I think of the two bills utilization of the exemption approach is better and a $600,000 exemption would be far better than a $192,800 credit.

I would like to say too, I endorse everything Mr. Reister said. I can see he and I are practicing in about the same areas. I listened intently to his testimony. I certainly endorse everything that he said.

I might make a comment too, if I may, on revenue loss. We have got-there was a question about whether-what the ultimate revenue loss is for estate tax.

I think there are some things that ought to be considered. One is that you have, of course, as Mr. Reister said, all of these deductions in connection with estate planning and the administration of estates which are deducted from fairly high-bracket income.

We have also got the lost business income of these businesses that have had to distribute that capital.

We have got the lost jobs of the people who would work at the machines that aren't bought, and we have got the lost investment income of-well, we have got the lost investments by those companies in machinery and equipment that they would make with that money if it were left in the businesses instead of being extracted. So I think the estate taxes are very counterproductive taxes. Our position is, we would support its repeal.

Thank you.

[Mr. Kolbe's prepared statement with attachment follows:]

PREPARED STATEMENT OF WILLIAM F. KOLBE ON BEHALF OF THE INDEPENDENT BUSINESS ASSOCIATION OF WISCONSIN

Mr. Chairman and members of the Committee, my name is William F. Kolbe. I am a practicing attorney in Racine, Wisconsin with the firm of DeMark, Kolbe & Brodek, S.C. I will first make some introductory statements concerning the Independent Business Association of Wisconsin and myself and then address myself to the impact of Federal Gift and Estate Taxes on small business.

The Independent Business Association of Wisconsin (IBAW) is in its tenth year representing independent owners and managers of Wisconsin small businesses. We generally define a small business as one having less than Five Hundred employees and approximately ninety percent of our Six Hundred members have less than Two Hundred employees. Thirty-five out of the fifty-three delegates elected from Wisconsin to the White House Commission on Small Business, which submitted its report in April of 1980, were members of IBAW. IBAW is a member of the Coalition of Small and Independent Business Associations and of "Small Business United", "Washington Presentation" which annually presents to the members of the House of Representatives and United States Senate the needs and recommendations of small business throughout the country on many subjects.

As to myself, I worked as a trial lawyer for the Tax Division, U.S. Department of Justice, representing the Internal Revenue Service, from 1955 until 1960 and have been engaged in the private practice of law, specializing in tax matters, from 1960 to date. For two years I have taught at our State Bar Tax School and for eight years I taught a course in adult education on estate planning at the University of Wisconsin. Our firm represents over one hundred and fifty small closely held businesses in Southeastern Wisconsin. We do not represent any publicly traded companies. One of our primary and constant concerns is the impact of the Federal Estate Tax on those small businesses. Please note that I am describing it as a tax on the businesses and not as a tax on the owners for this is where the problem lies and I will elaborate further on the importance of this distinction.

Let us first look at the role of small business in our economy, then at the amount of estate tax imposed upon it, the effect that the imposition of these taxes has on those businesses, whether that effect is acceptable and, finally, if not, what should be done about it.

As to the role of small business, President Reagan summarized the bottom line in his April speech to the Congress when he noted that these businesses provide over

fifty percent of all private employment and over eighty percent of all new jobs. Since these same businesses, by comparison, only provide forty-three percent of the Gross National Product, it is evident that they are more labor intensive than major industry and provide our most fruitful source for maintaining and creating jobs. Federal Estate and Gift Taxes now impose crushing burdens on these businesses— burdens which would destroy the major publicly traded industries if they also had to bear them. This burden is illustrated by the following chart which is based upon these assumptions:

(1) The business is owned 100 percent by one generation of one family.

(2) Other assets such as the home, savings, life insurance, etc. produce additional tax which is absorbed by the Unified Credit.

Through Sections 6166, 6166A and 303 of the Internal Revenue Code, Congress has provided for ten and fifteen year deferrals of this tax, bargain rate interest on the deferrals and for the tax-free extraction from the Company of the money necessary to pay the taxes. Due to these provisions some small businesses are able to pay the taxes and survive. Many must be sold.

In Racine, Wisconsin, where I practice law, many of our major small businesses have been sold. Western Publishing has been acquired by Mattel, J. I. Case and Walker Manufacturing have been acquired by Tenneco, Racine Hydraulics has been acquired by Rexnord, In-Sink-Erator and Dremel Manufacturing have been acquired by Emerson Electric, Jacobsen Lawn Mower has been acquired by Textron, Wrapping Machinery Company has been acquired by Reliance Electric Co., Hartman Hydraulic has been acquired by Koehring, Voorlas Manufacturing has been acquired by General Signal and lately Gettys Manufacturing has been acquired by Gould, Inc. From 1960 through 1976, 37,500 small business acquisitions have resulted in a 24.5 percent decrease in small business' contribution to the Gross National Product despite the fact that new business starts are averaging 500,000 per year. I have been counsel in several of these acquisitions and I can assure the Committee that impending Federal Estate Taxes were a significant factor in the decisions to sell. For many companies there is really no other escape; it is impossible to pay out half of a company's new worth, even over as much as fifteen years with interest, and remain competitive-much less be able to grow. They do not wish to face the forced sale situation created on the first or second owner's death and, therefore, select a negotiated sale prior to the owner's death.

Unlike owners of publicly traded securities, the owner of a closely held business cannot simply sell forty percent of the stock in order to raise the money to pay an effective forty percent tax rate on its value. No one is buying minority interests in closely held businesses and very few even wish to purchase control and then have to contend with continuing minority shareholders. The Congress has recognized this total lack of market by providing for the referred to deferrals in tax and for the taxfree withdrawal of funds from the business to pay these taxes. Because the business itself is the only available source of funds to pay the tax, these Federal Estate Taxes are actually taxes on the business rather than on its owners. It is the business that must marshall and pay out these percentages of its total value and, where goodwill is a factor, any given percentage of value may be a much higher percentage of book or net asset value. Surely, if one of our major industries, such as IBM or General Motors, were to embark on a program of distributing over one-half of its present value over the next ten or fifteen years it would simply cease to exist as a productive or competitive company. The same is true with a small business. As an illustration of the problem, we are now working on an estate plan for a gentleman who owns seventy percent of his business. In order to provide for Federal Estate Taxes, management must institute plans of cash preservation which have stunted product development and have prevented a plant addition. This company will be stagnant for the next fifteen years. It will not provide jobs or be able to purchase the production equipment to increase productivity.

I have described these estate taxes as taxes on the business and not on the owners as the taxes must come out of the business. The inherited stock will certainly lose value but that does not have an immediate effect on those inheriting it. The owners will still send their children to the same colleges, live in the same homes and generally maintain the same lifestyles. However, production machinery will not be purchased, workers may be laid off and those seeking new jobs will not find them. Those people are hurt immediately. I submit that this situation is unacceptable. The White House Commission on Small Business, April 1980 Session, concluded that relieving this estate tax burden was the third most important thing which could be done to assist capital formation for small business; it was only preceded by reduced income tax rates and depreciation reform.

If the Congress concludes that the imposition of these estate taxes on small businesses is not acceptable, then the next question is "What should be done about it?" I do have these suggestions:

1. The tax should be deferred until the inherited stock is sold. Interest on that tax would result in basis reductions.

2. Alternatively, the payment period could be further extended, without interest, with the interest not being charged resulting in basis reductions.

3. The four percent interest now available under Section 6166 should be extended to 6166A and applied to the entire amount of deferred tax, under both Sections. 4. The increases in the Unified Credit and rate reductions now proposed would be of significant help and we endorse those changes. Also, H.R. 3682 and "The Family Enterprise Estate and Gift Tax Equity and Reduction Act" would significantly reduce the taxes in the above schedule and we endorse them. However, to avoid having invested capital removed from these businesses to pay even these reduced taxes we suggest also incorporating the indefinite deferral suggested in "1" above. If that were done, then whatever estate tax burdens the law may impose would be fully born by business owners but the business would not have its invested capital impaired. The taxes would be paid on an eventual sale of the business and interest for the deferral period would be charged through income taxes on the sale resulting from reductions in basis.

Thank you for the opportunity of addressing your Committee.

SUPPLEMENT TO WILLIAM F. KOLBE STATEMENT-COMPARISONS THROUGH DEATHS OF BOTH

If the estate plans equalized taxable estates with less than a full (100 percent) Marital Deduction, the total tax on both deaths under the bipartisan proposal would always be $291,600 less than under present law. However, one-half of the resulting tax total would then be payable on the first death. For example, with a 5MM business (plus $300,000 in other assets), the tax at each death would be $912,500 for total tax of $1,825,000. The early payment of $912,500 on the first death by not taking a full Marital Deduction in order to eventually save $326,000 ($2,151,000 less $1,825,000) in total taxes would make sense in many situations where either 1) Sec. 6166 or 6166A deferral is available; or 2) both spouses are of advanced age.

Mr. NOWAK. Thank you very much, Mr. Kolbe.

The thrust of all of this, of course, is, we have talked about continuity. How can we react to the different environments that are out there in order to put something sensibly together. What has inflation done in the last 4 or 5 years? Your suggestion that a millionaire today isn't what a millionaire was 20 years ago or 10

years ago, is well taken. The businesses have grown and inflation has certainly played a very important role on the value of those businesses.

Then, of course, you have got this problem of concentration of businesses, and if that is a socially desirable thing to have. The estate tax is forcing these decisions to be made much before retirement or much before someone has to face the decision of what to do in case of death.

The suggestion that the vengeance that this tax attaches, especially where there is perhaps little liquidity, has to be faced by Congress. Hopefully, the Ways and Means Committee will look at that.

We are going to try to provide them with all the information we can by developing this record. That is one of the purposes of this testimony.

Mr. Tonneson, if I could ask one question about the ESOP encouragement that you allude to here in your testimony as one of the seven ways to help solve this problem. As we know, if a person does not have children or if the children go into a different profession, some of the key employees sometimes have a real interest in getting into the ownership of the business.

I was wondering if you could-if you have any personal experiences with a company that has looked at ESOP or how you would visualize this happening at the death of the head of a business?

Mr. TONNESON. Well, your question ties in very nicely with the illustration I used of Mr. Stearns. Mr. Stearns does not have a wife. He does not have children and he is the gentleman, if you remember, who has built a company that employs 40 people and is growing at the rate of 70 percent a year.

He has very competent, highly qualified employees. He would like to see those employees continue that company. When the SBA task force on business continuity met, the ESOP concept came up repeatedly. They had a special subcommittee on ESOP. The recommendation in my testimony in truth comes from those subcommittee hearings.

The idea is that a person like a Mr. Stearns would be encouraged if he could get a charitable deduction on his income tax return, if he made a contribution of stock to the ESOP so that he would be encouraged during his lifetime to make donations to the employees' stock ownership trust.

That encouragement would come the same way we now encourage people to make gifts to colleges, universities, and hospitals. That is the idea. It is to fit that particular problem.

The other thing that I was really amazed at these hearings on ESOP's and the whole continuity issue-and I am really digressing, if I may, for one second. It doesn't answer your specific question. Mr. NOWAK. Fine.

Mr. TONNESON. There were 38 businessmen from around the United States who convened for six meetings in Washington, 3 days each. I came away from a meeting after many trips, saying that the revenue loss in this country is fantastic because of the time businessmen take from their daily activity to try and figure out how to avoid the estate tax and how to avoid this whole continuity problem.

I submit to the committee that the loss of productive time by key management, I don't know how it could be measured, but after those meetings I can assure you we are losing a tremendous amount of revenue because people between the age of 50 and 60 get discouraged; they do not want to continue to build their small business; they run around trying to find a lot of schemes to avoid the estate tax, and they really do not give their full energy to making the company grow.

There is a significant revenue loss, and indirectly I have answered one of your earlier questions about revenue loss. It is a tremendous amount of money.

Mr. NOWAK. Mr. Marriott? Do you have questions?

Mr. MARRIOTT. Not too many questions. Just a couple of comments. I think Mr. Tonneson, your information or your recommendations on valuation are very timely.

I think that is a big problem and needs to be resolved. Your attribution question I think is another one that I have some specific interest in and would like to see some changes made.

Let me ask you this: I am a little bit unhappy about the small business groups just jumping on this Reagan revised tax cut plan. It seems to me that it has not been well thought out. There certainly are better ways to go.

I guess it is better than the status quo, but why don't we get the small business groups like yourself and your associate to put on your hats, and get your flags, and come down here and beat us over the head with some real proposals that are going to make some difference?

I think the small business groups, if they got united, could put enough pressures on to totally repeal the estate tax and we would not have to be monkeying around with all these Band-Aid approaches.

Why don't you do that?

Mr. TONNESON. Thank you for the question. To answer you directly I think the small business community-up to this point-has never felt it was never in reality-political reality-there was never an opportunity to repeal the estate tax.

The White House conference vote, if you look at that vote, was to repeal or amend the estate tax. The SBA report that has not been published yet will use the same language.

They begin with repeal and they say "or amend." They are dealing with political reality. What can we really get out of the Congress?

The Band-Aid approach, I agree with you, the bipartisan bill does not answer the problems. Everybody who has testified here today has demonstrated that clearly.

The third proposal in my testimony we feel is a novel approach, a new approach, and will answer some of the specific problems, because in our third recommendation here, we are saying that an executor, where you had the small business, could value at his election the small business at the decedent's original cost; so if the decedent's original cost was very, very low and you took the election to valuate at the decedent's cost, you would have very little estate tax and, in effect, get a postponement of that tax until the family sold those shares to outsiders.