[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



 
                 PAYING DIVIDENDS: HOW THE PRESIDENT'S
                    TAX PLAN WILL BENEFIT INDIVIDUAL
                        INVESTORS AND STRENGTHEN
                          THE CAPITAL MARKETS

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 18, 2003

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-12




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                            WASHINGTON : 2003
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska              PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana          MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice         JULIA CARSON, Indiana
    Chairman                         BRAD SHERMAN, California
RON PAUL, Texas                      GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio                BARBARA LEE, California
JIM RYUN, Kansas                     JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois         CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
    Carolina                         HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California                 RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
MARK GREEN, Wisconsin                JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut       STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona             MIKE ROSS, Arkansas
VITO FOSELLA, New York               CAROLYN McCARTHY, New York
GARY G. MILLER, California           JOE BACA, California
MELISSA A. HART, Pennsylvania        JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia  STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio              BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota           RAHM EMANUEL, Illinois
TOM FEENEY, Florida                  DAVID SCOTT, Georgia
JEB HENSARLING, Texas                ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey             
TIM MURPHY, Pennsylvania             BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona

                 Robert U. Foster, III, Staff Director
              Subcommittee on Oversight and Investigations

                     SUE W. KELLY, New York, Chair

RON PAUL, Texas, Vice Chairman       LUIS V. GUTIERREZ, Illinois
STEVEN C. LaTOURETTE, Ohio           JAY INSLEE, Washington
MARK GREEN, Wisconsin                DENNIS MOORE, Kansas
JOHN B. SHADEGG, Arizona             JOSEPH CROWLEY, New York
VITO FOSSELLA, New York              CAROLYN B. MALONEY, New York
JEB HENSARLING, Texas                CHARLES A. GONZALEZ, Texas
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
TIM MURPHY, Pennsylvania             JIM MATHESON, Utah
GINNY BROWN-WAITE, Florida           STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina



                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 18, 2003...............................................     1
Appendix:
    March 18, 2003...............................................    51

                               WITNESSES
                        Tuesday, March 18, 2003

Castellani, John J., President, The Business Roundtable..........    37
Fisher, Hon. Peter R., Under Secretary for Domestic Finance, 
  Department of the Treasury.....................................     4
Gramm, Hon. Phil, Vice Chairman and Managing Director, UBS 
  Warburg, LLC...................................................    18
Lazio, Hon. Rick, President and CEO, Financial Services Forum....    35
Moore, Stephen, President, Club for Growth.......................    41
Orzag, Peter, Joseph A. Pechman Senior Fellow in Economic 
  Studies, The Brookings Institution.............................    39
Rayburn, Bobby, First Vice President, National Association of 
  Home Builders..................................................    44
Spriggs, William E., Executive Director, National Urban League 
  Institute for Opportunity and Equality.........................    42

                                APPENDIX

Prepared statements:
    Kelly, Hon. Sue W............................................    52
    Oxley, Hon. Michael G........................................    54
    Fosella, Hon. Vito...........................................    55
    Hinojosa, Hon. Ruben.........................................    56
    Shadegg, Hon. John B.........................................    58
    Castellani, John J...........................................    60
    Fisher, Hon. Peter R.........................................    73
    Gramm, Hon. Phil.............................................    76
    Lazio, Hon. Rick A...........................................    79
    Moore, Stephen...............................................    81
    Orszag, Peter R..............................................    93
    Rayburn, James R.............................................   101
    Spriggs, William E...........................................   112

              Additional Material Submitted for the Record

Kelly, Hon. Sue W.:
    ``A Boon to Ordinary Investors; Eliminating the dividend tax 
      is just what the economy needs.'' The Washington Post, 
      March 11, 2003.............................................   118
    Defending the Dividend, Securities Industry Association......   121
    Estimated Impact of the Major Components of the Bush 
      Administration's Growth and Jobs Plan on Housing and the 
      Economy, Mortgage Bankers Association of America...........   135
    President's Jobs and Economic Growth Plan: The Benefits of 
      Ending the Double Tax on Dividends.........................   171
    Pricewaterhouse Coopers letter to The Business Roundtable, 
      January 21, 2003...........................................   172
    Report of Investigation of Enron Corporation and Related 
      Entities Regarding Federal Tax and Compensation Issues, and 
      Policy Recommendations, Joint Committee on Taxation........   177
    A Recommendation for Integration of the Individual and 
      Corporate Tax Systems, Department of the Treasury..........   198
    Strengthening America's Economy, The President's Jobs and 
      Growth Proposals, Council of Economic Advisors.............   225
    Tax Break, Tax Notes, January 20, 2003.......................   234


                 PAYING DIVIDENDS: HOW THE PRESIDENT'S
                    TAX PLAN WILL BENEFIT INDIVIDUAL
                        INVESTORS AND STRENGTHEN
                          THE CAPITAL MARKETS

                              ----------                              


                        Tuesday, March 18, 2003

             U.S. House of Representatives,
       Subcommittee on Oversight, and Investigation
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 3:10 p.m., in 
Room 2128, Rayburn House Office Building, Hon. Sue Kelly 
[chairman of the subcommittee] presiding.
    Present: Representatives Kelly, Hensarling, Garrett, 
Murphy, Brown-Waite, Barrett, Oxley (ex officio), Inslee, 
Moore, Crowley, Hinojosa and Sherman.
    Chairwoman Kelly. [Presiding.] The hearing will come to 
order please.
    The September 11 terrorist attacks and the end of the 
telecom and Internet bubbles, the corporate accounting 
scandals, and now the uncertainties accompanying war have left 
Americans feeling uncertain about their economic future. 
Business investment has been flat or down for about two years 
now. Only consumer spending has kept the economy afloat. Now, 
there are signs that consumer confidence is down to the 1992 
levels.
    President Bush's plan to eliminate the dividend tax is a 
sound, common sense approach to growing this economy. Cutting 
taxes and encouraging consumer spending and investment is the 
way to go. We want to create jobs. We need to spur growth. That 
will only happen by letting American investors keep more of 
their own money and giving them incentives to invest it in this 
economy.
    For millions of individual Americans, encouraging 
investment means encouraging the purchase of stock, which has 
been the best long-term return of any investment. Half of all 
American households, more than 84 million individual investors, 
already own stock directly or through mutual funds. Today, 
millions of Americans of all income levels receive dividends 
from stock. In fact, 45 percent of all dividend recipients make 
under $50,000 per year. I am going to repeat that, because that 
is important for people to understand--45 percent of all 
dividend recipients make under $50,000 per year. Three-fourths 
make less than $100,000 per year.
    The problem is that America has the second highest dividend 
tax rates among the 26 most developed nations in the world, 
second only to Japan. So it only stands to reason that if we 
need more corporate investment, we need to reduce the tax rate 
on the dividends which we receive from corporate stock. Those 
dividends are already taxed when the corporation earns income. 
It is fundamentally unfair for us to pay more taxes on that 
income.
    Another reason we need to end double taxation is to help 
our seniors live more independent lives. More than half of all 
dividend income goes to America's seniors, many of whom rely on 
these checks as a steady source of retirement income. More than 
nine million seniors would receive an average of $991 in tax 
relief in 2003 if they did not have to pay income tax on those 
dividends. Maybe there was a day when ending double taxation 
would have helped a small handful of rich, privileged 
Americans, but with 84 million individual investors owning 
stock, those days are over and it is time to bring economic 
thinking into the 21st century.
    Our witnesses today will discuss the increases in corporate 
investment, the hundreds of thousands of new jobs, and the 
improvement in the quality of life for seniors and all 
individual investors that will result from passing President 
Bush's proposal to end the double taxation on dividends. But 
there is yet another reason for ending double taxation of 
corporate dividends. On December 12, 2001, I co-chaired the 
first congressional hearing examining corporate fraud and 
mismanagement at Enron.
    Investigations by law enforcement and by this and other 
congressional committees found that senior Enron management 
intentionally twisted its corporate finances to hide billions 
of dollars in debt from investors.
    A massive and detailed report released last month by the 
bipartisan Joint Committee on Taxation shines a special light 
on Enron management's sordid actions. Part of the report lays 
out how Enron raised over $800 million through hybrid financial 
instruments called tiered preferred securities, which were 
specifically designed to be treated as debt for income tax 
purposes and as equity on their books. So Enron could deduct 
corporate interest payments on its tax returns without 
revealing its debt service on consolidated financial returns. I 
have provided copies of this section of the report to the 
members and to our witnesses, and I invite your attention to 
the last two pages in which the Joint Economic Committee stated 
four recommendations for dealing with tiered preferred 
securities.
    The very last recommendation states, and I quote, ``reduce 
or eliminate the disparate taxation of interest and dividends 
for both insurers and holders of financial instruments that 
creates the market for hybrid financial instruments.'' By 
providing more equivalence in the tax consequences of debt and 
equity, this approach would eliminate tax considerations from 
the process by which corporate taxpayers decide to obtain 
financing.
    Now, certainly the most important factor in Enron's demise 
was plain old greed, but the lesson from this bipartisan 
report, and it was hailed by members on both sides of the aisle 
and in both parties in both Houses, if we do not want anymore 
Enrons gaming the system to line their pockets, one step we can 
take is to end the double taxation on dividends. Ending double 
taxation is not a panacea for the stock market's ills, but it 
would add to this committee's record as the home of sound 
corporate governance on Capitol Hill.
    Numerous Presidents as far back as Franklin Roosevelt have 
proposed ending the double taxation of dividends, but the 
proposal always seems to get caught up in outdated, tired class 
warfare arguments. For the sake of our economy, for the sake of 
our seniors, for the sake of our financial markets and our 
investors, Congress should support the President's plan to end 
double taxation of dividends.
    Several members of the full committee who are not on this 
subcommittee have asked to give opening statements today. I am 
not sure that they are all here, but for those who are, I ask 
unanimous consent that all members participating today can give 
opening statements and insert them into the record.
    With that, I turn to you, Mr. Sherman.
    Mr. Sherman. As American troops head toward Iraq, it is a 
shame that when Americans should be coming together, we have 
these hearings which represent nothing more than something to 
divide America along class lines--a declaration of class 
warfare against American working families. Roughly 40 years 
ago, the corporate income tax, the alleged first of the two 
payments on corporate income, represented over 4 percent of our 
GDP. Now, it is below 1.5 percent because we should be in this 
Congress addressing the incredible loopholes that have made the 
corporate income tax a fiction, and have given the lie to the 
idea that corporate profits are taxed twice, for if this bill 
goes forward they will be taxed not even once.
    Now, this sneak attack, this class warfare against American 
working families, is not being done under the cover of 
darkness. Rather, it is under the cover of saying that anyone 
who resists it is starting a class warfare division of 
Americans. We in America had reached some consensus as to 
dividing the burdens of government among the economic classes, 
until the President came forward with this weapon of mass 
destruction against that accommodation. You see, 70 percent of 
the benefits from this will flow to the top 5 percent of 
Americans. Stated another way, the top .02 percent of tax 
filers will receive nearly as much benefit from this cut as 95 
percent of Americans, and do not tell me about the elderly 
without mentioning that 75 percent of the benefit goes to those 
seniors with incomes of over $75,000, while those seniors with 
incomes below $50,000 receive only 4 percent of the benefit.
    This is class warfare covered by deft use of statistics; 
covered by an attempt to intimidate those who would shine a 
light on it by saying we are waging class warfare. Keep in 
mind, a lot of Americans own stock, but an awful lot of those 
own stock only through their 401(k) or IRA. They get no 
benefits.
    This is also an attack on the American economy. It is an 
anti-investment proposal. It says if a corporation is thinking 
of building a new factory, hopefully in America, and instead 
they are pressured by their shareholders to distribute that 
money so that the shareholders can afford the new $350,000 
Mercedes, that is an improvement to the American economy. It 
takes money available from corporate investment and moves it 
further away from corporate investment. A policy this bad could 
not stand the light of day. Fortunately, these hearings are 
basically stacked with witnesses that will present pretty much 
one side.
    I yield back.
    Chairwoman Kelly. Thank you.
    We have three panels today, and I am hopeful that members 
will keep to the five-minute rule.
    Mr. Hensarling, have you an opening statement? Mr. Murphy? 
Mr. Garrett, have you an opening statement? Ms. Brown-Waite? 
Mr. Inslee, have you an opening statement? If there are no more 
opening statements, then I will introduce our first witness, 
Mr. Peter Fisher, Under Secretary for Domestic Finance at the 
Treasury Department.
    We thank you for testifying before us today, and I welcome 
you on behalf of the committee. Without objection, your written 
statements and any attachments that you have will be made part 
of the record. You will now be recognized for a five-minute 
summary of your testimony. As you I am sure know, when the 
light changes color from green to amber, that is the time you 
need to put your own timer on, because when it blinks red, your 
time is over. Please begin, Mr. Fisher. We welcome you here 
today.

STATEMENT OF HON. PETER R. FISHER, UNDER SECRETARY FOR DOMESTIC 
              FINANCE, DEPARTMENT OF THE TREASURY

    Mr. Fisher. Thank you for the opportunity to be here today 
to testify on the President's jobs and growth package.
    Let me focus my summary on two issues and try to pick up a 
third. First, the President's overall package is the right 
prescription for the macroeconomic circumstances that we face 
today, because it would support consumption and promote 
investment on a balanced, enduring basis. Second, by enacting 
the President's proposal to tax corporate income once and only 
once, this Congress has the opportunity to make the single 
biggest improvement in the efficiency of capital investment in 
our economy.
    First, our macroeconomic challenge. In my view, the United 
States is not just facing another swing of the business cycle, 
but the aftermath of the extraordinary events of the 1990s, as 
you, Madam Chairwoman, described. The Federal Reserve monetary 
policy, global economic integration, telecommunications 
advances combined to fuel real prosperity and higher 
productivity, but investors' overestimation of their impact 
contributed to a stock market bubble. We continue to live with 
the disinflationary consequences and the destruction of 
trillions of dollars in household wealth as the bubble burst.
    Under these circumstances, using fiscal policy to deliver 
only a short-term stimulus would be a mistake. The American 
people are smart enough to distinguish between a one-off 
injection of cash and an enduring improvement in their 
disposable income. When consumers refinance their mortgages at 
lower rates, they gain an enduring improvement in household 
cash flow. The same would be true of bringing forward to this 
year the tax rate reductions the Congress has already approved 
that are scheduled to come in later in the decade. Together 
with eliminating double taxation of dividends, these 
acceleration proposals would put cash in people's pockets right 
away and in the future.
    The scale of the President's package is central to 
accelerating growth and job creation. Over the next decade, 
U.S. economic output is projected to total $142 trillion, 
generating something on the order of $27 trillion or $28 
trillion in federal revenues. The President's jobs and growth 
package would reduce taxes by $695 billion over that period, 
scored with static macroeconomic effects. To have an impact on 
our economy, fiscal policy needs to be large enough to move the 
needle on the economy.
    In the past year, Congress, under Chairman Oxley's and 
Senator Sarbanes' leadership, took a major step toward 
improving our capital markets performance. Better run, better 
disclosing corporations make for better capital markets, but 
there is more to be done to provide the right incentives for 
corporate executives. By double taxing profits, but not 
interest, our tax code encourages executives to retain earnings 
instead of paying them to shareholders, to favor debt over 
equity finance, and to dedicate some of America's leading minds 
to tax alchemy instead of value creation.
    By imposing a higher marginal rate on profit, our tax code 
thins the vital blood of economic growth, risk capital. No 
other major industrial nation taxes profits at such a punitive 
effective rate. We have learned since recent testimony that the 
Japanese have made some changes, so they are no longer number 
one. We are, according to information I was told about from the 
Japanese embassy. The President's proposal would reduce that 
bias.
    A prime benefit would be to raise the burden of proof on 
corporate executives if they wish to retain profits instead of 
sending them to shareholders. Under the proposal, shareholders 
would be tax neutral between reinvesting profits in the best 
projects a company could offer versus the best projects that 
the market could offer. Today's tax code cordons off that 
choice inside the company. Some corporate executives may prefer 
today's tax code, which places a less onerous burden on them 
for justifying their decisions to retain earnings. Yet 
corporations exist to serve shareholders, and our tax code 
should reflect this.
    The impact on capital efficiency of freeing this boxed-in 
capital may be huge. Each year, American firms invest over $1 
trillion in fresh capital and generate $700 billion to $800 
billion in corporate profits. Think of the capital gains 
utilization and job creation if we accelerate and re-target 
this investment. The financial and economic markets will reap 
huge collateral benefits.
    Let me conclude by saying if dividends are suddenly a tax 
efficient way for paying shareholders, executives will have 
fewer arguments to justify cash mountains and share buy-backs, 
which a critic may be tempted to note, offer the insider 
benefit of boosting the value of executive stock options. 
Because the President believes that profits should be taxed 
once, but only once, the company's payment of tax actually 
accrues as an asset to shareholders. In such a world where 
corporations paying tax on dividends reduces shareholders' own 
tax liability, the rationale for corporate inversions would 
dissipate.
    Thank you, Madam Chairman. I look forward to the 
committee's questions.
    [The prepared statement of Hon. Peter R. Fisher can be 
found on page XX in the appendix.]
    Chairwoman Kelly. Thank you very much, Mr. Fisher.
    I have just a couple of questions for you. How many new 
jobs do you think would be created over the next five years by 
eliminating the double tax penalty on dividends? And how much 
economic growth do you see that as promoting?
    Mr. Fisher. There are a number of different studies, the 
administration's numbers that the CEA has put out, that 1.5 
million approximately new jobs, 1.4 million by the fourth 
quarter of next year. I know that there are studies by the 
Business Roundtable suggesting that perhaps 500,000 jobs will 
be added to total jobs over the coming years. There are a 
number of different estimates.
    Let me, though, stick my neck out a little bit. Forecast 
models are very bad at dealing with changes in behavior. What 
we are trying to do is re-engineer a profound change in 
behavior on the part of corporate executives. When we do that, 
I am confident we are going to have a bigger impact on job 
creation than anyone's forecast, anyone's model is prepared to 
project. I think both in terms of job creation in our economy, 
the numbers we are looking at from static modeling, will 
understate it, and they will understate it because they do not 
take into account the break in habit from accelerating the 
investment process.
    Chairwoman Kelly. If the tax penalty on dividends was 
removed, would it reduce the use of Enron-style accounting 
gimmicks and improve corporate governance, as it appears from 
the report by the Joint Committee on Taxation?
    Mr. Fisher. Yes, I think it would have a profound impact, 
especially if we do it as designed by the President. If you go 
back to the mid-1960s, 75 percent of large companies paid 
dividends in America. Today, it is about 25 percent. If we can 
re-direct corporate America to cash-flow rather than managed 
earnings, that will be the biggest thing we can do to improve 
corporate governance and avoid a lot of the shenanigans, some 
legal, some illegal, which we know have gone on in corporate 
America.
    I think that we also by leveling the playing field between 
debt and equity, we will increase equity in the system, 
reducing the risk of bankruptcy, and we will reduce the risk of 
what I call managed stock option plans. We know stock options 
are a legitimate tool of employee compensation, but where I 
think some companies have gone too far is using the stash of 
retained earnings to justify share buy-back programs, to 
engineer share prices higher to offset the dilutive effect of 
stock options they have granted. This became a self-justifying 
prophecy. We need to lean against that and make corporate 
management either justify their investment internally or pay 
the money out to shareholders.
    Chairwoman Kelly. I have another question for you. I think 
I still have a little time here.
    As I said in my opening statement, more than eight million 
seniors would get almost $1,000 in additional income a year if 
they did not have to pay income tax on the dividends. What 
impact do you think that would have on their lives? And do you 
think that corporations would be more likely to increase their 
dividend payouts or would it stop seniors from getting short-
changed by the dividend penalty that they now pay? That is 
really a triple question.
    Mr. Fisher. Yes, I am trying to keep track of all that. We 
know that 40 percent of tax filers, as you have said, a high 
number of them that receive dividend income have incomes under 
$40,000, and among seniors, 40 percent of dividend recipients 
have incomes below $30,000. Keeping the dividend income streams 
coming, and reducing the tax burden, is a very short-run effect 
which gives them a boost to their income.
    Again, I want to go back to thinking about if we can unwind 
the clock either 10 or 20 or 30 years, and double or triple the 
number of dividend checks that are mailed, we will have a much 
greater impact than any of these static numbers we are looking 
at. While we do not expect that to happen in any one or two 
year scenario, over time as corporations have a reduced 
incentive to hang onto earnings, a greater incentive to pay 
dividends out, then there will be even more dividend checks 
flowing to seniors and other Americans.
    Chairwoman Kelly. One more quick question. If we end the 
double taxation on dividends, how do you see that as changing 
the incentives on the pool of retained earnings? I think you 
talked about that--the incentives regarding the behavior with 
the pool of retained earnings. You talked about that in your 
testimony a little bit.
    Mr. Fisher. I think that what it will do--I want to be very 
clear. The President's proposal is about leveling the playing 
field. We have taken some criticism from some quarters that it 
is complicated. One provision that I admit adds to the 
complexity is that we want it to be a level playing field 
between retained earnings and dividends. So I think it does not 
distort the incentive structure. It means management of 
companies should make economic judgments about whether they 
want to reinvest in their business or pay the money out to 
shareholders. But it equalizes the hurdle rate, if you will, on 
internal investment and external investment. That will speed up 
the investment process.
    Let me just add, if I could, that one of the great 
strengths of our economy that the rest of the world is envious 
of is the efficiency of our investment process. Here, we have 
something which we know creates a huge distortion in that 
process. I know of no principled argument in favor of our 
current structure. There are arguments about transition costs, 
but I do not hear anyone arguing in favor of the current 
structure that we have. If we can eliminate this, we are going 
to accelerate investment, business formation, and job creation 
in America.
    Chairwoman Kelly. Thank you. My time is up.
    Mr. Inslee?
    Mr. Inslee. Thank you, Mr. Fisher.
    When did you or your department determine that this was 
such a tremendous idea? When did you make that decision?
    Mr. Fisher. I have been, about me personally, I have since 
the mid-1990s, and observing the acceleration of retained 
earnings inside corporate America, it then seemed to me most 
clear that this was creating a major distortion in our capital 
structure.
    Mr. Inslee. Just roughly, when did your administration 
propose this in the last year or so?
    Mr. Fisher. The President proposed it the first week of 
January of this year. There were many discussions between our 
tax policy shop over the last year, working on different reform 
proposals.
    Mr. Inslee. And there have been some changes since then in 
our both world and economic conditions, haven't there?
    Mr. Fisher. There continue to be a lot of uncertainties 
about the economic outlook.
    Mr. Inslee. Let me just mention a couple of them. Number 
one, we are starting a war in a couple of days and it is going 
to cost $100 billion just to start. And then it is going to on 
for years as we occupy Iraq--in the billions of dollars. We 
have had a recession which have reduced federal revenues 
dramatically, which since your department came up with this 
grand scheme, has left the U.S. economy in shambles because we 
have over a $300 billion deficit this year likely, in part 
because of the previous revenue reductions that your 
administration passed.
    I want you to think about the fact that since you came up 
with this idea, we have had a war; we have got people from my 
district who got on the USS Rodney Davis, it is a frigate, last 
weekend to go steam into harm's way, and the 8th hospital unit 
of the Bangor Military Naval Hospital. They believe, like John 
F. Kennedy, that we should be willing to, ``pay any price, bear 
any burden, meet any hardship, support any friend, oppose any 
foe, in order to assure the survival and the success of 
liberty.''
    But your administration believes that while we have a war 
overseas, it is okay to have a fiscal party at home. A lot of 
my constituents believe this is grossly irresponsible. It would 
be the first administration in American history to propose a 
major league tax cut in the middle of starting a war. I would 
like you to respond to their concerns as to how that is 
responsible, when we ask our men and women to go into harm's 
way next week, that you want to have this fiscal largesse at 
home.
    Mr. Fisher. Sir, I do not think it is irresponsible. As I 
look back over the history of the last 50 years, I see that 
federal task revenues as a share of GDP in our economy peaked 
at 21 percent in 1944--the last year of the Second World War. 
From 1960 to 2000, through five Democratic and five Republican 
administrations, federal revenues as a share of GDP has 
oscillated in a corridor between 17 and 21 percent, with a very 
tight average around 18.5 percent.
    Mr. Inslee. So you think it is responsible even though we 
start a war, we increase our expenditures over $100 billion, we 
increase our deficit over $300 billion--it is still 
responsible, you believe, to grow our federal deficit at the 
same time you are handing out tax cuts? You believe that is 
responsible, to have deficits in the $300 billion range, at the 
same time you are increasing expenditures to a war; at the same 
time you want to increase these tax cuts? You believe that is 
responsible fiscal behavior?
    Mr. Fisher. I think fiscal policy needs to focus on making 
sure our economy grows both now and over the coming 10 years.
    Mr. Inslee. So how do you explain it to our children? How 
do you explain it to our children?
    Mr. Fisher. There is nothing more important to our 
children's financial success than that we grow this economy 
over the coming decades as rapidly on a sustainable basis as we 
can. That is where federal revenues come from, to pay for all 
of the priorities which Congress votes when you enact outlays.
    Mr. Inslee. Let me explain and convey to you my three 
children's belief. They are not happy that your administration 
is putting onto their shoulders a chronic debt burden. They are 
not happy that 14 percent of all the taxes they pay goes to pay 
the debt tax. Fourteen percent of all the taxes my son, who is 
a carpenter, pays goes to pay a debt tax to service the debt 
that you are increasing, you are exploding on his shoulders. He 
does not think it is responsible. I do not think it is 
responsible either, and if you want to go ahead and comment, go 
ahead.
    Mr. Fisher. We disagree, I guess, sir.
    Mr. Inslee. We agree that we disagree. Thank you very much.
    Chairwoman Kelly. Thank you.
    Mr. Oxley?
    Mr. Oxley. Thank you, Madam Chairwoman.
    It is good to have you here again, Mr. Fisher, and also I 
want to ask unanimous consent that my full statement be made 
part of the record, and also while I am at it, welcome our 
former colleague and friend, Senator Gramm, who will be on the 
next panel, as well as former member and a member of this 
committee, Rick Lazio, who will be on the third panel, along 
with some other distinguished members.
    I am sorry my friend from Washington left. I was interested 
as to why he might oppose 431,000 jobs in the private sector, 
higher wages, I assume for his constituents, as well as mine; 
tax relief, particularly for senior citizens; a very positive 
impact on the stock market--as a matter of fact, probably a 10 
percent increase minimum. I know that the gentleman from 
Washington state voted for the Sarbanes-Oxley proposals, which 
brought about better corporate governance. Clearly, as you 
indicated, Mr. Fisher, the impact on corporate governance would 
be a very positive one by eliminating the double taxation on 
dividends, creating a much better climate and a much better 
incentive within the corporate structure; and of course 
international competition, which means more exports for the 
United States.
    So that is a pretty good record of what we can accomplish 
by eliminating the double taxation of dividends. I guess I 
would not want to be on the other side of that issue. I feel a 
lot more comfortable with a pro-growth package that would 
provide the kind of incentives and the kind of positive 
developments that would be brought about.
    I asked Chairman Greenspan when he was here two or three 
weeks ago about his opinion on the elimination of double 
taxation of dividends. He was very positive--as a matter of 
fact, so positive that we did a ``dear colleague'' quoting 
directly from Chairman Greenspan. We may do the same with your 
testimony, and we appreciate the efforts.
    Let me ask you, as you know, the telecom and high-tech 
sectors have been hit particularly hard. They are not making 
any money. Their earnings dropped precipitously in 2001 and 
2002. As a result, they may not be able to take advantage of 
the dividend exclusion proposal, which would disincentivize 
their shareholders. Has there been some consideration given to 
expanding the proposal to permit companies in these 
circumstances to apply their average tax liability over, say, a 
five-year period to guide issuance of tax-free dividends to 
their shareholders?
    It appears that of all of the sectors, perhaps, in our 
economy, the tech sector and telecom have been hit the hardest, 
and reflected certainly in their earnings and in their growth, 
and obviously a negative effect on their shareholders. Has 
Treasury given any thought to that proposal?
    Mr. Fisher. I do not believe there has been work done on a 
five-year carry-back, carry-forward. I know there is some work 
going on there in the tax policy shop. I do not think, though, 
they have been looking at it on that long a horizon, but I 
would be happy to talk about it with them and get back to you.
    Mr. Oxley. There has been some discussion about something 
less than a five-year?
    Mr. Fisher. We have heard from a lot of people wanting us 
to focus on that. There are discussions. I am not sure what the 
reaction is to the different proposals. I have not yet heard of 
any as long as five years, but I would be happy to get back to 
you, Mr. Chairman, after talking with our folks in tax policy.
    Mr. Oxley. Getting back to the issue of corporate 
governance, you and I were comrades-in-arms on some of these 
issues. As we look back on an Enron, for example, and as you 
know, this committee had the first hearing on Enron. It became 
quite evident, I think, to the committee that Enron was in a 
situation where they were desperately trying to bury and hide 
debt through SPEs--special purpose entities. To what extent do 
you think the tax code may have lent itself to some of the 
rather strange behavior that took place at Enron, particularly 
over the last year and a half?
    Mr. Fisher. I think there are at least three different 
channels, I would say, of regrettable incentive structures that 
the tax code puts in play. One is simply the debt equity ratio 
issue of encouraging companies to be more levered than they 
might otherwise be, given the tax disadvantage currently in 
place. The remedy would address, if we unwound this, we would 
get companies and give them another incentive to focus on cash 
flow, rather than managed earnings. I think that that is now we 
are getting toward the heart of some of the issues that came up 
in Enron, where they went further and further off into the 
wilderness of managed earnings.
    The third is managing tax liability as aggressively as they 
apparently did, is another sort of third dimension that this 
comes up. The remedy the President has put forward, this plan 
puts in place, as I was beginning to elaborate, is that it is 
really a fundamental change in thinking that corporate America 
would have to go through to think of the payment of corporate 
taxes as a shareholder asset. Instead of having every incentive 
to maximize tax shelters of every flavor and stripe, once we 
put in place what the President has proposed, the company has 
an incentive to think of the taxes they pay at the corporate 
level as offsetting taxes for the shareholder, and there as a 
shareholder asset.
    So in those three different channels, I think we would be 
driving really at the heart of some of the behavioral problems 
that came up.
    Mr. Oxley. Thank you.
    Thank you, Madam Chairwoman.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page XX in the appendix.]
    Chairwoman Kelly. Thank you.
    In the absence of subcommittee Democrats, I am turning to 
Mr. Hensarling.
    Mr. Hensarling. Thank you, Madam Chair. I hope I am not 
supposed to give their side of the story.
    [Laughter.]
    Chairwoman Kelly. No, take your pick. You can do whatever 
you want. This is an educational forum, if you will.
    Mr. Hensarling. Mr. Fisher, one of my colleagues from 
across the aisle, who is absent now, spoke quite passionately 
about his children and future deficits. I, too, am a father. I 
have a one-year-old and another on the way, and I am very 
concerned about leaving them a legacy of debt, because I want 
to leave them a legacy of freedom and opportunity.
    The gentleman spoke about deficits. Can you tell me how the 
tax relief in the President's package is scored for fiscal year 
2004? Isn't it approximately $100 billion?
    Mr. Fisher. Yes, it is about $100 billion. Yes, about $100 
billion in terms of the jobs and growth package.
    Mr. Hensarling. And the administration has proposed roughly 
a $2.2 trillion budget for fiscal year 2004, is that correct?
    Mr. Fisher. Yes. That is my understanding.
    Mr. Hensarling. So if I do the math correctly, is the tax 
relief less than 5 percent of the proposed spending?
    Mr. Fisher. That sounds right. That sounds about right, but 
maybe even a tad less.
    Mr. Hensarling. Might it be a fair conclusion then that 
over 95 percent of the problem appears to be on the spending 
side and not the tax relief side?
    Mr. Fisher. I would certainly share that view with you.
    Mr. Hensarling. The $100 billion is under static scoring, 
is that correct?
    Mr. Fisher. Yes.
    Mr. Hensarling. Okay. The administration has not employed 
dynamic scoring, but I assume that you believe that your tax 
relief package will indeed have some consequences on human 
behavior.
    Mr. Fisher. Yes.
    Mr. Hensarling. I assume the administration has looked at 
past tax relief, say, in the Reagan administration or the 
Kennedy administration, since we heard JFK's name mentioned 
earlier. If you look at the history of earlier tax relief 
packages, can you tell me what their impact was on economic 
growth and tax revenues?
    Mr. Fisher. I do not have those figures on the top of my 
head. We know they were positive and they had a dynamic effect. 
I am confident this package will, too, but I do not have the 
figures from 1962, 1964 and the early 1980s in my head. But I 
think you and I agree, it is going to have a positive impact, 
lower the loss of federal revenues considerably, and increase 
the job creation.
    Mr. Hensarling. One last question, can you go into further 
detail about how we in the U.S. tax capital and savings vis-a-
vis other industrialized nations, and what the consequences of 
that has been on the availability and cost of capital in the 
U.S.?
    Mr. Fisher. I think all other OECD industrial countries 
have worked through different formulas to integrate--it is 
called tax integration--personal income tax and the corporate 
income tax, to avoid effects such as the double taxation we are 
looking at. So they have all been working at it, and it is just 
in the last few weeks we learned that Japan has actually moved 
ahead of us, so we are now taxing capital at the highest rate, 
as they have put through some credits to try to offset.
    So we know it has a dampening effect on investment here, 
and all the perverse corporate incentives that we have been 
discussing, and other countries do not put this dampener in 
their investment process. We should take it out.
    Mr. Hensarling. Thank you, Mr. Fisher.
    Mr. Fisher. Thank you.
    Mr. Hensarling. Madam Chair, I yield the balance of my 
time.
    Chairwoman Kelly. Thank you.
    Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Chairwoman Kelly.
    I want to ask for unanimous consent to let my opening 
remarks, statement be made a part of the record.
    Chairwoman Kelly. So moved.
    [The prepared statement of Hon. Ruben Hinojosa can be found 
on page XX in the appendix.]
    Mr. Hinojosa. Thank you.
    Under Secretary Fisher, I apologize that I was unable to 
come in while you were making your statement. I was at another 
meeting and I just could not get out of it.
    Mr. Fisher. I understand, sir.
    Mr. Hinojosa. Currently, the interest payments on many of 
the State and local government bonds are exempt from federal 
income taxes, while capital gains on stocks and securities are 
not. This system is in place to stimulate private investment in 
our communities and schools, and makes it easier to build 
roads, schools, and other projects. So that is something that 
is very important to us, especially who come from congressional 
districts with large rural areas and school districts that need 
to have the sale of these government bonds so that it can keep 
all these projects that I mentioned to you.
    Will the elimination of taxation on capital gains and 
retained earnings for private securities harm these communities 
I mentioned, and result in more costly municipal and state 
construction projects? And will the reduction in taxation of 
dividends reduce the amount of funding available for community 
investment?
    Mr. Fisher. Sir, I do not believe that it will. I think it 
is very important to understand the different characteristics 
of municipal bonds and municipal borrowing from equity 
securities. While in an absolute sense, we see a diminishing of 
their relative advantage in terms of tax advantage of munis 
vis-a-vis equity dividends, investors recognize the profound 
difference between the safety and stability of a government 
bond issued by a state and local government, and the risks of 
equity securities, particularly after the last few years we 
have been through with the wild swings in the equity markets.
    So when investors approach this, they do not think of these 
as fungible instruments. They might think of a diversified 
portfolio where, in order to have a very safe and secure 
revenue stream, you might have some government bonds and 
municipal securities. A balanced portfolio might also include 
some equity investment, but it would be quite odd to think of 
those two instruments as comparable, given how different the 
risk characteristics of them are.
    So while in some absolute mathematical sense, the tax 
advantage decreases for municipal securities, these are such 
profoundly different instruments I think it mistakes how 
investors approach them to think there would really be an 
increase in the cost of financing State and local projects.
    Mr. Hinojosa. Let me tell you why I am not very clear on 
the reason that you give. In talking to some of our friends in 
New York about this problem, their comment was that once you 
take out the capital gains, then you do not have the advantage 
of these tax exempt bonds that they are investing in and 
getting a high return, for comparing tax exempt bonds. By 
taking out the capital gains on those stocks, will they still 
be attractive to the investors in New York?
    Mr. Fisher. Yes, I believe they will. It has to do with the 
risk to principle, is one issue, and therefore the volatility 
of the instruments. Someone who wants to hold a municipal 
security is looking for something that is very safe and secure, 
and in which the principle amount is not subject to 
fluctuation, and which gives them a regular income stream in 
the form of the interest. An equity instrument is subject to 
all the risks of the market going up and down, and to the risk 
the company does not declare a dividend. That is in the 
discretion of management.
    So the two instruments have fundamentally different risk 
characteristics, which make it extremely unlikely that 
investors think of them in fungible terms.
    Mr. Hinojosa. Investors also want the highest return 
possible. It is not just the risk, it has got to be balanced.
    Mr. Fisher. Investors are always struggling to find the 
highest risk-adjusted returns. That is, to simply say, I want 
an instrument that pays me the largest interest payment, that 
will turn out to be a very risk bond, for example, of some 
company that does not have a very good credit rating.
    Mr. Hinojosa. You and I both know that they are going to be 
low-risk, because in many cases they are guaranteed by 
somebody, especially in Texas where the State permanent school 
fund guarantees those bonds.
    But let me go to another question. I do not believe that I 
am sure that there is going to be a high enough interest rate 
to still make it as attractive as you seem to be anticipating. 
In your written testimony, you said that the deficits projected 
are manageable and declining. At their peak, the immediate 
future, they are below U.S. historical experience. They compare 
favorably with fiscal conditions in other G-7 countries. Our 
debt remains modest by historical and international 
comparisons, and as a share of U.S. credit market it is at a 
50-plus year low.
    My research indicates just the opposite. In 2001, the U.S. 
enjoyed a $127 billion surplus. In 2002, our budget went into a 
$158 billion deficit. CBO forecasts that the President's new 
tax cuts and his other budget initiatives would produce 
deficits of $1.82 trillion over the next 10 years. The CBO 
projects a deficit of $287 billion in fiscal year 2003, that we 
are in, and a deficit of $338 billion in fiscal year 2004.
    Chairwoman Kelly. Mr. Hinojosa?
    Mr. Hinojosa. Yes, ma'am.
    Chairwoman Kelly. Can you please conclude as quickly as 
possible. Ask your question.
    Mr. Hinojosa. In conclusion, how can these deficits be 
characterized as manageable and declining?
    Mr. Fisher. Looking at the 10-year forecasts that we are 
working with, that both CBO and OMB have done, we are looking 
at deficits as a share of our economy--that is the normal way 
we look at them; as a share of GDP--they are in a range inside 
our experience and consistent with other G-7 countries. So 
right now, we are looking at less than 3 percent of GDP. That 
is a very typical deficit-to-GDP ratio. The projections over 
the coming decade is that they are around here just a little 
beneath 3 percent, and then decline over the rest of the 
decade. That declining trend is one of the reasons that I think 
both financial markets and we at the Treasury responsible for 
debt management see these as entirely manageable. So I think 
that when we look at it scaled to our capital markets, as my 
testimony alluded to, scaled to our credit markets, we see 
these as entirely manageable.
    Mr. Hinojosa. I thank you for your response, and thank you, 
Chairwoman Kelly.
    Mr. Fisher. Thank you.
    Chairwoman Kelly. Thank you.
    Mr. Murphy?
    Mr. Murphy. Thank you, Madam Chairman, and welcome here.
    Mr. Fisher. Thank you.
    Mr. Murphy. I was talking with some folks on the street, 
and I agree oftentimes constituents, people around America know 
a heck of a lot more than we inside the Beltway give them 
credit for. This guy described himself this way. He said, I am 
just an average American Joe Sixpack that pounds nails and cuts 
wood during the day, mows my lawn in the summer, and cheers for 
the Steelers in the fall. He said, we are pretty tired of the 
Beltway bullfeathers, although he described it a little more 
colorfully. He said, all I want to know is this--with these 
plans, what is it going to do to my money in retirement? What 
is it going to do to my kids' college fund? What is it going to 
do for job opportunities for my kids? And what is it going to 
do to put food on my table and keep a roof over my head, for 
now and in the years to come?
    How would you respond to him?
    Mr. Fisher. I would say the single most important thing, 
both for his family finances and for our government's, is to 
get our economy growing and creating jobs over the next 10 
years. As I said in my written statement and alluded to in my 
summary, I am concerned that we have a little more to confront 
here than just another swing of the business cycle. If I really 
thought we just were looking at sort of a normal business cycle 
issue then maybe we would not need to do something on the scale 
that the President has proposed. But I think we need to 
overcome some greater obstacles. So getting the growth rate up, 
and nothing over the coming 10 years will do a better job of 
that than speeding up the investment process.
    Mr. Murphy. In plain speak, do you believe this plan will 
essentially boost the value of what people have saved in 
whatever kind of market funds or something else they put away 
for college or their retirement? And how much do you think it 
will increase it by?
    Mr. Fisher. There are estimates of the impact. We have not 
done one at the Treasury, but the estimates of impact on stock 
market valuations range from 5 percent to 15 percent positive 
impact.
    Mr. Murphy. Over how many years? Annually?
    Mr. Fisher. No, that is a one-off effect of doing this, but 
that is a pretty substantial boost, even just a 5 percent 
boost. So I think it is going to raise equity valuations and 
the value of investment.
    Mr. Murphy. Does this translate also to you saying that you 
cannot affect the job market unless you affect the stock 
market?
    Mr. Fisher. I think the effect comes back indirectly. What 
I would say is, businessmen and consumers want to see something 
that will be enduring support, so we need something that is 
going to drive investment higher so there are more jobs for his 
kids. We need something that is going to provide consumers with 
the confidence to buy something--a big ticket item--to keep 
their consumption on track. We need to do both of those things. 
That is what the President is trying to do.
    Mr. Murphy. Another avenue here--I heard someone say that 
those who oppose the President's plan are opposing a plan that 
forces corporations to pay their fair share of taxes. Could you 
respond to that? Does that sound about right? I guess they are 
referring to the way companies have, I think you were saying 
before, to keep money to finance buy-backs; they incur debts to 
falsely pay dividends to keep their stock value up, et cetera. 
They will find other loopholes to not pay taxes. Does this have 
any way of helping to keep companies more honest in what they 
are paying?
    Mr. Fisher. Yes, as I have said, I think it does. I even 
know one commentator who thinks this will overall increase 
corporate tax payments because of the incentive effects that if 
they pay the taxes, then their shareholders do not have to. I 
think it has a powerful impact on just the other side of 
getting us away from tax shelters and corporate inversions and 
the like, reducing the incentives for gaming the system by 
corporations.
    Mr. Murphy. What do you mean by ``gaming'' the system?
    Mr. Fisher. Aggressive tax shelters. We know there is a 
fine line between what the system permits and what then goes 
over the line--not tax avoidance, but tax evasion. Obviously, 
there are a lot of people out there who are trying to always 
push up against that line. We want to try to reduce the whole 
incentive to be playing that game to begin with.
    Mr. Murphy. Will this then lead to some job loss for 
attorneys and accountants whose whole job is to find ways to 
not pay taxes?
    Mr. Fisher. Yes, if it is successful, it would do that.
    Mr. Murphy. I am for that. Thank you.
    Chairwoman Kelly. Thank you, Mr. Murphy.
    Mr. Garrett? Mr. Barrett, have you questions?
    Mr. Barrett. Thank you, Madam Chairwoman.
    Mr. Fisher, just one quick question. I was reading an 
article in the Wall Street Journal that quoted Glenn Hubbard, 
of course, the head architect of the Bush tax package. It talks 
about urging people to invest more and pushing down the cost of 
capital. The part that intrigued me, that I really liked, he 
said a dividend tax cut is a way to raise wages. Tell me how 
that would work?
    Mr. Fisher. By lowering the hurdle cost of investment, we 
make it easier for firms. Firms then have a choice of what to 
do with that additional capital, that additional expense. Now, 
over time--I think this is in the context Glenn would be 
discussing that--that drives us to higher productivity. We are 
going to get more investment, and it is really productivity 
that leads to enduring improvement in our incomes. It may not 
change it--if you think about just one person, are they going 
to get a raise the day this thing is passed--no, I do not see 
it that way. But this is the key to unlocking productivity 
gains to beget more investment in our economy, more 
productivity. That is what leads to a higher level of income 
for all of us.
    Mr. Barrett. Thank you, Mr. Fisher.
    With that, Madam Chairwoman, I yield back the balance of my 
time.
    Chairwoman Kelly. Thank you.
    Ms. Brown-Waite?
    Ms. Brown-Waite. Thank you very much.
    One of the things when I got elected was I promised I would 
not fall in love with a place that people sent me to work at, 
namely D.C. So I go home every weekend, and I talk to people in 
the community, talk to seniors. I can just tell the rest of the 
panel and the rest of the members here that my seniors will 
appreciate having the dividend not be taxed. When you look at 
the figures, more than half of the dividend income goes to 
seniors, and that means about five million seniors nationwide 
would receive an average tax cut of somewhere around $900 in 
2003. That is a substantial impact. That is money that they are 
going to use in the community. If you cannot see how these jobs 
are going to be created, how it stimulates the economy, then I 
do not think you understand Economics 101. It is when people 
have more money in their pocket that they actually spend it.
    I was just wondering if you all have done a breakdown of 
State by State how much it would mean to seniors, to the 
residents in each State?
    Mr. Fisher. I think we have done that. I do not have it 
with me. Let me double check that we have done that analysis 
and we will try to get it to you as quickly as we can. I do not 
have it with me or in my head.
    Ms. Brown-Waite. Have you extended that to number of jobs 
created as a result of the tax break for each state? I saw some 
figures that came from a research organization, but I did not 
know if you all had official figures.
    Mr. Fisher. I am going to have to double check. I think we 
may be able to do a State by State analysis, but I do not have 
it in my head or with me. So let me try to get back to you on 
that.
    Ms. Brown-Waite. I can just tell you that the seniors in 
Florida are looking forward to paying lower taxes as a result 
of this. Thank you.
    Mr. Fisher. Thank you, ma'am.
    Chairwoman Kelly. Thank you.
    If there are no more questions, the chair notes that some 
members may have additional questions for Under Secretary 
Fisher and they may wish to submit those in writing. So without 
objection, the hearing record will remain open for 30 days for 
members to submit written questions to him and place their 
responses in the record.
    Mr. Fisher, there have been some requests by members of the 
committee for some additional information, so please feel free 
to--I will officially request that those figures get to us.
    Mr. Fisher. Yes.
    Chairwoman Kelly. We are very grateful that you were 
willing to be here with us today. You are excused with the 
committee's great appreciation for your time.
    Mr. Fisher. Thank you very much. It was a pleasure.
    Chairwoman Kelly. With the agreement of the members, I want 
to recognize Mr. Hensarling of Texas for the purpose of 
introducing our next witness.
    Mr. Hensarling. Thank you, Madam Chair.
    It is indeed a distinct honor and privilege to introduce 
our next witness. In many respects, Madam Chair, we are getting 
three witnesses for the price of one, for there is Dr. Phil 
Gramm; there is Senator Phil Gramm; and there is Vice Chairman 
Phil Gramm. Dr. Phil Gramm was a professor of economics, who 
taught economics to thousands of students at Texas A&M 
University over 12 years. Thousands of students learned about 
supply, demand, money, banking, and Seays Law due to his 
inspiring teaching. I was honored to be one of those students.
    He went on to have an almost quarter-century public service 
career in Congress, first as a Congressman and then as a 
Senator. He is indeed uniquely qualified to speak to us about 
economic growth, since he was the co-author of the Reagan 
economic program in the House, a program that cut marginal tax 
rates, increased government revenues, and caused one of the 
largest economic booms in American history to take place.
    As a Senator, he was responsible for the Gramm-Rudman 
legislation, and was one of the last people in this city to 
actually put binding restraints on federal spending. I hope he 
explores in his testimony the relationship between economic 
growth and the growth in government spending. Once again, I was 
honored to be his aide for many years during these years.
    Finally, there is now Vice Chairman Phil Gramm. Senator, we 
are very happy you finally decided to make an honest living.
    [Laughter.]
    Senator Gramm. So am I.
    Mr. Hensarling. We have the perspective of an investment 
banker.
    So Madam Chairman, I do think indeed we are getting three 
witnesses for the price of one, to the panel. We have an 
academician, we have a great public servant who is committed to 
principle, tenacity, courage; and finally we have an investment 
banker. But to me, he is a teacher, a friend, and a mentor. I 
am honored to introduce him, and one statement to the witness: 
Senator, for 25 years, I have answered your questions; 
turnabout is fair play.
    [Laughter.]
    Thank you, Madam Chair.
    Chairwoman Kelly. Thank you.

   STATEMENT OF HON. PHIL GRAMM, VICE CHAIRMAN AND MANAGING 
                   DIRECTOR, UBS WARBURG LLC

    Senator Gramm. Madam Chairwoman, members of the committee, 
Mr. Chairman, Congressman Hensarling, let me thank you for that 
wonderful introduction. If I had never done any of those things 
other than taught you, I would have had a life well spent, and 
I want to thank you very much.
    I want to thank you for inviting me to come today. I cannot 
imagine what is more important than getting America back to 
work, than rebuilding confidence in our equity markets, than 
rebuilding the foundations of our retirement program. To the 
extent that I get to play a small role in advising you on that, 
I am very flattered and very grateful.
    Let me start by defining the problem. In the 20th century, 
we had two different kinds of business downturns. In the middle 
and late part of the 20th century, we had a series of inventory 
cycles--seven of them--and they all worked basically the same 
way. Somewhere, signals got crossed between people that were 
selling things and people that were producing things. We would 
over-produce. There would be a buildup of inventories. It would 
be discovered. Orders would go back up the production chain to 
cut back on production. Businesses would re-trench. People 
would be laid off and we would have an economic downturn. 
Economists could never predict when they were going to happen, 
but we understood a lot about them once they started.
    In the early part of the 20th century, we had a series of 
financial panics. They were generated by the fact that we had a 
very difficult time converting checking account demand deposits 
into currency, and we had an agricultural economy so you had 
huge seasonal variants in the demand for money.
    I give you that little history lesson because one thing 
everybody should know in this debate is that the downturn that 
we are beginning to recover from is very different than 
anything we experienced in the 20th century. The downturn we 
suffer from was a speculative boom and a breaking of that 
speculative bubble. We do not know for sure whether all the gas 
is out of it. We do not have good precedents in recent history 
as to how post-speculative booms work in terms of recovery.
    So the first point I want to make is that we are kind of in 
uncharted waters here. I would urge you to be cautious and 
forward-leaning in terms of addressing this downturn and 
guaranteeing a strong recovery.
    Secondly, Madam Chairwoman, as you mentioned, this has been 
a very different kind of recession. Consumption has never 
declined. We are in the midst of a housing boom in the midst of 
a downturn. Our downturn has been produced by one thing and 
that has been a collapse in investment. Now, what I think that 
should tell us is if you want to get the economy growing again, 
you have got to affect investment. The old pump-priming where 
we give people money hoping they are going to spend it is not 
going to be very effective in a recession where consumption has 
never declined. The problem is investment, and if your policy 
does not affect investment, it is not going to have much of an 
impact.
    Now, in terms of the President's stimulus package, despite 
all the media hype and all the politics, the plain truth is it 
is not very big--2.4 percent of projected current services 
spending, which means what you would spend if you created no 
new programs and did not change anything over the next 10 
years. You could literally take 2.4 percent of projected 
current services spending and fly it over cities in airplanes 
and throw the money out and would have no substantial impact on 
this economy. If this stimulus package is going to affect 
anything, it has got to get people to invest not the money they 
get from your tax cut, but to invest money they have already 
got that they are not putting to work.
    I think there are two things in the President's package 
that are very important in doing that. One of them you have 
talked a lot about, and that is the dual taxation on dividends. 
Eliminating the dual taxation on dividends will change the 
after-tax rate of return on investment and will, in and of 
itself, change the value of equities on the American market. 
The lowest figure that Secretary Fisher talked about was 5 
percent. That does not sound very big until you realize that a 
5 percent change in equity values is $350 billion. So we are 
talking about a substantial impact simply by eliminating a 
current bias in the tax code.
    There are a couple of other things that I think are 
important. Number one, the current system basically encourages 
companies to invest internally even when the rate of return of 
investment in the market is greater than it is inside the 
company. That creates a wasting of capital and inefficiency, 
and eliminating this bias will go a long way toward correcting 
that, and ultimately will correct it.
    By eliminating the bias against dividends, companies will 
pay more dividends and you will make the internal conditions of 
companies more transparent. I had an old accounting professor 
long ago who said, cash flow is real; profits are a fiction. 
Letting companies exhibit cash flow by paying dividends 
probably will do more for corporate transparency than any law 
you could pass.
    Number four, the double taxation of dividends encourages 
businesses not to incorporate, even though they could get 
access to more capital; they could grow; they could create 
jobs. But by incorporating, they end up having to pay a dual 
taxation on dividends and they are disadvantaged. It cannot 
make sense to let tax policy dictate corporate structure.
    Finally, the elimination of the dual taxation on dividends 
will eliminate the non-economic use of debt. How many companies 
that have had problems during the current downturn overused 
debt and underused equity because the cost of debt is tax 
deductible and the cost of equity is not?
    Those are all sound reasons why this ought to be done. 
There is one other policy I wanted to touch on, Madam 
Chairwoman, and that is accelerating the reduction in rates. 
Let me just focus on one--the highest rate, 38.6 percent. That 
is in reality the small business tax rate in America, because 
38.6 percent is the tax rate paid by proprietorships, 
partnerships and subchapter S corporations filing as 
individuals. That tax rate and the revenues collected from it 
generate revenues 85 percent of which come from small business.
    Small businesses create most of the jobs in America. 
Probably dollar for dollar, the greatest stimulant in the 
President's package is accelerating those reductions in 
marginal rates, specifically the highest rate, from all four to 
the present, and from all six to the present. It does not 
change the long-term revenue stream of the government even in a 
static sense because it is going to go into effect anyway, and 
it ought to be made retroactive to January 1 and done now. 
There is no question about the fact that had Congress known how 
weak this recovery was going to be, how uncertain it was going 
to be, we would never have strung the tax cut out as we did.
    So I want to urge this committee to move forward. And let 
me address just two other issues, if I may. First of all, the 
question about revenues, and I think at least when I was here 
that I had as good a record on being concerned about the 
deficit as anybody. But when you are losing five times as much 
revenue from a recession as the static cost of the stimulus 
package, I think it makes sense to act, not to sit passively 
by.
    Secondly, if you take the Wilshire 5000, which is the 
broadest index of equity value in America, and you go back to 
the high water mark in 2001, and you compare that to today, we 
have lost $6.7 trillion in equity value; $6.7 trillion in 
equities that form the foundation of the life savings of our 
people; that form the foundation of our retirement programs. 
Whatever we can do to rebuild that equity value is going to 
produce many times more revenue than we are talking about in a 
static sense in this stimulus package.
    So I think it is very important that we act on it. I think 
the figure that over the next three years that we would have 
the potential of creating an extra two million jobs is not out 
of reach. I think it might be achievable. And I think this 
stimulus package should be adopted.
    Finally, in terms of this war, I did not see any evidence 
in 1991 that the war had any significant economic impact, and 
the economy is twice as big today as it was in 1991. I think 
the war is very important and I think it is something we ought 
to be concerned about. It is something we ought to be worried 
about and praying over. But this economic problem is something 
that is vitally important, and I do not think simply because we 
are staring a war in the face that we ought to forget the fact 
that unemployment is rising, that equity values have declined 
by $6.7 trillion, and that there is a lot of work to do 
economically. That is why I want to congratulate this 
subcommittee on holding this hearing, even when so much of our 
thought is on the war.
    [The prepared statement of Hon. Phil Gramm can be found on 
page XX in the appendix.]
    Chairwoman Kelly. Thank you so much, Mr. Gramm. Is it okay 
if I call you ``Senator'' still?
    You have been one of the key players in all of the tax 
debates over the past 20-plus years. You have talked about some 
of the lessons that those debates have given you, about 
economic growth and federal revenues that we should apply to 
the debate over ending double taxation of dividends. Which 
fears that were raised by the President's opponents are not 
valid, based on past experience? You have heard some people 
earlier today talk about some of their fears. Which of those 
fears do you feel are not valid?
    Senator Gramm. Well, first of all, I think that our first 
fear ought to be about the economic recovery. Let me make it 
clear right now, I believe the economy is going to recover no 
matter what we do. I think the economy is going to recover. It 
is going to overcome the illness and the absurd prescription of 
the doctor. But it is going to recover slower if we do not try 
to do something to stimulate it. For the people who are going 
to be affected over the next three years, I think we can make 
their lives better and I think we can strengthen the economy 
dramatically. So it is not a question of, is America going to 
recover economically--we are. The question is the speed of the 
recovery and how it is going to be affected.
    I would say this, Madam Chairwoman, and I do not want to 
get into a political debate. I have gotten out of political 
debates. But I would take the concern about the deficit more 
seriously if the people raising it had the same standard for 
spending money as they do reducing taxes. I think basically 
that is the test. In the end, I think that given the state of 
the economy and given the nature of this downturn we have, and 
how much uncertainty there is about it--and I can tell you, 
working today in New York, working with people who want to make 
investments, that have powerful economic ideas, there is still 
a great deal of uncertainty. And whatever we can do to allay 
some of that uncertainty, I think we should do.
    Chairwoman Kelly. Thank you.
    Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Chairwoman Kelly.
    Senator, it is a pleasure to see you again.
    Senator Gramm. Thank you.
    Mr. Hinojosa. Coming from Texas and seeing how you worked 
and worked so effectively, it is a pleasure to see you back on 
the Hill, and especially before this committee so that we can 
ask you some questions. Possibly the questions I am going to 
ask you may appear to be softball pitches because you come from 
Texas, but truly I want to ask you a question that is not very 
clear, and I certainly do not necessarily agree with the 
President's plan to stimulate the economy. Being the great 
economics instructor that you were at Texas A&M, I am going to 
focus my question on housing. Housing seems to be an industry 
that has created lots of jobs and continues in spite of the 
decrease of the GDP, which was projected to be at 3 percent and 
now will be 1.5 percent, according to some experts.
    Nine national housing lobbies have expressed concern that 
President Bush's proposal to eliminate the taxation on 
individual dividends would undermine the country's most 
successful program producing and rehabilitating affordable 
housing. The low-income housing tax credit gives investors a 
dollar for dollar reduction in taxes in return for investing in 
such housing, which you and I know is greatly needed down in 
South Texas. The dividend exemption could make all tax credits 
less attractive to investors and could move investment from tax 
exempt government bonds to dividend-paying stocks, thus 
reducing the allure of the low-income housing tax credit and 
endangering affordable housing programs in the United States. 
What are your views on this contention?
    Senator Gramm. Let me say, Congressman Hinojosa, I thank 
you for your kind comments. I have always appreciated my 
friendship with you and with your family.
    I have very strong views on this. Let me just begin with 
some history. When we cut taxes under President Reagan by 30 
percent, these same arguments were raised in 1981; that by 
lowering the highest marginal rate from 70 percent to a 30 
percent reduction from that rate, and ultimately with the 1986 
Act, by lowering it all the way initially from 1981 at 70 
percent to 28 percent, there was concern that the deductions 
you get for your mortgage interest would be lowered in value; 
there was concern about the marketability of municipal bonds--
you raised that earlier. But let me say, in both those cases, 
both the 1981 tax cut and the 1986 more simplification--but in 
neither case was housing affected in a negative way and in 
neither case was there a perceivable impact on municipal bond 
sales and on the viability of that market.
    The logic that you are quoting people as saying basically 
is the logic that if you wanted to make deductions more 
valuable, you would make the tax rate 100 percent. All I am 
saying is, in my career in 1981, in 1986, in 2001, when we cut 
taxes, we did not see any of these dire predictions come true. 
Remember this, the municipal bond market is a market that is 
driven by the fact that income is tax free. Even with the 
elimination of dual taxation on dividends, you are still 
talking about a 35 percent tax rate.
    So it is a concern that I do not see any evidence to 
substantiate it. If you just ask yourself the logic, this logic 
is used every time we reduce taxes. All I am saying is, I 
cannot speak for all of the history of mankind, but from 1981 
and 1986 and 2001, it just did not happen.
    Chairwoman Kelly. But Senator----
    Mr. Hinojosa. I am going to finish my question. Is that 
Okay, Chairwoman Kelly?
    Chairwoman Kelly. As long as it is a short one.
    Mr. Hinojosa. It is a short one.
    I will come back in the next round and ask you, so be 
thinking about it. How could it be that from 1980 to 1996, when 
we had this huge gap between house ownership between minorities 
and the average American, and we started producing a lot more 
jobs and reducing the unemployment rate down to its lowest; 
produced the most millionaires in that period from 1990 to 
2000, that national policies were to have taxes at about the 
rate that they are at now and to pay taxes on these dividends. 
So they must not have been too bad, because we paid off our 
deficit.
    Senator Gramm. That is right. We cut taxes in 1995, if you 
will remember on the budget summit agreement with the 
President. We cut taxes. We cut the capital gains tax rate. We 
controlled spending and we started moving, beginning in 1995 
toward a balanced budget. You know, everybody wants to claim 
credit for what happened. Really, from 1982 until about 2001, 
we were living in a golden age. I do now know if people knew it 
then, but I tell you, looking back at it now, in terms of the 
quality of consumer goods, in terms of the economic development 
reaching people that had not been reached in 30 years under 
Democrat or Republican Presidents--in the 1990s, this economic 
expansion started reaching those people and you and I have seen 
it all over South Texas. Creating millionaires did not create 
enough, but it created a lot of them.
    Mr. Hinojosa. Madam Chair, I reserve the right to come back 
in the next round and continue my question and his answer.
    Chairwoman Kelly. Mr. Hinojosa, there will not be a second 
round with this witness. However, if you would like to submit a 
question in writing, you certainly are able to do that.
    Mr. Hinojosa. Thank you.
    Chairwoman Kelly. Mr. Oxley?
    Mr. Oxley. Thank you, Madam Chairwoman.
    Senator Gramm, welcome. It is good to see you again and we 
hope this is the first of several appearances before the 
Financial Services Committee. Let me express my gratitude to 
you for your leadership, both in the House when we were 
colleagues here, and in the Senate, and particularly your work 
on what became known as the Sarbanes-Oxley bill, and your 
efforts working with me to make certain that we did not go too 
far in our efforts to seek more corporate accountability.
    To that end, in your testimony you say that eliminating the 
current bias against the payment of dividends will make the 
internal condition of corporations more transparent. I am 
wondering if you could help us with some details and elaborate 
on how ending the tax penalty on dividends will improve 
corporate governance and reduce the use of gimmicky off-shore 
tax shelters. Do you share with me the belief that some of 
these problems that developed in Enron in particular and other 
corporations in general in some ways were brought about by the 
rather odd way that we deal with corporate taxation, and 
specifically the double taxation of dividends?
    Senator Gramm. Here is basically my point, that when you 
have the tax code discriminate against equity financing, and 
discriminate against dividend payment--let me just give you an 
example. If I am running a company and I earn a profit, and I 
pay it out to my shareholders, I have got to pay corporate 
income taxes on it and then they have got to pay individual 
income taxes on it, the effective tax rate pushes over 50 
percent--up to 60 percent. But if I simply take it and 
repurchase my stock or if I take it and invest it internally, 
even though the rate of return inside my company may not be as 
high as my investors could get by investing somewhere else, 
they still can be better off economically. I think that when 
you have a policy that is biased against equity, then you get 
the instability that comes with these very heavy debt burdens; 
when you have a policy that discourages the payment of 
dividends, dividends give people information about companies. 
Companies cannot pay dividends unless they have got a positive 
cash flow. The ability to exhibit that tells you a lot about 
the health of the company.
    I just think that there just is no intellectual argument in 
favor of the dual taxation on dividends. The only debate about 
it is that people would like to have the money to spend. I have 
never heard anybody say that it is a good, sound economic 
policy. I am not claiming that the dual taxation of dividends 
was the source of all of our problems in corporate governance, 
but I am saying that allowing dividends to be paid by 
eliminating the bias in the tax code has a lot of other 
positives, and a big one is increased transparency. If my 
company is paying me dividends, I know they have got money from 
somewhere. My old accounting professor was trying to make a 
point, and as most professors do, overstated the point, but 
profit has to do with all kinds of complicated calculations--
write-offs, depreciations, et cetera. Cash flow has to do with 
money coming in, the money you are paying out, and the money 
you can then pay out in dividends. That is as real as real gets 
in the world we live in.
    Mr. Oxley. If that is the case, and you particularly make a 
strong point that it is very hard intellectually to argue 
against the elimination of double taxation, why has it never 
been seriously tried until now? I know that I think Charles 
Schwab really raised the issue with the President at the 
economic summit down in Texas. But obviously, this is the kind 
of issue that has been around for a long time. When Chairman 
Greenspan sat there where you are and testified two or three 
weeks ago and I asked him those same questions, I started out 
by saying I can remember studying Econ 101 in college, and that 
my professor at that point was talking about the double 
taxation of dividends and how inefficient it was and an odd 
situation. And yet, now 40 years later, we are still engaged in 
that debate.
    Is it just that it is so difficult? You were on the Ways 
and Means Committee over here in the House. Is it just because 
it is there and the inertia is such that we just cannot move 
it?
    Senator Gramm. I think it is hard to do because it is an 
easy issue to demagogue. It is an easy issue to take yourself 
back to the 1950s where only rich people owned stock. I think 
it is important. A question was asked earlier about corporate 
taxes. Corporations do not pay taxes. Corporations collect 
taxes from consumers, but they do not pay them. This idea that 
corporations are paying this tax, ultimately it is their 
customers that pay it when it is passed to the consumer.
    I think it is just a hard thing to eliminate and I think it 
would be good if we could work out a consensus to do something 
about it. You know, there is this age-old debate about how big 
should government be and how much of society's resources should 
go through government. I respect that. I have a strong opinion 
about it, but I respect other people's opinion. But the way we 
collect that revenue ought to be in a way that has the least 
damaging effect on the economy, because whether you want people 
to spend their money or whether you want the government to 
spend it, you want the pie to be as big as possible. So there 
ought to be some way to have this debate where everybody should 
end up on the same side of this particular issue.
    Mr. Oxley. Thank you.
    Chairwoman Kelly. Thank you.
    Mr. Chairman, I am glad you brought up the name of Charles 
Schwab. I have here, and with unanimous consent, will enter 
into the record a copy of a March 11 Washington Post op/ed 
written by Charles Schwab, entitled, A Boon to Ordinary 
Investors: Eliminating the Dividend Tax is Just What the 
Economy Needs. So without objection, I will enter that into the 
record.
    [The following information can be found on page XX in the 
appendix.]
    Chairwoman Kelly. We go now to Mr. Moore.
    Mr. Moore. Thank you, Madam Chairwoman.
    Senator Gramm, in January 2001 I believe the projected 
surplus by CBO was about $5.6 trillion. Does that sound about 
right, sir?
    Senator Gramm. For over a 10-year period, that is about 
right. My mind fades, but it was big.
    Mr. Moore. Right. I was speaking to a high school 
government class about the virtues of fiscal responsibility and 
balanced budgets and paying down debt last year. Even where I 
am on the other side of the aisle, I am not going where you may 
think I am going, because I voted for the President's tax cut. 
I thought it was the right thing to do and I still think it was 
the right thing to do two years ago. But at that time, we had a 
$5.6 billion projected surplus. I was talking to this group of 
high school students, and I said, how would you define 
``projected surplus?'' This girl raised her hand and she said, 
``Maybe yes; maybe no.'' A pretty good definition, isn't it? 
Because as it turned out, what we hoped would happen, what we 
projected would happen, did not happen, did it? Over the 10 
years, we did not have a $5.6 trillion surplus.
    Senator Gramm. It did not happen, and it did not happen 
really for several reasons. The economy got weaker.
    Mr. Moore. I understand.
    Senator Gramm. Number two, we spent a whole lot more money.
    Mr. Moore. My point is, when you project something, you 
hope it happens, but it will not necessarily happen. Isn't that 
correct?
    Senator Gramm. It is like an old woman once gave advice 
that when you are borrowing money, and you want a good analogy, 
write down on a handkerchief in indelible ink what you have to 
pay back, and then write down in fruit dye on the other part of 
it, where your revenues are coming from, and then wash it and 
see what is guaranteed.
    Mr. Moore. Fair enough.
    Senator Gramm. When you are predicting the future, you do 
not know.
    Mr. Moore. Exactly right. My point is, we were in surplus 
mode, and I am not blaming anybody for this. I am not blaming 
the President or the other party for this. I am just saying we 
were in surplus mode; now we are not. That is correct, isn't 
it?
    Senator Gramm. There is no question about it.
    Mr. Moore. And the President--and I am not blaming anybody 
for this; I am not making any political commentary on this--I 
am just saying we are or appear to be on the advent of a war 
right now, some sort of military action.
    Senator Gramm. The only thing I would say on that is----
    Mr. Moore. I have not asked the question yet. I am just 
asking. Thank you. With all respect, I do get to ask the 
questions here.
    We appear to be ready for a military adventure of some 
sort, and we do not know what it is going to cost. I do not 
think you know, and I am not going to try to pin you down on 
that, because you cannot know, I do not think, or anybody. The 
President has even said we cannot really project what that is 
going to cost. Would you agree with that, in fairness?
    Senator Gramm. I do not think anybody knows what it is 
going to cost, but in 1991 it did not have any significant 
impact on the economy.
    Mr. Moore. Of course, this is 10 years later, and we still 
do not know what it is going to cost.
    Senator Gramm. Well, the economy is twice as big as it was 
10 years ago.
    Mr. Moore. Right. We are in deficit mode. The President is 
proposing tax cuts, and I support some tax cuts, although I 
have some concerns about the size of the President's proposal. 
And we are, under the President's budget, at least $320-plus 
billion still in deficit, in his budget proposal. Isn't that 
correct?
    Senator Gramm. I do not think that--$320 billion sounds 
high to me, but it is too big to suit me.
    Mr. Moore. Okay. It is too big to suit me, too. I think we 
agree on that.
    And I do not disagree either with your characterization of 
the taxation of dividends, in concept at least, because I do 
have this--I am from Kansas, sir, and I called the state 
department of revenue in Kansas when the President first 
proposed this dividend elimination. I talked to analyst there, 
and I said, do you have any idea what kind of impact this might 
have on collection of revenues in Kansas if this passed? He 
said, as a matter of fact, we just did an analysis of that and 
it is going to cost the state of Kansas $51 million. Well, 
Kansas is a relatively small state compared to Texas or 
California or others, and $51 million does not sound like a 
bunch of money. But when you are in a $750 million revenue 
shortfall, it is a lot of money to our new governor and to our 
legislature.
    I submit that it is going to cost some other states a lot 
more money percentage-wise than it is Kansas in terms of this 
$51 million. Is that a concern or should it be a concern?
    Senator Gramm. Well, we have to believe that the 
elimination of dual taxation on dividends is going to create 
investment in America. Some of that will be in Kansas. How 
large it will be relative to the lost revenue I think is 
something you could speculate on. But let me make it clear that 
if we have this deficit and we did not have the current 
economic downturn that we are in, I would not be in favor of 
moving up these tax rate reductions. I think in that 
circumstance, we should be debating eliminating this 
inefficiency in the tax code and paying for it by either 
controlling or cutting spending, or by offsetting it somewhere 
else. I think the only reason it makes sense as a package is 
that we are in a downturn that is costing us five times as much 
as the revenues that we are talking about in terms of the 
economic growth package. That is the only reason it makes sense 
to me as a whole right now.
    Mr. Moore. Thank you, Senator.
    Chairwoman Kelly. Thank you.
    We go to Mr. Hensarling.
    Mr. Hensarling. Thank you, Madam Chair.
    Senator Gramm, in your testimony I believe you said that 
the aggregate value of the President's proposed tax relief is 
less than 2.4 percent of the projected current services federal 
spending. There obviously continues to be great concern about 
deficits. In my own earlier math dealing only with fiscal year 
2004, I came up with less than 5 percent. Can you tell us how 
you calculated the 2.4 percent?
    Senator Gramm. I took current services spending over the 
next decade. I took the value of the tax cut over the decade 
and divided. It is a little more front-end loaded because you 
are moving the rates forward to January 1, so in the first year 
it is more. In other years it is lower, but the average is 2.4 
percent. I also would note that the deficit that comes from the 
increases in spending that the President has proposed is bigger 
than the deficit that comes from the tax cut the President has 
proposed, and yet many people who say the tax cut is too big 
say spending is too small. Yet if that is the case, how can the 
basis of concern be the deficit?
    Mr. Hensarling. I assume the 2.4 percent is based on static 
scoring?
    Senator Gramm. That is based on static scoring; how much it 
costs if no behavior changes; and of course it is based on how 
much government costs if no behavior changes, but we are in the 
midst this year of increasing government spending.
    Mr. Hensarling. I appreciate the fact that you are no 
longer in the politics business, but I do appreciate the fact 
also that you are still in the policy business. So let me put 
it this way, there appears to be at least one alternative 
economic growth package and it talks about targeting tax 
relief. Wearing any of your three hats, have you perhaps looked 
at the alternative economic plan or do you have an opinion 
about targeted tax relief?
    Senator Gramm. I think people are getting confused between 
a stimulus package and just trying to give money away. What we 
are trying to do here is to get people to invest. A lot of 
people have trouble accepting that if America is going to be 
saved, it is going to be saved at a profit; that if you want 
people to invest their money, you have got to provide them with 
incentives to do it. The strength of the President's proposal 
is not in its aggregate value, as I said during my testimony. 
If you took the amount of money the President is talking about 
and simply threw it out of airplanes over the major cities of 
this country, you would have a very modest impact.
    The reason that I believe the two major parts of it will 
have a significant impact, and that is elimination of the dual 
taxation on dividends and accelerating these marginal tax 
rates, especially the highest rate, which is the small business 
rate--is that you are going to induce people that have got lots 
of money, that are not now investing it, to invest it. I think 
that is the hope we are talking about. I think it is a 
realistic hope. I do believe the stimulus package will help the 
economy and will stimulate investment if you pass it. Nobody 
knows by how much. So you know, there are uncertainties about 
it, but I think given the risk that we are facing, it is a risk 
you ought to take. At the same time, you ought to be very 
careful about the money you are spending.
    Mr. Hensarling. The same alternative growth package has tax 
relief in one year only it front-loads all the tax relief. Do 
you have an opinion on that impact on the economy and job 
creators?
    Senator Gramm. It is bigger in the first year than the 
President's, but again it is not aimed at investment. It is 
aimed at stimulating consumption, which has never declined to 
begin with. So you might very well get people to spend the 
money you give them, but that is not what the effort is. The 
effort is to get people to spend money they already have that 
they are not spending. That is what a stimulus proposal is 
about. It seems to me, if you want to measure the impact of a 
stimulus proposal, it is how many dollars do you get people 
that they have to spend based on the number of dollars that you 
have that you spend.
    If the best argument you can make is, well, if we give it 
to them, they will spend all of it, why don't you just drop it 
out of airplanes? By focusing on investment, that is where the 
problem is, and if we are going to get a substantial response, 
if we are going to put people to work, it has got to be in 
investment. Unfortunately, if you want to get into a debate 
about, well, equity and things of that nature--equity is 
growth. Equity is jobs. I think that is where people get 
confused. I think it is why we have such a hard time debating 
these subjects, but it is something I have watched for a 
quarter of a century, and it is not likely to be wished away.
    Mr. Hensarling. Thank you, Senator.
    Thank you, Madam Chair.
    Chairwoman Kelly. Thank you.
    Mr. Crowley?
    Mr. Crowley. Thank you, Madam Chair.
    Senator Gramm, both sides recognize your great service to 
this country and we are very pleased to have you here before us 
this afternoon.
    Senator Gramm. Thank you very much.
    Mr. Crowley. I know that you have probably gone over a 
little bit of the time, Madam Chair, so I will try not to keep 
you much longer than necessary.
    Senator, you said on the second page of your statement--I 
was not here for your statement; I read through it afterwards--
and I will just quote from the double taxation on dividends 
portion of your statement, the last paragraph and the last 
sentence, ``And finally, the elimination of dual taxation on 
dividends is both an effective stimulant and sound economic 
policy which will speed up the recovery and increase long-term 
growth.'' I am assuming the growth you are talking about is job 
development. Would that be correct?
    Senator Gramm. When I am talking about economic growth, I 
am talking about job creation and real income of workers.
    Mr. Crowley. Let me just read a statement from the Wall 
Street Journal, in fact, which is not known to be a liberal 
newspaper. A quote from a January 17 article of this year, and 
I quote, the elimination of taxes on dividends will diminish 
the abilities of businesses to take tax incentives on capital 
investment in R&D, things that actually create jobs, and 
basically saying that, my interpretation of it, that this 
stimulus package will not, through the reduction of the double 
taxation of dividends, create new jobs. In fact, I was just 
handed an article from today's--I am sorry--the March 13 Wall 
Street Journal that says that four Senators, including two 
Senators from the Republican side, Senators Olympia Snowe and 
Senator George Voinovich of Ohio, will not support the 
President's tax cut proposal.
    Is the Wall Street Journal wrong? Are these Senators wrong 
as well?
    Senator Gramm. Let me tell you what would be right. What 
they are saying is that if you lower tax rates that the R&D tax 
credit is not as valuable. Well, why don't you make tax rates 
100 percent and then we could just grow the economy like 
``hello?'' The problem is that then people would not have 
anything to invest. It takes a good idea to limit--I must be 
getting old using words like ``hello''--but it takes a good 
idea to sort of an absurd limit. I have supported the R&D tax 
credit. I support the deductibility of mortgage interest rates. 
I support the tax exempt nature of municipal bonds. But the 
idea that making people pay more taxes helps the economy by 
making those deductions more valuable, I think is taking a good 
idea and just extending it to where it is illogical.
    I would say this, and I would ask you to look at it. In 
1981, we cut the marginal rate from the top rate from over 70 
percent down to the 50 percent range, and then ultimately we 
cut it in 1986 to 28 percent. I have never seen any evidence to 
substantiate that that had a negative effect on municipal 
financing or home ownership. The point is, there is an income 
and a substitution effect. When people had more money, it is 
true that the value of the deduction was less, but they had 
more money to spend and housing was something they wanted, and 
they spent more money on housing.
    So I think you can take a little point and stretch it to 
the limit, but I just do not see any economic foundation to any 
belief that elimination of the dual tax on dividends would do 
anything other than help the economy.
    Mr. Crowley. Let me just reclaim the time, and that is, I 
come from a city, New York, where we have lost almost 250,000 
jobs--about half are related prior to 9-11. So this is not all 
9-11-created; 500,000 jobs statewide. We have seen two million 
jobs lost throughout this country in the last over two years. I 
see very little in terms of immediate stimulation in this 
package--maybe long-term, but not immediate. It is not going to 
put people back to work.
    Let me just ask you this question, do you have--I know you 
are not in the political realm anymore--do you have any 
reservations or are you uncomfortable in any way at the timing 
of this tax proposal, given the fact that we are poised to be 
in war. There are 300,000 young men and women sacrificing their 
time away from family right now, many of whom will be asked to 
make the ultimate sacrifice in defense of this nation. Do you 
have any reservations or concern about the timing of the 
calling for this tax cut, that will affect in essence the 
wealthiest in this country?
    Senator Gramm. Let me try to give you a totally honest 
reaction to that. First of all, it is not as if we ought to be 
raising their taxes because they are going to sacrifice for 
America. I mean----
    Mr. Crowley. It is not their taxes I am talking about.
    Senator Gramm. I understand that. Let me just make this 
point. In 1991 when we had the Gulf War, I do not see, other 
than bringing down oil prices, which was a rich bounty to the 
economy of the 1990s, I just did not see any real economic 
impact coming from the war. If we did not have this lingering 
downturn, I do not think you could make a case for part of this 
economic growth package right now. I think you could make a 
case on dual taxation on dividends, but I think the rest of it 
you could not take a case for. But the fact that we are getting 
ready to have a war probably this week does not change the fact 
that we have got some real economic risk out there.
    If you read the testimony, you know I made the point that 
this recession is different than the ones we had in the 20th 
century. We do not totally understand it. There are a lot of 
uncertainties about it. I am confident that the economy is 
going to get better. If I did not think so, I would not have 
gone to work for an investment bank. I would have gone to work 
for a law firm where you can make money on people's misery.
    But I think there is reason to be cautious about the 
economy, is all I am saying. I think that I would be for it, 
given the fears I hear from people in New York who are talking 
about investing money, the fears they have got about the 
economy, I would be a little forward-leaning knowing what I 
know now if I were in public office, in trying to sort of put 
on a little insurance in terms of this recovery. I think it is 
going to be fine. I think the recovery is going to occur no 
matter what we do. I think we can speed it up, but there is 
enough that is new and different about it that I would just 
urge in thinking about it. It is obvious in listening to you 
that you are thinking about it and that you are looking at a 
lot of different things.
    I think there is a reason to be cautious about this 
downturn because it is so different than any other one we had 
in the 20th century; that we just do not know how it is going 
to behave. That makes me a little bit nervous.
    Chairwoman Kelly. Thank you.
    Mr. Murphy?
    Mr. Murphy. Thank you, Senator. I wonder if you could just 
continue that thought--it makes you a little bit nervous, how?
    Senator Gramm. Well, because, you know, we have had some 
speculative bubbles historically. We had the South Sea bubble. 
We had the tulip bubble. But they were in the 17th and 18th 
centuries. I do now know anything about them. If any economist 
has looked back at speculative bubbles and how they behave, I 
am not aware of it.
    So all I know is during my lifetime of awareness, the kinds 
of recessions we have had were things that I knew something 
about. They were inventory cycles. We could never predict them, 
but we knew how they behaved. If we were at this point in an 
inventory cycle, we would have a pretty great deal of certainty 
about what is going to happen.
    This is a different kind of downturn, subject to different 
kinds of behavior. While I would bet money that things are 
going to be all right, I still, if I were in your position, I 
would be cautious--the reason I would vote for the stimulus 
package, even if I had questions about dual taxation of 
dividends or even if I had questions about accelerating this 
tax cut, is because of the economic uncertainty. I think this 
economic growth package is a good plan overall in terms of 
economic effect. I think there is one other part of the 
President's package that is not part of this that is good, and 
that is that $15,000 IRA-type investment where you can invest 
up to $15,000 for a couple. You could put after-tax money in, 
but the buildup for college education, retirement, house, 
housing, buying your own home is tax-free. I think that is a 
good policy as well. But I just would be cautious given the 
uncertainties of this downturn we are in.
    Mr. Murphy. Thank you. You made a statement in your opening 
statement I would like you to also elaborate on this, if you 
would. This has to do with the impact upon small businesses, 
which you portrayed as the basis of really so many jobs in our 
economy. You said the elimination of double taxation of 
dividends will help small businesses that are currently 
discouraged by tax policy from adopting a corporate structure, 
even if it would allow them greater access to capital.
    Do you see that small businesses are willing to--this would 
give them that incentive to jump in and take some of those? 
Would it be more risk, less risk for them? I would like for you 
to comment.
    Senator Gramm. Currently, if I am running a company and we 
are beginning to grow, up to a point, I have an incentive to 
stay away from the full-fledged corporate structure because of 
the double taxation on dividends, because I can be taxed as an 
individual with a proprietorship or partnership or subchapter S 
corporation. Once I start growing, then I begin to get into a 
conflict between the improved access to capital I can get 
through full incorporation versus the tax advantages I get by 
staying a subchapter S or by staying a partnership or 
proprietorship.
    All I am saying is that no rational society would let the 
tax code dictate the structure of the business firm. It would 
let the market do that. That is one of the reasons why the dual 
taxation on dividends is such bad policy.
    Mr. Murphy. Thank you.
    I yield back the rest of my time.
    Chairwoman Kelly. Thank you.
    Mr. Garrett?
    Mr. Garrett. Thank you, and professor in light of the 
splendid introduction that you received, my first question I 
guess is are there any grades currently being held back that 
have not been delivered as of this date?
    Senator Gramm. Well, if Congressman Hensarling had had poor 
grades, I would think about going back and changing them. I do 
not know if after all these years that they would let me do it. 
In fact, I would say in all of my years as a college professor, 
I only changed one grade, and it ended up being for now a 
Democrat member of Congress. So they do not always work out.
    [Laughter.]
    Mr. Garrett. You made a statement in your introductory 
comments with regard to the history. I found that interesting 
as far as that we are in the speculative phase right now in the 
equity markets, and that may be part of the cause of where we 
find ourselves now, and how that differs from what over history 
it was like. Right now, I am reading a book about the history 
of going into the late 1920s into the Florida speculative 
housing boom, and how you had the ups and the downs and the 
little panicky phases at that time as well. So maybe we have 
had certain--and I am not as good on history as you are--but 
maybe we had certain little periods like this in the past that 
we could look to.
    Senator Gramm. The Great Depression was a financial panic, 
and I do not think Alan Greenspan would disagree with this, 
that in part because of bad government policy, became a full-
fledged depression. This is a different kind of downturn, this 
speculative bubble. I do not see any significant chance of it 
becoming worse in terms of becoming of depression proportions. 
It is just not recovering as quickly as we might recover that I 
think the whole debate is about.
    I do not think there is or should be any realistic debate 
about, is America going to recover; is investment in American 
equities the best investment you can make. I think the answer 
is yes. The question is, how quickly is it going to recover, 
and what could we do to speed it up. I think that is the 
debate.
    Mr. Garrett. Okay. And in that, you continue with your 
opening remarks with regard to how in this period of time, you 
have seen the consumption remain strong. So for that reason, 
you do not want to necessarily go down the road of the 
consumption-driven alternatives. And yet, a lot of the--I will 
not use the word ``rhetoric''--but a lot of the language that 
we hear as far as proponents, and from the proponents of the 
tax measure is that the average family of this size will 
receive around $1,000 or $1,100 back, and that is one of the 
strong reasons why we should be supporting it. Obviously, that 
$1,000 or $1,100--and I am a supporter of this, I just wonder 
how we pin this down--that $1,100 is not, I do not think, the 
same classification where you are talking about the 85 percent 
language later on and it is really going to the investment 
side. That $1,100--that is really going to the consumer, the 
consumption side, correct?
    Senator Gramm. Well, there are two different debates here. 
The one debate is the so-called equity debate. It is always 
skewed by the fact that half of Americans pay very, very little 
taxes in income taxes. So it is so easy to stand up and say 50 
percent of Americans will get 5 percent of the benefits. Well, 
50 percent of Americans pay about 5 percent of the taxes. So 
all you are saying in saying that is the tax code is 
progressive, and not saying--but it confuses people.
    The real debate is what gets the economy growing so people 
are making more income so they can pay taxes with it? I think 
that that is where we get pulled off the track into this debate 
about the distribution of the tax cut. The truth is, this 
economic growth package will make the tax code more progressive 
than it is. But the reason you ought to vote for it is it gives 
us a good chance of making the economy bigger than it is going 
to be over the next three years, so everybody will benefit. I 
do not think we ought to worry about somebody profiting by 
investing. I do not understand loving capitalism and hating 
capitalists. I do not understand this preoccupation that 
somebody might somewhere benefit by doing something productive. 
If we do not let people benefit, they will not do it.
    Mr. Garrett. I will just close, then, on this. I think that 
point you made just 30 seconds ago as far as the progressive 
nature of this tax cut is a message that I hear here, and I 
have heard with the Secretary of Commerce in the past, but it 
is a message that seems to be lost in the entire discussion and 
maybe goes back to that last point that you made before with 
regard to those who are attacking this plan never look at the 
spending side of the equation, and the fact that that is really 
a larger cause than the tax cut side of the equation.
    Thank you for your testimony.
    Senator Gramm. Just always remember this when you are 
debating this issue, that 19 percent of Americans when they are 
polled believe they are in the top 1 percent of income and 40 
percent believe they are in the top 5 percent of income. So 
when people are talking about the top 5 percent, 40 percent of 
Americans believe they are in the top 5 percent and they are 
voters. So I would never be afraid of this issue.
    Finally, as sort of a solicitous comment, if this were a 
society where people somehow were set forever in some kind of 
class based on economics, maybe all this silly argument would 
make sense. But I do not know each of your backgrounds, but I 
know Congressman Hensarling's background and his father was a 
chicken-raiser. My dad was a sergeant in the United States 
Army. Congressman Hensarling is a member of the United States 
Congress and grew up scooping chicken manure out of coops. My 
dad was a sergeant in the Army. I am an investment banker and a 
former United States Senator. This class warfare stuff in 
America is an absolute farce and joke. It is hard for me to see 
how people can say it with a straight face.
    That is the end of my sermon.
    Chairwoman Kelly. Thank you very much.
    Mr. Sherman, have you any questions for this witness?
    Mr. Sherman. I do indeed.
    Senator, rest assured I love capitalists. My father was 
executive vice President of a New York Stock Exchange-listed 
company, but I am frankly embarrassed by this class warfare 
attack against working families. Only in a room like this could 
we refer to this exemption of dividends as a progressive tax 
cut, when I can remind the subcommittee that you take all the 
benefit for 95 percent of Americans--all those with incomes of 
under $140,000--and it just barely equals the benefit to the 
top 2 percent; no, correction--the top .02 percent.
    We had the chair of the full committee sit here and say 
that Alan Greenspan endorses this proposal--I was here. He said 
he endorsed this proposal if it was revenue-neutral. Senator, 
other than dynamic storing and other drug-induced fantasies, I 
would like someone to tell us how this is a revenue-neutral 
proposal.
    We have concluded or are about to conclude the second 
panel. We have yet to hear from a witness who opposes this 
program or would oppose any give-away to the wealthiest. That 
is why Peter Fisher sat there in the same seat the Senator is 
and said he had not heard of anyone who supports the present 
system for taxing dividend income. You know, he could have sat 
here until now--he may have said that twice--taxing it twice? 
Taxing it twice. Well, he has not obviously listened to any 
Democrats and he could have sat here and listened to both the 
first full two panels and he would not have heard anybody. But 
there are many advocates of the present system--myself 
included--but I guess according to Peter, he had not heard my 
opening statement, although he was sitting there, or I am among 
the people that do not exist.
    This proposal went over on the markets like a thud. The 
President announced it; the markets did not go up. Why? Perhaps 
there is an understanding that this is going to hurt the 
economy, or perhaps just an understanding that it is going to 
hurt the economy, then it is going to hurt the Republican 
Party, then it is going to get repealed so you cannot count on 
it as a long-term fixture of American tax policy.
    The Senator pointed out to us that 40 percent of Americans 
think they are in the top 5 percent, which means the success of 
this proposal politically is based on Americans being off by a 
factor of seven. That may not last. You may invest in stocks 
today assuming that a political party that believes that this 
is a progressive tax proposal will remain in power. It is just 
possible that Americans will not continue to be ignorant of the 
fact that seven out of eight Americans who think they are in 
the top 5 percent are not.
    Now, if you can bet on continued ignorance of economic 
facts by the American people, then you can bet on this 
continuing to retain its level of popularity. But what I want 
to point out here is the interesting shell game. When you can 
lower taxes on the ultra-wealthy by saying that we need to 
favor investment over consumption, then you trot out that 
argument and justify a low rate on capital gain income, which 
spends just like regular income, except it spends more because 
it is not subject to the same tax.
    But when you want to lower taxes on the wealthy and give 70 
percent of the benefit to the top 5 percent, then you are 
neutral as to whether the money remains locked in the 
corporation available exclusively for business investment, or 
whether it gets distributed to those who may decide not to 
reinvest in other stocks, not to re-deploy the money into other 
investments, but buy that new $350,000 Mercedes. As a matter of 
fact, I do not think it is a mere coincidence that Mercedes 
comes out with a $350,000 car and then there is pressure to 
exempt dividends from taxation. If only Mercedes limited their 
cars to $100,000, it would place less political pressure on 
this House to come up with ways to make sure that the top one-
tenth of 1 percent can afford the latest imported toy.
    Chairwoman Kelly. Mr. Sherman, if you have a question, 
would you ask it please, because your time is up.
    Mr. Sherman. My time is up. The flaws of this proposal 
cannot be summarized in a mere five minutes.
    Thank you. I yield back. If the Senator wants to respond, 
he can----
    Chairwoman Kelly. Senator Gramm, if you would like to 
respond, please feel free to do that.
    Senator Gramm. We had a debate about luxury taxes and taxed 
yachts. I would have to say that I do not know how the Senator 
from Maine, the Democrat majority leader at the time voted on 
the yacht tax, but he discovered something. That is, people 
build those yachts and they make a good living at it. We came 
back and repealed the yacht tax. Now, I do not ever intend to 
own a yacht. I do not intend to own a Mercedes. But I just 
would say this, that the Joint Committee on Taxation and 
everybody with any degree of knowledge that has looked at the 
President's proposal concludes that it makes the system more 
progressive. I can tell you why.
    Accelerating the marriage penalty, accelerating the child 
exemption--those are costly benefits that go directly----
    Mr. Sherman. Senator, if I can just interrupt--all the 
benefits that go to working families out of this bill are 
temporary. They take something that would have happened two 
years from now and for two years the law is made more 
progressive. The dividend cut and the estate tax repeal are 
permanent, so the benefits that go to the wealthiest 1 percent 
continue to be true next decade, the decade after, the decade 
after that.
    Senator Gramm. The President's proposal is to make all the 
provisions permanent.
    Mr. Sherman. But some are going to be permanent anyway 
because that is existing law.
    Senator Gramm. Anyway, Madam Chairman, thank you very much 
for giving me the opportunity.
    Mr. Sherman. Thank you, Madam Chair.
    Chairwoman Kelly. Thank you very much, Senator. We are very 
pleased to have had you here on your maiden flight testifying 
before this committee here on the House side. I want to note 
that some of the members may have additional questions for you 
that they may wish to submit in writing. So without objection, 
this hearing will be held open for the next 30 days for members 
to submit those written questions.
    Senator, we once again thank you so much for your 
appearance here today. This panel is now excused.
    I want to introduce the third panel as they are seated. 
First, we will welcome our former colleague in the House on the 
Banking Committee, the Honorable Rick Lazio, a proud New Yorker 
and now the President and CEO of the Financial Services Forum; 
John Castellani, President of the Business Roundtable; Peter 
Orszag, Joseph A. Peckman Senior Fellow in Economic Studies at 
the Brookings Institution; Stephen Moore, Senior Fellow in 
economics at the CATO Institute and President of the Club for 
Growth; William Spriggs, Executive Director of the National 
Urban League Institute for Opportunity and Equality; and 
finally, Bobby Rayburn, First Vice President of the National 
Association of Home Builders.
    I want to thank you gentlemen for testifying before us 
today and I welcome you on behalf of the full committee. Mr. 
Lazio, it certainly is a pleasure to have you back with the 
committee again. Without objection, your written statements for 
all of you will be made part of the record. You will have five 
minutes for your oral testimony, and we will begin with you, 
Mr. Lazio.

  STATEMENT OF HON. RICK LAZIO, PRESIDENT AND CEO, FINANCIAL 
                         SERVICES FORUM

    Mr. Lazio. Thank you, Madam Chair. It is wonderful to be 
back and to see you again, Madam Chair, and my other 
colleagues. I appreciate very much the opportunity to be here 
and to share this table with some distinguished speakers. I 
hope I can shed some light on our feelings on behalf of the 
Financial Services Forum on the proposal as it particularly 
relates to the exclusion of dividend income.
    The Financial Services Forum which I have the pleasure of 
being the chief executive officer of, is composed of the chief 
executive officers of some of the largest and most diversified 
financial institutions in the United States. The purpose of the 
forum is to promote policies and enhance savings and investment 
in the United States and that ensure an open, competitive and 
sound financial services marketplace that contributes to the 
long-term growth of the American economy.
    We believe that ending the double taxation of dividends 
will benefit investors, strengthen the capital markets, and 
improve our prospects for long-term growth. The measure will 
stimulate the economy in the short term. However, we strongly 
believe that longer-term positive consequences are most 
important.
    The most obvious benefit to ending the double taxation of 
dividends, which has been referred to earlier, is the promotion 
of a steady dividend payment to investors. Within normal ranges 
of share prices and business performances, individual investors 
receive cash in hand with reasonable certainty, and immediate 
ongoing return on shareholding. This flow of funds enhances the 
lives of American families, retirees and other individuals in 
our society. Currently, many shareholders receive the benefit 
of stock ownership only when they sell their stock. Clearly, it 
is desirable to increase investor benefits in a manner that 
does not require stock sales to achieve. Ending the double 
taxation on dividends also gives the average investor a simple 
basis on which to evaluate equities--the value of the dividend.
    Double taxation of dividends results in the inefficient 
allocation of our nation's resources. Companies are penalized 
for returning funds to shareholders. Under current law, 
businesses are incented to reinvest earnings, which often could 
be put to better use elsewhere. Eliminating these perverse 
incentives leads to a more efficient capital market and a far 
more productive economy. Further, this measure would make 
American firms more competitive in the international arena by 
lowering overall the cost of capital.
    It has been clear for some time, Madam Chair, that double 
taxation has created a bias in favor of debt, as opposed to 
equity capital because of the deductibility of interest 
payments. We have seen over and over again that excessive 
levels of debt become problematic during an economic downturn. 
Firms with too much leverage do not have sufficient flexibility 
to cope with adverse market conditions, to the detriment of 
their shareholders. Eliminating the double taxation of 
dividends removes the bias toward corporate debt, encouraging 
more equity in capital structures, which allows firms to 
weather adversity and protect investors in difficult times.
    Double taxation encourages corporations to engage in share 
repurchases because current law permits the distribution of 
earnings in this manner at lower capital gains rates. 
Investors, however, do not realize the cash benefit of the 
share repurchase until they sell their stock. Eliminating the 
double taxation of dividends makes it more likely that 
shareholders will receive higher dividends and realize 
corporate gains without having to sell their stock.
    Because the tax code discourages payment of dividends, 
publicly traded companies often are focused on goals that can 
become problematic. Under present circumstances, shareholder 
value tends to be equated with an appreciation of stock price 
by many firms. Regrettably, we have also observed too many 
companies resorting to accounting manipulation to inflate 
earnings and stimulate stock price appreciation. Correcting 
this bias against dividends will cause both firms and their 
investors to emphasize cash flow and cash dividends as true and 
more appropriate measures of true value.
    In summary, Madam Chair, removing the double taxation of 
dividends results in significant benefits to individual 
Americans and American families. The measure will restore 
balance to the manner in which publicly traded firms are 
managed by removing incentives to issue excess debt, repurchase 
shares, invest retained earnings in sub-optimal investments, 
and designing unproductive strategies just to avoid taxes and 
inflate earnings.
    We believe that eliminating the double taxation of 
dividends will cause firms to focus on creating true value for 
shareholders and other stakeholders. Share prices of dividend-
paying stocks tend to be less volatile, and thus are a 
stabilizing force in the capital markets and that certainly has 
been the case over the last few years, and that is empirically 
provable. Eliminating the dividend tax will contribute in a 
major way to restoring and increasing confidence in our markets 
and contribute to long-term productive growth in the economy.
    Finally, this proposed change would correct the fundamental 
lack of fairness in the tax code by ending the bias against 
equity capital and dividends, and increasing the 
competitiveness of United States firms.
    Thank you, Madam Chair.
    [The prepared statement of Hon. Rick Lazio can be found on 
page XX in the appendix.]
    Chairwoman Kelly. Thank you, Mr. Lazio.
    Mr. Castellani?

   STATEMENT OF JOHN J. CASTELLANI, PRESIDENT, THE BUSINESS 
                           ROUNDTABLE

    Mr. Castellani. Thank you, Madam Chair.
    I am pleased to be here this afternoon on behalf of the 
chief executive officers who make up the Business Roundtable. 
The Business Roundtable is an association of CEOs of major 
corporations that have a combined workforce of 10 million 
employees in the United States and $3.7 trillion of annual 
revenues. Although we are in the business of creating jobs and 
contributing to economic growth, we have serious concerns about 
our ability to do so in these times with a fragile economic 
environment.
    The chief executive officers of the Business Roundtable 
feel that the U.S. economy is not growing to its potential. 
Consumer demand and consumer confidence are shaky. The 
confluence of our nation's war on terrorism, the potential war 
with Iraq, and the decline in stock prices have resulted in 
diminished assets and savings and have led to consumer 
retrenchment. Our CEOs feel that business investment will only 
return when there is sufficient consumer demand to exhaust the 
existing capacity in the U.S. economy. Only by increasing 
demand will we return to a level that supports investment and 
more importantly supports job growth.
    We feel we need to ignite consumer confidence and stimulate 
consumer spending, and that is why we are urging the enactment 
of President Bush's economic growth and jobs package as 
reflected in H.R. 2. If enacted, we believe that it will 
significantly stimulate the economy in the short term, as well 
as boost long-term economic growth. PricewaterhouseCoopers 
recently conducted a study for us using a widely supported 
macroeconomic model that is housed at the University of 
Maryland. The study showed that if H.R. 2 was enacted this year 
by July 1, it would create an average of 1.8 million jobs in 
each of the next two years and an average of 1.2 million jobs 
per year in the next five years. It would boost gross domestic 
product in the U.S. economy by 2.4 percent by the end of 2004.
    The plan would boost incomes and jobs and help all sectors 
of the economy, including housing and capital markets. Working 
consumers will have more money to spend and more confidence to 
spend it on goods and services. By accelerating the 2001-
enacted rate cuts, the marriage penalty reduction and the child 
tax credit increase and by eliminating the double taxation of 
dividends, the proposal will not only provide immediate boost 
to the U.S. economy, it will also add millions of jobs and 
again increase confidence and economic growth.
    As importantly, the single element of eliminating the 
double taxation of dividends will have the most positive impact 
on long-term economic growth. That provision alone will create 
by the model's projections 500,000 jobs per year for the next 
five years. It will also have an additional number of important 
and multiplying effects. First, it will spur consumer spending 
by increasing the after-tax income of stock investors. 
Shareholders will benefit because they will no longer bear the 
unfair burden of paying taxes twice on the same income, and 
they will benefit again when companies boost their dividend 
payments. By our estimates, we would expect a 4 percentage 
point increase in dividend payout ratios over the next 10 
years.
    Second, eliminating the double taxation of dividends will 
improve corporate governance in a number of ways. Companies 
will have less incentive to engage in structured financing 
transactions that have little or nor business purpose. We can 
expect better transparency in the reporting of corporate 
earnings because investors will reward companies that pay tax-
free dividends. And companies will be less likely to take on 
excessive debt and risk bankruptcy in pursuit of lower taxes.
    Third, while it is difficult to predict stock market 
reaction, even the most conservative analysts predict increases 
in stock prices. All three combined will not only benefit the 
broad spectrum of the economy that receives dividends, 
particularly those people who depend on them in their 
retirement, but it will also benefit all of those funds which 
are invested in equities, including 401(k)s, IRAs, and public 
and private pension funds.
    The positive effect on stock prices that would arise from 
the elimination of the double taxation of dividends would, for 
example, translate into a potential increase of $4,200 per 
401(k) participant and $110 billion in the aggregate of all 
401(k) plans. On the defined benefit side, millions of 
Americans would see substantial improvement in their retirement 
security and companies would have additional operating capacity 
to invest, resulting in more profits and increased stock 
prices.
    The Roundtable urges the Congress to move quickly to enact 
an economic growth plan that will give both an immediate boost 
to the economy and put people back to work. The President's 
plan is the best means for creating jobs, encouraging business 
investment, strengthening the capital markets, enhancing 
corporate governance and igniting economic growth. It is the 
right prescription for an ailing economy.
    Thank you.
    [The prepared statement of John J. Castellani can be found 
on page XX in the appendix.]
    Chairwoman Kelly. Thank you, Mr. Castellani.
    Mr. Orszag?

 STATEMENT OF PETER ORSZAG, JOSEPH A. PECHMAN SENIOR FELLOW IN 
          ECONOMIC STUDIES, THE BROOKINGS INSTITUTION

    Mr. Orszag. Thank you, Madam Chairwoman.
    I would like to make five points in my five minutes, so if 
I stick to one point per minute, I should be fine.
    The first point is that the administration's tax proposals 
will exacerbate the long-term budget outlook. We have heard a 
lot about the effect of the proposals on the deficit, but let's 
just look at CBO's numbers in 2013. This is after any temporary 
downturn would presumably be over, when the economy is at full 
employment, and as Senator Gramm said, in that kind of setting 
he would be reconsidering the forms of various tax provisions. 
At that point, the tax cut that the administration is proposing 
would amount to 1.8 percent of GDP, and the cost would increase 
thereafter because many of the provisions are so back-loaded 
that their full cost is not apparent even in 2013.
    If you look out over the next 75 years, the tax cuts the 
administration is proposing would amount to 2.3 percent to 2.7 
percent of GDP. That may sound abstract, but just to put that 
in context, the Social Security deficit over the next 75 
percent is 0.7 percent of GDP, so these tax cuts are more than 
three times as large as the entire Social Security deficit over 
the next 75 years.
    The Medicare part A deficit is 1.1 percent of GDP, so even 
if you add Social Security and Medicare part A, that is 1.8 
percent, that is still smaller than the size of these tax cuts. 
So these are large.
    The Committee for Economic Development, a leading business 
organization, has put it in common sense terms. The first step 
in climbing out of a hole is to stop digging. We already face 
very large long-term deficits because of the retirement of the 
baby boomers. We do not need to make them worse. Second, on the 
economic effects, the long-term economic effects of the 
proposal, it is very important to remember that these are not 
revenue-neutral proposals. If it were a revenue-neutral 
proposal it would be a very different ballgame. Because it is 
not revenue-neutral and because it does expand the budget 
deficit, there is a positive effect from the improved 
allocation of capital across sectors, but a negative effect 
because of the increased budget deficit which reduces national 
savings, which is the flow of financing for investment. You 
have to weigh the two effects against each other. You cannot 
just look at the positive effect.
    An organization that did that, Macroeconomic Advisers, 
whose model by the way is the one that is used by the Council 
of Economic Advisers to produce its own numbers--in other 
words, it is the model used by the administration--has found 
that the negative effects from reduced national savings because 
of those larger budget deficits will outweigh any positive 
effects from the improved allocation of capital across sectors, 
so the long-term impact from the proposal is negative.
    I understand that the Business Roundtable model shows 
somewhat different results than Macroeconomic Advisers. In my 
opinion, although the details are a bit sketchy in terms of 
exactly what that model is or how it was applied, I think it 
was mis-applied for this purpose, and I would be happy to 
answer questions about that.
    The third point is on the distributional effects. We have 
heard a lot about the average tax cut. I think it is very 
important to remember that averages can be quite misleading. 
The average of my one-year-old son and Senator Gramm is a 30-
year-old who is about four-feet tall. That is not particularly 
insightful. Instead, you have to look at the distribution of 
people. When you do that, you see that half of tax filers would 
get a tax cut of $100 or less; two-thirds of tax filers would 
get a tax cut of $500 or less; and 78 percent of tax filers 
would get a tax cut of $1,000 or less.
    Similarly for the elderly, and here I think it is very 
important. We cannot just look at the number of elderly who 
benefit, because if an elderly couple had a penny in stocks and 
received a penny in dividends, they would be counted as 
receiving dividends. You have to look at the amounts that are 
involved. When you do that, what you see is that two-thirds of 
the elderly would get $500 or less from the administration's 
growth package, and for the dividend proposal alone, the two-
thirds of the elderly who have incomes below $50,000 in income 
would receive just 4 percent of the total tax cut. It is only 
when you throw in the elderly who have very high incomes that 
you start to get those numbers up.
    Fourth point, small businesses--58 percent of tax returns 
with small business income are in the 15 percent or lower tax 
bracket. Senator Gramm talked a lot about the top tax bracket. 
Only 2.3 percent of small business tax returns are in the top 
tax bracket. So most small businesses are not facing that 38.6 
percent rate. Furthermore, more than half of those 2.3 percent 
have a very small share of their income coming from small 
business income. They are not really small businesses in any 
meaningful sense.
    Finally, on corporate tax reform, I think it is very 
important to realize again this proposal is not revenue-
neutral. What that means is that as Chairman Greenspan has 
emphasized, if you did it as a revenue-neutral proposal, there 
is just that unambiguous positive effect, rather than the 
positive effect and the negative effect from the expanded 
budget deficits. From a political economy perspective, you are 
basically giving away the candy with this proposal. If you 
think that corporate tax reform is going to involve both 
spinach and dessert--the spinach of closing down corporate tax 
loopholes and the dessert of giving away some tax preferences, 
you want to combine them in a single package to make the 
package as a whole politically viable.
    What this proposal does is gives away the dessert without 
forcing corporations or the tax code as a whole to eat the 
equivalent of the spinach. It thereby undermines any chance of 
getting real corporate tax reform.
    Thank you.
    [The prepared statement of Peter Orszag can be found on 
page XX in the appendix.]
    Chairwoman Kelly. Thank you.
    Mr. Moore?

     STATEMENT OF STEPHEN MOORE, PRESIDENT, CLUB FOR GROWTH

    Mr. Moore. Thank you.
    I support the President's tax plan. I wish it were bigger, 
but I think it is a good tax plan. I would like it to include a 
capital gains cut, although there is a capital gains reduction, 
in that we should cut the capital gains rate to 15 percent. 
Every time we have cut the capital gains tax for the last 40 
years, we have gotten more revenues, not less.
    We also ought to do what Senator Gramm talked about and 
President Bush is talking about, which is the expansion of the 
IRAs. That would have a dramatic impact on increasing the 
investment and savings rate in this country. I thought I would 
just spend a couple of minutes just talking about some of the 
points that were made in earlier testimony and some of the 
questions, and try to clear up some of the points.
    First was the effect on the budget deficit. I hope that the 
Congress will focus on the most important deficit that we have 
right now, which is not the budget deficit, it is the growth 
deficit. The budget deficit that we are facing right now is a 
ramification of the growth deficit that we face. We have gone 
from 3 to 4 percent real economic growth rate in the late 1990s 
to closer to 1 to 2 percent right now. That accounts mostly for 
the increase in the budget deficit that we have seen. So the 
Bush tax cut, if it increases growth, which I think it will, 
can have a very dramatic impact on reducing the growth deficit, 
and thereby the budget deficit.
    Just to punctuate that point, if we could grow the economy 
just by 1 percentage point faster than is currently projected, 
that will erase about $1.5 trillion of deficits over the next 
10 years. So increasing growth can have a very substantial 
impact on the deficit.
    Second of all, it was brought up several times about the 
impact of this tax cut on States and localities. I must say I 
am absolutely baffled about how anyone can make the argument 
that cutting taxes by $750 billion over the next 10 years could 
possibly hurt State and city governments. We are talking about 
taking money out of Washington and putting into the pocketbooks 
of state and local taxpayers, where it never comes to 
Washington in the first place. That can only have a very 
salutary and healthy effect on states and localities. Of 
course, the best example of that is when we did the Reagan tax 
cut, which was about three times larger than this tax cut. It 
led to the most prosperous period in state and local finance in 
history. Senator Gramm touched on that as well.
    A third point that was made was that now is not the time--
that we are on the eve of war and that a time of war, should we 
really be cutting taxes. I would say again the best example of 
how a tax cut can actually help us win this war is what 
happened in the early 1980s with the Reagan tax cut, where 
basically President Reagan said we are going to do two things. 
We are going to have a massive increase in defense buildup to 
win the Cold War, and we are going to cut taxes. I think the 
evidence is now very clear that the tax cuts helped generate 
the economic growth that led to the victory in the Cold War. In 
fact, the Soviets now say that the reason that we won the Cold 
War was because of the superiority of our economy, and not just 
our military.
    Fourth and final point is about the revenue loss. I think 
this is such an important point to make because everybody is 
throwing around all these numbers about what the tax cut is 
going to cost. I would just urge you all to think about the 
fact that every time we have cut taxes over the last 40 years, 
we have always--always, 100 percent of the time--we have always 
overestimated how much revenues we are going to lose from the 
tax cut, in every single case. That was true when Kennedy cut 
taxes in the 1960s. It was true in the 1980s when Reagan cut 
taxes.
    The starkest example and the most recent example was what 
happened in 1997 when we cut the capital gains tax. If you look 
at the official revenue estimates that came out of this 
institution, the Joint Tax Committee, they estimated, Madam 
Chairwoman, that we were going to lose $50 billion over the 
next five years if we cut the capital gains tax. In fact what 
happened is we gained $100 billion in revenue. So oftentimes 
when we look at these static-based revenue estimates, they tend 
to be very wrong. We ought to move towards a more dynamic 
estimation model that takes into effect the economic growth 
consequences of tax cuts. So I would urge you to pass the Bush 
tax cut, grow it, and do it as fast as possible.
    [The prepared statement of Stephen Moore can be found on 
page XX in the appendix.]
    Chairwoman Kelly. Thank you, Mr. Moore.
    Dr. Spriggs?

 STATEMENT OF WILLIAM E. SPRIGGS, EXECUTIVE DIRECTOR, NATIONAL 
      URBAN LEAGUE INSTITUTE FOR OPPORTUNITY AND EQUALITY

    Mr. Spriggs. I am going to try and behave, Madam 
Chairwoman, because Steve just finished in under five minutes, 
so I am going to try and do the same thing.
    Chairwoman Kelly. I appreciate that.
    Mr. Spriggs. I want to thank you for allowing me to 
testify. I do appreciate that this panel does have a diversity 
of views, and thank you very much for the diversity reflected 
here.
    I represent the National Urban League, which is the 
nation's oldest and largest community-based organization 
dedicated to moving African Americans into the economic and 
social mainstream. We are very happy that the President and the 
Congress recognize that the economy is in a slump. However, we 
are very concerned about the consequences of some of these 
proposed fiscal policy changes and their unintended 
consequences as well.
    The President has proposed excluding dividend income from 
the taxes of individual taxpayers. Now, as currently 
constructed, the proposal would allow for the tax 
redistribution of corporate earnings on which the corporation 
has paid taxes. This, then, sets up actually our dichotomy, 
because there is going to be a different interest in terms of 
those who are institutional investors for whom the tax does not 
mean anything anyway, and the corporate directors and officers, 
who will be making the decision, for whom the tax does mean 
something. So we will have a difference between the motivation 
of officers and directors, between do they maximize shareholder 
after-tax income, or do they maximize the corporation's after-
tax income? Those two lead to, I think, not ending the type of 
uneasiness that investors have as to what our corporate 
leaders' motivations, since there would still be this conflict 
in what is to be done.
    Now, one of those key areas in which there are differences 
between what the corporation has in terms of tax liability 
results from acts of Congress to help encourage certain types 
of investment by corporations which benefit low-income 
communities in part, and the Secretary of Treasury talked about 
other loopholes for corporations as well, but I think that some 
of these are very well thought out items. They include such 
things as the low-income housing tax credit, the tax credit for 
the rehabilitation of historic structures, and the empowerment 
zone tax incentive, the renewal community tax incentives, the 
new market tax credits, tax credits for employee-provided child 
care, tax credits for holders of qualified zone academy bonds--
all of these things help low-income neighborhoods.
    I think that it is misleading, as we have heard before, to 
argue that the relative marginal tax difference for 
shareholders leads to corporations making decisions about 
whether they will use equity financing or whether they will use 
debt finance, then to argue that the change in the relative tax 
rates has nothing to do with whether businesses would decide to 
take advantage of these tax credits. Either the relative 
marginal tax rates matter and do something, or they do not 
matter.
    Now, if we live in a world where we are going to be 
consistent and we are going to say that these marginal tax 
rates do matter, then there will be negative impacts on these 
programs. Does that mean that they are going to be eviscerated? 
No, but it means that their costs will be increased. I think it 
does mean that we have to think about what are the collateral 
costs of ending the dividend tax.
    The low-income housing tax credit I am going to mention a 
little bit more because of its size. That is $15.1 billion over 
the next four years in terms of tax expenditures. So by 
comparison to the other ones, this is huge. Then also if you 
look at it relative to where does the money come from for low-
income housing tax credits, almost all of the money comes from 
corporations taking advantage of this tax credit. Then you look 
at what does it mean for the low-income housing tax market--the 
development of units--and it has a huge impact. Most of the 
growth has been attributable to that tax credit.
    Now, there has been much said about no one would 
ideologically be opposed to double taxation. Corporations are 
legal entities unto themselves. The assurance that an investor 
has is that the corporate officers ought to look after the 
health of that individual, that corporation. The income from a 
corporation therefore is not like the income from a 
partnership. The liability implications are very different 
between a partnership and a sole proprietorship. So this is not 
double taxation.
    In any event, even if one bought the idea that there was 
double taxation, there is no reason to buy into the idea that 
what we should do is end the tax on the individual as opposed 
to treating the dividend as an expenditure in the same way that 
we treat wages. So I do not think that ideologically the 
argument is there.
    Finally, as to cost, I think we raise the issue of cost 
because over the projected life of this budget, the 10-year 
period, this is going to cost $388 billion. That is more money 
than we are going to spend on the U.S. Department of Education 
for at least four years. That is more money than we are going 
to spend on the Department of Labor and Small Business 
combined. So it is the issue of priorities. Where could that 
money best be spent? If we try to solve the problem for these 
many tax credits, which are important to low-income 
neighborhoods, and increase the cost of this, isn't there a 
more effective way of achieving some of these same ends?
    So I would hope that you would think seriously about the 
size, the magnitude of this proposal, as well as its collateral 
cost.
    [The prepared statement of William E. Spriggs can be found 
on page XX in the appendix.]
    Chairwoman Kelly. Thank you, Dr. Spriggs. Although you did 
not make it to your goal on timing, I appreciate your 
testimony.
    Mr. Rayburn?

  STATEMENT OF BOBBY RAYBURN, FIRST VICE PRESIDENT, NATIONAL 
                  ASSOCIATION OF HOMEBUILDERS

    Mr. Rayburn. Thank you, Madam Chairwoman, for the 
opportunity to testify today on the impacts of the President's 
economic growth package. My name is Bobby Rayburn and I am a 
homebuilder and developer from Jackson, Mississippi. I am also 
the First Vice President of the National Association of Home 
Builders, which I am here today to represent.
    First, I want to say that NAHB supports President Bush and 
the Congress in their efforts to achieve an economic stimulus 
package that will provide near-term stimulus to consumer 
spending and capital investment, including more housing 
consumption and production. We were disappointed that the 
stimulus package did not contain a housing component, 
specifically the proposed homeownership tax credit. This 
proposal has bipartisan support in the Congress and has been 
part of the administration's budget for the previous three 
years.
    The primary focus of my testimony today is on the impact of 
the administration's proposal to eliminate the double taxation 
on corporate earnings on the low-income tax credit program. The 
distribution of a dividend from tax corporate earnings to a 
shareholder, who then pays tax on the dividend, is double 
taxation of the corporate earnings. One of the ways 
corporations reduce the impact of the double taxation and 
increase corporate earnings is to buy low-income housing tax 
credits. Unfortunately, the dividend exclusion proposal reduces 
the value of tax credits like the low-income tax credit. The 
value of tax credits is reduced compared to today's value of 
tax credits, because corporate earnings that are exempted from 
tax by the credit are taxable to the shareholder and will not 
increase the cost basis of the shareholder's stock when the 
corporation retains the earnings.
    Affordable housing uses a variety of financing sources, 
including the low-income housing tax credit, home funds, 
Federal Home Loan Bank affordable housing program, and revenue 
bonds. These projects operate on very narrow margins. States 
try to serve the lowest income tenants possible and locate 
affordable properties in areas where development frequently is 
difficult, such as rural and inner-city areas. Even a modest 
change in the value of the credit and the resulting reduction 
in the amount of equity the credit can generate will have 
adverse consequences to the low-income housing program.
    Two studies have been published that analyze the impact of 
the administration's dividend proposal on the low-income 
housing tax credit program. The first study prepared by Ernst 
and Young predicted that there would be a reduction of 40,000 
low-income housing tax credit units per year, which is a 35 
percent reduction from the current level of 115,000 units. The 
Mortgage Bankers Association published a second study that 
predicted the dividend proposal would actually benefit the 
production of low-income housing tax credits and have virtually 
no negative effects at all. We are still reviewing this 
particular study.
    It is our view that the Ernst and Young study overstates 
the impact of the credit. The emphasis on units produced fails 
to reflect the full range of the impact on the dividend 
proposal on the operation of the low-income housing tax credit 
program. NAHB estimates that a more realistic decline in the 
value of the credit is from 10 to 15 percent, rather than 21 
percent. We also believe that there will be significant 
revisions in state priorities for the low-income housing tax 
credit programs. Tenants at the upper end of the eligible 
income will be sought, and fewer properties will be built, 
particularly in hard to develop areas.
    There are several approaches that could be used to protect 
the credit. The first approach would be to exempt the low-
income housing tax credit from the dividend proposal. This can 
be done within the structure of the administration's proposal 
by treating earnings corresponding to the low-income housing 
tax credit as taxed earnings. Other solutions would be to 
exempt all or part of the dividends received by the 
shareholders from the tax and by providing the corporation with 
a deduction for dividends paid.
    The other approach to protecting the low-income housing tax 
credit would be to make up for any adverse impact on the 
program by expanding availability and the market for the 
credit. The first step in this approach would be to eliminate 
restrictions on the individual's passive loss reductions and to 
provide them with exemption from alternative minimum tax. Since 
the individual market for the credits is not as efficient as 
the corporate market, the amount of the credit that can be sold 
to raise equity, as well as the amount of the credits that can 
be dedicated to individual properties would need to be 
increased.
    Madam Chairwoman, that concludes my remarks. NAHB looks 
forward to continuing to work with you, the members of your 
committee, the Ways and Means Committee, and the Treasury 
Department to keep the low-income housing tax credit program 
operating at today's levels well into the future.
    Thank you.
    [The prepared statement of Bobby Rayburn can be found on 
page XX in the appendix.]
    Chairwoman Kelly. Thank you, Mr. Rayburn.
    Mr. Castellani, I have a question for you. You cited the 
Joint Committee on Taxation report for ending the double 
taxation of dividends. The Business Roundtable was among the 
first groups to encourage new measures for honest corporate 
governance last year. I wonder if you could quickly elaborate 
on the link between the double taxation of dividends and the 
use of the Enron-style accounting gimmicks that I spoke about 
in my opening statement.
    Mr. Castellani. I would be delighted to. As you know, we 
have been, particularly with this committee's leadership, 
working on trying to restore the confidence of the American 
investor in our system of corporate governance. I think the 
Sarbanes-Oxley Act has gone a long way in doing so. Part of the 
issue, which has been alluded to and discussed by several of 
the folks who have been testifying here, has been what the 
impact of the double taxation of dividends has been on 
corporate behavior.
    Since the tax code as it currently exists benefits debt 
financing over using equity to raise funds, stocks have not 
been valued as in the past, based upon their future dividends. 
When dividends are not paid, investors have to value stocks 
based on a corporation's earnings statement, which in the case 
of Enron could have been manipulated or can be manipulated to 
make a company appear to be more profitable on paper than it is 
in reality.
    In addition to removing this incentive to cook the books, 
which I guess, was the case with Enron, eliminating the double 
taxation of dividends will put more money in the hands of 
individuals because shareholders at all levels will demand 
that, and it will give an incentive to those companies that do 
pay dividends. So again, cash will be paid out; cash will 
become a premium; cash flow will become a premium; corporations 
that pay dividends will be rewarded, and the kind of paper 
manipulation that we saw in the Enron case will be further 
inhibited because shareholders will be looking for true cash 
flow.
    Chairwoman Kelly. Thank you.
    Mr. Lazio, I wonder if you would discuss how States like 
New York, Texas, Florida will benefit from this tax plan?
    Mr. Lazio. I would be happy to, Madam Chair. As you know, 
because I know you spend a lot of time with the people of the 
New York City prudential marketplace getting to know how those 
markets work and understanding what the problems and concerns 
are in the banking and securities market and the insurance 
industry, this is going to have a very significant impact on 
the employment base in the New York metropolitan area and the 
tax base. In New York alone, it is estimated that just the 
dividend exclusion would return about $2 billion in the first 
year. I think Texas is about $1.6 or $1.7 billion. I can get 
that exact number--and Florida is about $1.4 billion. So very 
significant returns to those states just on this one element of 
dividend exclusion.
    It is not difficult to see why, for two reasons. First of 
all, it obviously has the immediate impact of providing higher 
after-tax income for those individuals that depend on dividend 
income. That is skewed to, frankly, older Americans who benefit 
disproportionately on this initiative. The second, longer-term, 
and in my opinion more important reason is that it does overall 
strengthen corporate management, that it provides superior 
financing for expansion, for acquisitions. That, in turn, leads 
to jobs, higher income and more tax revenue.
    The real question, it seems to me, is between immediate 
consumption today and lowering taxes so that we can get higher 
growth numbers later. It is very difficult to see how we are 
going to create the kinds of jobs that Americans are calling 
for in the shorter, intermediate run unless we get on a higher 
growth path. We are not going to do that at 1.5 or 2 percent.
    Chairwoman Kelly. Thank you.
    Mr. Orszag and Mr. Moore, I have seen the two of you 
before, talking with each other about the various economic 
issues. I am going to fire this question to the two of you and 
let you answer it. I want to know what the record of the 
impacts on economic growth--now, you both presented two 
different views here--the impacts on economic growth and on 
federal revenues from the cuts in taxes on savings and 
investment, specifically the 1997 capital gains tax cut. By the 
way, Mr. Moore, I ran on my maiden flight for Congress was to 
zero the capital gains tax, so I am right there with you on 
that.
    I would like to know--the 1997 capital gains tax cut, the 
1981 Reagan tax cut, and the Kennedy tax cut in the early 
1960s. Mr. Orszag, let's go with you first.
    Mr. Orszag. Okay. You want to know what the impact was on 
the economy of those proposals?
    Chairwoman Kelly. Yes.
    Mr. Orszag. First, with regard to the 1997 capital gains 
reduction, I think it is very difficult to interpret the data, 
given that that was occurring in the midst of a stock market 
boom. Some may argue that the capital gains tax reductions is 
what caused the stock boom--which is what Mr. Moore will argue. 
But the stock market boom was occurring before that capital 
gains reduction, and if the capital gains tax reduction caused 
the boom, then it led to the bubble that everyone is 
complaining about now. So there is sort of an inconsistency 
there. But I think it is difficult to interpret because we were 
in the midst of such a strong stock market performance at the 
time, so there is a natural upswing in capital gains from year 
to year as the stock market continued to increase, which could 
outweigh the effect from a reduced rate.
    With regard to the early 1980s tax cuts, there is an 
ongoing debate about what the effect was. A couple of things 
are relevant. First, it is important to realize that we 
reversed about a third of the tax cut in 1982. So in 1981 we 
cut taxes; in 1982 we came back with TEFRA and reversed about a 
third of the tax cut that remained in place because of concerns 
about the long-term deficit. That is in marked contrast to what 
appears to be occurring now, when circumstances have changed, 
but we are not trying to reverse course to take that into 
account.
    Secondly, there is a lot of movement between personal 
income and small business income that makes it difficult to 
interpret the data. Some people have looked at what happens to 
personal income returns following a reduction in personal 
income tax rates. What you see is a significant amount of 
shifting from income from small businesses onto personal tax 
returns, which does not necessarily correspond to any change in 
the underlying economy.
    The bottom line is I think it is a very difficult question. 
I think people who give an unambiguous answer that is either 
unambiguously positive or unambiguously negative are probably 
oversimplifying the situation. There is an ongoing academic 
debate about it.
    Chairwoman Kelly. Thank you.
    Mr. Moore?
    Mr. Moore. We have a much better tax system today than we 
did 20 years ago. I do not think there is any question about 
that. When I first arrived in this town, we had a 70 percent 
top marginal tax rate; you could get tax deductions for 
investing in windmills and bull sperm and all sorts of things. 
I think the two Acts that we did in the 1980s were very 
positive--the 1981 Act which cut the top rate from 70 to 50 
percent, and all the rates, by the way, and indexed for 
inflation.
    And then, I am a big believer in what we did in 1986. I 
know there is some disagreement about that, but we brought the 
top rate down from 50 to 28 percent. The reason I mention that 
is that I do not think there is any question that nobody wants 
to go back to 70 percent rates. In fact, when you cut the rate 
from 70 to 50 percent, you are going to have an extremely 
strong supply side effect. You are not going to get the same 
kind of supply side growth effect when you got from 39 to 35 
percent that we did when we went from--well, when Kennedy went 
from 91 to 70 percent, and then Reagan went from 70 to 50 
percent. So we should not oversell the supply side effects from 
cutting these rates by a few percentage points.
    I guess my advice to you, Madam Chairwoman, is we ought to 
move toward the promised land in tax policy, and that is a flat 
tax type of regime where you have a single rate, where you are 
taxing consumption, you are taxing income only once, but once, 
with as little leakage as possible. The thing that I like about 
the President's approach to tax policy is if you look at what 
he has done over the last two or three years on tax policy, he 
has basically said we are going to get rid of the death tax, 
which is a double tax on savings; we are going to get rid of 
the dividend tax, which is a double tax on savings; we are 
going to expand IRAs; we are going to cut the rates. And all 
those things, I am in favor of.
    I probably would be in favor of some of the things that 
Peter is in favor of in terms of broadening the base at the 
same time, but I think the dividend tax cut is probably the 
jewel of this package. If we took out the dividend tax cut, I 
probably would not be very enthusiastic about the rest.
    Mr. Orszag. We did agree on something.
    [Laughter.]
    Chairwoman Kelly. Thank you.
    Dr. Spriggs, do you agree with the Home Builders' 
assessment of the flaws in the Ernst and Young study? Have you 
reviewed the MBA study, and if so, I would like to know what 
your judgment is on that.
    Mr. Spriggs. I have not reviewed the MBA study. I have 
reviewed the Ernst and Young study. I am not sure that they 
have, in fact, overstated, because again part of this has to do 
with how the gap financing takes place for low-income housing. 
Low-income housing tax credit picks up a portion of it, and 
then what happens is the local government steps in with a bond. 
Those bonds are going to cost more money. I think unambiguously 
the dividend break means that those bonds are going to have to 
cost more money. Given the current situation of where states 
are right now, it is unlikely that they will make it up in some 
other way. So I am not sure if you look at the totality of the 
issue that Ernst and Young have overstated what the likely 
impact would be.
    Part of this has to do with the growth pattern we see in 
the willingness of corporations to pay for the credit keeps 
going up. Part of that was reflected in making the credit 
permanent. So corporations could lock this into their tax 
strategy. This changes their tax strategy. We saw when it had 
to be annually reauthorized that corporations were not as 
willing to pay as much.
    So I think there are a number of issues within the Ernst 
and Young that actually make them understated, which I think 
will probably wash out with whatever the Home Builders think is 
overstating it.
    Mr. Lazio. Madam Chair, could I give some feedback on that 
as well?
    Chairwoman Kelly. By all means.
    Mr. Lazio. As you know, I was very active in housing issues 
and the tax credit in particular during my years in the House. 
Just a few observations--first of all, the thought that somehow 
the yields or municipal bonds would have to necessarily 
increase because an equity would be more attractive to an 
investor because of its tax free flow-through, I think probably 
overstates the case. Right now, you have, for example, taxable 
and non-taxable bonds. The spread is very small between taxable 
and non-taxable bonds. The reason why people invest in 
municipal instruments is for preservation of capital; for 
security for a long-term investment, in that sense. And there 
is a trade-off involved in that. So I just do not see that the 
same investor that invests in a municipal security or bond is 
going to be attracted to a more volatile equity simply because 
of the tax treatment of dividends.
    The second thing is, less than half of the earned income of 
the S&P 500 is paid out in dividends. Unless there is an 
enormous increase in the amount of dividends that we paid out, 
and I do believe in speaking to some of our members, for 
example, that companies will call for higher dividends if this 
passes, which will be very good for shareholders, and that is 
across the quadrants. There is still going to be plenty of room 
for companies to invest in tax credits.
    Finally, less than 1 percent of all corporate tax right now 
is offset by way of housing tax credits. So they are an 
exceedingly valuable housing tool. I think the case that is 
made that somehow that they are going to be overwhelmed or 
eviscerated because of this provision is overstated.
    Chairwoman Kelly. Thank you very much.
    Mr. Spriggs. If I can be allowed just one point, though, I 
think again this is inconsistent to argue that on the one hand 
marginal tax rates matter, and then to argue that they do not 
matter. Yes, there is a risk premium, but we are changing the 
size of that risk premium by making these things deductible. I 
think we have to look at it from the real world perspective. 
When Microsoft decided for the first time in its history that 
it would give an eight cents dividend, for Bill Gates that is 
$96 million. Now, under this proposal that is $96 million tax 
free. There is a huge difference for those who are making these 
investments, in terms of how much money we are talking about.
    So I think it is inconsistent, and I think we should be 
consistent about whether relative tax rates matter or not in 
terms of investment decisions.
    Chairwoman Kelly. Thank you, Dr. Spriggs.
    I want to thank all of you for testifying today. Without 
objection, I want to enter into the record the Business 
Roundtable's study that was done by Pricewaterhouse, the Ernst 
and Young study, and the MBA studies that are referred to 
today, and the SIA report ``Defending the Dividend,'' which was 
issued January 31, 2003.
    I note that some members may have additional questions for 
this panel they may wish to submit in writing. Without 
objection, the hearing record will remain open for 30 days for 
members to submit written questions to these witnesses and to 
place their responses in the record.
    The third panel is excused, with the great appreciation of 
the committee. I want to briefly thank all of the members and 
the staff for their assistance in making the hearing possible.
    This hearing is adjourned.
    [Whereupon, at 6:04 p.m., the subcommittee was adjourned.]


                            A P P E N D I X



                             March 18, 2003

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