(4) Livestock would not qualify for capital gains treatment until it was held at least one year after the animal normally would have first been used for draft, dairy, breeding or sporting (such as horse racing) purposes.

F. The Treasury Department proposed to the Senate Finance Committee on September 4, 1969 that the farm provisions of H.R. 13270 be amended as follows: (1) That the Excess Deductions Account rules apply to any farmer whose nonfarm income exceeds $25,000 and whose farm losses exceed $15,000. In such a case, all farm losses should be included in the E.D.A.

(2) The term "profit" in the proposed new hobby loss provision should "be specifically defined to include not only immediate economic profit but also any reasonably anticipated long-term increase in the value of property."

V. THE PROPOSED REMEDIES WILL HURT THE AVERAGE FARMER

All of these proposals fall into the following categories:

(a) threat to the cash method of accounting;

(b) limitations on the option to expense or capitalize certain costs;

(c) restrictions on Section 270, the hobby law;

(d) limitations on non-farm income.

Let us look briefly at each of these categories.

(a) Our response to the attack upon the cash method farmer is that the issue for the past 20 years has been between the technicians down in the Treasury Department who obviously want to increase tax revenues, and the Congress of the United States which looks at the broad spectrum of what is best and, indeed, what is essential for America's three million farmers.

Congress has always put the welfare of the average farmer first in its deliberations. We don't believe the sordid story of a handful of tax dodgers is going to persuade the Congress that attacks upon the farm community and farm traditions are an appropriate response.

(b) The Surrey and Metcalf proposals provide that, in addition to giving up the cash method, farmers may not offset farm losses against non-farm income unless they also capitalize all costs which the Congress has heretofore permitted the farmer the option of either capitalizing or currently deducting. These include costs of soil and water conservation, fertilizer and land clearing.

The Treasury proposal calls these expenses "tax preferences" upon which it would place a 50% limitation.

Congress just added the soil and water conservation provision to the Code in 1954. The provision on fertilizer was added in 1960 and that with respect to land clearing in 1962. Have conditions for the farmer improved so much in the past seven years that these provisions are no longer needed by the farm community? It is impossible for us to believe that the Congresses of recent years who wrote these provisions into the law for the benefit of farmers were so illinformed or short sighted.

(c) The present hobby law provides that if losses in a trade or business exceed $50,000 for five consecutive years, the individual's tax is re-computed for each of those years and limitations are placed on the amount of loss that can be deducted. In computing the $50,000 loss figure, certain deductions are exempted by law. For example, in 1954, Congress excluded from hobby loss computations those expenditures which may, at the taxpayer's option, either be capitalized or deducted when incurred.

The Surrey proposal called Section 270 “ineffectual.” However, a few years ago, while teaching at Harvard, Mr. Surrey posed this question about Section 270:5 how can it be withdrawn without affecting the genuine business activities of an individual with his finger in many pies, or those genuine activities carried on by individuals which generally show red figures for the initial years because of the nature of the business, such as horse breeding, fruit raising, mining or hotel operation or may suddenly show losses for several years due to adverse conditions.

Thus Mr. Surrey pointed a finger at the heart of this problem. It takes 6 to 7 years before new citrus trees begin to bear fruit. The cycle in purebred livestock operations is 5 years. There is a three year lapse from breeding until a race horse is even eligible to enter a purse race. All of these investments take time before they, hopefully, begin to show a profitable return.

5 "Federal Income Taxation, Cases and Materials," Stanley S. Surrey and William C. Warren, The Foundation Press, Inc., 1955.

After 25 years experience with Section 270, including at least one relaxation of its potentially penal characteristics, we believe that the Congress will finally decide against tightening its restrictions. If the law were changed, as has been proposed, it is a certainty that many taxpayers, who are making great contributions to our people as a result of their research investments into the rural communities of America, will be driven out of these areas.

(d) The proposals that limit the right to deduct farm losses against nonfarm income seriously damage and restrict the operations of the long-time zenuine farmer.

In today's farm economy, the farmer is increasingly turning to off-the-farm supplementary income. In so doing, he is simply following the recommendation of the Farmers Home Administration, which, through its predecessor agency, began urging the farmer to diversify his farm operations when the agency first opened in 1933. For the past decade, the admonition has been to diversify not his farm but his source of income.

The success of these efforts is reflected in a recent address by Dr. M. L. Upchurch, Administrator of the Economic Research Service, U.S.D.A.:

"Off-farm income has become an increasing factor in the life of farm families. In 1967, the farm population got $13 billion net from farming and $10.7 billion from non-farm sources. On the average, each farm operator family received $4,526 net from farming, and $4,452 from non-farm sources. Non-farm income per farm family more than doubled between 1960 and 1967."

If this rate of increase continues in the future, and it will probably accelerate if tax incentives are granted for industry locating in rural areas, the non-farm income of the average farmer will exceed $15,000 in 13 years. If the Metcalf or Surrey proposals were adopted, the average of all three million farmers in America would then be forced to relinquish the cash accounting method they have been able to operate under since 1915 or be denied the right to offset farm losses against their non-farm income.

The strange anomaly of these proposals is that if the farmer proved to be more successful at farming than he was in his other business investments, he could continue to deduct all his business losses against his income from the farm. We believe that fairness and equity require that the principle should work equally in either direction.

VI. THE QUESTION OF LAND VALUES

The Surrey proposal states that "the price of farmland (is) beyond that which would prevail in a normal farm economy." In effect, it says the price of farmland is too high. Senator Metcalf acknowledged that his proposal would bring farmland prices down "in some areas."

We don't believe there is any citizen, either on or off the farm, who wants the land he presently owns to decline in value. With lower land value, the farmer who desires to expand into contiguous acreage, will have less collateral to offer Banks will be reluctant to loan money. The percentage of the selling price the farmer can get on a purchase money mortgage will decline. He will need more cash for a down payment. If he hasn't got it, and there's equity in his existing holdings, he can put up the land he already owns as collateral. But with declining values, it may not be enough, particularly if, like the average American, he already has that homestead under mortgage. He'll find the same problem when he wants a loan for new equipment, or operating capital.

The many farmers who have been able to sell out to land developers, pocket an amount of money they could never have realized from farming, and move further out into the country where they can and do buy more acreage at a fraction of the price they sold for, have not been heard to complain of increased land values. They can do a lot of things for their wives and children they otherwise could not have done. They can upgrade their total standard of living. They can be sure that their children get the best education.

One of the arguments used by the sponsors of these proposed changes is that outsiders with money come in and buy up land so that locals can't buy it. Surely there is little logic to this. The farmer who covets his neighbor's land does not want the value of his land to diminish. Surely he should realize that as all our people grow more affluent, have more leisure time, they will normally move back to the farms or ranches as a second home, and of course this increases the price of the land-his neighbor's and his own. This movement upward of land values, we submit, is desirable overall surely it's better than a downward movement. Before the Annual Agriculture Outlook Conference, February 18, 1969.

To allege as some do that "outsiders," "tax avoiders" drive up the price of land and hurt the legitimate farmer, is to ignore the facts of our growing population, our growing wealth, our growing leisure time, our growing opportunities to enjoy the long-sought "country life."

VII. THE FARM COMMUNITY NEEDS OUTSIDE CAPITAL

Implicit in these proposed changes is the belief that outside capital which is good and desirable for all industries is somehow harmful to farming. Completely overlooked are all the benefits that investment capital have meant to the farmer, the rural community and to the American people in general. Outside capital built American agriculture. It made new technology possible. It has helped to produce the finest beef and the finest citrus of the world. It seems incomprehensible to suggest that we should, all of a sudden, stop our improvements in the food and nourishment we eat-any more than we should stop the investment of capital in the production of championship race horses which attracted over 65 million people to watch organized racing last year resulting in $427 million in state tax revenues to 30 states.

You can't breed an animal and raise a mature offspring ready for the track or the market overnight, anymore than you can plant a seedling and expect a crop the next day. All this takes time-and money. Farm research, like research in every other industry in America, is considered part of the overhead. It is not expected that research will immediately return a profit. But it is essential for the continued growth and development of the farm industry. Take the research dollars out of the space industry and we would never have put an American on the surface of the moon. Take research out of agriculture and the results will have a far more direct and immediate effect upon the pocketbooks and the dinner tables of all Americans. Take dollars away from rural communities and our rural citizens will be forced to move, in greater numbers, into our already overcrowded urban areas.

The Congress won't do that. As a matter of fact, it has numerous bills pending before it today to sweeten tax incentives for industry that move into rural areas. One of these is the Rural Job Development Act (S. 15) introduced by Senator Pearson and co-sponsored by 35 Senators. We don't think Congress really wants to increase incentives for all other rural industry and simultaneously decrease incentives for farming.

We applaud the purposes of S.15, but does it make sense to ask the Congress to establish new incentives for industries that move into rural communities and provide jobs, while, at the same time drive other businesses and individuals who are now supplying jobs out of our rural communities?

Our reading of Senator Pearson's bill leads us to believe that the incentives it calls for would be available to farm investors as well as investors in other rural industry. This is as it should be.

The Congress has already created a Small Business Investment Company, industry, to stimulate outside capital into small business. This industry has generous tax advantages which include the authority to write off certain capital losses against ordinary income. Perhaps a Small Farm Investment Act, with equally generous tax advantages, would portend an era of general prosperity for the farmer, especially the family farmer, that has somehow eluded all prior efforts.

VIII. CONCLUSIONS

The farming community today is beset with many problems. With production costs at an all-time record high and parity at only 73%, the farmer is getting far less of a return for his efforts than he deserves for having produced the best beef and pork and vegetables and citrus for the American family dinner table. The farmer needs help. His industry needs stimulation. It needs innovation. It needs research, it needs capital-it needs money. Surely this is no time to be taking money out of the farm community.

Somehow, we need to extract the finest principles of other industries that have made this country the free enterprise model of the world, and apply them to a new revolution in agriculture that would truly benefit all the three million big and little farmers in America.

What the farmer doesn't need is further restrictions and encumbrances that would enevitably diminsh his opportunities to achieve success in his chosen field-what he needs is a greater opportunity to achieve a parity with the rest of our prosperous economy.

We don't believe that the farmer who happens to lose money should be identified with or bear the blame or suffer the consequences of a handful of people who are "tax gimmick operators."

It is they and not the farmer-against whom action should be taken. There are laws on the books today to put the "tax dodger" out of business. Section 165 of the Internal Revenue Code prohibits the deduction of any losses from a farm that is not being operated for profit. If laws such as these were vigorously enforced, as they should be, we would not have to be considering ways to diminish the few incentives that the farmer, thanks to an understanding Congress, enjoys today.

Mr. SMATHERS. As our second witness, Mr. Chairman, I would like to call on Mr. Ed Honnen, who is the chairman of the American Horse Council. Mr. Honnen is a most interesting person, a genuine rancher, and farmer, and I think he has an accomplishment that nobody else in this room can claim. He is 70 years old, a member of the Rodeo Cowboys Association of America, and can still go out and in 9 seconds rope and throw down a steer.

Mr. Honnen, you just take off.

STATEMENT OF EDWARD H. HONNEN, CHAIRMAN OF THE TRUSTEES, AMERICAN HORSE COUNCIL

Mr. HONNEN. Thank you, George.

Gentlemen, it is an honor to be here. I appreciate the courtesy. I am a businessman from Denver, Colo., operating throughout Colorado. I have several ventures. I merchandise heavy construction equipment. I merchandise engines. I do some land development. I do some building construction, and I also have a horse ranch and racehorses.

All of these operations are run with the same endeavor, to make a profit. They are all run with the same type of bookkeeping. The energy and the effort and the business acumen that I possess is put into all of them equally, I have no problem with most of the ventures as far as the Internal Revenue is concerned, but I am continually challenged on the hobby provision, on the horse racing business.

To me this seems to be discrimination because it is not applied to my other businesses. My auditor tells me that if I have a loss in my engine merchandising business, that I could charge it against profits of my horse business, but I cannot charge off losses of my horse business against profit of my engine business.

I can see very little difference in this operation. Most of the challenging has been through the hobby provision of the present law. I believe that this hobby provision might have had some justification when it was enacted some 30 years ago, but today the horse industry is an entirely different setup.

We are at least a $7 billion industry today involved in many facets besides horse racing. The active participation of the numbers of horses in racing is minimal compared to the total number of horses.

I raise quarter horses, and we do a little racing of those horses, but the major part of our horses are used for utility purposes, recreation, youth activities, rodeo events, showing of horses, and as I say, to a minor extent, horseracing.

The U.S. Department of Agriculture alone is sponsoring through their Extension Service 210,000 horse projects with 4-H kids.

The American Quarter Horse Association alone has more than 1,100 youth shows, and I want to assure you that at these youth shows and at these 4-H projects I do not think that you will find any longhaired youth there. These are children that are gaining a wonderful experience in life from their association with horses.

In the horse industry we are talking about a minimum of 4 to 5 million horses. We are not only a heavy impact on the economy of this country, but we are also of great benefit to the social and the recreational welfare of our people.

To me I see no justification in crucifying an industry that is doing as much good for the United States as it is.

Under the present law of the hobby provision, we have learned to live with it. In my 18 years' experience in racing horses, I have been fortunate in being able to show a profit every 4 or 5 years, but it is still challenged each year.

This is a discriminatory clause. In the present legislation as proposed we have other measures in there that are of a similar discriminatory nature. The EDA is a method of bookkeeping that is adopted for people who keep their books on a cash basis that is definitely discriminatory and not applicable to other business.

The tightening and more severe provisions of the hobby provision are not applied in practice, to any other business.

Gentlemen, our business is normally a rather speculative business, a rather risky business, because we are dealing not only with the normal economics of a business but we are dealing with genetics, we are dealing with accidents, we are dealing with normal health catastrophes that we have in any animal industry, so rather than be abused, we should be assisted.

We should have some help from the Federal Government in developing an industry that is doing as much for the country as this is.

If you want to kill the horse industry, adopt the provisions in House bill 13270. If you want to bleed it to death, modify those provisions. But if you wish to help us, leave the statutes as they are, because I am sure that with the proper administration of the present laws, that we can weed out the violators, the loopholes that exist today.

Thank you.

The CHAIRMAN. Mr. Honnen, you said you would not see any longhaired youth at one of those quarterhorse shows?

Mr. HONNEN. Male youth I should have said.

The CHAIRMAN. That is why I started to correct you. You would have seen my daughter, because she loves horses, I bought her a $75 horse and she managed to win a fourth prize at somebody's show with a $75 horse. I bought a $500 horse, it darned near killed the judge kicking up in the air while she was trying to handle him, and then I decided why I would buy a better horse so I bought a $5,000 horse and now she has her place covered with trophies that she won with the better horse. But some farmer sold my daughter three horses. If it is that farmer you are supposed to be helping, all I can say is that there are three horses whose sales might have been in jeopardy.

I do not mind losing the money because it is fine for a young woman to get out and compete with other young women with horses. It is fine, and is the cleanest sport that there is so far as I know.