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Search Terms: internet W/10 sales W/10 tax, House or Senate or Joint

Document 95 of 142.

April 11, 2000, Tuesday

SECTION: PREPARED TESTIMONY

LENGTH: 3860 words

HEADLINE: PREPARED TESTIMONY OF TODD MCCRACKEN PRESIDENT OF NATIONAL SMALL BUSINESS UNITED AND SHARON MILLER OWNER/PRESIDENT, ITH STAFFING SOLUTIONS, INC. MIDLAND, MICHIGAN

BEFORE THE HOUSE COMMITTEE ON WAYS AND MEANS

SUBJECT - CONGRESSIONAL SUMMIT ON FUNDAMENTAL TAX REFORM

BODY:
Mr. Chairman and Members of the Ways and Means Committee:

My name is Todd McCracken, and I am President of National Small Business United (NSBU), the nation's oldest national small business advocacy organization. Accompanying me today is Sharon Miller, a small business owner of ITH Staffing Solutions of Midland, Michigan, and a past chair of both NSBU and the Small Business Association of Michigan (SBAM). I would like to share this testimony and the time I have allotted with Sharon so that we might offer both a national perspective and that of a real business owner.

Mr. Chairman, NSBU was founded when the income tax was just 23 years old - with only two pages in forms and several pages of instructions.

NSBU has not grown at the exponential rate of the income tax laws, but we now represent 65,000 businesses nationwide. We represent the varied tapestry of the America's entrepreneurs, from immigrants seeking a more fertile environments in which to grow their dreams to family businesses that have remained for generations. The average size of our membership is 12 employees. We are nonpartisan. We do not ask whether the policies we endorse are republican or democrat:, we ask whether the policies enable entrepreneurs to thrive. NSBU applauds this Committee for having the courage to explore the FairTax. In February, a national survey conducted by American Express confirmed what NSBU already knew. The survey showed that 74 percent of entrepreneurs consider tax reform a top priority. But since the vast majority of Americans share commons dislike for our present system, it is easier to demagogue the current system than to reach consensus on what a new and more ideal system should look like.

NSBU leads entrepreneurial organizations not only by defining the principles on which tax reform should be based, but lending our full support for a specific proposal: the FairTax national sales tax platt In 1997, our 32-member small business Board of Trustees decided that it was time for NSBU to take a hard look at a new tax system, rather than just continuing to take easy pot-shots at the system we have now. After a year-long process in which the current system and various alternatives-various flat tax plans and other forms of a sales tax among them-were held up and examined from all sides, our initially skeptical Board finally selected the FairTax as the best possible system for small businesses, without a single dissenting vote. If you knew this diverse group of independent-minded entrepreneurs like we do, you would realize just how remarkable this vote was. After we all had a chance to ask our questions and have them thoughtfully answered, this decision, that many of us thought we could never reach, suddenly seemed obvious.

We would like to explain to the committee why NSBU, consisting of firms in all sectors, including service firms and retailers, endorsed a national sales tax plan. We want to contrast the FairTax with such plans as the flat tax and other sales tax plans. And last, we want to suggest the next steps this committee should take if it is serious about considering reform.

The Current System: Fundamentally Broken Discouraging Entrepreneurs at Every Level. Most entrepreneurs-that is unless they make a career of selling tax shelters-correctly see our system as punishing each step towards the American dream. At every stage of a business' life, it faces significant tax obstacles. At the start-up level savings are taxed, and start-up costs are not deductible. Capital investments are made from after-tax dollars and then taxed multiple times, when the income is earned and when the underlying asset that generates that income stream is sold. They are taxed when growing because the government takes an increasing share of income as more money is made. They are taxed when exporting, because U.S. taxes raise the price of our goods relative to foreign goods. They are taxed when they add jobs, because our extraordinarily high payroll taxes increase costs of hiring. Family businesses are discouraged because they are taxed when they are sold. And finally, the owner gets to meet the undertaker and the IRS on the same day as the government effects a leveraged buy-out of the businesses.

The Burden of Payroll Taxes. But I think this committee is certainly familiar with the current income tax code and the many compliance obstacles it creates. So, I would like to call special attention to the current payroll tax (primarily FICA) burden that small businesses and their employees must endure. It is an enormous tax that receives relatively little attention given the share of revenues it accounts for. In fact, a survey by NSBU and Arthur Andersen found that small businesses cite payroll taxes as their most significant tax burden.The U.S. has made a fundamental shift toward payroll taxes in the last 30 years. In 1995, 38 percent of all federal revenues came from payroll taxes, compared to just 14 percent (of a lower tax bill) 40 years ago. From 1970 to 1990, business received nine social security (FICA) tax increases totaling 60%, three unemployment (FUTA) increases totaling 94%, three FUTA base increases totaling 133%, and 19 FICA base increases totaling 677%.

At first glance, payroll taxes might seem to be an equitable form of taxation. The unemployed are not taxed, and larger businesses with more employees are taxed more than smaller businesses with fewer employees. However, most small businesses are much more labor intensive than their larger counterparts. Payroll taxes cause these small businesses to be taxed at a higher effective rate than larger, more capital-intensive firms. Moreover, holders of corporations organized under Subchapter "S" (which are almost always small) have been forced to pay both sides of this tax, making for a substantial tax increase.

Businesses must pay their payroll taxes whether or not they make a profit. The fact that this huge tax must be paid regardless of the financial condition of the company creates substantial problems. First, it discourages new businesses. Most new businesses lose money in their early days, and payroll taxes amount to one more debt that must be somehow financed. Second, it discourages employment. The only way that a business in a financial bind can reduce payroll taxes is to reduce payroll; this means fewer jobs or lower wages.

A payroll tax amounts to a tax on employment. Today, businesses and their employees pay about 15% out of every wage dollar (below the cap) in FICA taxes. Through this substantial hike in the cost of hiring and working, the payroll tax reverses the needed incentives in the American economy. Taxing businesses for hiring an employee dearly discourages increased employment, which is damaging to the unemployed, the business, and the economy. And, of course, payroll taxes are the most regressive taxes we have, where only earned income (as opposed to investment income) is taxed, and only earned income up to a certain, annually adjusted level is taxed.

Unnecessary Complexity. Small firms are accountable to a protean system that is so complex simply because we choose to tax savings and investment. We waste an estimated $3.70 in compliance costs for every dollar we pay in taxes. We endure the lion's share of the $250 billion in annual compliance costs, when we cannot pass these essentially fixed costs on to consumers as larger firms can. We endure the lion's share of the more than 34 million civil penalties issued.

Our current tax system is certainly a testament to the indomitable spirit of American entrepreneurs, but it is not enlightened tax policy.

The FairTax: The Best System for Small Business

The FairTax is enlightened policy. Since the FairTax abolishes all federal income, FICA, estate, and capital gains taxes, it would allow small businesses to prosper as never before in this country. By instituting a 23 percent tax on all end-use goods and services, the FairTax would sweep away the burdens of the current tax system and create a new dawn for American entrepreneurship and economic growth.

The Fair Tax would allow businesses to begin with savings put aside with pre-tax dollars. It would allow them to grow unfettered by the income tax, and without an eye on the capital gains tax. It would allow them to hire without discouragement from the payroll tax. It would allow them to export, unfettered by punitive American taxes on our exports. It would allow them to make capital investments unfettered by hidden costs in the capital assets. It would not penalize good years and bad by implementing the best of income averaging, a zero rate of tax. It would discontinue the charade of taxing income multiple times. Most importantly, it would repeal the self-employment taxes which are the most despised by entrepreneurs. The Fair Tax would tax Americans on income, but only at the point that they consume that income, not when they invest and save. Small business owners would have greater access to capital, the life-blood of a free economy. Small firm owners would be able to pass their business on to their children.

Simplicity and Lower Compliance Costs. Compliance costs would diminish. Individuals not in business would never have to file a tax return again, and business returns would be vastly simpler. More than 7,000 incomprehensible sections of the Internal Revenue Code, would be exchanged for one simple question: how much is sold to consumers? This question is asked of retailers in 45 states of our Nation today, so the additional burden on these businesses would be negligible. Ninety percent of our $250 billion annual compliance bill would disappear.

Greater Visibility and Understanding. As complexity disappears, we would reinstate the novel concept that Americans have a right to understand the law to which they are subject. Moreover, they will immediately see and understand the tax rates and any changes that occur. The mentality of "Don't tax you; don't tax me; tax that fellow behind the tree" would be gone. The current complexity of the code leaves most Americans, rightly or wrongly, feeling that they bear an unfair share of the tax burden. The poor believe that advantages must lie with those who are more well-off. The wealthy see their high marginal rates and eliminated deductions and feel singled out by the tax system. And the middle class assume that credits for the poor and loopholes for the wealthy mean that they alone should the country's tax burden. While there are both fallacies and accuracies in each group's assumptions, the unfortunate side effect is a polarization of the country and a universal feeling of victimization. And it should be clear to any rational observer that this feeling leads to tax avoidance and cheating on an unprecedented scale. If we can remove these hard feelings about the tax code, we can markedly improve compliance and give a boost to national comity at the same time.

The FairTax would do just that, by making visible the taxes now buried in goods and services. We would have a uniform tax for all the world to see and understand. How would the rich guy avoid Some taxes? Only by saving and investing, which helps us all. But some day, he or his descendants will spend his profits, and taxes will be collected. At the same time, those less fortunate will receive a rebate lowering their total tax bill and effective tax rate, even if they don't save a nickel. This is a system all Americans can understand and be united behind-and voluntarily pay. The tax system would achieve greater enforceability with less intrusiveness. Today, more than $200 billion in income taxes, over 20 percent of the total collected, are not voluntarily paid.

Economic Growth. Almost every researcher who has examined the FairTax have concluded that the U.S. will experience significantly higher economic growth rates if this plan is enacted. Specifically, Harvard's Dale Jorgenson predicted a quick nine to thirteen percent increased in the GDP, while Boston University's Laurence Kotlikoff predicts a seven to fourteen percent increase. Essentially, this growth will happen because the tax code will no longer discourage work, investment, savings, and education. Even studies that start with more pessimistic assumptions, like that by Nathan Associates for the National Retail Institute, predict greater long-term economic growth, though to a smaller degree than others predict.

There are those, of course, who fear that the FairTax will discourage consumption and thereby cause a drop in economic growth. The FairTax is, after all, a tax on consumption, and we always get less of whatever we tax (like work, savings, investment, etc.). But there are several salient facts that mitigate, even eliminate, this fear. First, institution of the FairTax would mean that consumers have their entire paycheck to spend, free of any tax withholdings or FICA payments. Consumers would be able to spend this greater income on goods that cost no less than they do currently, because economists tell us that the elimination of taxes currently embedded in the price of goods and services will cause that price to go down dramatically. At the same time, the elimination of the tax on interest income will cause interest rates to drop dramatically, probably by about 25 percent. Taken together these two consequences of the FairTax should actually have the effect of increasing consumption.

But there are additional reasons why prices should fall and thereby encourage additional consumption. Since the FairTax will encourage savings and investment, greater investment dollars will be available to improve the productivity of American business, causing prices to drop still more. Greater productivity is likely to lead to greater corporate profits, which is likely to lead to improved stock market gains. The last few years have proven what stock market gains can mean for consumption and continuing economic growth. So, we have been persuaded that these very appropriate concerns are nevertheless unfounded.

Improved Work-Force. Any current survey of the small business community will show finding and keeping qualified workers is their greatest challenge. Businesses cannot find enough workers with specific educational backgrounds, nor can they find sufficient workers with broad-based educational backgrounds. To further compound matters, most small businesses cannot create and maintain their own education and training initiatives the way some larger businesses can. The FairTax comes to the rescue by essentially "un-taxing" education. Currently, a middle class taxpayer must earn $15,540 (ignoring state taxes) to pay $10,000 in tuition. Under the FairTax, only $10,000 must be earned, because education is not taxed.

Improved International Trade Position. The current tax system buries taxes in all sorts of goods and services. But this becomes an especially big problem in the international arena. These embedded taxes mean that American goods and services are more expensive than they otherwise would be, thereby hurting American exports. But it is even worse than that. Many of our competitors impose a Value Added Tax (VAT), which is rebated at the border. That means that we have foreign goods coming into the U.S. which have no embedded taxes, competing with domestic goods with very high embedded taxes. The FairTax reverse this position, creating much greater incentives for goods and services to be produced in the U.S. and making those products much more competitive abroad.

Retailers Aided by FairTax. Why should retailers support it? No single industry is more burdened by the multitude of state and Federal tax laws than retailers. Retailers are today both tax collectors and taxpayers. Under the FairTax, there will be no more uniform inventory capitalization requirements, no more complex government rules on employee benefits and retirement plans, no more tax depreciation schedules, no more tax rules governing mergers and acquisitions, and no more international tax provisions. Retailers will have "found" money in lower compliance costs.

Under the FairTax retailers will also receive an administration fee for complying with a greatly simplified law. The FairTax actually compensates the industry for compliance burdens. Moreover, the FairTax will encourage uniformity among increasingly disparate state taxing schemes that have pitted small retailers against large direct mailers. As we have seen with state income taxes, states will face great pressure to bring their system into line with the federal standard. The FairTax could lead to a way out of the current stalemate on the internet and sales taxes.

It is for all these reasons that there is increasing support for the FairTax among small businesses. In the most recent survey NSBU conducts with Arthur Andersen, we found that a national sales tax had surpassed a flat tax as the preferred form a tax reform among small business owners.

Even more interestingly, support for a sales tax among retailers in this survey was almost as high as support among manufacturers, though small retailers still gave the flat tax their narrow support.

While respected economists haggle over the dimensions of the economic benefits, they are unanimous in their view the FairTax would greatly enhance economic performance by improving the incentives for work and eliminating the current bias against saving and investment. Even the National Retail Institute's study by Nathan Associates shows that the economy would be one to five percent larger under a sales tax than in the absence of reform.

The FairTax Versus the Alternatives

The major alternative to a national sales tax is, of course a flat tax. And, while a sales tax and a flat tax are both improvements over the current system, and both are essentially consumption-based taxes, the sales tax is clearly preferable to small business for two key reasons.

The Flat Tax. First, a sales tax is vastly simpler to administer than a flat tax. While a flat tax creates uniform rates, it still leaves the question of determining income, and still leaves business owners with the need to hire tax advisers and accountants to sort through those remaining rules. And, of course a flat tax leaves in place the requirement for businesses to withhold and file taxes (of both payroll and wage taxes) on behalf of their employees. This system is the source of more civil penalties on small businesses than any other.

Second, a flat tax would have to leave in place the pillars of the income tax system we have today: tax withholding, a central enforcement agency, and the need to define and determine taxable income. Given this scenario, it is not a stretch to imagine that we could readily creep back to the same system we have now. Congress decides to allow an additional deduction or allowance for this or that. How to pay for it? Let's increase the rate, but only for people above a certain income level. Once the dam breaks, there is no turning back. With a sales tax, the entire income infrastructure is dismantled. It is very hard to conceive of it being easily reconstructed; it has an inherent integrity that is much more difficult to breach.

But not all sales taxes are created equal. The FairTax holds special appeal for the small business community for two reasons. First, it eliminates the payroll and self-employment taxes that are the most burdensome on small businesses, and which are easily the most regressive taxes this country has ever imposed. This elimination both greatly helps small business (we discussed the payroll tax burden at length above) and makes the FairTax system much more progressive than competing sales tax plans.Second, a key pillar of the FairTax is its uniformity. Rather than picking and choosing among end-use products to tax, it taxes everything. Going down a different path, and exempting certain goods or services from taxation would be very dangerous and greatly diminish the support the FairTax has from the small business community.

Conclusions

Defenders of the income tax system fondly quote Oliver Wendell Holmes who said, "taxes are what we pay for a civilized society". But this phrase does not stoically celebrate the 'income tax' per se and was made before the income tax even existed. What Holmes should have added is that a civilized society must also collect taxes in the most civilized manner.

The income tax is the antithesis of a civilized system for entrepreneurs. Unlike many unwise state sales taxes, the FairTax would fully exempt any business inputs from taxation, i.e. all business-to- business transaction would be free of tax. In this way it would remove the mythology that businesses pay taxes as opposed to their owners, employees or consumers. It would make all taxes visible. It would convey the true cost of government to every American on each purchase they make, precluding government from raising taxes other than by changing the rate for all. Quite simply, it would allow businesses to keep the entire profit from their operation and transfer the emphasis of taxation away from income-producing activities to consumption.

The FairTax would reinstate the novel concept that Americans have a right to understand the law to which they are subject. This would be a boon for small businesses that quite often lack the legal and accounting staffs necessary to be in compliance with the tax code. It would enhance compliance so honest taxpayers pay less.

Mr. Chairman, if we can get entrepreneurs who, by genetics I suppose, are independent minded, to agree upon this plan, than your committee can do so also. But in order to do so, you must put aside politics and predilection. We are confident that, as this Committee understands the essential differences in the proposals, you will favor the FairTax plan. Now here is what I ask of you.

First, this Committee must not consider its job done in one hearing. These plans deserve further introspection. Hearings should be conducted on all relevant topics affecting tax reform. We are confident that more you know about the FairTax, the more you will support it.

Second, the Joint Tax Committee and other institutions that analyze distribution should change their means of portraying the burden of consumption taxes. Why do we persist in scoring taxation of savings and investment as a gain? Income is not income until it is consumed. Why not present distributional tables as an alternative on taxes paid over consumption?

Third, we urge all members of this committee to understand the issues presented here. One of the reasons taxes have risen in this nation is because so much is hidden from the consumers on which all taxes ultimately fall. Do not fault the FairTax because it makes these taxes visible.

We want to thank you for the ability to appear hear today, and we especially want to thank you for holding these very significant hearings. You can do nothing more profoundly significant for the small business community and the entire nation, than to continue to push forward with fundamental tax reform.

END

LOAD-DATE: April 12, 2000

Document 95 of 142.


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