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Joint Hearing on Tax Reform and the Tax Treatment of Capital Gains

September 20, 2012

Joint Hearing on Tax Reform and the Tax Treatment of Capital Gains 











September 20, 2012

SERIAL 112-29

Printed for the use of the Committee on Ways and Means


DAVE CAMP, Michigan, Chairman

WALLY HERGER, California
PAUL RYAN, Wisconsin
DEVIN NUNES, California
JIM GERLACH, Pennsylvania
TOM PRICE, Georgia
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York

RICHARD E. NEAL, Massachusetts
JOHN B. LARSON, Connecticut
RON KIND, Wisconsin

JENNIFER SAFAVIAN, Staff Director and General Counsel
JANICE MAYS, Minority Chief Counsel

MAX BAUCUS, Montana, Chairman

KENT CONRAD, North Dakota
JOHN F. KERRY, Massachusetts

JON KYL, Arizona
TOM COBURN, Oklahoma
JOHN THUNE, South Dakota
RICHARD BURR, North Carolina

Russell Sullivan, Staff Director
Chris Campbell, Republican Staff Director





Mr. David H. Brockway
Partner, Bingham McCutchen LLP

Dr. Lawrence B. Lindsey
President & CEO, The Lindsey Group

Dr. Leonard E. Burman
Daniel Patrick Moynihan Professor of Public Affairs at the Maxwell School, Syracuse University

Mr. David L. Verrill
Founder and Managing Director, Hub Angels Investment Group LLC

Mr. William D. Stanfill
General Partner, Montegra Capital Income Fund, Founding Partner, TrailHead Ventures, L.P.



Joint Hearing on Tax Reform and the Tax Treatment of Capital Gains 

Thursday, September 20, 2012
U.S. House of Representatives,
Committee on Ways and Means,
Washington, D.C.


The committee met, pursuant to call, at 10:10 a.m., in Room HVC‑210, Capitol Visitor Center, Hon. Dave Camp [chairman of the Committee on Ways and Means] presiding.

[The  advisory of the hearing follows:]


Present:  Representatives Camp, Herger, Johnson, Brady, Nunes, Tiberi, Reichert, Boustany, Roskam, Gerlach, Price, Buchanan, Smith, Jenkins, Paulsen, Marchant, Berg, Black, Reed, Levin, Rangel, Neal, Becerra, Larson, Blumenauer, and Pascrell.

Senators Baucus, Wyden, Carper, and Hatch.

Chairman Camp.  Good morning.  Thank you for joining us today for the third joint hearing of this Congress House Ways and Means Committee and the Senate Finance Committee.  Prior to this Congress, our two committees had not met together for tax related hearings in more than 70 years. 

Through this series of hearings, as well as the ones we have held on our own and with the Joint Committee on Taxation, we have had very productive discussions about steps that we need to take to transform today’s broken Tax Code from one that hinders to one that fosters greater investment and job creation.  And after more than 43 consecutive months of unemployment over 8 percent, it is no secret that we are in a jobs crisis and comprehensive tax reform is a part of achieving much needed economic growth. 

Today’s hearing focuses on capital gains in the context of comprehensive tax reform.  For nearly its entire history, our income tax system has taxed capital gains differently than other income.  Even in the years following the 1986 Tax Reform Act, when the capital gains and ordinary income tax rates were aligned, we still recognized that capital investments raised specific tax policy questions and therefore required various rules to distinguish between capital gains and ordinary income. 

Today the maximum capital gains tax rate is 15 percent as compared to the maximum individual ordinary income tax rate of 35 percent.  And while the focus of this hearing is a longer‑term view on capital gains as a part of comprehensive tax reform, we can’t forget that, absent congressional action to stop the impending tax hikes we face at the year’s end, the maximum capital gains rate will increase to 25 percent and the maximum individual ordinary income tax rate will increase to 40.8 percent when certain hidden marginal tax rate increases are factored in. 

The potential tax increases that we face next year would have a devastating effect on the economy.  According to the Joint Committee on Taxation, a failure to enact a 1‑year extension of the low tax policies first enacted in 2001 and 2003, including an AMT patch, would result in a $384 billion tax increase.  On the other hand, extending these policies on a permanent basis or, as Republicans have called for, enacting comprehensive tax reform consistent with historic revenue levels would prevent a tax increase of more than $4 trillion over the next decade. 

Clearly those increases serve as a stark reminder that without action, more and more revenue that could be used to invest and hire will be taken out of the economy.  And as we consider the economic impact of the tax burden associated with capital gains, it is critical that we focus on the total integrated rate, which is nearly 45 percent, not just the statutory rate of 15 percent. 

The capital gains tax is often though not always a double layer of taxation.  For example, in the case of shares of stock, a company’s income is first taxed at the corporate rate.  Then when shareholders of the company later decide to sell their stock, they are subject to capital gains tax on the sale.  But the value of the stock they sell already has been reduced by the fact that the corporation previously paid out a portion of its earnings as taxes. 

So, even if we make current low tax policies permanent, the top integrated rate on capital gains is actually 44.75 percent, a 35 percent first layer of tax and a 15 percent capital gains tax.  If we allow current low tax policies to expire, the top integrated rate on capital gains would exceed 50 percent.  Along these same lines, I believe it is important to mention that regardless of what rate we apply to capital gains, we should strive to retain parity between the rates for capital gains and dividends.  Just as we need to eliminate the lock‑out effect that our worldwide tax system imposes on foreign earnings, we should also not restore the lock‑in effect on domestic corporate earnings that makes it more tax efficient to retain earnings inside a corporation when it might be more productive to push the cash out to shareholders so they can reinvest it elsewhere in the economy. 

There are compelling reasons for providing a preferential tax treatment for capital gains, but we all know there are important tradeoffs to be considered with each piece in the complex process of comprehensive tax reform.  One of the main objectives for this hearing is to examine the tradeoffs inherent in different proposals for capital gains taxation.  I look forward to hearing from our panel of witnesses who are assembled here today, and I want to thank all of you for your time for coming today. 

And with that, I will yield to my colleague, the chairman of the Senate Finance Committee, for his opening statement.

Senator Baucus.  I thank you very much, Mr. Chairman. 

I appreciate this joint hearing.  I believe we should have more, frankly.  I believe that in this partisan time, we are so polarized that the facts count.  The more we have hearings, the more we can ask factual questions and the more witnesses give us factual responses, not political responses, then the closer we are going to be to reaching some kind of an agreement, hopefully, after the election, lame duck, and in the following years.  But more hearings like this, just asking questions slowly, perhaps painfully, will help us get to a good result after the election. 

Winston Churchill once said, the pessimist sees the difficulty in every opportunity, and the optimist sees the opportunity in every difficulty.  As you work on comprehensive tax reform, the treatment of capital gains is one of the most difficult issues we face.  Some are pessimistic and don’t believe we can agree.  I am optimistic; we need to come together and find a workable solution. 

Through that process, there are four considerations.  First, we need to consider the capital gains rate to compare to the rates on wage income, dividends and corporate income.  The tax rate and the capital gains is currently lower than the rate on wage income.  Some say this is to avoid double taxation.  But most of the time, that claim doesn’t prove true.  Only a third of capital gains come from sales of corporate stock; the rest have never previously been taxed before reaching individuals. 

Second, we need to consider how capital gains rates affect different income brackets.  Capital gains grow disproportionately to high‑income taxpayers.  Last year, capital gains represented half the income of the top one‑tenth of a percent of earners with 3 percent for the lowest 80 percent of taxpayers.  Low capital gains rates are the main reason why many wealthy individuals pay lower tax rates than middle class families. 

Third, we need to consider our low savings rate.  Americans need to save over their lifetimes.  This is an opportunity for our witnesses to talk about the relationship between tax rates and capital gains and national savings. 

Fourth, we must consider complexity.  Experts tell us that about half of the U.S. Tax Code, more than 20,000 pages, exists solely to deal with capital gains.  That complexity, as well as the wide gap between the tax rates on income and capital gains invites people to use all kinds of shenanigans to game the system.  Our entire Tax Code, including this treatment of capital gains, needs to be rebuilt for the 21st century.  We need a system focused on broad‑based economic growth and jobs. 

I am glad today to be joined by Chairman Camp and my colleagues from the House, but in order to get tax reform done, we need members of both parties and both chambers willing to tackle these issues with an open mind.  So let’s set aside our differences, political differences, and listen.  Let’s see this as an opportunity, let’s be optimistic that we can reform the code to spark growth, create jobs and strengthen our economy.

Chairman Camp.  Thank you very much, Chairman Baucus. 

Let me now yield to the ranking member of the Ways and Means Committee, Mr. Levin, for his opening statement.

Mr. Levin.  Thank you very much. 

And we welcome the witnesses and welcome the opportunity to have this joint hearing.  I remember back when I was in the state legislature, we held joint hearings, and they were semi‑revolutionary, and I think it is a useful approach.  I think we all realize that when it comes to tax reform that it is integrated that in a sense, almost every issue relates to every other issue.  But I will resist the temptation to use the integrated nature of taxes to talk about other issues, including the difficult issues that we are facing and that divide us as to, for example, the taxation on high incomes.  There is a new CRS report that very much questions the argument that the high income tax break promotes economic growth.  But let me concentrate instead on this issue of capital gains.  I think the issue as to how to tax capital gains will be one of the major and likely most controversial issues as we undertake tax reform.  The reduced rate on long‑term capital gains is one of the largest individual tax expenditures, as we know, adding up to hundreds of billions of dollars over a decade.  It is also, as Mr. Baucus has said, a source of considerable complexity. 

I noted that, in reviewing the testimony for this hearing, that by some estimates, fully half of the Tax Code is devoted to defining the difference between capital gains and ordinary income, and I am not sure it is half, but I remember our tax course back in law school trying to wrestle with these issues, and it took up maybe half of the time.  When there is a significant capital gains preference, there is a lot of pressure on these rules, because the greater the tax preference for capital gains the greater the incentive to try to recharacterize ordinary income as capital gains. 

That, for example, is the source of the battle over carried interest.  So it is useful for all of us to really understand the issues surrounding capital gains.  That includes its history.  We have mostly had a preferential rate, but as we know, the 1986 tax reform eliminated it.  And it includes the various arguments for why you might want a lower rate, whether that is double taxation of corporate income, inflation, the so‑called lock‑in effect and incentive to invest, among others. 

It is also important that we understand the evidence about the different rationales and how they hold up to reality.  As mentioned by the chairman of the Finance Committee, most capital gains are realized by the highest earners.  Some 71 percent of the benefit of the preferential rate on capital gains goes to those making more than $1 million a year, according to the Joint Committee on Taxation.  So there is a real consequence from the preferential rate as to the progressivity of our tax system. 

Both our committees will have to wrestle with these issues as tax reform moves forward.  So I look forward eagerly to this testimony and hope that it will help us inform that process.  Thank you.

Chairman Camp.  Thank you, Mr. Levin. 

I now yield to the ranking member of the Senate Finance Committee, Senator Hatch, for his opening statement. 

Senator Hatch.  Thank you so much, Chairman Baucus and Chairman Camp, for holding this joint hearing. 

From 1921 through 1987 and then again after 1990, capital gains have been taxed at a lower rate than ordinary income.  A number of justifications have been given as to why we have preferential treatment for capital gains.  For example, the lock‑in effect is usually given as a reason for having preferential treatment for capital gains.  Since capital gains are only taken into account when realized by a sale or exchange, investors can avoid paying the capital gains tax by simply holding on to their capital assets.  As a result, the capital gains tax has a lock‑in effect, which reduces the liquidity of assets and discourages taxpayers from switching from one investment to another.  Other important reasons given for preferential treatment for capital gains are that a low capital gains tax increases savings and investment, counteracts the two levels of taxation of corporate income and corrects the income tax law’s bias against savings. 

Next year, an additional tax on capital gains is scheduled to go into effect.  As part of the President’s health care law, a new 3.8 percent tax on the net investment income of single taxpayers earning more than $200,000 and married couples earning more than $250,000 goes into effect.  These amounts are not indexed for inflation, and with the scheduled expiration of the 2001, 2003 and 2010 tax relief at the end of this year, capital gains will be subject to a 23.8 percent tax beginning in 2013, a whopping 59 percent increase from current law.  According to the OECD, the United States has the most progressive tax system in the industrialized world.  Should we make it even more progressive by raising the tax rate on capital gains?  The top 10 percent of households already pay 70 percent of all Federal income taxes.  So when is enough progressivity achieved? 

Over 50 years ago, a leading tax scholar wrote that everything there now is to say on the problem of capital gains has already been said.  I disagree.  I think the issue of preferential treatment of capital gains is critically important today with new evidence being generated, as witnessed by the joint report of the staff of the Joint Committee on Taxation and the Congressional Budget Office issued in June. 

We have a very distinguished panel here with us today. 

I welcome each one of you, as do all of us, to this hearing.  And we all have a great desire to hear what these witnesses have to say. 

Thank you, Mr. Chairman.

Chairman Camp.  Well, thank you, Senator Hatch. 

And without objection, any other member who wishes to have an opening statement included in the formal hearing record may submit one in writing. 

We are fortunate to have a panel of witnesses here this morning with a wealth of experience in private practice, academia and government.  Let me briefly introduce them. 

First, I would like to welcome David Brockway, the former chief of staff of the Joint Committee on Taxation during the process leading up to the enactment of the Tax Reform Act of 1986 and currently a partner at Bingham McCutchen here in Washington. 

Second, we will hear from Larry Lindsey, who is currently president and CEO of the Lindsey Group.  Dr. Lindsey formerly served as director of the President’s National Economic Council and is a governor on the board of the Federal Reserve. 

And third, we will hear from Leonard Burman, who is a professor of public affairs at the Maxwell School at Syracuse University.  Dr. Burman is the co‑founder and former director of the Urban‑Brookings Tax Policy Center. 

And fourth, we will hear from David Verrill, who is the founder and managing director of Hub Angels Investment Group in Cambridge, Massachusetts.  He has recently assumed the role of chairman of the Angel Capital Association. 

And finally, we will hear from William Stanfill, a general partner at the Montegra Capital Income Fund and a founding partner of TrailHead Ventures, L.P.  Mr. Stanfill has been in the investment management business for over 40 years. 

And thank you all for being with us today.  The committee has received each of your written statements, and they will be made part of the formal hearing record.  Each of you will be recognized for 5 minutes for your oral remarks. 

And Mr. Brockway, we will begin with you.  You are recognized for 5 minutes.


Mr. Brockway.  Thank you very much, Mr. Chairman. 

I am a strong advocate of comprehensive tax reform and want to commend Congress for thinking about this issue very seriously.  I think that the Code desperately needs reformation.  But I am not here today to advocate comprehensive tax reform or advocate any particular treatment of capital gains. 

I am here more to discuss my experiences in the 1986 legislation and the likely treatment of capital gains in comprehensive tax reform.  You have some great witnesses here today, and I think their is very informative, and useful in thinking about whether you wish to have comprehensive tax reform or not. The experience that I had in 1986 strongly suggests to me that it is highly unlikely that you will find it possible to have comprehensive tax reform with a top rate below 30 percent without raising the capital gains rate close to 30 percent or probably, once you are in the neighborhood, to 30 percent or less — whatever the top ordinary incomes rate is, 25 percent, 28 percent. 

Therefore, I tend to view the capital gains issue in the context of tax reform as a gating issue.  If, after you understand the policy issues in regard to taxation of capital gains, you believe that it is fundamental to keep a differential in the rate structure between capital gains and ordinary income, then I think you have to think seriously about whether you wish to go forward with comprehensive tax reform.  On the other hand, if you come to the same conclusion the Congress did in 1986 that overall the benefits of comprehensive tax reform outweigh the detriments of raising the tax rate on capital gains, then I think it is sensible to move forward. 

In any event, given the design constraints that governed the 1986 Act, it was not possible at that time to reach a reduction in the top rate on ordinary income to 28 percent without also increasing the capital gains rate to that level.  Raising of the capital gains rate to that level was absolutely not an objective in that process.  In both Houses, there was great resistance to doing that.  It was simply the only way that the legislation would move forward under the constraints that Congress was operating under. 

Those constraints were revenue neutrality and distributional neutrality together with a significant shift in tax burden off of the individual sector onto the corporate sector.  That is, the legislation we raised about $20 billion a year in base broadeners from the corporate sector and used that to help subsidize a reduction in the individual tax rates, which might be on the order of magnitude of something like $40 billion a year right now.  It was a very large shift.  And finally, the design constraints were governed by the estimating process of the Joint Committee staff, both distributional analysis and revenue analysis, using traditional revenue estimating methods.  That is, they did not take into account any potential change in the overall performance of the economy that the legislation might produce.  They assumed that the economy would operate at the same levels as in the CBO baseline. 

Those constraints were consciously designed and executed as a “time out” from the partisan ideological struggles in regard to the size and role of the Federal Government and, for want of a better term, the class warfare issues that were facing Congress. Obviously, these are still issues today, but, at that point, without that time out, I think that it would not have been possible to secure the bipartisan support that was necessary for that legislation to pass either House. 

I recognize what you are hearing this morning is designed to focus on capital gains, not the design constraints of overall comprehensive tax reform, but to my view, that is the key to the entire process, and it is the key, in the end of the day, to the tax treatment of capital gains in any such legislation. 

The situation you are dealing with today is different from 1986 in a number of respects, and you are obviously free to adopt whatever design constraints you think are appropriate for this context.  But my suspicion is that you are going to find that the forces that caused those designs constraints to be adopted in 1986 will be the same today.  You are going to have a much tougher time of it this time around, however.  Right now, you do have to decide whether you are going to look at current policy or current law for setting both the revenue target and the distributional target.  And I think the distributional target in that regard may even be more important.  You also have to answer the question whether you are going to adopt dynamic revenue scoring.  That wasn’t really an issue in 1986, but it will be front and center at this point.  And you will also have to decide whether you are going to look at changes in the relevant tax burden on income classes or whether you are going to look at the changes in the relevant after‑tax income. Particularly if you are thinking about taxation of capital gains and you are thinking about dynamic scoring, you have to ask the question, are people relatively in the same position after tax as they were before or not, not what the charts show about how much tax each particular income group pays.  I think have I have reached my time limit.  

Chairman Camp.  The time has expired, yes.  Thank you very much Mr. Brockway. 

[The statement of Mr. Brockway follows:]

Chairman Camp.  Dr. Lindsey you are recognized for five minutes. 


Mr. Lindsey.  Thank you, Mr. Chairman. 

I would like to thank both committees for staging this hearing.  I think it is very important.  I think we need to put this a little bit in the economic context.  Given the hole that we are in in the country, I think our whole focus should be on making America the best place in the world in which to invest, start a business and create jobs.  It is as simple as that. 

There is in that context a very strong relationship between the rate of taxation and the level of economic activity that is being taxed.  I would like to discuss that.  It is not as strong as some believe.  It is stronger than many believe. 

Finally, I would like to point out that the revenue collected from capital gains taxation depends not only on the capital gains tax rate but on the tax rate on ordinary income as well. 

And those are the three thoughts I would like to leave you with today. 

Let me begin with the effect of taxation on entrepreneurship and job creation.  As Chairman Camp pointed out, the effect of taxation of capital gains is much higher.  It is really not a taxation of capital gains; it is a taxation of capital income.  It is one tax levied on top of another tax. 

Moreover, if you look at the way we tax other types of receipt of capital income, such as dividends, we will be having an effective tax rate on capital income of over 60 percent next year.  Frankly, that is a preposterously high rate of tax for a country that wants to compete on a global economic basis.  It is simply too high.  We have to consider a way around it. 

That said, I understand the dilemma of the tradeoffs between capital gains taxation and ordinary income taxation.  And I do come down on the side on net of bringing them closer together; on balance, raising the capital gains rate and cutting the tax rate on others, other forms of income. 

In doing that, I think we need to keep in mind the experiment we are going to be running but now running backward.  We did some extensive work in 2001 and in preparation for the 2003 tax cut on the effects of dividend and capital gains taxation on the level of equity prices, not just because people hold equities, but many, many millions of Americans hold it through pension funds.  And frankly, we were very concerned with the plight of the Nation’s pension funds back then. 

The estimate we came up with was that the capital gains change would have ended up raising the level of the S&P by about 8 percent.  And I would point out that Allen Sinai, who has long been one of the Nation’s premier economic modelers, estimates that if we go over the cliff and all those taxes you were talking about take effect, that the decline in the S&P from current levels as a result of that tax would be 19.6 percent.  So we are talking about a rather substantial possible effect. 

I also think it is important that you keep in mind what happens on the small business level, and that is with regard to ordinary income tax rates.  We are going to have an effective tax rate on the cash flow of small businesses next year of roughly 44 percent.  If you look at any partnership and you look at the traditional partnership draw argument, most of that draw was to pay income taxes.  I can tell you, as a small business man, that is where most of my owner’s draw goes; it simply goes to pay income taxes.  And that money at the margin isn’t coming from me; it is coming from my ability to reinvest in my business and my ability to invest in other businesses.  And so the idea that this is somehow sterile money that doesn’t affect the performance of the economy I really don’t think comports with the facts. 

If I could ask you quickly to turn to table one, I would like to show you the experiment we ran in the 1990s and what its effect was.  I was a little bit startled, and you might remember that what we did then was to raise the ordinary income tax rate ‑‑ by the way, this is on page 6 in the testimony ‑‑ and leave the capital gains rate unchanged.  What I found interesting was that, between 1992 and 1994, when this tax took effect the AGI, adjusted gross income, reported by high‑income taxpayers actually declined.  This was in the prosperous 1990s.  When I did the numbers back, I found that the response was the same as it had been in the 1980s to the reduction of the tax rate, an income elasticity of about .7 percent ‑‑ elasticity of .7.  Capital gains, on the other hand, surged; proprietary income declined.  So the fact that there is an effect of tax rates on the behavior of small businesses I think is incontrovertible, and it is shown even in the 1990s data. 

Similarly, if you would ‑‑ I know we are running out of time here ‑‑ turn to figure 2, you can see what the effect of that was on revenue.  We did an analysis of what happened.  It turned out that about 62 percent of the expected revenue did not actually materialize from the 1993 tax rate increase on high‑income taxpayers; it reduced ‑‑ it came from ‑‑ resulted in less economic activity. 

Let me conclude then ‑‑ I realize my time is up ‑‑ with three points I would like to leave you with.  First, tax rates need to be moderate.  Once tax rates in general start to hit 40 percent, they begin to, although they still raise more revenue, the effect on the private sector is profound. 

Second, capital gains taxation should be as neutral as possible with regard to other capital taxation.  Currently, we are encouraging too much borrowing and not enough equity investment. 

And finally, I think that the conclusion should be that the ordinary and capital gains tax rate should probably be reduced.  I think it would lead to significant efficiency gains. 

Thank you, and I apologize for going over Mr. Camp.

[The statement of Mr. Lindsay follows:]

Chairman Camp.  Thank you, Dr. Lindsey. 

Dr. Burman, you are recognized for 5 minutes.

Mr. Burman.  Thank you very much for inviting me to speak before my two favorite tax committees on a very important subject. 

I think when you get around to comprehensive tax reform, capital gains will be very important. It is a special pleasure to be on a panel with David Brockway, who is one of the heroes in the 1986 tax reform.  And I remember I was a staffer at the Treasury Department working on capital gains, and I heard that the draft proposal would tax capital gains the same as other income.  And my first reaction was, that is a terrible idea.  I was a few years out of grad school and the first thing I thought, and Larry mentioned this, is that it would raise the effective tax rate on corporate capital. 

I have obviously come around in the intervening years that taxing capital gains like other income was actually genius.  It was the thing that made the income tax rate cuts in 1986 possible.  And I also think that the story in graduate school is vastly over-simplified.  And in fact, taxing capital gains at a lower rate than other income can do more harm than good. 

First, I will mention the equity issue, which obviously is a concern.  That was a big part of the reason why capital gains were taxed like other income, because capital gains are so skewed by income.  The top 400 taxpayers in 2009 had 16 percent of the capital gains.  It is very hard to maintain the progressivity of the income tax, and certainly without very, very high tax rates at the top, without taxing capital gains as something close to ordinary income tax rates. 

The other issue is, do we need to lower capital gains tax rates to boost the economy?  I certainly agree with Larry that we need the economy to grow robustly in the years to come, and we wouldn’t want to do anything that would cause the economy to stall.  But the issue for capital gains is complicated.  For one thing, it is the single biggest factor behind individual income tax shelters.  The differential in tax rates between ordinary income and capital gains, 35 percent, 15 percent, is a huge incentive to convert ordinary income into capital gains.  And there is a whole industry devoted to making compensation of high‑income people into capital gains. 

The kinds of investments that produce these tax shelters are extremely inefficient.  They often involve things that would make no sense to invest in absent the tax consequences, but you have money that could be going into productive investments that goes into investments that only make sense because of the tax break on capital gains. 

There is also just an enormous amount of wasted human capital.  Some of the smartest people, certainly in the tax profession, maybe in the country, are devoted to figuring out clever ways to get around the rules the IRS has put in place to try to keep people from converting ordinary income into capital gains.  Those people, under other circumstances, might be able to invent products that people would want to buy in the rest of the world.  I think that would be a better way for them to spend their time. 

It also affects allocation of labor.  There is a big incentive for very talented high‑income people to engage in activities where they can earn their income in the form of capital gains; private equity, hedge funds.  The people who do that, I think two of them are sitting to my left, I think they do enormously valuable work.  But we shouldn’t have a tax subsidy that tilts the balance in favor of that line of business relative to others.  It should be neutral. 

Now, there is the issue of cost of capital for corporations.  It is certainly true that taxing capital gains and dividends, as well as taxing corporate income, can result in a double tax.  But a lower tax rate on capital gains is a very blunt, poorly targeted instrument for dealing with that.  Some corporations pay a lot of tax; some corporations pay very little tax.  A lot of capital gains are on assets other than corporate stock.  We provide a capital gains tax break on all assets not just stock.  President Bush had a proposal that would have targeted capital gains and dividend relief to actually companies that were paying tax. 

Other countries have what is called corporate tax integration, a system where you get a tax credit for the tax paid at the corporate level.  That would save revenue, and it would eliminate a lot of the incentives for tax sheltering that exist under the current system. 

There is the issue of lock in.  I have actually done a lot of research on this.  There certainly is an incentive to hold onto assets to avoid paying tax on capital gains, but the economic impact of that is vastly overstated.  There is a chart in my testimony comparing individual capital gains with corporate capital gains.  The tax rates changed at different times, and the two lines are almost indistinguishable. 

I also have a proposal in my testimony for providing a tax credit effectively for capital gains taxes paid against the estate tax that would reduce the strongest incentive to, the so‑called angel of death loophole, that if you hold your assets until you die, you avoid tax altogether. 

There are a number of issues I can talk about in Q and A.  There is an argument to not tax capital gains because of inflation; that you don’t want to tax savings at a higher rate to encourage entrepreneurship.  I believe all of those arguments are arguments for lowering tax rates on capital overall.  They are not an argument for a lower tax rate on capital gains.  I think using the capital gains tax as a way to cut ordinary income tax rates would be a win‑win.  It would reduce the incentive for tax sheltering, and potentially it could be the basis for another bipartisan plan like the Tax Reform Act of 1986. I would hope that that would be the direction you would go.

Chairman Camp.  Thank you very much, Dr. Burman.

[The statement of Mr. Burman follows:]

Chairman Camp.  Mr. Verrill, you are recognized for 5 minutes. 


Mr. Verrill.  Thank you, Chairman Camp, Chairman Baucus, Ranking Member Hatch, Ranking Member Levin and members of both committees. 

Thank you for inviting the Angel Capital Association to speak before this joint hearing on tax reform and treatment of capital gains. 

The impact of the capital gains tax rate is of significant importance to those collectively referred to as Angel investors.  Those are individuals who provide most of the seed stage capital to start up businesses that drive our Nation’s innovation economy. 

My name is David Verrill, and I am founder of the Hub Angels in Boston, actually Cambridge, and chair of the Angel Capital Association.  Please know that the ACA supports a maximum capital gains rate of 15 percent. 

The story of Angel investing is a story of success in America.  Here is what we do:  First, Angel‑backed companies are the well spring of our innovation economy.  We fund early‑stage high‑growth companies that generate new high‑paying jobs.  Last year, Angels helped start more than 65,000 companies by investing more than $22 billion out of their own wallets.  These investments created more than 165,000 jobs in 2011.  This included companies like Advanced Battery Concepts in Michigan and RightNow Technologies in Montana, where our chairmen represent. 

Second, Angels invest on every Main Street in every State and every business sector.  We invest where we live in every congressional district.  We provide not just capital but time, expertise, mentorship and governance, often to first‑time entrepreneurs who dearly need all the help they can get. 

I should point out that the 60 members of your two committees represent 37 States and 150 of the 170 ACA member groups.  You know better than I do how important these young companies are to your State and our national tax base. 

Third, Angels are the only source of capital for many, many startups.  Angel groups like mine focus on development of disruptive technologies in critically important sectors, including medical breakthroughs.  In fact, one of our biggest hits this year was Intelligent Biosystems, a DNA sequencing company.  We invest, even though more than half of the companies that we invest in will fail and will lose our invested capital in those companies.  Just 7 percent of investments account for 75 percent of the positive returns.  Those positive returns have to make up for the losses.  This is a very, very illiquid and long‑term investment space. 

Fourth, Angels invest their own money of their own free will and capacity.  We don’t tend to invest other people’s capital, just ours.  There is no market for this private stock.  We have no way of predicting if or when a company will exit and when we will make our investment return. 

Fifth, successful Angel investments create a virtuous cycle.  Angels tend to plow returns back into more startups and the teams of those successful companies pay more taxes, consume more products and services and, even better, many of them become Angel investors themselves. 

An increase in capital gains would reduce Angel investment in these promising companies at the very time we need to create jobs in the United States.  It would be taking our foot off the gas pedal just when we need to accelerate this economic engine of growth.  And make no mistake, Angel investors are the source of much of this capital and drivers of much of this growth. 

Let me provide you with some data.  First, Angel investors support up to 90 percent of the outside equity raised by startups.  These companies are too embryonic to qualify for bank loans and too small or too early for most venture capital firms. 

Second, Angel investing is far more prevalent than venture capital in seed stage companies, startup companies.  This is the stage when companies need a few hundred thousand dollars to just get started. 

And third, private investment by accredited investors overall generates more new capital to our economy than the public equity markets. 

So here is the dilemma:  Raising the capital gains rate significantly will force many Angels to turn away from an asset class in which they are the most experienced recognized experts and dominant players.  There are no replacements for Angels. 

And I would note, as mentioned previously, there are other pending tax changes to the code that would increase a 5 percent increase in the effective tax rate on Angel investors next year. 

The best way to ensure a strong flow of Angel capital into innovative small businesses throughout this country is to provide tax incentives and education to allow and encourage private citizens to risk more of their own capital to support startups and early stage businesses. 

With that driving force in mind, the ACA advocates for a maximum capital gains rate of 15 percent.  Consistency in this rate has led to a tremendous surge in Angel investment over the past decade alone. 

Second, we ask your support for reinstatement of the 100 percent exclusion of the capital gains tax on qualified small business stock, Section 1202, led by Senators Kerry and Olympia Snowe, which is included in the Senate version of the tax extender bill.  We encourage the House to support it as well. 

Third, we recommend Congress consider instituting tax credit policies in support of Angel investors, like the Senate bill 256, supported by Senators Pryor and Scott Brown of Massachusetts; 22 States in our Nation have tax credits for a reason.  They create jobs.  We should have a tax credit at the Federal level. 

As my fellow panelists have commented, tax policy is complex.  My point is simple.  If Angel investors are taxed more, they will have less to invest. 

Thank you for the opportunity to speak today.  I would be happy to answer any questions about Angel investing.  I do have additional materials on Angel investing in the U.S. and respectfully request that that be accepted into the record.

Chairman Camp.  Without objection. 

Thank you Mr. Verrill. 

[The statement of Mr. Verrill follows:]

Chairman Camp.  Mr. Stanfill, you are recognized for 5 minutes. 


Mr. Stanfill.  Chairman Camp, Chairman Baucus, members of the committees, it will come as no surprise to any of you that I am closer to the end of my career than beginning.  Therefore, permit me to lead with my conclusion:  The sky will not fall if capital gains go up. 

I have been in the investment business for 45 years; first as a broker with Dean Witter, then as a money manager, a venture capitalist, an Angel investor and an asset‑based lender.  During the course of my career, capital gains rates have ranged from the current 15 percent to as high as 28 percent.  The capital gains rate has had little impact on our investment planning, our ability to attract investors or the financial results of those investments. 

As for the capital gains rate going forward, tell me what the rate will be, make sure it is fair, and we will work within the guidelines. 

During my career, I have competed for investors with all types of investment funds, oil and gas exploration funds, real estate development funds, timber funds, private equity, hedge funds, you name it.  They all had souped‑up tax treatments, accelerated depreciation, up‑front deductions for exploration and development, special rates for timber sales, big interest deductions for leveraged buyouts.  Invariably they spent more time and energy on the tax structure of the deal than on the economic merits of the investment. 

Frequently investors I lost to these sophisticated product offerings would boast about the money they saved on taxes.  Seldom did they care about the rate of return from the deal.  Occasionally, they screamed when they had to repay recaptured taxes. 

My goals and the goals of the firms and individuals I have worked with are simple:  Make money by leveraging the creativity, talent and passion of entrepreneurs.  Tax rates are merely part of the landscape.  We are looking to leverage talent, not tax breaks.  We manage risk, not the Tax Code. 

The preferential tax rates for capital gains and dividends are simply a windfall for wealthy investors.  In my view, this special tax treatment is neither fair nor equitable nor available to any other professional endeavor.  After all, a gifted teacher, who is inspiring and challenging our children and enriching human capital, gets no such special treatment. 

I would caution members of the joint committee to be skeptical when people like me testify to you that we give lip service to the idea of the level playing field.  We make campaign contributions.  We hire lawyers and lobbyists to persuade you that if the field is not level, it should be tipped in our favor.  In addition, we prepare elaborate spreadsheets to prove our point, while rejecting data that may lead to different conclusions resulting in what Woody Brock refers to as the dialogue of the deaf in his book “American Gridlock.” 

Frankly, I was reluctant to testify on this occasion, for like the vast majority of my fellow citizens, my faith in the U.S. Congress to set aside party and ideology and do the People’s business has been dashed.  But I am nothing if not resilient and hope springs eternal, so here I am urging you to lead and to find a win‑win solution and forge comprehensive tax reform. 

What better way to begin than to tax all income ‑‑ wages, dividends, capital gains, carried interest, royalties ‑‑ alike.  End preferences, close loopholes, eliminate most deductions, add a dash of progressivity.  Let the market, not the Tax Code, determine the allocation of investment capital.  Let various legal and accounting and lobbying industries refocus on more productive work. 

You have choices to make, change in the Tax Code in favor of equity, transparency and predictability, or continue to stroke the flames of public cynicism, a divisive option that ensures the widening gap between the government and the governed.  I wish you good luck in your efforts.  I look forward to your questions.  Thank you.

Chairman Camp.  Thank you, Mr. Stanfill. 

[The statement of Mr. Stanfill follows:]

Chairman Camp.  We will now proceed with member questions for the witnesses. 

Due to the joint nature of today’s hearing, questioning will alternate between Members of the Senate, as recognized by Chairman Baucus, and Members of the House, as recognized by myself, for a single round of questioning. 

Senators will be recognized in an order consistent with the rules and practices used at Senate Finance Committee hearings, and House Members will be recognized in an order consistent with the rules and practices used at Ways and Means Committee hearings.  Each Member will have 3 minutes to question witnesses. 

So, with that, let me invite Chairman Baucus to begin the questioning.

Senator Baucus.  Thank you, Mr. Chairman. 

Mr. Verrill, that is very clever of you to mention Michigan and Montana.  I coincidentally, because we are not a big State, spent one day working at RightNow Technologies.  That company, as you know, has done quite well.  It sold for $1.4 billion just about a year or two ago to Oracle.  They’ve done very well. 

The question I have, though, is listening to you and comparing with what Mr. Brockway said, I hear you basically saying to keep capital gains rates for Angel investors down to 15 percent so on and so forth because that is good for Angel investing. 

And Mr. Brockway has pointed out that, basically, you got a choice here:  If you want comprehensive tax reform, Congress, you are going to have to raise the capital gains rate.  That is, if you want to reduce the rates, the marginal rates on ordinary income, the only way you can do it is to get rid of a lot of the tax expenditures as well as capital gains differential or significantly raise capital gains rates.  So are you saying, I am just asking the question, that we should focus more on Angel investing venture capital incentives for investment and forget about tax reform? 

Mr. Verrill.  Well, I think there is a clear difference between Angel investing and venture capital that I can talk more to. 

But in response to your question, I think the longer‑term virtuous cycle of a tax benefit in terms of capital gains for Angels actually increases the amount of revenue that comes into the Federal Government over time rather than thinking of it as a tax break.

Senator Baucus.  My point is, are you basically saying to keep the capital gains rate very low, which means it is going to be very, very difficult to get the marginal rates down ‑‑ you have lots of proposals around here.  You got 25-10 and so forth.  And as I think as Mr. Burman pointed out, it is virtually impossible to get to 25-10.  In fact, it is impossible without either raising rates on middle‑income Americans and/or raising capital gains rates.

Mr. Verrill.  AC advocates for a low 15 percent capital gain rate, but equally importantly, consistency over time.  We don’t have a lock‑up issue in the Angel world.  We can’t determine when we exit a company.  So I think we need to have a long‑term stable tax policy so that we can understand that when we invest today, we understand how it will be taxed in 5, 6, 7, 8 years from now.

Senator Baucus.  So do you ‑‑ Mr. Brockway feels we should pursue comprehensive tax reform.  Do you agree? 

Mr. Verrill.  I think that you people have a very difficult decision to figure that out. 

My personal opinion is that, and with respect to the ACA, that we can’t have complete neutrality, we can’t have complete comprehensive taxes that are across the board.  We need to have some means of incenting people, particularly in my space, to continue to make investments in these companies.  Nobody else will.

Senator Baucus.  Mr. Chairman, I think somebody forgot to push the clock.  My 3 minutes is up.

Chairman Camp.  You are not on the clock.

Senator Baucus.  I am not on the clock?  Okay.

Chairman Camp.  Mr. Chairman, you are not on the clock.

Senator Baucus.  Well, I will keep myself to the clock.  Thanks.

Chairman Camp.  Thank you. 

Dr. Lindsey, you mentioned in your testimony, and I also in my opening statement, the focus on the statutory rate might be misplaced when you consider that is often based on income that has already been taxed in another layer another place.  And you said ‑‑ sort of suggested we should look at this integrated tax rate.  Can you elaborate on this, why that should be the focus for policymakers rather than whether there is a headline statutory rate of 15 or 20 percent? 

Mr. Lindsey.  Certainly.  Just to keep the math simple, let’s imagine we have ‑‑ our objective here is to tax capital at a reasonable rate.  And right now, if I am an investor who wants to earn through the corporate sector a dollar of dividends, the first thing that happens is the corporation is taxed at the margin at 35 percent on the money it earns, it has $0.65 left.  I am then taxed at a 15 percent rate on that $0.65 that it is going to ship to me in dividends.  That is another roughly $0.11.  So the combined tax is not 15 on the thing; it is a number like 46.  Now, if the capital gains tax is raised, if the ordinary income tax rate is raised, that number gets to be even higher.  If you do it via dividends, we are going to see an effective tax rate in January on a dollar earned — 63 percent.  Nobody that I know of in the economics profession thinks that that would be an optimal situation. 

And the one point of agreement on this panel was that even if you raised the ordinary rate ‑‑ excuse me, even if you raise the capital gains rate, it should be used to reduce the ordinary rate, because you have an interaction between the ordinary rate on taxation of income and capital gains rate that is very pernicious and comes right out of the cash flow of businesses.  And I would strongly urge you to look at the rate in a comprehensive fashion.

Chairman Camp.  I have a question for you and for Mr. Burman and for Mr. Verrill, if you could answer quickly.  At one point, Congress had modified the capital gains so that investments held for less than a year had ordinary income, investments held for 1 to 5 years had a 25 percent rate and more than 5 years at an 18 percent.  If you could, each of you, comment just on what the economic and tax policy considerations might be in multiple holding periods and rewarding what some people call patient capital, I would be interested in your views on that issue.

Mr. Lindsey.  I think, as with most things in this area, that solves one problem and creates another.  The problem that it creates is complexity.  Capital gains, it is half the Tax Code.  It also takes a lot of time to do your taxes right on it.

You know, I was listening to his testimony, and I think there is another way of solving the problem of Angel investors, and that has to do with the limitation that we have on capital losses being applied to other income.  I mean, the great risk to me as a prospective Angel investor is that I lose money on some investments, and if I happen to lose, the government washes its hands of me; it is no longer a partner with me.  If I happen to make money, the government wants to come in and be a full partner with me.  That is unfair.  It is inefficient, and I think that that is a better remedy to pursue with regard to Angel investing than manipulating the rate.

Chairman Camp.  Mr. Burman, quickly, I know we are running out of time here.

Mr. Burman.  The taxation on capital gains on realization already provides lower effective tax rates on long‑held assets.  Basically, you get to defer the tax, which is as valuable benefit.  My former boss Bob Rubin liked the idea behind the 18 percent rate for assets held 5 years or longer.  I disagreed with him.  I thought that we should actually be striving more toward neutrality. 

I also could say something about losses if you are interested because I think the issue is more complex.

Chairman Camp.  All right.  Thank you.

Mr. Verrill.

Mr. Verrill.  I think 1202 is the right direction.  I don’t think adding any phasing of years to it would help us because we simply don’t know the term which we will own these equities; 1202 could be made better.  The holding period could be made less in general, from 5 to 2 years.  The rollover period could be made longer.  This isn’t a mortgage transaction; this is a company.  So I think 1202 really goes to solving that problem if we tweak it a bit.

Chairman Camp.  All right.  Thank you.

Senator Baucus.  Senator Hatch.

Senator Hatch.  Let me ask a question for Dr. Lindsey. 

A popular talking point on capital gains is the revenue maximizing rate.  That is the tax rate on capital gains that will bring in the maximum amount of revenue to the Federal Government. 

But in your testimony, you believe too much attention is paid to the revenue maximizing rate, and the focus should be on the optimal or efficient rate of taxation, which is well below the revenue maximizing rate.  Would you please comment on why the focus should be on the optimal or efficient rate of taxation and where that rate should be today and where you would see that rate if the top corporate and individual tax rates were reduced to 25 percent?

Mr. Lindsey.  Certainly, Senator, I think it is an important point.  I am going to try and convert the words “revenue maximizing rate” into English.  What it really means is the government is soaking you for as much as they can possibly squeeze out of you without regard to what it does to your business. 

So at the revenue maximizing rate, or beyond the revenue maximizing rate, the government is losing and the individual firm is losing.  At the revenue maximizing rate they are just squeezing you for as much as possible, but that doesn’t mean that it is best in society’s interest.  You only want to be at the revenue maximizing rate if all you care about is the government and you don’t care at all about the private sector. 

If you take the standard assumptions we are using now, that even the Joint Tax Committee uses, and apply the loss to the private sector, to pull a dollar of revenue into the public sector, we are talking about $2.50 to $3 per dollar revenue.  In other words, you are harming somebody out there by $2.50 or more just to collect another dollar by raising the tax rate. 

To me, that is not a cost‑effective way of looking at taxation; and I do think you have to take into account the cost to the private sector, the dead‑weight loss, the other efficiency costs, and not just try and get as much revenue as you can. 

Senator Hatch.  Well, let me ask this next question to Mr. Verrill. 

As I stated in my opening statement, with the scheduled expiration of the Bush tax cuts at the end of this year, capital gains will be subject to a 23.8 percent tax beginning in 2013 –a whopping 59 percent increase from current law.  Now how would such an increase in the capital gains tax affect angel investment in early‑stage companies, companies that in many cases are highly dependent upon such funding? 

Mr. Verrill.  I think the uncertainty of that is going to create a lot of people that sit on the sidelines and sit on their money.  I think that fewer people will be contemplating investments early in the new year, and I think that will have a cascading effect on the number of companies started, the number of jobs created.  I think we need to figure this out before the new tax year and give people solid ground on how they are going to be taxed.  Even though it is a tax on the return, I think it will influence negatively the number of investments that people make early in 2013.

Senator Hatch.  Well, thank you. 

Thank you, Mr. Chairman. 

Chairman Camp.  Thank you. 

Mr. Levin is recognized. 

Mr. Levin.  Thank you. 

Well, I think this has been so far a very sobering hearing, and I am glad we are holding it.  Because I think there are a couple of lessons to be drawn.  One is that we need to be optimistic but realistic; and, number two, I think we need to have much less talk about targets and more discussion about trade‑offs.  Because I think the testimony of several of you has very much underlined the need for us to talk about trade‑offs. 

You know, I, some years ago, proposed some amendments to 1202, and I guess the law now reflects the changes.  But, again, if we are realistic, we wrestled with how we approached it; and it is a very limited and carefully crafted, up to a point, provision and doesn’t affect most investment.  And so I go back to the issue of trade‑off and also the issue of equity. 

Mr. Verrill, as I said, 71 percent of the benefit of the preferential rate on capital gains goes to those making more than $1 million a year, according to Joint Tax.  Do you have any idea as to how that would apply to angels?  How much are we talking about in terms of the capital gains tax?  Do you have any idea?  I mean, you want to differentiate between angels and venture capitalists.  What portion of this 71 percent is represented by angels?  Would you know? 

Mr. Verrill.  Well, first of all, angels are sympathetic to venture capitalists because they are the ones who fund a relatively high percentage of our companies.  In my portfolio, about three‑quarters of the companies are funded by VCs.  So we are important components to the value chain. 

The Kauffman Foundation did a study a couple of years ago that tried to get at the effect of an increase in the amount of income or investable capital on accreditation; and, surprisingly, it pointed out that something on the order of half of angel investors are not in the one percentile of income, that many of them are certainly accredited investors but investing significant amounts of their available capital. 

I don’t have a figure for you.  I apologize. 

Mr. Levin.  Okay, I guess my time is up.  Thank you. 

Senator Baucus. [Presiding.]  All right.  Next, Mr. Wyden.

Senator Wyden.  Thank you very much, Mr. Chairman. 

A question for you, Dr. Burman.  You and Mr. Brockway are really some of the heroes of the 1986 reform effort, and we dealing are some of the same challenges now.  I wanted to ask you about a particular approach that might help to bring people together. 

We have heard again this morning that conservatives want to keep rates down, and progressives want to ensure fairness.  And it seems to me that one of the ideas you are suggesting, Dr. Burman, the idea of an exclusion for capital gains, could achieve both.  And let me just ask you about some math that we ran. 

If you, for example, had a 35 percent exclusion from capital gains and you were in a 15 percent bracket, that would result in an effective capital gains rate of about 9.75 percent.  That same exclusion in a 25 percent bracket would result in an effective rate of a little over 16 percent.  So you could then say that there would be lower rates for capital gains and ordinary income rates, but you would also say there would be graduated rates so that those who earn most of their income from capital gains would pay higher rates. 

Wouldn’t this kind of idea give us an opportunity to bridge the gap, much like what was done in 1986, so that conservatives would have a path for lower rates for capital income but progressives could see that there would be a clearly outlined fairness in tax reform? 

Mr. Burman.  Mr. Wyden, as you know, I am a big admirer of yours because you worked tirelessly to try to advance bipartisan tax reform through your career. 

If there is a lower rate for capital gains, I think it would make a lot more sense to return to an exclusion, which was done for most of the history of the income tax until the 1986 act. You are right that it would produce some more progressivity in the taxation of capital gains. 

The other thing is the current alternative rates are extremely complex.  There is a 37‑line work sheet ‑‑

Senator Wyden.  A 37‑line work sheet.

Mr. Burman.  Basically, it is like an alternative maximum tax on capital gains.  I don’t know that anybody still does their taxes by hand, but if they do you would probably hear screams from them in the middle of the night when they get to line 28. 

So I think it would be a good idea to restore an exclusion. 

Senator Wyden.  Thank you. 

Mr. Brockway, you want to chime in on that? 

I understand that some are going to favor as their first choice making ordinary income and capital gains essentially the same.  I think that is going to be a real challenge in terms of creating a bipartisan approach again ‑‑ and last couple of seconds, perhaps, for you, Mr. Brockway. 

Mr. Brockway.  Well, I don’t have access to the estimating process anymore, so I am just going to speculate on this. 

If you are going to have a preference, I would probably say exclusion would be somewhat better.  But I would have thought that most of the capital gain income is for taxpayers in the highest‑income brackets, so I am not sure it would have a significant effect.  There would be some people in lower-income brackets that would have substantial capital gains, but I don’t think that the aggregate amount of capital gains for that group would be a large portion of the money. 

The comments I have been making about where I think you are going to be forced to be, as opposed to where you want to be and maybe what policy would lead you to be, is simply that, in constructing a reform package with a top rate at that level, and if you stay revenue neutral with current law or current policy, either one, as your baseline for the top‑income class, the top 10 percent, and certainly if you get narrower than that, there aren’t enough base broadeners out there that will pay for the rate cut to get into the 20s, other than attacking capital gains.  There may be ones that I am not aware of, but certainly I don’t think you are going to find enough in the tax expenditure budget.  You are going to have to do something else.  That is why I am saying that you have to ‑‑

Senator Wyden.  My time is way up.  I was just thinking about seniors on limited incomes who might have some stock and that kind of thing. 

Thank you for courtesy, Mr. Chairman. 

Chairman Camp. [Presiding.]  Thank you. 

Mr. Herger is recognized. 

Mr. Herger.  Thank you, Chairman Camp. 

In 2003, Congress tied capital gains and dividend rates together creating parity between gross stocks and dividend‑paying stocks.  The Obama administration’s latest budget calls for untying these two rates and allowing the rate on dividends to rise to 43.4 percent, while the top rate on capital gains would be 23.8.  I would like to get each of your thoughts on this proposal.  How would a nearly 20 percentage point disparity between the capital gains and dividend rates affect investment decisions?  Mr. Brockway? 

Mr. Brockway.  Well, I guess I tend to be a skeptic on all of this.  The country at times has had vastly different rates for capital gains and ordinary income, and also has had times where the rates were similar.  I don’t know that the economy performed better in one situation than in the other.  So I am reluctant to say whether you had a large differential or you had the same rate. that it would have a significant impact on the overall performance of the economy.  I think the overall performance of the economy is far too complex to ascribe a substantial difference based on the taxation of capital gains versus other income. 

Mr. Lindsey.  Just to show you how old I am ‑‑ I was going to do the calculation ‑‑ I think it was 25 years ago I wrote a paper with Professor Bolster at Northeastern University, the chairman of the Finance Department Business School there, that looked at the effect on the stock market after the reverse story was done in 1986.  And while I agree that it would have a very complex effect on the economy, there is no question it would lead to a liquidation of dividend‑paying stocks and a reallocation into capital‑gains‑paying stocks.

Mr. Burman.  My impression actually is that President Obama’s budget would tax dividends at a 20 percent rate, but the substantive question is about what it would mean to tax dividends the same as other income. 

First, I think most economists think that some kind of integration would make sense, providing a credit for taxes paid to company level.  The lower tax rate on dividends and capital gains is too much for some stocks, and some companies don’t pay any tax at all, and too little for others. 

The overall economic effects probably would be smaller than you would think.  If you actually look at the response to the cut in dividend rates in 2003, there was a short‑lived surge in dividend payments.  Basically, companies that intended to pay dividends over time sped those up.  But the long‑term effect, according to evidence from research at the Federal Reserve and others, was actually pretty modest.  So it is not clear that it would have a very large overall economic effect. 

Mr. Verrill.  I think the point was made toward public equities.  If you look in the private space where angels make their investments, a miniscule amount of investments use a dividend or royalty based model to pay back the investors, so ACA has no position on it. 

Mr. Stanfill.  And I think I would resort to simplicity, as I said in my testimony, taxing all income at the same rate. 

Mr. Herger.  Thank you. 

Chairman Camp.  Thank you. 

Mr. Neal is recognized.

Mr. Neal.  Thank you, Mr. Chairman. 

Mr. Burman, you recently wrote an op‑ed for the New York Times titled The Buffett Rule: Right Goal, Wrong Tool.  In the article you argue that instead of enacting the so‑called Buffett Rule, which has drawn considerable attention in Congress, you would require Americans with incomes over $2 million to pay an income tax rate of at least 30 percent.  And some of the defects that we are currently arguing over certainly have ‑‑ I think legitimately would allow those to dispute tax rates.  And, at the same time, Mr. Buffett has suggested that, in terms of consequence, he should not be paying at a lower rate than his secretary.  Do you want to elaborate on this point and how Congress in your judgment should address the inequity of very wealthy paying at a relatively low rate? 

Mr. Burman.  Sure, thank you for the question. 

My reaction to the Buffett Rule comes from the fact that I actually spent a lot of time working on the alternative minimum tax, which was originally intended to make sure millionaires, people earning over $200,000 in 1969, equivalent to $1 million now, paid some tax.  It was originally targeted at very high‑income people, it was poorly designed to begin with, it mutated and morphed over time, and now I pay it, and I take that really personally.  I am not a millionaire. 

I don’t like alternative taxes.  The problem with the AMT in the first place was that if there some loopholes the rich people are taking advantage of that are unwarranted, you should get rid of the loopholes. 

The reason that Warren Buffett pays a lower tax rate than his assistant is that he earns almost all of his income in the form of capital gains, and it is taxed at a 15 percent rate.  If you want to fix that problem, the thing to do would be to tax capital gains as ordinary income, or at least at higher rates.  If you think it should be a 30 percent rate, then capital gains tax rates should be up close to that.  And  narrowing the difference between ordinary income and capital gains makes that more viable as well. 

Mr. Neal.  Just a note based on your discussion of the AMT.  As you know, I spent a lot of time on this for a long, long part of my career, but with some interest.  When we get done, as we surely will be patching AMT again, we will then have been north of $600 billion in patches. 

Mr. Burman.  Yeah. 

Mr. Neal.  And I think it speaks to the ineffectiveness that some of us define common ground on an issue like that that we should be able and should have been able to address a long time ago. 

Mr. Lindsey, in your testimony, you suggested that limiting the favorable tax treatment of debt relative to equity will produce a better tax system.  We certainly heard a lot about the bias in the Code in favor of debt‑financed investment relative to equity financed investment.  Can you explain how you think we in Congress should limit the favorable tax treatment of debt relative to equity?  

Mr. Lindsey.  I am about to make myself very unpopular. 

I think that the conversation ‑‑

Mr. Neal.  You are talking to a group that is not exactly held in highest regard by ‑‑

Mr. Lindsey.  I think all of the discussion that is happening here, the fact that we have 20,000 pages on capital gains, points up to the fact that we have reached the end of the road with regard to income as the base of taxation.  There are a long range of distortions that we have, including an unfavorable trade consequence to this country by the fact that we use income‑based taxation.  It is a mistake.  We should get rid of all of this by moving towards a cash‑flow‑based taxation.  All of the questions of neutrality, all of the arguments of tax this or that would be solved by doing that, as would the difference in the tax treatment of debt and equity; and that would be the direction I would urge you to go. 

Mr. Neal.  Thank you, Mr. Chairman. 

Chairman Camp.  Thank you. 

Mr. Johnson is recognized. 

Mr. Johnson.  Thank you, Mr. Chairman. 

I think an important but perhaps overlooked issue that we should bear in mind as we look at tax reform is the role the Joint Committee on Taxation plays with respect to its revenue estimates which are based on how it analyzes tax changes. 

You may be familiar with the July 21st Wall Street Journal editorial, Washington’s Tax Oracles.  That editorial calls into account JCT’s complete revenue myths with respect to the 2003 capital gains tax cut.  Bottom line, instead of costing the government revenue, the capital gains tax cut generated tax revenue, significantly higher revenue, I think. 

As we seek to do reform, it is critically important we can rely on the revenue estimates from JCT.  Given your experience with the last major reform effort, as JCT’s chief, you no doubt can appreciate the importance of getting revenue estimates right, Mr. Brockway.  And, with that, don’t you believe there is a need ‑‑ indeed a need for dynamic impact when it comes to lower capital gains taxes?  In other words, don’t you believe the 2003 capital gains tax cut can have a positive macroeconomic impact, that such a tax cut can also generate greater tax revenues, not revenue losses? 

What are your thoughts, please? 

Mr. Brockway.  Well, I have no doubt that ‑‑

Chairman Camp.  Is your microphone on? 

Mr. Brockway.  Hopefully. 

I have no doubt that changes in the Tax Code can have some economic effects.  I think it is a political issue, not a scientific issue, as to what that economic effect will be.  I don’t think the staffs should be delegated the responsibility to decide.  If you all think that enacting a certain provision is going to expand the size of the economy, then I think you should decide to do it. 

I don’t think there is consensus on the question of whether or not tax reform, whether or not a particular tax cut will expand the economy. The fact of matter is the the economy grew after the 1982 Act, which was the biggest peacetime tax increase in history.  That helped turn around a very difficult situation.  We were in dire economic straits.  We also had a big tax increase in 1983, and another big tax increase in 1984.  These are the largest tax increases outside wartime in the country’s history, and the economy grew. 

So I am not sure what to make of these arguments.  I am not sure whether the Wall Street Journal is just saying post hoc ergo propter hoc, that, yes, the economy expanded in the 1990s following a capital gains rate cut.  Whether it is because of the cut in the tax rate on capital gains, I don’t know.  Someone may know, and the Journal may know. 

But all I do know is that you will have a very difficult time if you put on the staff the responsibility to make it what is essentially a political decision.  I don’t think you want to do that.  This is something that you all have to decide. 

If you think that what you are doing will expand the economy, then say, look, this is what we think it will expand the economy by, and staff can produce numbers that are consistent with that.  I don’t think that they are competent ‑‑ either JCT or CBO ‑‑ to make that decision. 

Mr. Johnson.  Thank you. 

Chairman Camp.  Thank you. 

Mr. Pascrell is recognized. 

Mr. Pascrell.  You have been in the business 40 years, and your expertise is the reason why you are here.  Are you familiar with the report that came out just a few days ago, Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945?  It is put out by the Congressional Research Service, Thomas Hungerford, a specialist in public finance.  Are you familiar with that, sir? 

Mr. Stanfill.  No, sir, I am not. 

Mr. Pascrell.  Well, now I would like your opinion on it, because this is what it says:  “Advocates of lower tax rates argue that reduced rates would increase economic growth, increase saving and investment, and boost productivity.”  In other words, increase the economic pie.  “Proponents of higher tax rates argue that higher tax revenues are necessary for debt reduction.”  You have heard that many times.  “The tax rates on the rich are too low and violate the Buffett Rule.”  And you have heard that today.  “And the higher tax rates on the rich would moderate increasing income inequality.”  In other words, change how that economic pie is that is distributed.  I am not afraid of that word. 

But it says this:  “There is not conclusive evidence to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth.  Analysis of such data suggests the reduction in the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution.  The evidence does not suggest, necessarily, a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced.” 

What is your opinion on that? 

Mr. Stanfill.  Well, to the extent I remember the question, I think I would default to fairness in tax matters.  I think that in a broader sense what is needed is a Marshall Plan for the middle class.  I think what we have had is a Marshall Plan for the top 1 or 2 percent; and I think, therefore, that fairness as you move through tax reform has to have an important place in your proceedings. 

Mr. Pascrell.  In the comparing of taxing income and taxing assets ‑‑ and there has been a shift over the last 30 or 40 years ‑‑ where does the burden fall when that shift took place and up until this point in taxing income and assets differently?  Where is the algebra here in terms of where does the major burden fall?  On the shoulders of those holding assets or those that still depend mainly on income? 

Chairman Camp.  And if you could answer briefly, because we are over time. 

Mr. Stanfill.  Yes, indeed. 

Well, I am one of those ‑‑ I am not in ‑‑ I am one of those whose assistant pays a higher rate than I do.  So I think the burden has fallen on my assistant more heavily than it has fallen on me. 

Mr. Pascrell.  Thank you very much. 

Chairman Camp.  Thank you. 

Mr. Reichert is recognized. 

Mr. Reichert.  Thank you, Mr. Chairman. 

Let me ask a question.  I want to focus a little bit on jobs and how this whole tax discussion affects job creation.  So, Dr. Burman, in your testimony, you talked about how raising the capital gains tax in order to lower the income tax rates could help to create jobs in the United States.  And I know that some of my colleagues would have concerns that raising the capital gains rate could discourage investment.  Could you tell me and the panel here a little more about your theory, and do you have any rebuttal for those who worry that raising the capital gains rate would discourage investment? 

Mr. Burman.  Thank you for the question. 

The basic point is that that differential between capital gains tax rates and ordinary income rates produces an enormous amount of unproductive activity that actually makes the economy work more poorly than it would. One argument people make for a lower capital gains tax rate is that it encourages entrepreneurship.  But if you actually look at the incentives to start your own business, even if the capital gains are fully taxed you have a very strong incentive to invest your own labor, your sweat equity into the business.  It is kind of like an IRA, you save payroll taxes as well as income taxes on the contributions of your own labor, and that is a strong incentive. 

The main thing, and I think what most economists believe, although there is obviously some disagreement about how best to achieve this, is that, to the extent you can, the tax system ought to be relatively neutral.  We shouldn’t be picking winners and losers.  We shouldn’t be favoring angel investors over other kinds of investors who are investing in other kinds of activities.  When the capital gains tax break favors particular kinds of investments over others, it provides a very strong incentive for inefficient tax shelters. 

Mr. Reichert.  Anyone on the panel wish to further comment? 

Mr. Verrill.  I will, if you don’t mind.  I thank you for the question. 

Mr. Reichert.  Your name was mentioned. 

Mr. Verrill.  I think the brush is too broad that Mr. Burman paints, and I think there is real economic value in efficient use of capital and energy and expertise in the angel domain.  And certainly entrepreneurs put sweat equity into a company.  They ultimately will generate some tremendous wealth out of that in a perfect world and they will give back.  They will purchase products and services.  Those companies will grow.  Their salaries will become more market‑oriented.  And I think, all‑encapsulated, it is a much better economic analysis than simply a broad stroke of a brush. 

Mr. Reichert.  Thank you, Mr. Chairman.  My time is expired. 

Chairman Camp.  Thank you.

Mr. Larson is recognized. 

Mr. Larson.  Thank you very, Mr. Chairman.

Chairman Camp.  Your microphone.

Mr. Larson.  Thank you, Mr. Chairman, and I want to thank all of the panelists. 

Mr. Lindsey, you said something very intriguing when you said this is going to be unpopular for me to say this, but I think that our revenue should be more cash‑flow based.  What did you mean by that? 

Mr. Lindsey.  There is a saying on Wall Street that cash is a fact and income is an opinion.  And right now ‑‑ and that is ‑‑ actually, you know, if you think about the typical business, right now, the Securities & Exchange Commission has one definition of income.  Generally Accepted Accounting Principles have another definition of income.  The IRS has another definition of income for purposes of the corporate income tax.  They have a different definition of income for purposes of the payroll tax and a different definition of income for the income tax.  So the government is now telling businesses that they need to keep five sets of books. 

Well, that can’t possibly be a good outcome, and that is why I think in the end we are going to have to move away from income‑based taxation towards a cash‑flow‑based taxation.  And, again, I know this is a curse word here, but, ultimately, I think Congress is going to be abandoning income taxation and moving to value‑added‑based taxation.  

Mr. Larson.  Would you describe cash‑flow‑based as transaction taxes? 

Mr. Lindsey.  Well, I would call it a net transaction tax, yes.  So that ‑‑

Mr. Larson.  Right.  A net or, you know, a broad transaction tax, not transaction on a specific industry. 

Mr. Lindsey.  Correct, and where you would pay tax only on the transaction that ‑‑ in other words, you would get ‑‑ if I hired my colleague here, he would pay a transaction tax. 

Mr. Larson.  How would that differ in many respects to what Mr. Stanfill’s point ‑‑ and I would like to see how people would have reacted to that when he says, let’s let the marketplace set it and let’s go through ‑‑ eliminate all of the tax breaks that are there, and whether it is royalties, whether it is ‑‑ how would you look at those two intersections and is there an intersection or an apex in which that could happen? 

Do you follow what I am saying?  Mr. Stanfill’s proposal I believe at the end was, whether it is wages, dividends, capital gains, royalties alike, end the preferences, close the loopholes, eliminate most, if not all, and add a dash of progressivity.  How would you respond to that? 

Mr. Lindsey.  That would actually accomplish what he said. 

Mr. Larson.  Do you agree with that, Mr. Stanfill? 

Mr. Stanfill.  I think I do. 

Mr. Larson.  Yeah. 

Mr. Larson.  Thank you. 

Chairman Camp.  Thank you. 

Dr. Boustany, is recognized. 

Mr. Boustany.  Thank you, Mr. Chairman. 

Mr. Brockway, I want to examine the kinds of assets that should be treated as capital assets consistent with policy rationale for a preferential capital gains rate.  In your testimony you suggest that the current definition of a capital asset in the Tax Code perhaps is not entirely consistent with the policy reasons behind a lower capital gains rate.  So can you elaborate on that some and maybe provide a current example of a particular asset or capital asset that we should review in this regard? 

Mr. Brockway.  Well, I mean, obviously ‑‑

Chairman Camp.  Your microphone, please. 

Mr. Brockway.  You all have had a fair amount of discussion about carried interests, so I am not going to be able to say anything here that is going to educate you further on that subject matter.  But, obviously, you are considering as what is the appropriate rate there — does income from gains on carried interests deserve taxation at capital gains rates or ordinary income rates? 

But let me give you a simple example.  Land.  There is a finite amount of land in the United States, more or less.  I guess that we created some more with the fill from the excavation to build this visitors center, but, as a general proposition, there is a finite amount of land.  So whatever you do with the capital gains rate there is going to be that amount of land.  The fact of the matter is, however, that you have a preferential rate for transactions in land. 

So it is not about economic growth.  It is not about jobs or anything else.  It is just you happen to have the preferential rate because you invested in land. 

I am not saying it is good or bad.  I am just saying, stand back, ask yourself, why do we think it is important to have this difference in treatment and does it make sense in that context? 

And I can look at a question that I think has been picked up in the testimony already, if you are concerned about the double tax on corporate investments, which I think is something serious to think about, perhaps the appropriate way to think about that is integration of the individual and corporate tax regimes. The plain fact of the matter is that I make my living by the fact that corporations do not effectively pay tax at a 35 percent rate.  You have to separate between what the Code says is the top marginal rate and what actually happens before determining whether there is a double tax and how it should best be addressed.

Another thing you can think about is what Professor Burman has been discussing about the benefits of deferring realization.  At some level, you may want to think about expanding the existing marking‑to‑market and loss capitalization regimes.  You have to think about something in that regard if you are going to expand the ability to deduct currently losses on capital assets.  You have to think seriously about capitalizing loss regimes so you don’t get a substantial amount of arbitrage. 

The staff can do a lot of thinking technically about your question and make some proposals.  I am not saying that, for example, that taxing gains on farmland at ordinary income rates is going to be particularly popular. It is just something to think about.  You are not going to get more farmland, whatever you do with the capital gains rate. 

Mr. Boustany.  Thank you. 

I see my time is expired.  Thank you, Mr. Chairman. 

Chairman Camp.  Thank you. 

Mr. Rangel is recognized. 

Mr. Rangel.  Thank you so much. 

I know we are concentrating really on capital gains, but having experienced the 1986 tax reform and thinking at that time that it was partisan and it was rough, I had no idea that the Congress could really get to the stage that we are today, where even allowing the President to be able to adjust the debt ceiling became a partisan issue. 

Having said that, I was talking to Senator Wyden to say that before we concentrate on this we have to get some sense of civility that the parties really want to talk.  And I assume that all of you are wishing, if you don’t believe, that after the election there will be a better sense of responsibility that Republicans and Democrats have to the economy and to the country. 

Having said that, I don’t think we will ever get away from the fact that everyone wants reform as long as it doesn’t adversely affect them; and the question of a mortgage and charitable contributions and local and State taxes would remain an issue.  But can anyone tell me before my time runs out exactly why religious institutions are exempt from taxes on income that they receive?  I mean, we just accept it, but does anyone just ‑‑ it shouldn’t be something you have to ‑‑

No?  Because I had thought it was because they provided the glue in terms of moral responsibility, that gap between capitalism that should work to make money and that bridge between government that should provide for the poor and the vulnerable.  And they play absolutely no role in the budget that we are dealing with today as the institution.  They play no role as relates to peace and war.  They play no role as to which countries we bomb.  Their voices are not heard except perhaps on same‑sex marriage.  But I assume none of you believe that we would ever contemplate of even considering taxing religious institutions.  That is correct, right? 

Having said that, do you think that there is an area that we could go into local and State taxes and have that not deductible?  Is that one of these third rails that we could get over if we were talking to each other? 

Mr. Burman, you remember in 1986 the problem we had with that.  At least I do. 

Mr. Brockway.  I think the question about religious institutions generally is a policy issue.  I don’t really think it is something that is an economic issue that tax experts can speak to. 

Mr. Rangel.  I don’t understand.  I would assume there is trillions of dollars out there if we looked at it as a tax issue.  I know politically ‑‑

Mr. Brockway.  But, Mr. Rangel, I think they generally operate as charitable institutions.  They are nonprofit, and they are performing services but not raising net profit by the time you look through their books.  To the extent they are running businesses, profit‑making businesses, I think they are already brought into the system. 

On the State and local tax issue, that obviously was a critical part of the 1986 discussion, and the bill almost cratered precisely over that issue.  It comes down in good part to being a regional issue.  At the end of the day when people understand the way that you are thinking about paying for the rate cuts is eliminating the deduction for State and local income tax, they may think that is a good idea if they live in Texas, Florida, or Oregon but not if they live in one of the other States that has a higher rate. 

Chairman Camp.  We really are out of time now. 

Mr. Rangel.  We are?  I am over? 

Chairman Camp.  You have gone over. 

Mr. Rangel.  Well, okay, Mr. Chairman.  Thank you for your great contribution in clarifying the religious institution issue.  I leave a better person.  Thank you. 

Chairman Camp.  Thank you. 

Mr. Marchant is recognized. 

Mr. Marchant.  Thank you, Mr. Chairman. 

For Mr. Lindsey and Brockway, I have been spending my time at home with two groups of investors lately, business owners, and seniors.  When you talk about the tax reform of 1986 and talk about the realignment of capital gains rates and dividend rates, in 1986, after the reform, there was a significant realignment of interest and liquidation in the real estate industry; and I wonder if in fact we could approach that subject in this tax reform in the time that we are living in now, where we have already had a significant amount of liquidation and realignment in the real estate industry.  I think that would be something we have got to talk about. 

Secondly, in 1986, there were options besides dividends for those that needed income, and there were less people in 1986 that depended on income.  There were fewer seniors.  So if you have a significant liquidation and realignment, if you raised the dividend rate now, there are no alternatives for income.  They are not the same alternatives for income that existed in 1986.  I think you could probably get 8 or 10 percent on a long‑term CD. 

So if that significant realignment and liquidation takes place, then does it, in fact, actually result in an increased tax revenue or does it have a very ‑‑ does have it a flat effect or does have it a negative effect on it? 

And the last thing is that the investors that I talked to say at 15 percent they do not spend any time or money on tax avoidance exchanges, et cetera.  They do the deal, they pay the tax, and they go on down the road.  They say that there is a rate at which they will return to the old behavior of avoiding the tax, doing tax free exchanges.  And, in fact, if we raise that too high, where would the sweet spot be where you would not in fact have a decrease in tax revenues? 

I know that is a long question. 

Mr. Brockway.  Well, certainly after the 1986 Act, if I were dealing with real estate investors, I would go under an assumed name.  So I am not arguing that it didn’t have an adverse impact on that industry. 

But I think where it most significantly had an impact was that a substantial part of the financing of real estate was in the form of tax shelter arrangements that had created a bubble in some real estate prices at that time, but it was because of the effective negative tax on real estate investment that was in place. 

So, yes, when you change things, there is going to be a discontinuity, a disruption in the marketplace, and that is inevitable whatever change you make, because the market will adjust to whatever current law is.  And that is unfortunate, but sometimes you just simply have to break a few eggs, if you will.  How big it would be in this situation, I am not sure. 

For the issue about the elderly who are dependent upon dividend income, if your concern is that elderly lower middle income taxpayers may be subject to increased tax on their retirement income, you can still have comprehensive tax reform and meet the design constraints if you provide preferences for up to a certain dollar amount.  Now I am not advocating that as a theoretical matter of tax policy, but if that is what your economic and social concerns are, which are very valid, then think of those alternatives as well, I guess I would say. 

Chairman Camp.  All right.  Thank you.  Your time is expired. 

Mr. Reed is recognized. 

Mr. Reed.  Thank you, Mr. Chairman. 

Mr. Brockway, I want to continue on that conversation.  Because I try to ask as many practical questions, being a new Member here. 

I know we spend a lot of time on numbers and rates and everything else and how it impacts investors and the theory.  But when I go back to my family farm or when I go back to my senior citizen, I want to learn from your experience in 1986 when the capital gains rate went up and the impacts it had on the markets and those sectors in particular.  Is there anything you could tell me, having lived that experience, that you could give me, as going through the upcoming experience, some guidance as to how to lessen the impact on those folks, especially the family farmers and the seniors that you were just referencing? 

Because, to me, it would seem like there is a potential threat here.  And a lot of these guys, especially my family farmers, they are planning their retirements.  A lot of that is based on the sale of their inventory, their family farms, and that tax bill that is going to be potentially in there.  And if people are talking about raising the rates to some of the rates that I hear being thrown around this town, I am very concerned about that. 

So is there a way to transition through that in a practical way or is that just not something we can expect to achieve? 

Mr. Brockway.  Well, again, it is a matter of what trade‑offs you want to accept, and you can provide benefits up to certain income levels if you wish to.  If you do move the rate of capital gains taxation to, let’s say, 25, 30 percent, somewhere in that range, it is obviously going to have a negative impact on someone who has had a farm for a long time in their family and all of a sudden has this very large amount of income after 30, 40 years of holding the farm.  And they thought that revenue was going to be for their retirement, and it turns out a lot of it is going to taxes. 

So it is a very difficult problem.  I am not sure what you do about it at the end of the day. For most investors, for real estate investors, for example, their problem was so much the capital gains rate increase in 1986; it was the limitations the Act put on passive losses.  For family farmers, I think a very major tax concern has always been the estate tax treatment. It is a similar problem for them where those is potentially a very large tax being imposed. 

But I do think you have to accept that if you raise the rate for capital gains, unless you make some special exception that goes against the theme of comprehensive tax reform, you will have a difficult problem for certain people. 

I don’t think the financial markets minded changing capital gains rates at all – nor do I think it was a major burden for the real estate markets.  I don’t think that affected them at all, as best as I can tell.  But in situations like that of the family farm, it may have been significant. In any event, the lower rate on capital gains only lasted 5 years, so it obviously was of significant concern to some people and  you will get feedback if you raise the rate.  There is no doubt about it. 

Mr. Reed.  Thank you.  My time is expired.  I yield back. 

Chairman Camp.  Thank you. 

And for our final question, Mr. Smith is recognized. 

Mr. Smith.  In the interest of time, it won’t take long. 

I was wondering if you could reflect a little bit in terms of investor behavior within the 1031 like‑kind exchange and the impact that that has had?  Anyone on the panel. 

Mr. Brockway.  Well, taxpayers certainly use those provisions to be able to reinvest in other assets.  Whether it is in real estate or in autos or leases or whatever else, all sorts of businesses use the like-kind provisions because the alternative is that they would be required to take a slug of their capital away and not reinvest it in their businesses. Deferring that tax, at least in terms of immediate cash flow, is the same position as not having a tax on that income.  So it certainly is beneficial to the business.  But, again, you have to have this choice.  If that tax isn’t being paid, then where is the tax coming from? 

Mr. Burman.  That is a good example of how taxation of capital gains along with other provisions in the Code can produce inefficient behavior. I think the idea behind 1031 was you trade one kind of business for can defer the gain.  But my understanding, which is fairly limited, is that there is a whole industry devoted chains of exchanges that are all tax free and go way beyond the original intent of the legislation. 

So it does mitigate the sort of cash‑flow burden that is created by taxation of gain on sale, but it would make sense for Congress to think about whether 1031 exchanges are actually encouraging a lot of really economically inefficient behavior. 

Mr. Smith.  Thank you.  I yield back. 

Chairman Camp.  Thank you. 

I see Mr. Tiberi has arrived.  You are recognized. 

Mr. Tiberi.  Thank you, Mr. Chairman. 

One question to all of you, if you would try to answer it.  And it revolves around the short‑term impact of raising capital gains rates.  In July, the Wall Street Journal published an article that was entitled:  Get Ready for the New Investment Tax, in which the author described how taxpayers were beginning to react to the 3.8 percent tax that is going to go into effect in January of next year. 

One analyst predicted that investors would likely apply ‑‑ or reapply, shift assets into investments that would not be taxed at that 3.8 percent tax like the municipal bonds, for instance.  Others said that they were ‑‑ another analyst predicted investors would accelerate their investments into other options. 

Anecdotally, I can tell you of a family in Columbus, Ohio, in my district that has been in the real estate investment field for two generations now, going on the third generation, and their tax lawyer has told them that they need to get out of that business and begin getting out of it quickly, which they are. 

So my question to all of you is, what would be the impact for taxpayers if we did the same with respect to capital gains?  Would we see the same sort of reaction on the street from investors who would say, I am going to do this because of that? 

Mr. Burman.  I actually did an article in 1986 where I looked at the response of capital gains to the increase in tax rates that took effect in 1987, and it would actually be very good for the Treasury in the short term.  There was a huge surge in realizations at the end of 1986, total realizations doubled.  Realizations on corporate stock, which are the ones that are easiest to get rid of, actually increased much faster and there was a huge short‑term boost in revenues. 

Whether this would actually cause investors to massively move out of capital gains assets into others is more questionable.  If you actually look at the data, there didn’t seem to be a huge amount of change in the ownership of assets. 

The other thing is whether it has an effect on markets overall.  Certainly on the stock market the effect would be pretty minimal, because even if individual investors decided that they wanted to hold less corporate stock, institutional investors, pension funds would just pick up the slack. 

Mr. Tiberi.  Can we hear from everybody else? 

Mr. Verrill.  Yeah, I will go quickly. 

We don’t have the luxury of immediately exiting a public stock in order to change the means on which we might be taxed.  A fellow board member of mine, when asked this precise question, said my asset allocation will shift from early‑stage companies to tax‑favored investments, such as municipal bonds.  For those companies that I do invest in, I will look towards safer later‑stage companies, further exacerbating the funding gap for small companies. 

So I don’t have a statistically significant response for you, but I suspect if I did take a poll of the 7,000 angel investors that represent the ACA, you would have a pretty representative sample that would find very significant change in their behavior. 

Mr. Tiberi.  Thank you. 


Mr. Stanfill.  I think in my case I would sell a public security, which we funded as a venture capital firm, and use the proceeds to do more angel investing.

Mr. Tiberi.  The last two. 

Mr. Stanfill.  I think I would refer you to Allen Sinai’s work on this.  He estimates that if the cliff were about to go over it would result in a 19.8 percent decline in the S&P, and I thought it was carefully done.  I don’t know that it described any one number, but it was a carefully done analysis. 

Mr. Tiberi.  Thank you. 


Mr. Brockway.  I don’t have a view on what would happen. In 1986 I am pretty comfortable that there wasn’t any drastic result from that change.  I think everybody thinks the economy performed reasonably well after that Act. 

If you simply allow current law to go back to where it was in the 1990s, I have no idea what would happen.  Obviously, in the 1990s, the economy worked well.  So my instinct is it is not the end of the world, but I am not an economist. 

Mr. Tiberi.  All right.  Thank you. 

Chairman Camp.  Thank you all very much.  I appreciate your participation in this hearing and your testimony.

Senator Baucus, would you like to make any closing remarks?

Senator Baucus.  No, just thank you very much.  This is one of many steps we all are going to take. 

Chairman Camp.  Thank you.  Thank you very much.  This hearing is now adjourned.

[Whereupon, at 12:03 p.m., the committees were adjourned]

Member Questions For The Record

Mr. David H. Brockway
Dr. Lawrence B. Lindsey

Public Submissions For The Record

Alliance for Saving sand Investment
American Council for Capital Formation 1
American Council for Capital Formation 2
American Farm Bureau Federation
Associated Builders and Contractors
Center for Fiscal Equity
Edison Electric Institute
Investment Company Institute
National Small Business Network 
Small Business Investor Alliance 
US Chamber of Commerce