[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

                              ----------                              

                                                                   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

                              ----------                              


                      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.
  

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