on 
Identified Tax Havens would implement substantive changes 
consistent with indications of Treasury's continuing discomfort 
with hybrid branch arrangements. The Coalition is particularly 
concerned that the proposal can be read to indicate that 
Treasury may continue to seek to attack the use of hybrid 
branch arrangements by proposing changes to ancillary rules, 
notwithstanding the events that led up to the effective 
withdrawal of Notice 98-35 and the issuance of the proposed 
hybrid branch regulations having a substantially delayed 
effective date in July of last year.
    The Coalition's concern is based in part on public 
statements by senior Treasury officials. For example, at the 
IRS/GWU international tax conference last December, one 
official stated that, in general, transactions resulting in 
differing U.S. and foreign tax results are against the policy 
of our tax rules, a statement that was made in the course of a 
discussion of a hybrid branch arrangement. More recently, 
Treasury's continuing concern with the use of such entities was 
noted by a member of Treasury's Office of International Tax 
Counsel, at a February 3 meeting of the International Tax and 
Finance Forum. A more tangible indication of Treasury's views, 
and basis for the Coalition's concern, is the issuance in late 
November 1999 of proposed regulations that would invalidate 
certain elections to treat foreign entities as hybrid branches 
(in the absence of an identified abuse).\1\
---------------------------------------------------------------------------
    \1\ Representatives of the Coalition testified at an IRS hearing on 
these regulations in January, and will submit written comments (on or 
before February 28, 2000) urging withdrawal of the regulations.

---------------------------------------------------------------------------
Potential Impact on Existing Hybrid Branch Arrangements

    Where a taxpayer has already entered into a hybrid branch 
arrangement, there is a question about whether the 
Administration's Budget proposal on Identified Tax Havens could 
apply to effectively negate the benefits of the hybrid branch 
arrangement--a result that would appear to be contrary to the 
moratorium on restricting the use of hybrid branch 
arrangements. Depending on how Treasury decides to define a tax 
haven, this result could occur in a fairly common situation 
where a hybrid branch located in a high-tax jurisdiction makes 
deductible interest or royalty payments to a controlled foreign 
corporation (``CFC'') located in a low-tax jurisdiction. Under 
current law, the CFC would not have a subpart F inclusion 
because the interest or royalty payment would be a nullity for 
U.S tax purposes. Under the Administration's proposal, however, 
the income otherwise eligible for deferral might be included in 
the CFC's income if the CFC is located in a country on 
Treasury's list of tax havens.

Conclusion

    Treasury has agreed to refrain from finalizing regulations 
that would restrict the use of hybrid branch arrangements 
during a six-year-plus moratorium. Therefore, the Committee 
should reject the ``Identified Tax Haven'' proposal because it 
has the potential to alter Treasury's agreement.
      

                                

Statement of Home Care Coalition

    On behalf of the Home Care Coalition, thank you for the 
opportunity to provide comments on the President's budget 
proposal for fiscal year 2001. The Home Care Coalition was 
founded in 1991 to unite the efforts of home care providers, 
family caregivers, health care professionals, manufacturers, 
consumers, and consumer advocacy organizations. The Coalition 
has become a major voice in support of home health care, which 
is often patient-preferred and more cost-effective than 
institutional care. As the only national organization 
representing providers, consumers and manufacturers of home 
health services, we urge you to support proposals to help 
America's caregiving families.
    This year, the President has placed more emphasis on 
providing home and community-based services through Medicaid 
and making assisted living facilities available to lower income 
elderly. Once again, he has called for the creation of a 
National Family Caregivers Support Program and non-subsidized 
long-term care insurance for federal employees, retirees and 
their families. In addition, a number of bills have been 
introduced in this Congress to expand access to long-term care 
insurance and provide relief to family caregivers.
    The Home Care Coalition urges this Committee to act this 
year to support programs needed to relieve the burdens on 
family caregivers and to increase access to the home and 
community-based services so essential to the well being of 
millions of frail elderly, disabled and chronically ill 
Americans.

                               Who we are

    The Home Care Coalition (HCC) is comprised of the 
following:

    Consumers of Home Care: Not all home care beneficiaries are 
alike. As a result, their at-home needs are wide and varied. 
Those with chronic conditions such as emphysema require the 
constant assistance of oxygen systems to make breathing easier. 
Consumers in the final stages of complications brought about by 
diseases such as AIDS require extensive levels of care. Active 
elderly persons who may be recuperating from an injury need 
products and services for an interim period until they 
recuperate. Younger persons with disabilities may require fewer 
products and services, but may need them for a lifetime.
    Family Caregivers: People who cannot completely care for 
themselves because of an illness or disability rely heavily on 
family members to provide a wide range of services. Typically, 
family caregivers provide assistance with basic needs such as 
feeding, toileting, and dressing, as well as transportation, 
shopping, and cooking. Family caregivers give injections, 
change dressings, and help with rehabilitative exercises. They 
teach, advocate, and provide emotional support. Family 
caregivers provide these services out of feelings of love and a 
sense of duty. They are not paid for their services. It is 
estimated that there are over 25 million family caregivers in 
the United States, providing three-fourths of all home care 
services. Family caregivers make the difference between someone 
being alive and having a life.
    Home Health Providers: Home health providers include 
individuals such as skilled nurses, rehabilitation specialists, 
therapists, pharmacists, physicians, nutritionists, medical 
social workers, home health aides, and homemakers. Health care 
services in the home setting provide a continuum of care for 
individuals who no longer require hospital or nursing home 
care, or to avoid an unnecessary hospital or nursing home 
admission. The range of home care services includes skilled 
nursing; respiratory, occupational, speech, and physical 
therapy; intravenous drug therapy; enteral nutrition; hospice 
care; emotional, physical, and medical care; assistance in the 
activities of daily living; skilled assessments; teaching; and 
financial assistance.
    Home Medical Equipment (HME) Manufacturers: Manufacturers 
of home medical equipment (HME) are committed to producing 
quality products that promote the ability of persons with acute 
and chronic health conditions and disabilities to lead 
productive lives in their homes and communities. Products 
include everything from disposable items such as bandages to 
high-tech equipment such as power-driven wheelchairs, infusion 
therapy pumps and home oxygen delivery systems. As HME 
manufacturers produce advances in medical technology (e.g., 
telemedicine), home care will become even more cost-effective 
than it is today.
    Home Medical Equipment Providers: Home medical equipment 
(HME) providers supply the equipment and related services that 
help consumers meet their therapeutic goals. Pursuant to the 
physician's prescription, HME providers deliver medical 
equipment to a consumer's home, set it up, maintain it, and 
educate and train the consumer and caregiver in its use. HME 
providers also interact with physicians and other home care 
providers as the consumer improves and his/her needs evolve. In 
addition, specialized providers of home infusion manage complex 
intravenous services, including chemotherapy and nutrition 
therapies, in the home.
    Hospital Discharge Planners: Hospital discharge planners 
are health care professionals who are involved in the 
coordination of continuing care services for consumers and 
their families in all health care settings. The discharge 
planner is proactive in the health care delivery planning 
process and will begin an assessment of the consumer's needs 
either in the ambulatory care setting, at home prior to an 
admission for elective surgery, or within 24 hours of an acute 
care admission. This proactive perspective allows discharge 
planners to develop a plan of care that decreases the length of 
the hospital stay and reduces unnecessary acute care 
admissions. The discharge planner facilitates the progress of 
consumers and their families along the health care continuum 
whether it be home care, hospice, or inpatient care.

          Family Caregivers and today's long-term care system

    Family caregivers are literally underpinning our healthcare 
system. The National Family Caregivers Association reports that 
approximately 80% of all home care services are provided by 
family caregivers who are not reimbursed for their time and 
effort. They are family, friends and neighbors who stand by 
those they love as they face chronic illness or disability. 
Their help can take many forms: physical assistance with daily 
activities from going to the bathroom to going to the drug 
store; monitoring medical devices from IVs to ventilators; and 
providing emotional, financial, legal and spiritual support.
    The National Family Caregivers Association conducted a 
study in 1997 that revealed the human face of caregiving. The 
results highlighted the experiences of today's ``sandwich 
generation'' that is increasingly asked to care for their 
ailing parents at the same time that they are juggling the 
demands of their own families and careers. More than 25 million 
individuals across the nation provide caregiving services. The 
vast majority of caregivers are married women over the age of 
35; in fact, more than one in five women between the ages of 35 
-64 are family caregivers. The majority of caregivers spend at 
least 40 hours a week in caregiving activities, mainly in their 
own homes. Nearly 70% of caregivers are providing care for 
their spouse or parent. Not only are the hours long, and the 
time spent considerable, 78% of caregivers expect to be active 
in caregiving for five years or more.
    The United Hospital Fund of New York estimates that it 
would cost at least $196 billion a year to replace the vital 
services provided by family caregivers. The economic value of 
this ``invisible'' health care sector dwarfs the costs of both 
paid home health care ($32 billion) and nursing home care ($83 
billion). Without the free and loving care provided by our 
nation's caregivers, the national health care system would be 
much sicker than it is today.

                 The need for family caregiver support

    The need for caregiving is exploding at the same time that 
the number of available caregivers is evaporating. The aging of 
the baby boom generation will only make this situation more 
dire. People over 85 years of age are the fastest growing 
segment of the population, and they are also the group most 
likely to need care. By 2020, there will be 14 million elderly 
in need of long-term care. It won't be long before every family 
in America is involved in family caregiving.
    Unfortunately, caregiving takes a high economic toll on 
America's families and businesses. Caregivers report that they 
suffer from headaches, sleeplessness and backaches as a direct 
result of their caregiving activities. Depression among 
caregivers is three times the norm for people in their age 
group. More than three-quarters of all family caregivers report 
they receive no consistent help from other family members, and 
feelings of isolation and lack of understanding from others are 
common. It is a sad fact that more people enter nursing homes 
because of caregiver burnout rather than an exacerbation of 
their own condition.
    A recent study by the Center for Women and Aging and the 
National Alliance for Caregiving shows that family caregivers 
can lose over $650,000 in wages, pensions and Social Security 
because of their caregiving responsibilities. Lost wages, 
promotions and career opportunities are the normal consequence 
of family caregiving. In addition, a study conducted by the 
Alzheimer's Association in 1998 found that Alzheimer's disease 
alone costs US businesses $26 billion a year in caregiver 
absenteeism. The Alzheimer's Association reports that increased 
use of respite care at mild and moderate stages of Alzheimer's 
has shown to delay nursing home placement significantly, at a 
net savings of $600 to $1,000 a week.
    Clearly, America's caregivers are in need of support. In 
addition, it is in the best interest of the health care system 
to help families care for their loved ones in their homes for 
as long a period as possible. Numerous studies have shown that 
simple caregiver interventions, such as respite care, 
counseling education and supportive services can have a major 
impact on the well being of caregivers and patients.
    The President's proposal would provide state governments 
access to a network that provides respite care and other 
caregiver support services, information about community-based 
long-term care services, and counseling and support services. 
The Administration estimates that this program would assist 
approximately 250,000 families nationwide. In addition, the 
President proposes a $3,000 tax credit for individuals or 
families that care for individuals with three or more 
limitations in activities of daily living (ADLs) or a 
comparable cognitive impairment.
    The Home Care Coalition believes that these proposals 
represent a critical first step in acknowledging the vital role 
that family caregivers play in our nations health care system. 
We can not assure the future of Medicare and there is no way to 
control the costs of Medicaid, if we let the family caregiving 
system collapse. We urge this committee to revisit the issues 
of family caregiver tax credits and caregiver support programs 
this year.

              Access to home and community-based services

    The Omnibus Budget Reconciliation Act of 1981 established a 
program that allows states to apply for waivers (known as 
1915(c) waivers) to reimburse home and community-based services 
for beneficiaries who would otherwise be institutionalized. In 
order to qualify for a waiver, the cost of institutionalization 
must be explicitly calculated and shown to be greater than the 
home and community-based services. Therefore, individuals must 
be shown to be deficient in at least three activities of daily 
living (e.g., bathing, dressing, toileting, transferring, 
continence, or eating) to qualify for a waiver. As states 
search for new and innovative means of controlling Medicaid 
costs, 1915(c) waivers have become more and more popular. There 
are currently 240 waiver programs in effect across the nation.
    The President's budget includes a proposal to enable states 
to provide services to nursing-home qualified beneficiaries at 
300% of the Supplemental Security Income (SSI) limit without 
requiring a federal 1915(c) waiver. This proposal would 
encourage states to implement these popular and cost-saving 
programs.
    We are very concerned, however, about funding for the Title 
XX Social Services Block Grant Program, which funds adult day 
services, home and community care and adult protective services 
in many states. Two years ago, the program was funded at a 
level of $2.38 billion. The program was cut to $1.775 billion 
and, much to our surprise, President Clinton has proposed 
freezing spending at this lower level, far below the 
Administration's request last year of $2.38 billion.
    The Home Care Coalition urges the Committee to support the 
President's proposal to recognize the effectiveness of home and 
community-based services by eliminating the need for 1915(c) 
waivers. However, we hope that you will back up this 
recognition by opposing drastic reductions in funding for the 
Title XX Social Services Block Grant.

                               Conclusion

    The services provided by home health care providers--be 
they formal providers or informal family caregivers--are vital 
to America's chronically ill, frail elderly and disabled. These 
services are also key to securing the financial viability of 
the Medicare Program. The Home Care Coalition urges this 
Committee to recognize the importance of family caregivers by 
enacting long-term care proposals such as those proposed by the 
President this year. The Coalition looks forward to working 
with this Committee to address the many issues facing home 
health care.
      

                                

Statement of Independent Sector

    Independent Sector (is) is a coalition of more than 700 
national organizations and companies representing the vast 
diversity of the nonprofit sector and the field of 
philanthropy. Its members include many of the nation's most 
prominent and far-reaching nonprofit organizations, leading 
foundations, and Fortune 500 corporations with strong 
commitments to community involvement. This network represents 
millions of volunteers, donors, and people served in 
communities around the world. is members work globally and 
locally in human services, education, religion, the arts, 
research, youth development, health care, advocacy, democracy, 
and many other areas. is is the only organization to represent 
a network so broad.
    America's ``independent sector'' is a diverse collection of 
more than one million charitable, educational, religious, 
health, and social welfare organizations. It is these groups 
that create, nurture, and sustain the values that frame 
American life and strengthen democracy. In 1980, a group of 
visionary leaders, chaired by the Honorable John W. Gardner, 
became convinced that if the independent sector was to continue 
to serve society well, it had to be mobilized for greater 
cooperation and influence. Thus a new organization, named to 
celebrate the independent sector's unique role apart from 
government and business, was formed to preserve and enhance and 
protect a healthy, vibrant independent sector.
    There are a number of initiatives relating to the nonprofit 
sector in the Administration's FY 2001 budget that we would 
like to bring to the committee's attention. These include a 
charitable deduction for nonitemizers, an increased limit for 
individual donations of appreciated assets, and taxation on the 
investment income of associations. IS would like to present the 
following comments to the committee.

Nonitemizer Deduction

    The President's budget would create a charitable deduction 
for taxpayers who do not itemize their deductions. These 
individuals would be able to deduct fifty percent of their 
annual charitable contributions above a $1,000 floor, $2,000 
for joint returns, through 2005. That floor will be lowered to 
$500, $1,000 for joint returns, beginning in 2006.
    IS has long been supportive of any legislative effort to 
encourage charitable giving, particularly by permitting 
nonitemizers to deduct their generous gifts. The Charitable 
Giving Tax Relief Act, H.R. 1310, introduced by Representative 
Philip Crane (R-IL) and cosponsored by William Coyne (D-PA), 
Wally Herger (R-CA), and Karen Thurman (D-FL), is a case in 
point. This legislation is similar to the President's proposal 
with the exception that the $500 floor would become effective 
immediately. The bill currently has 122 bipartisan cosponsors, 
including 18 members of the Ways and Means Committee.
    Charitable giving is a transfer of private resources for 
public purposes. Giving to charities promotes individual choice 
as well as public responsibility among nonprofit organizations. 
In a recent study, Giving and Volunteering in the United 
States, 1999, IS found that the average annual household 
contribution made by nonitemizers is $619. By creating a 
deduction for nonitemizers we would be recognizing those 
taxpayers who give above and beyond average levels.
    The nonitemizer deduction is also based on generosity and 
sacrifice, not personal gain. Individuals are motivated to make 
charitable contributions primarily by their altruistic nature. 
However, as with any decision related to the use of limited 
resources, the amount a person gives to charitable causes will 
be influenced by the cost to them of giving. The cost of giving 
can be significantly changed by the tax treatment of the gift.
    This deduction would restore fairness to the tax code for 
nonitemizers who give generously. Currently, nonitemizers 
represent more than two-thirds of American taxpayers B over 84 
million people. Americans who don't itemize on their returns 
would have a new opportunity to deduct some of their charitable 
contributions. In 1986, the tax deduction expired due to a 
sunset provision in the law. IS believes that it is time our 
public policies recognize those who give significant portions 
of their income to the causes they care about.
    This is also an example of effective and meaningful tax 
policy. It recognizes the contributions of individuals and 
families while it also acknowledges the contributions 
charitable organizations make to communities.
    We are grateful for the Administration's efforts to include 
incentives for charitable giving in his budget, and we urge you 
to support HR 1310.

Limitation on Individual Gifts of Appreciated Property 

    The President's budget includes a provision that would 
increase the limitation on the charitable deduction for gifts 
of appreciated property to charity. Current law permits 
taxpayers who itemize to take a deduction for gifts of 
appreciated property to a public charity or private foundation. 
However, the deduction is limited to a percentage of the 
taxpayer's adjusted gross income (AGI). We believe that the 
lowered value of the gift will discourage individuals from 
making the donation to the charity of their choice.
    Presently, the charitable deduction is limited to thirty 
percent of AGI for gifts of appreciated property to charities, 
and to twenty percent for such gifts to private foundations. 
The Administration's proposal would increase these limits to 
fifty and thirty percent, respectively. This would become 
effective for gifts made after December 31, 2000.
    As more Americans are acquiring additional income and 
assets as a result of the strong performance of the stock 
market, we hope the government will encourage these individuals 
to give a portion of their new wealth to charitable causes. For 
many Americans, donating gifts of appreciated property is a 
common form of philanthropy. We urge the committee to enhance 
this incentive by fully recognizing these generous 
contributions.

Association Investment Income Tax

    The Clinton Administration has proposed once again to place 
an income tax on the investments made by trade associations 
(501(c)(6) organizations). Identical to the provision 
introduced by the President last year, the tax affects all 
trade associations with income exceeding $10,000 during any tax 
year. The tax is levied on the interest, dividend, royalty, and 
rental income of associations and essentially alters section of 
the tax code that had previously granted such groups exempt 
from taxation.
    While the membership of many trade associations consists 
primarily of for-profit entities, some associations include 
substantial numbers of nonprofit organizations. We have 
concerns about this proposal since it erodes the principle of 
exempting from tax passive income earned by nonprofit 
organizations.
    IS joins the American Society of Association Executives 
(ASAE) in opposing this misguided proposal. While the 
Administration maintains that this provision would close a 
loophole in the tax code encouraging members of associations to 
pay higher dues in order to claim a tax deduction, associations 
are not permitted to pay dividends to their members, and 
therefore are more likely to keep their dues levels at a 
minimum. In addition, investment income helps an association 
enhance the services it provides its members while creating 
reserve funds for the future.

Conclusion

    Mr. Chairman, we appreciate the opportunity to submit these 
comments to the committee, and look forward to working with you 
and your staff on these matters.
      

                                

Statement of the Leasing Coalition, PricewaterhouseCoopers LLP

                            I. Introduction

    On behalf of a group of companies in the leasing industry 
(hereinafter the ``Leasing Coalition''), PricewaterhouseCoopers 
appreciates the opportunity to present this written statement 
to the House Ways and Means Committee in conjunction with its 
February 9, 2000, hearing on the Administration's FY 2001 
budget proposals.
    Our comments center on tax increases proposed by the 
Administration that would overturn the carefully constructed 
body of law, built over decades, governing the tax treatment of 
leasing transactions. These proposals include a leasing-
industry specific measure that would further penalize U.S. 
companies using leasing to finance the export of manufactured 
goods abroad.\1\ The Leasing Coalition also has strong concerns 
about the impact on leasing transactions of several general 
Administration proposals relating to ``corporate tax 
shelters,'' including a proposal empowering IRS agents to deny 
tax benefits in ``tax-avoidance transactions.'' \2\
---------------------------------------------------------------------------
    \1\ General Explanations of the Administration's Fiscal 2001 
Revenue Proposals, Department of the Treasury, February 2000, at 137-8.
    \2\ Id. at 124.
---------------------------------------------------------------------------
    In these comments, the Leasing Coalition discusses the 
rationale underlying the present-law tax treatment of leasing 
transactions and examines the impact of the Administration's 
proposals on commonplace leasing arrangements. We also discuss 
the adverse impact these proposals would have on the 
competitiveness of American businesses, on exports, and on the 
cost of capital.
    We conclude by urging Members of the House Ways and Means 
Committee to reject the Administration's tax proposals that 
would adversely affect the leasing industry. These proposals 
inappropriately would overturn the longstanding body of tax law 
governing common leasing transactions, branding these 
legitimate business transactions as ``corporate tax shelters.'' 
Instead of considering proposals at this time that would impair 
the competitiveness of the leasing industry, we respectfully 
suggest that the Administration and the Congress consider ways 
to help U.S. companies that use leasing as a form of financing 
expand in the global marketplace.

                        II. The Leasing Industry

    Leasing is an increasingly common means of financing 
investment in equipment and other property. It is estimated 
that approximately 30 percent of all domestic equipment 
investment is financed through leasing rather than outright 
acquisition.\3\ Approximately 80 percent of U.S. companies 
lease some or all of their equipment.\4\ The leasing industry 
in 1998 financed more than $180 billion in equipment 
acquisitions, an amount that exceeded $200 billion in 1999.\5\
---------------------------------------------------------------------------
    \3\ U.S. Department of Commerce.
    \4\ Equipment Leasing Association.
    \5\ U.S. Department of Commerce.
---------------------------------------------------------------------------
    Lessees, or the users of the property, find leasing an 
attractive financing mechanism for a number of reasons. Because 
a lease allows 100-percent financing, the lessee is able to 
preserve cash that would be necessary to buy or make a 
downpayment on a piece of equipment. Moreover, lessees 
generally are able to secure financing under a lease at a lower 
cost than under a loan. A lessee also may wish to use the asset 
only for a short period of time, and may not want to risk 
having the value of the equipment decline more quickly than 
expected -or become obsolete--during this period of use. For 
financial statement purposes, leasing can be preferable in that 
it allows the lessee to secure off-balance sheet reporting with 
respect to the asset. Finally, the lessee may find rental 
deductions for lease payments more beneficial, from a timing 
perspective, than depreciation deductions taken over a certain 
schedule (e.g., double-declining balance).
    Leasing also provides a number of business advantages to 
lessors. Manufacturing companies (e.g., automobile, computer, 
aircraft, and rolling stock manufacturers) may act as lessors 
through subsidiary companies as a means of providing their 
goods to customers. Financial institutions like banks, thrifts, 
and insurance companies engage in leasing as a core part of 
their financial intermediation business. As the owner of the 
equipment, the lessor is able to take full deductions for 
depreciation. Currently, more than 2,000 companies act as 
equipment lessors.\6\
---------------------------------------------------------------------------
    \6\ Equipment Leasing Association.
---------------------------------------------------------------------------
    Leasing also promotes exports of U.S. equipment, and thus 
helps U.S. companies compete in the global economy. Many lease 
transactions undertaken by U.S. lessors are cross-border 
leases, i.e., leases of equipment to foreign users. These 
involve all types of equipment, including tankers, railroad 
cars, machine tools, computers, copy machines, printing 
presses, aircraft, mining and oil drilling equipment, and 
turbines and generators. Many of these leases are supported in 
one form or another by the Export-Import Bank of the United 
States, which insures the credit of foreign lessees. Further, 
U.S. manufacturers demand global leasing solutions in support 
of their export activities.

                  III. Present-Law Treatment of Leases

    A substantial body of law has developed over the last forty 
years regarding the treatment of leasing transactions for 
federal income tax purposes. At issue is whether a transaction 
structured as a lease is respected as a lease for tax purposes 
or is recharacterized as a conditional sale of the property. If 
the transaction is respected as a lease for tax purposes, the 
lessor is treated as the owner of the property and therefore is 
entitled to depreciation deductions with respect to the 
property. The lessor also is entitled to interest deductions 
with respect to any financing of the property, and recognizes 
income in the form of the rental payments it receives. The 
lessee is entitled to a business deduction for the rental 
payments it makes with respect to the property. On the other 
hand, if the transaction is recharacterized as a conditional 
sale, the purported lessee is treated as having purchased the 
property in exchange for a debt instrument. The purported 
lessee is treated as the owner of the property and is entitled 
to depreciation deductions with respect to the property. In 
addition, the purported lessee is entitled to interest 
deductions for a portion of the amount it pays under the 
purported lease. The purported lessor recognizes gain or loss 
on the conditional sale and recognizes interest income with 
respect to a portion of the amount received under the purported 
lease. The purported lessor is entitled to interest deductions 
with respect to any financing of the property.
    Guidance regarding the determination whether a transaction 
is respected as a lease for tax purposes is provided pursuant 
to an extensive body of case law. There also have been 
significant IRS pronouncements addressing this determination, 
which have been maintained for more than 25 years. Finally, 
statutory provisions provide specific rules regarding the tax 
consequences of certain leasing transactions.

                              A. Case law

    The determination whether a transaction is respected as a 
lease for tax purposes generally is made based on the substance 
of the transaction and not its form.\7\ This substantive 
determination focuses on which party is the owner of the 
property that is subject to the lease (i.e., which party has 
the benefits and burdens of ownership with respect to the 
property).\8\ In addition, the transaction must have economic 
substance or a business purpose in order to be classified as a 
lease for tax purposes.\9\
---------------------------------------------------------------------------
    \7\ Helvering v. F. & R. Lazarus & Co., 308 U.S. 252 (1939).
    \8\ Estate of Thomas v. Commissioner, 84 T.C. 412 (1985).
    \9\ Rice's Toyota World, Inc. v. Commissioner, 81 T.C. 184 (1983), 
aff'd in part and rev'd in part, 752 F.2d 89 (4th Cir. 1985); Frank 
Lyon Co. v. United States, 435 U.S. 561 (1978).
---------------------------------------------------------------------------
    The most important attributes of ownership are the upside 
potential for economic gain and the downside risk of economic 
loss based on the residual value of the leased property.\10\ 
The presence of a fair market value purchase option in a lease 
agreement should not impact the determination of tax 
ownership.\11\ Moreover, the fact that such an option is fixed 
at the estimated fair market value should not by itself cause 
the lease to be treated as a conditional sale.\12\ However, 
where a lessee is economically or legally compelled to exercise 
the purchase option because, for example, the option price is 
nominal in relation to the value of the property, the lease 
likely would be treated as a conditional sale.\13\
---------------------------------------------------------------------------
    \10\ Swift Dodge v. Commissioner, 692 F.2d 651 (9th Cir. 1982), 
rev'g, 76 T.C. 547 (1981).
    \11\ Lockhart Leasing Co. v. Commissioner, 54 T.C. 301, 314-15 
(1970), aff'd 446 F.2d 269 (10th Cir. 1971).
    \12\ See Frank Lyon Co. v. United States, supra.
    \13\ Oesterreich v. Commissioner, 226 F.2d 798 (9th Cir. 1955), 
rev'g, 12 T.C.M. 277 (1953).
---------------------------------------------------------------------------
    Another important indicia of ownership for tax purposes is 
the holding of legal title; this factor, however, is not 
determinative.\14\ The right to possess the property throughout 
its economic useful life also is an attribute of ownership for 
tax purposes. For example, the entitlement of the lessee to 
possession of the property for its entire useful life would be 
a strong indication that the lessee rather than the lessor 
should be considered the owner of the property for tax 
purposes.\15\
---------------------------------------------------------------------------
    \14\ Coleman v. Commissioner, 87 T.C. 178, 201 (1986), aff'd 883 
F.2d 303 (3d Cir. 1987).
    \15\ Pacific Gamble Robinson v. Commissioner, 54 T.C.M. 915 (1987).
---------------------------------------------------------------------------
    The economic substance test finds its genesis in the 
Supreme Court opinion in Frank Lyon Co. There, the United 
States Supreme Court determined that a sale and leaseback 
should not be disregarded for federal income tax purposes if 
the transaction:
    is a genuine multi-party transaction with economic 
substance which is compelled or encouraged by business or 
regulatory realities, is imbued with tax-independent 
considerations, and is not shaped solely by tax-avoidance 
features that have meaningless labels attached. . . Expressed 
another way, so long as the lessor retains significant and 
genuine attributes of the traditional lessor status, the form 
of the transaction adopted by the parties governs for tax 
purposes.\16\
---------------------------------------------------------------------------
    \16\ Id. at 583.
---------------------------------------------------------------------------
    The IRS challenged the sale-leaseback transaction in Frank 
Lyon on the grounds that it was a sham. However, the Court 
concluded that, in the absence of specific facts evidencing a 
sham transaction motivated solely by tax-avoidance purposes, a 
lessor need only possess ``significant and genuine attributes 
of traditional lessor status,'' evidenced by the economic 
realities of the transaction, in order for a lease to be 
respected for federal income tax purposes. The Court recognized 
that there can be many business or economic reasons for 
entering into a lease. Legal, regulatory, and accounting 
requirements, for example, can serve as motivations to lease an 
asset. Instead of trying to identify one controlling factor, 
the Court used the same test as the other leasing cases--that 
all facts and circumstances must be considered in determining 
economic substance. Further, the Court noted that ``the fact 
that favorable tax consequences were taken into account by Lyon 
on entering into the transaction is no reason for disallowing 
those consequences.'' \17\
---------------------------------------------------------------------------
    \17\ Id. at 561.
---------------------------------------------------------------------------
    In the wake of Frank Lyon, the Tax Court has refined the 
analysis of whether a lease should be respected for tax 
purposes. Under Rice's Toyota World, Inc. v. Commissioner, and 
its progeny, the Tax Court will disregard a lease transaction 
for lack of economic substance only if (i) the taxpayer had no 
business purpose for entering into the transaction other than 
to reduce taxes, and (ii) the transaction, viewed objectively, 
offered no realistic profit potential. Further elaborating on 
this standard, the Tax Court in Mukerji v. Commissioner \18\ 
set forth the test that in subsequent cases has been used to 
determine whether a lease should be disregarded for tax 
purposes:
---------------------------------------------------------------------------
    \18\ 87 T.C. 926 (1986).
---------------------------------------------------------------------------
    [u]nder such test, the Court must find ``that the taxpayer 
was motivated by no business purpose other than obtaining tax 
benefits in entering into the transaction, and that the 
transaction had no economic substance because no reasonable 
possibility of a profit exists.'' \19\
---------------------------------------------------------------------------
    \19\ Id. at 959 Rice's Toyota World, supra, at 91).
---------------------------------------------------------------------------
    Once business purpose is established, a lease transaction 
should not be classified as a ``sham.'' A finding of no 
business purpose, however, is not conclusive evidence of a sham 
transaction. The transaction will still be valid if it 
possesses some economic substance. The Tax Court has developed 
an objective test for economic substance. A lease will meet the 
threshold of economic substance and will be respected when the 
net ``reasonably expected'' residual value and the net rentals 
(both net of debt service) will be sufficient to allow 
taxpayers to recoup their initial equity investment.\20\ 
Applying this analysis, the Tax Court in several cases has 
concluded that a purported lease transaction was devoid of 
business purpose and lacked economic substance because the 
taxpayers could not reasonably expect to recoup their capital 
from the projected non-tax cash flows in the lease.\21\
---------------------------------------------------------------------------
    \20\ See Mukerji, supra.
    \21\ See Goldwasser v. Commissioner, 56 T.C.M. 606 (1988); Casebeer 
v. Commissioner, 54 T.C.M. 1432 (1987); and James v. Commissioner, 87 
T.C. 905 (1986).
---------------------------------------------------------------------------
    Most recently, outside the context of leasing transactions, 
the Tax Court in Partnership v. Commissioner \22\ had the 
opportunity to apply a form of economic substance test. There, 
the Tax Court stated that ``the doctrine of economic substance 
becomes applicable, and a judicial remedy is warranted, where a 
taxpayer seeks to claim tax benefits, unintended by Congress, 
by means of a transaction that serves no economic purpose other 
than tax savings.'' \23\ The court further found that the 
taxpayer could not have hoped to recover its initial investment 
and its costs under any reasonable economic forecast. This 
proposition that the economic substance test cannot be 
satisfied if a taxpayer cannot demonstrate a reasonable 
expectation of pre-tax profit is consistent with the long-
standing body of case law regarding lease transactions.
---------------------------------------------------------------------------
    \22\ 73 T.C.M. (1997), aff'd in part and rev'd in part, 157 F.3d 
231 (3d Cir. 1998), cert. denied, 1999 U.S. LEXIS 1899 (Mar. 22, 1999).
    \23\ Id. at 130.
---------------------------------------------------------------------------

                    B. Administrative pronouncements

    Through revenue rulings and other administrative 
pronouncements, the IRS has identified certain principles and 
factors it considers relevant in determining whether a 
transaction should be treated for tax purposes as a lease or as 
a conditional sale.
    In Rev. Rul. 55-540,\24\ the IRS indicated that conditional 
sale treatment is evidenced where the lessee effectively has 
the benefits and burdens of ownership for the economic life of 
the property, as demonstrated by, for example, the application 
of rentals against the purchase price or otherwise to create an 
equity interest, the identification of a portion of rentals as 
interest, the approximate equality of total rentals and the 
cost of the property plus interest, or the existence of nominal 
renewal or purchase options. The passage of legal title itself 
is not determinative.
---------------------------------------------------------------------------
    \24\ 1955-2 C.B. 39. See also Rev. Rul. 55-541, 1955-2 C.B. 19.
---------------------------------------------------------------------------
    In addition, the IRS has issued a series of revenue 
procedures setting forth guidelines that must be satisfied to 
obtain an advance ruling that a ``leveraged lease'' (a 
transaction involving three parties--a lessor, a lessee, and a 
lender to the lessor) will be respected as a lease for tax 
purposes.\25\ According to Rev. Proc. 75-21, the guidelines set 
forth therein were published:
---------------------------------------------------------------------------
    \25\ See Rev. Proc. 75-21, 1975-1 C.B. 715 (setting forth several 
requirements that must be satisfied for the Service to rule that a 
transaction is a lease for tax purposes); Rev. Proc. 75-28, 1975-1 C.B. 
752 (specifying information that must be submitted pursuant to Rev. 
Proc. 75-21); Rev. Proc. 76-30, 1976-2 C.B. 647 (providing that the 
Service will not issue an advance ruling if the property subject to the 
``lease'' is limited use property); Rev. Proc. 79-48, 1979-2 C.B. 529 
(modifying Rev. Proc. 75-21 to allow the lessee to pay for certain 
improvements).
---------------------------------------------------------------------------
    to clarify the circumstances in which an advance ruling 
recognizing the existence of a lease ordinarily will be issued 
and thus to provide assistance to taxpayers in preparing ruling 
requests and to assist the Service in issuing advance ruling 
letters as promptly as practicable. These guidelines do not 
define, as a matter of law, whether a transaction is or is not 
a lease for federal income tax purposes and are not intended to 
be used for audit purposes. If these guidelines are not 
satisfied, the Service nevertheless will consider ruling in 
appropriate cases on the basis of all the facts and 
circumstances. (Emphasis added.)
    Thus, the IRS guidelines are intended only to provide a 
list of criteria that if satisfied ordinarily will entitle a 
taxpayer to a favorable ruling that a leveraged lease of 
equipment will be respected as a lease for tax purposes.
    With respect to economic substance, the IRS guidelines set 
forth a profit test that will be met if:
    the aggregate amount required to be paid by the lessee to 
or for the lessor over the lease term plus the value of the 
residual investment [determined without regard to the effect of 
inflation] exceed an amount equal to the sum of the aggregate 
disbursements required to be paid by or for the lessor in 
connection with the ownership of the property and the lessor's 
equity investment in the property, including any direct costs 
to finance the equity investment, and the aggregate amount 
required to be paid to or for the lessor over the lease term 
exceeds by a reasonable amount the aggregate disbursements 
required to be paid by or for the lessor in connection with the 
ownership of the property.\26\
---------------------------------------------------------------------------
    \26\ Rev. Proc. 75-21, supra.
---------------------------------------------------------------------------
    The IRS guidelines do not specify any particular amount of 
profit that a lease must generate.\27\
---------------------------------------------------------------------------
    \27\ The IRS guidelines understate the actual profit earned over 
the lease term by failing to adjust the residual value of the 
investment for inflation. The advance ruling practice of the IRS from 
1975 has been to require a pre-tax profit, cash on cash return, that 
approximates the inflation rate projected for the leased asset.
---------------------------------------------------------------------------
    The IRS itself has not relied exclusively on the criteria 
set forth in the IRS guidelines when analyzing the true lease 
status of a lease transaction. Moreover, the courts have not 
treated the IRS guidelines as determinative when analyzing 
whether a transaction should be respected as a lease for tax 
purposes.\28\ Rather, the IRS guidelines are viewed as 
constituting a ``safe harbor'' of sorts. Accordingly, 
satisfaction of the conservative rule set forth by the 
applicable IRS guideline with respect to a particular criterion 
usually is viewed as an indication that the transaction should 
not be challenged on such a criterion.
---------------------------------------------------------------------------
    \28\ In a footnote in Frank Lyon, supra at n. 14, the Supreme Court 
specifically recognized that the IRS guidelines ``are not intended to 
be definitive.'' Moreover, in Estate of Thomas v. Commissioner, 84 T.C. 
412, 440 n. 15 (1985), the Tax Court viewed the failure to satisfy all 
the IRS guidelines as not determinative because the facts and 
circumstances demonstrated that the transaction satisfied the 
``spirit'' of the guidelines.
---------------------------------------------------------------------------
    The IRS in March 1999 issued Rev. Rul. 99-14, with respect 
to a narrow class of relatively recent cross-border leasing 
transactions commonly referred to as ``LILO'' transactions. The 
IRS ruled that a taxpayer may not deduct rent and interest paid 
or incurred in connection with a LILO transaction that lacks 
economic substance.

                        C. Statutory provisions

    The party that is treated as the owner of the leased asset 
is entitled to depreciation deductions in respect of such 
asset. The Deficit Reduction Act of 1984 enacted the ``Pickle'' 
rules (named after one of the sponsors of the provision, 
Representative J.J. Pickle), which restrict the benefits of 
accelerated depreciation in the case of property leased to a 
tax-exempt entity.
    The Pickle rules generally provide that, in the case of any 
``tax-exempt use property'' subject to a lease, the lessor 
shall be entitled to depreciate such property using the 
straight-line method and a recovery period equal to no less 
than 125 percent of the lease term.\29\ Tax-exempt use 
property, for this purpose, generally is tangible property 
leased to a tax-exempt entity, which is defined to include any 
foreign person or entity.\30\
---------------------------------------------------------------------------
    \29\ I.R.C. section 168(g).
    \30\ I.R.C. section 168(h).
---------------------------------------------------------------------------
    In applying the Pickle rules, Treasury regulations adopted 
in 1996 provide that the lease term will be deemed to include 
certain periods beyond the original duration of the lease. 
Under these regulations, which extend beyond the reach of the 
statutory provision, the lease term includes both the actual 
lease term and any period of time during which the lessee (or a 
related person) (i) agreed that it would or could be obligated 
to make a payment of rent or a payment in the nature of rent or 
(ii) assumed or retained any risk of loss with respect to the 
property (including, for example, holding a note secured by the 
property).\31\
---------------------------------------------------------------------------
    \31\ Treas. Reg. Section 1.168(i)-2(b)(1).
---------------------------------------------------------------------------

             IV. Administration's FY 2001 Budget Proposals

    The Administration's FY 2001 budget includes several 
proposals that could have the effect of completely rewriting 
longstanding tax law on leasing transactions. These proposals, 
if enacted, would replace the substantial and specific body of 
law regarding leasing transactions that has developed over the 
last forty years with broad and largely undefined standards 
that could be used by IRS revenue agents to challenge 
traditional leasing transactions undertaken by companies 
operating in the ordinary course of business in good-faith 
compliance with the tax laws. Moreover, the proposal that would 
modify the tax rules applicable to cross-border leasing would 
penalize U.S. lessors and would further hamper the ability of 
U.S.-based multinationals to compete in export markets.

         A. Proposal to codify the economic substance doctrine

    The proposal would authorize the IRS to disallow any deduction, 
credit, exclusion, or other allowance obtained in a ``tax-avoidance 
transaction.'' A ``tax avoidance transaction'' is defined generally as 
any transaction in which the reasonably expected pre-tax profit is 
insignificant relative to the reasonably expected net tax benefits. A 
financing transaction would be considered a tax-avoidance transaction 
if the present value of the tax benefits of the taxpayer to whom the 
financing is provided significantly exceed the present value of the 
pre-tax profit or return of the person providing the financing.
    This proposal creates the entirely new and vague concept of a 
``tax-avoidance transaction.'' The inclusion of so many subjective 
concepts in this definition precludes it from operating as an objective 
test. As an initial matter, what constitutes the ``transaction'' for 
purposes of this test? \32\ Next, what are the mechanics for computing 
pre-tax economic profits and net tax benefits and for determining 
present values (e.g., what discount rate should be used, particularly 
where rentals, residuals, and their tax benefits have significantly 
different risk and reward profiles?)? Further, where is the line drawn 
regarding the significance of the reasonably expected pre-tax economic 
profit relative to the reasonably expected net tax benefits? Moreover, 
is the determination of ``insignificance'' transaction-specific; stated 
otherwise, does the form of the transaction affect the determination of 
what will be considered ``insignificant'' for these purposes? The 
presence of these same vague and undefined elements in the concept of a 
tax-avoidance financing transaction renders that test equally 
subjective.
---------------------------------------------------------------------------
    \32\ By itself, the determination of the scope of the transaction 
is both extremely complex and vitally important to the application of 
this test. Some of the questions to be resolved include: Do the 
qualified nonrecourse indebtedness rules control the determination of 
whether debt is considered part of a transaction? If recourse debt is 
taken into account in defining the transaction, how is the 
appropriately allocable amount of such debt to be determined? In 
addition, in defining the transaction, will an implicit charge for the 
use of capital be taken into account? Will allocations of internal 
expenses and corporate overhead to the transactions be required? 
Moreover, will a lease of multiple assets or multiple classes of assets 
be treated as a single transaction or multiple transactions? All of 
these questions and more must be answered in order to determine the 
scope of the transaction, which would be only the starting point in 
applying this test.
---------------------------------------------------------------------------
    Under this proposal, once the IRS had used its unfettered authority 
to determine independently that a taxpayer had engaged in a tax-
avoidance transaction, the IRS would be entitled to disallow any 
deduction, credit, exclusion, or other allowance obtained by the 
taxpayer in such transaction. Thus, even though a taxpayer's 
transaction has economic substance and legitimate business purpose, the 
IRS would be empowered to deny the tax savings to the taxpayer if 
another route to achieving the same end result would have resulted in 
the remittance of more tax. In other words, if an IRS revenue agent 
believed for any reason that a taxpayer's transaction was too tax 
efficient, he or she would have the power to strike it down, even if 
the actual pre-tax return on the transaction satisfied any objective 
benchmark for appropriate returns. That power could be invoked without 
regard to the legitimacy of the taxpayer's business purpose for 
entering into the transaction or the economic substance underlying the 
transaction.
    In the context of leasing transactions, this proposal effectively 
could wipe out the entire body of law that has developed over the last 
forty years. A leasing transaction that is scrutinized and passes 
muster under the benefits and burdens of ownership, business purpose, 
and economic substance tests could run afoul of this vague new 
standard. This proposal would completely disregard the presence of a 
business purpose, ignoring the business reality that lease transactions 
often are motivated by criteria that would not be taken into account 
under this new standard. It would replace the traditional economic 
analysis of lease transactions with this new and largely undefined 
standard. The long-standing law regarding the treatment of leasing 
transactions allows taxpayers to employ prudent tax planning to 
implement business objectives while giving the IRS the tools it needs 
to address potentially abusive transactions. The extraordinary power 
that would be vested both in Treasury and in individual IRS revenue 
agents is unnecessary and would create substantial uncertainty that 
would frustrate commerce done through traditional leasing transactions.

B. Proposal to increase depreciation life by service term of tax-exempt 
                              use property

    The proposal would require lessors of tax-exempt use 
property to include the term of optional service contracts and 
other similar arrangements in the lease term for purposes of 
determining the recovery period under the Pickle rules.
    As an initial matter, it should be noted that the reach of 
the proposal is not clear. The proposal does not define 
optional service contracts and does not provide any guidance 
regarding what would fall within the reach of the proposal as 
an ``other similar arrangement.''
    The proposed legislation overlooks significant business 
purposes that give rise to use of service contracts. Service 
contracts involve a tradeoff between rights and risks. Relative 
to a lessor, the service provider enjoys more control over the 
asset used to generate such services, but also assumes 
additional performance and operational risk with respect to 
such asset. The parties' preferences as to the division of 
rights and risks with respect to property determine the form of 
contractual arrangement they choose. The service contract 
arrangement has long been commercially recognized, particularly 
within certain industries such as the utility, specified 
manufacturing, and shipping industries.
    This proposal would exacerbate the anti-competitive impact 
of the Pickle rules by further limiting depreciation deductions 
for U.S. lessors financing assets being sold or developed in 
overseas markets. Domestic manufacturers, distributors, and 
retailers alike avail themselves of export leasing, not only as 
a pure financing vehicle for major equipment sales, but also as 
a powerful sales tool to promote equipment sales abroad. The 
proposal would put these U.S. companies at a further 
disadvantage compared to foreign-based companies that are able 
to offer lease financing for their goods on more favorable 
terms. The proposal similarly would adversely affect the 
ability of U.S. financial institutions to compete 
internationally with foreign lenders and financiers.
    The service contract issue was addressed explicitly at the 
time the Pickle rules were enacted in 1984. Code section 
7701(e), which was enacted with the Pickle rules, provides 
rules regarding the distinction between a service contract and 
a lease, and further specifically provides that certain service 
contracts will not be subject to potential recharacterization 
as leases. This proposal would reverse the safe harbor provided 
in 1984 for service contracts with respect to certain solid 
waste disposal, energy, and water treatment facilities and 
would subject these facilities to the penalty of delayed 
depreciation. Moreover, the proposal would further extend the 
reach of the Pickle rules to other services contracts and to 
any arrangement that constitutes an ``other similar 
arrangement,'' a concept which has not been defined. When the 
Pickle rules were enacted in 1984, their reach was limited by 
the rules of Code section 7701(e). Removing those limitations 
and expanding the reach of the Pickle rules would further 
impair the ability of U.S. leasing companies to compete in the 
global economy. As discussed further below, given the 
increasingly competitive global environment for leasing, this 
is not the time to remove those carefully considered 
limitations and expand the reach of the Pickle rules.

           V. Administration's Proposals Are Anti-Competitive

                    A. Impact on Common Transactions

    Consider a standard domestic leveraged lease under which an 
airline carrier enters into a ``sale-leaseback'' transaction in 
order to finance a newly manufactured aircraft. Under this 
transaction, the airline carrier purchases the aircraft from 
the aircraft manufacturer and immediately sells it to an 
institutional investor. The investor finances the acquisition 
through an equity investment equal to 25 percent of the $100 
million purchase price and a fixed-rate nonrecourse debt 
instrument from a third-party lender equal to the remaining 75 
percent. Immediately after the sale, the investor leases the 
aircraft to the airline carrier pursuant to a net lease for a 
term of 24 years. Upon the expiration of the lease term, the 
aircraft will be returned to the investor (the lessor). During 
year 18 of the lease, the airline carrier (the lessee) will 
have an option to purchase the aircraft from the investor for a 
fixed amount, which will be set at an amount greater than or 
equal to a current estimate of the then-fair market value of 
the aircraft. As the tax owner of the aircraft, the lessor is 
entitled to depreciation deductions in respect of the aircraft 
and deductions in respect of the interest that accrues on the 
loan.
    The lease in this example complies with applicable case law 
and with the cash flow and profit tests set forth in Rev. Proc. 
75-21. In fact, the sum of the rentals and the expected 
residual value exceeds the aggregate disbursements of the 
lessor and the lessor's equity investment, together with 
applicable costs, by approximately $18 million (or 18 percent 
of the asset purchase price).
    Even though this transaction complies with the established 
body of leasing law, it appears that it potentially could be 
characterized as a ``tax-avoidance transaction'' under the 
Administration's proposal, discussed above. As noted above, the 
manner in which the proposal would test whether a transaction 
is or is not a ``tax-avoidance transaction'' is capable of 
numerous different interpretations and appears to be highly 
subjective. Under a range of potential applications of the 
proposal to this transaction, it might be determined that the 
lessor would reasonably expect an annual pre-tax return 
anywhere in the range of 2.5 percent to 5.5 percent. On an 
after-tax basis, the lessor might be determined to reasonably 
expect an annual return anywhere in the range of 6.5 percent to 
8.5 percent. Depending on the particular manner in which the 
proposed test might be applied, the differential between the 
pre-tax and the after-tax returns could be large enough to 
suggest that an IRS agent might take the position that the 
discounted value of the reasonably expected pre-tax profit is 
not sufficient under the proposed test when compared to the 
discounted value of the reasonably expected net tax benefits.
    Regardless of how the test is applied, however, the tax 
advantages received by the lessor in this example are identical 
to the tax benefits that would be received by any owner of the 
property financing the property in a similar manner and in the 
same tax bracket. If the tax benefits are disallowed only for 
lessors, leasing will be put at a disadvantage relative to 
direct ownership. There is no sensible policy that would 
declare a leasing transaction to lack economic substance where 
the same cash flows and tax benefits would occur for any 
similarly situated direct owner of such an asset.

          B. Impact on Global Competitiveness and U.S. Exports

    The ability of U.S. equipment manufacturers to compete in 
global markets depends in part on their ability to arrange 
financing terms for their potential customers that are 
competitive with those that can be arranged by foreign 
producers. The Administration's budget proposals would make it 
much more difficult and potentially impossible to arrange 
financing on competitive terms.
    For example, consider the case of a U.S. aircraft 
manufacturer seeking to expand into the European market.\33\ A 
European airline may find cost to be a final determining factor 
in comparing an aircraft manufactured by a U.S. company with 
one produced by a European manufacturer. Financing provisions, 
such as lease terms, directly influence the cost. The U.S. 
manufacturer's ability to sell its aircraft to the European 
airline may be contingent on its ability to assist the airline 
with arranging a suitable lease that is competitive with the 
lease terms that can be offered with respect to the European 
aircraft.
---------------------------------------------------------------------------
    \33\ About half of the aircraft flown in Europe are leased rather 
than owned by airlines.
---------------------------------------------------------------------------
    A U.S. aircraft manufacturer would have to take into 
account the current U.S. tax law in determining the rate at 
which it could offer a European airline a short-term operating 
lease or a long-term financial lease. In contrast, a European 
aircraft manufacturer, if it worked through a German investor, 
for example, might be able to offer financing to the airline at 
a much lower rate. A chief reason for this disparity is the 
favorable tax treatment of leased property under German law, 
including significantly accelerated depreciation for the lessor 
even when the lessee is a tax-exempt entity under German tax 
law. Under the present Pickle rules, a U.S. export lease on 
U.S. equipment cannot compete with a German lease on similar 
German equipment. The availability of favorable lease rules in 
foreign jurisdictions, such as the German rules, already 
hinders the ability of U.S. companies to compete in the global 
market. Changes to the rules further impairing the tax 
treatment of export leasing will further disadvantage U.S. 
leasing companies and U.S. manufacturers vis-à-vis their 
foreign counterparts.
    If enacted, the Administration's budget proposals would 
tilt the balance in these competitive financing situations even 
further against the U.S. manufacturer. For leasing-intensive 
industries, the proposals could make it prohibitive to expand 
in existing markets or to enter emerging markets on a 
competitive basis. Because the Administration's proposals 
effectively would make U.S.-manufactured goods in leasing-
intensive industries more expensive in foreign markets, these 
measures could be expected to have an adverse effect on 
American exports.
    A significant percentage of American exports is 
attributable to leasing. While no exact data regarding this 
percentage is available, consider that data discussed in 
section II, above, indicated that nearly one third of all 
equipment investment, at least on a domestic basis, is financed 
through leasing. Further, consider that exports of equipment in 
1998 represented 44 percent of all goods exported by the United 
States.\34\ Moreover, the share of exported goods accounted for 
by equipment has been rising steadily since 1980. Despite the 
strong showing of U.S. exported equipment, we live in a highly 
competitive world and face worldwide competition in our export 
markets and at home for these products.
---------------------------------------------------------------------------
    \34\ U.S. Department of Commerce, Bureau of Economic Analysis, 
Survey of Current Business, January 2000.
---------------------------------------------------------------------------
    In certain sectors most likely to be leasing-intensive, 
exports are accountable for a substantial share of domestic 
production. For example, in 1996 exports accounted for 50 
percent of U.S. production of aircraft, aircraft engines, and 
other aircraft parts; 28 percent of U.S. production of 
construction equipment; 31 percent of U.S. production of farm 
machinery; 40 percent of U.S. production of machine tools; and 
56 percent of U.S. production of mining machinery.\35\ In the 
absence of these exports, domestic employment in these 
equipment-producing industries would be substantially reduced.
---------------------------------------------------------------------------
    \35\ U.S. Department of Commerce, International Trade 
Administration.
---------------------------------------------------------------------------
    The Administration's proposals also would impede the 
ability of U.S.-based financial institutions to compete in the 
worldwide leasing market. If enacted, the Administration's 
proposals would give foreign-based financial institutions a leg 
up in providing financing. The impact of these proposals on the 
U.S. financial sector, an important part the U.S. economy, 
should not be overlooked.

       C. Impact on Start-Ups and Companies in Economic Downturn

    Some companies that directly own their assets may find that 
they have a higher cost of capital than their competitors due 
to special tax circumstances. For example, companies in a loss 
position (as is the case for many businesses in the start-up 
phase) and companies paying AMT (which often hits companies 
experiencing economic downturns) often have a higher cost of 
capital because they cannot immediately claim all of the 
depreciation allowances provided under the tax law. These 
companies may be at a competitive disadvantage relative to 
other firms. Some regard it as unfair that a company in the 
start-up phase or recovering from an economic downturn faces 
higher costs for new investment than its competitors.
    Through leasing, a company in these circumstances often can 
achieve a cost of capital comparable to that of its 
competitors. Leasing helps to ``level the playing field'' 
between companies in an adverse tax situation and their 
competitors by equalizing the cost of capital. For certain 
assets, leasing can lower the cost of capital for a firm in 
this tax situation by as much as one percentage point. This can 
mean the difference between successfully competing and 
bankruptcy. Rehabilitation or liquidation in bankruptcy can be 
more detrimental to U.S. revenues than the granting of ordinary 
depreciation and interest deductions.
    By denying the benefits of leasing, the Administration's 
proposals would further increase the cost of capital for 
companies in such circumstances. As a result, the economy 
suffers real losses. Investment may be allocated not on the 
basis of who is the most efficient or productive producer, but 
who is in the most favorable tax situation. In the absence of 
leasing, a company in a loss position--facing a higher cost of 
capital than its competitors--might not be able to undertake 
new investment even if, in the absence of taxes, it would be 
the most efficient firm.

   VI. Reforms Needed to Strengthen Competitiveness of U.S. Leasing 
                                Industry

    As discussed above, the leasing industry is important to 
the American economy. U.S. manufacturers use leasing as a means 
to finance exports of their goods in overseas markets, and many 
have leasing subsidiaries that arrange for such financing. Many 
U.S. financial companies also arrange for lease financing as 
one of their core financial intermediation services. 
Ultimately, the activities of these companies support U.S. jobs 
and investment.
    The present-law Pickle rules place the American leasing 
industry at a competitive disadvantage in overseas markets. 
Because of the Pickle rules and their adverse impact on cost 
recovery, U.S. lessors are unable in many cases to offer U.S.-
manufactured equipment to overseas customers on terms that are 
competitive with those offered by foreign counterparts. Many 
European countries, for example, provide favorable lease rules 
for home-country lessors leasing equipment manufactured in the 
home country. The 1996 Treasury regulations regarding 
replacement leases compound this competitive disadvantage faced 
by the U.S. leasing industry. It is unclear why the 
Administration, through the proposals in its FY 2001 budget 
submission, would choose to further increase these competitive 
disadvantages.
    Rather than follow the Administration's lead, the Leasing 
Coalition respectfully submits that Congress should consider 
reversing course. Specifically, we would ask that Congress 
explore whether, in light of the globalization of the economy, 
there is any tax policy or economic rationale for the present-
law Pickle rules. The Leasing Coalition knows of no such 
legitimate rationale, and urges repeal of the Pickle rules 
applicable to export leases, which serve only to penalize the 
U.S. leasing industry. As an immediate step, we also would call 
on Congress to overturn the 1996 Treasury regulations that 
treat the lease term, for purposes of the Pickle rules, as 
including periods beyond the actual lease term. These 
regulations have no basis in the legislative history underlying 
enactment of the Pickle rules and have no policy justification. 
These changes would greatly strengthen the competitiveness of 
the U.S. leasing industry.

                            VII. Conclusion

    The Leasing Coalition urges Members of the House Ways and 
Means Committee to reject the Administration's tax proposals 
that would adversely affect the leasing industry. As discussed 
above, we believe these proposals inappropriately would 
overturn the longstanding and carefully crafted body of tax law 
governing common leasing transactions and would have a 
deleterious impact on the U.S. economy. Moreover, we find it 
highly objectionable that these common and legitimate business 
transactions effectively are being cast by the Administration 
as ``corporate tax shelters.''
    The Leasing Coalition appreciates the concern that a 
bipartisan majority of Ways and Means Committee Members 
expressed, in a June 9, 1999, letter to Committee Chairman 
Archer and Ranking Member Rangel, over the impact that the 
Administration's FY 2000 budget proposals would have had on the 
leasing industry and our ability to compete internationally. 
Those same concerns hold equally true today with respect to the 
Administration's FY 2001 budget proposals.
    Instead of considering proposals at this time that would 
impair the competitiveness of the leasing industry and 
industries that manufacture goods commonly acquired through 
lease arrangements, we respectfully would suggest that the 
Administration and Congress consider ways to help U.S. 
companies that use leasing as a form of financing expand in the 
global marketplace. The Congress should act to reverse the 
overreaching 1996 Treasury regulations regarding replacement 
leases and, further, should consider repeal of the Pickle rules 
themselves.
      

                                

Statement of the National Association of Real Estate Investment Trusts

    As requested in Press Release No. FC-17 (February 2, 2000), 
the National Association of Real Estate Investment 
Trusts (``NAREIT'') respectfully submits these 
comments in connection with the Committee on Ways and Means' 
hearing on the President's Fiscal Year 2001 Budget 
(``Budget''). NAREIT thanks the Chairman and the Committee for 
the opportunity to share its views on several important issues 
affecting REITs and publicly traded real estate companies.
    NAREIT's comments address (1) the Budget's proposal to 
increase a real estate investment trust's (``REIT'') 
distribution requirement to avoid the 4% excise tax; (2) the 
Budget's proposal to modify the treatment of closely held 
REITs; and (3) the Budget's proposal to made permanent the 
ability to deduct remediation expenses for Brownfields sites. 
We appreciate the opportunity to present these comments.
    NAREIT is the national trade association for REITs and 
publicly traded real estate companies. Members are REITs and 
publicly traded businesses that own, operate and finance 
income-producing real estate, as well as those firms and 
individuals who advise, study and service these businesses. 
REITs are companies whose income and assets are mainly 
connected to income-producing real estate. By law, REITs 
regularly distribute most of their taxable income to 
shareholders as dividends. NAREIT represents over 200 REITs and 
publicly traded real estate companies that own over $250 
billion of real estate assets, as well as over 2,000 industry 
professionals who provide a range of legal, investment, 
financial and accounting-related services to these companies.

Executive Summary

    Excise Tax. The Budget's proposal to increase the 
distribution requirement to avoid the 4% excise tax ignores the 
capital intensive nature of REITs, as well as the practical 
differences between REITs and mutual funds in timely 
calculating the required distribution amounts. Further, this 
proposal would effectively nullify Congress' decision reached 
only a few months ago to restore the general distribution 
requirement from 95% to 90%, effective in 2001.
    Closely Held REITs. The Budget proposes to prevent any 
entity from owning 50% or more of the vote or value of a REIT's 
stock. NAREIT does not oppose the Administration's intention to 
craft a new ownership test intended to correspond to a REIT's 
primary mission: to make investment in income-producing real 
estate accessible to ordinary investors. However, we believe 
that the Administration's proposal is too broad, and therefore 
should be narrowed to prevent only non-REIT C corporations from 
owning 50% or more of a REIT's stock (by vote or value). In 
addition, the new rules should not apply to so-called 
``incubator REITs'' that have proven to be a viable method by 
which small investors can access publicly traded real estate 
investments. Last, the proposal should not apply to publicly 
traded REITs when one person owns less than 80% of the vote or 
value of a REIT's stock because it would deter legitimate 
business transactions.
    Brownfields Expenses. The Budget proposes to make permanent 
the provision contained in the Tax Relief Extension Act of 1999 
that allows a taxpayer to deduct remediation expenses for 
Brownfields sites. NAREIT strongly supports this proposal, but 
also recommends that Congress extend the expensing treatment to 
properties that do not currently fit within the definition of a 
``qualified contaminated site.''

Background on REITs

    A REIT is a corporation or business trust combining the 
capital of many investors to own, operate or finance income-
producing real estate, such as apartments, shopping centers, 
offices and warehouses. REITs must comply with a number of 
requirements, some of which are discussed in detail in this 
statement, but the most fundamental of these are as follows: 
(1) REITs must pay at least 95% of their taxable income to 
shareholders (90% after 2000); (2) most of a REIT's assets must 
be real estate; (3) REITs must derive most of their income from 
real estate held for the long term; and (4) REITs must be 
widely held.
    In exchange for satisfying these requirements, REITs (like 
mutual funds) benefit from a dividends paid deduction so that 
most, if not all, of a REIT's earnings are taxed only at the 
shareholder level. On the other hand, REITs pay the price of 
not having retained earnings available to meet their business 
needs. Instead, capital for growth and significant capital 
expenditures largely comes from new money raised in the 
investment marketplace from investors who have confidence in 
the REIT's future prospects and business plan.
    Congress created the REIT structure in 1960 to make 
investments in large-scale, significant income-producing real 
estate accessible to investors from all walks of life. Based in 
part on the rationale for mutual funds, Congress decided that 
the only way for the average investor to access investments in 
larger-scale commercial properties was through pooling 
arrangements.
    In much the same ways as shareholders benefit by owning a 
portfolio of securities in a mutual fund, the shareholders of 
REITs can unite their capital into a single economic pursuit 
geared to the production of income through commercial real 
estate ownership. REITs offer distinct advantages for smaller 
investors: greater diversification through investing in a 
portfolio of properties rather than a single building and 
expert management by experienced real estate professionals. 
REITs are owned primarily by individuals, with 49% of REIT 
shares owned directly by individual investors and 37% owned by 
mutual funds, which are mostly owned by individuals.

                   I. REIT DISTRIBUTION REQUIREMENTS

    Background. Under current law, to maintain their tax 
status, REITs are required to distribute 95% of their taxable 
income while mutual funds are required to distribute 90% of 
taxable income. The Tax Relief Extension Act of 1999 (the 
``1999 Act'') reduced the distribution requirement for REITs 
from 95% of taxable income to 90% of taxable income for years 
beginning after December 31, 2000.
    In addition to the distribution requirement necessary to 
maintain their tax status, both REITs and mutual funds are 
subject to a 4% excise tax on the difference between their 
``required distribution'' for a calendar year and their 
``distributed amount'' for that year. For REITs, the required 
distribution under current law equals the sum of 85% of 
``ordinary income'' for the calendar year (essentially, REIT 
taxable income for the year without reduction for the dividends 
paid deduction and without reference to capital gain or loss) 
plus 95% capital gain net income for that calendar year. For 
mutual funds, the required distribution equals 98% of a its 
``ordinary income'' plus 98% of its capital gain net income.
    For example, a REIT that generates $100x in ordinary income 
in 1999 must distribute at least $95x to its shareholders to 
receive a dividends paid deduction for 1999. However, if a REIT 
makes an election under I.R.C. Sec.  858, the Code treats as 
paid in 1999 any dividend declared before it files its tax 
return (due, with extensions, on September 15, 2000) and paid 
in 2000 before its first regular dividend payment date after 
such declaration. To avoid the 4% excise tax for 1999, the REIT 
must distribute at least $85x during 1999 or, under the ``look 
back'' rule of I.R.C. Sec.  857(b)(8), in January of 2000 if 
the dividend is declared in the last quarter of 1999.
    Budget Proposal. The Administration proposes that in order 
to a REIT not to be assessed the 4% excise tax, its required 
distribution would be increased to the sum of 98% of its 
ordinary income and 98% of its capital gain net income. The 
Administration believes that this provision is necessary in 
order to conform the REIT excise tax to the mutual fund excise 
tax rules.
    NAREIT Analysis and Position. While REITs were modeled 
after mutual funds, REITs have evolved separately as investment 
vehicles. The Budget would ignore Congress' recognition last 
year of the special capital needs of REITs and the increased 
difficulties a REIT faces in accurately calculating its taxable 
income during a taxable year.
    Congress has mandated that REITs concentrate on owning and 
operating real estate. Unlike mutual funds that have relatively 
low overhead because they own the securities of other 
companies, REITs must continually invest capital into its 
projects for both upkeep and to prevent them from becoming 
obsolete. Reinvestment needs span the gamut of ordinary upkeep 
such as painting to capital expenditures (such as a installing 
new roof or repaving a parking lot) to renovations needed to 
meet customer demand (such as installing fiber optic lines for 
telecommunications). Thus, REITs have clear reasons why they 
need to retain more capital than mutual funds.
    In addition, it takes considerable more time for a REIT to 
compute its taxable income than does a mutual fund. A mutual 
fund only needs to tabulate the dividends or capital gains from 
its portfolio, and the sources of this public information are 
manifold in this Age of the Internet. Conversely, a REIT must 
rely on non-public sources of information for which it does not 
control.
    A REIT that owns shopping malls illustrates this lag time 
of information. A significant source of a typical retail REIT's 
annual taxable income is ``percentage rents,'' under which the 
REIT landlord receives base rent throughout the year and then 
additional rent if the tenant generates sales at the REIT's 
property above an agreed threshold. The Christmas Holiday 
Season is by far the biggest sales period for most shopping 
malls, and a retail REIT cannot compute its taxable income 
until its tenants have informed it of their sales and the 
consequent percentage rents. Since the Code does not compel the 
tenants to provide this information by any deadline, often a 
retail REIT does not receive the necessary breakdown of 
percentage rents until February or March. Accordingly, the REIT 
can approximate by year-end how much it needs to distribute to 
satisfy the current 85% requirement, but would be hard pressed 
to reach the precision required by a 98% requirement, as 
proposed in the Budget.
    The increased distribution proposal would vitiate much of 
the benefits of Congress' decision in the 1999 Act to lower the 
95% distribution requirement to 90%. To avoid the 4% excise 
tax, REITs very well could be compelled to distribute more than 
necessary during a taxable year because they would not have the 
necessary information to estimate 98% of their taxable income. 
This would be the opposite of what Congress authorized by 
restoring the 90% distribution requirement.\1\ Accordingly, 
NAREIT strongly opposes this provision.
---------------------------------------------------------------------------
    \1\ Since REITs likely would distribute extra amounts during a 
taxable year so the excise tax would not be imposed, it is unclear how 
this provision would raise any revenues. We note that the 90% rule was 
scored in the 1999 Act as a revenue raiser, so that any proposal such 
as that contained in the Budget that would deter a REIT from paying 
corporate taxes on its undistributed amounts would appear to be a 
revenue loser.
---------------------------------------------------------------------------

                         II. CLOSELY HELD REITS

    Background and Current Law. As discussed above, Congress 
created REITs to make real estate investments easily and 
economically accessible to the small investor. To carry out 
this purpose, Congress mandated two rules to ensure that REITs 
are widely held. First, five or fewer individuals cannot own 
more than 50% of a REIT's stock.\2\ In applying this test, most 
entities owning REIT stock are ``looked through'' to determine 
the ultimate ownership of the stock by individuals. Second, at 
least 100 persons (including corporations and partnerships) 
must be REIT shareholders. Neither test apply during a REIT's 
first taxable year, and the ``five or fewer'' test only applies 
in the last half of each subsequent taxable year of the REIT.
---------------------------------------------------------------------------
    \2\ I.R.C. Sec. 856(h)(1). There is no apparent reason why the 
proposed ownership test similarly should not be aimed at limiting more 
than 50% stock ownership, rather than 50% or more as now proposed.
---------------------------------------------------------------------------
    Budget Proposal. The Administration appears to be concerned 
about non-REITs establishing ``captive REITs'' and REITs 
engaging in transactions which the Administration finds 
abusive, such as the ``liquidating REIT'' structure curtailed 
by the 1998 budget legislation.\3\ The Budget proposes changing 
the ``five or fewer'' test by imposing an additional 
requirement. The proposed new rule would prevent any ``person'' 
i.e., a corporation, partnership or trust, including a pension 
or profit sharing trust) from owning stock of a REIT possessing 
50% or more of the total combined voting power of all classes 
of voting stock or 50% or more of the total value of shares of 
all classes of stock. Certain existing REIT attribution rules 
would apply in determining such ownership, and the proposal 
would be effective for entities electing REIT status for 
taxable years beginning on or after the date of first committee 
action.
---------------------------------------------------------------------------
    \3\ NAREIT supported the Administration's and Congress' move to 
limit the tax benefits of liquidating REITs.
---------------------------------------------------------------------------
    NAREIT Analysis and Position. NAREIT agrees that the REIT 
structure is meant to be widely held and that it should not be 
used for abusive tax avoidance purposes. Therefore, NAREIT 
supports the intent of the proposal. Nevertheless, we are 
concerned that the Budget proposal casts too broad a net. A 
limited number of exceptions are needed to allow certain 
``entities'' to own a majority of a REIT's stock. For instance, 
NAREIT certainly agrees with the Administration's decision to 
exclude a REIT's ownership of another REIT's stock from the 
proposed new ownership limit.\4\ NAREIT would like to work with 
Congress and the Administration to ensure that any action to 
curb abuses does not disallow transactions necessary to foster 
the future REIT marketplace and to recognize the widely held 
nature of certain non-REIT entities.
---------------------------------------------------------------------------
    \4\ If the proposed test remains applicable to all persons owning 
more than 50% of a REIT's stock, then Congress should apply the 
exception for a REIT owning another REIT's stock by examining both 
direct and indirect ownership so as not to preclude an UPREIT owning 
more than 50% of another REIT's stock. NAREIT supports the rule 
providing such clarification that was contained in the Taxpayer Refund 
and Relief Act of 1999.
---------------------------------------------------------------------------
    First, an exception should be allowed to enable a REIT's 
organizers to have a single large investor for a temporary 
period, such as in preparation for a public offering of the 
REIT's shares. Such an ``incubator REIT'' sometimes is majority 
owned by its sponsor to allow the REIT to accumulate a track 
record that will facilitate its going public. The Budget 
proposal is silent on this important approach which, in turn, 
could curb the emergence of new publicly traded REITs in which 
small investors may invest. NAREIT supports the incubator REIT 
exception that was included as part of the Taxpayer Refund and 
Relief Act of 1999.\5\
---------------------------------------------------------------------------
    \5\ NAREIT recommends that the 10% annual growth requirement 
contained in the Taxpayer Refund and Relief Act of 1999 as proposed 
section 856(l)(4)(v) be replaced with a requirement that the REIT not 
lease more than half of its properties to the principal owner of the 
REIT's stock.
---------------------------------------------------------------------------
    Second, there is no reason why a partnership, mutual fund, 
pension or profit-sharing trust or other pass-through entity 
should be counted as one entity in determining whether any 
``person'' owns 50% of the vote or value of a REIT. A 
partnership, mutual fund or other pass-through entity usually 
is ignored for federal tax purposes. The partners in a 
partnership and the shareholders of a mutual fund or other 
pass-through entity should be considered the ``persons'' owning 
a REIT for purposes of any limits on investor ownership. 
Similarly, the Code already has rules preventing a ``pension 
held'' REIT from being used to avoid the unrelated business 
income tax rules, and therefore the new ownership test should 
not apply to pension or profit-sharing plans.\6\ Instead, 
NAREIT suggests that the new ownership test apply only to non-
REIT C corporations that own more than 50% of a REIT's 
stock.\7\ NAREIT is encouraged by the Budget's proposal for a 
``limited look-through rule'' for partnerships, and suggests 
that any such rule be flexible enough to provide for the 
typical allocations used by real estate partnerships, such as 
preferred returns.
---------------------------------------------------------------------------
    \6\ NAREIT supports the pension plan look-through rule contained 
int the Taxpayer Refund and Relief Act of 1999.
    7 As under the current ``five or fewer'' test, any new ownership 
test should not apply to a REIT's first taxable year or the first half 
of subsequent taxable years. See I.R.C. Sec. Sec. 542(a)(2) and 
856(h)(2).
---------------------------------------------------------------------------
    Third, none of the transactions identified by the 
Administration have involved publicly traded REITs. Such REITs 
must divulge information to the Securities and Exchange 
Commission that is then available to all. This ``Sunshine'' 
exposure typically is antithetical to tax shelters, and there 
is no reason to expect that such public attention should not 
work in this case. In fact, there does not appear to be a 
single example of a publicly-traded REIT serving as a tax 
avoidance vehicle. Therefore, NAREIT recommends that any 
closely held REIT legislation contain an exception for a REIT 
the stock of which is regularly traded on an established 
securities market, so long as no entity owns 80% or more of the 
vote or value of its common stock. NAREIT would support certain 
limits on this exception that would ensure that it would not be 
used for tax avoidance purposes. This exception would allow one 
entity to acquire a majority of the common stock of a public 
traded REIT for business purposes, such as forcing a change in 
strategy or certain types of takeover transactions.

                       III. BROWNFIELDS EXPENSING

    Background. Under the Taxpayer Relief Act of 1997, certain 
remediation costs are currently deductible if incurred with 
respect to a ``qualified contaminated site'' (a ``Brownfields'' 
site). As part of the 1999 Act, this provision was extended for 
one year to allow deductions for expenditures paid or incurred 
on or before December 31, 2001.
    Budget Proposal. The Budget would extend permanently the 
ability to deduct remediation expenses for Brownfields sites.
    NAREIT Position. NAREIT applauds the Administration for 
proposing a permanent extension of current deductions for 
Brownfields remediation expenses. In addition, NAREIT 
encourages the Administration and other policymakers to 
consider the tremendous potential remediation that could occur 
at contaminated sites if the extension were expanded to 
properties that do not currently fit within the exact 
definition of a ``qualified contaminated site,'' but are 
nevertheless in need of significant environmental remediation. 
NAREIT supports the Brownfields expansion contained in S.1792, 
the Senate version of the Taxpayer Refund and Relief Act of 
1999, and urges Congress to enact such provision this year.
    NAREIT thanks the Committee for the opportunity to comment 
on these important proposals.
      

                                

Statement of PricewaterhouseCoopers LLP

                            I. INTRODUCTION

    PricewaterhouseCoopers appreciates the opportunity to 
submit this statement to the Committee on Ways and Means for 
the record of its February 9, 2000, hearing on the proposals in 
the Administration's FY 2001 budget. This statement 
specifically addresses the Administration's general proposals 
regarding ``corporate tax shelters.''
    PricewaterhouseCoopers, the world's largest professional 
services organization, provides a full range of business 
advisory services to corporations and other clients, including 
audit, accounting, and tax consulting. The firm, which has more 
than 6,500 tax professionals in the United States and Canada, 
works closely with thousands of corporate clients worldwide, 
including most of the companies comprising the Fortune 500. 
These comments reflect the collective experiences of many of 
our corporate clients.
    We respectfully urge the Committee to reject the 
Administration's general ``corporate tax shelter'' proposals. 
We believe no justification has been presented that would 
support enactment of such sweeping changes. Economic data does 
not suggest any systemic erosion of the corporate income tax 
base attributable to tax shelters. Current-law administrative 
tools, if used properly, are more than adequate to detect and 
penalize abuses. Further, the Administration's proposals are at 
odds with sound tax policy principles and efficient tax 
administration, would threaten legitimate tax-planning 
activities undertaken by corporate tax professionals, and would 
exacerbate the complexity of the tax code.

      II. THE ADMINISTRATION'S ``CORPORATE TAX SHELTER'' PROPOSALS

    The Administration's latest general proposals regarding 
``corporate tax shelters,'' included in its FY 2001 budget, 
reflect a number of modifications to the proposals originally 
advanced in the Administration's FY 2000 budget. These 
modifications, which were discussed in the Treasury 
Department's ``White Paper'' \1\ released in July, generally 
narrowed the scope of the original proposals. For example, the 
Administration dropped proposals to eliminate the reasonable 
cause exception to the accuracy-related penalty and to disallow 
deductions for fees paid to tax shelter promoters and advisors.
---------------------------------------------------------------------------
    \1\ The Problem of Corporate Tax Shelters, Department of the 
Treasury, July 1999.
---------------------------------------------------------------------------
    Surprisingly, Treasury estimates that its FY 2001 corporate 
tax shelter proposals, even though narrower in scope, would 
raise significantly more revenue than its previous proposals. 
The prior proposals were estimated by Treasury to raise $1.5 
billion over five years. The new proposals are estimated to 
raise nearly five times as much--$7.3 over five years and $14.5 
over ten years. It is difficult to understand this upward re-
estimate, especially given the significant victories (discussed 
further below) won by the Internal Revenue Service (IRS) in the 
courts over the past year, which have strengthened the hand of 
the government in challenging aggressive tax positions taken by 
corporations. These court decisions presumably would operate to 
reduce the revenues that could be generated by further 
legislative changes.
    Before turning to specific concerns over the 
Administration's proposals, we want to restate a general 
observation. Like individual taxpayers, corporations have the 
right to seek legitimate minimization of tax liabilities, i.e., 
to pay no more in taxes than the tax law demands.\2\ Indeed, 
corporate executives have a fiduciary duty to preserve and 
increase the value of a corporation for its shareholders. Some 
commentators decry this responsibility, termed ``profit center 
activity'' in current management parlance. We disagree. 
Responsible minimization of taxes in conjunction with the 
business activity of a corporation is an important function of 
corporate executives and one that long has been viewed as 
consistent with sound policy objectives.\3\
---------------------------------------------------------------------------
    \2\ Individual taxpayers often undertake actions to obtain 
favorable tax treatment, but this alone is not considered a reason 
simply to disallow the benefits. For example, an individual holding an 
appreciated security may decide to hold it for sale until a particular 
date solely to obtain long-term capital gain treatment. Also, an 
individual may take out a home-equity loan to pay off credit-card debt 
because interest on the home loan can be tax deductible. As another 
example, an individual renting a home may decide to purchase it, 
viewing the tax benefits as a principal purpose for entering into the 
transaction. In such cases, Congress has not been concerned that the 
taxpayer acted out of tax motivations; the tax benefits still are 
allowed.
    \3\ Judge Learned Hand wrote: ``Over and over again courts have 
said that there is nothing sinister in so arranging one's affairs as to 
keep taxes as low as possible. Everybody does so, rich or poor; and all 
do right, for nobody owes any public duty to pay more than the law 
demands: taxes are enforced extractions, not voluntary contributions.'' 
Comm'r v. Newman, 159 F.2d 848, 850-851 (2d Cir. 1946) (dissenting 
opinion).
---------------------------------------------------------------------------
    The following are our specific comments on the 
Administration's proposals.

 A. Increase Disclosure with Respect to Certain Reportable Transactions

Summary

    The proposal would require a corporation to disclose a 
transaction that has ``significant tax benefits'' if it has 
some combination of the following ``filters'': (1) a book/tax 
difference in excess of a certain amount; (2) a rescission 
clause, unwind clause, insurance, or similar arrangement; (3) 
involvement with a tax-indifferent party; (4) contingent 
advisor fees in excess of a certain amount; (5) the offering of 
the transaction to multiple taxpayers; and (6) a difference 
between the form of the transaction and how it is reported. 
Disclosure would be made on a short form or statement filed 
with the return; the form or statement would have to be signed 
by a corporate officer who has, or should have, knowledge of 
the transaction. Failure to disclose would subject the taxpayer 
to a penalty of $100,000 per failure.

Comment

    This proposal would create considerable uncertainties for 
taxpayers seeking to determine whether disclosure is required. 
Consider, for example, the proposed requirement to disclose 
transactions that are reported differently from their form. 
Does ``form'' refer to the label given to the transaction or 
instrument, or does it refer to the rights and liabilities set 
forth in the documentation? For example, if an instrument is 
labeled debt, but has features in the documentation typically 
associated with an equity interest, is the form debt or equity? 
What if the taxpayer reasonably believed that it was reporting 
the transaction in accordance with its ``form,'' but later 
interpretations of ``form'' suggested that it had not so 
reported the transaction? Furthermore, it is unclear how a 
company would know whether the tax consequences of a 
transaction constitute a ``significant tax benefit,'' a term 
that is not defined by Treasury.
    The disclosure requirement would be redundant in a number 
of respects. First, companies already are required to account 
for book/tax differences on Schedule M of the corporate income 
tax return. Treasury has not indicated why a second level of 
reporting of these differences is necessary. Second, the 
disclosure requirements would overlap with tax shelter 
reporting requirements enacted by Congress in 1997.\4\ More 
than two years later, the Treasury Department has yet to take 
the steps necessary to implement the new tax shelter reporting 
rules.
---------------------------------------------------------------------------
    \4\ Taxpayer Relief Act of 1997, P.L. 105-34.
---------------------------------------------------------------------------
    The proposed disclosure requirement would add significantly 
and unnecessarily to the burdens already shouldered by 
corporate tax officials.\5\ Companies would be forced to report 
thousands of transactions and arrangements in order to guard 
against the $100,000 penalty for failure to report. Remarkably, 
this penalty would be imposed on the taxpayer regardless of 
whether the the taxpayer's treatment of the unreported 
transaction is sustained. Examples of commonplace transactions 
that presumably would have to be reported would include 
purchases of equipment that qualifies for accelerated 
depreciation, thus creating a book-tax difference, and 
transactions with foreign companies--hardly a rarity in today's 
global economy -and other ``tax-indifferent parties.'' It would 
be patently unfair to assess a tax shelter penalty for 
nondisclosure of legitimate transactions.
---------------------------------------------------------------------------
    \5\ Of the $1.7 trillion in tax revenue collected by the federal 
government in FY 1998, corporate tax officials were responsible for 
remitting more than 50 percent.
---------------------------------------------------------------------------
    The utility to the IRS of this flood of information is 
questionable. By point of reference, the United Kingdom last 
year dropped a proposal made by the Labor Party in 1997 that 
would have imposed a ``general anti-avoidance rule'' to counter 
perceived tax avoidance in the corporate sector. The proposal 
was dropped, in part, because of concerns that arose over 
Inland Revenue's ability to process reports that UK corporate 
taxpayers would have been forced to file with respect to 
transactions in order to have any certainty that the tax 
treatment would be respected. Similar difficulties surely would 
arise for the IRS if the Administration's proposals were 
enacted.
B. Modify Substantial Understatement Penalty for Corporate Tax Shelters

Summary

    The substantial understatement penalty imposed on corporate 
tax shelter items generally would be increased to 40 percent 
(reduced to 20 percent if the taxpayer discloses). The 
reasonable cause exception would be retained, but narrowed with 
respect to transactions deemed to constitute a corporate tax 
shelter--for these transactions, taxpayers would have to have a 
``strong'' probability of success on the merits and to make 
disclosure.
    For this purpose, a ``corporate tax shelter'' would be 
defined as any entity, plan, or arrangement in which a 
corporate participant attempts to obtain a tax benefit (other 
than those clearly contemplated in the Tax Code) in a ``tax 
avoidance transaction.'' A ``tax avoidance transaction'' would 
be defined generally as any transaction in which the reasonably 
expected pre-tax profit is insignificant relative to the 
reasonably expected net tax benefits. A financing transaction 
would be considered a tax avoidance transaction if the present 
value of the tax benefits of the taxpayer to whom the financing 
is provided significantly exceed the present value of the pre-
tax profit or return of the person providing the financing.

Comment

    This proposal is inconsistent with the goals of 
rationalizing penalty administration. If the proposal were 
enacted, an IRS agent proposing a different treatment of a tax 
shelter item than on the taxpayer's return would feel compelled 
to impose a penalty even if the agent determines that (1) there 
is substantial authority supporting the return position taken 
by the taxpayer, and (2) the taxpayer reasonably believed 
(based, for example, on the opinion or advice of a qualified 
tax professional) that its tax treatment of the item was more 
likely than not the proper treatment. It is doubtful that the 
agent would decline to impose the penalty based on the 
taxpayer's arguing that its position had had a ``strong 
probability of success,'' an undefined term setting an 
unrealistically high threshold. Indeed, one might question how 
a return position that was challenged successfully could ever 
be shown to have had a strong probability of success.
    The near-automatic nature of the proposed increased penalty 
would alter substantially the dynamics of the current process 
by which the vast majority of disputes between the IRS and 
corporate taxpayers are resolved administratively. Today, even 
where a corporation and the IRS agree that there is a 
substantial understatement of tax attributable to a tax shelter 
item, the determination as to whether the substantial 
understatement penalty should be waived for reasonable cause 
continues to focus on the merits of the transaction and the 
reasonableness of the taxpayer's beliefs regarding those 
merits. If, however, the reasonable cause exception no longer 
were effectively available, the parties necessarily would have 
to focus on whether the transaction in question was a ``tax 
avoidance transaction'' and other definitional issues unrelated 
to the underlying merits of the transaction.
    The proposal also runs directly counter to the goal of 
maintaining transparency (i.e., the ability for a taxpayer to 
determine the tax rules applicable to transactions) in our tax 
system. The inclusion of so many subjective concepts in the 
definition of ``tax-avoidance transaction'' precludes it from 
being an objective test. As an initial matter, what constitutes 
the ``transaction'' for purposes of this test? Next, what are 
the parameters for ``reasonable expectation'' in terms of both 
pre-tax economic profit and tax benefits? Further, where is the 
line drawn regarding the significance of the reasonably 
expected pre-tax economic profit relative to the reasonably 
expected net tax benefits? Given these ambiguities, this 
definition would threaten to sweep in legitimate transactions 
undertaken in the ordinary course of business, such as 
financing transactions, capital restructuring transactions, and 
corporate reorganizations. It also could sweep in many start-up 
ventures--how many ``dot coms'' can be said to have a 
reasonable expectation of profit? It is safe to say that it is 
highly unlikely that this definition would be applied uniformly 
by IRS agents.
    The difficulty of defining ``corporate tax shelter'' is 
highlighted when one compares Treasury's FY 2000 and FY 2001 
``Green Book'' descriptions of the Administration's revenue 
proposals. Some proposals (e.g., a proposal to modify the 
treatment of ``built-in losses'') that were characterized as 
targeting ``corporate tax shelter'' transactions in Treasury's 
FY 2000 Green Book no longer are characterized as such in 
Treasury's FY 2001 Green Book. Conversely, some proposals 
(e.g., a proposal to amend the ``80/20'' company rules) that 
were not characterized as targeting ``corporate tax shelter'' 
transactions in the FY 2000 Green Book are now characterized as 
such in the FY 2001 Green Book. This inconsistency illustrates 
the inherent difficulties in the Administration's proposed 
definition.

    Finally, it should be noted that the proposed 40-percent 
penalty rate is out of line with other penalty rates in the tax 
code.

               C. Codify the Economic Substance Doctrine

Summary

    The proposal would disallow tax benefits from any ``tax 
avoidance transaction,'' as defined in B., above.

Comment

    While couched as merely codifying an existing common-law 
doctrine, the proposal would have the plain effect of 
encouraging IRS agents to challenge taxpayer positions that 
meet the objective rules provided by Congress and set forth in 
the tax code. Given the loose definition of ``tax avoidance 
transaction,'' the proposal essentially would grant IRS agents 
unfettered authority to disallow deductions, credits, 
exclusions, or other allowances where they see fit. This power 
could be invoked without regard to the legitimacy of the 
taxpayer's business purposes for entering into the transaction. 
If a transaction is viewed as too tax efficient, it could be 
challenged on those grounds alone. As a result, audits would 
become more protracted, and corporate tax officials would find 
it impossible to rely on the statute in planning transactions.
    The proposed disallowance rule strongly resembles a test 
that was included in the new U.S.-Italy Income Tax Treaty and 
the new U.S.-Slovenia Income Tax Treaty that drew strong 
criticism last year from the staff of the Joint Committee on 
Taxation (``JCT''). ``Main purpose'' tests in the treaties as 
proposed would have denied treaty benefits (e.g., reduced 
withholding rates on dividends) if the main purpose of a 
taxpayer's transaction is to take advantage of treaty benefits. 
The JCT staff correctly raised policy objections to this 
proposed test:
    The new main purpose tests in the proposed treaty present 
several issues. The tests are subjective, vague and add 
uncertainty to the treaty. It is unclear how the provisions are 
to be applied. . . This uncertainty can create planning 
difficulties for legitimate business transactions, and can 
hinder a taxpayer's ability to rely on the treaty.. . . This is 
a subjective standard, dependent on the intent of the taxpayer, 
that is difficult to evaluate.. . . It is also unclear how the 
rule would be administered.. . .In any event, it may be 
difficult for a U.S. company to evaluate whether its 
transaction may be subject to Italian main purpose 
standards.\6\
---------------------------------------------------------------------------
    \6\ ``Explanation of Proposed Income Tax Treaty and Proposed 
Protocol between the United States and the Italian Republic,'' October 
8, 1999 (JCS-9-99); see also, ``Testimony of the Staff of the Joint 
Committee on Taxation before the Senate Committee on Foreign Relations 
Hearing on Tax Treaties and Protocols with Eight Countries,'' October 
27, 1999 (JCX-76-99).
---------------------------------------------------------------------------
    These very same objections--``vague,'' ``subjective,'' 
``difficulties for legitimate business transactions''--apply 
equally to Treasury's proposed definition of ``tax-avoidance 
transaction.'' In light of concerns raised by the JCT staff and 
the Senate Foreign Relations Committee, the Senate last year 
approved the treaties subject to a ``reservation'' that has the 
effect of eliminating the ``main purpose'' test.
    It would be inappropriate for the Congress to hand the IRS 
this authority to deny tax benefits at this time, less than two 
years after Congress enacted significant new limitations \7\ on 
the authority of IRS agents in audit situations. Congress also 
should note that Treasury and the IRS could use the authority 
that would be provided under this proposal to make changes 
administratively that Congress has not seen fit to make 
legislatively. For example, Treasury in its FY 1999 budget 
proposals asked for expansive authority to ``set forth the 
appropriate tax results'' and ``deny tax benefits'' in hybrid 
transactions.\8\ Congress dismissed this proposal. The FY 2001 
budget proposals now ask for authority of the same type but 
significantly broader than the authorization that Congress 
rejected. The Treasury's new proposals thus can be seen as an 
attempted end run around earlier failed initiatives--this time 
accompanied by the shibboleth of ``stopping tax shelters.''
---------------------------------------------------------------------------
    \7\ Internal Revenue Service Restructuring and Reform Act of 1998, 
P.L. 105-208.
    \8\ General Explanation of the Administration's Revenue Proposals, 
Department of the Treasury, February 1998, p. 144.
---------------------------------------------------------------------------

D. Impose a Penalty Excise Tax on Certain Fees Received from Corporate 
                              Tax Shelters

Summary

    The proposal would impose a 25-percent excise tax on fees 
received in connection with promoting or rendering tax advice 
related to corporate tax shelters.

Comment

    The imprecise definition of a corporate tax shelter 
transaction would make it difficult for professional tax 
advisers to determine the circumstances under which this 
provision would apply. The substantive burdens of interpreting 
and complying with the statute and the administrative problems 
that taxpayers and the IRS would face cannot be overstated.
    Further aggravating the complexity and burdens that are 
imbedded in this proposal is the fact that the ultimate 
determination that a particular transaction was a corporate tax 
shelter may not be made until several years after the fees are 
paid. In that situation, issues arise as to when the excise tax 
is due, whether the applicable statute of limitations has 
expired, and whether and upon what date interest would be owed 
on the liability.
    More fundamentally, the creation of the proposed excise tax 
subjects tax advisors to an entirely new and burdensome tax 
regime, a regime that again shifts the focus away from the 
substantive tax aspects of the transaction to unrelated 
definitional and computational issues. It is also unclear who 
would administer or enforce this new tax regime. For instance, 
if the existence of a tax shelter is determined as a result of 
an income tax examination of a corporation, would the revenue 
agents conducting that examination have jurisdiction over a 
resulting excise tax examination of the taxpayer's tax adviser? 
Would the income tax and excise tax examinations be conducted 
concurrently? How would conflicts of interest between the 
taxpayer and the adviser be identified and handled? These are 
only a few of the serious real-world issues that would have to 
be resolved to administer an inherently vague and cumbersome 
proposal.
    Finally, the real possibility exists that the effect of the 
proposal may be to deter certain taxpayers from seeking and 
obtaining necessary advice and guidance from a qualified tax 
professional in many transactions where the broad and vague 
scope of the prohibition calls into question the ultimate 
deductibility of fees. In many such cases, it is likely that 
qualified tax advice would have either convinced the taxpayer 
that it would be unwise or improper to enter into the 
transaction, or resulted in the restructuring of the 
transaction so as to bring it within full compliance with the 
letter and spirit of the internal revenue laws.

  E. Tax Income from Corporate Tax Shelters Involving Tax-Indifferent 
                                Parties

Summary

    Any income allocable to a ``tax-indifferent party'' (e.g., 
a foreign person; a foreign, State, or local government; a 
Native American tribal organization; a tax-exempt organization) 
with respect to a corporate tax shelter would be taxable to 
that party. The corporate participants in the transaction would 
be jointly and severally liable for the tax.

    Comment

    Treasury itself has conceded that this proposal ``may be 
difficult to administer.'' \9\
---------------------------------------------------------------------------
    \9\ The Problem of Corporate Tax Shelters, supra n.1, at 114.
---------------------------------------------------------------------------
    This overreaching Treasury proposal cannot be justified on 
any tax policy grounds. The proposal ignores the fact that many 
businesses operating in the global economy are not U.S. 
taxpayers, and that in the global economy it is increasingly 
necessary and common for U.S. companies to enter into 
transactions with such entities. The fact that a tax-exempt 
person earns income that would be taxable if instead it had 
been earned by a taxable entity surely cannot in and of itself 
be viewed as objectionable.
    Moreover, as it applies to foreign persons in particular, 
the proposal is overbroad in two significant respects. First, 
treating foreign persons as tax-indifferent ignores the fact 
that in many circumstances they may be subject to significant 
U.S. tax, either because they are subject to the withholding 
tax rules, because they are engaged in a U.S. trade or 
business, or because their income is taxable currently to their 
U.S. shareholders. Second, limiting the collection of the tax 
to parties other than treaty-protected foreign persons does not 
hide the fact that the tax-indifferent party tax would 
constitute a significant treaty override.

                III. ARGUMENTS AGAINST SWEEPING CHANGES

          A. The Myth of the Eroding Corporate Income Tax Base

    The Treasury Department has cited as justification for its 
proposals a possible erosion of corporate income tax revenues 
attributable to ``corporate tax shelters,'' but has not 
presented any evidence to support this concern. Rather, 
Treasury has cited statements made Joseph Bankman of Stanford 
University that ``corporate tax shelters'' are responsible for 
$10 billion in lost corporate income tax revenues each year. 
Bankman essentially admits he has no data supporting his $10 
billion figure in his Internet tax policy chatroom,\10\ where 
he answers a question from a reader as to the references for 
his $10 billion figure as follows: ``The $10 billion figure 
that I am quoted on is obviously just an estimate.'' This 
unsubstantiated claim hardly represents the type of serious 
economic analysis that should be undertaken before adopting 
sweeping tax policy changes of the scope envisioned by 
Treasury.
---------------------------------------------------------------------------
    \10\ http://www.law.nyu.edu/bankmanj/federalincometax
---------------------------------------------------------------------------
    An analysis of actual data shows no evidence of a loss of 
corporate income tax revenues attributable to shelter 
activities. Since 1992, corporate federal income tax payments 
have grown by more than 80 percent, from $100.3 billion in 
fiscal 1992 to $184.7 billion in fiscal 1999 (see Appendix 1). 
By point of comparison, GDP has grown by 44 percent over this 
period. Over the fiscal 1993-1999 period, corporate tax 
payments averaged 2.1 percent of GDP; only once in the 
preceding 1980-1992 period were corporate income tax payments 
higher in percentage terms (in 1980).
    Despite the high level of tax payments in the post-1992 
period, some commentators have pointed to a two-percent drop in 
federal corporate tax payments in fiscal 1999, as compared to 
the prior year, as possibly indicating corporate tax shelter 
activity.\11\ This claim has been made despite the fact that 
corporate tax payments as a percentage of GDP in fiscal 1999 
were higher than the average for the 1980-1999 period.
---------------------------------------------------------------------------
    \11\ See, Martin A Sullivan, ``Despite September Surge, Corporate 
Tax Receipts Fall Short,'' 85 Tax Notes 565 (Nov. 1, 1999).
---------------------------------------------------------------------------
    A possible explanation for this drop is a relative decline 
in corporate profits attributable to depreciation deductions 
associated with increased equipment investment and the increase 
in employee compensation relative to corporate profits.\12\ The 
Congressional Budget Office in its January 2000 budget outlook 
noted depreciation as among the factors putting downward 
pressure on corporate profits.\13\ It also should be noted that 
the slight falloff in corporate profits was not unforeseen--the 
Office of Management and Budget (OMB) last year projected that 
corporate income tax payments would fall in FY 1999, before 
rising again in FY 2000.\14\ It should be further noted that 
actual corporate income tax payments for FY 1999 ultimately 
exceeded the OMB forecast by more than $2 billion.
---------------------------------------------------------------------------
    \12\ See, New York Times, September 21, 1999, ``When an Expense is 
Not an Expense.'' This article points to rising compensation paid in 
the form of stock options as a possible explanation. An increase in 
employee compensation increases personal income tax (at the employee 
level) at the expense of corporate income tax, because employee 
compensation generally is deductible in computing corporate income tax 
and includable in computing personal income tax.
    \13\ Congressional Budget Office, The Budget and Economic Outlook: 
Fiscal Years 2001-2010, January 2000, p. 60.
    \14\ The Administration's FY 2000 budget projected that corporate 
income revenues would total $182.2 billion in FY 1999, or $2.5 billion 
less than actual.
---------------------------------------------------------------------------
    In this section, we examine whether the recent dip in 
corporate income tax payments provides any evidence that 
``corporate tax shelter'' activity is proliferating. After a 
thorough review of the data, including data from the IRS, the 
Bureau of Economic Analysis (BEA), and corporate financial 
statements, we find no basis for assertions that increased 
shelter activity has caused corporate tax burdens to fall.

       1. Corporate tax liability and the timing of tax payments

    Corporate tax payments received by the IRS during a given 
year fail to reflect that year's tax liability for several 
reasons. First, large corporate taxpayers frequently have five 
to ten ``open'' years for which final tax liability has not 
been determined. Thus, current corporate tax payments may 
include deficiencies (plus interest and penalties) for a number 
of prior tax years. Similarly, current corporate tax payments 
may be reduced by refunds arising from overpayments of 
corporate tax in a number of prior tax years. In addition, 
current tax payments may be reduced by previously unused net 
operating losses and tax credits that are carried forward from 
prior years. Thus, current data on corporate income tax 
payments received by the IRS are not a reliable indicator of 
current year tax liability; rather, current year tax receipts 
reflect a blend of current and past year tax liabilities, and 
are reduced by carryforwards of unused losses and credits from 
prior years.

Corporate tax payments

    Monthly information on receipts of corporate income taxes 
by the U.S. Government is published by the Financial Management 
Service of the U.S. Treasury Department.\15\
---------------------------------------------------------------------------
    \15\ U.S. Dept. of the Treasury, Monthly Treasury Statement of 
Receipts and Outlays of the United States Government.
---------------------------------------------------------------------------
    The Treasury defines net corporate tax receipts in any 
month as gross receipts less refunds. Net corporate tax 
receipts were $185.0 billion in calendar year 1998 and $185.9 
billion in 1999. Gross corporate tax receipts were $213.5 
billion in 1998 and $217.0 billion in 1999. Net corporate tax 
receipts increased by a smaller amount than gross corporate tax 
receipts due to an increase in corporate tax refunds, from 
$28.5 billion in 1998 to $31.1 billion in 1999. Refunds can 
increase as a result of overpayments of estimated tax (which 
may occur when profits turn out to be lower than expected) or 
as a result of amendments to prior year tax returns (for 
example, when current year losses or credits are carried back 
to a prior tax year). Until the IRS tabulates tax return data 
for 1998 and 1999, it is not possible to determine the reason 
for the recent increase in refunds.

Corporate tax liability

    For purposes of the National Income and Product Accounts, 
BEA makes current estimates of corporate tax liability based on 
IRS and other data. The IRS calculates annual corporate income 
tax liability by tabulating corporate tax returns (before 
audit). The most recent publicly available corporate income tax 
return information is for IRS years 1996 (i.e., tax years 
ending after June 1996 and before July 1997).\16\
---------------------------------------------------------------------------
    \16\ See, IRS, Statistics of Income Bulletin, Winter 1998/1999.
---------------------------------------------------------------------------
    In summary, it is important to distinguish between 
corporate tax liability and corporate tax receipts. Because 
corporate tax receipts are a mix of estimated tax payments for 
the current year as well as adjustments (both up and down) to 
taxes paid with respect to prior years, a drop in corporate tax 
receipts does not imply a drop in corporate tax liability. For 
example, in 1985, corporate tax receipts increased over the 
prior year at the same time that corporate tax liability 
decreased (see Appendix 2).

            2. Effective tax rates: Commerce Department data

    Corporate tax liability can be broken down into two 
components: (1) a reference measure of profits arising in the 
corporate sector; multiplied by (2) the effective tax rate 
(which is equal to corporate tax divided by reference profits). 
A decline in corporate tax liability can occur as a result of 
lower profits or, alternatively, as a result of a lower 
effective tax rate. A decline in corporate tax liability due to 
a fall in real corporate income is not, of course, evidence of 
tax shelter activity. By contrast, a decline in the effective 
tax rate may warrant investigation to determine if there is tax 
avoidance not intended by lawmakers.
    Calculation of the effective corporate tax rate requires a 
measure of corporate income tax liability as well as a 
reference measure of corporate profits. Two data sources are 
used in this analysis: (1) the National Income and Product 
Accounts (NIPA) published by the U.S. Commerce Department; and 
(2) data from audited financial statements of public companies 
filed with the Securities and Exchange Commission (SEC) on Form 
10K. Effective tax rate calculations based on NIPA data are 
described in this section; calculations based on SEC data are 
described in the following section.
    One of the items used by BEA to calculate GDP is 
``corporate profits before tax.'' \17\ This concept of profits 
includes income earned in the United States (whether by U.S. or 
foreign corporations) and excludes income earned outside the 
United States. For purposes of calculating an effective tax 
rate, several adjustments are made to ``corporate profits 
before tax'': (1) profits of the Federal Reserve Banks are 
subtracted; (2) profits of subchapter S corporations are 
subtracted; (3) payments of State and local income tax are 
subtracted; and (4) corporate capital gains are added. These 
adjustments follow the methodology developed by CBO to estimate 
``taxable corporate profits.'' \18\ BEA estimates that 
corporate profits before tax, as adjusted, increased from $587 
billion in calendar 1998 to $603 billion in 1999 (see Appendix 
3).\19\ As a percent of GDP, pre-tax corporate profits are 
estimated to have reached a post-1980 high of 7.0 percent in 
1996, with a dip to 6.9 percent in 1997-1998, and a further dip 
to 6.8 percent in the first half of calendar 1999 on an 
annualized basis.
---------------------------------------------------------------------------
    \17\ BEA makes two adjustments to this measure of corporate profits 
in determining GDP: (1) BEA uses an ``economic'' measure of 
depreciation rather than tax depreciation (i.e., the ``capital 
consumption adjustment''); and (2) BEA removes inventory profits 
attributable to changes in price (i.e., the ``inventory valuation 
adjustment''). Note that the BEA data uses in this report are based on 
information available as of October 1999 and do not reflect the 
subsequently released comprehensive revision of the National Income and 
Product Accounts (NIPA).
    \18\ See, Congressional Budget Office, The Shortfall in Corporate 
Tax Receipts Since the Tax Reform Act of 1986, CBO Papers, May 1992. 
The first adjustment reflects the fact that the Federal Reserve system 
is not subject to corporate income tax; the second adjustment is made 
because S corporations generally do not pay corporate level tax (rather 
the income is flowed through to the shareholders); the third adjustment 
is made because state and local income taxes are deductible in 
computing federal income tax; and the fourth adjustment is necessary 
because corporations are taxed on capital gains while GDP excludes 
capital gains.
    \19\ 1999 data are annualized based on the first six months of the 
year, seasonally adjusted.
---------------------------------------------------------------------------
    Based on adjusted NIPA data, the effective corporate tax 
rate, measured as federal corporate tax liability divided by 
corporate profits before federal income tax, is projected to be 
32.7 percent in 1999, higher than the 31.2 percent rate in 1998 
and higher than the 32.6 percent average for the 1993-1999 
period (see Appendix 3). Thus, based on the National Income and 
Product Accounts, there is no evidence of a decline in the 
effective rate of corporate income tax.

                    3. Effective tax rates: SEC data

    Corporate effective tax rates also can be estimated from 
the audited financial statements that publicly traded companies 
are required to file with the SEC. This method was used by the 
General Accounting Office in its 1992 study of corporate 
effective tax rates.\20\ Following the GAO methodology, the 
effective corporate tax rate is measured by dividing the 
current provision for federal income tax into reported U.S. 
operating income, reduced by the current provision for State 
and local income tax. U.S. operating income is determined by 
subtracting foreign operating income from total operating 
income net of depreciation, based on geographic segment 
reporting.
---------------------------------------------------------------------------
    \20\ See, General Accounting Office, ``1988 and 1989 Company 
Effective Tax Rates Higher Than in Prior Years,'' GAO/GGD-92-11, August 
1992.
---------------------------------------------------------------------------
    Standard & Poors publishes SEC 10K data in its Compustat 
database, which is updated monthly.\21\ Based on the August 
1999 Compustat data release, effective corporate tax rates were 
calculated for the 1988-1998 period using information from 
every corporation in the database that supplied all of the 
necessary data items. Recognizing that the results for 1998 
might not be comparable to prior years due to the limited 
sample size, the effective tax rates for 1996 and 1997 were 
recomputed using information from the same companies as in the 
1998 sample.
---------------------------------------------------------------------------
    \21\ Financial statements for companies with fiscal years ending 
after May of 1998, and before June of 1999, are classified as 1998 
statements in Compustat. Because there is a lag between the end of a 
company's fiscal year and the time it files Form 10K, and another lag 
between the time the form is filed and the time it is processed by 
Standard & Poors, information for Compustat's 1998 year was incomplete 
as of August 1999.
---------------------------------------------------------------------------
    For purposes of this analysis we excluded publicly traded 
corporations and partnerships that are not generally taxable at 
the corporate level (i.e., mutual funds and real estate 
investment trusts). Separate calculations were made for 
companies that reported foreign activity (multinationals) and 
for companies that reported no foreign activity (domestics). A 
multinational's current provision for U.S. tax may include U.S. 
tax on foreign source income; consequently, measured relative 
to domestic income, the effective tax rate of U.S. 
multinationals may be higher than for comparable domestic 
firms. In theory, U.S. tax on foreign source income should be 
removed from the numerator of a domestic effective tax rate 
calculation; however, this adjustment cannot accurately be made 
with financial statement data.
    The results of this analysis are shown in Appendix 4. For 
1997, the most recent year for which annual reporting is 
complete, companies included in the Compustat sample report $78 
billion of current federal income tax liability, accounting for 
over 40 percent of federal corporate tax liability in the 
National Income and Product Accounts. The Compustat sample of 
firms excludes private companies and public companies that do 
not report all of the items necessary to calculate the 
effective tax rate. While the average firm in Compustat is much 
larger than the average corporate taxpayer, the main purpose of 
our analysis is to examine the trend in effective corporate tax 
rates over time. We have no reason to believe that there is a 
systematic difference in trend effective tax rates between 
companies in Compustat and other corporate taxpayers. Indeed, 
if there were a proliferation of corporate tax shelter 
activity, we might expect to see indications of this first 
among the largest and most sophisticated corporations, of the 
type included in the Compustat sample.
    In general, we find that the effective tax rates calculated 
from financial statement data are lower than those calculated 
from the National Income and Product Accounts. One reason for 
this is that the profit definition used for the NIPA 
calculations is based on tax depreciation, while the profit 
definition used for the financial statement calculations is 
based on book depreciation. Another reason is that the income 
element of nonqualified stock options is deductible for tax 
purposes when the option is excercised (and included in the 
employee's income), but is not treated as an expense against 
income for financial statement purposes. We also find that, on 
average, over the 1988-1998 period, effective federal tax rates 
are higher for multinational corporation than for domestic 
corporations.
    Based on financial statement data, the corporate effective 
tax rate for all corporations (domestic and multinational) was 
higher in 1997 (19.9 percent) than the average over the ten-
year period 1988-1997 (18.5) percent, and for the sample of 
companies reporting financial results for 1998, the effective 
tax rate increased between 1997 (19.4 percent) and 1998 (20.7 
percent).\22\
---------------------------------------------------------------------------
    \22\ These results also generally hold up when effective tax rates 
are measured relative to U.S. assets or U.S. revenues. Among domestic-
only firms, however, income has grown more slowly than either assets or 
revenues since 1995, with the result that the ratio of tax liability to 
either assets or revenues has declined slightly for companies without 
foreign operations.
---------------------------------------------------------------------------
    In summary, based on audited financial statements, there is 
no evidence for a decline in the effective corporate tax rate. 
This is consistent with our findings using National Income and 
Product Account data.

                       4. Corporate capital gains

    One category of corporate ``tax shelter'' that has received 
recent attention is the use of transactions designed to avoid 
tax on capital gains. Indeed, one commentator believes these 
transactions are so prevalent that the tax on corporate capital 
gains has essentially been rendered ``elective.'' \23\ If this 
assessment of the corporate income tax system were accurate, we 
would expect to see a marked decline in corporate capital gain 
realizations in recent years.
---------------------------------------------------------------------------
    \23\ Michael Schler, as quoted in the September 1, 1999, Wall 
Street Journal ``Tax Report,'' A1.
---------------------------------------------------------------------------
    The IRS data, however, do not support the view that 
corporations easily can avoid tax on capital gains. Excluding 
mutual funds, net corporate gain on capital assets increased by 
54 percent from $53 billion in 1992 to $82 billion in 1996 (the 
most recent year for which IRS data is available)--an average 
annual increase of 11.5 percent per year (see Appendix 5). In 
short, notices of the death of the corporate capital gains tax 
are premature.

                             5. Conclusion

    If unusually high levels of corporate tax shelter activity 
have been occurring over the last few years, we would expect to 
see a drop in corporate tax liability relative to normative 
measures of pre-tax corporate income. To test this hypothesis, 
we measure corporate effective tax rates using data from the 
National Income and Product Accounts and audited financial 
statements. Neither measure shows a suspicious drop in tax 
liabilities relative to corporate income; to the contrary, both 
measures show flat or rising corporate effective tax rates over 
the last five years. Moreover, if corporate capital gains tax 
was easily avoidable using tax shelter techniques, we would 
expect to see little or no growth in net capital gains reported 
on corporate tax returns. Again, the data disprove this 
hypothesis, showing instead a robust rate of increase over the 
most recent four-year period for which data are available.

                    B. Efficacy of Current-Law Tools

    Proponents of extensive new legislation to address 
``corporate tax shelters'' overlook the formidable array of 
tools currently available to the government to deter and attack 
transactions considered as abusive. In our view, the tools 
described below are more than sufficient to achieve compliance 
with the corporate income tax. That is, these tools enable the 
IRS and courts to ensure that corporations pay the corporate 
income tax liability that results from application of the 
Internal Revenue Code.

                         1. Threat of penalties

    As an initial matter, the tax Code includes significant 
disincentives to engage in potentially abusive behavior. 
Present law imposes 20-percent accuracy-related penalties under 
section 6662 in the case of negligence, substantial 
understatements of tax liability, and certain other cases. In 
considering a proposed transaction that may turn on a debatable 
reading of the tax law, a corporate tax executive must weigh 
the potential for imposition of these penalties, which could 
have a negative impact on shareholder value and on the 
corporation.
    Furthermore, it should be noted that Congress, in the 1997 
Taxpayer Relief Act, strengthened the substantial 
understatement penalty as it applies to ``tax shelters.'' Under 
this change, which was supported and encouraged by the Treasury 
Department, an entity, plan, or arrangement is treated as a tax 
shelter if it has tax avoidance or evasion as just one of its 
significant purposes.\24\ The Congress believed that this 
change, coupled with new reporting requirements that Treasury 
has failed to activate, would ``improve compliance by 
discouraging taxpayers from entering into questionable 
transactions.'' \25\ Although this change is effective for 
current transactions, the IRS and Treasury have not yet issued 
regulations providing guidance on the term ``significant 
purpose.''
---------------------------------------------------------------------------
    \24\ Section 6662(d)(2)(C)(iii). Prior law defined tax shelter 
activity as an entity, plan, or arrangement only if it had tax 
avoidance or evasion as the principal purpose.
    \25\ General Explanation of Tax Legislation Enacted in 1997, Staff 
of the Joint Committee on Taxation, December 17, 1997 (JCS 23-97).
---------------------------------------------------------------------------
    The 1997 Act changes have made it even more important for 
chief tax executives to weigh carefully the risks of penalties 
and even more difficult to determine which transactions might 
trigger penalties. At this time, there is no demonstrated 
justification for making these penalties even harsher.

                          2. Anti-abuse rules

    The Code includes numerous provisions that arm Treasury and 
the IRS with broad authority to prevent tax avoidance, to 
reallocate income and deductions, to deny tax benefits, and to 
ensure taxpayers clearly report income.
    These rules long have provided powerful ammunition for 
challenging tax avoidance transactions. For example, section 
482 authorizes the IRS to reallocate income, deductions, 
credits, or allowances between controlled taxpayers to prevent 
evasion of taxes or to clearly reflect income. While much 
attention has been focused in recent years on the application 
of section 482 in the international context, section 482 also 
applies broadly in purely domestic situations. Further, the IRS 
also has the authority to disregard a taxpayer's method of 
accounting if it does not clearly reflect income under section 
446(b).
    In the partnership context, the IRS has issued regulations 
under subchapter K aimed at arrangements the IRS considers as 
abusive.\26\ The IRS states that these rules authorize it to 
disregard the existence of a partnership, to adjust a 
partnership's methods of accounting, to reallocate items of 
income, gain, loss, deduction, or credit, or otherwise to 
adjust a partnership's or partner's tax treatment in situations 
where a transaction meets the literal requirements of a 
statutory or regulatory provision, but where the IRS believes 
the results are inconsistent with the intent of the Code's 
partnership tax rules.
---------------------------------------------------------------------------
    \26\ Treas. Reg. Sec.  1.701-2.
---------------------------------------------------------------------------
    The IRS also has issued a series of far-reaching anti-abuse 
rules under its legislative grant of regulatory authority in 
the consolidated return area. For example, under Treas. Reg. 
Sec. 1.1502-20, a parent corporation is severely limited in its 
ability to deduct any loss on the sale of a consolidated 
subsidiary's stock. The consolidated return investment basis 
adjustment rules also contain an anti-avoidance rule.\27\ The 
rule provides that the IRS may make adjustments ``as 
necessary'' if a person acts with ``a principal purpose'' of 
avoiding the requirements of the consolidated return rules. The 
consolidated return rules feature several other anti-abuse 
rules as well.\28\
---------------------------------------------------------------------------
    \27\ Treas. Reg. Sec.  1.1502-32(e).
    \28\ See, e.g., Treas. Reg. Sec.  1.1502-13(h) (anti-avoidance 
rules with respect to the intercompany transaction provisions) and 
Treas. Reg. Sec.  1.1502-17(c) (anti-avoidance rules with respect to 
the consolidated return accounting methods).
---------------------------------------------------------------------------

                        3. Common-law doctrines

    Pursuant to several ``common-law'' tax doctrines, Treasury 
and the IRS can challenge a taxpayer's treatment of a 
transaction if they believe the treatment is inconsistent with 
statutory rules and the underlying Congressional intent. For 
example, these doctrines may be invoked where the IRS believes 
that (1) the taxpayer has sought to circumvent statutory 
requirements by casting the transaction in a form designed to 
disguise its substance, (2) the taxpayer has divided the 
transaction into separate steps that have little or no 
independent life or rationale, (3) the taxpayer has engaged in 
``trafficking'' in tax attributes, or (4) the taxpayer 
improperly has accelerated deductions or deferred income 
recognition.
    These broadly applicable doctrines--known as the business 
purpose doctrine, the substance over form doctrine, the step 
transaction doctrine, and the sham transaction and economic 
substance doctrine--give the IRS considerable leeway to recast 
transactions based on economic substance, to treat apparently 
separate steps as one transaction, and to disregard 
transactions that lack business purpose or economic substance. 
Recent applications of those doctrines have demonstrated their 
effectiveness and cast doubt on Treasury's asserted need for 
additional tools.
    The recent decisions in ACM v. Commissioner \29\ and ASA 
Investerings v. Commissioner \30\ illustrate the continuing 
force of these long-standing judicial doctrines. In ACM, the 
Third Circuit, affirming the Tax Court, relied on the sham 
transaction and economic substance doctrines to disallow losses 
generated by a partnership's purchase and resale of notes. The 
Tax Court similarly invoked those doctrines in ASA Investerings 
to disallow losses on the purchase and resale of private 
placement notes. Both cases involved complex, highly 
sophisticated transactions, yet the IRS successfully used 
common-law principles to prevent the taxpayers from realizing 
tax benefits from the transactions.
---------------------------------------------------------------------------
    \29\ 157 F.3d 231 (3d Cir. 1998). See also Saba Partnership, T.C.M. 
1999-359 (10/27/99).
    \30\ T.C.M. 1998-305.
---------------------------------------------------------------------------
    More recent examples of use of common-law doctrines by the 
IRS are the Tax Court's decisions in United Parcel Service v. 
Commissioner \31\ (8/9/99), Compaq Computer Corp. v. 
Commissioner \32\ (9/21/99), and Winn-Dixie v. Commissioner 
\33\ (10/19/99). In United Parcel Service, the court agreed 
with the IRS's position that the arrangement at issue--
involving the taxpayer, a third-party U.S. insurance company 
acting as an intermediary, and an offshore company acting as a 
reinsurer--lacked business purpose and economic substance. In 
Compaq, the court agreed with the IRS's contention that the 
taxpayer's purchase and resale of certain financial instruments 
lacked economic substance and imposed accuracy-related 
penalties under section 6662(a). In Winn-Dixie, the court held 
that an employer's leveraged corporate-owned life insurance 
program lacked business purpose and economic substance.
---------------------------------------------------------------------------
    \31\ T.C.M. 1999-268.
    \32\ 113. T.C. No. 17.
    \33\ 113. T.C. No. 21.
---------------------------------------------------------------------------
    This recent line of cases and the IRS's increasingly 
successful use of common-law doctrines in these cases argue 
against any need for expanding the IRS's tools at this time or 
(as the Treasury Department has suggested) for codifying the 
doctrines.

                           4. Treasury action

    Treasury on numerous occasions has issued IRS Notices 
stating an intention to publish regulations that would preclude 
favorable tax treatment for certain transactions. Thus, a 
Notice allows the government (assuming that the particular 
action is within Treasury's rulemaking authority) to move 
quickly, without having to await development of the regulations 
themselves--often a time-consuming process--that provide more 
detailed rules concerning a particular transaction.
    Examples of the use of this authority include Notice 97-21, 
in which the IRS addressed multiple-party financing 
transactions that used a special type of preferred stock; 
Notice 95-53, in which the IRS addressed the tax consequences 
of ``lease strip'' or ``stripping transactions'' separating 
income from deductions; and Notices 94-46 and 94-93, addressing 
so-called ``corporate inversion'' transactions viewed as 
avoiding the 1986 Act's repeal of the General Utilities 
doctrine.\34\
---------------------------------------------------------------------------
    \34\ The General Utilities doctrine generally provided for 
nonrecognition of gain or loss on a corporation's distribution of 
property to its shareholders with respect to their stock. See, General 
Utils. & Operating Co. v. Helvering, 296 U.S. 200 (1935). The General 
Utilities doctrine was repealed in 1986 out of concern that the 
doctrine tended to undermine the application of the corporate-level 
income tax. H.R. Rep. No. 426, 99th Cong., 1st Sess. 282 (1985).
---------------------------------------------------------------------------
    Moreover, section 7805(b) of the Code expressly gives the 
IRS authority to issue regulations that have retroactive effect 
``to prevent abuse.'' Although many Notices have set the date 
of Notice issuance as the effective date for forthcoming 
regulations,\35\ Treasury has used its authority to announce 
regulations that would be effective for periods prior to the 
date the Notice was issued.\36\ Alternatively, Treasury in 
Notices has announced that it will rely on existing law to 
challenge abusive transactions that already have occurred.\37\
---------------------------------------------------------------------------
    \35\ See, e.g., Notice 95-53, 1995-2 CB 334, and Notice 89-37, 
1989-1 CB 679.
    \36\ See, e.g., Notice 97-21, 1997-1 CB 407.
    \37\ Notice 96-39, I.R.B. 1996-32.
---------------------------------------------------------------------------

                        5. Targeted legislation

    To the extent that Treasury and the IRS may lack rulemaking 
or administrative authority to challenge a particular type of 
transaction, one other highly effective avenue remains open--
that is, enactment of legislation. In this regard, over the 
past 30 years dozens upon dozens of changes to the tax code 
have been enacted to address perceived abuses. For example, 
Congress last year enacted legislation (H.R. 435) addressing 
``basis-shifting'' transactions involving transfers of assets 
subject to liabilities under section 357(c).
    These targeted legislative changes often have immediate, or 
even retroactive, application. The section 357(c) provision, 
for example, was made effective for transfers on or after 
October 19, 1998--the date House Ways and Means Committee 
Chairman Bill Archer introduced the proposal in the form of 
legislation. Chairman Archer took this action, in part, to stop 
these transactions earlier than would have been accomplished 
under the effective date originally proposed by Treasury (the 
date of enactment).

 C. IRS National Office Activities Regarding ``Corporate Tax Shelters''

    The question whether broad legislative action regarding 
``corporate tax shelters'' is warranted at this time should be 
considered in view of current administrative initiatives now 
being undertaken at the IRS. Larry Langdon, Commissioner of the 
IRS's new Large and Mid-Size Business Division, has announced 
that the IRS is establishing a special office to coordinate IRS 
efforts to address corporate tax shelter issues.\38\ The new 
office will allow for quick communication between IRS 
examiners, the IRS Chief Counsel, and the Treasury Department 
in identifying and addressing abuses. These IRS efforts will 
serve as a strong deterrent to abusive transactions and further 
call into question the need for legislative action at this 
time.
---------------------------------------------------------------------------
    \38\ GNA Daily Tax Report, January 18, 2000, G-4.
---------------------------------------------------------------------------

                             IV. CONCLUSION

    Congress should reject the broad legislative proposals 
regarding ``corporate tax shelters'' that have been advanced by 
the Treasury Department. The revenue and economic data indicate 
no need for these radical changes. Further, the proposals are 
completely unnecessary in light of the array of legislative, 
regulatory, administrative, and judicial tools available to 
curtail perceived abuses. Finally, these proposals would create 
an unacceptably high level of uncertainty and burdens for 
corporate tax officials while potentially imposing penalties on 
legitimate transactions undertaken in the ordinary course of 
business.
      

                                

                               Appendix 1

                                   Corporate Income Tax Receipts, FY 1980-1999
                                          [Billions of current dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                      Federal
                                                                                     corporate     Corporate tax
                           Fiscal year                             GDP (dollars)    income tax     receipts as a
                                                                                     receipts     percent of GDP
                                                                                     (dollars)       (percent)
----------------------------------------------------------------------------------------------------------------
1980............................................................           2,719            64.6             2.4
1981............................................................           3,048            61.1             2.0
1982............................................................           3,214            49.2             1.5
1983............................................................           3,423            37.0             1.1
1984............................................................           3,819            56.9             1.5
1985............................................................           4,109            61.3             1.5
1986............................................................           4,368            63.1             1.4
1987............................................................           4,609            83.9             1.8
1988............................................................           4,957            94.5             1.9
1989............................................................           5,356           103.3             1.9
1990............................................................           5,683            93.5             1.6
1991............................................................           5,862            98.1             1.7
1992............................................................           6,149           100.3             1.6
1993............................................................           6,478           117.5             1.8
1994............................................................           6,849           140.4             2.1
1995............................................................           7,194           157.0             2.2
1996............................................................           7,533           171.8             2.3
1997............................................................           7,972           182.3             2.3
1998............................................................           8,404           188.7             2.2
1999............................................................           8,851           184.7             2.1
Period averages:
  1980-99.......................................................         5,529.9           105.5             1.9
  1980-82.......................................................         2,993.7            58.3             1.9
  1983-85.......................................................         3,783.7            51.7             1.4
  1986-89.......................................................         4,822.5            86.2             1.8
  1990-92.......................................................         5,898.0            97.3             1.6
  1993-99.......................................................         7,611.6           163.2            2.1
----------------------------------------------------------------------------------------------------------------
 Sources: Congressional Budget Office, Historical Budget Data, The Economic and Budget Outlook: Fiscal Years
  2000-2009, released January 1999.
 Congressional Budget Office, The Economic and Budget Outlook: An Update, July 1999. U.S. Treasury Department,
  Monthly Treasury Statement, October 1999 and earlier issues.
 US Treasury Department, Monthly Treasury Statement, October 1999 and earlier issues.

                               Appendix 2

                             Federal Corporate Tax Liability and Receipts, 1980-1999
                                              [Billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                   Federal corp.         Federal corp. income tax receipts
                  Calendar year                    tax liability -----------------------------------------------
                                                        \1\            Gross          Refunds           Net
----------------------------------------------------------------------------------------------------------------
1980............................................            58.6            72.0             8.6            63.4
1981............................................            51.7            75.1            13.4            61.7
1982............................................            33.9            63.5            19.5            44.0
1983............................................            47.1            64.6            22.7            41.9
1984............................................            59.1            75.5            16.9            58.6
1985............................................            58.5            78.7            16.1            62.6
1986............................................            66.0            84.1            17.8            66.3
1987............................................            85.5           105.2            18.0            87.2
1988............................................            93.6           114.4            16.0            98.5
1989............................................            95.5           113.9            14.1            99.8
1990............................................            94.4           112.9            15.9            96.9
1991............................................            89.0           112.9            16.6            96.4
1992............................................           101.8           119.7            16.6           103.1
1993............................................           122.3           137.3            13.7           123.6
1994............................................           136.2           158.9            14.7           144.2
1995............................................           155.9           180.4            17.9           162.5
1996............................................           172.9           191.8            19.8           172.1
1997............................................           189.5           211.1            19.8           191.3
1998............................................           183.2           213.5            28.5           185.0
1999............................................       197.0 \2\           217.0            31.1           185.9
----------------------------------------------------------------------------------------------------------------
\1\ Determined from the National Income and Product Accounts as profits before tax (domestic basis) minus
  profits of the Federal Reserve Banks minus state and local income taxes. See text for details.
\2\ Federal corp. tax liability is seasonally adjusted at an annual rate based on first six months of the year.
Sources:
1. U.S. Commerce Department, Bureau of Economic Analysis, Survey of Current, October 1999. Note that the data do
  not reflect changes in the most recent comprehensive revision of the National Income and Product Accounts
  (NIPA), which came out after our study was completed.
 U.S. Treasury Department, Monthly Treasury Summary, January 2000 and earlier issues.
PwC calculations.

                               Appendix 3

                                  Effective Corporate Tax Rate, NIPA, 1980-1999
                                              [Billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                          Federal
                                                                                         corp. tax      Corp.
                                                                 Corp.                   liability     profits
                                                                profits      Federal     (BEA adj.)   before tax
                                                     GDP       before tax   corp. tax       as a      (BEA adj.)
                 Calendar year                    (dollars)       (BEA      liability    percent of      as a
                                                                adj.\1\     (BEA adj.)     corp.      percent of
                                                               (dollars)    (dollars)     profits        GDP
                                                                                         before tax   (percent)
                                                                                         (percent)
----------------------------------------------------------------------------------------------------------------
1980...........................................      2,784.2        200.8         58.6         29.2          7.2
1981...........................................      3,115.9        193.6         51.7         26.7          6.2
1982...........................................      3,242.1        142.9         33.9         23.7          4.4
1983...........................................      3,514.5        181.1         47.1         26.0          5.2
1984...........................................      3,902.4        212.3         59.1         27.8          5.4
1985...........................................      4,180.7        215.4         58.5         27.2          5.2
1986...........................................      4,422.2        238.0         66.0         27.7          5.4
1987...........................................      4,692.3        255.9         85.5         33.4          5.5
1988...........................................      5,049.6        305.2         93.6         30.7          6.0
1989...........................................      5,438.7        290.0         95.5         32.9          5.3
1990...........................................      5,743.8        281.1         94.4         33.6          4.9
1991...........................................      5,916.7        287.3         89.0         31.0          4.9
1992...........................................      6,244.4        317.8        101.8         32.0          5.1
1993...........................................      6,558.1        369.5        122.3         33.1          5.6
1994...........................................      6,947.0        399.5        136.2         34.1          5.8
1995...........................................      7,269.6        499.9        155.9         31.2          6.9
1996...........................................      7,661.6        537.6        172.9         32.2          7.0
1997...........................................      8,110.9        559.7        189.5         33.9          6.9
1998...........................................      8,511.0        587.3        183.2         31.2          6.9
1999 \2\.......................................      8,873.4        603.4        197.5         32.7          6.8
Period averages:
  1980-99......................................      5,609.0        333.9        104.6         31.3          6.0
  1980-82......................................      3,047.4        179.1         48.1         26.8          5.9
  1983-85......................................      3,865.9        203.0         54.9         27.1          5.2
  1986-86......................................      4,900.7        272.3         85.1         31.3          5.6
  1990-92......................................      5,968.3        295.4         95.1         32.2          4.9
  1993-99......................................      7,704.5        508.1        165.4         32.5         6.6
----------------------------------------------------------------------------------------------------------------
\1\ Figures for 1997-1999 are based on CBO fiscal year projections. Because actual corporate capital gains data
  were not available for 1980-82, imputations were used.
\2\ Figures for 1999 are annualized based on first six months, seasonally adjusted.
Sources:
1. U.S. Commerce Department, Bureau of Economic Analysis, Survey of Current Business, October 1999. Note that
  the data are based on information available as of October 1999 and do not reflect the subsequently released
  comprehensive revision of the National Income and Product Accounts (NIPA).
2 U.S. Treasury Department, Monthly Treasury Summary, October 1999.
3. PwC Calculations

                                                                                           Appendix 4
                                                         U.S. Corporate Income Tax Liability per Audited Financial Statements, 1988-1998
                                          [Dollar amounts in billions; Tax years ending after May of indicated year, and before July of following year]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                                                        Avg '88-
                 Item                      1988       1989       1990       1991       1992       1993       1994       1995       1996       1997      96Aug      97Aug      98Aug        97
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              A. Companies with foreign operations
U.S. fed. inc. tax liability \1\......        $25        $24        $25        $23        $23        $27        $34        $41        $42        $48        $19        $22        $24        $31
U.S. oper. inc. after state inc. tax..       $127       $144       $138       $123       $128       $149       $181       $222       $231       $234        $89       $103       $105       $168
U.S. assets...........................     $1,408     $1,587     $1,753     $1,904     $1,996     $1,988     $2,310     $2,433     $2,595     $2,494       $905     $1,050     $1,071     $2,047
U.S. revenues.........................     $1,063     $1,212     $1,313     $1,371     $1,423     $1,373     $1,529     $1,745     $1,794     $1,770       $736       $817       $841     $1,459
U.S. fed. inc. tax liability as % of:
  U.S. oper. inc. after state inc. tax      19.9%      16.6%      18.2%      19.1%      18.3%      18.2%      19.0%      18.3%      18.4%      20.7%      21.7%      21.4%      22.6%      18.7%
  U.S. assets.........................       1.8%       1.5%       1.4%       1.2%       1.2%       1.4%       1.5%       1.7%       1.6%       1.9%       2.1%       2.1%       2.2%       1.5%
  U.S. revenues.......................       2.4%       2.0%       1.9%       1.7%       1.6%       2.0%       2.2%       2.3%       2.4%       2.7%       2.6%       2.7%       2.8%       2.2%
Number of corps.......................        700        746        806        886        963        820        934      1,057      1,159      1,178        633        633        633        925
 
                                                                             B. Companies without foreign operations
U.S. fed. inc. tax liability \1\......        $17        $19        $20        $23        $24        $22        $25        $27        $29        $29        $24        $26        $29        $24
U.S. oper. inc. after state inc. tax..       $106       $116       $118       $123       $136       $115       $130       $149       $157       $157       $131       $144       $150       $131
U.S. assets...........................     $1,332     $1,488     $1,570     $1,658     $1,825     $1,627     $2,061     $2,295     $2,526     $2,676     $2,124     $2,493     $2,907     $1,906
U.S. revenues.........................       $913     $1,016     $1,117     $1,182     $1,286     $1,079     $1,252     $1,398     $1,509     $1,564     $1,214     $1,403     $1,593     $1,232
U.S. fed. inc. tax liability as % of:
U.S. oper. inc. after state inc. tax..      15.7%      16.3%      17.3%      18.4%      18.0%      19.2%      19.6%      18.2%      18.7%      18.6%      18.1%      18.0%      19.4%      18.1%
  U.S. assets.........................       1.2%       1.3%       1.3%       1.4%       1.3%       1.4%       1.2%       1.2%       1.2%       1.1%       1.1%       1.0%       1.0%       1.2%
  U.S. revenues.......................       1.8%       1.9%       1.8%       1.9%       1.9%       2.1%       2.0%       1.9%       1.9%       1.9%       2.0%       1.9%       1.8%       1.9%
Number of corps.......................     3,681%     3,573%     3,646%     3,731%     3,945%     3,696%     3,847%     4,209%     4,249%     4,052%     3,357%     3,357%     3,357%      3,863
 
                                                                        C. Companies with and without foreign operations
U.S. fed. inc. tax liability \1\......        $42        $43        $45        $46        $48        $49        $60        $68        $72        $78        $43        $48        $53        $55
U.S. oper. inc. after state inc. tax..       $233       $261       $256       $246       $264       $264       $310       $372       $387       $391       $220       $247       $256       $298
U.S. assets...........................     $2,740     $3,075     $3,323     $3,562     $3,821     $3,615     $4,371     $4,727     $5,120     $5,171     $3,030     $3,543     $3,978     $3,952
U.S. revenues.........................     $1,976     $2,228     $2,430     $2,553     $2,709     $2,452     $2,781     $3,143     $3,302     $3,333     $1,950     $2,220     $2,434     $2,691
U.S. fed. inc. tax liability as % of:
  U.S. oper. inc. after state inc. tax       18.0      16.5%      17.8%      18.8%      18.2%      18.7%      19.2%      18.3%      18.5%      19.9%      19.6%      19.4%      20.7%      18.5%
  U.S. assets.........................       1.5%       1.4%       1.4%       1.3%       1.3%       1.4%       1.4%       1.4%       1.4%       1.5%       1.4%       1.4%       1.3%       1.4%
  U.S. revenues.......................       2.1%       1.9%       1.9%       1.8%       1.8%       2.0%       2.1%       2.2%       2.2%       2.3%       2.2%       2.2%       2.2%       2.0%
Number of corps.......................      4,381      4,319      4,452      4,617      4,908      4,516      4,781      5,266      5,408      5,230      3,990      3,990      3,990      4,788
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1. Current provision for tax.
 Source: Standard and Poors, Compustat, September 1999; PwC calculations.

                               Appendix 5

                            Net Capital Gains for All Active Corporations, 1980-1996
                                     [Excluding RICs in Billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                            Net gain on capital assets
                                                                 -----------------------------------------------
                                                                                   Net long-term
                              Year                                Net short-term   gain less net
                                                                   gain less net    short-term       Subtotal
                                                                  long-term loss       loss
----------------------------------------------------------------------------------------------------------------
1980............................................................            11.4            22.1            23.5
1981............................................................             1.7            25.6            27.3
1982............................................................             1.9            24.1            26.0
1983............................................................             2.7            28.4            31.1
1984............................................................             2.4            35.1            37.6
1985............................................................             4.3            45.9            50.2
1986............................................................             8.2            74.2            82.4
1987............................................................             4.4            54.5            58.9
1988............................................................             4.0            56.7            60.7
1989............................................................             6.0            62.5            68.5
1990............................................................             2.9            43.4            46.3
1991............................................................             7.1            41.1            48.2
1992............................................................             7.9            45.1            53.0
1993............................................................            10.8            53.3            64.1
1994............................................................             2.4            47.9            50.3
1995............................................................            10.0            60.9            70.8
1996............................................................             6.6            75.2            81.8
----------------------------------------------------------------------------------------------------------------
Source: IRS. Corporate Source Book, various issues.

      

                                

Statement of the Real Estate Roundtable

    The Real Estate Roundtable \1\ appreciates the opportunity 
to submit comments for the record of the February 9, 2000 
hearing of the House Committee on Ways and Means regarding the 
revenue provisions of the Administration's fiscal year 2001 
budget proposal.
---------------------------------------------------------------------------
    \1\ The Real Estate Roundtable is a Washington based policy 
organization comprised of America's leading public and private real 
estate owners, investors, lenders and managers as well as the leaders 
of major national real estate trade associations actively involved in 
shaping federal policies affecting income producing real estate. The 
Real Estate Roundtable is engaged in a range of important policy issues 
in the areas of tax, capital and credit, telecommunications and 
technology and the environment.

---------------------------------------------------------------------------
Background

    The Administration's budget contains proposals that could 
significantly affect the real estate industry, both positively 
and negatively, and we look forward to working with the 
Committee as it deliberates on these proposals. We welcome 
those proposals in the Administration's budget intended to be 
favorable to real estate, however, we oppose a number of 
proposals that are detrimental. Furthermore, we favor a 
comprehensive and related approach to real estate tax policy. 
In this testimony we will comment briefly on some of the real 
estate tax policies we believe the Committee should consider. 
If these tax policies were enacted, current tax impediments 
that otherwise discourage sound economic real estate decisions 
would be removed from the Internal Revenue Code and bring about 
fairer tax treatment and a more productive flow of real estate 
capital and credit.

Overall State of the Commercial Real Estate Industry

    Real estate represents about 12 percent of America's gross 
domestic product and accounts for nearly 9 million jobs. About 
$293 billion in tax revenues is generated annually by real 
estate and almost 70 percent of all tax revenues raised by 
local governments come from real property taxes. 
Unquestionably, real estate is a direct, vital and major 
contributor to the nation's economy.
    Today's real estate markets, as a whole, are in overall 
good health. Interest rates, although rising are relatively 
low, inflation is in check, availability of capital and credit 
is good; and demand for work and shopping space, in most 
regions, is relatively strong. Nevertheless, the financial 
markets on which real estate depends are quite sensitive and 
volatile. The financial crisis that erupted during the summer 
of 1998 in Japan and Russia demonstrated how quickly things can 
change in the credit markets. This crisis seriously impacted 
the real estate industry despite the underlying fundamentals of 
real estate investment being strong.
    Real estate is similarly sensitive to changes in tax 
treatment. The turmoil in the industry created by the whipsaw 
effect of the tax changes of the Economic Recovery Tax Act of 
1981 and the Tax Reform Act of 1986 is evidence of this. Real 
estate tax policy changes should be implemented through a 
carefully thought through and deliberative course of action 
that brings about a rational relationship between the economics 
of a transaction and its taxation.

The Real Estate Roundtable Tax Agenda

    The Real Estate Roundtable recommends the Committee adopt, 
(in addition to those provisions in the President's budget we 
support) the following tax proposals:
     10 year depreciation recovery period for leasehold 
improvements. Today's depreciation rules do not differentiate 
between the economic useful life of building improvements, 
(i.e. internal walls, ceilings, partitions, plumbing, lighting, 
floor coverings, electrical and communication outlets and 
computer data ports), and the life of the overall building 
structure. The result is that current tax law dictates a 
depreciable life for leasehold improvement of 39 years--the 
depreciable life of the entire building--even though most 
commercial lease terms average between 7-10 years.
    As a result, the after-tax cost of reconfiguring or 
building out space to accommodate new tenants, modernize the 
space or upgrade technology is artificially high and out of 
step with the economics of the transaction. The tax implication 
of this could negatively impact decisions relating to leasehold 
improvements--particularly when extensive improvements are 
involved. Providing a depreciation life for leasehold 
improvements that more closely matches the lease terms, 
(typically about ten years), would more closely align the tax 
treatment for these assets and better reflect economic reality.
    Current law provides a tax obstacle to reinvesting in 
existing properties. Without proper reinvestment, tenants will 
leave older buildings for more modern buildings that offer 
desired amenities and efficiencies. This would enhance new 
development demand and contribute to a deterioration of 
existing property. H.R. 844 (Shaw) provides a 10-year 
depreciation period for leasehold improvements and currently 
has 122 bipartisan cosponsors. Its companion bill S. 879 
(Conrad, Nickles) has 15 bipartisan cosponsors.

     Expensing or Rapid Amortization of Environmental 
Cleanup Costs. Costs to cleanup land purchased in a 
contaminated state must be capitalized and added to the basis 
of the non-depreciable land. These contaminated sites are known 
as ``brownfields'' and are less toxic than Superfund sites but 
still must be remediated prior to redevelopment. The U.S. 
Conference of Mayors estimates that there are approximately 
400,000 brownfield properties across the country.
    The 1997 Taxpayer Relief Act provided immediate expensing 
of brownfield cleanup costs in empowerment zones and other high 
poverty targeted areas (Section 198). The President's budget 
proposes to make this provision permanent. Section 198 should 
be extended to brownfields located in non-targeted areas as 
well and the definition of ``hazardous substance'' expanded to 
include common contaminants such as petroleum and pesticides. 
Also, if not immediate deductibility, then a rapid amortization 
period such as 60 months would be appropriate. The expansion of 
Section 198 beyond targeted areas, (H.R. 2264-Johnson, R-CT), 
was included in the Taxpayer Refund and Relief Act of 1999 and 
should be included in the community renewal legislation the 
Committee intends to mark up this year.

     At-Risk Rules: The definition of qualified 
nonrecourse financing in the at-risk rules needs to be modified 
to allow for the inclusion of publicly traded real estate debt 
(general obligation bonds issued by public real estate 
companies). Qualified nonrecourse financing is nonrecourse 
financing provided by a person in the business of lending (i.e. 
banks, insurance companies, pension funds) that is secured by 
the real property. This exception was adequate for the type of 
real estate lending that existed in 1986 -property specific 
financing from traditional lending institutions. Since 1986, 
however, real estate financing has undergone significant 
changes. The most significant being the use of publicly traded 
debt to finance real estate.
    Currently, publicly traded debt does not meet the technical 
requirements of the qualified nonrecourse financing because the 
lender--in this case the public--is not in the business of 
lending. Furthermore, the debt is a general obligation of the 
company and is not secured by a specific property interest as 
is a typical mortgage loan. The failure of the at-risk rules to 
be updated as real estate financing has evolved is creating 
unfair potential tax liabilities for many real estate owners 
and serious compliance headaches. The Real Estate Roundtable 
worked closely with the Joint Committee On Taxation to develop 
an modification was included in the Taxpayer Refund and Relief 
Act.

     Amortization of Demolition Costs. Current law 
(Code Section 280B) requires that demolition expense and the 
unrecovered basis of the demolished structure must be 
capitalized and added to the basis of the land rather than 
deducted. This tends to discourage redevelopment of land that 
includes a structure which must be demolished, because the 
costs of demolition are not recovered until the underlying land 
is sold. A more appropriate tax result would permit these 
expenses to be added to the tax basis of the replacement 
structure and depreciated.

     Update the Placed in Service Date for Properties 
Eligible for the Rehabilitation Tax Credit. The 1986 Tax Reform 
Act provided that the only properties eligible for the 
rehabilitation tax credit are those placed in service before 
1936. Prior to 1986, a 10% tax credit was allowed for 
rehabilitation of properties placed in service at least 20 
years prior to the rehabilitation activity. Qualifying a 
building for the rehabilitation credit based on its age, rather 
than a fixed placed in service date, is a preferable approach 
because it continually adds buildings to the credit eligibility 
pool as they reached the required age. The pre-1936 placed in 
service requirement excludes all buildings placed in service 
from 1936 on--regardless of age. Allowing buildings of a 
minimum age to be eligible for the credit would update the pool 
of eligible buildings and help achieve the social, economic and 
aesthetic goals brought about by rehabilitating and preserving 
older structures.
    We believe the above-proposed policies, (with the exception 
of the at-risk rules), comprise a related package of tax 
changes aimed at promoting smart growth through redevelopment. 
In communities across the nation, rapid land development -often 
called ``sprawl'' -is having unwanted side effects such as 
traffic congestion, higher taxes, loss of open spaces and parks 
and overcrowded schools. Although the problems and solutions 
are primarily at the state and local level, the Federal 
government can help provide solutions, particularly through tax 
policy.
    Current federal tax law discourages redevelopment of 
existing property through its uneconomic tax treatment of 
leasehold improvement depreciation, demolition costs and 
brownfield cleanup expenses. Enacting the changes proposed 
above would mitigate these tax impediments and level the tax 
implications associated with new versus re development 
decisions, thus making redevelopment more viable. Renewing the 
viability of the rehabilitation tax credit by allowing more 
buildings to be eligible also would promote redevelopment and, 
in turn, ease pressure to develop new space. We look forward to 
working with the Committee to shape and implement these real 
estate tax policies.

  REAL ESTATE RELATED REVENUE INCREASES IN PRESIDENT'S BUDGET PROPOSAL

     Modify the treatment of closely held REITs. The 
Administration proposal would impose an additional requirement 
for REIT qualification that no person can own stock of a REIT 
possessing 50 percent or more of the total combined voting 
power of all classes of voting stock or 50 percent or more of 
the total value of all shares of all classes of stock. The 
stated reason supporting this proposal is that ``[a] number of 
tax avoidance transactions involve the use of closely held 
REITs.''
    Recommendation: We believe the Administration's proposed 
prohibition on almost all closely held REITs is overly broad 
and unnecessary. We are concerned with the impact the 
Administration's closely held proposal could have on capital 
flows to real estate and the potential resulting negative 
effect on asset values and jobs. The capitalization of real 
estate through REITs that has occurred in the 1990s has been an 
important factor in the recovery of the real estate industry 
which itself is making a significant contribution to the 
strength of the overall economy.
    We are pleased that the Administration has revised this 
proposal over the last three years to provide look through 
rules for certain entities owning interests in REITs in 
determining whether the REIT is closely held. These rules 
include a look through for a REIT or a domestic pension fund 
owning another REIT. A limited look through rule for 
partnerships is included in this year's budget. We believe, 
however, that these exceptions need to be broadened as follows:
    Pass-through entities. Allow an unlimited look-through of 
all pass through entities -domestic and foreign. The lack of 
such a look-through would undercut the recently negotiated 
treaty with the Netherlands that is designed to improve foreign 
investment in REITs. The treaty allows up to 80 percent 
ownership of a U.S. REIT by a Dutch pension fund without 
dividend withholding. In the absence of the treaty, foreign 
pension funds and investors are also subject to 30 percent 
withholding tax. The Netherlands treaty has facilitated a 
significant amount of capital to flow to U.S. real estate. 
Similarly, the treaty allows U.S. pension funds to own up to 80 
percent of a Dutch venture without dividend withholding. This 
is a significant benefit to outbound international investment. 
The failure to allow the closely held private REIT structure 
for foreign investors would dampen foreign investment interest 
cause a significant amount of capital that is presently flowing 
into U.S. real estate to dry up.
    Incubator REITs. Any closely held proposal must provide for 
the use of ``incubator REITs.'' Incubator REITs sometimes have 
a majority shareholder corporation for a transition period in 
order to prepare the REIT for going public by allowing it to 
develop a track record. Corporate majority shareholders of 
private REITs are also used for legitimate state and local 
income and real property tax planning purposes and as a vehicle 
for legitimate foreign investment in real estate.
    Joint Ventures with Publicly traded REITs. Public REITs 
benefit from being able to joint venture with third parties 
that often take the form of closely held private REITs. In 
present market conditions, depressed stock prices can hamper 
the ability of some public REITs to go back to the stock market 
to raise equity capital. Many of these same REITs want to limit 
borrowings under their lines of credit to maintain, or improve, 
their investment grade ratings. They, therefore, are relying on 
privately structured joint ventures with closely held REITs to 
raise equity in order to complete new transactions and to grow.
    In many cases, a third party investor owns a majority share 
of the closely held REIT. Although the Administration's 
proposal would allow a REIT to own another REIT, such ownership 
effectively would be limited to REITs that meet the ownership 
requirements of the proposal. This would have a material 
adverse impact on the ability of public REITs to tap into the 
much needed alternative source of capital provided by joint 
ventures with closely held private REITs.

     Eliminate non-business valuation discounts (for 
family limited partnerships). The budget proposal asserts that 
family limited partnerships are being used to take ``illusory'' 
valuation discounts on marketable assets. The proposal contends 
that taxpayers are making contributions of these assets to 
limited partnerships, gifting minority interests in the 
partnerships to family members, and then claiming valuation 
discounts based on the interest being a minority interest of a 
non-publicly traded business. The proposal would eliminate such 
valuation discounts except as they apply to ``active'' 
businesses.

    Recommendation: The Real Estate Roundtable opposes this 
proposal in concept because it increases the estate tax burden 
and specifically because it defines non-business assets as 
including ``real property.'' The reference to real property, 
which lacks any elaboration, could be interpreted broadly to 
include much of the nation's directly or indirectly family-
owned real estate. In all events, further clarification by the 
Administration is needed to determine the definition of ``real 
property'' and whether it is considered part of an active 
business.
    Nevertheless, The Real Estate Roundtable does not believe 
that real property or interests in real property should be 
included in a proposal targeted at truly passive investments, 
such as publicly traded stocks and bonds. We applaud the 
Committee for its continuing effort to reduce the estate and 
gift tax burden. This proposal would take a number of steps 
backward and increase the estate tax burden. As a result, 
successors in family-owned real estate businesses could be 
faced with the troubling scenario of having to sell real 
property in the estate (often at distressed value prices) in 
order to pay death taxes.

     Disallow interest on debt allocable to tax-exempt 
investments. The President's proposal would expand the 
definition of ``financial institution'' in Section 265(b) of 
the Code to include ``any person engaged in the active conduct 
of banking, financing, or similar business, such as securities 
dealers and other financial intermediaries.'' As a result, a 
``financial institution'' that invests in tax-exempt 
obligations would not be allowed to deduct a portion of its 
interest expense in proportion to its tax-exempt investments. 
Under current law, (Revenue Procedure 72-18) taxpayers, other 
than financial institutions, are not subject to such 
limitations provided the average amount of the tax exempt 
obligations does not exceed 2 percent of the average total 
assets of the taxpayer.

    Recommendation: The Real Estate Roundtable opposed a 
similar proposal last year and opposes this proposal because it 
would reduce corporate demand for tax-exempt securities, such 
as industrial development and housing bonds. Reducing corporate 
demand for these important investment vehicles would increase 
the borrowing costs of municipalities throughout the country--
thus, hindering urban reinvestment activity--and it would 
discourage corporate investment in state and local housing 
bonds issued to finance housing for low and middle income 
families.

     Limit Inappropriate Tax Benefits For Lessors of 
Tax Exempt Use Property. Under current law, certain property 
leased to governments, tax-exempt organizations, or foreign 
persons is considered to be ``tax-exempt use property.'' There 
are a number of restrictions on the ability of lessors of tax-
exempt use property to claim tax benefits from transactions 
related to the property. For example, such property must be 
depreciated using the straight-line method over a period equal 
to the greater of the property's class life (40 years for non-
residential real property) or 125 percent of the lease term. 
The Administration contends that certain leasing transactions 
involving tax-exempt use property are being structured using a 
short-term lease and optional service contracts to avoid the 
special depreciation rules for tax-exempt use property. 
Therefore, the budget proposes to require lessors of tax-exempt 
property to include the term of optional service contracts and 
other similar arrangements in the lease term for purposes of 
determining the recovery period.

    Recommendation: We stand ready to work with the Committee 
and the Administration on this proposal to determine the extent 
and nature of any potential tax abuse in lease arrangements for 
tax-exempt use property. Until that time, we must oppose the 
proposal due to a concern that it may be overly broad. Should 
the transactions prove to be without economic justification and 
solely tax motivated, we would be pleased to work with the 
Committee and the Administration on an appropriate and targeted 
remedy.

     RIC excise tax application to undistributed REIT 
profits. The Administration is proposing that REIT distribution 
rules conform to the Regulated Investment Company (RIC) 
distribution rules. Therefore, it is proposing that a REIT 
distribute 98 percent of its ordinary income and capital gain 
net income for a calendar year in that year in order to avoid 
the four percent excise tax that applies to insufficient RIC 
distributions. Currently REITs are only required to distribute 
85 percent of the REITs ordinary income for the calendar year 
and 95 percent of its capital gain income.

    Recommendation. The current differentiation between the RIC 
and REIT distribution rules exists for a reason. RICs are 
mutual funds that own stocks and bonds. This allows them to 
determine relatively easily by the end of a calendar year the 
amount of ordinary and capital gain income for that year. As a 
consequence, RICs are able to distribute in such year a very 
high percentage (98%) of its income. REITs derive their income 
primarily from rents -in the retail sector the rents are based 
on a percentage of sales. Year-end holiday shopping accounts 
for a significant amount of these sales. As a result, it is 
more difficult for REITs to determine their income for a 
calendar year and distribute it in such year. Current law 
requires a lower distribution level for that reason. This is 
logical and relates to the economics of leases. Therefore, we 
oppose the Administration's conforming proposal since it does 
not take into the account that the assets of RICs and REITs are 
different and this difference affects their respective ability 
to determine and distribute income in a calendar year.

     Start-up Cost Amortization. Currently, start-up 
and organizational expenditures for a new trade or business can 
be amortized over 60 months. Acquired intangible assets, such 
as goodwill and trademarks, may be amortized over 15 years. The 
Administration proposes to allow a taxpayer to elect to deduct 
up to $5,000 of start-up expenditures and up to $5,000 of 
organizational expenditures. However, these amounts would be 
reduced by the amount cumulative costs exceed $50,000. Any 
amount of expenditures that is not deductible must be amortized 
over 15 years.

    Recommendation. Real Estate Roundtable opposes this 
proposal. Start-up and organizational costs are a significant 
cost for real estate--particularly because many real estate 
assets are now held in single purpose entities. Single purpose 
limited liability companies (LLCs) are widely used because they 
allow for the pass-through tax advantages of a partnership and 
the limited liability of a corporation. In fact, lenders often 
require their use. Real estate companies can hold dozens, even 
hundreds, of properties in separate LLCs. This results in 
significant amounts of start -up expenses. For many real estate 
companies, the Administration's proposal would result in most 
start-up expenses being amortized over 15 years as opposed to 
the current 60 months. We do not believe such a tax increase is 
warranted or justified and we strongly oppose the proposal.

       REAL ESTATE RELATED TAX INCENTIVES IN THE BUDGET PROPOSAL

     Energy-efficient building equipment tax credit. 
The Administration's budget proposes a 20 percent tax credit 
for the purchase of certain highly-efficient building 
equipment, including fuel cells, electric heat pump water 
heaters, advanced natural gas and residential size electric 
heat pumps, and advanced central air conditioners. Specific 
technology criteria would have to be met to be eligible for the 
credit. The credit would apply to purchases made after December 
31, 2000 and before January 1, 2005.

    Recommendation: The Real Estate Roundtable believes the 
immediate objective of this proposal--encouraging energy 
efficiency in buildings--is appropriate. In preparing for the 
21st century, the real estate industry, like other major 
industries, is looking for ways to improve its overall 
performance from an economic and environmental perspective. The 
Real Estate Roundtable has taken notice of statistics from the 
Department of Energy identifying office buildings as consuming 
about 27% of the nation's electrical supply. If this is an 
accurate assessment, we are surprised that, of the six specific 
tax credit proposals for energy efficient building equipment, 
only one (fuel cells) has any practical application to 
commercial office buildings. More specifically on the matter of 
the fuel cell credit, while the amount of the incentive is not 
insignificant, it is not yet sufficient to encourage the use of 
this technology except in limited circumstances.
    Furthermore, because of the December 31, 2000 effective 
date, the credit provides no incentive to taxpayers considering 
making energy efficient building equipment decisions this year. 
Optimally, the credit should be available for purchases made in 
2000. Postponing the credit until 2001 could affect negatively 
decisions to purchase certain energy efficient building 
equipment this year resulting in a missed opportunity for the 
new building stock coming on line.

     Expensing of brownfield remediation costs. The 
Administration proposes to make permanent the deduction for 
brownfield remediation costs. This sunset date for this 
provision was extended to December 31, 2001 as part of last 
year's tax bill.

    Recommendation: The Real Estate Roundtable has supported 
making section 198 permanent since its enactment in 1997 and is 
pleased the Administration is seeking to take this important 
step. However, further broadening of the provision's scope is 
warranted and necessary.
    The deductibility of clean-up expenses applies only to 
brownfields in specifically targeted areas, such as empowerment 
zones. We understand the need to revitalize these acutely 
distressed communities. However, there are almost 400,000 
brownfields across the nation, most of which are outside of 
these targeted areas. Many brownfields are located in prime 
business locations near critical infrastructure, including 
transportation, and close to a productive workforce. These 
sites need to be put back into productive use, contributing to 
the economy and producing good paying jobs where they are need 
most. Allowing the expensing or amortization of clean-up costs 
for all of these brownfields would help restore brownfields 
across America to viable and productive use.

     Fifteen year depreciable life for distributed 
power property. The budget proposes to assign a 15 year 
depreciation recovery period and a 22-year class life for 
distributed power property. Distributed power property is 
property used to generate electricity and/or heat and can be 
more energy efficient and generate fewer greenhouse gases than 
convention generation methods. Typically, it is used in an 
industrial manufacturing setting and is depreciated using the 
150 percent declining balance method over 15 years. 
Technological advancements have made it possible to place 
electrical generation assets in or adjacent to commercial and 
residential rental properties as well as industrial sites. 
Distributed power property used in commercial or rental 
residential buildings, however, is likely to be classified as a 
building component and currently depreciated over 39 years.

    Recommendation: The Real Estate Roundtable supports this 
proposal because it would simplify current law by clarifying 
and rationalizing the assignment of recovery periods to 
distributed power property. It would reduce taxpayer 
uncertainty and controversy and promote the use of more 
efficient technologies. Further, this provision is consistent 
with our position that certain building components should be 
treated separately from the structure for depreciation 
purposes.
     Increase limit on charitable donations of 
appreciated property. This proposal would repeal the special 
lower contribution limits for gifts to charity of capital gain 
property. As a result, both cash and non-cash contributions 
would be subject to the general 50 percent deductibility limit 
for gifts to public charities and the 30 percent deductibility 
limit for gifts to private foundations. It would be effective 
for contributions made after December 31, 2000.

    Recommendation. The Real Estate Roundtable supports this 
provision as philanthropists often contribute appreciated real 
property to charities. The special lower contribution limits 
that apply to contributions of capital gain property create 
added complexity and could discourage gifts of valuable real 
property to charitable organizations. Contributions of 
conservation easements and open spaces are often gifted to 
charitable organizations with the intent of promoting more 
livable communities. This provision would facilitate such 
contributions.

     Low-income housing tax credit expansion. The 
budget proposes a major expansion of the low-income housing tax 
credit, which could facilitate the construction of 150,000-
180,000 new affordable housing units over five years. Under the 
Administration's proposal, the annual state low-income housing 
credit limitation would be raised from $1.25 per capita to 
$1.75 per capita for calendar year 2001and indexed for 
inflation for each year thereafter.

    Recommendation: The Real Estate Roundtable supports this 
proposal. We also support related legislation, H.R. 175 
introduced by Representative Nancy Johnson (CT) and cosponsored 
by several other Members of the Committee on a bipartisan 
basis. We are encouraged by the consensus developing between 
the Administration and Members of Congress on the need for 
increasing the amount of low income housing tax credits 
allocated to the states.

     Tax credits for holders of Better America Bonds. 
The Administration is proposing a tax credit for holders of 
certain bonds issued by state and local governments for the 
purpose of protecting open spaces; creating forest preserves 
near urban areas; rehabilitating brownfields; improving parks 
and reestablishing wetlands.

    Recommendation: Although we have no specific comment on how 
the Better America Bonds would, or should, function from a tax 
perspective, we believe the Committee should consider tax 
policies that would improve the livability of our communities 
by encouraging redevelopment, protection of open spaces and 
clean up of contaminated sites. The Real Estate Roundtable tax 
agenda described in this testimony is intended to achieve a 
similar goal and we welcome the opportunity to work with the 
Committee on these proposals.

    Conclusion

    Again, we thank Chairman Archer and the Committee for the 
opportunity to comment regarding the revenue proposals in the 
President's fiscal 2001 budget. We are encouraged by the 
proposals to make permanent the deductibility of brownfield 
clean-up costs and implement credits for energy-efficient 
improvements for buildings. We are also pleased that the 
Administration is again seeking an increase in the low-income 
housing tax credit and simplifying the charitable contribution 
limits for appreciated property.
    We are concerned, however, about the proposals for closely 
held REITs ownership and the application of the RIC excise tax 
to undistributed profits by REITs. We also object to the 
proposals to amortize start-up costs over 15 years, eliminate 
valuation discounts for non-business, family limited 
partnerships and disallow interest on debt allocable to tax 
exempt investments.
    Finally, we encourage you to adopt the tax agenda we 
outlined in the beginning of our comments. A 10 year 
depreciation life for leasehold improvements is our top 
priority and is strongly justified by the economics of typical 
leases. Allowing the expensing of brownfield clean up costs for 
any brownfield site would remove a significant tax impediment 
to community revitalization. Modification of the ``at-risk'' 
rules to incorporate publicly traded real estate debt within 
the definition of qualified nonrecourse financing is an 
important updating of these rules that would free real estate 
owners from an unintended and unfair tax liability.
      

                                

                              Vanguard Charitable Endowment
                                Southeastern, PA 19398-9917
                                                  February 22, 2000
A.L. Singleton, Chief of Staff
Committee on Ways and Means
1102 Longworth Building
Washington, D.C. 20515

    Dear Mr. Singleton:

    The purpose of this letter is to comment on a provision contained 
in the Administration's Fiscal Year 2001 Revenue Proposals, to 
``clarify public charity status of donor advised funds.'' In this 
regard, we note that one commentator has characterized the recent surge 
in the creation of donor-advised funds as a form of ``democratization 
of endowment giving,'' with ``exciting prospects for the future of 
philanthropy.'' \1\
---------------------------------------------------------------------------
    \1\ Steuerle, ``Charitable Endowments, Advised Funds & the Mutual 
Fund Industry,'' The Exempt Organization Tax Review, Vol. 23, No. 2 
(February 1999) at 299.
---------------------------------------------------------------------------
    By way of background, the Vanguard Charitable Endowment Program 
(the ``Endowment Program'') was founded by The Vanguard Group, Inc. It 
is an independent public charity that was recognized by the Internal 
Revenue Service as exempt from federal income tax under Section 
501(c)(3), and as a public charity under Sections 509(a)(1) and 
170(b)(1)(A)(vi), on December 8, 1997.
    We are writing to observe that the Administration's proposal 
concerning donor-advised funds is generally consistent with the 
Endowment Program's current operations, and in our view would codify 
some ``best practices'' for charitable organizations maintaining donor-
advised funds. For example, the Endowment Program has adopted a policy 
of making minimum annual distributions of at least 5% of the aggregate 
average net asset value on a five year rolling basis. We believe this 
requirement, which is included in the Administration's proposal, 
provides an important assurance that there will be an immediate 
charitable benefit for the beneficiaries of donor-advised fund 
organizations. Similarly, the Endowment Program maintains a prohibition 
against the use of funds in donor-advised accounts for the personal 
benefit of the donors and/or advisors of those accounts. This is an 
important safeguard to ensure that funds are used for the proper and 
intended charitable purposes, and the Administration's proposal would 
further this objective by imposing a penalty on donors and/or advisors 
who violate this prohibition.
    Our only question about the Administration's proposal relates to 
its reliance on the ``no material restriction'' test under Section 507. 
We believe that test is complicated and subjective, and that it could 
be replaced by a simple and explicit requirement that donors and/or 
their advisors have only the right to recommend grants and no legal 
right to direct the use of funds in the donor-advised accounts.
    The Endowment Program is proud to be at the forefront of the 
movement to expand the accessibility of philanthropy, and we believe 
that legislation along the lines described in the Administration's 
proposals will help to ensure that the intended philanthropic 
objectives are achieved.
            Sincerely,
                                         Benjamin R. Pierce
                                                 Executive Director

cc: Timothy L. Hanford
 Susan D. Brown
      

                                

Statement of LaBrenda Garrett-Nelson, Gary Gasper, Nicholas Giordano, 
and Mark Weinberger, Wahsington Counsel, P.C.

    Washington Counsel, P.C. is a law firm based in the 
District of Columbia that represents a variety of clients on 
tax legislative and policy matters.

THE ADMINISTRATION'S BUDGET PROPOSAL TO TAX SHAREHOLDERS ON THE RECEIPT 
OF TRACKING STOCK SHOULD BE REJECTED

                              Introduction

    Although 28 of the 39 members of the Committee on Ways and 
Means opposed the Administration's proposal to tax the issuance 
of tracking stock in the President's Budget for FY2000, and the 
Congress did not enact that proposal, Treasury has proposed yet 
another attack on tracking stock in the form of a proposal to 
tax shareholders on the receipt of ``tracking stock.'' In 
effect, this proposal would increase the cost of capital to 
corporations by inhibiting the use of ``tracking stock'' as a 
financing option. Apart from proposing a new tax and granting 
broad regulatory authority to Treasury, the Administration's 
proposal represents an arbitrary departure from established tax 
principles and fails to offer any tax policy reason for the 
change. Moreover, it is not at all clear that the issuance of 
tracking stock is an appropriate time to impose a tax, because 
there is no bail out of corporate earnings. For these and other 
reasons set forth below, the ``tracking stock'' proposal should 
be rejected.

      Summary Of The Administration's ``Tracking Stock'' Proposal

    The Administration's proposal would impose a new tax on a 
shareholder's receipt of tracking stock as a distribution or in 
a recapitalization or similar exchange of stock or securities 
for tracking stock. Under the proposal, tracking stock would be 
treated as ``property'' other than stock in the issuing 
corporation. As a result, a shareholder who receives a 
distribution of tracking stock would be subject to tax on the 
entire value of the tracking stock received. Similarly, a 
shareholder who exchanges stock in the issuing corporation for 
tracking stock would be treated as having engaged in a taxable 
disposition of the stock surrendered in the exchange (and 
subject to tax on any gain, determined by reference to the 
excess of the fair market value of the tracking stock over the 
tax basis of the stock surrendered). ``Tracking stock'' would 
be defined generally as ``stock that relates to, and tracks the 
economic performance of, less than all of the assets of the 
issuing corporation (including the stock of a subsidiary).'' 
Two characteristics are identified as factors to be taken into 
account in applying this definition: (1) whether dividends are 
``directly or indirectly determined by reference to the value 
or performance of the tracked entity or assets,'' and (2) 
whether liquidation rights are ``directly or indirectly 
determined by reference to the value of the tracked entity or 
assets.'' Treasury would be authorized to prescribe regulations 
treating ``tracking stock as nonstock (e.g., debt, a notional 
principal contract, etc.) or as stock of another entity as 
appropriate to prevent tax avoidance. The provision would be 
effective for ``tracking stock'' issued on or after the date of 
enactment.

I. The Administration's Proposal Would Inhibit The Use Of A 
Valuable Corporate Financing Tool

    Over the last 16 years, corporations have utilized 
``tracking stock'' as a vehicle for raising capital and to meet 
a variety of non-tax, business needs. By limiting the financing 
options of U.S. corporations, the Administration's ``tracking 
stock'' proposal would impinge on the ability of corporations 
to raise low-cost capital in an efficient manner, and thereby 
have an adverse impact on economic growth, job creation, and 
the international competitiveness of U.S. businesses. The 
``tracking stock'' proposal would also inhibit the ability of 
businesses to use ``tracking stock'' in several other 
beneficial situations, such as issuing the stock to better 
align management and shareholders interests.

 A. Corporations Have Issued Tracking Stock For a Variety of Business 
                                Reasons

    ``Tracking stock'' is issued by corporations that have 
multiple lines of business that the marketplace would value at 
different prices if each line of business were held by a 
separate corporation. By issuing ``tracking stock,'' a 
corporation can raise capital in a manner that improves the 
attractiveness of the issuer's stock to the public. The 
valuation of the entire enterprise increases, because 
``tracking stock'' provides a mechanism for ``tracking'' the 
performance of individual businesses. There is, however, no 
actual separation of a tracked subsidiary or other asset. The 
corporate issuer continues to benefit from operating 
efficiencies that would be lost if different lines of business 
became independent. These efficiencies include economies of 
scale, sharing of administrative costs, and reduced borrowing 
rates based on the issuing corporation's overall credit rating. 
Thus, it is clear that corporations issue ``tracking stock'' 
for the business purpose of obtaining the highest values for 
the separate tracked businesses, while maintaining legal 
ownership and other operating synergies.

B. The Essential Elements of ``Tracking Stock'' Are Consistent With the 
    Form of the Transaction as A Class of Common Stock of The Issuer

    Typically, ``tracking stock'' is issued as a class of common stock, 
the return on which is determined by reference to less than all of the 
issuer's assets. The ``tracked'' asset can take a variety of forms 
(e.g., a line of business, a separate subsidiary, or a specified 
percentage of a separable business). There is no legal separation of 
corporate assets, and thus an investor's return remains subject to the 
economic risks of the issuer's entire operation: (1) the holder of 
tracking stock retains voting rights in the issuer (not, for example, a 
``tracked'' subsidiary); (2) dividend rights, although based on the 
earnings of a tracked subsidiary or other asset, are subject to whether 
the parent/issuer's board of directors declares a dividend, as well as 
state law limitations on the parent/issuer's ability to pay (without 
regard to a ``tracked'' subsidiary's ability to pay); and (3) 
liquidation rights might be determined by reference to the value of 
tracked assets, but investors in tracking stock have no special right 
to those assets; rather they are entitled to share in all of the 
issuer's assets on a pro rata basis.

II. The Administration's Tracking Stock Proposal Presents Serious Tax 
Policy Concerns, in Addition to Technical Issues

 A. Unjustified and Radical Departure From the Normal Treatment of the 
                        Receipt of Common Stock

    Sections 305 \1\ provides tax-free treatment to a 
shareholder who receives a proportional distribution of common 
stock on common stock. This treatment is based on the fact that 
a common shareholder already owns all the corporate assets that 
are not devoted to preferred shareholders, and they do not 
receive anything more by a common stock dividend that re-
divides the same ``pie.'' Similarly, tax-free treatment is 
provided to a shareholder who surrenders common stock for 
common stock by either Section 1036 or Section 354 (where the 
exchange is a reorganization in the form of a 
recapitalization). In the case of an exchange, tax-free 
treatment is justified on the ground that the transaction 
represents a mere reshuffling of an existing corporation's 
capital structure. The Administration's proposal represents a 
radical departure from these established tax principles, and 
inappropriately relies on the typical features of tracking 
stock to justify the result.
---------------------------------------------------------------------------
    \1\ Except as provided, references to ``Sections'' are to the 
Internal Revenue Code of 1986, as amended (referred to herein as the 
``Code'').
---------------------------------------------------------------------------
    Consistent with the theory that underlies the tax-free 
treatment of stock dividends and recapitalizations, the 
issuance of tracking stock is not an appropriate time to impose 
a tax on a shareholder, to the extent that a taxpayer's 
investment remains in corporate solution, and the stock 
represents merely a new form of participation in a continuing 
enterprise.\2\
---------------------------------------------------------------------------
    \2\ See generally Bittker and Eustice, Federal Income Taxation of 
Corporations and Shareholders, par. 12.01[3] regarding the theory 
underlying tax-free treatment.
---------------------------------------------------------------------------
    Nevertheless, the Administration's proposal would trigger a 
tax on receipt of tracking stock, even in a case where a 
distribution of the tracked subsidiary would satisfy the strict 
requirements for tax-free distribution.

                          B. Technical Issues

    Circular Definition Of Tracking Stock. The proposed 
definition of ``tracking stock'' could include stock that has 
no tracking-stock features. For example, consider a corporation 
with one class of common stock outstanding, which then issues a 
new class of tracking stock, dividends on which are based on 
the operating results of one of the corporation's two 
subsidiaries. In such a case, by definition, the pre-existing 
common will constitute ``stock that relates to--less than all 
of the assets of the issuing corporation;'' similarly, 
dividends on the pre-existing common will (effectively) track 
the results of only one of the two subsidiaries. (Note that 
last year's Treasury proposal included a specific statement 
that the ``issuance of tracking stock will not result in 
another class of the stock becoming tracking stock if the a--
rights of such other class are determined by reference to the 
corporation's general asset. . .'')

    Failure To Provide Any Substantive Guidance. Apart from the 
imposition of a new tax, the Administration's proposal fails to 
provide any substantive guidance on the treatment of tracking 
stock under the Code. Rather than providing operating rules to 
deal with identified issues, the Administration proposes to 
grant new and exceedingly broad regulatory authority for 
Treasury to prescribe rules treating tracking stock as 
nonstock, etc. Note that the effect of the Budget proposal is 
to treat tracking stock as nonstock for purposes of the rules 
regarding stock dividends and recapitalizations. Thus, it is 
unclear what other circumstances Treasury might identify as 
candidates for an exercise of this regulatory authority. 
Presumably, regulatory guidance would be applied prospectively; 
however, it is not at all clear whether Treasury contemplates a 
grant of authority to recast a transaction on a retroactive 
basis.

III. The Administration Has Failed To Establish A Reason To 
Single Out Tracking Stock for Congressional Action

    The Administration has failed to set forth a basis for 
either legislative action or the delegation of additional 
regulatory authority to Treasury. Tracking stock is not a new 
concept in the tax law. Moreover, the enactment of the proposal 
would effectively put an end to the market for tracking stock, 
and thus little if any revenue would be raised.

    A. Over Fifty Years of Tax Law Contradicts the Administration's 
  Statement that ``Tracking Stock is. . .Outside the Contemplation of 
           Subchapter C and Other Sections of the. . .Code.''

    The stated rationale for the Administration's proposal includes the 
statement that the ``use of tracking stock is clearly outside the 
contemplation of subchapter C and others sections of the. . .Code.'' It 
is quite clear, however, that present law is adequate to the task, 
particularly in view of the existence of case law that pre-dates the 
Internal Revenue Code of 1954,\3\ as well as numerous grants of 
specific regulatory authority relating to tracking stock.\4\
---------------------------------------------------------------------------
    \3\ As early as 1947, the U.S. Tax Court had occasion to consider 
the federal income tax consequences of the issuance of tracking stock 
in the case of Union Trusteed Funds, Inc. v. Commissioner. Similarly, 
the Congress has taken account of the existence of tracking stock, as 
appropriate for purposes of particular tax provisions. For example, in 
1986 the Congress reversed the result in the Union Trusteed Funds case; 
as another example, in the original enactment of the Passive Foreign 
Investment Company (``PFIC'') regime, the Congress included regulatory 
authority to treat ``separate classes of stock. . .in a corporation. . 
.as interests in separate corporations.'' Interestingly, the Congress 
did not suggest that all tracking stock should be so treated, thus 
allowing for circumstances in which the form of an issuance of tracking 
stock should be respected.
    \4\ For example, in 1990, the Congress specifically addressed a 
tracking stock issue in the legislative history of Section 355(d), a 
provision added to deny tax-free treatment to a ``disguised sale'' of a 
subsidiary. Very generally, section 355(d) triggers a tax on the 
distributing corporation in a divisive reorganization where 50 percent 
or more of the corporation's stock was acquired by purchase during the 
preceding five years. In measuring the five-year window, section 
355(d)(6) reduces the holding period for stock for any period during 
which the holder's risk of loss is substantially diminished by any 
device or transaction. In this regard, the Conference Report on the 
1990 legislation specifically cites the use of ``so-called 'tracking 
stock' that grants particular rights to the holder or the issuer with 
respect to the earnings, assets, or other attributes of less than all 
the activities of a corporation or any of its subsidiaries.'' H.R. 
Conf. Rep. No. 5835 p. 87.
---------------------------------------------------------------------------

   B. It is Questionable Whether the Administration's Proposal Would 
                         Increase Tax Revenues

    It is arguable that the use of tracking stock increases tax 
revenues. This view is based on the availability of financing options 
such as the issuance of debt, an alternative that would generate 
interest deductions and thereby eliminate tax on corporate earnings. By 
comparison, the issuance of tracking stock does not reduce a 
corporation's tax liability because dividends are paid out of after-tax 
income. In any case, one likely consequence of the Administration's 
proposal is that few (if any) corporations will issue tracking stock.

IV. A Similar Proposal Was Rejected By The Congress Last Year

    The tracking stock proposal in this year's Budget is a reiteration 
of a proposal that was considered but not acted upon by Congress last 
session. Last year, the Administration's budget contained a ``tracking 
stock'' proposal that taxed the issuing corporation on the issuance of 
tracking stock, or a recapitalization of stock or securities into 
tracking stock. This year's proposal changes the point of taxation from 
a tax on the issuing corporation to a tax on a shareholder who receives 
tracking stock in a distribution or in exchange for other stock. While 
the point of taxation has changed the underlying tax policy concerns 
presented by the proposal (described above) remain the same.


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