IMPACT OF ESTATE AND GIFT TAXATION ON CAPITAL FORMATION WEDNESDAY, JUNE 17, 1981 HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON TAX, ACCESS TO EQUITY CAPITAL AND BUSINESS OPPORTUNITIES, COMMITTEE ON SMALL BUSINESS, Washington, D.C. The subcommittee met, pursuant to notice, at 9:35 a.m., in room 2359-A, Rayburn House Office Building, Hon. Henry J. Nowak (chairman of the subcommittee) presiding. OPENING STATEMENT OF CHAIRMAN NOWAK Mr. NOWAK. Good morning. The subcommittee will come to order. Unfortunately today there is a lot of conflicting business in the House. The caucus just went into session on the House floor, and there are many other different hearings going on. I wanted to give everybody the opportunity to testify this morning. I thought we would start. As people free up, I am sure others will be coming in. I just want to mention again for all the witnesses that will be testifying, your complete testimony will be accepted into the record and you may summarize it or continue as you so desire. This morning we will continue the hearings we began yesterday on the impact of the Federal estate and gift tax on the continuity of ownership of the closely held business and farm. Yesterday we heard testimony to support our contention that estate and gift tax provisions are extremely complex, that large sums of money are being spent on estate planning and life insurance, which could be more profitably used for capital formation and that comprehensive reform is urgently needed in this area. Our first witness this morning is John Fitch, vice president, Government Relations, for the National Association of WholesalerDistributors. They have been especially concerned with inventory valuation and urban enterprise. It is a pleasure to have you before the committee once again, Mr. Fitch. TESTIMONY OF JOHN H. FITCH, JR., VICE PRESIDENT—GOVERNMENT RELATIONS, NATIONAL ASSOCIATION OF WHOLE SALER-DISTRIBUTORS Mr. FITCH. Thank you, Mr. Chairman. Briefly, I will summarize my statement and then draw your attention to some specific items in the statement I think are important. (61) 82-735 0-81--5 First of all, I would like to emphasize the fact there is a crisis in perpetuation for the small family owned wholesaler/distributor and small business generally. There is a need to address the issue immediately. The results of our survey that we conducted back in 1973 will point that out. The irony is they are still valid today. Generally speaking, we advocate the total repeal of the estate tax laws for reasons that I will outline later. The alternative to that would be to significantly increase the exemption in the estate tax law and to provide for an unlimited marital deduction, even to the extent of providing an unlimited deduction to children who might be actively involved in the business. We also feel that there needs to be an increase in the brackets to counter the bracket creep that has occurred in estate taxes as well as individual and corporate tax rates. The repeal of the estate tax laws is one issue we are totally committed to. We believe that the purposes of the estate tax laws as originally designed: One, to provide a revenue source to the Federal Government; two, to increase mobility and redistribute wealth; and three, to enhance the progressivity of the tax system have either been accomplished or are not valid today. As a revenue source, I think witnesses yesterday pointed out the fact that estate tax laws very definitely are not. In fact, it may be a revenue loss depending upon how you look at the calculation of the administrative costs involved in administering the laws. As a social goal of increasing mobility and redistributing wealth, I think it is obviously clear that a broad spectrum of society is participating to a very great degree in the economic activity of this country and those who have accumulated wealth through their entrepreneurial efforts are passing it along to their families outside the context of the estate laws. They are obviating the estate laws so the estate tax falls primarily on the smaller, family owned businesses and individuals. I might also point out that estate taxes distort the normal processes by which small business owners and others would use in the distribution of their estates upon death. For example, a CEO may sell out or merge with a larger company prior to death strictly as a means to avoid estate taxes rather than as a considered business decision. This not only distorts the natural development of the economy but arbitrarily and artificially reduces the number of independent, family owned businesses. It increases concentration and reduces the incentive for the CEO's family members to become involved in the business. I think that is an important point that we would like to emphasize. On estate tax rates, I would like to draw your attention to page 14, table 2, where we have a chart that describes the impact of estate taxes on the typical wholesale/distribution firm based on asset size. The important point to take away from this is the ratio of estate tax liability to asset earnings. The typical wholesale/ distributor has a ratio of 3 to 1. It is very difficult for a spouse or family of a CEO who is faced with this kind of situation to determine how to pay the estate tax and keep the business. The general tendency is to sell the business, and that is in a distress situation which many larger companies have a knack for keeping their eyes out for and not necessarily giving the best price for the business. I would now like to focus on our study which is attached as an appendix to this statement. I particularly want to highlight some of the things about that study. We initiated it in 1973. I might add that an updated study like this may be helpful. This subcommittee might want to get involved in this kind of project to see what the figures look like for 1981 or beyond. The study involved 38 commodity line associations and covered about 18,000 firms with a response rate of about 5,000, which is extremely good. It was conducted by Robert Banasic and Harold Squire, Ph. D.'s of Capital University Graduate School of Business Administration in Columbus, Ohio. The typical ownership profile of a CEO in the wholesale/distribution industry was characterized in 1973 as having a net worth between $250,000 to $499,000. A CEO owns 51 to 74 percent of the firm's outstanding stock. The CEO is between 50 and 59 years of age. The minimum-maximum Federal tax bracket for the CEO is 35 to 49 percent. His ownership represents 51 to 74 percent of his total net worth and the corporation has a minimum of $100,000 in life insurance payable to it upon his death. I think it was pointed out yesterday what the impact of the payment of life insurance premiums has on the business. I would like to also point out the fact that the survey shows, using standard mortality tables, that 61 of the 4,700 owners replying to the survey in 1973 would die by 1975, and the chief executive officers of the firms surveyed are dying at the rate of about 1 per week. I would like to emphasize further the urgency of the problemmainly because after World War II many of these individuals came out of the service and started their businesses at age 20 or 25. Right now they are in the 60-65 age bracket. They are making their decisions now as to what to do with their businesses; but, the phenomenon it is cyclical in nature. There are many new industries that have been created since World War II, in the fifties and sixties-like the electronics and chemical industry, for examplewhich will peak probably later on in this decade. These will lead to another bunching situation. I might point out that on page 7, the table shows the age distribution and mortality in terms of deaths expected by 1985. It shows that 892 of those surveyed will have died by 1986. That is a significant number. I think in closing, Mr. Chairman, I would like to emphasize the fact that the impact of the estate tax on the small family owned business is dramatic and it is immediate. I think something needs to be done quickly to alleviate this problem and to continue the entrepreneurial enterprise concept on which this country was founded. Thank you very much. [Mr. Fitch's prepared statement with attachments follow:] PREPARED STATEMENT OF JOHN H. FITCH, JR., VICE PRESIDENT FOR GOVERNMENT RELATIONS, NATIONAL ASSOCIATION OF WHOLESALER-DISTRIBUTORS SUMMARY Mr. Chairman, on behalf of NAW's 119 national commodity line associations and their 45,000 wholesaler-distributor members, I would like to commend this Subcommittee for the efforts it has undertaken to reform the estate tax laws. There is a "crisis of perpetuation" for the small, family-owned wholesaler-distributor. Each succeeding year, it becomes harder and harder to continue the independence of the business and keep it within the family structure under today's estate tax laws. Unless efforts such as yours here today are successful, the entrepreneurial uniqueness of America's free enterprise system will wither and die, and with it will go much of the competitive and innovative nature of our economy. The National Association of Wholesaler-Distributors supports the outright repeal of the estate tax laws or, in the alternate, the following legislative initiatives which would significantly reform the current estate tax laws: 1. increase the estate tax exemption to include an unlimited deduction for the passing of a closely held business to a spouse or to children; 2. revise current estate tax brackets to counter "bracket creep" that has occurred as a result of inflation; 3. increase the time allowed for filing and payment of estate taxes; and 4. reduce the requirement for a decendent's interest in a closely held business to 20 percent of gross estate or 35 percent of taxable estate, which would allow for use of ESOPs in closely held business estate tax valuation. FULL STATEMENT Mr. Chairman, Members of the Subcommittee, this statement is presented on behalf of the wholesale distribution industry by the National Association of Wholesaler-Distributors. My name is John H. Fitch, Jr., Vice President-Government Relations for NAW. Mr. Chairman, before I get into the substance of my statement, I would like to commend your efforts and those of the Subcommittee to address the crisis of perpetuation. For the small, family-owned wholesaler-distributor, it is difficult to continue the independence of the operation and keep it with the family structure. Unless the estate tax laws are changed, the entrepreneurial uniqueness of America's free enterprise system will wither and die, and with it will go much of the competitive and innovative nature of our economy. NAW The National Association of Wholesaler-Distributors is a federation of 119 national wholesale distribution associations which have an aggregate membership of approximately 45,000 wholesaler-distributors, with 150,000 places of business. The members of our constituent associations are responsible for 60 percent of the $1 trillion of merchandise which will flow through wholesale channels this year, according to the Commerce Department. They employ a comparable percentage, or 2.5 million, of the 4 million Americans who work in wholesale trade. Although the individual firms which our organization represents are small- to medium-sized businesses individually, their collective economic importance is most significant. The industry The wholesale distribution industry, in contrast to the manufacturing sector of the economy, continues to be dominated by small- to medium-sized, closely held, family-owned businesses. Of the 238,000 merchant wholesaler-distributor corporations filing tax returns in 1977, 99 percent had assets of $10 million or less. These smaller firms accounted for about 58 percent of the industry's sales volume. In contrast, in the manufacturing sector, approximately 2 percent of the firms controlled about 88 percent of the assets and accounted for approximately 80 percent of sales. The wholesale distribution industry provides year-round employment for over 4 million individuals. In 1977, average hourly earnings ($6.78) in wholesale trade exceeded those for all private industry ($5.14), while average weekly earnings ($212) 1 Appendix A. |