price since the full cost of creating the asset has previously been deducted against ordinary income. In reporting on my original bill S. 2613, in July of 1968, the Treasury reviewed the two principal methods of accounting used in reporting business income for tax purposes. Generally speaking, those businesses which do not involve the production or sale of merchandise may use the cash method. Under that method, income is reported when received in cash or its equivalent, and expenses are deducted when paid in cash or its equivalent.

However, in businesses where the production or sale of merchandise is a sig nificant factor, income can be properly reflected only by deducting the costs of merchandise in the accounting period in which the income from its sale is realized. This means that costs are recorded when incurred and sales when made, and costs attributable to unsold goods on hand at year's end are included in inventory. Under this method of accounting, the deduction of costs included in inventory must be deferred until the goods to which they relate are sold rather than being deducted when the costs are incurred. Thus, under this second method of accounting, income from sales of inventory and the costs of producing or purchasing such inventory are matched in the same accounting period. The end result in this type of business is a proper reflection of income.

The Treasury Department has historically permitted farmers to deviate from general accounting practices to spare the ordinary farmer the bookkeeping chores associated with inventories and accrual accounting. In addition the Treasury has in the case of some capital outlays permitted farmers to write them off as if they were current expenses.

On 5 February of this year, the House Ways and Means Committee published a study of needed areas for tax reform conducted by the Treasury Department during the last two years of the Johnson Administration. In discussing the effect that tax-dodge farmers have on the farm economy the study points out that "when a taxpayer purchases and operates a farm for its tax benefits, the transaction leads to a distortion of the farm economy. The tax benefits allow an individual to operate a farm at an economic breakeven or even a loss and still realize an overall profit. For example, for a top-bracket taxpayer, where a deduction is associated with eventual capital gains income, each dollar of deduction means an immediate tax savings of seventy cents"-or seventy-seven cents with the surtax-"to be offset in the future by only twenty-five cents of tax. This cannot help but result in a distortion of the farm economy, and it is harmful to the ordinary farmer who depends on his farm to produce the income needed to support him and his family.

"This distortion may be evidenced in a variety of ways: For one, the attrac tive tax benefits available to wealthy persons have caused them to bid up the price of farmland beyond the price which would prevail in a normal farm economy, and is harmful to the ordinary farmer who must compete in the marketplace with these wealthy farm owners who may consider a farm profit-in the economic sense unnecessary for their purposes."

My bill would eliminate these distortions by limiting to $15,000 or to the amount of the "special deductions" listed in the bill, whichever is higher, the amount by which a "farm loss" may offset a taxpayer's nonfarm income. The $15,000 figure is reinforced by the following observation contained in Treasury's two-year study, and I quote: "If a taxpayer has more than $15,000 of nonfarm income, his primary source of livelihood is not likely to be his farming efforts, and, thus, he is not the type of farmer for whom the special accounting rules were devised." Generally, a farm loss would be the amount by which farm deductions exceeded farm income in any given year. For this purpose, as the 1968 Treasury report suggested, the untaxed one-half of long-term capital gains attributable to farm property would not be included in farm income. Farm deductions include all deductions that are attributable to the business of farming. If the taxpayer's nonfarm income is in excess of $15,000 in any given year, the limit on his deductible loss in that year would be reduced by one dollar for each dollar of such excess. However, economic losses are protected by providing that the $15.000 loss limitation will be raised to the amount of the taxpayer's special deductions if that amount is higher than $15,000.

When Assistant Secretary of the Treasury Edwin S. Cohen testified before this Committee on 5 September he referred to the fact my bill is now pending before this Committee. He was then asked by Senator Hartke and I quote: "What is wrong with that bill?" Answer by Mr. Cohen, "Well, suppose as Senator Gore said, a short while ago, there were an actual economic loss of $50,000, suppose there is an actual economic loss from tornado, floods, low prices, drought, any number of

factors, why should we disallow a true economic loss to the farmer or where
Should we disallow it in any event at strictly $15,000 a year."

There are two observations I must make with respect to that answer. First,
if there were an actual economic loss of $50,000 from tornado, floods, low prices,
drought or any other factor beyond the control of the taxpayer under the pro-
visions of my bill the entire amount of that economic loss could be used to offset
onfarm income. Assistant Secretary Cohen's answer simply demonstrated that
he had never read my bill. My bill specifically takes into account the nature of
the deductions that generate a loss in a given year. It provides that if the sum
total of deductions paid or incurred in the business of farming and which are
attributable to taxes, interest, the abandonment or theft of farm property, or
josses of farm property arising from fire, storm, or other casualty, losses and
expenses directly attributable to drought, and recognized losses from sales,
exchanges and involuntary conversions of farm property-if any one or all of
those deductions adds up to a figure that is higher than $15,000 then the tax-
payer is allowed to use the higher figure as an offset against nonfarm income.
An exception is made in my bill for such deductions since they are in general
deductions which would be allowed to anyone holding farm property without
regard to whether it was being used in farming or because it is the type of
deduction that is clearly beyond the control of the taxpayer.

My second observation is that assuming an actual economic loss of $50,000
caused by any of the economic factors listed by Assistant Secretary Cohen, and
assume one additional fact . . . that the taxpayer has an adjusted gross nonfarm
income in excess of $25,000 in that same year, it is the Administration's proposal
that would penalize the taxpayer for an economic loss. Although the loss could
be used as an offset against nonfarm income the entire amount of that loss
would have to be included in the Administration's excess deductions account.
To the extent of the balance in that account, what would otherwise be a long-term
capital gain from farming in a subsequent year would be converted into ordinary
income. The House-passed bill would also attempt to recapture an economic loss
by the same method but to a lesser degree because it only applies to that portion
of a farm loss above $25,000 and then only if nonfarm adjusted gross income
is above $50,000. When Assistant Secretary Cohen testified he observed that the
dollar exclusions contained in the House-passed bill render the bill ineffective.
Getting back to the loss limitation approach, my bill adopts a suggestion made
in both the 1968 Agriculture and Treasury reports as well as in Mr. Houthakker's
article. If the farm loss in any given year is greater than the allowable amount,
it would be carried backward three years and forward five years to offset farm
income of those years. This safeguard is in the bill to protect new farmers who
are sincerely interested in farming but who understandably might be unable
to turn an economic profit in those years.

My bill also provides that a taxpayer may treat a nonfarm business as a part of his farming operation if it is related to and on an integrated basis with the farm business. Some recent inquiries about this provision indicate that there are those who would attempt to use it to offset some artificial farm losses arising from the farm tax accounting rules against income earned in another business. This provision is not intended to allow a business to be considered as related and conducted on an integrated basis with the farming operation unless it consists of the processing of a product raised in the farming operation. Furthermore, it is only equitable that to qualify to elect this provision, the sale of such processed product should produce a substantial portion of the total receipts of the over-all operation. Moreover, this provision is intended only for purposes of measuring the size of the "farm loss" to ascertain whether certain deductions are allowable. This provision is not meant to allow the nonfarm business to be treated as a farm operation for the purpose of adopting accounting methods, the filing of estimated tax returns, or the filing of final returns, and the like. The House-passed bill and the Administration's proposal both adopt the proposal contained in S. 500 which would exclude from the application of any limitation, the taxpayer who is willing to follow with respect to his farming income, accounting rules which apply generally to other taxpayers; that is if he uses inventories in determining taxable income and treats as capital itemsbut subject to depreciation in cases where other taxpayers would take depreciation-all expenditures which are properly treated as capital items rather than treating them as expenses fully deductible in the current year.

My bill has gained substantial bipartisan support in both the House and the Senate. Twenty-six other Senators, including three members of this Committee

(Senators Hartke, McCarthy, and Harris) are cosponsors of S. 500. At last count, the loss limitation approach contained in the bill had been specifically endorsed by members of at least thirty different Congressional delegations. Aside from Congressional support the method of approach taken in S. 500 has the full support of all those who are sincerely interested in the working farmers of our Nation. For example, the National Farmers Union, the American Farm Bureau Federation, the National Grange, the National Farmers Organization, the National Council of Farmer Cooperatives, the National Association of Wheat Growers, the Cooperative League of the U.S.A., the National Association of Farmer Elected Committeemen, the Farmland Industries Cooperative, the MidContinent Farmers Association-formerly known as the Missouri Farmers Association, the Farmers Grain Dealers Association, the AFL-CIO, the Industrial Union Department of the AFL-CIO, the United Steelworkers, the South Texas Cotton and Grain Association, Inc., and the Amalgamated Meat Cutters and Butcher Workmen, have all called for a limit to be placed on the amount of artificial farm losses that can be used as an offset against nonfarm income. Contrast this type of support with the testimony of the National Livestock Tax Committee before the House Ways and Means Committee some six years ago. This is what the National Livestock Tax Committee had to say about the excess deductions account approach in 1963 and I quote: "We cannot say whether it would work or would not, but it is the most modest approach that has come to our attention."

Well, that sort of grudging praise coming from an organization that has been fighting tax reform in this area every step of the way made be take a hard look at the EDA approach when I first considered ways to get at this problem without hurting the legitimate farmer.

The basic problem with the EDA approach is that it allows the tax-dodge farmer to defer any recognized capital gains until he chooses to sell and at the same time, allows him to continue along his merry way each year using artificial farm losses as an offset against nonfarm income. With proper tax planning the balance in the excess deductions account can be milked dry by the time the taxpayer decides he is ready to recognize long-term capital gains. Such a proposal will not remove any of the incentive from existing clients of cattle management firms such as Oppenheimer Industries. Instead of catching the tax-dodge farmer with his hand in the cookie jar by limiting premature deductions each year, the EDA approach lets the tax-dodge farmer put us in the position of having to refill an empty jar.

Farm operations carried on by corporations usually are not separately reported on the corporation tax return. Consequently, data concerning the number of corporations and revenue effect with respect to corporations could not be be determined with respect to either the EDA approach or the loss limitation approach.

However, I do have revenue figures that provide some insight into the comparative effectiveness of the House bill, the Administration's proposal, and S. 500. At my request the Chief of Staff of the Joint Committee on Internal Revenue Taxation, Laurence N. Woodworth, has provided me with the following statistics. My bill would affect in the neighborhood of 14,000 individual tax returns. It is estimated that it would raise an additional $205 million a year from these individuals. The number of returns affected by the "Excess Deductions Account" provision of H.R. 13270 is estimated to be in the neighborhood of 3,000. By 1979 the estimated increase in tax liability under the farm provisions of the House bill are as follows: excess deductions account, $10 million; depreciation recapture, $5 million; holding period of livestock, $5 million; hobby losses, negligible; for a total of $20 million by 1979. It is estimated that sometime after 1979 the increase in tax liability ascribed to the excess deductions account provision would increase an additional $5 million. So we are talking in terms of increased revenue under the House-passed bill of $25 million a year as opposed to $205 million under S. 500. These revenue estimates do not include comparative figures for corporations. We can only leave to the imagination the amount by which the gap between the two bills would widen even further.

The Administration estimated on 4 September that its modified EDA rule "would apply to only 9,300 individuals" and that the long-range revenue effect of its farm loss provisions would be $50 million, still a far cry from the amount of revenue that could be raised by equitably and effectively dealing with this problem.

this

Elimination of the exception for livestock from the depreciation recapturerales was analyzed in detail several years ago by the President of Oppenheimer Industries, General Harold L. Oppenheimer. General Oppenheimer has been described by Time magazine as the "Bonaparte of Beef." He has authored three books for the cattle industry, Cowboy Arithmetic, Cowboy Economics and Cowboy Litigation. I have been informed by his Washington representative that a fourth book, Cowboy Politics is now in preparation. Here is what the General had to say in 1966 in his book, Cowboy Economics, about the depreciation recapture provision that has since been adopted in the House-passed bill :

"Members of Congress and officials of both the old and the new administrations have suggested that where accelerated depreciation is taken, on any subsequent sale, the portion of the capital gain which represents the recovery of previously taken depreciation should be treated as ordinary income. This is essentially the system now used in Canada.

"Evaluation. This piece of legislation is undoubtedly going to get passed within the next year or so, although it was deleted by the House Ways and Means Committee from the 1964 Tax Bill. However, as far as breeding herds are concerned, this is a matter of relatively little significance. During the first two years of a purchased breeding herd, the culls sold from the herd on a capital gain basis are very unlikely to exceed the depreciated value by more than a few dollars. During the third and fourth years, this could be a matter of some importance in the sale of culls but without an appreciable percentage effect on the overall picture. During the fifth year, most of the animals with an original capital base will have been sold and the herd will consist almost entirely of animals born to it at no cost basis, so the effect this legislation would achieve would then be zero."

General Oppenheimer's book, Cowboy Litigation, contains an interesting chapter, "Tax Play in Race Horses." Here are some of the observations contained in that chapter.

"The tax aspects of the horse business are unique, but in most instances, parallel the cattle business . .

...

"Stud fees paid by the owner of a mare are currently deductible or they can be capitalized and depreciated over the life of the foal. Unless the breeder is in a loss position and concerned about a so-called hobby loss, it would be better to expense the fee...

"Depreciation can produce considerable tax benefits as with cattle . . .

"Animals held for breeding are treated the same as other livestock such as cattle...

"Continued losses are a problem and always subject to scrutiny. . . . Breeding, racing, and the showing of horses have always been suspect, particularly when conducted by a high-bracket taxpayer that endeavors to write the losses off against other income . . . As with cattle, the decision turns on the subjective motives and profit potential of the owner. . . Country estates and small operations are in the face suspect. The more attention paid to the business and the professional manner in which the business is operated are all plus factors."

I shall turn now to some of the more common allegations made by those who oppose my bill. For example, there are some who say that the bill would force farmers to use the accrual system of accounting; that the bill would prevent the successful farmer or rancher from engaging in nonfarm operations with outside income for fear of losing his right to deduct farm losses; that the bill would discourage the flow of outside money into ranching and farming operations and so on.

I have repeatedly denied these allegations. Statistics reveal that there are a comparatively few taxpayers who enter into farming as a tax-dodge device. The 32-page report, "Statistics of Income-1967, Preliminary, Individual Income Tax Returns," published on January 14 of this year reveals that for 1967 there were approximately 770 thousand taxable individual income tax returns filed that reported a net loss from farming. My bill would affect in the neighborhood of 14 thousand or slightly less than 2 percent of those returns. This is statistical evidence that my bill will only affect the tax-dodge farmers who are currently distorting the farm economy.

In discussing statistical evidence of this problem, the Treasury's two-year study, published on 5 February of this year, points out that a growing body of investment advisors is currently advertising that they will arrange farm investments for high-bracket taxpayers to enjoy deductions on dollars that are really spent to acquire capital assets. It is because of that kind of advertising that people are being drawn to farm "tax-loss" situations.

Just last year I saw an ad in a magazine called the Airline Pilot that rea in part-"Own a citrus grove using tax dollars as your total investment, . . The ad was headed "Tax Shelters for 1968." You can pick up the Wall Stre Journal on any given day and find ads of this type. For example, the other da I came across one that read in part: "Pistachio Nuts, The Green Nut with th Golden Future . . . Outstanding opportunity for land investment and Pistach nut tree planting program . . . Most of growing costs deductible."

As I evaluated each of the proposals pending before this Committee, I mu admit that I have become even more convinced that the fairest and most effe tive way to get at this problem is to adopt the loss limitation approach containe in S. 500. Here is a unique opportunity to scale down the long run revenue los that results from the sum total of all the provisions of the 368-page House bi while at the same time we increase substantially the equity of our tax law through a healthier farm economy.

[H.R. 13270, 91st Cong., first sess.]

[Amdt. No. 139]

IN THE SENATE OF THE UNITED STATES

AUGUST 13, 1969

Referred to the Committee on Finance and ordered to be printed

AMENDMENT

Intended to be proposed by Mr. METCALF to H.R. 13270, an Act to reform the income tax laws, viz: Page 139, beginning with line 10, strike out al through line 6, page 152 (section 211 of the bill), and insert the following SEC. 211. FARM LOSSES.

(a) IN GENERAL.-Part IX of subchapter B of chapter 1 (relating to items not deductible) is amended by adding after section 279 (added by section 411(a) of this Act) the following new section:

“SEC. 280. LIMITATION ON DEDUCTIONS ATTRIBUTABLE TO FARMING "(a) GENERAL RULE.-In the case of a taxpayer engaged in the business of farming, the deductions attributable to such business which, but for this section would be allowable under this chapter for the taxable year shall not exceed the

sum of

"(1) the adjusted farm gross income for the taxable year, and

"(2) the higher of—

"(A) the amount of the special deductions (as defined in subsection (d) (3)) allowable for the taxable year, or

"(B) $15,000 ($7,500 in the case of a married individual filing a separate return), reduced by the amount by which the taxpayer's adjusted gross income (taxable income in the case of a corporation) for the taxable year attributable to all sources other than the business of farming (determined before the application of this section) exceeds $15,000 ($7,500 in the case of a married individual filing a separate return). "(b) EXCEPTION FOR TAXPAYERS USING CERTAIN ACCOUNTING RULES.— "(1) IN GENERAL.-Subsection (a) shall not apply to a taxpayer who has filed a statement, which is effective for the taxable year, that

"(A) he is using, and will use, a method of accounting in computing taxable income from the business of farming which uses inventories in determining income and deductions for the taxable year, and

"(B) he is charging, and will charge, to capital account all expendi tures paid or incurred in the business of farming which are properly chargeable to capital account (including such expenditures which the taxpayer may, under this chapter or regulations prescribed thereunder, otherwise treat or elect to treat as expenditures which are not chargeable to capital account).