It is therefore a conclusion of the study that as it relates to the

establishment, operation, and economic health of small business, the existing taxing system discourages small business independence by:

Penalizing the sale of a business to independent operators but

Imposing the estate tax in such a way as to force the sale of a

small business to meet its administrative and payment requirements. The recommendations of the study for solution of these problems include: Establishing the Small Business Enterprise as a separate tax entity, and taxing it in a manner to facilitate the distribution of funds from the enterprise to the estate of a deceased equity owner for payment of estate taxes (discussed in Chapter 5);

Establishing simplified rules for valuation of Small Business
Enterprises in the estates of deceased equity owners (discussed in
Chapter 10);

Imposing less tax than that imposed under existing law on gains from
the sale of small businesses to independent operators (discussed in
Chapter 10).

Financial Security of the Small Business Owner and His Family

A major goal of any economic endeavor is to provide financial security both during the period of activity and after retirment. The tax relief recommended to provide for the current operating needs of small business should help the small

businessperson attain personal financial security while he is actively operating

the business. His security during the retirement years, however, is another

problem. The 1958 report of the Senate Small Business Committee remains
depressingly relevant today:

"It has long been evident that persons eligible for membership
in pension, profit-sharing, or stock-bonus plans, as provided
for by section 401 of the Internal Revenue Code of 1954, were
highly favored by drafters of tax legislation. Only these
people have been assisted, by favorable tax treatment, toward
proper provision for their declining years. This is a most
worthwhile purpose to be fostered by tax legislation, but it is
wrong that most taxpayers are discriminated against by not being
permitted equally advantageous tax treatment."

"This discrimination causes several unfortunate consequences to
the small businesses of the country. These results were not
intended, but have developed like so many others where discrimina-
tory legislation is permitted to exist. Small businesses are less
able to set up and maintain plans which will qualify for the
preferred treatment under section 401. This is true because the
professional expense an overhead charges of such plans will not
be spread over as large a group of employees and, thus, will be
relatively more costly even where it is used. Many are the
small employers who simply may not set up such a plan because of
the excessive cost..."

"More importantly, most of the small businesses of this country
are not incorporated. An operator of an unincorporated business
may not be an 'employee' for the purpose of membership in a
qualified plan under section 401. Thus, the individual proprietor,
unlike his counterpart in the corporate organization, may not get
favorable treatment for himself, even if he chooses to set up a
plan for his employees. This is a factor which looms large in any
determination to provide such a plan."

"For these and other reasons, professional and self-employed groups
have for some time been attempting to get equal treatment for
their members."15

16

Since 1958, Congress has acted to remove some of the discrimination against unincorporated businesses in establishing retirement plans. The socalled H.R. 10 (Keogh) plan was created for use by unincorporated businesses. The benefits of an H.R. 10 plan, however, are not as extensive as those of qualified pension plans, and the costs and paperwork required for compliance are 17 A major step forward was taken in the Pension Reform Act of

substantial.

1974 (ERISA), by the creation of the Individual Retirement Account (IRA) for 18

individuals not covered by any other pension plan. Although compliance with

19

IRA requirements is easy, the extent of its benefits are extremely limited. Thus, much of the problem as summarized in 1958 still exists. More than 80% of the responses to the Ad-Hoc St. Louis Tax Task Force questionnaire indicated that expansion and simplification of retirement plan provisions of the tax law would 20 be helpful to their businesses.

It is therefore a conclusion of the study that the existing tax system compounds difficulties encountered by the operator of a small business in providing for his retirement security, because existing retirement plan opportunities:

O

Place unwarranted emphasis on the legal form of business organization.

The recommendations of the study for solution of these problems are to

increase the benefits to be obtained by utilization of the Individual Retirement Account to conform to the benefits obtained by utilizing an H.R. 10 plan (discussed in Chapter 10), and to institute a reverse income averaging procedure for equity

16/

IRC Section 401 (c), added to the law by Section 2(3) of P.L. 87-792,
Oct. 10, 1962

17/ The maximum deduction for contribution to the plan is the lesser of 15% earned income or $7500. IRC Section 404 (a)

IRC Section 408, added by Sec. 2002 (b) of P.L. 93-406, Sept. 2, 1974

The maximum deduction is $1500 (sometimes $1750 in the case of joint accounts).
IRC Section 408

18

19

owners of the newly created Small Business Enterprise tax entity (discussed

in Chapter 10).

Other Tax Problems

It is recognized that this is not an exhaustive list of the tax problems of small business. This study has determined that small business also encounters problems with excise taxes, state taxes, employment taxes and other taxes.

It

is the conclusion of the study, however, that adoption of the recommendations of this report will solve the major tax problems of small business and create a framework for further analysis and correction of adverse tax biases.

Obstacles to Small Business Tax Reform

Much has been written about the impact of taxation on small business. The appropriate committees of Congress, small business organizations, the Small Business Administration and other government and private organizations have advanced many suggestions for amending federal and state tax laws to aid small business. Why, then, have there been only two comprehensive small business tax proposals presented to Congress, and why have these encountered such resistance in passage? Several arguments are consistently leveled againt any changes in the tax law. ments have been especially harmful to attempts for small business tax reform:

These argu

Any tax incentive which reduces the

"it will cost too much in revenue" tax payable will, by definition, deprive the government of revenue it might otherwise obtain. Since the primary objective of the tax law is to raise revenue, the Treasury is particularly interested in the revenue effect of tax reform. In determining the revenue effect, however, all that is usually considered is the short-term impact, given the status-quo of the taxpayers at the time of the passage

of reform legislation.

A basic weakness in such formal revenue estimates is

that they do not take into account the increases in revenue created by the establishment of new taxpaying firms or the increase in size of existing firms as a result of more capital being released to these firms by reduction of taxes payable. 21 Also, this revenue deterioration can be offset by shifting the burden of taxation to those segments of the economy more able to bear that burden. (This is, admittedly, usually a very unpopular move)

"it is unfair" There is a widely held belief that a fair and equitable tax system should not single enterprises out for special treatment simply because they are small. Without discussing the merits of this argument, it must be noted that special tax benefits have been accorded to other types of activities considered worthy by Congress for special treatment. One need not look far to see the special tax provisions affecting construction, oil and gas exploration,

21/ No less an authority than Wilbur Mills, former Chairman of the House Committee on Ways and Means, confirmed this fact in an interview reported in the U.S. News and World Report, April 6, 1973, p. 55. Chairman Mills was asked: "Some of the changes you are talking about seem to involve some easing of taxes on people. Wouldn't that mean less revenue for the government? To which Chairman Mills replied:

We

"If you do these things I'm talking about, my own estimate is that
you get more revenues. It isn't always true that you have to raise
tax rates to get revenue. You can raise rates and lose revenue.
proved that you can cut rates and gain revenue starting with the
1964 Tax Act. We proved you gain revenues over a period of time.
Look how our revenues have jumped with the various tax cuts we have
legislated since 1964.

You get more revenue by reducing rates of tax, because that generates
greater incomes through greater growth. As standards of living go up
and wages go up, we get additional revenues from the same or lower
rates of tax. We would get more today if the rates were less than
they are."