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

                        FEDERAL REVENUE OPTIONS



                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION




                           Serial No. 108-26


           Printed for the use of the Committee on the Budget

  Available on the Internet: http://www.access.gpo.gov/congress/house/


96-374                      WASHINGTON : 2004
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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
CHRISTOPHER SHAYS, Connecticut,      JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
GIL GUTKNECHT, Minnesota               Ranking Minority Member
MAC THORNBERRY, Texas                JAMES P. MORAN, Virginia
JIM RYUN, Kansas                     DARLENE HOOLEY, Oregon
PAT TOOMEY, Pennsylvania             TAMMY BALDWIN, Wisconsin
DOC HASTINGS, Washington             DENNIS MOORE, Kansas
ROB PORTMAN, Ohio                    JOHN LEWIS, Georgia
EDWARD SCHROCK, Virginia             RICHARD E. NEAL, Massachusetts
HENRY E. BROWN, Jr., South Carolina  ROSA DeLAURO, Connecticut
ANDER CRENSHAW, Florida              CHET EDWARDS, Texas
ROGER WICKER, Mississippi            ROBERT C. SCOTT, Virginia
KENNY HULSHOF, Missouri              HAROLD FORD, Tennessee
THOMAS G. TANCREDO, Colorado         LOIS CAPPS, California
DAVID VITTER, Louisiana              MIKE THOMPSON, California
JO BONNER, Alabama                   BRIAN BAIRD, Washington
TRENT FRANKS, Arizona                JIM COOPER, Tennessee
SCOTT GARRETT, New Jersey            RAHM EMANUEL, Illinois
J. GRESHAM BARRETT, South Carolina   ARTUR DAVIS, Alabama
THADDEUS McCOTTER, Michigan          DENISE MAJETTE, Georgia
MARIO DIAZ-BALART, Florida           RON KIND, Wisconsin

                           Professional Staff

                       Rich Meade, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel

                            C O N T E N T S

Hearing held in Washington, DC, October 6, 2004..................     1
Statement of:
    Hon. John Linder, a Representative in Congress from the State 
      of Georgia.................................................     4
    Hon. Michael C. Burgess, a Representative in Congress from 
      the State of Texas.........................................     9
    Hon. Max Sandlin, a Representative in Congress from the State 
      of Texas...................................................    16
    Hon. Phil English, a Representative in Congress from the 
      State of Pennsylvania......................................    21
    Hon. David E. Price, a Representative in Congress from the 
      State of North Carolina....................................    25
    Hon. Richard K. Armey, Co-Chairman, Freedomworks.............    51
    Hon. William Archer, PriceWaterhouseCoopers..................    55
    William G. Gale, Senior Fellow, the Brookings Institution....    68
    Robert E. Hall, Professor, the Hoover Institute, Stanford 
      University.................................................    81
    C. Eugene Steuerle, Senior Fellow, the Urban Institute.......    85
Prepared statement of:
    Mr. Linder...................................................     7
    Mr. Burgess..................................................    11
    Hon. Nick Lampson, a Representative in Congress from the 
      State of Texas.............................................    14
    Mr. Sandlin..................................................    17
    Mr. English..................................................    23
    Mr. Price....................................................    27
    Hon. Charles B. Rangel, a Representative in Congress from the 
      State of New York..........................................    28
    Mr. Armey....................................................    53
    Mr. Gale.....................................................    70
    Mr. Hall.....................................................    83
    Mr. Steuerle.................................................    88

                        FEDERAL REVENUE OPTIONS


                       WEDNESDAY, OCTOBER 6, 2004

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:02 a.m., in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Gutknecht, Brown, 
Wicker, Franks, Garrett, Barrett, Diaz-Balart, Spratt, Neal, 
Edwards, Scott, Thompson, Emanuel, Davis, and Kind.
    Chairman Nussle. Good morning and welcome, everyone, to 
today's Budget Committee hearing.
    We have several current and former Members of Congress as 
well as other tax policy experts testifying before us today. We 
have, actually, a very large lineup, so I want to get started 
here right on time.
    Our witnesses will be divided into three panels today, so 
in an effort to ensure that all our members are able to get 
their questions and comments in, I will try and keep my remarks 
brief and ask that all members try and stick to their allotted 
time as well, so that we can hear from our panel of witnesses 
who have assembled here today to give us, as representatives on 
the Budget Committee, who will start this process of tax 
reform, if it starts at all, some opportunity to hear their 
wisdom and their advice as we consider tax reform.
    Back in July, this committee held a hearing to try and get 
a reasonable comprehensive understanding as to why our current 
Tax Code isn't working and the best interests, really, for that 
matter, anyone involved for America's workers who pay into the 
system and the Federal Government, which it funds.
    I thought it was a pretty effective visual then, at the 
last hearing, so today I have asked to bring in the Tax Code 
again; and it sits across the hall over on the side table 
there. As you can tell from just looking at the pile on the 
desk, that is probably one of the main reasons why we are here. 
We have got 23 volumes of the IRS Code itself, with 21 volumes 
of Federal tax regulations written by the Treasury Department, 
which apparently are necessary to explain the first 23 volumes.
    And that is just the base of our Tax Code. There is also 
walls and walls in the Library of Congress dedicated to housing 
the Tax Court decisions, IRS rulings, which were needed to 
further explain the 44 volumes which we have here. But we 
really had no adequate staff or space to bring in those volumes 
and get them over here for visual.
    I think you get my picture. It is complicated. Although tax 
writers have perfectly good intentions, and I can tell you that 
because I am one of them serving on the Ways and Means 
Committee, we have good intentions providing tax relief to 
struggling American workers to make ends meet, to help boost 
our economy, which it certainly has. We have provided the 
relief and our economy has received a jolt and a boost, and 
that is positive. We just end up making the Code bigger and 
more complicated every year, even with those good intentions.
    Ideally, we should have a Tax Code that is reasonably 
simple, efficient, not overly burdensome, as fair as we can 
possibly make it, and as understandable or transparent as 
possible. And I bet that we can all agree that our current tax 
system provides few, if any, of those things.
    An important issue that was brought up at the last hearing 
was why do we have to deal with this now? The problems in our 
Tax Code certainly aren't new. It has been 20 years since we 
passed major tax reform legislation. 1986 was the last time 
this was attempted, so why should we do this now, with 
everything else that is going on?
    Well, as we are all aware, several factors have been coming 
to a head in these next few years, including the retirement of 
the baby boomers, the expiration of tax provisions, and the 
individual alternative minimum tax, or the AMT. And we face all 
of these on top of a whole host of large relatively new demands 
in our budget, in a climate of deficits we have incurred in 
response to extraordinary circumstances in these past few 
    So now is exactly the right time to get about addressing 
the problem of our revenues. Given the background created by 
the previous hearing today, we have taken the next step. Today 
we have invited a whole range of experts, both within our 
Congress, fellow members and colleagues, to discuss some of the 
most prevalent proposals for reforming and, in some cases, 
totally replacing our Federal Tax Code.
    This is an immensely complicated challenge, but it is also 
a great opportunity to get everything on the table and really 
begin the discussion on what may be one of our best options as 
we proceed forward. And I want to make it very clear that I am 
not here or we are not here to try and pick one of those that 
we think is best today. The purpose of this hearing, again, is 
to get a decent understanding of what there are in terms of a 
better way to tax.
    I am not expecting today's discussion to give us an ``aha'' 
moment, where we all of a sudden say that's the answer to the 
problem. Well, maybe Mr. Linder may have one of those moments; 
we will see. He has had them before, I know; I have heard him 
give his talk before. But I do know that we will learn a lot if 
we listen closely to the ideas of our colleagues and members 
from outside our Congress who are experts on this issue.
    Finally, I am sure that we could fill up an entire hearing 
with finger pointing on which parties to blame. I hope, even 
though there might be that temptation, today really was meant, 
I think on members' parts on both sides, to use this as a 
learning opportunity. If people want to take that opportunity, 
I guess I would invite you to take it outside to the 
microphones; I am sure someone would want to listen to you. But 
today we really do want to learn; that is what the purpose of 
this hearing is all about.
    So, with that, we have a very serious and important subject 
matter before us, and I would be happy now to turn to Mr. 
Spratt for any comments he would like to make.
    Mr. Spratt. Thank you, Mr. Chairman.
    In the fiscal year just ended, revenues hit an all-time 
low, or at least a low level that has not been seen since 1950, 
16.2 percent of GDP. This precipitous drop in revenues is 
directly related to a precipitous rise in the deficit. It too 
hit a record this year, $422 billion, the highest in history; 
$47 billion worse than last year. And even though the economy 
is eking out a recovery, slowly getting better, the bottom line 
is the burden is not getting better. We have what economists 
call a structural deficit built into the Tax Code and built 
into the spending side of the budget as well.
    Faced with this same sort of problem in the 1990s, we 
adopted three multi-year budgets and put the budget in surplus 
phenomenally by $236 billion in the fiscal year 2000. Just four 
short years ago we had a surplus of $236 billion. Looking back 
at those years at the end of the 1990s and analyzing the budget 
and what accounted for this success finally in subduing the 
deficit, CBO attributed half of our success, half of our 
success to the increase in revenues and half to the curbs in 
spending that we adopted from 1990 to 1993 to 1997.
    In the year 2001, when President Bush took office, he had 
an advantage that no president in recent times has enjoyed: a 
budget in surplus, big-time surplus, $127 billion that year. We 
begged him not to bet the budget on huge tax cuts tilted to the 
rich. He did, and we see the result today: worse than we 
feared, a deficit of $422 billion.
    As we go into fiscal year 2005, we have no budget 
resolution, no multi-year plan, no plan at all, and no prospect 
of any kind of program for erasing the deficit over the next 
fiscal year. Sooner or later the day of reckoning will come; 
the deficit will have to be dealt with, and when it is revenues 
will have to be part of the solution, as they were in the past.
    One way to increase revenues is to broaden the tax base by 
abolishing the accretion of deduction, credits, preference in 
exemptions that have grown up over time. We did this in 1986; 
we broadened the tax base and brought revenues and rates down 
significantly. And, frankly, the Tax Code is long overdue, 
another closet cleaning like that, where we go through the 
accretion of deductions and exemptions and credits and 
preferences. Instead, we are doing just the opposite; every 
time a tax bill is passed, it picks up more accretions like 
    One purpose of tax reform is simplification, and it is a 
worthy purpose. There is no question that the Tax Code and tax 
regulations even more have grown enormously. But there is 
another, and in my feeling, more important goal, and that is 
tax fairness, and we never should lose sight of it, 
distributing the tax burden equitably over all income classes 
and all people in our society. In this connection it is 
important that we not buy into plans that are superficially 
simple, but shift the burden of taxation off wealth and onto 
wages, off capital and onto salaries and wages and earned 
    That is not just some rhetorical concern. We had a chairman 
of the Council of Economic Advisors say not long ago that the 
best rate for income from wealth is zero; and you see that 
pattern in many of the proposals presented today. Indeed, 
virtually all of the proposals presented today do just that, 
they shift the burden of taxation off wealth and onto wages. 
And I don't really think that, stated in that fashion, that is 
a goal that I know Democrats don't share, and I don't think 
most Americans share, that our objective in tax reform is to 
shift the burden off those who have done well onto those who 
are still working, and leaving them bearing the weight of the 
    So as these complicated proposals are made today, in the 
interest of simplicity, we have got to discern and be careful 
we evaluate them as to whether or not they shift the burden. If 
so, who ends up holding the real burden of supporting the 
Federal revenues. And I hope that today's hearing will begin to 
help us see the advantages and disadvantages of the different 
proposals before us, but also help us keep in mind that we do 
not want to sacrifice fairness for simplicity.
    That said, we need to be looking at new ways of raising 
revenues, because if the next Congress gets earnest about the 
deficits, revenues will have to be part of any serious 
    Mr. Chairman, thank you very much, and I thank our 
witnesses for taking the time to come and prepare their 
    Chairman Nussle. Thank you, Mr. Spratt.
    I would ask unanimous consent that all members be given an 
opportunity to put a statement in the record at this point.
    I will also tell our witnesses that your entire testimony 
will be made part of the record, and you may summarize your 
testimony as you wish. I will take you in the order in which 
you arrived, that way I assume for that reason your effort to 
get here will be rewarded so you can go out and take care of 
other business. I know Mr. Linder needs to be no the floor, so 
we will begin with Mr. Linder from Georgia.
    Welcome to the Budget Committee, and we are pleased to 
receive your testimony.

                         STATE OF TEXAS


    Mr. Linder. Thank you, Mr. Chairman. I would like to have 
my statement put in the record, and I would also like to put in 
the record a response to a recently distributed critique of a 
national sales tax by Ms. Pelosi in a press conference, 20 plus 
pages, purporting to criticize H.R. 25, my bill, but obviously 
criticizing something of their own design. The criticism was 
simply not aimed at the bill that I actually drafted.
    I would like to summarize by saying any plan we have for 
tax relief or tax reform ought to follow some guiding 
    I think it ought to be fair. I think anything we do ought 
to un-tax essentials so that people living at or below the 
poverty line pay no taxes whatever.
    It ought to be simple and easy to understand for every 
American. My bill is 132 pages, as compared to 55,000 pages of 
    It ought to be voluntary. Our current system is coercive, 
corrosive, intrusive and abusive. We ought to have a voluntary 
system where everybody pays taxes when they choose, as much as 
they choose, for how they choose to spend.
    Anything we do ought to be transparent. We ought to know 
all the costs, including the hidden costs. One of the studies 
we commissioned out of Harvard, the head of economics at the 
time, Dale Jorgenson, concludes that on average 22 percent of 
what we are currently paying for at retail represents the 
embedded cost of the current system. We are paying all the 
income tax costs, the payroll tax costs, and compliance costs 
of every business entity that had a roll in building that house 
or that loaf of bread. On average, we are losing 22 percent of 
our purchasing power to the current system.
    What we do ought to be border-neutral. Our exports must be 
unburdened by any tax component in the price system. We are 
uncompetitive in world markets simply because nations with 
which we compete that have a VAT, a value added tax, and we are 
uncompetitive because everything we sell has our social welfare 
costs embedded in it, as well as our other costs.
    It ought to be industry-neutral. I never understood why I, 
as a dentist serving on the Georgia legislature, could make a 
pretty decent income without having to collect a State tax, but 
all my neighbors and retailers had to collect it. I think it 
should tax all goods and all services equally.
    We ought to strengthen Social Security, Medicare, whatever 
we do. Larry Cutlicoff, an economist from Boston University, 
has concluded in a recent study that the 75-year unfunded 
liability in Social Security and Medicare in today's dollars is 
$51 trillion--trillion. The entire household wealth in America 
is $43.8 trillion.
    If we took everything away from every American and took the 
value of their assets and applied it against the shortfall, we 
would cover 80 percent of it; and setting aside a few percent 
of whatever we do--of Social Security or Medicare--is simply 
not going to save it. Any system that is predicated on workers 
paying for retirees, when the baby boomers retire is going to 
fail. We are going to increase the number of retirees in the 
next 30 years by 100 percent. We are going to increase the 
number of workers paying for them by 15 percent.
    That system simply cannot survive. If you go to a tax on 
personal consumption like I propose, what you wind up doing is 
tripling the numbers of people paying into the system; you go 
from 138.5 million in workers to about 290 million Americans 
every time they buy something, plus 40-50 million visitors to 
our shores.
    The last thing is it must have manageable transition costs. 
The $51 trillion is simply unsustainable in our current system. 
Under my plan, the national consumption tax, we would have one 
transition rule, and that is any inventory held on the 31st of 
December can be used as a credit against collecting the tax in 
future years because that inventory already has a tax embedded 
in it. We should only tax everything one time. We have about 
$1.4 trillion in inventory in the economy at any given time. 
Roughly a fourth of that is $350 billion. That is the entire 
transition cost of my proposal.
    There are some economic drivers that are going to force us 
to take a hard look at this. The first one is the 22 percent 
embedded. Every time we sell something overseas, we are losing 
to our competition because we have such a large embedded cost 
in the goods and services we sell.
    Secondly, we spend somewhere in the range of $400 billion 
just complying with the Code. We spend 6-7 billion man hours 
filling out IRS paperwork. We spend probably that amount of 
time just calculating the tax implications of a business 
decision. We lose 18 percent of our economy to making tax 
decisions, as opposed to economic decisions. That adds up to 
somewhere in the range of $400 billion a year just complying 
with the Code.
    We have a trillion dollar underground economy just in 
pornography, illicit drugs, and illegal labor. That doesn't 
include all the other things that happen under the table. But 
those three components make up a trillion dollar untaxed 
    We have driven offshore $6 trillion in capital. The IRS 
thinks it is $5 trillion; offshore financial centers say it is 
$6 trillion. Those are dollars offshore that it is too 
expensive to repatriate; they would rather borrow at 6 percent 
interest than repatriate at 35 percent taxes. Those dollars 
would all come to our shores if we were to un-tax capital and 
labor, and my bill would totally eliminate all taxes on income 
whatsoever; personal income tax, corporate income tax, gift 
tax, State tax, capital gains tax, alternative minimum tax. All 
those would be gone for a one-time tax on personal consumption. 
The number is 23 cents. Currently, if you earn a dollar, you 
give 36 cents to Uncle Sam. Under my system, if you spend a 
dollar, you give 23 cents to Uncle Sam.
    The rebate system that we have devised in this, to every 
household--not rich or poor, because we are not going to know 
who is rich or poor--totally rebates the tax consequence of 
spending up to the poverty line. For a family of one, that is 
$9,500 a year; for a family of six, that is $30,000 a year. 
They could spend that amount of money totally untaxed.
    So low-income people are the big beneficiaries of going to 
a personal consumption tax as devised by H.R. 25, because they 
no longer lose the 22 percent of their purchasing power of the 
current system. Competition drives that out of the price system 
and prices decline by 20-30 percent. And then everybody gets 
rebated, a check sufficient to totally un-tax to the poverty 
    Who is going to pay for this? Accumulated wealth; people 
who have paid taxes on their earnings in older life. Pay taxes 
when they sell the company, pay taxes on interest it earns, and 
they are going to pay taxes one more time when they spend it. 
And to those with accumulated wealth, I just say you are 
already paying this. America is paying a hidden 22 percent 
sales tax today; it is just not recognized.
    I think the transparency is a huge issue. I think my mother 
should know every time she buys a loaf of bread how much goes 
to the Government. I think that we have untaxed 47 percent of 
America's income tax payers. We have a huge bias for more 
Government and more taxes because of that, and I think that 
everybody should be pay every time they purchase something.
    Mr. Chairman, I would be happy to take any questions.
    [The prepared statement of Mr. Linder follows:]

 Prepared Statement of Hon. John Linder, a Representative in Congress 
                       From the State of Georgia

    Mr. Chairman, thank you very much for giving me a chance to testify 
before the Budget Committee this morning on fundamental tax reform 
generally, and H.R. 25, the FairTax specifically. I appreciate having 
the chance to share with the committee my thoughts on this pressing 
    When debating any fundamental tax reform proposal, the Congress 
should judge any such bill by the following eight (8) key principles:
    1. Fair: It must protect the poor and treat everyone else the same. 
No exemptions--no exclusions--no advantages.
    2. Simple: It must be easy to understand for all Americans--no 
matter one's education, occupation, or station in life.
    3. Voluntary: It must not be coercive or intrusive.
    4. Transparent: We should all know what the government costs. There 
must be no ``hidden'' taxes.
    5. Border-Neutral: Our exports must be unburdened by any tax 
component in the price system, while imports carry the same tax burden 
at retail as our domestic competition.
    6. Industry-Neutral: It must be neutral between businesses and 
    7. Strengthens Social Security & Medicare: Fundamental reform must 
address the long-term solvency of Social Security and Medicare.
    8. Manageable Transition Costs: It must not be costly or difficult 
to implement.
    The FairTax, which eliminates all Federal income and payroll taxes 
and replaces them with a national retail sales tax, meets these 
criteria. The FairTax is a compelling proposal that would benefit the 
U.S. economy, businesses across the nation, and all American taxpayers.
    Allow me to briefly describe the problems associated with our 
current income Tax Code:
    1. We spend 7 billion man-hours each year filling out IRS forms.
    2. We spend at least that much calculating the tax implications of 
a business decision.
    3. We lose 18 percent of our economy making ``tax decisions'' 
instead of ``economic decisions''.
    Some economists believe that it currently costs us about $500 
billion to comply with the income Tax Code in order to remit $2 
trillion. Studies show that it costs the average small business $724 to 
collect, comply with the Code and remit $100 to the Federal Government.
    We have $5 [trillion]-$6 trillion in overseas accounts because it 
is cheaper to borrow at 6 percent than repatriate dollars at 35 
percent. Additionally, individuals shelter wealth in offshore accounts 
costing the U.S. an estimated $100 to $250 billion each year.
    Just three activities--pornography, illicit drugs and illegal 
labor--constitute a $1 trillion economy that is untaxed.
    The current dollar 75 year unfunded liability in Social Security 
and Medicare is $51 trillion. The total household wealth in America is 
less than $44 trillion. Taking every asset from every American and 
applying it to our retirement programs would cover only 80 percent of 
the shortfall.
    The Alternative Minimum Tax (AMT) was passed in 1969 to ensure that 
those high income taxpayers, who have no tax liability due to their 
legal use of deductions and credits, would still be forced to pay some 
taxes. Within 6 years over 35 million Americans will be subject to the 
    We spend over $30 billion per year on the Earned Income Tax Credit 
(EITC) which is intended to refund the payroll tax burden of low income 
workers. It is estimated that nearly a third of that amount is fraud.
    Upon close examination, it is crystal clear that the FairTax solves 
these problems: All of the above goes away if we stop taxing income and 
start taxing consumption.
    HR 25 repeals all taxes on income and abolishes the IRS. Gone are 
personal and corporate income taxes, payroll and self employment taxes, 
capital gains, AMT, EITC, gift and estate taxes. They would be replaced 
by a single retail sales tax. Out of every dollar you spend on personal 
consumption--23 cents goes to the Federal Government.
    The FairTax is fair. It contains a rebate for every household, 
which would totally rebate the tax consequences of spending up to the 
poverty line. This rebate mechanism ensures that every household could 
buy necessities untaxed. It totally untaxes the poor. All Americans 
receive equal, fair treatment.
    The FairTax is simple. The FairTax eliminates 55,000 pages of 
Federal tax rules and replaces them with a 134 page law.
    The FairTax is a voluntary tax system. Every citizen becomes a 
voluntary taxpayer, paying as much as they choose, when they choose, by 
how they choose to spend.
    The FairTax creates transparency within the Tax Code. The FairTax 
eliminates the hidden tax component from the prices of goods.
    According to a Harvard study, the current tax component in our 
price system averages 22 percent, meaning that those spending all they 
earn lose 22 percent of their purchasing power to the current system. 
The only mechanism businesses have to pay payroll taxes, income taxes, 
or compliance costs is price. Consumers pay those costs. By abolishing 
the IRS and abolishing the income paradigm in favor of a consumption 
paradigm we let the market drive the tax component out of the price 
    Knowing how much we pay in Federal taxes on every purchase would 
make all Americans more aware of the cost of government. The next tax 
increase will not be able to be sold with the argument that it only 
applies to the top 2 percent of Americans. The reason for any future 
tax increase must necessarily be so compelling that all of America 
would be willing to pay it.
    The FairTax is border-neutral. Under a national sales tax, imported 
goods and domestically produced goods would receive the same U.S. tax 
treatment at the checkout counter. Moreover, our exports would go 
abroad unburdened by any tax component in the price system.
    The FairTax is industry-neutral. There is not a good reason that 
our neighbor who builds a bookstore, hires our kids, votes in our 
elections and supports our community should be placed at a 7 percent 
disadvantage against Amazon.com. Governors have a keen interest in this 
due to the loss of tens of billions of dollars in revenue to Internet 
and catalog sales. A national system would collect that.
    Nor is there a good reason why I, as a dentist, didn't have to 
collect a sales tax in Georgia while my neighbor, the retailer, did. 
The first principle of government ought to be neutrality. Services 
would be taxed the same as goods.
    The FairTax would solve our Social Security problem. All of the 
arguments about private accounts saving Social Security miss an 
important point--we will increase the number of retirees in the next 30 
years by 100 percent and increase the number of workers supporting them 
by 15 percent. That system will only survive by dramatically reducing 
benefits, increasing taxes or increasing the number paying into it.
    Under the FairTax, Social Security benefits will be paid out of the 
general sales tax revenues. The sales tax will be collected from 300 
million Americans and 40 million visitors to our shores. Revenues to 
Social Security and Medicare will double, as we expect the size of the 
economy to double, in 15 years.
    The FairTax has manageable transition costs. The only transition 
rule would allow retailers to use inventory on hand on December 31, as 
a credit against collecting taxes on sales in the New Year. This is 
based on the principle that things should be taxed only once and goods 
produced before the transition would already have the current tax 
embedded in them. U.S. businesses have about $1.4 trillion in inventory 
on hand at any given time. Not collecting taxes on that inventory would 
cost the Treasury about $350 billion. Compare that to any estimates of 
transition costs just trying to bring some private investment into 
Social Security alone.
    The FairTax would efficiently tax the underground economy. This 
alone would increase revenues by over $200 billion.
    Beyond the above arguments, what will the new paradigm do in our 
present economy? Passing the FairTax does several things that will 
directly affect the economy.
    1. The monies saved on compliance costs will immediately be put to 
efficient and profitable use. We will create millions of new jobs.
    2. Our GDP will grow by $180 billion per year because we would no 
longer make ``tax decisions.''
    3. Eliminating the income tax will bring long-term interest rates 
down to municipal bond rates, ultimately reducing interest rates by 30 
percent. That is good for corporate profits and the market.
    4. If all the world's investors could invest in our markets with no 
tax consequences, values would rise. With no tax on capital or labor, 
foreign domiciled international firms would build their next plant in 
America. We would be the world's ``tax haven'' and the $6 trillion 
offshore would come home, increasing values in our markets and creating 
    5. Having no complicated depreciation schedules, AMT, credits and 
deductions to confuse investors, and no tax or compliance costs, would 
force a whole new look at corporate accounting. Only three numbers have 
meaning: earnings, expenses and dividends. Nothing to hide behind. It 
will be easier for shareholders to evaluate and monitor the companies 
they own.
    6. Deficits spook the market. Instead of a 20 percent decline in 
collections over the last 3 years, we would have had increased revenues 
in 11 of the last 12 quarters.
    7. Add to the above a 26 percent increase in exports in the first 
year, as well as a 78 percent increase in capital investment. Capital 
investment increases lead to increases in productivity and then 
increases in real wages. We also will have a 10.5 percent increase in 
economic growth in the first year.
    How does the FairTax compare to other fundamental tax reform ideas? 
The FairTax is decidedly simpler and fairer than flat tax proposals. 
The U.S. instituted a flat tax in 1913. Since then, it has been amended 
over and over, resulting in the very plan we are working to correct 
today. In 1986, we eliminated most deductions and drastically lowered 
tax rates to only two levels. We have amended the Code over 6,000 times 
since then. We have walked the flat tax path before, to no avail, and 
it simply does not make sense to implement the same mistake again. 
Also, by keeping the payroll tax and corporate tax in place, the flat 
tax proposals fail to remove the tax component from the price system.
    Other sales tax proposals leave in place the payroll tax--the 
largest hidden tax component in the prices of our goods and services. 
The FairTax would completely eliminate these hidden taxes, allowing 
competition to bring prices down an average of 20-30 percent and 
increasing the transparency of the tax system.
    In reviewing the FairTax, here are some important concepts to 
     Because of the tax component incorporated into prices 
under the current income Tax Code, we are already paying the equivalent 
of the FairTax!
     The FairTax eliminates payroll taxes, which are the most 
regressive of existing taxes.
     The FairTax is a tax on accumulated wealth. However, the 
holders of accumulated wealth are already paying it. It is just hidden. 
Their wealth will increase geometrically with all of the new investment 
     The FairTax saves Social Security and Medicare as Federal 
     The FairTax efficiently taxes the underground economy.

    Chairman Nussle. Thank you, Mr. Linder.
    Next to arrive was Mr. Burgess from Texas.
    Welcome, and we are pleased to receive your testimony.


    Mr. Burgess. Well, thank you, Mr. Chairman. I appreciate 
the opportunity to be here today. I thank the ranking member 
and members of the committee. I too have a formal statement 
that I will leave for the record.
    One thing I feel I must correct, there may be a panel of 
experts down here, but I am not an expert. I am a country 
doctor who was elected to Congress. But under that guise of 
being just a regular guy, back in 1995 or 1996, I picked up an 
read an extraordinary book called ``The Flat Tax.'' I believe 
in the flat tax. I could not understand why Congress was 
holding back. If they had a concept that was this good in front 
of them, it seemed like a reasonable proposal. Let us debate, 
let us hear about it, and let us see if we can't pass something 
that is simpler and fairer for the American people.
    When I came to Congress, believing in the flat tax as I 
had, I thought it was important to keep that concept alive, and 
I have tried to do that. The difference in the flat tax that I 
have introduced last year, or actually last year, in H.R. 1783, 
was that I made the flat tax voluntary. One of the concerns I 
had, and Mr. Spratt eloquently pointed to it when they did the 
closet cleaning back in 1986. Again, I was a regular guy back 
in north Texas taking care of patients, but the closet cleaning 
resulted in a drastic change in behavior. People who had been 
encouraged to run their business or construct their lives in a 
particular way by the Tax Code suddenly had the rug pulled out 
from under them. In Texas the real estate sector and the energy 
sector were hit particularly hard and, as a consequence, we had 
some significant employment problems in Texas, and it affected 
my patients, and I got to see that pain up close and personal 
as people worked through those problems.
    I feel that it is important for whatever we do up here to 
inflict minimal pain on the American people, and for that 
reason I think making the flat tax voluntary, allow a family or 
a business to elect whether or not to go into a simplified tax 
system. That is, if they like what they have got going on in 
the IRS Code, they should be able to stay in the Code. But if 
they are willing to give up their shoe box full of receipts and 
the quality time with their accountant every April, we ought to 
give them the opportunity for a flat tax.
    I believe that part of our job here in Congress is to trust 
the American people to make the right decision. I think the 
voluntary flat tax would conform with being a pro-growth 
system, and I believe that the flat tax will encourage savings 
and investment.
    I will give you another example from my life as a private 
citizen. When I started my private practice of medicine, I 
thought the prudent thing to do would be to keep 3 months of 
operating capital in a bank account where I could readily 
access it if I came on hard times. Having to borrow to make a 
payroll one time, I was extremely uncomfortable with that 
concept, and I thought, well, next time I am going to have 
those funds available. But what happened when I did that was I 
ended up paying corporate taxes on that money at the end of 
that year, and when that money eventually came back to the 
practice and was distributed as income, we got to pay taxes on 
it again; and my partners weren't happy with my prudence when 
that was pointed out to them by our accountant, and we did 
change accountants shortly after that.
    I think it is reasonable to provide another option for our 
system that will reduce the complexity for the American people. 
And Mr. Spratt again eloquently alluded to the fact that we do 
need to have a Tax Code that is more simple, and I agree, and I 
believe the voluntary flat tax conforms to that.
    We take a lot from the American people. We take their 
money, but, Mr. Chairman, just as importantly, we take their 
time. And Dr. Linder eloquently pointed out with the FairTax 
that he would be giving time back to the American people, and 
that is exactly right with the voluntary flat tax. We would 
offer the American people 6.1 billion hours of compliance time 
that they now spend filling out their forms and reading the 
regulations that we could refund to them immediately.
    Mr. Spratt also said we needed to make the system fair, and 
I couldn't agree more. One of the moments that comes to me was 
back in 1993, when you all passed a retroactive tax back to 
January 1, of that year. By some strange coincidence, President 
Clinton and I earned about the same amount of money that year. 
Well, actually, I earned a couple of thousand dollars more, but 
I think I had a better year. But President Clinton paid about 
19 or 20 percent of his total income in taxes; I paid 33 
percent. And I think he was eligible for public housing that 
year, so clearly the system did not treat the two of us fairly.
    I think the flat tax will ease the burden on the taxpayer 
and ease the burden on entrepreneurs. I know, as a young person 
starting out, if someone said you can either form a close 
relationship with your accountant through the rest of your 
business life or you can just simply fill out a postcard size 
form, I would elect for the postcard size form.
    The fact of the matter is there are other countries who 
have adopted a concept along the lines of a flat tax, the 
former Soviet Union being one, and their economy has responded 
accordingly. This is, I think, one of the most important 
points: the flat tax right now is doable. With a minimum of 
heavy lifting, we could make a voluntary flat tax available to 
the American people, and it wouldn't inflict that much pain on 
the American people. But immediately it would eliminate the 
marriage penalty. Consider this: For a husband or wife whose 
spouse earns $60,000 a year, that spouse pays in at the 50 
percent level from the first dollar earned for the rest of 
their life. That is not fair. That is truly a marriage penalty, 
and we could do away with that.
    We have made some efforts to repeal the death tax, which is 
one of the things that has put us on a glide path to a 
fundamentally flat or a fair system. The alternative minimum 
tax is really what is looming out there, which is going to give 
us the political courage to do something about our tax system, 
because the American people are going to demand it when the 
alternative minimum tax begins to erode more and more of their 
earning power.
    Finally, the flat tax would eliminate the capital gains tax 
and would allow for immediate expensing of capital equipment.
    The 2001 and 2003 tax cuts were good starts on repealing 
the harmful provisions, but now it is time for us in Congress 
to finish the job and give the American people the power to 
choose an alternative tax that would be fairer.
    Thank you.
    [The prepared statement of Mr. Burgess follows:]

  Prepared Statement of Hon. Michael C. Burgess, a Representative in 
                    Congress From the State of Texas

    First, I want to thank Chairman Nussle for holding this important 
hearing today. As a long-time supporter of fundamental tax reform, I 
believe that this is one of the most important issues that Congress 
will face in the next few years. I would also like to thank the 
chairman for the opportunity to testify before you to explain my 
voluntary flat tax proposal.
    Ten years ago, when I was a private citizen living in north Texas, 
I thought the flat tax made a lot of sense. It meets the criteria by 
which all tax systems should be evaluated--it is fair, simple, 
transparent, and efficient, thereby promoting economic growth today. I 
will discuss how the flat tax meets each of these important criteria, 
but first I would like to explain how the Freedom Flat Tax works.
                        the freedom flat tax act
    In April 2003, shortly after coming to Congress, I introduced H.R. 
1783, The Freedom Flat Tax Act, which would establish a voluntary flat 
consumption tax. It is simpler, fairer, more transparent and more 
efficient than the current income Tax Code. The flat tax concept is 
simple--there are two components, the individual wage tax and the 
business tax.
    Individuals pay a flat rate on their wage and pension income, and 
there will be no deductions. H.R. 1783, however, would allow for the 
following personal exemptions:
     $24,600 for a married couple filing jointly;
     $15,700 for a single head of household;
     $12,300 for a single person; and,
     $5,300 for each dependent.
    A family of four, for example, would not be subject to the flat tax 
until their combined income reached $35,400, which is 194 percent above 
the 2002 Federal poverty level of $18,244. Thus, the flat tax system is 
slightly progressive because the exemptions ensure that lower wage 
earners do not pay any Federal tax until they reach a certain 
threshold, after which they pay the flat rate of 17 percent.
    It is important to note that the marriage penalty is repealed under 
the flat tax because the exemption for a married couple filing jointly 
is twice that of a single person.
    Businesses would pay a flat rate on the total costs of taxed inputs 
subtracted from total sales; only employee wages and pensions will be 
tax deductible--this ensures that income is only taxed one time. Under 
H.R. 1783, both the business and individual tax rates are 19 percent, 
but would decline to 17 percent after the initial 2 years of 
    Unlike past flat tax proposals--The Freedom Flat Tax Act allows 
taxpayers to choose if and when to opt into a flat tax system. That is 
because I do not believe that we should penalize those who have made 
investments based on the market-distorting Tax Code. It would be like 
changing the rules in the middle of the game. My flat tax plan allows 
taxpayers to transition to the flat tax system on their own timetable.
    Now that I have explained the mechanics of my flat tax proposal, 
I'd like to discuss the advantages to the flat tax system. Why would 
anyone want to opt into the flat tax system?


    First, it is fair--no matter how much money you make, what kind of 
business you are in, or whether or not you are married, you will be 
taxed at the same low rate as every other taxpayer.
    The Tax Code should strive to be fair both vertically and 
horizontally. The flat tax system has vertical fairness because it 
taxes everyone at the same rate, while ensuring that the tax burden 
does not fall too heavily on lower wage earners.
    The Tax Code should also have horizontal fairness, and that is best 
illustrated by what I call the ``Clinton paradox,'' which I encountered 
in 1993. 1993 was the year that Congress increased the tax rate, 
retroactive to the first of the year. By some quirk of fate, former 
President Clinton and I earned almost an identical amount that year. 
But when it came time to pay to the Federal Government, President 
Clinton paid just over 20 percent, and I paid over 30 percent. Why 
should such a discrepancy exist? What is the benefit for the country 
when we are taxed at different rates on exactly the same income? 
Currently, simplicity and fairness in taxes are sacrificed for the sake 
of pursuing a social agenda.
    But a social agenda is not the purpose of the Federal income Tax 
Code. That is why the Freedom Flat Tax Act does not allow credits or 
deductions, which means that people who earn the same wages pay the 
same amount in taxes, thus the flat tax has horizontal fairness.
    Congressman English's Simplified USA Tax, however, does allow 
deductions for home mortgage interest, charitable donations, and 
secondary education. My concern is that allowing deductions now allows 
additional deductions in the future. Look what has happened since the 
1986 tax reform, during which a large number of deductions were 
repealed. Over time, many of those deductions have been restored, which 
has added complexity to the Code.


    A major advantage of the flat tax is its simplicity--a tax system 
so simple that you can understand it without a CPA. By eliminating tax 
credits and deductions, abolishing multiple layers of taxation, and 
eliminating the complex depreciation schedules for businesses, the flat 
tax will simplify the Tax Code. The flat tax will allow families and 
businesses to take back the more than 6 billion hours per year that 
they currently spend to comply with the income tax. Some simple 
arithmetic is all that is needed to determine your tax liability each 
year. The flat tax has the ability to give time back to families 
because it is easy to understand and easy to comply with.
    The Simplified USA Tax, by contrast, is more complicated than the 
flat tax for individual taxpayers because it allows several deductions 
and has several tax brackets.
    The FairTax, on the other hand, is very simple for individual 
taxpayers--after they get over the sticker shock--but is extremely 
onerous for businesses, especially small businesses. That is because 
the Fair Tax would require small businesses to become the tax 
collector. I am concerned that this would serve as an additional tax on 
mom-and-pop shops and would discourage entrepreneurs from starting new 
small businesses.


    It is important that the tax system be transparent--otherwise the 
government can easily raise rates, as they have done in Europe with the 
VAT tax. With a flat tax, you will easily be able to tell how big a 
bite the Federal Government takes out of your income each year. After 
some simple and brief subtraction, you simply pay 17 percent percent of 
your wages above your personal exemptions. And because everyone pays 
the same rate, it would be obvious to all Americans if it was raised.
    The FairTax, in contrast, is less transparent than it would appear 
at first glance. Although the FairTax would be separately stated on 
each receipt, to determine your total Federal tax liability, you'd have 
to add up all your receipts from the whole year. That means saving 
receipts from every trip to the grocery store for milk, every latte 
from Starbucks, every newspaper, or magazine, etc.


    An efficient Tax Code is one that does not cost a lot. The current 
system is clearly not efficient--according to the CATO Institute, 
collecting the income tax costs the Federal Government 10-20 percent of 
all tax revenue collected. That is a lot of deadweight in the Tax Code.
    The flat tax will encourage economic growth by easing the burden on 
the taxpayer and entrepreneurs by reducing the cost and time spent on 
tax forms. A flat tax would be much less costly, saving taxpayers more 
than $100 billion per year and reducing tax compliance costs by over 90 
percent, according to one estimate by The Tax Foundation, a non-profit, 
non-partisan 501(c)(3) educational organization. This savings will give 
people and businesses more money to spend, ultimately boosting take-
home pay, spurring the economy and creating jobs.
    The flat tax will especially benefit small businesses, which today 
create the majority of new jobs and account for half of the economy's 
private output, by allowing for major simplification and the immediate 
expensing of capital equipment.
    Multiple layers of taxation on savings and investment discourage 
taxpayers from adding to the capital stockpile for our economic engine. 
The flat tax encourages economic growth by ensuring that income is only 
taxed one time.
    I would like, at this point, to raise my concern that under the 
FairTax there is a very real possibility that business purchases would 
be double taxed. The FairTax would ostensibly give businesses a rebate 
on business-to-business purchases in order to avoid double taxation, 
but the rebate would be very difficult to implement. Businesses, like 
individuals, would have to save all of their receipts--for everything 
from office supplies to raw materials--every year. Most large companies 
would not be hurt by this requirement; it would be the Main Street 
businesses to suffer. These are the same mom-and-pop shops that would 
now have to collect taxes under a national retail sales tax.
    Perhaps my most serious concern with the FairTax is that it would 
discourage economic growth. By only taxing new goods, the Fair Tax 
creates an incentive to purchase used goods. To buy a used couch or a 
new couch does not seem like it would be all that significant to the 
economy, but imagine the ramifications if only new houses and new cars 
are taxed. We tax what we want less of, and I am concerned that taxing 
only new goods would discourage new production and ultimately shrink 
the economy.

                          POLITICAL DIMENSION

    It is my belief that the flat tax is better than the Simplified USA 
Tax and the FairTax because it is fundamental tax reform that is 
    Unlike other tax proposals, the flat tax would not require 
repealing the 16th Amendment to the Constitution. If we cannot get \2/
3\ of the House and Senate to agree to protect marriage, it is doubtful 
that we could get \2/3\ to vote to repeal the 16th Amendment.
    I believe that the flat tax is achievable because we are already on 
the glide path after the 2001 and 2003 tax cuts. The Bush tax cuts 
allowed for bonus expensing for capital equipment, abolished the 
marriage penalty, reduced the multiple layers of taxation, reduced 
capital gains taxes and lowered rates.
    To conclude, the American people deserve a tax system and a 
government that rewards them for their hard work. It is time for 
Congress to give that to them and I believe that the flat tax is the 
best way to achieve this goal.

    Chairman Nussle. Thank you, Mr. Burgess.
    Next up is our colleague from the Ways and Means Committee, 
Max Sandlin from Texas.
    Welcome, and we are pleased to receive your testimony.
    Mr. Sandlin. Thank you, Mr. Chairman. It is good to be here 
with you this morning.
    Mr. Spratt. Would the gentleman yield for a moment?
    Mr. Sandlin. Certainly.
    Mr. Spratt. Mr. Lampson was to testify also and was not 
able to be here. I would like to ask unanimous consent at this 
point that his testimony be made part of the record.
    Chairman Nussle. Without objection.
    [The prepared statement of Mr. Lampson follows:]

 Prepared Statement of Hon. Nick Lampson, a Representative in Congress 
                        From the State of Texas

    Thank you, Mr. Chairman, for holding this hearing and allowing me 
to testify today. I believe there are dangers inherent in the proposed 
National Retail Sales Tax. I am glad we finally have an opportunity to 
discuss the proposal seriously.
    I am deeply concerned about potential problems with this proposal, 
that it will hurt home builders and automobile manufacturers, State 
governments and small businesses, and most importantly seniors and the 
middle class. I am also concerned that this supposedly simple proposed 
tax structure would be incredibly complex in its implementation, the 
cost of which has been grossly understated.
    Under the current National Retail Sales Tax proposal, an additional 
$30 in taxes would be levied against every $100 in goods and services. 
That means southeast Texans would pay $130 for $100 in groceries. Where 
I come from that's a 30 percent sales tax--not the 23 percent many 
supporters claim.
    Even this outrageously high projected rate is too low. Many 
economists estimate a true estimate between 50 percent and 60 percent. 
Even Harvard economist Ken Jorgenson, cited by many sales tax defenders 
as confirming a 30 percent or 23 percent tax rate inclusive, indicated 
that the rate would need to be 40 percent or 28.5 percent tax 
    Former Republican leader Dick Armey discussed the many failures of 
a National Retail Sales Tax in a 1995 Policy Review article. He cites a 
1993 report by the Organization for Economic Cooperation and 
Development arguing that while several countries have tried, almost no 
industrialized country has managed to sustain a National Retail Sales 
Tax above 12 percent.
    A high tax rate assessed at the cash register would increase demand 
for black market goods. Consumers receive large price savings for 
engaging in what some consider low risk and minor criminal behavior. To 
prevent this we could assess the tax not at the cash register, but 
instead have each firm pass the tax on to consumers by charging it to 
their distributors. European nations have done this through a Value 
Added Tax (``VAT''). Unfortunately, administering a VAT requires 
government oversight and careful tracking by companies, creating 
additional work to our business community and a new, large governmental 
    The National Retail Sales Tax also hurts small businesses. In 
states that use a sales tax, like my home State of Texas, small 
businesses generate between 20 percent and 40 percent of all sales tax 
revenue. Small businesses are not supposed to be impacted by State 
sales tax, yet if employees head over to Office Depot periodically to 
pick up supplies, that small business would pay an additional 30 
percent tax on those items, unless it keeps all their receipts and asks 
the government for a refund. This amounts to a heavy tax levied against 
businesses. It's reasonable to assume that a similar 20 percent to 40 
percent of the total revenue raised by a National Sales Tax would come 
from the same small business community.
    The impact of this proposal on automobile dealers and home builders 
is also alarming. The National Sales Tax only taxes new goods. That 
means an $85,000 new home in my hometown of Beaumont would now be a 
$110,500 home, while an equivalent older home would still cost $85,000. 
This is a strong disincentive for people considering the purchase of a 
new home or a car. As a homeowner, this might be good for me because my 
home's value would go up, but what is the impact on new home sale rates 
our Administration sees as signs of recovery?
    Many people would turn away from new consumer durables like cars 
and home appliances, instead opting to maintain older items or purchase 
older, used versions of the same items. Antique dealers and repair 
shops may benefit heavily from this, but our nation's automakers, 
dealers, and major retailers would suffer greatly!
    Under this proposal, it is estimated that the Texas State 
government would now owe the U.S. government over $20 billion. The only 
way to make up that money is to increase an already high sales tax--
further driving up home, health, food, and energy costs--or increase 
property taxes by around 82 percent. This does not even include the 
money Texas would now spend enforcing the Federal Government's new tax 
laws. This added cost would fall most heavily upon Americans whose 
paycheck is largely spent on housing. Rental rates would increase, and 
between losing their mortgage tax exemption and the increase in 
property tax rates, lower and middle income homeowners may be unable to 
pay for their current housing.
    I've read the arguments about how the Texas State government 
already pays taxes to the U.S. Government. Any reputable economist 
would acknowledge that employees of the State government are the ones 
who pay in the form of their income and payroll taxes. Unless the Texas 
State government offsets its new tax burden by cutting State employees 
wages, it would have to increase its property taxes.
    The biggest question is not how this proposal impacts big or small 
businesses or State governments, but rather, how does this proposal 
affect average Americans?
    This proposal would crush seniors in my district. Currently seniors 
pay little or no income tax, spending from their savings and pensions. 
The most horrifying tax increase will be upon them. Seniors will surely 
be surprised to see the price of all their goods rise by 30 percent, 
and appalled as the cost of medication and health care also increase by 
the same percentage. Many seniors currently find it very hard to 
balance their budgets. This policy would make that task impossible.
    Even with a reasonable exemption, this policy would amount to a tax 
increase on the poorest Americans. Under current law, the refundable 
earned income tax credit actually provides income subsidies to the 
poorest Americans. This essentially gives them a negative tax rate, 
meaning the government pays them more than they pay in taxes. Current 
provisions in this bill aim to give these Americans a zero percent tax 
rate, ignoring secondary effects from increased rental rates. Even with 
this optimistic assumption, it still amounts to a tax increase.
    The richest Americans would benefit from this policy. If someone 
has the means to own two Ferraris, he or she likely has the ability to 
put more money into investments or the bank. All that money would go 
untaxed in a National Retail Sales Tax scheme. Some people estimate 
that their tax rates would drop to as low as 5 percent, while many less 
well-off Americans would experience rates much closer to 30 percent.
    Even if one grants generous assumptions about how well poorer 
Americans would do under this proposal, one must ask where the tax 
burden falls if the rich go untaxed and the poor go untaxed. We talk a 
lot in this body about helping the middle class, but it is very clear 
that this proposal means bad news for the middle class. Ultimately, the 
consequences of a National Sales Tax are burdens that come to rest on 
the shoulders of America's working families. I hope the members of this 
committee will agree we must not be the ones to put them there. Thank 

    Chairman Nussle. Please proceed.


    Mr. Sandlin. Thank you, Mr. Chairman. Mr. Chairman, I 
wholeheartedly support meaningful efforts to reform our tax 
system to reduce a comparatively extreme burden and to ensure 
efficiency combined with ease. We need to focus our efforts on 
reforming our Nation's revenue generation in ways that ease the 
burden on working families and small businesses, are fiscally 
responsible and realistic, and provide a foundation for solid 
economic growth.
    Along those lines, I would like to comment for just a 
moment this morning on H.R. 25, the national retail sales tax. 
The unquestioned reality is that consumption taxes such as the 
national retail sales tax proposed in H.R. 25 are 
extraordinarily regressive and punitive on the vast majority of 
working families. Far from providing the much touted relief, 
the national retail sales tax would dramatically increase the 
effective tax rate on at least 60 percent of American working 
families, while simultaneously dramatically decreasing the 
effective tax rate on the 20 percent of Americans who earn the 
most money.
    An additional problem arises from the proposal embodied in 
H.R. 25 because the tax increase imposed on the 60 percent of 
American working families is based on excessively rosy revenue 
assumptions of its proponents. The reality of the scope of the 
tax increase under H.R. 25 is likely far worse, according to 
most experts. According to the Joint Committee on Taxation, the 
23 percent tax inclusive rate is not revenue-neutral and, in 
fact, grossly understates the national retail sales tax rate 
required to maintain current services.
    The JCT estimate suggests that the actual rate required to 
maintain revenue neutrality under the H.R. 25 proposal would 
exceed 50 percent. Economists agree that the rate proposed in 
H.R. 25 will have extraordinarily deleterious economic effects 
on the Federal tax burden and household budgets of our Nation's 
working families.
    Despite its proponents' claims, H.R. 25 is anything but 
pro-family and pro-business and pro-growth; it amounts to a 
massive tax increase on a clear majority of Americans.
    Under current law, effective tax rates start low and 
increase as income goes up. Accordingly, at present, the 
effective Federal tax rate on the lowest 20 percent of earners 
is around 5 percent, while the top 1 percent of earners, 
individuals making in excess of $315,000 per year, have an 
effective Federal tax rate of 25 percent. By contrast, under 
H.R. 25 as introduced, at minimum--and this is based on the 
assumption that H.R. 25 is revenue-neutral, which is almost 
certainly not the case--60 percent of American workers would 
experience a Federal tax increase, in many cases a dramatic 
increase, while the top 1 percent of earners would see their 
effective Federal tax burden drop to 5 percent.
    Under current law, a family of four is exempt from the 
Federal income tax until their household income exceeds 
$40,000. Thanks to the earned income tax credit, a family of 
four with an income below $25,000 does not even bear the burden 
of payroll taxes and is in effect exempt from all Federal 
earnings taxes. By contrast, under H.R. 25 as introduced, these 
lower income working families would experience dramatically and 
potentially devastating Federal tax increases. Instead of being 
virtually exempt from Federal tax, these families would see 
fully 30 percent of every dollar of their income over $19,000 
eaten away by the national retail sales tax. For hardworking 
families such as these, who are already struggling, such a tax 
increase would push many over the edge and into bankruptcy.
    Even working families with moderately higher incomes would 
see their Federal tax burden increase dramatically if H.R. 25 
were enacted. A home-owning family of four with a household 
income of $65,000, and more or less typical expenses and 
savings patterns, would see its Federal tax more than double, 
from $4,417 under current law to $9,600 under the proposed 
national retail sales tax embodied in H.R. 25.
    Tax affects not only individuals, but also local and State 
governments. In Texas, H.R. 25 would cost State and local 
governments $20 billion per year, which according to one 
estimate could require property tax increases of up to 80 
    Again, there is no doubt that our Tax Code is riddled with 
complexity and must be simplified. But there is just as little 
doubt that increasing the Federal tax burden on the vast 
majority of working Americans is not an appropriate solution to 
that problem. That is exactly what the national retail sales 
tax proposed in H.R. 25 would do.
    Thank you, Mr. Chairman. Appreciate the opportunity to be 
before your committee this morning.
    Thank you, Mr. Spratt.
    [The prepared statement of Mr. Sandlin follows:]

  Prepared Statement of Hon. Max A. Sandlin, Jr., a Representative in 
                    Congress From the State of Texas

    Mr. Chairman, Ranking Member Spratt, distinguished members of the 
committee, colleagues--current and former--I first want to thank you 
for affording me the opportunity to appear before the committee today 
to address one of the most important issues within the jurisdiction of 
    More often than not, the debates on the floor of the House and in 
the committee rooms revolve around defending our nation against the 
threat of terrorism at home and abroad, the education of our children, 
access to health care for the uninsured, improving health coverage for 
our nation's seniors, ensuring that our nation's highways and 
infrastructure are adequately improved and maintained, enhancing the 
opportunity of our nation's working families, or protecting our 
environment. All of these are without question noble goals and worthy 
of debate. However, the common thread running through each and everyone 
of these issues is the fundamental question: How do we pay for it?
    The Constitution confers original authority over this question on 
this, the People's House, in Article I, Section 7: ``All Bills for 
raising Revenue shall originate in the House of Representatives * * 
*.'' Accordingly, it is fitting that we gather today to discuss several 
options for raising the revenue needed to fulfill our constitutional 
admonition to ``establish Justice, insure domestic Tranquility, provide 
for the common defence, promote the general Welfare, and secure the 
Blessings of Liberty'' for the American people.
    For more than 10 years, my friends on the other side of the aisle 
have made tax reform and simplification a cornerstone of their economic 
program. Their commitment to this notion is one with which I 
wholeheartedly agree. Their expertise and understanding of many of 
these issues is indeed admirable. However, for all their effort, they 
seem to have fallen far short.
    There can be little doubt that taxpaying American citizens and 
businesses--particularly small businesses--spend far too much time not 
just preparing their tax returns and paying their taxes, but in even 
figuring out just how to file, which forms to fill out, what tax 
preferences they qualify for, what they can deduct, and what elections 
they should make to best serve their personal needs or the interests of 
their family, business and employees. The need for simplification is 
something on which we can all agree.
    On top of that is the anxiety that all taxpayers experience when 
confronting the daunting complexity of the Tax Code and trying to make 
sound tax-planning decisions with the prospect of taking a wrong turn 
in a mind-numbing maze that makes tax lawyers and accountants shudder.
    In January 1996, then Speaker Newt Gingrich stated, ``The Tax Code 
has over the years become increasingly politicized and is seen less as 
a simple tool for raising revenue than as an instrument for social and 
economic engineering * * * exponentially increasing the complexity of 
the Code * * *. The current system is indefensible. * * * Today's Tax 
Code is so complex that many Americans despair that only someone with 
an advanced degree in rocket science could figure it out. They are 
wrong. Even a certified genius such as Albert Einstein [would have] 
needed help in figuring out his Form 1040.''
    Such complexity is both unnecessary and unhealthy for the taxpayer 
and our nation's economy. Accordingly, let me be clear. I 
wholeheartedly support meaningful efforts to reform our tax system to 
reduce a comparatively extreme burden and to ensure efficiency combined 
with ease. We need to focus our efforts on reforming our nation's 
revenue generation in ways that (1) ease the burden on working families 
and small business, (2) are fiscally responsible and realistic, and (3) 
provide a foundation for solid economic growth.
    Nine years ago, then Ways & Means Committee Chairman Bill Archer 
declared his intention to ``tear out the income tax by its roots and 
discard it and replace it with a new form of taxation.'' Just 3 years 
ago, continuing this theme, Majority Leader DeLay derided the ``mind-
numbing complexity'' of the Tax Code and declared his intention to make 
the Code ``fairer, flatter, simpler and less burdensome on the American 
    Again, easing the burden our Tax Code imposes on working families 
and small business is a worthwhile goal, and I will gladly join with my 
colleagues in working toward that end. However, the proposals that have 
gained the most popularity and attracted the most attention of late are 
neither realistic nor fair. They may represent a ``new form of 
taxation'' and have a ``flatter'' rate structure, but they are hardly 
``fairer, simpler * * * [or] less burdensome.''
    The unquestioned reality is that consumption taxes, such as the 
national retail sales tax proposed in H.R. 25, are extraordinarily 
regressive and punitive of the vast majority of working families. Far 
from providing the much-touted relief, a national retail sales tax 
would dramatically increase the effective tax rate on at least 60 
percent of American working families, while simultaneously dramatically 
decreasing the effective tax rate on the 20 percent of Americans who 
earn the most money.
    An additional problem arises from the proposal embodied in H.R. 25, 
because the tax increase imposed on 60 percent of American working 
families is based on the excessively rosy revenue assumptions of its 
proponents. The reality of the scope of the tax increase under H.R. 25 
is likely far worse. According to the Joint Committee on Taxation, the 
23 percent tax-inclusive rate (30 percent tax-exclusive) is not revenue 
neutral and, in fact, grossly understates the national retail sales tax 
rate required to maintain current services.
    The JCT estimate suggests that the actual rate required to maintain 
revenue neutrality under the H.R. 25 proposal would exceed 50 percent. 
Economists agree that the rate proposed in H.R. 25 will have 
extraordinarily deleterious economic effects on the Federal tax burden 
and household budgets of our nation's working families, many sectors of 
our business community, and the American economy overall. Despite its 
proponents' claims, H.R. 25 is anything but pro-family and pro-growth. 
It amounts to a massive tax increase on a clear majority of Americans.
    Under current law, effective tax rates start low and increase as 
income goes up. Accordingly, at present, the effective Federal tax rate 
on the lowest 20 percent of earners is around 5 percent, while the top 
1 percent of earners--individuals making in excess of $315,000 
annually--have an effective Federal tax rate of 25 percent.
    By contrast, under H.R. 25 as introduced, at minimum, 60 percent of 
American workers would experience a Federal tax increase--in many 
cases, a dramatic increase--while the top 1 percent of earners would 
see their effective Federal tax burden drop to 5 percent.
    When the 60 percent of American workers with the least income would 
experience a substantial Federal tax increase, as they would under H.R. 
25, that is hardly the ``relief'' American taxpayers deserve, and it 
certainly is not the reform or simplification we should be considering 
    When we focus on consumption-based tax systems, particularly as a 
replacement for a graduated, progressive income tax, we are really 
asking ourselves ``which middle class tax increase do we prefer?'' For 
my part, I believe middle-income working Americans have suffered enough 
and deserve relief and reform that benefit their household budgets--not 
so-called ``reform'' that punishes their hard work, rewards wealth that 
will be increasingly difficult for working families to obtain, and 
significantly widens the opportunity gap.
    On Monday, in Des Moines, IA. President Bush signed bipartisan 
legislation that continues the tax relief for working families we 
passed in 2001. I was proud to support that legislation in 2001 and in 
2004, because it provides directed and meaningful relief for American 
taxpayers who very much need it. It extends the $1,000 child tax 
credit, marriage penalty relief and the expanded 10 percent tax 
bracket. As a consequence, according to the President, 7 million low-
income families will see an increase in their child tax refunds, and 
``94 million Americans will have a lower tax bill next year, including 
70 million women and 38 million families with children.''
    That's genuine tax relief. That is what we should be doing for the 
American people.
    Yet today we gather to consider tax reform proposals that would 
deny working families with children their personal exemptions, the 
child tax credit, the earned income tax credit, and the mortgage 
interest deduction.
    Under current law, a family of four is exempt from the Federal 
income tax until their household income exceeds $40,000. Thanks to the 
earned income tax credit, a family of four with an income below $25,000 
does not even bear the burden of payroll taxes. By contrast, under H.R. 
25 as introduced, these lower income working families would experience 
dramatic and potentially devastating Federal tax increases; instead of 
being virtually exempt from Federal tax, these families would see fully 
30 percent of their income over $19,000 eaten away by the national 
retail sales tax. For hard working families such as these, who are 
already struggling to survive, such a tax increase would push many over 
the edge and into bankruptcy. America's hard working families deserve 
much better.
    Even working families with moderately higher incomes would see 
their Federal tax burden increase dramatically if H.R. 25 were enacted. 
A home-owning family of four with a household income of $65,000 and 
more or less typical expenses and saving patterns would see its Federal 
tax more than double from $4,417 under current law to $9,600 under the 
proposed national retail sales tax embodied in H.R. 25. A similar 
family of four with a household income of $130,000 would see its 
Federal tax liability jump more than 50 percent from around $17,000 
under current law to $27,000 under the tax plan proposed by H.R. 25.
    Again, there is no doubt that our Tax Code is riddled with 
complexity and must be simplified, but there probably is equally no 
doubt that increasing the Federal tax burden on the vast majority of 
working Americans is absolutely not an appropriate solution to that 
problem. That is exactly what the national retail sales tax proposed in 
H.R. 25 would do.
    I would call on the committee to consider just a few of the 
extraordinarily adverse impacts H.R. 25 would have on the American 
people and economy.
    The national retail sales tax as proposed by Mr. Linder would 
impose a huge unfunded mandate on State and local government well in 
excess of $300 billion in the first year alone, because State and local 
governments would not be exempt from paying the tax proposed by H.R. 
25, except with respect to education-related expenditures. Accordingly, 
every time a State or municipal government buys a new fire truck or 
improved communications equipment for its law enforcement agencies, 
they will have to pay a 30 percent Federal tax on those purchases. Such 
increased costs will either lead to the financial ruin of our State and 
local governments or require significant increases in State and local 
taxes to make up the difference. In my home State of Texas, enactment 
of H.R 25 would cost State and local governments $20 billion per year, 
which, according to one estimate, could require property tax increases 
of up to 80 percent. Under H.R. 25, ``simplification'' of our Federal 
tax system would lead to dramatic tax increases at the State and local 
level. I have every confidence that proponents of the national retail 
sales tax will have a hard time convincing Texans that H.R. 25 is a 
good idea.
    The passage of H.R. 25 would lead to huge tax increases on our 
nation's seniors and effectively require them to pay twice for their 
Social Security and Medicare benefits. Moreover, such consumption taxes 
would have particularly harsh effects on seniors who live on their 
lifetime savings, monies on which they have already paid Federal taxes, 
because they will now be required to pay a new, much higher Federal tax 
each time they buy a prescription, see a physician, fill up their car, 
or go to the grocery store.
    H.R. 25 imposes a new 30-percent Federal tax on health insurance, 
health care services, the purchase of new houses, housing rents, and 
energy, virtually all of which are not presently subject to Federal 
tax. Accordingly, a person's $100 monthly health insurance premium will 
now be $130. His $1,000 monthly rent will now rise to $1,300. At 
current prices, every gallon of gasoline he consumes will go up 60 
cents. Moreover, a portion of the interest payments families pay on 
their mortgages, instead of being allowed as a deduction from their 
income, will be subject to a new, 30-percent Federal tax.
    H.R. 25 will deal a double blow to our nation's charitable 
institutions. First, under current law, they are exempt from Federal 
tax; that exemption is eliminated under H.R. 25, and their costs will 
increase concomitantly, thereby reducing their ability to serve the 
communities and missions to which they are dedicated. Second, under 
current law, Americans have an incentive to contribute to their 
churches, schools and other charitable agencies: they can deduct those 
contributions from their income. Under H.R. 25, that incentive is 
stripped away, a potentially crippling blow to charities that often 
barely survive as it is.
    Automakers and homebuilders will suffer an extreme setback if the 
national retail sales tax proposed by H.R. 25 becomes the law of the 
land. Consumers will rethink purchasing new cars when the reality that 
a $15,000 car they thought they could afford, becomes an out-of-reach 
$19,500 car after the national retail sales tax is tacked on. Domestic 
production of new cars will be decimated. Those along the southern and 
northern borders will be advantaged, however, as they will be able to 
go to new car dealers in Canada and Mexico and purchase their new cars 
without being subject to the national retail sales tax.
    Moreover, the impact on new home sales will be equally negative; a 
new $200,000 home will now cost $260,000, which is quite a different 
proposition for many young families. Add to that the fact that those 
families, under H.R. 25, will both lose the mortgage interest deduction 
and pay a new Federal tax on their mortgage payments. The effect on our 
nation's new home market will be dramatic to say the very least--and 
not in a positive way.
    Our nation's farmers will also face an unsustainable situation, 
which will likely lead to the elimination of one of our nation's most 
important institutions--the family farm. Under current law, family 
farmers buy seeds and feed--the factors of farm production--and are 
able to deduct those expenses for purposes of calculating their annual 
Federal tax bill. In years when nature works against them--crop loss, 
drought, disease--farmers may account for those losses against future 
income, which, in good years, serves to reduce their tax liability and 
make them whole.
    Under H.R. 25's national retail sales tax, family farmers face an 
entirely different reality. They will be forced to pay this new Federal 
consumption tax on every packet of seeds, pound of feed, and bag of 
fertilizer. The national retail sales tax is an upfront cost for 
farmers. If it's a good year, then they will have merely dealt with a 
dramatic tax increase; by contrast, in a bad year, all those costs will 
be lost with no allowance for prior or future year offsets. In sum, for 
family farmers who already struggle to make it, H.R. 25 will be a 
perfect storm that will drive far more into bankruptcy. The traditional 
family farm is likely unsustainable under H.R. 25's national retail 
sales tax.
    Other sectors of the economy that benefit from tax preferences 
under current law will also be dealt a serious blow should H.R. 25 
become law. Under its national retail sales tax proposal, developers of 
affordable housing and renewable energy projects, among others, will 
face a retroactive repeal of the tax credits that provided the 
incentive for those entrepreneurs to take those business risks.
    In sum, H.R. 25 is regressive. It punishes working families in our 
society with dramatic tax increases. While proposed as a means of tax 
simplification, the national retail sales tax proposed by H.R. 25 is 
neither simple nor fair. Moreover, the assumptions underlying it are 
terribly flawed. Virtually every economist and tax authority agrees 
that such a national retail sales tax would create extraordinary 
problems of administration and enforcement. Moreover, while H.R. 25 
proposes a tax-inclusive rate of 23 percent (30 percent tax-exclusive), 
the Joint Committee on Taxation acknowledges that as a gross 
understatement of the real rate required to maintain revenue 
neutrality; some estimates set the rate as high as 57 percent. If, as 
has been demonstrated, the 30 percent rate provided for in H.R. 25 
represents a tax increase on at least 60 percent of America's families, 
then doubling that would be economically devastating and is totally 
politically untenable. Making matters worse, H.R. 25 allows for no 
evasion, no avoidance, and no statutory base erosion. It is not rooted 
in reality.
    We need reform. We need fundamental tax reform. However, we do not 
need more cynical, unworkable, election-year plans that create a world 
of losers in a redistribution whirlpool without any real gains in 
economic efficiency or fiscal responsibility. H.R. 25 represents 
radical reform, but it is reform of the worst kind--reform with 
virtually no winners and a sea of economic casualties.
    Thank you again for the opportunity to testify this morning. I look 
forward to continuing to work with my colleagues on both sides of the 
aisle to enact meaningful, workable, pro-growth tax reform and 

    Chairman Nussle. Did the gentleman have a proposal for 
reform? We will mark you down as against H.R. 25, I guess is 
what your point is.
    Mr. Sandlin. Yes, Mr. Chairman. We were here this morning 
and I was commenting on H.R. 25. I don't have a particular 
proposal at this time other than to comment on H.R. 25 would be 
a simplification, but it would be an increase and a tax burden 
on working families and local government and small business, 
and I don't think it is a viable alternative to the current 
progressive system that we have. So I think Mr. Linder's 
proposal should not be considered. While we certainly should 
consider some sort of simplification of the current code, this 
isn't an acceptable alternative.
    Chairman Nussle. OK. We will mark you down.
    Mr. English, colleague from the Ways and Means Committee 
from Pennsylvania. We are pleased to receive your testimony.


    Mr. English. Thank you, Mr. Chairman. It is a real 
privilege to be here this morning.
    Mr. Chairman, the American tax system is a Frankenstein's 
monster that haunts individual taxpayers while casting a cold 
shadow over the productive sectors of the U.S. economy. It is 
too complicated, it is riddled with obvious inequities, it 
punishes savings and investment while reducing economic growth 
and burdening domestic industries struggling to remain 
    To address these inequities, and because I want to reform 
the American tax system in a way that makes sense to average 
tax citizens, I introduced the Simplified USA Tax Act, H.R. 
269. Not only do we need a Tax Code that is fair and simple, we 
need one that is stable. As bad, as awful as the current Tax 
Code is, and I am one of its severest critics, the last thing 
we need to do is enact some reform that is so radical and 
experimental that we have to redo it all over again a few years 
hence. The new Tax Code I have developed, the Simplified USA 
Tax, is based on sound and familiar principles that are easy to 
understand and will provide the correct incentives for today's 
modern economy.
    Although the Joint Committee on Taxation has never 
completed a revenue score of SUSAT, it is designed to be 
    The USA Tax for individuals is simplicity itself, a 
minimalist approach that achieves a great deal without a lot of 
complex rules. In terms of past studies of the complexity of 
this system, they have indicated it would reduce the complexity 
of the current tax system by 75 percent, as opposed to 91 
percent for the flat tax. In addition to providing a simple way 
to calculate taxes, the USA Tax brings several key reforms to 
the table.
    First, the Tax Code must give Americans a fair opportunity 
to save part of their earnings. Thrift has helped to provide 
Americans the security and independence that is the foundation 
of freedom. Productivity raises our living standards to the 
highest in the world.
    In my tax reform proposal, USA stands for unlimited savings 
allowance. Everyone is allowed an unlimited Roth IRA in which 
they can put the portion of each year's income they save after 
paying taxes and living expenses. After 5 years, all money in 
the account can be withdrawn for any purpose and all 
withdrawals, including accumulated interest and other earnings 
or principal, are tax free.
    Nothing can be simpler and nothing would give people a 
better opportunity to save, especially young people.
    The Tax Code must also give everyone the opportunity to 
keep what they save and, if they wish, to pass it on to 
succeeding generations. My tax reform proposal repeals the 
Federal estate and gift taxes permanently.
    Under the new Tax Code, tax rates must be low, especially 
for wage earners who now pay both an income tax and a FICA 
payroll. The Simplified USA Tax starts out with low tax rates: 
15 percent at the bottom, 25 percent in the middle, 30 percent 
at the top. Then the rates are reduced even further by allowing 
wage earners a full tax credit for the FICA payroll tax that 
they pay that is withheld from their paychecks under current 
law. I don't propose to repeal the payroll tax because of its 
impact on the Social Security system, but the Simplified USA 
Tax would provide tax relief for all Americans, especially who 
own their home, give to their church, educate their children, 
and set aside some savings for a better tomorrow. What we 
anticipate under this tax system is very low tax rates on 
workers' wages, in the 7-17 percent range for nearly all 
    Under my proposal, everyone gets a deduction for the 
mortgage interest on their home and for charitable 
contributions they make. We also provide for a deduction for 
tuition paid for college and post-secondary education. Generous 
personal and family exemptions are also allowed under my 
proposal. On a joint return, the family exemption is a little 
over $8,000, and there is an additional $2,700 exemption for 
each member of the family. Thus, a married couple with two 
children pays no tax on their first $18,940 of income.
    This tax is simplicity itself. The tax return will be 
short, only a page or two for most of us. But more to the 
point, the tax return will be comprehensible.
    In summing up, I also want to make the point my proposal 
contains a better and new way of taxing corporations and other 
businesses that will allow them to compete and win in global 
markets in a way that exports American made products, not 
American jobs. I have studied this issue and I believe, if 
enacted in America, this innovative approach to business 
taxation will soon become the worldwide standard to which all 
other countries subscribe. In a nutshell, it is a simple 
subtraction method value-added tax on the business side that 
would provide full expensing and also, importantly, border 
adjustability so that our products, as they go offshore, do not 
contain the cost of the tax system built in; and as we import 
products, they will pay their share of taxation.
    I believe that this is a huge reform and potentially a 
hybrid of several of the other systems, including the flatter 
tax that have been proposed and also the consumption tax, 
because this system has all of the incentives of a consumption 
    I apologize to my colleagues, though, for one. This tax 
reform will not fit on a bumper sticker. I realize it will 
require a certain amount of salesmanship, but I do believe it 
has the potential to provide America with a modern tax system 
that will allow our economy to grow, savings to grow, 
investment to grow, productivity to grow, and improve our trade 
    I thank you, Mr. Chairman.
    [The prepared statement of Mr. English follows:]

 Prepared Statement of Hon. Phil English, a Representative in Congress 
                     From the State of Pennsylvania

    Thank you Chairman Nussle, Ranking Member Spratt and members of the 
committee for the opportunity to appear before this committee today.
    The American tax system is a Frankenstein's monster that haunts 
individual taxpayers while casting a cold shadow over the productive 
sectors of the U.S. economy. It is too complicated, and riddled with 
obvious inequities. It punishes savings and investment, while reducing 
economic growth and burdening domestic industry struggling to remain 
    To address these inequities and because I want to reform the 
American tax system in a way that makes sense to average citizens, I 
introduced the Simplified USA Tax Act, H.R. 269. Not only do we need a 
Tax Code that is fair and sensible, we need one that is stable. As bad 
as the current Tax Code is--and I am one of its severest critics--the 
last thing we need is to enact some reform that is so radical and 
experimental that we may have to redo it all over again a few years 
later. The new Tax Code I have developed--the Simplified USA Tax Act or 
``SUSAT''--is based on sound and familiar principles that are easy to 
understand and will provide the correct incentives for today's economy.
    Although the Joint Committee on Taxation had never completed a 
revenue score of SUSAT, it was designed to be revenue neutral.

                           TAXING INDIVIDUALS

    The USA Tax for individuals is simplicity itself; a true minimalist 
approach that achieves a great deal without a lot of complex rules. In 
addition to providing a simple way to calculate taxes, the USA tax 
brings several key reforms to the table.
    First, the Tax Code must give Americans a fair opportunity to save 
part of their earnings. Thrift has helped provide Americans the 
security and independence that is the foundation of freedom. Savings 
buys the tools to make Americans more productive. Productivity raises 
our living standards to the highest in the world.
    In my tax reform proposal, ``USA'' stands for unlimited savings 
allowance. Everyone is allowed an unlimited Roth IRA in which they can 
put the portion of each year's income they save after paying taxes and 
living expenses. After 5 years, all money in the account can be 
withdrawn for any purpose and all withdrawals--including accumulated 
interest and other earnings or principal--are tax free.
    Nothing can be simpler and nothing could give the people a better 
opportunity to save; especially young people. Because only new income 
earned after enactment of the Simplified USA Tax can be put into the 
USA Roth IRA, young people starting to move into their higher-earning 
years are the ones who will benefit the most for the longest time.
    The Tax Code must also give everyone the opportunity to keep what 
they save and, if they wish, to pass it along to succeeding 
generations. To that end, my tax reform proposal repeals the Federal 
estate and gift taxes.
    Under the new Tax Code, tax rates must be low; especially for wage 
earners who now pay both an income tax and a FICA payroll tax on the 
same amount of wages. The Simplified USA Tax starts out with low tax 
rates--15 percent at the bottom, 25 percent in the middle, and 30 
percent at the top. Then, the rates are reduced even further by 
allowing wage earners a full tax credit for the 7.65 percent Social 
Security and Medicare payroll tax that is withheld from their paychecks 
under current law. I do not propose to repeal the payroll tax because 
to do so would imperil Social Security, but I do allow a credit for it 
and when the credit is taken into account, the rates of tax on workers' 
wages are very low indeed--in the 7 percent to 17 percent range for 
nearly all Americans.
    The Simplified USA Tax provides tax relief for all Americans, 
especially those who own their home, give to their church, educate 
their children and set aside some savings for a better tomorrow. Under 
my proposal, everyone gets a deduction for the mortgage interest on 
their home and for charitable contributions they make. In addition--and 
this is brand new and long overdue in my opinion--the USA plan allows a 
deduction for tuition paid for college and post-secondary vocational 
education. The annual limit is $4,000 per person and $12,000 for a 
    Generous personal and family exemptions are also allowed under my 
proposal. On a joint return, the family exemption is $8,140 and there 
is an additional $2,700 exemption for each member of the family. Thus, 
a married couple with two children pays no tax on their first $18,940 
of income.
    The Simplified USA Tax is simplicity itself. The tax return will be 
short, only a page or two for most of us, but more to the point, the 
tax return will be understandable. For the first time in a very long 
time, America's tax system will make sense to the citizens who file the 
tax returns and pay the taxes.
    Since inception of the Federal income tax, Americans will have a 
full and fair opportunity to save whatever portion of their income they 
wish and for whatever purpose they wish. For the first time, working 
people will be allowed a credit for the payroll tax they pay, and also 
for the first time, families will have generous tax-free allowance for 
the education of their children.

                           TAXING BUSINESSES

    My proposal also contains a new and better way of taxing 
corporations and other businesses that will allow them to compete and 
win in global markets in a way that exports American made products, not 
American jobs. I have studied this issue and believe that, if enacted 
in America, this innovative approach to business taxation will soon 
become the worldwide standard to which other countries aspire.
    All businesses--corporate and non-corporate--are taxed alike at an 
8 percent rate on the first $150,000 of profit and at 12 percent on all 
amounts above that small business level. All businesses will be allowed 
a credit for the payroll tax they pay under current law.
    All costs for plant, equipment and inventory in the United States 
will be expended into the year of purchase. This is a major departure 
from our current, and frankly archaic, depreciation system, but a 
crucial element of the Simplified USA Tax.
    If they are to survive and prosper, American manufacturers must 
make big-dollar purchases of capital goods, but they need the lower 
cost and financing help that first-year expensing provides. If American 
manufacturers have state-of-the-art machinery and equipment, they will 
not only create high-paying jobs, they will be able to compete 
effectively with low-cost producers outside of the U.S.
    Since its enactment last March, the 30 percent expensing allowance 
followed by a 50 percent allowance stopped and reversed a 2-year 
decline in capital spending that was one of the worst in history. Every 
economic principle and every piece of data tells us that first-year 
expensing must be a major component of fundamental tax reform because 
it directly translates into high-paying manufacturing jobs and 
decreases the cost-of-capital thus making American companies more 
    Another key element of the business side of the Simplified USA Tax, 
is the way income earned outside of our borders is taxed. What we need 
to move toward--and what SUSAT embodies--is a system that does not tax 
foreign-source income on a worldwide basis or export sales of American 
made products and services.
    The absence of some type of border tax adjustments for exports of 
American made goods to correspond to the export rebates under foreign 
countries' Value Added Tax systems puts our businesses--manufacturers 
and eventually service providers--at a severe disadvantage. If anyone 
doubts the disadvantage American exporters are faced with, they should 
to look at our trade deficit of astronomical proportions. The trade 
deficit is so large in part because the relative cost of producing a 
good or service for export in the U.S. is much higher than in those 
countries that employ VAT or other consumption-tax systems.
    One of the underlying fundamental absurdities is that we currently 
condition territoriality on foreign subsidiaries reinvesting profits in 
foreign countries instead of repatriating the profits for investment in 
the U.S. In the least, the Tax Code should be amended to provide that 
investment in an active trade or business in the U.S. does not trigger 
U.S. tax any more than investment in France triggers U.S. tax.
    Under SUSAT, all export sales income is exempt, as is all other 
foreign-source income, and all profits earned abroad can be brought 
back home for reinvestment in America without penalty. Because of a 12 
percent import adjustment, all companies that produce abroad and sell 
back into U.S. markets will be required to bear the same tax as 
companies that both produce and sell in the United States.


    The Simplified USA Tax is a hybrid of the others we often hear 
about. This plan combines the biggest strengths of other mainstream tax 
proposals and most importantly, it does not contain their weaknesses.
    For too long the Tax Code has been a needless drag on the economy. 
That is unproductive as a national policy and more importantly, is 
unfair to those Americans whose living standards are lower because of 
it. For years, its complex inanities have been the object of ridicule. 
It is also the ultimate source of bureaucratic excess that is 
inconsistent with a free society.
    It is high time that we restore people's faith in the integrity and 
competence of their tax system and, in the process, take a major step 
toward restoring people's confidence in the good character of their 
    Thank you Chairman Nussle, Ranking Member Spratt and members of the 
committee for the opportunity to testify.

    Chairman Nussle. I thank the gentleman for his proposal.
    Next is a former member of the Budget Committee.
    I notice you didn't break out in hives when you walked in, 
so that is at least good news. Welcome back to the committee, 
and we are pleased to receive your testimony, Mr. Price.


    Mr. Price. Thank you, Mr. Chairman. It is good to be back.
    Mr. Spratt, other members, it is an honor to be able to 
testify before you today on this important topic.
    I would like to begin by saying there is no question in my 
mind that the U.S. Tax Code has become excessively complex and 
convoluted. I believe we probably would all agree on that, as 
would the American people. The IRS estimates it takes the 
average American 28 hours plus to complete a tax return. I 
believe most Americans actually would accept a basic tax reform 
bargain, that is, fewer deductions and credits in exchange for 
lower rates and a simpler system.
    And I would hope that with all the focus on taxes these 
past few years, Congress would have done something to simplify 
our Tax Code. Instead, the changes to the Tax Code during the 
past 4 years have made it more complex. I believe they have 
made it less fair.
    At the heart of the proposals before us today, the ones 
that you have been considering, is whether or not the United 
States will have a progressive or a regressive tax system. 
Particularly in the midst of a sluggish economic recovery, 
there are strong arguments for a progressive tax that puts more 
money in the hands of those most likely to spend it and 
stimulate the economy.
    But ultimately this is a debate about values. I was brought 
up believing that from those to whom much is given, much is 
expected. That principle at the heart of the progressive tax 
structure has guided our tax system through America's most 
prosperous economic years. A progressive tax is sound economic 
policy and it is indicative of an advanced and enlightened 
society where those who have reaped the benefits of living in a 
free, stable, and prosperous land understand their obligation 
to contribute to the common good.
    The problem with the flat tax and the sales tax being 
discussed today is that both violate the principle of 
progressive taxation, resulting in significant tax savings for 
the rich, significant tax increases for the poor and middle 
class. Such a redistribution of the tax burden is bad economic 
policy, and I believe it is ethically deficient as well, 
violating our common sense of equity and justice.
    Because of time constraints, I will focus my comments on 
the national sales tax, a proposal that has been introduced and 
has some 55 cosponsors, H.R. 25.
    Nationwide, only Americans in the top 20 percent of income 
would benefit from converting from an income tax to a national 
sales tax. Everyone else would see their tax burden increase by 
an average of 50 percent. Some national sales tax advocates 
have described the tax rates required in their proposals in a 
way that is simply misleading, creating an inaccurate 
perception that we could replace the current tax system with a 
national sales tax rate as low as 15 percent. It just isn't so.
    The Joint Tax Committee, the Brookings Institution, 
Citizens for Tax Justice, and the Institute on Taxation and 
Economic Policy have all stated that in order to keep Federal 
tax revenues constant, a 50 to 60 percent sales tax would be 
required. That is, a levy of $50 to $60 would be imposed on a 
$100 purchase.
    I would like to draw your attention to the chart on the 
screen, which shows the grossly unfair redistributive effects 
of what H.R. 25 would do in my home State of North Carolina. I 
know that the supporters of H.R. 25 claim that their bill's 
rebate would offset the regressive impact on the poor. So the 
numbers in the chart include all of the rebates and other 
assumptions in H.R. 25, with the only difference being that I 
am using a true revenue-neutral tax rate of 50 percent, which 
in fact is a conservative estimate.
    The reason the poor would be negatively affected by this 
type of proposal is that they would lose the earned income tax 
credit and other income tax rebates they have under the current 
system. In North Carolina, a working family in the bottom 20 
percent income bracket makes on average $9,100 a year. A 
national sales tax, assuming a 50 percent tax rate, including 
the rebate, but also eliminating the EITC, would increase their 
Federal tax burden by $4,214.
    For a family in the 20 to 40 percent income bracket making 
an average of $19,700 a year, this national sales tax would 
increase their tax burden by $4,013. For the middle 20 percent 
the average tax burden would increase by $3,811. For those in 
the 60-80 percent income bracket, the taxes would increase by 
$2,935. And even North Carolinians in the 80-95 percent income 
bracket, making up to $124,000, would see their taxes increase 
by an average of $600 a year.
    So why are we even considering a tax proposal that would 
significantly raise taxes on 9 out of 10 Americans? The answer 
to that question can be found by following the money. The 
proponents of a national sales tax cannot deny that if low-and 
moderate-income people are paying more in taxes, then other 
people must be benefitting by paying less. And we know who 
those people are. North Carolinians making between $124,000 and 
$333,000 would see their tax burden decrease by an average of 
$4,722 under a national sales tax under the terms of H.R. 25. 
And those making over $333,000 a year would see their tax 
burden decrease by an average of $151,268.
    Finally, here are a few concrete examples of how North 
Carolinians would be affected by a national sales tax. The 
median cost of a house in North Carolina last year was 
$110,000. A national sales tax would raise the cost of buying a 
new home in North Carolina to $165,000, while at the same time 
eliminating the significant home ownership tax incentive of 
being able to write off mortgage interest payments. It would 
raise the cost of a $20,000 new car to $30,000; it would raise 
a $100 grocery bill to $150; a $200 bill for medication to 
$300; and a gallon of gas from $2 to $3. And seniors would be 
especially hard hit because most are paying very little tax now 
because they have little or no income. But, instead, they are 
spending down their savings and, therefore, they would do much 
worse under the national sales tax than they do under our 
current system.
    Mr. Chairman, it boggles my mind to imagine that any 
legislator would even consider such a policy as H.R. 25. Yet I 
am sad to say that even some members of my own North Carolina 
delegation have expressed their support for this gross 
redistribution of the tax burden.
    This and other tax proposals being considered today I 
believe do not represent what is best for my constituents and 
my State, or what is best for the economy, or what is right, 
and I believe that as the elected representatives of the 
people, we can and should do much, much better. Thank you.
    [The prepared statement of Mr. Price follows:]

Prepared Statement of Hon. David E. Price, a Representative in Congress 
                    From the State of North Carolina

    It is an honor to be able to testify today before this committee. 
I'd like to begin by saying that there is no question in my mind that 
the U.S. Tax Code has become excessively complex and convoluted. The 
IRS estimates that it takes the average American over 28 hours to 
complete a tax return. I believe most Americans would accept a basic 
tax reform bargain: fewer deductions and credits for lower rates and a 
simpler system. And I had hoped that with all the focus on taxes these 
past few years, Congress would have done something to simplify our Tax 
Code. Instead, the changes to the Tax Code during the past 4 years have 
made it more complex and less fair.
    At the heart of the proposals before us today is whether or not the 
United States will have a progressive or regressive tax system. 
Particularly in the midst of a sluggish economic recovery, there are 
strong arguments for a progressive tax that puts more money in the 
hands of those most likely to spend it and stimulate the economy. But 
ultimately, this debate is about values.
    I was brought up believing that from those to whom much is given, 
much is expected. That principle, at the heart of a progressive tax 
structure, has guided our tax system throughout America's most 
prosperous economic years. A progressive tax is sound economic policy, 
and it is indicative of an advanced and enlightened society where those 
who have reaped the benefits of living in a free, stable, and 
prosperous land understand their obligation to contribute to the common 
    The problem with the flat tax and the sales tax being discussed 
today is that both violate the principle of progressive taxation, 
resulting in significant tax savings for the rich and significant tax 
increases for the poor and middle class. Such a redistribution of the 
tax burden is bad economic policy, and I believe it is ethically 
deficient as well, violating our common sense of equity and justice.
    Because of time constraints, I will focus my comments on the 
national sales tax. Nationwide, only Americans in the top 20 percent of 
income would benefit from converting from an income tax to a national 
sales tax. Everyone else would see their tax burden increase by an 
average of 50 percent.
    Some national sales tax advocates have described the tax rates 
required in their proposals in a way that is simply misleading, 
creating an inaccurate perception that we could replace the current tax 
system with a national sales tax rate as low as 15 percent. The Joint 
Tax Committee, the Brookings Institution, Citizens for Tax Justice, and 
the Institute on Taxation and Economic Policy have all stated that in 
order to keep Federal tax revenues constant, a 50-60 percent sales tax 
would be required--that is, a levy of $50 to $60 would be imposed on a 
$100 purchase.
    I'd like to draw your attention to the chart on the screen, which 
shows the grossly unfair redistributive effects of what HR 25 would do 
in my State of North Carolina. I know the supporters of HR 25 claim the 
bill's rebate will offset any regressive impact on the poor. The 
numbers in the chart include all of the rebates and assumptions in HR 
25 with the only difference being that I'm using a true revenue-neutral 
tax rate of 50 percent. The reason the poor would be negatively 
affected by this type of proposal is that they would lose the Earned 
Income Tax Credit and other income tax rebates they have under the 
current system.
    In North Carolina, a working family in the bottom 20 percent income 
bracket makes on average $9,100 a year. A national sales tax, assuming 
a 50 percent tax rate including the rebate but also eliminating the 
EITC, would increase their Federal tax burden by $4,214. For a family 
in the 20-40 percent income bracket making an average of $19,700 a 
year, this national sales tax would increase their tax burden by 
$4,013. For the middle 20 percent, their average tax burden would 
increase by $3,811. For those in the 60-80 percent income bracket, 
their taxes would increase by $2,935. Even North Carolinians in the 80-
95 percent income bracket, making up to $124,000 would see their taxes 
increase by $600 a year.
    So why are we even considering a tax proposal that would 
significantly raise taxes on 9 out of 10 Americans? The answer to that 
question can be found by following the money. The proponents of a 
national sales tax cannot deny that if low and moderate income people 
are paying more in taxes, then other people must be benefiting by 
paying less. North Carolinians making between $124,000 and $333,000 
would see their tax burden decrease by an average of $4,722 under a 
national sales tax, and those making over $333,000 would see their tax 
burden decrease by an average of $151,268.
    Here are a few concrete examples of how North Carolinians would be 
affected by a national sales tax. The median cost of a house in North 
Carolina last year was $110,000. A national sales tax would raise the 
cost of buying a new home in North Carolina to $165,000, while at the 
same time eliminating the significant home-ownership tax incentive of 
being able to write off mortgage interest payments. It would raise the 
cost of a $20,000 new car to $30,000. It would raise a $100 grocery 
bill to $150, a $200 bill for medication to $300, and a gallon of gas 
from $2.00 to $3.00.
    Seniors would be especially hard hit because most are paying very 
little tax now because they have no income, but instead are spending 
down their savings and therefore would do much worse under the national 
sales tax than our current system.
    It boggles the mind to imagine that any legislator would even 
consider such a policy, yet I am sad to say even some members of my own 
North Carolina delegation have expressed their support for this gross 
redistribution of the tax burden.
    The tax proposals being considered today do not represent what is 
best for my constituents and my state; they do not represent what is 
best for our economy; they do not represent what is right; and we as 
the elected leaders can and should do much, much better.

    Chairman Nussle. Thank you.
    My understanding is that Mr. Rangel, our final witness, is 
appropriately detained at the conference on FSC and the tax 
bill that is being discussed and negotiated. They are having a 
conference now. So I guess I would ask unanimous consent that, 
at this point in the record, Mr. Rangel would be allowed to put 
in written testimony, because I am sure he has some very 
interesting thoughts on this as well.
    [The prepared statement of Mr. Rangel follows:]

 Prepared Statement of Charles B. Rangel, a Representative in Congress 
                       From the State of New York

    Chairman Nussle and Congressman Spratt, I am very pleased to 
participate in your hearing on fundamental tax restructuring.
    I am rather surprised that these hearings are being held by this 
committee rather than the Committee on Ways and Means. Perhaps it is a 
recognition by this committee that only tax increases, disguised as 
fundamental tax reform, can address the long-term fiscal problems faced 
by our country.
    The Republicans took control of the House of Representatives in 
1994 with big promises to ``pull the Tax Code out by its roots'' and 
substitute a simpler, fairer tax system. Despite that rhetoric, the 
Republican Congress has enacted legislation since 1994 that has 
dramatically increased the complexity of our current tax system:
    According to the Internal Revenue Service, today it takes an 
average middle-income American family 7\1/2\ hours longer to fill out 
their Federal income tax return than it did in 1994, an increase from 
11\1/2\ hours in 1994 to 19 hours today.
    Since 1994, the Republican-controlled House of Representatives has 
successfully initiated 42 new laws with 3,533 changes to our Tax Code 
contained in more than 10,000 additional pages of complex public laws.
    Millions of Americans now are required to fill out two Federal 
income tax returns each April 15, the regular tax return and the 
alternative minimum tax (AMT) return. All of this complexity is due to 
the decision by the Bush Administration to use the AMT to take back 
many of the benefits promised in the big print of the 2001 Bush tax 
cut. Before the Republicans took control, only 369,000 individuals were 
subject to the AMT.
    President Bush has continued to complicate our tax law. Even 
conservative economist Bruce Bartlett concedes that ``over the past 
three and a half years, Bush has made the Tax Code more complicated.''
    Now it appears that the Republican House Leadership intends to use 
the complexity of our current system, much of which they are 
responsible for, to argue for tax reform.
    Frankly, I enthusiastically support efforts to reform and simplify 
our current system. I am hopeful that the rhetoric will be followed by 
action, unlike what has happened in the past. The only issue that may 
divide me and some of the other members of this panel is whether we 
should attempt to reform our current income tax system, or enact a new 
tax on consumption. Although our current tax system is too complex, I 
strongly dispute the notion that abandoning it in favor of a more 
consumption-based system is the magic cure-all.
    I think Representative Linder's national retail sales tax proposal 
(H.R. 25) is an especially bad idea and have detailed why in a recent 
report issued by my Ways and Means staff, which I submit along with 
this testimony. To summarize:
    It is extraordinarily regressive. The effective tax rates under 
Rep. Linder's bill would start at over 30 percent at the bottom of the 
income scale, and then decline to 5 percent at the very top. This is 
the reverse of the current law pattern of effective rates.
    The Linder bill would impose over $300 billion per year in unfunded 
mandates on State and local governments in the form of sales taxes on 
their purchases.
    It repeals all current-law deductions and credits, including 
current-law benefits for healthcare and housing.
    It repeals the charitable deduction at a time when the Republicans 
are attempting to place more burdens on the charitable sector.
    The other proposals for fundamental tax reform discussed at this 
hearing are essentially the same. They may be more complicated than 
Rep. Linder's bill, but they essentially are all taxes on consumption, 
and they all are quite regressive. Any doubt over their regressivity 
was eliminated when one of the architects of the Armey flat tax (who 
will be on the panel of economists) described the flat tax as ``a 
tremendous boon for the economic elite.''
    Rep. Linder's bill and Rep. English's bill also dramatically change 
the nature of our Social Security system. Both essentially repeal the 
current payroll taxes used to fund the Social Security system. They 
replace the revenue through new consumption taxes.
    These taxes will place large burdens on the elderly since they 
apply to all goods and services, including healthcare, long-term care, 
and prescription drugs. Essentially, the elderly will be forced to pay 
twice for their Social Security and Medicare benefits, once during 
their working years, and again when they purchase goods and services in 
their retirement.
    I believe that everyone should examine with care the studies 
conducted by the Treasury Department during the Reagan Administration. 
Those studies considered several different alternatives for tax reform, 
including consumption tax proposals very similar to the ones being 
proposed today.
    The conclusion of the study insofar as a retail sales tax is 
concerned was straightforward:
    ``Because if its inherent regressivity, a Federal, value-added tax, 
or other form of general sales tax, should not be adopted as a total 
replacement for the income tax the disadvantages are regressivity, a 
one time increase in prices, Federal intrusion into the sales tax area, 
and compliance costs of a new Federal sales tax.''
    All other consumption tax proposals also were rejected by the 
Reagan Treasury Department, and I believe that an objective analysis of 
the various consumption tax proposals being discussed today would reach 
conclusions similar to the Reagan Administration.
    Therefore, I believe that instead of talking about a radical and 
frankly unrealistic switch to a broad-based consumption tax, we should 
begin the difficult task of reforming our current income tax system.

    Chairman Nussle. Are there questions for our panel of 
witnesses that remain? I know there are members that had to 
leave, but are there any questions for these witnesses?
    Mr. Spratt.
    Mr. Spratt. Mr. Price, let me just make clear your 
testimony. Is it your understanding that the correct rate of 
sales taxation is 30 percent per the advocates? They 
acknowledge that what you would really be paying is 30 percent. 
In other words, under their proposal, if I bought a shirt for 
$10 and paid, I would have to pay, under their tax, $13 with 
the sales tax added. They then convert that to 23 percent by 
taking the $13 and claiming that the right number to derive is 
what percentage of 13 is the total tax, and that is 23 percent. 
But, in truth, the add-on to the price you would pay at the 
retail counter is 30 percent.
    Mr. Price. That is correct. And I stress that this is the 
advocates' own estimate. The estimates from objective analysts 
is much higher. But even from the advocates' own standpoint, 
the rate is 30 percent. They are using a tax-inclusive rate in 
citing 23 percent. That is not the way anybody I know 
calculates a sales tax.
    Mr. Spratt. They propose to repeal the individual income 
tax, the corporate income tax, the State and gift taxes, and 
FICA, payroll tax and all. So this is $1.9 trillion, probably. 
It is virtually all of the tax base, and, consequently, their 
consumption base to which this sales tax applies has to be 
extremely broad and all-inclusive also.
    Mr. Price. That is right. Almost nothing is left out. As a 
matter of fact, this 30 percent rate wouldn't be even close to 
being revenue-neutral. But from their own standpoint it is 30 
    Mr. Spratt. The base includes new homes, new cars. In our 
State new cars are at least exception. New homes aren't taxed. 
I am not aware of any place in the United States where new 
homes are subject to a sales tax. But this would subject a new 
home, if you had a home priced at $200,000, you would have to 
pay $260,000 for it under their proposal. Medical care, which 
in most places is not taxes; electricity, a big rate increase; 
    And then this comes as a surprise to many people. In order 
to have a sufficient consumption base to which to apply this 
tax so you can replace all of the taxes they would repeal, you 
have to tax State and local government expenditures under H.R. 
25. Is that your understanding?
    Mr. Price. That is right. National defense expenditures are 
subject to this tax, as are non-defense Federal expenditures. 
Veterans health care is subject to the tax; a whole range of 
things that I think haven't been discussed fully.
    Mr. Spratt. Notwithstanding McCulloch v. Maryland and all 
these other constitutional precedents about the Federal 
Government being able to tax the local government, this, for 
the first time, would impose a Federal tax, a sales tax on what 
county governments spend or State governments spend. In 
addition, it would impose a sales tax on what the Federal 
Government spends, on what the Pentagon spends. Hundreds of 
billions of dollars every year would be subject to taxation 
when the Defense Department spent that money.
    Now, there was one particular mistake of some magnitude 
that we will explore a little bit later when Dr. Gale comes 
here from The Brookings Institute, and that is in levying the 
tax on Federal expenditures, the proponents of a national 
retail sales tax acknowledge the receipt of income from levying 
that 30 percent tax, but they don't acknowledge the cost; the 
fact that if the Government receives the money with one hand, 
it will be paying it with the other hand. And, in fact, you 
either have to raise the rate to cover the additional cost or 
you have to cut Government spending by 30 percent.
    Do you know if any correction has been made in the sales 
tax to account for that anomaly?
    Mr. Price. No, I don't. It will be important to hear from 
Dr. Gale on this point. I understand that that mistake alone is 
a $500 billion mistake in calculating the amount of revenue we 
are talking about.
    Mr. Spratt. Let me show one last thing, which is a chart, 
then I will turn it over to other members to ask questions of 
their own. As to distribution, as to fairness, which I think is 
the cardinal objective, this is what a national retail sales 
tax would do. The bottom line is annual consumption, thousands 
of dollars. The bar charts measure the percentage increase in 
taxes for different income groups. For example, this would have 
no exemptions at all, so this is a sales tax that applies to 
everything. The shift in taxes paid for those who consume 
between $27,000 and $36,000 a year, modest income Americans, 
would be 59 percent. For those consuming between $36,000 and 
$54,000 per year, the increase in taxes would be 38 percent. 
You would have to get to a consumption level well above 
$135,000 a year, upper income Americans, before the sales tax 
became net-gainer. For the most part, for middle Americans and 
low-income Americans, this would be a huge shift in the tax 
burden from the wealthy to those who make wages.
    Does this comport with your own studies?
    Mr. Price. Yes, it does. The figures I quoted are slightly 
different because they refer to North Carolina, and there the 
average income is a bit lower than the national figure, but 
those are the correct national figures as far as I know.
    Mr. Spratt. Thank you very much.
    Chairman Nussle. Before you take that chart off, could you 
put it back up? Just so we are clear, that is before exemption?
    Mr. Spratt. Without exemption.
    Chairman Nussle. I don't know whose chart that is. Mr. 
Linder, unfortunately, had to go and manage a rule on the 
floor, and it is his bill; he can defend it just as well on his 
own. But just so we are clear, he testified, at least, that 
there was a fairly substantial exemption, and this says the 
burden sales tax without the exemption. So it is fine to put up 
the chart, but----
    Mr. Price. Well, Mr. Chairman, I can tell you about my 
figures, and maybe Mr. Spratt can tell you about his. My 
figures included the exemption.
    Chairman Nussle. Let me finish my question.
    Mr. Price. My figures included the exemption.
    Chairman Nussle. That may be, but just so we are clear, 
because there is a lot of interest in this chart, the sales tax 
without exemption----
    Mr. Spratt. Mr. Chairman, to the best of my knowledge, the 
bill has no exemptions. That is one of the other unrealistic 
aspects; it assumes no tax avoidance, no tax evasion, and it 
provides no exemptions.
    Mr. Scott. Mr. Chairman.
    Mr. Spratt. It does have a emigrant. It does have a 
demigrant equal to the sales tax rate times the poverty level, 
and that demigrant is factored into these figures here.
    Mr. Scott. Mr. Chairman.
    Chairman Nussle. Again, I am not trying to argue with you 
or defend Mr. Linder's bill; that is something he can do. But 
just to clarify, he testified there was an exemption.
    Mr. Scott. Mr. Chairman.
    Mr. Price. Mr. Chairman, maybe I can shed some light on 
this. When I said the exemption was included----
    Chairman Nussle. Well, I will be the judge of that, but go 
ahead and try.
    Mr. Price. Alright. We have a semantic problem, perhaps.
    Chairman Nussle. Alright.
    Mr. Price. When I said that the exemption was included, I 
was in fact referring to the rebate or the demigrant.
    Chairman Nussle. That Mr. Linder was referring to.
    Mr. Price. That is right.
    Mr. Scott. Mr. Chairman.
    Chairman Nussle. OK. Thank you.
    You will have your own time.
    Mr. Gutknecht is recognized.
    Mr. Scott. Were you on your time during that?
    Chairman Nussle. I control all the time.
    Mr. Gutknecht.
    Mr. Gutknecht. I will yield to the gentleman.
    Mr. Scott. Thank you.
    There are four different charts, Mr. Chairman. There are 
four different combinations and permutations: with a cash 
payment, without a cash payment, with exemptions and without 
exemptions. There are four different charts; that was one of 
them. All of the charts have the same pattern.
    Mr. Gutknecht. Reclaiming my time.
    Mr. Scott. On my time I will show all four charts.
    Mr. Gutknecht. Reclaiming my time.
    We can all have charts. The problem is--in fact, let me 
start with thanks to my friend, Mr. Wicker. Yesterday we lost a 
patron saint, Rodney Dangerfield. In some respects he was the 
patron saint of those of us who believe it is time to reform 
the Code. One of my favorite lines from Rodney is he comes home 
one night; his wife is packing. He says, are you leaving? And 
she said, yes. He said, is there another man? She looked at him 
and said, there must be.
    It is just amazing to me to listen to some of this 
discussion, and with all due respect to all the people who have 
testified, but essentially for those who are opposed to the 
national consumption tax, the arguments come down to a 
fundamental argument we have around here an awful lot of the 
time, and that is equality of opportunity versus equality of 
result. All of a sudden we have made the assumption of how 
people will react if you change the Tax Code.
    More importantly, we have forgotten, in this discussion we 
have been having for the last 5 minutes, that the truth of the 
matter is the tax system today isn't fair. It isn't fair to 
those who save and invest. Now, I know there are people in this 
room and people in this country who will disagree with me, but 
my assumption starts with this. There are only three things 
that people can do with their money: they can spend it, they 
can save it, or they can pay taxes.
    Now, if at the end of the day one of our goals in terms of 
Federal policy is to help grow the economy faster to encourage 
more manufacturing jobs to stay here in the United States, to 
repatriate more of the dollars that are currently being 
invested around the rest of the world, it strikes me that one 
of the first things you ought to look at is the tax system. And 
essentially what we are saying is we couldn't change that 
because behavior would remain the same and, therefore, we would 
have to tax even more.
    The other thing that unfortunately the critics of the 
national consumption tax have missed, it seems to me, is a very 
important point, and that is that people will get to keep 
everything they earn, and then they decide whether they are 
going to spend it or whether they are going to invest it. OK? 
And I think people will decide. I have a lot of faith in the 
American people and how they spend their money.
    Now, how you handle the rebate, at least I will say I do 
understand if you convert from an income tax system where 
roughly 20 percent of the taxpayers pay 80 percent of the 
taxes, anything you do to reform that system and try to 
redistribute the way taxes are collected, or any reform, is 
going to create some inequities from the systems that exist 
today. But that assumes that this system is fair and that it 
ultimately is good for our economy. I don't assume that. But 
that is a fundamental debate we have to have.
    But in terms of getting charts out and saying this is what 
will happen, I don't think anybody here is smart enough to know 
exactly how people will react. Once people get to keep all of 
their paychecks, I think it will change consumer behavior.
    Now, the other point that the charts tend to ignore that 
Mr. Linder pointed out is that there is an enormous amount of 
money going to the underground economy. We can argue how much 
that is; the truth of the matter is we don't know. But what we 
do know is that if you are a drug dealer and you go down and 
you buy a brand new Maserati, you are going to pay tax on that. 
If you spend an expensive yacht, you are going to pay tax on 
that. There are two things that I think are important about the 
consumption tax, in my opinion. First of all, it recovers an 
awful lot of the money that is going through the black economy. 
They are not filing their taxes. The second thing is it makes 
American made manufactured products, American products period, 
services as well, because embedded in the cost of every one of 
those products and services that we try to sell in other places 
around the world are taxes, whether we want to admit it or not.
    And we can argue whether it is 18 percent or 20 percent or 
22 percent or 30 percent. But the bottom line is there are 
embedded costs in that, and all of a sudden it makes everything 
made in the USA anywhere from 18 to 30 percent more competitive 
in the international marketplace. I think that is something 
that is worthy of serious discussion.
    Now, it is great to be a critic and it is great to come in 
here and say we can't do that because this is exactly what will 
happen. We don't know what will happen. I think in the end the 
consumption tax, like Rodney Dangerfield, gets no respect, but 
I think the American people are beginning to figure out we have 
got to get out of this business of predicting equality of 
opportunity versus equality of result. We have to worry about 
saying let us have a system that is fair and let the American 
consumer decide how they want to spend their money.
    I yield back.
    Chairman Nussle. Mr. Edwards.
    Mr. Edwards. Mr. Chairman, are we operating under the 5 
minute rule?
    Chairman Nussle. Yes.
    Mr. Edwards. OK, good.
    Let me first say that the problem with today's economy is 
not that sales at Saks Fifth Avenue and Neiman Marcus are in 
trouble, it is that sales at Wal-Mart and J.C. Penney and 
Target have not been increasing like sales at Neiman Marcus and 
Saks Fifth Avenue. And I want to commend the people for looking 
at tax reform ideas, but I will say, Mr. Chairman, there are 
two common bonds I find in each of these tax reform proposals. 
One is the promise of no pain, all gain. We have heard that 
before in 1981, when we were told that we could have massive 
tax increases, huge defense increases, and balanced budgets. We 
quadrupled the national debt in 12 years.
    Well, we heard no pain, all gain in 2001, 2002, and 2003 
with tax cuts. And we could increase defense spending, a 
promise 20 years after the false promises made in 1981. We 
could balance a budget and have massive tax cuts. What did we 
do? We, this year, as a consequence of some of the people 
proposing tax reform now, have the largest deficit in American 
    And I would point out, Mr. Chairman, that while I do 
welcome this hearing, 2 days before the scheduled end of the 
108th Congress, we don't have a budget resolution passed. We 
haven't pass 12 out of 13 appropriation bills, and we have the 
largest deficit in American history and an economy that is 
struggling for middle class families. It seems to me we should 
keep first things first and focus on the huge problems that 
have been caused by those who promised no-pain simple solutions 
to massive tax cuts and balancing the budget.
    What I would like to ask you, Mr. Price, since Mr. Linder 
understandably could not be here to answer questions, on the 
national sales tax proposal, I want to be sure I am correct in 
what they are proposing. A new home costing $200,000 would have 
a $60,000 tax added to that $200,000 purchase price, is that 
    Mr. Price. That is right, assuming a tax rate that made the 
overall proposal revenue-neutral.
    Mr. Edwards. And I believe this is a proposal, either 
exactly or almost like it, that Majority Leader Tom DeLay has 
    So a new home buyer would pay $60,000 sales tax on that new 
    Then I understand that bill would get rid of the home 
mortgage interest deduction. Is that correct?
    Mr. Price. That is correct.
    Mr. Edwards. So that is a second burden put on new home 
purchases for hardworking families.
    And then the third thing I understand, instead of getting a 
deduction on your home mortgage interest payment each month, 
you would actually have to pay this 30 percent sales tax on 
that home mortgage interest payment, I think less 1.5 percent. 
Say if it is a 6 percent mortgage, you would pay 30 percent tax 
on 6 percent minus 1.5 percent.
    So what this proposal would do is not only put a huge 
increase in tax burden on middle class families making $40,000 
a year with a couple of children, it would devastate the 
housing and real estate industry, one of the most important 
segments of our economy, the segment of our economy that kept 
us from going into a deep recession over the last several 
years. And you would hammer new sales in three ways: $60,000 
national tax on the purchase of your new home; you would no 
longer get the home mortgage interest deduction; and you would 
even have to, to add insult to injury, pay a tax on the 
interest payment you pay to the mortgage company every month. I 
would just suggest that would have a devastating impact on one 
of the most important industries in our country.
    Do I understand also, Mr. Price, on the Linder bill that 
Mr. DeLay is supporting, a senior citizen buys $300 worth of 
prescription drugs every month, they are struggling to pay 
their prescription drug bill. Thirty percent on that would be a 
$90 tax on $300 of drug purchases every month, is that correct?
    Mr. Price. That is right. And if the provision is to be 
revenue-neutral, it would be twice that.
    Mr. Edwards. And then even using their underestimated sales 
tax rate, their 30 percent rate, if someone struggling, making 
$20,000 a year, goes out and buys groceries for what costs $100 
today, it would be $130; and if they bought $100 worth of 
gasoline over a period of a month or two, that would be a $30 
tax on the groceries and $30 new tax on the gasoline, right?
    Mr. Price. That is my understanding.
    Mr. Edwards. But we are going to assume that the market 
system is so perfect that all these oligopolies and foreign 
companies selling products to the United States are going to 
automatically reduce the embedded tax cost. There is no real 
proof that is going to happen, is there?
    Mr. Price. No, there is not.
    Mr. Edwards. I thank the gentleman.
    Chairman Nussle. Thank you.
    Mr. Wicker, do you have questions for the witnesses?
    Mr. Wicker. Thank you, Mr. Chairman. Well, I had some very 
pointed and, I think, excellent questions that I was going to 
ask Mr. English, but, unfortunately, he had to leave.
    Let me observe one thing and then ask Mr. Price something.
    There is certainly some truth in ``no such thing as no 
pain, no gain,'' or however Mr. Edwards put it, but the fact is 
President Reagan led this Nation to a significant tax cut in 
1981 and revenues increased dramatically. Revenues to the 
Government increased dramatically. The tax tables are there; I 
could go back to the corner of the room and find them. There is 
no question about it, we got a lot more money into the Treasury 
after we cut taxes.
    Now, Mr. Price, I haven't signed onto this bill either. I 
think it is good that we are having this debate. I want to 
commend all of you; you are in the arena, you are thinking, and 
I think this is one of the most important debates of the next 
    But with regard to your assumptions, Mr. Price, do you 
discount completely what Mr. Linder says about the built-in 
cost on everything, whether it is the building supplies that go 
in to build that house or the ingredients in a loaf of bread 
over time, that there is 22 percent, even some people say as 
much as 30 percent, built in cost, a hidden tax because of the 
way we have an income tax in the United States? Do your 
calculations totally discount that?
    Mr. Price. No, they do not totally discount that. There are 
some built-in costs of those sorts. I do not have precise 
figures before me, but that is not a totally fallacious 
analysis. What I think is indisputable, though, is that we are 
talking here about radical redistribution. And I don't want to 
take your time, Mr. Wicker, but Mr. Gutknecht was saying that 
we don't know what kind of behavioral results there are going 
to be from this. I actually think we can guess pretty well that 
for the lowest quintile of earners, $99,100 a year average in 
North Carolina, I think we know how that money is being spent 
now and how it is going to be spent under any Tax Code, and 
that is it is going to be spent on the necessities of life, 
because that is what is required. And we also know that under 
this proposal these people would pay $4,214 more in taxes. That 
I think is virtually indisputable.
    Mr. Wicker. I will be happy to yield. You are so much 
better than I am.
    Mr. Gutknecht. For him to say that it is indisputable, if 
you get all of your money back, how do you lose?
    Mr. Price. Excuse me? What money?
    Mr. Gutknecht. If you get all of that tax money back from 
the Federal Government, how does that family lose?
    Mr. Price. The family is not getting all that money back.
    Mr. Gutknecht. Yes, they do. Under the Linder plan they get 
it all back.
    Mr. Price. My calculation includes that rebate. My 
calculation includes it.
    Mr. Gutknecht. How do they lose if they get all their money 
    Mr. Price. They don't get all their money back; they get a 
certain portion of the sales tax money back, but they lose the 
EITC. They lose all of the EITC. They lose the refundable child 
tax credit; they lose the dependency care tax credit; they lose 
the hope and lifetime learning tax credits. The average 
additional tax burden for those low-income families is well 
over $4,000.
    Mr. Wicker. OK, and I appreciate my friend, and I was 
sincere when I complimented my friend from Minnesota, because 
he has done a lot of study on this subject. But let me make 
sure I understand, David. When you give the chart about North 
Carolina and you talk about the extra money that that person in 
a certain income bracket is going to pay you do not assume for 
purposes of argument Mr. Linder's assumption that the loaf of 
bread itself will cost less because of the absence of the 
built-in cost of the income tax throughout the process. You do 
not assume that for purposes of your chart, do you?
    Mr. Price. I do not have a precise assumption as to the 
costs of these items.
    Mr. Wicker. So if he is correct about that, that this 
hidden built-in 22 percent of a loaf of bread would not be 
there, then your numbers would not add up, would they, because 
you don't assume that that is a fact at all?
    Mr. Price. The changes, I think, in those numbers would be 
minor. I am drawing here on----
    Mr. Wicker. But you don't build them into your chart about 
North Carolina.
    Mr. Price. I am drawing on the work of four institutions 
here, and the exact assumptions about costs I can furnish you 
for the record, but basically nothing comes close, even Mr. 
Linder's own assumptions don't come close to a 60 percent 
surcharge basically on these consumer goods. They don't come 
    Mr. Wicker. How do you explain the fact that so many of the 
European countries that are left wing and are considered so 
progressive rely heavily on a consumption-based tax?
    Mr. Price. They relay on a value-added tax, which has a 
modest tax on various stages of the production process; it is 
not levied all at once on all consumer goods and transactions. 
And, moreover, it is not layered on top of State and local 
taxes, which in this country, of course, already approach 10 
percent in many jurisdictions, sales taxes, I mean.
    Chairman Nussle. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Price, you had one of these charts up. Let us just go 
through all four of them right quickly. You can go through all 
four of the different charts. This is tax with a payment, 
without exemptions.
    The next chart.
    Chairman Nussle. We will give you some time here, Bobby, at 
the end.
    Mr. Scott. Well, let me ask another question.
    Mr. Burgess, does your plan expect to raise the same amount 
of revenue that we are raising now?
    Mr. Price. I am sorry, I was distracted. Your question?
    Mr. Scott. To Mr. Burgess.
    Mr. Price. Oh, I am sorry.
    Mr. Scott. Do you expect to raise the same amount of money 
that we are raising now?
    Mr. Burgess. Under the bill introduced by Congressman Armey 
in previous congresses that was scored to be revenue-neutral. 
No, I do not have figures back from Joint Committee on Taxation 
about a voluntary flat tax. Obviously, the behavior may be 
different and the scoring may be different. So I do not have 
that information for you, but when it becomes available I will 
make it available to you.
    Mr. Scott. Does your voluntary flat tax exempt capital 
gains interest and dividends from taxation?
    Mr. Burgess. That is correct.
    Mr. Scott. So that if a person had----
    Mr. Burgess. If a person, from a business aspect, opted 
into the flat tax.
    Mr. Scott. Right. You have an option to pick which form you 
are in, so if you make all of your money in capital gains 
interest and dividends, you would pay no tax.
    Mr. Burgess. That is correct.
    Mr. Scott. OK. And if you pay less tax, then somebody else 
has to pay more tax to be revenue-neutral. Everybody can't pay 
less tax and raise the same amount of money.
    Mr. Burgess. But I would point out Mr. Wicker's point, that 
when you reduce the capital gains tax, you end up increasing 
productivity in the country, thereby increasing the tax base.
    Mr. Scott. Well, some people would pay less tax and no one 
will have to pay more tax, is that your testimony?
    Mr. Burgess. Well, at the present time I don't have a 
precise answer for you, but the increase in productivity was 
felt to be, on the flat tax, the basis for allowing the flat 
tax to be revenue-neutral. To what extent we will capture that 
with a voluntary flat tax I am not certain.
    Mr. Scott. That is with exemptions, without a cash payment.
    And the next one? That is with a cash payment, exempting.
    Basically, with all combinations and permutations, you have 
the same form, right around $100,000 in consumption you start 
paying less; under that you are paying more.
    Mr. Linder, under this form, I like a progressive form of 
tax where the more the make, the higher percentage of your 
income goes to taxation, and ability to pay is important. 
Someone who makes $100,000 and spends $50,000, someone who 
makes $50,000 and spends $50,000, and someone who makes $40,000 
in income and spends $50,000 because they borrowed money to buy 
the car, all spent the same amount but, in my view, would have 
different abilities to pay.
    You are one of the more thoughtful Members of Congress, and 
I appreciate that. Does ability to pay factor in to your 
calculation as to who should pay how much?
    Mr. Linder. Frankly, this tax is progressive. Nobody will 
be taxed on anything up to the poverty line. Today people are 
losing 22 percent of the purchasing power to the current 
system. Everybody will get to keep their entire check; no 
deductions for payroll tax or income tax. And the more you 
spend, the more you pay. But we need to get out of the business 
of worrying about who pays what. If Bill and Melinda Gates want 
to move to a farm and grow their groceries and live off the 
rebate, why should we care? We will borrow their money and we 
will create jobs with it. Costs about $100,000 to create a job 
in this country.
    Mr. Scott. For the very low-income, does your plan 
eliminate the earned income tax credit, child tax credit, and 
other tax credits such as that?
    Mr. Linder. Correct. We have no taxes on income whatever. 
So, currently, if you are spending 100 percent of what you 
earn, you lose 22 percent of your purchasing power.
    Mr. Scott. You pay tax on a new car, but not a used car?
    Mr. Linder. Correct. Only new goods.
    Mr. Scott. You pay tax on a new house, but not an old 
    Mr. Linder. Correct. Let me touch on the house thing for a 
    Mr. Scott. Let me ask another question, then you can get 
them all in. And if you buy something made in Canada, sold to 
somebody in Canada, and then you kind of buy the car with 50 
miles on it, as an individual, you wouldn't pay----
    Mr. Linder. No, there would be a cost at customs. There 
would be a cost at customs, everything coming in.
    Let me deal with the house. Currently, 28 percent of what 
we spend on a new house represents the embedded cost of the 
IRS. Any new construction, 28 percent of that new construction 
is the embedded cost of the IRS. You are paying all the 
business taxes and compliance cost of every business entity 
that had a role in producing the products that go into the 
production of that new house.
    Under our system it would be 23 percent. So the house would 
be less expensive. Under our system, if you make $60,000 a 
year, you take home $5,000 a month; currently you take home 
$3,800 a month. So you have an easier time making the payment 
and interest rates fall by 30 percent because the difference 
between a municipal bond rate and a corporate rate is 
essentially tax complication. When we have no taxes on 
investment, interest rates will fall by 30 percent.
    Sixty six percent of us file a short form and don't take 
advantage of the interest deduction anyway, so we think housing 
will do very well under this system because people will have 
more money to take home.
    Chairman Nussle. Mr. Brown.
    Mr. Brown. Mr. Linder, I know that we all have a concern 
with the current Tax Codes and we are all trying to make a fix 
for it, and I appreciate your presenting your plan today. And 
we have talked about, while you were out of the room, whether 
it was a 23 percent consumption tax or whether it is 30 
percent. Have you heard the debate on that? Which is accurate? 
And I guess your plan is revenue-neutral, right?
    Mr. Linder. That is correct. I have also heard what has 
been booted about here, that it is a 50 percent tax. I want to 
deal with that first, and then I will come to yours.
    There has never been an analysis of H.R. 25. Joint 
Committee for Taxation did an analysis of a bill that they 
thought might pass and changed it dramatically; it got an 
increased rate. The 25 or 27 page release last week by the 
Democratic minority analyzed a bill that was not my bill. We 
have done everything we could to find out how they got their 
analysis. The most interesting thing to me is that whoever did 
the analysis didn't sign it. But nothing has ever been done on 
our bill to analyze what the costs will be.
    We say it is an inclusive 23 cents. We compare it with the 
tax we are replacing, which is an inclusive tax. You pay 36 
percent of everything you earn today; under ours you would pay 
23 percent of everything you spend. If we were to treat it like 
a State sales tax, which would be you spend a dollar and it is 
on top of that, it would actually be a 29.9 percent tax. But 
then if you are going to compare it to the income tax and 
divide the $64 you have left to spend out of the $100 you 
earned after you give the Government $36, divide 64 into 36, 
you would get an exclusive income tax of 56 percent.
    So if you are going to compare it to exclusive, I would be 
the first to tell you it is 30 percent compared to 56 percent 
income tax exclusive, or it is 23 percent inclusive of what you 
spend, just like you are giving the Government 36 percent 
inclusive of what you earn.
    Mr. Brown. Under the current plan, approximately 43 percent 
of Americans don't pay any Federal income tax.
    Mr. Linder. I think it is 47 percent now.
    Mr. Brown. Don't pay any income tax now. So it is difficult 
to formulate a plan that won't have the bumps in it. If people 
aren't paying now, I noticed under your plan you have some 
rebate coming back to try to offset some of that deficiency. 
But, according to Mr. Price, apparently all that is not 
included. Is that correct?
    Mr. Linder. We provide for every household a check at the 
beginning of every month sufficient to totally rebate the tax 
consequences of spending up to the poverty line. Poverty level 
spending, by definition, in this country is that spending 
necessary for a given size household to buy your essentials. 
Using that definition, we effectively un-tax essentials. For a 
family of one, that is $9,500 a year; for a family, it is about 
$25,000; for a family of six, it is about $30,000. They would 
spend that much money totally untaxed.
    Mr. Brown. Do you agree with that, Mr. Price? I know you 
said they would pay $4,000.
    Mr. Price. Yes. And I don't believe Mr. Linder disputes the 
studies that suggest that. And where that comes from is from 
the cancellation of the earned income tax credit, the removal 
of other credits that many of these lower income families now 
enjoy: the child tax credit, the dependency care tax credit, 
the hope and lifetime learning credits. These studies that I 
cited are virtually unanimous in suggesting that for a person 
in that bottom quintile. That is, in North Carolina someone 
making on average only $9,100 a year, they would be paying 
$4,214 more than they are paying now in taxes.
    Mr. Linder. I dispute that. I dispute that aggressively.
    Mr. Price. Does your proposal preserve, for example, the 
earned income tax credit, which is what accounts for most of 
this problem?
    Mr. Linder. An individual earning $9,100 a year in North 
Carolina, or any other State, would pay no taxes whatever.
    Mr. Price. We are not talking about whether they pay no 
taxes whatever; we are talking about how much they would lose 
vis-a-vis what they now pay. That is a differential figure. All 
of my figures I quoted have to do with additional tax burden 
that everybody but the top 5 percent would incur.
    Mr. Linder. Nothing in our bill prevents the Congress from 
making available cash contributions or grants to any family 
whatever. All we do is change the income paradigm to a 
consumption paradigm. The income paradigm is a limited--first 
of all, we had eight quarters in a row of declining revenues to 
the Federal Government, from the middle of 2001 to the middle 
of 2003. Under our proposal, the last 14 quarters would have 
been only two quarter would have a modest decline, so we would 
have dramatically increased revenues to the Federal Government. 
But nothing that we do precludes the Congress from making 
grants to families on any basis whatever; all we do is change 
the way we raise the revenues. And it is a more steady 
predictor of economic activity than is the income economy.
    In 2003 we had about $9.1 trillion, roughly, in 
consumption. The adjusted gross income, against which we levy 
an income tax, for the Nation was about $4.2 trillion. So the 
consumption economy was twice as large as the adjusted gross 
income economy. You could have a dramatically reduced tax and 
raise the same revenues.
    But we do not take any other positions with respect to 
programs. If you want to give a grant to a low-income family, 
you are perfectly willing to do that; you are just not going to 
be able to use the income tax system to do it with.
    Mr. Price. All I am saying is whatever the hypothetical 
future programs may be, we are talking here about the instant 
impact of H.R. 25. Those are the ground rules of the analysis. 
We are looking at the impact on various income quintiles of 
this particular proposal.
    Mr. Linder. Are you aware that those people will not pay 
any payroll taxes either?
    Mr. Price. I am quite aware of that. This is taken into 
account, as is the rebate feature that you have written into 
the bill.
    Chairman Nussle. Mr. Emanuel.
    Mr. Emanuel. Thank you, Mr. Chairman. Thank you for holding 
the hearing.
    I think it is ironic we are having this hearing on the fact 
that there is some discussion of passing another tax cut, which 
would actually further complicate the Code like the additional 
three that were passed from 2001 forward that now we are 
becoming bastions and advocates for reforming the Code and 
simplifying it, when the last three tax cuts did anything but 
that, No. 1.
    No. 2, what I find interesting is that everybody that has 
talked about how Europe has a consumption model, many of those 
countries also have an income tax on top of consumption model, 
and that gets left out of the discussion.
    Three, the one consistent point about all these reforms is 
there is a regressive nature to them. That is the thing that 
you can say is most consistent.
    If you take a step back, in 1986, when we simplified the 
Code and reduced deductions and definitions, and we had 
basically three categories for income, we made great progress 
on simplification. The problem since 1986 is that--and it has 
been under Democratic administrations and Republican--in 
achieving certain social goals, whether that is in health care, 
whether that is in savings, whether that is in affording 
college education, we have loaded up the Tax Code with credits 
and deductions and, therefore, made it more complicated. And we 
don't aspire to expand Pell grants by putting more money into 
it. So what do we offer? A tax deduction. We do that on other 
areas as an example. I am for the tax deduction on higher 
education, but I would be for a massive expansion of public 
financing of higher education. We decided not to do that; we 
gave it as a tax credit.
    We all, since 1986, basically in the last 18 years, have 
made the Code more complicated. And, to tell you the truth, it 
has never been worse than in the last 3 years, number two on 
that point.
    And John knows this; we have talked about it. He doesn't 
particularly like the idea, which makes me even warmer to my 
idea at some points. I have offered the idea of a simplified 
family credit. It takes the earned income tax credit, the per 
child, and the dependent care and makes it one credit; takes 
2,000 pages of code down to 12 questions. And takes that 
segment of the population, well over 30 million families, and 
reduces the tax burden, simplifies it, and makes it more 
    Now, one of my objections to all the plans here, whether it 
is flat or consumption, is that they all, in one way or 
another, are more regressive. Yes, they do shift the burden to 
consumption away from savings, hopefully encouraging savings, 
but they end up, regardless, more regressive in nature.
    Now, since we can't reform health care, I don't believe we 
are going to throw out the Tax Code and end up with a 
consumption code base code. It is not going to happen. So take 
a segment of the population and try to reform the Code and 
simplify it for that area.
    Ronald Reagan was the one that created the earned income 
tax credit, but Bill Clinton, under his administration, 
expanded it. I believe it is a very good credit. It is 
progressive. Richard Nixon admired it, Ronald Reagan created 
it, Bill Clinton expanded it. But we have about $8 billion 
worth of some type of fraud or abuse you all hype on all the 
time, and the main reason is because of complexity.
    Now, I think if we simplified the earned income tax credit 
and the dependent care and the per child, and put it into one 
family credit, you would achieve a great deal of progressivity 
and a great deal of simplicity, and do it the right way. But 
the notion that we are going to take the Code and throw it out 
I don't think is politically possible, and I don't think we 
would end up with the results we want.
    Lastly, because of the complexity we have in the Code, $340 
billion goes uncollected and under-reported, mainly by very 
wealthy individuals who can game the system. And that is where 
the fraud exists. Now, I would be willing to attack and tackle 
the fraud in the earned income tax credit, but I find the 
silence deafening on the other side when it deals with what has 
happened, all of it reported by IRS, not exactly political 
entities, saying that the major part of fraud that exists in 
the system and the major types of problems, because $350 
billion goes unreported. We basically cut the deficit by more 
than what the President is promising in 5 years; we would do it 
in 1 year. It happens mainly on very wealthy individuals who 
are moving their income and their tax contribution outside this 
country and basically try to figure out games to not pay it.
    I know I have a couple seconds left.
    Saturday's New York Times reported in a little story that 
in 2004 we had more individuals than ever making $200,000 and 
above who paid no income taxes at all. Highest ever over year 
over year, from 2003 to 2004. And that is where this code is 
regressive and needs to be reformed. You should take the low- 
and moderate-income people, simplify it for them, be 
progressive and reach simplification.
    Chairman Nussle. Does the gentleman have legislation on 
    Mr. Emanuel. I do.
    Chairman Nussle. Thank you for bringing that up. We 
appreciate any proposal for simplification and reform. I am 
serious. That is the reason I asked. Do you have a bill number, 
for the record? If you don't, we will put it in the record 
later. But I appreciate that.
    Mr. Emanuel. I knew you would try to make me act like a 
legislator. No, I don't have the bill number here. I didn't 
expect any movement on it.
    Chairman Nussle. Today is called Federal revenue options, 
so all of the options are on the table.
    Mr. Emanuel. I do appreciate the fact that we are having 
this hearing. This is going to be, I think, regardless of who 
wins in November, the piece of reform we are going to do, and I 
think we have got to all seriously look at it. I don't think 
you are going to throw out the entire Code; it is not going to 
be accomplished. So can we take a part of the population and 
achieve the two goals of progressivity and simplicity? I offer 
    Chairman Nussle. That is part of the discussion today.
    Mr. Neal.
    Mr. Neal. Thank you very much, Mr. Chairman. After all 
those years we spent on the Ways and Means Committee, I am not 
nearly as optimistic as Mr. Emanuel is about what we are going 
to do with the Tax Code.
    I would like to yield two of my minutes to Mr. Edwards, and 
then I would like to come back with a question I have for my 
friend John Linder.
    Mr. Edwards. I thank the gentleman.
    Mr. Burgess, I want to ask about your proposal. Do I 
understand that someone making $1 million a year in capital 
gains and dividend income would pay zero dollars in taxes on 
that income?
    Mr. Burgess. That is correct. This is a consumption tax, 
and capital gains and dividend income would not be taxed.
    Mr. Edwards. You would have no tax on that?
    Mr Burgess. That is correct.
    Mr. Edwards. But an Army sergeant making $30,000 a year who 
just returned from Iraq, would that sergeant pay taxes on his 
$30,000 salary for having served his country in uniform?
    Mr. Burgess. The standard exemption for a family of four 
would be 200 percent of the poverty level, or about $36,500.
    Mr. Edwards. So an Army sergeant with one child would pay 
more taxes under your plan than someone sitting here safely at 
home making a million a year in dividend and capital gains 
    Mr. Burgess. Tell me the income that you are reporting for 
that individual?
    Mr. Edwards. Let us just say it is a first sergeant making 
$40,000 a year with one child. Would that sergeant, who just 
returned home from Iraq, serving our country in Iraq, pay more 
in taxes than someone sitting here at home who just made $1 
million a year in dividend and capital gains income?
    Mr. Burgess. That is correct. But I think as Mr. Emanuel 
just pointed out before he left, the tax avoidance that is 
currently going on allows that to happen every day of the week 
right now.
    Mr. Edwards. Well, thank you for answering the question. So 
someone making $1 million a year, sitting here safely at home, 
would pay zero dollars in taxes, wouldn't even contribute to 
the cost of national defense for which that person is 
benefitting, but the Army sergeant having to defend our country 
would pay more taxes than that person. Thank you.
    Mr. Neal. Thank you, Mr. Chairman.
    Even though Mr. Linder and I disagree with the proposal he 
has offered, I must tell you that he has approached this very 
thoughtfully, and I think it kind of elevates the discussion 
that we have had in the House over the last 2 years.
    But let me ask you something, John, if I can. Dick Armey is 
going to testify, former majority leader. In an article that he 
offered in 1995 he wrote, ``Any sales tax will inevitably 
become a complex, pervasive, multi-rate value-added tax. The 
evasion at the retail level will necessitate reaching back into 
various levels of production to ensure compliance and adequate 
revenues.'' He also went on to warn: ``A national sales tax may 
well exempt many basic necessities from this tax. This will 
lead to bitter disputes over the differences between food and 
candy, between real clothes and costume accessories.'' Finally, 
he doesn't hold out much hope for the abolition of the IRS 
either. He goes on to say, ``Under a sales tax, there is no 
direct tax on individuals, so businesses will be responsible 
for collecting several times what they collect today. That 
means IRS scrutiny of American businesses could be expected to 
rise proportionately.''
    John, why is it that Dick Armey so thoroughly dislikes your 
    Mr. Linder. Because he has got his own proposal he 
authored, and he would like to have us consider it. He is 
simply wrong.
    Mr. Neal. Did you ever say that while he was majority 
    Mr. Linder. Sure I did. Sure I did. He is simply wrong. A 
universal across-the-board tax on personal consumption would be 
the easiest tax to collect. Most States, 45 States collect 
sales tax; they claim 90 to 92 percent compliance. Under the 
current system, all you have to do is lie on your tax and send 
it in, and your wife doesn't even have to know about it. Under 
our system you have to have two people conspire to cheat. I 
don't know how many friends you have that are willing to save 
you 23 percent, I have none, if they ever risk going to jail. 
We have an underground economy.
    Rahm is wrong about the $350 billion in the underground 
economy that is avoided. We have just three components of the 
underground economy: pornography, illicit drugs, and illegal 
labor. They constitute a trillion dollar underground economy. 
    It would be the easiest tax to collect. The reason we have 
no exclusions or exemptions is so that nobody gets in a fight 
in front of your committee about what is a necessity. We define 
necessities as up to poverty level spending and leave it at 
that. And everybody gets that check no matter how much they 
    I would like a system that gives the American people in a 
free society the privilege of anonymity. Nobody should know as 
much about us as the IRS does. I would like a system where the 
only role for the IRS is about 5,000 people in the Treasury 
Department that contract with the States, the States get a 
quarter of a point for collecting the tax; the retailer, 
whomever sells you the product, gets a quarter of a point for 
collecting the tax. But we contract with the States to do the 
collecting for us.
    And there will be some problems and there will be some 
cheating. We are Americans; we cheat. But we cheat on the 
current system. I don't know if you have ever owned a company 
and taken your wife out to dinner and written it off as a 
company expense, but I know some people who have. That is 
    It is going to be tough for the States to collect money on 
services. What is going to happen is the guy who paints your 
house, personal consumption, is going to charge you the tax and 
not remit it. That is the biggest risk we have. But already the 
IRS says they are collecting 75 percent of what they know is 
due. Charles Rosetti has just recently written a book in which 
he says there are $350 billion a year that we know is due and 
is not collected. It is just not collected. So there is going 
to be cheating. I think we will have better than a 75 percent 
compliance rate. I think we will get a significant part of the 
underground economy.
    But the most important thing, and this is the most 
important point in any tax reform, we must get the tax 
component out of the price system. It is crazy for us to 
continue to sell goods and services in a global economy with a 
22 percent tax component in the price system. And for those 
people who, I think it was Mr. Emanuel who said, are going 
offshore with their money, I think I mentioned there are $6 
trillion offshore. There is a reason for that: a confiscatory 
tax policy is chasing people and jobs away. And if we got rid 
of the tax on capital labor, we would be the world's tax haven. 
Those trillions would be in our economy creating jobs in 
    Mr. Neal. Thank you.
    Mr. Chairman, I would disagree with the latter part of that 
statement strongly. The fact that the Ways and Means Committee 
has been reluctant to take up the issue of offshoring, and 
apparently is not going to take it up again in the Fisk bill 
that is going to be before us in the next couple of days, I 
think indicates how little enthusiasm there really is for 
chasing down that money that is owed.
    Mr. Linder. Well, the way to fix it is not to punish 
people. The way to fix it is to change the Tax Codes so they 
are attracted here.
    Mr. Neal. A minute?
    Chairman Nussle. Well, not a minute, but----
    Mr. Neal. Thirty seconds.
    Chairman Nussle. Sure.
    Mr. Neal. The idea that corporations move profit offshore 
in a time when there are 135,000 American soldiers in Iraq and 
12,000 in Afghanistan, and they preach patriotism and they put 
profits between patriotism is simply outrageous.
    I thank the chairman.
    Chairman Nussle. Mr. Davis.
    Mr. Davis. Thank you, Mr. Chairman.
    Let me try to go back to the colloquy that Mr. Price and 
Mr. Linder were having when I initially walked in the room. If 
I understood it correctly, Mr. Linder, your mindset and your 
argument is that your sales tax proposal would actually remove 
the tax burden from a significant number of lower-and middle-
income individuals, and it would cancel out a certain portion 
of liability that they would otherwise hold.
    And if I understood his point correctly, Mr. Price's 
argument is that while that might be the case that the sales 
tax would not incorporate such things as the earned income tax 
credit, the child tax credit, any host of other redistributive 
features, if you will, of our tax system. That was the 
philosophical debate you all were having.
    Mr. Linder, your response was, well, it may well be the 
case that under a consumption-base system we would sacrifice 
certain redistributive elements, but I think your quote was 
there is nothing that would prevent this Congress from engaging 
in whatever grant-making that it wished to do, whatever direct 
transfers of cash that it wished to do that might in effect 
serve the same purpose as these things such as the earned 
income tax credit
    My first question to you is it strikes me that--and you 
have obviously been here a lot longer than I have, but it 
strikes me that this is an institution that appears to be very, 
very deeply reluctant, and our whole political culture seems 
somewhat reluctant, to embrace the idea of giving poor people 
anything. When we have managed to give poor people something, 
it is almost always been in the context of something like the 
earned income tax credit or the child tax credit. In other 
words, we have had to staple our generosity onto the very 
familiar vehicle of the progressive tax system.
    Do you think that there would be any political enthusiasm 
in this Capitol on your side of the isle if we were to do away 
with the income tax system? Do you think there would be any 
political enthusiasm on your side of the isle for making direct 
cash transfers to low-income Americans?
    Mr. Linder. Yes.
    Mr. Davis. And what is your basis for that? Because Richard 
Nixon proposed doing that in the early 1970s, and Ronald Reagan 
strongly opposed it, a number of people in his party strongly 
opposed it, and I don't know of any bills on your side of the 
isle that would do that.
    Mr. Linder. The earned income tax credit is one of those 
things that was, I believe, sponsored by Dan Quayle.
    Mr. Davis. But it is stapled onto a progressive tax 
structure. I understand that we have got enthusiasm for it and 
the familiar guise for a progressive tax structure, but if, as 
you want to do, you slice away the progressive tax structure, 
where is the political enthusiasm to do the equivalent of what 
the child tax credit does, the equivalent of what the earned 
income tax does through just a direct transfer of cash or some 
other kind of allotment? Wouldn't your side denounce that as 
welfare and giving people something for nothing?
    Mr. Linder. We have had a Republican chairman of the 
Agriculture Committee for about 10 years, and they have 
destroyed the WIC program yet. Sixty two percent of the 
Agriculture budget goes to food programs for low-income people. 
That has not been taken away.
    I just think you are wrong. The whole notion----
    Mr. Davis. Let me give you an example.
    Mr. Linder. Do you mind if I finish?
    Mr. Davis. Sure. Sure.
    Mr. Linder. The whole notion that we are some kind of ogres 
that don't like poor people is just simply wrong. I never lived 
a day above the poverty line until I was in the Air Force.
    Mr. Davis. Alright. Well, rather than have you engage that 
strawman, let me give you a very specific recent example. When 
Congress was debating the expansion of the child tax credit 
last year, as you know, initially the House bill, unlike the 
Senate bill, did not expand the child tax credit from $600 to 
$1,000 for certain portions of Americans earning less than 
$26,000 a year.
    And when Ms. DeLauro, Mr. Rangel and myself introduced a 
bill that would correct that discrepancy, the response from 
many on your side of the isle was, well, a lot of these folks 
really aren't paying income taxes, or the income taxes they are 
paying is so low that they don't deserve this benefit. So the 
argument was that we shouldn't be engaging a redistribution for 
people who aren't paying taxes.
    Mr. Linder. Did they get the benefit in the final analysis?
    Mr. Davis. It was about 14 months later, and initially they 
didn't get it. As you recall, your leadership wouldn't even 
bring it to the floor.
    Mr. Linder. Did they get it ultimately?
    Mr. Davis. After 15 months, and only after producing a bill 
that stuck a lot of things that were completely unrelated.
    Mr. Linder. You are welcome.
    Mr. Davis. That kind of leads to my next point.
    Mr. Linder. You are welcome.
    Mr. Davis. That conveniently leads to my next point. Mr. 
Emanuel I think made a very sound argument that the hallmark of 
tax simplification was the 1986 reform, which I concede to you 
was bipartisan and President Reagan embraced it. We have had a 
long-running retreat from that hallmark of simplification the 
last 18 years.
    Now, I think you would concede to me that your party has 
been in control of the Congress since 1994, you have been in 
control of all three branches for the last 4 years, and I think 
it would be enormously difficult to argue that we have had 
greater simplification, not less.
    If the Chair would just let me finish this question up.
    It is near impossible to argue that we have had greater 
simplification, not less, in the last 4 years. As you know, the 
corporate tax bill that we will see on the floor perhaps as 
early as tomorrow is undoubtedly one that will contain a number 
of additional elements of complexity. A lot of the bills from 
the past several years have that feature.
    So my question to you is why has your party been so 
resistant to tax simplification in the last 4 years?
    Mr. Linder. You are not speaking to me on that one. I am 
author of a bill that goes from 55,000 pages of regulations to 
132 pages. You are going to come to this because the public is 
going to demand it. The people are so far ahead of the 
politicians on this issue, it is amazing.
    Mr. Davis. No, I hear that. But I just want to get one 
simple answer to my question, if I can.
    Chairman Nussle. Why don't we let the witness answer it?
    Mr. Davis. Well, I would like to, but I would simply like 
to get an answer as to why your party has consistently been 
resistant to tax simplification the last 4 years.
    Chairman Nussle. That is fine. The gentleman's time has 
expired. The witness may answer the question.
    Mr. Linder. I think I did.
    Chairman Nussle. OK.
    I would like to use my time to end up by offering our 
witnesses, who have been very patient and have engaged in what 
I think has been a very spirited, high-minded debate here, 
which I think has been excellent. I think this has been an 
excellent kickoff to a discussion that we have to have, 
regardless of where it ends up and regardless of people's 
opinions. This is the kind of discussion that members need to 
have on this policy. We are going to disagree, and that is 
fine; that is what this is about. But at least we are having 
the discussion.
    What I would like to do is to use my time offering it to 
the witnesses to wrap up, to close, to give their final 
thoughts before they leave, and I will go in reverse order. 
Because Mr. Linder's bill has been the subject of probably the 
most discussion today, I am going to give you the chance to be 
the last one.
    Mr. Price, I will start with you, and then Mr. Burgess, and 
then Mr. Linder. Two minutes each just to kind of sum up what 
your feelings are on tax reform here today as we move forward.
    Mr. Price. Thank you, Mr. Chairman. I do think it has been 
a good discussion, and I commend you for holding the hearing 
and the obvious interest to the members in pursuing these 
issues. I hope this will be on the agenda as a lead item, 
however the elections come out in the next Congress. As I said 
at the beginning of my statement, I think there is widespread 
support for the basic bargain of tax reform, which is 
simplification and lower rates in exchange for less in the way 
of credits and deductions. That was the bargain struck in 1986, 
more or less, and I think it is a bargain that we can strike 
now, although one is always struck with how much devil there is 
in the details of figuring out just which credits and 
deductions are dispensable and exactly what the terms of that 
bargain are.
    My main focus here today has simply been on the question of 
the fairness of the Tax Code and the implications of both the 
flat tax and H.R. 25, the national sales tax, for how that 
burden is distributed. And I do believe that there is very 
little dispute that we are talking with both proposals and I 
focused on the latter--about a major redistribution of the tax 
burden away from the wealthiest 5 percent of payers to almost 
everyone else, including some of the poorest people in this 
    And it has been interesting to me to hear Mr. Linder 
basically acknowledge that we are talking here about an 
increased burden of some $4,000 on the average taxpayer in that 
lower quintile, and he is saying some interesting things, I 
think, about the possibility of additional congressional action 
that would rectify that.
    But the point holds that H.R. 25, the proposal we are 
talking about, does have that profoundly regressive impact. I 
don't believe that has been disputed here today, and I know you 
are going to hear from other witnesses who will have more in 
the way of technical backup for that proposition. So I think 
the basic case for a progressive Tax Code where we affirm that 
principle, from whom much has been given, much will be 
required, and that those who have benefitted most from the 
blessings of our society have a special responsibility for 
maintaining the common good, I think that principle is sound, 
and I would hope that whatever we do by way of tax 
simplification could also honor that principle of fairness.
    Chairman Nussle. Thank you for helping us engage in this 
debate today, Mr. Price. And, again, welcome back to the Budget 
    Mr. Burgess for 2 minutes to get the last word in.
    Mr. Burgess. Well, again I thank the chairman and the 
ranking member for holding this hearing, and I thank the 
members who have stuck with us through the long morning. I 
think we have heard some good ideas today. Again, I am not an 
expert, but simply wanted to continue an idea that back in 1995 
or 1996 I thought was an exemplary idea, and I couldn't 
understand why Congress would not enact it.
    Again, back in 1986 the Tax Code was simplified and, 
unfortunately, it was not left alone. Perhaps if it had been, 
or perhaps if we went back to those changes back in 1986 and 
left them alone, that would be a good enough change. But I am 
afraid without some sort of fundamental change in our Tax Code, 
we in Congress, from what I have seen in the past 20 months, we 
don't have the ability to not meddle in something even if it 
seems to be working OK.
    Finally, as far as Mr. Price's comments about those who 
have had the blessings of the American society--and certainly I 
am one of them and I am certainly willing to pay my fair 
share--the issue is, though, why do we have to make it so 
painful to do that? Why does it cost $100 billion a year for 
the American taxpayer to have to do that?
    And, Mr. Edwards, that would include the young sergeant 
coming back from Iraq. Why is it that our tax compliance could 
be increased by 90 percent and we won't take the simple steps 
to do that?
    So I am certainly not someone who has all the answers, but 
I am grateful that the committee sought fit to have this 
discussion. Certainly in Mr. Bush's second term he has said we 
are going to address this in a great deal more detail, and I 
look forward to being part of the discussion then.
    Thank you.
    Chairman Nussle. Thank you for helping us engage in this 
    Mr. Linder for the actual last word.
    Mr. Linder. Thank you, Mr. Chairman, for having this 
discussion. I hope this is a beginning, and not an end. There 
are a lot of good ideas around that we ought to listen to all 
of them. I do not agree with Mr. Price that there is a $4,000 
burden on some low-income people. I have not seen any studies 
of my bill yet. I have seen a lot of studies of bills similar 
to mine or what people think might pass, but I have seen no 
studies of my bill.
    The fact of the matter is my tax is a tax on accumulated 
wealth. People have paid taxes all their life, paid tax when 
they sold the company, are paying tax on the interest it earns 
are going to pay tax one more time when they spend it. And to 
those people I just say you are already paying this tax. People 
living at or below the poverty level today are losing 22 
percent of their purchasing power to the current system. Under 
my system they would not pay that tax; prices would fall, and 
everybody would be rebated the tax up to the poverty line.
    This is going to be a long discussion, and it is a 
complicated discussion. I think the people are so far ahead of 
the politicians that they are going to demand a simplification 
of the Code.
    We have gotten so out of line with income tax, I don't 
think it is fixable. When 49 tax preparers were sent the same 
information for Money Magazine, they had 49 different tax 
returns, none of which were right; and 50 percent of the 
answers you get from the IRS on the help line to do your tax 
returns are given to you in error.
    I am reminded of a comment made in 1911 or 1912, when they 
were starting to discuss the income tax. A southern Senator was 
ridiculed and laughed off the floor of the Senate for saying 
something terribly outrageous. This is what he said: ``Mark my 
words. Before this is over, they will be taking 10 percent of 
everything you earn,'' which gives fresh meaning to my favorite 
country song: ``If 10 percent is enough for Jesus, it ought to 
be enough for Uncle Sam.''
    Chairman Nussle. I thank the gentleman. As I say, this 
really has been a good discussion, and I hope members have 
learned from it and taken something away. We appreciate the 
members of our panel who have stuck with us and helped us with 
this discussion, and this will no doubt continue as we go into 
the next Congress.
    With that, we will dismiss this panel. Thank you again.
    We next will turn to our second panel, and we will invite 
those witnesses forward.
    I would like to welcome our second panel before the Budget 
    Let me say both personally and professionally, first, with 
regard to both Majority Leader Armey and Chairman Archer, we 
are honored to have probably the two godfathers of tax reform 
before us today in both Representatives Armey and Archer, 
former colleagues of ours here in the House of Representatives.
    I can say personally it was an honor to serve with you and 
in both instances, under you as majority leader and as the 
chairman of the Ways and Means Committee when I served on that 
committee. I can tell you both there is no question that I am, 
in part, sitting here today because of both of your leadership 
and your support as well as, let me say to my friend, Mr. 
Archer, in particular, that if I run the Budget Committee half 
as well as you ran the Ways and Means Committee I think at 
least by some measure I will be successful. I appreciate that.
    Dick, in particular I know that because your support, I 
have the honor of being the Budget Committee chairman.
    Today, we have the opportunity to discuss tax reform which 
is something that I know personally and professionally has been 
something on your agendas for quite some time. Both of you had 
legislation, made spirited attempts to do what you could in 
order to push reform, some of it successfully, some of it I 
know you know the spade work is still left to be done.
    Today, we wanted to talk about Federal revenue options for 
reform, talk a little bit about the doability which has been 
discussed today; is it possible to even reform this Tax Code in 
any measure and what are some of the options we have available 
to do that.
    We welcome you both before the committee. Your entire 
testimony will be made a written part of the record. We would 
be particularly pleased if you would summarize your testimony 
and give us some of that spirit in your testimony here today.
    Mr. Spratt.
    Mr. Spratt. Mr. Chairman, let me join you in welcoming both 
of our witnesses. It is good to see you again and I look 
forward to your testimony.
    Thank you very much for coming and participating.
    Chairman Nussle. It is always difficult, especially looking 
at both of you, which one do you let go first. I am going to 
pick the majority leader. That was the way I think we were 
supposed to do it. I am going to yield first for testimony to 
my friend, Mr. Armey. Welcome to the Budget Committee.


    Mr. Armey. Thank you, Mr. Chairman. I think that was 
exactly the correct choice because one should always save the 
best for last.
    Let me thank you for the invitation to be here. It is 
particularly enjoyable for me having served on this committee, 
to be here. I should say I am here today as co-chairman of 
FreedomWorks, an organization that is the integration of the 
Citizens for A Sound Economy and Empower America. I enjoy my 
co-chairmanship with Jack Kemp and Boyden Gray.
    We represent some 360,000 activists across the Nation, all 
of whom hold tax reform as a very high objective for the 
    I can summarize and enter the statement. Let me say, I 
became very actively interested in tax reform in the fall of 
1993 I think largely out of the frustration I am sure I share 
with millions of Americans over the complexity and the 
difficulty and the insecurity that they feel in trying to 
comply with the existing Tax Code.
    When I decided I wanted to once again engage this issue, I 
went back to my core roots as an economist and began with what 
I thought was fundamental propositions. The two fundamental 
propositions that I began my thinking with was one, every 
nation state must have a Tax Code and means by which they raise 
revenue and that was the legitimate objective of a Tax Code.
    I also had the observation that no matter how you levy 
taxes, in the final analysis, all taxes are paid by people and 
all taxes are paid out of current income flows.
    Thirdly, I went back to the Wealth of Nations, circa 1776, 
and recalled that great text axiom of Adam Smith that ought to 
strip the down off the goose with the least amount of squawks. 
I was clearly aware that we were not doing that with our 
current Tax Code.
    I began my study quite frankly with the national sales tax 
with the idea that I might go in that direction in terms of my 
own advocacy and the more I studied the efforts across the 
globe to implement a national sales tax, the more I saw the 
difficulties governments had in its implementation and finally 
turned my attention away from it on the premise that it was 
virtually impossible to legislate and even more impossible to 
    Having looked at a couple of plans, went back to the work 
of Hall and Rabushka from 1984 and rediscovered the flat tax. 
The flat tax comported with my fundamental premises and allowed 
in my estimation for us to fulfill what should be I think the 
generally agreeable tax objectives.
    I might mention by the way my colleague, Jack Kemp, who 
chaired the Kemp Commission that we created in 1995, came to 
these sort of general principles and Chairman Archer and myself 
had general agreement on that. The principles I think are 
foundation enough that there are any number of ways you can 
fulfill them.
    First, the Tax Code should be direct, obvious and simply 
understood so that compliance with the Code should not be in 
any way mysterious, costly or rigorous.
    Secondly, the Tax Code should not engage in efforts to 
socially engineer or efforts for income redistribution. Its 
fundamental purpose should be to raise money. The compliance 
costs should be nominal and the Code should be very clear and 
    The flat tax fulfills these objectives. It makes the 
Government neutral with respect to decisions. If you are making 
family or business decisions, the decision criteria should be 
economic criteria, family criteria, not criteria that are 
directed along the lines of minimizing your tax burden.
    One of the aberrations we see in the current Tax Code 
causes American business enterprise to make the rational 
decision in the interest of minimizing tax burden, to engage in 
offshore operations. This is regrettable and is something that 
we often are offended by but in fact, if you can advantage 
yourself legally under the law to engage in a business practice 
that minimizes your cost of doing production, which business 
considers tax to be, it is the most logical expectation we 
should have that business will do that.
    I would like to point out to my friends and colleagues, and 
I am sorry that Ms. DeLauro is not here because she and I 
always enjoyed this discussion.
    There s a sharp difference between tax evasion, which is 
illegal, and tax minimization which is of course something we 
all attempt to do in full compliance with the law to minimize 
the burden of the tax. Most American business enterprise that 
takes what otherwise would seem to be the irrational course of 
action of moving the enterprise offshore to do so because they 
are trying to reconcile their business interest, the interest 
of their stockholders and employees against what is a 
fundamentally prejudicial and irrational Tax Code. That is just 
one of many examples of what we find in the complexity of the 
current Code.
    There will be differences of opinion about what would be 
the best formula by which we can replace the current Code but I 
would daresay you could rarely find a proposition with greater 
national consensus than the general proposition that the 
current Code must be replaced with something.
    In my belief the flat tax as first iterated by Hall and 
Rabushka, as later iterated by myself, is the best way to go 
one, because it is most easily legislated and two, because it 
is most easily enforced and can fulfill the general 
propositions for Tax Code.
    One final point, I would be very careful of anybody who 
promised you they have the solution by which you will get rid 
of the IRS. The fact of the matter is when any nation state has 
a Tax Code by which they expect to collect the level of 
revenues that this Nation must, they will have a tax collection 
agency. It can be called the IRS, it can be called the National 
Sales Tax Agency. You can call it what you will, but it will 
need to be there for the purposes of collection and compliance.
    If the agency we have today does not seem civilized to us, 
it is because they have an uncivilized Code to enforce. My own 
personal attitude toward the employees of the IRS is pity the 
poor souls, we have given them an impossible Tax Code, an 
impossible job and now we criticize them because they don't 
always enforce it with what I would say is the highest of good 
    The last time I had what I perceived to be an impossible 
job, I don't recall whether I approached it with the best of 
humor. So these are good, decent, honest, hard working people 
who I don't think are properly appreciated for what must be for 
them day in and day out as they try to earn their living, an 
even more frustrating experience than it is for those of us who 
visit the Code only periodically.
    Thank you.
    [The prepared statement of Mr. Armey follows:]

 Prepared Statement of Hon. Richard K. Armey, Co-Chairman, FreedomWorks

    Good morning Mr. Chairman and members of the committee. I am Dick 
Armey, former House majority leader, and currently co-chairman of 
FreedomWorks, a non-partisan, non-profit grassroots organization with 
more than 360,000 members that works for lower taxes, less government, 
and more freedom. Thank you for inviting me here today to discuss the 
issue of fundamental reform of the U.S. Tax Code.
    As you know, Speaker Dennis Hastert has renewed the call for 
sweeping, fundamental reform, and at the Republican Convention this 
summer President Bush further revitalized the issue in his acceptance 
speech when he told the nation, ``The American people deserve--and our 
economic future demands--a simpler, fairer, pro-growth system.'' \1\
    This debate is important because America has one of the most 
outdated and complex Tax Codes in the industrialized world. Taxpayers 
are forced to spend many frustrating hours fighting forms and figures, 
digging for documentation, and checking and rechecking their math to 
make sure everything is right first to comply with the Tax Code, and 
gain to make sure they do not fall prey to the parallel alternative 
minimum tax (AMT). The Code exceeds 60,000 pages,\2\ and it takes 
Americans 6.2 billion hours to complete their taxes every year. Simply 
complying with the Tax Code imposes national costs as high as $194 
billion, according to the Tax Foundation.\3\
    Even worse, these cost of compliance figures do not include the 
broader economic distortions and inefficiencies caused by the current 
code that begins with an overly broad definition of income--which has 
necessitated the creation of any number of ``loopholes'', i.e., 
exemptions, deductions and credits to ameliorate the perverse 
disincentives to work, save and invest resulting from that overbroad 
definition of income. For example, Congress taxes savings and 
investment--the engines of economic growth--two, three, and sometimes 
even four times. This punitive approach puts many American businesses 
at a competitive disadvantage and even encourages some of them to move 
offshore. John Kerry may like to scorn ``Benedict Arnold companies,'' 
\4\ but these corporate inversions are often rational moves in response 
to anti-business tax, labor, and regulatory policies coming out of 
Washington, DC.
    Most importantly, I think, is that the current Tax Code offends our 
sense of what it means to be an American. This country was founded on 
the right of everyone to be treated equally before the law, but the 
current tax system doles out special treatment to those who have the 
power and money to lobby for it. The Code is so complicated and 
expansive that it now touches nearly every aspect of our lives. 
Americans can no longer make a decision in the family or in business 
based simply upon family or financial economic criteria. We have to 
make decisions based on tax criteria, and it is an undue burden. 
Politicians, in this way, are using the Tax Code to expand the reach of 
government control of our economy and of our lives.
    Complete and fundamental tax simplification and reform is the only 
answer. Other ideas, such as giving more power to the IRS, will fail or 
even make the problem worse. The IRS assessed nearly 28 million 
penalties last year,\5\ and it wants more power and control.
    No, it is time to completely scrap the Tax Code. We need to get rid 
of all the Code's social engineering and special interest handouts. We 
need a new Tax Code that recognizes the goodness of the American 
people, not the guile of the Federal Government and crafty tax 
    No doubt, fundamental tax reform has been on the Congressional 
agenda since Republicans first took control of Congress in 1994. At 
that time, Congress created the National Commission on Economic Growth 
and Tax Reform, chaired by Jack Kemp, which concluded in 1996 that 
America needed to completely scrap the Tax Code.\6\
    The Kemp Commission produced Six Points of Principle for tax 
    1. Economic growth through incentives to work, save, and invest.
    2. Fairness for all taxpayers.
    3. Simplicity, so that everyone can figure it out.
    4. Neutrality, so that people and not government make choices.
    5. Visibility, so that people know the cost of government.
    6. Stability, so that people can plan for the future.
    It is interesting to note that this past July, Jack Kemp and I 
helped merge Empower America and Citizens for a Sound Economy (CSE) 
into a new organization, FreedomWorks, where we both serve as co-
chairmen. Along with C. Boyden Gray, Jack and I are leading a renewed 
grassroots effort to educate and mobilize ordinary Americans on the Tax 
Code and the urgent need for reform.
    No doubt, there is a way forward. Supporters of fundamental tax 
reform have rallied around five basic principles--``Five Easy 
Pieces''--first put forward by veteran Washington tax lawyer Ernest 
Christian. They are 1) Lowering and flattening marginal rates, 2) 
moving toward full expensing of business investment, 3) reducing or 
eliminating the double taxation of dividends and capital gains, 4) 
expanding tax-free savings vehicles, and 5) international tax reform.
    These five goals will move us toward a simpler, fairer, and flatter 
tax system. Reducing marginal rates makes the tax burden more equitable 
and creates incentives for people to work. As both Ronald Reagan and 
George W. Bush have proved, cutting marginal tax rates creates 
incentives to work more, save more and invest more resulting in greater 
economic growth. Allowing corporations to fully expense investments in 
business plant, equipment and technology will maximize business 
investment necessary for long-term economic growth. And it's obvious 
that lowering taxes on dividends and capital gains reduces the 
penalties on saving and investment, creating economic growth.
    Finally, the current code is hostile to U.S.-based firms that have 
significant operations overseas. The Kerry-Edwards detailed 
international tax reform plan states, ``John Kerry does not believe 
that we should force a U.S. company that chooses to create jobs in the 
United States to pay higher taxes and suffer a competitive disadvantage 
with a company that chooses to move jobs to a tax haven and keep 
profits there permanently.'' His solution? Eliminating the tax deferral 
for foreign-earned income as they earn it rather than being allowed to 
defer taxes.
    In other words, Senator Kerry would create incentives for companies 
to take not just the jobs overseas, but to move the entire operation 
overseas as well. The Kerry campaign misses the obvious solution. As is 
written in their own report, a U.S.-based firm can ``expect to pay an 
average tax rate of 31 percent. When this company invests abroad, it 
faces an average tax rate of 21 percent.'' The same Kerry report 
acknowledges that 80 percent of U.S. manufacturing assets abroad are 
based in countries with tax rates lower than the rate in the United 
    It seems obvious to most people that if U.S. tax rates are so high 
and uncompetitive that firms are being encouraged--driven--overseas, 
the solution is not to punish the firms, but to reduce the tax rates to 
more competitive levels. Cutting the tax rates by 5 percent, as Kerry 
wants to do, is a good starting point for debate, but is simply 
insufficient to make America's Tax Code more competitive 
    The ultimate purpose in all of this is that we need a simple pro-
growth Tax Code that is consistent with our values. A better code would 
reward hard work, encourage investment, and reflect our fundamental 
belief that individuals can spend their own money better than 
Washington can. This new system, by harnessing the power of freedom, 
would make the American economy stronger and more dynamic. I think that 
millions of taxpayers agree. Americans deserve a ``simpler, fairer, 
pro-growth system,'' and we are working hard to that end.
    In the past, as you may recall, Citizens for a Sound Economy (CSE) 
helped organize the Coalition for Fundamental Tax Reform (CFTR), a 
loose confederation of groups committed to fundamental overhaul of the 
Tax Code. One of the group's activities was to promote a set of six 
principles that were essentially a distillation of the Kemp 
Commission's Six Points of Policy and Six Points of Principle.
    The CFTR principles were incorporated into a ``Commitment to Tax 
Reform'' pledge that candidates for public office were asked to sign. 
As everyone here knows, candidate surveys and pledges of this kind can 
be a powerful political and policy tool.
    Now that Citizens for a Sound Economy has joined with Jack Kemp and 
Empower America as FreedomWorks, we will again be leading with a tax 
reform pledge based on core principles that should guide sound tax 
reform. For the purposes of discussion, I'd like to share our current 
working draft of a new legislative tax reform pledge:
       commitment to tax reform candidate pledge [working draft]
    I pledge to support tax reform legislation that:
    Applies a single, low rate to all Americans
    Provides tax relief for working Americans
    Eliminates the bias against savings and investment
    Requires a supermajority of both chambers of Congress to raise 
    Protects the rights of taxpayers and reduces tax collection abuses
    Promotes economic growth and job creation
    I think you'll all agree that these ideas all form an excellent 
basis from which to build consensus on fundamental reform. And, rest 
assured, we, at FreedomWorks, are not standing still. FreedomWorks and 
our 360,000 members nationwide care deeply about our economy and the 
state of our Tax Code. On behalf of all of our members, we look forward 
to working together you to scrap the Code, replacing it with a system 
that is fair, flat, and simple.
    Thank you.


    1. ``Transcript: George W. Bush'', Fox News, 9/02/04
    2. ``Fiscal Facts and Figures'', The Cato Institute, 2004
    3. ``The Cost of Tax Compliance'', The Tax Foundation, 2/02
    4. ``The Kerry-Edwards Plan to Protect and Expand Automotive Jobs 
in the United States'', www.johnkerry.com,
    5. Internal Revenue Service Data Book 2003, page 34.
    6. ``Unleashing America's Potential'', National Commission on 
Economic Growth and Tax Reform, 01/96

    Chairman Nussle. The last impossible job that I am aware 
you had, Dick, was managing the House of Representatives and 
you did it always with good humor and we appreciate your 
testimony here today.
    Chairman Archer, welcome to the Budget Committee and we are 
pleased to receive your testimony.


    Mr. Archer. Thank you, Mr. Chairman. Thank you for letting 
me come and talk to you about what I think is the single most 
important economic issue facing this country, one where you can 
do more good with far reaching effects on the economy and on 
jobs, which as all of us know, is very, very important.
    I am currently associated with PriceWaterhouseCoopers but I 
do not appear on behalf of PriceWaterhouseCoopers. I come to 
talk to you about my own personal views. I have no written 
testimony and therefore you won't have to wade through anything 
other than perhaps the record when this is all over.
    I agree with my friend, Dick Armey, on almost everything he 
said. We are going to have to have taxes. I had a town meeting 
several years ago in my district and laid out my view that we 
should get rid of the income tax and go to a consumption tax.
    I got a lot of applause and at the end in the question 
period, a man in the back of the room held his hand up and I 
recognized him. He said, I don't like your idea. I said, why 
not? He said, because we still have to pay taxes. I said that 
is right, and Dick Armey is right, we have to raise revenue in 
order to pay the Government's bill. So the real question is how 
are you going to do it.
    There aren't a lot of options. There is an income tax 
whether it be in the form of a flat tax or whether it be in the 
form we have today. There are several vehicles for a 
consumption tax. You could levy a property tax or a wealth tax, 
I suppose. I certainly would oppose any of that and I agree 
with my friend, Dick Armey, that it should come out of the 
stream of commerce in some way or another.
    I think you first have to determine your goals and then try 
to figure how you are going to get there. You have to set 
priorities to your goals.
    Everybody wants to have a simpler tax. Dick Armey and I 
differ. I submit that you will never simplify an income tax. I 
had great hope in 1985 when Reagan pushed for reforming the 
income tax. I don't know if Dick knows this but I went to the 
White House and said, do a flat tax. I was very intrigued with 
using a postcard, which would simplify everything.
    However, after we got through the tax reform deliberations, 
I gave up on ever fixing the income tax; because in spite of 
the fact that it was proposed in 1986 as fairness, growth and 
simplicity. That was the front page title. It was a 500 page 
summary of what they were going to do.
    I scanned through it the night before the hearing before 
the Ways and Means Committee and in disbelief I read the part 
on foreign source income and it said as follows, ``The current 
law is very complex and difficult to administer. Our proposal 
will make it even more complex and more difficult to 
    At the hearing I read this to my friend, Jimmy Baker, then 
Secretary of the Treasury, and I said, how can you claim 
simplicity? He said, Congressman, that is why we put simplicity 
third in the order of things.
    In the end, the simplicity that came out of that massive 
effort in 1986, in retrospect, was to knock 6 million people 
off the rolls at the lower income levels.
    I said, I won't argue with that. If you don't have to file 
an income tax, it's simpler than having to file one, but for 
those of us who continue to have to file our income taxes, it 
is more complicated now than before you started.
    I would submit to you that complexity is the history of any 
income tax, no matter how you devise it because no two 
economists agree on the definition of income. That was what I 
began to realize early on. So you have to redefine and redefine 
and every time you redefine, you create inequities and then you 
have to try to fix those with patch after patch after patch. 
That is why we have the Code that we have today.
    I think you have to determine what are your goals. If you 
want simplicity, with lower costs of administration and 
compliance, a flat tax--if you could keep it--would go a long 
way to getting there.
    I would submit to you that history tells you that you can't 
keep a flat tax because of what I just said. An income tax is 
like an attractive nuisance for those of you who are lawyers, 
it just brings in all kinds of untoward things that become 
negative over time. We have plenty of history to show that.
    It is a big jump to get away from an income tax. I don't 
know if you can do it but I will tell you that if you want the 
goals of the lowest possible administrative cost, less 
underground economy, ultimate incentive for savings, taxpayer 
personal privacy from the IRS and economic advantage to U.S. 
exports/disadvantage to foreign imports, then you cannot use 
any form of an income tax.
    I will submit to you that with the income tax we have now 
and the advent of the smart card where you can put a computer 
chip in the card and transfer money electronically without 
trace anywhere in the world, the IRS is going to have more and 
more and more problems with non-compliance and how do you get 
after it.
    It has been estimated and you have seen some of the 
estimates that range anywhere from $200 [billion]-$300 billion 
a year being lost to the underground economy under our current 
income tax. So I think one of the goals should be how do we 
have a tax where we can actually have more compliance.
    The compliance costs themselves are unbelievable with our 
current income tax. They have been estimated to be anywhere 
from $250 [billion]-$600 billion a year just for the compliance 
costs. Part of that is that 3 days a year I spend doing my own 
income tax. That doesn't show up in dollars and sense anywhere 
but that is part of the compliance cost. When you get into 
bigger corporations, it boggles your mind
    The last audit Exxon had done which I was privy to before I 
left the Congress, included paperwork for the audit alone was 
200 feet high, the equivalent of a 20 story building and Exxon 
regularly has anywhere from 35-50 IRS employees in their office 
every day.
    All of these compliance costs and the litigation in the Tax 
Court just boggles your mind. That is all wasted money in our 
    Yes, it produces jobs. It even produces jobs for people in 
my shop at PriceWaterhouseCoopers but in the long run, it is 
not producing wealth. So I think you have to focus on that and 
decide what you want to do, but also how important is privacy 
and intrusion into the lives of individual citizens. You can't 
put a dollar and cents value on it but I think you should think 
about that goal.
    Thomas Jefferson made only two speeches while he was 
President. One was his second inaugural address, where he said 
one of his most notable achievements while in public office was 
to eliminate the Federal taxpayer from any direct contact with 
the citizens of the country. How important is that?
    I had one witness before my committee in one hearing, and 
Jim, you may have been there, I don't know, but it was a woman 
from Connecticut, a middle-income woman. I asked her what she 
would you give not to have to deal with the IRS. She said ``I 
would give my firstborn child.'' The reality is you had an 
untoward experience with the IRS and privacy from the IRS in 
her life was very, very important. Any income tax puts the IRS 
in the middle of the lives of every American. They can get your 
records. You have to keep those records and you are always on 
call to the Federal Government. How important is that? You have 
to determine your goal in tax reforms.
    Finally, and perhaps most important to a lot of people is 
what is it going to do for the economy. If you use the flat 
tax, it is clearly going to do more for the economy. It is 
going to lighten the load on savings which we desperately need 
to invest to create jobs, but it doesn't give you border 
    In the world marketplace, the global marketplace where our 
products being exported have to carry the cost of government, 
incoming foreign products bear no part of our cost of 
government under any income tax.
    If you use a consumption tax, and there are a number of 
vehicles, you then reduce the price, and I think John Linder 
just talked about this, of our products being exported to the 
world marketplace by an average of over 20 percent and you tax 
incoming foreign products by an equal amount. It is all WTO 
legal without starting a trade war.
    To me, in the long run, these jobs for export which pay 17 
percent more on average than jobs for the domestic market, are 
worth trying to get. This is a big way to get it.
    How do you get from A to B assuming you have to decide what 
goals you want. It is not going to be easy. I realize now being 
on the outside it is going to be more difficult than I did when 
I was actually in the Congress. This is a massive change.
    People who are used to the current Code are going to resist 
you if they feel they have any niche in the current Code that 
helps them. That is human nature. I don't know that I can tell 
you the best way to get there but I have about come to the 
conclusion that you are better off reforming the corporate 
income tax first and then taking on the reform of the 
individual income tax.
    Then, of course, what are you going to do about the payroll 
tax? So you have three elements you have to work with.
    Our friend, Congressman Linder, believes you can do it all 
in one fell swoop and maybe he is right. I don't know, but you 
are going to have all kinds of transition problems that you 
have to deal with and I won't get into the details of a lot of 
    I thank you for giving me the opportunity to at least give 
you a thumbnail sketch of my feelings about structure tax 
    Chairman Nussle. Thank you.
    Mr. Spratt.
    Mr. Spratt. Thank you both for your testimony.
    I am sorry, Mr. Armey, we couldn't sit you side-by-side 
with Mr. Linder and recite a few things you have to say about 
the sales tax in your pilgrimage and finally coming to the flat 
tax as a better alternative.
    You both remember, I am sure, the bill called Bradley-
Gephardt, a precursor of 1986, which tried to strip out as many 
deductions and credits and preferences from the Code and get it 
down to what they thought was a bare minimum. That included 
home mortgage interest, State and local property taxes, 
charitable contributions and maybe a couple other things.
    They recognized there was no political prospect of 
repealing those particular provisions. They were popular and 
that was why they were in the Code to start.
    As we got the bill, even though it was a complicated bill, 
the 1986 tax reform bill, we started getting phone calls from 
lots of people who were about to lose their particular 
provision or exemption deduction or credit in the Tax Code. You 
found out they weren't there by accident, those things had been 
put there for a reason and they were dearly loved by the people 
whom they benefitted.
    I have to wonder if you can realistically propose the 
passage of a tax reform bill that doesn't accommodate the home 
mortgage interest deduction, the State and local property tax 
deduction and the charitable contributions. Do you think that 
is realistic? You are both astute politicians.
    Mr. Armey. Let me begin and under the general heading of 
eating your crow when it is served up to you, may I acknowledge 
the fact that I not only made what I consider to be the most 
bad judgment vote of my lifetime when I voted for the 1986 
bill, but I even had the audacity to do that against Bill 
Archer's advice. So I think it is only appropriate that I take 
that big dish of crow right now and gulp it down.
    Yes, it is difficult. I understand, Mr. Spratt, what you 
are saying and I appreciate the work that was done by Bradley 
and Gephardt in the early 1980s to try to kick this thing off.
    I am sort of guided in my thinking here by a couple of song 
titles, first, ``I Can Dream Can't I,'' and then a second one 
called ``All or Nothing at All.'' There is indeed a very, very 
broad spectrum of what I call tax complexity professionals that 
will work very hard to retain the SOPs that they have in the 
current Code, so there is also a good deal of confusion about 
    If you are going to do the flat tax as I vision it, it is 
going to have to be done I think in one fell swoop and that is 
a big load, a big task to undertake. Anything done a bit at a 
time as for example, the 1986 bill, will likely be even more 
complex and difficult.
    I had made the decision in 1994-1995 that this was a big 
job that was worth doing but it would only be done as I like to 
say when America beats Washington because 90 percent of all the 
tax complexity professionals make their living in this town. It 
is not a small task.
    Yet, I think my own view it is a dream worth dreaming and a 
goal worth fighting for and an objective work pursuing. That is 
why I have sought in my after congressional life to pursue it 
through an activist organization such as FreedomWorks to engage 
the American people to, in effect, demand that they get this 
relief in the Tax Court.
    I still remain convinced despite all the difficulty that it 
is a doable thing and it is the one formula we can find that 
will get the simplicity and the civility in the Tax Code that 
the American people desire.
    Mr. Spratt. Your proposal has an additional complication 
and that is depreciation on existing undepreciated assets which 
would not be available.
    Mr. Armey. I think we expense business decisions at the 
outset and moving from where we are now.
    Mr. Spratt. Assets which had not been fully depreciated, 
could not be depreciated?
    Mr. Armey. There would be a clear transition problem there 
that would have to be addressed, but in the final analysis, 
after the transition, business capital expenditures would be 
expensed at the time they are made.
    Mr. Spratt. Let me read you what Rabushka said in exalting 
over their idea in their book, their first publication called, 
``Low Tax, Simple Tax, Flat Tax.'' On page 67, he said, ``This 
will be a tremendous boon to the economic elite.'' Then he went 
on to acknowledge some bad news, ``It is an obvious 
mathematical law that lower taxes on the successful will have 
to be made up by higher taxes on the average people.''
    Do you acknowledge there will be this kind of shift from 
higher income people to lower income people in implementing 
this tax?
    Mr. Armey. I think it is really difficult to make a good 
measure but let me give you some of the observations I would 
    First of all, the majority of tax loopholes, as it were, 
tax avoidance mechanisms, are advantageous to the wealthy as 
opposed to the lower income Americans. One thing the flat tax 
does is eliminate that. For example, we discerned in 1996 that 
in that year under the flat tax, H. Ross Perot would actually 
have paid a higher rate of tax, average tax rate on his 
earnings than he would have and did in fact pay in that year 
because all his tax avoidance opportunities would have been 
    There is today a maldistribution of the burden of taxes. 
Generally speaking, it goes like this. The top 20 percent of 
taxpayers in Americas pay around 46 percent of the total tax 
burden. That is over twice a proportionate share. The bottom 20 
percent of the taxpayers pay 1 percent of the tax burden. The 
middle, 60 percent of the taxpayers pay 54 percent of the total 
tax burden. So there is a maldistribution.
    The flat tax is predicated on this simple assumption and 
definition of fairness. Fairness is when you treat everybody 
exactly the same as everybody else. In the flat tax world, 
everybody would pay exactly the same rate as everyone else so 
that when you broke it down into tax paying percentiles like 
this, it would always come out proportionate in the 
    The fact of the matter is there are many people, I happen 
to be one of those who think that when you have a large caste 
of non-taxpaying citizens, you create what is known in the 
discipline of economics as free riders. Free riders always want 
more of the transportation they are riding because they don't 
pay the cost and that gives you a foundation impulse and a 
large segment of the population for big government.
    I happen to be of the school of thought that subscribes 
that old adage that the Government that governs best governs 
least and one of the things I feel is sort of a general 
disposition regarding America is that we have too much big 
government in America.
    The reduction of the number of people that subscribe to big 
government theories through the free rider impulse I believe in 
the long run is not only an appropriate correction in the 
course of our Nation, but it is also an equitable correction 
given my definition of fairness being as I said to treat 
everybody exactly the same as everybody else.
    Mr. Spratt. Thank you both for your testimony.
    Mr. Archer. I would like to take a stab at your question. 
It is a very good one.
    I think it is going to be exceedingly difficult to get rid 
of a lot of deductions because it is human nature. No matter 
what the long term benefit is, it is human nature to say, wait 
a minute, next year I am not going to be as well off under the 
Tax Code and that is one of the tough obstacles we have to 
overcome. It is a sales job to the American people to let them 
understand that taxes are a part of their economic life but 
they can be a big part or they can be a small part and 
ultimately, what do you have in spendable economic income at 
the end of the day to buy the things you want for your family 
and the things that you need.
    It is a tough sales job because people will myopically 
focus just on the immediate tax impact of a specific provision. 
This is true of individuals, it is true of businesses and that 
is where the big problem has come in passing the FISC-ETI bill 
because businesses fight each other to see who is going to get 
the benefit and who is going to be hurt the most.
    It is a microcosm in my view of what you are going to run 
into when you start talking about fundamental structural tax 
reform but one thing I didn't mention is if you get rid of an 
income tax, and you use the consumption tax vehicle, there are 
several vehicles with three major ones.
    It is not just the sales tax. You have can have a valued 
added tax, the European style of which I do not think would be 
suitable for the United States or you can have a uniform 
business transfer tax like the Japanese use for part of their 
revenue raising. So there are a number of ways you can look at 
it to have an alternative.
    You can have another problem which is growing in doing any 
fundamental tax reform, regardless of whether it is a flat tax 
or it is a consumption tax. Today, 43 percent of the American 
people pay no income tax and we Republicans are mainly 
responsible for that, beginning with Reagan in 1981 and then 
again in 1986 where 6 million people were dropped from the 
    When I passed the child credit in 1997, that dropped 
millions of people from the income tax rolls. It has been a 
succession of events as time has gone on where as I said today 
you have 43 percent or 125 million Americans who pay no income 
tax. Many of those Americans actually get a check from the 
Treasury under the earned income tax credit.
    If you don't have a vested interest in getting rid of the 
current tax system, you have a hard time motivating the 
political force at the grassroots to get the job done.
    Chairman Nussle. Are there other members who wish to 
inquire? Mr. Edwards.
    Mr. Edwards. I, first, want to thank you, Mr. Chairman, for 
bringing these two distinguished leaders before our committee. 
It is not often we have a chance to think outside the box and 
gain the benefit and practical real world implementation 
insights from two members who have had the distinguished 
careers the two of you had. I thank you for inviting them and 
thank you both for being here.
    Mr. Archer, I am a former constituent of yours and thank 
you for all your courtesies.
    Chairman Nussle. There are experts outside Texas.
    Mr. Edwards. I understand. In fact, speaking of Texans, I 
am reminded of our other former colleague, a Texan, Senator 
Phil Gramm, a former economics professor at A&M, who said he 
taught me everything I knew but I didn't learn everything he 
knew. I think he said something, a paraphrase, we all want to 
go to heaven, a lot of people just don't want to do what it 
takes to get there. I think that is one of the challenges we 
face in trying to take the important idea of simplifying and 
making a fairer Tax Code.
    It is great there are two leaders out there thinking 
outside the box.
    Mr. Armey, I would like to ask you this question. You have 
been consistent in this throughout your public career, that you 
want social engineering tax policy or even fiscal spending 
policy and you define fairness as treating everyone the same as 
everyone else.
    Yet, the flat tax proposals that we have heard from other 
members, Mr. Burgess a minute ago said that someone making $1 
million a year in dividend income would pay zero dollars in 
taxes but a sergeant making $40,000 serving his or her country 
would pay a flat tax rate on that.
    If we want to define fairness as you have and don't want to 
do social engineering, should it be the Government's business 
to put a value and a bias on how they earn their income?
    Why shouldn't a factory worker making $50,000 a year pay 
the same marginal tax rate, if you want a flat tax, as someone 
making investments and making dividend income sitting in an air 
conditioned office making $50,000 a year and specifically, does 
your flat tax proposal treat everyone the same in terms of 
$50,000 income from one source is treated the same as $50,000 
from another source?
    Mr. Armey. Again, thank you for the question. Let me say, 
by the way, you are dragging me back into my old academic 
classroom again.
    One of the principles of the flat tax is that every dollar 
is taxed in the year in which it is earned and taxed only once. 
Under current Tax Code, dollars earned from the capital sector 
contribution to production, usually dividends, are double and 
triple taxed. Where you get into problems in terms of imagery 
is if I earn my wage, I pay tax on it one time. If I own half 
the stock in the business, we have first a tax on the earnings 
of the business, then when we distribute the earnings of the 
business, then I pay taxes on my dividends. So I am double 
    The fact of the matter is it is efficient and I am not sure 
I think it is the appropriate way. I think if I could write it 
exactly the way I would prefer to do it, I would do away with 
withholding taxes so that every taxpayer in America had to sit 
down at his kitchen table at the end of every month as I did 
and still do when I write my check to the gas company, I cuss 
the gas company. When I write my check to the electric company, 
I cuss them. When I write my mortgage payment, I cuss them and 
when I write my check to the Government, I could cuss them with 
equal enthusiasm and an equal awareness of the burden of the 
    That would be collecting the tax then by the person who 
finally pays it so he clearly sees the burden of his tax. Do 
the same thing with capital earnings and rather than tax it as 
earnings to the business, tax it to the recipient of the 
dividends. Tax it one time. You would have a greater sense of 
the equitable treatment of people. You would have to give up 
the fiction that when you tax business earnings, you didn't tax 
people. You would tax the people when they finally receive 
their earnings and tax them the same way.
    I think that would be probably the most transparent and 
socially more desirable.
    Mr. Edwards. It would seem fairer, certainly, from taxing 
all income at the same rate.
    Mr. Armey. It is very important though to eliminate the 
double taxation on capital because it is through capital 
expenditures that we innovate technology, science and 
engineering which gives us increased productivity, enhancing 
the workers wages. I think probably the best way would be to 
not collect any taxes at their source but at their 
    Mr. Edwards. Thank you and I had a question for Chairman 
Archer but my time is up, I will wait until others have a 
    Chairman Nussle. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Armey, that was a long answer but as I understand the 
answer, if you make all your money in capital gains, interest 
and dividends, you would pay no tax on that income, is that 
    Mr. Armey. No. I am saying you should pay taxes on it once 
just like I pay taxes once on my wages and I would prefer that 
as we do away with the withholding tax and I write my own check 
to the IRS that we do away with the first element of the double 
taxation by not taxing it at its source as business earnings 
but tax it as distribution, as dividends or bond interests or 
    Mr. Scott. If you are just going to tweak the present 
system, do I hear you repealing corporate taxes?
    Mr. Armey. In order to eliminate double taxation of capital 
earnings, I would repeal corporate taxes by not taxing it at 
its source as business earnings but tax it as distribution, as 
dividends or bond interest or whatever.
    Mr. Scott. If you are just going to tweak the present 
system, do I hear you repealing corporate taxes?
    Mr. Armey. In order to eliminate double taxation of capital 
earnings, I would repeal corporate taxes and tax dividends, 
yes, but I would not double tax the same source of income, same 
    Mr. Scott. And if the holder of the stock were a non-profit 
or tax exempt or held in tax exempt in some kind of way, it 
wouldn't be taxed at all?
    Mr. Armey. No, they would pay taxes. There would be some 
changes. One of the reasons, for example, I find a great deal 
of opposition to a flat tax from the university community is 
because they now enjoy the certain benefits under the Tax Code 
that they believe guides public generosity in their direction. 
These things would change.
    Mr. Scott. Mr. Armey, rather than asking Mr. Archer 
questions, can you tell me what is wrong with the national 
sales tax?
    Mr. Armey. One of the first things I would like to tell you 
is there is no entity that applies the sales tax that I know of 
that doesn't have a very complex law that is fraught with 
exceptions, whether it be certain products are exempt and so 
forth. As an example, in Texas when I go to the store and buy 
something for my home, I pay sales tax. If I say it is for the 
ranch, I do not because it is a farm exemption. So sales taxes 
are very complex.
    The biggest problem I have is that in every nation state 
that has ever tried to implement a sales tax, there has been a 
growth of the underground economy to the extent that the tax 
became unenforceable and that is the principal reason why 
Europe has gone to the value added tax. You cannot achieve the 
simplicity, you still get the social engineering and in the end 
you don't have an enforceable tax.
    Mr. Scott. Mr. Archer, isn't that right? [Laughter.]
    Mr. Archer. As I mentioned earlier, I have never identified 
with any specific vehicle to try to get rid of the income tax. 
That ultimately, of course, has to be done and I have struggled 
with what would be the best way to do it.
    Another thing that really bothers me about the income tax, 
particularly the one we have today, is that we are in a tax 
trap. The harder you work, the longer you work, the more you 
pay. I think that is wrong. I think that is basically, 
economically wrong. I think it is a far better and fairer to 
tax that the more you spend, the more you pay.
    We see all the anomalies within the income tax, for 
example, and I don't want to get into the presidential debate 
but let me take some fictional characters and say that there 
are some people who have large amounts of annual income who pay 
an effective tax rate of 12 percent. There are other people who 
have large amounts of income that are not as large as the first 
hypothetical individual who pay an effective tax rate of 28 
percent. Gee whiz, what are we doing with our Tax Code?
    If you look at the polls taken of the public, one of the 
reasons they don't like the income tax and, by the way, 
Congressman Scott, these polls show the same in the inner 
cities as they do in the suburbs and in the rural areas, the 
same basic results come back that people believe if you are 
rich, you can hire the best PriceWaterhouseCoopers type people 
to find ways to reduce your effective tax burden. If you are 
not that rich, you don't have the capability of doing it. There 
are just a lot of factors.
    I am not directly responding to you and I will try to do a 
better job but there are problems with every tax system. There 
is going to be some leakage in every tax system. You can debate 
what one is going to have the most leakage or not going to have 
the most leakage but to me I am not going to defend the sales 
tax other than in my book it is better than the income tax for 
a lot of reasons, the time we don't have to get into today.
    In the end, if you want to get rid of the income tax, you 
are going to have to take a long look at the three basic 
vehicles you can use to replace that income tax and make a 
judgment as to the pros and the cons.
    The last thing I will tell you is that there is any system 
that is going to be perfect or any system that isn't going to 
be flawed, or any system that isn't going to have objections to 
it in some way or other. That is why I started out talking 
about goals. You have to determine what are your goals, what 
are your priorities and then try to get as close as you can to 
those goals.
    Chairman Nussle. Mr. Baird, do you want to sneak in a 
question? We have two votes on the floor.
    Mr. Baird. First of all, I want to thank you for being 
here. I applaud your efforts to try to think out of the box, so 
the questions are not meant hostilely. I agree we have to 
simplify this.
    My father passed away a couple of years ago but before he 
did, he worked with the RSVP Program volunteering to help 
seniors with their taxes. He had a doctorate in education. He 
said, son, I can't tell you how to do the damned Tax Code and I 
am supposed to advise people how to do it. He said, when you 
are in Congress, don't make the Tax Code more complicated. 
Well, I am glad, in some ways, he passed away a couple of years 
ago because he would perhaps chastise me.
    Mr. Armey, here is the puzzle I have and I don't understand 
it. Let us say my father, which he didn't, but let us suppose 
he had given me $1 million of inheritance. I say terrific, I 
have $1 million in inheritance from my dad, I am going to 
invest it at 6 percent, I am going to do pretty well. I don't 
ever have to work a day in my life. Do I pay taxes?
    Mr. Armey. Yes. Again, this is the problem with double 
taxation. The question is where you levy the tax. You can levy 
the tax on the corporations in which you invest and take the 
tax at the source or you can levy the tax on the dividends as 
they are distributed and take the tax at that end.
    I think most people would perceive the burden of the tax, I 
go back to my initial principle, all taxes are paid by people, 
all taxes are paid out of current income. I think a prudent 
Nation ought to have the people who pay the tax clearly 
perceive the burden of the tax. Yes, you would under my system 
pay those taxes because I think the transparency of the tax 
burden is a greater public benefit than what efficiencies you 
might get by collecting them at their source.
    Mr. Baird. Mr. Archer, I live in a State that is unique and 
there are seven of us but we have no income tax on our side of 
the river and there is no sales tax on the other side of the 
river. It is a pretty great place to live. You can make your 
income on our side, shop the other side and not pay sales tax, 
so I appreciate what Mr. Armey said earlier about people 
dodging taxes.
    I also appreciate your principle that you want to reward 
savings. One of the questions I have is would there be adverse 
sort of dis-stimulative effects if you put a heavy sales tax on 
the products people buy, do you suppress the consumer aspect of 
the economic engine of the country?
    Mr. Archer. Again, I am not here to defend the sales tax 
but there is an answer to that and the answer is that you 
already have embedded in the price of every product you buy, 
the incidence of the income tax. You just don't see it.
    Different economists disagree on where the burden of the 
income tax goes. Part of it clearly goes to the investors, part 
of it goes against labor but a big, big chunk of it has to be 
passed through as a cost of doing business to the ultimate 
consumer. If you did away with the income tax, you are not 
going to have that embedded in the price of the products. So 
you get that benefit.
    From a perception standpoint, it is tough. It is tough to 
explain all of this and the ultimate impact of who pays what 
under what circumstances, but the reality is that you are going 
to eliminate that built-in part of the price of the product.
    Mr. Armey. May I make a quick response? Even as an 
undergraduate, I pondered the question of what is the public 
interest? I found my definition of public interest in Adam 
Smith where I found so many things--if I may, the real Adam 
    Consumption is the sole end and purpose of all economic 
activity and to the extent that the Government intervenes in 
the affairs of the community, it should do so on behalf of the 
consumer. This also coincides with my mama saying you work to 
    I find it difficult to accept a Tax Code that is expressly 
directed at taxing consumption. That is what we are living for. 
I understand the idea of not being adverse toward savings and 
investment, but then being, as it were, prejudicial against 
consumption activity I think is a poor correction of that.
    Mr. Archer. Let me jump in quickly and say one of the 
things that concerns me about our society today economically is 
that we are not a saving society and we all know that, so what 
do we have to do to get the money to build the plants, to 
invest to create the jobs, foreigners. We are dependent more 
and more and more on the influx of foreign investments here. 
What if some day they decide, it is not as appealing to invest 
in the United States. We are in big, big trouble.
    Chairman Nussle. In the time I have, I saved my time to 
give to you because we are done with questions and we have 
votes. I noticed you got a little twitch in your face when you 
heard the bells go off again. I noticed you weren't used to 
hearing those for some time and it is a nuisance.
    Just to wrap up, I would like to reverse the order and let 
you give us your advice based on what you have said today, on 
the consumption based tax, on a more income based tax and just 
wrap it up, give us your advice in closing. Mr. Archer, go 
    Mr. Archer. I would like to simply recap what I have 
already said. The Congress has to decide what is the goal or 
what are the goals, what are the priority goals and then decide 
the best way to get there. It isn't going to be easy. It will 
be one of the most difficult lifts that you have ever done 
maybe other than health care.
    I reached this conclusion because on the outside I now 
think it is going to be even more difficult than I did when I 
was on the inside. As I spoke to labor union halls or I spoke 
to the CFOs of the Fortune 500, it didn't matter. I got a 
resounding, standing ovation when I said I want to get the IRS 
completely and totally out of your individual life. Wow. But it 
is a long way to get from there to the implementation. You see 
all of the struggles of those people who have a vested interest 
in some portion of the income tax today that are going to be 
out there fighting you in whatever you do.
    I don't think an individual Member of Congress can make 
this happen. I don't think a group of you can make it happen. I 
don't know whether it can be developed at the grassroots level. 
I think it is going to take a President who is willing to 
invest his political capital to go directly to the American 
people to override all of the objections and the special 
interests that are going to come when you try to find a way to 
get to this goal.
    Chairman Nussle. Mr. Armey.
    Mr. Armey. Let me just say after years and years of 
studying this and looking at the other alternatives, and I hope 
with a reasonable degree of academic objectivity, I have 
remained convinced that while it is no policy for the timid and 
a difficult job, the first best solution to our problems and 
our concerns is the flat tax as first originated by Hall and 
    Now I am drawn to my natural humility when I say that in 
1995, I took their very academic work and translated it into a 
book of my own called, ``The Flat Tax'' which is written, as it 
were, in common parlance. I say again, as I do through this 
natural humility that is a compulsion I have, if you would buy 
and read my book, we would all profit. [Laughter.]
    Chairman Nussle. We deeply appreciate your advice and your 
testimony and the discussion that you stimulated today. We hope 
and trust this will not be the last opportunity for that kind 
of discussion to take place.
    Thank you.
    Mr. Archer. Thank you, Mr. Chairman.
    Chairman Nussle. We have two votes on the floor, therefore, 
we will recess and then after the second vote, we will 
reconvene and take the third panel at that time. [Recess.]
    At this point, I am pleased to call and invite to our 
witness table three very distinguished economists and experts 
in a number of different fields. We have before us for the 
final panel, William G. Gale, Doctor and Senior Fellow at the 
Brookings Institute; Dr. Robert E. Hall, Professor of Economics 
and Senior Fellow of the Hoover Institute and Stanford 
University; as well as Dr. Eugene Steuerle, Senior Fellow of 
the Urban Institute.
    We have three very distinguished panelists and I also 
observed they were here for I believe almost all of the morning 
debate and discussion, so they are fresh with new ideas, I am 
sure as well as arguments and maybe even some rebuttal to our 
earlier witnesses.
    We will begin in that order. Dr. Gale, welcome back to the 
committee. You have been here many times before.
    All of your testimony as written will be made a part of the 
record and you may summarize during your 5 minutes.
    Thank you very much and welcome.


                  STATEMENT OF WILLIAM G. GALE

    Mr. Gale. Thank you very much. It is a pleasure to be here.
    I think we learned this morning what we already knew which 
is that almost everyone believes the tax system could be 
improved but agreement on the nature and severity of the 
problems and how to fix them remain allusive.
    I would like to make several points in general and then 
talk about the flat tax and the national retail sales tax in 
    The single most important point to think about in 
evaluating fundamental tax reform is to compare realistic 
alternatives to the existing system. Anyone can write down a 
simple tax system on paper and there is nothing wrong with 
that, but when we think about realistic alternatives, we have 
to think about tax systems that (a) survive the legislative and 
lobbying process, (b) are consistent with the public's view of 
fairness, and (c) are not subject to attacks by the tax shelter 
    A number of the tax reform plans that are out there, I can 
design tax shelters for and I am not a tax lawyer, I am just an 
economist. If an economist can design shelters, the lawyers 
could go nuts with the new proposals.
    The second thing to think about is whether these new taxes 
are add-on taxes or replacement taxes. This was not an issue in 
the 1980s and the 1990s when we debated fundamental tax reform 
the last time but now we have a long term fiscal gap that is 
getting closer and closer and we really don't have the luxury 
of considering only changes in the structure of taxation. To 
put it bluntly, unless Congress is willing to cut future 
spending by 20 percentage points of GDP, we will have to 
consider ways to raise revenue as well as ways to restructure 
the tax system.
    Third, let me tell me what I think we should do before I 
talk about the flat tax or the sales tax. I think we need to do 
a combination of two items. One is simplify the income tax. If 
we can reasonably consider the flat tax and the sales tax, 
there is no reason we can't consider massive, wholesale 
simplification of the income tax.
    The second thing we need to think about doing is adding on 
a value added tax to help meet future revenue needs.
    These two taxes basically are base broadening and 
simplifying on the one hand and the value added tax could be 
used for some combination of funding social programs and fixing 
the budget situation or reducing tax rates. In any case, I 
think that is where we need to head.
    I am going to talk very briefly about the flat tax because 
I presume that Bob Hall is going to talk about that, so I will 
spend most of the rest of my time talking about the sales tax.
    I do want to mention the flat tax is a well conceived, 
internally consistent tax reform plan as opposed to the 
national retail sales tax which I will come back to in a 
second. The basic issue with the flat tax is that it generates 
wrenching tradeoffs. For example, if we had a flat tax rate of 
about 20 percentage points, we could break even, we could 
replace the existing income tax.
    If we did that, according to work by a couple of MIT 
economists, we would increase the number of people without 
health insurance by 10 million. We would also hurt the 
charitable sector, we would have repealed the earned income tax 
credit, we would have firms not being allowed to deduct their 
payroll taxes, we would have to think about transition relief, 
et cetera.
    Once we accommodated all those things, and notice I am not 
mentioning the mortgage interest deduction here because there 
is a way to solve that problem, but once we accommodated all 
those things like the health deduction, the earned income 
credit, payroll tax deductions for business, transition relief, 
State and local tax deductions, stuff like that, we are talking 
about rates of 28 to 30 percent. Most of the economic gains and 
economic growth that come from the pure flat tax with no 
transition relief disappear when you talk about a flat tax of 
28 or 30 percent with transition relief.
    On top of that, the flat tax would be regressive relative 
to the current system which has been discussed.
    In addition, I just want to add that replacing the entire 
Federal Tax Code is not likely to be something that happens 
right the first time and it may be something that is very 
difficult to enact completely accurately. The flat tax would 
create new loopholes. It might eliminate some of the old ones, 
but it would create new ones and those would have to be dealt 
with. So it is not a cure-all by any means but it is an 
interesting proposal. It is worth talking about and I am sure 
Bob Hall will talk about it more.
    I would like to spend the rest of my time talking about the 
national retail sales tax. I think there is a real disconnect 
here between reality and the sales tax proposal.
    The required tax rate to replace all Federal taxes would be 
60 percent on a mark up basis, 26 percent to replace the income 
tax alone. Those are my estimates. The JCT had similar 
estimates but it is important to note that both of these 
estimates are likely to be too low. They assume very low rates 
of evasion.
    You heard Representative Linder acknowledge that evasion 
would be an issue and he hoped and expected the compliance rate 
would be above 75 percent in a retail sales tax. That is a very 
low hurdle to get over and if the compliance rate were 75 
percent, the required rate would be significantly higher. These 
estimates assume the compliance rate is about 95 percent which 
is bigger than Representative Linder noted existing State sales 
taxes have. So it seems quite unlikely that the compliance rate 
would actually be that high.
    Even if it were, the tax would be easy to evade. In the 
income tax, we collect revenue from several sources. Employers 
withhold taxes on wages, then send workers a W-2, workers file 
the W-2 because they know the employer has already sent in the 
money. There isn't any third party reporting in a sales tax. 
The possibility of altering sales contracts, selling you a car 
at $10,000 with a high interest rate on the loan instead of 
$20,000 in cash is another easy way to evade sales taxes.
    For all these reasons, several countries and the OECD and 
even the Bush Administration in the economic report of the 
President last year have noted that rates above 10 to 12 
percent don't seem to be enforceable. On top of that, the idea 
that States run sales taxes and therefore, we can run a Federal 
sales tax is completely misguided. The States have very low 
rates, they have lots of exemptions, they end up taxing 
businesses tremendously and they are just not a model for a 
Federal sales tax at all.
    There was some discussion of the underground economy and 
Representative Linder discussed how the sales tax would capture 
revenues from the underground economy. All the evidence we have 
suggests that is wrong. Richard Armey, in an article in the 
mid-1990s, explained this very succinctly. There is an issue 
about border adjustments with the national retail sales tax. 
Economists are virtually unanimous in arguing that the border 
adjustment issue is a non-issue, that the exchange rate would 
adjust and hence, it would not be any more advantageous.
    The last issue I want to talk about is the discussion of 
price level effects in the sales tax. There is an issue about 
whether prices fall or not if we move from an income tax to a 
sales tax, but it is a completely unnecessary issue in that 
none of the effects change, none of the distributional effects 
that Representative Price reported change if you allow the 
price level to fall as long as you allow wages to adjust also. 
You can't have the price level falling and wages staying 
constant unless workers are actually becoming more productive, 
for example.
    As long as you make consistent assumptions about the price 
level, you will get that it is a very regressive tax. The 23 
percent rate that Representative Linder discussed is based on 
an inconsistent treatment of the price level. When they 
calculate how much revenue the Government will collect, they 
hold the price level fixed. When they calculate how much the 
Government has to spend to maintain the programs, they assume 
the price level falls.
    You can make either of those assumptions both times but you 
can't make one in the revenue case and one in the spending 
case. That might sound like green eyeshade but it is a $500 
billion a year mistake and leads to the 23 percent tax being 
way too low. This is a simple math question, not an issue of 
ideology or anything else. If you look at the equations, they 
made a mistake in how they calculated the tax rate.
    Let me close on that note. I think the flat tax provides a 
viable framework for talking about tax reform. Personally, I 
wouldn't go to the flat tax but it is a viable framework for 
talking about tax reform. I think the sales tax is non-starter. 
It is based on a variety of claims that verge on the fraudulent 
rather than just being simply value judgments. I think the 
debate would improve dramatically if we could get the sales tax 
off the table and discuss realistic reforms like either valued 
added tax, a base broadening income tax or a flat tax.
    [The prepared statement of Mr. Gale follows:]

 Prepared Statement of William G. Gale, the Brookings Institution, Tax 
                            Policy Center\1\

    Chairman Nussle, Ranking Member Spratt, and members of the 
committee: Thank you for inviting me to testify today on Federal 
revenue options. Almost everyone concurs that the tax system could be 
improved. But agreement on the nature and severity of the problems and 
how to resolve them remains elusive.
    The basic goals of tax reform seem clear. First, taxes should be 
simple. Second, taxes should be fair. Third, taxes should be conducive 
to economic prosperity and market efficiency. Fourth, they should raise 
sufficient revenue to cover the ``appropriate'' level of government. 
Fifth, to the greatest extent possible, tax rules should respect 
people's freedom and privacy.\2\
    Despite the ``motherhood and apple pie'' quality of these goals, 
tax policy remains controversial. One problem is that controversy 
arises over how to achieve each goal. Supporters of increased growth 
disagree over whether across-the-board income tax cuts, targeted tax 
cuts for saving and investment, or paying down public debt will do most 
for the economy. Another obstacle to consensus is that the goals are 
imprecise: views of what constitutes a fair tax, for example, vary 
widely. The most important source of controversy, however, is differing 
value judgments concerning the relative importance of the goals coupled 
with the fact that the goals sometimes conflict with one another. 
Research and data may answer technical questions, but they cannot 
resolve disagreements based on divergent values and preferences.
    One strategy for reform is to improve the performance of the 
existing tax system. A second strategy, so-called fundamental tax 
reform, would toss out the current system and install an entirely new 
set of taxes. These approaches can also be combined in a hybrid 
reform--which improves some parts of the current system, throws out 
other parts, and installs new taxes.
    The most important issue in analyzing tax reform options is to 
compare the current system to realistic alternatives. Anyone can write 
down a simple tax system on paper. Whether that tax system can survive 
the legislative process, the scrutiny of the tax shelter industry, and 
public notions of equity, and still raise sufficient revenue and remain 
simple is open to question. I have not yet seen a fundamental tax 
reform proposal that meets that test.
    The focus on realistic options has at least three implications. 
First, it implies that almost all of the claimed benefits of various 
proposed systems have to be taken with an enormous grain of salt. Most 
of these benefits disappear when more realistic versions of the taxes 
are considered. Second, it implies that policymakers and the public 
won't be able to ``have it all'' in tax reform. That is, we won't be 
able to come up with a whole new system that everyone finds simple, 
fair, and more conducive to economic growth. We will have to make 
trade-offs. Third, it is possible to do worse than the current system.
    A second key issue is whether the new taxes are considered to be 
add-ons or replacements for the current system. Given the current long-
term fiscal imbalance, either revenues will have to be raised 
substantially, or spending cut, or both. This observation also changes 
the nature of tax reform debates. In the past, analysts debated 
revenue-neutral reforms. Now, however, unless policy makers intend to 
cut future spending by about 20 percent of GDP, revenue-neutral reforms 
are no longer sufficient, and serious thought needs to be given to the 
best way to structure taxes designed to raise additional revenues.
    Proposals like a national retail sales tax, a flat tax, and a 
value-added tax have several common features. They are all consumption 
taxes, would tax at a flat rate, and would allow few or no deductions 
or credits. They would be regressive relative to the current system. In 
their pure form, they could have positive effects on economic growth, 
but once subjected to the realistic considerations noted above 
(legislative processes, tax shelters, public views of fairness), they 
would likely provide little net growth effect. The potential to 
simplify exists with each of these taxes, but it is likely to be 
overstated substantially. In particular, avoidance and evasion would 
continue under each of the plans, and could even increase in certain 
    My estimates suggest that a sales tax that marked up the price of 
goods and services by at least 26 percent would be required to replace 
the income tax, and one that marked up the price of goods and services 
by at least 60 percent would be required to replace all Federal taxes.
    The rest of my testimony provides more discussion of the national 
retail sales tax, the flat tax, and the relation between recent tax 
policy and fundamental tax reform.

                     NATIONAL RETAIL SALES TAX \3\

    One proposal for fundamental tax reform is to replace part or all 
of the current tax system with a national retail sales tax (NRST). The 
NRST is one potential form of a consumption tax. Retail sales occur 
when businesses sell goods or services to households. Neither business-
to-business nor household-to-household transactions are retail sales. 
For example, the sale of a newly constructed home to a family that will 
occupy it is a retail sale. But the sale of that same newly constructed 
home to a business that is planning on renting it to others is not a 
retail sale. Nor is a sale of an already existing home from one 
occupant to another.
    Typically, proposed NRSTs would aim to tax all goods or services 
purchased or used in the United States. Exemptions would be provided 
for business purchases and education (both considered investments). 
Domestic purchases by foreigners would be taxed; foreign purchases by 
domestic would not. To ensure that no family in poverty has to pay the 
sales tax, the sales tax proposals typically also offer equal per 
household payments called ``demogrants'' and equal to the sales tax 
rate times the poverty line.
    A national retail sales tax structured along these lines would 
represent a sharp break from the current tax system. The tax base would 
shift to consumption. Rates would be flat. All exemptions, deductions, 
and preferences would be eliminated. Tax administration, enforcement, 
and point of collection would altered radically.
    To make sensible comparisons across tax systems, it is important to 
distinguish between two ways to express tax rates. Suppose a good has a 
sticker price of $100, excluding taxes, and that a $30 sales tax is 
placed on the good. The ``tax-exclusive'' sales tax rate is 30 percent, 
calculated as T/P, where T is the tax payment and P is the pretax price 
of the good. The ``tax-inclusive'' sales tax rate is about 23 percent, 
calculated as T/(P+T). The tax-inclusive rate is always lower than the 
tax-exclusive rate. At low rates there is little difference. But a 100 
percent tax-exclusive rate corresponds to a 50 percent tax-inclusive 
rate. Sales taxes are usually quoted in tax-exclusive terms. Income 
taxes are usually quoted in tax-inclusive terms. Neither method is 
superior, but they must be distinguished to avoid confusion.

                             REQUIRED RATE

    To determine the revenue- and budget-neutral tax rate in a national 
sales tax requires estimating the rates of evasion, avoidance, the 
extent to which deductions, exemptions and credit would be re-
introduced, and the impact on economic growth. With extremely 
conservative assumptions about the magnitude of evasion, avoidance, and 
statutory base erosion, it would require a 60 percent tax-exclusive (38 
percent tax-inclusive) tax rate to replace existing Federal taxes, and 
a 26 percent tax-exclusive (21 percent tax-inclusive) tax rate to 
replace the existing personal income tax. These estimates do not 
include any allowance for economic growth, but even if the economy grew 
by 5 percent, which would be an enormous effect relative to existing 
estimates, the tax-exclusive tax rates would only come down to 57 
percent and 25 percent to replace all Federal taxes, or the income tax, 
    Note that the eventual sales tax rate that households would face 
would likely be significantly higher because existing State sales tax 
would be added. In addition, most or all State income taxes would 
probably be abolished in the absence of a Federal income tax system 
(since the states depend on the Federal income tax system for reporting 
purposes) and converted to sales taxes. These would add considerably to 
the combined sales tax rate. Any transition relief provided to 
households would reduce the tax base and raise the required rate 
further. And if major consumption items like food, housing, or health 
care were exempted from the base (the assumption above do not allow for 
such large exemptions), the tax-exclusive rate could rise to over 100 
percent. In short, any realistic plan for a national retail sales tax 
that replaced the bulk of the Federal tax system would require 
extremely high combined federal-state tax rates. Sales taxes at such 
high rates raise crucial questions about enforceability.
    Advocates and sponsors of sales tax proposals have suggested that 
much lower rates, on the order of 23-30 percent would be sufficient to 
replace the entire Federal system. These estimates are lower than the 
ones above for three reasons. First, they are quoted in tax-inclusive 
terms. Second, they assume that there is no evasion, no avoidance, and 
no statutory base erosion due to political pressures or hard-to-tax 
    Third, quite simply, the advocates made a mathematical mistake in 
calculating their required tax rate. An analysis of the required rate 
in a sales tax requires some assumption about what happens to the level 
of the prices that consumers see (before sales taxes are imposed) in 
the transition to a sales tax. Producer prices could (a) remain 
constant in nominal terms, (b) fall by the entire amount of the 
previously embedded taxes, or (c) fall by an amount between the first 
two benchmarks. In calculating their required rate, the NRST advocates 
assumed that producer prices would remain constant when they calculated 
the amount of revenue the government would obtain from a sales tax, but 
assumed that producer prices would fall when calculating the amount of 
spending the government would have to do to maintain current programs. 
These assumptions are obviously inconsistent, and they either 
understate government spending needs, overstate the revenue likely to 
be obtained, or both. Making a consistent assumption about producer 
prices--regardless of whether the assumption is (a), (b) or (c), leads 
to a higher rate than the advocates have assumed.


    The results above suggest that even with rates of evasion much 
lower than in the existing income tax system, the required national 
retail sales tax would be well into the 30s and possibly even higher 
(on a tax-inclusive basis). Governments have gone on record noting that 
at rates of more than 12 percent, sales taxes are too easy to evade. 
Thus, the most optimistic assessment would be that there is no 
historical precedent for a country to enact a high-rate, enforceable, 
national sales tax. That does not mean it is impossible, but extreme 
caution would be appropriate.
    Sales tax advocates admit that evasion would be a certainty, yet 
make no account for it in their estimates and hope that sentiments of 
fairness will induce taxpayers not to cheat. They also point to low 
marginal tax rates as an inducement not to cheat, but as shown above, 
the tax rate would not likely be low. Another claim is that detection 
of cheating would rise dramatically since only retailers would have to 
be audited, but this is misleading. Under the sales tax, businesses 
that make retail sales would be responsible for sending tax payments to 
the government, unless the buyer used a business exemption certificate, 
in which case no tax would be due. But the buyer would have the legal 
responsibility for determining whether the good is used as a business 
input or a consumption item. This means that auditing and enforcement 
would have to focus not just on retailers, but also on all businesses 
that purchase from retailers, to ensure that business exemption 
certificates were used appropriately.
    Most importantly, the sales tax would generate tremendous 
opportunities for evasion. For example, in the income tax, the rate of 
evasion is around 15 percent. But income where taxes are withheld and 
reported to government by a third party has evasion rates of around 5 
percent. For income where taxes are not withheld and there is no cross-
reporting, evasion is around 50 percent. Since the sales tax would 
feature no withholding and no cross-reporting, the possibility of high 
evasion rates needs to be taken quite seriously.
    Advocates also assert that the sales tax would be more effective 
than the current system at raising revenue from the underground 
economy. The classic example is that of a drug dealer who currently 
does not pay income tax on the money he earns, but would be forced to 
pay taxes under a sales tax if he took the drug money and bought, for 
example, a Mercedes. The problem with this argument is laid out best by 
Rep. Richard Armey (R-TX): ``If there is an income tax in place, he 
[the drug dealer] won't report his income. If there is a sales tax in 
place, he won't collect taxes from his customers'' and send the taxes 
to government. In the end, neither system taxes the drug trade. Many 
other countries have attempted to implement a retail sales tax, or 
variants, and almost all have abandoned the tax and moved to a value-
added tax.
    Finally, some sales tax advocates would eliminate the IRS and have 
the states administer the tax. Even though the states would keep 1 
percent of the revenue they collect, they would have poor incentive to 
collect Federal taxes adequately. Even the Wall Street Journal, no fan 
of big government, notes that ``it is fantasy to think of 'getting rid 
of the IRS.'''
    Few savings in compliance costs would be achieved, however, unless 
states also abandoned their personal and corporation income taxes. And 
if they replaced their income taxes with sales taxes, the combined 
rates would be astronomical, compounding the administrative 
difficulties that high Federal rates would cause. Furthermore, 
experience with the State sales taxes provides no guidance on how to 
administer a demogrant to over 270 million people. Payments would be 
based on family size, a design feature that necessitates filing by all 
families and raises problems of enforcement because two separate one-
person families would receive larger grants than would one two-person 
family. In addition, almost all states collect a significant share of 
their sales tax revenue from business-to-business sales. Inputs may 
pass through many stages before reaching consumers, and taxes can 
accumulate. This situation is tolerable when rates are low, but not 
when rates are high. Distinguishing sales to businesses from sales to 
consumers will require detailed audits of retailers and other 
businesses, because incentives for households to masquerade as 
businesses to evade the tax will increase with the increases in the tax 
    Almost all states exempt a large number of difficult-to-tax 
consumer goods or services. At low rates these gaps in coverage matter 
little, but when rates are high, distortions and inefficiencies would 
become serious. No state, for example, taxes financial services, and 
only a handful tax services generally, yet the NRST proposals would tax 
all services. A threshold administrative question regarding a national 
retail sales tax is whether it could be enforced at rates necessary to 
sustain revenues.\4\ Retail sales tax rates in foreign countries are 
typically in the range of 4-6 percent, although a few countries have 
had higher rates.
    No country has run a sales tax at anywhere near the rates that 
would be required to sustain revenues in the United States.\5\ Although 
implementation of the sales tax at realistic rates might not prove 
impossible, extreme caution would be appropriate.


    The debate over whether consumption or income is a better measure 
of ability to pay taxes has been going on for centuries. Proponents of 
consumption taxes argue that consumption usually approximates lifetime 
income because few people inherit or bequeath more than a small 
fraction of their lifetime earnings. For that reason, taxing 
consumption is equivalent to taxing households on the basis of their 
ability to pay taxes over long periods of time. However, advocates of 
the income tax counter that current income may be a better measure of 
ability to pay because few households can borrow much against future 
income and the prospect of having a large future income may not prove 
much help.
    The NRST would significantly redistribute tax burdens. The shift 
from an income base to the consumption base of the NRST would tend to 
reduce the burden on high-income filers because they consume a smaller 
than average share of their income. The shift from graduated rates to a 
flat rate would also tend to reduce their burden. It is also likely 
that avoidance options would be more available to high-income than to 
low-income households. As a simple matter of arithmetic, if wealthy 
households pay less in taxes, others have to pay more, assuming 
revenues are held constant.
    If households are classified by annual income, the sales tax is 
sharply regressive. Under the AFT proposal, taxes would rise for 
households in the bottom 90 percent of the income distribution, while 
households in the top 1 percent would receive an average tax cut of 
over $75,000. If households are classified by consumption level, a 
somewhat different pattern emerges. Households in the bottom two-thirds 
of the distribution would pay less than currently, households in the 
top third would pay more. Still, households at the very top would pay 
much less, again receiving a tax cut of about $75,000. There appears to 
be little sound motivation for heaping huge tax cuts on precisely the 
groups whose income and wealth have benefited the most from recent 
events, and raising burdens significantly on others (Feenberg, Mitrusi 
and Poterba 1997).
    Advocates like to assert that sales taxes are pro-family relative 
to the income tax. But children and families benefit disproportionately 
from numerous features of the current system, including dependent 
exemptions, child credits, child care credits, earned income credits 
and education credits. And the preferential treatment of housing, 
health insurance, and State and local tax payments also plausibly helps 
families, since they consume relatively more housing, medical services, 
and government-provided services such as education. All of these 
preferences would be eliminated under a sales tax. Moreover, compared 
to childless couples, families with kids generally have high 
consumption relative to income, so switching from income tax to a 
consumption tax would further raise tax burdens during years when 
family needs were highest. Based on 1996 data, a recent study found 
that enactment of a broad-based, flat-rate consumption tax like the 
sales tax or flat tax would hurt families with incomes less than 
$200,000, because of the loss of tax preferences, but would help 
families with income above $200,000, due to the dramatic reduction in 
the top tax rate. Incorporating the 1997 and 2001 tax changes--
especially the child and education credits--would only exacerbate these 

                            THE FLAT TAX \6\

    Under a VAT, each business would pay tax on the difference between 
its total sales to consumers and other businesses less its purchases 
from other businesses, including investment. Thus, the increment in 
value of a product at each stage of production is subject to tax. 
Cumulated over all stages of production, the tax base just equals the 
value of final sales by businesses to consumers--that is, the same as 
in an NRST.
    The flat tax, originally developed by Hoover Institution scholars 
Robert Hall and Alvin Rabushka, is simply a two-part VAT: the business 
tax base would be exactly like the VAT except that businesses would be 
allowed deductions not only for purchases from other businesses but 
also for cash wage and salary payments and employer pension 
contributions.\7\ Individuals would pay tax on wages, salaries, and 
pension income that exceeded personal and dependent exemptions. 
Businesses and individuals would be taxed at a single flat rate. This 
implies that the flat tax is a consumption tax.

                             REQUIRED RATES

    The Treasury Department has estimated that a pure flat tax with a 
20.8 percent rate would have generated as much revenue as the personal 
and corporation income taxes and the estate tax in 1996.\8\ Unlike the 
advocates' estimates for the sales tax, the flat tax estimates include 
tax evasion and are based on logically consistent assumptions about 
price level changes. Nevertheless, in practice, rates would likely be 
higher for several reasons. Congress would face intense pressure to 
offer transition relief to businesses that would be treated less 
generously under the new rules than under current rules. Repeal of the 
income tax would destroy remaining depreciation deductions for 
businesses that own capital at the time of transition. Owners of such 
``old capital'' would be at a disadvantage in competition with owners 
of ``new capital'' purchased after the implementation of the new tax, 
which could be expensed. Similarly, companies that have borrowed funds 
would lose deductions for interest payments and would have a 
disadvantage in competition with companies that have not borrowed. The 
flat tax would also eliminate carryforwards relating to net operating 
losses, alternative minimum tax payments, and other items that business 
can currently use to reduce future taxes. Business owners would 
doubtless seek relief.\9\
    More generally, taxes are deeply embedded in the structure of 
existing contracts and other transactions. Moving to a flat tax could 
upset these arrangements. For example, the flat tax would change the 
substance of every alimony agreement, because alimony payments are 
currently deductible and alimony receipts are taxable, but under the 
flat tax, those treatments would reverse. Likewise, the flat tax would 
alter every loan repayment plan because interest payments are currently 
deductible and interest receipts are taxable, but neither activity 
would affect tax liabilities under the flat tax.
    These problems would create a dilemma. Most of the gains in 
economic efficiency and much of the political appeal of the flat tax 
derive from low rates made possible by a broad tax base. But providing 
transition relief would raise rates and would reduce gains in economic 
efficiency. Transition rules would also erode gains in simplicity. 
Beyond transitional concerns, the permanent elimination of existing 
deductions and credits would prove difficult. Removing deductions for 
mortgage interest and property taxes would raise tax burdens for about 
29 million homeowners who itemize, reduce the real value of homes, and 
possibly increase mortgage defaults.\10\ Terminating deductions for 
charitable donations under the personal, corporation, and estate and 
gift taxes would reduce contributions by about 11-23 percent.\11\
    Eliminating deductions for health insurance premiums employers pay 
for workers would have increased the number of uninsured in 1994 by 
between 5.5 million and 14.3 million, about 14 to 36 percent.\12\ 
Removing the deduction for State and local taxes would increase the 
effective burden of subfederal government on taxpayers who currently 
itemize. Deductions for casualty losses would end, meaning that a 
victim whose earnings were stolen would still have to pay taxes on 
them. Businesses would lose more than $300 billion in deductions for 
payroll taxes. The flat tax would also eliminate the earned income 
credit, which raises the labor supply of, and redistributes income to, 
low earners.\13\ If Congress provided limited transition relief; 
retained individual deductions for mortgage interest, charitable 
contributions, and State and local income and property taxes; continued 
business deductions for health insurance premiums and payroll taxes; 
and kept the earned income tax credit the revenue-neutral rate would 
rise from 20.8 percent to 31.9 percent.\14\
    Regardless of the economic wisdom of retaining these aspects of the 
current income tax under a flat tax, political support for them will be 
powerful. Even flat-tax designers now acknowledge that transition 
relief will be inescapable in practice.\15\ And some recent proposals, 
termed ``McFlat'' taxes, would allow the flat tax to include deductions 
for mortgage interest and charitable contributions.\16\ These cracks in 
the armor, which have appeared long before any serious legislative 
consideration has occurred, suggest that more would open in the 
political horsetrading surrounding actual legislation.


    The appeal of fundamental tax reform stems in no small measure from 
claims that it would greatly simplify taxes, reducing compliance costs 
for households and businesses and defanging or even eliminating the 
IRS. However, while the NRST and flat tax clearly have some advantages 
over the existing system, they also create new problems. And 
responsible observers on all sides agree that an IRS-like agency is 
here to stay.


    The alleged simplicity of the flat tax, symbolized by a post card 
sized return, is one of its great selling points. A pure flat tax would 
be simpler than the current income tax, but some problems would carry 
over to the new system. These include distinguishing independent 
contractors from employees, determining who are qualified dependents, 
enforcing tax withholding for domestic help, limiting home office 
deductions, determining and collecting taxes from the self-employed, 
reconciling State and Federal taxes, and distinguishing travel and food 
expenses incurred while doing business, which should be deductible, 
from other travel and food expenses, which should not be 
    Several problems for tax administration could actually intensify, 
including the sheltering of personal consumption as a business expense, 
the tax treatment of mixed business and personal use property, rules 
regarding how taxes or losses may be allocated among different 
taxpayers, and distinctions between financial and real transactions. 
The flat tax would also create new opportunities for avoidance and 
evasion. For example, wages and salaries would be deductible business 
expenses but fringe benefits would not. Businesses might find it 
desirable to hire physicians and nurses directly rather than purchase 
health insurance for their employees. Because sales proceeds are 
taxable to businesses but interest income is not, businesses would find 
it profitable to discount prices for installment purchasers who 
accepted high interest rates. One author concluded that the flat tax 
would create a dilemma--either a complicated tax law would be necessary 
to reduce the evasion possibilities or complicated business 
transactions would arise to game the law or both.\18\ After a careful 
review of estimates of the costs of administering the income tax, 
another study concluded that administrative costs for a pure flat tax 
would be about half those of the corporation and individual income 
taxes.\19\ If Congress retained some itemized deductions and the earned 
income tax credit and granted transition relief, however, these savings 
would shrink.

                       EFFECTS ON ECONOMIC GROWTH

    Many of the problems and trade-offs created by fundamental tax 
reform could be reduced if reform boosted growth dramatically. 
Fundamental tax reform could increase growth by reducing marginal tax 
rates on capital and labor income, reducing the disparity in taxation 
of different types of capital and labor income, and imposing a lump-sum 
tax on old capital by not providing transition relief. But the impact 
on growth depends critically on the ``purity'' of the reform.\20\
    A pure consumption tax--like the flat tax--with no personal 
exemptions or product exemptions and no deductions, credits, or 
transition relief could increase the size of the economy by 9 percent 
in the ninth year after reform and would require a tax-inclusive rate 
of 14 percent. Compared with the estimated impacts of other policies, 
these are enormous. Unfortunately, the growth effect shrinks rapidly as 
the pure reform is made more realistic. Adding modest personal 
exemptions (smaller than in the flat tax proposed by Representatives 
Richard Armey and Richard Shelby) \21\ and providing transition relief 
for existing depreciation deductions (but not interest deductions) 
reduces the growth impact by 80 percent, leaving increased growth of 
only 1.8 percent in the ninth year, and requires a tax-inclusive rate 
of 24 percent. Allowing for additional deductions, credits, and child 
exemptions or other forms of transition relief would raise the tax rate 
considerably. There are no estimates of the growth impacts of these 
changes, but the available data suggest that at the required rates, the 
growth effect would likely be near or below zero.\22\


    Some advocates of moving to a consumption tax have shifted to 
trying to achieve fundamental tax reform in several steps, rather than 
in one fell swoop, and defend the Bush tax cuts as effecting such a 
piecemeal move toward a consumption tax. Indeed, as Bartlett (2003) 
argues, ``By Bush's second term, it is possible that we will have made 
enough incremental progress toward a flat rate consumption tax that we 
may finally see fundamental tax reform fully enacted into law.''
    Although they bear a superficial and partial resemblance to broader 
tax reform measures, the recent tax cuts create new structural flaws in 
the tax system, have the opposite effect of well-designed fundamental 
tax reform in key areas like saving and growth, and will actually make 
fundamental reform more rather than less difficult.
 the recent tax cuts and consumption taxes: comparing rules and effects
    The recent tax cuts share several features with fundamental reform 
plans. They reduce the top marginal individual income tax rates, reduce 
tax rates on capital income (dividends and capital gains) even further, 
and eliminate the estate tax. The bonus depreciation rules move toward 
a system where investments are expensed in the first year, albeit on a 
temporary basis.
    Recent regulatory changes also push in the same direction. For 
example, in January 2002, the IRS published a notice of proposed rule-
making to clarify its interpretation of the 1992 Supreme Court decision 
in INDOPCO, Inc. v. Commissioner. In INDOPCO, the Court ruled that 
expenses incurred by firms preparing for a friendly take over had to be 
capitalized rather than expensed. The IRS rules put forward categories 
of safe harbors under which intangible assets could be expensed rather 
capitalized. Many practitioners are concerned that under the IRS rules, 
firms are given too much leeway to expense investments rather than 
depreciate them over time.\23\
    Moreover, proposals for greatly expanded tax-free saving accounts 
would push even further toward elimination of tax on capital income. 
The Administration has proposed two new types of individual accounts 
called Lifetime Saving Accounts (LSAs) and Retirement Saving Accounts 
(RSAs). LSAs would allow annual contributions of $5,000 per person per 
year. Although contributions would not be deductible, account earnings 
and withdrawals would be tax-free. Anyone could make a contribution to 
their own account or anyone else's with no income, age, or other 
restrictions. Withdrawals could be made at any time for any purpose. 
RSAs are basically Roth IRAs, but with no income limit for 
contributions. They would have similar features to LSAs, except that 
contributions could not exceed earnings and withdrawals made before age 
58 (or the death and disability of the owner) would be subject to a 
small penalty. Over time, these proposals would allow an increasing 
share of the returns to wealth to be sheltered from taxation (Burman, 
Gale, and Orszag 2003).
    Despite these similarities, the tax cuts differ from fundamental 
reform in both their rules and their effects. A key difference in rules 
between the recent tax cuts and fundamental reform involves the tax 
treatment of interest payments. A well-designed income tax would tax 
interest income and allow deductions for interest payments. A well-
designed consumption tax could treat interest the same way, or it could 
allow for nontaxation of interest income coupled with nondeductibility 
of interest payments. The key point is that any well-designed tax 
system would treat capital income and capital expenses in a consistent 
manner. Yet although it is embracing proposals that reduce or eliminate 
the tax on interest income, the Administration has not endorsed or 
proposed any such restrictions on deductions for interest borrowing.
    Without such restrictions, cuts in the taxation of capital income 
expand the opportunities for tax sheltering. For example, consider 
someone who borrows $100 and deposits the money in a tax-free savings 
account. If the individual borrows the money in a tax-deductible form 
(for example, through a home equity loan), the net effect is to create 
a tax shelter. The investment returns on the account would be free from 
taxation, so no tax would be owed on the income, but the individual 
would still enjoy a deduction for the borrowing costs. Note also that 
there is no net investment in the example--simply a tax-motivated asset 
purchase financed with debt. Gordon, Kalambokidis, Rohaly, and Slemrod 
(2004) argue that if ``the ultimate destination of this set [i.e., the 
Bush Administration's] of tax reforms is a consumption tax base, then 
the most glaring omission from the discussion to date concerns interest 
    The recent tax cuts and fundamental reform also differ in their 
effects. Perhaps the central reason to consider a consumption tax is 
the potential to raise national saving and thereby raise economic 
growth (Aaron and Gale 1996). It is therefore instructive to understand 
why many studies show that a well-designed consumption tax could raise 
national saving and growth while the analysis in earlier sections shows 
that the recent tax cuts will reduce national saving and growth.
    One difference arises because the studies that show that 
consumption taxes raise growth examine revenue-neutral shifts in the 
structure of taxes (see the papers in Aaron and Gale 1996 and Zodrow 
and Mieszkowski 2002), whereas recent tax policies significantly 
reduced revenues. National saving is equal to private saving minus the 
government's budget deficit. A revenue-neutral switch to a consumption 
tax leaves the deficit unaffected and thus only needs to increase 
private saving in order to raise national saving. Most studies suggest 
that positive, albeit modest, increases in private saving would occur 
under a well-designed consumption tax. Thus, the deficit-financed 
nature of the recent tax cuts reveals one flaw in the argument that the 
tax cuts are helping the nation evolve in steps toward a well-designed 
consumption tax. The revenue costs and the limited private saving 
response discussed above imply that the recent tax cuts reduce national 
saving, exactly the opposite of a fundamental goal of a consumption 
    A second difference is that the recent tax cuts move the nation 
more toward a wage tax than a consumption tax. The fundamental 
difference between wage and consumption taxes involves the treatment of 
people who own assets at the time the new tax system is enacted.\24\ A 
wage tax does not tax assets held at the time of the transition. A 
consumption tax does; it provides a tax break only for new saving, not 
for income or consumption out of existing capital. As a result, a 
consumption tax actually reduces the value of existing assets to their 
    Research indicates the taxation of assets held at the time of 
transition to a consumption tax is the source of almost all the 
increase in economic growth from such taxes.\26\ Thus, a wage tax, 
which exempts from taxation the assets held at the time of the 
transition, does not provide the macroeconomic benefits that a 
consumption tax would.
    By way of comparison, the 2001 and 2003 tax cuts not only do not 
impose a new tax on existing capital; they reduce taxes on existing 
capital. The reductions in capital gains and dividends taxes, for 
example, provide large benefits to owners of existing stocks and hence 
are not well-targeted toward exempting just new saving.
    In effect, from the standpoint of economic growth, a major 
attraction of a consumption tax is the ability to place an additional 
tax on existing assets at the time of the transition. Yet the 2001 and 
2003 tax cuts do exactly the opposite, reducing such taxes, and hence 
omitting much of the potential economic gains from a consumption tax.


    From a political economy perspective, tax reform always combines 
gain and pain. The 2001 and 2003 tax cuts do the easy part of tax 
reform, but ignore the difficult part. Consider the 2003 dividend tax 
cut. Even before the dividend tax reduction, most corporate income in 
the United States was not taxed twice. A substantial share was not 
taxed at the corporate level due to shelters, corporate tax subsidies, 
and other factors. And half or more of dividends were effectively 
untaxed at the individual level because they flow to pension funds, 
401(k) plans, and non-profits (Gale 2002). The problem is that the 
dividend tax cut undermines the political viability of true corporate 
tax reform. Any such reform would have to combine the carrot of 
addressing the ``double taxation'' of dividends with the stick of 
closing corporate loopholes and preferential tax provisions, to ensure 
that corporate income is taxed once and only once--but at least once. 
The dividend tax cut instead just gave the carrot away.
    The same problem has occurred in the taxation of capital income 
generally. Enacting meaningful reform will require conforming the 
treatment of capital income and interest deductions. Yet by reducing 
the taxation of capital income without also restricting the ability to 
deduct interest payments, legislators gave away the easy part of reform 
and now have little to bargain with to make the treatment of interest 
income and expense compatible.


    Tax cuts that reduce national saving, reward owners of existing 
capital, and retain deductions for borrowing costs while reducing the 
taxation of new capital income are not consistent with any sensible tax 
system--whether based on income, consumption, or wages. Taken to their 
logical conclusion, these tax cuts will not lead to a consumption tax, 
but rather to a system in which capital is actually subsidized (i.e., 
faces a negative tax rate on average) and labor income ends up bearing 
the full weight of supporting government services and more.


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Smetters, Jan Walliser. 2001. ``Simulating Fundamental Tax Reform in 
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    1. Arjay and Frances Fearing Miller Chair, Economic Studies 
Program, and Co-Director, Tax Policy Center. The views presented are my 
own and should not be taken to represent the views of the Brookings 
Institution or the Tax Policy Center.
    2. Taking exception to these statements is a group of economists 
who believe that an inefficient, unfair, or complex tax system makes it 
more difficult politically to raise revenues, which helps hold down the 
size of government. They argue that, on balance, a smaller government 
with a more cumbersome tax system is better for the economy than a 
larger government with a more efficient tax system (Friedman 1993 and 
Becker and Mulligan 1998).
    3. For additional information, see Gale (1999) and Gale and 
Hotlzblatt (2002).
    4. For a detailed analysis, see Gale and Hotlzblatt (1999). 
Mastromarco (1998) presents an opposing view.
    5. The OECD has stated that ``Governments have gone on record as 
saying that a retail sales tax of more than 10 to 12 percent is too 
fragile to tax evasion possibilities.'' Vito Tanzi, director of Fiscal 
Studies at the International Monetary Fund has said, ``The general view 
among experts, a view obviously shared by most governments, is that 10 
percent may well be the maximum rate feasible under an RST'' (Tanzi, 
1995, pp. 50-51). British fiscal expert Alan Tait expressed a similar 
view: ``At 5 percent, the incentive to evade [the retail sales tax] is 
probably not worth the penalties of prosecution; at 10 percent, evasion 
is more attractive, and at 15-20 percent, becomes extremely tempting'' 
(quoted in Tanzi, 1995, p. 51). Slemrod (1996) and others have 
expressed similar sentiments.
    6. For additional information, see Aaron and Gale (2000) and Gale 
and Holtzblatt (2002).
    7. Hall and Rabushka (1985).
    8. U.S. Department of Treasury (1996, p. 451). This includes 
personal exemptions of $10,700 (single), $21,400 (married), and $14,000 
(head of household), and child exemptions of $5,000.
    9. Perlman (1996).
    10. The impact on housing prices is controversial. Capozza, Green, 
and Hendershott (1996, p. 201) estimated that the flat tax would reduce 
the price of owner-occupied housing (the structure plus the land) by an 
average of 29 percent if interest rates were constant. If the flat tax 
led to a fall in interest rates of 2 percentage points, the estimated 
average fall in housing prices would be 9 percent (p. 190). Bruce and 
Holtz-Eakin (1998) estimate that nominal house structure prices would 
rise by 10 percent in the short run and 17 percent in the long run. 
However, Gale (1999b, pp. 6-7) shows that under consistent assumptions 
about price-level effects, and including land in the analysis, the 
Bruce and Holtz-Eakin model suggests that real housing prices would 
fall by 7-10 percent in the short run and by 2-6 percent in the long 
run, depending on how interest rates adjust.
    11. Clotfelter and Schmalbeck (1996, pp. 229, 232, 234) estimate 
that the end of the charitable contributions deduction would reduce 
individual giving by 10 percent to 22 percent, corporate giving by 15 
percent to 21 percent, and testamentary gifts by 24 percent to 44 
    12. Gruber and Poterba (1996, p. 142).
    13. Dickert, Houser, and Scholz (1995); and Eissa and Liebman 
    14. This estimate understates the increase in rates that would be 
necessary because it is based on itemized deductions claimed under the 
personal income tax. But many taxpayers who use the standard deduction 
and therefore do not explicitly list such outlays as mortgage interest 
or charitable contributions also incur these expenses and would claim 
them under a flat tax if such itemized deductions were retained. 
Furthermore, if political pressure or policy consideration led Congress 
to retain itemized deductions, similar considerations might lead to the 
retention of such provisions as child care or education credits.
    15. Representative Richard Armey and Professors Robert Hall and 
Alvin Rabushka, for example, have already acknowledged the need for 
transition relief. A commission studying tax reform chaired by former 
Representative Jack Kemp blandly remarked that ``policymakers must take 
care to protect the existing savings, investment, and other assets'' 
during a transition to a new tax system. Although the Kemp Commission 
did not elaborate on this seemingly innocuous statement, it has far-
reaching implications for tax reform. Kemp Commission Report; http://
www. flattax.house.gov/reptoc.htm [August 13, 1999].
    16. See Specter (S. 488, 1995); and the Kemp Commission Report.
    17. Graetz (1997) describes numerous problems in the current system 
that will not disappear with the flat tax.
    18. Feld (1995, p. 615).
    19. Slemrod (1996, p. 375).
    20. Estimates of the effects on growth also depend on how the 
current system is characterized. Engen and Gale (1996) document that 
most private saving and growth now occurs in tax sheltered forms. If 
one recognizes this fact, the impact on saving and growth of switching 
to a consumption tax will be smaller than it would be if one assumes 
that the current system is a pure income tax.
    21. H.R. 2060 and S. 1050, The Freedom and Fairness Restoration Act 
of 1995.
    22. Other models, reported in Joint Committee on Taxation (1997) 
generate a range of results that, dropping the high and low estimates, 
are fairly close to the results reported in the text. See also Auerbach 
(1996); Engen and Gale (1996); and Fullerton and Rogers (1996).
    23. See, for example, Jack Taylor, ``Tax Deductibility of Business 
Expenses,'' CRS Report for Congress, RS21194, April 2002.
    24. Intuitively, this result stems from the fact that, under some 
simplifying assumptions, future consumption can be financed from 
existing assets or future wages. Thus, both items are taxed under a 
consumption tax. If existing assets are exempted, the result is a tax 
on wages.
    25. To see why, think of someone with $100 in the bank at the time 
a consumption tax is adopted. Under an income tax, the owner of the 
bank account could withdraw the money and spend it without being taxed. 
Under a consumption tax, though, the $100 would be taxed when it is 
withdrawn and spent. Since the $100 bank account does not buy as much, 
after tax, its value is reduced under a consumption tax.
    26. For example, Altig et al (2001) show that a standard flat tax 
with a personal exemption of $9,500 would raise the size of the economy 
by 2.2 percent after 14 years if assets held at the time of transition 
were subject to the tax, as they would be under a consumption tax. But 
if at least partial transition relief were granted for assets held at 
the time of transition (by continuing to allow depreciation allowances 
on such assets), the economy would only be 0.5 percent larger after 14 

    Chairman Nussle. Thank you, Dr. Gale.
    Dr. Hall.

                  STATEMENT OF ROBERT E. HALL

    Mr. Hall. Thank you, Mr. Chairman. I am delighted to have 
this opportunity to talk about tax reform.
    Let me say first that, there is a very strong consensus, 
and Bill's remarks just now strongly conform to this, that the 
best type of tax system that the United States should move to 
is a value added tax. First of all, a value added tax is proven 
in practice in Europe and other countries that have been using 
it for half a century.
    The thing I want to stress here is that the ideas I pushed 
in the past, and I am the Hall of Hall and Rabushka, are to 
institute a value added tax. We were always very clear on this 
point. It is called the flat tax and that was Rabushka's 
contribution in terms of naming, to call it the flat tax. 
Rabushka came to me in 1981 and said, the people want a flat 
tax, what is it? I said it is a value added tax but it is 
different from the European value added tax in one critical 
way. It has all the strengths of the European value added tax 
but it has one additional feature and that is it is 
    The failure of progressivity of the European value added 
tax model is central to why we don't want a European value 
added tax but we do want something you could call an American 
value added tax. So the real question is how can we get from 
here to there, especially in this town. We want to get there in 
    The steps are pretty clear and they have been discussed in 
different ways today but let me tick off what those key steps 
are. First of all, you eliminate the personal taxation of 
business income. You eliminate personal taxes on dividends, 
capital gains and interest. There are many ways of doing that. 
The simplest is to take them off the form. Another way to do it 
is to extend IRA type instruments and have an unlimited 
entitlement to IRA that is an unlimited savings allowance and 
that would accomplish the same thing. So there are different 
ways of doing that. It is up to Congress to decide which of 
those is going to be most successful politically.
    A second step is that we have a corporate income tax but 
that is actually a big mistake. We should have a business 
income tax. We would extend the corporate income tax to be an 
air tight, comprehensive business tax. In that tax, we would 
remove the deduction for interest.
    If you read Bill's testimony, he didn't express this just 
now but if you read his testimony, he is properly insistent on 
the point that the business deductibility of interest is really 
the central weakness of the American tax system today. The very 
top priority should be to remove the deduction of interest from 
the business tax.
    That will raise the question that in parallel you would 
want to remove the personal deduction from mortgage interest. I 
recognize that is not something Congress is likely to do soon 
and there are various ways of working around that.
    The final step, again central to the value added concept, 
we need a consumption tax. That is what Europe has. Economic 
efficiency demands a consumption tax. A VAT is a consumption 
tax because it allows first year write off of investment, plant 
and equipment. That is all it takes and that is what we want.
    I want to come back to the point that a proper 
implementation of this idea in the American context needs to be 
progressive and although Rabushka named our idea the flat tax, 
he has given me permission to advocate the not so flat tax. I 
think there is a reason to do that and that is that the 
distribution of income and wealth in the United States has 
shifted dramatically since 1981 when we first started pushing 
this idea and we now have a very substantial economic elite who 
have very high levels of wealth, consumption and income. They 
are the tax heroes today. They pay a very disproportionate 
share of the income tax. We, I think, probably should retain 
that feature.
    I don't align myself with the branch of this thinking that 
says everybody should have the same rate. We never said that 
because we have always had a zero rate bracket. It has never 
really been a flat tax. We could have more brackets. One thing 
I feel strongly about is that the top bracket shouldn't be 
above 30 percent. You don't actually get any tax from taxing 
successful people at rates above 30 percent because they always 
figure out a way around it.
    What we really need is an air tight way of enforcing a 
rate, say a top rate of 25 percent and make it stick as opposed 
to putting on the books a higher rate. For example, for a while 
we have a 50 percent top marginal rate and that is a real 
mistake. It was a huge step forward in the 1980s when we 
systematically stripped away these unrealistically high rates 
down to the 28 percent top rate that we achieved in 1986 and it 
was a big mistake in 1993 when we rolled that back and put back 
in higher rates. We really need to stick to this principle that 
progressivity does mean there should be brackets but it doesn't 
mean that the top bracket should be an unrealistically high 
    So a system based on these principles of centralizing the 
taxation of business income at the business level, taxing wages 
at the personal level for just one reason and that is that is 
the way you can most realistically make the system progressive. 
By taking a piece of the value added tax and moving it to the 
individual, you can then make it progressive because that is 
the right way to implement multiple brackets, in particular a 
zero bracket at the bottom.
    It would also be possible in that framework to retain the 
earned income tax credit, something that has properly gotten a 
lot of attention here. A design in this framework that 
preserved the ITC and the other similar low income credits 
would be completely feasible. I think administratively it is 
the right way to do it.
    Let me close by saying what we shouldn't do. I have told 
you what we should do and we have done some of it. For example, 
we have cut capital gains and dividend rates. Last year, that 
was a very good step forward. Let me close with what we 
shouldn't do.
    We shouldn't just adopt a European VAT because it is not 
progressive. We should have an American VAT. We should be sure 
that it is adequately progressive. We should not expand saving 
incentives at the personal level, we should have a single 
investment incentive in the VAT at the business level. Those 
are the two important things not to do.
    We should certainly not have a sales tax and the criticism 
of the administrative side of the sales tax is absolutely 
compelling. We need a VAT, not a sales tax and we can make the 
VAT progressive using the design I have discussed. Thank you.
    [The prepared statement of Mr. Hall follows:]

  Prepared Statement of Robert E. Hall, Hoover Institution, Stanford 

    I am grateful for the opportunity to present testimony on the next 
steps in tax reform. My expertise is in the operation of the U.S. 
economy and in tax policies to achieve higher growth. I serve as the 
McNeil Joint Senior Fellow of the Hoover Institution at Stanford and 
Professor in Stanford's economics department. I am co-author, with 
Alvin Rabushka, of The Flat Tax, which lays out the ultimate goal of 
tax reform as we see it. My testimony today deals with practical steps 
that could be taken in the direction of that ultimate goal. I will 
consider improvements that could be made in the personal and corporate 
income taxes. I will not comment here on the other major component of 
the Federal revenue system, the payroll tax for Social Security.
    A number of goals of tax reform command widespread support. First 
is simplification. The personal income tax today is ridiculously 
complicated. An improved tax would result in a one-page filing for 
every taxpayer.
    The second goal is uniform, powerful incentives for capital 
formation. In today's tax system, entrepreneurial startups are heavily 
taxed while tax shelters are subsidized. Uniformity of powerful 
investment incentives is key to a pro-growth tax policy.
    The third goal is progressive distribution of the tax burden. 
Today's tax system shields the poor from any income tax--a feature that 
should be retained--but its distribution across middle- and upper-
income taxpayers is cruelly uneven. We need an airtight progressive 
    The fourth goal is economic efficiency. Once the other goals are 
achieved, efficiency calls for moderate top tax rates. Experience 
everywhere in the world at all times has taught that tax rates above 
about 30 percent generate inefficiencies that far outweigh the limited 
revenue that they collect.
    The basic structure of a tax system that could achieve all of these 
goals is the American value-added tax. The VAT is the backbone of the 
revenue system of every country in Europe. It is the essence of 
simplicity. It provides exactly the right incentive for capital 
formation, because all investment is deducted from the tax base. The 
VAT is efficient because its rate is in the safe zone below 30 percent. 
The only defect of the standard European VAT--but a serious one--is its 
lack of progressivity. European countries complicate their VATs by 
applying higher rates to luxury goods, but they have not succeeded in 
achieving a fair distribution of the burden of the VAT. I will show how 
to make a simple VAT progressive without sacrificing any of its 
desirable features. The result is the American VAT.
    Some proponents of tax reform are pushing a Federal sales tax. In 
principle, a sales tax that exempts sales of investment goods has the 
same benefits as a VAT. But a VAT is much easier to administer than is 
a sales tax. In a VAT, every business pays the tax on all of its sales, 
whether to other businesses or to final customers. If the customer is a 
business, the customer deducts the purchase, so there is no double 
taxation. A seller does not need to keep track of whether its customers 
are businesses or final customers. Under a sales tax, the seller does 
need to make that distinction. Customers masquerade as reselling 
businesses when they are actually final customers. Sales taxes are 
notoriously leaky and cannot sustain tax rates much above 10 percent. 
The case against the sales tax is practical. In addition, a sales tax 
suffers from the same defect as a standard VAT--it is not progressive.
    The following steps would take us to the progressive American VAT. 
The reformed tax system would meet all four of the key goals and would 
replace all of the current revenue of the personal and corporate income 
    1. Eliminate personal taxation of business income: interest, 
dividends, and capital gains
    2. Bring all businesses under the corporate income tax, to be 
renamed the business tax
    3. Remove the deduction for interest in the business tax and the 
personal deduction for mortgage interest
    4. Extend depreciation of plant and equipment to first-year write-
    The result of all of these reforms would be a VAT, though its 
administration would be different from a standard European VAT. In 
Europe, the typical family does not have direct contact with the VAT. 
The tax is embedded in the prices the family pays, but the family does 
not fill out a form. That is why the VAT cannot be sensitive to the 
family's income level. Accordingly, the standard VAT cannot be 
progressive. In the American VAT, families would continue to fill out a 
personal tax form, but it would be simple enough to fit on a postcard. 
Only earnings are taxed on the form. The personal tax has a generous 
exemption and could have a couple of rates, say 15 and 25 percent.
    In the business part of the American VAT, businesses report total 
revenue and deduct purchases of inputs, including the wages they pay. 
They also deduct purchases of plant and equipment. The business part of 
the American VAT is the same as the European VAT, except for the 
deduction of wages.
    The business and personal parts of the American VAT mesh to form a 
standard VAT. Collecting the tax on earnings at the personal level is 
the secret of making the VAT fair and progressive. The American VAT is 
a big step forward over the European VAT because of its progressivity.
    The American VAT meets all four of the key goals of tax reform. 
First, it is simple. Both the business and personal taxes fit on 
postcards. Second, it provides exactly the right incentives for capital 
formation, across the board, through first-year write-off. Third, it is 
progressive, because of the exemption and graduated rates in the 
personal part of the tax. Fourth, it is economically efficient because 
its top rate would be no more than 25 percent.
    The American VAT would overcome grave inefficiencies in the current 
income taxes. The central problem is inconsistent incentives for 
capital formation that result in subsidies for some types of investment 
and high taxes on others. Incentives to capital formation come in two 
varieties. First is depreciation, including first-year write-off. 
Second is deduction of saving at the personal level. When both 
incentives are provided--as happens when a business finances investment 
by selling bonds to a pension fund and takes depreciation on the 
investment--the investment is inefficiently subsidized. This is the 
essence of a tax shelter. By far the best way to eliminate tax shelters 
is to move to a single coherent investment incentive.
    Tax designers have developed a complete, coherent system based on 
personal deductions for saving. This is called the cash-flow 
consumption tax. Under such a system, businesses pay no taxes. 
Households file complex returns that account for all the inflows and 
outflows of cash--the base of the tax is the residual spent on 
consumption. The cash-flow tax is vastly more complicated and much 
harder to administer than any form of value-added tax.
    The central issue in tax reform in the coming year will be the 
choice between evolving toward a VAT, on the one hand, or toward a 
cash-flow tax, on the other hand. Tax reform in recent years has taken 
steps in both directions, increasing the likelihood of conflicts that 
create tax shelters that exploit both investment and saving incentives 
and gain inefficient subsidies. We have been adding investment 
incentives and saving incentives and thus worsening opportunities for 
tax shelters without coordination.
    In my view, we should move purposely toward the American VAT. The 
reductions in the dividend and capital gains taxes adopted last year 
were important steps in that direction. We made the right choice by 
reducing the personal rates on these types of income rather than 
reducing the corporate rates.
    The next step should be the elimination of all personal taxation of 
dividends and business capital gains. The public needs to be educated 
that these types of income have already been taxed at the business 
level. Removing personal taxation is not a giveaway to the rich, 
because the tax on these types of income has already been paid, at the 
top tax rate, at the business level. The corporate tax is a withholding 
    Another important step is the rationalization of interest taxation. 
In some ways this step is easier, because the removal of interest 
deductions raises more revenue than is lost from removing taxation of 
interest at the personal level. The decrease in business interest 
deductions could be offset by an increase in depreciation, as I will 
discuss shortly. To avoid dislocations, certain transition rules would 
be needed. I will not try to spell these out here.
    Of course, the big issue in interest taxation and deductions is 
home mortgage interest. Even an ivory tower dweller like me knows that 
the mortgage deduction is sacrosanct. The deduction could be retained 
in the American VAT setting if there were a special corresponding tax 
on mortgage interest receipts that recaptured the tax lost from the 
deduction and maintained the VAT principle overall. Lenders would 
receive a small incentive to offer alternative mortgages at lower rates 
that lacked the privilege of interest deduction. The interest on these 
mortgages would not be taxed when received by the lender. Eventually, 
Americans would be weaned of deductible-interest mortgages.
    At the same time that we are moving the taxation of all business 
income to the business and limiting personal taxation to earnings, we 
should phase in improvements in depreciation of plant and equipment. 
After a period of a decade or so, all plant and equipment should be 
written off for tax purposes in the year of purchase, in accord with 
the principle of the VAT. During the period of transition, depreciation 
and write-offs will be higher than normal, because we will be honoring 
past commitments to depreciation at the same time that new investment 
is written off immediately.
    At the end of this process, we will have created the American VAT. 
The additional revenue from plugging existing loopholes will permit a 
top tax rate of about 25 percent for both the business and personal 
taxes. We will achieve the four key goals of simplification, uniform, 
powerful incentives for capital formation, progressive distribution of 
the tax burden, and economic efficiency.
    Let me conclude with a few remarks about what we should not do. We 
should not consider a national sales tax--it is an administrative 
nightmare. We should not consider a European VAT--it is not 
progressive. We should not expand saving incentives at the personal 
level or make any other changes that anticipate moving to a cash-flow 
consumption tax--it too is an administrative nightmare. The progressive 
American VAT is the desirable goal of tax reform.

    Chairman Nussle. Thank you, Dr. Hall.
    Dr. Steuerle, welcome back to the Budget Committee. We are 
pleased to receive your testimony.


    Mr. Steuerle. Thank you, Mr. Chairman, and members of the 
    I appreciate the time you are giving to us, especially 
given we have moved well into the afternoon. In fact, I 
remember one time when I was called to testify for the Senate 
Finance Committee and it was 11:55 a.m. Senator Moynihan was 
the Chair and the lone Member left in the room and he sat up 
there and said, ``Well, it is 11:55 a.m. and I would like to 
end at 12 p.m.'' And there were five of us to go. You haven't 
done that to us and I appreciate it.
    Let me also comment that this is one of my favorite 
congressional committees before which to testify because you 
examinine issues in-depth in ways I find commendable.
    Today, the topic is tax reform, that ever elusive elf that 
is beginning to again charm us a bit. Because of my background 
as an original organizer and economic coordinator of the tax 
reform effort of Treasury that led to the Tax Reform Act of 
1986, you have asked me to reflect on some of the lessons from 
that period as well as on what might make reform possible 
    I suppose if I have any basic message to you, it is 
probably consistent with my fellow panelists, but I am not sure 
it is consistent with all the previous discussion: it is that 
systematic tax reform is actually hard work. It is very, very 
hard work, requires substantial leadership and requires a well 
thought out vision. I have three examples that I will give you 
today and there are further examples in my testimony.
    The first one has to with the fact that systematic reform 
basically creates identifiable losers. Unlike simple tax cuts 
or simple expenditure increases, when you do tax reform you are 
really systematically creating winners and losers and some of 
those are going to be identifiable.
    The second issue is that reforming the tax system requires 
attention to a whole myriad of issues, housing policy, pension 
policy, charitable policy, wage subsidy policy. I could go on 
and on because all of these are in the Tax Code. Whether we 
want them in the Tax Code or not, we now have to deal with 
    The third point along these lines is that many taxpayers 
now face tax rates of 50-100 percent because they face all 
sorts of implicit income tax systems. Those are due largely to 
the phaseouts of all sorts of benefits. Some benefits are in 
the tax system, such as the earned income credit or education 
subsidies, the tax system, or the phase out of the child credit 
and the dependent exemption. We also phase out food stamps and 
TANF and other sorts of benefits. The phase-outs are all based 
on income, so you still have a system of income accounting and 
very high tax rates that apply to these taxpayers. Now to a bit 
more detail.
    My first point was unlike simple tax cuts or expenditure 
increases, systematic tax reform creates identifiable losers. 
If you look at a couple of the figures I have attached to my 
testimony, the first one show phase-outs of a variety of 
programs. A few of them are only in the tax system; to these I 
have added ones that are not directly in the income tax system 
but rely upon income accounting to be phased out.
    If you look at the educational subsidies alone, you will 
see that you already have three of them in the tax system. 
There are more that are being proposed. In trying to reform 
those, I think all of us agree one educational incentive or two 
educational incentives would be a lot better than three in the 
tax system and Pell Grants in the direct expenditures system. 
If we want to reform them and make them uniform, make them do 
what we think we want educational subsidies to do, we are going 
to create some losers along the way--these who basically got 
some extraordinary benefits out of that crazy quilt system we 
now have in place.
    My second point was that reforming the tax system requires 
attention to an extraordinary range of issues. The simple point 
is that pension policy, health care policy, charitable giving 
policy, fiscal federalism policy toward State and local 
governments, education policy, as well as tax policies toward 
international transactions, depreciation, research and 
development, even local school construction, are all sitting 
there in the tax system. It is one thing to say we do not want 
them in the tax system. But if we are going to reform that tax 
system, we have to address every one of these items.
    As coordinator of the tax reform effort back in Treasury in 
1984, I divided tax issues into 20 modules and those 20 modules 
each had at least 10 or 12 items in them. And all of those 200 
or 300 items had to be examined if you were going to do tax 
reform. You cannot get around the issue. Somebody could 
conclude, ``I do not care if we cut back on this deduction or 
credit, I do not care if we eliminate it,'' but you still have 
to make that choice.
    To give you a simple example, conversion of an income tax 
to a pure consumption tax would remove the incentive for 
pensions. In fact, you have a number of Republican as well as 
Democratic members who are now concerned if we go too far in 
making unlimited IRA deductions, for instance, whether we will 
have an incentive for pensions. You may agree with that choice, 
you may not agree with that, but it is an issue that has to be 
dealt with.
    My third point was that high tax rates distort behavior. 
But if we really want to deal with high tax rates, we really 
have to be honest about where they are now coming from. And 
they are really not coming from taxes on very high income 
people, although they do apply to some high income people.
    We have now moved down that very high tax rate system--I am 
talking about marginal tax rates, the tax rate that applies to 
the next dollar of earnings or investment--to many low and 
middle income taxpayer. And if you look again at Figure 2 in my 
graph, I show you a variety of marginal tax rates often at 50 
or 100 percent of income, as people phase out of earned income 
credits, phase-out of educational benefits, phase out of TANF, 
phase out of food stamps, and have Medicaid eliminated if they 
earn one more dollar of income, all of these systems where we 
have created these implicit income taxes, have to be dealt with 
at the same time.
    Let me turn, in my final minute, to the possibility of tax 
reform and the lessons that we might have from history. While 
it is true that tax reform is very hard work, it is equally 
true that opportunity is important. If one looks back 
historically at when we have had major systematic tax reform, 
there are probably three instances that stand out in the post-
World War II period. Those are 1954, 1969, and 1986. Looking 
closely at those three efforts, what we find in every case is 
that there was broad bipartisan support for what took place. I 
will give you a couple of examples.
    In 1969, the tax reform that took place under President 
Nixon was largely developed by the Treasury Department under 
President Johnson. And hardly a beat was skipped as, in a 
bipartisan way, the Congress and the President agreed to move 
on to deal with those issues.
    In 1986, people may remember a little better the agreement 
of Chairman Rostenkowski with President Reagan: Chairman 
Rostenkowski would be allowed to design tax reform, that is, 
take up the President's proposal, and President Reagan would 
not criticize the Democratic House while they were undertaking 
that effort. Those types of bipartisan efforts are vital.
    Now I cannot speak to what will lead to bipartisan 
consensus or cooperation today. I do see in the current laws an 
opportunity. One set of opportunities is just simply created by 
the problems we know we have to deal with, such as the growth 
in tax shelters. It is a different type of tax shelter, but we 
have to deal with it again today. The other example is the 
movement of tens of millions of taxpayers onto the Alternative 
Minimum Tax. I think both political parties are ready to 
recognize that we have to do something about it. Right now, 
they are not willing to pay the cost, but we all recognize that 
something is going to have to be done. It may be the reform of 
tax shelters and reform of the Alternative Minimum Tax that is 
the hearse upon which broader tax reform rides.
    So, in summary, I think there are many gains in efficiency 
equity and simplicity that derive from systematic tax reform. 
However, to achieve these gains requires attention to many 
details. Tax reform efforts have often failed. But they have 
also succeeded on occasion, especially when rising problems 
created the opportunity and demand for reform and tough issues 
were tackled in a spirit of bipartisan cooperation. Thank you.
    [The prepared statement and attached material of C. Eugene 
Steuerle follows:]

  Prepared Statement of C. Eugene Steuerle, Senior Fellow, the Urban 
             Institute, Co-Director, the Tax Policy Center

    Any opinions expressed herein are solely the author's and should 
not be attributed to any of the organizations with which he is 


    Mr. Chairman and members of the committee: Thank you for the 
opportunity to testify before the House Budget Committee--one of my 
favorite Congressional committees because of its continual efforts to 
examine issues in depth. Today the topic is tax reform, that ever 
elusive elf that is beginning to tease us again with its potential 
charm. Because of my background as the original organizer and economic 
coordinator of the Treasury's tax reform effort that led to the Tax 
Reform Act of 1986, you have asked that I reflect on some of the 
lessons from that period and on what might make reform possible again.
    As much as I believe in this elf and the possibilities it offers 
for improving economic and national well-being, I am also wary about 
thinking about it in mystical or magical terms. I have no doubt that we 
can create a better tax system that can improve equity, increase 
economic efficiency, and simplify our lives. Nonetheless, if I have any 
basic message, it is that systematic tax reform--if it is to achieve 
true economic gains--is hard work, very hard work, requiring 
substantial leadership and a well-thought out vision. Here are some 
further reflections on that theme:
    Unlike simple tax cuts or expenditure increases, systematic reform 
creates identifiable losers. Systematic reform recognizes important 
societal trade-offs, and trade-offs mean that something must be given 
up to achieve something better. Simple increases in expenditures or 
reductions in tax only hide elsewhere--often in future changes--those 
who pay for the initial changes. The only way to create no losers in 
tax and budget policy is to maintain current law. It is a fundamental 
law of budget economics and accounting that almost any budget change 
has an impact on the other side of the ledger. Systematic reform 
usually makes those losers more identifiable up front.
     Example. My Urban Institute colleague, Adam Carasso, and I 
have suggested combining the child credit and the Earned Income Tax 
Credit, which are needlessly separated. However, they have different 
maximum ages for eligibility. Taking an average maximum age would 
reduce the availability of the EITC for some college kids, thereby 
creating some losers. Alternatively, extending upward the child credit 
to the maximum age of the EITC makes the costs skyrocket, and these 
must be covered somehow, perhaps by reducing subsidies in some other 
part of the reform package.
     Example: There are many interactions among the three 
higher education incentives in the tax laws, as well as with Pell 
grants and other direct expenditures. Simplifying the law by combining 
them into one program or even two is likely to simplify taxes, as well 
as lead to a more efficient and productive use of educational 
incentives. But it is also likely to lead to some losers if no more 
revenue is made available since the combined program is likely to more 
rationally relate assistance to need (see Figure 1).
     Example: Saving incentives, if they are to work, must 
treat consistently both sides of the ledger: negative, as well as 
positive saving; interest payments as well as interest receipts. There 
are dozens of incentives today for making deposits that can be financed 
by borrowing, thus allowing taxpayers to arbitrage the tax system--to 
save taxes as if they had saved on net when they have not.
    Reforming the tax system requires attention to an extraordinary 
range of policy issues. Being for tax reform is like being for 
expenditure reform, a level of generality that lacks enough specifics 
to give it any real meaning. There are literally hundreds of policies 
in play. When I set up the organization of the Treasury's 1984 tax 
reform study, I divided issues into roughly twenty different modules, 
each of which had to be examined by a team. Reforming taxes requires 
deciding upon policies for housing, pensions, healthcare (especially 
for the non-elderly), wage subsidies, charitable giving, fiscal 
federalism among national, State and local governments, and education, 
as well as tax policies for international transactions, depreciation, 
research and development, empowerment and enterprise zones, and local 
school construction--to mention only a few. One can't dodge these 
issues. Even when reform attempts to be more narrowly constructed so as 
to deal with only some of them, many stragglers force their way onto 
the agenda because they interact with the ones that are targeted.
     Example: The conversion of an income tax to a consumption 
tax must deal with the incentives for separately putting aside money 
for pensions and what retirement policy Congress wants to put into 
     Example: Many programs, including tax subsidies and direct 
expenditures, use income accounting to determine eligibility for 
benefits. Therefore, elimination of income accounting for the direct 
income tax would not remove the requirements for income reporting and 
correct bookkeeping for many other purposes.
     Example: Congress has put in place a law that will soon 
provide an increase in tax subsidies of more than $25 billion annually 
for the employee exclusion for employer-provided health care. Existing 
subsidies are sufficient to encourage insurance purchase; the 
additional subsidies (from the uncapped preference) encourage the 
purchase of higher cost insurance. The encouragement to purchase high 
cost insurance leads to higher costs, which, in turn, discourages some 
employees and employers from offering or buying insurance. The net 
result of these additional subsidies, therefore, is to increase the 
number of uninsured.
    High tax rates distort behavior, but they are hidden in many tax 
subsidies, alternative taxes, and direct expenditure programs. A few 
decades ago one could approximate the marginal tax rate for earning an 
additional dollar simply by looking at the statutory income tax rate 
structure. No longer. Economists now must look to the ways that 
alternative tax and subsidy schemes create their own implicit tax 
systems. Often these additional tax rates derive from the way that 
benefits are phased out as one's income rises.
     Example: The earned income tax credit phases out as income 
grows. So do many other tax subsidies, such as those for higher 
education. So do most transfer programs, such as food stamps. The total 
marginal tax rate (combining explicit and implicit taxes) for many 
households today, it often rises above 50 percent and frequently 
reaches 100 percent (see Figure 2).
     Example: Partly because of the very high tax rate on 
additional earnings from many tax subsidies and direct expenditure 
programs, most couples today face significant marriage penalties--often 
10 to 20 percent, sometimes even 50 percent, of their combined income. 
Thus, a person making $10,000 a year could, by marrying someone making 
$30,000, potentially lose earned income tax credits, higher education 
subsidies, food stamps, housing vouchers, Medicaid, and child care 
    Systematic reform requires a truce from the fights over 
progressivity and higher statutory tax rates. Let me be clear: both 
progressivity and low tax rates or lean government are both worthy 
economic principles, even if emphasized differently on the two sides of 
the Congressional aisle. All families require more from their more 
affluent and able members, and high tax rates do distort behavior. 
Reform is very difficult to achieve when some advocates will fall on 
their swords over progressivity, and others do likewise over statutory 
tax rates. I am trying to make an economic, not political point: when 
one consideration alone is allowed to trump all others, and issues like 
simplicity or equal justice (equal treatment of equals) always get 
shoved to the side, there is a higher-than-necessary cost of taxation 
to the economy as a whole.
     Example: The alternative minimum tax (AMT) raises marginal 
and average tax rates, but few are willing to fold it into the regular 
rate schedule.
     Example: During the initial stages of 1984-86 tax reform 
process, progressivity was not an issue when deciding whether to 
remove, amend, or keep any particular item of tax preference. A bad 
preference didn't have to be kept because it was progressive, and a 
good preference didn't have to be removed because it was regressive. At 
the end of the process of choosing the tax base, Treasury would 
determine overall proposed progressivity of the tax system (in that 
case, approximating current law) by adjusting the statutory rate 


    While it is true that reform is hard work, and equally true that 
opportunity is important, it is mistaken to believe that many instances 
of failure were due solely to the absence of opportunity. Instead, the 
process itself was often ill-conceived and poorly carried out. Still, 
while history warns us that attempts at systematic reform often failed, 
there are notable exceptions. For modern examples of systematic reform, 
tax bills enacted in 1954, 1969, and 1986 stand out. (Interestingly, if 
we follow that trend for significant reform about every 15 to 17 years, 
then we are about due right now.) The difficulties of reform I noted 
above should not deter us. Right before the Tax Reform Act of 1986, 
attempts at major reform had failed so many times that some writers 
were beginning to call it the impossible dream.
    All three cases of significant tax reform involved both a felt need 
to act and bipartisan cooperation and bipartisan agreement on the need 
to move forward and to work together. The 1954 reform centered around 
codifying and simplifying the much more complex system that had grown 
up in World War II and its aftermath. Wilbur Mills, as chair of Ways 
and Means, exercised substantial leadership, Congressional support was 
quite bipartisan, and President Dwight Eisenhower approved the 
legislation. The 1969 reform, interestingly enough, began to be 
developed in 1968 under President Johnson and arose partly because of 
Treasury reports on abuses by foundations and on ways that wealthy 
taxpayers avoided paying any tax. Hardly a beat was missed when 
Treasury moved to Republican hands in the Nixon Administration; the 
work continued, eventually leading to the Tax Reform Act of 1969. In 
the efforts leading to the Tax Reform Act of 1986, a Treasury study 
galvanized support by at least some conservatives and some liberals, in 
no small part because of the growing use of the tax shelters of the day 
and because the poor increasingly were being made subject to income 
taxation. President Reagan and Dan Rostenkowski, chair of the Ways and 
Means Committee, reached an agreement not to criticize each other as 
the Democratic House took up what had now become the Republican 
President's proposal.
    I cannot speak to what will lead to bipartisan cooperation today. I 
will state that one trend over the last couple of decades is 
disturbing: the dearth of useful published studies from the executive 
branch--in particular, the Treasury Department and the Office of 
Management and Budget--about problems that need to be addressed. But 
they are still good departments, so the potential is there. However, I 
do believe that there is current opportunity--an opportunity, if one 
wants, that derives, as in the past, from growing problems that need to 
be addressed. In this case, the complexity of the system has become 
even more overwhelming, and few, if any, understand what the tax system 
means or how it works. The scheduled movement of tens of millions of 
taxpayers onto the Alternative Minimum Tax is more of a political than 
economic problem, but the need to address it provides a catalyst for 
broader reform. Alternatively, the requirement to get the deficit under 
control also presents an opportunity to return toward base broadening 
(which in most cases is equivalent to a reduction in spending), as was 
done under President Reagan.


    At the risk of oversimplification, tax reform issues can roughly be 
compartmentalized into those affecting three groups: moderate-, middle-
, and higher-income taxpayers. Although there is much overlap, the 
issues affecting each group are often very different.
    For moderate-income taxpayers, the most important tax rates derive 
from the phase-outs of benefit programs, including the EITC, and from 
the Social Security tax (which, for almost everyone for some time to 
come, is more than offset by the insurance value of Social Security and 
Medicare benefits). My work with Adam Carasso shows that many moderate- 
and middle-income taxpayers face combined tax rates from the phase out 
of EITC, Food Stamps, Medicaid and so forth of 100 percent or more for 
much of their earnings. Many also face enormous marriage penalties.
    Some of these issues relate to provisions in the tax Code, such as 
the EITC and educational subsidies; some to other programs. To the 
extent that high tax rates distort economic behavior, it is now to the 
moderate-income taxpayer that we should devote our attention. 
Meanwhile, filing for the EITC has itself become complex, and most low-
income taxpayers face more complex tax returns than many at higher 
income levels.
    For middle-income taxpayers, combined tax rates continue to be high 
because of the phase-out of benefits, in this case stretching into such 
issues as the phase-out of educational benefits for post-secondary 
education programs. The middle-class gathers many benefits from dozens 
of exclusions, deductions, and credits in the tax system. Sometimes 
reformers look first to itemized deductions, but there are many other 
sources of preference. The number of saving incentives and retirement 
plan options not only adds complexity to that system; the cost of all 
the intermediaries--accountants, financial advisors, human resource 
personnel, insurance salespeople, lawyers--figuring out the tax law 
reduces the net return available from that saving.
    For higher-income taxpayers, the issues often surround the taxation 
of capital income. In truth, the tax system at that income level has 
evolved in fitful stages, with any way to tax the rich often advocated 
on one side and any way to reduce their taxes advocated on the other. 
Much consolidation and integration could be considered, regardless of 
whether effective marginal tax rates are increased or reduced. An 
extremely important issue at higher income levels and for business is 
whether, for a given level of revenue collection, the tax system should 
favor existing wealth or new wealth. Under the Reagan tax reform, 
Treasury argued that lower rates were preferable to tax breaks because 
the latter tended to favor existing business over new business (which 
often couldn't generate enough taxable income to make use of special 
tax breaks). The alternative minimum tax started out also as a high-
income tax issue but has evolved quickly downward to the middle class.
    This tri-level view of the system is quite simplified and leaves to 
the side many issues. My main purpose in presenting it is to recognize 
that fixing one part often tells us very little about what to do with 
the other parts. One might fix up the EITC and tax rates facing low-
income taxpayers without doing much about all the deductions and 
exclusions affecting the middle class; likewise, one might tackle those 
middle-class issues without considering how capital and business income 
is taxed, especially among those at higher incomes.


    In summary, the gains in efficiency, equity, and simplicity from 
systematic tax reform could be substantial. However, to achieve those 
gains requires attention to many details. Tax reform efforts have 
failed often, but they have also succeeded, especially when rising 
problems created the opportunity and demand for reform, and tough 
issues were tackled in a spirit of bipartisan cooperation.

    Chairman Nussle. Thank you. Mr. Spratt.
    Mr. Spratt. Let me direct your attention, first, to the 
sales tax. And Mr. Gale, if you could amplify a couple of 
things you touched upon that would be helpful. For example, let 
me just take the basics. Because the advocates of H.R. 25, the 
Americans for Fair Tax, propose to repeal the individual income 
tax and the corporate income tax, and the payroll tax, and the 
gift and estate tax, they have got a huge amount of revenue to 
make up with the sales tax. Consequently, they have to have a 
very substantial and inclusive tax base upon which to apply the 
sales tax.
    Am I reading your article and their description of the bill 
correctly to state, first of all, that State and local 
expenditures would be among the things that would be subject to 
    Mr. Gale. Yes. The bill would tax State and local 
government spending, which would be a source of revenue for the 
Federal Government. That is essentially placing an unfunded 
mandate on State and local governments that runs into a couple 
hundred billion dollars a year.
    Mr. Spratt. Now, are you taking this at face value when you 
try to derive what you believe the correct rate must be in 
order to replace the revenues repealed? Are you simply assuming 
this tax will be levied and collected on all State and local 
    Mr. Gale. There are two issues here. One is that if you 
look at total personal consumption expenditures in the national 
income accounts, it includes State sales taxes. So if you buy 
something for $1 and you pay a 5 cent sales tax, that is $1.05 
of personal consumption. I take out that 5 cents.
    So I calculate this Federal sales tax on the dollar itself, 
and I do not include State and local purchases in the tax base. 
I also do not include Federal purchases in the tax base for the 
simple reason that the Federal Government cannot raise money on 
a net basis by taxing itself, and that is another misconception 
in the whole H.R. 25 world.
    Mr. Spratt. Let me go back to the beginning. First of all, 
they acknowledge that the tax rate that most ordinary citizens 
would consider the understandable rate is 30 percent.
    Mr. Gale. Right.
    Mr. Spratt. That means that if I buy a shirt for $10.00, I 
will pay $13.00 for it; therefore the tax is 30 percent.
    Mr. Gale. Right.
    Mr. Spratt. The 23 percent rate is derived by treating the 
tax, the $3.00, as a percent of the end price with tax 
    Mr. Gale. Right.
    Mr. Spratt. And what you are say is when you are looking at 
the revenues derived from this system, if they include State 
and local property taxes, you are treating this as 30 percent 
of the tax base? The 30 percent of State and local expenditures 
would be included in Federal Government's tax take?
    Mr. Gale. No. My 60 percent calculation is based on the 
assumption that the Federal sales tax does not include State 
sales tax in the base.
    Mr. Spratt. State expenditures?
    Mr. Gale. And that it does not include State expenditures.
    Mr. Spratt. OK. So you have to make up for it by raising 
the rate?
    Mr. Gale. Right.
    Mr. Spratt. OK. Do you think that is impractical, 
    Mr. Gale. I do not know about the Constitutional aspects of 
it. I am certain a Constitutional challenge would be raised 
somewhere along the way. But in terms of the plausibility of 
the tax base, there is already going to be two issues. One is 
that the States are going to feel impinged upon, because 
historically sales taxes have always been their province and 
they do not want the Federal Government moving in on them.
    The other thing is that if we eliminated the Federal income 
tax and create a sales tax, the States are going to have no 
choice but to switch over and create a sales tax as well. So 
the total sales tax that people are going to face is the 
Federal tax, the 60 percent, plus existing State sales taxes, 
plus the cost of converting existing State income taxes into 
sales taxes. So the combined Federal-State rate would be 
something like 80 percent rather than 60 percent. And that is 
the thing that has to get collected on a voluntary basis with 
no cross reporting.
    Mr. Spratt. Yes. And in addition to levying a tax on State 
and local government expenditures in their proposal, their 
proposal will also levy the same sales tax on all Federal 
expenditures, which you just mentioned. So you have the oddity 
of the Federal Government collecting taxes with one hand and 
spending the money with the other hand. It is a wash and you 
have questions why you even put yourself to the effort.
    But as it turns out, you have detected a major mathematical 
miscalculation which grossly understates the rate because of 
the way they treated the collection and dispersement of that 
tax. Could you explain that a little more completely than you 
did in your testimony?
    Mr. Gale. Sure. Normally, we look at revenue neutral tax 
plans. If we were going to take out the income tax and put in a 
flat tax, we would look at a revenue neutral tax plan. That is 
fine in that case because the flat tax taxes at the same point 
in the economic process as the income tax does. The sales tax, 
though, does not. It taxes at a different point. It puts a tax 
on the retail sale.
    So, there is an issue about what happens to the price level 
when you switch to a retail sales tax. Therefore, a consistent 
plan has to be both revenue neutral and budget neutral. And the 
reason it is an issue is because the price has changed and 
Federal spending has to change.
    So you have to make some assumption about what happens to 
the price level, and you have to make the same assumption when 
you look at how much money the Government is going to raise 
from the tax and how much spending the Government is going to 
have to do to maintain the real value of the services that it 
currently provides. And they did not do that.
    When they calculated how much revenue they needed, they 
assumed the price level would stay constant. When they 
calculated how much spending the Government would have to do, 
they assumed the price level would fall. That is a big 
difference. If you think of spending as two or three and a half 
a trillion dollars, you are talking about 20 or 25 percent of 
that, that is a half a trillion dollars.
    Mr. Spratt. How big a difference is this discrepancy of 
    Mr. Gale. In terms of the sales tax--well, it depends on 
what you assume about all the other things. But that alone is 
basically 5 to 10 percentage points in the sales tax rate.
    Mr. Spratt. Now, do you correct for this, when you restate 
the rate, do you correct for this by assuming that the 
Government would be paying the unadjusted price level, that it 
would be collecting the tax on the unadjusted price level and 
buying at that level also?
    Mr. Gale. You get the same answer whether you assume that 
prices are constant in both cases or prices fall in both cases. 
As long as you make a consistent assumption, it does not affect 
any of the results, like the required tax rate, the 
distributional effects, et cetera. The only issue is you cannot 
make an inconsistent assumption or you are basically cheating.
    Mr. Spratt. We had some charts earlier that showed that 
there were no exemptions. Are there any exemptions in H.R. 25?
    Mr. Gale. Right. Just to clarify that chart, I am sure it 
referred to product exemptions, not to personal exemptions. 
H.R. 25 and the numbers in there had demogrants built into 
    Mr. Spratt. Which are rebates.
    Mr. Gale. Rebates, right. H.R. 25 has a limited number of 
exemptions. Education is one of them. Some portion of foreign 
travel is another. But I think education is the biggest. And 
there is some consensus that to the extent that education is an 
investment and not consumption, it is appropriate to exempt it 
from a retail sales base.
    Mr. Spratt. One of the attractions here is that allegedly 
you get rid of the Internal Revenue Service. And in our view, 
one of the ways that you would lure attention away from the 
real distribution of this tax is by holding out the phenomenal 
prospect of wiping out the Internal Revenue Service. Actually, 
there is a fair amount of complexity in what superficially 
seems a simple bill.
    As I understand it, first of all, America's shopkeepers, 
merchants would become the tax collectors for this tax. We are 
talking about a couple trillion dollars. So they would have to 
be policed pretty carefully in the reporting and transmission 
of the tax to the Government. Secondly, as I understood it from 
reading your article, not theirs, a business would pay a tax on 
intermediate or component goods and materials, not end prices 
or end goods, but on intermediate goods and then apply for a 
rebate of that tax, which would be a complication.
    And then, of course, you have got demigrants and who 
qualifies for it. You may have, as you point out in one of your 
articles, two families living in the same household, you may 
have a mother-in-law or someone who is older who claims that 
she is a separate entitlement to the demigrant. You have got 
that complication. Politically, there are bound to be 
exemptions. And then you have got the layer of different sales 
taxes all over the country. Different municipalities and States 
have certain exemptions.
    So all of those complications bedevil this particular tax 
and make it a lot more complex than it does seem on its label. 
Would you agree with that?
    Mr. Gale. Absolutely. If the demogrant is based only on the 
poverty thresholds, every single married couple in the country 
would face a marriage penalty.
    Mr. Spratt. It would require also some kind of report or 
some kind of an application, would it not?
    Mr. Gale. That is right. Yes. Administering a demogrant for 
270 million people is not a simple thing. The States, by the 
way, do not have demogrants because they are complicated to 
administer. Family circumstances change. I was surprised to 
learn a couple years ago when I wrote a paper with a Treasury 
Department employee, Janet Holtzblat, about how complicated it 
is to keep track of family arrangements for tax purposes. And 
that would be an issue with the demogrant. The fact that no 
agency does this worldwide is telling.
    Mr. Spratt. Tells you why, yes. Here is the chart that we 
showed earlier which indicates the differential in sales taxes 
paid as opposed to previously paid income taxes, according to 
what your consumption level is. This assumes no exemptions, but 
it does assume a demogrant?
    Mr. Gale. Yes.
    Mr. Spratt. A demogrant but no exemptions. And as you can 
see, for a taxpayer in a household consuming in the range of 
$27,000 to $36,000, the sales tax increase would be 59 percent 
more than the income taxes paid; 38 percent for the next income 
bracket. Really, you have got to get about over $135,000 in 
total consumption before this tax gets to be an advantage to 
you. Is this consistent with your understanding and what you 
have done also in distributional analyses?
    And I put that as a final question to the whole panel. Is 
this consistent with your own perception of what a sales tax 
like H.R. 25, or the American Fair Tax proposal, what its 
impact and instance would be?
    Mr. Gale. It is certainly consistent with mine. Let me just 
note, this study bases it on annual consumption, so it is not 
subject to the criticisms of looking at annual income. The 
second thing to note is this study was actually particularly 
funded by Americans for Fair Taxation. Now that I am sitting up 
here I can see the source. The Feehberg, Matussi, Poterba 
article was partially financed by the Americans for Fair 
Taxation, which is the group that is pushing this tax proposal. 
This study shows that the sales tax is regressive relative to 
the current system. The estimates that I have done using the 
Tax Policy Center model are not quite at as a developed stage 
as the Feeberg, Matsussi, Peterba estimates, but they generate 
relatively consistent results.
    Mr. Spratt. Dr. Steuerle, Dr. Hall, any comments you would 
care to make?
    Mr. Steuerle. Mr. Spratt, I think the panel here, the three 
of us, would be in uniform agreement on if one wants to move 
toward a consumption tax, two things. One is there are ways to 
do it, or move partially toward it, that could retain 
progressivity. However, a pure flat tax, particularly a 
national retail sales tax, would not achieve that goal. And the 
type of distributional effect you see here would occur. 
Treasury, including Republican Treasuries have testified to 
that effect.
    I guess there is one other comment I would like to make. 
Since my colleagues on this panel talked about the national 
retail sales tax in-depth, I did not include a lot in my 
testimony, but we are all in agreement as well as to the very 
difficult issues regarding administration, regardless of 
progressivity. One administrative issue that has not even come 
up here is the extent to which we would require customs 
officials to be enormously empowered to deal with cross-border 
transactions. Whereas, we have moved somewhat in the opposite 
direction in recent years by trying to reduce the requirements 
on customs officials lean toward collecting customs and more 
toward trying to get at illegal----
    Mr. Spratt. What you are touching upon here is what Dr. 
Hall touched upon in his testimony. Once your rate gets above 
10 percent on a sales tax, there is an enormous opportunity, 
first, for legal avoidance, if you can possibly construe your 
transaction that way, and then second, just for tax evasion.
    Mr. Steuerle. We have also got the issue of how to deal 
with goods versus services, which is a problem that the States 
have right now. There are issues having to do with how to deal 
with intermediate goods versus final goods, and when a 
particular good is consumption versus whether it actually used 
for production purposes. All of these issues do come into play.
    Mr. Spratt. It is not simple. Dr. Hall.
    Mr. Hall. I would say two issues here. One is, it is just 
purely an administrative issue whether to structure something 
as a national sales tax or a value-added tax. The value-added 
tax is the proven principle for collecting what has exactly the 
same substantive effects as a sales tax; that is, it is a 
consumption tax. The other issue is, how do you design a system 
that is adequately and fairly progressive? The problem with 
H.R. 25 is that it has a very small demogrant and it has only a 
single bracket which applies to everybody. The result 
inevitably is going to be, as this picture shows, a shift in 
the distribution, probably a politically and morally 
unacceptable shift.
    You need to design a better system. You can do that, 
especially in the value-added setting, and especially if you 
connect the zero bracket to people's earnings, which is what we 
have always done traditionally and it is the administratively 
practical way to do it. So you could take H.R. 25 and make some 
relatively small changes in it that would make it an effective 
consumption tax and one that was fair. It would not be a flat 
tax because it would have multiple brackets. But it would have 
all the other efficiency advantages and it would be 
administratively feasible. So, H.R. 25 has the right philosophy 
but it needs some fine tuning, I would think. One is to get 
away from the sales tax principle and back to the value-added 
principle. And the other is to make it more progressive.
    Mr. Spratt. Any further comments from the panel? Mr. Gale, 
do you have a reaction to that, that you could fine tune H.R. 
    Mr. Gale. Well, I guess it is a matter of judgment whether 
it is fine tuning or----
    Mr. Spratt. Complete revamping.
    Mr. Gale. Yes. Dumping it and starting over. But Bob is 
right, the economic structure of a sales tax and a value-added 
tax are the same, but the administrative stuff is completely 
different. And the administrative issues are the central issue 
with the national retail sales tax.
    Mr. Spratt. Thank you very much, all three of you.
    Chairman Nussle. Mr. Brown, do you have questions? Mr. 
Brown is recognized.
    Mr. Brown. Thank you, Mr. Chairman. We have gone through 
three different panels now, so we have gotten I guess three 
different ideas of how the process might work. I guess if we 
look at a different method to collect taxes from the citizens, 
which I guess is our primary goal, under the current system, I 
believe we collect tax from about anywhere from 53-57 percent 
of our population today. And so if we went to some flat tax or 
some value-added tax or sales tax, we would shift some of that 
tax burden back to I guess the poorest people. Is that a 
correct assumption?
    Mr. Hall. Not in a system that I would design. See, there 
are two separate issues. One is the structural issue of what 
kind of a tax you have. Is it a sales tax, is it a value-added 
tax, is it an income tax. You can take what I think, and I 
think this panel agrees, is the superior form; namely, the 
value-added tax, and then it is a policy decision that Congress 
would make as to who bears the burden of that.
    If you wanted to retain the feature today which is that a 
significant fraction of the population either pays no tax or 
actually gets a credit back, that is important to understand, 
that could be built in and that would affect the rate. That is 
a design issue. There is nothing about adopting an efficient 
tax system like a value-added tax that prevents having it be as 
progressive as you want it to be. So that is something that you 
would decide. It is not something built in to this choice about 
tax reform. You can have tax reform and a highly progressive 
result in tax. That is the important message.
    Mr. Brown. Go ahead.
    Mr. Gale. Just to add a little bit. The issues are you are 
moving from an income to a consumption tax, which is an 
inherently regressive move if you keep the rate structure the 
same. You are moving from a progressive rate to a flat rate, 
which is an inherently regressive move if you keep the tax base 
the same. Now having gone from a progressive income tax to a 
flat consumption tax, you are very likely to end up with a less 
progressive or a more regressive system. What Bob is saying is, 
in principle, you could take changes to restore that 
progressivity. But even if you do that, you will probably be 
hard-pressed to get the top 1 or 2 percent paying the same 
share as before. That is, because the value-added tax and the 
sales tax have a flat rate, it is very difficult to reach back 
up into the very top of the distribution and capture what they 
are paying, at least according to the estimates that I have 
    Mr. Steuerle. Mr. Brown, in my testimony--I did not comment 
on it orally but it is in my written testimony--I had another 
way of dividing up these tax issues into what I am going to 
call moderate, middle, and high income tax issues. That, I 
think, helps a little bit. It is somewhat of a simplification. 
But a lot of the high income tax issues have to do with how 
progressive do we want the system to be and what do we want to 
collect from them. It also has to do with whether we could tax 
them, since a special portion of their income is in the form of 
capital income. If you decide you want to tax consumption more 
and income less, how can you retain progressivity. And those 
are the issues which we have actually talked about.
    At the middle income levels, a lot of the issues have to do 
with deductions and exclusions and credits. It used to be that 
a lot of those applied more at high income levels. Now they are 
very much of a middle class type of issue. And a lot of reform 
proposals have as part of their implicit structure trying to 
get rid of all of those subsidies in the system, some of which 
I, personally, would get rid of, some of them I probably would 
not. But there is that set of issues.
    At the bottom end, the issue is not so much how much do we 
tax the rich. It is the many ways we redistribute to those who 
are low or moderate income. The earned income credit even in 
the budget itself is actually treated for the most part as an 
expenditure. It is actually treated as a direct expenditure to 
the extent it exceeds tax liability. Thus, it really is a 
spending program administered by the IRS. Now there are reasons 
you probably want to administer that particular spending 
program by the IRS. That is largely because it depends on the 
wage statement of the employer. And so there is some efficiency 
in having the IRS do some of the administration. Regardless of 
its problems, it would be hard for HHS to administer it.
    With low income issues, it is not even clear to me that one 
wants to be dealing only with the tax system itself. Most of 
the issues there are really spending issues. I realize that the 
subject at hand is tax reform. But at some level, when you 
start talking about redistribution, it is hard to just sit over 
here and only talk about a tax system and not also include 
earned income credit, which is a spending issue, or the 
educational subsidies, which are spending issues.
    I do not know if that helps. But sometimes dividing the 
world into those three compartments helps us to realize that we 
have got to deal with all of them. You could solve the capital 
income issues perhaps to everybody's delight and not solve the 
middle income deduction issues. You could solve those middle 
income deduction issues and not solve the issue of whether you 
are redistributing what you really want to low and moderate 
income wage earners.
    Mr. Brown. Thank you. I think my time has expired.
    Chairman Nussle. Mr. Scott.
    Mr. Scott. Just following up on that. If you believe in a 
progressive tax system, is it fair to just assume that all of 
these will be a step backwards?
    Mr. Steuerle. No.
    Mr. Hall. No.
    Mr. Gale. Definitely not.
    Mr. Scott. Which ones of these, in the likely way it would 
probably be enacted, it seems to me that all of them--you saw 
the chart up there with one of them--that all of them are going 
to be worse from a progressivity point of view than what we 
have. That is not true?
    Mr. Gale. I think if you are looking at the range of 
realistic options, a move from a progressive income tax to a 
flat consumption tax is going to end up being less progressive 
than is currently.
    Mr. Scott. Is anything we have discussed today more likely 
to be more progressive than what we have got?
    Mr. Gale. No. I refer back to the discussion where Mr. 
Linder was saying you could add the EITC back in separately. 
OK. Obviously, you could do that in a sales tax. You could also 
expand it in an income tax. You could always add on more 
spending programs.
    Mr. Scott. Or you could just leave things as they are.
    Mr. Gale. That is right. My sense is that all of these 
programs will turn out less progressive than the current 
    Mr. Scott. Let me ask a couple of direct questions. On the 
flat tax, all the ones I have seen exclude capital gains, 
interest, and dividends. Is that right?
    Mr. Hall. No. They are taxed at the business level. 
Representative Armey explained how that works. You have a 
business tax and you tax it at the source, at the business. 
When it flows to the individual, it is like----
    Mr. Scott. Suppose you have a personal savings account and 
draw interest. Is that taxed under the flat tax since it is 
interest, unearned income?
    Mr. Hall. Yes. Because the interest is no longer deductible 
at the business level. So it is taxed at the business level. We 
correct a big problem in the current tax system----
    Mr. Scott. Wait a minute. I understood the flat tax not to 
include capital gains, interest, and dividends. If you have a 
savings account and get interest----
    Mr. Hall. No. Congressman, that is not correct. There are 
two parts to it. There is a business tax and there is a 
personal tax. Under the personal tax, it is not taxed because 
it has already been taxed under the business tax. But there are 
two pieces to it. There is a business and a personal tax.
    Mr. Scott. So, interest would be taxable. Is that what you 
are saying?
    Mr. Hall. At the business level. It would no longer be 
    Mr. Scott. A personal savings account interest.
    Mr. Hall. It would be taxed before it got to the savings 
account. The flow of income to the savings account would have 
tax already withheld from it before it got to that account. The 
holder of that account would not have to pay again because the 
tax would already have been paid.
    Mr. Scott. A personal savings account, interest generated 
from a personal savings account would be taxed but would not be 
    Mr. Hall. It would be taxed at the business level, as I 
explained, before it got to the account.
    Mr. Scott. OK. I made the cash in the business account. But 
once I stick it into the personal savings account and draw 
interest on that account, the interest would not be taxed or 
would be taxed?
    Mr. Hall. It would be taxed at the business that generated 
that income in the first place.
    Mr. Scott. The personal savings account----
    Chairman Nussle. Use a bank as an example. OK? So it is a 
bank. You have a personal account at your bank. The bank pays 
the tax before the money goes into your account.
    Mr. Scott. If I have a 4 percent----
    Chairman Nussle. I am not arguing for it, I am just----
    Mr. Scott. If I have, well, right now I guess it is about 2 
percent savings account at the credit union and they pay me my 
little 2 percent, is that taxable?
    Mr. Hall. It is not taxable to you because the tax has 
already been paid.
    Mr. Scott. OK. Thank you. Under the national sales tax, you 
pay sales tax on the new house but not the old house, the new 
car but not the old car, used car, right? What about rent, do 
you pay tax on rent?
    Mr. Gale. Renters would pay tax on their monthly rental 
    Mr. Scott. So if the rent is $500 a month, what is the tax 
if this thing passes? Is it 60 percent?
    Mr. Gale. If it replaces the whole Federal system, right.
    Mr. Scott. My rent would go up from $500 a month to $800?
    Mr. Gale. Yes.
    Mr. Scott. Dr. Hall.
    Mr. Hall. Please understand, Congressman, that I am not 
remotely an advocate of sales tax, and I have not done the 
calculations that Dr. Gale has done. So you might better 
address these questions to him. I am not prepared at this point 
to talk about a system that I do not believe in.
    Mr. Scott. If you have a corporation that is subject to the 
alternative minimum tax for corporations and, in fact, did not 
pay any taxes and paid dividends out of cash flow because the 
generating cash flow would have so many deductions, loopholes, 
and everything else, the effective rate for the business of 
course would have been zero. They paid dividends. That would be 
zero, too. Is that right?
    Mr. Hall. Do you mean under the current tax system?
    Mr. Scott. No, under the flat tax.
    Mr. Hall. Under the flat tax that would not exist because 
the situation you describe is generated by interest deductions 
and they would no longer be allowed.
    Mr. Scott. Or depreciation?
    Mr. Hall. Possibly. But then that is all done on a carry 
forward, carry backward basis. There is no business that it 
does not face the tax if the tax is uniform on business.
    Mr. Scott. If you do not have a deduction for interest and 
the business has to pay interest, then they lost money.
    Mr. Hall. Well, that is how a value-added tax works. There 
is no promise in a value-added tax that you--it is not a profit 
    Mr. Scott. How do you have different brackets in a value-
added tax if that is kind of a sales tax? How would you have 
different brackets?
    Mr. Hall. By splitting the value-added tax into two pieces. 
You have got the business tax, on the one hand, and a personal 
tax, on the other. The two mesh together and form a value-added 
tax. But because the range part of it is put on the individual, 
then it can be sensitive to the individual's actual level of 
earnings. And that is how it is made progressive. This is the 
essential new idea in the original Howard Buskha plan and in a 
progressive non-flat tax version of it.
    Mr. Scott. I yield back.
    Chairman Nussle. Mr. Moran, do you have questions?
    Mr. Moran. Thank you, Mr. Chairman. I would like to explore 
this just a bit further with Mr. Hall. First of all, what tax 
would you pay on profit from investment in capital goods?
    Mr. Hall. At the business or personal level?
    Mr. Moran. Well, both.
    Mr. Hall. OK. The taxation of all business income is 
centralized in the business tax. So the base for the business 
tax is revenue minus cost, including wage costs, and minus 
investment in plant equipment. And what is left over is the 
base for that tax. Then with that tax collect, the flow of 
business income to the personal level is after tax income. It 
is not taxed again. That is the central idea here, is to get 
rid of the double taxation that currently exists. And you 
centralize it all at the business level. So you make sure that 
all business income is taxed exactly one. We get rid of the 
fact that lots of the business income is not ever taxed at all 
because of the interest deduction. And we get rid of the 
problem that some business income is taxed twice; first at the 
business, and second as dividends. We iron out all those 
problems and come up with a coherent tax exactly once system, 
which is the efficient system.
    Mr. Moran. It is efficient. My concern is the distribution 
of the tax burden. You would expect that of the Democratic 
Party. But it does seem as though it is the working class that 
are going to be paying a higher proportion than they are now. 
You do not think so?
    Mr. Hall. No. That is a question of design. I am a life-
long Democrat, Congressman, first of all, and I share your 
concern about the distribution. The distributional effect of 
this is something that you can design. When you pass a bill 
that gives us a value-added tax, you can decide who bears the 
burden of it. You can say that nobody under $75,000 a year pays 
any tax. You could make it a tax only on people above $75,000. 
Now the rate would have to be high, of course. But that is a 
decision that you make. It is not built into the system. That 
is a decision made right here. It is a design of the tax. You 
could, in particular, give the burden of the value-added tax 
across individuals, make it approximately the same as it is 
now. That would require keeping the earned income tax credit, 
for example, it would require keeping the features that 
basically excuse about half the population from paying any 
significant income tax. You could reproduce that. That is 
doable. There is nothing about tax reform that requires that 
you shift the burden of taxation. You can separately choose 
what that burden is.
    Mr. Moran. Both staff and I on our side want to know what 
the effective rate on income from capital would be if you take 
into account the fact that investment is expensed in your plan. 
I do want to ask Mr. Steuerle, can I get a short answer on that 
before the time expires.
    Mr. Steuerle. It is slightly complicated. The simple answer 
is, if you expense all business equipment, the tax on capital 
income is zero. However, there are ways of doing it where the 
zero tax essentially applies to what economists call the normal 
return as opposed to the extraordinary return; that is, if one 
gets an extraordinary return and you are taxing consumption 
tax, those people who get that extra layer of consumption would 
pay some additional tax. I realize that is a complication. The 
simple answer is you are moving closer to a zero rate of tax on 
the capital income.
    However, to the extent you start at the nova, at the 
beginning, the basic argument for a consumption tax, which I 
think has legitimacy on both sides of the aisle, is the 
following: if you take a wage earner who saves, and you take a 
wage earner who does not save, and they both earn exactly the 
same amount of income and you tax them equally, but then the 
one who saves you start taxing again and again, you have taxed 
the saver more than you have the other. I think that is a 
perfectly legitimate argument.
    The issue that comes up, and it is a difficult issue, I 
think, revolves around progressivity. We end up having in 
society a lot of people who are very big winners. We do not 
think they are winners because they have been saving and 
putting money in passbook accounts and earning 3 or 5 percent. 
They have often leveraged up people or dollars or have just 
been very lucky. In a winner-takes-all society, they have 
gotten there ahead of somebody else and they have made very, 
very large gains, often measured as capital income. Sometimes 
we do not know whether it is capital income or wage income. Now 
how do we tax those people at the same time. That is the 
difficulty. There is a fundamental equity argument for a 
consumption tax. But it seems to me there is a fundamental 
equity argument for taxing more some of the big winners in 
society. And that is what we are trying to grapple with.
    Mr. Moran. I do not think there is any of us that does not 
want a simpler, more understandable system, one that is less 
prone to evasion and to disproportionately benefitting based 
upon how much you can pay your accountants and tax lawyers and 
so on. But while we want simpler tax systems, we do not want 
systems that are not going to do a better job of distributing 
    We had a session last night, it was a Town Hall meeting, 
and there were several hundred people there who live in 
northern Virginia, where we live, Gene, and I do not know about 
the other panelists, but it was on home ownership. The reality 
is that if you do not own a home, you are never going to be 
economically self-sufficient. You cannot acquire economic self-
sufficiency in this society unless you have an appreciating 
asset. Our tax laws are geared toward that. If you own a home, 
you get a mortgage deduction, you can borrow money, you can use 
it as collateral, et cetera. These folks, until they can afford 
a $400,000 home, they are swimming upstream. And we have got to 
find a system that is fairer to the working class. I do not 
think that the flat tax or the sales tax is going to accomplish 
that objective, not without a whole lot of manipulation. I 
guess we do not have enough time to explore that further, Mr. 
Chairman. They are well-meaning proposals. In reality, the net 
effect is not going to give us the kind of fairer society that 
we are looking for.
    Mr. Steuerle. May I just have a very short answer to that?
    Mr. Moran. Please.
    Mr. Steuerle. In both the case of home ownership and 
pensions, which are the main ways our current tax system 
actually favors an ownership society, we have had a great deal 
of difficulty in getting those incentives down to moderate 
income taxpayers. I could show you how the way the current 
system works for homeowners is to provide higher tax breaks to 
people who are upper-middle to higher income taxpayers. But 
particularly for some lower income taxpayers, it could raise 
housing prices enough and give few enough tax benefits that 
they actually come out behind. And this gets, as I said 
earlier, to the whole expenditure side of the budget. Because I 
could argue with you that the way we set up rental vouchers 
actually discourages home ownership.
    So, this gets back to a point in my testimony, which was 
that if we want to deal with housing policy, we have got a lot 
of issues we have to address. I do not think Professor Hall or 
Dr. Gale would disagree that if you want to get into housing 
issues, you want to get into pension issues, you want to get 
into charitable contribution issues, we have a lot of work to 
do to figure out how we want to design each of those systems. 
There is no one reform fix that is going to make those problems 
magically go away.
    Mr. Moran. In our society, it is virtually impossible to 
become economically self-sufficient on earned income. You have 
got to have income that is in addition to your wage. It has got 
to be income off of investments or asset ownership, I agree. 
But let me look at your testimony more closely, Gene. I thank 
all three panelists for their thoughtful consideration of a 
very important issue.
    Chairman Nussle. I thank the gentleman. And we will take 
more time. This has been a good discussion today and we will 
take more time. I think this has been a worthwhile discussion 
today and debate.
    Picking up on the gentleman from Virginia's last comment, 
and I think it is the reason why so many are tempted by the 
national sales or consumption-based tax is exactly the point 
that the gentleman made, and that is, you are not going to get 
wealthy or you are not going to be more than just at some level 
of subsistence unless you are doing something more than just 
earning. I think that is the reason why they are looking at 
something that encourages more than just earning, and that is 
consumption. I wanted to ask the question, as economists, 
because I think, for me at least, it is a fundamental question, 
and that is, what is the best way to determine wealth? Or who 
should bear the burden, income or consumption? What is the best 
determinant on that? From an economic standpoint, how would you 
address that kind of a debate or that kind of a question? I 
will just throw it open. Dr. Gale, do you want to try and 
tackle that?
    Mr. Gale. Sure. If you forget about bequests given and 
bequests received, the difference between income and 
consumption is just a timing issue. Your lifetime income will 
equal your lifetime consumption. Now, when I say just a timing 
issue, you know, the difference between life and death is just 
a timing issue, too.
    I think in relatively standard but simple models, you will 
come out with the conclusion that consumption is the best 
measure of someone's lifetime ability to pay. Those models 
depend heavily on both a fully rational consumer and the 
absence of any constraints on people to borrow and lend money 
over time. When you start building in more realism, the fact is 
people cannot borrow across time the way they might like to. So 
they are sort of constrained by their current circumstances. 
They may not have the foresight, in fact, the whole pension 
system is based on the notion that they do not have the 
foresight to do planning on their own. The whole Social 
Security system is based on that notion. When you work those 
in, then you can get I think a reasonable argument that current 
income is also a useful indicator.
    So my view is that it is not a clear-cut case either way 
and that, frankly, it makes sense to tax on the basis of both 
consumption and income for a variety of reasons, not just this 
underlying question, but general equity issues and general 
administrative issues. So I do not think it is a black and 
white issue. I am familiar with economic models and textbooks 
that say it is a black and white issue and that consumption is 
the measure of lifetime ability to pay. But I think in the real 
world it is a little more complicated and some combination of 
income and consumption is a reasonable measure.
    Chairman Nussle. Dr. Hall, evidently you are my witness 
here today, and then I heard you are a lifetime Democrat, and I 
am shocked that I had the audacity to invite you here today. 
But barring that one oversight, let me ask you the same 
    Mr. Hall. I do not actually strongly disagree with what 
Bill said, except that I would put more enthusiasm on 
consumption. I think as a practical matter, when you get done, 
the best way to measure how someone is faring in this economy 
is by how much they have available to spend on all the 
different things they choose to spend on. That is not just an 
implication of our economic models. I think it has got a lot of 
common-sense. When you think about the wealthy, either wealthy 
because they have lots of wealth or wealthy because they earn a 
lot, they also consume a lot. And so I think that we would be 
well guided by a general philosophy, with some exceptions, but 
a general philosophy which says we can identify who the winners 
are in our society by those who consume a lot. And that is why 
I believe in a progressive consumption tax.
    Chairman Nussle. Dr. Steuerle.
    Mr. Steuerle. Well, once again I think you are going to 
have fairly uniform agreement among the members of the panel. I 
think ideally my preferential way to tax would be on the basis 
of ability. Unfortunately, we cannot measure ability very well. 
Income or consumption are rough approximations we sometimes 
use. A case in point where neither works very well right now, 
in my view, is the extraordinary encouragement we have in our 
current tax and transfer system to retire people for the last 
third of their adult lives when we desperately need their 
productive capability to maintain our revenue base. And neither 
an income tax nor a consumption tax is fully getting at that 
    So in the end, I guess if we cannot measure ability 
perfectly, it ends up that we often end up having to go to some 
sort of hybrid system. Even the people who advocate consumption 
taxes, I think, would say that when you get to all the implicit 
tax systems, they still would use income as a base. We are not 
going to give a millionaire's spouse food stamps, for instance, 
if her consumption is low.
    So we say, no, we will phase out food stamps. Or forget 
about a millionaire with a low-earning spouse, just take any 
family. If their consumption is low, we say, no, we are going 
to have an asset test or we are going to have some sort of way 
of phasing out their benefit on the basis of income, not just 
consumption. So we are going to have these income tests in the 
system one way or the other--whether we are talking about low 
income people and phasing our their transfers, or whether we 
are trying to measure the ability of high income people.
    Having said that, I made the case earlier, there is a 
strong equity argument for not double taxing the wage earner 
who happens to put money aside in savings. My difficulty in the 
current political context is that for the most part we tend to 
apply the consumption tax arguments to higher income people 
where it seems to me the issues are much more complex in terms 
of measuring their ability as opposed to moderate and middle 
income people where we could move much more toward a 
consumption tax base, give them that equity benefit if they 
save, and help them out better.
    So the bottom line answer to your question is, I, too, 
think that we probably end up in some sort of hybrid system.
    Chairman Nussle. The interesting thing about your answers--
and I am not trying to argue with you, it is more just an 
observation--the interesting thing about your answers is that 
you all tend to, what I am hearing is that you tend to suggest 
and agree and suggest there are many who agree that consumption 
is a better way to determine somebody's ability to pay or as a 
determination of their burden in the overall community or 
society or Nation.
    And yet two of you, in particular, I think, and maybe I am 
misunderstanding you, Dr. Hall, but my thought was you were 
trying to determine, even though you say it is consumption-
driven, it is based off income, it is not based off 
consumption, it is based off your income.
    And if that is true, then you say it is fairer--I guess I 
am trying to be a little bit argumentative here--but you say it 
is fairer to determine someone's burden by consumption. And yet 
Dr. Gale said it is a non-starter to determine a consumption-
based tax as a starting point. And I hear at least Dr. Hall 
suggesting that the multiplier is income. So how do you 
rationalize those two points?
    Mr. Hall. A value-added tax is just like a sales tax. It is 
a way of collecting tax revenue from the act of consumption. 
But the way I think about this is you start with a sales tax. 
That is obviously a consumption tax, everyone agrees on that. 
Then it is just an administrative change, it does not change 
the economic substance to go to a value-added tax. Then, to 
make a value-added tax progressive by using a wage-based system 
for creating an exemption and for creating brackets, you move 
it back another stage to the actual wage earner.
    But it is very important to understand as a matter of 
economics, this is still a consumption tax. It is still taking 
advantage of the principle that you start off, and it is 
obvious in a sales tax, that even if you cannot measure 
people's consumption, you can tax consumption. You can tax 
consumption because you can just have people every time they 
buy something pay a tax. The value-added tax is just a 
different way to administer that.
    Fundamentally, this whole consumption tax approach is based 
on this nice idea that you can tax consumption even if you 
cannot measure it at the individual level, which I would agree 
with. It is very hard to measure consumption at the individual 
level. It is easy to tax consumption without measuring it. That 
is the neat thing about a sales tax or a value-added tax, 
because you can tax it just by the fact that by choosing to 
consume, you choose to pay the tax. So it is a very neat 
    Mr. Gale. I love simple tax systems on paper because they 
are so easy to understand and they look like they work just 
right. But in practice, if we try to tax income, a goodly 
portion of income is going to slip through. If we try to tax 
consumption, I think a goodly portion of consumption is going 
to slip through. So there are many advantages to having a 
system that taxes both, both from an administrative perspective 
and from an equity perspective. I tried to say that I think 
both are legitimate bases for taxation, consumption and income, 
and not that consumption was the measure and income was not.
    Chairman Nussle. Do any of you want to try and tackle the 
issue of accuracy? Dr. Gale, you have in suggesting that there 
is a $500 billion error. What time period are you suggesting?
    Mr. Gale. Per year.
    Chairman Nussle. That is a year. OK. What other accuracy 
issues in scoring something that would be revenue neutral, so 
to speak, how accurate is the ability to call this revenue 
neutral, whether it is Joint Taxation, CBO, OMB, you, anyone 
else? And I am not trying to quibble with you. I am just 
asking, generally speaking, if we are going to make a change 
like this, how certain can we be about the ability for us to 
replace the revenue over a period of a year, a couple years, 5 
years, et cetera?
    Mr. Gale. The problem with doing that, the certainty in the 
sales tax, the bias is sort of all one direction. That is, you 
are likely to overstate how much revenue you would get, 
especially if you go with the assumptions in H.R. 25. The 
reason is, what H.R. 25 does is look at aggregate consumption 
in the national income and product accounts and says, 
basically, we are going to tax that.
    We are going to subtract out education, we are going to 
subtract out something else, but we are going to tax that. 
Well, that is not a taxable concept. There is no form anyone 
fills out right now that is consumption. In contrast, the flat 
tax is based on actually understandable, used, current 
concepts. You can look at tax forms and see what people's taxes 
would be if you taxed wages, pensions, Social Security 
benefits. You can recalculate firms' tax returns if you have 
their--all the information needed on the flat tax is already 
reported on the tax form, is what I am saying. So there is a 
behavioral issue.
    But you could get the purely static estimate in the flat 
tax in a fairly straightforward basis. There is no basis for 
doing that in a sales tax because people do not report 
aggregate consumption. What would happen is that a big chunk of 
what is reported as aggregate consumption would just not show 
up on any of the forms. And that is an uncertainty and it would 
make the required rate go up.
    Chairman Nussle. Dr. Steuerle, do you want to tackle that?
    Mr. Steuerle. I would just add that I am a firm believer 
that if the questions are asked the right way, we have 
enormously talented staff at your Congressional Budget Office 
and at the Joint Committee on Taxation and at the Treasury who 
can help you answer the questions. It is not just a question of 
accuracy of revenues, it is also the accuracy of claims as to 
progressivity. These things can be measured. I am not saying 
there is one pure measure. But I think in terms of accuracy, 
these staffs can do a fairly good job.
    Chairman Nussle. OK. Dr. Hall, do you have anything you 
want to add to this?
    Mr. Hall. I think only that there is sort of a consensus in 
this panel that you cannot have a sales tax rate much above 10 
percent. That is just illustrative of the fact that predicting 
what would actually happen with a sales tax is that actual 
revenue would be very disappointing relative to projected 
    Chairman Nussle. Not only the base, but also what the 
behavior would be?
    Mr. Hall. Right. It is so difficult to get a sales tax to 
work because it is so easy for a buyer who is actually a final 
consumer to misrepresent themselves as an intermediate 
purchaser. The value-added tax has a built-in way of solving 
that problem. The sales tax does not. That is why Europe has 
value-added taxes. It is not sort of arbitrary, it is practical 
experience. And that is experience that we need to harness.
    Mr. Spratt. Mr. Chairman, could I ask one final question of 
Mr. Gale?
    Chairman Nussle. Mr. Spratt.
    Mr. Spratt. Since your report of the miscalculation in the 
rate of the H.R. 25 sales tax in 1999, as I recall, in an 
article you published, have the Americans for Fair Taxation 
made any effort to correct for that in their architecture of 
the proposed tax or in their calculation of what the actual 
rate has to be?
    Mr. Gale. Not that I am aware of. I do not check their 
website on a regular basis. But if they are still talking about 
a 23 percent sales tax, then no adjustment has been made.
    Chairman Nussle. Do our witnesses want any final comments? 
I gave that to the other panels and I would offer the same as 
well. Dr. Steuerle?
    Mr. Steuerle. Mr. Chairman, I would just like our 
discussion of fundamental tax reform not to distract us from 
issues of more basic tax reform. We can disagree on whether we 
want an extra retail sales tax or a consumption tax or a value-
added tax, we can think about many of these big issues.
    But, to me, tax reform is like expenditure reform. There 
are a lot of items where we can do things a lot better. That 
is, there are principles we might disagree on and we might have 
to reach for a balance, but there are some items where we I 
think would all agree they just do not belong in the tax 
    We really do not need ten different capital gains tax 
rates. We really do not need three different educational 
subsidies in the tax system adding on to a couple in the direct 
expenditure system that confuse everybody and lead to real 
losses in the economy. We do not need three or four different 
types of child benefits: earned income credits, child credits, 
and dependent exemptions all flying off loosely on their own 
and not being coordinated. There are a lot of things in the tax 
system that we can do to make it better and we should not let 
fundamental tax reform distract us from the job we all agree we 
have at hand.
    Mr. Moran. Mr. Chairman, could I ask them, as they respond, 
if they have any comments related to the globalization of our 
economy and trade overseas. I know it benefits the value-added 
tax because it is more compatible with other systems. But if 
they have any comments on that, they might add it in to their 
    Chairman Nussle. Let us do that. In your summaries, if you 
would just take a couple of minutes and wrap us up here and 
give us the benefit of your wisdom on these things, and also, 
as Mr. Moran asked, if there is any comment you would like to 
make about that. We will go in reverse order. I think we will 
start then with Gene. Do you have anything else you would like 
to add in closing?
    Mr. Steuerle. I think I pretty much made my summary. Just 
to respond to Mr. Moran, I quite honestly do not think that 
most changes in the tax system, whether they are the ones being 
discussed today or even the ones that are being discussed in 
the campaign, fundamentally change the dynamics of 
international mobility of capital and labor. Such mobility is 
often motivated by much more powerful factors, including 
differential wage rates among countries.
    I do not think that one undertakes fundamental tax reform 
driven by some notion that one is going to be able to, 
fundamentally shift jobs either to this country or to other 
countries. That is, you undertake to create the type of tax 
system that you think is right in the first place. That is the 
best guideline. There are exceptions, but for the most part, I 
do not think international mobility of labor and capital is 
going to be driven by the types of tax changes we are talking 
about. There are other things that adjust, wage rates, price 
levels, and other items that tend to mitigate tax-induced labor 
    Chairman Nussle. Thank you. Dr. Hall.
    Mr. Hall. Well, there is global competition in tax systems. 
I think it is very important to recognize that. The rest of the 
world relies very heavily on consumption taxation. That is, the 
effective tax rate on capital, as we discussed before, is low 
or zero. And I think we need to recognize that to stay 
competitive we need to have a similar system, because it is a 
good system.
    And you see that competition all over and I do not think we 
should ignore it. I think that it is a factor in decisions 
about the location of important types of economic activity. We 
need to be competitive in that respect and that means following 
the rest of the world to consumption taxation.
    Chairman Nussle. Dr. Gale.
    Mr. Gale. Thanks. Four very brief points. One is to end 
where I started, which was to focus on realistic reforms is 
absolutely crucial rather than fantasy taxes. The second is to 
think about tax reform in the context of the longer term fiscal 
gap. We cannot think of it as structure and the revenue level 
as separate issues anymore. That is actually useful because 
consumption taxes can help us solve the longer term fiscal 
    As far as globalization is concerned, I agree with what Bob 
just said. I just want to add that one of the factors in tax 
changes that we do not often consider is how other countries 
respond. So if we cut our capital income taxes, we expect to 
get a big capital inflow coming in. But if other countries then 
cut theirs, the capital is going to go right back out. So there 
is an interesting issue about how effective capital income tax 
cuts are if other countries respond and then you get this race 
to the bottom.
    The last point to talk about relating to capital income is 
that some of the tax reform or tax proposals on the table now 
are justified with sort of a bow toward fundamental tax reform. 
Glen Hubbard said the other day the goal is to cut the tax rate 
on capital income to zero. Regardless of the merits of that 
proposal, I want to stress something that Bob Hall mentioned, 
is you cannot treat the capital income side without treating 
the interest deduction side too. And if you reduce the taxation 
of capital income to zero but you still allow deductions for 
interest payments like we currently have, you have created an 
enormous loophole and basically you have created not just a 
wage tax, but a wage tax that only applies to poor people. So 
you can screw up the system worse than it currently is, believe 
it or not. And going to a system that treats capital income and 
expense even more differently than they are currently treated 
would be a big step in that direction.
    Chairman Nussle. We appreciate all three of you being here 
today and remaining for the entire hearing for this discussion. 
We appreciate your advice and wisdom and I hope that it will 
continue as we move this discussion and debate forward.
    So, with that, if there is nothing further to come before 
the committee, we will stand adjourned for this session of 
    [Whereupon, at 2:48 p.m., the committee was adjourned.]