The Business Enterprise Income Tax

1. May 2005 The Business Enterprise Income Tax President’s Advisory Panel on Federal Tax Reform Edward D. Kleinbard Cleary Gottlieb Steen & Hamilton LLP

2. The Business Enterprise Income Tax • The Business Enterprise Income Tax (BEIT) reforms the income tax rules that apply to operating or investing in a business. • The BEIT’s tax base is income, not consumption. • Current law would apply to activities not related to operating or investing in a business enterprise, such as employment income. • The BEIT is designed to reduce greatly the role of tax considerations in business thinking. • The BEIT does so by replacing current law’s multiple elective tax regimes with a single set of tax rules for each stage of a business enterprise’s life cycle: • Choosing the form of a business enterprise; • Capitalizing the enterprise; • Selling or acquiring business assets or entire business enterprises. 2

3. Overview of BEIT • The BEIT has four components: 1. Taxation of all businesses at the entity level. • Partnerships and even sole proprietorships are taxable entities. • Similar in this one respect to Hall-Rabushka and 1992 Treasury Comprehensive Business Income Tax (CBIT) proposals. 2.True consolidation principlesfor affiliated enterprises. • Separate tax attributes of consolidated subsidiaries no longer are tracked. • Instead, affiliated entities are treated as part of one single business enterprise. 3

4. Overview of BEIT (cont’d) 3.Repeal of all ‘tax-free’ organization and reorganization rules. • All transfers of business assets (or entry into a consolidated return) are taxable asset transactions. • Tax rates on such sales are revised to be ‘tax neutral.’ 4.A uniform cost of capital allowance (COCA) to measure a business enterprise’s tax deductions for any form of financial capital (e.g., debt, equity, options) that it issues to investors. • Analogous income inclusion rules for holders of financial capital instruments. • COCA replaces interest deductions. COCA does not replace depreciation deductions. • Result is quasi-corporate integration. 4

5. One Tax System for All Business Enterprises • All business enterprises are taxed at the entity level. • Rules are similar to current taxation of corporations (other than acquisitions and the COCA regime). • Recognizes that our largest pools of business capital (public corporations) already are taxed as entities. • A sole proprietor thus is taxed both as an investor and as a separate business entity. • Proprietorships today must segregate business from personal expenditures, so recordkeeping issues are not insurmountable. • Taxing business entities – rather than the owners of those entities – reduces complexity and increases consistency. • Different rules for collective investment vehicles (mutual funds). 5

6. True Consolidation Principles • Current law’s corporate consolidated return rules are stupefyingly complex. • These rules do not consolidate companies in the everyday or accounting sense of the word. • Instead, the rules track separate tax attributes of every affiliate. • The BEIT provides a true consolidation regime. • All business enterprises (whatever the form) held through a common chain of ownership are treated as part of a single business enterprise (like financial accounting). • Minority investors in subsidiaries are treated as investors in the common enterprise. • New ownership thresholds for consolidation look to all of an enterprise’s long-term capital, not just stock. 6

7. Tax-Neutral Acquisition Rules • All tax-free organization or reorganization rules are repealed. • The true consolidation model effectively requires the elimination of current law’s stock/asset acquisition electivity. • Any acquisition of a business asset or a controlling interest in a business enterprise is treated as a taxable asset sale/acquisition. • Thresholds for business enterprise transfers are the same as the tax consolidation rules. • ‘Business assets’ comprise assets subject to depreciation, so inventory and financial instruments are taxed separately (as ordinary income and under the COCA regime, respectively). • Gain/loss taxed at ‘tax-neutral’ rates. • Seller’s tax rate = PV of tax value of buyer’s asset basis step-up / step-down. • So different rates apply for different depreciation classes. 7

8. Tax-Neutral Acquisition Rules (cont’d) • Result economically is similar to making every acquisition a carryover basis asset-level transaction. • But eliminates loss duplication trades. • Eliminates exceptions to realization principles. • Eliminates administrative issues of tracing basis back through former owners. 8

9. COCA – Overview • Replaces current law’s differing treatment of interest and dividends with a uniform annual cost of capital allowance to issuers, and a correlative income inclusion for investors. • Implements two different agendas: • A quasi-integration regime. • One set of rules in place of current law’s enormous and internally inconsistent infrastructure for taxing different financial instruments. • Comprehensive in scope. • Applies (with minor modifications) to derivatives & cash investments. • Revenue neutral, if so desired. Key drivers are: • Statutory formula for setting the annual allowance. • Treatment of tax-exempt and foreign investors. 9

10. COCA – Issuer’s Perspective • A business enterprise (financial institutions excepted) deducts an annual allowance for the financial capital invested in it. • Rate set by statute, e.g., at a fixed % above 1-year Treasuries. • Rate is uniform, regardless of the form of capital raised by an enterprise (e.g., debt or equity). • No further deduction (income) to issuer if actual payments to investors exceed (are below) the annual COCA rate. • Similarly, no gain or loss to issuer on retiring a financial capital investment. • COCA rate is applied to issuer’s total capital to determine the issuer’s annual COCA deduction. • By definition, total capital = total tax basis of assets. • So total asset basis x COCA rate = COCA deduction. • COCA deduction is in addition to, not in place of, asset depreciation. • COCA and depreciation are related, as depreciation reduces asset basis. COCA thus mitigates distortions from expensing/accelerated depreciation. 10

11. COCA – Investor’s Perspective • ‘Minimum Inclusion’ – taxed as ordinary income. • Annual amount = the investor’s tax basis in investments in business enterprises x COCA rate. • Investor includes Minimum Inclusion as income each year, irrespective of cash distributions from issuer. • Distributions from issuer then treated first as tax-free return of accrued Minimum Inclusions. • Unpaid Minimum Inclusions added to investment basis (like zero coupon bonds today). • Minimum Inclusion is not tied directly to issuer’s COCA deduction, so holders do not require any issuer-specific information reporting. • Tax policy best would be served if all holders, including tax-exempts, included Minimum Inclusion amounts as taxable income. 11

12. COCA – Investor’s Perspective (cont’d) • ‘Excess Distributions’ – taxed at low rate (10-15%). • Amount = gain on sale of financial capital instrument or issuer distributions in excess of prior accrued Minimum Inclusions. • Excess Distributions would be tax-free to tax-exempts. • Tax roughly compensates for any remaining issuer-level preferences, and is justifiable on traditional ability to pay grounds. • Low rate not available for gains from collectibles, etc. • Losses – reverse prior income inclusions. • First, deductible at Excess Distribution rates, to extent of prior Excess Distributions. • Then, deductible at Minimum Inclusion rates, to extent of prior Minimum Inclusions (whether or not paid). • Remaining principal loss deductible at Excess Distribution rates. • Capital loss limitations can be replaced with rules to tax-effect the amount of Excess Distribution loss deductible vs. ordinary income. 12

13. COCA – Impact • For issuers, the COCA system removes tax considerations in choosing an optimal capital structure. • An issuer obtains the same COCA deductions regardless of the form of financial capital instruments it issues. • Current law’s incentives to over-leverage and to package equity-based returns as debt thus are eliminated. • Assuming that interest rates do not fully adjust for the new regime, immediate winners likely are companies with little or no debt (limited interest deductions today) and higher quality credits (whose cash costs for financial capital are low relative to a nationwide blended COCA rate). • Immediate losers likely are highly leveraged companies and the weakest credits. • Over time, capital structures will adapt, because current tax law distortions will have been eliminated. 13

14. COCA – Impact (cont’d) • For investors, the COCA system rationalizes the taxation of economic investment income and eliminates tax distortions. • The COCA system distinguishes in a logical and consistent manner between ordinary (time value of money) returns (Minimum Inclusions) and extraordinary (capital gain) returns (Excess Distributions). • Including a current time value return on all financial instruments reduces the opportunities for indefinite deferral – and its distortive effects of understating income and ‘locking-in’ investments. • The replacement of capital loss limitations with (tax-effected) full utilization of losses eliminates a substantial economic distortion that today limits the attractiveness of risky investments. • Investors benefit from quasi-integration; for investments in profitable issuers, full integration is achieved to the extent of Minimum Inclusions. 14

15. BEIT– Transition Issues • For first three proposals (uniform entity-level tax, true consolidation principles, revised asset/business acquisition regime), new rules would apply immediately. • These rules do not work under a phase-in model. • Some consolidated groups would lose advantage of higher stock basis than asset basis for consolidated subsidiaries, but simplicity and efficiency of new regime compensate. • For COCA, a phase-in rule is essential. • Companies will need time to adapt their capital structures. • 5 – 10 year period in which interest deduction scales down and COCA ramps up. 15

16. Appendix

17. COCA – Additional Material

18. Opening of Year 1 TaxBalance Sheet Assumptions COCA Rate = 5% No cash return on portfolio investment Operating business earns $130 EBITDA Cash payments to holders of all liabilities and equity = $46 Tax depreciation on machinery = $50 For simplicity, COCA calculations done once annually, using opening balance sheet COCA – Example Assets Cash 100Portfolio Investment 200Greasy Machinery 500Land 200 1,000 Liabilities and Equity Short-term liabilities 100Long-term debt 200Funky contingent payment securities 200Preferred stock 100 Common stock 400 1,000 A-1 18

19. Year 1 Results Income Net income from operations 130 Deemed returns on portfolio investment 10 Total Gross Income 140 Deductions COCA deduction 50 Depreciation 50 Total deductions 100 Taxable income 40 Tax @ 35% 14 Cash Flow Net income from operations 130 Less cash coupons on liabilities and equity (46) Less taxes (14) Net Cash Flow 70 COCA – Example (cont’d) Opening of Year 2 TaxBalance Sheet Assets Cash 170Portfolio Investment 210Greasy Machinery 450Land 200 1,030 Liabilities and Equity Short-term liabilities 100Long-term debt 200Funky contingent payment securities 200Preferred stock 100 Common stock 430 1,030 • Notes • Year 2 COCA = $51.50 • Issuer does not need to accrete any amount to liabilities for prior year’s COCA expense, because no gain or loss on retirement of any liability or equity. A-2 19

20. COCA – Holder Example (Assume constant 5% COCA rate) • Holder invests $1,000 in a security. • First 3 years, no cash coupons, but Minimum Inclusion = $158. • Basis therefore = $1,158 • End of Year 3, cash distribution of $500. • $158 = tax-free return of accrued but unpaid Minimum Inclusions (Basis => $1,000) • $342 = Excess Distribution (taxable at reduced rates) • Hold another 2 years, no cash coupons, but Minimum Inclusion = $103 • Basis therefore = $1,103 • a) Sell for $1,303: $200 Excess Distribution.b) Sell for $1,000: ($103) loss, deductible at Excess Distribution rates.c) Sell for $403: ($700) total loss.–$342 at Excess Distribution rates – $261 at Minimum Inclusion rates – Remaining $97 at Excess Distribution rates A-3 20

21. COCA – Issuer’s Perspective (Additional Material) • Financial institutions are not taxed under COCA. • Money is their stock-in-trade, and the rough justice of COCA would materially distort the income of such highly leveraged institutions. • Optimal alternative for financial institutions is to mark to market all assets and liabilities; second best is to preserve current law rules as a special carve-out to COCA. • Special rules apply to financial derivatives, but the overall theme is the same. • See below, this Appendix. • Sole proprietor is both an issuer (a business enterprise) and an investor (the owner of that enterprise). • Result effectively is the same as paying interest to oneself. • Special small-business rule permits the consolidation of enterprise-level COCA deductions against investor-level income inclusion. A-4 21

22. COCA – Issuer’s Perspective (Additional cont’d) • Issuers that hold portfolio investments in other enterprises: • Are treated as investors in respect of that investment. • But hold an asset (the portfolio investment) with a tax basis, which in turn gives rise to a COCA allowance. A-5 22

23. COCA – Investor’s Perspective (Additional Material) • Mark-to-Market. • Dealers in financial instruments taxed (at ordinary rates) on mark-to- market basis. • Mark-to-market elections generally available to other holders (mitigates effect of excess Minimum Inclusions vs. cash receipts, at cost of accelerating Excess Distribution tax). • Special rule for basis recovery from self-amortizing instruments. • In all other cases, distributions are presumed to be income. • Administrative Issues. • No information required from issuer or prior holders (issuer’s COCA allowance does not drive investors’ Minimum Inclusions). • Holders will need to track their own prior Minimum Inclusions and Excess Distributions to calculate future years’ income or loss. • Financial intermediaries could be required to report that information for investors in public companies (like 1099s today). A-6 23

24. COCA – Derivatives • First Priority: Tax hedge accounting principles. • Based on current law (e.g. Reg §1.1275-6). • Presumption that financial derivatives of a business enterprise that is a non-dealer/non-professional trader are balance sheet hedges, and as a result gain/loss is ignored (i.e., subsumed into general COCA regime, where cash coupons on financial capital instruments are ignored). • Taxpayer may affirmatively elect out. • Second Priority: Mark-to-market. • Generally, mandatory regime for dealers/professional traders. • Dealers/traders may elect tax hedge accounting treatment for their liability hedges. A-7 24

25. COCA – Derivatives (cont’d) • Third Priority: Asset/Liability Model. • Treat all upfront, periodic and interim payments as (nondeductible) investments in the contract. • Apply COCA Minimum Inclusion/Deduction rules to resulting net ‘Derivative Asset’ or to increase in asset basis corresponding to ‘Derivative Liability.’ • Amount, and direction, of Derivative Asset/Liability fluctuates from year to year, with no consequence other than Minimum Inclusions on any net investment (and COCA deductions on assets). • At maturity/termination, ‘settle up’ by recognizing gain/loss. • Maturity/termination gain taxed at Excess Distribution rates. • Maturity/termination loss taxed identically to general COCA regime for holders (i.e., first deductible at Minimum Inclusion rates to extent of prior Minimum Inclusions, then Excess Distribution rates). • Result is identical to general COCA rules for gain, or for loss on Derivative Assets, but different for Derivative Liabilities (because gain/loss recognized). • Consequence is that a bright line test is still required to distinguish derivatives from financial capital investments. A-8 25

26. COCA – Derivatives Example (Assume COCA rate = 5%) • X pays $50 to Y for 3-year option on S&P 500. • X has Minimum Inclusions over 3-year life = $8 (rounded). • So X’s basis at maturity = $58. • Y receives COCA deductions on cash proceeds – i.e., on assets, not directly on Derivative Liability. • At maturity, contract pays either: • $88 – X recognizes $30 in Excess Distribution gain; Y recognizes $38 (not $30) in loss deductible at Excess Distribution rates. • $0 – X recognizes $8 loss deductible at Minimum Inclusion rates, $50 loss deductible at Excess Distribution rates; Y recognizes $50 gain(not $58), taxable at Excess Distribution rates. A-9 26

27. Tax-Exempt Investors& International Applications

28. COCA – Tax-Exempt Holders • Exempting tax-exempts from tax on Minimum Inclusion amounts effectively makes a portion of business income tax-exempt. • Tax-exempts cannot directly engage in unrelated businesses, so why should they be able to do so indirectly (by holding financial capital instruments)? • Issue compounded by consideration of foreign portfolio investors (below); answers for one naturally drive the other. • Compromises are possible as a technical matter, even if undesirable as a policy matter. • Tax at reduced rates? • Distinguish among different classes of tax-exempts? • Pension plans, etc. are primarily investment vehicles in ways that charities arguably are not. A-10 28

29. COCA – Foreign Portfolio Investors in U.S. Securities • Unavoidable tension between COCA system (which can tax income before distributions) and withholding tax collection mechanisms (which rely on cash distributions). • Problem exists today for original issue discount (in cases where ‘portfolio interest’ exception does not apply). • Catch-up withholding on cash distributions is easier than withholding on secondary market sales. • Proposal: General withholding tax with extensive tax treaty relief. • Require broker reporting and withholding on proceeds as general case. • Provide extensive relief for residents of tax treaty partners, where income in fact is taxed locally. • Consider limitations on treaty relief where ‘at risk’ holding period is not satisfied (to limit gaming through Delta 1 OTC derivatives). A-11 29

30. COCA – U.S. Portfolio Investors in Foreign Securities • General rule – COCA applies. • COCA regime should apply here as it does to investments in domestic business enterprises. • Foreign tax credit rules will require tweaking to match withholding tax credits with prior/subsequent income inclusions. • Use tax treaty relief for treaty partner residents as negotiating tool to obtain broader relief from treaty partner withholding taxes. A-12 30

31. BEIT – Foreign Direct Investment • Current law is schizophrenic. • Ultimate protection from double taxation is the foreign tax credit, but interest allocations, etc. continue to limit its utility (although 2004 Act obviously helps). • Subpart F 'anti-deferral’ (a/k/a ‘acceleration’) regime is enormously complex, and in a state of complete disarray. • Deferral vastly complicates IRS compliance task in transfer pricing. • Why is deferral important to taxpayers? • Financial accounting – ‘Permanently reinvested’ earnings taxed at lower foreign rates reduce reported financial accounting tax costs, and therefore are highly valued. • Master blender – Tax Director functions as a master distiller, rectifying foreign tax credit problems by artfully blending reserve stocks of high-taxed and low-taxed deferred foreign earnings to produce a perfect 35% tax-rate blend of includible foreign income. • If financial accounting rules were different, basic U.S. business entity tax rates reasonably low, and foreign tax credit rules less onerous, the deferral debate would become irrelevant. A-13 31

32. BEIT – Foreign Direct Investment (cont’d) • Proposal (against the background of lower overall business enterprise tax rates): • Full inclusion of foreign subsidiaries’ income (via consolidation). • Full consolidation of foreign subsidiaries (so foreign loss offsets domestic income). • Repeal ‘interest’ allocation (now, COCA allocation) and similar rules. • Consider steps to harmonize FTC limitation with foreign measures of income. • Results: • Vastly simpler system. • Substantial reduction in importance of transfer pricing issues to IRS. • Fair system that respects international norm that source country should have priority in taxing income. • Ultimate protection of U.S. fisc against taxpayers using foreign taxes as credits against domestic income should be lower U.S. tax rate on business enterprise income (compared to major trading partners). A-14 32

33. Tax Policy Considerations

34. BEIT – Overview of Goals • The BEIT has three objectives: 1. To simplify the income tax rules applied to operating or investing in a business. • Do not confuse ease of recordkeeping with true simplicity. Recordkeeping is a nuisance, but it is not difficult. True simplicity requires consistent conceptual clarity, to reduce ambiguity in applying the law. 2. To increase consistency of tax results by rooting out deeply embedded structural flaws in our current system for taxing business operations and investments. These structural flaws distort economic behavior. 3. To reduce tax avoidance/gaming opportunities. A-15 34

35. BEIT – Goals: Simplifying Current Law • Current law – Multiple elective tax regimes for economically similar, but formally different, types of: • Business organizations. • Acquisitions. • Investments. • The BEIT – Promotes simplicity by adopting one set of rules that applies to all forms of: • Business enterprises (corporation, partnership, proprietorship). • Acquisitions of businesses or business assets (incorporation, merger, sale) through one or more companies (true consolidation). • Financial investments in business enterprises, however denominated (debt, equity, derivatives). • The BEIT – Is comprehensive and unambiguous in application. A-16 35

36. BEIT – Goals: Eliminating Structural Flaws • Current law – Riddled with tax-induced distortions in economic behavior: • Over-reliance on the realization principle: leads to understatement of economic income, and to ‘lock-in’ of inefficient investments. • Inconsistent rules for taxing different forms of financial capital: lead to arbitrage transactions based on ordinary income vs. capital gain, or debt vs. equity. • The BEIT – Roots out these structural flaws: • Eliminates deferral from tax-free reorganizations and similar transactions. • Requires an easily-measured and universal current return to all financial investments. • Clearly distinguishes between ‘time value’ and ‘risky’ returns, and applies consistent rules to each, however denominated. • Applies one set of rules to all financial instruments, regardless of legal labels. A-17 36

37. BEIT – Goals: Reducing Tax Avoidance • Current law – Multiple elective tax regimes for business entities and investments lead to complex ‘optimization’ (at best) – or abusive (at worst) – behavior. • Of 31 IRS ‘listed’ abusive transactions, 13 are the direct result of manipulation of the carryover basis or consolidated return rules, or inconsistencies in the rules applicable to different types of entities. • The BEIT – Eliminates electivity based on form, and imposes instead a single uniform system: • Imposes entity level tax on all forms of business organization. • Replaces consolidated return rules with true consolidation principles. • Replaces competing forms of taxable and ‘tax-free’ acquisitions with a single new ‘tax-neutral’ taxable acquisition model. A-18 37

38. COCA – Constitutional Issues • Current academic consensus is that realization requirement is a rule of convenience, not a constitutional imperative. • COCA (through loss deductions and mark-to-market election) in fact reaches a taxpayer’s net income over time. • Courts regularly have rejected constitutional challenges to tax provisions that diverged from realization precepts: • Accrual taxation generally. • Estimated taxes. • Personal holding company/subpart F deemed inclusion regimes. • Mark-to-market. • Original issue discount. A-19 38

39. COCA vs. CBIT • CBIT (proposed by 1992 Treasury) proposed a uniform COCA-like system, with a COCA rate set permanently at zero – i.e., interest disallowance. • Distributions to investors (interest or dividends) generally would not be taxed. • To ensure that distributed amounts bore tax at the entity level, CBIT contemplated that issuers would maintain an ‘Excludable Distributions Account’ (rejected in 2003 debate on dividend tax rates for complexity reasons), or a similar mechanism. • Disadvantages of CBIT. • Apparently preserved all of current law’s bias in favor of expensing over capitalizing. • Example: Enterprise X spends $100 on a perpetual machine that earns $10/year; Enterprise Y spends $100 on deductible R&D to develop a perpetual intangible that earns $10/year. • COCA (but not CBIT) mitigates the difference by giving a deduction in the former case, but not the latter. A-20 39

40. COCA vs. CBIT (cont’d) • Disadvantages of CBIT (cont’d). • An issuer-level compensatory tax as part of the EDA mechanism would materially have affected issuer payout policies. • Did not address derivatives at all. • Did not propose rules distinguishing ‘time value’ from ‘risky’ returns generally and did not resolve capital gains taxation. • Presumably would have been inefficient to the extent interest rates did not fully adjust for new tax regime (like municipal bonds today). • Advantages of CBIT. • Indirectly imposed tax on tax-exempt institutions. A-21 40

41. In Praise of the Income Tax • Income, Wealth and Consumption. • Imagine normative income and consumption taxes, in which gifts or bequests are realization events/consumption to the donor/decedent. • Annual income = [beginning wealth] + [consumption] - [ending wealth]. So income tax = taxing lifetime wealth (other than gifts/bequests received) once & only once. • If gifts/bequests are treated as consumption to donor/decedent, then a consumption tax is identical to an income tax in its tax base over a lifetime, but for time value of money considerations. Taxes are deferred on lifetime savings, but are imposed on a higher lifetime base. • Effective and nominal tax rates diverge under the two systems, however. A consumption tax must always have higher (and steeper) nominal rates than an otherwise identical income tax to achieve the same progressivity and revenues (because in an income tax model the fisc can invest earlier tax payments at a pre-tax rate of return). • A periodic wealth tax and an income tax are conceptually identical, but administratively very different. A consumption tax differs only in that it exempts the time value return to savings. A-22 41

42. In Praise of the Income Tax (cont’d) • Our income tax system reflects 90 years of invested intellectual capital. • A vast number of issues and applications have been fully mapped out. • By contrast, most consumption tax proposals in the U.S. remain abstractions; if implemented, those systems also will be complex, and require many line-drawing exercises, but without decades of law to guide taxpayers and policymakers. • Taxpayers have intuitive understanding of broad contours of current system. • Principal acknowledged defects (e.g. inconsistent treatment of financial capital) can be addressed – through BEIT, or similar proposals. • The income tax’s lower nominal tax rates (for comparable revenues and progressivity) reduce evasion incentives. • Politically-driven exceptions to a consumption tax will create greater distortions of economic behavior, and encourage more creative avoidance tactics, as nominal rates increase. • ‘Efficient transitional tax’ as part of switch to consumption tax system is a sneak attack on existing wealth. • This ‘efficient’ double taxation contained in some proposals is a large percentage of estimated economic benefits of switching. A-23 42

43. In Praise of the Income Tax (cont’d) • Tax the Rich! • (Paraphrasing Schenk, Saving the Income Tax With a Wealth Tax) Why should deferring consumption be privileged over deferring leisure? I can work less and save for the future purchase of a plasma TV, or I can work overtime now (deferring leisure) and buy the TV sooner. Why is one tax-deferred and the other currently taxed? • Current participation in funding government is a hallmark of a democratic society; permitting the wealthy temporarily to scale back their participation strains the social fabric and exposes the system to the risk of tax hemorrhaging from future temporary rate cuts or exceptions. • Neither wealth nor income is a perfect measure of virtue, aptitude, industry or thrift: Luck still determines a great deal of life’s outcomes. But wealth (and its surrogate, income) is a very good measure of ability to pay. A-24 43