    [Senate Hearing 108-6]
    [From the U.S. Government Publishing Office]

                                                              S. Hrg. 108-6

                                 TAX FAIRNESS:
             DOES DOUBLE TAXATION UNFAIRLY TARGET OLDER AMERICANS?

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

                                    HEARING

                                   before the

                           SPECIAL COMMITTEE ON AGING
                              UNITED STATES SENATE

                          ONE HUNDRED EIGHTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 WASHINGTON, DC

                                   __________

                                FEBRUARY 4, 2002

                                   __________

                                Serial No. 108-2

             Printed for the use of the Special Committee on Aging

                           U. S. GOVERNMENT PRINTING OFFICE
    85-624                          WASHINGTON : 2003
    ____________________________________________________________________________
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                           SPECIAL COMMITTEE ON AGING

                          LARRY CRAIG, Idaho, Chairman
    CONRAD BURNS, Montana                JOHN B. BREAUX, Louisiana, Ranking
    RICHARD SHELBY, Alabama                  Member
    RICK SANTORUM, Pennsylvania          HARRY REID, Nevada
    SUSAN COLLINS, Maine                 HERB KOHL, Wisconsin
    MIKE ENZI, Wyoming                   JAMES M. JEFFORDS, Vermont
    GORDON SMITH, Oregon                 RUSSELL D. FEINGOLD, Wisconsin
    JAMES M. TALENT, Missouri            RON WYDEN, Oregon
    PETER G. FITZGERALD, Illinois        BLANCHE L. LINCOLN, Arkansas
    ORRIN G. HATCH, Utah                 EVAN BAYH, Indiana
    Elizabeth Dole, North Carolina       THOMAS R. CARPER, Delaware
    TED STEVENS, Pennsylvania            DEBBIE STABENOW, Michigan
                   Lupe Wissel, Ranking Member Staff Director
                        Michelle Easton, Staff Director

                                      (ii)

                                C O N T E N T S

                                  ----------
                                                                       Page
    Opening Statement of Senator Larry E. Craig......................     1
    Statement of Senator John Breaux.................................     3
    Statement of Senator Orrin Hatch.................................     4
    Statement of Senator Gordon Smith................................    27
    Statement of Senator Thomas Carper...............................    50
    Statement of Senator James Talent................................    83

                                    Panel I

    Hon. Glenn Hubbard, Chairman, President's Council of Economic
      Advisors, Washington, DC.......................................     6
    Hilary J. Kramer, Senior Strategist and Advisor, Montgomery Asset
      Management, and Business Commentator, Fox News Channel, New
      York, NY.......................................................    30

                                    Panel II

    Dick Buxton, Boise, ID...........................................    55
    Dan Mitchell, McKenna Senior Fellow in Political Economy, The
      Heritage Foundation, Washington, DC............................    60
    W. Mark Crain, Director, Center for Study of Public Choice, and
      Professor of Economics, George Mason University, Fairfax, VA...    70

                                     (iii)

      TAX FAIRNESS: DOES DOUBLE TAXATION UNFAIRLY TARGET OLDER AMERICANS?

                                  ----------

                           TUESDAY, FEBRUARY 4, 2003

                                           U.S. Senate,
                                    Special Committee on Aging,
                                                        Washington, DC.
        The committee convened, pursuant to notice, at 10:05 a.m.,
    in room SD-628, Dirksen Senate Office Building, Hon. Larry
    Craig (chairman of the committee) presiding.
        Present: Senators Craig, Smith, Hatch, Talent, Breaux, and
    Carper.

         OPENING STATEMENT OF SENATOR LARRY E. CRAIG, CHAIRMAN

        The Chairman. If the room would come to order, let me
    convene this U.S. Senate Special Committee on Aging. Before we
    start the hearing this morning, this is a difficult day in our
    country and I would ask that you join me in a moment of
    silence.
        [A moment of silence was observed.]
        I thank you very much for that. It is a difficult morning
    in America, but those seven who lost their lives on Saturday
    that we honor and recognize today at the Johnson Space Center
    in Houston would be the first to tell us it is important to get
    on with life and for this country to continue to function so
    well and to be able to properly deal with the problems that it
    faces, and that is, in part, what this hearing is about today.
        I have been joined with my colleague, Senator Breaux, who
    has chaired this committee for the last nearly 2 years and we
    have worked very cooperatively on a variety of issues. This is
    one, as I began to delve into it, that I found absolutely
    fascinating and appropriate for this committee to deal with.
    Why? Because I really do believe it speaks to the issue of
    double taxation, and after I have looked at this, the method by
    which double taxation unfairly targets older Americans.
        We are pleased to have some of the nation's top economic
    experts testifying on what impact double taxation has on our
    senior citizens, with a particular eye on the President's tax
    relief plan. I look forward to their testimony.
        When you study the tax code, it becomes apparently clear
    that older Americans, both working and retired, are subject to
    double taxation more than most other age groups. The question
    we hope to explore today is whether the rhetoric about tax cuts
    for the rich is really about tax relief and fairness for our
    seniors.
        Older Americans are more likely to hold investments in
    assets that pay dividends than other age groups. Millions of
    seniors, many on fixed incomes, rely on dividend income to make
    ends meet from month to month. The pie chart to my right, your
    left, shows that 52 percent of seniors receive taxable income.
        Ironically, my wife is en route back from Tucson this
    morning, where she has spent the last 4 days with her 85-year-
    old mother, who is now a widow living in a retirement community
    in Tucson. She was a nurse all of her life. Her husband, my
    late father-in-law, was a career military person. They were not
    wealthy, but they were frugal and they cautiously and quietly
    invested all of their lives for their retirement. I asked my
    wife this morning, when she had taken all of the materials with
    her mother over to the tax accountant these past few days,
    about how much of Shirley's income is going to be dividends. My
    wife said, ``Over 50 percent.''
        It is interesting that that work is being done now as we
    get ready to visit our accountant and pay our taxes, that the
    pie chart and the studies really are reflective of a good many
    seniors across this country, and I will tell you that my
    mother-in-law, like many in our country, does not classify as a
    wealthy person. But most assuredly, she receives a large share
    of her income from the very issue we talk about today.
        The Cato Institute recently published data from the
    Organization for Economic Cooperation and Development showing
    dividends and corporate tax rates around the world. The bar
    chart to my right, your left, is a summary of the Organization
    for Economic Cooperation and Development data. The U.S. has the
    second-highest combined Federal, State, and local dividend tax
    rate in the world. The chart begs the question, why would any
    company pay a dividend under these stifling tax rates? We hope
    to hear from our witnesses on this question.
        I also find it ironic that we are second from the top and
    the top is Japan, and Japan for the last decade has struggled
    to try to get its economy going and get investment back into
    it.
        Older Americans are also subject to double taxation by the
    Federal Government in the form of the death tax and the
    taxation of Social Security benefits. The death tax has forced
    the break-up of family farms and the sell-off of small
    businesses in order to pay the government after death. It is
    unfair to tax a person's savings and earnings twice while they
    are alive, but it is immoral to tax those life savings again,
    in my opinion, when a person dies.
        Today's seniors already pay income taxes on their payroll
    taxes when they work, and now a growing number of modest and
    middle-income seniors must pay income taxes again on already
    taxed Social Security benefits. For many seniors, 85 percent of
    their Social Security benefits are taxed. This tax is a
    disincentive for seniors who want to work.
        I am looking forward to the testimony from the Chairman of
    the President's Council on Economic Advisors who is with us,
    Glenn Hubbard, and also Hilary Kramer of Montgomery Asset
    Management, a regular business expert appearing on Fox News, as
    our first panel.
        Our second panel will be Dick Buxton, one of my
    constituents, who will describe the impact of double taxation
    on his family in Idaho. Also testifying are Dr. Dan Mitchell, a
    tax reform expert from the Heritage Foundation, and Dr. Mark
    Crain, a Professor of Economics at George Mason University and
    a Trustee for the Virginia Retirement System.
        We look forward to hearing more about these issues from our
    panels of witnesses, and so I welcome them.
        But before I turn to the panels, let me turn to my
    colleague John Breaux from Louisiana, who has been an outspoken
    and appropriate leader for the senior community for a good
    number of years.

                    STATEMENT OF SENATOR JOHN BREAUX

        Senator Breaux. Thank you, Mr. Chairman. I will try to be
    very brief. I think it is appropriate that we look at tax
    recommendations on a regular basis, particularly to determine
    whether the tax code targets any group of Americans unfairly or
    differently from others, and I think that the purpose of the
    hearing this morning is to look to see if there are problems in
    the existing code which unfairly treat seniors.
        The fact is, on Social Security taxes, the benefits of most
    recipients are not taxed. Most seniors who are retired do not
    pay taxes on their Social Security income because you don't
    start paying it until you reach a certain threshold. The 85
    percent taxation coverage only kicks in when seniors have a
    single income in retirement of over $34,000, or $44,000 for a
    couple. The average income in Louisiana for working people is
    about $22,000 a year. That is for working people, so for
    retired people, it is much less than that.
        So most of the benefits of people who get Social Security
    are not taxed. Some are. The concept is that there should be
    taxation of those benefits that exceed the contribution of an
    individual that they have placed in over their working years.
    Congress has determined back, I guess, in 1993, that that was
    an appropriate request for seniors who reach a certain income
    level in requirement to help shore up the Social Security
    system, which, if you have seen the projections on the
    difficult situation that it is in, as well as the Medicare
    program under the HI portion of the Social Security tax. So it
    is appropriate that we can look at this, but we also need to
    keep it in proper perspective.
        The second portion is the double taxation of dividends. I
    think as a policy measure, double taxation is not a good idea.
    Having said that, over half of the President's tax proposal is
    addressing this problem, which originally was a proposal to
    stimulate the economy. Almost every economist that we have
    talked to has indicated both publicly and privately that
    elimination of the double taxation on dividends is not going to
    be short-term stimulative to the economy. Is it correct policy
    in the long term? The answer is probably yes and I think we
    need to take a look at it in that vein.
        But at the same time, I would point out that in my State,
    which a lot of other States fall in the same category, only 8
    percent of the people in my State of Louisiana are subject to
    any tax on dividends at all, 8 percent, IRS figures. So we are
    going to spend $374 billion on a program that 92 percent of the
    people in Louisiana don't pay taxes on anyway. Now, is that
    good tax policy? Maybe. Is it worth over half of the total
    package? I question it. Does it stimulate the economy? The
    answer is no.
        So these are all questions that are appropriately being
    discussed here today and we need to hear both sides of the
    issue and I thought that is why I would say what I said. Thank
    you.
        The Chairman. John, I appreciate those comments and your
    frankness and the openness. That is the value of this committee
    and the purpose of hearings, to build an objective record on
    this important issue.
        We have now been joined by my colleague, the senior Senator
    from the State of Utah, Orrin Hatch. Orrin?

                  STATEMENT OF SENATOR ORRIN G. HATCH

        Senator Hatch. Thank you, Mr. Chairman. I want to welcome
    both of you here. We appreciate both of you being here. Dr.
    Hubbard, I have watched your career down at the White House and
    I think you are doing a terrific job. I think as one of the
    designers of the President's tax program, you have made some
    bold moves here that I think could make a real difference in
    our society.
        I am appreciative, Mr. Chairman, of you scheduling this
    hearing today. I am new to this committee and I look forward to
    working with you and Senator Breaux on the issues that matter
    to Utah's seniors and seniors all over the country.
        I am especially glad we are here today discussing the
    double taxation of senior citizens. Millions of older Americans
    pay far too much in taxes, and this year, we are going to cut
    those taxes. Our nation's seniors spent decades working long
    hours, scrimping and saving for their well-deserved retirement,
    only to find that no matter how old they get, the tax man still
    has seniors in his sights. Age springs wisdom, but not tax
    relief, and this year, I want to help the President change
    that.
        President Bush wants to cut income taxes for seniors. He
    wants to lower their marriage penalties, and he wants to
    eliminate the double tax on their dividends. I think this is
    the right plan for America's seniors as well as everybody else.
        This hearing examines the double tax on dividends. Over
    half of all income tax filers over 65 years of age pay tax on
    dividends, and over one-third of all filers between age 55 and
    age 64 have taxable dividends. Millions of people saving for
    retirement, close to retirement, or working for an early
    retirement are also paying these double taxes. Right now,
    corporations give more than a third of their profits over to
    the government in taxes, and then we demand that when investors
    get their share of these profits in the form of dividends, they
    have to pay income tax on it again. As President Bush keeps
    reminding us, taxing income once is fair, but taxing it twice
    is not fair.
        Mr. Chairman, this is not a question of rich versus poor.
    Elderly Americans with modest incomes receive substantial stock
    dividends. In fact, more than half of all tax filers over the
    age of 65 earning between $30,000 and $40,000 per year receive
    taxable dividend income. Because our nation's senior citizens
    have been so thrifty during their lives, these dividend
    payments are sizable. Seniors who receive dividends and earn
    between $30,000 and $40,000 per year in total income receive an
    average of over $2,000 per year of that income as taxable
    dividends.
        Further, ending the double tax on dividends will decrease
    the risk of bankruptcy and improve corporate accountability.
    Over my years of public service, I have met far too many
    seniors who have lost part or all of their savings because the
    companies that they invested in went bankrupt. Last year, we
    enacted tough corporate accountability reforms to help
    strengthen our nation's capital markets. This year, we should
    enact the President's corporate reform tax cut to finish the
    job. America's seniors will be rewarded with safer investments
    and a more secure retirement.
        I am very interested in this issue, but unfortunately, my
    duties are not going to permit me to stay at all here because I
    have got to be over in the Capitol in just a few minutes, but
    let me just say one thing. I have got an analysis that says
    this more than $300 billion revenue loss from the dividend plan
    would be more than made up over the years and that if you use
    any kind of scoring total besides static analysis, the country
    would wind up actually benefiting, not only because we wouldn't
    be paying double taxation, but because, in essence, Treasury
    would get as much revenue anyway.
        I remember when we were arguing for capital gains rate
    reductions on the Hatch-Lieberman bill in 1997. The argument
    against it was, using a static analysis, that we were going to
    lose revenues. Our argument was, the Treasury wouldn't lose
    revenues and we would probably gain revenue. Well, a study by
    DRI, not a conservative econometric modeling firm, concluded
    that, yes, we didn't lose revenues, that we slightly gained on
    the capital gains rate reduction.
        I suspect removing the double taxation of dividends is
    going to have a similar effect over time. So I would be
    interested in knowing what you feel about that, both you, Ms.
    Kramer, and you, Dr. Hubbard, because I think sometimes people
    around here using static analysis are wrong. In fact, many
    times, they are wrong. Now, I think we could go too far in
    using a dynamic analysis, too, but there ought to be something
    in between that acknowledges that there is some dynamism in the
    economy that will work in favor of tax rate reductions.
        I just want to compliment both of you, but especially you,
    Dr. Hubbard, for the work you are doing down there at the White
    House. It isn't easy to make these type of decisions. It isn't
    easy to promulgate them. It is certainly not easy to win on
    them, but I intend to see that you win this year and I just
    hope that we can.
        Thanks, Mr. Chairman. If you will forgive me, I had better
    get over there.
        The Chairman. Orrin, thank you very much, and in the course
    of their testimony, it is possible that Mr. Hubbard could
    respond to your query. But I do thank you for coming this
    morning.
        Now let us turn to our first panel. I had mentioned in my
    opening comments their introduction. Dr. Glenn Hubbard is
    Chairman of the President's Council of Economic Advisors, and
    as I think Senator Hatch has said, ``He has worked with the
    President to put forth a daring tax reform stimulus package
    that is now before the Congress and will clearly be before us
    soon.''
        Again, this morning, we want to focus on the impact on the
    senior community, a community of fixed-income Americans who vie
    with inflation and a variety of costs in which they and we all
    live, but unlike us, in many instances, their incomes are
    fixed.
        Second on the panel is Hilary Kramer, a Senior Advisor and
    Strategist at Montgomery Assets Management and Business
    Commentator for Fox News Channel.
        We welcome you both. Dr. Hubbard, please proceed.

    STATEMENT OF HON. GLENN HUBBARD, CHAIRMAN, PRESIDENT'S COUNCIL
                  OF ECONOMIC ADVISORS, WASHINGTON, DC

        Dr. Hubbard. Thank you very much, Mr. Chairman, for holding
    this hearing, and thank you, Senator Breaux. I think this is an
    extremely important topic that you have raised, Senator, and
    the implication for seniors.
        What I want to do in my oral remarks is really just focus
    on a couple of things with you. One, to go over the questions
    you asked directly about seniors in your remarks, but also to
    tell a little story of why I think this is economic policy that
    the Aging Committee should be concerned with going long-term,
    as well, and to get at the issue of why, if you never receive a
    dividend check, this is still very much in your interest.
        To start, of course, with what the President was trying to
    accomplish, the President in his Jobs and Growth Initiative was
    trying to provide near-term growth insurance for the economy
    while also being consistent with very good long-term tax
    policy. This policy toward bolstering the economy in the short-
    term and the long-term, we believe, helps America's seniors in
    important ways.
        To start with, as you made, Mr. Chairman, the point in your
    opening remarks, ending the double tax on corporate income
    directly benefits seniors who receive dividend checks. About
    half of all the dividend income in the U.S., whether it is
    measured just as total dividends or dividends that would be
    excludable under the President's proposals, goes to America's
    seniors, who often, as you indicated in your example, Mr.
    Chairman, rely on those checks for a steady source of
    retirement income.
        It is also important to note that even among seniors, low-
    and moderate-income seniors benefit. About 40 percent of
    seniors with incomes below $50,000 receive dividend income,
    and, of course, seniors generally benefit from overall relief.
        But just as important as this increasing after-tax income
    is for seniors and reducing double taxation, it is important to
    tell a story of why this is so much in our economy's interest.
    When we double tax something, like double taxing corporate
    income, the burden gets borne somewhere, and surprisingly, who
    pays it is all of us. It is not just who gets dividends, but
    all of us in terms of our wages.
        To see this, if we double tax corporate income, we raise
    the tax burden on capital, we get less investment in our
    economy, and ultimately lower wages for all of us. For this
    committee, Mr. Chairman, as you think about aging policy, there
    is no variable more important for the long-term integrity of
    the Medicare program or the Social Security program than our
    economy's capacity to grow. These are very important long-term
    issues for seniors.
        There is an important long-term piece of good news to start
    out with, as well. The American economy has very strong
    fundamentals. Those don't come from the sky. They result from
    the flexibility of the American private sector and from public
    policies that try to promote flexibility in capital
    accumulation in the consumer.
        To get to the here and now reasons the President was so
    bold in his growth package, I think it is important, if I
    might, Mr. Chairman, to say a bit about the current economic
    situation. We all know where we are and we all know that events
    of over-investment in the late 1990's, the terrible tragedy of
    September 11, corporate governance scandals, have placed a
    cloud on the nation's economic activity and recovery. A good
    chunk of what makes this particular episode in our economy
    different is the pattern of business investment.
        In a typical recession and recovery, investment drops and
    then sharply rebounds. In the current recovery, we are seeing a
    lagged and delayed recovery of investment. As I travel across
    the country talking to business people, as I am sure you do, as
    well, you hear stories of very high hurdle rates, very high
    bars placed on new investment, and this is really a key drag to
    our economy. The uncertainty surrounding the recovery,
    uncertainty surrounding tax policy, is a key risk to the
    outlook, as well as consumers deciding, perhaps, to increase
    their saving a bit in the near term in response to declines in
    equity values.
        In response to these downside risks, the President put
    forth a growth package which would shore up consumer incomes,
    the acceleration of the marginal rate cuts you have already
    enacted, increasing small business investment incentives
    through expensing, and importantly, eliminating the double tax
    on corporate income, not just on dividends, but on corporate
    income generally.
        We believe that these proposals will help the economy a
    great deal in the near term. To those who say that the
    corporate income double taxation has no short-term effect, I
    beg to differ. Most of my professional career has been spent
    studying investment, and I believe it is fair to say that the
    bulk of research on this topic would suggest very large effects
    on the cost of capital of what the President is doing.
        To be concrete, were the President's proposal to be enacted
    by you in its entirety, the cost of capital for investment
    could fall by as much as 10 to 25 percent, depending on the
    life of the equipment we are talking about, and that is
    equivalent to an investment tax credit of between 4 and 7
    percent. That is very big. This is perhaps the most radically
    pro-investment tax policy in decades.
        In addition, of course, the President remains very focused
    on job creation in the short run. The President's proposal
    would get $58 billion into the economy in 2003, and that is the
    down payment on a long-term tax cut with very large projected
    responses from consumers.
        I think it is important to close, if I might, again with a
    couple of longer-term obligations. One, of course, ultimately,
    economic policy, whether it is in the short-term or the long-
    term, has to be about our economy's fundamentals. The best way
    to tax capital from a purely economic perspective is not to tax
    it at all, and again, the reason for this has little to do with
    who gets dividends, although that is important, too, and
    everything to do with all of our wages. The person who writes
    the check to the IRS is not the person bearing the burden of
    the tax.
        The final point I would raise is there is caution, and
    rightly so, as we think about the nation's fiscal health going
    forward. The President's budget remains very committed to
    restoring fiscal health through pro-growth tax policies and
    through spending restraint. It is important to look at a fiscal
    anchor, and to me, as an economist, a good fiscal anchor is our
    country's debt-to-GDP ratio, which, again, is not rising as a
    consequence of the President's proposals.
        Are the current deficits welcome? No, of course, they are
    not. Are they understandable? We know they are, and the
    administration's pro-growth plans have a way to get out of
    them.
        I will just close with you, Mr. Chairman, with the
    observation that were the President's proposals to be enacted,
    we believe the level of GDP would rise by almost a percentage
    point in 2003, and by the end of 2005, be close to 2 percentage
    points higher and remain so. So going back to Senator Hatch's
    observations when we started, this is a permanent feedback in
    Federal revenue from higher economic growth.
        Thank you very much, Mr. Chairman.
        The Chairman. Dr. Hubbard, thank you.
        [The prepared statement of Mr. Hubbard follows:]
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        The Chairman. Ms. Kramer, before we turn to you, let me
    turn to my colleague from Oregon who has just joined us for any
    comments he would make to make in opening statement, Senator
    Gordon Smith. Gordon?

                   STATEMENT OF SENATOR GORDON SMITH

        Senator Smith. Thank you, Mr. Chairman. I am pleased to be
    here and honored to be on this committee. I think the topic we
    are discussing today is very important because of the simple,
    logical conclusion you can reach, that if you tax something,
    you will discourage it, the activity you tax, and if you tax it
    twice, you will doubly discourage it. I think whether it is
    dividends or taxing Social Security twice, which is another
    double taxation in our system, we ought to, as a matter of
    whether you call it stimulus or just to improve tax policy, we
    certainly ought to pursue this.
        For several Congresses now, Mr. Chairman, I have introduced
    a bill that ends the double taxation on Social Security
    benefits that was begun in the Clinton Administration in 1993.
    My colleagues probably know that senior citizens pay Federal
    taxes on a portion of their Social Security benefits if they
    receive additional income from savings or from work, and this
    is something that if we are serious about helping seniors to be
    able to provide for themselves, we ought to end this practice
    and encourage work and encourage saving. I am going to
    introduce that bill again in this Congress, Mr. Chairman, and
    certainly invite my colleagues' support and cosponsorship.
        I have a more lengthy statement I would like to include in
    the record, Mr. Chairman. In the interest of time and hearing
    Ms. Kramer, I will just do that and look forward to her
    testimony.
        The Chairman. Thank you very much, Senator.
        [The prepared statement of Senator Smith follows:]
        [GRAPHIC] [TIFF OMITTED] 85624.019

        [GRAPHIC] [TIFF OMITTED] 85624.020

        The Chairman. Now, let me turn to Ms. Hilary Kramer, who,
    if you have caught her on Fox News, is an open critic, an
    outspoken critic of double taxation, and so we thank you very
    much for being with us. Please proceed.

     STATEMENT OF HILARY J. KRAMER, SENIOR STRATEGIST AND ADVISOR,
    MONTGOMERY ASSET MANAGEMENT, AND BUSINESS COMMENTATOR, FOX NEWS
                         CHANNEL, NEW YORK, NY

        Ms. Kramer. Thank you. Mr. Chairman and members of the
    committee, I am very, very thankful that you invited me to
    testify on the relationship between corporate governance and
    the double taxation of dividends. It is extremely important at
    this moment in our nation's history that we take care of
    abolishing the double taxation on dividends because it is
    contributing to problems with corporate governance and we
    cannot once again go through another round of WorldCom, Enron,
    Adelphia. We cannot afford that and we need to see our stock
    market come back up.
        But most important, we need to protect senior citizens and
    give them another option, and the option is--the option would
    be dividend-yielding stocks, and this gives them as asset that
    can grow and income going forward.
        How does it work today? Today, we encourage companies to
    keep the money they have earned. Instead of issuing dividends
    to shareholders, what we do is we have this inefficient system
    in which senior management has been able to exercise creative
    control over the financial results they report to the public
    and has provided them the freedom to stray and wander away from
    their core competencies. Abolishing the double taxation on
    dividends is about keeping companies honest, competent, and
    resourceful and allowing shareholders to enjoy the financial
    returns that they deserve as owners of the companies.
        With a reduction in the taxation of dividends, the interest
    of corporate management would become better aligned with the
    interest of shareholders. Right now, the way it works, a
    significant portion of management compensation in companies
    today is through stock option ownership rather than actual
    ownership of shares. Since an option holder doesn't receive a
    dividend but instead receives all his benefits, or her
    benefits, from the appreciation of the stock, the interest is
    to take extra cash in the company and try to invest it in
    whatever kind of enterprises could create the hype that could
    create a stock price to go up.
        Where have we seen this? Everyone can talk about United
    Airlines and U.S. Airways and talk about the fact that the
    aviation industry is broken and the model doesn't work. As far
    as I am concerned, United Airlines twice has made the same
    mistake. They took the money they made in the boom days of the
    late 1990's and they spent it on fractional jet aviation
    ownership companies, spent it on the Internet. They did it in
    the 1980's by deciding to become a hotel chain company, buying
    Westin, buying rental car companies. We can't see this happen
    again. It would have been much more beneficial if the money had
    been careful used and given to shareholders to decide if they
    wanted to go and rent a car. That is the way it needs to work.
        Moreover, companies also use the cash to buy back stock or
    simply to hoard it for future opportunities, like with
    Microsoft. In many cases, none of these actions is as good for
    shareholders as would be receiving a dividend and having the
    discretion to spend it as we need. But with the current
    punitive tax treatment of dividends, management has
    significantly less pressure to change this damaging and
    negative behavior.
        Finally, with the present double taxation of dividends,
    most companies have a major incentive to raise a significant
    amount of debt and, therefore, have unhealthy balance sheets.
    So it is not just companies going into bankruptcy because of
    accounting fraud, but you have companies that weren't prepared
    for the downturn and that is the problem. So companies like K-
    Mart, for example, and what we have seen in the retail space,
    Montgomery Ward, Bradley's, there is a whole list of them, and
    we keep hitting new records of bankruptcies across the board.
        The bottom line, implementing President Bush's tax reform
    proposal promises wide-scale impact on the stock market. It
    will help boost stock prices, encourage more responsible
    investing, strengthen corporate governance and responsibility,
    provide investors, especially senior citizens, with income, and
    with long-term ownership and the opportunity to make money
    because the stock itself can go up in value.
        Plus, we need to never have a stock bubble like we have now
    because we are still going through the correction and we are
    still paying the price today, and I am out there talking to
    people all the time and senior citizens especially are hurt.
    They are hurt, their portfolio is down, and many are broke.
    Just go to retirement areas. I was just in Palm Springs at a
    conference. I go to Florida. You know what? I see 85-year-old
    people at the cash register instead of enjoying the fruits of
    their labor and the work that they have done.
        Now, on the positive side, and I think it is important to
    end on the positive side, history proves to us that our country
    and our stock market is about dividend-paying enterprise, and
    when we look back--I took a look and I have done research and I
    have made analysis on this. If you look at companies that are
    around 50 years, 100 years, they pay dividends, where
    prosperity is integral to dividend-paying companies.
        For example, Johnson and Johnson, over 100 years old, a 1.5
    percent dividend yield. Bristol Myers, 4.8 percent. General
    Motors, 5.5 percent. J.P. Morgan Chase, 5.8 percent. Another
    point with this is the reason J.P. Morgan Chase is going to
    make it through their problems, through their clouds of
    uncertainty, is that shareholders know they are going to
    receive a check in the mail, and that is what matters at the
    end of the day.
        So dividends don't lie and it is very important senior
    citizens have other options besides a 1.5 percent C.D. Thank
    you. Thank you.
        The Chairman. Ms. Kramer, you lived up to expectations and
    we thank you very much for that.
        [The prepared statement of Ms. Kramer follows:]
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        The Chairman. Let us go through a round of questions with
    the panel and get your responses to a variety of our concerns.
        Dr. Hubbard, the President talked about how the proposal of
    ending the double taxation of dividends was especially good for
    seniors, and while I am not an investor in any major way, I do
    know that in studying it a bit, you hear investment advisors
    talk about active and aggressive investments during your
    earning years and as you become more senior, you shift your
    assets in your portfolio and you move to much more stable,
    secure investments and dividend-earning capacity. When you
    leave the job market, that is where the largest portion of your
    investment ought to be.
        My questions are, is that a true pattern with most seniors
    as they move toward retirement and as they shift their
    investment, and do you agree that these figures that I have
    offered that Cato has come up with are accurate as it relates
    to seniors and as it relates to investment dividend to their
    income? Last--that would be two questions. The other one would
    be, can you tell us the average dividend income and the average
    potential dividend tax savings per senior?
        Dr. Hubbard. Sure. Just to take up your questions in turn,
    Mr. Chairman, it is, of course, true that seniors, on average,
    have higher levels of assets because they have been saving for
    their retirement, and as you pointed out, often more
    conservative portfolios as they become elderly, which makes
    them particularly benefiting from the President's proposals.
        If you look at Treasury estimates of who is paying the
    dividend tax now, about $37 billion in dividends that are
    currently received by seniors would become tax-free. There are
    more than that received by seniors, but that much would be
    excludable. As you noted in your opening, more than half of the
    seniors are getting excludable dividends.
        It might interest you to know that if you look at the
    seniors making under $50,000, and then I will get to your more
    general question, roughly five million tax returns in that
    area, would still get about $1,500 in dividend income and save
    a few hundred dollars a year, and this is just the seniors
    making less than $50,000. Obviously, higher-income seniors
    would benefit more.
        If you look at the totality of what the President is
    proposing, the typical senior would get an average tax cut of
    about $1,400. So this is actually quite substantial.
        Your question about the OECD numbers, it is quite correct
    that for equity-financed investments, the U.S. has a punishing
    tax system. There is really no other country in the G-7 that
    fails to provide some sort of relief for double taxation, so
    this is a real problem. It shows up, as Ms. Kramer was saying,
    in biasing toward other kinds of investments that expose the
    economy to financial fragility. It makes our companies less
    competitive abroad as well as at home. So these are all very
    important issues the OECD study raises.
        The Chairman. I thank you.
        Ms. Kramer, while I am going to work mightily to keep this
    focused on the impact on seniors, because that is the guide and
    the direction of this committee, we also understand the impact
    of the economy on seniors and the reality of declined incomes
    for them. You have mentioned, and, therefore, having to shift
    lifestyles, and we are not talking about wealthy people, but
    people who have saved all of their lives to build a nest egg to
    gain those rewards, and then to have the difficulty of seeing
    them disappear and/or substantially be reduced.
        In your testimony, you have listed several critically
    important corporate governance advantages from the President's
    dividend proposal. Can you think of any disadvantages for
    corporate governance if Congress ends the double taxation of
    dividends?
        Ms. Kramer. No. There would be no disadvantage to ending
    it. The concern we keep hearing is concern about what would be
    lost in terms of tax revenue, but that would be more than made
    up for in terms of a stock market that would rise quickly, and
    we have lost $8 trillion dollars of wealth in the stock market,
    right? We have gone from $18 trillion to $10 trillion. We would
    make up that $300 billion and whatever possibly could be lost
    immediately.
        In terms of disadvantages, there are none on the corporate
    governance level because we would get everybody on the same
    page, the shareholder, senior management, and the boards of
    directors.
        The Chairman. You would still have in the economy,
    obviously, startups and venture capitalists and all of those
    kinds of things, and once that company began to grow and build
    its base and do all of that, and this is obviously showing my
    ignorance, I am assuming the transition occurs at a point of
    profitability and a strive to gain profitability.
        I am looking at Microsoft, sitting there with the hugest
    bucket of cash of almost any corporation in America, never
    having paid dividends. I found it fascinating that after the
    President's proposal, they are now talking about dividends. Is
    that a reaction to, or have they simply come to a point in time
    where to secure investment, they feel they have got to start
    rewarding the investor beyond stock value?
        Ms. Kramer. There is an absolute correlation, Senator,
    because Microsoft understands with their brilliant management
    team that with a tax cut, with the abolishing of the double
    taxation of dividends, investors will want to buy Microsoft
    shares to get that dividend. There is $43 billion that needs to
    be paid out.
        Also, Microsoft has lost money by, again, not sticking with
    core competencies. For example, they went and invested in a
    cable company in Brazil. Now, I would have much rather have a
    dividend than to know that Microsoft went, made this investment
    in a saturated market in an area where they couldn't make
    money, they have lost all their money, and me, as a shareholder
    in Microsoft, would prefer that dividend. Microsoft understands
    that, and Bill Gates, yes, he is to gain $100 million in taxes
    he won't have to pay, but so is the shareholder who owns one
    share, or the person who owns it through whatever pension fund
    they might have.
        The Chairman. Thank you. Let me turn to my colleague from
    Louisiana, Senator Breaux.
        Senator Breaux. Thank you, Mr. Chairman. I thank the panel
    for their presentation.
        Dr. Hubbard, you had indicated and were trying to make the
    case that the President's dividend tax elimination proposal
    would be good short-term stimulus to the economy. Alan
    Greenspan disagrees with you, and vocally and, I think, very
    strongly. While elimination of the double taxation on dividends
    is good tax policy in the long-term, which I agree, in the
    short-term, it is not stimulative at all. He points out that
    over 62 percent of dividends that are declared are not taxable
    now because of the fact they are going into pension funds,
    retirement funds, and tax-exempt funds.
        But on the question of short-term stimulus, I can't think
    of anyone that is probably more respected by Democrats and
    Republicans than Mr. Greenspan and he doesn't agree with your
    statement on it being a stimulus in the short-term. What would
    you tell him?
        Dr. Hubbard. Certainly, Senator, I think first to your
    point about the dividends that are received currently by exempt
    entities, what matters for the cost of capital asset prices is
    in econ-speak the marginal investor, and almost all the
    evidence we have in finance is that that is a taxable entity.
    So even if the bulk of dividends went to tax-exempts, that
    would have little to do with the pro-investment aspects of the
    argument.
        I suspect that a lot of this is over what the word
    ``stimulus'' means. It is certainly the case the President does
    not view government's job as fine-tuning the economy, and when
    people say the word ``stimulus,'' that often is what comes to
    mind. But go back to the diagnosis I mentioned that the
    President believed that was the problem, which was this delayed
    investment recovery. That is very much centered on hurdle rates
    and costs of capital, and there, eliminating the double tax has
    a very large effect on the cost of capital. I can't comment on
    remarks I didn't hear----
        Senator Breaux. OK. Well, let us assume that is what he
    said, for the sake of argument. Does the White House say that
    Alan Greenspan is wrong in his belief that dividend tax
    elimination is not short-term stimulus?
        Dr. Hubbard. Again, the way I would put it, Senator, is we
    believe that the dividend tax proposal lowers the cost of
    capital now and in the future.
        Senator Breaux. Is it short-term stimulus?
        Dr. Hubbard. I don't like the word ``stimulus.'' More
    importantly, the President doesn't because it has this fine-
    tuning feel to it. I think what we believe is that----
        Senator Breaux. When you all first proposed the program, it
    was a stimulus package. It was going to be short-term, it was
    going to be stimulus, and over half of it was going to the
    elimination of the double taxation on dividends. Greenspan says
    that is not short-term stimulus. Does the White House disagree
    with Mr. Greenspan?
        Dr. Hubbard. We believe that the dividend tax part of what
    the President is doing is good for the economy generally. It is
    good in the short-term, it is good for the long-term. In
    economic policy, you can't so nicely put things into short-term
    and long-term boxes. It is a policy that, over time, gets even
    better. So in that sense, it is a long-term policy. But it very
    much would be pro-investment in the short-term, as well.
        Senator Breaux. So you disagree with him, then, in that
    regard? If he says it is not short-term stimulative to the
    economy, the White House disagrees with him, then.
        Dr. Hubbard. Yes. I can't comment on words I didn't hear
    and terms that I wouldn't use, but I think what I can say to
    you is a very straight answer. We think this lowers the cost of
    capital in the same way that a quite significant investment tax
    credit would, and it is hard for me to believe that is not pro-
    investment today and in the future, and this, again, is coming
    from somebody who has studied this for many, many years.
        Senator Breaux. You sort of dodged the question.
    [Laughter.]
        You have done your best. I agree that the estimates that I
    have seen is that a large portion of the tax package does
    affect seniors, and I think that is a fact. It seems that
    nearly 15 percent of the total tax cut benefits, in what they
    are now calling a growth package as opposed to a stimulus
    package, go to filers who are over the age of 65. But while
    that, I think, is positive, it also has to be fair in who it
    goes to, and thus the concern that I have.
        I look at Louisiana, my State, and only 8 percent of the
    working people end up paying taxes on dividends. When you get
    to retired people over 65, the number drops exponentially lower
    than even 8 percent that are affected by any dividend tax
    elimination at all.
        The information I have seen is that about 14 percent of the
    total tax package benefits go to people who are over 65 with
    incomes over $1 million. I don't know if there is a single
    person in Louisiana that would fit that category. Maybe, but
    you could probably count them on one hand.
        Over 60 percent of the benefits in the total package go to
    elderly with incomes over $100,000. Now, my State has an
    average income of working people of about $22,000. We are
    talking about basically retired people, where over 60 percent
    of the benefits go to those who are retired making over
    $100,000 a year. From my standpoint, spending that much money,
    it has to hit the largest number of people possible.
        On the dividend income, nearly 43 percent of the benefits
    of the dividend exemption that go to elderly individuals go to
    those with incomes over $200,000, on the dividend exemption.
    Again, I don't know how many in Louisiana I have in that
    category, but I will tell you, you can count them on one hand
    or two hands, probably. It is not a lot.
        So I am just concerned that while we are spending a lot of
    money and it is affecting a lot of people--you point out that--
    you said that the average cut, I think, was almost $1,400, the
    average tax cut for seniors. The average cut for seniors, 13
    million elderly would receive a tax cut of about $1,384, but
    almost 80 percent of them will get less than that amount. We
    can play numbers and statistics and averages. If you take the
    average, that is probably true. But almost 80 percent would get
    less than the average, with about 40 percent getting something
    like $100 or less from the proposal.
        Now, I have laid out a lot of facts on the other side of
    what you have said and I would ask you to comment on them.
        Dr. Hubbard. Certainly, Senator. I think there are really
    two key responses to your question. One, just to play the
    traditional game of distribution tables, and I won't go through
    all the numbers. I think your question raises important
    points----
        Senator Breaux. Do you disagree with any of the factual
    numbers I used?
        Dr. Hubbard. Some of the numbers are----
        Senator Breaux. Which ones?
        Dr. Hubbard. Well, I can work with you on that because I
    have some Treasury data, but the patterns you are mentioning
    are accurate, but I would say two things. One, if you look at
    the distribution table as it is currently done in Washington,
    before and after the President's plan, it looks almost the same
    in terms of share of tax burden, because the President's plan
    has a great deal in it for low- and moderate-income families.
    But that is not the point.
        As I tried to say in my remarks, what is really surprising
    as the economic result here is when you spoke well of working
    people, you were exactly on the point. Who ultimately bears
    this tax is working people, even if they never get a dividend.
    This isn't about who gets dividends today. It is about the
    wages of everybody in the future, whether they are seniors or
    all of us as we are getting lower. That is the surprising
    result of economics. That is what the President is focused on.
    Yes, it affects seniors today, but the real issue here is our
    country's productivity and long-term growth. That, to me, is
    the biggest fairness question.
        Senator Breaux. That will be the argument. I mean, a worker
    that is making $22,000 in Louisiana is not going to feel that
    comfortable and feel that he is getting a lot of benefits from
    a retired person who has an income of over $200,000 getting 43
    percent of the dividend tax exemption value. That is not going
    to make that person with a family of four feel very good as he
    struggles, that I am going to really benefit because someone
    over 65 is getting 43 percent of the value of the dividend
    exemption and he is making over $200,000 in retirement income.
        Dr. Hubbard. But, Senator, you are not benefiting as a
    working person because the older, more affluent senior is
    getting dividend checks. You are benefiting because that is
    leading to greater capital accumulation in our economy and
    higher wages. I understand that that does not fit----
        Senator Breaux. I am going to bring you with me to sell
    that point in Louisiana and see what kind of reaction you get.
    [Laughter.]
        Thank you very much.
        The Chairman. Let me turn to my colleague, Gordon Smith
    from Oregon, but before I do, is that $22,000 a year working
    man or woman in Louisiana with a family of four paying any
    taxes under the current----
        Senator Breaux. Hopefully not. Some of the points of the
    President's package are good.
        The Chairman. Yes.
        Senator Breaux. I mean, the child exemption credit is good.
    The marriage penalty is good.
        The Chairman. Actually, that family gains more under the
    President's package than the seniors we are talking about here,
    the $1,400, if they are getting the child tax credits.
        Senator Breaux. I don't know the number on that. We could
    take a look at it. It is----
        The Chairman. Very close to it.
        Senator Breaux. The question, though, and the whole point,
    obviously, is fairness.
        The Chairman. Yes.
        Senator Breaux. If we are going to spend that much money on
    a dividend tax exemption, in my State of Louisiana, only 8
    percent pay any tax on dividends.
        The Chairman. OK. Let me turn to my colleague from Oregon,
    and then we will turn to Senator Carper if he wishes to make an
    opening comment. Gordon?
        Senator Smith. Thank you, Mr. Chairman, and I want to thank
    our witnesses for excellent testimony.
        To Senator Breaux's point about who pays taxes, it is a
    fact that many of these dividends, as they are currently going
    out, are already sheltered because they are in pension funds.
    They are sheltered until they are pulled out. So you could
    argue it is not stimulative in that sense right now.
        That raises for me a question I have had ever since this
    was proposed. I understand why, politically speaking, it makes
    a lot of sense to end the taxation at the individual level, but
    I wonder if you can comment as to the efficiency of markets,
    whether it makes more sense to end it at the corporate level
    and then perhaps give some of what we had before the 1986 Tax
    Act, some allowance for deductibility, though not full
    deductibility, to individuals. Is there a way to, in fact,
    increase the efficiency of this proposal? Ms. Kramer?
        Ms. Kramer. Senator, because the stock market, because the
    economy is all emotion, it is pure psychology, it makes sense
    that it really has to be on the individual level, because an
    individual investor has to feel the benefit of having more
    money in their pocket and that is the bottom line with that.
    Now----
        Senator Smith. Your point, I would assume, is even though
    the corporation still pays the tax----
        Ms. Kramer. The corporation----
        Senator Smith [continuing]. The board room will feel the
    heat because the shareholders will be demanding the dividends.
        Ms. Kramer. The shareholder will demand the dividend. The
    stock market needs to go back up. We need--we have very serious
    systemic problems right now, and if we don't fix them and we
    don't jump-start our economy, we are going to keep losing money
    out of our stock market.
        Yes, I agree that to a certain extent, corporations, if
    they were to have the exemption on terms of the tax, yes, they
    would start capital spending immediately. But no, if their
    stock price goes up, companies will be in a position to start
    engaging in capital spending. Two-thirds of the economy is the
    consumer, but the consumer is almost spent out. Interest rates
    are as low as they are going to go right now. How many more
    mortgage refinancings can we have? Everyone has whatever money
    they are going to have in their pocket and we need companies to
    spend.
        So your argument is well taken, but at the same time, we
    need people to get excited and we need that foreign money,
    also, back into our stock market, because it keeps going out
    and companies can't spend and we need them to invest in high-
    tech and get out there and upgrade all their systems.
        Senator Smith. Mr. Hubbard, did you all consider the
    corporate proposal as opposed to the individual proposal?
        Dr. Hubbard. Yes, Senator. I don't think it is politics so
    much as the principles in economics. If you think about it, if
    everybody paid the same rate of tax, say the corporate rate
    were the same as individual rates, nobody was tax-exempt
    anywhere, it really wouldn't matter in the simplest world
    whether you took the double tax away at the corporate level or
    the individual level.
        But, of course, there are a lot of tax-exempt and foreign
    shareholders and I think what the President said in his
    rhetoric is no double taxation. That means tax it once, not tax
    it not at all. To do that in the current environment would
    require individual relief. It also has the very important
    benefit that Ms. Kramer mentioned, which is in corporate
    governance. It really is a discipline to management to have to
    go to the capital markets to be monitored whenever new money is
    needed, to try to pay money out of corporate solutions.
        So I think the reasons to do it are entirely principled,
    although there are certainly good arguments for doing it at the
    corporate level, as well.
        Senator Smith. How about a combination of both? Was that
    ever considered?
        Dr. Hubbard. I don't think, again, you would want to do
    both in the sense that the goal here is to tax once and only
    once.
        Senator Smith. Hilary, you mentioned that we are competing
    against foreign nations, as well, and we have capital flight
    now, apparently. What is the policy in Europe, generally? What
    is the policy in Asia, generally, in terms of the taxation of
    dividends?
        Ms. Kramer. Well, we have the second-highest, the United
    States, taxation on dividends, only next to Japan. So Europe,
    the rest of the world, got savvy to this long ago, long ago.
        By the way, foreign companies that trade on our stock
    exchange, Senator, in the form of ADR, American Depository
    Receipts, they have gotten savvy to this. They are sort of
    looking from a distance and have realized the importance and
    significance that abolishing the double taxation dividend will
    have on raising their stock price, so they have jumped ahead in
    increasing their dividend. I have seen companies. Elbit
    Systems, Royal Dutch Petroleum, Unilever, British Petroleum,
    take a look at their dividend yields compared, let us say, ``To
    Exxon or Mobil and you will see that they know what is going on
    because they have experienced it themselves outside of the
    United States.''
        Senator Smith. I see this chart now. I think, Mr. Hubbard,
    you all have started a very important debate. I hope you will
    continue with it. Whether it is part of a stimulus package or
    not, I don't know at this point what is possible to get through
    the U.S. Senate, but eventually, this needs to happen for the
    sake of our markets and our system in the United States, in
    order to be competitive and, frankly, in order to pursue what
    will be much more productive tax policy. So if not in this
    Congress, I hope as soon as possible, and a lot of us are
    anxious to help you win this fight. Thank you.
        The Chairman. Thank you very much, Senator.
        Now let me turn to Senator Tom Carper of Delaware. Tom,
    welcome.
        Senator Carper. Mr. Chairman, good morning.
        The Chairman. Opening comment and/or questions, your
    pleasure.

                 STATEMENT OF SENATOR THOMAS R. CARPER

        Senator Carper. First of all, let me say welcome to both of
    you. We are delighted that you are here and we thank you for
    your testimony and for your response to our questions.
        Before I was a Senator, I was a Governor, and I was
    privileged to be Governor of Delaware for 8 years. I inherited
    an economy that was in recession and we came out of that and
    had eight very, very good years. I was Governor when it was
    easy to be Governor. I used to say, ``With an economy this
    strong, even I look like I know what I am doing most days,''
    and people would nod their heads and say, ``Yes, he does look
    like he knows what he is doing most days.''
        But we cut taxes, I think, 7 out of the 8 years I was
    Governor. We always had a litmus test for our tax cuts. One,
    they had to be stimulative to the economy, really, I think
    arguably, each time, create more jobs. We wanted to simplify
    the economy, so we didn't want to make it more complex; so that
    was another piece of our litmus test. I always wanted to make
    sure that the tax cuts were reasonably fair and broad-based.
    The last element of our litmus test was to say that we wanted
    to be able to sustain a balanced budget, so we didn't want what
    we were doing to unbalance our budget.
        I was elected State Treasurer back in 1976 at the tender
    age of 29. Pete DuPont was elected Governor that year. About a
    month or two later, we ended up getting the worst credit rating
    in the country. Pete DuPont's first State of the State message
    said Delaware is bankrupt, and he was trying to get the
    legislators to focus on the spending side. They really didn't
    focus that much, but the folks up on Wall Street focused a lot
    and they lowered our credit rating the next week to the lowest
    in the country, and we were crowded out of the credit markets.
        We had the worst credit rating in the country, tied for
    dead last with Puerto Rico. They were embarrassed to be in our
    company. When I stepped down as Governor, we had gotten a AAA
    credit rating, so I am somebody who thinks a little bit about
    these issues and have worked a little bit in these vineyards.
        I want to ask a couple of questions, and just be thinking
    about these. First of all, when we issued the debt in my State,
    we could issue it as a credit rating B-AA-1, which is what we
    were in 1977, to today having a AAA. As you might imagine, it
    makes a difference, what your credit rating is. One of the
    questions I want to ask, but not just yet, is what effect will
    the President's proposals have on issues of tax-exempt bonds,
    State, local governments, counties, cities, so forth, school
    districts?
        Second, I want to just kind of go back and look at the last
    couple of years. I say this not as an economist, because that
    is really your specialty, but I have studied a little bit in
    that area and I am fascinated by getting the economy moving and
    cycles, economic ups and downs.
        Mike Castle, who was our Governor, succeeded me as
    Congressman--I took his job in 1992 as Governor as we kind of
    swapped places. He now serves as our Congressman. We were
    invited back by the Delaware Business Roundtable last month to
    speak to them like we used to do when we were Governors. One of
    the questions I asked of all the CEOs there from Delaware
    businesses, including some pretty big businesses, I said,
    ``What do we need to be doing, Congressman Castle and myself,
    to help in our jobs in Washington to get the economy moving?''
    The President had just laid out his proposal and I was looking
    at them to comment on the proposal.
        They didn't really have much comment on the President's
    proposal, which had just literally been put on the table, I
    think, the day before. They talked a lot about uncertainty,
    though. They talked about the fact that while the elections
    were over, that uncertainty was behind us, the uncertainty with
    respect to Iraq, the uncertainty with respect to North Korea
    are still with us. We talked about the uncertainty that still
    flowed out of potential terrorist attacks or reprisals, whether
    we went to war with Iraq or did not.
        Several of them raised concerns about uncertainty with
    respect to the stock market and what were we going to do with
    the SEC, who is going to be the head of the SEC, will they be
    tough and will they restore investor confidence? A couple of
    them talked about Afghanistan.
        A number of them talked about health care costs and how
    their health care costs for their employees and health care
    costs for their pensioners were really hurting them on their
    bottom line and those were the issues they talked about. I
    couldn't get them to talk a lot about tax cuts, but they talked
    about those other issues and they really focused on
    uncertainty.
        We have cut taxes in 2001 by a fair amount. We cut them
    again by not as much in 2002, and the administration has come
    forward with another proposal to cut taxes in 2003. What I am
    hearing from some of our business folks is the idea of trying
    to do away with the double taxation of dividends, which I think
    is laudable could be done in a better way. Some folks say,
    ``You ought to let businesses expense their dividend payments
    just as they do their interest payments.'' So I am not sure
    what is the best way to do it, but I think in the context of
    overall tax reform, it actually makes pretty good sense.
        Some folks on my side, Mr. Chairman, complain about the tax
    cut proposal and say, ``Well, there they go again, unfair,
    class warfare, helps the rich, doesn't help the middle-income
    folks.'' As it turns out, wealthy people actually do pay a lot
    of taxes. If we are going to get some tax cuts, they are going
    to get some of the benefit, and I think it is hard to argue
    with that.
        That was kind of my opening statement, Mr. Chairman.
    [Laughter.]
        What I would now like to do is just ask a couple of
    questions, and I will go back to the first one and I will
    telegraph the others.
        The Chairman. The Chairman will be tolerant and lenient,
    especially in light of the last portion of your overall
    comments. [Laughter.]
        Senator Carper. Thank you, Mr. Chairman.
        The Chairman. Please proceed.
        Senator Carper. Thanks a lot. I want to ask you to take up
    with me the effect of the issue of tax-exempt bonds. States are
    struggling. My State is not in as bad of shape as some others,
    but some of the States are just getting killed right now and
    they are looking to us to help them on their health care costs,
    they are looking for us to help them fund No Child Left Behind,
    they are looking for us to help them on funding first
    responders and all that stuff. But talk first about the effect
    of this proposal, eliminating the double taxation of dividends,
    how will that affect issuers of tax-exempt bonds? When they
    come to us and say, ``God, help us, don't do that, that doesn't
    really help us,'' what do we say? What do you say?
        Dr. Hubbard. Let me start, if I might, with a story I told
    the Bond Market Association on the same question. Suppose we
    were all sitting in 1975 and I told you that I had perfect
    foresight, I could tell the future, what is going to happen to
    marginal tax rates over time, what is going to happen to
    financial innovation. If I told you that future and you were in
    the muni bond business, you would have grabbed your chest and
    run for the door because there would have been big see-saws and
    tax rates and----
        Senator Carper. What year?
        Dr. Hubbard. Nineteen-seventy-five, but you can pick
    another year if you like one better.
        Senator Carper. That is a good one.
        Dr. Hubbard. But just the notion there that there are major
    changes in tax rates that have not had overly adverse effects
    on the muni bond market.
        To your question, if you are a State, there are really
    three things at issue here. One are the yields on muni bonds.
    The second is the effect on your tax base if the Congress went
    along with the President's proposal and exempted dividends. and
    the third would be the effects on economic growth and State
    revenues. Let me start with the last and work back.
        We have estimated at the Council that State revenues would
    be higher by about $6 billion a year. Most States are a little
    more than one-for-one responsive to State income. We have done
    this State-by-State. I don't have Delaware on the top of my
    head, but I would be happy to get it for you.
        Muni bond yields, we feel, would go up by minimal amounts.
    The largest effects we have been able to get would be 10 to 15
    basis points, and that is from both the acceleration of the
    marginal rate cuts and eliminating the double tax, which is
    just to say our capital markets are very liquid, indeed. So I
    know this concern is raised and it is important to raise the
    concern, but it is also important to net that against growth
    effects that we believe are much, much larger.
        Senator Carper. All right, good.
        Ms. Kramer, any comment at all on this one? You can take a
    pass if you want.
        Ms. Kramer. Have you been to Knott's Berry Farm? It is an
    amusement park.
        Senator Carper. You know, I have not.
        Ms. Kramer. OK. The company is Cedar Fair----
        Senator Carper. California, right?
        Ms. Kramer [continuing]. Ticker FUN, F-U-N. Actually, they
    are based in Sandusky, OH, a 7.5 percent dividend yield, and a
    company that is 140 years old that has served six, seven, eight
    generations of families. When people go to Cedar Fair Park or
    Knott's Berry Farm, they are still going to drive on the roads
    and they are going to pay the tolls and they are still going to
    use whatever city services, State services. I mean, the pie is
    only going to get bigger. People are still going to buy
    municipal bonds. I am still going to have municipal bonds in my
    portfolio and I am still going to recommend it as an important
    part of everyone's portfolio core holding.
        Now, any issues with municipal bonds and any potential
    problems in the future, Senator, may not have anything to do
    with abolishing the double taxation on dividend. It is going to
    have to do with the fact that people are paying less State
    taxes because there are more people that are unemployed and
    there are companies that are not doing well and they are not
    selling their products as fast and as profitably as they had in
    the past. Thank you.
        Senator Carper. Thank you. The other question that I tried
    to telegraph, and let me just come back to it, and someone may
    have raised it before me, and if they have, I apologize, but
    there are a couple of different ways to skin this cat. Some
    have said, ``No, the way the President wants to do it is
    probably not the best way.'' The best way to do it is to allow
    corporations who have a dividend to expense those dividend
    payments like they expense their interest payments from their
    debt.
        Could you just comment for me, I am sure you considered
    that as an option, and just maybe the relative merits of either
    approach and why you chose the approach you have chosen?
        Dr. Hubbard. Sure. It did come up, but I would like to go
    over it again with you, with Senator Craig's indulgence.
    Basically, the Business Roundtable for the country, and I can't
    speak for the business people you spoke with, but the Business
    Roundtable has endorsed the way the President did his plan for
    removing the double tax, and I think from the President's
    perspective, this reflected a principled concern that you only
    want to tax income once. It turns out if that is your
    principle, you are really driven to do this at the individual
    level, because if you do corporate-level relief, you won't tax
    much of the income at all because it will simply flow to tax-
    exempt or foreign shareholders. So the President was very
    serious in sticking to that principle.
        It also provides very important corporate governance
    benefits, because facing the judgment of the capital market,
    paying out funds and having to go back to the capital market if
    you have a good project, is discipline that I think many
    corporate finance specialists would believe is heartily needed
    in corporate America.
        Obviously, removing the double tax is, we believe, very
    important. There are many ways to do it, but those were the
    principled reasons the President picked his way.
        Senator Carper. Maybe one last comment, Mr. Chairman----
        The Chairman. Please.
        Senator Carper [continuing]. I will be done. My mom is 80
    years old and she doesn't have much in the way of investments,
    but she has a few. She has Alzheimer's disease these days and
    she is not really cognizant of really what she has, but she has
    two grandsons. I will never be able to have this conversation
    with her because of her condition, but it would be interesting
    to ask her, Mom, how would you feel about not having to pay
    taxes on dividend income, or how do you feel about your
    grandsons paying more taxes further down the road because we
    have not done a very good job managing our budget deficits?
        I worry a whole lot about budget deficits. I know some
    people say they don't amount to much and it is not something we
    ought to be concerned about, but when we went as a country
    from, gosh, was it 1969 to, I want to say, ``1998 or 1999 and
    never had a balanced budget and finally got into a way of
    having balanced budgets again, which I thought was good--and I
    am not one who worships at the altar of balanced budgets.''
        Senator Craig and I, a long time ago in an earlier role, he
    and I worked very hard on a balanced budget amendment to the
    Constitution, almost got it approved in the House, not one that
    mandated a balanced budget every year, but one that said if you
    are going to unbalance the budget, you need a three-fifths vote
    in the House, three-fifths vote in the Senate. You need a
    three-fifths vote in order to raise the debt ceiling. By the
    way, the President had to propose a balanced budget, which I
    think is maybe the most important element of all. We got it
    close, but we didn't get it done.
        But I don't worship at the altar of balanced budget, though
    I think it is important. I am concerned as the CBO gives us the
    new budget estimates and deficit estimates for the rest of this
    decade that pretty much all we see is red ink and I find that
    troubling.
        The last thing I will say, ``I had a chat with Dan Crippen,
    outgoing CBO Director the other day, and we talked a bit about
    the impact of this proposal on the economy, or other tax
    proposals on the economy, and he put it in this context, which
    I thought was very interesting.'' He said, ``If you look at the
    economy for the next 10 years, it might be $10, $12, $14
    trillion--excuse me, $120, $140 trillion over the next 10
    years.'' He said, ``What you are looking at here is a tax cut
    of about $650 billion over the next 10 years.'' He said, ``Just
    to put it in context, and take $140 trillion versus $650
    billion, it is about a 65-cent change on $140, a 65-cent
    impact, not percent impact but cent impact, on $140.''
        He said, ``Sometimes we delude ourselves into thinking that
    the tax cuts that we make here are going to have some huge
    effect, but sometimes they really don't.'' They make us feel
    better. Maybe it is the psychology that Ms. Kramer talked
    about. Maybe psychology is a helpful thing for the economy. But
    in terms of actually stimulating the economy, a far better
    stimulus is probably resolving these uncertainties that we
    talked about, getting the price of oil down and having some
    certainty on the price and availability of energy.
        With that, I will say thank you. It was great to see you
    both and we welcome your presence here. It is just a real
    pleasure. I read a lot about you, Mr. Hubbard, and it is just a
    real pleasure to have a chance to actually meet you.
        Dr. Hubbard. Could I actually try to answer your question,
    if it is----
        Senator Carper. I didn't ask a question there, but----
    [Laughter.]
        Dr. Hubbard. You had an interrogatory----
        Senator Carper. But----
        Dr. Hubbard. With your indulgence, because you posed what I
    think is the best analogy when you raise the issue of your
    mother and grandchildren. The administration obviously shares
    the concerns about deficits, but the human element of this is
    very important because this isn't about dividend recipients. It
    is about the economy's future and economic growth, so that is
    precisely the right point. We believe that the wages and the
    incomes of her grandsons are going to be much higher as a
    result of what the President is proposing, and that is exactly
    what we are about.
        Dan Crippen is right. Economies are large. You don't steer
    battleships easily. But what you can do is set the right
    environment for growth, and that is what the President is
    trying to do.
        Senator Carper. My thanks to both of you. Mr. Chairman,
    thank you for your indulgence.
        The Chairman. Well, thank you, Senator. Tom is right. Both
    he and I partnered up in the House to aggressively advocate in
    the decade of the 1980's a balanced budget, and I must tell
    you, I was very pleased in the post-1994, 1995, 1996 period
    when we got there with the help of some fiscal responsibility
    here and some great growth in the economy. I must tell you, I
    would be the first to agree with you that a $307 billion
    deficit budget as proposed yesterday is very perplexing to this
    conservative Republican. We will work our way through it.
        Panelists, thank you so much for being with us today. Dr.
    Hubbard, we thank you, not only for your openness, but your
    insight into a broader aspect of double taxation as it relates
    to dividends that I think many people miss in the overall
    gaming of the issue. While this is a committee that deals with
    the concerns of aging Americans, we clearly know that a strong
    economy is the best that can ever happen to a senior citizen
    because it stabilizes all aspects of the world around them,
    including their income, and that is of real concern and
    importance to us, so we thank you.
        Ms. Kramer, thank you for your openness, your
    outspokenness, your advocacy, and keep up the issue of
    championing this cause. I think it is the right cause, and in
    this instance, for elderly Americans, it certainly is a very
    important cause. Thank you.
        The Chairman. Let us move now to our second panel. Please
    take a seat, gentlemen, and we will proceed.
        We will first start with Dick Buxton, a constituent of mine
    from Idaho who will describe the impact of double taxation on
    his family in Idaho.
        Then we will turn to Dr. Dan Mitchell, a tax reform expert
    from the Heritage Foundation.
        Last, but certainly not least in all of this discussion,
    Dr. Mark Crain, Professor of Economics at George Mason
    University and a trustee for the Virginia Retirement System.
        Gentlemen, thank you very much. Dick, please proceed.

                  STATEMENT OF DICK BUXTON, BOISE, ID

        Mr. Buxton. Good morning. My name is Dick Buxton and I am
    from Boise, ID. I am a graduate of the United States Naval
    Academy, Class of 1959, and have retired as manager from U.S.
    West, now Quest, and as a Captain in the Naval Reserve. Since
    retirement, I have worked several different businesses, to
    include teaching in the public schools. I wish to thank
    Chairman Craig and the other members of the committee for
    inviting me to testify about the issue of double taxation of
    seniors. Double taxation is basically immoral.
        We face double taxation on Social Security benefits. It
    used to be simple. Social Security was not taxed. But now,
    seniors pay a tax of 50 percent or 85 percent of income over a
    certain amount. This is not fair.
        Seniors also face double taxation on dividend income.
    Companies pay income tax and folks who receive dividends pay
    individual income tax on those same earnings, as well.
        I don't have a lot of dividend income, maybe a few hundred
    dollars a year. I also purchased IRAs and have some mutual
    funds. It is my understanding that IRA dividends will not
    benefit from the removal of the double taxation on dividends.
        But my 89-year-old father, who is a retired railroad
    switchman living in Caldwell, ID, depends on his dividends. He
    purchased stocks such as Idaho Power, energy stocks and utility
    stocks, and has income stocks to supplement his railroad
    retirement income. The removal of the double taxation on
    dividends will be of great benefit.
        My 91-year-old mother-in-law, a retired school teacher,
    also depends a great deal on her dividends. She has invested in
    utility and other dividend-paying stocks that provide a large
    portion of her retirement income. The removal of the double
    taxation on dividends will be of great benefit.
        Finally, when someone dies, the government taxes what might
    be left over. Making the tax-free limit of up to $600,000--I
    believe this is increasing, and Senator Symms was kind of
    involved in that when he was in the Senate, especially for
    people who own family farms and small businesses. Increasing
    the tax-free limit will help hold these farms and businesses
    together after the founder dies.
        There are reasons I support the President's proposal to
    give tax relief to all Americans. His plan should open the eyes
    of investors in stocks that the objective of business is to
    make a profit. In my view, a major cause of the stock market
    decline and the corporate breach of trust can be attributed to
    high degrees of speculation in tech stocks that were losing
    money. Companies that pay dividends usually have to make a
    profit, and most of these companies do make a profit.
        In the last few years, stocks were hard to follow. Illinois
    Power became Dynergy and went from a high-dividend stock to a
    stock with a big increase in stock value and later decimated.
    With the debacle of Enron, many stocks in energy trading and
    telecommunications were decimated. These stocks, for the most
    part, were highly speculative. With the elimination of the
    double taxation of dividends, analysts should be more honest in
    their stock evaluation endeavors and people purchasing stock
    should be more aware of the stocks they are purchasing.
        I am not an accountant, but I have made a point of doing my
    own taxes to more fully understand and be directly
    knowledgeable of the contents of my tax return. I also do my
    parents' return.
        Thank you, Senator Craig and the committee, for allowing me
    to testify.
        The Chairman. Dick, thank you for traveling from Boise to
    be here to testify. I think it is important to recognize when
    we talk about the impact on seniors, and there will be some who
    will speculate that this kind of double taxation issue will
    only affect the rich, I doubt that your retired railworker
    father, is it?
        Mr. Buxton. That is correct.
        The Chairman [continuing]. Views himself as a wealthy man.
        Mr. Buxton. No. Senator Carper indicated that the effect on
    the States, he pays no State tax. He will benefit really from
    the other, though.
        The Chairman. Thank you. We will move to questions later,
    but it struck me and I thought that was the valuable part of
    your testimony, is there a broad range of folks out there who
    have the potential of benefiting.
        [The prepared statement of Mr. Buxton follows:]
        Me graphics 32 to 33 here
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        The Chairman. Now, let us turn to Dr. Dan Mitchell, tax
    reform expert with the Heritage Foundation. Thanks for being
    with us.

     STATEMENT OF DAN MITCHELL, McKENNA SENIOR FELLOW IN POLITICAL
            ECONOMY, THE HERITAGE FOUNDATION, WASHINGTON, DC

        Mr. Mitchell. Thank you very much, Senator, members of the
    committee. This is a very important topic. I am glad you are
    taking the time to look at it. With your indulgence, perhaps my
    full testimony could be submitted for the record and I can
    highlight some of the things that haven't already been covered,
    I think.
        The Chairman. Without objection, all of your texts will be
    a part of the record. Thank you.
        Mr. Mitchell. Both Glenn Hubbard and Ms. Kramer, I thought,
    did an excellent job.
        We do have a very serious problem with double taxation in
    this country. I don't know that it was designed to deliberately
    target the elderly, but they certainly are the ones that are
    bearing the brunt of the policies.
        I passed on to your staff a chart that I just did
    yesterday, so it wasn't part of the official testimony, showing
    that if a taxpayer spends his after-tax income, there is no
    additional Federal taxation on that decision. But if a taxpayer
    saves and invests, that same dollar of income can be taxed as
    many as four different times when you factor in the capital
    gains tax, the corporate income tax, the personal income tax,
    and the death tax, and that clearly is something that is bad
    for the economy.
        Every economic theory, even Marxism, they all agree with
    the notion that capital formation is the key to long-run growth
    and higher living standards. It is the common sense notion of
    setting aside some seed corn so you can have greater production
    and greater living standards in the future, and that is what I
    think the President is trying to do with his tax plan, not only
    eliminating the double tax on dividends, but also the policy to
    try to provide relief from the double taxation for savings with
    the lifetime savings accounts, and, of course, 2 years ago, the
    elimination, at least hoped-for elimination, of the death tax.
        Let me talk a little bit about how these policies affect
    senior citizens. The death tax, as we all know, is imposed upon
    a taxpayer's assets upon death if they have assets above a
    certain level. That is clearly double taxation, maybe even
    triple or quadruple taxation, because those assets were
    purchased with after-tax dollars.
        The tax on Social Security is another example of double
    taxation. Under current law, 50 percent of Social Security
    payroll taxes are deductible, the corporate side. Anything
    above and beyond taxing 50 percent of benefits clearly would be
    an example of double taxation. Some people even make the
    argument that any tax at all would be an example of double
    taxation. But certainly, what happened in 1993 shifts from
    neutral treatment, at best, to double taxation.
        Then, of course, we have the example of the double tax on
    dividends. Again, I think the chart from the data put together
    by the Cato Institute from OECD data highlights not only that
    this is double taxation, but it is very, very damaging in terms
    of America's competitive position in the global economy, and on
    the issue of what is short-term stimulus, long-term growth, I
    agree that those things shouldn't be separated. Good long-term
    policy is good short-term policy.
        But I will note that in terms of eliminating the double
    taxation on dividends, we live in a very competitive global
    economy now. If we make the right decisions in our economy, our
    ability to attract capital to the U.S. economy is much bigger
    than it was perhaps 20 years ago. In other words, with the
    economy the way it is today around the world, the rewards of
    good policy are magnified more than they were in the past and
    the punishment for bad policy is magnified more than it was in
    the past. There is a reason why France is suffering the
    economic stagnation they are suffering, why Germany, why Japan,
    why countries like that are suffering, whereas other countries
    that are reforming their tax codes, reducing the burden of
    government, why they are doing so well.
        Let me talk a little bit about increasing economic growth.
    In my full testimony, I cite a number of different papers by
    academics looking at the economic growth impact. I look for the
    Heritage Foundation. Allow me just to cite what our number-
    crunchers in the Center for Data Analysis came up with, that
    the President's proposal would increase the employment level by
    an average of more than 300,000 jobs a year, increase GDP by an
    average of $40 billion, increase business equipment new
    purchases by $32 billion a year.
        Also, very importantly, because you are getting additional
    economic growth from fixing the double taxation of dividends,
    you will get revenue feedback. Our Heritage number-crunchers
    estimate that the dynamic cost of the tax cut is only about
    one-third of the static cost of the tax cut.
        Let me go ahead and touch on the death tax real quickly.
    Again, we see numbers, not only from all the academics, but
    again from our people at Heritage, showing higher GDP, more
    jobs in our economy, increases in disposable income for
    workers.
        On the issue of Social Security benefits, unfortunately,
    there isn't a lot of data out there. We made a search of the
    literature. It is not something that has been pored over. But
    as an economist, I am perfectly happy to stick with theory, and
    one important thing about the double tax on Social Security
    benefits, you only pay that tax if you have non-Social Security
    income that pushes you up into that $25,000 range, and then, of
    course, the $34,000 and up for the 85 percent tax. So, in other
    words, it is only if a taxpayer, an elderly taxpayer, is
    providing labor and capital to the economy that that taxpayer
    is going to get hit by this double tax of Social Security
    benefits, and that, of course, means that there must be some
    adverse economic impact, although, again, I am sorry to say
    that we don't have a whole lot of research out there that
    allows us to put our finger on that.
        With that, I see that the red light is on. Why don't I go
    ahead and turn it back over to you, Mr. Chairman.
        The Chairman. Thank you very much.
        [The prepared statement of Mr. Mitchell follows:]
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        The Chairman. Now, let us turn to Dr. Mark Crain, a
    Professor of Economics at George Mason University. Doctor,
    welcome.

       STATEMENT OF W. MARK CRAIN, DIRECTOR, CENTER FOR STUDY OF
        PUBLIC CHOICE, AND PROFESSOR OF ECONOMICS, GEORGE MASON
                        UNIVERSITY, FAIRFAX, VA

        Mr. Crain. Thank you, Mr. Chairman and Senator Carper.
    Thank you for inviting me.
        I really want to highlight three effects of the double
    taxation of dividends. The first is to highlight the economic
    distortions; second, to highlight the potential for improving
    corporate governance if dividends are excluded from taxation;
    and third, I would like to discuss some recently provided data
    from the Federal Reserve on the Survey of Consumer Finances
    that, I think, really illustrates this idea that older workers
    and seniors are likely to benefit disproportionately from the
    President's proposal to exclude dividends from taxation.
        I do want to maybe restate this, because I do think it is
    so important in this debate and it seems to have been missed,
    it has been emphasized but maybe hammering it home again is
    worth the effort here, and that is that the most important, I
    think, perspective here is the effect on the economy and that
    economy growth research now almost universally recognizes the
    fundamental role of well-functioning financial markets, and the
    reason is straightforward.
        Financial markets provide the mechanism whereby national
    savings are channeled into new investments in plants and
    equipment. The rate of investment determines the available
    capital stock per worker and whether that is going to increase,
    decrease, or remain the same,  and the  amount  of capital per
    worker  is the critical determinant of how much the Nation
    produces, and how much the Nation produces ultimately
    determines our standard of living.
        The current system that taxes shareholders twice, once at
    the corporate level and once at the shareholder level, is a bad
    policy, and this policy of double taxation affects capital
    markets and thereby limits living standards in two ways. First,
    it is going to reduce the rate of permanent investments that
    would be lower than they would be without double taxation, and
    second, even for a given amount of savings, double taxation
    distorts incentives in financial markets to channel these funds
    into investment activities that would produce the highest
    return, that is, those investment activities that would be most
    productive and generate the highest returns.
        Now, on the first point, the elasticity of savings
    investment with respect to the taxation rate, the empirical
    evidence is a little mixed on that. I think if you have a
    cautious reading, we might say there might not be a major
    response in terms of the total amount of investment. But on the
    second point, the impact of double taxation on the efficiency
    of capital markets, the evidence and the theoretical analysis
    is compelling.
        First, double taxation creates an incentive to invest in
    non-corporate rather than corporate businesses. Second, it
    creates an incentive to finance the corporate investments with
    debt rather than new equity. Third, corporations have distorted
    incentives to retain earnings and thereby avoid the double tax.
        There are some quite important empirical analyses of these
    effects and I think the results, again, are quite convincing,
    that the effect of the reduction of dividend taxations would
    increase dividend payouts, would increase corporate spending on
    investments, and reduce the firms' cost of capital. In other
    words, reducing or eliminating dividend taxation facilitates
    the incentive of corporations to raise equity capital as
    opposed to debt finance capital and this gets channeled into
    the purchase of new plants and equipment.
        The effect has been stressed here before that increasing,
    or reducing the tax would also increase dividend payouts, and
    this adds liquidity to the capital market in the sense that
    earnings that were otherwise retained within the firm are now
    going to be unlocked and put back into the hands of
    shareholders to invest that capital in other higher-return
    opportunities.
        The effects on corporate governance have been stressed.
    Paying dividends is an easy way to monitor corporate
    performance. It really reduces the cost of monitoring corporate
    governance and we would expect there to be, with the lower
    cost, to be more of that monitoring of corporate governance,
    and I think we would see broad effects and improvements in
    corporate governance in the several ways that have been
    mentioned.
        Finally, Mr. Chairman, and I won't have time to go through
    all these, maybe we can come to them in the questions, but I
    have provided three tables from the January data on the Survey
    of Consumer Finances which show a breakdown of the holdings of
    corporate equity, of stock by age group, and essentially, these
    data reflect this life cycle behavior of asset accumulation
    that Dr. Hubbard talked about, over one's lifetime, how you
    begin to accumulate assets and that by the time you hit
    retirement age, above 65, you have accumulated a substantial
    amount of equity holdings.
        In fact, in 2001, the latest data reveal that the median
    holding of equities was $150,000 for individuals 65 and older,
    which was almost double the size of the next cohort group. So
    seniors are heavily invested in the stock market, the latest
    data reveal, and I think that these proposals to cut the
    dividend tax and to improve capital markets will have a major
    impact on seniors who hold a lot of this stock market wealth.
        Thank you, Mr. Chairman.
        The Chairman. Doctor, thank you.
        [The prepared statement of Mr. Crain follows:]
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        The Chairman. Thank you all very much. Dr. Mitchell, Dr.
    Crain, I am going to ask some questions of both of you that I
    would appreciate your responding to.
        In Dr. Hubbard's testimony, he said that the double
    taxation elimination could, in the end--and I thought this was
    very fascinating, an aspect of it I did not understand--could
    reduce the cost of capital anywhere from 10 to 25 percent. Do
    you agree with that statement?
        Mr. Crain. I agree in the sense that I believe he was
    talking about the corporations, and I think that----
        The Chairman. He was----
        Mr. Crain [continuing]. That is the----
        The Chairman. But he was also, therefore, as I understood
    it, and you can follow me up on this, therefore talking about
    investment, therefore talking about corporate stability,
    therefore talking about stock market stability, therefore
    talking about growth in the economy.
        Mr. Crain. Absolutely, and I think part of that is this
    distortion caused by the tax, which causes funds to go into
    either debt-financed capital or investments in other types of
    activities, real estate, other types of investments rather than
    corporate investments, and the idea here would be that those
    investments would be more productive and, by reducing the tax,
    would attract capital to the numbers he gave back into
    corporate investments.
        The Chairman. Do you agree with that?
        Mr. Mitchell. I agree with Dr. Hubbard's testimony. When
    individuals are looking whether to invest, they are making that
    decision based on what the after-tax income they expect to
    receive is, compared to the amount of consumption that they are
    currently willing to forego by setting that money aside and
    investing it. People invest in hopes of making a profit.
        I forget, I think it was Senator Hatch who said, or Senator
    Smith, ``That if you tax something once, you are going to get
    less of it.'' If you double tax it, you are going to get doubly
    less of it. When we are looking at whether corporations are
    able to attract capital at reasonable cost, investors obviously
    are less willing to provide capital when you have these two
    layers of tax imposed upon that income, not to mention then you
    have to factor in that a lot of these people are also going to
    be hit by the death tax and other forms of taxation, as well.
        The Chairman. While this question was not asked, and I am
    not sure that in her testimony Ms. Kramer mentioned it,
    although we were visiting about it earlier, the impact of the
    elimination of double taxation on that senior, let us say,
    using your chart, Dr. Crain, who has got an investment at age
    65 of about $150,000 worth of assets or stock, and he or she or
    they are being taxed on it today, not only would the tax
    elimination there obviously benefit them directly by less taxes
    paid, but Ms. Kramer makes the argument that corporate America
    more than likely, with the enhancement of the environment in
    which dividends are paid, would end up paying more dividends or
    it would become more attractive for corporations to do that
    and, therefore, would cause investors to seek out companies
    that paid higher dividends.
        Is there a scenario there in your mind where not only does
    the senior benefit from not paying a tax in this doubly taxed
    environment, but could actually gain more dividend receipt?
        Mr. Crain. Absolutely, in that it is--the analogy to static
    analysis was mentioned, in the sense it is hard to say exactly
    right now how senior citizens would behave if dividends were
    not taxed, surely they would invest more in dividend-paying
    companies if the law were changed. So you can't really look at
    the data today to get a handle on that because investment
    behavior would change if you eliminated the double taxation.
    More seniors would invest in these non-taxable dividends, as
    everyone would.
        The Chairman. Part of my question, though, was would there
    be a higher rate of dividend return on the current investment?
    Would it change the corporate environment in that way?
        Mr. Crain. By eliminating the tax, yes, you are going to
    encourage more dividend payments and it would raise the return.
        The Chairman. Do you agree with that, Doctor?
        Mr. Mitchell. Yes, I do, and we also have some
    international evidence to this effect. Many of the countries
    that are in the lower range of the chart over there, that have
    much lower combined tax rates on dividends, used to make the
    same mistake we made about double taxing dividends, or at least
    of having less relief, and in my full testimony, you will see
    that New Zealand and Australia are two of the countries that
    eliminated double tax on dividends and there is already some
    evidence, even though we are only talking 10, 15 years of data,
    there is already some evidence that it has had a positive
    effect on both aggregate levels of investment in the economy
    and on dividend payment rates.
        We also see that--as a matter of fact, President Clinton's
    Treasury Secretary, Larry Summers, did a paper with another
    economist looking at what has happened when the United Kingdom
    made reforms to their dividend taxation, and again, we saw
    positive responses.
        Now, of course, it is always difficult to estimate ahead of
    time the level of these responses, and I think Mr. Hubbard was
    being very responsible in giving a range, as opposed to trying
    to pick an exact number, but there is no question that his
    direction is the right direction in terms of the numbers he is
    talking about.
        The Chairman. Thank you.
        Senator Carper, questions?
        Senator Carper. Thanks, Mr. Chairman.
        Not so much a question, but to Mr. Buxton, I noted with
    interest that you are an old Navy guy.
        Mr. Buxton. Yes, sir.
        Senator Carper. I was a Navy Midshipman at Ohio State,
    graduated in 1968. When you were on active duty, what were your
    assignments?
        Mr. Buxton. I had a variety of assignments, but primarily,
    I am a qualified surface warfare officer.
        Senator Carper. What kind of ships did you serve on?
        Mr. Buxton. Destroyers, LPHs, the Valley Forge, Cone DD866.
        Senator Carper. I am a retired Captain, as well, so I feel
    a certain kinship with you. Your Governor out there is Dirk
    Kempthorne, who used to serve here in the Senate. I was
    Chairman of the National Governors Association when he first
    became Governor in 1998 and attended New Governors School in
    Wilmington, DE. I hope he is doing well. If you ever see him,
    tell him that an old Governor from Delaware sends his very
    best.
        Mr. Buxton. He is struggling with the tax issue, too.
        Senator Carper. I am sure he is. So are most of the
    Governors. A lot of the States, as you know----
        The Chairman. In fact, Tom, it is fascinating you make that
    comment. I think our Governor right now would find that it
    would be easier being a U.S. Senator than a Governor, where you
    found it very easy being a Governor during those great years of
    growth. Excuse me.
        Senator Carper. Absolutely, and most Governors would
    certainly agree with that, and that is not to say our load here
    is not heavy at times.
        You are from Boise, right?
        Mr. Buxton. Yes.
        Senator Carper. Your mayor, I think, Mayor Coles, used to,
    I believe, be the head of the Mayors Conference----
        Mr. Buxton. Last year.
        Senator Carper [continuing]. He was a very good partner of
    a number of us who were interested in passenger rail service.
    He was a great champion of that. So we think well of you and
    your State and it is a pleasure to serve with your Senators
    now.
        I guess the question I have--is this the last panel, Mr.
    Chairman?
        The Chairman. It is.
        Senator Carper. The first panel was the panel that included
    Dr. Hubbard and Ms. Kramer, is that correct?
        The Chairman. Yes.
        Senator Carper. I was just wondering, the five witnesses
    that we had before us today seemed to be pretty much in tune
    with one another and their message is consistent in supporting
    what the administration has proposed. I am just wondering, did
    we invite anybody with a contrary opinion?
        The Chairman. You had that opportunity, surely.
        Senator Carper. But we didn't take it up? We will have to
    do that, just to make things interesting.
        The Chairman. All of these hearings are balanced off with
    minority and majority staff in the selecting of witnesses and
    those kinds of things.
        Senator Carper. Next time, we will have to be sure that we
    suggest that. That is not to take anything away from the
    testimony of each of these witnesses. They are stimulating and
    provocative and interesting.
        I just want to conclude by saying thank you. I have no
    questions, but I want to thank each of you for coming and for
    sharing your thoughts with us, and a special welcome to my Navy
    buddy over there, Captain Buxton. Thank you for joining us.
        The Chairman. Tom, rest assured, I would be very happy to
    allow the record to show that the support of the President's
    proposal for eliminating double taxation on dividends is not
    unanimously supported, either in the Congress or the country,
    but I think it has us all scratching our heads at this moment
    and I think what our intent of this hearing was, not only the
    double taxation of seniors, but the increased double taxation
    of seniors in a variety of income levels that they have, and,
    of course, because they are fixed-income people, that there is
    substantial impact.
        What attracted me to this was when the President was
    proposing his package. He called it relief for seniors, and at
    the time, it had not really focused--I had not focused on the
    fact that we now have the figures that over 52 percent of the
    tax benefit would go to seniors, and we see that there is a
    broad cross-section out there that now hold investments--you
    can't call them wealthy if their whole life savings is tied up
    in a retirement program and $150,000 worth of assets in stocks.
    That is their life savings, if you will, and the impact that it
    is having on that.
        Dick, would your investment, or do you think your parents'
    investment would be different if they had recognized early on
    that dividends would not be double taxed?
        Mr. Buxton. No. I think that they invested, and their
    investment is primarily in energy stocks, utilities, was for a
    return on investment with dividends.
        The Chairman. But they were looking at it for purpose of
    dividend return, not speculation on stock values as much?
        Mr. Buxton. No. That is correct. No. Idaho Power pays a
    dividend of almost 6 or 7 percent, as you are probably well
    aware.
        The Chairman. Yes.
        Mr. Buxton. They are highly invested in Idaho Power and
    they did it for that reason.
        The Chairman. So for your family, owning stock that
    returned dividends was critical to their investment plan or
    strategy?
        Mr. Buxton. Even my own, I tried to invest in that. Of
    course, a lot of my stock is now in my IRA----
        The Chairman. Sure.
        Mr. Buxton.--which I still do that because I think that
    they are more responsible if they are paying a dividend.
        The Chairman. Thank you.
        Dr. Crain, your testimony discusses the potential for
    increasing returns for all investors if we end the double
    taxation of dividends, including those who have stock holdings
    in tax-deferred accounts. Could you elaborate on how these
    increased returns might occur?
        Mr. Crain. Yes, Senator. Broadly, through this improved
    efficiency of capital markets, for example, this change in the
    reliance on equity financing as opposed to debt financing that
    has been mentioned a couple of times today. Through the
    dividends, again, make it easier to monitor corporate
    performance and corporate governance, which I think is a major
    factor here that is going to increase and improve the returns,
    even in stocks that are held outside of--in a tax-deferred
    account.
        The Chairman. Does that mean this proposal will be a
    positive force for returns of defined benefit pension plans
    with company stock, including State pension plans and union
    pension plans?
        Mr. Crain. Absolutely, Senator. I chair the Corporate
    Governance Committee----
        The Chairman. That is where I was headed. Does this change
    the character of the thinking of that organization?
        Mr. Crain.--for the Virginia Retirement System, and
    sometimes, it is overlooked of how hard it is to really get
    information about what is going on inside a company. Even a
    large organization like the Virginia Retirement System, a $29
    billion plan, it is almost prohibitively expensive for us. We
    must hold stocks in 3,000 companies. How do you monitor all
    those? It is extremely costly to do that. This would reduce
    that cost, not only for us, but for all other plans in that we
    would see benefits, benefits in terms of improved performance
    of companies.
        Senator Carper was asking, I thought, a very good question
    about what is the tradeoff with the effect on States and their
    borrowing costs and so. But I do think, and this wasn't
    mentioned by Dr. Hubbard, is that States have an enormous
    liability to their pension plans. The States are going to have
    to pay that if the returns don't come in to fund those plans.
    The taxpayers will ultimately be liable to pay those benefits,
    and here is a way to help fund, fully fund the plans and, I
    think, reduce the liability on future taxpayers in the States.
        The Chairman. Thank you very much.
        Let me turn to our colleague who has just joined us from
    the State of Missouri, Senator Talent. Welcome.

                  STATEMENT OF SENATOR JAMES M. TALENT

        Senator Talent. Thank you, Mr. Chairman. My apologies for
    being late. I did want to attend this hearing and I want to
    congratulate you and Senator Breaux on the direction you are
    taking the committee. I really sought, as you know, to be on
    this committee, because I think a lot of the issues that we are
    going to be exploring are just second to none in terms of
    importance to America as a whole, as well as the nation's
    seniors.
        The thing I am concerned about is what is going to happen
    to people who are now at or entering middle age and have, to
    this point, planned their lives on certain assumptions about
    the position seniors have been in in the past, assumptions
    which I think are generally not going to be true at the time
    that they are retiring, and we had a hearing which I think
    Senator Breaux originally scheduled on Social Security.
        One of the answers, and I think we are going to have to
    package a lot of answers to that, but one part of the answer is
    to really publicize to people the need to prepare themselves
    more for retirement than they had thought they might have to
    and then empower them to do it. I see the subject of this
    hearing as an avenue of accomplishing that.
        Now, let me just ask you, and I don't know, if this has
    come up, I apologize and maybe just deal with it and dispose of
    it briefly, but the taxation of Social Security benefits, which
    I hear about all the time back home. Seniors really don't like
    it. Have any of you commented on a feature of it that I think
    is particularly unfair, because payroll taxes are supposed to
    go to Social Security and Medicare, and except for the surplus
    that we spend on other things, they do. But when you tax the
    Social Security benefits, isn't that just a way, really, of
    converting the payroll tax into a general tax?
        I mean, you collect the payroll tax, you pay the Social
    Security benefits, you tax the Social Security benefits, and
    then that money comes into the general revenue. Seniors back
    home have figured this out. Am I wrong in saying that? Isn't
    that the effect of taxing Social Security benefits?
        The Chairman. Gentlemen?
        Mr. Mitchell. Under current law, Social Security payroll
    taxes are 50 percent deductible, the so-called employer half of
    it. If you want a neutral tax system, in other words, if you
    want to treat Social Security the way you would treat savings
    under a neutral tax code, then the benefits should be 50
    percent taxable.
        So it is very clear that the tax increase on benefits that
    was enacted in 1993 does represent double taxation of those
    benefits, and as was discussed a little bit earlier, that will
    have some adverse consequences on the economy because people
    only pay that double tax if they have non-Social Security
    income by either providing labor or capital to the marketplace.
    So it is double taxation and it is double taxation that, like
    other forms of double taxation, undermines the economy's
    performance.
        Senator Talent. And pulls the money, Mr. Chairman, out of,
    if you will, the use for which it was originally intended. I
    mean, it is not like the money that we collect through that tax
    we then turn around and use for other kinds of senior programs
    necessarily. It goes in the general fund with everything else.
    So the effect of it is to take the payroll tax and use it for
    other kinds of measures.
        I thank the Chairman for hosting this. Again, I am sorry
    for being late. I intend to look through your statements. This
    is an important subject, and I know we are planning to do
    hearings on a number of other subjects, Mr. Chairman, to
    examine where we need to be 15 or 20 years from now in order to
    have a viable and high-quality system that cares and meets the
    needs of the seniors of the next generation, and I thank you,
    Mr. Chairman.
        The Chairman. I thank you very much. I think the hearing
    that Senator Breaux chaired a couple of weeks ago as we looked
    at the overall view of Social Security and we had General
    Accounting up, I mean, it was obvious to us then, and I think
    we all agreed, that the ``do nothing'' strategy just does not
    work, and at some point in the very near future, hopefully, we
    wrestle through the tough choices there.
        Senator Talent. Mr. Chairman, will you yield on that point?
        The Chairman. I would be happy to.
        Senator Talent. I mean, one other area, for example, I am
    very interested in, and you and I have talked about this
    privately, is what the spectrum of services and care of a long-
    term nature needs to be for seniors 10, 15, 20 years from now,
    you know, everything from assisted living to independent living
    centers to long-term care, and how do we get people from here
    to there. Part of that is going to be empowering people and
    urging them to save on their own for those kinds of
    alternatives.
        So I see all this as a seamless web, as we lawyers say
    periodically, and each one of these hearings has part of the
    kind of decisions we are going to have to confront soon if we
    are going to be effective in helping the nation's seniors.
        Thank you. You have been very patient, Mr. Chairman.
        The Chairman. I thank you and I think your point is very
    real, even though when we talk of Social Security and today
    talking about double taxation of dividends, what is obvious is
    that there is a very real impact on today's wage earners. Even
    though they may not be the subject of the tax or the person who
    is the immediate recipient of the program, it does impact, and
    you have all said that, wages, job opportunity, the general
    economy itself, and that is all an important part of it.
        Of course, the thing that I have grown increasingly
    concerned about--it is part of the reason I am on this
    committee--the beautiful thing that is going on out there right
    now, I just penned a note this morning to a neighbor of mine
    who celebrated his 90th birthday at the Weiser, Idaho, Senior
    Citizen Center on Sunday. He walked in under his own power. He
    drove his own car with his wife. He is having a great time in
    life. His problem is, and it is a beautiful problem, he had
    eight children, and if he has got those kinds of genes, he has
    probably produced eight children that are going to live to be
    90-plus and they are going to drain Social Security.
    [Laughter.]
        Unless we reform it to respond to the demographics, Senator
    Talent, that you have spoken to and the very reality of the
    community that we are dealing with here.
        Thank you all very much to our panelists. Thank you very
    much for being here. Dick, thank you for coming from Boise.
        The committee will stand adjourned.
        [Whereupon, at 11:59 a.m., the committee was adjourned.]

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