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



 
                    TAX REFORM AND THE TAX TREATMENT

                           OF DEBT AND EQUITY

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



                             JOINT HEARING

                               BEFORE THE

                      COMMITTEE ON WAYS AND MEANS

                     U.S. HOUSE OF REPRESENTATIVES

                                AND THE

                           FINANCE COMMITTEE

                              U.S. SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             July 13, 2011

                               __________

                           Serial No. 112-14

                               __________

         Printed for the use of the Committee on Ways and Means




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                      COMMITTEE ON WAYS AND MEANS

                     DAVE CAMP, Michigan, Chairman

WALLY HERGER, California             SANDER M. LEVIN, Michigan
SAM JOHNSON, Texas                   CHARLES B. RANGEL, New York
KEVIN BRADY, Texas                   FORTNEY PETE STARK, California
PAUL RYAN, Wisconsin                 JIM MCDERMOTT, Washington
DEVIN NUNES, California              JOHN LEWIS, Georgia
PATRICK J. TIBERI, Ohio              RICHARD E. NEAL, Massachusetts
GEOFF DAVIS, Kentucky                XAVIER BECERRA, California
DAVID G. REICHERT, Washington        LLOYD DOGGETT, Texas
CHARLES W. BOUSTANY, JR., Louisiana  MIKE THOMPSON, California
PETER J. ROSKAM, Illinois            JOHN B. LARSON, Connecticut
JIM GERLACH, Pennsylvania            EARL BLUMENAUER, Oregon
TOM PRICE, Georgia                   RON KIND, Wisconsin
VERN BUCHANAN, Florida               BILL PASCRELL, JR., New Jersey
ADRIAN SMITH, Nebraska               SHELLEY BERKLEY, Nevada
AARON SCHOCK, Illinois               JOSEPH CROWLEY, New York
LYNN JENKINS, Kansas
ERIK PAULSEN, Minnesota
KENNY MARCHANT, Texas
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York

                       Jon Traub, Staff Director

                  Janice Mays, Minority Staff Director

                                 ______

                          COMMITTEE ON FINANCE

                     MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West         ORRIN G. HATCH, Utah
Virginia                             CHUCK GRASSLEY, Iowa
KENT CONRAD, North Dakota            OLYMPIA J. SNOWE, Maine
JEFF BINGAMAN, New Mexico            JON KYL, Arizona
JOHN F. KERRY, Massachusetts         MIKE CRAPO, Idaho
RON WYDEN, Oregon                    PAT ROBERTS, Kansas
CHARLES E. SCHUMER, New York         MICHAEL B. ENZI, Wyoming
DEBBIE STABENOW, Michigan            JOHN CORNYN, Texas
MARIA CANTWELL, Washington           TOM COBURN, Oklahoma
BILL NELSON, Florida                 JOHN THUNE, South Dakota
ROBERT MENENDEZ, New Jersey          RICHARD BURR, North Carolina
THOMAS R. CARPER, Delaware
BENJAMIN L. CARDIN, Maryland

                    Russell Sullivan, Staff Director

               Chris Campbell, Republican Staff Director


                            C O N T E N T S

                               __________

                                                                   Page

Advisory of July 13, 2011 announcing the hearing.................     2

                               WITNESSES

Mr. Thomas A. Barthold, Chief of Staff, Joint Committee on 
  Taxation
    Testimony A..................................................    10
    Testimony B..................................................   157
Dr. Mihir A. Desai, Mizuho Financial Group Professor of Finance, 
  Harvard Business School
    Testimony....................................................   269
The Honorable Pamela F. Olson, Partner, Skadden, Arps, Slate, 
  Meagher & Flom, Former Assistant Secretary of the Treasury for 
  Tax Policy
    Testimony....................................................   259
Mr. Victor Fleischer, Associate Professor of Law, University of 
  Colorado Law School
    Testimony....................................................   267
Dr. Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, 
  Massachusetts Institute of Technology Sloan School of 
  Management, former Economic Counsellor and Director of the 
  Research Department at the Inter-national Monetary Fund
    Testimony....................................................   295

                        QUESTIONS FOR THE RECORD

Mr. Thomas A. Barthold...........................................   330
Dr. Mihir A. Desai...............................................   340

                       SUBMISSIONS FOR THE RECORD

Sen. Olympia J. Snowe, Statement.................................   343
National Association of Home Builders, Statement.................   345
The Center for Fiscal Equity, Statement..........................   353


                  JOINT HEARING ON TAX REFORM AND THE



                    TAX TREATMENT OF DEBT AND EQUITY

                              ----------                              


                        WEDNESDAY, JULY 13, 2011

                     U.S. House of Representatives,
                               Committee on Ways and Means,
                                                   Washington, D.C.

    The joint hearing met, pursuant to call, at 9:07 a.m., in 
Room HVC210, Capitol Visitors Center, the Honorable Dave Camp 
[chairman of the House Committee on Ways and Means] presiding.
    [The advisory of the hearing follows:]

ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                   Chairmen Camp and Baucus Announce

                  Joint Hearing on Tax Reform and the

                    Tax Treatment of Debt and Equity

Wednesday, July 13, 2011

    Congressman Dave Camp (R-MI), Chairman of the House Committee on 
Ways and Means, and Senator Max Baucus (D-MT), Chairman of the Senate 
Committee on Finance, today announced that the Committees will hold a 
joint hearing to review the tax treatment of debt and equity and to 
consider distinctions in the treatment of each in the context of 
comprehensive tax reform. In connection with the hearing, the staff of 
the Joint Committee on Taxation (JCT) will release two reports that 
analyze the taxation of household debt and business debt. The joint 
hearing will take place on Wednesday, July 13, 2011, in Room HVC-210 of 
the Capitol Visitor Center, beginning at 9:00 A.M.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. However, 
any individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committees and for 
inclusion in the printed record of the hearing. A list of invited 
witnesses will follow.
      

BACKGROUND:

      
    At the March 15, 2011 organizational meeting of the Joint Committee 
on Taxation, Chairman Camp and Chairman Baucus--in their capacities as 
JCT Chair and Vice Chair, respectively--directed JCT staff to analyze 
how debt financing is taxed relative to equity financing and to report 
on the effects of such differences on household and business debt 
levels. Chairman Camp and Chairman Baucus believe that the policy and 
economic information provided by JCT staff will be important for the 
tax-writing committees to consider in the formulation of comprehensive 
tax reform legislation. The two JCT reports will be formally presented 
to the Ways and Means Committee and Senate Finance Committee at the 
joint hearing.
    With regard to the joint hearing, Chairman Camp made the following 
statement:``The relative taxation of debt and equity has serious 
consequences for the economy and job creation, and it needs to be given 
careful consideration in the context of comprehensive tax reform. With 
both the Ways and Means Committee and the Senate Finance Committee 
actively pursuing tax reform, it will be critical for Congress's two 
tax-writing panels to be working together closely. I look forward to 
having our two committees convene this historic joint hearing--the 
first on a tax issue since 1940--to receive these staff reports on this 
important issue.''
      
    Chairman Baucus said, ``As part of tax reform, we must examine how 
we can improve our economy and create jobs, and to do so, we need to 
ask how to encourage businesses to invest in growth. This hearing will 
look at the effects of different tax treatment of debt and equity on 
our economy. We'll need to work together to simplify and improve our 
tax code to help businesses create jobs, which is why these joint 
hearings between our two committees are so important.''
      

FOCUS OF THE HEARING:

      
    The hearing will focus on the taxation of debt and equity and the 
broader economic implications of this treatment. At the hearing, JCT 
staff will formally present two reports on the taxation of debt 
financing relative to equity financing. These JCT staff reports were 
requested by Ways and Means Committee Chairman Camp and Senate Finance 
Committee Chairman Baucus at the organizational meeting of the Joint 
Committee on Taxation on March 15, 2011.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
written comments for the hearing record must follow the appropriate 
link on the hearing page of the Committee website and complete the 
informational forms. From the Committee homepage, http://
waysandmeans.house.gov, select ``Hearings.'' Select the hearing for 
which you would like to submit, and click on the link entitled, ``Click 
here to provide a submission for the record.'' Once you have followed 
the online instructions, submit all requested information. ATTACH your 
submission as a Word document, in compliance with the formatting 
requirements listed below, by the close of business on Wednesday, July 
27, 2011. Finally, please note that due to the change in House mail 
policy, the U.S. Capitol Police will refuse sealed-package deliveries 
to all House Office Buildings. For questions, or if you encounter 
technical problems, please call (202) 225-3625 or (202) 225-2610.
      

FORMATTING REQUIREMENTS:

      
    The Committee relies on electronic submissions for printing the 
official hearing record. As always, submissions will be included in the 
record according to the discretion of the Committee. The Committee will 
not alter the content of your submission, but we reserve the right to 
format it according to our guidelines. Any submission provided to the 
Committee by a witness, any supplementary materials submitted for the 
printed record, and any written comments in response to a request for 
written comments must conform to the guidelines listed below. Any 
submission or supplementary item not in compliance with these 
guidelines will not be printed but will be maintained in the Committee 
files for review and use by the Committee.
      
    1. All submissions and supplementary materials must be provided in 
Word format and MUST NOT exceed a total of 10 pages, including 
attachments. Witnesses and submitters are advised that the Committee 
relies on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. All submissions must include a list of all clients, persons and/
or organizations on whose behalf the witness appears. A supplemental 
sheet must accompany each submission listing the name, company, 
address, telephone, and fax numbers of each witness.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days' notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://www.waysandmeans.house.gov/.

                                 

    Chairman CAMP. Good morning, and thank you all for joining 
us this morning. According to the Congressional Research 
Service, the last time both the House Ways and Means and the 
Senate Finance Committees met together for a joint hearing on 
tax issues was 1940, more than 70 years ago, to discuss a war 
profits tax.
    And while I have said that I have been looking forward to 
our two committees working closely together on tax reform, I 
hope that you all know I didn't necessarily mean that we would 
be squeezed in here quite so tightly. But it is a beautiful new 
room, and I appreciate the opportunity to be able to use it.
    I want to thank Senator Baucus and his staff, and all of 
the staffs, for working out the details. And also, I want to 
thank my colleagues in both the House and Senate for being here 
today. It is a clear illustration of how serious the issue of 
tax reform is to both of these committees and, of course, to 
the American economy.
    As former Treasury Secretary James Baker said at the April 
6th Joint Tax Committee hearing, ``Tax reform has something in 
it for everybody.'' For an American family, it means greater 
simplicity, fairness, and predictability, so that families can 
plan and prosper. And for employers and their employees, 
transforming our tax code is critical to making America a more 
vibrant competitor abroad, and a more attractive place to 
invest and create the jobs we need here at home.
    However, before we can begin to tackle and craft a plan for 
comprehensive tax reform, we must take the time to better 
understand how the current code influences our economy and the 
decisions made by families and businesses. The issue of debt 
and equity, the topics of our hearing today, is among the most 
complex issues we must grapple with, and among the most 
important to get right in moving forward.
    Earlier this week, the staff of the Joint Tax Committee 
issued two reports responding to a request Chairman Baucus and 
I made, one on household debt, and one on business debt. The 
report on household debt examines provisions in current law 
related to the deduction of interest expenses, including 
personal interest deductions for mortgage interest, interest on 
student loans, and investment interest.
    The business debt report focuses more on the tax treatment 
of debt, relative to equity, and its implication for corporate 
capital structures. These are all crucial issues, and I think 
it is fitting to have both of Congress's tax-writing committees 
here today to receive these reports and hear from our 
distinguished panel of experts.
    And before I yield to my friend from Montana, I would like 
to just take a moment to congratulate him on his recent 
marriage. And I now recognize Senator Baucus for his opening 
statement.
    Chairman BAUCUS. Oh, well, thank you very much, Mr. 
Chairman. That was something I did not expect. That is very 
thoughtful, that is very sensitive, is very nice, and I deeply 
appreciate it.
    Also, I appreciate our holding a joint hearing. I think 
there is an opportunity here for the Ways and Means Committee 
and the Finance Committee to work together in many areas--in 
this case, with tax reform, both individual and corporate. We 
have been working together, we have already set good precedent 
by working out an agreement with the trade adjustment 
assistance, you and I and our staffs, and I hope that is good 
precedent for future cooperation, because both--with us working 
together, it is clear that we are more likely to get something 
accomplished than if we don't. And I deeply appreciate that.
    The author, Henry Wheeler Shaw, once wrote--and I quote 
him--``Debt is like any other trap: easy enough to get into, 
but hard enough to get out of.'' We meet together today because 
we share a common goal. We believe the tax code should boost 
American competitiveness, should encourage economic growth and 
job creation. It should be fair, simple, efficient, and 
certain. And it should also not encourage households or 
businesses to take on too much debt that they cannot get out 
of.
    Today we examine the taxation of debt and equity. Right now 
we are confronting a massive debt problem due, in part, to 2008 
financial crisis. The year before the crisis, the 5 major 
investment banks had a leverage ratio of 40 to 1, which means 
for every $40 in assets, there is only $1 in equity to cover 
losses. This raises the question of whether excessive private 
debt played a major role in creating that meltdown.
    As we work to emerge from that crisis, we seek to 
understand how our tax code affects private debt, and how does 
debt affect stability and growth. Does the code encourage 
households and businesses to become more leveraged? Do tax 
preferences for corporate debt or equity provide incentive for 
riskier capital structures? And did the tax code's treatment of 
debt contribute to the crisis?
    We clearly did not want to encourage households and 
business to assume too much. Yet we want to ensure that 
businesses can borrow at modest rates, because that is an 
essential step on the road to economic recovery.
    In today's code it can be hard to tell what is considered 
borrowing and what is equity investment. A business can make an 
infusion of cash that looks like either one. And naturally, 
some businesses choose to cast their financing in a light that 
gets the best tax treatment. But this requires sophisticated 
tax planning, which not everyone can afford.
    Debt and equity can both be vital tools in today's economy. 
But as we work to inspire growth, we must make sure our code 
does not encourage businesses and individuals to put themselves 
in precarious positions. Tax reform should simplify these 
issues, make our code fairer. Americans deserve a tax system 
they can understand and benefit from, without an extensive tax 
planner.
    So, let us work together to address these issues, make our 
code more competitive, more fair. Let us find creative 
solutions to our nation's pressing problems. Given all the debt 
discussion, Mr. Chairman, it is my hope that as that proceeds 
in whatever way it does proceed, that we, in the meanwhile, 
have extensive hearings on tax reform, individual and 
corporate, because I think that will provide a good foundation 
for whatever we do this year or next, or perhaps even in 2013. 
But let us work together, have our separate hearings, have 
joint hearings, but provide a real service to our country. 
Thank you.
    Chairman CAMP. Well, thank you, Chairman Baucus. And let me 
now yield to the ranking member of the Ways and Means 
Committee, Mr. Levin, for his opening statement.
    Mr. LEVIN. Thank you very much. I think you noticed this is 
the first time I have been in this room. There are TV sets 
here. I want you to know that they have been, I think, turned 
off. I noticed that FOX News, CNN, and ASPN is on these sets. I 
am not sure why. I missed the baseball game last night. But I 
think we have turned it off.
    Chairman BAUCUS. Yours isn't off.
    Mr. LEVIN. No.
    [Laughter.]
    Mr. LEVIN. I pushed it and it says, ``U.S. House Guest, no 
new messages.''
    [Laughter.]
    Mr. LEVIN. As you mentioned, Mr. Camp, this is the first 
time since 1940 that there has been this kind of a combined 
meeting on tax issues. And, as we know, it is scheduled, and we 
will discuss certain aspects of the current tax law relating to 
debt and equity.
    But let me make this comment that I deeply feel. Because of 
the uniquely serious challenge facing this nation, action on 
the debt limit, today would seem most appropriate, if we are 
gathering to discuss this challenge. The issue, the debt limit, 
is squarely within the jurisdiction of our two committees.
    That does not mean that the specific topic before us is 
unimportant. Indeed, if we are to seriously address tax reform, 
issues relating to debt and equity must be considered and, like 
other significant issues, done so in depth and with open 
debate.
    As our witnesses' prepared testimony very much 
demonstrates, the subject is complex and answers do not always 
automatically fall into usual ideological frameworks. But I 
fear the chances of the discussion at this joint hearing 
leading to fruitful action have been dimmed immeasurably by the 
environment created on the overarching action on the debt 
ceiling.
    Yesterday, Senator McConnell said--and I quote--``After 
years of discussions and months of negotiations, I have little 
question that as long as this President is in the Oval Office, 
a real solution is probably unattainable.'' In my judgement, 
this approach politicizes and can poison the well for tax 
reform in the near future. It also flies in the face of basic 
facts. President Obama inherited a debt that had risen under 
President Bush from 5.7 trillion to 10 trillion. And he 
inherited a record 1.5 trillion deficit that had wiped out the 
record surplus inherited by President Bush.
    President Obama has said very clearly that we need a 
balanced framework to reduce the deficit now and in the future, 
while allowing for needed investments to promote economic 
growth and job creation. It is not helpful to walk away from 
the table. It is not helpful to insist on an ideological agenda 
that cannot become law.
    We should hear and review carefully the testimony now to be 
presented to us by our distinguished--and if you have read 
these documents in advance--very knowledgeable witnesses. But 
my fear is that any insights that we gain in the process today 
will be washed away if the debt ceiling is not raised and we 
suffer the momentous consequences that would result from 
destroying the full faith and credit of the United States of 
America.
    Thank you, Mr. Chairman.
    Chairman CAMP. Thank you. I now yield to the ranking member 
of the Senate Finance Committee, Senator Hatch, for his opening 
statement.
    Senator HATCH. Well, thank you, Chairmen Baucus and Camp, 
for this historic hearing. And thank you, Mr. Barthold, and the 
staff of the Joint Committee on Taxation for producing this 
important report on the tax treatment of debt and equity, and 
we appreciate you other witnesses, as well.
    Tax reform should be based on the same three principles 
that led to the enactment of the Tax Reform Act of 1986: 
fairness, simplicity, and economic growth. I am very much 
looking forward to hearing what our witnesses have to say on 
these three principles, as they relate to the tax treatment of 
debt and equity.
    Allow me to share a few of my initial thoughts, first with 
respect to individuals, and then with respect to corporations, 
on the topic of debt and equity.
    On the individual side, we can all agree that savings and 
investment is a good thing, and that the savings rate in the 
United States has traditionally been low when compared to many 
other countries. But an income tax system, by its nature, 
discourages savings and investment by taxing the returns to 
such savings and investment. This was an observation made by 
John Stuart Mill over 160 years ago. Thus, the code encourages 
consumption, and even ``negative savings.'' That is, debt.
    Our tax system encourages the use of debt, rather than 
equity, in the area of corporate finance, as well as household 
finance. If a corporation is in need of additional funds, our 
tax system encourages the corporation to borrow money, rather 
than raising funds by issuing stock. And why? Because any 
interest payments on the borrowing are deductible, while any 
dividends paid on the stock are not deductible.
    In addition, many U.S. multinational corporations are 
sitting on large piles of cash. Yet these corporations are 
borrowing money. One reason is that their cash is trapped 
offshore, and the corporations will be subject to a 35 percent 
U.S. tax on repatriating the cash back to the United States.
    The increased use of debt by both households and 
corporations makes both more vulnerable to the risks of 
bankruptcy and other downturns in the economy.
    I would like to thank our witnesses for attending this 
historic hearing. I thank our two chairmen and all others on 
this--on these two very important committees. And I look 
forward to the comments of our witnesses here today on the tax 
treatment of debt and equity.
    So, again, Chairman Camp and Chairman Baucus, thank you 
very much for this important hearing that you have called on 
tax reform. I appreciate it.
    Chairman CAMP. Well, thank you, Senator Hatch. And without 
objection, any other Member who wishes to have an opening 
statement included in the formal record may submit one in 
writing.
    We are fortunate to have a panel of witnesses here this 
morning with a wealth of experience in private practice, 
academia, and government. And let me briefly introduce them.
    First, I would like to welcome Tom Barthold, the chief of 
staff for the Joint Committee on Taxation. We thank you and 
your staff for your efforts in putting together the household 
and business debt reports for today's hearing, and we look 
forward to your presentation.
    Second, we will hear from Pam Olson, who is currently 
serving as the head of the Washington office tax group of the 
law firm Skadden, Arps, and has also formerly served as the 
Assistant Secretary for Tax Policy at the Treasury Department, 
and has held several positions at the IRS.
    Third, we will hear from Victor Fleischer, who is an 
associate professor of law at the University of Colorado Law 
School. His research is focused on tax planning and the 
structuring of corporate transactions.
    And fourth, we will hear from Mihir Desai, who is a 
professor of finance at Harvard Business School, and recently 
accepted an appointment as a tenured professor of law at 
Harvard Law School. He is also a research associate in the 
National Bureau of Economic Research's public economics and 
corporate finance program.
    And finally, we will hear from Simon Johnson, the Ronald A. 
Kurtz professor of entrepreneurship at the Massachusetts 
Institute of Technology. He is also a senior fellow at the 
Peterson Institute for International Economics in Washington, 
D.C. And from March 2007 to August 2008, Mr. Johnson was an 
economic counselor and director at the research department at 
the International Monetary Fund.
    Thank you all for being here with us today. The committee 
has received each of your written statements, and they will be 
made part of the formal record. Each of you will be recognized 
for five minutes for your oral remarks.
    And, Mr. Barthold, we will begin with you, and you are 
recognized for five minutes.

    STATEMENT OF THOMAS A. BARTHOLD, CHIEF OF STAFF, JOINT 
                     COMMITTEE ON TAXATION

    Mr. BARTHOLD. Well, thank you very much, Chairman Camp, 
Chairman Baucus, Mr. Levin, and Senator Hatch, and members of 
the committees. It is my pleasure to deliver to the Ways and 
Means Committee and the Finance Committee two reports requested 
by the chairmen relating to the tax treatment of the use of 
debt by households and the use of debt finance, as compared to 
equity finance, by business.
    Now, the Joint Committee's staff's efforts in these reports 
was to describe what the law is, and what incentives the law 
might create. And I will just use my brief time here to 
highlight a few points.
    First, while, as was noted in some of the opening 
statements, the recent recession raised valid concerns about 
leverage in the U.S. economy, it is important to remember that 
there are many sound economic reasons for both households and 
businesses to finance with debt. Debt is not inherently a bad 
thing.
    Now, relative to the growth of the economy, as measured by 
the gross national product, over the past 25 years non-
financial corporate debt has been largely unchanged, while the 
debt of the household sector and the debt of the Federal 
Government have increased by more than 50 percent each. This is 
shown in table I of each of the two documents that we prepared.
    In looking at the household debt, the primary source of the 
growth of household debt is the growth of mortgage debt, and 
that is documented in figure 3 on page 18 of the household 
document. As you know, mortgage interest is favored as an 
itemized deduction in the Internal Revenue Code.
    Yet over this same 25-year period where we see this 
substantial growth in household debt, Congress has generally 
lowered individual tax rates, which lowers the benefit of that 
interest deduction, Congress has capped the aggregate amount of 
acquisition indebtedness that a taxpayer may claim as part of 
the itemized deduction, and Congress has limited the interest 
deductibility of home equity debt. With those factors, it is 
difficult to conclude that the deductibility of mortgage 
interest would explain the growth of household debt over that 
period.
    On the business side, one cannot discuss debt finance 
without discussing equity finance. And, as our staff report 
details, there are tax rules that create incentives to choose 
debt finance over equity finance. Most initially, for the 
issuer, the deductibility of interest expense and, oppositely, 
the non-deductibility of dividends, make debt a cheaper source 
of capital for the business.
    Also, other incentives exist to choose debt finance. In a 
partnership, for partners, the inclusion of debt at the 
partnership level increases the partners' basis, and increases 
the limit on the deductibility of partner shares of partnership 
losses and deductions. Debt finance of investments can create 
interest deductions that can shelter other taxable income of 
the business, and can lead, in some situations, to negative 
effective tax rates on returns to investment.
    On the other hand, there are also tax rules that favor 
equity finance. At the individual level, the individual 
investor may often prefer equity finance because, under present 
law, there are low rates of--relatively low rates of tax on 
dividend income, compared to interest income. And if the 
investor recognizes a capital gain that results from the 
retained earnings of the business, that is also taxed at a 
lower rate than would be interest income.
    For a corporate equity holder, there are low effective tax 
rates from the dividends received deduction, whereas a 
corporation which had lent money would be paying tax on the 
interest earned at full corporate rates. For both investors and 
issuers, equity promotes the possibility of tax-free mergers, 
and reorganizations, facilitating fluidity in the business 
sector.
    Taxpayers have considerable flexibility to design 
instruments that are characterized as debt or equity under the 
code. And it is difficult to create bright-line rules to 
distinguish debt from equity. The courts, through time, have 
identified multiple indicia of what is debt. And because of 
these factors, instruments can be constructed that, as an 
economic matter, and as our two finance experts can probably 
explain better than I, that can blend the characteristics of 
debt and equity.
    In the 1950s, the Congress attempted to define ``debt'' and 
``equity'' in the Internal Revenue Code, but retreated from 
that effort. Treasury has the authority to issue regulations to 
identify debt and equity but has never exercised that authority 
to do so.
    I think those are some broad points that you can draw from 
our reports. Thank you for the opportunity to prepare this 
material for you. We would be--our staff would be happy to 
provide more detailed work on any questions that might arise in 
today's hearing. And, of course, I am happy to answer any 
questions that you may have today.
    [The prepared statements of Mr. Barthold follow:]
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    Chairman CAMP. Thank you, Mr. Barthold.
    Ms. Olson, you are recognized for five minutes.

 STATEMENT OF PAMELA F. OLSON, PARTNER, SKADDEN, ARPS, SLATE, 
MEAGHER & FLOM, FORMER ASSISTANT SECRETARY OF THE TREASURY FOR 
                           TAX POLICY

    Ms. OLSON. Thank you, Chairman Camp, Chairman Baucus, 
Senator Hatch, Mr. Levin, distinguished members of the 
committee. Thank you for inviting me to testify this morning.
    I am appearing on my own behalf, and not on behalf of any 
client or other organization. And the views I express are 
solely my own, and are based on my experiences in both the 
private and the public sector.
    My compliments, first, to the chairmen, for your decision 
to tackle tax reform on a bicameral and bipartisan basis. The 
tax code's treatment of debt and equity is one of many issues 
that should be considered carefully as Congress considers 
reform of the tax system.
    It has been observed that the one law Congress cannot 
repeal is the law of unintended consequences. Individuals and 
businesses respond to economic incentives and disincentives, 
including those provided through the tax laws. It is important 
for the tax-writing committees to be cognizant of the tax 
system's incentives and disincentives, particularly with 
respect to the disparate treatment of debt and equity, so that 
potential consequences can be factored in as you consider 
reform of the tax system.
    In its current form, as Mr. Barthold has observed, the 
Internal Revenue Code provides an incentive for businesses to 
raise capital through the issuance of debt, rather than equity. 
The incentive arises from the interplay of the two features of 
our tax system that he identified as well, the double taxation 
of corporate income, and the tax deductibility of interest 
payments.
    Incurring debt serves as a straightforward means of 
mitigating the double tax on corporate income. It is worth 
noting that the disparate treatment of debt and equity has been 
the subject of numerous disputes between taxpayers and the 
Internal Revenue Service that continue today, and that there 
have been several failed efforts to draw a bright line between 
the two, both legislatively and administratively. Treasury and 
the IRS proposed regulations under Code Section 385 back in the 
1980s that were subsequently withdrawn.
    The impact of the Internal Revenue Code's preferential 
treatment of debt has been a concern for a number of years, and 
has led to proposals to neutralize or equalize the tax 
treatment of debt and equity. The disparate treatment of debt 
and equity, particularly the double tax on dividends, has also 
given rise to corporate governance concerns, which affected the 
Treasury Department's design of a dividend exclusion proposal 
that was included in the Bush administration's fiscal year 2004 
budget.
    Prior to 2003, the tax on dividends brought the top tax 
rate on corporate income distributed as dividends to nearly 60 
percent, creating an opportunity for corporate managers to cite 
the tax inefficiency of dividend payments as a basis for 
reinvesting corporate profits, rather than distributing them as 
dividends.
    The payment of dividends is a healthy financial discipline, 
because it requires free cash flow to fund the payment. But 
that discipline was dulled by the tax disincentive to paying 
dividends. Prior to 2003, the lower tax rate on capital gains 
made methods of delivering capital gains to shareholders, such 
as stock redemption, a more tax-efficient means of distributing 
excess cash to shareholders.
    The 2003 dividend exclusion proposal would have brought a 
measure of transparency to corporate taxes as well, because 
dividends would only have been excludible, to the extent they 
were paid out of earnings on which corporate tax had been paid. 
The attractiveness of tax-free dividends was seen as giving 
corporations an incentive to pay income tax, at least to the 
extent of dividends expected to be paid to shareholders, and 
shareholders an interest in the extent to which the corporation 
had paid tax. Thus, the proposal could have reduced the value 
of corporate tax incentives, by preventing the value of those 
incentives from flowing through to the shareholders.
    There are simpler means of reducing or eliminating the 
double tax on equity, including the reduced rate Congress 
ultimately adopted, or making dividends deductible at the 
corporate level. A dividends paid deduction would have a 
significant effect on tax revenues, because it would have the 
effect of eliminating all tax on dividend income, where the 
stock is held by a tax-exempt entity, as is the case with 
interest income, where the indebtedness is held by a tax-exempt 
entity. Thus, a dividends paid deduction could result in the 
removal from the U.S. tax base of a significant amount of 
corporate income.
    As the tax-writing committees consider tax reform options, 
one simple means by which to reduce the preference for debt 
financing is to lower the corporate tax rate. The preference 
for debt financing is a result of the ability to deduct 
interest payments from taxable income, and lowering corporate 
tax rates would reduce the value of the interest deduction, 
thus reducing the disparity in the taxation of debt and equity 
investments.
    Besides reducing the distortion between debt and equity 
financing, lowering the corporate rate would have the benefit 
of more closely aligning our rate with rates of other 
countries, which have fallen in recent years.
    Another reform option would be to integrate the corporate 
and individual tax systems, along the lines of the Bush 
administration's 2004 budget proposal, by eliminating the 
shareholder level tax on corporate income distributed as 
dividends. The dividend exclusion proposal could eliminate the 
debt financing incentive associated with double taxing the 
return to corporate equity investment.
    You could also go for full parity between debt and equity, 
through the adoption of a comprehensive business income tax, 
which has also been studied by the Treasury Department.
    In considering corporate tax reform, I encourage the 
committees to make sound policy the primary objective.
    Thank you for the opportunity to testify. I would be 
pleased to respond to questions you may have.
    [The prepared statement of Ms. Olson follows:]
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    Chairman CAMP. Thank you very much.
    Mr. Fleischer, you are recognized for five minutes.

  STATEMENT OF VICTOR FLEISCHER, ASSOCIATE PROFESSOR OF LAW, 
               UNIVERSITY OF COLORADO LAW SCHOOL

    Mr. FLEISCHER. Thank you for inviting me to participate 
today. I am an associate professor of law at the University of 
Colorado, where I teach deals, partnership tax, and tax policy. 
My research focuses on how tax shapes the structuring of deals, 
and so I will focus my testimony from that perspective today.
    The main point that I want to make is that the debt equity 
distortion is costly on two levels. The first level of cost is 
obvious. Deals are restructured to reduce taxes, which erodes 
the tax base. This is the explicit cost of the debt-equity 
distortion.
    The second level of cost is implicit. When a corporation 
restructures a deal to reduce taxes, the restructuring imposes 
an implicit cost on the corporations themselves. It adds 
complexity to their capital structure, distorts corporate 
governance, and even changes critical business decisions.
    The debt-equity distortion imposes an additional implicit 
cost on the public, in the form of increased systemic risks, 
taxpayer bailouts, and the like. It also encourages a lot of 
wasteful tax planning. One can think of these implicit costs 
collectively as the collateral damage of the debt-equity 
distortion.
    The best way to reduce this collateral damage is to 
eliminate the underlying distortion in the tax code. Legal 
distinctions in the tax code that have no basis in underlying 
economics are almost always a bad idea. The tax lawyers that I 
know are very, very clever. If you give them an economic 
incentive to turn equity into debt, or a corporation into a 
partnership, or ordinary income into capital gain, they will 
work tirelessly until you are convinced that a dog is properly 
treated as a cat for tax purposes.
    With that introduction, I will briefly elaborate on the 
implicit cost of the debt-equity distortion. The first implicit 
cost is risky managerial behavior. As firms take on more debt, 
common stock behaves economically like a risky stock option, 
giving executives unlimited upside, but limited downside risk. 
With enough debt, it even becomes rational for executives to 
make negative expected value bets with company assets. The debt 
holders, not the executives, bear most of the downside risk.
    The second cost is the social cost from increased 
bankruptcies and systemic risk. Excessive leverage fuels risky 
speculation that has repercussions, even for taxpayers that 
never engage in risky behavior themselves. The problem is 
especially acute with banks and other financial institutions, 
because the externalized social costs are larger than in other 
sectors.
    The third cost is wasteful tax planning. In a world without 
tax distortions, corporations would make financing decisions 
based on market conditions, not a tax calculation. Instead, 
many corporations and financial institutions, in particular, 
issue new financial products to engage in regulatory arbitrage, 
exploiting the inconsistencies of two different regulatory 
regimes.
    In the typical scenario, bank executives want to increase 
the amount of leverage in the firm to reduce taxes and to 
supercharge return on equity. But taking on too much debt runs 
afoul of banking regulations and the guidelines of credit 
agencies.
    Platoons of lawyers and investment bankers then create 
complex new financial products that qualify as debt for tax 
purposes, and equity for financial accounting or credit agency 
purposes, or as tier one capital for bank regulatory purposes. 
These hybrid instruments allow financial institutions to appear 
safer by appearing to have greater equity capital. In fact, 
they mask an increase in debt. They are dogs that are treated 
as cats for tax purposes.
    AIG, Lehman Brothers, Bear Stearns, and other failed 
institutions all had large amounts of these hybrid instruments 
on their balance sheets before the crash. These instruments did 
not perform well in the financial crisis. Because they 
typically contained ongoing obligations to make cash payments, 
the instruments were properly perceived by trading 
counterparties as debt obligations that would not provide a 
cushion in the way that real equity would. The resulting loss 
and instability was borne largely by the public, and not the 
banks themselves.
    So, what is the bottom line? The best solution is a broader 
corporate tax reform effort that would eliminate the debt 
equity distortion all together. There are several different 
ways to do this, including eliminating the deduction for 
interest, allowing a deduction for corporate equity, or moving 
to a corporate cash flow or consumption tax system.
    If Congress is interested in moving more immediately on the 
debt-equity distortion, my suggestion is to focus on financial 
institutions. Financial institutions are where the problem is, 
they have the most excessive leverage, and the failure of a 
systemically risky financial institution imposes enormous 
social costs.
    One approach would be to eliminate the deduction of 
interest by financial institutions to the extent that debt-
equity ratio exceeds five to one. The goal of such a limit is 
not to punish banks, but rather to remove the tax incentive to 
increase leverage beyond the ratio that would arise in a world 
without taxes.
    I would be happy to answer any questions you may have, and 
I thank you for the honor of participating in this hearing.
    [The prepared statement of Mr. Fleischer follows:]
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    Chairman CAMP. Thank you very much, Mr. Fleischer.
    Mr. Desai, you will be recognized for five minutes.

 STATEMENT OF MIHIR A. DESAI, MIZUHO FINANCIAL GROUP PROFESSOR 
              OF FINANCE, HARVARD BUSINESS SCHOOL

    Mr. DESAI. Chairman Baucus, Chairman Camp, and members of 
the committees, it is a pleasure to appear before you today to 
discuss tax reform and the treatment of debt and equity. I am a 
professor of finance at Harvard Business School, professor of 
law at Harvard Law School, and a research associate of the 
National Bureau of Economic Research.
    In my comments, I want to describe the fundamental problem 
raised by the current tax treatment of debt and equity, how 
changes in the economy and the tax system have raised novel 
complications to this underlying problem, and outline several 
alternative solutions. As an aside, I will comment on the 
possibility that the tax treatment of debt and equity 
contributed to the recent financial crisis.
    My written testimony can be summarized in five points. 
First, a classical corporate income tax with an entity level 
and individual level taxation creates the potential for 
asymmetric treatment of debt and equity income. This asymmetric 
treatment can distort financing, organizational form, and 
investment decisions.
    In the U.S. system, equity income is taxed twice, while 
debt income is taxed once, though assessing the actual relative 
tax burdens of equity and debt income is complicated by several 
factors. Indeed, the simple narrative that debt is tax favored 
is not necessarily true, nor is it borne out by recent patterns 
in the data, as I elaborate on in my recent testimony. In 
addition to distorting financing choices, the differential in 
tax treatment creates a host of opportunities for financial 
engineers to innovate around that distinction.
    Second, this asymmetric treatment of debt and equity income 
has been complicated by three significant developments that any 
reform measure should grapple with. The first development is 
the rapid globalization of firms and capital markets. This 
development makes the tax treatment of multinational firms and 
transfer pricing concerns central to the corporate tax, creates 
situations where investor-level taxation now often involves 
foreign investors, and allows the possibility of allocating 
various headquarter and domicile functions across multiple 
jurisdictions.
    The second development is that the simple characterization 
of entity-level taxation and taxable investors that is 
customary to use in these discussions does not reflect two very 
rapid--two very important developments: the rapid rise of pass-
through entities for business income, and the rise of tax-
exempt investors as major players in the capital markets.
    The third development is that corporate tax is now largely 
for public corporations, where financial reporting incentives 
compete with tax obligations, and these incentives can 
compromise tax policy goals.
    My third major point is that while excessive leverage is 
sometimes associated with the tax code because of a presumed 
debt bias for corporations, concerns over the role of tax 
policy in fostering the financial crisis appear unfounded. It 
is difficult to describe significant roles for tax incentives 
in the housing market or for financial institutions as primary 
or secondary actors in the drama of the financial crisis.
    For the non-financial corporate sector, where the presumed 
debt bias is thought to exist, the startling fact is how 
unlevered that sector was, prior to the crisis. In particular, 
as Senator Hatch outlined, the rise of cash balances and the 
decline of net debt is the dominant corporate finance trend of 
the last decade.
    A brief and remarkable burst in leverage buy-out activity 
that is not related to changed--to tax incentives is likely 
responsible for the perception of excessive leverage in the 
non-financial sector. The increased reliance on equity 
financing also speaks to the potential scope of the current 
bias towards debt. In my opinion, the excesses of financial-
sector leverage, which are very important, are best addressed 
through regulatory approaches, rather than tax instruments.
    Fourth, the corporate tax is ripe for reform for many 
reasons, but excessive leverage may not rank highly amongst 
them, in my view. In my testimony, I highlight three approaches 
to the debt equity distinctions: regulatory, structural, and 
rate solutions all can be deployed to correct perceived 
concerns regarding the debt equity distinction. Regulatory 
approaches which provide arbitrary limits to leverage must be 
crafted with care, as they can create added complexities with 
limited payoffs.
    If the stripping of earnings by multinational firms is the 
concern, then new regulation should be integrated with current 
policy instruments that already target that problem, such as 
interest allocation rules and Section 163(j). Indeed, a lowered 
corporate rate is likely the best antidote to that behavior.
    If firm leverage is the concern, then limits on interest 
deductibility must consider how highly-levered industries and 
organizational forms will be impacted, and the consequent 
effects on their cost to capital and investment levels. Given 
the uncertainty of the current debt bias, such regulations 
would appear to engender more tax planning than economic 
benefits.
    Fifth, reforming the corporate tax structurally via 
comprehensive business income tax can provide a solution-based 
symmetric treatment of debt and equity, can undo distortions to 
organizational form decisions, and provide a first step towards 
fundamental tax reform.
    A more modest approach to modernizing the corporate tax 
should couple a rate reduction with a move toward 
territoriality that is funded by better alignment of book and 
tax reporting, and by some taxation of non-C corporation 
business income.
    As other countries have learned, reducing rates, 
simplifying international taxation, and broadening the base, 
are cornerstones of reforms that can improve the lives of 
American workers and the firms that employ them. Such reform 
efforts, rather than regulatory approaches that target 
excessive leverage, would best advance your admirable agenda of 
strengthening tax policy and America's economic future.
    Thank you, and I look forward to any questions you might 
have.
    [The prepared statement of Mr. Desai follows:]
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    Chairman CAMP. Thank you, Mr. Desai.
    Mr. Johnson, you are recognized for five minutes.

   STATEMENT OF SIMON JOHNSON, RONALD A. KURTZ PROFESSOR OF 
 ENTREPRENEURSHIP, MASSACHUSETTS INSTITUTE OF TECHNOLOGY SLOAN 
SCHOOL OF MANAGEMENT, FORMER ECONOMIC COUNSELOR AND DIRECTOR OF 
   THE RESEARCH DEPARTMENT AT THE INTERNATIONAL MONETARY FUND

    Mr. JOHNSON. Thank you very much. I would like to speak 
about household debt, non-financial corporate sector debt, and 
financial sector debt as three separate issues for your 
consideration.
    However, there is a common problem across all these kinds 
of debt which is now, I think, apparent to all American 
homeowners. If you buy a house that costs $1 million with only 
$5,000 down--so the rest is leverage--you are much more at risk 
when house prices go down than if you had put down $50,000 or 
$500,000. You also, of course, get great upside if house prices 
go up. You get a better return on your equity.
    And the issue, I think, before us, certainly with regard to 
the previous financial crisis, and also with regard to what may 
happen in the future, is to what extent individuals or 
corporations create a spillover, an externality, a form of 
system risk when they choose to be over-leveraged, from a 
social point of view.
    Now, looking at households, I am afraid--I think it is 
somewhat obvious--that the tax code has encouraged households, 
over a long period of time--and it wasn't the primary 
instigator of the crisis, but it encourages households to 
massively over-leverage, to take on a great deal of risk, which 
they may or may not fully understand themselves.
    But, in any case, it creates really bad macroeconomic 
consequences when house prices go down. I would strongly urge 
you to consider phasing out the mortgage interest deduction 
over a long period of time, such as 20 years. This has been 
done in other countries. If handled properly, it would not be 
disruptive and dangerous. Obviously, I am not proposing to do 
it right away.
    On the non-financial corporate side, I think we don't have 
a major problem. I agree with what the previous witnesses have 
said, with regard to the attractiveness of making the system 
more neutral between debt and equity. And I think there are a 
number of reforms you could do, either lower the tax of equity 
or lower the deduction for interest payments, or, even better, 
move to a new system, a more integrated system for corporate 
taxation, perhaps also with individual taxation.
    That, I think, is not the pressing number-one issue, 
though, with regard to macro risks and financial stability. 
Those risks are about the financial sector. And Senator Baucus 
said it exactly right at the beginning. We had financial firms 
going into the crisis in 2008 with leverage of at least 40 to 
1. And that was not--those are not isolated examples. We have 
tried for a long time, through regulation, to limit leverage, 
to have so-called capital requirements, which have a similar 
effect to leverage caps, and it hasn't worked.
    Not only that, but the Basel III attempt to limit leverage, 
to require more capital, the major international response to 
the crisis, has also not had a dramatic effect, either now or 
in terms of what will happen later in the cycle, as firms want 
to take on more leverage.
    For the financial sector, it is very clear that the top 
bankers and traders are paid on a return on equity basis. If 
they have less equity in the business, and things go well, they 
get nice compensation. If things go badly, there is a downside 
risk.
    But who, I would ask you, bears that downside risk? It is 
largely borne by the rest of the economy, by the non-financial 
sector, by households, either--whether or not you are in favor 
of bail-outs, whether or not you think you will get a bail-out 
doesn't matter. You will get an awful recession, you will get 
devastating losses. You get an increase of debt to GDP, if you 
just want to think in fiscal terms.
    As Mr. Levin pointed out, the debt level has gone up 
dramatically in the past few years in the United States, mostly 
because of the recession caused by the excessive leverage in 
the financial system. It makes no sense to have a tax code that 
encourages that leverage, at the same time as we try and pull 
it back rather ineffectively with regulation. At a minimum, the 
tax code should be neutral between debt and equity for 
financial sector firms.
    I, though, would strongly advise you to follow the lead of 
some other countries in taxing excessive leverage. In the UK 
they now have a tax of 7.5 basis points on what they define as 
excessive leverage. That tax, I think, is actually rather low, 
if you consider that the International Monetary Fund and other 
organizations assess the value of being too big to fail, the 
funding advantage you get from being a mega-bank today--not 
just in the United States; in other countries, as well--that 
funding advantage is 50 basis points, half a percentage point. 
We should be taxing away that advantage.
    I would actually suggest going--speaking to the points made 
by Mr. Hatch. If you want a fair, simple, and pro-growth 
system, you should tax excessive leverage in the financial 
system and use the revenue that generates to reduce corporate 
taxation for the non-financial sector, because the non-
financial sector is what really got hit hard.
    That is why the jobs aren't coming back.
    That is why this has turned out to be such a painful 
recession. Thank you.
    [The prepared statement of Mr. Johnson follows:]
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    Chairman CAMP. Well, thank you, Mr. Johnson. We will now 
proceed with Member questions for witnesses. And due to the 
joint nature of today's hearing, questioning will alternate 
between members of the Senate, as recognized by Chairman 
Baucus, and members of the House, as recognized by myself, for 
a single round of questioning.
    Senators will be recognized in an order consistent with 
rules and practices used at Senate Finance Committee hearings. 
House members will be recognized in an order consistent with 
rules and practices used at Ways and Means Committee hearings.
    And each Member will have three minutes to question 
witnesses. I realize this is a little shorter than we are used 
to having in the Ways and Means Committee. But in order to 
accommodate everyone, we want to hold to the three minutes for 
each Member.
    So, with that, let me invite Chairman Baucus to begin the 
questioning.
    Chairman BAUCUS. Thank you, Mr. Chairman. I am curious 
about this question--the degree to which financial institution 
over-leveraging and the ability of those companies to create an 
infinite number of financial products to affect their own needs 
should best be dealt with through the code, or best dealt with, 
as Mr. Desai said, through the regulatory regime. Or, is there 
some combination--are there some areas where maybe a tax change 
to the tax code is better? There is some general feeling 
lowering the rate, and trying to flatten the corporate tax code 
a little bit helps.
    I only have three minutes. I would like to throw in the 
implication of pass-throughs, the rise of pass-throughs. What 
effect does the rise of pass-throughs have? I will see a little 
bit of difference between you, Mr. Johnson, and Mr. Desai and 
Mr. Fleischer. But if you could--the three of you--just briefly 
comment on that basic question. Which is more important, and 
what about pass-throughs?
    Mr. FLEISCHER. So, on the question of whether we should try 
and address excessive leverage through the tax code or through 
regulatory responses, the answer is yes to both.
    On the tax side, I think what is important is to remove the 
extra incentive to borrow. I don't think we should use the tax 
system to try and solve all of our issues in the bank 
regulatory area. The critical thing on the tax side is to try 
and make it more neutral.
    On pass-throughs, I think the development of pass-
throughs--it used to be that when you think of a partnership, 
you think of a small business. Now we see very large companies, 
including large financial institutions like hedge funds that 
are organized as partnerships. To me, that shows they are very 
sensitive to tax distortions, and will do--will go to great 
lengths to try and avoid the corporate tax.
    Chairman BAUCUS. So what is the solution?
    Mr. FLEISCHER. Well, as I said, I think the short-term 
solution, if you want something in the short run, would be to 
limit or cap the deductibility of interest by financial 
institutions, based on a leverage ratio. And I could talk more 
about comprehensive tax reform, but in the short run--
    Chairman BAUCUS. Okay, thank you. Mr. Desai?
    Mr. DESAI. So, you know, just briefly, to outline what the 
possibilities are, I think--within the tax policy realm I think 
there are several variants.
    One is what would be called a financial transaction tax, 
which would be akin to kind of throwing sand in the wheels of 
financial markets, for the purpose of kind of disrupting 
excessive levels of transactions.
    The second type would be financial activities taxes, where, 
you know, broadly, anybody involved in finance has a specific 
kind of tax.
    One could have a too-big-to-fail kind of tax, which is if 
your assets are above some threshold level, then you have 
potentially to pay an extra tax.
    You know, roughly speaking, I think that is the variance 
that one can have. And then, of course, one can limit interest 
deductibility.
    So, you know, I think the first thing to realize is 
financial institutions are highly specialized. And 
understanding them is extremely difficult. And in situations 
like that, regulatory apparatuses are best used. That doesn't 
mean that we succeeded in the past, but it also doesn't mean 
that we should try a tax instrument in a very complex setting 
with highly responsive taxpayers and a lot of institutional 
detail.
    So, that is why I am very skeptical about tax instruments 
to address financial leverage. Not because it is not a problem, 
but because I think there are better ways to do it. And I 
understand there has been a failure to do it, but there is 
little evidence that--in my mind--that these kinds of taxes are 
little more than kind of a representation of the vengeance that 
many of us feel--
    Chairman BAUCUS. But Mr. Johnson says the financial 
planners just plan all around any financial regulations that 
you come up with. They are so clever--
    Mr. DESAI. Well, indeed they are--
    Chairman BAUCUS. And they are so driven to try to find a 
product that will yield the greatest return.
    Mr. DESAI. Indeed they are, and they will do even more so 
when one tries to think about a tax instrument. And that just 
means that we need to strengthen regulatory approaches, where I 
think that specialized knowledge exists, where we can actually 
govern them in a much more thoughtful way than through the tax 
system.
    And finally, I will just say that it is useful to remember 
that a lot of the leverage was hidden, right? So let's think 
about Lehman Brothers. I don't think anybody knew how levered 
they were. And that is a part of this crisis, which is there 
was behavior that was even beyond the realm that you might have 
imagined.
    Chairman BAUCUS. Mr. Johnson, your thoughts?
    Mr. JOHNSON. Whether you like it or not, Senator, the Code 
impacts the leverage choice these firms make. I think we all 
agree with what the JCT staff has determined, that this is a 
big bias towards debt, including for the financial sector.
    It makes no sense to have regulation and tax code pointing 
opposite directions here. I work a great deal on regulation 
with regulators, and I am very supportive of what they are 
trying to do. But it is not enough. They are all so 
constrained, perhaps by their own choice, but they are 
constrained by international approach to regulation, including 
Basel III on capital, where the Japanese, the Germans, and the 
French were the--provided the lowest common denominator. So, 
why should we regard that as the last word, as the appropriate 
constraint on the extent--excessive leverage?
    I agree with Mr. Fleischer. There are many appropriate ways 
to tax excessive leverage, including a version of a thin 
capitalization tax, which is part of what he discussed. And the 
IMF made a very good report to the G-20 on exactly these issues 
that I commend to all of you.
    Chairman BAUCUS. Thank you very much. Appreciate it. Thank 
you, Chairman.
    Chairman CAMP. Well, thank you. Mr. Desai, you, in your 
testimony, say that a lower corporate tax would alleviate 
pressure on the tax bias in favor of debt over equity. Can you 
explain how a lower tax rate would address the sort of debt-
equity bias that we have heard about?
    Mr. DESAI. Sure. And I think Mr. Barthold made reference to 
this as well, which is the most simple version of this is that 
that entity-level taxation is part of the problem. And so, 
reducing that rate ends up taking away that distortion, to some 
degree.
    But it kind of goes further than that, insofar as one of 
the problems here is not just debt in the aggregate for non-
financial corporations, but the possibility that the corporate 
tax base is being eroded in the U.S. by earnings stripping, 
which I think is a widespread concern. And there, you know, 
lowering statutory rates is a very valuable thing to do, 
because it takes out that incentive for relocating profits 
outside of the United States.
    So, I would say it is at two levels. It is at one level of 
the system, which is part of the reason why the system may be 
tax biased towards debt, is because of the high corporate tax 
rate, the high deduction. And once you take that away, you 
reduce that. And second, if we think that earnings stripping 
and reallocations of income, which are legitimate concerns 
today, given how easy it is to reallocate income, then lowering 
the rate has the additional salutary effect of taking away that 
incentive.
    Chairman CAMP. There seems to be a general consensus that 
the federal tax code favors debt over equity for C-corporations 
and financial firms. And to the extent that you consider this a 
problem, is the solution to change the treatment of equity, or 
the treatment of debt? And how would any of those changes to 
the treatment of debt and equity affect taxpayers that take 
advantage of the current debt bias?
    And if each of you would like to just briefly answer--I 
don't know if, Mr. Barthold, you really want to address that--
but why don't we start with Ms. Olson and just quickly go down 
the line? And I know time is short.
    Ms. OLSON. I think you can go either direction. I mean I 
think right now we have a little bit too much of a bias towards 
debt and against equity. And so I think you can go in either 
direction. You could go in the direction of reducing the double 
tax on corporate income, or you could go in the direction of 
some restrictions on interest.
    I think if you go in the direction of some restrictions on 
interest, you need to first think about significantly reducing 
the corporate rate, and you need to think about transition, 
because there are capital structures in place that would be 
significantly affected by that kind of a change.
    Chairman CAMP. All right. Mr. Fleischer?
    Mr. FLEISCHER. I largely agree with that. My preference 
would be to limit the--on the interest side, to limit interest 
deductions. And the big benefit there is that you could reduce 
corporate tax rates, which reduces all sorts of distortions and 
incentives to tax planning. Thank you.
    Mr. DESAI. Just briefly I would say that, you know, I think 
this is an opportunity that one shouldn't squander, and there 
is the possibility of more comprehensive approaches. Mr. Rangel 
has put forward things, other folks have put forward things, 
and I think that is a very useful opportunity.
    So, to try to fix this on the margin is not as advisable as 
something like the comprehensive business income tax, which I 
think would be very useful.
    Chairman CAMP. Thank you. Mr. Johnson?
    Mr. JOHNSON. My suggestion for the non-financial sector is 
to have an allowance for corporate equity, where you are 
allowed to deduct some of the dividends payments, based on an 
assessment of what is the normal rate of return on capital.
    But for the financial sector, I think you have to go 
further. For the financial sector, I am proposing that you tax 
excessive leverage, because that is what generates the big 
negative--now, it is a form of pollution, a very bad form of 
pollution that doesn't hit you every year. But every 5 to 10 
years you are going to have some very nasty consequence to 
this. And you should take that revenue and use that as general 
revenue, and use that to reduce tax rates on other parts of the 
economy. Because it is those parts of the economy that are 
going to be hit very hard when the banks go bad again.
    Chairman CAMP. All right, thank you. Chairman Baucus?
    Chairman BAUCUS. Thank you. We will experiment with this 
new regime here. Under Senate rules, we go according to a first 
come first served, early bird system. And the earliest bird 
that arrived from the Senate was Senator Hatch. You are next.
    Senator HATCH. Well, thank you. Thank you, Mr. Chairman, 
and both of you.
    Professor Desai, this is a question for you. And I would 
like it also to be answered by Ms. Olson and Mr. Barthold, if 
they could weigh in briefly on this question, as well.
    Professor Desai, in your written testimony you said that 
``the current corporate tax system has the worst of all worlds: 
high statutory rates and low average rates.'' Could you please 
explain that a little bit more?
    For instance, if--say the average rate is 17.5 percent, and 
say that the statutory rate is 35 percent, and the ratio of 
average rate to statutory rate would be 1 to 2, as I see it. Do 
you think there is some ideal ratio--one to one, maybe? Or 
would it actually be ideal to have a statutory rate somewhat 
lower than the average rate, if that could be accomplished?
    And if you would, go weigh in on that and then, after that, 
Ms. Olson and Mr. Barthold.
    Mr. DESAI. So, I guess what I was trying to get at there is 
a few things. The first is the statutory rate is high. And by 
``high,'' I mean by global standards the statutory rate is 
high.
    When I said it was the worst of all worlds, if one is going 
to have a high statutory rate, one would like lots of revenue, 
presumably, or at least there would be some benefit that would 
come from that. And we are living in a world where we are not 
getting that.
    So, we have highly responsive taxpayers, we have very high 
statutory rates, which, on the margin, is distorting 
incentives, as we know marginal rates will do. And we are not 
collecting very much.
    So, the promise of tax reform, of course, that other 
countries have embarked on and that I hope you embark on, is 
lower rates, broader base, and bringing together statutory and 
average rates in a way that is much more consistent with 
economic efficiency and, I should mention, is also more 
consistent with political viability. The corporate tax is now 
viewed--I think widely by the American people--as something 
that is not paid at all. And it discredits the overall tax 
system and, I think, has a wide series of repercussions. So, 
bringing those two back in line is, I think, a very worthy 
goal.
    Senator HATCH. Thank you. Ms. Olson?
    Ms. OLSON. I agree with Mr. Desai's comments. I do think 
that it would be much better if we had a lower statutory rate, 
and if we did some things to broaden the base, which would have 
the effect of increasing the effective rate, or bringing the 
effective tax rate closer to the statutory rate.
    The differences now, I think, of the ways in which the tax 
code directs resources, as opposed to resources being directed 
on the basis of what produces the best pre-tax return. And we 
will maximize national income, and therefore, economic growth, 
if we remove some of those distortions.
    Mr. BARTHOLD. Senator Hatch, I will probably just re-
emphasize a point that Mihir Desai made. When we are looking at 
the statutory rate, we are usually thinking of it as the 
marginal tax rate that applies, and economists emphasize the 
importance of marginal tax rates. Because, at the margin, that 
influences the next investment that will be made, or the next 
financing choice that will be made.
    And so, high marginal tax rates tend to distort choice. 
They could promote more debt than equity. They could promote 
tax shelter behavior. They can reduce incentives to invest, 
which reduces incentives for future growth. And so, that is why 
economists generally are always in favor of lower marginal tax 
rates. As to an optimal ratio of marginal to average, remember 
that average also reflects a number of other policy concerns 
that Members may have in the design of the tax code. And so, 
the optimality of that is your decision.
    Senator HATCH. Well, thank you. My time is up, Mr. 
Chairman.
    Chairman CAMP. Mr. Levin is recognized for three minutes.
    Mr. LEVIN. Thank you, Mr. Chairman. Now, this has been, I 
think, interesting and, I hope, helpful. I do think that the 
complexities emphasize that as we approach these issues we kind 
of need to leave ideology at the door, and try to dig into 
these issues.
    In a sense, it is easy to say lower the rates and broaden 
the base. The problem is when we start talking about how you 
broaden the base. And that is not at all easy. We have held 
hearings, for example, on transfer pricing. And it is not easy. 
We have held hearings on tax havens. And there is often 
disagreement about that.
    By the way, let me just say quickly on the mortgage 
interest deduction--some of you have mentioned it--I just urge 
that we be careful about our proposals. That--because that is 
one way to kind of lower the rate, but the impact, when you 
look at the distributional analysis of mortgage interest, it 
has been very much a middle-income tax provision. And I think 
most of us have to ask where we would be if it hadn't been in 
existence the last 40 years. And there are some problems of 
excess, but I think we have to be careful about not throwing 
out the baby with the bath water.
    So let me, on corporate, ask each of you just directly--
some of you have already expressed yourselves--do each of you 
favor taxation of excessive leverage in the corporate sector? 
Yes or no, or however you would like to modify that.
    Ms. Olson, let's start with you. I won't ask Mr. Barthold.
    Ms. OLSON. I would go in the direction of eliminating some 
of the bias between debt and equity. I don't think I would 
think that it would be a great idea to tax excessive leverage, 
because I am not sure how we would define it, or how we would 
apply it. I had some experience with Section 163(j) proposals 
when I was at the Treasury Department. We made an effort to try 
to cap interest deductions, and it didn't turn out very well.
    Mr. LEVIN. All right. Mr. Fleischer, there are just 20 
seconds left, I see here.
    Mr. FLEISCHER. I favor removing the tax incentives to be 
excessively levered. Going beyond that, you have to proceed 
carefully. If you want to impose a kind of penalty tax on 
excessive leverage, I might support that. But you would have to 
be careful in the design.
    Mr. LEVIN. Mr. Desai?
    Mr. DESAI. No on very targeted things towards excessive 
leverage.
    And on your point about revenue, you are absolutely right 
on broadening the base. There are two solutions in my 
testimony. One is the non-corporate business income, which has 
grown enormously, and then the second is the gap between book 
and tax income, which also, I think, can generate some revenue.
    Mr. LEVIN. Mr. Johnson, I think you have already spoken, 
so--
    Mr. JOHNSON. But if I could just add, the tax on excessive 
leverage is where European Union is heading, including the UK. 
London is our major competitor, vis-a-vis New York. So we are 
behind the curve on taxing excessive leverage, compared to 
major comparative countries.
    Mr. LEVIN. Thank you. Thank you, Mr. Chairman.
    Chairman BAUCUS. Okay. Next is Senator Wyden.
    Senator WYDEN. Thank you, Mr. Chairman. And, Chairman 
Baucus and Chairman Camp, let me thank you both for your 
bipartisan leadership in putting together this important 
hearing.
    I believe that tax reform is now the major unused tool in 
the economic recovery toolshed. The Federal Reserve has cut 
interest rates repeatedly. The Economic Recovery Act was 
passed. Numerous initiatives are in place to help hard-hit 
homeowners. But bipartisan tax reform is now sitting, in effect 
ready, in the economic recovery toolshed. And I hope, as we 
consider this, we know that a variety of factors go into job 
creation, but the last time there was bipartisan tax reform, 
our country created 6.3 million new jobs in the 2 years after 
it was passed.
    Now, on the debt equity issue specifically, Mr. Barthold, a 
question for you. Senator Coats of Indiana and I put in, as 
part of our broad tax reform, an idea that suggests that one 
way to make the tax code less tilted towards debt finance is to 
disallow a portion of the deduction for interest cost that is 
attributable to inflation. That would make the interest on debt 
a bit less deductible and, in turn, would make equity finance a 
bit more attractive.
    Now, you all scored that, as part of our proposal, as 
raising $163 billion over 10 years. My question is--and see if 
we can put this into English--Mr. Barthold, wouldn't that mean 
that if you had broad tax reform, and you had that one feature 
in it, that means you would have that substantial sum--$163 
billion--so you could cut rates for middle class folks, focus 
on creating jobs in our country, pay down the deficit? Isn't 
that what that score really means?
    Mr. BARTHOLD. Senator Wyden, yes, sir. I mean our estimate 
was you had a proposal that would limit interest deductibility, 
and you chose to do that by measuring the inflation component 
annually.
    As we noted in our report, there is a substantial amount of 
interest expense claimed annually by business. And so, a 
reduction in the deductibility of that is a substantial base-
broadener, given the existing--the rest of the Internal Revenue 
Code.
    Senator WYDEN. Thank you, and thank you for your 
professionalism always, for all the Members on both sides of 
the aisle.
    Question for you, Mr. Fleischer, and we appreciate your 
involvement in this, as well. Jane Gravelle, of the 
Congressional Research Service, has found that in recent years, 
over the life of a loan, about half the value of the interest 
deduction is now inflation. Isn't that another argument for 
limiting the deduction to its non-inflation component?
    Mr. FLEISCHER. I think it is. I think there are different 
ways to limit interest deductibility, and I think you want to 
think about inflation as one possibility. My own personal 
opinion would be for something closer to comprehensive business 
income tax, which I think would actually be simpler, along 
those lines. But yes, you are right.
    Senator WYDEN. Thank you, Mr. Chairman. My time is up.
    Chairman CAMP. Thank you. Mr. Herger is recognized for 
three minutes.
    Mr. HERGER. Thank you, Mr. Chairman. Several of you 
mentioned in your testimony that the tax code's bias towards 
debt investment may encourage some businesses to take on an 
excessively risky amount of debt, increasing the risk of 
bankruptcy and the associated cost to society. Among the most 
serious of these consequences is a loss of jobs, resulting from 
major bankruptcies.
    Since one of the most important issues facing Congress is 
the urgent need to create jobs, could you--maybe beginning with 
you, Mr. Fleischer--comment on whether reforming the tax 
treatment of debt and equity might help to create a better 
foundation for stable job growth?
    Mr. FLEISCHER. I do think it would, and I think you will 
probably find some unanimity from the panel. The more simple, 
efficient, fair our corporate tax system is, the easier it is 
for businesses to make planning decisions, including hiring 
workers, going forward.
    Mr. HERGER. Thank you. Mr. Desai?
    Mr. DESAI. So, just two quick thoughts. You know, the first 
is, as I mentioned in my written testimony, it is remarkable 
that we have not had more corporate bankruptcies, given the 
nature of the credit crisis. And I think that is because the 
non-financial corporate sector is under-levered, relative to 
historic standards, and we should be happy and grateful for 
that nice outcome.
    Would it have a salutary effect for kind of--if we kind of 
made debt not deductible? The one thing one has to keep in mind 
is that the cost of capital would rise, as a consequence of 
that.
    So, some of the social spillover effects of bankruptcies 
that you are worried about would certainly be a benefit. The 
cost of capital would likely rise, as a consequence of that. 
And that would have some potentially offsetting effects, as 
well. So, I am not so sure it is quite easily a job-winner.
    Mr. HERGER. Mr. Johnson?
    Mr. JOHNSON. As long as we are putting this in the context 
of medium-term fiscal consolidation--so, over a 5 to 10-year 
horizon, until the financial markets believe you have credible 
plans for bringing down the deficit, controlling the deficit, 
and preferably bringing down the debt, then yes, I think that 
there is ample scope for measures that would encourage short-
term job creation.
    But I would strongly caution against focusing only on that. 
Experience in Europe, including in the last days and weeks, 
tells you that countries that previously thought that they had 
an impeccable credit rating can come under market pressure much 
more quickly. So, please, whatever you do, put it in the 
framework of medium-term, credible, committed fiscal 
consolidation.
    Mr. HERGER. Ms. Olson?
    Ms. OLSON. I think there is definitely some value in doing 
whatever we can to make the tax system more rational. And 
something along the lines of what you are talking about might 
well move in that direction.
    Mr. HERGER. Thank you. Thank you, Mr. Chairman.
    Chairman BAUCUS. Okay. Next is Senator Stabenow.
    Senator STABENOW. Thank you very much, Mr. Chairman. And, 
first, a thank you to you and to Chairman Camp for doing what I 
hope will become more than just one meeting. I think this is 
really important to do, and congratulations.
    As we talk about all of this--and we clearly are having 
important hearings and discussions on tax reform, which clearly 
needs to happen--and we look at how we need to create tax 
fairness for small businesses, as well as large, multinational 
businesses, how do we create incentives for investments in 
American jobs, and in this global economy, and how do we create 
incentives for American families to be able to plan themselves 
and achieve important goals for their families like home 
ownership which has, of course, been under attack, given what 
has happened with the fact that the majority of families think 
they were saving through equity in their home, and then we've 
seen what is happening in the housing market, and so on. And 
so, it has been very difficult, I think, obviously, for 
families, on a number of fronts.
    But there is another area in the code where we encourage 
people to save, and that is through the Pension Protection Act 
of 2006. And I am wondering, Dr. Desai, if you might respond to 
the fact that Congress has allowed firms to auto-enroll 
employees into 401(k) plans, but allowing employees to then opt 
out if they desire. And the goal was to encourage savings.
    However, the Wall Street Journal reported earlier this week 
that while more people were now contributing to 401(k) plans, 
many of them are making contributions that are actually less 
than what they otherwise would be with the typical 3 percent 
default.
    So, I am wondering if you have suggestions or if any of you 
have suggestions on how we can improve this provision to 
encourage greater savings as we focus on pensions, which are 
another important part of, you know, economic security for 
families.
    Mr. DESAI. So, Senator Stabenow, I think you are absolutely 
right to turn the discussion toward savings, in some sense, 
that is underneath it all, one of the most important metrics 
that we can measure our success by, especially given the 
history of the American citizen over the last several decades 
as being a ``dis-saver''.
    So--and you are also right to kind of put your finger on 
pensions, which are an important piece of the savings picture.
    So, just briefly, I think, you know, one of the revolutions 
in economics in the last decade or two decades has been about 
behavioral biases. And so, when you force people or rather, 
when you give them default options that allow them to save 
easily, that is an incredibly powerful device, it turns out.
    So, I think, in the design of pensions, and in the design 
of legislation around pensions, paying attention to default 
provisions, and paying attention to making it extremely easy 
for a person to save, is a very important part of this.
    Of course, one would be remiss without mentioning the 
broader point, which is the distortion to saving in the tax 
code that is primary is the nature of the income tax. And the 
opportunity for fundamental tax reform provides you an even 
bigger lever on that than would be otherwise available.
    Senator STABENOW. Thank you very much. Thank you, Mr. 
Chairman.
    Chairman CAMP. Thank you. Mr. Rangel is recognized for 
three minutes.
    Mr. RANGEL. Thank you, Chairman Camp and Chairman Baucus. I 
don't remember the meeting in 1940, but--
    [Laughter.]
    Mr. RANGEL. But I certainly do welcome this meeting. Not 
only do we have Democrats and Republicans looking civil and 
acting civil, but we have the House and Senate coming together. 
And even though they are close by physically, people don't 
recognize how seldom we have a chance to see each other.
    This panel is extraordinary. And I think all of us, 
especially our chair, is excited about the possibility of tax 
reform. And it takes this type of cooperation in order for us 
to move forward. And it takes a better understanding of equity 
and debt in order to develop a system that is fair and 
equitable.
    Having said that, there is a big elephant in this room, and 
it is called debt ceiling. And until we get that out of the 
way, it will be impossible for us to, in a bipartisan way, deal 
with this very serious problem that everyone admits is really 
dampening our economic growth, by not having a fairer system 
with lower corporate rates and closing loopholes.
    Having said that, I wonder, Mr. Chairman, whether I would 
be out of order if I took advantage of the minds of our great 
panel here to ask them, is there anyone here that sees any 
connection at all in terms of increasing the debt ceiling, as 
we have 17 times to make certain that our great nation pays our 
debt, and the solution to the budget problem that we have 
which, of course, involves revenue and cut-back in spending?
    As economists and people who understand these serious 
problems, is there anyone here that sees where there is any 
connection between dealing with reduction of our debt and 
authorizing the President to increase the debt ceiling? And if 
you do, I wish you could share it with me in 30 seconds.
    Having seen no response--
    Ms. OLSON. Mr. Rangel, I hope that the cooperation you are 
seeing here today sets the stage for the debt ceiling 
negotiations.
    Mr. RANGEL. But you don't see any connection between 
increasing the debt ceiling with the President and dealing with 
our serious problem with the national debt, do you?
    Ms. OLSON. They are all important steps towards getting--
    Mr. RANGEL. I know that. God knows every day it is 
important. But really, as a professional that has worked with 
the Internal Revenue and served presidents in the past, do you 
see a connection between the two, except politics, which is not 
really why you are here?
    Ms. OLSON. I think there are important policies that have 
to be addressed. You have got to address them on the spending 
side, and you have got to address them on the revenue side. It 
is very important for us to get our fiscal house in order 
across the board.
    Mr. RANGEL. So you do believe that we can hold the question 
of debt and spending and revenues with denying the President 
the opportunity to pay our debts internationally? You do see a 
connection? What Administration did you serve under?
    Ms. OLSON. President Bush.
    Mr. RANGEL. Oh, okay. I have completed my questions, thank 
you.
    Chairman CAMP. Thank you, Mr. Rangel.
    Chairman BAUCUS. Okay. And I will recognize Senator Nelson 
from Florida.
    Senator NELSON. I am afraid we are going to fritter away 
this opportunity to get tax reform done in this debt ceiling. 
But if we had our d'ruthers, the Senate Budget Committee has 
come out and said you could do a $4 trillion package and 2 
trillion of revenues could come from just eliminating 17 
percent of the tax expenditures over the next decade, which 
amount to $14 trillion.
    So, if you were to whack 17 percent of those tax 
expenditures, where would you go first?
    Mr. FLEISCHER. So I will start. I have written and 
testified previously about some loopholes, some of which might 
be characterized as tax expenditures. The carried interest 
loophole is the one where I have testified before, and that is 
converting--when fund managers convert their labor income into 
capital gain.
    There are other examples, including the--some of the 
treatment of the hybrid instruments that I talked about before 
that banks use to exploit the debt equity distinction. So I do 
think there is some low-hanging fruit in order to generate 
significant revenue.
    Mr. DESAI. So just briefly I would say, you know, in 
general, in these discussions I am always loathe to 
characterize anything as a loophole, because that makes it 
sound like it is easy to get rid of. And I think tax 
administrators know that there is no free money hanging around 
here and we can just snap our fingers and close something and 
it will work.
    What is at play, of course, are serious policy choices. And 
if you want to look at the expenditure side, the tax 
expenditure side--you know, I haven't looked at this in the 
last week or two, but my understanding, as I recall, is that 
the big numbers are going to be on owner-occupied housing, 
which is the mortgage interest deduction, and it is going to be 
on the preference for employer-provided health insurance.
    And as, you know, people have written about, those are both 
significant sources of revenue. I think the distortion on 
health care choice that's created because the employer 
deduction on health insurance is significant, that would be a 
place to look. And, you know, of course, housing is hugely 
important. But you know, that--I don't think it has to do with 
leverage in the financial crisis. But the preference for owner-
occupied housing is another place to look, where you can get 
the kind of money that you are talking about.
    Mr. JOHNSON. Excessive leverage in the financial sector. 
You could be steeply progressive on this. It is the very 
biggest banks with their huge debts that pose a 
disproportionate risk to the system.
    And this is an obvious thing to go after. It is completely 
consistent with the broader assessment from the right and from 
the left, with regard to the fact that too-big-to-fail has 
become a massive government subsidy operation. And while we 
have tried to deal with that in various ways, nobody is 
impressed. Standard & Poor's just ruled yesterday that they 
think the government would still have to come and support major 
financial institutions if they fail. That is a systemic risk. 
That is pollution. That is a negative externality you should be 
taxing on.
    Chairman CAMP. Mr. Johnson is recognized.
    Mr. JOHNSON of Texas. Thank you, Mr. Chairman. Ms. Olson, 
in your testimony you talk about reform alternatives that you 
believe could address this bias in the tax code. One of the 
reform proposals you mention is the lower corporate tax rate. 
In your view, what should that rate be? And how far would that 
proposal go toward addressing a bias?
    Ms. OLSON. Mr. Johnson, I think that--I am not sure what 
the optimal corporate rate is. But I think one of the things we 
have to look at is what the rate has fallen to in other 
countries around the globe that are major trading partners. And 
that would suggest that a rate of somewhere around 25 percent 
would be about the top rate. Now, that would include the state 
and local rate, which adds about four or five points to the 
overall rate. So you've got to take that into account, as well.
    I think that companies use leverage for a lot of reasons 
besides the interest deduction. In fact, lots of times 
companies find that equity capital is less expensive than debt 
even taking into account the deduction of interest and the non-
deductibility of dividends.
    So, I think that bringing the corporate rate down would go 
a long ways towards eliminating the bias that currently exists.
    Mr. JOHNSON of Texas. Well, we also eliminate the taxation 
of dividends as a measure of improving the system?
    Ms. OLSON. I think that there has to be a connection 
between the two. And so, to the extent that you have got a high 
corporate rate, you need a lower rate on dividends, and vice 
versa. If you bring down the corporate rate, you don't need, 
perhaps, to reduce the rate on dividends quite as much.
    But if you have too high a rate of tax on dividends, you 
will give companies a disincentive to pay dividends, and that 
has been a problem for us--
    Mr. JOHNSON of Texas. Yes, that is kind of double taxation, 
isn't it?
    Ms. OLSON. Yes.
    Mr. JOHNSON of Texas. Okay. Mr. Barthold, the mortgage 
interest deduction, did it have a role to play in the tax 
underwriting standards? Should we do something about that? 
Could you elaborate on what tax incentives could reduce the 
cost of renting, as well?
    Mr. BARTHOLD. The code currently provides several benefits 
for rental housing, to try and increase the supply of rental 
housing and reduce rents to moderate to low-income individuals. 
There are provisions in Section 42 to provide the low-income 
housing tax credit to expand the supply of rental housing to 
qualifying lower-income families.
    Similarly, under Section 142 of the code, states may issue 
tax-exempt bonds to help finance at lower cost multifamily 
housing, again, targeted at lower income. So there are 
provisions in the Internal Revenue Code to help benefit the 
rental market.
    But I don't think I am fully addressing your question, sir.
    Mr. JOHNSON of Texas. Well, I have kind of run out of time, 
so--
    Mr. BARTHOLD. Well, the chairman may--since I misspent it, 
maybe the chairman will grant an extra 30 seconds?
    [Laughter.]
    Mr. JOHNSON of Texas. Thank you, Mr. Chairman.
    Chairman BAUCUS. Mr. Chairman, we have some votes that are 
going to start in the Senate fairly quickly. There are no more 
senators at this moment. I think Senator Carper is on his way. 
I suggest that you continue on your side. So--well, just 
continue on your side. When the vote does occur, the Senate 
will cross that bridge when we get there. And when Senator 
Carper comes, we can address him, too.
    Is he here? Senator Carper? No, he is not here yet. Why 
don't you go ahead?
    Chairman CAMP. All right, thank you. Mr. Neal is 
recognized.
    Mr. NEAL. Thank you, Mr. Chairman. And actually, in the 
House we have done a pretty good job this year at the Ways and 
Means Committee of conducting a lot of hearings, in an effort 
to examine how we might revamp the code. But I think that it is 
also important to acknowledge today that, unless the 
presidential candidates next year take up the issue in earnest, 
it is going to be very hard for us, even having accumulated a 
great deal of evidence as to how the code might be altered, to, 
in fact, make it happen.
    And I think insisting that after we come up with competing 
products, perhaps, or even one product, that the presidential 
candidates address the extensive hearings and evidence that we 
have assembled--now, Mr. Barthold has heard this question 
before, but I want to go back to it because of the hearings 
that the Select Revenue Subcommittee held last year.
    One of the witnesses testified at that hearing that 
foreign-owned multinationals in the United States have a 
competitive advantage over U.S.-based corporations, with 
respect to certain U.S. investments. The witness stated, 
further, that the tax advantage afforded to inbound investors 
arises because of their ability to erode the U.S. tax base 
through base erosion payments, such as earnings or interest-
stripping payments.
    Maybe we might hear from Professors Fleischer or Desai as 
to what your thoughts are on whether foreign-owned U.S. 
subsidiary corporations engaged in earnings strippings on their 
debt-financed U.S. investments have a competitive advantage 
over U.S.-owned corporations. And should some of the tax rules 
related to debt financing rules be modified in order to prevent 
this competitive disadvantage for U.S.-owned corporations?
    Mr. FLEISCHER. I am going to defer to Professor Desai on 
that.
    Mr. DESAI. So I think there are a few things to say. The 
first is it is striking that the profitability of foreign 
multinationals in the U.S. is low, relative to American firms. 
And one explanation for that is, in fact, lots of earnings 
stripping by these foreign firms out of the U.S. base. There 
are alternative explanations, which is it is hard to make money 
in America versus American multinational firms.
    But if, in fact, base erosion is the problem, then you have 
to ask the question, are they able to do something that 
American firms aren't able to do? And at first approximation, I 
would have thought that they are subject to the same 
regulations and the same rules that American multinational 
firms are.
    So I understand the source of the concern, which is very 
low profitability of foreign firms in the U.S. And I understand 
the possibility that part of what is going on here is they are 
stripping all their earnings out. What I am less convinced of 
is the degree to which that represents earnings stripping or 
something else. And given that they face the same rules, it is 
a puzzle why they would be more capable, in some sense, than 
American firms.
    Mr. NEAL. Professor Fleischer?
    Mr. FLEISCHER. Well, just to add that there is two ways to 
look at that. One--
    Mr. NEAL. Yes, there generally is, in tax policy.
    Mr. FLEISCHER. Yes. I think Mihir is right. On the other 
hand, it also just shows that American multinationals are also 
very good at moving profits offshore through things like 
transfer pricing.
    Mr. NEAL. Okay.
    Chairman CAMP. Thank you, Mr. Neal.
    Mr. NEAL. Thank you, Mr. Chairman.
    Chairman CAMP. Mr. Tiberi is recognized.
    Mr. TIBERI. Thank you, Chairman Camp and Chairman Baucus, 
for holding this hearing today. Great panel of witnesses, as 
well.
    I first want to associate myself with the remarks by Mr. 
Levin with respect to the home mortgage interest deduction, and 
kind of piggyback on something that Mr. Johnson had said.
    In addition, on the rental side, Mr. Barthold, you have 
rental owners that have the ability to not only take advantage 
of the mortgage interest deduction, but a series of other 
deductions that, in theory, would reduce, if taken away, their 
ability to keep rents lower, meaning if, through the tax code, 
you took away deductions from rental housing owners, they would 
have to increase the rent. That is not a question, just a 
comment.
    The question I have is more on the business side to all of 
you. Joint Tax actually came out with a report that stated that 
the debt to equity issue concerning the Tax Code's preferential 
treatment for financing with debt doesn't really apply to 
owners of businesses that are pass-through entities.
    As we have heard on this committee, more than half of 
American businesses are set up as pass-through entities. The 
Administration has suggested switching, or changing the way 
that pass-through entities are taxed to the corporate side, tax 
them as C-corps, instead. Wouldn't that have a negative effect 
on those pass-through entities today, and continue to 
exacerbate the debt-to-equity issue through the tax code? 
Starting with Joint Tax.
    Mr. BARTHOLD. Well, thank you, Mr. Tiberi. I think the main 
point that you are raising is that the corporate income tax 
itself, at its simplest level, is a tax on the return of income 
to the equity owners.
    Mr. TIBERI. Right.
    Mr. BARTHOLD. And it is an extra tax. We have noted on the 
panel the double taxation.
    So, if you were to make, by whatever criteria, entities 
that are currently pass-through entities subject to a second 
level of tax, and the tax were just on the return-to-equity 
owners, it would increase the relative burden on equity 
returns, and so would favor debt financing by those entities, 
just as we argued is the case for a C-corporation.
    Mr. TIBERI. That is exactly my question. Ms. Olson?
    Ms. OLSON. Yes. I agree with that, and I think it would be 
better to move in the opposite direction of integrating the 
corporate system with the individual system, rather than to 
push pass-throughs into the corporate system.
    Mr. TIBERI. Thank you.
    Mr. FLEISCHER. So I do want to note there are distortions 
from debt versus equity in the pass-through context. In a lot 
of partnerships they are very flexible vehicles, from a 
structuring perspective. And the interest deductions that you 
can generate by financing with debt, those deductions can be 
moved around to a large extent to one partner or another, 
depending on which partner has the higher tax rate. So it 
doesn't always match up with the underlying economics.
    So, you know, my preference here would be to move towards a 
system where pass-throughs and--where--I should say what are 
currently pass-throughs and what are currently C-corps are 
treated the same. I think doing that, it removes the penalty of 
operating in C-corp form, which, from an economic perspective, 
doesn't make much sense to me.
    Mr. TIBERI. All right, thanks.
    Chairman CAMP. Thank you. Thank you, Mr. Tiberi.
    Mr. TIBERI. Thank you.
    Chairman CAMP. Mr. Thompson is recognized for three 
minutes.
    Mr. THOMPSON. Thank you, Mr. Chairman. Thanks for holding 
the hearing. And thanks to all of you for being here.
    There has been--a number of you have mentioned that--the 
need to do the tax reform, and the whole idea of lowering the 
rate and broadening the base, which, I assume, suggests that 
you believe we should pay for any tax reform that we do. It 
should be revenue neutral, is that a good assumption? Start 
with Ms. Olson.
    Ms. OLSON. I think it is important for the country to size 
its budget so that there is a better match-up between revenues 
and spending. But I think that we have made an awful lot of 
decisions throughout our recent history on the basis of our 
revenue constraints, and that has led to some bad policy.
    Mr. FLEISCHER. So--
    Mr. THOMPSON. Revenue-neutral tax reform?
    Mr. FLEISCHER. Yes, revenue-neutral is--
    Mr. THOMPSON. If we--because of the time, if you could, 
just tell me if revenue-neutral tax reform is the way we should 
be going.
    Mr. FLEISCHER. I think it is the right starting point.
    Mr. THOMPSON. Thank you. The rest of you?
    Mr. DESAI. Yes. Yes.
    Mr. JOHNSON. I think that is a minimum, Mr. Thompson, 
revenue neutrality. However, if you were taking on broader tax 
reform, including a switch away from an income tax towards a 
VAT-type system, then you have the option of being either 
revenue neutral, or raising significant revenue in a way that 
is not distorting, and doesn't hurt savings, doesn't hurt 
investment.
    Mr. THOMPSON. Thank you. I just want to point out that on 
lowering the rate and broadening the base on the corporate 
stuff, if you do away with all the tax expenditures, it only 
gets you to about 28 percent, not the 25.
    Ms. Olson, what I have been hearing most about here 
recently--and it deals with this debt ceiling debate, and I am 
hearing from people all over my district. Yesterday, 100-
percent Vietnam--a disabled Vietnam veteran who says if he 
doesn't get his Social Security check he is living in his car. 
Farm credit folks were in yesterday, and they finance 
everything from grapes to rice to pears to walnuts in my 
district. And they tell me that it is going to be devastating 
for agriculture, and that we--it will take years, decades, to 
recover from the loss of not doing the debt ceiling.
    Can you tell us how and what the priority would be for 
paying our debts, if we don't pass the debt ceiling?
    Ms. OLSON. I am afraid that that is not within my area of 
expertise.
    Mr. THOMPSON. So it would be--from your experience at 
Treasury?
    Ms. OLSON. No, my experience at Treasury was all on the tax 
collection side, as opposed to paying out.
    Mr. THOMPSON. Okay, thank you. Can anyone tell us what the 
fiscal impact would be if the debt ceiling is not raised? How 
many years would it take for us to recover from the hit, even 
if it is just a few days or a week or a month without raising 
the debt ceiling? I understand that this is a fiscal 
consequence that will haunt us forever. Mr. Johnson?
    Mr. JOHNSON. Mr. Thompson, we don't know, exactly. We have 
never done it. We shouldn't do it. I hope we don't do it. It 
would be very bad for the economy, particularly at this point 
in time, for all the reasons that you have enumerated.
    Chairman CAMP. All right. Thank you very much. Dr. Boustany 
is recognized. And because of the discrepancy in the number of 
Members, I will be recognizing two Republicans for one Democrat 
at this point. So, Dr. Boustany?
    Dr. BOUSTANY. Thank you, Mr. Chairman. Let me first express 
my support for moving forward with fundamental tax reform, 
rather than trying to do this piecemeal with tax policy 
changes, because of the distortions that we will create if we 
try to do that.
    Ms. Olson, in your testimony you mention the adjustments to 
the deductibility of interest expense would need to be 
considered in connection with any further moves toward 
expensing capital investments. And clearly, in recent years we 
have seen a number of efforts and laws enacted to spur economic 
activity by increasing accelerated depreciation provisions and 
moving toward more generous expensing for certain types of 
assets.
    And at the same time, we have interest remaining as a 
deductible expense. So talk a little bit about the distortions 
that could be created. Could we, in effect, see negative 
effective tax rates and other types of distortions? I would 
like all of you to comment on that. Thank you.
    Ms. OLSON. Yes. The short answer to your question is yes, 
we would see negative tax rates. You know, I think it is sort 
of one thing to do it on a temporary basis, where you are 
trying to spur some investment, accelerate some investment. It 
probably doesn't have the same impact. But certainly, if you 
are going to do expensing on a long-term basis as part of 
fundamental tax reform, then you do need to look at interest 
expense.
    Mr. FLEISCHER. I agree. Any time that you are allowing 
borrowing to invest in an investment that is going to throw off 
tax-exempt income, you have created an opportunity and an 
incentive to engage in tax arbitrage. And as I said in my 
testimony, tax lawyers are very clever. And once they spot 
these opportunities, they are going to try and design 
structures to take the fullest advantage.
    Mr. DESAI. I would echo what has been said. It is exactly 
the reason why one should move not towards incremental efforts, 
but to think about this in a systematic way, precisely so we 
avoid these kinds of situations, where you can easily end up 
with negative effective tax rates.
    Mr. JOHNSON. I agree also.
    Dr. BOUSTANY. Thank you. I yield back, Mr. Chairman.
    Chairman CAMP. Mr. Buchanan is recognized.
    Mr. BUCHANAN. Thank you, Mr. Chairman, for the opportunity 
today. And I want to thank all the panelists, as well.
    Let me just ask you. We are talking about the debt ceiling, 
getting people back to work. In the environment we find 
ourselves in today, do you think that raising taxes on 
individuals or small businesses makes sense, in terms of what 
is going on today? Do any of you feel that that makes some 
sense as a policy decision, here in Washington? Ms. Olson, I 
will start with you.
    Ms. OLSON. Well, certainly on a near-term basis, I think we 
need to be very careful with anything we do that would raise 
taxes. I think one of the most important things we can do for 
the country is to get things set so that, for the long term, we 
know where we are going to stand. Because I think what we 
learned in 2001 was that it was the permanent changes that had 
the most impact.
    Mr. BUCHANAN. Yes. Mr. Desai, because I'm short on time.
    Mr. DESAI. Just briefly, I--
    Mr. BUCHANAN. I am talking about individuals and small 
businesses. Does it make any sense in the near future to raise 
taxes on individuals or small businesses?
    Mr. DESAI. To the degree that we want to take a shot at 
actually fixing our structural problems, then we are going to 
have to raise taxes on someone.
    Mr. BUCHANAN. Okay.
    Mr. DESAI. At some point. Clearly, there are short-run 
consequences of doing it right now.
    Mr. BUCHANAN. Now, let me go to the other issue that we are 
talking about, debt and equity. And I have had the good fortune 
to have been in business for 30 years, and have been involved 
in a lot of leverage transactions.
    But you look at the 1980s, what happened? I remember the 
``predators balls''--that happened with Milken and all those in 
the 1980s, and we ended up--in 1990, 1991--with S&L bank 
crises. Now we move forward, we find ourselves in this 
scenario, of having a lot of leverage.
    But at the end of the day, what I find, if you don't have 
viable financial institutions, is that you put everything at 
risk. And what is happening--at least in Florida; I am sure 
around the country is that a lot of these banks that are 
leveraged 10 to 1, because they have been taking such a hit to 
their equity, they have had to shrink all the banks.
    So, not only do you affect the companies that are trying to 
create jobs, but you affect a lot of good companies, where they 
come in, they scoop all their equity. And that is why it is so 
critical, in my experience, that you have sound financial 
institutions. And if you go back 100 years, we get in this trap 
every 10 or 15 years.
    So, Mr. Johnson, do you agree that we have to take a look 
at the viability, long-term, of financial institutions, as it 
relates to small businesses especially? It is nice to talk 
about equity, but it is hard to get equity for small business. 
And those are job creators.
    Mr. JOHNSON. Absolutely, Mr. Buchanan. If you go back to 
when we had a real free market system around finance in this 
country, more than 100 years ago, before deposit insurance, 
before the Federal Reserve was created, banks at that time 
routinely had 30 percent equity. No risk adjustment in that 
calculation. Thirty percent equity, relative to their total 
assets. And they had big buffers against losses. And when you 
had a downturn, they didn't have to cancel all their other 
loans, all their good loans. They didn't squeeze out the small 
businesses.
    We cannot go back to a system without deposit insurance, 
unfortunately. We have to recognize that regulation has 
encouraged and allowed banks to have too little capital for too 
long. If we are going to have big shocks in our economy, going 
forward, you need to be discouraging debt and encouraging 
equity in the heart of the financial--including big banks and 
small community banks.
    Chairman CAMP. Thank you, Mr. Buchanan. Mr. Larsen is 
recognized for three minutes.
    Mr. LARSEN. Thank you, Chairman Camp and Chairman Baucus, 
for being a part of this historic hearing. And this comes at a 
historic time for the nation.
    I would like to know the opinion--we have received letters 
from more than 400 CEOs about the pending potential of default 
on the--our--the nation's debt. The CEOs, in their letter, 
outline--they say that even a technical--technical--default in 
this case would have catastrophic events. In 1979 this 
happened, even under the well intentions of Congress. It was 
late, resulting in interest rates that plagued the country for 
the next 10 years.
    Given what is happening around the globe as we speak, 
what--Moody's downgrading of Ireland again today--what is your 
advice to the Congress in terms of acting, given the deadlines 
that Treasury Secretary Geithner has outlined?
    Mr. JOHNSON. My advice, sir, would be simple, the same 
advice as Christine Legarde, the new director of the IMF, has 
given to the United States, which is you need to extend the 
debt ceiling. You cannot play games with something this 
serious. World financial markets are much more fragile than you 
might like to believe.
    Mr. LARSEN. Mr. Desai?
    Mr. DESAI. I would echo that. I think what is worth 
considering is exactly why. And one piece of that is the 
technical default, which is, you know, people may stop 
receiving their payments, which is extremely problematic.
    But it can also become a broader manifestation of a system 
that appears broken to the rest of the world. And that is where 
we run into really significant problems. So, I am less--you 
know, have less of a position on exactly how we fix that, but I 
think it is very important that this particular deadline is not 
ignored, and taken--
    Mr. LARSEN. With regard to the deadline, if I might just 
follow up quickly here, before the others respond, is this not 
the equivalent of knowing about Lehman Brothers? With all the 
other nations that we see in jeopardy, and knowing what we 
know, isn't it essential that we act now?
    Mr. DESAI. It is essential that we act now. I would caution 
us to use parallels to private sector actors, only because the 
government is very special. And--
    Mr. LARSEN. Point well taken.
    Mr. DESAI. And--but I take your point that it is a very 
serious issue.
    Mr. JOHNSON. I would use the Lehman example. Frankly, the 
situation in Europe right now is very bad. It is getting worse. 
The eurozone does not have control over the situation in Italy, 
in Spain, much more broadly. It is absolutely essential that 
the United States remain a beacon of safety and clarity to 
international investors. Otherwise, there will be consequences 
for all of us around the world.
    Mr. LARSEN. Would you say what is at stake is the United 
States's reputation as a governing entity, both globally and 
domestically?
    Mr. JOHNSON. Yes.
    Chairman CAMP. Thank you very much. Mr. Smith is 
recognized.
    Mr. SMITH. Thank you, Chairman Camp, Chairman Baucus, for 
holding this hearing today. We have heard a little bit about 
home mortgages and home ownership being a priority in our 
society, and certainly in the tax code. Could you, starting 
with Mr. Fleischer, reflect on the effectiveness of the 
mortgage interest deduction? How effective has that been, and 
are there any alternatives that you might propose?
    Mr. FLEISCHER. Well, I think it has had an impact in 
putting more people into houses. And, from that perspective, 
that is good. But if you were to take a step back, and try and 
think about designing housing policy, it is hard to conceive 
that using an interest deduction, a mortgage interest 
deduction, would be the right way to accomplish that goal, 
particularly one that is not capped at a certain number.
    So, for example, allowing it at all on second homes or on 
super-expensive homes doesn't make a whole lot of sense to me, 
if the goal is to get lower-class and middle-class people into 
houses.
    Mr. SMITH. And would you propose an alternative in our 
public policy, in terms of encouraging home ownership?
    Mr. FLEISCHER. Sure. I mean I think in the short run, 
limiting the mortgage interest deduction would be beneficial in 
the short run. In terms of what the other policy goals are, I 
guess I am not quite sure what you are getting at.
    I think we do have a lot of people in houses, probably more 
than we need to, in fact. There are people that do move around 
a lot, and would benefit from some sort of equivalent subsidy 
to renters.
    Mr. SMITH. Okay. Mr. Desai?
    Mr. DESAI. You know, so briefly I would just say that there 
is a bit of a puzzle which is, given how large this preference 
is, it has not been easy to find evidence of its effects on 
behavior. So it is a very large preference.
    And then, the question we have to ask--is maybe we like it, 
and we have to ask why we like it. And I can think of three 
reasons we like it. You know, one is we like it because home 
ownership is good. It creates good citizens, it creates good 
people. And that is just what we believe. The second is that we 
believe the construction sector is very important. And we think 
that, in a cyclical recovery, it is potentially something that 
you want spur. And finally, maybe you think that it is just a 
vehicle for savings, and you want to preference it that way.
    I think it is important to kind of nail down which of those 
we really believe. We have had very high levels of home 
ownership. And it is not clear that more home ownership is 
good. We should understand that there are chunks of the 
population for which renting is a really good thing to do.
    Mr. SMITH. Okay. Mr. Johnson?
    Mr. JOHNSON. We are not directly encouraging home 
ownership. We are encouraging leverage as part of home 
ownership. So we are encouraging households to take on these 
very large debt burdens. And there are absolutely other ways to 
encourage home--if you want to do it revenue-neutral, we could 
reduce the mortgage interest deduction and find other ways to 
encourage people to buy first homes, for example, if that is 
what you wanted to do, if the goal was home ownership.
    I think you should be very clear. We encourage households 
to take on and believe in an enormous amount of leverage. And I 
think, frankly, many of them didn't understand the risks, the 
downside risks, that they now see in many parts of the country.
    Mr. SMITH. Okay, thank you. I yield back.
    Chairman BAUCUS. I will now recognize Senator Carper.
    Senator CARPER. Hi, everybody. Up here, on the right.
    Chairman BAUCUS. I see you down there.
    Senator CARPER. Pretty big room, isn't it? This is bigger 
than the Senate, I think. Glad I found it. It is nice to be 
here with the chairman of the Ways and Means Committee. How are 
things in Detroit? Those Tigers are in first place in the 
American League Central, as we go to the all-star break. That 
was good to see, and to see another guy from Michigan, Carl 
Edwards's big brother. Sandy, nice to--very nice to be with 
you.
    To our witnesses, thanks very much for joining us in what 
is really a unique setting. And it is kind of fun to do this.
    One of the main reasons that tax reform has again become 
necessary is the proliferation of new tax breaks that we add to 
the tax code, it seems like, every year, as well as some of the 
increased use of the existing tax expenditures by taxpayers. I 
am told if you add up the cost of these tax expenditures, the 
total comes over the next 10 years to something like $15 
trillion over the next decade. It is more than the Federal 
Government will spend on Social Security or, I believe, on 
national defense. No small amount of money.
    Some of these tax incentives are for individuals. Some are 
for corporations. And some are pretty good policy. Others, less 
so. Many--I guess it probably just depends on where you sit, as 
to whether or not they make good policy sense. But many tax 
preferences are inefficiently designed. Some lose more revenue 
than is necessary and don't deliver benefits to the taxpayers 
who, arguably, need them the most.
    And with those thoughts in mind, tax treatment of debt 
versus equity is certainly something that needs to be examined 
and, I think, closely. One of the keys to tax reform in 1986, 
when I served in the House with some of these fellows here--
including this fellow from Massachusetts, to my right--one of 
the keys to reforms that we adopted in 1986 was that Congress, 
working with the Reagan administration, partially cleaned up at 
least some of the tax preferences, in exchange for lower rates.
    I would just like to ask each of our witnesses to take a 
couple of seconds and directly and frankly tell our committees 
which one policy change--one policy change--would do more than 
any other that you can think of to reduce the bias in favor of 
debt in the current tax code.
    Let me say that again. Just take a couple of seconds and 
just tell our committees which one policy change do you think 
would do more than anything else you can think of to reduce the 
bias in favor of debt in our current tax code. Thanks.
    Ms. OLSON. Greater integration of the corporate and 
individual tax systems.
    Senator CARPER. Say that one more time.
    Ms. OLSON. Greater integration of the corporation and 
individual tax systems.
    Senator CARPER. All right. Thank you.
    Mr. FLEISCHER. I agree. I think equalizing the treatment of 
debt and equity.
    But I will take just a second to add that, you know, 1986 
is kind of like the Holy Grail in the tax academy. It was an 
amazing achievement that broadened the base and lowered the 
rates. And one of the keys to that was sort of not focusing 
only on one thing at a time, but focusing on the system as a 
whole, and tackling a lot of different tax expenditures at the 
same time. I think that that was part of the magic of that 
reform.
    Senator CARPER. All right, thank you.
    Mr. DESAI. One version of the integration proposal would be 
the comprehensive business income tax, which--
    Senator CARPER. I am sorry, were you saying--
    Mr. DESAI. One version of the integration effort would be 
the comprehensive business income tax, and I think that is a 
very worthwhile way to go.
    Senator CARPER. All right, thank you.
    Mr. JOHNSON. I suggest that you tax excessive leverage in 
the financial sector, and use the proceeds of that to introduce 
some deductibility for dividends, therefore equalizing the 
treatment of debt and equity.
    Senator CARPER. All right. That is an interesting idea. 
Thank you. Anybody else?
    [No response.]
    Senator CARPER. All right. Do--is my time expired? Let me 
just ask our chairs.
    Chairman CAMP. It has.
    Senator CARPER. Yes? Okay. Well, it was great. It was great 
while it lasted.
    [Laughter.]
    Senator CARPER. And it was great to see all of you. Thank 
you for those simple, direct answers.
    Chairman CAMP. Thank you very much, Senator Carper. Ms. 
Jenkins is recognized.
    Ms. JENKINS. Thank you, Mr. Chairman, and thank you for 
holding this hearing. Thank you all for being here.
    In general, since 1945, household debt has steadily 
increased. There has been some decrease in the combined 
mortgage and consumer debt for households. But the total 
combined debt for 2010 is approximately 120 percent of 
disposable income. In particular, debt has rapidly increased 
since tax reform back in 1986, which eliminated the deduction 
for interest on personal credit.
    So, my questions for the panel are, is this level of debt 
sustainable? Why has household debt increased when no deduction 
is available for interest on personal credit? And what is the 
appropriate private debt ratio for households, and how long do 
you think it will take for us to achieve that? Tom, do you want 
to start?
    Mr. BARTHOLD. Well, thank you, Ms. Jenkins. You recited the 
statistics that we provided to the Members, which I think is--a 
first point shows that there is not an obvious link between our 
tax policy related to household debt and what has been going on 
in the household market.
    Also, though, do remember that it is a reasonable and sound 
economic matter for households to incur debt. It can be a 
matter of when you are young and you are starting out, you 
purchase a home. So you carry a large debt load, which you 
gradually pay down, as you pay down the mortgage. You may 
borrow to purchase automobiles or to furnish the home or to buy 
other durable goods. It is part of what--you know, we use the 
jargon in the pamphlet that the economists like, of the life 
cycle theory of consumption.
    So, what that doesn't answer is why has the overall debt 
load on households increased. And I don't have a good take on 
that. I will defer to my other panelists.
    Ms. JENKINS. Ms. Olson?
    Ms. OLSON. I think I should defer to the economists down at 
the end of the--
    Ms. JENKINS. Okay.
    Mr. FLEISCHER. I will just add one factor to the mix here, 
which is that--which is the housing bubble. So, as real estate 
prices were going up, people were able to increase household 
debt with larger and larger mortgages to finance current 
consumption. I think with the housing bubble burst, I think we 
are observing people de-leveraging in significant ways.
    Ms. JENKINS. Okay. Mr. Desai?
    Mr. DESAI. Well, two things. You know, the first is I think 
you are right to put your finger on what is a long-term process 
of leverage, and what is going to be a long-term process of de-
leverage, as we move forward. The reasons for it can be 
cultural, and they can be economic.
    And I think one thing to highlight here, of course, in the 
context of the tax code, is the absence of a consumption tax, 
or a value-added tax, or the--alternatively, the presence of an 
income tax which disfavors saving is a piece of that puzzle. 
How much of it is, it is hard to say. But certainly, if we 
think about the things that are within our domain and our 
ability to control, it is yet another reason to really think 
hard about whether the income tax we have now is the right one.
    Chairman CAMP. Thank you. Mr. Marchant is recognized.
    Mr. MARCHANT. Thank you, Mr. Chairman. Is it fair to say 
that the main takeaway from this hearing could be that a way to 
bring the equity and debt issue into focus is to devalue the 
value of the debt deduction in the code by simplifying the code 
and lowering the rate, and making that debt deduction less 
valuable?
    Also, Mr.--I don't know if Mr. Fleischer or Desai--but I 
think one of you said that there were some hybrid debt 
instruments that were distorting the system. Could you identify 
what those hybrid debt instruments are?
    Mr. FLEISCHER. Sure. On the first question, the goal is 
neutrality between debt and equity, broadly speaking. And so 
you can either do that by limiting interest deductibility, or 
what you called lowering the value of that interest deduction, 
or you could do it by allowing a deduction for corporate 
equity. So, looking at the amount of equity that a firm has, 
and allowing them an imputed deduction. Either of those 
approaches would achieve tax neutrality.
    So, some of the hybrid instruments, I am thinking of 
things--they all have trade names that the investment banks 
come up with, but I am thinking of things like--Feline Prides 
was one of the first, and these are instruments that are part 
debt and part equity. And what they do is they get the--on the 
balance sheet, or for bank regulatory purposes, they look like 
they are equity, but they are deductible. So at one time these 
were referred to on Wall Street as tax-deductible preferred 
stock.
    But, of course, it is not preferred stock. There are 
ongoing obligations that the banks have to make to pay to the 
people who buy these securities. And so, in the financial 
crisis, those--they cannot skip those payments, like you could 
with--on stock. So that added to the crisis.
    Mr. MARCHANT. Could you limit the tax preference on those 
specific instruments without--or would that just--
    Mr. FLEISCHER. Well, it is hard, because all you are doing, 
then, is kind of moving the line. So there--you can move the 
line a little bit, but you are going to see a lot of activity, 
then that just shifts to wherever you have moved the line. 
Again, tax neutrality would be the better solution.
    Mr. MARCHANT. Okay.
    Mr. FLEISCHER. And, failing that, a tax on excess leverage 
that reduces the value of the interest deduction, I think, 
would be a very good short-term solution.
    Mr. MARCHANT. Okay. Mr. Desai?
    Mr. DESAI. I would just underscore Vic's point about the 
futility of line-drawing in the context of managers and 
financial engineers, who can capitalize on that kind of line 
drawing.
    Mr. MARCHANT. Okay.
    Chairman CAMP. All right, thank you. Mr. Becerra is 
recognized.
    Mr. BECERRA. Thank you all for your testimony. And in the 
three minutes that I have, let me see if I can focus a bit.
    I know we have been talking quite a bit about the treatment 
of debt and equity for corporations, how we move forward with 
the tax code that tries to reform our system of taxation, and 
make us more competitive. But I think most eyes that are 
focused on the Congress today, and on Washington, D.C., are 
still worried about the debt issues that confront us right now.
    Mr. Barthold, perhaps you can give me an answer to this 
question. Does increasing the debt ceiling have anything to do 
with reducing future spending by the Federal Government?
    Mr. BARTHOLD. Well, Mr. Becerra, I am not an expert on the 
overall fiscal position of the United States. The members of 
Congress vote on outlays and vote on revenues.
    Mr. BECERRA. But in terms of future spending, spending next 
year, spending in 10 years, if we vote in Congress to increase 
the debt ceiling limit today, or before August the 2nd, does 
that have anything to do with what we will spend directly in 
2020?
    Mr. BARTHOLD. Well, sir, as a simple statutory matter, the 
two issues are separate.
    Mr. BECERRA. Okay. And I know you have had a chance to 
speak a bit about this, and I know with the short amount of 
time--let me ask Mr. Johnson a question.
    Should revenues be part of the debt limit discussion, as we 
start to discuss how we move forward in dealing with our 
deficits and our national debt? If you want to have an approach 
that resolves this issue of our national debt, should revenues 
be part of that conversation?
    Mr. JOHNSON. In any situation where a fiscal adjustment is 
required, such as in the United States today, I would suggest 
that you look at both revenue and expenditures. So, yes, I 
would definitely include revenues in the discussion.
    Mr. BECERRA. And if we are able to resolve these large 
deficits and this large national debt in a way that is 
comprehensive, long-term, does that help the private sector, 
our companies that are trying to do business both here, 
domestically, or abroad?
    Mr. JOHNSON. Of course. The best thing you could do for the 
economic recovery at this point is to have a medium-term fiscal 
framework that is completely credible, people understand that 
the debt is on a sustainable trajectory. That will bring down 
long-term interest rates. That will encourage investment. That 
will boost job growth.
    Mr. BECERRA. In the alternative, if we take the country to 
the brink and say August the 2nd we don't have any solution or 
resolution to the debt ceiling issue, what happens in the eyes 
of the business community?
    Mr. JOHNSON. We don't know what happens, but we don't want 
to find out. Other countries that have tried to play these 
kinds of games with the financial markets usually end up being 
burned. The limited experience we had in the 1970s with the so-
called technical default was it had an impact on base interest 
rates for a prolonged period of time. Why would you want to 
take that risk?
    Chairman CAMP. Thank you. Mr. Berg is recognized.
    Mr. BERG. Mr. Chairman, thank you. You know, obviously, I 
have been sitting here listening to a lot of analogies. One of 
the analogies is between personal household debt and the 
Federal Government debt.
    And to me, maybe I look at it too simplistically. I think 
there is an analogy. People loaded up on residential debt 
because they need money. Inflation was driving values up, and 
people were able to make that leveraged investment and get a 
higher return. I think our U.S. debt has soared out of control 
because it has been too easy to simply borrow the money and not 
make some of the difficult decisions that need to be made.
    I truly think that if we don't take this issue seriously, 
and we don't look long-term and have a serious discussion about 
how to rebalance and get our country back on track, I think the 
private sector and financial markets will say, ``Hey, 
Washington still does not get it. They are just going along.''
    You know, the fundamental question that we have got here, I 
think is, what is the impact of interest deductions? And, 
obviously, as we looked at this trend over the last 20-plus 
years, it hasn't had that big an impact. Although, in my sense 
of things, it is changing business decisions.
    So, I have two questions. One question, are we clear that 
the deduction on interest is really not the right incentive, as 
we move forward? And if it were a revenue-neutral situation, 
what would you do with those tax dollars in another way? Would 
you just reduce, for example, the corporate rate? Would you 
eliminate the interest deduction and focus on the corporate 
rate? Or, what would you do with those dollars?
    So--you look deep in thought, Tom, so we should start with 
you.
    Mr. BARTHOLD. Well, I think you have asked the broad 
question of how to undertake major tax reform. I mean you could 
undertake a tax reform, and maintain deductibility of interest. 
You could undertake tax reform. You could create new 
preferences for equity. You could, as Ms. Olson has suggested, 
and Mihir Desai, integrate corporate tax with the individual 
tax, and change overall incentives. But that is--I mean, I 
assume that is part of the purpose of this hearing.
    Mr. BERG. Well, maybe I asked too many questions. The first 
question is, should we keep the interest deduction, in your 
opinion on this panel?
    And if we didn't have an interest deduction, would you be 
here advocating that we put one in?
    Mr. BARTHOLD. Well, you know, sir, that I don't advocate 
before the committees, I work for the committees. So I will 
defer to my colleagues on the panel.
    Ms. OLSON. There are certainly good arguments for limiting 
the interest deduction. But you can't, in my view, limit the 
interest deductions without taking into account a lot of ripple 
effects. I think that the interest deduction affects financing 
decisions. I don't think it dictates them. I think we make a 
mistake any time we think that the tax rules are the things 
that ultimately decide what people do. They have an impact on 
them.
    And if we are going to limit interest deductions, then we 
have got to do it on a comprehensive basis. We ought to take a 
comprehensive look, and we have got to think about transition. 
Things like the comprehensive business income tax set up a 
system that is more like the treatment of equity. So you 
wouldn't have a deduction for interest on the business side, 
but on the recipient side, it wouldn't be taxable income. So 
you shift things around, much along the lines of the way 
consumption taxes operate.
    Chairman CAMP. All right, thank you. Mr. Kind is 
recognized.
    Mr. KIND. Thank you, Mr. Chairman. I want to thank our 
panelists today, an excellent panel. And, Mr. Chairman, I want 
to thank you and Chairman Baucus for this format. I think this 
is very helpful. I think it makes sense for us to, hopefully in 
the future, have more joint hearings like this, so that we can 
better coordinate the action in the House and the Senate, 
especially over something as important and crucial as 
comprehensive tax reform.
    Mr. Johnson, let me start with you. I mean you have been an 
advocate for some time about taxing excessive leverage right 
now. But you had admitted earlier in your testimony in the 
Lehman case, and coming out of the financial crisis, that it 
was often difficult to be able to identify what excessive 
leverage looked like at the time.
    Have we made improvements, in regards to--with the passage 
of Dodd-Frank or other steps coming out of the financial 
crisis--of having a better ability of identifying excessive 
leverage when it existed, as opposed to a retrospective look-
back, and then identifying it?
    Mr. JOHNSON. It was Mr. Desai who made the point about 
Lehman's leverage.
    Look, the New York Fed and the SEC were living at Lehman 
for the last six months. I think they knew what the leverage 
was, and I am sure they could have told you what the excessive 
leverage was, if that was the framework. But, more broadly, 
taking on the--I think the spirit of your question, which is do 
we understand the risks that arise from this kind of leverage, 
do we know the damage that can be done, do we know who will be 
impacted, all the small businesses and small community banks 
will be devastated next time there is a big problem.
    Or, if Italy were to run into serious debt problems today, 
no, we don't know. The Financial Stability Oversight Council, 
which was created for this purpose, as far as we can see from 
the outside, does not have a determination on this in any 
precise manner. These risks are huge, and they impact the rest 
of the economy. And they come directly and immediately from 
excessive leverage, particularly in our biggest financial 
institutions.
    Mr. KIND. Well, let me ask the rest of the panel, maybe 
starting with you, Ms. Olson, that, obviously, there are 
capital structures that are in place right now, based on the 
current tax code as it exists. And we really haven't gotten 
into the transition period that we should be considering, when 
making these type of changes. But what type of time period do 
you think we should realistically be looking at, as far as a 
transition pace of tax reform?
    Ms. OLSON. Well, that will be determined, at least in part, 
by the kind of change that you make, and how--whether it is 
very incremental, or whether it is much more comprehensive.
    But even incremental change, I think, needs some transition 
period of, say, 5 years, 10 years--
    Mr. KIND. Well, just the issue that we have been dealing 
with mainly today on debt, and the incentives for increased 
debt in the tax code today.
    Ms. OLSON. Again, I think it would depend on how radical 
you want to be in making changes. If the changes are 
incremental, then they could be phased in more quickly. But if 
they are more radical changes, then you would need a very long 
period of time to adjust.
    Mr. KIND. Mr. Fleischer, you have an opinion?
    Mr. FLEISCHER. I want to go back to the point on excessive 
leverage.
    Mr. KIND. All right.
    Mr. FLEISCHER. It is very difficult to determine even how 
much leverage there is, especially once you start thinking 
about the embedded leverage in derivatives, and the use of off-
balance-sheet entities.
    But the point that I would make is you don't have to get it 
exactly right to make things better. Right now, the tax system 
is tilted in the wrong direction. And so, any move towards 
neutrality is likely to make things much better, rather than 
worse.
    Mr. KIND. Sure. Mr. Desai?
    Chairman CAMP. Quickly, please.
    Mr. DESAI. Again, I would echo Pam's comments, that the 
scope of the transition has to mirror the scope of the change. 
So you can imagine a narrow change that--which I would not 
support--but which could be done quickly, or you can imagine a 
broader change, which has to embrace the--
    Chairman CAMP. thank you.
    Mr. KIND. Thank you.
    Chairman CAMP. Mr. Reed is recognized.
    Mr. REED. Thank you very much, Mr. Chairman. I guess I am 
the newest member to the committee, so I get the last question.
    I have really enjoyed the testimony--and I find it very 
informative--from the panel today. And I do want to focus on 
just a very limited area, if we could.
    One thing I hear, as I go through my district, from a lot 
of younger folks is that the college tuition that they are 
facing--and the loan and the debt associated with that tuition 
burden--is going through the roof.
    I would be interested in anyone from the panel offering 
their insight as to whether the subsidies that we provide 
through the tax code with the student loan deduction, what 
impact, if any, do you see them having in regards to tuition 
growth that has clearly been demonstrated over the past few 
years?
    Mr. JOHNSON. I think you are raising a very important 
issue, Mr. Reed, and one that doesn't get enough attention. 
Obviously, the issue is what kind of education are you getting 
for the money that you are paying, and questions are 
increasingly being raised about some parts of the education 
sector.
    And there are rules in place, as you know. If a 
sufficiently high proportion of graduates default on a loan, 
then that institution is no longer able to get these kinds of 
loans for its applicants. But these rules seem not to be 
particularly effective right now.
    And perhaps we should consider, on a revenue-neutral basis, 
shifting away from this loan structure towards an alternative 
way of financing. For example, through using some form of 
grants that are based on--also on assessing people's means to 
pay for themselves.
    Mr. REED. Any other comments from any of the panelist? 
Because I am really interested in seeing is the tax code 
itself, by allowing the deduction for student loan interest, 
encouraging higher tuition costs because of the inflationary 
impact of that policy? Does anyone have any counterpoints, or 
any other information on that?
    Mr. BARTHOLD. Mr. Reed, some people have raised that 
possibility, that the incidence--some of the benefit of the 
numerous provisions that we have enacted to benefit education 
may redound to the providers of education. But the economic 
evidence to this point couldn't be described as anything more 
than mixed.
    Mr. REED. Okay.
    Mr. DESAI. I would just echo that, and not just because I 
am in the higher education business. But it has been very 
difficult to find this out. And, in part, it has to do with the 
fact that pricing in higher education is a very curious 
practice. And part of what we have seen is increased list 
prices, and then lots of discounting with fellowships. So there 
is a whole market structure there, which is complicated.
    I just want to echo Simon's point, though. A big part of 
this concern may be about the heterogeneity in the educational 
sector today, which didn't exist 20 years ago, where you have 
various different providers providing different kinds of 
quality. And that is worth looking at.
    Mr. REED. Thank you. My time has expired.
    Chairman CAMP. Thank you. Mr. Crowley is recognized.
    Mr. CROWLEY. Timing is everything. I am the last man on the 
totem pole. But thank you, Mr. Chairman. I appreciate you 
holding this hearing, this historic joint hearing between the 
House and the Senate on a very important issue of debt in the 
tax code.
    More pressingly, I think, as has been expressed by many of 
my colleagues, we should be talking about the overall issue of 
debt.
    In three weeks, the U.S. will hit the so-called debt limit, 
which is like maxing out on a credit card. But while an 
individual with a credit card can stop paying--making future 
payments with the card once they hit their limit, the same 
can't be said for the U.S. Government.
    The spending debt will be financed by debt limit increase--
paying for past obligations, not future spending. For example, 
we just can't stop paying out Social Security. We just can't 
stop paying out veterans compensation and pensions. We just 
can't stop paying out military pay and benefits to our troops 
at war.
    But if we do not increase the debt limit, that is exactly 
what will happen. Funds that were promised--and, in terms of 
Social Security, funds that were [sic] even the government's 
money, but the people's own money--will not be paid, because we 
won't have the funds to do so. Could you imagine if Social 
Security checks bounced? It is a real possibility, if Congress 
continues to play games on the budget, and if they continue, as 
the Senate Republican leader said yesterday, refuse to work 
with President Obama on the pressing problems of this country.
    The number one job of this Congress should be to create 
jobs and get our fiscal house in order, not to play politics 
and bow to special interest groups. That is why I salute 
President Obama for continually extending his hand in 
cooperation and negotiation to work with Congress to ensure we 
can meet our obligations of paying out Social Security on 
August 3rd, while also working for long-term debt reduction for 
our children and our great-grandchildren.
    But any debt reduction plan will require a shared 
sacrifice. Seniors on Social Security, veterans who rely on 
their VA pensions, and the troops in battle should not have to 
lose their rightful benefits, while others do not meet that 
same sacrifice. And I will oppose a plan that does not involve 
shared sacrifice, but makes seniors and veterans and military 
families pay the bills created after a decade of fiscal 
irresponsibility.
    It is amazing that we have people in this room who 
supported trillions in tax cuts and two unpaid-for wars, but 
now say it is up to veterans and the seniors and the troops to 
sacrifice a bit more so millionaires don't have to. This 
President is trying to work out returning our country to a 
policy of fiscal discipline last seen when President Bill 
Clinton was in the office, while ensuring we promote economic 
growth and stability. And I urge all of us to focus on this 
critical mission, and to stop playing politics and the blame 
game.
    And with that, I yield back the balance of my time, Mr. 
Chairman.
    Chairman CAMP. All right. Mr. Paulsen is recognized for 
three minutes.
    Mr. PAULSEN. Thank you, Mr. Chairman. And I also want to 
compliment you for holding the hearing with the Senate, and for 
laying the foundation for what we heard from some of our 
colleagues and Senator Wyden, in particular, about this being 
an important foundation for tax reform for economic growth. And 
I think we have heard from our panelists the negative 
implications of the preference for debt financing, and ideas 
for equalizing the treatment between debt and equity.
    And I guess I just want to go back to the design of what 
the tax system should look like--what the tax code should look 
like, what tax reform should look like--if we are going to 
promote economic growth, if we are going to promote jobs. I 
mean that should be our number one goal here, I think. Because, 
obviously, issues like spending and debt are a big issue. But 
we have to increase economic growth.
    When you only have 18,000 jobs coming out in the last jobs 
report, that is pretty embarrassing. It is embarrassing, when 
you think we have got more college graduates probably in 
Minnesota than we have jobs coming out nationally.
    So, knowing that that's the case, we want a tax code that 
is going to promote work, savings, and investment. What should 
be the focus on that, in the context of debt and equity? Ms. 
Olson?
    Ms. OLSON. Well, I think there is a lot of economic 
literature that supports the notion of moving in the direction 
of a consumption tax. And there are lots of ways to get there. 
Something like a comprehensive business income tax would be one 
thing that Congress might look at to move in that direction.
    Mr. PAULSEN. Yes. Mr. Fleischer, anything to add?
    Mr. FLEISCHER. I largely agree with that. I mean I think 
the basic principles of what we are aiming for I think a lot of 
us agree on, that broad-based lower rates are the place to 
start. And to try and reduce the distortions in the code that 
lead not only to a reduction in tax revenue, but an incentive 
to engage in wasteful tax planning, that from a long-term, 
economic perspective, it is not encouraging long-term growth.
    Right. And we have had a lot of, I think, comments from the 
panelists about lowering the rate, broadening the base. And in 
the context of helping small businesses, too, please share if 
there is any thoughts on that, because that is a driver of the 
economy, is the small business economy.
    Mr. DESAI. Right, absolutely. And I think the remarkable 
thing, of course, is the level of consensus on what, you know, 
tabula rasa, if we started the world, what a good tax code 
would look like. And there is a remarkable level of consensus 
on that, which is some notion of a consumption tax base, 
coupled with progressivity that can be achieved in a variety of 
ways.
    So, in some sense, that is not the hard part. The hard part 
is, you know, where you said--you know, I think sitting where 
we sit, I think there is wide consensus about what the code 
should look like. But getting there is the harder part.
    Mr. PAULSEN. And, Mr. Johnson, before my time runs out?
    Mr. JOHNSON. I think you should focus on moving towards a 
value-added tax system. And you can make that as progressive or 
as not progressive as you want, and you can generate the same 
revenue or less revenue or more revenue. There is a variety of 
VAT systems around the world.
    The U.S. system, taxing income, is always going to get in 
the way of your goals. You want to promote work, savings, and 
investment. Well, anything that is primarily--or as much income 
tax-based in our system is not going to do that. And I think I 
would echo--or encourage you to look at the specific proposals 
put forward by my colleagues here, and look at other 
proposals--for example, that the IMF has available--in terms of 
how countries can move and transition smoothly to a VAT system.
    Chairman CAMP. All right, thank you.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    Chairman CAMP. I want to thank our panelists this morning, 
all of you, for being here and for participating in the 
hearing. I also want to thank Chairman Baucus and the Senate 
Finance Committee, as well as their staff, for making this 
joint hearing possible.
    This hearing is now adjourned.
    [Whereupon, at 11:23 a.m., the committees were adjourned.]
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    [Submissions for the Record follow:]
                    Sen. Olympia J. Snowe, Statement
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            National Association of Home Builders, Statement
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                The Center for Fiscal Equity, Statement
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