Dick Patten

President

American Family Business Institute

1920 L Street, NW

Washington, DC

Statement for the Record

U.S. Senate Finance Committee

Federal Estate Tax: Uncertainty in Planning Under the Current Law

November 14, 2007

The statement below is divided into two parts:

I. The effect of the Death Tax on Family Businesses and Farms

II. A Response to Mr. Buffett’s Testimony:
Not your Mom and Pop’s “Equality of Opportunity”

I. The effect of the Death Tax on Family Businesses and Farms

Chairman Baucus, Ranking Member Grassley, and members of the Committee. It is a great honor to present testimony on behalf of my organization, the American Family Business Institute (AFBI), and the hundreds of family-owned businesses and farms which we represent. Our name quite appropriately describes the purpose for which we exist – to protect and preserve family-owned businesses and farms. Most specifically, we exist to advocate for full repeal of the death tax, which as my following testimony will show, is the greatest threat to the survival of family-owned businesses.

American Family Business Institute was founded in 1994. I have been with the organization as member from the early days. As an entrepreneur and owner of several businesses, I am acutely familiar with the death tax issue. In fact, before coming on board with AFBI, I successfully led a campaign to defeat the death tax in my home-state of Washington. My message then was the same as it is today – that the death tax threatens family-owned businesses and farms.

To the American Family Business Institute’s many members, the preservation of family-owned businesses is more than just protecting a key source of economic growth and jobs, it is about protecting our legacies and our families. I believe that the family is the bedrock institution of a society, and that our laws should not damage the institutions which hold families together.

How the Death Tax Hurts Family-Owned Businesses and Farms

One of the common characteristics of a family business owner or farmer is that their net worth is tied up in their business and farm, and not in cash assets. This is due to the fact that unlike publicly-traded corporations, which are able to acquire considerable outside investment, family-owned businesses must rely on their own capital. Moreover, most family-owned businesses reinvest almost all of their profits in order to keep the businesses competitive. Profits are used to purchase the best possible machinery, new land, or to hire new employees. None of these assets can be sold, or in the case of employees, fired, without considerable cost to the company.

Family businesses and farms represent the majority of those families’ net assets. One study found that the typical small-business owner in particular has 60 percent of the family net worth invested in the business. For the purposes of the estate tax, the business is the estate and any tax will have to be paid out of its assets.

Though there are ways to prepare to pay the death tax, these involve a misallocation of resources away from the business. For instance, if a business owner purchases life-insurance in anticipation of the death tax – as many do – the owner is forced to take money away from expanding or otherwise maintaining current business operations. I have heard from hundreds of business owners and farmers who have told me that they are spending hundreds of thousands of dollars each year on life-insurance, rather than building the business. Unfortunately, most of them tell me that even this is often not enough to meet the cash demands of paying the death tax.

When cash-strapped business owners and farmers are faced with paying the death tax, they are forced to choose among several destructive options.

One option is to take out a large loan. The difficulty is, most businesses are already using credit to invest in their business. Adding an unproductive debt to their balance sheet is not sustainable business practice. Hence, many businesses which initially survive the death tax end up so strapped with debt that they are forced to sell – often at a loss – within a few years. In some cases, businesses are certainly able to find the cash to repay the loan over the course of an extended period of time. However, most family business owners are relying upon all revenue to meet payroll and handle day-to-day operating expenses. A large new debt forces the owner to reduce future investment. For those many small and medium-sized family-owned businesses who depend on the smallest of margins and are always fighting to be competitive against larger corporations, this simply is the beginning of the end. Hence, many businesses which initially survive the death tax end up so strapped with debt that they are forced to sell – often at a loss – within a few years.

Another option is to “trim fat” by laying off unneeded or low-performing employees, and sell assets. Unfortunately, this is a very difficult decision because, again, most family-owned businesses are already as lean as possible in order to stay competitive. Unlike publicly-traded corporations, which have the advantage of large capital reserves and thereby the ability to temporarily maintain unprofitable ventures, the family-owned business must achieve maximum profitability from every dollar. The same is true for farmers, whose production potential depends upon the amount of land in use. When forced to sell land to pay the death tax, the farmer permanently loses long-term production potential and an investment in the land which can never be recouped. This is why the sale of partial assets almost always ultimately leads to the diminishing of the business or farm.

The final “option,” to the extent that it can properly be described as one, is to sell the business. Many families who anticipate the death tax years in advance will sell early, in order to avoid the destructive consequences of selling at death and to get the best possible price. While this is never the preferable option, prudent families who do not want to be strapped with debt or the slow, unprofitable demise of their company, will sell while the business is strong and the owner is still alive. This enables the survivors to pay the death tax and continue their lives. It also means the end of a way of life, the end of a legacy, and always has consequences for the surrounding community.

Preserving Family Businesses and Farms, the Moral Implications

Family-owned businesses cannot be easily labeled according to a certain size or business model. A family-owned business ranges from the 500-acre farm to the 25-employee manufacturer to the 100,000 acre forest and lumber mill. The common strand running through all of these businesses is that that they belong not to a large group of shareholders, but to an entrepreneur who usually diversifies their private holdings among family members. These businesses were almost always started with very little capital but with heavy sweat equity and a belief in the American dream. The entrepreneurs who built these businesses epitomize the core values of hard-work, delayed gratification, love for family, and care for their community.

To punish these individuals and their families through a confiscatory tax is to tell them that our nation does not value their hard work and achievements. It says that we really are a nation of consumers, who prefer that wealth be spent and consumed rather than diligently reinvested.

Family-owned businesses are the pillars of middle America. The owners of these businesses are the elders of their churches, the supervisors of their local school boards, the chairs of their Kiwanis clubs and coach of the little league softball team. Simply put, the family-owned business is a key bedrock of strong communities in America. Hence, when family-owned businesses disappear, the community is irrevocably changed for the worse.

II. A Response to Mr. Buffett’s Testimony:
Not your Mom and Pop’s “Equality of Opportunity”

Mr. Buffett offered four specific arguments concerning the death tax.

(1) He objected to the use of the term “death tax,” arguing that it is not accurate since many people who die do not pay the tax.

(2) He argued that the tax is necessary to preserve equality of opportunity, which he defined to mean equality of income.

(3) He proposed using the tax’s revenues to address his concerns about wealth disparity, by instituting a redistributive entitlement program for low-income citizens.

(4) He suggested restructuring the tax to make it “less burdensome” for family-owned businesses and farms, by deferring the liability of the tax until the sale of the family business or farm. In this new model of death tax payment, the family would be forced to annually pay interest on each generation’s death preceding sale of the businesses.

(1) “The term death tax.” Mr. Buffett opened his remarks by questioning the semantics of the debate. He complained that the term “death tax” is intellectually dishonest and is in fact, “Orwellian.” He argued that the death tax cannot be an accurate term due to the fact that many Americans don’t pay it. Does this make the death tax somehow inaccurate for those who do pay it, and lose significant portions of their livelihood because of it? I have to ask Mr. Buffett, how is a tax which takes up to 55% of a person’s wealth when the heart stops beating, not a death tax? When government charges a tax on the sale of an item, we call it a “sales tax.” When government charges a tax on the earnings of an individual, we call it an “income tax.” And when the government taxes us because our heart stops beating, we call it a “death tax.” Finally, Mr. Buffett should know that the term “death tax” has been used by the legal profession since the 1930’s.

(2) “The meaning of equality of opportunity.” Mr. Buffett is not simply challenging the use of semantics; he is opposed to the very notions on which the debate is held. He charged that the lack of income equality in America is fundamentally at odds with the American ideal of “equality of opportunity,” and that a death tax is necessary to restore a contrived egalitarianism to the American republic. The gross illogic of equating “equality of opportunity” with “equality of outcomes,” or income disparity, is troubling enough. To suggest that government should confiscate wealth – a form of property – to rectify this perceived problem, entails a fundamental misunderstanding of basic logic, to say nothing of American political freedom.

Most Americans believe that America is a land of opportunity, in which all citizens have the freedom to work hard, increase their wealth, and pass it on to their family or anyone else. Foundational to this concept is our historical legal and philosophical protections for private property. It is understood that unless Americans are free to purchase, own, trade and bequeath property without fear of confiscation, the notion of “opportunity” is meaningless. There was no “opportunity” in the Soviet Union, because without property, the lowest of citizens had no way to improve their economic condition.

Mr. Buffett wants to discuss “equality of opportunity” in a vacuum. He states that America must remain a country that prides itself on equality of opportunity, but suggests maintaining, if not increasing, the very tax which most hampers the opportunities of entrepreneurs and family-business owners. He wants to tell these families “you are free to pursue your dreams,” while taking over half of their property, the fruit of their labors, right out from under them.

(3) “Income redistribution.” Mr. Buffett moves another step away from the American dream, and demands that Big Brother redistribute family wealth in what can only be described as an “Orwellian” nightmare. Mr. Buffett suggests taking the revenue from the estate tax, and using it to give $1,000 to every household with $20,000 or less in annual income. In other words, Buffett wants to continue to plunder the property of family-owned businesses and use it to subsidize the less well-off. This is not the American dream, this is plain old redistribution of wealth.

(4) “The Warren Buffett Indentured Servitude Plan.” Finally, in de facto recognition of its negative impact on family-owned businesses, Mr. Buffett suggested a strange “restructuring” of the death tax under the guise of minimizing its impact. In what I call the “Warren Buffett Indentured Servitude Plan,” families would defer the death tax until the family chooses to sell the business or farm, instead of paying it at the death of the mom or dad. In the meantime, businesses would be forced to pay annual interest on each generation’s death, on the full amount of the death tax liability. For the first death, the family would pay interest on 55% of the businesses assets. However, with the second generation’s death, the family would additionally pay interest on half of what remains, or 22.5%, for a total of 77.5%. By the third generation’s death, the family would pay interest on an additional 6%, for a total of 84%.

Obviously, in the event that the family could not pay the interest on the tax, it would be forced to sell. I have no doubt that one of the nation’s most willing buyers of family owned businesses, Mr. Buffett himself, would only be more than willing to purchase these debt-strapped businesses. In reality, Mr. Buffett’s proposal would substantially exacerbate the harm of the death tax, and likely destroy family businesses we know it.

What Mr. Buffett has proposed is effectively a means by which the federal government becomes a majority partner in all private businesses in America. Moreover, he has created a mechanism by which many family businesses – those which cannot make the interest payments – will be forced to sell. If there have been two generations of deaths in the family, then the federal government would own more than three quarters of the business or farm. If there have been three generations of deaths, then the government will have ownership over 80 percent.

Far from reducing the impact of the death tax on family-owned businesses, Mr. Buffett’s proposal would make the death tax an even more onerous event for family-businesses and farms. Under his proposal, upon the death of the owner, Big Brother would become a “silent partner” in the business without even having contributed a single dollar of capital. However, this partner would make no contribution to the businesses growth, while confiscating a majority of its wealth upon final sale. Having considerable experience in business, I have to ask the question, why should the moment of a person’s final heartbeat make the federal government an instant partner in the family’s business?

Mr. Buffett’s proposals will not expand equality of opportunity, but will shatter the very foundation of the American dream for thousands of families. The death tax cannot be “restructured” in order to become less onerous for these families, and it should not be maintained in order to satiate Mr. Buffett’s redistributionist tinkerings. Mr. Buffett’s proposals do not bring a fresh approach to the death tax or to the justifications for which it exists. Rather, his comments show that despite the meaningful good which he can voluntarily do through his own wealth, he is more interested in using other families’ wealth to toy with redistributionist schemes.

Members of the Senate Finance Committee, I urge you to reject the proposals of Mr. Buffett, and instead, end the burden of the death tax once and for all. Family business owners and farmers across America are depending on you.