STATEMENT OF
THE AMERICAN FARM BUREAU FEDERATION
TO THE SENATE AGRICULTURAL, NUTRITION AND FORESTRY COMMITTEE

REGARDING CAPITAL GAINS AND ESTATE TAXES

Presented by

William Sprague, President
Kentucky Farm Bureau Federation

February 25, 1997

My name is Bill Sprague. I am a farmer who operates a 3,000-acre corn, soybean, beef and hog farm in Union County, Kentucky. I serve on the Board of Directors of the American Farm Bureau Federation and as president of the Kentucky Farm Bureau Federation. My statement today is made on behalf of the 4.7 million families who belong to the American Farm Bureau Federation.

Production agriculture is a capital intensive industry with total assets of more than $1 trillion. Yet, despite its size, it is an industry dominated by family businesses, many of which are multi-generational. Like so many of my fellow farmers, the operation of my business involves family members. My wife, Julia, and children, Andy and Shelly, are my partners and, in fact, keep things going when I am away on Farm Bureau business.

I have been farming for a lifetime and so it goes without saying that I am the senior member of our family farm business. As I attend farm meetings across Kentucky and the United States, I realize how many others, like me, are concerned about transferring our farm businesses to our sons and daughters when we die. Like me, they worry about the negative impact the capital gains tax has on the operation of our businesses. When you consider that 47 percent of farm and ranch operators are 55 years or older, you realize that agriculture is fast approaching a transformation.

The timing of this hearing on estate and capital gains taxes could not be better. These taxes greatly impact the efficient use of farm capital and the transfer of assets from one generation to another. Estate tax and capital gains tax reform is long overdue. Thank you for providing this forum where the reasons for reform can be put forward and for allowing me to speak today.

ESTATE TAXES

Farm Bureau's position on estate taxes is straightforward. We recommend repeal. Farmers and ranchers work long, hard hours over a lifetime to build their businesses. Along the way they paid income taxes on their earnings and it is wrong to tax those earning again at death. Farmers and ranchers should be able to save for the future without having to worry about sharing the outcome of their efforts with the federal government after already paying a lifetime of income taxes. Family farms and other family businesses should be passed from generation to generation without complex and costly estate planning.

Until repeal is possible, Farm Bureau supports increasing the exemption to $2 million and cutting the tax rate by half for assets over $2 million. The gift tax should be increased from $10,000 to $50,000 per year. These changes would lift the burden of estate taxes for thousands of farmers and ranchers. Internal Revenue Service figures show that by increasing the estate tax exemption to $1 million, over 37,000 estates, 54 percent of the returns filed, would no longer have to file estate tax forms.

A $2 million exemption would eliminate the tax on most farms and ranches. Failure to increase the exemption discourages the continuation of family farms. Often, farm heirs must sell business assets to pay estate taxes. When taxes drain capital from a farm business, the profit-making ability of the farm is destroyed and the farm business dies.

The story of a Fauquier County, Virginia, farmer makes clear the need for estate tax reform. His wife inherited an 85-acre beef farm that he now operates with his family. Through extensive estate planning and use of Section 2032A special use valuation, a portion of the farm was passed from father to daughter. The family wants to continue to farm but will be unable to pay the estate taxes on the mother's portion because the tax due will exceed their ability to pay. When asked if selling a part of the farm to obtain cash was an option, he said, "There won't be much left."

The estate tax exemption hasn't been increased since 1981. Since then, average prices in the U.S. economy have increased by 70 percent. Farm Bureau believes that the exemption should be increased to $2 million and indexed for inflation. This would provide the same protection from inflation as is provided by the adjusting of income tax brackets, personal exemptions and the standard deduction.

Two million dollars may seem like a lot of money to some. But for many farmers and ranchers, it is simply a family business. According to Purdue University, good Indiana farmland sells for $2,300 an acre. A multi-generation family farm may involve 1,000-2,000 acres, with half the land owned and half rented. One thousand acres of land at $2,300 per acre is worth $2.3 million. That doesn't include buildings, livestock, farm equipment and other assets whose value would easily be worth another third of a million dollars on a 1,000-acre farm.

Some people argue that estate taxes do not impact small business if estate planning is effectively used. While sometimes effective at protecting farm businesses from estate taxes, estate planning tools and life insurance are costly and constantly drain resources that could be better used by farmers and ranchers to upgrade and expand their operations.

The situation of an orchard and farm market operation in Allegheny County, Pennsylvania, illustrates this point. Knowing that the estate tax burden will be great, this family operation of a mother, father and four children has developed an estate plan requiring money to be set aside for estate taxes. The amount of money that the business puts into a trust each year is almost as great as the individual earnings of each of the children. According to the family, this significantly reduces funds for things that the farm could use to operate more efficiently, like equipment purchases and building improvements.

The Indiana and Pennsylvania examples show that the estate tax is not a tax on the rich, as opponents of estate tax cuts argue, but rather a penalty on middle-class men and women who chose to make their living by operating their own businesses. Internal Revenue Service data from 1995 clearly shows that those with the greatest worth are also the best at using estate tax planning to reduce or eliminate taxes at the time of death.

While farmers spend hundreds of hours and thousands of dollars for estate plans and life insurance, relatively little revenue is generated for the federal government. In fact, Internal Revenue Service figures for 1995 show 54 percent of returns (37,000 estates) had assets of less than $1 million and generated only $650 million. The estate tax raised a total of about $14.8 billion in fiscal year 1996, as reported by the Office of Management and Budget. But, the estate tax can also cause huge revenue losses. People who believe they will be subject to the estate tax seek ways to transfer assets to avoid the tax. That often includes investing in less productive assets that reduce taxable income in the short term.

It follows that one of the reasons that revenue collected from the estate tax is low is that not very many people pay the tax. During 1995, 31,565 estates paid estate taxes. This is roughly 1.4 percent of the estimated 2.3 million adults who died that year. Opponents of estate tax reform say there is no reason to change a tax that affects so few middle income Americans. But each death affects children, grandchildren and other close family members. The impact is greatest for multi-generation family farms and ranches and other family businesses.

Farm Bureau supports changes in Section 2032A of the tax code that allows land to be appraised at its agricultural value for estate tax purposes. While beneficial to farms that operate near towns and parks, the amount that land value can be reduced is limited to $750,000. Use valuation is sound public policy and the limit should be removed so that the program can be applied to all farm and ranch land.

In addition, Section 2032A requires that the land be kept in agricultural production and "operated" by the heirs for 10 years. The rules have become so complex that some choose not to use the program because they fear they may not be able to comply with all the rules. Farm Bureau recommends improvements in the law so that cash leasing to family members and the harvest of timber does not trigger the recapture of estate taxes.

Farm Bureau also supports the deferral of estate taxes until a farm is sold outside the family. In addition, land protected by a conservation easement or participating in a farmland preservation program should not be subject to estate taxes.

CAPITAL GAINS TAXES

Farm Bureau supports repeal of capital gains taxes. Until repeal is possible, Farm Bureau supports cutting the rate to no more than 15 percent. Capital gains taxes result in the double taxation of income from capital assets. I don't know any farmers who have bought farmland, buildings, equipment or livestock with untaxed dollars. It is wrong to tax earnings twice. In addition, the tax interferes with the sale of farm assets and causes asset allocation decisions to be made for tax reasons rather than business reasons. The result is the inefficient allocation of scarce capital resources, less net income for farmers and reduced competitiveness in international markets.

Farmers need capital gains tax relief in order to insure the cost and availability of investment capital. Access to affordable capital influences agriculture's ability to compete with overseas production. Most farmers and ranchers have limited sources of outside capital. It must come from internally-generated funds or from borrowing from financial institutions. The capital gains tax reduces the amount of money available for reinvestment by farmers and ranchers. Financial institutions look closely at financial performance, including the impact of the capital gains tax on the profit-making ability of a business.

Capital gains taxes affect the ability of new farmers and ranchers to enter the industry and expand their operations. While many think of the capital gains tax as a tax on the seller, in reality it is a penalty on the buyer. Older farmers and ranchers are often reluctant to sell assets because they do not want to pay the capital gains taxes. Buyers must pay a premium to acquire assets in order to cover the taxes assessed on the seller. These higher costs for asset acquisition negatively impact the ability of new and expanding farmers and ranchers to make a profit and compete in international markets.

Farm Bureau supports adjusting capital gains for inflation so that only real gains in the value of assets would be taxed. Under current law, many farmers and ranchers pay an effective tax rate that is extreme and sometimes end up paying more in capital gains taxes than the increase in the real value of the assets. Farmers and ranchers are reluctant to sell land and farm assets and reinvest in other assets, even when that may make the best business sense. For assets held for long periods of time, adjusting their value for inflation is a matter of fairness.

Farmland provides a good example. Farmers and ranchers on average hold farmland for about 30 years. In 1966, farmland in Kentucky was selling for an average of $196 per acre. In 1996, the average was $1,377. A farmer who bought 300 acres of land in 1966 for $58,000 and sold it in 1996 would have a taxable gain of $354,000 and owe $99,120 at a 28 percent tax rate. The average prices in the U.S. economy are now 4.26 times what they were 30 years ago. This means that the real increase of value on those 300 acres was $162,600, making the effective tax rate on the real capital gain 61 percent.

Farm Bureau supports allowing receipts from the sale of farm and ranch assets to be placed directly into a pre-tax individual retirement savings account (IRA). Withdrawals would be taxed at the regular applicable income tax rate. Farm and ranch assets accumulated over a lifetime are often the "retirement plan" for farmers and ranchers. Allowing these funds to be placed into a pre-tax account would treat farmers and ranchers in the same manner as other taxpayers who contribute to IRAs throughout their working life.

A similar result for yearly income could be achieved by allowing farmers and ranchers to establish individual investment accounts. Taxes on money placed in these accounts would be deferred, as with IRAs. Funds could be withdrawn for any purpose with taxes due at the holder's regular tax rate. This would allow farmers and ranchers to save for future needs as well as for retirement. Because farmers and ranchers could save money before taxes in high-income years and draw that money out in low-income years, they would pay taxes at a rate similar to people earning the same aggregate amount with more stable incomes.

Farm Bureau also believes that the current once-in-a lifetime exclusion of $125,000 on the sale of a primary residence by a taxpayer over 55 years of age should be increased to $500,000 and expanded to include farms and ranches. The exclusion should not be limited to a single use by a taxpayer over age 55 and, if not used, should be added to an individual's estate tax exemption.

TAX REFORM

Farm and ranch concerns over capital gains taxes and estate taxes raise many questions about the need to fundamentally reform the current tax system. Consideration should be given to a new and different taxing systems that encourage savings, investment and entrepreneurship. Changes are needed to simplify tax laws, reform Internal Revenue Service rules and regulations and simplify tax forms. Fundamental tax reform which completely replaces the current personal income tax and corporate income tax should eliminate estate taxes and capital gains taxes.

CONCLUSION

American farmers and ranchers are the most productive in the world, producing 16 percent of the world's food on just 7 percent of the land. Farm and ranch productivity allows U.S. citizens to spend only 9.3 percent of their income on food, the lowest percentage in the world.

Agriculture and related industries provide jobs for more than 21 million people. Nearly 3.5 million people operate farms or work on farms. Another 3.6 million produce the machinery and inputs used on the farm or process and market what farmers produce. More than 14 million work in wholesale or retain businesses helping get farm products from the farm to consumers.

In order for farmers to continue this high level of productivity, reform of estate tax and capital gains tax laws is needed without delay. The results will benefit farmers, consumers and the economy.

 APPENDIX

FARM BUSINESS STRUCTURE

According to the 1992 Census of Agriculture, 85.9 percent of the farms and ranches are individual or family proprietorships and 9.7 percent are partnerships. Family corporations make up 3.4 percent of the farm and ranch operations. Most of these have 10 stockholders or less.

DISTRIBUTION OF FARM ASSETS BY AGE

According to the 1992 Census of Agriculture, 477,650 farm and ranch operators were 65 years old or older, out of a total of 1,925,300 farm and ranch operators. Thus, roughly one-quarter of the farm operators are over 65 years old. They owned and rented land and buildings valued $153 billion, 22.3 percent of the total value of land and buildings for all farms and ranches of $687 billion. They also had farm machinery and equipment valued at $17.8 billion, 19.1 percent of the total of $93 billion. Another 429,839 of the farm and ranch operators were 55-64 years old, 22.3 percent of farm and ranch operators. They owned and rented land and buildings valued at $165 billion, 24.0 percent of the total, and had equipment valued at $21.1 billion, 23.7 percent of the total.

INTERNAL REVENUE SERVICE 1995 ESTATE TAXES COLLECTIONS

Estates with a gross value of $600,000 or more are required to file an estate tax form even if no tax is owed. In 1995, 69,772 estate tax forms were filed with a gross value for estate tax purposes of $117.7 billion. Of that total, 38,207 filers, 54.8 percent, did not owe any estate taxes after the various adjustments were made. The category called farm assets includes only machinery and livestock and not land, buildings or other farm assets. The IRS does not accurately identify the assets of farmers and ranchers.

Over half of the estate tax forms filed in 1995, 37,328 or 53.5 percent, had estates valued at $600,000 to $1 million. Of this total, only 13,830, 37.0 percent actually owed any tax. They paid a total of $651.2 million in taxes, an average of $47,085 per return, and 5.5 percent of total estate taxes.

For 1995, 61,887 of the 69,772 estates that filed, 88.6 percent, had estates with a gross value of $2.5 million or less. They paid $3.65 billion in taxes, 30.9 percent of the $11.8 billion paid.

Three hundred estate tax returns were filed with gross assets of $20 million or more with a total gross value of $15.5 billion, $51.6 million per estate. Of those 300 estates, 69 or 23 percent, with a gross value of $2.8 billion, owed no estate taxes at all. For those who did pay estate taxes, they had gross estates of $12.7 billion, but adjusted taxable estates of only $5.4 billion.