[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

                              ----------                              

                     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

                              ----------                              


                        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.
                               __________






                                  
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