[Joint House and Senate Hearing, 112 Congress]
[From the U.S. Government Publishing Office]






                                                        S. Hrg. 112-290

      COULD TAX REFORM BOOST BUSINESS INVESTMENT AND JOB CREATION?

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

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                           NOVEMBER 17, 2011

                               __________

          Printed for the use of the Joint Economic Committee



















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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

SENATE                               HOUSE OF REPRESENTATIVES
Robert P. Casey, Jr., Pennsylvania,  Kevin Brady, Texas, Vice Chairman
    Chairman                         Michael C. Burgess, M.D., Texas
Jeff Bingaman, New Mexico            John Campbell, California
Amy Klobuchar, Minnesota             Sean P. Duffy, Wisconsin
Jim Webb, Virginia                   Justin Amash, Michigan
Mark R. Warner, Virginia             Mick Mulvaney, South Carolina
Bernard Sanders, Vermont             Maurice D. Hinchey, New York
Jim DeMint, South Carolina           Carolyn B. Maloney, New York
Daniel Coats, Indiana                Loretta Sanchez, California
Mike Lee, Utah                       Elijah E. Cummings, Maryland
Pat Toomey, Pennsylvania

                 William E. Hansen, Executive Director
              Robert P. O'Quinn, Republican Staff Director










                            C O N T E N T S

                              ----------                              

                     Opening Statements of Members

Hon. Kevin Brady, Vice Chairman, a U.S. Representative from Texas     1

                               Witnesses

Mr. Stephen J. Entin, President and Executive Director, Institute 
  for Research on the Economics of Taxation (IRET), Washington, 
  DC.............................................................     5
Dr. Chad Stone, Chief Economist, Center on Budget and Policy 
  Priorities, Washington, DC.....................................     7
Mr. Dan R. Mastromarco, Principal, The Argus Group, Arlington, VA     9
Mr. Seth Hanlon, Director of Fiscal Reform, Doing What Works, 
  Center for American Progress, Washington, DC...................    10

                       Submissions for the Record

Prepared statement of Vice Chairman Kevin Brady..................    30
Prepared statement of Mr. Stephen J. Entin.......................    32
Prepared statement of Dr. Chad Stone.............................    52
Prepared statement of Mr. Dan R. Mastromarco.....................    64
Prepared statement of Mr. Seth Hanlon............................    91

 
      COULD TAX REFORM BOOST BUSINESS INVESTMENT AND JOB CREATION?

                              ----------                              


                      THURSDAY, NOVEMBER 17, 2011

             Congress of the United States,
                          Joint Economic Committee,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:07 a.m. in Room 
216 of the Hart Senate Office Building, the Honorable Kevin 
Brady, Vice Chairman, presiding.
    Senators present: Casey, DeMint, and Coats.
    Representatives present: Brady, Campbell, Duffy, and 
Mulvaney.
    Staff present: Gail Cohen, Will Hansen, Colleen Healy, 
Jesse Hervitz, Brian Phillips, and Ted Boll.

 OPENING STATEMENT OF HON. KEVIN BRADY, VICE CHAIRMAN, A U.S. 
                   REPRESENTATIVE FROM TEXAS

    Vice Chairman Brady. Good morning everyone. On behalf of 
Senator Casey and myself, I want to welcome you to this 
morning's hearing on ``Could Tax Reform Boost Business 
Investment and Job Creation?'' Senator Casey will be with us in 
a few moments. We are joined by Congressman Mulvaney.
    There is no question that President Obama inherited a poor 
economy, but after three years his policies have made it worse. 
The massive stimulus failed to jumpstart the economy and 
restore consumer confidence as he promised.
    In fact, today there are 1.3 million fewer payroll jobs in 
America than when the first stimulus began. And now, 25 million 
Americans can't find a full-time job or any work at all. 
Hardworking taxpayers have paid a steep price in this Obama 
economy.
    After exploding America's national debt in his first round 
of stimulus, the President now is out campaigning to raise 
income taxes on hardworking, successful Americans and local 
small business owners to pay for yet a second round of stimulus 
spending aimed at jobs in the government sector.
    It is a basic principle of economics that if you want less 
of something, ``tax it more''; and if you want more of 
something, ``tax it less'' or not at all. Common sense tells us 
that Washington taking more of what investors earn will only 
reduce investment in new jobs, research and expansion.
    History proves that it's business investment in new 
buildings, equipment, and software that drives jobs along Main 
Street. One glance at the chart behind me, if you take a look 
at the chart here, which tracks business investment and 
private-sector job creation for the past 40 years in America, 
it clearly shows that job creation in America will not rebound 
unless private investment rebounds.
    While government spending in America is still above the 
level when the recession began, it is jobs and real business 
investment that have not recovered to their pre-recession 
levels more than two full years after the recession officially 
ended.
    Putting Americans back to work--not taking more from small 
businesses and successful professionals--is the most effective 
way to grow federal revenues. Instead of increasing marginal 
tax rates, how about permanently lowering marginal rates to 
encourage business to invest and hire more workers? Or how 
about creating a 21st Century tax code based on flatter rates 
and a territorial tax regime like our global competitors?
    Why not consider a transparent, straight-forward retail 
sales tax that replaces the income, business, payroll, gift, 
and death taxes and finally eliminates much of the complexity, 
burden, and special interest provisions that comprise our 
current mess of tax laws.
    If lower rates, for example, were accompanied by the 
removal of many of the complicated provisions that have been 
added to the tax code--often because marginal rates are so 
high--we would kick-start investment and jobs creation by the 
private sector while naturally generating additional tax 
revenue to lower future federal budget deficits. A consumption-
based tax could do the same.
    Consider our high corporate tax rate and the requirement 
that U.S. companies pay that high rate when bringing home 
profits that were earned and taxed overseas. We should lower or 
remove that tax gate to allow an estimated $1 trillion in 
stranded profits overseas to flow back into America to fund new 
jobs, research, buildings, and expansions. It is a free-market 
stimulus that does not cost federal money--but rather, 
generates it.
    Many of my Democratic colleagues charge that lowering tax 
rates would favor the ``rich.'' But nearly half of American 
families already pay no federal income tax and the top one 
percent of wage earners already shoulder nearly 40 percent of 
the income tax burden--the top 10 percent over 70 percent.
    America already has one of the most progressive tax codes 
in the world, and now the highest corporate tax rate among our 
global competitors. How much more should Washington take?
    As for job creation, capital income is subject to multiple 
layers of taxation in the form of corporate income, dividend, 
and estate taxes. Business taxation is inordinately complex and 
imposes economic distortions and compliance costs that have no 
offsetting benefit to society whatsoever.
    Yet, history proves that lowering the marginal tax rate on 
capital income increases business investment. In turn, more 
investment creates new private sector jobs. More investment 
means higher real wages for American workers. This happened in 
the 1960s and the 1980s and can happen again.
    A common myth has arisen surrounding the so-called Buffett 
rule. But an analysis by my Joint Economic Committee staff of 
IRS taxpayer data prove President Obama's campaign assertions 
to be untrue: high-income Americans on average pay income tax 
rates three times higher than the middle class, more than 60 
percent of their income is ordinary income not passive 
investment income, and the 400 highest income earners in 
America are not the same people year to year, but a constantly 
changing set of taxpaying Americans.
    That last point is important. For 17 years--from 1992 to 
2008--the 400 highest income returns each year were comprised 
of 6,800 returns in total representing 3,672 different 
taxpayers. Of these taxpayers, only one-quarter appeared more 
than once, and only 15 percent appeared twice.
    In any given year, on average about 39 percent of the top 
400 adjusted gross income returns were filed by taxpayers that 
are not in any of the other 16 years--not any. Only 4 of the 
more than 3,000 taxpayers made the top 400 all 17 years.
    That is because America is the land of opportunity. Anyone, 
anywhere, regardless of your birth or your station in life, you 
can earn your way into the wealthiest taxpayers in the Nation.
    Mr. President, what is so wrong with that? Why are you 
intent on dividing our Nation, pitting one American against 
another because of their success?
    Americans who work hard and play by the rules want 
productive jobs and a fair shot at success. They do not want 
handouts, bailouts, stimulus, or temporary make-work jobs. They 
understand that paying taxes is part of citizenship.
    Americans should be able to find a good job and be able to 
make some contributions to the cost of the Federal Government. 
But for American workers to win in the global economy, American 
entrepreneurs must risk their capital to create the tools that 
American workers need to succeed.
    If Washington is intent on growing the government rather 
than growing the economy and insists on taxing those 
hardworking taxpayers who supply the opportunities and the jobs 
at high rates, in the end it is the American workers who will 
be worse off.
    Today we have before us witnesses who are advocates of 
major tax reforms designed to generate revenue for the Federal 
Government with a minimum of economic interference and 
allowances for very low-income families. What both ideas share 
is a commitment to reduce the after-tax cost to making job-
creating, income-producing investments here in the United 
States. And that is what the American economy needs to kick-
start the engine of job creation.
    I look forward to hearing the testimony of the witnesses 
today. Let me introduce our panel:
    Stephen J. Entin is currently President and Executive 
Director of the Institute for Research on the Economics of 
Taxation, a pro-free market economic public policy research 
organization based here in Washington. He advised the National 
Commission on Economic Growth and Tax Reform, the Kemp 
Commission; assisted in the drafting of the Commission's 
report, and was the author of several of its support documents. 
He is a former Deputy Assistant Secretary for Economic Policy 
at Treasury. He joined the Treasury Department in 1981 with the 
incoming Reagan Administration, and participated in the 
preparation of economic forecasts in the President's budgets, 
the development of the 1981 tax cuts, including the Tax 
Indexing Provision that keeps tax rates from rising due to 
inflation. He has a great deal of other experience in a wide 
variety of areas.
    Mr. Entin, thank you for joining us. He is a graduate, by 
the way of Dartmouth College and received his graduate training 
in economics at the University of Chicago.
    Dr. Chad Stone is the Chief Economist at the Center on 
Budget and Policy Priorities, where he specializes in the 
economic analysis of budget and policy issues. Dr. Stone was 
the Acting Executive Director with the Joint Economic Committee 
in 2007. Before that, he was staff director and chief economist 
for the Democratic staff of the Committee from 2002 to 2006. He 
held the position of chief economist for the Senate Budget 
Committee in 2001 to 2002. Previously he had served on the 
President's Council of Economic Advisers as senior economist, 
and chief economist from 1996 to 2001.
    His other Congressional experience includes serving as 
chief economist to the House Science Committee. Dr. Stone has 
also worked at the Federal Trade Commission, the FCC, the OMB, 
and was a senior researcher with the Urban Institute, and co-
authored the book entitled ECONOMIC POLICY IN THE REAGAN YEARS. 
He earned his Ph.D. in economics at Yale University.
    Dr. Stone, thank you for joining us.
    Dan Mastromarco was founder of the Argus Group, a public 
policy law and economic consulting firm for more than 16 years. 
He is a partner in the Mastromarco firm based in Michigan. He 
has counseled clients ranging from Fortune 500 companies to 
not-for-profit organizations on tax, trade, and labor issues.
    In his Washington career he served as counsel to the U.S. 
Senate's Permanent Subcommittee on Investigations under the 
Chairmanship of Senator Roth. He also served as Assistant Chief 
Counsel for Tax Policy with the U.S. Small Business 
Administration. He was a special U.S. trial attorney with the 
Department of Justice in the Tax Division. He also worked as 
the Director of the Trade and Tax Division of the Jefferson 
Group, then one of the largest public affairs firms in 
Washington.
    He has written extensively about tax reform, publishing 
more than 100 articles in a wide variety of outlets from law 
reviews to The Wall Street Journal. His latest book, entitled 
THE SECRET CHAMBER OR THE PUBLIC SQUARE: How Washington Makes 
Tax Policy, was published by the Heritage Foundation as a 
constructive critique of the tax policymaking process, 
particularly the process of revenue estimating and 
distributional analysis.
    He attended Albion College where he earned his BA, 
Georgetown University Law Center, and the London School of 
Economics.
    Welcome, Dan.
    Mr. Seth Hanlon is Director of the Fiscal Reform for the 
Doing What Works Project at American Progress. His work focuses 
on increasing the efficiency and transparency of tax 
expenditures in the federal budget, and on tax issues 
generally.
    Prior to joining CAP, he practiced law as an associate with 
the Washington, D.C., firm of Kaplan & Drysdale, where he 
focused on tax issues facing individuals, corporations, and 
nonprofit organizations.
    Before law school, he served on Capitol Hill for more than 
five years as a legislative and press aide to Representative 
Harold Ford, Jr., and Marty Meehan of Massachusetts.
    Mr. Hanlon also worked at the Initiative for a Competitive 
Inner City in Boston. There he was part of a team that 
partnered with Inc. magazine to launch the inaugural Inner City 
100, a list of the fastest growing companies located in inner 
cities.
    Mr. Hanlon received his bachelor's degree in history and 
literature from Harvard, and his J.D. from Yale Law School.
    Gentlemen, thank you very much for joining us today. We 
have reserved five minutes for opening comments. We will submit 
your entire testimony for the record.
    Mr. Entin, you are recognized.
    [The prepared statement of Representative Brady appears in 
the Submissions for the Record on page 30.]

  STATEMENT OF MR. STEPHEN J. ENTIN, PRESIDENT AND EXECUTIVE 
 DIRECTOR, INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION 
                     (IRET), WASHINGTON, DC

    Mr. Entin. Thank you, Mr. Brady, and thank you Members of 
the Committee:
    Prior to Treasury I was on the staff here for five years, 
so it is a little like coming home, except this building was 
not built when I was working here.
    I thank you for the opportunity to testify today on tax 
changes that would generate investment and growth for the 
economy while being affordable for the federal budget.
    The growth-in-jobs element in this exercise is critical. If 
we look only at the federal budget effects of tax proposals and 
forget about the economic consequences, we will miss what is 
most important: the public welfare--and we will get the budget 
numbers wrong.
    To summarize, taxes affect the economy by altering 
incentives to work, save, and invest--not by handing out money 
to spend, or taking it away. Forget anything you have heard 
about Keynesian multipliers and the need to stimulate spending.
    The income tax is heavily biased against saving and 
investment. True tax reform would remove the biases not just 
between industries but between saving and investment versus 
consumption. That is absolutely key to restoring growth.
    The amount of capital--plant, equipment, and buildings--is 
highly sensitive to its tax treatment. Higher tax rates on 
capital shrink the capital stock, shrink the productivity of 
labor, reduce employment output, and income. The burden of 
higher taxes on capital formation falls largely on labor in the 
form of lower wages and hours worked.
    The definition of the tax base--the income that we tax--is 
at least as important as the tax rate. Overstating business 
income by under-counting investment expenses leads to less 
investment and lower wages.
    Trading away legitimate costs of production for a broader 
tax base may mean higher tax rates at the margin, even if the 
statutory rate is cut. That is what happened in the Tax Reform 
Act of 1986, which was bad for growth and should not be a model 
for any current reform effort.
    We should not repeat the Tax Reform Act of 1986, which 
tried to perfect the broad-based income tax by supposedly 
evening out treatment among industries. Rather, we should adopt 
a different tax base that is more neutral in its treatment of 
saving and investment relative to consumption. That is a much 
broader shift.
    Mindless base-broadening is simply not the answer to our 
deficit problem. Expensing is the right approach to measuring 
the cost of investment. The current expensing provision if made 
permanent would boost GDP by 2.7 percent and would more than 
repay its static revenue cost. It is the most efficient way to 
encourage additional investment.
    A 25 percent corporate rate would raise GDP by about 2.3 
percent, almost as much as the expensing provision. It would 
cost more--about $25 billion more--in static terms, and require 
more offsets to make up the difference, if you go by static 
scoring.
    But the corporate rate cut, too, would more than recover 
its revenue over time by raising wages and employment. Do not 
swap expensing for lower corporate rates. Do both. You do not 
have to choose. Neither costs you any revenue over time.
    Expensing favors capital-intensive manufacturing and 
rapidly growing businesses, and corrects a mismeasurement of 
income that penalized them relative to other industries in the 
past. A corporate rate cut is preferred by businesses with 
intellectual property instead of physical property, and by 
established slower growing businesses that want higher returns 
on capital that they've already bought. They also get the 
benefit of expensing as they replace that old capital over 
time.
    You can satisfy both by keeping expensing and, if 
necessary, phase in the corporate rate cuts to reduce the 
static revenue score. It is better to do a dynamic score and 
cut the rate faster. If the Joint Tax Committee is not able to 
provide a dynamic score, get one from a major academic and 
modeling outfit and use that. The budget rules permit that.
    Increasing double taxation of corporate income by raising 
tax rates on capital gains and dividends to 20 percent, for 
example, would cut GDP by about 1.2 percent and would wipe out 
the expected revenue gain. In addition, realizations would 
collapse as they did after the 1986 Act and you would get less 
revenue out of the existing gains because people simply 
wouldn't take them.
    Raising the two top tax rates back to 36 and 39.6 would cut 
GDP by about half a percent and lose about 40 percent of the 
expected revenue.
    I have to say, with some regret, that the Bowles-Simpson 
Commission Proposal, and the Wyden-Coats bill, were not 
examined for their effects on the service price of capital. 
That's the required pre-tax return on capital needed to pay its 
taxes, cover the costs, and leave a normal return to the 
investor.
    The proposals did not cut tax rates enough to offset the 
longer tax depreciation lives and the higher tax rates on 
capital gains and dividends, and they would both reduce GDP 
significantly.
    It is important that any tax reform proposal promote growth 
because, as I explained in the testimony, we are at about 12 
percent below trend GDP, and that plus the added spending we 
did in the vain attempt to get out of the stagnation is 
responsible for well over half the deficit.
    Every tax bill that you consider should be examined for its 
effect on the service price of capital. If the Joint Committee 
of Taxation and the Congressional Budget Office can't do that 
right now, again, go outside and get an outside estimate. They 
should always report that calculation to you when you're 
considering a bill.
    If you cut the service price, you are going to get more 
investment and jobs. If you raise it, you are going to get 
less. And you really ought to know what you are doing to your 
constituents before you hold that final vote.
    Thank you, very much.
    [The prepared statement of Mr. Stephen J. Entin appears in 
the Submissions for the Record on page 32.]
    Vice Chairman Brady. Thank you, Mr. Entin.
    Dr. Stone.

STATEMENT OF DR. CHAD STONE, CHIEF ECONOMIST, CENTER ON BUDGET 
             AND POLICY PRIORITIES, WASHINGTON, DC

    Dr. Stone. Thank you, Vice Chairman Brady, and other 
Members of the Committee:
    I guess I should say: And now for something completely 
different.
    My bottom line is that tax reform is unlikely to be an 
effective tool for speeding up economic growth in the short 
run. Tax reform could be a useful tool for enhancing growth in 
the long run, but only in the context of a sound, overall 
program for achieving long-term fiscal stabilization, and not 
if it is used as an excuse to avoid the revenue increases that 
must necessarily be a part of any credible, sustainable deficit 
reduction plan.
    In my testimony I have a chart that illustrates the 
distinction I want to make between the short run and the long 
run. I'm sorry we don't have a chart, but it is figure one in 
my written testimony, which shows the growth path of the 
economy if we were producing at full employment with full 
utilization of our existing capacity, and the actual GDP.
    We know that the economy is in a deep hole and growing very 
slowly. That is why we have 9 percent unemployment.
    So I want to distinguish between policies that would move 
the actual GDP line in the chart and policies that would move 
the potential GDP line in the chart.
    So talking about the short run, the most compelling 
explanation to most economists for why we have a 9 percent 
unemployment rate, tame inflationary expectations, and a large 
output gap, is the textbook one: weak aggregate demand.
    Businesses are not able to sell all the goods and services 
they are capable of producing right now. Putting more customers 
in their stores, and giving those customers more money to spend 
is a far better way to encourage businesses to expand and hire 
more workers than giving a tax break when their stores are 
still half empty.
    Measures the President has proposed, like extending Federal 
Emergency Unemployment Insurance, extending and expanding the 
Payroll Tax holiday, relatively quick-acting infrastructure 
investments like repairing schools, and help to relieve 
pressure on state and local governments so they won't lay off 
more teachers, police, and fire fighters, are the policies that 
are likely to be most effective at getting the economy back on 
its feet and operating at full capacity, because they operate 
on the demand side and they don't make long-term deficit 
problems materially worse because they are temporary.
    Policies like corporate tax reform, and cutting top 
marginal rates for individuals, add to the budget deficit 
without generating much new spending in an economy with a huge 
output gap, high unemployment, and too much idle productive 
capacity, because they operate on the supply side. And right 
now we have plenty of potential supply, but not enough actual 
demand.
    Looking at the long run, policies to move the blue line--
this is where tax reform can come in. The longer term question 
is: What are the best policies for raising the economy's 
capacity to produce goods and services?
    Here are my key points: Tax rates in the range we're 
talking about as part of a credible and sustainable debt 
stabilization plan are less harmful to growth than budget 
deficits of the kind we are projecting in the absence of such a 
plan. Reducing deficits in fact is a more potent way to 
increase long-term growth than cutting taxes, and revenue-
neutral tax reform is not good enough because we need to raise 
revenue. With all due respect, supply-side fantasies and 
dynamic scoring pipe dreams won't cut it. That does not mean we 
should not embrace the enduring principle of tax reform that a 
broader tax base allows rates to be lower than a narrower tax 
base.
    But we also have to ensure we have enough revenue to pay 
for the things we want government to do, ranging from national 
defense to an adequate safety net.
    The debate should be about what we want government to do 
and how we should pay for it. Setting arbitrary limits on 
spending or revenue does not advance that debate.
    I want to touch briefly on a couple of other topics. The 
first is the repatriation of foreign earnings. We tried a 
repatriation tax holiday in 2004 and it did not work. There 
were no effective mechanisms to ensure that repatriated 
earnings would be used for their intended purposes of 
investment in the United States, and just as economic and 
finance theory would predict the earnings multi-national 
companies brought back under the tax holiday ended up being 
returned to shareholders largely through stock repurchases.
    There is scant evidence of any new investment having been 
generated. And indeed, many of the firms that repatriated large 
sums during the holiday actually laid off workers subsequently. 
Doing the same thing again--which is what CBO and other 
analysts and the Joint Committee on Taxation has scored--would 
add to the budget deficit without doing much, if anything, for 
the jobs deficit. The 2004 model is not a good model.
    On small businesses and the question of higher marginal tax 
rates: Unlike large corporations, which are for the most part 
flush with cash, small businesses appear to still face 
difficulty financing expansion. That may justify short-term 
measures that target job creation in small businesses that 
would respond to such an incentive, but it does not justify 
costly and poorly targeted measures like keeping the current 
very low top marginal tax rates from expiring as scheduled.
    Three quick points: The number of truly small businesses 
that would be affected by the top marginal tax rates is greatly 
exaggerated in most discussions of the issue.
    Second, in many cases the effective tax rate on small 
business income is likely to be zero or negative regardless of 
reasonable changes in marginal tax rates because of the 
valuable array of tax subsidies that small businesses receive. 
Finally, the justification for those subsidies should be 
examined more carefully. The best recent research indicates 
that it is important to distinguish between young firms, start-
ups, which are the main source of job creation and dynamism in 
the small business sector and other more established small 
businesses.
    Thank you, and I look forward to discussing these issues 
further.
    [The prepared statement of Dr. Chad Stone appears in the 
Submissions for the Record on page 52.]
    Vice Chairman Brady. Dr. Stone, thank you.
    Mr. Mastromarco.

   STATEMENT OF MR. DAN R. MASTROMARCO, PRINCIPAL, THE ARGUS 
                      GROUP, ARLINGTON, VA

    Mr. Mastromarco. Yes, Mr. Chairman, thank you.
    You know, there is an old adage that if we could line up 
all the economists end to end on Pennsylvania Avenue and make 
them hold hands, they still would not reach a conclusion.
    [Laughter.]
    And I think you can say that that is true when you 
juxtapose the testimony today of Drs. Stone and Entin. But in 
reality, they should sing with the harmony of chorus girls when 
they are asked about the principles that should guide tax 
reform.
    Economists ought to tell you an optimal tax regime imposes 
minimum costs for maximum voluntary compliance. But that is not 
what we do. We waste $431 billion in compliance only to endure 
a tax gap that is equally large and growing. That is the dollar 
value of all the finished goods and services in the State of 
Virginia, and 41 other states--resources unavailable for 
payroll, plant, or equipment.
    The IRS embroils Americans in 72,000 litigation actions, 7 
of 10 involving small firms, only to enforce a system that is 
apparently so confusing not even the Treasury Secretary, or two 
former Members of the Ways and Means Committee, can fully 
understand it.
    Economists say an optimal system applies low marginal rates 
on a base neutral toward savings and investment. That is what 
Dr. Entin said is so important. But that is not what we do.
    Our corporations pay a national statutory marginal rate of 
35 percent on that chart. That is the highest in all of the 
OECD countries; a dubious distinction. These rates impose 
efficiency costs, according to the GAO, of as high as $728 
billion. And if Dr. Stone has a problem with that analysis, he 
should talk to the Government Accountability Office about that.
    After all, that explains why our 9,000 code sections of 
gibberish have been cobbled together by America's finest 
lobbyists, not America's finest economists.
    Economists tell you an optimal system would not favor 
imports over exports, or discourage repatriation of profits. 
But that is not what we do.
    The U.S. is alone in applying punishing rates--the highest 
in the OECD, and 50 percent higher than the average OECD rate 
at 23 percent--to domestic and foreign earnings alike, and in 
refusing to adopt a border-adjustable tax system. 33 of 34 OECD 
countries impose an average border-adjustable VAT of 18.5 
percent. It is as if Congress is urging global producers: 
invest in overseas plants and facilities. Hire those foreign 
workers. And then market your products back to the American 
consumer who is punished for saving and rewarded for 
consumption.
    Don't take my word for it. Look to the World Bank. They 
rate us the 124th worst nation for total tax cost, behind the 
Russian Federation.
    Mr. Chairman, the FairTax, which replaces income and 
payroll taxes with a single-stage consumption tax, addresses 
these infirmities. It eliminates an estimated 90 percent in 
compliance cost, relieving individuals and nonretail businesses 
from filing returns or paying taxes. It would impose the lowest 
marginal rates on the broadest base of any plan that does not 
tax income more than once.
    Laurence Kotlikoff estimates that this increases capital 
stock over the century by 96 percent, 44 percent by 2030, 
increasing real wages by 17 percent over that same period 
rather than the projected decline of 8 percent.
    It would transform the U.S. from one of the least to the 
most tax-favored jurisdictions for business, meeting the 
challenges of border-adjustable regimes by exempting foreign 
consumption of U.S. goods from taxation, while imposing the 
FairTax on foreign goods consumed here just as we do on 
domestic goods--complete neutrality.
    A zero marginal rate on productive income is better than a 
territorial tax because it issues our competitor nations an 
ultimatum: Reduce your tax rate on savings and investment, or 
lose that investment to America. And that sparks global tax 
competition.
    By not taking the fruits of our labor until consumed, the 
FairTax gives taxpayers control over their tax obligation, 
which in turn lubricates upward mobility--what Chairman Brady 
was talking about earlier--and it proves we do not need to 
trade growth for equity.
    Now I know I am running out of time, but with--with 
permission, I will just take a few more seconds of the 
Committee's time?
    Vice Chairman Brady. If we may, Mr. Mastromarco, because we 
want to stay within the five-minute limit, I will ask you a 
question if you want to make a point to finish up.
    Mr. Mastromarco. Very well.
    [The prepared statement of Mr. Dan R. Mastromarco appears 
in the Submissions for the Record on page 64.]
    Vice Chairman Brady. So, Mr. Hanlon, you are recognized.

STATEMENT OF MR. SETH HANLON, DIRECTOR OF FISCAL REFORM, DOING 
    WHAT WORKS, CENTER FOR AMERICAN PROGRESS, WASHINGTON, DC

    Mr. Hanlon. Thank you, Vice Chairman Brady, Chairman Casey, 
and the Members of the Committee:
    Thank you for the opportunity to testify. It is a privilege 
to be here. This morning I will focus on four points that I 
discuss at greater length in my statement for the record.
    First, tax reform, if done right, has the potential to 
improve economic growth over the long term, but it is not a 
solution to the urgent jobs crisis we face today and therefore 
should not come at the exclusion of immediate measures to boost 
demand and create jobs.
    In this regard, I would associate myself with Dr. Stone's 
analysis.
    Second, one of the most important things tax reform can do 
to boost long-term growth prospects is to adequately fund our 
needs as a country--including investments that will keep us 
competitive. Under any realistic fiscal scenario, that will 
require substantially more revenue than our current tax code 
raises.
    For the last three years, federal revenues were less than 
15 percent of GDP, the lowest since 1950. And if we maintain 
current tax policies, revenues will average just 17.7 percent 
of GDP over the next decade, not nearly enough to prevent 
continued deficits even under the house-passed budget, which 
brings federal spending down to about 20 percent by the end of 
the decade only by shifting health care costs onto seniors and 
dramatically reducing the public investments that are needed 
for long-term growth.
    Recognizing these realities, all of the major bipartisan 
proposals to reduce the deficit--Bowles-Simpson, the Bipartisan 
Policy Center, the Gang of Six--raise revenues to 20 percent of 
GDP or higher.
    With revenues at that level, the U.S. would still be a very 
low tax country. We now have the fifth lowest revenues among 
the more than 30 countries in the OECD, one-quarter less than 
the OECD average.
    In the current fiscal context, tax reform cannot just be 
revenue neutral; it has to raise revenues.
    Third, tax reform should not shift more of the tax burden 
onto middle class and low-income Americans who have experienced 
almost none of the real income gains in recent years, which is 
why we should let the Bush tax cuts expire for top income 
earners. There is little reason to believe that requiring the 
highest-income 2 percent of Americans to pay the modestly 
higher tax rates that they paid only a short time ago would 
slow economic growth.
    Lest we forget, business investment, job growth, and real 
income growth were all stronger under the post-1993 tax code. 
18 million private sector jobs were created in 6 years after 
1993, compared to job growth of just 4.7 million in the 
corresponding period after the first Bush tax cuts were 
enacted, which does not even count job losses from the 
recession. And small businesses created jobs more than twice as 
fast.
    That is not the only reason to doubt that small businesses 
will be harmed. About 97 percent of them are not in the 
brackets that would see any change. And 92 percent of the total 
benefit of extending the high-end tax cuts would go to high-
income people who are not small business employers.
    My fourth and final point is that the corporate tax code is 
in need of reform. But Congress should not finance corporate 
tax cuts either with regressive tax increases or additional 
debt. We often hear that the U.S. has the second-highest 
statutory corporate tax rate among major economies, pending 
what Japan does, which is true. But given the wide variety of 
tax preferences and loopholes that exist in the code, effective 
rates are the better measure.
    In a recent analysis of 280 public company financial 
statements by Citizens for Tax Justice and the Institute for 
Taxation and Economic Policy, it was found that these large 
U.S. corporations paid an average effective rate of 18.5 
percent over 2008 to 2010, just over half of the statutory 
rate.
    We also often hear that the U.S's corporate tax system is a 
drag on our multi-national corporations' ability to compete in 
global markets. Again, however, corporate financial statements 
tell a different story.
    Researchers studying the effective rates of the 100 largest 
U.S. companies and 100 largest EU companies over the last 
decade found that the American companies paid lower income 
taxes on average than the European rivals. And a 2007 Treasury 
Department report also found that the average tax rate of U.S. 
corporations was below the OECD average. The U.S. raised 2.2 
percent of its GDP in corporate taxes--well below the OECD 
average of 3.4 percent.
    And so an accurate picture of the corporate tax burden in 
the U.S. leads to the conclusion that fiscally responsible tax 
reform should raise revenue from the corporate income tax by 
broadening its base, and at the very least be revenue neutral.
    Thank you again for this opportunity and I look forward to 
your questions.
    [The prepared statement of Mr. Seth Hanlon appears in the 
Submissions for the Record on page 91.]
    Vice Chairman Brady. Thank you, Mr. Hanlon. We are joined 
by the Chairman of the Joint Economic Committee, Senator Casey. 
He is recognized for his opening statement.
    Chairman Casey. Mr. Vice Chairman, thank you very much.
    I want to make two points.
    First of all, when people across the country--no matter 
where you are from--when they look at Washington, they have 
said two things to us. Number one is they want us to create 
jobs and deal with deficits and debt. That is the substantive 
message.
    But they also want us to work together and come up with 
bipartisan solutions. What they want to see in the context of 
that is what we are doing today: Having what we will have, and 
I can tell by the opening statements, it is plainly evident 
that we will have a good, robust debate about tax policy, and 
that is good. People like that. What they do not like is when 
we do kind of the usual name-calling in Washington.
    So this is a very constructive process that we are 
undertaking today. I think when we talk about the basics of 
this agreement, number one is there is broad agreement in this 
room and across the country that we need tax reform, and a lot 
of it. Whether we get that or not in the next couple of weeks 
remains to be seen, but I think that is at least one thing we 
can all agree on.
    Secondly, what concerns me about some of the ideas that 
have been and will be presented today is what are the effects 
on at least two basic priorities? Number one is: What will 
happen to the middle class? And what will happen to deficit and 
debt?
    I think they are two basic concerns that I have. But I 
think the Vice Chairman has done a very good job of gathering 
us together and getting some very smart folks to help us better 
understand what our challenges are and what some of those 
solutions can be. So I really appreciate the work that he has 
done to make this hearing possible.
    Thanks, very much.
    Vice Chairman Brady. Mr. Chairman, thank you.
    We will begin the questioning.
    Mr. Entin, thank you--this is a comment more than a 
question--thanks for making the point that the goal of tax 
reform is not simply broadening the base, or the effect on 
demand, but ought to be measured by the incentives to invest. 
Because that drives job creation consistently in this country.
    Mr. Mastromarco, the FairTax seeks to replace a number of 
taxes--the personal income tax, the corporate tax, payroll 
taxes, gift and death taxes--with a single-stage retail sales 
tax.
    Since the title of this hearing is ``Can Tax Reform Boost 
Business Investment and Job Creation?'' can you talk a moment 
about what you believe will be the impact on our economy as a 
result of the FairTax and who would be impacted by the change 
to that system?
    Mr. Mastromarco. [Inaudible].
    Vice Chairman Brady. If you could hit your microphone and 
make sure that it is on.
    Mr. Mastromarco. The FairTax would unleash significant 
growth. In a way we can think of the FairTax is as being a Roth 
and a regular IRA all combined, where the earnings are not 
taxed. Think about investment in business--it is both pre-
payroll and pre-income tax--where then the business can grow 
with its earnings tax-free. The business can then be sold tax-
free. What it does it go back to a theory of Dr. Irving Fisher 
many years ago that income really is not income until it is 
consumed. The FairTax does not tax productive income.
    And so let me show a chart, if I may, that we have that was 
done by Beacon Hill Institute. The FairTax, Chairman Brady, is 
a proposal that has been the most researched plan, I venture to 
say, in the history of the United States--certainly one of the 
most popular plans. These are the economic effects according to 
David Tuerck of the Beacon Hill Institute. Real GDP grows in 
all of the years--year five, year one, year ten; jobs increase; 
investment grows, and wages rise.
    The chart that you looked at earlier showed that wages 
increased as a result of capital investment. Here capital stock 
grows and that is what increases wages. Farmers are not more 
efficient today than they were at the turn of the Century 
because they work harder hours, longer hours; they are more 
efficient because they have tractors, and capital to work with. 
And this capital comes in the form of investment, and it comes 
in the form of intellectual capital.
    What the FairTax does is relieve the tax on that capital 
entirely.
    Vice Chairman Brady. Thank you. And can you address for a 
moment the revenue-neutral issue? We sometimes see all sorts of 
numbers fly around about what their tax is from a revenue-
neutral standpoint. Can you address that?
    Mr. Mastromarco. I will address that. And I appreciate that 
question.
    I think it is a very large question, because it opens the 
door to a criticism of the way in which revenue-estimating and 
analysis is done in this country. You know, the raison d'etre 
of tax reform is supposed to be economic growth, real wages; 
the things we are talking about today.
    And yet, when the Joint Tax Committee comes up with their 
estimates such as the rate of the FairTax, we close our eyes to 
the economic growth. We say we do not want to hear this. We 
want to just look at the static estimates.
    We do not know whether the Joint Tax Committee has analyzed 
the FairTax because the Joint Tax Committee operates with 
secrecy that rivals the CIA.
    They should be disclosing to you their spreadsheets. They 
should say: Here is how we came up with it. We are scientists. 
We believe in our answer. We came up with the right answer, so 
we can accept the criticism of it. That is the way the Joint 
Tax Committee should function. And the Joint Tax Committee 
should not function by simply giving you a static estimate as 
if all tax cuts and increases are created equal, which they 
most certainly are not.
    Vice Chairman Brady. May I ask--and we are closing out on 
time--but is the 23 percent rate in the FairTax revenue 
neutral?
    Mr. Mastromarco. It is, sir. As a matter of fact, if the 
FairTax had been adopted last year, we would have $267 billion 
more dollars in our federal coffers than we do today.
    Vice Chairman Brady. Thank you, sir.
    Chairman Casey.
    Chairman Casey. Thanks very much.
    Dr. Stone, I wanted to start my questioning with a very 
basic question to you. How do you evaluate the proposal that 
was enunciated just a moment ago in terms of the analysis 
presented by the chart? What is your assessment of that 
proposal?
    Dr. Stone. Well, the FairTax proposal is----
    Chairman Casey. Oh, the mike. Yes.
    Dr. Stone. The FairTax proposal is a version of a 
consumption tax. There are all kinds of consumption taxes: a 
value-added tax, a consumption tax like the FairTax--but we 
know the characteristics. They tend to be regressive compared 
with the current system.
    I know the FairTax proposal has something to address what 
is going on at the bottom. But in terms of economic efficiency, 
you mentioned Dr. Kotlikoff, there are economists who looked at 
the efficiency of moving to a consumption tax. And what you 
learn is that almost all of the efficiency gains come as a 
result of taxing existing capital: people who have saved, 
already paid income taxes on the money they saved. They have to 
pay again when they consume.
    And so in that situation what you do is you decide you had 
better work harder and you better invest more. It is like a 
natural disaster that knocks down a building. You have lost 
wealth, but you work harder to repair that wealth and you save 
more. That is where almost all the efficiency gains come from 
is the taxation of old existing capital in the FairTax 
proposal.
    There is also a question of transition. You can have lots 
of transition rules to avoid those problems, but that takes 
away most of the efficiency gains.
    Chairman Casey. I started in my statement with a concern 
about the impact on the middle class. Can you assess that?
    Dr. Stone. The FairTax proposal does attempt to deal with 
folks at the very bottom, but like all consumption taxes very 
high income individuals get a much bigger break than the middle 
class. And so it would shift benefits towards--it has 
unattractive distributional characteristics if you think that a 
lot more after-tax income going to the very top of the 
distribution is not a good idea. The middle class gets hurt 
compared with the rich.
    Chairman Casey. I wanted to ask as well, and I know we have 
limited time, there is a 2010 analysis by the Citizens for Tax 
Justice. Corporate taxpayers and corporate tax dodgers in the 
calendar year 2010, manufacturers paid 23.2 percent of their 
profits in taxes compared with 2.2 percent for IT companies, 
and 5.2 percent for telecom companies.
    On average, the tax rate for the companies in their study 
was 17.5 percent.
    Is anyone on the panel familiar with this data? Give me 
your assessment of those differentials.
    Mr. Hanlon. Sure, I can jump in. I mean, Citizens for Tax 
Justice and ITEP have been doing this kind of analysis for 
basically 30 years. Actually one of their reports was one of 
the impetuses behind the 1986 Tax Reform Act when President 
Reagan read and saw the number of companies that were not 
paying--profitable companies that were not paying federal 
income taxes and said they have to do something about this.
    So it is an analysis of only profitable companies. They 
screen out the ones that are not profitable. And it looks at 
their overall effective rate. And I think you had mentioned 
those--you know, it was very interesting, the disparities among 
industries, and in particular manufacturing being a 23 percent 
rate.
    I think another thing that is masked in the way they do it 
is that there is also a differential between domestic 
manufacturing and foreign manufacturing, which I think is 
another distortion created by the tax code, and an important 
one, that we have to address.
    So I think, you know, overall as you may----
    Chairman Casey. Are you talking about the manufacturing 
being adversely impacted?
    Mr. Hanlon. Right, the domestic manufacturing.
    So I think the study on the whole survey undermines the 
notion that corporations are over-taxed in general compared to 
other countries, and certainly would lead to the conclusion 
that we need a base-broadening that levels the playing field 
among competing industries.
    Chairman Casey. I know I am out of time but, Mr. 
Mastromarco, I know you will get rebuttal time.
    Mr. Mastromarco. No, I appreciate the opportunity. I do not 
know whether Dr. Stone has actually had the opportunity to read 
the FairTax, but it is the only plan that completely untaxes 
the poor. Through its rebate mechanism it makes sure that no 
one pays their FairTax to meet the sustenance in life.
    The amount that is at the poverty level is completely 
untaxed. That is not what we do today. Under the Earned Income 
Tax Credit, for example, in order to escape poverty we impose 
some of the highest marginal rates on those individuals. And 
that keeps them in that position. It is very bad.
    In terms of equity, here is what the data of Dr. Kotlikoff 
showed when he looked at 42 family sets and ran his simulation 
model. He said that the lifetime average effective rates would 
decrease for lower-income taxpayers 86 percent over what it is 
today, and 42 percent for upper income folks. In other words, 
these are highly progressive results. And his study shows that 
the welfare gains are equally progressive.
    Twenty-seven percent of the welfare gains go to low income 
individuals. Eleven percent go to the middle income, and five 
percent to the upper income.
    Here is the problem, Mr. Chairman. We assume here----
    Chairman Casey. I did not mean to give you this time. Can 
you hold that so we can move----
    Mr. Mastromarco. Absolutely.
    Chairman Casey. Can you hold that?
    Mr. Mastromarco. Yes.
    Chairman Casey. Thank you.
    Vice Chairman Brady. Thank you very much.
    Mr. Mulvaney.
    Mr. Mulvaney. Thank you, Mr. Vice Chairman.
    Mr. Mastromarco, I appreciated your comments at the outset 
about how all too often it is difficult to get economists to 
agree between various groups. I am always stunned at the number 
of times they do not seem to be able to agree with themselves.
    Since we have been up here today I have heard now that tax 
reform will not create jobs, but in the next breath folks will 
extol the payroll tax cut, which is designed supposedly to do 
exactly that.
    I have heard that we are seeking to increase aggregate 
demand, and in the next breath suggesting that the Bush/Obama 
tax cuts expire, which unequivocally will have the exact 
opposite impact on aggregate demand.
    What is more frustrating is the number of economists who 
seem completely able to ignore the real world. It is like we 
have moved away from Adam Smith's worth, his beautiful insight 
into the real world, and human nature, and what actually 
existed outside of these walls, to Samuelson's text which I 
read in college which was--I always wondered if the guy 
actually ever wandered outside of a classroom.
    And what it leads us to is a situation where today still 
some of you are arguing that infrastructure spending is the 
best way to spur adequate demand--despite the fact that we have 
tried that and it did not work; that you are still here today, 
gentlemen, some of you, pushing for an extension to things like 
Unemployment Benefits and extension to the payroll tax cuts 
when we already have unequivocal evidence that it did not work.
    And I am just wondering if we have not learned anything 
from this most expensive economics lesson that anybody has ever 
received? We spent $800 billion to try to put exactly what 
you--Mr. Hanlon and Dr. Stone especially--have extolled here 
today, and the only possible conclusion you can come to in the 
real world is that it did not work. But that is my comment, and 
here is my question:
    Dr. Stone, you mentioned something I want to come back and 
talk to a little bit, which is about the base, broadening the 
tax base. And here I am talking about not the size of the 
income that we have available to tax, but the number of people 
who are actually participating in that tax base.
    One of the numbers you hear a lot is that half of the folks 
in the country who make money, who earn money, do not pay the 
income tax. I am just wondering if you think that is fair, or 
needs to be changed?
    Dr. Stone. I am not sure that the statistic is fair. The 
high figure that you cite is for a particular period. It is 
lower in years when the economy is not so weak.
    But more importantly, people do pay federal taxes. Most 
people do pay federal taxes. They pay payroll taxes, and they 
pay income taxes. And to simply focus on the income tax is to 
miss the fact that people are paying taxes.
    Mr. Mulvaney. But the payroll tax, I've always--since I got 
my first check when I was 14 or 15 years old, you know, my Dad 
laid out to me, this is the income tax, and then this is FICA. 
And what that is is that is Social Security--isn't that a 
segregated fund, supposed to be at least in theory? When you 
pay payroll taxes, you are paying for what people perceive to 
be their own benefits in the future, their Social Security, 
their Medicare. They are not paying for defense, USDA food 
safety, they're not paying for the FAA, they're not paying for 
the FBI. Correct?
    Dr. Stone. The FICA tax is--is--goes into the Social 
Security Trust Fund, but revenues are all mixed together, and 
spending is all mixed together. It is not as though it is 
completely segregated.
    It says, this--it is an indication of promises to pay 
future benefits.
    Mr. Mulvaney. No, I understand that we raid the Trust Fund. 
I understand how that works, and that we buy nontradeable 
public debt. I understand all that. But the point of the matter 
is, if you are only paying payroll tax you are not paying for 
national defense, are you?
    Dr. Stone. You're
    Mr. Mulvaney. I'm what? I'm right?
    [Laughter.]
    Dr. Stone. It's more complicated than that. Nobody's dollar 
is going to national defense versus going to paying for 
Medicaid. It is all one pot.
    Mr. Mulvaney. Do you think everybody should pay something 
towards national defense? Everybody in the country?
    Dr. Stone. I think the people should pay taxes in 
proportion to their ability to pay, and receive benefits in 
proportion to their--to what they--to how they benefit.
    Mr. Mulvaney. I've heard that before. I heard that before. 
I read that someplace. It's called: From those according to 
their abilities to those according to their needs, isn't it?
    Dr. Stone. It's--It's about--it's about the system that we 
have had in the United States for a long time of a progressive 
tax and benefit system. That's what we have.
    Mr. Mulvaney. Thank you, sir.
    Thank you, Mr. Chairman.
    Vice Chairman Brady. Mr. Duffy.
    [Pause.]
    Excuse me, Senator, you are recognized.
    Senator Coats. Thank you. I have got a little bit of a time 
constraint, so I appreciate the yielding of the time.
    First of all, thank you for your testimony. A lot of very 
interesting questions have been raised. I happened to co-
sponsor a bill, a bipartisan bill, along with Senator Wyden, 
and it was really crafted by Senator Wyden and Senator Gregg 
over about a three-year period of time.
    I got the baton handed off to me when Senator Gregg retired 
from service. I have worked with Senator Wyden tweaking some of 
the provisions of the plan. What we have both said--what he 
said with Senator Gregg and what he and I are saying today is, 
this is not the be-all and end-all of tax reform. These are 
some ideas and some thoughts based on some basic principles 
that have been invented over about a three-year period of time 
by a number of organizations, and we still leave the door wide 
open for suggestions for improvement, or even major changes to 
it if we can find adequate substitutes that better lead us 
toward the goals that we all are trying to reach with tax 
reform.
    Clearly there is a growing consensus that we need this 
reform and need it badly. And I am hopeful that that consensus 
will lead to actual reform, and obviously we want to do it the 
right way.
    In the limitation of time, let me just focus on one aspect 
of the Wyden-Coats provision. That is, addressing the corporate 
tax rate, which was mentioned and was on the chart.
    We see that as a strong impediment to the competitiveness 
in a global economy. There is a difference of opinion as to how 
much of an impediment it is, but there is pretty much a 
consensus that we do not need to be at the top of the 36 OECD 
countries in tax rate. And then being at least at the average 
level would be a benefit to the United States.
    And so ours brings it down to 24, but we are looking for 
ways to actually bring it down to 21 or 22. And we do that by 
eliminating a lot of the exclusions, exemptions, subsidies, and 
so forth that has been said by the panel, some of the more 
effective lobbyists have been able to insert into the tax code 
through--actually the Congress did--but through some effective 
lobbying by some corporations than others.
    Now I met with and talked to a lot of heads of multi-
national companies. Almost exclusively I have heard two things. 
One, well, our company does not have a problem with that 
because we have been able to use the X, Y, Z subsidies, 
credits, et cetera, et cetera, and that brings our rate down to 
a level where we are competitive.
    And others say, you know, this is very unfair because those 
who have more--who have been successful with the tax-writing 
committees get a break at the expense of the others. And many 
have said to me: Look, if you could get us down into the low to 
mid 20s, I don't care what exemptions I have, or what breaks I 
will take, I will take that over having to go through the 
process of continuing to work to save my subsidies, save my 
credit, save my exclusion, or get a new one, or whatever.
    So I would just love to get rid of all that effort, all 
that time, all that cost, all that uncertainty, just give me a 
rate where I am competitive with my competitors.
    Any problems with that goal in mind? And if any of you have 
examined our particular legislation, any comments you could 
provide for us, that would be helpful and would be appreciated.
    Mr. Entin. Senator, a good friend of mine who in fact used 
to intern with us, was one of the staff people who worked with 
Senator Gregg on this bill, and I asked him as he was putting 
it together: Are you checking the rate cuts versus the offsets? 
And Joint Tax was not providing decent information.
    In two areas there is a problem with the bill. First, the 
increase in taxes on capital gains and dividends is not a good 
idea.
    Second, they really----
    Senator Coats. I happen to agree with that, even though it 
is my own bill.
    Mr. Entin. Okay. But Joint Tax gave you estimates and 
notions on depreciation that really were extraordinarily 
harmful and wrong. You have been put back to asset lives that 
Kennedy used, but not the double-declining balance that he 
used, so you have the worst tax treatment on depreciation of 
capital since the Eisenhower Administration.
    Some industries do not care about that. If you have nothing 
but, for example, royalties and software, perhaps without any 
big manufacturing costs, that will not bother you, you prefer a 
lower tax rate. But if you have got manufacturing equipment and 
other capital intensive industries, that will cause a great 
deal of trouble.
    We tried to measure the relative effects of these changes, 
and in our model it comes out very badly.
    One of the points that you need to note is that you will 
have of course in your bill an elimination of the domestic 
production or manufacturing credit which already lowers the 
corporate rate to some extent for those companies, and that 
means that the rate cut you are apparently giving is not as big 
as it appears to be.
    So the depreciation then weighs very heavily against what 
is in fact not quite a big-enough corporate rate cut. If you 
can get the corporate tax rate down to the very low 20s, or 19, 
with that depreciation schedule you might make up for it. But I 
think you are going to have a great deal of trouble getting a 
lower service price of capital in the structure that you have.
    I also think that if you have a revenue problem, and cannot 
keep the expensing, you can still keep the depreciation 
allowances just as valuable by switching to a neutral cost 
recovery system. Keep the longer asset lives, but pay an 
interest rate, a respectable one like a long-term return on 
capital of about 3 percent plus inflation on the unused 
balances going forward.
    The present value would be the same as expensing, but it 
would give you enough time to get all the added capital into 
place before you actually had to have the bigger depreciation 
writeoffs over time. This mismeasurement of the cost of 
investment in the bill is causing it real problems.
    Now there are many other subsidies to the corporate sector 
that can and should be closed to lower the rate, and in that 
general framework I would agree. But when you have these 
specific provisions which hit at the service price of capital, 
it does not come out quite right.
    Senator Coats. Well thank you for that. I take that as a 
constructive suggestion. I guess what I would ask of you is 
that you have the individual who wrote that who now works for 
you issue a mea culpa and send me details of what you just 
said, and we will go to work on it.
    [Laughter.]
    Mr. Entin. He was an intern 20 years ago, but I will get in 
touch with him again.
    [Laughter.]
    Senator Coats. Your suggestion is very helpful. My time is 
up. Thank you.
    Vice Chairman Brady. Senator, thank you. And now, Mr. 
Duffy.
    Mr. Duffy. Thank you, Mr. Chairman. And I appreciate the 
panel coming in today.
    If you look at what has changed over the last 50 years, is 
it fair to say that as we look at the global marketplace we 
compete with China, India, Mexico, Vietnam, Brazil, Canada, at 
a far greater rate today than we even did 10 years ago? Or more 
than 40 years ago? Is that correct?
    Mr. Entin. Yes.
    Mr. Duffy. Would you all say that capital is pretty free-
flowing? It goes to the best home possible? Right? I mean it is 
kind of like as we look at our own spending habits, Wal-Mart 
has become successful because people want their dollar to go as 
far as possible, right? They go to Wal-Mart instead of maybe 
another store that does not provide the best value?
    [Panelists nod in the affirmative.]
    Is capital kind of the same way? It goes to the best place? 
Am I right on that?
    [Panelists nod in the affirmative.]
    You are shaking your heads ``yes.''
    Mr. Entin. Yes.
    Mr. Duffy. And so if we look at raising taxes in America, 
doesn't that make us less competitive on this global stage? I 
mean, is it not as good a home for capital as some of the other 
OECD countries that were put up in the chart?
    Mr. Entin. Yes.
    Mr. Duffy. Okay. I guess, I don't know if you guys looked 
at Switzerland, Ireland, Germany, Canada, Chile. Are those 
countries, Mr. Stone, is there a movement within those 
countries to create economic growth by raising their tax rates 
right now?
    Dr. Stone. There is not, although right now their short-
term economic problems are so great that the question of 
attracting investment is less important to them than getting 
their budgets in order and worrying about high unemployment.
    On the question of capital mobility, yes, capital is 
mobile, and yes, we are competing with more people. But there 
is an awful lot of considerations that go into whether it is 
worthwhile to be producing in, you mentioned Vietnam, versus 
producing in Pennsylvania or in Texas. And there's a lot more 
considerations.
    The United States still enjoys many advantages of producing 
right here in the United States. Capital is not flying all the 
way out. And capital is not quite as mobile as we all nodded 
our heads to. There are some limitations.
    Mr. Duffy. And maybe your thinking is different than I do, 
but when I am talking to business leaders they all tell me it 
is not the only consideration. They look at the American 
workforce, its productivity, its intelligence, but they also 
look at the tax code.
    Do they tell you something different than what they are 
telling me?
    Dr. Stone. No, no. I am saying all these things figure in.
    Mr. Duffy. Right. And so isn't it fair to say, if you guys 
are advocating raising taxes, you are too advocating for a less 
competitive American economy?
    Mr. Hanlon. So I think, you know, we need to balance the 
fiscal priorities. You mentioned that one of the factors in our 
competitiveness is our workforce, and certainly other factors 
are infrastructure and the strength of the consumer base in the 
United States.
    And so I think we need to balance, you know, the concern 
about statutory rates with the need to fund the investments 
that are going to maintain our competitiveness. In particular, 
if we think about workforce, education, investing in our 
infrastructure, and I think those things are indispensable to 
long-term economic growth and competitiveness.
    Mr. Duffy. And I might not have the right number for this, 
but we are sitting at about a $98 trillion in unfunded 
liabilities? Is that roughly the right number? Anyone?
    Dr. Stone. That is the number I have heard. We have large 
deficits in the future, yes.
    Mr. Duffy. Do you think we can tax our way out of these 
unfunded liabilities? Or at some point do we have to say:
    What promises have we made? If you look at the expansive 
growth of government, at some point, instead of going we have 
to tax more to meet the obligations, should we not at some 
point say we have too many obligations? We have to cut back. We 
have to scale back. Instead of adding, you know, more onto the 
unfunded liabilities this country has.
    Mr. Stone.
    Dr. Stone. Our long-term budget deficit problem--unfunded 
liabilities is one measure. It is a little bit of a shaky 
measure. But there is no question that we have big budget 
deficits in the future.
    It is almost exclusively driven by rising health care 
costs. Health care costs are rising faster than other costs in 
the economy, faster than GDP, and that is happening not just in 
the government programs but it is happening in the private 
programs as well.
    If we find a way to get a handle on those costs, our budget 
deficit problem down the road becomes much more manageable. It 
is not about Social Security being out of control. It is not 
about discretionary spending being out of control. It is----
    Mr. Duffy. One quick question before I have to turn it 
over. Am I correct that there is not an historic correlation 
between tax rates and revenue as a percentage of GDP? The 
actual correlation of revenue to the federal coffers will 
actually correlate with GDP growth? So the basic point is, if 
you grow your economy so too do you grow revenues to the 
federal coffers, as opposed to raising taxes, doesn't 
necessarily bring in the growth that would be projected?
    Dr. Stone. Well, we did in the 1990s have a very strong 
economy, raised a lot of revenue, brought the budget deficit 
down, produced surpluses, and then we gave it away.
    Mr. Duffy. My time is up, and I hope we will have a second 
round and I will yield back.
    Vice Chairman Brady. Thank you, Mr. Duffy. I would point 
out that from 1981 to 2001 we actually lowered the size of our 
Federal Government from about 23 percent of the economy to 18 
percent and during that period grew about 37 million jobs. So 
there is no--in the private sector, predominantly, so there is 
no question there is a correlation between the size of 
government and job growth.
    Mr. Campbell.
    Mr. Campbell. Thank you, Mr. Chairman.
    And to Mr. Mastromarco's opening comment about economists 
holding hands, I agree with some of what each of you said, and 
disagree with what some of each of you said. So I guess I am in 
that same camp.
    But Mr. Hanlon, first for you. You mentioned about 
repealing the Bush tax cuts for higher income individuals. 
Okay, let's assume we do that. It's done. It's all done. That 
does not come close to closing the deficit. So are there other 
tax increases that you believe we ought to have?
    Mr. Hanlon. Sure. No, I agree. It is certainly a first 
step, and it is not the only thing. And I would think, just in 
response to the questions before, I mean there is no doubt we 
need to do things on both the spending and the revenue side. I 
mean, I am not advocating for only raising taxes, and 
particularly health care. We need to get health care costs 
systemwide under control.
    And so--but in terms of what else we can do to raise 
revenues beyond that, I think we do need to do that. I think 
the best way is to broaden the tax base and look at the tax 
expenditure budget. In particular, tax expenditures that 
provide a greater benefit for high income people because of 
what is called the upside-down effect, that people who pay 
higher marginal rates benefit more from the various incentives 
that are in the tax code.
    There is a proposal to----
    Mr. Campbell. Sorry, no, what I'm getting at is, there is a 
lot of rhetoric around this town these days about taxes on 
high-income individuals, but even if you do that it still is 
not that big an amount of money relative to the problem.
    So my question is--and you have said there ought to be some 
stuff on the spending side as well. I understand that. But 
let's say we do whatever for high-income, raise the rate to 
whatever, do whatever you think ought to be there, do you also 
believe that as a part of this that there should be tax 
increases on--or reductions in tax expenditures, whatever, on 
people who are not high-income, or not?
    Mr. Hanlon. So have a--we developed a plan called the--it's 
called ``Budgeting for Growth and Prosperity,'' and it is 
basically a, it was the challenge to basically balance the 
budget over a 20- 25-year time frame. And we tried to do that 
by avoiding tax increases on middle class people.
    I mean, I think one way--you know, something we need is to 
put a price on carbon emissions, which solves two problems. I 
think you definitely want to protect low-income people from 
that. But that is another potential revenue source that can 
help in the long term.
    Mr. Campbell. But that obviously hits middle class 
taxpayers.
    Mr. Hanlon. Sure, it could, depending on how you structure 
it; yes.
    Mr. Campbell. Okay. All right, Mr. Mastromarco, FairTax. 
One of the things you did not mention in this argument, one of 
the arguments that a lot of FairTax people say is we can get 
rid of the IRS. There has to be a whole lot less enforcement, 
et cetera.
    My concern has always been, if you take--and I do not know 
what number of a FairTax you have, but I have heard 23 percent 
or something. Let's just take that. I am from California. You 
add to our 10 percent sales tax, state sales tax. You are now 
up to 33 percent effectively consumption tax.
    The incentive to avoid that tax and to take transactions 
and things underground would be enormous. And I have always 
thought that one of the problems with the FairTax is that it 
would be the opposite. You would actually need a much more 
intrusive enforcement mechanism than currently exists on the 
income tax.
    What are your thoughts on that?
    Mr. Mastromarco. Right. I really couldn't disagree more 
with that statement. And this is from somebody who has 
experience both as a tax practitioner and also has worked in 
tax----
    Mr. Campbell. And by the way, I am a CPA and did tax 
returns for a living, and have a Masters in Taxation.
    Mr. Mastromarco. So we should be kindred spirits on this.
    Mr. Campbell. We should be. But like you say, joining hands 
and don't agree.
    Mr. Mastromarco. Well, but part of it is defining the 
problems. That's the beginning, you know, and that's the good 
thing about what this Committee is doing, is to ask the right 
questions that lead to the right answers.
    The good news is tax reform is coming. The bad news is, it 
is undefined.
    There has been a lot of good work that Ms. Nina Olson, the 
National Tax Payer Advocate, has done, and through various 
reports, concerning what causes the tax gap; what causes this 
massive tax gap? Is it under-reporting.
    What are the influences that deal with evasion? The first 
thing you have to understand, Congressman, is that the tax gap 
is really four different elements:
    Honest taxpayers;
    Confused taxpayers;
    Game players; and
    Evaders.
    Under the FairTax, you pretty much eliminate the game 
players and the confused. I mean, it reduces the 9,000 code 
sections into how much did you sell the consumers? That is a 
pretty basic, easy question. So it divides the line between 
evaders, game players, and those with excuses, pretty well.
    All right, so then we look to evaders. What influences 
that? The number of taxpayers, they diminish by about 90 
percent. 85 percent of the consumption taxes are paid by about 
15 percent of the retailers. The opportunities they have for 
evasion in the code diminish. I could drop the code on the 
floor, you could too, and we could tell people how to avoid the 
taxes on any page. This is a very simple plan.
    Third, marginal rates--and that is where you were focusing 
on--marginal rates; marginal rates under the FairTax are the 
lowest of any conceivable plan that could be developed. The 
base is twice that taxable income--23 percent--as opposed to 
15.3 percent payroll taxes under the current system, plus. 
Let's take a taxpayer at 28 percent; that's 43 percent.
    So if you're going to rob a bank, the question is: Do you 
rob the one with gold? Or do you rob the one with iron ore?
    Mr. Campbell. Yes. And I think the Chairman is saying my 
time is up, so this will be a continuing discussion. But my 
concern is that you turn--it is like prohibition. You turn a 
lot of honest people into dishonest people because of the size 
of the benefit of becoming someone who does not pay taxes. But 
my time is over. Thank you, Mr. Chairman.
    Vice Chairman Brady. Thank you, Mr. Campbell. We normally 
conclude at the end of the first round, but let me quickly 
offer the chance for a follow-up question from any of the 
members here on the panel.
    Mr. Duffy.
    Mr. Duffy. If I could just quickly. Mr. Hanlon, I think you 
indicated you would support a carbon tax? Is that right?
    Mr. Hanlon. Some kind of price on carbon emissions.
    Mr. Duffy. Is that so we would have a cleaner environment 
and less carbon emissions?
    Mr. Hanlon. Yes.
    Mr. Duffy. Okay. And you would admit that if you tax 
carbon, you get less of it? Less carbon emission, right?
    Mr. Hanlon. Sure.
    Mr. Duffy. And we tax cigarettes, as well, because we want 
people to smoke less, too, right?
    Mr. Hanlon. Um-hmm.
    Mr. Duffy. And so if we extend this argument out, if you 
tax income, if you tax capital, you will get less of that, as 
well? Right?
    Mr. Hanlon. I see where you're going. I mean, certainly----
    Mr. Duffy. Why does it work for carbon and it does not 
apply to every other principle we have talked about today?
    Mr. Hanlon. Well it does apply, but you need to look at, 
you know, for example--we've talked about savings a lot, but we 
need to look at our national savings rate. And when we----
    Mr. Duffy. But I think the point is, when we talk about 
taxes, I think you made the exact point. You tax carbon because 
you want less of it. You want to tax income, you want to tax 
capital, and you are going to get less of it. And if you look 
at the issues in the country today, it is an issue about the 
economy and jobs.
    We want to see investment in America. We want to see 
expansion in America which will in the end lead to economic 
growth, and job creation. But here you sit here and advocate 
for greater taxes, and we will get less of that when we 
increase taxes. And that is my concern with the two of your 
positions, Mr. Stone and Mr. Hanlon.
    I know that you guys have probably followed what we have 
done in the House. We have tried to, in our budget, make a 
proposal for tax reform where we are going to take the top rate 
from 35 to 25 percent and do away with quite a few of the 
loopholes, make it fairer, flatter, simpler. We're not quite 
where Mr. Mastromarco is with a FairTax, but we are going in 
that direction.
    Would you all agree that that is a better system? Was 
anyone opposed to what we were trying to do in our budget with 
tax reform?
    Dr. Stone. Sure. I'll be the devil's advocate here.
    Mr. Duffy. I thought you would be.
    Dr. Stone. The problem is that when we talk only about the 
problems with marginal tax rates affecting activities that we 
value, there are also government activities that only 
government can do--defense, some kinds of infrastructure--for 
the size of government that we need. And the problem that we 
have with most of the proposals in the House is that they just 
set the level way too low for the revenue that they are trying 
to raise relative to what is realistic in our political system, 
what is realistic in terms of our aging population and our 
needs.
    And so if you--the principle is fine. It is just that the 
level of spending and revenue does not seem as though it will 
work.
    Mr. Duffy. Mr. Entin.
    Mr. Entin. If you get the tax base right, you are going to 
get some added growth. Then the needs may go down. If you get 
the tax base right, people will see the full cost of government 
instead of having it hidden here and there. And they might not 
want as much government.
    You don't know what you need until you get things right. So 
that needs to be done.
    Second, the burden tables that people talk about--this tax 
falls on this person, this tax falls on that person are 
misleading. If the tax is changing the size of the economy and 
the level of wages, it is bound to be shifted to the middle 
class. If you do something that depresses wages, they are going 
to be hurt even if it is not on the burden table.
    The burden tables are nonsense. They do not take the effect 
on the economy into account.
    Mr. Duffy. Right.
    Mr. Entin. The tax expenditure list is a problem. In the 
late Bush Administration, right up through the 2009 budget, 
they had a chapter on tax expenditures. That is required. But 
in those years, they put in the tax expenditures as they would 
appear under the so-called broad-based income tax, and then 
another set of tax expenditures as they would appear under a 
neutral tax system. And most of the major tax expenditures 
simply vanished because under a neutral tax system they are not 
tax expenditures, they are the right treatment. All pension 
plans under a consumed income tax--where you put down your 
income, subtract your saving, and pay tax on what is left, and 
when you withdraw from a pension you add it to your income--are 
the norm. But they are viewed as a big tax expenditure under 
the income tax. That misperception goes away under the 
consumption base.
    The same is true as you go down through all the major tax 
expenditures, even in the housing sector. OMB got that one 
wrong. They messed that up. Under current law, even housing is 
treated correctly as it would be under a consumption tax base.
    When you look at tax expenditures as they are commonly 
presented, you get a bad idea for tax reform because you are 
going to start raising taxes on capital. Capital responds more 
to taxes than labor. I am not an advocate of higher tax rates. 
But if I had to choose one thing in the Bush plan to let go, I 
would say let the two top rates go up. They hit CEOs. They hit 
high-paid attorneys. They hit high-paid athletes. They hit 
entertainers. And they also hit some entrepreneurs. But give 
the entrepreneurs expensing in exchange on a permanent basis 
and they will be held harmless.
    If you want a lot of revenue, you are going to have to tax 
middle class workers. But if you tax them on consumption 
instead of income, at least they will be free to save and 
invest and try and get out from under it and have a decent 
retirement. Watch your base. That is more important than almost 
anything else.
    Mr. Duffy. And it is fair to say that is why we went from 
not just millionaires and billionaires, as the President talked 
about, he actually went to those who made $200,000, $250,000 
because that is where the money is at. The lower you go, the 
more people you hit.
    Mr. Mastromarco. Yes. But you will not just hit them. There 
will be less capital formation, and then everybody will have a 
lower wage, including all the way down the income scale.
    Mr. Duffy. Absolutely. I yield back. But I appreciate the 
panel coming in. I think it is a great discussion, seeing a 
couple of different sides of you and everyone sitting nicely 
and engaging. I appreciate you guys.
    Mr. Campbell. Holding hands.
    Mr. Duffy. Holding hands, yes.
    Vice Chairman Brady. Well I want to follow up on that. I 
want to thank our witnesses for being here today. You know, 
some experts believe the 1800s was the British Century. 1900s 
was the American Century. And this is the China Century. I am 
not convinced we need to cede the strongest economy in the 
world to our Asian competitor.
    Part of that competitiveness and retaining that is a tax 
code for the 21st Century, that makes us competitive, that 
rewards that investment, that boosts our economy. Today we 
heard both pros and cons on how best to do that, but I think 
the lawmakers today who believe this is perhaps, along with 
getting our financial house in order, the strongest reform and 
change we can make to keep the world's largest economy are 
right. This is critical to get the broad range of debate about 
this. I want to thank our witnesses for being here today, and 
your insights on the various areas. I want to thank our 
lawmakers for taking time again to focus on the most important 
issue before us in the economy. And with that, the hearing is 
adjourned.
    [Whereupon, at 11:21 a.m., the hearing was adjourned.]


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