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Washington, DC.

The subcommittee met, pursuant to call, at 9:30 a.m., in room 1100, Longworth House Office Building, Hon. J.J. Pickle (chairman of the subcommittee) presiding.

[The press release announcing the hearing follows:]

[For immediate release, Friday, Sept. 13, 1985]


The Honorable J.J. Pickle (D., Tex.), Chairman of the Subcommittee on Oversight, Committee on Ways and Means, U.S. House of Representatives, today announced a hearing on high-income individuals who pay little or no tax and the use of partnerships to reduce individuals' tax liabilities. The Subcommittee will receive testimony from the Department of the Treasury based on the results of its recent study and analyses of the subject. The Subcommittee hearing will be held on Friday, September 20, 1985, in the Main Committee Hearing Room, 1100 Longworth House Office Building, beginning at 9:30 a.m.

In announcing the hearing, Mr. Pickle stated, "The tax laws should ensure that everyone pays their fair share of taxes. The Department of the Treasury's study clearly shows that is not the case for a number of wealthy taxpayers. Deductions taken for losses from investments in certain partnerships seem to be the primary means by which high-income taxpayers drastically reduce or wipe out their tax liability altogether. These loss deductions do not necessarily reflect true economic losses. As we move into comprehensive tax reform, it is imperative that the Committee examine the operation and impact of our present law rules if we are to restore fairness and the public's confidence in our tax system."

Among the issues of concern to the Subcommittee are the types of tax shelters used and deductions claimed by high income taxpayers to avoid paying taxes, the growth in recent years of partnerships, the impact of partnership losses on high income taxpayers, and how the various tax code provisions are utilized to generate losses. The Subcommittee anticipates additional hearings on other tax shelter issues later this session.

Chairman PICKLE. The Chair will ask the committee to come to order and ask our guests to take their seats. We are going to proceed. We have other members on the way, but in the interest of time, I would like to make an opening statement. Then we will proceed with our first witness.

The Subcommittee on Oversight will conduct a hearing today to examine how high-income individuals are able to avoid Federal taxes. The Department of the Treasury will report on results of its study of taxes paid by high-income taxpayers and the recent


growth in partnerships. Also, the Treasury will report the resu of its review of selected partnership returns by outlining how t various Tax Code provisions can be combined to generate loss and which Tax Code provisions are utilized the mostist let me th As we move into tax reform next year, it is important that th subcommittee explore how our tax system currently affects a si nificant portion of the high-income population and identify tho issues which should be carefully considered before adopting a ne tax system. nalysis of both high-income taxpayers and, m

During recent trips home, Members of Congress found that on fundamental aspect of the current tax debate stirs the most inte est. This issue is the issue of fairness. A recent Democratic Stud Group survey in 60 congressional districts reinforces this finding The current tax system is perceived as unfair because a significan number of high-income taxpayers and corporations can take advan tage of investments which afford huge tax benefits to reduce thei taxes to almost nothing. As a result, many high rollers pay little o no income tax to the statement we have included two other doc Further, what should the public think about advertisements for legal tax shelters offering tax deductions of $10 for each $1tcontrib uted? Unfortunately, many of these well-meaning Tax Code provi sions have been used by some wealthy individuals and corporations to eliminate their tax liability. de het intend to refer to those doc It is not my intention to use this hearing to look for ways to soak the rich because most wealthy people do pay a higher rate of taxes. What we must be concerned about is that some high-income people have found ways to use the Tax Code to avoid paying their fair share.for debate in the issue of * Dese As the comrattuen pr Clearly, Congress has intended to provide some investment incentives in our Tax Code. And these tax provisions have become very important, particularly now in helping American businesses compete with foreign businesses that receive subsidies from their governments. But I don't really think that Congress ever intended to allow a person making more than a million dollars a year to pay no taxes price a simm ficant portion of ineses reflected in high-incom Finally, let me note that a tax reform bill that will garner both public and congressional support must directly address the issue of fairness. I know this will be a complicated task, but this subcommittee's effort will contribute to this essential goal. x. and on th We are happy to have with us today Mr. Ronald Pearlman who will describe the results of the Treasury Department's study on high-income nontaxpayers. Mr. Pearlman is, the Assistant Secretary for Tax Policy in the Department of the Treasury is, that mids Before you proceed, Mr. Pearlman, let me yield to Mr. Dorgan for any statement he might make.


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Mr. DORGAN, I would like to commend the chairman for calling these hearings. I think they are important hearings. Holiers or ta The chairman used the phrase soak the rich, and he and I know full well the rich don't have any particular danger of being soaked these days with the kind of Tax Code we have. Our Tax Code, unfortunately, has become a lot of exclusions and deductions that allow you, if you have enough money, to pay a good deal of money to the best minds around to search for the widest loopholes possi ble. Those whose income is listed on a W-2 form have no flexibility,

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of course, and continue to bear the burden of financing our Government.

The reason this is becoming very, very important to us is that this is the first generation of Americans, those who have been raised in the last 15 years, who have actually seen demonstrated evidence that the rich can make a great deal of money and pay nothing. The President and have, either inadvertently or by their own actions, their income taxes disclosed and incents have, have shown a great deal of income for which they paid nothing in taxes.

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Another President did pay taxes, but my guess is just Another residentiome couldn't figure out how not t how not to pay. If he had the wherewithal, he would find somebody who would allow him to avoid his taxes as well. he subcommittee presting. or immediate release, Friday, Sept. 13, 1985]

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The point is, we have a tax system which is not fair to the work-ON ing people in the country because a lot of big folks and big corpora-ON tions are able to make big money and pay nothing I have said in the past the system has become a feedlot for the rich. I think thatht is the case. If you Me rich enough, you can figure out a way to a move your tax That 1 is fundarus mentally wrongnent of the Treasury based on the results of its recent study and As a former tax administrator MreaChairman, especially feelm that we have a responsibility with respect to our revenue system, weg! t but the storm clouds are growing over thate system and they are at dark and ominous. The reason the clouds are dark and Tominoussisdy ductions the American people perceive, correctly in many instances in The orary judgment, that this system reeks with unfairness and that some-libody ought to make it fair. deductions do not necessarily reflect true economic I think that demonstrations of the unfairness through testimony today will propel us further toward tax reform and toward cleaning up a system that desperately needsbitmThank you, Mr. Chairman PICKLE. Thank you, Mr. Dorganvers to avoid paying taxes, the to aver Mr. on: high Secretary, I notice you have a lengthy statement cludes many charts and statistics. Loam going to ask we puttyouries entire statement, including the charts, in the record, so it will be made part of this hearing, and we will ask now that you proceed toto summarize itask our guests to take their seats. We are going to proBut if you follow your testimony, try to indicate just where you of are and what reference you make, if you follow it that closely, soowe can follow yoursas best we can. We will not limit you to any 5minute summary. We want yous to give us ca fullt analysis of this ifto you can. Mr Pearlman come individuals are able to avoid Federal taxes. The Department of the Treasury will report on results of its study of taxes paid by high-income taxpayers and the recent

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Mr. PEARLMAN. Thank you, Mr. Chairman. First let me thank you for the opportunity to appear before the subcommittee this morning.

We have spent, as you know, a good deal of time the last several months trying to put together some data in response to your two requests for an analysis of both high-income taxpayers and, more specifically, partnerships and partnership losses. What I am going to try to do this morning is summarize that data as best I can for you.

We have included in the written materials to which you refer a statement that includes some tables. Just to make sure we are all talking about the same tables, when I refer to tables during my comments, they are the tables that follow page 11, the last page of my written statement.

In addition to the statement, we have included two other documents you have received previously. First is the report we transmitted to you, Mr. Chairman, on July 31 on high-income taxpayers. The second item, which you received this week, is a detailed analysis of our partnership study. It goes into more specifics about the methodology of that study. I do not intend to refer to those documents with any specificity this morning.

Let me begin by saying that we share, and I want to make it clear, it is the administration that shares the view that I know you and the Ways and Means Committee hold that a major focus of the tax reform debate is the issue of fairness. As the committee proceeds to develop legislation on fundamental tax reform, we think it is quite appropriate to examine the tax burden borne by some highincome taxpayers relative to others.

Similarly, it is appropriate, we think, to examine partnership activities since they are frequently seen as vehicles for tax shelters, and I think our data will be helpful to you since partnership losses do comprise a significant portion of losses reflected in high-income taxpayer returns.

With any analysis of high-income taxpayers and partnerships, a natural reaction is to focus on the negative aspects, that is on how many high-income taxpayers pay little or no tax, and on the growth of partnerships with losses. These are clearly parts of the picture, but I think it is also important, as you have indicated in your opening statement, and indeed as Mr. Dorgan indicated in his comments, to keep in mind the positive aspects. That is, that most high-income families do pay a fair share of taxes, and most partnerships earn a profit.

Unlike corporations, partnerships flow through their income and expenses, and, therefore, they are conducive to tax shelters or taxsheltered investment. The partnership form of organization does serve important business purposes in allowing individuals and other enterprises to conduct business together or to invest together. Partnerships are not the only vehicle in which investors can receive preferential tax treatment. Individuals can conduct business as sole proprietorships, and groups of individuals can associate together in corporate form with the small business corporation, so

there are other ways in addition to partnerships in which individual taxpayers can also undertake tax-sheltered investments.

But neither the business entity used for the shelters nor the high-income individuals who participate in them are responsible for the unfairness in our tax system and the prominence of tax shelter activity. Rather, I think we totally agree with Mr. Dorgan's comment, the problem arises from the high marginal tax rates and the ability of taxpayers to reduce those rates by investing in activities that are given preferential treatment in our existing tax system. Thus, in many instances those tax provisions which are intended to encourage certain kinds of economic activity are also those that cause the perception that the system is unfair.

Now, my statement and my comments will be divided into three sections. The first reviews the high-income taxpayer analysis that we transmitted to you, to the subcommittee, in July. Second, I would like to review our more recent analysis of the growth in partnership activity over the past two decades; and then third, I will review with you our analysis of the most recent partnership tax return data and try to point out some of the highlights of those data.

In order to undertake the high-income taxpayer analysis, it was necessary for us to develop some concepts that are not commonly referred to and which are not part of normal tax return jargon. Therefore, I would like to spend at least a moment in explaining to you the concept of total positive income, which is very important to our analysis of high-income taxpayers.

In analyzing high-income taxpayer returns, we must be able to measure income before deductions or offsets to income reported on those returns. There are two categories of deductions or offsets. First the items that receive most attention are the so-called belowthe-line deductions in taxable incomes, the itemized deductions, and tax credits with which we are familiar and which show up very prominently on the tax return.

The second, but certainly as important a category of items, are the so-called above-the-line offsets. These include business and investment losses, exclusions, including the capital gains exclusion, and income adjustments. The above-the-line offsets do not always appear quite as clearly on the tax return. It is easy, as I indicated, to identify the below-the-line offsets because we can look at a tax return and identify those items of deduction or credit that are claimed so-called below the line. It is much more difficult, however, to identify the above-the-line offsets..

In order to be able to identify both, which is important in undertaking the analysis that we presented to you, we utilized a concept called total positive income. This concept uses tax return data, and includes primarily wages, salaries, dividends, interest, and income from profitable businesses and investments. Because total positive income excludes the current law capital gains exclusion, IRA contributions, Keogh contributions, business and investment losses, it permits a comparison of, if you will, the beginning point in terms of identifying income before both above-the-line and below-the-line offsets.

I want to point out, however, and I consider it an important point, that many losses reported on a tax return, whether from

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