He could use that stock transfer to Calgon but he has to worry about paying $5,000 more every year in life insurance payments just to cover his death taxes. He is going to do it. That is not right. Buffalo, New York, Bed-Stuy, you name it. We have to have some new looks here. One of them, as I see it, is the depreciation proposal that gets rid of ADR. The other one you so strongly support, Mr. Chairman, is cash accounting which will get us into a simplified approach rather than using a crucial, LIFO, FIFO, and FISH, first in, still here. Mr. Ullman put his finger on an important point, the underground economy. NBC projects that at $40 to $50 billion right now. It would be nice to pull those people out of the underground and make them start paying taxes again. Thank you, sir. [Mr. McKevitt's prepared statement with attachment follows:] PREPARED STATEMENT OF JAMES D. "MIKE" MCKEVITT, DIRECTOR OF FEDERAL LEGISLATION, NATIONAL FEDERATION OF INDEPENDENT BUSINESS Mr. Chairman, my name is James D. "Mike" McKevitt, Director of Federal Legislation for the National Federation of Independent Business. On behalf of our more than one half million member firms, I would like to discuss the impact of estate taxes on small business. Upon initial consideration your reaction may be to ask what major problem a small business could have with estate taxes. After all, the unified credit exempts from taxation all gross estates with values of less than $175,000 without taking into account other allowable exclusions, such as the marital deduction. The public's general perception is that estate tax laws somehow force the very wealthy few to redistribute enormous amounts of family wealth upon death. We know that the truly wealthy actually redistribute very little family wealth because these wealthy few have sophisticated inter-generational tax planning devices to substantially avoid estate taxes. Table A illustrates that approximately 95 percent of all 1976 estate tax returns filed represented gross estates of $500,000 or less in size. The estate tax has been affected by inflation and bracket creep in much the same way as the income tax. Inflation has also affected the problem of placing a fair market value on a business and continues to cause great concern because of complex valuation rules that create inflated values. Valuing an ongoing business at a specific point in time is difficult under normal conditions but impossible when the economy fluctuates as it has been doing over the last few years. Often the difficulties result in inflated asset values and substantial estate tax liabilities that can force the liquidation or sale of the business to provide sufficient cash to pay the estate tax bill. Naturally strategies do exist for minimizing estate taxes, but they create their own distortions. One NFIB member in Virginia owns a lumber mill and is currently using 20 percent of his profits to purchase life insurance to ensure that there will be sufficient cash to satisfy an estate tax liability. Another member owns a soap manufacturing plant in a small city. The plant is a major economic factor for the city and for years the company has been very involved in community affairs. If the owner dies, the estate tax would force his heirs to sell the business so he pays exorbitant life insurance premiums which will allow the family to retain the business. A less expensive alternative would be to sell the business and take advantage of certain nontaxable exchange provisions in the tax code. Unfortunately, selling the business involves the real probability that the plant would be closed and the community would lose its major source of employment. The continuity of small businesses is being threatened by ever increasing estate taxes. While we are not espousing a policy goal that does not allow for changes in business ownership, by the same respect our tax laws should not encourage or make it more advantageous to sell a business than to keep it. In a recent survey of urban areas, participants were asked how they went into their present business. The response from northeastern cities indicated a substantial number either inherited or purchased the business from a member of the family. Policy considerations on the estate tax need to consider whether this factor could create the potential for distortion of business ownership patterns in these areas. Northeastern cities are already facing severe resource drains that would be further exacerbated if the rising cost of estate taxes forced the liquidation or sale of a business to a larger business. In 1976, $5.3 billion in tax revenue was generated by the estate and gift tax.1 According to Table A the major number of filers of estate tax returns were the smaller estates. We do not have the data on the distribution of taxes paid by the size of the estate. The facts lead to a question that needs to be answered. Is the estate tax necessary? Based on the percentage of small estates filing estate returns, it is probable that substantial financial resources are being spent on tax counsel and life insurance premiums. It might be that when the costs of government administration, tax counsel, and life insurance premiums are compared to the revenue generated, the estate and gift taxes are not cost effective. If this is so, can another, less costly way of raising this revenue be found? Additionally, is current estate tax policy placing too great an administrative burden on the small business? Since the wealthy minimize their estate taxes, it is possible that a relatively higher burden is being placed on smaller firms. To summarize, the following are the problems of small business with the estate tax: 1. Inflated valuation of business assets is causing inflated estate taxes to be paid. The result is that the Treasury Department, through the estate and gift tax provisions of the tax code, subsidizes life insurance companies. 2. The family owned business is being threatened by high estate taxes and the attractive tax benefits of non-taxable exchanges that encourage the sale of many family owned businesses to larger firms. 3. The rules which govern the determination of a business' fair market value are in need of revisions. 4. The rules that allow an estate to spread out any estate tax liability payments need to be liberalized to make this option more readily available to the heirs of a business. Solutions of various designs have been proposed by members of this committee. I would counsel you to attempt to attain three policy goals: 1. Overall reduction in estate taxes; 2. Simplification of estate tax rules; and 3. Certainty of estate tax responsibility. Our membership's ultimate goal with respect to estate taxes would be abolition of the estate tax. Statistical evidence leads one to the conclusion that the estate tax does not raise sufficient revenue in an efficient manner. Additionally the severe cost of life insurance premiums drains off profits that would otherwise be used for inventory or business expansion. Senator Symm's proposal for abolition of estate tax law is one our members would support if this committee decides to commit to that goal. However, abolition of estate taxes will require intensive study because of the legal and technical difficulties that may be encountered. The revenue loss would have to be picked up from other taxes, a major problem given the current_tax debate. We also strongly support the proposals of the National Committee to Preserve the Family Business, which entails amending Senator Wallop's proposal, S.395. Senator Wallop's bill provides an excellent framework for substantial relief from estate tax rules by small business. The proposed amendments provide more fundamental assistance to small business in the areas of valuation and liquidity than S.395. The proposal outlined by Mr. Ullman is necessary to preserve small business continuity and deserves serious consideration in the short term by this subcommittee. 1 Office of the Secretary of Treasury, Office of the Tax Analysis DISTRIBUTION OF GROSS ESTATE ON RETURNS WITH TAXABLE ESTATE—Continued Mr. NOWAK. Thank you for a concise and articulate statement. We have really tried to bring to the attention of many people this problem of trying to continue the small business community and what small business does for America. I think that is another aspect of the capital formation problem that discourages the passing on of the small business to another small business person, but discourages people from entering into the small business community in the first place. They realize that these problems are there and unless we start focusing on many aspects of this consolidation that has been in vogue for the last 15, 20 years, it will continue and perhaps even increase if we don't take direct action. I think this is one of the problems that we really should face as soon as we can, because as many will testify, there is greater productivity, greater efficiencies in a lot of the small businesses that are out there. Yet, because of the tax code and other problems, they are just not going to be able to exist in this country for a long period of time. It is interesting you mentioned the amount of dollars that had to be put aside for someone's estate planning through the purchase of life insurance. I don't think people realize what kind of dollars you are really talking about, if someone is 60 or 65 years old and he has to go out and buy insurance in an amount that will cover estate taxes and provide something for his widow or his children to continue that business. I wondered if you had any other surveys or examples of the kind of initiatives that have to be undertaken today just to cover that prospect within a small business? Mr. McKEVITT. Well, it is so intriguing. I think we will get into it more. One guy has a lumber yard in Martinsburg, W. Va. I am sure he is up there in that size Mr. Ullman was talking about, or Mr. Austin, or others, but we are talking about big bucks. That is just $5,000 add-on every year for Harry Austin over and above the others. Mr. SCHNEIER. Recently I spoke to a member of NFIB, Bruce Fielding, a member of the board. He is a CPA in Mountain View, Calif. He has a client who is protecting a potentially large estate tax of about $1 million. The gentleman is 73 years old. It is costing him $100,000 a year for life insurance. Mr. NOWAK. To cover that? Mr. SCHNEIER. Yes. Mr. NOWAK. Mr. Marriott? Mr. MARRIOTT. Always good to see you. Mr. MARRIOTT. I appreciate the work you are doing for small business. You, frankly, could support repealing the estate tax, period, could you not? Mr. McKEVITT. Yes. Mr. MARRIOTT. There is no need to mess around with unlimited marital deductions, expanded gifts, this and that. Don't you think we could get NFIB behind the move to make it a repeal? Mr. McKEVITT. We are going to poll our members on that. We always get a formal approval from our membership before we move. I would be surprised if they voted otherwise. I am saying the problem you have on this is that what if you can't get to that point of a total repeal? What we are working on is an alternate approach where maybe you have exclusion way up to a certain amount that does cover small business. Then you put on a cap against bases, maybe 20 percent. I talked to a couple of entrepreneurs, wealthy ones, who are not entrepreneurs any more, who said they would pay it under that circumstance rather than getting into all these shelters. Mr. MARRIOTT. I think your point is well taken I just want to make one other point about insurance and banks and estate planning. A ton of money is being made in planning estates, and I think your point was well taken. I have got books and books and books full of examples of what it has cost people to cope with estate taxes. If you put that money to some economic benefits other than to insurance agents, commissions, and insurance companies, all kinds of interesting things might happen. I think that we really ought to look at that. In fact, I would like to see this committee do some kind of a study or commission a study in terms of how much money is really spent in attorneys' fees and estate planning and trust departments and life insurance deals in terms of complying with an estate tax, and when all the smoke clears, who really winds up paying it. If we had that, I think it might give us a little more momentum toward an outright repeal. Mr. McKEVITT. I think that is an excellent idea. We have a tremendous data base to work from, with our 500,000-plus members. We would be more than glad to do that with the subcommittee. I think it is a super idea. Mr. MARRIOTT. Perhaps we could discuss that, Mr. Chairman. Mr. McKEVITT. I am a lawyer myself, so I will not be hypocritical about that. If it wasn't going to attorneys, or banks, or life insurance companies, it would be going into payrolls. Labor intensive small busi nesses. That might be a big shot in the arm for more jobs in this country for one thing. I think it would add to the continuing excitement of an entrepreneur to keep going. Mr. MARRIOTT. I thank you for your testimony. I hope we can put together a solution that will work. Mr. McKEVITT. Excellent point. Thank you. Mr. Nowak. As you know, NFIB did a similar study on inventories for us last year. It worked out very well. Perhaps we can structure something to get that kind of input. The ultimate cost of estate planning is going to be passed to the consumer. You are going to have higher prices and certainly more inefficiencies because of the forcing of these additional costs to the business. Mr. Roemer? Mr. ROEMER. Thank you, Mr. Chairman. Mike, I would like to add my sentiments to those expressed by my colleagues. If and when NFIB does a nationwide poll and finds that support for repeal or drastic modification of estate taxes are in order by your members, the one way to pursue it from that point would be an economic study, as to who actually paid the death tax. We have already individually and collectively accumulated the logical reason for a change, the fact that one of the great incentives for running small businesses and family organizations is to pass them on to one's children. It is an incentive as real as making money. It is an incentive that you can't shut off after 20 years or one generation. It is lifetime on lifetime. How can we put dollars and cents on that? We are ready to make those arguments. If you can assist us with the economic bottom line as to what revenue is brought in as compared to the ill effects of the dislocations, the transfers, the skewing of decisions, the complexity in a code that ought to be simple and clearly understood, you would be providing a service not only to this Congress, but to all of your members. I encourage you to do that. Mr. MARRIOTT. Would the gentleman yield? Mr. ROEMER. I would be glad to. Mr. MARRIOTT. I think you make a good point I would like to follow up on. Back 20 years ago it was easy for some of us young guys to go out, start business, find capital at reasonable prices, buy homes. There is a good argument for not taxing estates to heirs because nowadays you can't buy a home, young people can't buy homes. Getting into business is a lot tougher than it was 20 years ago. College tuitions are five times as high. The whole complexity of the system is greater. I think with that change there ought to be allowed a tax-free transfer of estates from papa to son or daughter. I think a good case could be made for that just in the times we are in. Mr. McKEVITT. Not only to papa, son, or daughter, Mr. Marriott, but I think also to-what about those loyal employees who have been around 17, 15, or 20 years? Or that partner whom you could |