[Joint House and Senate Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
S. Hrg. 112-422
HOW THE TAXATION OF CAPITAL AFFECTS GROWTH AND EMPLOYMENT
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
__________
APRIL 17, 2012
__________
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
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Opening Statements of Members
Hon. Kevin Brady, Vice Chairman, a U.S. Representative from Texas 1
Hon. Michael C. Burgess, M.D., a U.S. Representative from Texas.. 3
Witnesses
Dr. Kevin Hassett, Senior Fellow and Director of Economic Policy
Studies, American Enterprise Institute, Washington, DC......... 4
Dr. Jane Gravelle, Senior Specialist, Government and Finance
Division, Congressional Research Service, Washington, DC....... 6
Submissions for the Record
Prepared statement of Vice Chairman Kevin Brady.................. 26
Prepared statement of Dr. Kevin Hassett.......................... 27
Prepared statement of Dr. Jane Gravelle.......................... 50
Letter, dated April 30, 2012, to Vice Chairman Brady from Kevin
Hassett........................................................ 60
Letter, dated April 25, 2012, transmitting posthearing questions
from Vice Chairman Brady to Jane G. Gravelle................... 61
Jane G. Gravelle's responses to posthearing questions from Vice
Chairman Brady................................................. 65
HOW THE TAXATION OF CAPITAL AFFECTS GROWTH AND EMPLOYMENT
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TUESDAY, APRIL 17, 2012
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The committee met, pursuant to call, at 10:00 a.m. in Room
216 of the Hart Senate Office Building, the Honorable Kevin
Brady, Vice Chairman, presiding.
Senators present: Coats and Lee.
Representatives present: Brady (presiding), Burgess, and
Mulvaney.
Staff present: Conor Carroll, Gail Cohen, Will Hansen,
Colleen Healy, Patrick Miller, Robert O'Quinn, and Steve
Robinson.
OPENING STATEMENT OF HON. KEVIN BRADY, VICE CHAIRMAN, A U.S.
REPRESENTATIVE FROM TEXAS
Vice Chairman Brady. Good morning. Today is April 17th,
unfortunately Tax Day, for Americans. In recognition of
America's hardworking taxpayers, it is appropriate that the
Joint Economic Committee hold its first of two hearings on how
taxes affect America's economy. Today's hearing focuses on the
taxation of capital, and on Wednesday, May 16th, the second
hearing will focus on the taxation of labor.
My goal as Vice Chairman of this Committee is to ensure
America has the strongest economy in the world throughout the
21st Century. To do that, we must get our monetary policy right
and we have to get our fiscal policy right. A competitive tax
code is more than just getting the rate right. It is about
creating a pro-growth tax code that recognizes the importance
of the cost of capital.
There are two schools of economic thought on how taxation
of capital affects long-term economic growth and job creation.
The purpose of this hearing is to examine the empirical
evidence offered by both sides of the debate.
Some economists contend that taxes on capital have, at
most, modest effects on the economy over time. These economists
cite studies that show a large variation in both the size and
direction of responses to tax changes. Therefore, these
economists claim that the effects of tax changes on long-term
growth and job creation are either insignificant or
unpredictable.
The Joint Committee on Taxation uses these arguments to
justify the static scoring of proposed tax changes. Static
scoring may acknowledge some behavioral changes among taxpayers
due to changes in tax policy such as realizing capital gains
before an increase in the tax rate on capital gains, but does
not acknowledge any effect on the overall growth of gross
national product over time. Under static scoring, tax policy
is, by definition, impotent in stimulating or suppressing long-
term growth and job creation.
Other economists contend that tax policy has significant
and predictable effects on economic growth and job creation. In
particular, these economists find that business investment in
new buildings, equipment, and software is highly responsive to
changes in the after-tax cost of capital.
From my Chamber of Commerce experience prior to serving in
Congress, there's little doubt, in my view, that tax policy
affects business decision-making on Main Streets across
America. States and local governments have long used tax
incentives to attract investment, especially since U.S.
businesses face global competition. Tax policy affects where
businesses choose to locate and where they expand their
operations.
It is also common sense that the decisions of all
businesses collectively of whether and how much to invest
affects overall economic growth and job creation. In contrast,
the assumption that changes in tax policy cannot affect long-
term economic growth and job creation in predictable ways
defies common sense.
However, we should not rely on common sense alone. We must
also look at the empirical evidence. In his written testimony,
Dr. Hassett reviews major studies conducted by prominent
economists in recent years on various aspects of taxation of
capital: the corporate income tax, tax depreciation and
expensing of business investment, taxes on capital gains, and
taxes on dividends. The conclusions of these studies are
remarkably consistent: Taxes on capital have significant
adverse effects on business investment, economic growth, job
creation, and the real wages of workers.
Despite a growing body of empirical evidence on the adverse
effects of taxing capital, President Obama and many
Congressional Democratic colleagues are advocating a series of
tax increases that will raise the cost of capital. These tax
increases include:
Imposing higher income tax rates on sole proprietorships,
partnerships, and subchapter S corporation;
Boosting the tax rate on dividends from 15 percent to 44.6
percent;
Raising the tax rate on capital gains from 15 to 20
percent;
Tripling the tax rate of traditional local real estate
partnerships;
Eliminating long-standing business expensing for energy
manufacturing; and
Lengthening tax depreciation schedules.
If the empirical studies are correct, these tax proposals
will reduce business investment, slow economic growth, and
deter job creation. Moreover, these tax increases will hurt
hardworking taxpayers by reducing their real wages over time.
These are the very men and women which the President and some
in Congress claim they want to help.
The purpose of today's hearing is to determine whether the
empirical evidence supports these adverse economic assumptions,
or whether we should continue to accept the static scoring
currently used by the Joint Committee on Taxation.
I look forward to the testimony of our distinguished
witnesses. I would ask Congressman Burgess if he has a brief
opening statement.
[The prepared statement of Representative Brady appears in
the Submissions for the Record on page 26.]
Representative Burgess. Yes.
Vice Chairman Brady. I yield.
OPENING STATEMENT OF HON. MICHAEL C. BURGESS, M.D., A U.S.
REPRESENTATIVE FROM TEXAS
Representative Burgess. I thank the Chairman for yielding.
I thank our witnesses for being here. Obviously this is an
important day in the lives of a lot of Americans. A little
confession here: Because of the extra two days that we got this
tax season, I actually got my taxes filed on time. I did not
have to file an extension for the first time in probably two
decades. After several terms in Congress, my income tax
calculation is much less complex than it was when I ran a small
business, a medical practice. But still, even with a relatively
straightforward, straightline arrangement between wages and
taxes, the tax forms that have to be completed are enormously
complex. And, there is the hidden cost of the hours that are
spent in preparation, plus the monies that I must pay to a tax
preparer. Because even though my income situation is much more
straightforward, I do not trust myself, nor do I trust anyone
who wants to examine those returns, because we all know if you
put 10 accountants in a room with tax data, they're going to
come up with 10 different figures. And as a consequence, no one
can sign their name at the bottom with a clear conscience that
they've done everything right when no one knows what actually
``right'' is.
I am glad we are having the hearing today. Tax day is
important to Americans. I think that there is a lot of the
American electorate, a lot of the American people, feel that
simplifying the tax system should be one of our highest
priorities. The discussions that we are going to have today
will cover what our tax system should look like, what form it
should be, how much it should tax, what it should tax.
And there are so many opinions about this. Some feel that
tax revenue should be about funding the government, while
others want to use it for achieving social goals. And however
laudable those agendas may be, my personal feeling is the Tax
Code is not the proper means for achieving those.
My predecessor in Congress, Dick Armey, was the author of a
book about a flat tax. I bought this book back in 1995 or 1996,
and it seemed so straightforward I did not understand why it
had not already been adopted and why we could not use it.
For that reason, every year that I have been in Congress I
have introduced H.R. 1040, which is a derivative of the flax
tax that Mr. Armey introduced, but this one would be optional.
You have the right to opt into the flat tax. You have the right
to continue your life under the complexity of the Code. If you
have responded to the signals given by the Tax Code and
arranged your finances in a way that the Tax Code is your
friend, then so be it.
But if you want to simplify things, if you want to simplify
your life, you can use a flat tax. And it is simple. You just
put in some personal information, your income, personal
exemptions, a general personal exemption to put some
progressivity into the system, you compute the tax and the
amount already withheld and it's done. It's that simple.
And for those who are worried about fairness in the Tax
Code, for a family of four there would be no tax on the first
$43,000 of income. That's nearly double the federal poverty
limit.
The Chairman mentioned that he wanted to get it right. The
tax rate that I've proposed is 17 percent. Now, look, if you
just look at the headlines today, Mitt Romney is paying 15
percent, Barack Obama is paying 20 percent; if you average
those two percentages, it's 17 percent.
It seems like we could do this if we just had the political
will to take it. So, Mr. Chairman, even if we don't implement a
flat tax, we must have a simpler system that people can
understand. For such a complicated subject as taxes, we don't
need more rhetoric. We don't need more complexity. We need
serious proposals and not election year theatrics.
And I certainly look forward to the testimony of our
witnesses today. And thank you for yielding the time.
Vice Chairman Brady. Thank you, Dr. Burgess.
I would like now to introduce our panel of witnesses,
starting with Dr. Kevin Hassett. Dr. Hassett is a Senior Fellow
and Director of Economic Policy Studies at the American
Enterprise Institute.
His area of research includes fiscal policy and the
economy. Before joining AEI, Dr. Hassett was a senior economist
at the Board of Governors of the Federal Reserve System; an
Associate Professor of Economics and Finance at the Graduate
School of Business of Columbia University.
He has been a consultant to the U.S. Treasury Department,
and an economic advisor to the presidential campaigns of George
W. Bush and John McCain.
Dr. Hassett received his doctorate in economics from the
University of Pennsylvania.
Our other witness today is Dr. Jane Gravelle. Dr. Gravelle
is a Senior Specialist in the Government and Finance Division
of the Congressional Research Service, known as CRS.
Her area of research includes the economics of taxation.
She has written extensively on the subject of tax policy and
economic growth. In addition to her work at CRS, she is the
author of numerous articles and books and professional
journals, and she is the past president of the National Tax
Association.
Dr. Gravelle received her Ph.D. in Economics from George
Washington University.
I welcome you both today, and I would recognize Dr. Hassett
for his testimony.
STATEMENT OF DR. KEVIN HASSETT, SENIOR FELLOW AND DIRECTOR OF
ECONOMIC POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE,
WASHINGTON, DC
Dr. Hassett. Thank you very much, Chairman Brady, Dr.
Burgess, Mr. Coats.
The topic of this hearing is something that is near and
dear to my heart. I have been working on these issues since
graduate school. My dissertation was even one of the first
papers that used cross-section analysis to estimate the impact
of taxes on corporate investment.
And it is an honor and a pleasure to be testifying next to
my friend, Jane Gravelle. I can remember just after I graduated
with my Ph.D. and started being a professor at Columbia, I
wrote a paper about the user cost elasticity, joint with Jason
Cummins, who is now at Brevan Howard, and Jane was our
discussant at one of the first professional presentations I
ever made.
I can remember that at that presentation Jane criticized my
work saying that the elasticities were too large. I would say
that dispute between us has been going on ever since, and you
will see some of it today.
I think, Mr. Chairman, and Members of the Committee, that
the biggest problem we have in the U.S. right now is that our
corporate tax is totally out of whack with the rest of the
world.
If you go back into the 1980s, the OECD countries on
average had corporate rates of about 48 percent, but they have
been lowering them like mad and they are all the way down to an
average that is about 25 percent today.
While the rest of the world has been changing their
corporate rates, we have been more or less standing pat. In
fact, we are one of the last countries on earth to increase its
rates, although we did it just a smidge under the Clinton
Administration.
In addition to having a high rate, there are several
deviations from efficient design in our current system that are
worth mentioning as we think about what a reform might look
like.
First, the double taxation of corporate income discourages
investment in equipment and structures. The dividend tax raises
the cost of funds to firms, and increases the hurdle rate for
new projects.
Second, the asymmetric treatment of debt and equity
encourages heavy debt loads and increases the overall level of
risk in the corporate sector. The tax system should not really
encourage debt-finance over equity-finance. It increases the
riskiness and increases the risks of bankruptcy.
Now the relatively unfavorable position of the U.S.
relative to the rest of the world, combined with our worldwide
tax system, gives firms a strong incentive to move their
profits and activities overseas.
Now these data should provide food for thought for those
who would contend that the reduction in double taxation or
otherwise cutting the corporate rate disproportionately
benefits the wealthy. The fact is that Scandinavian countries,
France, much of the rest of the world where I think most
political scientists would tell you the politics are
significantly to the left of those here in the U.S., treat
capital more favorably than we do.
I would argue that is because the rest of the world has
been more responsive to the academic literature, the academic
literature that is exhaustively reviewed in my testimony, which
is up to 23 pages single-spaced by the end--I won't try to go
through it all here, I think that if you wanted to look at one
thing, a nice place to start would be an OECD study by Arnold
in 2008 that provided an empirical analysis of the effect of
tax structure on long-run GDP.
The main findings include--and now I'm quoting them, and I
will say when I stop quoting them: That property taxes, and
particularly recurrent taxes, on immovable property seem to be
the most growth-friendly taxes, followed by consumption taxes,
and then by personal income taxes. Corporate income taxes
appear to have the most negative effect on GDP per capita. This
intuition is supported by the review of the literature that I
conducted with University of Berkeley economist Alan Auerbach
in 2005. And looking at a mountain of evidence, we concluded
that if the U.S. were to switch to an ideal system, then we
might expect medium-term output to increase between 5 and 10
percent.
So that goes to really up the stakes of fixing our tax
system. And I think that it is really a big, squandered
opportunity. If you were to give me two faltering economies,
one that had a really stupid tax system like ours, and another
that had a perfect tax system, I'd rather take a faltering
economy with the crazy tax system because it's easier to fix.
And yet, you know, through this mess we haven't done that. We
have put off fixing our problems. And I think we are suffering
for that today.
To think about what would happen if we were able to go
after our big problems and fix it, or if we had done so in the
past, in my testimony I do a simple calculation. I estimate
what our fiscal situation might be today if the United States
had implemented a fundamental tax reform 10 years ago. It was a
counter-factual.
And, assuming that we hit the high-end growth estimate that
Auerbach and I mentioned, if that had happened GDP would be
$17.1 trillion in fiscal year 2012, rather than the expected
$15.5 trillion under CBO projections.
Moreover, if we assume that revenue stayed fixed as a
percent of GDP and outlays stayed fixed in dollar terms, then
the 2012 deficit would be $830 billion rather than the expected
$1.1 trillion under the CBO alternative fiscal scenario, and
the long-run budget deficit would be about $7 trillion over the
next 10 years instead of $11 trillion.
Those are big differences, and those are the differences
that are attainable if we pursue a fundamental tax reform, and
if 10 years from now people don't look back, thankfully, to
this Congress and celebrate that extra trillions of dollars of
GDP and all that extra revenue, then we should feel some fault
for that.
Thank you very much, Mr. Chairman.
[The prepared statement of Dr. Kevin Hassett appears in the
Submissions for the Record on page 27.]
Vice Chairman Brady. Thank you, Dr. Hassett. Dr. Gravelle.
STATEMENT OF DR. JANE GRAVELLE, SENIOR SPECIALIST, GOVERNMENT
AND FINANCE DIVISION, CONGRESSIONAL RESEARCH SERVICE,
WASHINGTON, DC
Dr. Gravelle. I would like to focus my attention on the
corporate income tax where effects on international capital
flows are more likely to have an output effect, given the
evidence that savings is not very responsive to tax rates.
Much has been claimed for the economic benefits of lowering
the corporate rate in a global economy by attracting capital
from abroad. However, the consequences for economic growth in
labor income are likely to be modest. My estimate suggests that
a 10 percentage point reduction in the corporate rate from 35
percent to 25 percent would induce an increase in U.S. output
of less than two-tenths of one percent. Even the most generous
set of assumptions--and that is infinitely large elasticities--
would lead to an increase of no more than one-half of one
percent. However, labor income would expect--would be projected
to rise by the same proportion.
This estimate may actually be too large, or perhaps in even
the wrong direction, because lowering the corporate rate would
discourage debt inflows which are subsidized and more mobile
than equity. In addition, other countries might react by
lowering their tax rates. Also, these estimates measure long-
term effects that would not be achieved in the short run.
Now these small numbers should not be surprising, because
the corporate tax is small as a percent of U.S. overall output.
The revenue lost from this rate reduction is only six-tenths of
one percent of output.
Now these are output effects, but the gain in income to
U.S. citizens is even smaller. Part of the output gain appears
as profits to foreign suppliers of capital, and part of it is
already income to multi-nationals that have brought capital
back from abroad. The net gain in income is expected to be only
about ten percent of the output gain, or two-one hundredths of
one percent of U.S. output.
No effect on employment would be expected. It is very
important to understand that there is no need to undertake a
permanent policy to create jobs. The economy will naturally
create those. Job creation is a short-run demand side issue.
Labor income, however, would rise by the same percentage
change, less than two-tenths of one percent. Labor would
receive a benefit equal to 20 percent of the revenue lost from
the rate cut. And a reduction in the corporate tax rate of this
magnitude would cost over $100 billion a year in investment and
involves a significant revenue cost.
Based on the analysis of output increases, additional
revenues on the induced output would offset only about 5 to 6
percent of this revenue loss, largely from increased taxes on
wage income.
Claims for larger revenue feedback effects, or even revenue
gains, are based on empirical studies that have methodological
deficiencies. International profit shifting is sometimes cited
but is not large enough. And, moreover, given that profits are
shifted to jurisdictions with very low rates, they are unlikely
to be affected by lowering the rate to 25 percent.
Domestic profit shifting might occur as high tax rate
individuals move their income out of unincorporated businesses
or wages into lower tax corporations, especially given the low
tax rate on dividends. This protection of the individual income
tax base is an important justification for having a corporate
tax whose rate is not much below the top individual rate.
So this effect, while increasing corporate revenues, would
reduce overall income tax revenues. One effect that would be
more certain is that the revenue loss itself, if not offset
elsewhere, would expand the deficit and reduce the capital
stock, as well as increasing costs for accumulated interest.
Within 10 years, output reductions would be twice the size
of increases from the international capital flows and would
increase the revenue lost by 15 percent to 23 percent,
according to my estimates. Over a 10-year period, interest
costs are also estimated to increase the effects on the deficit
by 25 percent.
It is possible to envision some corporate base broadening
that would offset the revenue loss from a small rate cut, but
not one as much as 10 percentage points, unless we take some
probably unpopular--very unpopular--base broadening. And in
most cases these reforms would cause the marginal tax rates on
capital income to rise.
You could have a revenue-neutral combination of increasing
taxes on the income of foreign subsidiaries and rate reductions
which would be most likely to increase capital flows into the
United States, but these results would still be small.
Economists traditionally criticize the corporate income tax
due to the distortions it produces, but these distortions have
declined significantly with reductions in the corporate tax
burden since the post-war period, which is about two-thirds,
and are estimated at only one-quarter of one percent of output.
These distortions, which mostly involve favoring debt in owner-
occupied housing, could be largely eliminated with revenue
neutral reforms. Thank you.
[The prepared statement of Dr. Jane Gravelle appears in the
Submissions for the Record on page 50.]
Vice Chairman Brady. Thank you, Doctor, and I am pleased we
are joined by Senators Coats and Lee today, as well as
Congressman Mulvaney. Thank you.
Let me lead off with, not a housekeeping question but in
reading the testimony last night, there are obviously divergent
opinions on the impact of taxes on capital and the corporate
tax rate. There seems to be a consensus in the economic
literature that the Cobb-Douglas Production Function provides a
rough proxy for the private business sector of the American
economy.
The consensus is based on the empirical observation that
the factor of income shares going to labor and capital tend to
be relatively constant over time. Would you both agree that the
Cobb-Douglas model is widely accepted within the economic
literature? Doctor?
Dr. Hassett. Mr. Brady, my old friend and mentor, Albert
Andau was one of the inventors of the Life Cycle Hypothesis and
gave his first macro lecture at Penn on the Cobb-Douglas
Production Function. And the first sentence of that lecture is
that Cobb-Douglas is very dangerous.
And so I think that Cobb-Douglas is a very useful way to
think about back-of-the-envelope big macro questions, but it
also has some features that can lead you to conclude things
that are unrealistic in some applications. And so I don't want
to make a sweeping ``yes'' answer to that question.
Vice Chairman Brady. Thank you.
Dr. Gravelle.
Dr. Gravelle. Well I use Cobb-Douglas in my models, so I do
what a lot of people do. I think there's some recent evidence
that suggests that that substitution elasticity might be a
little lower, which would reduce the capital inflows, increase
the share to labor, the relative share to labor. But I think
it's a pretty reasonable estimate.
And it is backed up by a long period of Constant Factor
shares, which is some important evidence, I think.
Vice Chairman Brady. Could I ask, Dr. Gravelle, in your
testimony you suggest that the max--the revenue maximizing rate
on corporate tax is closer to 80 percent than it is 30
percent----
Dr. Gravelle. Right. That's based----
Vice Chairman Brady. Yes, go ahead.
Dr. Gravelle. That's just from real capital flows. So it
doesn't include any of these other profit-shifting
possibilities. But that's just the constraints.
Vice Chairman Brady. But when you're looking at the
revenue, just so I understand, are you only counting corporate
tax revenue? Or are you----
Dr. Gravelle. That 85 percent number is only corporate tax.
The numbers that I gave in my testimony count the effect on
wages. But that's just from this constraint about how much
capital can flow, both because of imperfect willingness to
substitute, but also because of the natural limited ability of
the economy to absorb a lot of capital because it has a fixed
amount of labor. I mean, that's just economics.
Vice Chairman Brady. What happens--if you increase the
corporate tax rate to 80 percent, what's the after-tax rate of
return on corporate capital? Clearly you've dramatically driven
up that cost.
Dr. Gravelle. Well I presume if you drove the tax up to 80
percent, you would get some kind of world-wide equilibrium, but
I would have to work on that to tell you how much that would
be. But it would obviously be a lot smaller after-tax rate of
return than we have now.
Vice Chairman Brady. Do you know what happens when you do
that, what happens to output? What happens to wages and the
capital stock, if you raise----
Dr. Gravelle. I would--yeah, I would think there would be--
a 10 percentage point change is worth .2, so you can--I mean,
you can probably roughly multiply that, you know, every 10
percentage points. So you would get up to 2, 3 percent, I
guess.
Vice Chairman Brady. We will probably follow up with you on
that.
Dr. Gravelle. Okay.
Vice Chairman Brady. With written questions.
Dr. Gravelle. I just can't quite do that in my head right
now.
Vice Chairman Brady. Can I ask, Dr. Hassett, before we move
on, on the tax burden. The empirical data which you cite
repeatedly in your testimony suggests that additional
investments typically result in high real wages. There's sort
of, in Congress people forget about the impact on wages and
workers.
If taxes on capital affect the level of investment,
shouldn't they also affect the level of real wages?
Dr. Hassett. Yes, they absolutely should. And, you know,
the effects--and this is discussed at length in both the recent
CRS report and in my testimony--the effects you see in the data
are very large.
You see capital flows in response to tax differentials, and
then you see big increases in blue collar wages. There have
been a number of papers that have confirmed this finding. The
CRS itself has taken our data. You know, we've shared it with
them and replicated the results when they use our
specification. They have their own favorite specification at
CRS where the effects are smaller, or insignificant even in
one.
But I think that that balance of the evidence is that there
pretty large wage effects. And I think that the wage effects
that we see are a challenge to the traditional type of theories
that Gravelle and her colleagues use.
I think that one of the reasons why we see these big
effects is that multi-nationals have a lot of good will. They
have patents. They have cool ideas that they can move around.
They can locate the smartest people, and the most valuable
intellectual property, and the most attractive tax haven, and
then have every subsidiary around the world transfer price
their profits to that tax haven.
When that kind of activity happens, it is really elastic
and it is really good for that--for the market conditions in
that tax haven. And so I think in the old kind of models that
traditional tax people used, especially when I was in graduate
school, which is a long time ago now, then pretty much the
model you would have of the economy could be that there's this
big iron machine making Chevettes. And that if output goes up,
it's because we're making a whole lot more Chevettes this year.
But I think that in today's world, it's we have iPads. We
didn't have iPads before. The guy who invented the iPad is
making lots and lots of money, and the countries that are smart
enough to align their taxes to take advantage of that cool idea
reap some of the rents that the company has, too. I think that
that's the kind of story that would be consistent with the size
of the effects that we and other scholars, including people at
Oxford, the University of Michigan, have been seeing in the
data.
Vice Chairman Brady. All right. Thank you, Doctor.
Senator Coats.
Senator Coats. Thank you, Mr. Chairman. Thank you both for
your testimony.
I am not an economist, so I am not going to delve into deep
economic theory, but in listening, Dr. Gravelle, to you
indicating in your statement that other countries might lower
their corporate tax rates if we lowered ours, is that not a
good thing?
Dr. Gravelle. Well, if we----
Senator Coats. I almost came to the conclusion that you
thought it would be to their benefit to raise their tax rates,
that it would have less of a negative effect by raising than
lowering. I would be pleased to have you help me sort that
thinking out.
Dr. Gravelle. Well first is the reason that we should be
concerned about other countries lowering their tax rates, from
our perspective is that if they do that any gains in capital
flows that we're attracting from them are going to be lessened.
So that is why it is important.
And also, I guess the world-wide lowering tax rates on
corporate income first was caused by the United States, I think
most people would say, I certainly would say, in our '86 tax
rate cut.
Senator Coats. But 35 countries that we compete with around
the world have lowered their rates from a previous average of
48 percent to now the current average of 25 percent.
Dr. Gravelle. Yes.
Senator Coats. Are all their analysts and economists and
policymakers wrong?
Dr. Gravelle. Well I said to the people at the OECD, I
said, why don't you put some numbers on this? I mean, they--
they did a presentation. I said, corporate taxes need to be
lowered. I said, well, where's the numbers? That's what I did.
I mean I tried to estimate, as best I could, what the
effects would be and you're just not going to have dramatic
effects from something that is so small relative to the
economy. It's just not reasonable to think so.
Senator Coats. Well isn't there at least some effect, if
it's not dramatic, isn't some effect positive?
Dr. Gravelle. Well the effect I found was positive. It was
just very small.
Senator Coats. Well----
Dr. Gravelle. It was almost----
Senator Coats [continuing]. These days we're looking for
small stuff.
Dr. Gravelle. Right.
Senator Coats. I mean, anything we can get is better than
nothing.
Dr. Gravelle. I guess the other question you have to ask
is, you know--I think that's fine. I mean, I'm not opposed or
supportive of keeping the corporate tax where it is or lowering
it, but I think that one has to be concerned about replacing
revenues. So you have to decide how you're going to do that.
Senator Coats. But why do you think our 35 competitors
globally all came to a different conclusion than you have?
Dr. Gravelle. I don't know. Because maybe they had multi-
nationals lobbying them who succeeded? I don't know. But I do
know that this kind of analysis that I have done has not
happened when those countries were making their decisions. The
other thing is----
Senator Coats. Well then why wouldn't they then raise the
rates back up? If they've seen that it hasn't had a positive
effect. I almost take from your testimony that you think
raising our corporate tax rate would have less of a negative
effect than lowering it?
Dr. Gravelle. Well probably if you raised our corporate tax
rate and used the revenues to reduce the deficit, it would. I
mean, what you do about the deficit is very important.
Senator Coats. But what about our competition worldwide
with the 35 other countries?
Dr. Gravelle. What about it? I mean, what is the problem?
If we----
Senator Coats. The problem is that our corporations, as Dr.
Hassett said, are paying double taxes. They're paying taxes on
earnings, and then the stockholders are paying taxes on
dividends----
Dr. Gravelle. Well that happens----
Senator Coats [continuing]. And we're not competitive with
the rest of the world, and our money is flowing out to these
other----
Dr. Gravelle [continuing]. That happens--that happens in
any country that has a classic corporate tax. But, you know, I
don't know why other countries made their choices. The
impression I have with European countries is that they are
much--they have much more mobile capital. They're much more
worried because they're like, you know, they're right next to
each other and they felt also some concerns about plants moving
to the new Eastern Bloc countries.
We are separated in lots of ways in ways that they aren't.
Senator Coats. Do you ever contemplate the fact that if 35
of our competitors are lowering or have lowered their rates--
and I think a pretty solid majority of Americans feel that
lower corporate tax rates are better--that you want to maybe
reexamine your theories?
Dr. Gravelle. Senator, I put infinite elasticities in this
model. They can't get any higher than infinity. And still, I
got an effect but I didn't get a large effect. And I didn't get
a large effect because real capital flows are constrained by
the economic circumstances: by your preferences for products,
by your labor supplies, by what you combine it with. That's
what the model says, and it's a reasonable model.
Senator Coats. My time is running out. Let me ask Dr.
Hassett to tell me where I'm off base here.
Dr. Hassett. I just would like to add that, you know, the
way I think that an economist should go about addressing your
question is, or as a scientist, any scientist, is that models
are naturally very, very simple. They have to be, because that
is why it is a model. You can't model the whole world. There
are just too many variables.
And that when the model is inconsistent with observation,
then you question both the observation and the model. And I
think that it is appropriate to do both. And I think that the
model might be wrong; the observation might be wrong; but sort
of some humility about both possibilities is something that I
think I don't see in the CRS report.
That's my one criticism of it; that I think that its prior
way of looking at the world being the correct one doesn't
adjust as new evidence comes in, at least as much as I would do
if I were doing the exercise.
Senator Coats. Just a last question. My time is up. But you
seem to think it tilts in a different direction?
Dr. Hassett. Yes. I'm must more of just an empirical
economist, and I look at the data and use traditional
econometric techniques to see what the data tell me. And then I
talk to you about what I think I find, and sometimes you like
it, and sometimes you don't. But I'm not a person who has spent
as much time with the general equilibrium type models that
Gravelle uses. Those models are often very useful for thinking
about effects you wouldn't have thought of, and helping you
think about what regressions to run.
And so it's not that those models have no use. But I think
that in this particular application, there is just so much in
the world--I talk about this a little in my testimony--that if
you believe the Laffer curve results that Brill and I have, and
the wages results that Aparna and I have, then everything else
that's going on in the world--and I list a bunch of things--
kind of makes sense.
And if you don't believe it, and if the CRS is right and
our reports are incorrect, then it creates a lot of puzzles
like those that you were addressing.
Senator Coats. I just wonder why all the rest of the world
is coming to a different conclusion than Dr. Gravelle, but in
any event my time is up.
Vice Chairman Brady. Thank you, Senator. Representative
Mulvaney.
Representative Mulvaney. Thank you, Mr. Chairman.
I'm going to try real hard to do something that politicians
are not really good at, which is not asking a stupid question.
It has been a lot longer than I studied economics than it has
been for most of you, and my mind is clouded by law school and
business school on top of that. So I am going to try and keep
it real simple for my own purposes.
Let's talk about Dynamic Scoring for a second, because it
strikes me that while you all seem to disagree on some of the
outcomes, aren't we having a dynamic discussion in terms of
using a dynamic model to discuss the impacts of tax changes?
And if that is the case, even though you seem to disagree
on the outputs--Dr. Hassett would suggest the impact of a tax
reduction would be significant; Dr. Gravelle you would say it
is not--but those are both dynamic statements, aren't they? And
shouldn't we be looking for some place that we can agree on,
that we need to move away from this zero-impact model that the
CRS currently has toward something that perhaps allows for a
range of outcomes that reflects perhaps that a scope or a scale
of possible outcomes reflected by you folks here today?
Why aren't we having that discussion? I'll start with you,
Dr. Gravelle, since you're CRS. Why--Does CRS oppose dynamic
scoring?
Dr. Gravelle. No, no. And my model has results. I mean, it
has effects. It's just the effect are small, as is the
provision you're changing. They're both small.
Representative Mulvaney. Sure.
Dr. Gravelle. So you wouldn't expect huge effects.
Representative Mulvaney. But that would be different than
the static model we're required by law to use now?
Dr. Gravelle. But the Joint Tax Committee uses a model that
has micro responses. They have, for example, very, very large
capital gains realization response, which is probably why they
haven't scored the Buffett Rule, you know the Buffett Tax, as
being very high.
They have a rule that they keep output--labor and capital
inputs, total GDP constant. But they have done studies in the
past, and so has CBO, but the problem with those studies is
they just depend on what you're doing about the deficit.
I mean, they have the same kinds of results that I do. You
know, if you look at a tax cut in isolation like the corporate
tax, you're likely to find an increase. You can argue about
whether it should be five--you know, a half of a percent, or
two-tenths of a percent, or the size of the revenue, whatever,
but they have those. But then if you don't pay for it, if you
run the deficit, then you do a crowding out of capital which
can end up worse.
So both CBO and JCT have done studies, and the problem is
they aren't--you know, the assumptions are what matter as far
as the magnitude. So I think they have probably decided it is
safest just to keep that constant.
Representative Mulvaney. And I think I would probably tend
to agree with that, that it's--you say it's safest. It sounds
to me like you could spin it a different way and say it's just
too hard to do it another way.
Dr. Gravelle. Maybe too hard. Maybe not-ready-for-prime-
time. I mean, I don't know.
Representative Mulvaney. But I share the same frustration
that Dr. Hassett has, which is that the net result is that we
use a model that doesn't seem to tie to reality. You can go
back and look at the tax reductions of the '80s and see that it
clearly was not a zero impact. You can look at tax increases in
the '90s and make the same determination.
So I guess, what is CRS's position on moving away from a
static model into a dynamic?
Dr. Gravelle. Well I think my position would be I think I
want to do whatever leads you to the truth the best. The
problem is the ``truth'' is elusive and depends on what
assumptions you are making.
Representative Mulvaney. Does the static model give us the
truth?
Dr. Gravelle. I don't think so, no. How could it? It would
be a point observation that you would never expect to find. But
the question is: Is it better for policymaking when you have
differences depending on the various assumptions you make, not
only about deficit financing, but by short-run monetary policy,
about the size of elasticity. There's no consensus about a lot
of that.
Representative Mulvaney. Dr. Hassett, because I tend to
agree with Dr. Gravelle in that sense that once you start
moving to a static model--excuse me, away from a static model
to dynamic, the debate will simply switch from whether or not
we should have static versus dynamic to a discussion over what
sorts of multipliers we're going to use. And we will have the
same lack of consensus that we have now.
Is it possible, do you think, to develop a system that
would allow us to use a dynamic system that would provide for
say a possible range of outcomes that would at least give us a
better look into the future as to what the impact of tax
changes would be?
Dr. Hassett. Yeah, sure. And in fact Bill Thomas assembled
a blue ribbon panel to discuss dynamic scoring, which I served
on a long time ago.
Dr. Gravelle. So did I.
Dr. Hassett. Yes, that's right. And they introduced a
couple--John Diamond, who is down at Rice, helped develop a
model for the Joint Tax to do dynamic scoring. CBO has worked
on it.
I think that the capability is now, you know, I like to say
in Washington: All proof proceeds by induction. Something is
true today because it was true yesterday. And so actually these
models have been around long enough that they are true by
induction.
And so maybe that we could start to use them. Because right
now focusing all of our budget rules and everything on the zero
effect, which everyone knows is false, seems incorrect to me.
And, you know, the argument in favor of it has always been,
well, if we allow dynamic scoring then we will lose fiscal
discipline, and the deficit will get too high.
Well the existing system has not really done a good job of
enforcing fiscal discipline. And so I think that we should look
for, you know, more reasonable ways to score.
Representative Mulvaney. Thank you. Thank you, Mr.
Chairman.
Vice Chairman Brady. Thank you.
Senator Lee.
Senator Lee. Thank you, Mr. Chairman.
Dr. Hassett, some have suggested that the compliance costs
associated with the corporate income tax in America tends to
rival the actual yield, the revenue yield, to the government.
Do you have any opinion on that matter?
Dr. Hassett. Yeah. There are estimates, and I think that
the CRS has probably talked about these, too, but there are
estimates, especially for the international tax code, that the
compliance costs are enormous relative to the amount of
revenue.
And it's, you know, relative to the kind of forces that are
discussed in my testimony sort of make sense because, you know,
the companies can spend a lot of money on smart people who then
help them locate the intellectual property in just the right
place, and then they arrange, you know, fully legal activity in
a way that gets more money in the low tax place. And firms are
really able to do that.
You know, there's a whisper number around town amongst tax
planners that multi-national tax rates are about 17 percent on
foreign income. And they're able to do that because they're
moving all these parts around. But the movement of the parts--
so in the end, you spend a lot of money moving the stuff, and
then the end result for the U.S. is that there's not much money
left here.
Senator Lee. It has also been suggested that corporations
tend to pass along, pass downstream, so to speak, their costs,
both their compliance costs and what they actually pay in
corporate income taxes such that individuals end up paying for
those, just in terms of higher prices for goods, or higher
prices for services in some instances, or perhaps they pay for
it through diminished wages or diminished job opportunities.
Do you share that view?
Dr. Hassett. Yeah. The passing-on-to-workers result is
really powerful in the evidence that Aparna and I have looked
at. In fact, we have looked at other tax rates, too. And, you
know, when I say the result it almost feels like I am some
radical left-winger because the data seem to say that no matter
what you try to tax, in the end it is the little guy who pays
for it.
Senator Lee. The 99 percent.
Dr. Hassett. Yes. In the sense that if you try to tax the
capital, then they move it around, and then the wages go down
and you are hurting the little guy.
So basically all the taxes--the capital is very elastic,
very moveable, and the labor is not. And I think that, you
know, sales tax, just about any kind of tax that you can think
of is mostly being passed on to wages and the workers.
Senator Lee. But I guess the difference is that when it is
passed on to the workers, or passed on to the consumer, or
whatever the case may be, it is veiled.
Dr. Hassett. Correct.
Senator Lee. It is more opaque. You cannot really see what
is happening.
Dr. Hassett. And indeed on that point, I had a piece in The
Washington Post on tax day a couple of years ago, which we can
send to your office, which I commend to you, that makes even
the direct point in kind of a chilling way. Which is, that
Congress is really virtuous about redistribution with the
income tax, and so they're always arguing about the top 1
percent of this, and it's as if everyone in the Democratic
Party on the Hill is the absolute defender of people who are in
the bottom half of the income distribution, but that stops as
soon as you stop talking about the income tax.
And if you look at total taxes paid by Americans, then, you
know, there's a lot less redistribution than you might think.
But we tend to tax the little guys with taxes that are hard to
attribute. So sales taxes, property taxes, gasoline taxes,
cigarette taxes, you can imagine with the incidence of those
would look like.
I have a study where we sort of summed all those things up
and found that pretty much everybody in the U.S. was paying
about 30 percent of their income in taxes--even people
relatively far down on the income distribution--and it was as
you get down to the poorer people, they are paying these taxes
which aren't labeled ``rich'' and ``poor'' because they're
indirect and hard to attribute.
Senator Lee. Right. But when we're talking about income
taxes--specifically, Federal Income Taxes--and most pointedly
here Federal Corporate Income Taxes, those do get passed on to
the consumer and to the worker.
Dr. Hassett. Sure.
Senator Lee. So in a sense, would it be fair to say that,
you know, there are at least a couple of functions played by
our tax system?
First, that it is there to collect revenue for the
government. Obviously we need money to operate. But it should
be there, I suppose, to communicate accurately to the public,
to the Electorate, to the Voters, the cost of government so
that people will understand that there is a relationship
between how much government we have and the economic well being
of an individual.
Would you agree with me if I were to say that our tax
system performs that second function very poorly, and is
perhaps even impeded in its ability to perform that second
function by virtue of having a very significant corporate
income tax?
Dr. Hassett. Yes. Absolutely.
Senator Lee. That would diminish rather than enhance the
capacity of the tax system to perform that second function of
communicating to the public what it costs?
Dr. Hassett. Right. We have all these hidden taxes, all
this hidden revenue, incidents that are poorly understood, and
a public debate about taxes that is really far from the truth
in so many ways.
The tax system is so complex--I can finish with this--that,
you know, I have a Ph.D. in Tax Economics. That is what I've
been working on my whole life. I've got many papers in tax
journals.
I will not do my own taxes. I will not do it. It is
unthinkable for me to try to do it because they are just too
complicated. And I know that if I mess it up, then they're
going to come after me hard because I should have known better
because I've got a Ph.D. in Taxes. So I am too fearful to do my
own taxes, and I think it is just a shame that our system has
reached that point.
Senator Lee. That is fascinating. Thank you very much. I
see my time has expired.
Vice Chairman Brady. Thank you, Senator. That reminds me of
the question you asked in this same room as we were talking
about the complexity of the Tax Code.
Senator Lee asked one of the witnesses who was here with a
BioTech company that helped break essentially the Human Genome,
you know, a brilliant scientist. And Senator Lee asked him
about making the Tax Code more simple.
And he said, Oh, no, that's too complicated for me. He
didn't want to really address that. It really is complex in a
major way.
I want to follow up Dr. Gravelle's line of questioning with
Senator Coats. In your testimony, and in your conversation with
Senator Coats, you suggest the tax on capital gains and
dividends can be safely ignored because they are such a small
share of output.
Are you referring ``output'' to the U.S. economy?
Dr. Gravelle. Well what I mean was that, given the
evidence--those are savings sides. In other words, they're not
at the level that can attract global capital flows. And because
of the evidence that I've looked at, it indicates that savings
is not very responsive to tax rates.
In fact, it can actually go either way because of income
and substitution effects. But empirically, there's not much
evidence. I didn't want to talk about those partly because I
think the effects they have would be extremely small and
uncertain. And also they're a lot smaller than the corporate
tax.
The dividends--I think I have some numbers in my paper, but
they're like a half a percent. Corporate tax is not large, but
still is 2 percent. So that was the main reason, both because
of the effect and the size.
Vice Chairman Brady. Well I want to make the point that if
you're looking at the impact of a tax, you would look at not
the broad GDP but on the tax base itself. In this case to make
sure you're not looking at the wrong base, you would, if you
were calculating the marginal after-tax return on corporate
investments, you'd compare the tax on dividend and capital
gains to the amount of the earnings subject to the tax, rather
than the broad economy.
Dr. Hassett, I made the comment at the outset that there is
a great deal of interest in Washington on fundamental tax
reform. My view is that, while a lot of discussion is about the
rate, what that number should be, our goal should be to have
the most pro-growth tax policy in our tax code possible,
recognizing the importance of cost of capital.
That is generally defined ``gross return on investment that
is needed to cover replacement costs and taxes, while providing
a positive rate of return.'' Do people make an investment if
they don't expect to be able to cover all the expenses related
to that investment?
I mean, just within the business community, within
economics? Do they make the investment if the rate of return
is----
Dr. Hassett. No, but they sometimes make mistakes and don't
earn the investment that they expect to. But, yes, this is
again the literature that I think has converged to a broad
consensus.
Back in the day when we were first arguing about the user
costs, there were a lot of people who found that these
variables didn't have a big effect on investment. But now there
have just been hundreds of studies that find that firms really
do think that way, I think in part because business schools
train folks to get their user cost formulas right to get the
tax variables in the right place.
And so absolutely if you change the user costs, you see
responsiveness that's, you know, pretty large but not enormous
to changes in the user costs. It's clear that businesses are
weighing the pluses and minuses with each machine purchase. If
you make it easier to buy a machine by giving accelerated
depreciation, it has an impact on purchases of that type of
machine.
Vice Chairman Brady. Does the economic literature you're
referencing, does it tend to be constant over time when
referring to after-tax rate of return on capital?
Dr. Hassett. Is the after-tax rate of return on capital
constant over time? I think that it's not clearly so. I'd have
to get back to you on this one. I'd have to look at it. But,
yeah, I think that around big tax changes then you can see it
takes a while for the capital stock to adjust. So I would have
to get back to you on that.
Vice Chairman Brady. Okay, great. Thank you.
[Letter, dated April 30, 2012, to Vice Chairman Brady from
Kevin Hassett appears in the Submissions for the Record on page
60.]
Vice Chairman Brady. Representative Mulvaney.
Representative Mulvaney. Very briefly, just a couple of
follow-ups on a different topic.
Dr. Hassett, you mentioned something that I have tried hard
to explain to folks back home and I do a lousy job of it, so I
am hoping you can help me. You mentioned something I believe to
be correct, which is that our current relatively high level of
corporate tax rates encourages debt, encourages debt financing.
Could you expound on that a little bit, please?
Dr. Hassett. Sure. And I think this is something we agree
about, that because interest is a deductible expense for firms,
and, you know, a dividend is not, then there's a tax advantage
for firms to borrow to finance a new enterprise as opposed to,
you know, have issue equity.
And this tax advantage for debt can actually, depending on
where interest rates and inflation are, and so on, can get you
a negative user cost for 100-percent-debt financed investment.
Which, you know, maybe at times we want it because we think
that if investment is going to slow because people are too
cautious, or something, but the fact is that a reduction of
user cost is something that I almost always celebrate.
But when the Tax Code encourages firms to be heavily debt-
laden, then if their plans fail a little bit, they have
negative surprises on profits, well then all of a sudden the
bondholders are lining up and throwing them into bankruptcy and
trying to get their cash out. And so I think this is one of the
bigger distortions in the corporate tax.
There are some arguments for it. Especially tax lawyers
tend to favor it. But I think economists generally view that as
one of the larger problems with the Corporate Tax Code.
Representative Mulvaney. Certainly, and I think everybody
acknowledges the risks it exposes the businesses to in the
business cycle.
Dr. Gravelle, you mentioned in discussing one of the
possible impacts of lowering the Corporate Tax Rate of
discouraging debt flows.
Dr. Gravelle. That just shows that there is never an easy
answer to anything. Because it is true that our favoritism to
debt causes all the things that Kevin mentioned, they can also
have adverse effects for the flow of capital because debt is
far more substitutable across countries than equity.
And there were a couple of Treasury researchers who looked
at this effect of debt, and they concluded that if you lowered
the Corporate Tax Rate you would actually reduce the flow of
capital in the United States.
So it makes it difficult to decide what to do about debt.
Because on the one hand it is causing this debt/equity
distortion; on the other hand, it might be attracting capital
from abroad.
Representative Mulvaney. And finally--and I know this is
off the top, but Dr. Hassett said something in his testimony
just a few minutes ago that's perhaps one of the most eye-
opening things I have heard since I have been in Congress, and
that is a tough list to make.
It is, that he did not prepare his own taxes, despite the
fact that he has a Ph.D. in Tax Economics. So, Dr. Gravelle, I
have to ask you the question:
Do you prepare your own taxes?
Dr. Gravelle. Yes, I do.
Representative Mulvaney. Good.
Dr. Gravelle. And without a big fear.
Dr. Hassett. I would let her do mine.
[Laughter.]
She's better organized.
Representative Mulvaney. Do you do Geithner's, as well?
[Laughter.]
Dr. Gravelle. No, no, no. But on the other hand, Kevin's
might be a little more complicated than mine, because I am
mostly a wage earner with some passive investments. So...
Representative Mulvaney. Thank you all both very much for
coming today.
Vice Chairman Brady. Thank you. Senator Lee.
Senator Lee. Dr. Hassett, if you were king for a day and
you could change our Tax Code, what would you put in its place?
Dr. Hassett. I mentioned this in my testimony, Senator, and
after checking Ethics rules found that I was able to promise to
send you all a book that is about to publish by our top tax
economist, Alan Viard. He has written it with another tax
economist, Bob Carroll. And it lays out a Progressive
Consumption Tax called an ``x-tax'' in the kind of gory detail
that people who are going to write tax law actually need to
see.
Mr. Viard, many people know, writes a regular column in Tax
Notes, and is very schooled in tax law and has sort of looked
at where all the dead bodies are buried, if you're trying to
make something like this law.
So I think that the most ready for prime time conservative
tax reform out there is a Progressive Consumption Tax called
the x-tax, and that our book is coming out in a few weeks and
is going to show everybody exactly how they can make it happen.
Senator Lee. You referred to that in your written
testimony, I believe, as part of the--kind of a variation of
the VAT?
Dr. Hassett. It is--all consumption taxes you could sort of
think of as a variation of the VAT. The Hall-Rabushka Flat Tax
is, as well. In fact, if you've ever seen Bob Hall give a
presentation about it, one reason--you know, one reason he
calls it the ``flat tax,'' they decided on that design, is they
think that a Value Added Tax, as it's structured in Europe,
would be very unpopular in the U.S. And so he kind of moves the
places where collection happens around a little bit to make it
conform more to the U.S. system. And so it looks a lot more
like what we do, but the economic effect of it would be very
similar to that if we had a sales tax, or VAT.
The Viard enterprise is exactly the same thing. So it looks
a lot like what we do, but by moving things around and
exempting capital from taxation and so on, you end up with
something that looks very much like a Value Added Tax, which is
a good thing when you're running tax reform models because the
Value Added Tax is the type of tax that gives you the biggest
economic growth effect and welfare effect in the long run.
Senator Lee. So this type of model would render obsolete
this debate that we have had recently about what to do about
capital gains, as far as at what rate you tax that because it
would be focused on consumption rather than income----
Dr. Hassett. Right.
Senator Lee [continuing]. Or capital gains.
Dr. Hassett. That's correct. That's correct. And, you know,
I think that there is so much to commend an approach like that,
both distributionally since it is a progressive consumption
tax; then the folks who have that as their number one issue,
they can come to the table and help you set the rates.
There are also interesting transitional distributional
effects. If Warren Buffett were to go out and buy an airplane
today, he would not pay a consumption tax on it. But if all of
a sudden you have a consumption tax, then he would. And so his
old wealth is being taxed.
There are just many, many reasons why I think that in some
Congress soon it is quite likely that there is going to be a
big tax reform again. Because, again, I gave you the scale of
the challenge, or the target of what we could get if we had
done it 10 years ago, where we would be today, how much better
it would be.
I think that if the economy continues to be weak, that
something like that x-tax should get broad bipartisan support.
Senator Lee. Okay. And I assume you would say that, going
back to my two-part analysis earlier of the purpose of the Tax
Code having two purposes, to raise revenue and communicate
adequately and accurately to the electorate the true cost of
government, I assume your insistence would be that this would
perform that second function much better?
Dr. Hassett. It would be, yeah, much more transparent what
was happening, that's correct.
Senator Lee. Okay. Dr. Gravelle, what would you do if made
king, queen, czarina for the day and you could do anything to
our tax code?
Dr. Gravelle. I probably wouldn't do a lot different from
what we have now. We just--CRS just released a report where we
looked specifically at base broadening and individual income
tax reform. And tax reform looks--and fundamental tax reform
looks a lot easier when you talk about it in generalities than
when you talk about specifics.
So, for example, ideas such as eliminating tax expenditures
by taxing Medicare, which would be a disaster for low-income
people, by taking capital gains at death, by taxing pensions.
We have a list of the 20 top tax expenditures. You start
looking at those, and you see that they are very hard.
Now Kevin, the thing Kevin talked about, the Progressive
Consumption Tax, I mean that would be a very radical change and
there would be some big windfall gains and losses--a very
difficult transition to that tax.
And I think once you start looking at this, you might want
to rethink whether that is a good way to go.
With respect to the Corporate Tax, I just think we need to
be careful, because Corporate Tax doesn't have as many tax
expenditures. And if you do something about depreciation or
things like that, you are actually going to increase the cost
of capital on a revenue neutral change.
So also I found that if you eliminated every tax
expenditure, you could only reduce the Corporate Tax by about 5
percentage points.
So I think you have to look very realistically at exactly
what you have to do with tax reform before you decide which way
to go.
Senator Lee. So every loophole, every deduction, every
credit, everything under the current system would allow you to
reduce that only by 5 percent?
Dr. Gravelle. On the Corporate Tax, only about 5 percentage
points, yeah, to maybe 30 percent. Maybe a little less. That's
the long-run revenue neutral, not the short-run. The short-run
has some budget scams in it.
Senator Lee. Okay. Thank you.
Vice Chairman Brady. Thank you.
Before we conclude, let me ask, because like other members
of this Committee we do a lot of town halls. Dividend income is
an important part of seniors' lives. The President in his
budget has proposed tripling the tax on dividends.
My question is perhaps more direct.
Dr. Hassett, when taxes on dividends go up, do businesses
give more dividends? Less? The same? Is there an impact?
Dr. Hassett. Yeah, that's the one area of the literature
that I didn't go into in my testimony, but there's a big
literature on this that I've also participated some in.
I think that when, back when we were discussing the
dividend tax and thinking about whether it should be reduced, I
can remember testifying before maybe Ways and Means and Senate
Finance--I don't remember the exact committees--but there are a
number of testimonies. And one of the key things that I thought
motivated the dividend tax reduction back then was the problem
that when you have a high dividend tax, then it gives companies
an incentive to just hold the cash rather than pay a dividend.
And then every now and then, repurchase shares. But I--and
I said this back then--I really don't trust managers. I would
rather they give the cash to the investors, and that they
didn't have an excuse not to, because I think that the bigger
the pile of cash that's piling up in the firm, the more likely
you are to have bad things happening with management.
And so I thought that the dividend tax reduction, one of
the strongest arguments for it--there are user cost arguments,
too--was that it would increase dividend payouts, and that that
had good corporate governance implications. And I think that
there is no dispute in the literature at all that that effect
was seen, that dividends skyrocketed when the dividend tax cut
went down. And I think that we could expect that that would
reverse itself radically if the dividend tax were to go back
up.
Especially if one considers that it seems like now that the
dividend tax cut has occurred once, and has been proven quite
effective in the literature, that if you were to repeal it, the
dividend tax cut, then I think that the firms would logically
expect that the dividend tax would go down again at some point
in the future as soon as, say, Republicans had enough power to
make it happen.
So if you think that the dividend tax is going to be lower,
then you should set dividends today to zero, basically, waiting
for that dividend tax reduction. That's what shareholders would
want you to do, unless they weren't taxable.
And so I think that if something like the Buffett Rule, and
the dividend tax, and the capital gains tax, and all those
things are allowed to go back to old high rates, then we will
see a really steep reduction in dividend payout, a big
reduction in capital gains realization, and a lot of movement
towards things like municipal bonds which still pay tax pre-
interest.
Vice Chairman Brady. Sure.
Dr. Hassett. I think, you know, as a last point, that if
you look at the Buffett Rule proposal, it sort of shows how
crazy a policy can get if you don't think through these things.
But the Buffett Rule proposal that everyone is talking
about this week exempts municipal bond interest from the
calculation. No one has ever explained to me why it is that if
a millionaire pays a lower tax than a secretary because he gets
muni bonds, that's fair. But if it's because he gets dividends,
it's not.
And I would like to ask the drafters of the bill if they
exempted muni bonds because Berkshire Hathaway owns so many
municipal bonds. You know, I mean it's the Buffett Rule because
it's so good for Buffett, but it doesn't make any economic
sense at all.
Vice Chairman Brady. Thank you, Doctor.
I want, as a courtesy particularly to the Democrat members
of the Committee who could not attend the hearing today, and to
allow for a full discussion of the economic issues raised
today, I am going to keep the record of this hearing open for
written questions to the witnesses until Monday, April 23rd, of
this year. And I am asking both witnesses to respond to those
written questions by Monday, April 30th.
With that, thank you very much for your testimony today.
The meeting is adjourned.
Dr. Hassett. Thank you, Mr. Chairman.
[Whereupon, at 11:03 p.m., Tuesday, April 17, 2012, the
hearing was adjourned.]
SUBMISSIONS FOR THE RECORD
Prepared Statement of Representative Kevin Brady, Vice Chairman,
Joint Economic Committee
Today, April 17th, is Tax Day. In recognition of America's
hardworking taxpayers, it is appropriate that the Joint Economic
Committee holds the first of two hearings on how taxes affect America's
economy. Today's hearing focuses on the taxation of capital and on
Wednesday, May 16th; the second hearing will focus on the taxation of
labor.
My goal, as Vice Chairman of the Committee, is to ensure America
has the strongest economy in the world throughout the 21st Century. To
do that, we must get our monetary policy right and our fiscal policy
right. A competitive tax code is more than just getting the rate right.
It's about creating a pro-growth tax code that recognizes the
importance of the cost of capital.
There are two schools of economic thought on how taxation of
capital affects long-term economic growth and job creation. The purpose
of this hearing is to examine the empirical evidence offered by both
sides of the debate.
Some economists contend that taxes on capital have, at most, modest
effects on the economy over time. These economists cite studies that
show a large variation in both the size and direction of responses to
tax changes. Therefore, these economists claim that the effects of tax
changes on long-term growth and job creation are either insignificant
or unpredictable.
The Joint Committee on Taxation uses these arguments to justify the
static scoring of proposed tax changes. Static scoring may acknowledge
some behavioral changes among taxpayers due to changes in tax policy,
such as realizing capital gains before an increase in the tax rate on
capital gains, but does not acknowledge any effect on the overall
growth of gross national product over time. Under static scoring, tax
policy is, by definition, impotent in stimulating or suppressing long-
term growth and job creation.
Other economists contend that tax policy has significant and
predictable effects on economic growth and job creation. In particular,
these economists find that business investment in new buildings,
equipment and software is highly responsive to changes in the after-tax
cost of capital.
From my chamber of commerce experience prior to serving in
Congress, there's little doubt that tax policy affects business
decision-making on Main Streets across America. States and local
governments have long used tax incentives to attract investment,
especially since U.S. businesses face global competition. Tax policy
affects where businesses choose to locate and expand their operations.
It is also common sense that the decisions of all businesses
collectively of whether and how much to invest affect overall economic
growth and job creation. In contrast, the assumption that changes in
tax policy cannot affect long-term economic growth and job creation in
predictable ways defies common sense.
However, we should not rely on common sense alone. We must also
look at the empirical evidence. In his written testimony, Dr. Hassett
reviews major studies conducted by prominent economists in recent years
on various aspects of the taxation of capital: the corporate income
tax, tax depreciation and expensing of business investment, taxes on
capital gains, and taxes on dividends. The conclusions of these studies
are remarkably consistent--taxes on capital have significant, adverse
effects on business investment, economic growth, job creation, and the
real wages of workers.
Despite a growing body of empirical evidence on the adverse effects
of taxing capital, President Obama and many Congressional Democrats are
advocating a series of tax increases that will raise the cost of
capital. These tax increases include:
Imposing higher income tax rates on sole proprietorships,
partnerships, and subchapter S corporations;
Boosting the tax rate on dividends from 15 percent to
44.6 percent;
Raising the tax rate on capital gains from 15 percent to
20 percent;
Tripling the tax rate of traditional local real estate
partnerships;
Eliminating long standing business expensing for energy
manufacturing; and
Lengthening tax depreciation schedules.
If the empirical studies are correct, these tax proposals will
reduce business investment, slow economic growth, and deter job
creation. Moreover, these tax increases will hurt hardworking taxpayers
by reducing their real wages over time. These are the very men and
women which the President and Democrats in Congress claim that they
want to help.
The purpose of today's hearing is to determine whether the
empirical evidence supports these adverse economic assumptions, or
whether we should continue to accept the static scoring currently used
by the Joint Committee on Taxation.
I look forward to the testimony of our distinguished witnesses.
__________