[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
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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
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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?
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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:]
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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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