But if we fail to deal with soak-up rights, more audits cannot solve the problem. We think that is a fundamental problem of artificiality in the valuation process.

Mr. CARDIN. Thank you.

Mr. GIBBONS. Mr. Brown.
Mr. Thomas.

Mr. Brown.

Mr. McGrath.

Mr. Chairman.

I will try to get-are there members on either side?

Mrs. Johnson.

Mrs. JOHNSON. Thank you.

I am very interested in your testimony and I believe you make some very valid points. But when you look at the revenue estimates, current law generates $1 billion, and the reform bill would cost only $50 million.

The implication is that the draft will help very few people. That the draft doesn't, in fact, go to the problem that Mr. Schulze talked about and my concern is that it doesn't go to the problem of the small manufacturer who is the strength of our industrial base, at least in my part of the Nation.

There are big guys. But the little guys, many of whom are family-owned, are terribly important-whether or not the big guys will succeed out there in a very competitive environment.

In those small manufacturers, which is where I first came across this problem, the action we took in 1986 has been very hostile, not only to their ability to stay, but their ability to invest in the new equipment that will have future productivity and quality implications, but only over a number of years and would not directly benefit the current owners.

So when I look at your revenue estimates, I will have to ask you, if you were going to loosen this up a little bit to be somewhat more generous, which provision is key to that loosening process? Is it the 20 percent? Is it some other aspect of the bill? If you were going to look to make this somewhat more generous to the businesses affected, what is that lever that you would pull?

Mr. GIDEON. I really am not in a position today to comment on what changes would look like.

One of the things I have learned about the revenue estimating process is it is important to score a specific proposal. Therefore, I think it is dangerous to speculate on what revenue effects might result from specific changes.

Let me say I think it is important that we sort out two different issues here. One issue is the issue of whether we should give special relief to small business.

The other issue, which is I think the issue that is implicated by this provision, is whether we should have appropriate and proper valuations for gift and estate tax purposes. If the committee believes it should spend money in giving small business relief, it ought to do that explicitly.

It ought not to do it through a mechanism that would not be targeted to small businesses, that might benefit much larger entities as well-that permits, in effect, misvaluation.

I think it is important to get the valuation rules right and then to consider as a separate matter whether there needs to be specific relief in specific small business contexts.

Mrs. JOHNSON. I am reluctant to conclude that our ability to be that specific without policy overlays is really there. Family-owned businesses do represent a unique kind of small business with narrow-based risk and narrow-based benefits.

I think they deserve special consideration. Moreover, I don't know how you can be necessarily that precise without policy implications and without the prejudice your goals bring to us

I hear your point about wanting to deal only with revenue estimates of specific measures. I think the revenue estimates that you bring to the table today indicate to me that we have got a long way

to go.

I will be interested throughout the day to hear from those testifying to try to determine where it is that we need to look.

Mr. GIDEON. I would urge you to take a look at the revenue pattern in evaluating those estimates as well.

Mrs. JOHNSON. I appreciate that. That is also important.
Thank you.

Mr. GIBBONS. Mr. Levin.

Mr. LEVIN. Thank you, Mr. Chairman.

I am sorry, Mr. Gideon, I was in another hearing. I missed your testimony. Let me ask you a couple of questions that may not have been covered. The effective estate tax rate today is what?

Mr. GIDEON. On average, I am sorry, I don't know.

I think that material might be covered in the joint committee

Mr. LEVIN. It would appear on table 3, the value of gross estates subject to tax is $70 billion; right?

The return is $6 billion to the-if you look at table 3.

Mr. GIDEON. I might note this is estate tax, by the way, and not gift tax.

Mr. LEVIN. This is estate tax?

Mr. GIDEON. Yes.

Mr. LEVIN. That would seem to indicate there was an effective tax rate, I don't know if you can call it that, of what, 15 percent or a little more? I am not sure that is relevant.

We probably need to keep it in mind when we look at this issue. Don't you think it has some relevance?

Mr. GIDEON. I think it is important to realize there are substantial provisions for giving relief for family farms. There are substantial provisions providing significant exemptions at the bottom end of the estate tax sequence.

Again I would simply observe that if there is a feeling that more needs to be done with respect to small business exemptions, that ought to be the issue explicitly considered.

We should not engage in or allow misvaluation of transactions that do occur with the idea that somehow that is helpful in a small business context. This would be helpful to taxpayers in all contexts, but it basically undermines the appropriate working of an estate tax and transfer tax system generally. I just don't think that it is in the interest of the system to permit misvaluation.

Mr. LEVIN. Well, I hope that everybody hears that. I think what you are saying is that if there is too high a tax even with the present provisions, the 14-year provisions and others, if it still is too high a tax, we ought to change the rate for certain types of assets rather than doing it indirectly and essentially benefiting those who hired professional assistance and not those who did not. Isn't that in terms of public policy a better way to go at it? Mr. GIDEON. I couldn't agree more with that.

Mr. LEVIN. It seems to me that the committee ought to look at this openly. If small business and family farms, both of which we want to be darned sensitive to in terms of their place in the economy, if they are today being dually disadvantaged by the rates, change them.

Mr. GIDEON. I think that woulu be appropriate. As always, there are revenue concerns in any sort of change of that sort. But the appropriate way to deal with a problem like that is head on and directly where you know that the relief you are providing is going to go to the place you intend to provide it and not in a manner that would essentially be capricious as occurs by permitting misvaluations.

Mr. LEVIN. And to everybody, not those who simply are hiring the technical assistance necessary to lower their effective rate. Thank you very much.

Chairman ROSTENKOWSKI. Further questions?

Thank you, Mr. Gideon.

Mr. GIDEON. Thank you.

Senator Symms, welcome to the committee. You know our procedures here. The committee is ready to receive your testimony.

STATEMENT OF HON. STEVEN D. SYMMS, A U.S. SENATOR FROM THE STATE OF IDAHO

Senator SYMMS. Thank you, Mr. Chairman, and members of the committee.

I wish to thank you and the committee for the opportunity to appear here today. Mr. Chairman, I am the sponsor in the Senate of S. 659, a bill to repeal section 2036(c) of the Internal Revenue Code. I am here today to comment on the proposal to modify that section of the code, which you have published.

In my comments, I will discuss a number of reasons why I believe the proposal to reform section 2036(c) is not satisfactory. I appreciate that a lot of careful work went into the proposal, but I do not believe it has resolved the problems created for family businesses. I intend to continue my efforts to repeal section 2036(c) and correct the injustice imposed by that part of the Tax Code.

Before I address the specific concerns I have found in the proposal, let me say a few general things about the problem I see in section 2036(c).

First, I believe the estate tax as it is presently structured in our Internal Revenue Code is flawed in several ways. After a relatively generous exclusion for smaller estates-albeit an exclusion that is not indexed for inflation, and therefore one that becomes less and less in real terms year after year-the first bracket of the estate tax is a confiscatory 55 percent.

Is it any wonder, therefore, that family business owners and estate planners expend a lot of time and money working on clever devices and techniques to avoid paying such a high tax rate? The principle was clearly established by Congress in 1981 that the highest reasonable tax rate should be 50 percent on income from any

source.

Senator Bradley and Congressman Brodhead led the effort in 1981 with the very logical argument that Congress had to make it more worthwhile for an American to earn an extra dollar than to hide an extra dollar from the tax collector. That is why the maximum tax rate should never ever exceed 50 percent, and indeed should be more like 28 percent or even lower.

I believe if we would extend this very simple principle of tax logic to the estate tax area, the problems we are trying to solve with section 2036(c) would cease to be problems at all.

I think the estate tax generates far too little revenue for the Federal Treasury, relative to what families expend on estate planning to avoid it. That is a sure sign that the tax rates are irrationally high.

The "estate freeze" that was seen as the problem section 2036(c) is designed to solve was simply one way around the confiscatory estate tax rates. It was, however, a meat axe approach-an approach that I believe is all too typical of the Treasury's philosophy. When they encounter an artful way to get around some provision of the code, they ask for more power to prevent it. We in the Congress are all too willing to grant the IRS an excess in discretionary enforcement power.

In the first place, a family business by definition will pass from one generation to the next. The younger generation will grow up in the business, learning how to make the business expand and succeed. At some point in the lives of both the younger family members and the senior family members, it will be appropriate to "pass the torch." Since the retirement income of the older generation may be critically dependent upon the continuation of the business, they will retain some ownership interest from which retirement income will flow. The needs of all businesses to have working capital will most of the time make it unfeasible for the retired family members simply to take their accumulated savings out of the business entirely.

Yet, from that moment in time, it is simply wrong for the estate tax liability of the older generation to remain linked to the business. Section 2036(c) basically says that the younger generation cannot get a clear title to the business. Section 2036(c) essentially says that all of the value added to the business during the lifetime of the senior family members must be taxed in the estate of the senior family members. And taxed, as I have said, at rates in excess of 50 percent.

Mr. Chairman, this is simply unfair. It is a violation of our basic concepts of justice and fairness. That is why I say we must repeal section 2036(c) and start all over again to think about the estate tax and problems in administering it.

Now, Mr. Chairman, let me turn to specific problems that I have with the proposal to reform section 2036(c). Let me begin by noting that the suggested new code sections are ridiculously complex.

Read sections 2701(d) and 2701(e), for example, and try to explain their meaning.

For about 100 years it has been part of our economic policy in this country to tilt in favor of the family farm. I think the general principle of that should apply to all family businesses, not just agriculture. I believe we should totally exclude from a person's gross and taxable estate the family business interests that are taken over by other family members. Families should be encouraged to keep their businesses and farms.

The vast majority of family businesses and farms will not be able to achieve a practical estate freeze if the proposed chapter 14 to the estate and gift tax laws is enacted. Owners will not be willing to commit to the cash flow mandated by the "qualified fixed payments."

The alternatives provided will not help the owners. Thus, there will continue to be significant estate taxes levied on family businesses and farms preventing orderly transfers to family members. It is wrong to force corporations to either declare preferred dividends or face gifts or inclusions for the holders of preferred stock. The advisability of paying dividends is a business decision by boards of directors and it depends upon profits, working capital needs, plans for expansion, et cetera. The holder of the preferred stock frequently will have voting control and should not make or influence business decisions for his personal gain which might adversely affect other stockholders. He could be sued. This does happen between family members, but the drafters of this section seem to presume there would not be an arm's length business relationship. The concept is thus flawed and should be opposed.

Section 2702, as a practical matter, rules out all meaningful buysell agreements for family businesses. Buy-sell agreements containing formulas that may or may not equate fair market value at death are just as appropriate and necessary in family business situations as when the co-owners are not related.

In fact, they may be more important in family situations. Such agreements are made when neither party is sure who will be the first to die, and thus contain safeguards without the need for more statutory prohibitions and rules.

Section 2703 creates another set of family attribution rules. In fact, there are two new sets in this chapter 14. Add this to the sets in section 318 and 267, plus other provisions, and we may now have an approximate total of 10 different sets of family attribution rules. Section 2703 provides that the "Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of this chapter." The Treasury is now more than 10 years behind in issuing regulations. Why have more?

The new proposed statutory language must have been drafted by the same team that did section 2032A in 1986. You may recall that Congress had a wonderful idea to let family farms be taxed as farms. The staff converted this simple concept to 11 pages of statutory complexity. Many pages of regulations have only explained some of the questions. By my latest count, there have been 80 court decisions deciding 2032A issues. Sections 2701, 2702, and 2703 will provide a wonderful bonanza for tax lawyers to litigate.