[Joint House and Senate Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 108-381
RETHINKING THE TAX CODE
=======================================================================
HEARING
BEFORE THE
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
NOVEMBER 11, 2003
__________
Printed for the use of the Joint Economic Committee
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
SENATE HOUSE OF REPRESENTATIVES
Robert F. Bennett, Utah, Chairman Jim Saxton, New Jersey, Vice
Sam Brownback, Kansas Chairman
Jeff Sessions, Alabama Paul Ryan, Wisconsin
John Sununu, New Hampshire Jennifer Dunn, Washington
Lamar Alexander, Tennessee Phil English, Pennsylvania
Susan Collins, Maine Adam H. Putnam, Florida
Jack Reed, Rhode Island Ron Paul, Texas
Edward M. Kennedy, Massachusetts Pete Stark, California
Paul S. Sarbanes, Maryland Carolyn B. Maloney, New York
Jeff Bingaman, New Mexico Melvin L. Watt, North Carolina
Baron P. Hill, Indiana
Donald B. Marron, Executive Director and Chief Economist
Wendell Primus, Minority Staff Director
C O N T E N T S
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Page
Opening Statements of Members
Senator Robert F. Bennett, Chairman.............................. 1
Representative Pete Stark, Ranking Minority Member............... 8
Representative Ron Paul.......................................... 23
Witnesses
Panel I
Statement of Senator Arlen Specter, a U.S. Senator from
Pennsylvania................................................... 3
Statement of Representative Jim McDermott, a Representative in
Congress from Washington....................................... 4
Statement of Representative John Linder, a Representative in
Congress from Georgia.......................................... 6
Panel II
Statement of Dr. Michael J. Boskin, Senior Fellow, Hoover
Institution,
Stanford University, Stanford, CA.............................. 9
Statement of Cliff Massa, Manager, Patton Boggs LLP, Washington
DC............................................................. 11
Statement of Edward J. McCaffery, Professor of Law and Political
Science, University of Southern California Law School, Los
Angeles, CA.................................................... 13
Statment of Robert S. McIntyre, Director, Citizens for Tax
Justice, Washington, DC........................................ 15
Submissions for the Record
Prepared statement of Senator Robert F. Bennett, Chairman........ 35
Joint Economic Committee Reports:
``The Tax Reform Act of 1986: A Primer''..................... 37
``Constant Change: A History of Federal Taxes''.............. 39
``A Portrait of the Personal Income Tax Burden in 2001''..... 46
Prepared statement of Representative Pete Stark, Ranking Minority
Member......................................................... 48
Prepared statement of Representative Ron Paul, a Member of
Congress from Texas............................................ 48
Prepared statement of Senator Arlen Specter, a U.S. Senator from
Pennsylvania................................................... 50
Prepared statement of Representative John Linder, a Member of
Congress from Georgia.......................................... 61
Prepared statement of Dr. Michael J. Boskin, Senior Fellow,
Hoover
Institution, Stanford University, Stanford, CA................. 64
Prepared statement of Cliff Massa, Manager, Patton Boggs LLP,
Washington DC.................................................. 91
Prepared statement of Edward J. McCaffery, Professor of Law and
Political Science, University of Southern California Law
School, Los Angeles, CA........................................ 109
Prepared statement of Robert S. McIntyre, Director, Citizens for
Tax Justice, Washington DC..................................... 113
RETHINKING THE TAX CODE
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WEDNESDAY, NOVEMBER 11, 2003
Congress of the United States,
Joint Econonomic Committee,
Washington, DC
The Committee met at 9:30 a.m., in Room 628, Dirksen Senate
Office Building, the Honorable Robert F. Bennett, Chairman of
the Committee, presiding.
Senators present: Senators Bennett, Sessions, Sununu.
Representatives present: Representatives Paul, Stark.
Staff members present: Melissa Barnson, Gary Blank, Ike
Brannon, Daphne Clones-Federing, Sean Davis, Jason Fichtner,
Nan Gibson, Colleen Healy, Brian Higginbotham, Brian Jenn, Tim
Kane, Rachel Klastorin, Donald Marron, John McInerney, Tom
Miller, Wendell Primus, Diane Rogers, Frank Sammartino, Rebecca
Wilder, Jeff Wrase.
OPENING STATEMENT OF SENATOR ROBERT F. BENNETT,
CHAIRMAN
Senator Bennett. The Committee will come to order. Before
making my prepared opening remarks, I'd like to say that we're
going to be very strict on time during this hearing, because in
the wonderful world of Senate scheduling, I have to be on the
Senate floor at 10:30 to begin managing the Agriculture
Appropriations bill. We had no idea when that would come, but
the stars have lined up that it comes exactly at the same time
as we have scheduled this hearing. I apologize that that's the
way it is.
In May of this year, under the prodding of Senator Specter,
the Senate overwhelmingly approved legislation acknowledging
the serious problems of our current tax code and called for a
Congressional review of ways to overhaul the antiquated system.
It is especially gratifying to me, because tax reform has
been a central piece of my agenda in the Senate, and it's been
a little frustrating to not see it move much more rapidly than
it has. But 70 members of the Senate agreed that the Joint
Economic Committee should be the key point for this debate, and
today's hearing is a direct response to that vote. It is a part
of a series of hearings and studies and related events that the
Joint Economic Committee is undertaking to help the Congress
find a path to real tax reform.
The present tax system is unduly cumbersome, inefficient,
and incomprehensible. Over the years, through revision after
revision, the tax code has become a confusing, burdensome web
that hampers economic growth, places undue burdens on American
businesses, and needlessly complicates the lives of the
American people.
As I reflect upon all of the debates held over the years on
tax policy, I realize that there is one word that comes up over
and over again, and that word is fairness. Every time we make a
change in the tax law, we are told that it is necessary to make
things more fair.
But what we have done is tipped the tax code this way and
that to encourage one activity, and discourage another. And
every time we do this, the tax code gets bigger and more
complex.
I find it ironic that in the name of fairness, we have
created a system that is unfair to everybody.
Today, during this hearing, I hope we can start with a
clean sheet of paper. Let's not talk about tax cuts or mere
adjustments to specific parts of the existing system. Let's
talk about creating from scratch, a system that is simple, that
is fair, and once established, a system that will endure for
years to come.
We're not prejudging the issue; we're not coming to the
hearing with recommendations already in mind. This is an
opportunity to listen and learn and look at the issue from a
different perspective.
Whether one is in favor of getting more tax dollars out of
the rich, or using the tax code to spur faster economic growth,
or implementing a flat tax for all individuals, everyone can
agree that the existing code is so badly broken that the
principles of simplicity, fairness, and efficiency are not
being met.
If we can achieve the goals I have just laid out, then
another challenge begins. We must ensure that the new tax
system endures.
Businesses cannot make intelligent plans if the tax system
constantly changes. That slows economic growth and that slows
job creation.
For individuals, the shifting sands of the existing tax
code create painful uncertainty. People who want to buy a
house, take out a loan, put money aside in a savings account,
or make an investment, need and deserve to know that there
won't be any surprises coming up after the next election.
Now, that's the predicate for the hearing today. And we
have assembled a balanced group of witnesses that will present
diverse views about how the government should tax its citizens.
[The prepared statement of Senator Robert F. Bennett
appears in the Submissions for the Record on page 35.]
Senator Bennett. And for our first panel, we are pleased to
have as a distinguished guest, Senator Arlen Specter of
Pennsylvania, who was the primary sponsor of the Sense of the
Senate Resolution that brings us here today, and who has for
years been a champion of tax reform. We're also pleased to have
Representative Jim McDermott of Washington and John Linder of
Georgia, and we thank all of you for joining us here today.
With that, I recognize the arrival of Mr. Stark, the Ranking
Member, and have him give whatever opening statement he might
have.
Mr. Stark.
Representative Stark. Mr. Chairman, I'd be glad to withhold
on the opening statement and let our colleagues proceed. I'll
send them an autographed copy later.
Senator Bennett. I'm sure they will frame it and put it on
their walls. Thank you, Mr. Stark. We appreciate it.
Senator Specter, we appreciate your leadership in getting
us here, and we look forward to hearing what you have to say to
us.
PANEL I
OPENING STATEMENT OF SENATOR ARLEN SPECTER,
U.S. SENATOR FROM PENNSYLVANIA
Senator Specter. Thank you, Mr. Chairman and Ranking
Member, Congressman Stark. I urge this Committee, this
distinguished Joint Economic Committee, to take a forceful,
unambiguous stand in support of the flat tax, because if this
Committee doesn't get the ball started, nobody will.
These issues have been pending before the Ways and Means
Committee in the House and the Finance Committee in the Senate
for years, and, understandably, they are preoccupied with many,
many subjects as we speak: Prescription drugs, the Energy bill,
and a host of other issues on Medicare, and, as you, Mr.
Chairman, have already outlined, the serious situation on tax
complexity.
And my prepared statement, which I know will be made a part
of the record, goes into great detail on the problems. I
studied the flat tax back in 1995 when Congressman Dick Armey
introduced it in the House in the Fall of 1994. And in the
Spring of 1995, I introduced legislation for a flat tax and
have reintroduced it every year since, and it is currently
pending as Senate Bill 907.
And as you, Chairman Bennett, have noted, I offered the
resolution to have this hearing, and you and I have discussed
it privately, and somebody has got to take the ball and carry
it down-field in an official way. And this Joint Economic
Committee has a unique opportunity to really do this very, very
important work.
The flat tax would enable taxpayers to file their return on
a postal card in 15 minutes, compared with voluminous hours
now. This is a carefully worked out program by two
distinguished professors from Stanford, Professor Hall and
Professor Rabushka, where the flat tax is neutral at 19
percent.
My proposal adds one percent to that to retain modest
deductions on home mortgages up to $100,000 and charitable
contributions up to $2500, because those two items are so
deeply ingrained in the American taxpayer psyche. But I would
be glad to see those two eliminated and going back to 19
percent, or see some variation, depending on what this
Committee wants, just to move forward on the flat tax
principle.
The flat tax does not have any tax on interest, on
dividends, on capital gains, or on estates. There is no
depreciation. Everything is expensed in the first year.
The flat tax does not benefit the wealthy. As my statement
outlines, with a group of income levels, a married couple with
two children and $35,000 income will have a savings of $176.
The tax structure is outlined for the upper brackets and it
is about the same, or a slight increase, so put to rest the
notion that the flat tax is going to benefit the rich at the
expense of the poor.
We hear a great deal of talk about having the tax flatter
and fairer, but we have not come to the point of really saying
we're going to oppose the flat tax. Mr. Chairman, I see that my
yellow light has just started on, and I'm going to do something
very unusual in a filibuster-prone body, and yield back about a
minute of my time. Thank you.
[The prepared statement of Senator Arlen Specter appears in
the Submissions for the Record on page 50.]
Senator Bennett. Thank you very much, Senator Specter, both
for your statement and your leadership.
Representative McDermott.
OPENING STATEMENT OF REPRESENTATIVE JIM McDERMOTT,
A MEMBER OF CONGRESS FROM WASHINGTON
Mr. McDermott. Thank you, Mr. Chairman. I want to thank you
and Representative Stark for having this hearing. I really wish
that the Committee were talking about the deficit, because I
think we ought to be paying more attention to that and how it
affects our economy by increasing interest rates and reducing
savings and inflating the value of the U.S. dollar, which has
made the American products less competitive overseas.
Next year's deficit may top $500 billion, and there's not
an organization in the governmental agency of Washington that
knows when we will return to a balanced budget. President Bush
inherited a government that took in about 20 percent of GDP in
revenue and spent a little less than that. He inherited a
budget surplus that could have been used to shore up Social
Security and pay off the deficits that piled up during the
Reagan-Bush era.
We have quite a different picture today, and mostly due to
three rounds of tax cuts in Fiscal Year 2003, revenues dropped
to 16.6 of GDP, while our deficit exploded. Revenues now are at
the lowest levels since 1959, which was near the end of the
Eisenhower Administration.
I want to be sure everyone knows that taxes in America are
not high. The U.S. tax revenue as a percentage of GDP, is among
the lowest in the developed world. Only two OECD members have
lower taxes.
Now, I understand that the hearing is about rethinking the
tax code, and the Ways and Means Committee held a host of
hearings about this same issue in the mid-1990s under Chairman
Archer. At one point during the hearings in 1995, the Chairman
said he was convinced that the tax code needed to go a flat
tax.
He even said he was going to introduce legislation to do
it, but after all the hearings and the rhetoric, he never even
introduced the bill.
Today, income taxes, as a share of GDP, are at the lowest
level since 1991, but payroll taxes, which takes the heaviest
bite from the lower income workers, rose to its biggest share
of federal revenue. This is unfortunate because it means our
tax system has become more regressive over the past few years.
In other words, poor people are bearing more of the tax burden
today than in an awful long time.
Now, everybody knows that you can do two things with money:
You can save it or you can spend it. Rich people have more to
save than poor people, and if all that we do is impose taxes
where people spend money, then poor people are going to spend a
larger share of their paycheck on taxes than rich people are.
A system based on consumption taxes hardly seems fair to
me. Legislation has been introduced in the past to convert our
tax system to one that relies solely on consumption tax.
Representative Linder, who will talk in a minute, has
introduced legislation to abolish the IRS and force the Federal
Government to rely on a national sales tax.
This proposal would involve an extraordinarily regressive
shift of tax burden from the affluent to everybody else and
would be a boon for the wealthy elite. His proposal would tax
all purchases of goods and services in our economy, including
food, healthcare, home rents, and new home purchases.
The Joint Committee on Taxation did an analysis of H.R.
2525, and the study indicated that in order for the bill to be
revenue-neutral over ten years, the estimated national sales
tax rate would be between 36 and 57 percent. In other words,
the price of blood transfusions, prescription drugs, and a pair
of sneakers would all increase between 37 and 57 percent.
I don't know how anybody could think that is fair. I don't
know how you could sell that proposal to the Baby Boomers, just
when they are about to live on a fixed income.
There have been several flat tax proposals floated in the
past. As you have heard, Dick Armey was a staunch proponent of
the flat tax. Mr. Armey introduced a bill to create a flat tax,
consisting of a permanent 17-percent rate.
The Treasury estimated his bill would cost $138 billion
each year.
The rate would need to be closer to 21 percent. At this
rate taxes would double for the American working poor while
they would be cut in half for millionaires. Every time someone
talks about a flat tax, my question to them is, what about
pensions, health care, home ownership and charitable giving?
The Health Insurance Association of America states that one
of the consequences of flat tax bill is likely to be a rapid
increase in the number of people without private health
insurance. One economist estimated there would be eight million
more people without health insurance if a flat tax were
enacted.
James Poterba, an economist at MIT, estimated that
eliminating the current tax benefits for purchasing homes would
result in a 17 percent decline in the value of the U.S. housing
market.
Payroll taxes? A flat tax would eliminate the deduction
that employers pay for their share, amounting to a massive tax
increase on businesses of all size.
Furthermore, it is a bit naive to think that the pressures
that we currently have to change the tax code for public policy
reasons would go away with the new tax regime. I think it is
highly unlikely our tax code would not just become as complex
over time as it is today.
I believe we have to stress a few important things--the
first fundamentally is the cold question of fairness, as you
have indicated. A 20 percent tax to someone making $20,000 is
much different than a 20 percent tax to someone making
$200,000.
Secondly, a tax system must bring in enough revenue to pay
for government expenditures.
Third, our IRS code should try to provide as much
efficiency in our economy as possible and, lastly, we should
try to reduce the complexity of the code by doing things such
as reforming the alternative minimum tax, which is increasingly
creeping into the pocketbooks of middle income families.
Thank you, Mr. Chairman.
Senator Bennett. Thank you very much.
Representative Linder.
OPENING STATEMENT OF REPRESENTATIVE JOHN LINDER,
A MEMBER OF CONGRESS FROM GEORGIA
Mr. Linder. Thank you Mr. Chairman and Mr. Stark.
I appreciate the opportunity to comment on the fundamental
tax reform. I believe that the Congress should judge any such
bill following on fundamental tax reform on how it follows
eight key principles. It should be fair and it should protect
the poor and treat everyone else the same. It should be simple
and easy to understand by everyone. It should be voluntary and
not coercive or intrusive. It should be transparent. We should
all know what the government costs us. It should be neutral at
our borders. It should be industry neutral. It should
strengthen Social Security and have manageable transition
costs. I believe my bill, H.R. 25, meets all those tests.
I will first begin by commenting on the flat tax. The tax
you have today, that you come to know and love, is a flat tax
on income--ninety years later. As long as we know how people
make money, how much they make, we can find the way to get the
rest.
My proposal eliminates all income taxes and payroll taxes,
replaces them with a national retail sales tax. It is fair, it
is understandable, and it totally untaxes the poor.
If you get rid of the income tax, the payroll tax, the gift
tax, the estate tax, capital gains tax, the alternative minimum
tax, and replace it with a one-time national sales tax of 23
percent, it will be revenue neutral.
We have spent $25 million over the last eight years on
economic and market research. The most compelling study was out
of Harvard done by Dale Jorgenson, who is head of economics,
and he said that 22 percent of what we are currently spending
at retail is the embedded cost of the current code.
That is to say, we are losing 22 percent of our purchasing
power to the embedded cost of the current code. If we were to
get rid of the code, repeal the code, get rid of the IRS, and
let competition drive those costs out of the system, and
replace it with an embedded 23 percent, it would increase the
cost of living by one percent, but everybody would get to keep
their whole check, they would be voluntary taxpayers paying
taxes when they choose, as much as they choose, by how they
choose to spend.
What would happen in our economy? Well, we know that, in
the first year we would have a 26 percent increase in exports.
In the first year we would have a 76 percent increase in
capital spending. We know that from 1945 to 1995 real wages,
take home pay, increased in exact correspondence with increases
in capital spending--we spend today anywhere from $250 billion
to $500 billion just complying with the current code. Hardly
efficient.
We know that, for small businesses to remit $100, collect
and remit $100, it costs them $724 to do so. We would have the
largest magnet for capital in the history of the world. There
are today anywhere from $500 billion--a low estimate--to $2
trillion--in funds stranded overseas because it is cheaper for
American businesses to borrow at five percent or six percent
than to repatriate at 35 percent--all those dollars would come
to our shores and put a new liquidity into our markets and
creating new jobs.
We have had problems with government, with companies going
offshore recently. They are not going off because they are
angry or mean. They are going off because they cannot deal with
the tax code. We would have those companies flocking to our
shores as well as all the wealth in the world into our capital
markets because there would be no tax consequences. We would
create huge numbers of new jobs.
There is a recent book out called ``Reefer Madness'' that
says prostitution, pornography, illicit drugs and illegal labor
constitute a trillion dollar economy. Those dollars would be
taxed at the retail checkout by the Fair Tax.
We believe that we would have no deficits today and indeed
have increased revenues. A study done from 1945 to 1995 shows
that the consumption economy is a much more steady predictor of
activity than the income economy and, indeed, we would have had
increased revenues in 10 of the last 11 quarters instead of
declines that Mr. McDermott spoke about.
Lastly, to protect the poor, we say that every household
should get a check at the beginning of every month that totally
rebates the tax consequences of spending up to the poverty
line. That would give people spending at or below the poverty
level a 22 percent increase in purchasing power that would
totally untax them on necessities because that is the
definition of poverty level spending. That is spending
necessary to meet, to buy, our necessities.
It would save Social Security. Over the next 75 years, we
are going to increase the number of people on Social Security
by 100 percent. We are going to increase the number of people
paying for it by 15 percent. I don't care how much you set
aside, that is something that is irretrievably broken and
cannot be fixed.
Under our system, the revenues to Social Security and
Medicare will double in the next 14 years by doubling the size
of the economy.
Lastly, the transition costs are doable. The only
transition rule in my bill is that any inventory on hand on
December 31, the value of it can be used as a credit against
sales in the following year because we think things should only
be taxed once, since we have at any given time, a $1.3 to $1.4
trillion in inventory in this country, a fourth of that is
about $350 billion. That would be the total transition cost.
I say let's unleash the American people, the economy, turn
them all into voluntary taxpayers and we will have a new system
that will be endurable.
Thank you, Mr. Chairman.
Senator Bennett. Thank you very much. We appreciate the
range of opinions we have got here and the thoughtfulness that
has gone into the presentations and recognize that you have
other responsibilities. You are welcome to join us here on the
dais, if you wish, either one of you, but you are also excused
if you feel you have to move on.
Mr. Linder. Thank you very much.
[The prepared statement of Representative John Linder
appears in the Submissions for the Record on page 61.]
Mr. McDermott. Thank you.
Senator Bennett. Thank you.
Representative Stark, do you want to do your opening
statement now or shall we go on to the next panel?
OPENING STATEMENT OF REPRESENTATIVE PETE STARK,
RANKING MINORITY MEMBER
Representative Stark. Mr. Chairman, I would just summarize
it if I may and ask that you include it in the record. I want
to thank you for this hearing. It is a topic about which those
of us on the tax writing committees have puzzled over a long
time and under various philosophies and suggestions for
revising the tax code.
I had a guy years ago who wanted to give every American
some stock--every American, and I cannot even remember that
one, but----
Senator Bennett. Who got to pick the company?
Representative Stark. I do not know what he was going to
do. Probably a mutual fund.
But my question now is this. Ken Keyes, who is still around
town and used to be staff director of the Joint Committee on
Taxation and represents as a staff person, many of the
Republicans on the Ways and Means Committee suggested that the
time to do tax reform is when we are running a big surplus,
because then we have got some money to patch over the
inequities or the transition problems that will invariably come
up in changing any kind of a commercial tax system that affects
commercial intercourse in this country.
So, while it is a topic about which I have great interest,
my only suggestion is that this might not be the best time
because I think one of the ways to get political support for
any kind of tax reform is to get some tax relief.
And at this point, I have to join with most of my
Democratic colleagues in saying that our plate is kind of full
in terms of tax relief and we may be looking for a little
revenue down the line. But, it is a topic that is not going to
go away. It is going to be with us and I appreciate the
opportunity to hear from my colleagues and we have an excellent
panel ahead of us. Thank you very much.
[The prepared statment of Representative Pete Stark appears
in the Submissions for the Record on page 48.]
Senator Bennett. Thank you, sir. Your statement will, of
course, be included in the Record in its entirety.
We now turn to our second panel. I believe we have been
able to attract a wealth of knowledge on the subject of tax
reform. We have Dr. Michael Boskin from Stanford University
where he is a professor of economics. He has served as Chairman
of the President's Council of Economic Advisors.
Cliff Massa is currently a tax attorney for Patton Boggs,
and has served as Chairman on the Committee on Value-Added
Taxes at the American Bar Association, and Professor Ed
McCaffery joins us from the University of Southern California
and is author of a book called ``Fair, Not Flat: How to Make
the Tax System Better and Simpler.''
Finally we welcome Robert McIntyre, the executive director
of Citizens for Tax Justice.
So I think we have a mixed but balanced body of opinion
here. We look forward to hearing from all four of you.
Before you came in, Congressman Stark, I indicated that, in
the genius of Senate scheduling, I have to be on the floor at
10:30 a.m. to manage the Agriculture Appropriations Bill and
so, if I can trust you, and I think I can and no one else has
shown up, the Vice Chairman does not appear, I will leave the
witnesses to your tender mercy at that point and I think the
Republic will still stand among those who get concerned about a
Republican dealing with a Democrat thusly.
Let's go in the direction that I have indicated. Mr.
McCaffery has apparently not shown up yet. So he is on his way,
and we will start at this end of the table, then, Dr. Boskin,
you go first and then move across.
PANEL II
OPENING STATEMENT OF DR. MICHAEL J. BOSKIN,
SENIOR FELLOW, HOOVER INSTITUTION, STANFORD UNIVERSITY
Dr. Boskin. Thank you, Chairman Bennett, Ranking Member
Stark--a pleasure to be back before the Joint Economic
Committee.
I was asked to make some comments about how we would design
a tax system if we could start de novo. What would be the basic
principles we would use and what would the tax system look
like?
Of course, moving from the current one to that one raises a
variety of issues of transition and so on, so I am sure you are
aware that the desirable properties of a tax system have been
debated since the dawn of political philosophy.
Adam Smith had four canons of taxation: equality,
certainty, convenience in payment and economy in collection--
that is, equity, efficiency and administrative simplicity, the
things that we still debate today. And that was two-and-a-
quarter centuries ago.
I have five big tests that I like to apply to tax reform to
put taxes and tax reform into the context of the overall
economy and society.
The first is, will tax reform improve the economy, and I
will spend the bulk of my remaining time on that, but also,
second, will it affect the size of government? There are many
people who believe a new tax device might just be used to raise
revenue and after closing the deficit perhaps grow the
government, and that should be a separate debate. So we will
talk about tax reform of roughly the same revenue.
Third, will it affect federalism? Fourth, will a new tax
structure likely endure and over time, and fifth, will tax
reform contribute to a prosperous stable democracy by making
sure we have an abundance of taxpayers relative to people
receiving payments from the government. We see as Europe
progresses with their demography and very generous social
welfare states, that they get into some very awkward politics
of budget policy as a majority of the population receives
benefits rather than paying taxes.
In designing a tax system there are some key decisions that
have to be made. The key decisions that have to be made are
four--what is the tax base, should it be income or consumption?
Our current system is a hybrid of the two. Should we tax people
or transactions?
What should be the tax rate or rates? A flat tax?
Progressive rates? And at what level should they be levied?
What is the unit of account? Should we use the family? The
individual? Or should we tax transactions?
And what time period should we use? Should it be an annual
tax? Should we tax individual transactions as they occur daily
or should we have a longer horizon view of equity and
efficiency?
I will say a few words about each of these. Modern tax
theory as it has developed in Academe across America primarily
but also importantly, in the U.K., is often called ``optimal
taxation.'' It came to the conclusion that the best tax system
would be a system with broad bases and low rates and would
integrate the personal and corporate tax, and probably tax
consumed income rather than taxing savings twice or three times
as in separate corporate and personal income taxes.
This occurs for a couple of reasons, but let me just start
by emphasizing that economists, starting in ECON 1, teach that
the harm done to the economy from taxes goes up with the square
of the tax rates, so if you double tax rates--you quadruple the
cost of the distortions in the economy to how much people work
or save or invest or innovate.
That puts a pretty severe cap on how high tax rates can get
before they cause substantial harm.
There are many ways to do this sort of taxation, to tax
consumption. You can tax consumption or income in a personal
tax or impersonal tax. It could be done at the business level.
It could be done at the personal level or some combination of
the two. So because consumption and saving are the two uses
people have for their income, if we taxed income minus savings,
if we had sort of a super IRA where people could deduct all of
their savings, you would by this deductible saving method, wind
up taxing consumption.
Alternatively, you could do this with a business tax that
allowed immediate writeoff of investment. The business tax
expensing method, would combine a labor income tax at the
personal level and a capital income minus investment tax at the
business level--and that would wind up taxing consumption.
Finally, as was said earlier this morning, retail sales or
direct value-added taxes are alternative methods of getting to
the same result of taxing consumption.
Each of these approaches has its strengths and weaknesses.
The retail sales tax would probably do the best job of getting
at the underground economy. A personal consumed income tax
could have more variations in its features to accommodate
personal circumstances. It could have progressive rates if that
were desirable.
But the main thing is that the rate or rates be low.
A flat rate has a lot of advantages in simplicity. It
eliminates the need to process lots of information and lots of
data and can greatly simplify the tax code, for example,
deductible interest and taxable interest at the same rate means
that the two things would net and you would not have to keep
track of it as it would not be taxed at all in the flat tax.
So these are some of the approaches. I would just make a
couple of other statements about rate or rates. It is important
to take a longer time horizon than just an annual tax. We used
to have income averaging in the tax code. It was abolished in
1986.
Over a lifetime, a consumed income tax or consumption tax,
would tax lifetime income other than bequests, because over
your life you consume your income, and many of us believe that
a consumed income tax would do a better job of measuring long
run average income than would an annual income tax, because of
that fluctuation.
I would also say that the studies that have been done in
Academe suggest that the gains from such a tax reform, 7.5 to
15 percent increase in per capita consumption, a decade's worth
of per capita consumption--are quite large and would indeed be
of an order of magnitude that would be hard to find in any
other type of public policy reform.
Thank you.
[The prepared statement of Dr. Michael J. Boskin appears in
the Submissions for the Record on page 64.]
Senator Bennett. Thank you very much.
Mr. Massa.
OPENING STATEMENT OF CLIFF MASSA, MANAGER,
PATTON BOGGS LLP
Mr. Massa. Thank you, Mr. Chairman. Good morning, Members
of the Committee.
In your invitation I was asked to comment on fundamental
tax reform, what might replace the current system, as well as
how you could hold it, if you could ever do it.
My perspective is as a trained tax lawyer, but really a tax
policy lobbyist for most of the last 20 years, and I have spent
a lot of time on these subjects, including chairing the VAT
committee of the ABA tax section, which came up, believe it or
not, with principles that all of the tax lawyers agreed to.
They are attached to my statement and I will come back to them.
But it is based on that experience that I would recommend
that the individual and corporate income tax systems as we know
them, simply be scrapped and be replaced with, and the term I
use is a business activities tax, provided that the principles
that I am going to cover as quickly as I can, are the ones that
implement that system.
If we do not implement a new system with a reasonable set
of principles, most of them can morph eventually into the
current mess that we have now, and I would simply say, if that
is where we are headed, stay where we are. At least we
understand the current mess.
The second question quickly, are there ways to assure that
you can hold on to tax reform once you have it?
I know there are proposals for constitutional amendments
and super-majorities, and they may have some benefits. My own
sense observing the scene for a while is that, if the public
and policy makers can actually summon the will to change the
system and to change the system using the kinds of principles
that I will get to, that probably is the strongest protection
that you have for maintaining the reform in the first place,
because the pressures for screwing it up come from individuals
and businesses, people that I and people like me represent--
that is the summary.
The principles I refer to for implementing any kind of new
tax--and particularly for a consumption tax--basically are
these.
They are slightly restated versions of what the Tax Section
Committee approved in January 2000. That position, by the way,
was not adopted by the ABA House of Delegates. Frankly I was
surprised we got it through the Tax Section and I am satisfied
to have had hundreds of tax lawyers, except for one audible
``no'' in the room, agree to it.
But those principles are these--first, that any tax system
that is imposed on consumption should use the most
comprehensive definition of economic value-added we could come
up with, should apply only one rate of tax to that base,
provide no exemptions, exclusions, credits, deductions,
anything which is going to favor one group or penalize one
group over any other.
Second, all kinds of businesses and organizations need to
be in the system. Individuals would be out as remitters and
collectors and businesses would simply do what they do now,
which is to collect taxes from us in our various roles as
consumers or employees, but particularly consumers, and remit--
so that all business organizations ought to be in the system,
regardless of their corporate versus non-corporate form or
anything else.
Third, a topic that is current these days in both the
Finance Committee and the Ways and Means Committee, the
destination principle--in other words, impose this tax on
imports and not impose it on exports. All of the current
argument about replacing ETI which replaces FSC, which replaced
DISC, is a function of the fact that we have been trying for
years to illegally use the income tax to subsidize exports. We
know the rules do not permit that, so under a consumption-based
tax, we can, in fact, use legal border adjustments.
Fourth, the efforts to offset whatever is perceived or
actually is the regressivity of a system of consumption taxes
ought to be just dealt with directly. Write the checks to
whomever the government decides needs to have those benefits.
There are some complexities that have to be dealt with.
Ours is not a simple economy, so a fifth principle is that, in
some areas, and financial intermediation is one, it is
difficult to find the price, but we have to dig in and come up
with some alternative mechanical rules in those services where
it is just not clear that this is the price charged.
And finally, keep the bookkeeping and the rules as simple
as possible. There are going to be pressures to leave small
businesses out and others out because it is too complicated to
deal with. I would be very leery of allowing that kind of thing
to happen.
Among the options that are available, very quickly, I would
see the spectrum of four major proposals as these:
The flat tax could be better than what we have, but it sets
right back up the opportunity for people like me and our
clients to mess the system right back up. The more people you
leave in the system in an attempt to compute income, the worse
off you are.
Sales tax, a little better, but it is rife with the ability
for revenue to be lost when it is not all collected at the
retail level at the last minute. The European style value-added
tax, better yet, because you have every business in the economy
in the system to varying degrees.
My personal favorite is what is called a Business
Activities Tax, which is basically a European style value-added
tax computed with a subtraction method, and if time permits, I
can get into more details.
But those are my views, based on practice and working with
a lot of tax lawyers. If we keep it simple and do it correctly,
a new system can be worthwhile. If we do not follow principles
like these, let's not even start.
[The prepared statement of Cliff Massa appears in the
Submissions for the Record on page 91.]
Senator Bennett. Thank you very much.
Mr. McCaffery.
OPENING STATEMENT OF EDWARD J. McCAFFERY,
PROFESSOR OF LAW AND POLITICAL SCIENCE, UNIVERSITY OF SOUTHERN
CALIFORNIA LAW SCHOOL
Mr. McCaffery. Thank you very much, Mr. Chairman.
Let me begin with a true conversation I had with my 12-year
old daughter before I left for California. I told Cathleen that
I was going to Washington to testify.
``Oh, no, Daddy, you didn't do something wrong, did you?''
she said.
``No, honey, I am testifying about fundamental tax
reform.''
``I know, Daddy, that is what I meant.''
[Laughter.]
Mr. McCaffery. I have learned since my first days of
talking about tax reform to try to keep things short and
simple, perhaps especially in a complex field.
Fundamental tax reform, the subject matter of these
hearings, is a topic near and dear to my heart. What follows is
my attempt to distill decades of critical reflection into ten
easy-to-digest truths:
Number one, fundamental tax reform is needed. I hold this
truth to be self-evident, that the current tax system is a
disgrace.
Two, simplification can only occur with fundamental tax
reform. I hold this truth, too, to be self-evident, or at least
abundantly clear after too many decades of incrementalism.
Three, fundamental tax reform is possible. Many followers
of tax policy draw a despairing lesson from the Tax Reform Act
of 1986. At the time this Act, which broadened the income tax
base and lowered its rates, seemed the last best hope for some
semblance of sanity in tax on earth.
Less than two decades later, the tax system is as
complicated as ever. Perhaps fundamental tax reform, like
federal budget surpluses, are doomed not to persist.
But this is the wrong lesson to be learned. The 1986 Act
chose one of two routes for tax reform laid out in the classic
Treasury study, Blueprints for Tax Reform: Namely, that of
perfecting the income tax by broadening its base. Sophisticated
foresight would have shown then what hindsight has since
proven: this was the wrong means to take to the right end.
Four, fundamental tax reform must center on the tax base.
It is easy enough to get blinded by the rates when thinking
about tax, but one way or another total taxes in America are
going to be pretty close to one-third of our gross domestic
product, on average, because this is what government at all
levels is spending.
Truly fundamental tax reform, any tax reform that has any
chance of effecting permanent gains in equity, simplicity,
efficiency, and accountability, must take the question of the
tax base or the ``what'' of taxes at its heart.
Five, the tax base is logically distinct from its rates.
The simplest analytic truths can get lost in the fog of tax.
Reduced to its essence, any tax consists of the product of a
base and a rate structure.
There ought to be, as I shall continue to argue, broad and
bipartisan consensus on the base question, yet confusion over
the analytics has impaired reasonable compromise. Liberals miss
the point that redistribution can be effected under any base by
choosing an appropriate rate structure.
Conservatives deserve their part of the blame for the
intellectual stalemate, by continuing to link flat rates and
consumption taxes. Finally, academics, by lumping all
consumption taxes together, have not served the public
discourse.
Six, fundamental tax reform must begin with the elimination
of all direct taxes on capital, meaning a move to a consistent
consumption base. An income tax, under the Haig-Simons
definition that Dr. Boskin put up on the board, is supposed to
tax all consumption plus all savings.
John Stewart Mill pointed out that this is a double tax on
savings; Professor William Andrews, before the Blueprints
study, pointed out that the worst problems in the income tax
come with its taxation of savings. Consider again the choices
confronting policymakers before the 1986 Act.
The path chosen was that of perfecting the income tax.
The other path laid out was to abandon the attempt to have
an income tax and to move to a consistent consumption tax. That
was the right path to have taken.
But it does not mean giving up the claims for fairness in
tax, or the attempt to tax the yield-to-capital in the hands of
the socially fortunate.
Seven, all consumption taxes are not created equal. Here is
a point where the academy has led policymakers astray.
There are two broad forms of consumption tax. In one model,
the tax is imposed up front and never again, a wage tax like
Social Security or a prepaid or yield-exempt consumption tax.
The second form of consumption tax imposes its tax on the
back end, like a sales tax, a cash-flow, or qualified account
model. Under flat rates, the two consumption taxes are
equivalent. Under progressive rates, they are not.
Eight, a consistent progressive, postpaid consumption tax
is a tax on the yield-to-capital, under just the circumstances
in which it is fair and appropriate to tax such yield.
Individuals save for two reasons:
One, as Dr. Boskin alluded to, is to smooth out their labor
earnings, to take uneven labor market earnings and translate
them into a consistent consumption pattern.
The other reason they save is to do better or to do worse.
An income tax double taxes all savings, not differentiating
between good and bad savings. A prepaid consumption tax ignores
all savings, not differentiating between the savings that
enable the lifestyles of the wealthy and all other forms.
A postpaid consumption tax splits the difference by
allowing people to smooth and taxing at higher levels only
those who enhance their lifestyles through capital.
Finally, the last two points: Actual tax policy, as we read
today in the front page of The Wall Street Journal, is moving
towards a flat prepaid consumption tax.
And, finally, implementation of a consistent progressive,
postpaid consumption tax is practical and the case for it is
compelling. There are two simple ways to do it:
One, keep the basic income tax system in place, but repeal
the limits on savings accounts: The unlimited savings accounts
model of the Nunn-Domenici plan.
Two, a three-step plan consisting of a sales tax, a rebate,
and a supplemental consumption tax. The two routes lead to the
same place.
And, finally, under either means for getting to a
consistent postpaid consumption tax and consistent with the
principled basis of such a tax, we could and should repeal all
capital gains taxes under the income tax, all rules for the
basis of investment assets, all rules about maximum
contributions to and minimum distributions from savings
accounts, the corporate income tax, and the gift and estate
tax.
We should do it. It is high time to stop the insanity of
tax.
[The prepared statement of Edward J. McCaffery appears in
the Submissions for the Record on page 109.]
Senator Bennett. Thank you very much.
Mr. McIntyre, you get the last word.
OPENING STATEMENT OF ROBERT S. McINTYRE, DIRECTOR,
CITIZENS FOR TAX JUSTICE
Mr. McIntyre. Thank you, Mr. Chairman. I think I am here
for balance. We heard from the semi-right, the center-right,
and the far, far, far-right, plus me and Jim McDermott, so
there you go.
People have talked today about some of the basic principles
of tax reform--fairness, simplicity, economic efficiency--and
my testimony touches on those. But I want to emphasize the most
important thing that we are not doing with our tax system:
raising enough money to pay for the government.
That is the catastrophe we are facing right now. Last year,
income taxes fell to their lowest level since before World War
II as a share of the economy. Now income taxes are generally
how we pay for most of the government, outside of Social
Security.
And when they fall to the levels that they have fallen to,
and there does not seem to be any relief in sight, we are
looking at funding one-third of the non-Social Security part of
the government with borrowing. That is what it looks like for
the next ten years and beyond.
You cannot sustain that. We cannot do that as a country.
Something has to give. We will either see our economy take a
big nose-dive as we use up investment capital to fund
government consumption, or we will have to cut back on basic
public services that we need, whether it be defending the
country or taking care of the elderly or healthcare, all things
that all of us want.
So the situation that we have put ourselves in right now is
not sustainable. Any tax reform proposal that says, well, we
will be revenue-neutral, or, even worse, say, the Linder Plan
for a sales tax that cuts revenues in half, that says we will
lose a lot of revenue, I think you should dismiss out of hand.
If we cannot fix our revenue problem, it is not worth doing
anything else to the tax code. That ought to be the number one
thing.
Now in terms of having a system that raises enough money to
fund the government, does it fairly, efficiently, and
reasonably simply, we have had that system. Ronald Reagan and
Bill Clinton put it together for us.
It began under Reagan, who after a terrible start in his
first year when he did everything wrong, realized his errors
and spent the rest of his time in office doing penance for
them. He came back the year after his 1981 loophole bill with
the biggest loophole-closing measure in history at the time,
led by Bob Dole and signed by Ronald Reagan.
The next year, he raised taxes again. The next year, he
raised taxes again. And the next year he raised taxes again.
And in 1986 he gave us the biggest reform of the income tax
that we had ever seen, a new tax system that taxed most income
at the same rates. Capital gains even were treated the same as
other income. It was a huge triumph for truth, justice, and the
American way--with one exception: it did not raise enough money
to pay for the government.
And so we had tax increases in 1987 and 1989 and 1990,
under Bush I, the President's father. Not big ones, but some.
And then Bill Clinton came in and finished the job that Reagan
started. He pretty much kept the Reagan base, but he raised the
rates up enough to pay for the government.
When the economy boomed, particularly for people at the
upper end of the income scale in the late 1990s, those rates
kicked in with a vengeance or with a goodness, and all of a
sudden, we saw the first balanced budgets since the year 1969,
the year I turned 21. So I had my adult lifetime without a
balanced budget until then. Some of you guys might have seen
some earlier, but we are all getting pretty old.
So there is a lesson there. It can be done. That was a
bipartisan effort, by the way. You had Dan Rostenkowski and Bob
Packwood and Ronald Reagan, so, two-to-one Republican, but
bipartisan, leading the way for something that was terrific.
And then you had something a little less bipartisan in 1993.
Okay, it was partisan. In any event, it can be done.
That is the direction I think we ought to go in. In
contrast, these consumption tax ideas inevitably will lead to a
hugely more regressive tax system.
You hear people endorsing the so-called progressive
consumption tax. Well, yeah, you can make the rates work out
arithmetically to come up with a progressive system. The
problem is that the top rate has to be 200 or 300 percent. That
is not going to happen. So in practice that is a non-starter
for me.
The other proposals, flat tax, Dick Armey style, or
national sales tax, which we have heard two different proposals
for, all of them would take such high rates that the public
would not tolerate them, and in the meantime, they would be
hugely unfair, and there would be huge tax evasion because the
rates would be so high.
So, my advice is to scrap everything that you have done
since 1993, and go home. Thank you.
[The prepared statement of Robert S. McIntyre appears in
the Submissions for the Record on page 113.]
Senator Bennett. Thank you all. This has been very
provocative, and it is the kind of dialogue that we would hope
for.
Let me--if my fellow Committee members would indulge me--
let me engage in my round of questioning, and then I will turn
the gavel over to Senator Sessions who was the first Senator to
arrive, and we are going to stay on the Senate side as I go
deal with the Agriculture bill.
Mr. McIntyre, I am very interested in your comments, but
let me give you some numbers out of my own personal experience.
We are all prisoners of our own personal experiences.
I was involved in starting a business, incorporated on the
first of September 1984. And that was what The New York Times
and some others referred to as the ``decade of greed,'' because
the top personal rate was 28 percent and with an S-corporation,
that meant that we could have the federal tax rate, effective
rate on our earnings in that corporation at 28 percent, so we
got to save 72 cents out of every dollar we earned.
Now if you have ever started a business, you know that in a
struggling business the worst thing that can happen to you is
to earn some money, because the Feds want theirs in cash right
now, and you do not have cash. You have got to have that money
that you have earned in inventory or receivables or other
things to grow the business.
And you either have to sell some stock or you have to
borrow some money from the bank in order to pay your taxes.
Now, yes, you want to earn some money, but you are doing
everything you can to try to make it look on the books as if
you are not.
And we did it legally. The folks at Enron chose a different
route, but we did it legally to find ways to report no income
so that we could save that money. But when the company started
to grow, we got to save 72 cents out of every dollar that we
earned, and because we were an S-corporation it was not taxed
twice. It all ended up on our personal account, so that
statistically we were all rich.
Actually, the amount of take-home pay I got stayed exactly
the same even though the company's money showed up on my 1040.
That made absolutely no difference to my family--all of a
sudden it was showing that I was a millionaire, but I did not
get to keep any of that money. It all stayed in the company,
but for tax reporting purposes, that is the way it was.
Now we grew that company. We started out with four full-
time employees. I was number five when I was recruited as the
CEO. We grew that company into 4,000 employees, listed on the
New York Stock Exchange. At one point it had a market cap of
close to three-quarters of a billion dollars.
That is not there now. It got caught in all of the problems
of the 1990s, but my point is, as I look back on it, if we had
started that company in 1994, instead of 1984, we would have
had a top effective rate of 42 percent after the Clinton tax
increases of 1993, plus the Medicare item, coming back to us as
an S-corporation.
The difference between 28 percent and 42 percent in terms
of the survival of that company is very, very great. And I
suggest to you that that company, founded in the ``decade of
greed'' with a 28-percent top marginal rate and top effective
rate, would not have been able to create the 4,000 jobs that
produced the rivers of revenue to the government in the 1990s.
We could afford 42 percent as an effective rate in the
1990s, once we were established. But the great engine of growth
in this country has always been the growth of small business.
We created jobs while United Airlines, General Motors, and
others were downsizing.
Having lived through that experience, I have a hard time
believing that long-term economic growth has been benefitted by
the two step increases from the 28 percent up to the 42
percent, the first one by Bush I and the second one by Clinton,
and that we--I am perfectly agreeable to some of the things
Ronald Reagan did in his tax increases because he kept the
marginal rates down, and he raised the gas tax. I think we
probably ought to do that again. Grover Norquist will have a
heart attack to hear me say that, but for our infrastructure of
roads, bridges, et cetera, we need more money in the Highway
Trust Fund to build those things we need. And user fees to me
make sense.
But income taxes impact small business where jobs are being
created in a way that too many people who have never gone
through the experience of creating a small business do not
understand.
So having given my five minutes, would you and some of the
others react, and then I will flee, so that I am free from
hearing your criticism.
Mr. McIntyre. Well let me just say that I am sure, had you
started your business in 1994, that being as smart and
hardworking as you are you would have been successful anyway,
like so many other businesses were.
Senator Bennett. Flattery will get you nowhere.
Mr. McIntyre. As you know, after the 1993 tax legislation,
when many of its opponents predicted that the economy would be
destroyed forever by raising tax rates on one percent of the
population, our economy went into its longest sustained boom in
peacetime in our history, including a business investment boom.
So, I think you could have been part of that wave.
Certainly, most other businesses were.
Senator Bennett. My own reaction to that is that the
business cycle is alive and well, and President Clinton was
very fortunate to have become President when the cycle was
going up.
Mr. McIntyre. Well, fine, call it irrelevant, then.
Senator Bennett. And I do not think----
Mr. McIntyre. At least we paid for the government.
Senator Bennett. Well, you know, I have heard that the boom
of the 1990s was because Clinton got elected in 1992, and I
have heard that the boom of the 1990s was because Newt Gingrich
got made Speaker in 1994, and I frankly do not think either one
of them had that much to do with it. I think it had far more to
do with the American entrepreneurial spirit than it did with
who was sitting in either the White House or the Speaker's
chair.
Mr. McCaffery.
Mr. McCaffery. Yes, Chairman, I wanted to comment on your
story before. I think that another way to sort of simplify and
try to see some forest through the weeds and shrubs and
microcosms of tax is to think that it is a matter of timing.
I am an advocate of at least moderate progressivity. I do
not think you need the absurd and unsustainable rates that my
colleague to the left, I suppose, said. But I think it is a
question of when is it that we should impose progressive rates
on individuals.
The current tax system imposes those rates when they work,
when they save, when they give, and when they die.
Those are bad times to do it. There is no reason to tax
someone who is building up a business, who is saving, who is
working hard. Those are mutually beneficial win/win activities.
We can tax people when they spend. And when they spend, we
can impose progressive rates. So if you are working hard and
building up a business, if you are carrying an estate to your
grave, there is no reason to tax you.
So I think we should systematically eliminate all taxes on
the build-up of investment assets and wait until and unless
people cash it out in personal consumption.
Senator Bennett. I would love to stay and participate, but
I have to go worry about country of origin labeling.
Senator Sessions, I give you the gavel and let you carry
this forward.
Senator Sessions. [Presiding.] Thank you, Mr. Chairman. You
know, we have all seen those little old ads for ``When E.F.
Hutton speaks, people listen,'' well, when Bob Bennett speaks
on the economy, people in the Senate listen. He is certainly
doing a great job as Chairman of this Committee and I am
pleased to fill in. I know you have an unfortunate conflict
this morning.
Mr. Stark.
Representative Stark. Well, I think, Mr. Chairman, that
perhaps Dr. Boskin and others wanted to respond to the
Chairman's comment and I would withhold for a second.
Dr. Boskin. Yes, I would just make the technical important
point that as debates occur, including the one over whether 42
percent or 28 percent was a better tax rate, it is important to
remember that a large number, a vast majority of businesses,
not a vast majority of GDP generated, but a vast majority of
businesses pay taxes on the personal forms as either LLCs or
partnerships or sole proprietorships or S-corporations.
So it is important when we get into the rhetoric of
taxation and the political debate to understand that when we
are talking about taxing the rich we are also talking about
taxing small business.
Mr. Massa. And I would add that I think it is more than
coincidence that the explosion of concern about tax shelters,
the amounts of money that are spent on tax lawyers, financial
planners and accountants, has gained attention again in an era
when rates have gone up and people are happy to have those
rates high.
The amount of money that is spent on and, from my
perspective I would say wasted on tax lawyers and accountants
and financial planners, even on perfectly legal tax planning,
is enormous. And it occurs because the base is income and
because the rates are high.
So whatever the revenue generating potential of high rates
is, the potential for encouraging more and more people to go
find sketchier and sketchier ways to avoid those rates is just,
it is there. And the only people who actually end up making
quite good livings out of it are people in my business,
unfortunately.
Senator Sessions. Any other comments?
[No response.]
Senator Sessions. Well I do remember that ``60 Minutes''
show in Italy over 20 years ago at least where people were
cheating. The tax rates were 60 or 70 percent and they were
unhappy with the cheating, so they raised the rates to 90
percent.
Mr. Stark.
Representative Stark. Thank you, Mr. Chairman.
As I say, all of the incidents that my friend, Mr. McIntyre
indicated, I guess I participated in those reforms, increases,
decreases in rates, and I do not know if the dialogue was any
different in those days in over 30 years of changing the tax
code, than it is today.
Well-to-do people who paid substantially more in taxes
complained the loudest, and basically I do not think I ever
heard anybody suggest they ought to pay more for the privilege
of living here or enjoying what we enjoy in this country. So I
think that greed and selfishness are alive.
I am concerned with how we are going to pay, whether you
want to think about paying for six or eight or ten more years
in Iraq, whether you want to think of paying for Social
Security so that the youngsters here at the table can enjoy the
same generous Social Security benefits I now enjoy.
I think all of those things. We do not have the money. I am
enjoying low interest rates as all of you are. I do not see how
we can continue to con our foreign investors into buying our
debt when our income stream is decreasing and we are going to
see this problem extend to states.
I am terribly concerned about our unwillingness to deal, to
even really discuss under Republican leadership any revenue
changes, much less increase. I mean, this abject, almost
paranoiac psychotic fear of suggesting that we might increase
revenues I find disappointing and, at some point, I guess I
could, in a sense of black humor, find it humorous.
But it is going to come home to roost one of these days and
it will come home politically. And I think it is inevitable
that this country is going to need more revenue. And I do not
think the discussion here is how to get more. I think the idea
is that we are going to relieve some of these magical
entrepreneurs from their unholy tax burden.
I happen to be subject to that and I do not mind it. There
are others who do not.
I am curious and, Mr. Massa, one of the things that all of
these programs that we heard about earlier from our colleagues
and we have heard from Mr. McCaffery and others talk about, I
do not suspect any of you have been in business, as the
Chairman has, so that you are probably not concerned nor have
given a great deal of thought to what the disruption in the
normal commercial intercourse, what would happen to our way of
doing business?
One of the reasons I oppose the VAT so strenuously is
because I have enjoyed the opportunity to go to Italy and
France generally every year. I find it much better to study the
VAT in April and May than I would in February or January, but I
have spent a lot of time in those countries looking at the VAT
and looking at the extent to which people cheat, and hide
income, and make stupid decisions because of it just as they do
in this country because of what our tax code does.
But there would be a tremendous change. I do not know if
any of you understand this, but the transfer of title to goods
changes by the whole thing.
You are a lawyer, Mr. Massa, you probably understand this
far better than I do, but it would completely disrupt how we
sell goods and how we store them and who pays taxes.
One of the things, I have been a client from time to time,
of Patton Boggs. Other than their extensive lobbying, they have
sheltered some of my taxes for me and have done a hell of a
job.
But think of this, and I am a slow pay. Think of the
lawyers and accountants and everybody else in this country.
Let's say the VAT was 30 percent. You would have to pony up 30
percent cash the day you sent me my bill. And you do not know
when you would collect from me.
The doctors, Dr. Paul, would have to pay their 30 percent
on their doctors bills the day they did the surgery. And then
if Medicare did not pay him for a long time--and I just suggest
that as the disruption, admittedly we would get used to it and
figure out a way to handle it, but I do not ever hear any of
these people who talk about how this is all going to fit into a
commercial tradition in this country that serves us quite well.
That is what you learn at the Stanford Business School and
for those of you who went to other--Bob Jones West, as I call
it, but it is a good school. And it teaches people a
vocabulary, how to operate business, how to sound
sophisticated, how to make presentations on their computers so
that they can go into board meetings and tell people how to
steal without getting caught.
All of this stuff would change dramatically and I guess my
bottom line is, is it worth it?
We have got a code that can be changed. I would, as I told
the Chairman earlier, I could see supporting if I had to
politically, a modest federal retail sales tax if it were
dedicated to pay, say for health care or education. That may be
the only way we will get funding for some of those issues and I
could compromise and make a deal.
But I wonder if this idea of completely changing the tax
code would, one: get us the money to operate; and, two: whether
our commercial system could function?
Mr. Massa. Mr. Stark, on the second, I think the issue of
how painful would it be to get from here to there and how
disruptive it would be is a real one. It is often in the tax
section committee discussions we had referred to as, you know,
transition rules and there was another small fortune to be made
by those of us who would try to work on the transition rules.
My personal view is that it is worth the hassle and there
are going to be a lot of it, because looking at clients with
whom I am familiar and just other stories, so much of what
their professional tax planners, their corporate tax officers,
do is unproductive and so much of the thinking that goes
through a CFO or a CEO's mind is, ``All right now, this is what
I want to do. What is the tax implication? Do I want to go
through a corporate inversion? Do I want to locate a plant here
or pick some other country?''--is being driven by the income
tax.
But yes, it would be very disruptive to begin ripping that
out of the system.
My personal hope is that we understand that this is dead
weight. It is wasted resources, it is diversion of money into a
lot of bright minds, leaving myself aside, a lot of bright
minds who could actually be doing something productive for the
economy.
But I do not underestimate the difficulty of trying to pull
out 90 years worth of thinking in the business community and
reorient the commercial system, but I do think it is worth it.
Dr. Boskin. I would just make two comments repeating points
I made briefly in my opening statement. The harm done to the
economy by the misallocation of resources by altering savings,
by sheltering, goes up with the square of the tax rate.
So there is a big difference between adding a consumption
tax on top of the existing tax system and replacing the
existing hybrid of income and consumption taxation, corporate
and personal income tax, with a consumed income tax or some
other variant.
I do agree that there is a pretty big range in how
disruptive that transition would be with a broad-based VAT
being the most disruptive--retail sales taxes, you have
federalism issues--my point three, but you still have the fact
that most people pay sales taxes in their states.
When people talk about a broad-based sales tax they are
talking about extending to services which most states really do
not tax, so there are issues there.
But in a consumed income tax, either of the deductible
saving method or of the expensing method, we could indeed wind
up, in my opinion, much simpler than what we have now.
Senator Sessions. Mr. Paul.
OPENING STATEMENT OF REPRESENTATIVE RON PAUL,
A MEMBER OF CONGRESS FROM TEXAS
Representative Paul. Thank you, Mr. Chairman.
I get asked frequently at home about what is happening on
tax reform and there was a lot of talk about tax reform,
especially after 1994, and my answer has generally been that
nothing--we hardly even talk about it.
So I am delighted to have at the hearings today at least
know that there are a couple of people still thinking about
it--not that it makes me very optimistic that we are going to
have it soon.
But certainly in 1994, with the new Congress, there was
some enthusiasm for true tax reform and that helped motivate me
to get involved in politics once again.
But I respect all the qualifications, the academic
credentials that you all have.
The only credential that I have that I am very proud of
dealing with taxes is that each year I win the National
Taxpayer Union's Award for the Taxpayer's Best Friend.
Which means that I vote for the least amount of taxes and
the least amount of spending of anybody in the Congress, and
the people in my district sort of like that.
I would take challenge with Mr. McIntyre's statement when
he said we do have a revenue problem. But it depends on how you
look at it. I think we have a spending problem. You know, two
trillion bucks. Not a bad sum of money to run a country. It
would be plenty if we were doing the right things and limiting
our government to constitutional functions and maybe not
pretending we are the policemen of the world and the savior of
everybody who wants something in this country--$2 trillion
would be way too much.
So we have a revenue problem in that there is much too much
taken out of the economy and I would like to see a heck of a
lot returned.
But still, even with our discussion, it always frustrates
me because to me it comes down to the principles of the
technical aspects--should it be consumption tax and what kind
of consumption tax? Should it be a flat tax and what kind of a
flat tax? And it just goes on and on.
And I really think that misses the entire point. Because if
you had a sales tax to cover the revenues and say we go and
cover the revenues for the current spending because my argument
is not going to win, we are going to continue spending.
So sales tax might not be 20, it might be 28 or 30. The
only argument I can give for that that is really practical, is
it would cause the most horrendous tax revolt. People just
would not pay it.
Like Mr. Stark points out, you know--cough up. And they are
not going to cough up on an automobile with 30 percent or so.
So there would be a great revolution and then maybe we would
get down to serious business. Maybe the people would decide,
you know, ``I did not know I was paying so much for my
government. I would like a little less government and a little
more freedom, a little more chance to keep my own revenues.''
But the tax, there is another tax that nobody ever talks
about that is probably the most important to me, and that is
the inflation tax. Last year we spent--the national debt went
up approximately $550 billion, if you count everything that we
borrowed. That is a horrendous amount, but nobody sweats it
really.
We fuss about it a little bit, but I think this is an
outcome of some of our conservative friends who preach that, in
the 1980s it was a very, very popular philosophy and that was
the philosophy of the supply siders.
Part of that philosophy I really strongly endorse, and that
is, get the rates down, because rates, you know, that is how
you win NTU awards--get the rates down.
So I am always for lower, lower rates and I think they are
very beneficial. But they taught one other thing that I think
we as conservatives in the last 20 years have totally
accepted--do not sweat the deficits. Deficits do not really
matter.
But how do we get away with it? We get away with it because
we tax the people through inflation. If we do not have enough
revenues, if we do not have these patsies from overseas and
there are a lot right now who will loan back just about
everything we need, but if we come up short like we are and if
we think interest rates should be lower than the market says
they should be, we have that money machine and we have the
money machine there, that monetizes the debts, buys these
securities, and then who pays? Well, nobody pays.
Except for the fact that prices will go up and some people
argue that this is a great tax. The politicians love it because
nobody sees it. Everybody gets taxed and they figure it is
probably very fair. Everybody's prices go up the same--which is
the fallacy, which is a myth.
Because the cost of living goes up for middle income and
especially low middle income much more so than anybody else. So
middle class people get wiped out.
It is very regressive, so taxes on education and medicine
and services and energy and food--that goes up. So the real tax
hits the middle class and low income people and we go merrily
on.
So I do not see the solution with the tinkering. And I am
for tinkering in one direction, less taxes, less IRS, less tax
on income--and but, if we fail to address the subject of trying
to finance this government that is pretending that we can
police the world and do all these things around the world about
the deficit and, at the same time, add on new welfare programs
here at home, I see very little hope for your suggestions.
I would like you to just comment on that and see if I am
not saying something worth thinking about in that we should
think the bigger picture and that is more important than the
tinkering with the tax code. Any comments?
[The prepared statement of Representative Ron Paul appears
in
Submissions for the Record on page 48.]
Mr. McCaffery. Well, I definitely agree we should look at
the big picture. In terms of inflation, all the taxes that we
are sort of obsessed with are now pretty well indexed for
inflation. That was a Reagan era change.
Before that change, there used to be a tax increase every
year and then the government could pretty much cut taxes.
But your comments do make me think. One thing I often teach
my students is the very simplest tax system would be a printing
press--if the government just printed money to pay its bills.
Now, the problem with that, nobody would fill out forms,
there would not be high rates, the problem with that would be
that you would have a tax working through the economy falling
on individuals through the monetary effect, through the
inflation effect.
The reason we buy all the complexity we buy with payroll
taxes, personal income taxes, corporate income taxes, gift and
estate taxes, is that we believe in some sense of individuated
justice. We believe that somehow or another we should make
determinations on the basis of individuals' ability to pay.
To me that then gets back to the question of when should we
make those decisions? I do not think when people work, I do not
think when people save--the first book I wrote showed that I do
not think when people get married is an occasion when their
taxes should go up. I do not think when people give, I do not
think when people die. I think if we are going to buy the
complexity of an individuated tax system, we should get it
right and we should tax people when they spend.
A comment on other than finding out Mr. Stark is a
representative from my home state as I know and I could tell
from his comments he has a very safe seat, so that he is not
particularly worried about raising taxes, so I am delighted to
hear that.
But getting back to a comment in colloquy that Mr. Stark
had with Dr. Boskin. I do not think if we have a sales tax or
VAT, that should be one-stop shopping because of that rate
problem.
So I think we can have a national sales tax as part of a
consumed income tax at a moderate rate, maybe 10 percent, that
would then take care of the consumption taxes for the masses,
we could give them a rebate to give them in effect a zero
bracket or a family allowance, then we could have a
supplemental consumed income tax for those who make $70,000 or
$80,000 along the Nunn-Domenici lines--a proposal very similar
to Michael Gretz'.
Senator Sessions. As you think about sales tax, let me add
one other thing as long as you brought up California, that the
public ought to be concerned about and that is us politicians.
I mentioned earlier how much difficulty any of us would
have voting increased taxes, but that is not true on sales
taxes. We have increased under the clean up tax for the
Superfunds, we have increased that an eighth, a quarter--
without anybody looking or knowing about it.
California, when I first moved there, sales tax was about
three percent. It is now 8.5. I have never had a letter
complaining even though I do not have anything to do with it.
But what I am saying is, it is so easy politically to
ratchet that up a quarter here, a half there, and--think about
that as whether, I guess as politicians, to pay the bills we
would love it--but it is a concern that I have about
administering these consumption taxes. Thank you.
Dr. Boskin.
Dr. Boskin. I will just make three points, one with respect
to what Mr. McCaffery and Mr. Stark just said. What I was
referring to earlier was adding a consumption tax on top of the
current system so that the size of government got to European
levels, that is indeed how Europe financed going to half of GDP
going through the government relative to our one-third--and one
of the reasons, our economic performance, despite its ups and
downs, has been much better than Europe's--is because we have a
lighter hand of government. Some would say too light. I
personally think it is probably still too heavy.
But in any event, a major part of our success is we did not
go the European route, it would have caused much higher
unemployment and much slower growth.
Secondly, inflation--Mr. McCaffery is right. We did index
the brackets, but we never indexed the definition of income so
we still tax nominal interest, not inflation adjusted interest.
We still deduct nominal interest. We use historic cost
depreciation, we tax nominal capital gains so sometimes even
though it is a lower rate and with deferral, sometimes you will
pay positive capital gains taxes on real losses.
So it is important to understand that is a big part of the
complexity. One advantage of a consumption or a consumed income
tax is avoiding all these inflation adjustments.
And let me answer Mr. Paul's question about the deficit in
my own views. I think that, unfortunately, there is no
simplistic answer to what are the economic effects of deficits.
The effect of the economy on the budget is larger, surer and
faster than the effect of the budget on the economy.
So if we have a downturn or a recession or slowdown or a
stock market collapse, there is a big hit to revenues and,
conversely, in a boom, with bracket creep and a variety of
other things.
I personally believe that not only the level and structure
of taxes and of spending, but the deficit does eventually have
some impact on investment, but it is far less than dollar-for-
dollar and it varies over the business cycle.
We should indeed not only accept a deficit or a decline in
a surplus and run a deficit in a recession or in the early part
of an expansion--we might, when we get into a situation as we
recently did, where the Fed had used up most of its ammunition,
want to supplement monetary policy with a tax cut to try to
stimulate the economy.
So I think that was the right thing to do and I am not
particularly concerned about the deficit right now. I think it
is the right policy.
I think out the other end, five or seven years from now,
putatively into a long expansion, we ought to be in a situation
where the budget is getting close to balanced.
I would also suggest that we do not in our budgeting
separate out capital expenditures from current expenditures.
And if we are in a period where we have a big increase in
government investment--in the military, let's say for example,
when you have a big expansion of things that can be viewed as
investment, it may well be desirable to fund that at least
partly with debt as many states do and spread the cost of
financing over a longer period than just the current year.
Representative Paul. May I make one brief comment? I think
you miss my point about the inflation tax, when we create new
money the value of the money goes down. I am talking more not
about bracket creep, but the cost of living hitting low middle
income and poor people a lot worse than rich people. That was
the point I was trying to make. Thank you very much.
Senator Sessions. Thank you.
Senator Sununu.
Senator Sununu. Thank you. Let me state at the outset that
the beauty of sitting on a committee with Pete Stark and Ron
Paul is that I become the centrist.
[Laughter.]
Senator Sununu. Let me also note that it made it just a
little disappointing to find out that, as a member of the Ways
and Means Committee, Pete Stark does not do his own taxes--but
I am pretty sure if he checks with his lawyers at Patton Boggs,
there is nothing that prevents him from writing a bigger check
and sending a little more into the federal government.
Dr. Boskin, I think you said, and I am sorry I did not hear
your opening testimony and it is a lot of testimony, which is a
good thing to have, and I will read it, but you said that the
cost, I think the cost of the system increases with the square
of the rates.
What about the impact on growth, or are you using those
changes interchangeably? In other words, what is the impact on
forecasted growth rates or the relationship between growth
rates and tax rates?
Dr. Boskin. That is a very good question, Senator. There
are two aspects to that. One is in an economy that is not at
full employment, higher taxes will be a drag on the economy,
prevent it from getting back to full employment on its own
rapidly enough and that can be fairly substantial and that is
why I personally favored a tax cut in the recent circumstances
with interest rates down to one percent, the Fed about out of
ammunition.
With respect to long term growth over decades, the basic
issue is how is it affecting a broad measure of capital
accumulation and investment? Saving and investment in plant and
equipment and in human capital and so on.
So the advantage of moving to a consumed income tax or tax
on consumption is it gets rid of the double or triple taxation
that we have now on saving and investment in the economy.
A progressive rate structure would still affect human
investment and slow growth as people invested in themselves and
drove themselves into a higher tax bracket--but a flat rate
consumption tax or a flat rate consumed income tax would be
relatively neutral with respect to savings and investment
versus consumption and would not have an effect on growth above
and beyond the shifting of the resources from the private
sector to the government and then you would have to reflect the
differential efficiency with which the private sector did its
activity versus the government.
So I would say if we ranked the order, the most pernicious
taxes with respect to long term growth are those that affect
saving and capital accumulation, and the higher the rates the
more the harm, as I said earlier, going up on the square of the
rate. While the cost of the distortions go up with the square
of the tax rates, you cannot take the growth rate and multiply
it by some tax rate squared and get an answer, it is more
subtle and more complicated than that and I will not bore you
with the mathematics here.
Senator Sununu. With regard to federalism, you raise that
as a concern when we look at proposals for tax reform. What
kinds of approaches either strengthen federalism or harm it the
least?
Dr. Boskin. I think there is concern on the part of mayors
and governors that the federal government launching into a tax
vehicle that has primarily been the preserve of state and local
governments, like a sales tax, would make it harder for them to
collect the revenue they need to collect.
And I think they have historically opposed these types of
suggestions and also a value-added tax, which they see as
closely related to a retail sales tax.
I think those are the big concerns that mayors and
governors have and I think are most likely to affect
federalism.
If we could get a broad-based tax that everybody would
agree on and each individual state legislature would be happy
to piggyback on the federal tax system because they thought it
was really good, that might enhance federalism in some way,
certainly increase the overall efficiency of the combined state
and local and federal tax system.
But I think the primary concern is a new tax device that
invades the province that has usually been preserved for state
and local governments.
Senator Sununu. Well, that is the historic norm. To what
extent do you think that the practicalities of, I think as you
just described, leaving consumption taxes to the states and at
the federal level focusing on taxing income, either at the
corporate or the individual level, to what extent is that maybe
no longer the best model?
And when we are talking about the practicalities or the
issues of taxing internet commerce right now and the degree to
which you have greater and greater volumes of interstate
commerce, both at the business and the individual level, and so
that may be taxing models based on states that can control and
monitor consumption that initiates in their borders and is
completed in their borders--it is just becoming tougher and
tougher. Do we have the model mixed up?
Dr. Boskin. You are exactly right. A lot of things, such as
the mobility of the population, the mobility of economic
activity are rendering that old model less and less relevant.
You will still get a lot of argument from governors and mayors
about federal sales tax for example.
But I do believe that the basic issue is the concern at the
state and local level for being able to raise sufficient
revenue to pay their bills and they believe that, if the
federal government had a sales tax, for example, it would make
it harder for them to raise their own because people would see
the aggregate.
I think that is a legitimate concern if you see it
decreasing.
Senator Sununu. But if the federal government got out of
the business of taxing income at the individual and corporate
level, would that not create an opportunity for the states to
address whatever----
Dr. Boskin. I think that is exactly right. A big difference
between replacing the income taxes or greatly reducing them
with a consumption tax at the federal level and just adding it
as another tax device--I think part of what you hear from
governors and mayors is not just the type of tax, but the
resistance of the population to an increase of the overall
level of taxation, I think you are exactly right about that.
Senator Sununu. Mr. Massa, I guess along those lines, which
do you think is more of an abomination? The complexity in the
corporate income tax or the individual income tax? In other
words, which of these is in most need of reform, either from a
policy standpoint or from an economic standpoint?
Mr. Massa. I wish I could separate them that way, Senator.
I cannot, since so much of the corporate community is now taxed
and the individual community through Subchapter S and so forth,
I do not think there is a way to say that. There are different
kinds of problems and complexities to be solved.
My personal view is they are both a mess and they both need
work. But I cannot rank it that way.
Senator Sununu. From a political perspective, let's stop
talking about the theory. How do we get this done? I have only
been around for six years, and I think I talked about tax
reform in the first, ``political'' speech that I gave, and I do
not feel like we are any further along.
I think that, in some ways, if you look at the tax package
that is in the Energy Bill, if you look at the sunset
provisions that exist in some of the 2001 tax reform, I think
you could argue that we are further away from the goal of
simplification.
So from a practical standpoint, I will let each of the four
of you at least offer some political advice. What is the best
way to move forward? Incrementally? Do you have to have a
national dialogue and build consensus? Do you need to put three
people in a room and do not let them come out till they agree
on a solution? What is, practically speaking, in your opinion,
the path forward. We will start with Mr. McIntyre.
Senator Sessions. We are interested in your answers, but if
you can keep them as brief as possible, because we could talk a
lot about that.
Mr. McIntyre.
Mr. McIntyre. How do we get to a better tax system? I think
you probably have to elect some different people than have been
running things for the last decade-and-a-half, because none of
the current crowd has any interest in real tax reform.
Mr. McCaffery. Well, I will briefly plug my book, ``Fair,
Not Flat.'' I think part of the answer is that we need public
education. The people have to get involved.
As I often say in my books, tax is too important to leave
to the people who understand it. We probably need political
entrepreneurialship; we need Presidential leadership. I think
history has really shown that we need a John F. Kennedy, the
first great tax-cutting President. We need a Ronald Reagan. We
need someone who is not going to pander and add complexity to
the code by adding token, you know, deck chairs to this
Titanic, but we need someone who is really going to take it on
as an issue.
So I think public understanding, and strong leadership at
the Presidential level.
Mr. Massa. I have given up on being an incrementalist. I do
not think it works. The only winners are people in my
profession and others.
I think that if it is worth doing, you say we are going to
start again, here is the clean sheet of paper, adopt some
principles. I have suggested some, and you can come up with
your own and adhere to them and just say ``new system, old
system,'' but incrementalism, I think, just makes it worse.
Dr. Boskin. I have a slightly different perspective on
this. I think there are issues which are timeless like tax
reform, that every once in a while percolate up, and if you are
ready to take advantage of it when the political process is
right, as it was in 1985 and 1986, then you can get something
substantial done.
I will remind you, for those of you who were not around
back then, what happened in 1986 was not what was originally
proposed and originally discussed, and, indeed, the original
discussion was for rates of 15, 25, and 35 percent and a very
different tax law that was defeated in the House, originally,
and then was eventually passed.
And in the end, what happened was Senators Packwood and
Bradley hammered out a compromise in private. They had been
working on tax reform for a long time, and spent a lot of time.
I was privileged to advise both the Ways and Means and Finance
Committees at the time.
And that is sort of how we took the general interest in tax
reform, pushed by President Reagan and the concern in the
population, and transformed it into what I thought was a very
good tax reform, far from perfect, but a very good one.
So I think that the answer is all the things people have
been saying: Concern of the population, Presidential
leadership. But you in the Congress have to have a core of
people who have developed a set of principles and ideas about
what you want to come to, so that when you actually get to the
legislation, you mold it into the right kind of reform. I think
that there may well be an opportunity in the not-too-distant
future.
It may not be this year, it may be in 2005, but in the
meantime, what you might think of is, in part, evaluating
individual proposals that come along, by whether they move us
in the right direction or not.
Senator Sessions. There is no doubt we can make this system
simpler. That is indisputable, I would say, and I would think
it is also fair to say that the taxes we impose could be less
hurtful to the economy. There is no doubt in my mind that a tax
is detrimental to an individual's standard of living.
It reduces the amount of money they have to spend as they
choose. It also reduces the amount of money a business has to
spend as they choose, so it is detrimental to both, but we do
need a certain amount of revenue, and the question is, let's
get it in the simplest way possible, with the least possible
adverse impact to the economy and jobs and people's ability to
save and build for the future.
I do remember when I came here in 1997, about 40 Senators
signed legislation to end the tax code as we know it, by 2000,
was it? Is that the year? I have often wondered why that did
not go anywhere. I really think maybe Mr. Forbes, who ran on
that and did not win, maybe somehow that took the steam out of
the issue, the momentum there.
And so I would just say that it is a very real issue. I
agree with Mr. Paul that I am still hearing that when I am out
there. People are telling me it is too complicated, so I know
we can fix that.
Tax rates, I believe, should be as low as possible.
Dr. Boskin, you mentioned that and their lack of
competitiveness with the United States, and you noted that it
is because, your opinion, it is there at 50 percent of GDP
going to the government, where we are a third. I asked Mr.
Greenspan about that at my first hearing here. I was somewhat
nervous to ask him about it, and I asked him about three
businessmen who had been interviewed in USA Today, and they
asked why our economy was better than Europe's, and they said
unanimously, ``the United States had less taxes, less
regulation, and a greater commitment to the free market.''
I said, ``Do you agree?'' And Mr. Greenspan looked up and
he said, ``I absolutely agree.'' So I have sort of taking that
as marching orders.
Now, Mr. Schroeder of Germany just last week--I am looking
at the Associated Press--said, pointing to the acceleration of
United States economy, 7.1 percent growth last quarter,
pointing to the acceleration of United States economy after tax
cuts there, Schroeder hopes to give German growth a boost in
2004 by moving an $18 billion tax cut up. So I think the
message is out there that a vibrant, free market is good for
the economy, as much as possible.
Let me ask this: I was present at one of those great
debates between Congressman Tauzin and Armey over the flat tax
and the consumption tax in Mobile, Alabama. It was a
fascinating debate, and there was a very packed house. People
were very engaged and interested. I would like to ask you this:
Is there a conflict between these two ideas? Can there be a
merger? I believe Mr. Tauzin's view was, if you leave any
income tax in, and you throw a sales tax on top, the income tax
will grow and will just be a way to increase revenue.
But what are your opinions? Do you have any thoughts about
that? Would this make the economy healthier, if we could do it
in a restrained and effective way? And is there a conflict at
all between these two issues?
Mr. McCaffery.
Mr. McCaffery. Well I think we should get--and I think
there is a consensus here for the most part, that we should get
to a consistent consumption tax. I favor a postpaid consumption
tax, which is on the sales tax model with some progressivity,
but I think we should only do it--I think Mr. Stark's concern
about the ease of raising a sales tax is a legitimate one, so
we might move to a single consumed income tax.
But I think, as Mr. Massa said and as Dr. Boskin said, tax
reform has to be fundamental, and I think part of this package
should be to eliminate all direct taxes on capital, so we are
getting rid of the corporate income tax. I guess Senator Sununu
asked about that. I personally think it is about one-fourth the
magnitude of the personal income tax.
The problem with the corporate income tax is that nobody
knows who pays it. It is a hidden tax. It either falls on
workers or it falls on capital, generally, or in some
combination. It is not individuated.
Get rid of the corporate income tax, lock, stock, and
barrel, get rid of the gift and estate tax. You do not need it
under a consistent consumption tax, because you can tax the
heirs when they spend.
Get rid of capital gains, get rid of all this other stuff.
If you do that, I do not think there is a tension between a
moderate national sales tax and a supplemental income tax,
putting aside the very important political economy points that
Mr. Stark pointed to.
Senator Bennett. Any others comments?
Mr. Massa. I would encourage that there not be two, simply
because there is more opportunity for messing up two systems.
The written statement emphasizes a bit the desirability, from
what I think is an administrative and complex point of view, of
simply taking individuals out of the system.
It reduces the amount of returns and makes the IRS job
easier. But I think it also substantially reduces the pressure
points that members of the Congress face. Turn businesses into
the tax collectors and remitters through a sales tax, or a
value-added tax or the business activities tax.
I think that one of the eventual fatal flaws of the flat
tax--and you have already heard testimony along this line this
morning--let's have it a flat tax, except I will raise the rate
a little bit, and I want that mortgage deduction and I want
that--what was the other one this morning--charitable
contributions.
When Senator Long was the Ranking Member in 1986, he told
my distinguished partner, Mr. Boggs, do not worry about not
having anything to do after the 1986 Act. You all are going to
spend 10 or 15 years putting it right back, because we are
still taxing people.
That is exactly what has happened. My personal as well as
lawyer views are, do not do two systems, and I would personally
prefer that individuals simply not be in the system, not be in
the system as remitters. We are the only ones that actually pay
the taxes. Just do not have 130 or so million returns remitting
taxes.
Dr. Boskin. Let me just make a very simple point: As a
practical matter, we have both right now, because most states
have substantial sales taxes.
Senator Sessions. That is an interesting thought, and I was
going to say that it really does require creating two complex
systems, and a lot of the complexity that we complain about,
really is an attempt to achieve fairness. Some say it is
loopholes and benefits for corrupt reasons, and there may be
some of that, but sometimes people are clever to get around a
tax and beat a tax, and you have to amend the law to make sure
that they are not escaping their rightful liability because one
person is paying and another one is not in a very similar way.
So perhaps having two systems to defend and protect and
complicate, would be unwise.
Mr. Stark.
Representative Stark. Mr. Chairman, without the votes to
move ahead on either side of the aisle with any changes, I find
this fascinating, but I just come back to my concern. What are
we going to do about the deficit? And I do not think we can
make any of these changes quickly enough to deal with that.
And I am afraid that is going to be a very tough political
strategy for all of us. How do we get some more revenue some
time in the next four years, let's say, without you and I
having to vote for it?
[Laughter.]
Representative Stark. If we can figure that one out, if our
panel of experts here----
Senator Sessions. Seven percent growth, continue that
level. It is a dream, anyway, but not likely.
Representative Stark. That is what I think we are going to
have to find, and I am not finding it here this morning. Thank
you very much.
Senator Sessions. Thank you.
Mr. Paul.
Representative Paul. Briefly, I would say that our problem
is that we are trying to make taxes enjoyable and make
everybody comfortable about it.
[Laughter.]
Representative Paul. And it is not going to happen.
We are trying to tinker and change a tax code and get the
revenues that everybody wants, but unfortunately, I am a
pessimist on this. I think that the tax problem that we face is
merely a symptom, and unfortunately whether we do go with
direct taxation, excessive spending, or we go the inflation
route by devaluing the value of the dollar, we always hit the
poor and the middle income the worst.
Thank you.
Senator Sessions. Dr. Boskin, you mentioned something that
I am not sure of the effect of the economy on the budget. That
has become very real to me now that I am on the Budget
Committee. We saw, what, an $80 billion turnaround in the
estimates of how large the deficit was going to be. And part of
that, it strikes me, is when the stock market is down and
people sell stock, they don't take a gain.
They are offsetting some, at least, revenue. Small
businesses, mid-size businesses, where the entrepreneurs may be
making large incomes, can plummet substantially and I am
looking at the Joint Economic Committee's numbers that says in
the year 2001, the top 50 percent of taxpayers paid 96 percent
of the income tax. So we have created, have we not, a very,
very economy-driven revenue stream to the government?
And when the economy's growth ceases and drops even a
little bit, we will find a larger impact adversely to our
income to the government? And when the economy goes up a little
bit, we are likely to see a larger increase in revenue to the
government? Is that a fair analysis?
Dr. Boskin. That is correct. It is heavily due actually to
the progressive rate structure, and it is also due to who gets
the income and where it is accruing if a lot of it is in
capital gains and bonuses and stock options and other things
tied to stock performance.
Senator Sessions. Well, if a corporate executive gets a
$200,000 bonus and pays the maximum tax rate on it, well. But
if his corporation is not doing well, he does not get a bonus
at all and he pays no tax, or at least none on that money.
Dr. Boskin. You are exactly correct. This is driven home
most, unfortunately, in Mr. Stark's and my home state of
California and Mr. McCaffery's, where we have a very
progressive personal income tax. And of course, California,
Northern California, was the epicenter of the technology
industry and the bubble in the stock market, where all the
stock option income, and capital gains were taxed in full under
the California income tax, not at a lower rate. So 9.3 percent
more or less came off the top and went straight to Sacramento.
When the bubble burst, revenues collapsed substantially. So
it creates a kind of a political economy problem that Mr. Paul
mentioned and Mr. Stark mentioned. If the revenue is pouring in
and you can't constrain yourself on the spending side, it is
hard to constrain yourself, and then you are going to be in a
very difficult situation the next time there is a downturn,
because you will have these spending programs which have been
matched to super-normal revenue. That is what happened in
California, and we are struggling to get out of that at the
moment.
Senator Sessions. That is a valuable insight, too.
Mr. McCaffery, I would ask, but maybe we will do it by
written questions, some questions about the death tax, the
estate tax.
We have got some analysis now that indicates that if you do
not obtain a complete, stepped-up basis, it has very little
revenue cost over ten years. We need to be looking at that. If
that could be eliminated, that would be a tremendous savings in
terms of paperwork burden and unwise allocation of resources, I
think.
Representative Stark. Mr. Chairman.
Senator Sessions. I think I got your attention, Mr. Stark.
Representative Stark. Does that chart say that 50 percent
of all Americans earn less than the top one percent? In other
words, what I am reading in that chart, it says the top one
percent of all Americans earn more than the bottom 50 percent,
combined? Is that what that chart says?
Senator Sessions. No, it says that they--because they are
paying at the top rate, and don't have the personal exemptions,
they don't pay as much tax.
Representative Stark. Just the gray bars, what they earn.
Mr. McIntyre. That is why they call them rich.
[Laughter.]
Dr. Boskin. Let me just repeat what was said earlier, that
in these data are a lot of businesses, not just people.
Senator Sessions. Very good. Anything else for the agenda?
[No response.]
Senator Sessions. We stand adjourned. Thank you very much.
[Whereupon, at 11:24 a.m., the hearing was adjourned.]
Submissions for the Record
=======================================================================
Prepared Statement of Robert F. Bennett,
Chairman
Good morning and welcome to today's hearing on ``Rethinking the Tax
Code.''
In May of this year, the Senate overwhelmingly approved legislation
acknowledging the serious problems in our current tax code and called
for a congressional review of ways to overhaul the antiquated system.
This was especially gratifying to me since tax reform has been a
central piece of my agenda in the Senate. Seventy members of the Senate
agreed the Joint Economic Committee should be the key point for this
debate, and today's hearing is a direct response to that vote. It is
part of a series of hearings, studies, and related events the JEC is
undertaking to find a path to real tax reform.
The present tax system is unduly cumbersome, inefficient, and
incomprehensible. Over the years, through revision after revision, the
tax code has become a confusing, burdensome web that hampers economic
growth, places undue burdens on American businesses, and needlessly
complicates the lives of the American people.
As I reflect on all of the debates held over the years on tax
policy, I realize that there is one word that comes up over and over
again--and that word is fairness. Every time we make a change in the
tax law, we are told that it is necessary to make things more fair.
What we have done is tip the tax code this way and that way to
encourage one activity, and discourage another. Every time we do this
the code gets bigger and more complex. I find it ironic that in the
name of fairness for some we have created a system that is unfair for
everybody.
Today, during this hearing, let us get out a clean sheet of paper.
Let's not talk about tax cuts or mere adjustments to specific parts of
the existing system. Let's talk about creating from scratch a system
that is simple, that is fair, and once we have accomplished that, a
system that will endure for years to come.
We are not prejudging the issue. We are not coming to the hearing
with recommendations already in mind. This is our opportunity to
listen, and learn, and look at the issue from a different perspective.
Whether you are in favor of getting more tax dollars out of the
rich, whether you believe the tax code should spur faster economic
growth, or whether you think we should implement a flat tax for all
individuals, we can all agree that the existing code is so badly
broken, that the principles of simplicity, fairness, and efficiency are
not being met.
If we can achieve the goals I have just laid out, then another
challenge begins. We must ensure that the new tax system endures.
Businesses cannot make intelligent plans if the tax system constantly
changes. That slows economic growth and that slows job creation. For
individuals, the shifting sands of the existing tax code create painful
uncertainty. People who want to buy a house, take out a loan, put money
aside in a savings account or make an investment need--and deserve--to
know that there won't be any surprises coming after the next election.
Today we have a balanced group of witnesses that will present
diverse views about how our government should tax its citizens.
For our first panel, we are pleased to have as a distinguished
guest Senator Arlen Specter of Pennsylvania who cosponsored the Sense
of the Senate Resolution that brings us here today and who has for
years been a champion of tax reform. We also welcome Representatives
Jim McDermott of Washington and John Linder of Georgia and thank them
for joining us today.
Our second panel brings a wealth of knowledge on the subject of tax
reform. Dr. Michael Boskin is a Stanford University professor of
economics, and previously served as chairman of the President's Council
of Economic Advisors. Cliff Massa is currently a tax attorney for
Patton Boggs, and has served as chairman of the Committee on Value
Added Taxes at the American Bar Association. Professor Ed McCaffery
joins us from the University of Southern California, and is the author
of ``Fair Not Flat: How to Make the Tax System Better and Simpler.''
And finally we welcome today Robert McIntyre, the executive director of
Citizens for Tax Justice.
I look forward to hearing each witness's thoughts on the challenges
before us today. And I ask all of you to join me in a bipartisan spirit
as we engage in this important task.
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Prepared Statement of Representative Pete Stark,
Ranking Minority Member
Thank you, Chairman Bennett for holding this hearing on
``Rethinking the Tax Code.'' While we're at it, we should be rethinking
President Bush's tax cuts. Three rounds of tax cuts since 2000 have
contributed significantly to empty treasury coffers and ballooning
federal budget deficits for the foreseeable future.
President Bush would have us believe that taxes are an unnecessary
burden--unless, of course, they're supporting the commitments he's made
in Iraq. But taxes are a necessary means to meeting important
responsibilities, such as providing affordable health care and
prescription drugs, educating our children, or protecting the homeland.
Unfortunately, federal income tax revenues are no longer sufficient
to meet the basic obligations of the federal government, even as non-
Social Security spending has been falling. By the year 2000, federal
spending on all programs except Social Security had fallen to just 15
percent of the nation's GDP, down from an average of 16.8 percent for
the previous four decades. Meanwhile, federal revenues (excluding
Social Security) have fallen to about 12 percent of GDP, their lowest
levels since 1942--before Medicare, Medicaid, aid to education, and a
host of other popular programs were created.
In addition to bankrupting the federal government, the recent tax
cuts have also shifted the distribution of taxes. The combination of
income tax cuts that disproportionately benefit higher-income families,
elimination of the estate tax, and unchanged payroll taxes, means that
lower- and middle-income families are shouldering more of the tax
burden.
The President's tax cuts have also made the tax system much more
complex. Many provisions slowly phase-in or abruptly phase-out, and all
provisions sunset by the end of the decade, increasing the costs, of
tax planning and compliance. And since Congress failed to fix the
alternative minimum tax (AMT) problem, an increasing number of
taxpayers will be forced to calculate their taxes twice.
We hear the cries for reform in order to simplify the tax code, but
most proposals for ``fundamental tax reform'' involve replacing the
current income tax with a broad-based consumption tax. As our witness
Robert McIntyre has observed, ``Virtually any flat-rate tax plan that
adds up must, by simple arithmetic, produce huge tax cuts for those
with the highest incomes and therefore big tax increases on almost
everyone else.''
While a consumption tax might address complexity issues with the
Internal Revenue code, replacing the income tax with a consumption tax
raises serious questions about fairness. None of the progressive
consumption taxes proposed so far would keep taxes the same for the
highest income families. However, proposed higher sales taxes would be
damaging to low- and moderate-income families because they spend a
larger percentage of their income on necessary consumer goods. Their
ability to ``choose'' how much of their income they spend is a dubious
notion. Low-income families would be the biggest losers unless the
earned income tax credit remained in place.
Most consumption tax proposals would eliminate long-standing
provisions in the tax code that give favorable treatment to housing,
employer-sponsored health insurance, state and local taxes, and
charitable giving. Eliminating these subsidies could be detrimental. If
employers could no longer deduct the cost of health insurance, for
example, workers would face higher costs for insurance and the ranks of
the uninsured would grow even larger. Retaining these subsidies would
mean higher tax rates on other consumption.
These are just some of the hard questions that need to be addressed
before Congress leaps into a radical overhaul of the tax code in the
name of reform.
Thank you Mr. Chairman and I look forward to the testimony of our
witnesses.
__________
Prepared Statement of Representative Ron Paul,
a Member of Congress from Texas
I would like to thank Chairman Bennett for holding this much-needed
hearing, and also thank our panelists for devoting their time and
energy to study our tax system and educate members of this committee.
The statements and articles submitted certainly are provocative, too
provocative, I fear, for Congress and the administration. I say this
because we've been debating tax reform, or at least pretending to
debate it, for years.
In fact, some very powerful members of Congress have advocated real
changes in our tax laws in recent years, all to no avail. We've heard
about the flat tax, the national sales tax, capital gains taxes,
alternative minimum taxes, etc., but we've made zero progress toward
coherent tax reform. The two most recent overhauls of the tax code, in
1986 and 1997, produced only more complexity and frustration. Tax
simplification and basic fairness seem almost completely out of reach
as a political and legislative matter.
As members of Congress we've all heard how frustrated the American
people are with the tax code and the IRS. They hate the complexity of
the tax laws, the hate the time it takes them to fill out the forms,
they hate living in fear of an audit, and they hate paying so much.
They bombard our congressional offices with complaints about taxes and
the IRS, but nothing ever changes.
We also hear from our nation's businesses about the tremendous
compliance costs associated with the tax code. Countless man-hours and
millions of dollars are consumed every year by companies large and
small around the country, all trying to comply with the rules
concerning withholding for employees, corporate income tax, and
accounting issues.
So while I'm eager to hear from our panelists today, I hope that we
can start from the premise that the current approach is not working. If
we as legislators don't make some fairly radical changes, this
committee surely will find itself holding another tax reform hearing
ten years from now.
We should remember that no rational discussion of tax reform or tax
policy can ignore the other side of the equation: government spending.
We cannot talk about tax reform without talking about a federal
government that will spend roughly $2.3 trillion in 2004. We need to
ask ourselves why the federal government increases spending by 3 or 5
or 7 percent each and every year. We need to recognize that the federal
government's voracious appetite for tax dollars is the real problem;
taxes are just a symptom. Unless and until Congress changes the
spending culture in Washington, tax reform will remain a political
shell game. With the federal government hell-bent on collecting and
spending $2.3 trillion, the only ``reform'' available is tinkering with
the code to shift the tax burden around from one group to another.
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Prepared Statement of Congressman John Linder,
a Member of Congress from Georgia
Mr. Chairman, thank you very much for giving me a chance to testify
before the Joint Economic Committee this morning on the need for
fundamental tax reform generally, and H.R. 25, the FairTax, my
fundamental tax reform proposal specifically. I appreciate having the
chance to share with the Committee my thoughts on this pressing issue.
In debating any fundamental tax reform proposal, I believe that the
Congress should judge any such bill by the following 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
industries.
7. Strengthens Social Security: Fundamental reform must address the
long-term solvency of Social Security.
8. Manageable Transition Costs: It must not be costly or difficult
to implement.
My FairTax proposal, which eliminates all 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.
The FairTax plan is fair. It contains a monthly rebate of the sales
tax for every household, which would totally rebate the tax
consequences of spending up to the poverty line. This rebate mechanism
ensures that every household can buy necessities taxfree, and it
totally untaxes the poor. All Americans receive equal, fair treatment.
If Bill and Melinda Gates want to move to a farm and grow their own
groceries and live off the rebate, what do we care? We'll borrow his
money and create jobs.
The FairTax plan is simple. It totally eliminates the more than
10,000 pages of complexities in the current income tax code once and
for all, replaces them with a simple uniform sales tax.
The FairTax plan 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 plan creates transparency within the tax code. It
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 the least well off among us lose 22
percent of their purchasing power.
Any system that burdens business with any payroll tax, income tax,
or compliance costs embeds that cost in our price system. 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
system.
Moreover, knowing how much we pay in federal taxes on every
purchase we make would make all Americans more aware of the cost of
government. The next time someone wants to raise taxes, they will not
be able to be sell such a bad idea with the old argument that it only
applies to the ``wealthiest amongst us.'' The rationale for any future
tax increase must necessarily be so compelling that my mother would be
willing to pay it.
The FairTax plan 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 plan 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 seven
percent disadvantage against Amazon.com. Governors have a keen interest
in this due to the loss of hundreds millions of dollars in revenue to
Internet and catalogue sales. A national retail sales tax would collect
these revenues, and in doing so help the states.
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 tax policy ought to be neutrality.
The FairTax plan would also strengthen Social Security's longterm
future. The arguments about partial private investments saving Social
Security seem to 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, or some combination of both.
Under the FairTax, Social Security benefits would be paid out of
the general sales tax revenues. The sales tax would be collected from
roughly 285 million Americans and 51 million visitors to our shores.
Revenues to Social Security and Medicare would double, as we expect the
size of the economy to double, in 13 to 14 years under the proposal.
The FairTax plan has manageable transition costs. The only
transition rule we envision is to allow retailers to use inventory on
hand on December 31 as a credit against collecting taxes on sales in
the new year, 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.
According to the U.S. Census Bureau, at any given time, U.S.
businesses have about $1.1 trillion in inventory on hand at any given
time. Not collecting taxes on that inventory would cost the treasury
about $300 billion. Compare that to any estimates of transition costs
just trying to bring some private investment into Social Security
alone. According to the Social Security Administration, the 75-year
unfunded liability in Social Security is nearly $5 trillion. Remember
this proposal fixes Social Security in 13 to 14 years.
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 U.S. economy:
1. We currently spend anywhere between $250-500 billion a year on
compliance with the tax code. Most of that is spent by corporate
America and high-income investors. The savings that accompany a simpler
tax system will go to bottom lines and investment for job creation.
2. Corporate America spends additional billions calculating the tax
implications of business decisions. The savings generated by the
FairTax will go to the bottom line.
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. What do you think will happen to the stock market if all the
world's investors could invest in our markets with no tax consequences?
5. Having no complicated depreciation schedules, no Alternative
Minimum Tax, no credits and deductions to confuse investors,, and no
tax or compliance costs forces a whole new look at corporate
accounting. Only three numbers have meaning: earnings, expenses and
dividends.
This will make it much easier for shareholders and investors to
evaluate and monitor all publicly-owned companies.
6. Deficits spook the market. Instead of declining Federal revenues
because an income-based tax system depends on ever growing incomes, the
Federal government would collect higher revenues under the FairTax, as
revenues would track consumption. A study from 1945 to 1995 shows that
the consumption economy is a far more predictable revenue base than the
income economy, which has much higher amplitudes of volatility.
7. The FairTax would bring a 26 percent increase in exports in the
first year as well as a 76 percent increase in capital investment.
Capital investment increases lead to increases in productivity and then
increases in real wages.
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 you are working to
correct today. In 1986, we eliminated many itemized deductions and
drastically lowered tax rates to only two levels. We have amended the
code over 6,000 times since then.
I know that you recognize the need for a more fundamental change--
we have walked the flat tax path before, to no avail, and it simply
does not make sense to implement the same mistake again.
Some 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.
The FairTax has the following other benefits:
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's just hidden.
In closing, thank you for the opportunity to testify. I'll be more
than happy to answer any questions the Committee members may have about
H.R. 25, the FairTax.
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Ten Facts about Fundamental Tax Reform
[By Edward J. McCaffery, University of Southern California, California
Institute of Technology]
The older I get, the less time I seem to have to read, or to pay
attention to anything at great length. I presume, or hope, that this is
because I am busy, not on account of any biological decline. In any
event, I have learned since my first days of talking about tax reform
to try to keep things short and simple, especially in such a complex
field.
Fundamental tax reform, the subject matter of these hearings, is a
topic near and dear to my heart. What follows is my attempt to distill
decades of critical reflection into ten easy to digest truths.
1. Fundamental tax reform is needed. I hold this truth to be self-
evident: The current tax system is a disgrace. It is too complicated,
too inefficient, too unfair. Its unpopularity, itself a problem, is
fully warranted. Among the many deficiencies of the status quo, its
very complexity and the lack of transparency in its principles holds
tax hostage to the whims of politicians and the fads of academics.
2. Simplification can only occur with fundamental tax reform. I
hold this truth too to be self-evident, or at least abundantly clear
after too many decades of incrementalism. The current tax system is
flawed at its root. Federal tax policy is an incoherent and
inconsistent blend of conflicting policy elements, effected through a
confusing mixture of income, payroll, corporate income, and gift and
estate taxes. It is hard to see any forest through its weeds and shrubs
and micro-organisms. If we are to obtain simplification--and any hope
for political accountability and economic stability in tax can only
come with simplification--we must revisit first principles, and create
a consistently principled tax system.
3. Fundamental tax reform is possible. It is easy to lose hope for
a better future and thus to cling to a hopeless present.
In particular, many followers of tax policy draw a despairing
lesson from the epochal Tax Reform Act of 1986. At the time, this act,
which broadened the income tax base and lowered its rates, seemed the
last best hope for some semblance of sanity in tax on earth (Birnbaum
and Murray 1987). Less than two decades later, the tax system is as
complicated as ever. (McCaffery 1999). Perhaps fundamental tax reform,
like federal budget surpluses, is doomed not to persist.
But this is the wrong lesson to be learned. The 1986 act chose one
of two routes for tax reform laid out in the classic Treasury study,
Blueprints for Tax Reform (Bradford et. al., 1984)--namely that of
``perfecting'' the income tax by broadening its base and lowering its
rate structure.
Sophisticated foresight would have shown then what hindsight has
since proven: This was the wrong means to have taken, not a wrong end
to pursue.
4. Fundamental tax reform must center on the tax base. It is easy
enough to get blinded by the topic of tax rates when thinking about
tax. But one way or another, total taxes in America are going to be
fairly close to one-third of GDP, on average, because this is what
government spending (at all levels) is. Truly fundamental tax reform--
any tax reform that has any chance of effecting permanent gains in
equity, simplicity, efficiency and accountability--must take on the
question of the tax base, or the ``what'' of taxes. And here we must
come to see that the current system is an incoherent mishmash of
conflicting bases.
5. The tax base is logically distinct from its rates. The simplest
analytic truths can get lost in the fog of tax.
Reduced to its essence, any tax consists of the product of a base
(what is being taxed) times a rate structure (how much it is being
taxed). There ought to be, as I shall continue to argue below, broad
and bipartisan consensus on the base question. Yet confusion over the
analytics has impaired reasonable compromise.
Liberals miss the point that redistribution can be effected under
any base by choosing an appropriate rate structure.
Conservatives deserve their part of the blame for the intellectual
stalemate, by continuing to link flat rates and a consumption base.
Finally, academics, by lumping all consumption taxes together, have
not served the public discourse.
If we set aside disputes over the appropriate rate structure, and
focus instead on the base question under at least moderately
progressive rates, as we have had for nearly a century now, we can at
last begin to see fundamental tax reform in a new and better light.
6. Fundamental tax reform must begin with the elimination of all
direct taxes on capital, meaning a move to a consistent consumption
base. Now we start getting to the heart of the matter.
An income tax, under the so-called Haig-Simons definition of
income, is supposed to tax all consumption plus all savings, the two
all-encompassing and mutually exclusives uses of ``income'' (McCaffery
2002). John Stuart Mill pointed out in the mid 19th Century that this
leads an income tax to be a ``double tax'' on savings; Professor
William Andrews of Harvard Law School observed in 1974 that the worst
problems with the so-called income tax come in its commitment to taxing
savings (Mill, 1848; Andrews, 1974).
Consider again the choices confronting policymakers at the time of
the Tax Reform Act of 1986. The path chosen, as noted above, was that
of ``perfecting'' the income tax. It failed, both because it did not
really perfect the income tax (McCaffery 2003), and because no one
really wanted it to do so, in any event.
The other path laid out in Blueprints was to abandon the attempt to
have an income tax altogether and move instead to a consistent
consumption tax. This is the right path to take. It means eliminating
all attempts to tax savings directly under the income tax--having
unlimited savings accounts, no capital gains taxes, no tax-law concept
of ``basis.'' It also means eliminating the adjutants or ``backstops''
to the income tax's porous and flawed commitment to taxing capital,
namely the corporate income and gift and estate taxes (McCaffery,
2003). But it does not mean giving up the claims for fairness in tax,
or the attempt to tax the yield to capital in the hands of the socially
fortunate.
7. All consumption taxes are not created equal. Now here is a point
where the academy has led policy-makers astray.
There are two broad forms of consumption taxes.
In one model, the tax is imposed up-front, and never again: a wage
tax, like social security, or so-called pre-paid or yield-exempt
consumption tax. ``Roth'' IRA's work on this model (pay tax now, never
again).
The second form of consumption tax imposes its single tax on the
back-end: this is a sales tax, a postpaid, cash-flow or ``qualified
account model'' consumption tax. Traditional IRAs work this way (no tax
now, only later).
Under flat or constant tax rates, the two principal forms of a
consumption tax are equal. Both taxes are single taxes on individual
flows of wealth.
But this equivalence does not hold under non-constant or
progressive rates.
8. A consistent, progressive, postpaid consumption tax is a tax on
the yield to capital, under just the circumstances in which it is fair
and appropriate to tax such yield.
The simple analytic truths lead to a different understanding of the
traditional choices of tax policy, as I have been attempting to explain
in my academic work (McCaffery, 2003). Better understanding points the
way out of the current morass of tax policy politics, and towards a
grand compromise.
Consider where the debate stands.
For some time now, conservatives have been clamoring for a flat
consumption tax. Flat consumption taxes of all sorts are indeed broadly
equivalent--none effectively tax the normal yield to capital under any
conditions. And so the choice among a Hall-Rabushka style flat wage
tax, a national sales tax, or a value-added tax (VAT) is largely one of
administrative convenience (Slemrod & Bakija, 2000).\1\
---------------------------------------------------------------------------
\1\ There is important work showing that the supra-normal rate of
return to capital may be captured under a postpaid, but not a prepaid,
consumption tax. (Bankman and Griffith, 1992, Warren, 1996). In my more
general argument, this fact serves as one of the reasons to prefer, on
normative grounds, a postpaid to a prepaid consumption tax. (McCaffrey
2003).
---------------------------------------------------------------------------
Liberals for their part are opposed to any such tax, both because
of its flat rate, and because of the thought that a consumption tax
ignores the yield to capital altogether, and that such yield is the
domain of the socially fortunate. So liberals insist on maintaining,
even strengthening, a progressive income tax, with its corollaries, the
gift and estate and corporate income taxes.
But once we assume that we are going to have at least some
progression in the rate structure, the traditional understanding of
consumption taxes is no longer accurate. The two forms of consumption
taxes, prepaid and postpaid, differ under progressive rates. Now there
are three--not two--alternatives. The differences come in when the tax
falls, and how this impacts choices of work, savings, education, and so
on.
One, an income tax falls on all labor market earnings and savings,
at the time they come into a household. Savers are hurt by the ``double
taxation'' of savings, whatever the intended or actual use of the
savings. Individuals, like the highly educated, who see their earnings
come in relatively short concentrated bunches, are hurt by the timing
of the imposition of progressive rates.
Two, a prepaid consumption tax falls on labor market earnings
alone, again at the time they come into a household. Once more, people
whose earnings profiles are uneven throughout their lifetimes are hurt
by the timing of the imposition of the progressive rate structure.
But--and here is the rub for most liberals and even moderates--those
who live off the yield to capital are never taxed.
Three, a post-paid consumption tax does not come due at the time of
initial inflows, but rather at the time of outflows, when money is
spent in consumption. This means that a progressive postpaid
consumption tax stands between an income tax, which double taxes all
savings, and a prepaid consumption tax, which ignores all savings. A
consistently progressive postpaid consumption tax treats savings
differently depending on its use.
We can think of two broad uses of savings. One is to smooth out
consumption profiles, within lifetimes or across individuals--to
translate uneven labor market earnings into smooth consumption flows.
We do this by borrowing in our youth and saving for retirement in
midlife. A second use of savings is to shift consumption profiles, up
or down. An upward shift occurs when the fruits of our own or another's
savings allow us to live a ``better'' lifestyle than we could on the
basis of our own labor market earnings, alone, smoothed out over time.
A downward shift occurs when beneficence or bad fortune means that we
will live at a lower lifestyle than we otherwise could, again on the
basis of our smoothed out labor market earnings profile alone.
Once again, whereas an ideal income tax double taxes all savings,
whatever their use, and a prepaid consumption tax ignores all savings,
again whatever the use, a consistent progressive postpaid consumption
tax splits the difference, in a principled way, and by design. It
allows taxpayers to lower their taxes by smoothing, but it does fall on
the yield to capital when such yield is used to enhance lifestyles.
This reflects simple, commonsensical attitudes about life, income, and
savings. It can lead to a dramatically simpler tax system that is at
the same time far fairer.
Consider for example the role of a separate freestanding gift and
estate tax system within this construct. The current system aims to
``backstop'' the income tax, which tax is (in ideal theory) supposed to
burden savings, by levying a hefty tax on those decedents who die with
large estates. This tax is obviously desired as a matter of fairness.
But its very existence encourages the rich to consume more, and die
broke, whether the spending is on themselves or their heirs. In
contrast, a consistent progressive postpaid consumption tax never taxes
savings directly. Saved assets have a zero basis. These can be passed
on to heirs on life or at death, without the moment of transfer
triggering tax. On the other hand, spending by the heirs will generate
tax, and under the progressive rate structure. A consistent progressive
postpaid consumption tax does not need, in principle, a separate gift
and estate tax, because the very design of the tax entails an
accessions or inheritance tax.
A similar argument can be made against a separate corporate income
tax. The problems with this tax begin with its uncertain incidence:
since corporations are not real people, they do not really pay taxes. A
corporate tax falls on workers and consumers, on capital generally, or
on some combination thereof. But to the extent it does falls on
capital, it does not do so in any individuated way. Savers bear the
burden of the corporate income tax whether they are rich or poor,
saving for lifetime needs or emergencies or to support a high-end
lifestyle. Once again, under a consistent, progressive, postpaid
consumption tax--which falls on the yield to capital as a source of
personal consumption--such a tax is not needed.
9. Actual tax policy is headed towards a flat prepaid consumption
tax. In fact, when we observe the status quo, we see a slow but steady
movement towards a flat or flattened prepaid consumption tax. Second
taxes on capital have long been fairly easily avoided (McCaffery 2000).
Recent legal changes, such as the lowering of the capital gains rate
and the exclusion of corporate dividends from income, and more recent
proposals, such as those for more expansive Roth-style savings
accounts, continue and confirm the trend. These changes are moving and
will move the United States ever farther towards a wage tax, in which
the yield to capital is never taxed. This is the wrong place to go, in
the name of fairness. But whereas most liberals today, laboring under
the traditional understanding of tax, feel that they can only counter
the trend by insisting on retaining the status quo, a better
understanding of tax shows that a consistent progressive postpaid
consumption tax is an attractive option, for just the reasons liberals
oppose consumption taxes--because such a tax does, whereas a prepaid
consumption tax does not, reach the yield to capital.
10. Implementation of a consistent, progressive, postpaid
consumption tax is practical, and the case for it is compelling.
Academics tend to be idealists who get nothing done. These traits are
reflected in the endless discussions over transitions from an ideal
income to a consumption tax. But we do not have, and have never had, an
ideal income tax. The current tax is so far on the path towards a
consumption one that transition concerns should not deter the movement
towards principled consistency.
There are two broad ways to implement a consistent, progressive,
postpaid consumption tax.
One is to keep the basic income tax system in place, but repeal the
limits on savings accounts: adopting unlimited IRA or savings account
treatment, as in the Nunn-Domenici USA tax plan. These savings accounts
must be on the postpaid model.
Two is to take advantage of the analytic equivalence of sales taxes
and postpaid consumption ones, and replace the income tax with a three-
part plan, consisting of:
A national sales or value-added tax at a modest,
sustainable rate, say 10 to 15 percent;
A system of rebates to effect a ``zero bracket'' under the
national sales tax, say $500 per person, which would offset $5,000 of
taxable consumption (at a 10 percent rate);
A supplemental ``consumed income tax'' for the wealthiest
Americans, modeled along the lines of the existing income tax with
unlimited deductions for savings. This tax could apply to households
consuming say $80,000 a year or more, and would back out the national
sales tax rate.
The net result of this three-step plan would be to have a zero
bracket of $20,000 for a family of four; followed by a 10 or 15 percent
bracket extending to $80,000 of consumption; followed by 20 or 30
percent brackets, and so on, but effected by a consumed income tax with
rates starting in again at 10 or 15 percent (to add to the national
sales tax).
The choice of which mechanism to choose comes down to
administrative and political concerns, including the wisdom of having
two taxes rather than one. But the simple analytic fact of the matter
is that the two broad choices lead to the same place: a consistent,
progressive, postpaid consumption tax (McCaffery 2002).
Under either means for getting to a consistent postpaid consumption
tax, and consistent with the principled basis of such a tax, we could
and should repeal:
All capital gains taxes under the income tax;
All rules for ``basis'' of investment assets;
All rules about maximum contributions to and minimum
distributions from the savings accounts;
The corporate income tax; and the
Gift and estate tax.
Taxes would, at last, rest on a simple and consistent principle:
tax people when they spend, not when they work or save. Simplicity,
transparency, and efficiency would be enhanced; fairness would not be
abandoned. Such a tax system would apply to the yield to capital, when
but only when it is appropriate to do so. The rich would not be let off
the social hook; their tax would come due when, as, and if they spent
wealth on themselves. Progressivity could be maintained, even
strengthened.
Here, at last, would be something fundamental, to get us off the
treadmill of incrementally increasing complexity.
We should do it. It is high time to stop the insanity of tax today.
REFERENCES
Andrews, William D. 1974. A Consumption-Type or Cash Flow Personal
Income Tax. Harvard Law Review 87, 1113-1118.
Bankman, Joseph and Thomas Griffith. 1992. Is the Debate Between an
Income and a Consumption Tax a Debate about Risk? Does it Matter? Tax
Law Review 47, 377-406.
Bradford, David F. and the U.S. Treasury Tax Policy Staff. 1984.
Blueprints for Basic Tax Reform, 2d. ed., revised (Arlington Virginia:
Tax Analysts).
Birnbaum, Jeffrey H. and Alan S. Murray. 1987. Showdown at Gucci
Gulch: Lawmakers, Lobbyist and the Unlikely Triumph of Tax Reform. (New
York: Random House).
McCaffery, Edward J. 2003. The Fair Timing of Tax. USC Law School,
Olin Working Paper 03-21, available at: http: // papers.ssrn.com/sol3/
papers.cfm?abstract--id=441344
McCaffery, Edward J. 2002. Fair Not Flat: How to Make the Tax
System Better and Simpler. (Chicago: University of Chicago Press).
McCaffery, Edward J. 2000. A Voluntary Tax? Revisited. National Tax
Association Papers and Proceedings.
McCaffery, Edward J. 1999. The Missing Links in Tax Reform. Chapman
University Law Review, 2, 233.
Mill, John Stuart. 1848. Principles of Political Economy. (W.J.
Ashley, ed.; London: Logmans, Green & Co. 1909).
Slemrod, Joel and Jon Bakija. 2000. Taxing Ourselves, 2d ed: A
Citizen's Guide to the Great Debate over Tax Reform. (Cambridge, Mass:
MIT University Press).
Warren, Alvin C. Jr. 1996. How Much Capital Income Taxed Under an
Income Tax is Exempt Under a Cash Flow Tax? Tax Law Review, 52, 1-16.
__________
Prepared Statement of Robert S. McIntyre, Director,
Citizens for Tax Justice
Thank you for the opportunity to appear before the Committee today
to discuss fundamental tax reform. This is an issue near and dear to my
heart. Since 1976, I have devoted my career to promoting fairer taxes
and to keeping the public informed about the meaning of various tax
change proposals. That is also the mission of my group, Citizens for
Tax Justice.
In my view, our nation's current tax policies are a disaster:
morally, fiscally and economically. In my brief testimony today, I want
to discuss what I think should be the principles of fundamental tax
reform, illustrate how they have been applied in real life, and touch
on what I see as false paths to reform.
I. PRINCIPLES OF FUNDAMENTAL TAX REFORM
Tax reform experts have traditionally pointed to three basic goals
for a good tax system: fairness, simplicity and economic efficiency. l
would add one more essential ingredient: revenue sufficiency. All four
are interrelated.
Principle 1: Revenue sufficiency. The fundamental goal of any tax
system is to raise the money needed to pay for public services. Our
current tax system is failing miserably in this regard.
In the just-completed fiscal year, combined federal personal and
corporate income taxes fell to only 8.3 percent of the economy, their
lowest level since before World War II and a third lower than in fiscal
2000--with no relief in sight.
Personal income taxes have fallen to their lowest level as
a share of the economy in more than 50 years.
Corporate taxes have plummeted even more than personal
taxes. In fact, at only 1.2 percent of the economy over the past two
fiscal years, corporate income taxes are at their lowest level since
the 1930s, except for one year during Ronald Reagan's first term. The
most recent OECD data show that U.S. corporate taxes as a share of the
economy are now virtually the lowest in the industrialized world.
Some of the recent tax shortfall and the resulting huge budget
deficits reflect the weak economy, but most of it is self-inflicted.
President Bush's personal income tax cuts enacted in 2001 and 2003, for
example, are expected to total $197 billion next year. The decline in
corporate taxes mainly stems in about equal parts from President Bush's
big corporate tax cuts enacted in 2002 and 2003 and the huge amount of
offshore tax sheltering that corporations now engage in with
congressional tolerance. Counting tax breaks that have been on the
books for longer, corporate taxes are now almost 60 percent below the 3
percent of GDP they averaged from 1950 through 2000. To put that in
perspective, if corporate taxes had equaled that 3 percent of GDP
average last year, then revenues would have been $180 billion higher
than they actually were.
For the foreseeable future under current policies, a third of the
regular government will be financed with borrowed money. Obviously this
can't be sustained for very long, either fiscally or economically. Such
excessive borrowing endangers essential government programs and robs
investment capital from our economy that we will need to sustain
growth.
So a central goal of fundamental tax reform must be to address our
huge revenue shortfall. Correspondingly, any ``reform'' proposal that
purports to be ``revenue-neutral''--let alone revenue-losing!--should
be dismissed out of hand.
Principle 2: Fairness. Tax fairness is not only morally right, it's
also essential to maintaining public support for the tax system.
Traditionally, fairness has been dividend into two important elements:
horizontal equity and vertical equity.
First of all, taxpayers with similar incomes should pay similar
taxes, no matter how they happen to earn their money. It's not fair to
tax wage-earners more heavily than investors, and it's not fair to tax
investors in, say, fake synthetic coal, more heavily than investors in
non-tax-sheltered activities.
Second, taxes ought to be based on people's ability to pay them.
Those who have benefitted most from our society should pay the highest
share of their income in taxes to support our country. Those who are
struggling should pay the lowest rates.
Unfortunately, our current tax system violates both of these
principles of fairness. An array of loopholes favors some taxpayers and
some kinds of income over others. And the progressivity of our tax
system has declined markedly over the last quarter century.
According to Congressional Budget Office data, the effective tax
rate on the best-off one percent of Americans dropped by 16 percent
from 1977 to 2000, despite rapidly rising incomes at the top end that
normally would have produced higher effective tax rates. Since 2000,
according to calculations by the Institute on Taxation and Economic
Policy, President Bush's tax cuts have lowered the effective tax rate
on the wealthiest by another 17 percent. In combination, that's a 30
percent drop.
This sharp decline in progressivity has a lot to do with our
government's revenue shortfall, by the way. If the effective tax rate
on the top one percent were as high today as it was in 1977, the
government would collect more than $200 billion in additional revenue
in 2004.
Principle 3: Simplicity. In a complicated world full of would-be
tax avoiders and their highly paid advisors, no tax system can be
completely simple. But a tax system that is generally understandable
and that is devoted to raising revenue fairly would be much simpler
than the one we have today. Unfortunately, the past decade or so has
seen rapid growth in tax complexity, largely because lawmakers have
chosen to use the tax code as a vehicle for numerous programs unrelated
to fair tax collection. Some of these ``tax expenditures'' have noble
goals; others would never be seriously considered if they were proposed
as part of the regular budget process. But all these programs make tax
filing and tax enforcement far more difficult than they need to be.
Principle 4: Economic efficiency. Most of us would be reluctant to
endorse central planning as an ideal economic system. Instead, we'd
probably insist that letting market forces drive consumer and business
decisions is usually the best way to maximize our economic well-being.
Virtually the entire economics profession agrees. But our tax code is
increasingly becoming an ad hoc tool of central planning, as we lard
the code with more and more ``incentives'' to shift economic activity
into areas that have gained congressional favor. In contrast, an even-
handed, level-playing-field tax code without favoritism for some
business activities over others would improve the allocation of capital
and enhance economic growth.
II. TAX REFORM PRINCIPLES IN ACTION:
A fair, revenue-sufficient tax code is certainly difficult to
achieve, but history shows us that it's not impossible. In fact, we
came rather close to having such a tax code for a brief period a decade
ago, due to the efforts of President Reagan, President Clinton, and to
a lesser degree, the first President Bush.
After a dismal start with his loophole-laden, budget-busting 1981
tax act, President Reagan dramatically shifted gears. For the rest of
his time in office, he devoted his tax policy primarily to closing
unwarranted loopholes and boosting revenues. Reagan's tax reform drive
began with the loophole-closing 1982 tax bill and reached its
fulfilment in the 1986 Tax Reform Act.
To be sure, Reagan's post-1981 tax changes did not come close to
bringing revenues in line with spending, nor did they fully restore the
progressivity that the 1981 act had sharply eroded. But the tax code
Reagan bequeathed to his successors was as close as our country may
have ever come to a horizontally equitable, simple and economically
efficient tax system. Its major flaw was that its upper-income tax
rates were much too low.
Reagan's successors, the first President Bush and President
Clinton, retained most of the Reagan reforms, at least initially, while
addressing the continuing revenue problem. Bush I increased the top
income tax rate in 1990, although he unfortunately resurrected the
Reagan-repealed capital gains tax loophole at the same time. President
Clinton further increased the tax rates on the highest earners in his
1993 legislation. When incomes boomed at the top of the income scale in
the second half of the nineties, those higher tax rates helped give us
our first balanced budgets since 1969.
I suggest that would-be tax reformers take the Reagan tax code of
1986, supplemented by the Clinton tax rate hikes of 1993, as an
excellent paradigm for future fundamental tax reform. (Most of what's
happened to the tax code since 1993, on the other hand, I suggest you
spurn.)
III. FALSE PATHS TO REFORM:
On the other side of the tax reform issue are those who totally
repudiate the Reagan-Clinton legacy. Specifically, they would scrap the
progressive income tax in favor of a flat-rate consumption tax. One
version of this approach calls for a high-rate national sales tax.
Another is the flat-rate wage tax promoted by former president
candidate and publisher Steve Forbes along with former House Majority
Leader Dick Armey.
These and similar proposals are designed to drastically reduce
taxes on the wealthiest people, both by lowering their tax rate and by
exempting a large share of their income from tax. The plans would also
increase taxes dramatically on middle- and low-income Americans,
especially if they came even close to raising enough money to pay for
the government.
Proponents of consumption taxes often argue that their plans would
discourage consumer spending, promote savings and thereby increase
long-term economic growth. But unbiased experts who have examined these
claims generally find little if any economic improvement from switching
to a regressive tax system. Indeed, since these consumption tax
proposals would require tax rates that are implausibly high to avoid
even bigger deficits, their net effect would probably be to reduce
total national savings.
IV. CONCLUSION: CURRENT PROSPECTS FOR REFORM
I wish I could reasonably hope that the current management in the
White House and Congress will rush to repeal the Bush tax cuts, crack
down on offshore corporate tax sheltering, reinstate the estate tax and
otherwise take us back to the days when a fair, progressive tax system
paid the government bills and even started to reduce the national debt.
But despite my pessimism that you'll listen to my advice, I do
recommend that you take all these steps.