evidence -- which did reduce financial accounting income tax expeeps nse reveals the respons the -- cash tax savings constant. this evidence suggests that the accounting effect is important and serves to mitigate the responsiveness to accelerated depreciation because there is no financial accounting benefit. in conclusion, the main point of my testimony is that what many consider to be cosmetic accounting effects actually play a role in responsiveness to tax policy. these financial accounting implications can often mitigate the effectiveness of policies such as bonus depreciation for public firms. in addition, as i discuss more fully in my written testimony, sometimes the accounting implications lead to other untended consequences such as exasperating the tax incentives to leave cash overseas for u.s. multinationals. in addition, at times concern over the accounting implications has caused tax policy to be inacted in a particular manner as was the case with section 199. in sum, it is important to recognize that both tax and financial accounting effects are included in the set of factors

that public corporations will consider in their decision making process. thank you for inviting me to testify today. i look forward to your questions. >> thank you, ms. hanlon. mr. neubig, you're recognized for five minutes. >> thank you for the opportunity to testify. i was an economist at the u.s. treasury's office of tax analysis from 1980 to 1990 during the development of the 1986 tax reform act. financial accounting issues were not very important then, but over the last 25 years, i've seen their importance grow not only at the federal level, but also in terms of state tax policy and tax policy in other countries. in 2005, president bush's advisory panel on federal tax reform outlined a business cash flow tax that allowed first year 100% writeoff of capital investment like bonus depreciation. one might have expected that this plan, which many of my economists brethren claim

results in a zero effective tax rate for new capital investment would have received strong support from the business community, but it did not. this led me to consider a number of reasons why many economists often predict the effects of tax reforms much differently than the business community. although i am not an accountant, in testimony before the select revenue measure subcommittee in 2006, i noted the importance of financial accounting rules when many corporate executives evaluate alternative tax reform proposals. i will restrict my comments to several reasons why many corporations may prefer a lower corporate tax rate to more targeted tax reductions. i will use accelerated tax depreciation as one example. since its repeal has been proposed in combination with lowering the corporate tax rate in several recent tax reform plans. also, a number of countries have moved toward economic depreciation to partially finance their reduction in their

corporate tax rates. timing of taxes matters, and particularly for cash constrained firms, accelerated depreciation can provide important cash flow benefits. accelerated deductions provide benefits similar to an unsecured, zero interest rate loan from the federal government. at today's historically low interest rates, the value of accelerated tax deductions is relatively modest for corporations with access to capital markets. many corporate tax executives, as dr. hanlon noted, focus not only on their cash tax liabilities but also on their reported financial statement effective tax rates and reported book earnings. temporary book tax differences such as accelerated depreciation and many other provisions do not affect the total financial statement effective tax rate, which is based on the total accrued tax expense, both current and deferred. a lower corporate tax rate and

accelerated depreciation both reduce the economic effective tax rate on tangible business capital investments, but a lower corporate tax rate also reduces many other tax distortions. including the double tax on corporate equity, the bias toward corporate debt, taxable income shifting across tax jurisdictions, the lock in effect on corporate capital gain realizations, lock out effect on foreign dividend repatriations and reduces the tax on corporate entrepreneurship and innovation. a number of reports emphasize the necessity of combining permanent expensing with repeal of interest deductibility in order to prevent negative effective tax rates. in 1982 congress peeled back accelerated depreciation -- due to what were considered excessive tax benefits from combining an investment tax

credit with both accelerated depreciation and interest deductibility. the 1986 tax act was a key starting point. the base broadening in 1982 enabled the lower individual income tax rates to continue to be indexed for inflation while also reducing the deficit. it was clearly a trade-off between base brondening versus lower tax rates which continued in 1984 and then culminated in the 1986 tax reform act. finally, i'd like to point out a recent study by two treasury economists. a report found that only 50% to 60% of corporations and only 30% to 40% of pass-through businesses took advantage of the reason bonus appreciation rules. the study notes that while accelerated depreciation in theory reduces the cost of investment, quote, in practice various factors limit the use of bonus depreciation and its

relative value. financial statement accounting is one of those factors that influence companies' business decisions and which economists generally don't include in their tax modeling. in addition to financial accounting, tax risk and uncertainty, compliance burdens and other nonincomes taxes also affect business decisions. financial accounting is one of several reasons why many corporations may prefer a permanently lower corporate tax rate to more targeted tax incentives. i'd be happy to answer any questions about my testimony. >> thank you very much, mr. neubig. mr. heenan, you're recognized for five minutes. >> good morning. >> good morning. >> thank you for inviting me today. i appreciate it. i'd like to just start by commending you chairman for tackling -- and the rest of the committee for tackling this important topic of tax reform. we support the efforts and appreciate the time to talk about it here today. i'd like to just start to give a little bit of a background about praxair, not maybe a household name. we sell air.

we sell the components in air. we have a diverse customer mix. we can sell to a food and beverage company for the nitrogen in your potato chip bag, the fizz in your soda. we also sell to big companies, steel companies who use tons and tons of gases. so very, very diverse customer group. we have about $11 billion in sales worldwide. we're the largest industrial gas producer here in the united states. importantly, we spend about $2 billion a year on new capital investment. we go through a very rigorous process. we sit at the table with senior leaders on each new project. and they tend to be big projects. and we discuss capital investment. and we compare projects around the world. and for -- for us, you know, cash is king. to answer the question that was posed, you know, in what way does financial accounting affect our business investment

decisions, our answer is simple. it really does not affect our decisions. for us, it's about cash. cash is king. you know, earnings will follow the cash. if we get more cash, we have more to invest and the earnings will follow. so we do not focus on financial accounting. it's important to focus on earnings for other decisions in the business. on the investment decisions, cash is -- cash is king. so we use sort of a net present value cash flow model, and we don't vary from it. i can tell you, thursday this week we'll go through ten projects and not one of those projects is going to say anything about earnings. all of them will talk about internal rate of return, which is the cash flow model we focus on. so while i support tax reform, i think that we really have to take a close look at the targeted deductions that we may eliminate that pay for that tax reform.

and, specifically, you know, many members here, folks here that have been testifying have mentioned accelerated depreciation. under the current u.s. rules, you know, that is a very important factor that helps influence our investment decisions. so if we're going to remove accelerated depreciation in favor of a lower rate, we really need to weigh the two very closely to see what it's going to do to investment -- investment decisions for companies like praxair. so thank you, and i'd be happy to take any questions you might have. >> thank you. and thank you, all, for your excellent testimony. now i'll move into a question time. mr. fryt, mr. schichtel and mr. heenan, i have a question for all of you. you were invited here today because you do represent capital intensive businesses that could be asked to consider trading off a substantial amount of tax benefit if there is a comprehensive reform plan put forward that could alter pretty

dramatically the corporate tax rate, reduce it somewhat drastically. the committee wants to understand better how businesses such as yours evaluate those trade-offs. and that will be part of tax reform. now, i understand that we're not talking about details today, but especially with respect to choosing the right base broadening measures, could a revenue neutral reform package that reduces the corporate rate to 25% and moves to a territorial system, could that improve the competitiveness of your companies? if you each could just take a few minutes -- a few moments to answer that. >> my answer would be yes. at 25%, i think that's close to the oecd average, which is about 25% right now. and given our international competition, that's about where we need to be, at a minimum. you talk about base broadeners as a trade-off. there certainly is as i mentioned in my prepared remarks.

that's something we take into consideration. cash flow effects are detrimental, there's no question about it. but lowering a tax rate overall to something around 25%, i think, would be well received. >> mr. schichtel? >> i agree with mike. resounding yes. i think if we can get to a 25% rate or something close to that that's in line with the rest of the developed world, you'll find the vast majority of the business community coming out in support of it. i know it's a challenge to get there. from our perspective as a company, our health and growth is tied inextricably to the growth and health of the overall economy. no question about it. that's the biggest driving factor in how well we do over the long run. our view is that a significantly lower rate and a simpler tax code will -- be done to the benefit of the entire economy,

will encourage overall -- more growth and development, and that will, in turn, increase the returns that we have to our shareholders and the opportunities that we have out there. >> all right. mr. heenan? >> i'd like to give you an answer, yes or no, but really for -- i've been doing this a long time. the devil is in the detail. and, in our view, clearly all tax expenditures are not created equal. you know, to focus on accelerated depreciation, a tax rate will affect both our old business and our new investment. and, you know, so we have -- we're the largest industrial gas company in the u.s. we'll certainly benefit from a rate reduction. but to your specific question on investment decisions, that's a future question. a rate benefit is not going to impact our future decision. and so when i look at something like accelerated depreciation, that is very focused on new investment. new investment will bring growth

and jobs. so i think we just have to be very cautious as to which tax expenditure we're using, and we're particularly focused on accelerated depreciation because we think it has a special place in promoting new growth, and we think with that will come jobs. >> but if the right base broadening measures were chosen, do you think a revenue neutral package that reduced the rate to 25% would help the competitiveness, including a territorial system? >> i can clearly say if accelerated depreciation remains the same and everything else goes, we could -- >> from your point of view, i'm asking, yeah, your opinion. >> yeah. >> so if the right base broadening measures were choesen from your point of view, it would be something that would increase the competitiveness of -- >> absolutely. >> the other, just to follow up, could you envision a package, the three of you, being designed that would lead employers to invest more and hire more american workers? >> absolutely. i think the package -- well, i describe in my prepared remarks

the ideal one, maybe not practical, but the ideal one would be some rate close to the oecd rate with 100% expensing. i think you'd see tremendous new investment, additional global expansion, u.s. expansion and job growth. absolutely. >> all right. >> even if you went with the base broad ners that you were talking about, chairman camp, if you got down to a rate around 25% i think there's no doubt in my mind that also would increase growth. >> thank you. mr. schichtel? >> i would love to keep our tax incentives like accelerated depreciation. i would love to see expensing extended as part of an overall tax reform that lowered the rate to 25%. but i don't see how that's possible in a revenue neutral fashion. i think for the short term until we do have corporate tax reform, i think expensing, extending bonus depreciation is tremendously important and impactful.

certainly from our vantage point and our -- i get calls all the time. it is tremendously important. that being said, if we all put everything on the table and we start working towards a targeted rate and a simpler code, i think we will see more growth and, for us, that will definitely result in more jobs and more investment. >> all right. i have a question for ms. hanlon and mr. neubig. in congress we measure revenue neutrality by looking at cash taxes over a ten-year period. without using a discount rate. and that's very different how public companies calculate book earnings under gap. even very different than how public companies calculate cash flow benefits. but if this committee succeeds in defining tax reform legislation that is revenue neutral over a ten-year period the way congress measures it,

but that in the aggregate increases companies' book earnings, do you think that such a tax reform package would lead to more economic activity being located here in the united states and, therefore, more jobs for american workers? ms. hanlon, why don't i start with you. >> i guess the -- the main thing i would say to that is that if you would, you know, remove the mitigating effect of financial accounting, there seemings to be no negative effect that would come from that. so to the extent that doing the tax side of it would increase jobs and investment, then releasing the mitigating effect from accounting could only help those incentives. >> all right. mr. neubig? >> i think companies are going to be looking at a lot of different measures of taxes. and you mentioned that although it might be revenue neutral over a ten-year period from a government scoring standpoint, it might be actually higher

total taxes on the corporate community. i think there would certainly be concern about that having some adverse effect. there certainly are lots of benefits from a lower corporate tax rate. but they are going to be looking at the total tax burden in the u.s. you can factor in the other -- >> sorry. we're having microphone problems. >> other tax-base issues. so it really is the whole tax reform package that they'll be looking at. >> and to the two of you again, some commentators say that cash is king and that investors are sophisticated enough to sort of look through the differences between cash flow and book earnings. how do you respond to the arguments that investors look through book earnings and see only y start, then i'll go to mr. neubig, briefly. >> this is a great question. it's been asked many times in accounting workshops when we present research on earnings management, for example. so i think the first thing to

recognize is that accounting earnings are used for two purposes, both the equity markets and contracting purposes. so, for example, debt contracts and compensation contracts. and the extent to which those are written based on accounting numbers, you'll see managers respond to those same incentives. equity markets and these contract writers, they're not stupid or not -- not savvy enough, i wouldn't say, in using accounting earnings, because accounting earnings is general kind of like a scorecard. in other words, there's research that shows that accrual accounting earnings can predict future cash flows better than current cash flows. so it's reasonable for these people to use accounting earnings. yeah, finally, the other thing is that, you know, investors may be savvy, but they're still only human. so there's a long line of behavioral finance research that shows investors have limited attention and limited processing ability to process very complicated information like you would find in an annual report of a complicated company.

>> all right. >> there are differences across the different companies. and accelerated depreciation and the cash flow benefits -- >> maybe if you could borrow somebody else's microphone. that one doesn't seem to be working. >> cash constrained companies, in an economic downturn there are a lot of cash constrained companies that can certainly benefit from a number of cash flow benefits from a number of time progress visions. not all companies are alike. there are going to be a number of companies as dr. hanlon noted. you look specifically at the financial statement earnings and book earnings. i found that in terms of my discussions with a number of corporate executives. but also there are a number of corporations that do the type of project evaluation, looking at the cash flow benefits. i guess i would say that at the current time for companies that have access to capital markets, interest rates are at a historic

low. to the extent that accelerated depreciation really is a zero interest rate loan from the federal government, the benefits of accelerated depreciation at the current time are modest for those that have access to capital. >> all right. thank you. ms. hanlon, just finally, you mentioned in your testimony the important point that some of the analysis that we've been talking about today doesn't really apply to closely held businesses. and could you just explain how closely held businesses might analyze tax reform differently than publicly held companies? >> yes. there's a long line of literature in the accounting research that examines this exact book tax trade-off. often what we'll find if we can get the data, we'll line up private companies and public companies. essentially you find that private companies are much more responsive, you know, to the tax incentives and tax reporting incentives than are public companies. the idea is that the public companies have this financial accounting constraint. so it is probably true that

private companies will respond to these incentives more than -- than public companies will. >> thank you very much. mr. levin is recognized. except for the last few questions, we've been discussing broader tax reform and not book accounting issues. we may be relieved by that. we need to look at it. they're not easy issues. you're going to have to, i think, have a few seminars with us on -- on that subject as we look at these broader issues. it's really the broader issues that have been most lly discuss here. let me just say a word about

that. there's no doubt we need to look at tax reform. there's no need, as i said earlier, to look at it with care. and not simply grab ahold of a specific figure without looking at its consequences. because according to the joint tax analysis, when we asked them, they said if the rate were reduced to 28%, half of that reduction would come from ending accelerated depreciation. so when people say they want the rate dramatically reduced, but not at the expense of -- expensing accelerated depreciation, that doesn't really fit. and it was interesting in the testimony of the first two of

you that you referred to that. for example, in the testimony -- you know this well. mr. fryt, you said our investors applaud capital incentives like expensing. because our after tax cash flow on a new capital investment can be up to 35% less than it would be otherwise in the first year. of course, that evens out. but it's kind of a broad embrace of the importance of that. and then i just -- mr. schichtel, your testimony, if i might, you know it well. i'll just read it. this is important for us to have a full intelligent discussion of this vital issue. and this is on page three.

given the capital intensity of our business, however, we rely even more on -- let me just read. like most companies, we are strongly influenced by tax incentives that improve our reporting metrics. such as our reported income effective tax rate and our earnings per share. items like the research credit in section 199 incentives are differences that permanently reduce our taxes paid and can - affect our tax rate thereby encouraging new investment. let me just indicate. i was looking, as we were reading over your testimony last night, at marty sullivan's analysis of winners and losers, if there were a reduction in the rate to 30% with slower

depreciation repeal the domestic production credit and repeal the research credit. this is his analysis. i think all of us need to look at this and do other analyses. and it's really interesting, and it's not very surprising. the industries that benefit from that, and i'll just read a few. they apply to you, i guess. securities, insurance, retail trade. these are winners. bank holding companies, real estate. other services. it diminishes as i'm going down the line. wholesale. mining is essentially even as is construction. and then those who are losers, food manufacturing, utilities, other manufacturing, chemicals,

meadows, minerals and machinery manufacturing, transportation, internet. i don't quite understand that. but agriculture, technical services, computer and electronics, very dramatically and transport equipment very dramatically and elect cal products most dramatically. so i think since the testimony are mostly focused on these larger issues and not on the technical stuff that was headlined in our -- in the announcement of our hearing, i think your testimony today does underline the importance of our looking deeply into this issue. when we say everything is on the table, that doesn't really settle what's left on the table, right?

in a sense, it's somewhat easy to say, put everything on the table. we do that all the time here. the real issue becomes what is taken off and what's left. so we welcome your testimony, and i hope that today's hearing is another step towards our comprehensively looking at these issues so that we can come out with a -- a proposed revision of the tax code that very much keeps in mind what our objectives are. and i go back to what i said in the opening. i do think that with the return of understanding of the importance of manufacturing, we need to look at tax reform in terms of how we promote a continued growth in services, in

agriculture and the like. but also in the industrial sector of the united states. mr. heenan, that's where you come from. and i think that somewhat motivates your -- i won't say hesitation. i think it's kind of a well-rounded response. thank you. >> thank you. mr. johnson is recognized for five minutes. >> thank you, mr. chairman. mr. fryt, how low would we have to get the rate before you guys could take over the postal service? >> do i have to answer that question? >> well, you're doing a good enough job right now. >> can i have a lawyer with me? >> i've got a place out in new mexico where you'd deliver to the door, and the postal service doesn't even come. >> well, if you ever have a problem, just give me a call, please. i'll help. >> in your testimony you say the ideal reform would lower the rate to at least 25% and include

incentives for investments such as bonus depreciation. however, you also say you are willing to put all base broadeners on the table for significantly central reform tax code with a materially lower tax rate. what rate would that be if we were to give up all the other nicks? zblit really depends, mr. johnson. it depends on what's in the package. but given our competition overseas, we think it would have to be something close to the oecd rate. if you get there, presuming that doesn't continue to decline, i think as chairman camp asked earlier, i think it would be a good place to be. >> well, does that mean r & d tax credit and those kind of things would be -- >> our position is -- i'm sorry, sir? >> i