[Senate Hearing 118-742]
[From the U.S. Government Publishing Office]
S. Hrg. 118-742
EXAMINING HOW THE TAX CODE AFFECTS
HIGH-INCOME INDIVIDUALS AND
TAX PLANNING STRATEGIES
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HEARING
BEFORE THE
COMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED EIGHTEENTH CONGRESS
FIRST SESSION
__________
NOVEMBER 9, 2023
__________
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Printed for the use of the Committee on Finance
__________
U.S. GOVERNMENT PUBLISHING OFFICE
62-125- PDF WASHINGTON : 2025
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COMMITTEE ON FINANCE
RON WYDEN, Oregon, Chairman
DEBBIE STABENOW, Michigan MIKE CRAPO, Idaho
MARIA CANTWELL, Washington CHUCK GRASSLEY, Iowa
ROBERT MENENDEZ, New Jersey JOHN CORNYN, Texas
THOMAS R. CARPER, Delaware JOHN THUNE, South Dakota
BENJAMIN L. CARDIN, Maryland TIM SCOTT, South Carolina
SHERROD BROWN, Ohio BILL CASSIDY, Louisiana
MICHAEL F. BENNET, Colorado JAMES LANKFORD, Oklahoma
ROBERT P. CASEY, Jr., Pennsylvania STEVE DAINES, Montana
MARK R. WARNER, Virginia TODD YOUNG, Indiana
SHELDON WHITEHOUSE, Rhode Island JOHN BARRASSO, Wyoming
MAGGIE HASSAN, New Hampshire RON JOHNSON, Wisconsin
CATHERINE CORTEZ MASTO, Nevada THOM TILLIS, North Carolina
ELIZABETH WARREN, Massachusetts MARSHA BLACKBURN, Tennessee
Joshua Sheinkman, Staff Director
Gregg Richard, Republican Staff Director
(II)
C O N T E N T S
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OPENING STATEMENTS
Page
Wyden, Hon. Ron, a U.S. Senator from Oregon, chairman, Committee
on Finance..................................................... 1
Crapo, Hon. Mike, a U.S. Senator from Idaho...................... 3
WITNESSES
Huang, Chye-Ching, executive director, Tax Law Center, New York
University School of Law, New York, NY......................... 5
Pearl, Morris, chair, Patriotic Millionaires, New York, NY....... 7
McBride, William, Ph.D., vice president of Federal tax policy and
Stephen J. Entin fellow in economics, Tax Foundation,
Washington, DC................................................. 9
Holtz-Eakin, Douglas, Ph.D., president, American Action Forum,
Washington, DC................................................. 11
ALPHABETICAL LISTING AND APPENDIX MATERIAL
Crapo, Hon. Mike:
Opening statement............................................ 3
Prepared statement........................................... 37
Holtz-Eakin, Douglas, Ph.D.:
Testimony.................................................... 11
Prepared statement........................................... 38
Responses to questions from committee members................ 40
Huang, Chye-Ching:
Testimony.................................................... 5
Prepared statement........................................... 44
Responses to questions from committee members................ 55
McBride, William, Ph.D.:
Testimony.................................................... 9
Prepared statement........................................... 58
Responses to questions from committee members................ 72
Pearl, Morris:
Testimony.................................................... 7
Prepared statement........................................... 78
Wyden, Hon. Ron:
Opening statement............................................ 1
Prepared statement........................................... 79
Communications
Center for Fiscal Equity......................................... 81
Desai, Anand..................................................... 86
National Women's Law Center...................................... 87
Patriotic Millionaires........................................... 91
(III)
EXAMINING HOW THE TAX CODE AFFECTS
HIGH-INCOME INDIVIDUALS AND
TAX PLANNING STRATEGIES
----------
THURSDAY, NOVEMBER 9, 2023
U.S. Senate,
Committee on Finance,
Washington, DC.
The hearing was convened, pursuant to notice, at 10:07
a.m., in Room SD-215, Dirksen Senate Office Building, Hon. Ron
Wyden (chairman of the committee) presiding.
Present: Senators Menendez, Carper, Cardin, Casey, Warner,
Whitehouse, Hassan, Warren, Crapo, Cassidy, and Blackburn.
Also present: Democratic staff: Grace Enda, Tax Policy
Analyst; Sarah Schaefer, Chief Tax Advisor; and Joshua
Sheinkman, Staff Director. Republican staff: Courtney Connell,
Chief Tax Counsel; Michael Gould, Tax Counsel; Gregg Richard,
Staff Director; and James Williams, Tax and Economic Policy
Advisor.
OPENING STATEMENT OF HON. RON WYDEN, A U.S. SENATOR FROM
OREGON, CHAIRMAN, COMMITTEE ON FINANCE
The Chairman. The committee will come to order.
This Congress, the Senate Finance Committee has
investigated a number of tax schemes that the very wealthy,
with the help of armies of high-priced tax lawyers and
accountants, are using to pay virtually no Federal tax for
years on end.
Today, we are going to examine one strategy called ``buy,
borrow, die.'' You can see those three words in back of the
dais. Those three words on the chart behind me have an enormous
impact from the standpoint of taxes. Here is how it works.
A corporate raider buys a business. Then, they borrow
against its growing untaxed value to fund an extravagant
lifestyle--everything from superyachts and luxurious vacations,
expensive art deals, you name it. It just goes up and up in
value, while not paying a dime in taxes. When they die, the
assets are passed to the kids, often entirely tax-free, and
this cycle I have described just continues.
Now let us contrast buy, borrow, die against the tax system
mandated for everybody else in America. If you are a nurse or a
firefighter living in Philomath, OR, you are required to pay
taxes on every paycheck. Working people do not get to play by
the same rules as billionaires. They do not get to call up an
accountant every time they do not feel like paying taxes.
Right now, the average billionaire can wriggle their way to
paying 8 percent as a tax rate, while the nurse or firefighter
making $45,000 is paying a 22-percent tax on their wages. How
is that fair?
Americans overwhelmingly believe it is not fair. So it is
time to look to solutions that restore fairness to the tax
code, while still rewarding success. Success is what America is
all about, and we want to reward it. That is what our country
is founded on, that is, the idea that everybody--let me
emphasize that--everybody has a chance to get ahead.
Fortunately, there is a solution that achieves both
fairness and economic growth. It is called mark to market. And
here is the kicker: there is already a version of mark to
market in the Federal tax code. So what that means, colleagues,
is we've got a blueprint right in front of us to use as a model
for mark-to-market provisions that would apply to billionaires.
Put simply, mark to market would require billionaires to
pay tax every year, just like everybody else. Buy, borrow, die
is the primary mechanism billionaires use to avoid taxes. If
left unchecked, you are inviting more gaming into the system.
Ending buy, borrow, die is the best way to ensure that
billionaires pay their fair share.
Tax laws just do not apply to billionaires in the same way
they do to everybody else. They are optional for billionaires,
where everybody else's tax rules are mandatory. It is time to
close these loopholes and make sure that those at the very top
are paying taxes on their income as it is earned, like
everybody else.
Now, I will close with this. Our Finance team and I have
been fighting tax injustices throughout this session. We
investigated crooked Swiss bankers who are hiding wealthy
Americans' income; $34 billion in unpaid taxes from
millionaires who just do not feel like even filing a tax
return; tax dodging schemes between Leon Black and Jeffrey
Epstein; and Supreme Court Justice Clarence Thomas's wealthy
buddy secretly forgiving a massive private loan. Americans
deserve a tax system that is both fair and encourages success.
My hope is that this could be bipartisan. The invention of
Roth IRAs, for example, was bipartisan, a Republican idea.
Chairman William Roth helped working Americans save for the
future and get ahead, and Chairman Roth, when you read the
documents, always talked about being there for the people of
modest means. My friend, Senator Carper, of course remembers
Chairman Roth. But that is what the Roth IRA was about. It was
for people of modest means.
Now the ultra-wealthy are abusing these to shield their
vast fortunes from Federal tax. It is time to end this
exploitation of current tax laws, and use the funds--that
portion that is way, way, way up at the top for a handful--use
that money to help families. For example, it could be used to
get a jump start on child savings accounts, something that our
colleague, Senator Bob Casey, has been working on for years.
So I have laid out just a few of the endless ways the
super-wealthy avoid paying their fair share, and I will close
with a gut punch. Everything I have described is legal--
everything; perfectly legal. I just know when I go home and I
have a town meeting--I have had 1,060 of them--and I say that,
people are just boiling. ``All that stuff is legal, Ron?''
``Yep, all legal.'' And that is why people feel the deck is
stacked against the working families.
Wealth continues to build up in the hands of the fortunate
few, and so many are left behind. Over one-third of American
families do not have the cash on hand to pay for a $400
emergency. Meanwhile, during the pandemic when families were
forced to make tough choices between paying rent and buying
groceries, billionaires increased their wealth by over a
trillion dollars. So, time to set aside business as usual.
There is growing support, in my view, in demands for solutions
that restore fairness to the tax code, level the playing field
for working families, and promote success.
I want to close by saying you can only have a successful
economy if you have a tax code that treats everybody fairly. It
is just that simple. It is past time to close the gap between
those at the top and everybody else. I look forward to working
with my colleagues on the committee.
It has been a busy week for the Finance Committee. Senator
Crapo deserves enormous credit for yesterday, and we got a 26
to nothing vote on a really landmark health-care bill to rein
in these middlemen. And probably here today we have some
differing opinions, but I just want people to understand that I
so appreciate Senator Crapo's willingness to debate these
issues and find common ground where we can, which is quite
often, as people saw yesterday.
Senator Crapo?
[The prepared statement of Chairman Wyden appears in the
appendix.]
OPENING STATEMENT OF HON. MIKE CRAPO,
A U.S. SENATOR FROM IDAHO
Senator Crapo. Well, thank you very much, Mr. Chairman, and
I agree with you. You and I have a track record, I think, of
finding the doable, where we can build consensus on a
bipartisan basis. There will be a few areas where we disagree
today, but I look forward to our discussion today on the effect
of the tax code on individuals and families, as they work,
save, and invest.
The scope of today's hearing provides members the
opportunity to cover a broad range of topics, and we will no
doubt hear a number of concerns raised about how the code
treats high-income taxpayers. We should dispel the notion that
there is any support for taxpayers who evade their tax
obligations. We all agree that taxpayers should pay the tax
they legally owe.
Senator Wyden indicated what he is talking about are
legally undertaken activities. And for the gray areas of
taxpayers who aggressively structure their affairs to reduce
their tax liability, we should constantly assess how the code
can better and more fairly target activities.
But framing this issue through the subjective lens of
fairness often ignores the facts and turns a blind eye to
favored initiatives or incentives. Rather than focusing on
rhetoric, we should examine the data and how the code affects
behavior. That includes examining provisions that primarily
benefit a select group of the financially well off, including
tax credits for those who can afford expensive electric
vehicles, costly energy home efficiency upgrades, and proposals
to repeal the cap or expand the highly regressive deduction for
State and local taxes. All of these primarily benefit the
wealthy.
As for the data, these are the indisputable facts: most of
the Federal tax burden is paid by high earners; Federal tax
collections have been near all-time highs; the voluntary tax
compliance rate is high and stable; and higher income taxes
serve as disincentives to work, save, and invest.
My Republican colleagues and I remain focused on
safeguarding taxpayers and their rights; reducing barriers to
work, savings, and investment; and promoting opportunity and
wealth to improve the quality of life for all Americans.
In 2017, the Republicans lowered individual tax rates
across the board, with middle-income taxpayers getting the
largest proportional benefit. Republicans also simplified
filing for many, expanded the Child Tax Credit, and limited
regressive tax spending like the SALT deduction.
Critics charged that letting Americans keep more of their
earnings would stifle the economy, dry up Federal revenue, and
favor the wealthy. Instead, it created one of the strongest
economies in our Nation's history, including an unemployment
rate that reached a generational low; increased Federal tax
collections to near all-time highs; grew wages across the
income spectrum; and expanded job participation. All Americans
benefited.
Notwithstanding claims that high earners pay the least
taxes, the reverse is actually true. According to the Biden
Treasury Department, in 2023 the top 1 percent of all earners
paid 42 percent of all Federal income taxes, the highest
despite only earning 19 percent of all of the income. In 2001,
the top 1 percent of earners contributed 33.2 percent of income
tax revenue, 9 points lower. In other words, the country's
income tax burden is more progressive today than it was decades
ago.
Expanding the aperture to examine the top 5 percent of
taxpayers, those with incomes above $200,000 a year, mirrors
this same dynamic. Those Americans pay 65.3 percent of all
Federal income taxes, while making only 34 percent of all
income. Meanwhile, Federal tax collections have reached an all-
time high of $4.9 trillion in Fiscal Year 2022, with individual
income tax collections contributing the most, growing by 29
percent year over year.
In fact, individual income tax collections reached 10.5
percent of GDP in Fiscal Year 2022, the highest level on
record. All of this is after the impact of the Republican-led
tax reform. In arguing for tax code fairness, some have pointed
to a recent tax gap projection from the IRS, which shows an
increase over the previous estimate.
This growth actually shows one of the many effects of
inflation. Despite headlines to the contrary, the tax gap is
proportionately flat and historically average, relative to the
economy's size. According to the Cato Institute's examination
of the tax gap as a percentage of GDP, for 2021 that ratio was
2.9 percent, squarely in line with the 20-year average, and the
voluntary tax compliance rate, around 85 percent, remains
substantially unchanged.
While we should work to find bipartisan measures to narrow
that tax gap, any such effort must not reduce economic growth.
I look forward to hearing the perspective of today's witnesses
on how the individual tax system affects taxpayers from all
income groups, and how increased taxes in the midst of high and
sustained inflation would impact our economy.
Thank you, Mr. Chairman.
[The prepared statement of Senator Crapo appears in the
appendix.]
The Chairman. Thank you, Senator Crapo, and I share your
views that we are going to have a good debate, and I think the
four witnesses that we have are going to reflect it. Let me
introduce everybody. If I miss something about your background,
we will make sure we get it in the full record.
Chye-Ching Huang is executive director of the Tax Law
Center at NYU. I think you all are around the corner from the
Strand Bookstore--I think. I know somebody there.
Senator Crapo. You do.
The Chairman. Before starting at the Tax Law Center, she
was senior director of economic policy for the Center on Budget
and Policy Priorities. We have worked with her often and
appreciate her expertise.
Our second witness will be Morris Pearl, chair of the
Patriotic Millionaires, a group of high-net-worth Americans who
support fair taxation of wealthy individuals and large
corporations. He was a managing director at BlackRock, so we
are going to get a very important perspective from a major
investment firm leader.
Our third witness will be William McBride--we have worked
with him often--vice president of Federal tax policy at the Tax
Foundation. Previously, he was a manager in the National
Economic and Statistics Group at PriceWaterhouse. We welcome
Mr. McBride.
The fourth witness we have had often to this committee,
Douglas Holtz-Eakin. I have known Dr. Holtz-Eakin for years and
years, going back to our days at the CBO, and I very much
appreciate having a chance to get his input. We are glad that
he could be with us.
So, all our witnesses bring considerable experience in tax
policy to the table. Your full statements are going to be
entered into the record. We will ask that you keep your remarks
to no longer than 5 minutes. And, Ms. Huang, why don't we start
with you, and I think you are going to give us kind of the nuts
and bolts for the operation of how this thing goes, because
that is what people really want to know.
STATEMENT OF CHYE-CHING HUANG, EXECUTIVE DIRECTOR, TAX LAW
CENTER, NEW YORK UNIVERSITY SCHOOL OF LAW, NEW YORK, NY
Ms. Huang. Well, thank you, Chairman Wyden, Ranking Member
Crapo, and distinguished members of the committee. I am really
honored to join you today.
The highest-income filers receive tax breaks of income from
wealth to the tune of hundreds of billions of dollars each
year. Largely unknown to most Americans, these tax breaks
increase deficits and deepen inequality. The outright tax
breaks inevitably spur tax avoidance and evasion that harms the
economy by locking up capital on old investments where the tax
breaks are the most lucrative, instead of it flowing to new and
productive ventures.
Talent goes to waste dreaming up new tax shelters for the
ultra-wealthy, instead of driving business and scientific
innovation. Those who want to focus on work and
entrepreneurship face competition from tax avoiders and
evaders.
Here is how the system works. Tax breaks on wealth allow
the highest-income filers to choose when to pay income tax, at
what rate, and even whether to pay it at all. Most Americans
make the bulk of their income from work, but the highest-income
filers make the bulk of their income from their wealth. That is
stocks and bonds, real estate, personal property like art, and
ownership in pass-through noncorporate businesses. These assets
throw off income, including dividends and the capital gains
from when they increase in value.
But while the top rate on salaries is 40.8 percent, the top
rate on long-term capital gains and dividends is dramatically
lower, at 23.8 percent. And while most Americans pay taxes on
salaries in the year that they earn the income, and often
withheld in every paycheck, most capital gains are invisible to
the tax system until they are realized; that is, when the asset
that has increased in value is actually sold.
So the wealthiest filers can choose when capital gains show
up on tax returns, and meanwhile they see that income in their
banking statements, and they can borrow and spend against it.
If they hold the assets that have gained in value until they
die, then neither they nor their heirs will ever pay income tax
on that gain, and that is how billions of dollars in income
gets an income tax rate of zero.
These are large outright tax subsidies for wealth. JCT
estimates that the zero and low rates on capital gains and
dividends cost the Federal Government more than $200 billion
last year, and that is more than the CHIPS and Science Act's
entire investments in innovation over a whole decade.
That's also just the start of how wealthy filers can
benefit from low rates on income from wealth. Their tax
planning techniques can be complex, but they have a simple aim:
just shift as much income from assets and work into the lowest
possible tax rates on wealth. Carried interest is used by fund
managers to get low capital gains rates on income from their
services.
Pass-through businesses can help the wealthy to avoid
income and payroll taxes, and there is an alphabet soup of
other vehicles that are getting co-opted to shelter capital
income from tax: things like private placement life insurance,
the ETF loophole, HSAs, mega-Roths, many more.
These wealthiest filers have well-paid lawyers and
accountants to set up spider webs of entities and transactions.
And then sometimes this egregious but lawful tax planning goes
from those gray areas and right on into tax evasion.
The complex and opaque tax system for the wealthy can also
give cover to money launderers, sanctions evaders, and corrupt
officials looking to hide assets and income. All income
underreporting by the top 1 percent was $80 billion per year
added to the tax gap of taxes owed but not paid, and that is
more than the annual budget of the Small Business
Administration.
Lawmakers can move Federal and private resources away from
tax breaks on wealth, and instead make better investments in
the Nation's future. Various tax cuts for wealthy filers should
expire as scheduled in 2025. That includes the pass-through
deduction and the doubled estate tax exemption.
The IRS should have the resources and tools it needs to
continue to ensure that wealthy filers pay more of the taxes
that they owe, and various tax breaks on income from wealth can
be repealed or scaled back so that the wealthy pay effective
rates that are closer to the rates on salaries.
Members of this committee have responded over many years on
a bipartisan basis to all the tax shelters that pop up to try
to seek the benefit of those breaks. But they will continue to
pop up unless the underlying problem is addressed.
My testimony lays out a menu of options, and I would be
happy to take your questions.
[The prepared statement of Ms. Huang appears in the
appendix.]
The Chairman. Very good, Ms. Huang. Thank you. And taking
us through the nuts and bolts is what we are going to have to
do, because I know when I bring this up at town hall meetings,
people still have you take them through it once or twice.
People say, ``They can actually do that? It's legal?'' And then
you have to say, ``Yes, it's legal.'' And so, we have some work
to do to fix this, and we appreciate your leadership.
Mr. Pearl, welcome.
STATEMENT OF MORRIS PEARL, CHAIR,
PATRIOTIC MILLIONAIRES, NEW YORK, NY
Mr. Pearl. Yes; thank you, Chairman Wyden and Ranking
Member Crapo, and all the Senators, for giving me the honor of
appearing before you today. I have had a long career on Wall
Street. I currently serve as the chair of the Patriotic
Millionaires. And most importantly for the purpose of this
hearing, I am exactly the kind of person that our tax code is
designed to advantage.
The cost of these advantages is a permanent upper hand for
the wealthy over people who work for a living, the economic
instability of an extreme concentration of wealth and income at
the very top, an eroding consumer base and tax base, and social
instability as more and more people realize that putting in a
hard day's work is no longer a path to dignity and a
financially stable life.
The original sin of our tax code is the way we value money
and wealth above work and wages. Your constituents who work for
a living have taxes deducted from their paycheck every single
week. I earn money just by watching the numbers in my brokerage
statement go up. I can decide to have that income become
taxable if and when I feel like it.
We do not tax capital gains until the time of sale, which
means for people like me, taxes are essentially optional. We
can take out loans to fund living expenses and never realize
capital gains--and never pay taxes on them. And when we die,
thanks to the step up in basis, we are able to pass that wealth
onto the next generation completely free of income tax, and the
whole buy, borrow, die process starts again.
The problem is, people who are rich do not need taxable
income. They are already rich. We suggest the money made by
investors should be subject to taxes, just like the money made
by your constituents who work for a living, and that is the
essence of the proposal from Chairman Wyden and the proposal
from President Biden.
My own family benefited from the step-up basis rule,
inheriting shares of stock at a gain of over 62,000 percent--
62,000 percent-- and we enjoyed millions of dollars of gains on
which no one has ever paid any income tax, and on which no one
ever will pay any income tax. And we did not need any army of
lawyers or accountants. We simply followed the rules as they
are written in the current tax code.
Even when I do choose to realize gains and pay taxes, the
rate I pay is far below the rate of people who earn that much
from their work. This is supposed to incentivize investment,
but that fundamentally misunderstands what drives investors.
My options are to invest my money and get some growth or to
stuff my money under my mattress or something, and mattresses
do not have very high returns. Perhaps even more ridiculously,
we give the same benefit to fund managers who are managing
other people's investments, through the carried interest
loophole. If we believe that we should be using the tax code to
incentivize people to enter certain professions, I would put
emergency room nurses above fund managers.
Even the wealthy people who earn most of their income from
work do not experience a truly progressive tax code. Our top
bracket for married couples starts at a little below $700,000.
A lot of money, but we are not even talking about people in
that tax bracket. We are talking about people who earn $7
million or $70 million or $700 million.
That couple earning $700,000, they pay Social Security tax
on a substantial portion of their income. But the burden of
that tax on a couple making $70 million is negligible, well
under 1 percent of their income. Many people, including some of
you on this committee, have offered serious solutions that
would help reorient the way we tax the ultra-wealthy.
Your proposals to tax extreme wealth include Senator
Warren's Ultra-Millionaire Tax and the OLIGARCH Act proposed by
Representative Barbara Lee and others in the House. We also
need to tax unrealized capital gains, as in Chairman Wyden's
proposal or President Biden's proposal. To be clear, I am not
against being rich. I lead an organization of millionaires. We
know being rich is great. We recommend that everyone try it.
[Laughter.]
But investors and businesspeople do not want a Nation with
a few rich people and lots of people just struggling to get by.
That is not where we can invest and build businesses. Money
does not trickle down. Money trickles up from every mortgage
payment and every phone bill payment you make to investors like
me who invest in mortgages and phone companies. We need a
Nation filled with people who have enough money to spend on
things. That is what makes the economy work for everyone,
including investors.
The tax code can and should be used to reduce and constrain
inequality, as the status quo is doing the exact opposite.
Thank you; happy to answer any questions.
[The prepared statement of Mr. Pearl appears in the
appendix.]
The Chairman. Thank you, Mr. Pearl.
And just so we are clear, you were managing director at the
major firm BlackRock, is that right?
Mr. Pearl. Yes. I was one of hundreds of managing directors
there. Mostly I worked for the Federal Government, figuring out
how much the bailout was costing the taxpayers when Citibank
was bailed out.
The Chairman. Good.
Dr. McBride?
STATEMENT OF WILLIAM McBRIDE, Ph.D., VICE PRESIDENT OF FEDERAL
TAX POLICY AND STEPHEN J. ENTIN FELLOW IN ECONOMICS, TAX
FOUNDATION, WASHINGTON, DC
Dr. McBride. Thank you, Chairman Wyden, Ranking Member
Crapo, and members of the committee. I appreciate the
opportunity to speak with you. My testimony will focus on the
size and distribution of the Federal tax burden. Over the last
2 years, we have seen an extraordinary rise and fall of Federal
tax collections.
In Fiscal Year 2022, the Federal Government collected an
all-time high of $4.9 trillion in taxes, nearly 20 percent of
GDP, the highest level as a share of GDP in 22 years, and prior
to that, World War II. In Fiscal Year 2023, Federal tax
collections dropped to $4.4 trillion, or about 16\1/2\ percent
of GDP.
In a typical year, more than half of Federal tax revenue
comes from individual income taxes, which reached an all-time
high of 10.4 percent of GDP in Fiscal Year 2022, before falling
to 8.1 percent of GDP in Fiscal Year 2023. The volatility
reflects broader fluctuations in the economy and financial
markets, combined with the fact that a large share of Federal
tax revenue comes from taxing capital gains, profits, and other
volatile income sources mainly reported by high-income
individuals.
The Federal tax burden over the last 2 years has, on
average, been relatively high, with individual income tax
collections as well as total collections well above their long-
run averages since World War II, measured as a share of the
economy. Most of the Federal income tax burden is paid by high
earners, as is the majority of the entire Federal tax burden.
According to the latest IRS data, of all Federal individual
income taxes collected, the top 1 percent of individual
taxpayers paid a 42.3-percent share, a larger share than the
bottom 95 percent of individual taxpayers combined. The top 1
percent share of taxes is the highest in at least 20 years.
High-income taxpayers also pay the highest tax rates,
according to the IRS. The average individual income tax rate in
2020 was 13.6 percent. The top 1 percent of taxpayers paid a
26-percent average rate, more than 8 times higher than the
average rate paid by the bottom half of taxpayers.
When accounting for all Federal taxes, including taxes on
corporate income, payroll, estates, and other sources, the
Federal tax code remains very progressive. According to the
latest data from the CBO, the top 1 percent of households paid
about 25 percent of all Federal taxes in 2019 and had an
average Federal tax rate of 30 percent. In contrast, the bottom
20 percent of households paid about 0.1 percent of all Federal
taxes, and paid an average Federal tax rate of 0.5 percent.
There is nothing simple about the way in which the Federal
Government collects these taxes, especially individual and
business income taxes, which in many ways are inherently
complex--and various credits and preferences add to the
complexity. The tax code currently totals about 4 million
words, such that no taxpayer can reasonably be expected to
fully comprehend it. In 2022, Americans spent more than 6\1/2\
billion hours trying to comply with the tax code, equating to
about $313 billion a year in lost productivity. This does not
include the cost of tax planning or uncertainty in the law,
which makes planning for taxes as well as investment and other
economic activities difficult and costly.
The increasing complexity of the tax code has contributed
to an overwhelming administrative challenge for the IRS. Last
year, for instance, the IRS answered only about 13 percent of
the 173 million phone calls received from taxpayers asking for
help. Call volume declined this tax season, and the IRS
answered a higher percentage of calls, but other metrics
worsened, including longer processing delays and an increased
backlog of identity theft cases.
There are also the substantial and well-documented economic
costs of high marginal income tax rates arising from
disincentives to work, save, and invest. For instance,
researchers at the OECD concluded that corporate income taxes
are the most economically damaging way to raise revenue,
followed by individual income taxes, consumption taxes, and
property taxes.
One of the most problematic and economically destructive
aspects of the U.S. tax code is the double taxation of
corporate income, first by the corporate income tax and also
the book minimum tax, and then by shareholder taxes on capital
gains and dividends, yielding a combined top tax rate that
approaches 50 percent after accounting for Federal and State
taxes.
In short, we as a country have built a Federal tax system
that is inherently complex, costly, and controversial. To the
extent it is comprehensible at all, taxpayers do not perceive
it as fair. The IRS has real challenges administering such a
complicated tax system, but boosting the IRS budget will not
fix the underlying problem that causes millions of taxpayer
calls to the IRS every year seeking help.
As a top priority, lawmakers should simplify the tax code
so that taxpayers can understand the laws and the IRS can
administer them with minimum cost and frustration. Second,
lawmakers should reduce the economic drag caused by the tax
code, particularly in the current environment of high interest
rates and still-too-high inflation.
My written testimony outlines certain revenue-neutral
reforms that would greatly simplify the tax code and improve
economic growth. I am happy to discuss this further in follow-
up questions.
Thank you for your time and attention.
[The prepared statement of Dr. McBride appears in the
appendix.]
The Chairman. Thank you very much, Dr. McBride. I can tell
you, you will have me at ``hello'' if we can get rid of buy,
borrow, die and add some simplification to the tax system. That
is a winner.
Okay. Doug Holtz-Eakin, welcome. You have been here often.
Glad to have you.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, Ph.D., PRESIDENT, AMERICAN
ACTION FORUM, WASHINGTON, DC
Dr. Holtz-Eakin. Well, thank you, Mr. Chairman, Ranking
Member Crapo, and members of the committee. It is a privilege
to be here to discuss these issues.
Let me begin by just putting them in context. The U.S. has
two major policy problems, in my view. One is subpar economic
growth over the long term; trend growth is about a percentage
point lower than it was in the 20th century. And the second is,
our fiscal house is fundamentally unsustainable looking
forward.
Now, accepting the slower rate of growth in the 21st
century has cost the average person in the United States
$19,000 in real income. GDP per capita is $19,000 lower than it
need be, and it means a sacrifice of about $12 trillion in
Federal revenues.
So, improving economic growth will also be a route to
improving our fiscal outlook. The fiscal outlook is dreadful.
CBO's baseline includes $20 trillion of deficits over the next
10 years. Debt-to-GDP is going to rise from about 100 to 120
percent, and the structure of the Federal budget, these large
deficits, is a headwind to growth, and threatens to further
reduce the pace at which we grow.
Now, how should we address this? The bulk of the increase
in deficits, as I outline in my written testimony, is going to
occur on the spending side, in particular large mandatory
spending programs in your jurisdiction: Social Security and
Medicare. They more than explain the rising deficits over the
next 10 years, and they, as a result, are the most important
reforms that you can undertake.
Beneficiaries deserve having a financially sustainable
social safety net. The red ink is a danger to the economy, and
to reduce this will in fact improve economic growth. How does
tax policy fit in this context? Well, it is imperative that we
have faster and sustained economic growth, and tax policy
should be, in a very disciplined way, focused on being
progrowth.
That means where revenue needs to be raised, it has to be
raised in the least economically damaging way possible.
Consumption taxes, as Dr. McBride mentioned, are top of the
list. Broadening the tax base to cover currently exempt
consumption would serve to do that, and we should keep taxes on
the return to saving, investment, and innovation as low and
uniform as possible.
That is the recipe for supporting more rapid economic
growth. It also turns out to be the recipe for getting rid of
the tax avoidance that is troubling to Americans, the subject
of this hearing. The recipe for putting together a tax shelter
is to take advantage of the differential tax rates on corporate
and noncorporate returns to capital income, to show it as
interest, dividends, and capital gains. These are all legal,
and they are the result of a tax code that is too complicated
and sets up incentives for avoidance. It makes it easy to do.
The thing to do for economic growth is to reduce those taxes
and make them more uniform. The thing to do to get rid of
avoidance schemes is to reduce those tax rates and make them
more uniform. So this hearing is right in line with what is
necessary to support the problems that the United States faces
going forward.
Finally--and I will just close--the avoidance is a very
real product of the tax code as it is designed. The evasion is
unforgivable, and so I think we need to simply have an IRS that
is equipped, staffed, and has a mission focus that is to
enforce the tax code in a fair fashion across the income
distribution, and not focus mainly on high-income individuals.
Any examination of the tax gap shows that this occurs in
both small businesses, large businesses, affluent, less-
affluent Americans. We need an IRS that is looking for those
dollars wherever they may be.
So, I thank you for the chance to be here today. I look
forward to your questions.
[The prepared statement of Dr. Holtz-Eakin appears in the
appendix.]
The Chairman. Thank you, Dr. Holtz-Eakin. And all of you
are going to get some questions. I am going to try to take this
whole tax debate, which sometimes sounds like prolonged root
canal work, and put it into kind of English.
The little sign in back of us here is what is especially
troubling. You can buy, you can borrow, you die, and
billionaires can avoid taxes. Now, I want to ask Ms. Huang a
little bit about how this actually goes down, and I want you to
sort of flesh out the example that I am giving.
A corporate raider buys a business. Then the raider borrows
against its growing, untaxed value, and they are doing that to
fund an extravagant lifestyle. That means they can get
superyachts, luxurious vacations, expensive art deals--you name
it--and it just keeps going up and up in value, while not
paying a dime in taxes.
Ms. Huang has been educating me on this, and when this
person dies, their assets get passed to their kids, often
entirely tax free. And what a surprise: the cycle just goes
around and around and around. So, Ms. Huang, you are an expert
in the field, and you teach it. Tell us a little bit more about
how this takes place, because as far as I can tell, somebody
who wants to do this, Mr. or Ms. Big, calls up their accountant
and their tax lawyers and says, ``Get over here.'' ``What do
you want to talk about?'' ``I want to make sure I do not have
any taxable income this year. That is my goal. I want to make
sure I do not have any taxable income this year.''
So they set out to be able to do something very different
than the firefighter and teacher. They do not want taxable
income, and the accountant and the lawyers come over, and what
do they do? I mean, how does it all go down?
Ms. Huang. I mean, you've got it almost exactly right to
start with. A couple of questions that people often ask are
like, well, aren't they paying interest rates? So doesn't this
cost them something? And usually the answer is, they get very
low rates because they have a lot of wealth and a lot of
collateral and a very low risk.
The Chairman. They get low interest rates from the bank?
Ms. Huang. Exactly.
The Chairman. Okay.
Ms. Huang. And then another question people ask is, well,
how do they pay back those loans? And quite often they do not.
They just roll them over again and again, and if they do, they
might do it with some of their other sources of income that are
taxed, such as dividends. Very, very wealthy people tend to
have multiple sources of income.
And as you said--I mean, you could be working as a tax
advisor. You laid it out so clearly. But as an advisor who
works on these loans said, you can buy a boat. You can go to
Disney World. You can buy a company. This is real income, and
you can use it for real things, and you get stunning tax
benefits because it escapes the income tax entirely.
The Chairman. And I gather there are tax lawyers and
accountants who are experts at buy, borrow, die. I mean, there
are people who, when they get called by a client who does not
want to pay Federal income taxes, does not want to do what
firefighters and nurses do, there is a pretty good squad of
them who are ready to go?
Ms. Huang. Exactly. And you know again, this is--you can do
the basics of this pretty simply, but if you want to shove some
of your labor income or your income for other types of assets
into this scenario and also avoid the estate tax that is
supposed to be a backstop on the system, that is where some of
the more complex games come in.
The Chairman. Okay.
Question for you, Mr. Pearl. You come from the private
sector, from a very large firm, and you basically said, you
know, this idea that if you do something about fixing buy,
borrow, die, that if you do, some critics will say western
civilization is practically going to end, you know? We will
lose investment, and there will be a parade of horribles that
will be visited upon our Nation, which of course we do not
want. We want people to be successful. We want everybody to be
successful. I think what you have tried to do is put on the
record that there is no way that is going to happen.
Well-to-do people that you have worked with are not going
to, this weekend, rush out and put everything under their
mattresses, to defend themselves from the U.S. Senate. They are
still going to have plenty of opportunities to do well, to be
successful, to invest. Is that essentially your argument?
Mr. Pearl. Yes, Chairman Wyden. We wealthy people invest
money, and I would certainly rather invest my money at a high
return and keep half and pay the other half in taxes, than get
no return at all. Paying high taxes is great, because it means
you have high income.
I think one of our issues is that many people think high-
income--oh, a United States Senator has high income. No, we are
not talking about people who earn a few hundred thousand
dollars or a few million dollars a year. The people who would
be affected by your proposals from mark to market are people
who earn hundreds of millions or billions of dollars in
economic income, but almost nothing in taxable income.
I think that part of the issue is, we have to redefine what
we mean by taxable income as money you make regardless of how
you make it. Whether it is from a paycheck or from just
watching your stock market investments go up, you are making
money, and you should pay taxes on that money the same as
everyone else does.
The Chairman. I am well over my time.
Senator Crapo?
Senator Crapo. Thank you very much.
It seems to me as I have listened to the testimony today,
probably the major focus is on the differential in tax rates
between capital gains and other taxable income. So, in thinking
about this, it seems to me that the impression is that only
rich people have capital gains.
But we all know that anybody who has been investing in a
retirement plan for their future, anybody who owns a home,
anybody who owns a capital asset, has a capital gain. So it
seems to me that if the solution were to make the tax rate the
same for capital gains and ordinary income, we would be putting
a tax increase on a tremendous number of people who are not in
the category of your millionaire's club, Mr. Pearl.
And I do not think that that is what anybody on this panel
was suggesting either. So my question is--and I guess I will go
to you, Dr. Holtz-Eakin--what is the solution? Have I
identified the issue that is being raised here accurately, and
what is the solution if differential tax rates are causing
these kinds of problems?
Dr. Holtz-Eakin. Well, the solution is to have tax rates
equalized at as low a rate as possible, so that you do not
build the ingredients of the tax avoidance schemes. I mean,
this tax avoidance scheme hinges on interest deductibility and
a low tax rate on capital gains and other sources of capital
income. So that----
Senator Crapo. So, if we were to make the tax rate on
capital the same as the tax rate on ordinary income, we could
then lower the tax rates, and people would not actually see,
overall, a tax increase. Is that what you are saying?
Dr. Holtz-Eakin. Yes, and I think the key is to--you know,
this hearing is focused on the individual income taxes, but if
you look at the scheme that the chairman described, it is the
system. It is a corporate raider, and it is the tax treatment
of both the entities and the individuals. The system has to
collect taxes on capital and labor income, and that is not what
we do very well.
Senator Crapo. Now, what about the notion that you do not
pay taxes, capital gains taxes, until you realize the gain? Do
we have to make everybody realize the gain in their house every
year? Do we have to make everybody realize the gain in their
investments in their retirement fund every year?
Dr. Holtz-Eakin. No. I am actually not a big fan of those
strategies. There are approaches which focus on collecting such
taxes at the entity level. Things like the X tax, personal
progressive consumption taxes, all have a system where
essentially the tax on capital income is collected at the
entity level. It never gets out into financial markets.
You do not chase it around the globe and do all the
expensive things that are being proposed here. You simply
collect it efficiently at the entity level, and it is collected
on behalf of the individuals at that point.
Senator Crapo. All right.
Dr. McBride, could you comment on this general set of
questions?
Dr. McBride. Sure. I fully agree with these comments from
Doug over here. It can be done, and it should be done as a
general principle to pursue uniform taxation, and you can even
go so far as to equate the tax rate on ordinary income and
capital gains.
We have a plan that does that--or we have a plan that we
have modeled. It is not a hypothetical plan. It is actually a
real tax system that exists out in the real world in a small
country called Estonia. They have a 20-percent tax rate that
applies uniformly to all sources of income, including capital
gains, wages, et cetera.
And it is a very simple system. It has a lot going for it.
We have shown that if we implemented it in the U.S., it would
produce a lot of growth, a lot of jobs, a lot of increase in
wages, et cetera.
Senator Crapo. So what does that plan do with regard to
when gain is realized?
Dr. McBride. Well, no country has really experimented with
that, as far as I know, not on the broad scale that is being
contemplated here. It is true we do in very limited cases, in
the current U.S. tax code, apply the tax to unrealized capital
gains for some certain financial derivatives, et cetera.
But there is no country or jurisdiction that I am aware of
in history that has tried to apply this approach broadly to a
majority of assets held by any income class.
Senator Crapo. All right; thank you.
Just one other really quick question. I am kind of shifting
gears here rapidly, but an issue that comes up here often is,
well, why don't we just tax corporations and not people, and so
then, we have this endless source of income. Who pays corporate
taxes? Could you answer that, either of you? Dr. Holtz-Eakin?
Dr. Holtz-Eakin. Individuals pay the corporate tax. It is
either the shareholders or the customers in higher prices, or
the workers in lower wages.
Senator Crapo. Yes. My understanding is that a pretty
significant portion of it is paid by labor, and a pretty
significant portion of it is paid by those who are in
retirement plans, and a very small portion is paid by the
actual individuals who own the corporation.
Dr. Holtz-Eakin. Right.
Senator Crapo. Other than through their tax----
Dr. Holtz-Eakin. That is a fair summary, yes.
Senator Crapo. All right. My time is up. Sorry.
The Chairman. I thank my colleague, and I look forward to
working with you, Senator Crapo, to explore these issues.
Senator Menendez?
Senator Menendez. Thank you, Mr. Chairman.
Over the last decade, the IRS budget shrunk by 20 percent,
resulting in 20 percent of its workforce being laid off. And
because of the IRS's lack of resources, audit rates for those
with incomes over $5 million dropped from 16 percent to just 2
percent over the same time period. And, while middle-class
families and small businesses have borne the brunt of the IRS
customer service problems, wealthy individuals and large
corporations have been all too happy to take advantage of the
IRS's limitations and underpay taxes that they legally owe.
That is why the historic $80-billion investment we made in
the Inflation Reduction Act has significantly improved customer
service and ramped up the enforcement on the highest earners.
But we have our colleagues on the other side of the Capitol, on
the Republican side, continuing to propose cuts to this
critical funding.
Ms. Huang, does cutting the IRS's budget for enforcement
increase or decrease the Federal Government's revenue?
Ms. Huang. It decreases the Federal Government's revenue
and it overall adds to deficits.
Senator Menendez. So it decreases the government's revenue?
Ms. Huang. Decreases the government's revenue and adds to
deficits.
Senator Menendez. And who pays the price of tax evasion by
the wealthiest and large corporations?
Ms. Huang. Well, the addition to deficits means either
underinvestment in pressing issues in the Nation, including
raising workers' living standards, meeting global challenges,
investing in innovation. It also could mean tax increases on
other folks further on down the track to deal with those
issues.
And it also means that honest filers have to compete with
tax avoiders and evaders when they are just trying to focus on
their business and real-world work.
Senator Menendez. And obviously the corollary of that is,
it affects negatively our national debt and annual budgeting
abilities?
Ms. Huang. Exactly.
Senator Menendez. Now, I do not understand how some of our
colleagues continue to push for a policy that makes it easier
for tax cheats, which at the same time cuts resources that are
projected to reduce deficit spending, which is what I want to
talk about next.
There are just 8 days left for the government's funding
before we no longer have the funds necessary to continue to
operate the services that the Federal Government provides for
its people. Some of our colleagues are threatening a shutdown
in order to extract spending cuts in the name of fiscal
responsibility. It seems hypocritical to me to threaten a
shutdown and call for spending cuts on the backs of working
families, when they have depleted the revenue side of the
ledger over the last 5 years.
Ms. Huang, how much did the 2017 Republican tax law add to
the Federal deficit over 10 years?
Ms. Huang. When it was enacted, about $1.9 trillion over 10
years.
Senator Menendez. $1.9 trillion. Did the bill pay for
itself, as some of my Republican colleagues claim?
Ms. Huang. Not at all. That estimate included any very
small positive impact on the economy. That has been very hard
to see in the reality.
Senator Menendez. So, we have $1.9 trillion that is lost on
the revenue side--and this is very basic. If you have a
business, and revenue is not being produced, you have one of
two choices. You either cut spending, or you find another
revenue source to increase it. Here we have revenue being cut
dramatically, and then at the same time saying, well, we should
have spending cuts for fiscal responsibility.
But the revenue side of the equation never seems to be part
of the fiscal responsibility. That is why--you know, when I
supported the Inflation Reduction Act, it actually cuts deficit
spending while supercharging investments in some things that
make our economy even greater.
Finally, it is important, I think, to understand why we ask
large corporations and wealthy taxpayers to pay for their fair
share of taxes. It is not to punish success or tax just for the
sake of taxing. It is because we have real issues in front of
us today, many of which impact our economic growth and our
competitiveness on the global stage.
For instance, we are currently in the midst of a child-care
crisis. Families across the country are forced to make
impossible decisions, such as whether to leave the workforce
altogether, or to leave their children in unsafe situations
while they go to work. Child-care centers are being forced to
close, and they pay invaluable teachers less than the minimum
wage.
So, Mr. Pearl, from your perspective as an asset manager,
isn't using some of this potential revenue source toward making
child care affordable a worthwhile investment that increases
economic activity and business productivity?
Mr. Pearl. Yes. Business in our country depends on
consumers who are able to pay for things, depends on parents
who are able to work, and work at their jobs. Even in New York,
as we have increased child-care availability for their young
children, that has increased greatly the number of mothers who
are able to work and earn money, and has actually increased our
tax revenues in the city where I live.
Senator Menendez. Thank you, Mr. Chairman.
The Chairman. I thank my colleague. So many members have
come.
Senator Blackburn, you are next.
Senator Blackburn. Thank you, Mr. Chairman, and thank you
all for being here.
Dr. Holtz-Eakin, I want to come to you. There is this term
that came up in one of our hearings, and the chairman has heard
me talk about this several times, and it was a new term that
Commissioner Werfel used. It was ``total positive income,'' and
this came up in relation to that $400,000 threshold, where the
administration claims they are not going to audit people who
are making under $400,000 a year. Well, we also had Marjorie
Rollinson in front of the committee in September, and she
seemed to have a little bit of trouble giving us a clear
definition of what is total positive income.
I had done a little digging through Tennessee. I think you
know my State fairly well. The National Federation of
Independent Business has just hundreds, thousands of members,
small business owners. We are a very entrepreneurial State. And
as I have looked and talked with businesses and reviewed this
issue, it does not matter if it is a quilt shop or a tavern in
east Tennessee, or if it is an independent electrician over in
west Tennessee trying to do some work with BlueOval City, what
people keep saying is, ``What is total positive income and who
is going to be affected by these new audits that are coming on
that?'' Because a lot of LLCs, LPs, sub-S, they are all on that
individual return.
And I would love to hear from you if you can give me a
definition, a working definition of what that is supposed to
be, and what is that benchmark, and small businesses, what
should their concern be about this?
Dr. Holtz-Eakin. I cannot give you a working definition or
any other definition. It is a concept that they have developed
and they are using.
I will say this: I cannot support this notion that the
President's pledge to not raise taxes for people under $400,000
is the same thing as saying you are allowed to cheat on your
taxes.
That is just not okay. It does not matter what your income
is. And those audits ought to be applied on the basis of
evasion, the probability of evasion, and the ability to collect
taxes that are legally owed, and no other criteria should
matter. It makes no sense. Total positive income, total
negative income, hypothetical income, I do not care what the
income measure is, apply it across the board and collect the
taxes.
Senator Blackburn. Is there anybody on the panel who can
give a definition of total positive income as it relates to
this $400,000 threshold?
Ms. Huang. I would agree with Dr. Holtz-Eakin that one of
the things that you need to be very careful of is not setting a
threshold that then allows the worse tax evaders to just file
their returns pretending that they have income below that level
and therefore avoid detection on audit.
And that is one of the tricky things about having a bright
line. And I also agree with Dr. Holtz-Eakin that----
Senator Blackburn. And no one knows where that bright line
really is, yes? Well, that has been perplexing for a lot of
Tennessee businesses, thousands of them. They cannot figure out
what is going to be coming at them.
Mr. Pearl, did you have something you wanted to say?
Mr. Pearl. No; I would agree. I think that everyone who
should be potentially subject to examination by the Internal
Revenue Service shouldn't be scared of the Internal Revenue
Service if they are following the laws.
I think the changes we are talking about in these proposals
are really things meant not even for the 1 percent, barely for
the hundredth of 1 percent, for the few tens of thousands of
the most wealthy people in our country, not for all these----
Senator Blackburn. That may be what the intention is, but I
have to tell you, people are just really--if you all are
confused about what this is, imagine how Main Street businesses
are confused about what all of this means.
Now, talking about the audits, this July, GAO examined IRS
audits of large partnerships and found that the agency is
starting from a very weak position when they talk about
bolstering these audits.
Much to the comments that you all have made, between 2010
and 2018, four out of every five of those audits resulted in no
change, and of those that changed, the company overpaid taxes
and they were owed money back by the IRS.
So I think that what we need to do is have some clarity
around this, when you are talking about this new wave of audits
and being focused on these complex partnerships. And then the
GAO does a study, and that is not where they found the problem
to be. I think we need to be mindful of that.
Mr. McBride--well, my time has expired. Mr. McBride, I will
submit a question to you on this issue for the record.
Thank you, Mr. Chairman.
The Chairman. I thank my colleague, and I just want--
because she has been a very, very constructive member of the
committee, I want her to know I am going to stay at it until we
get the official definition of total positive income from the
IRS. They know that I feel strongly about it, and we are going
to----
Senator Blackburn. Well, I appreciate that, because people
are so confused on this, and they keep saying, ``How does this
affect me?'' And I am in each of Tennessee's 95 counties every
year, Mr. Chairman, and this is not a statutory definition.
This is a Biden administration definition, but there is not a
working framework on this.
And small businesses are trying to prepare for next year,
and they are trying to make longer-term plans, and they are
looking at business structures, and they have this undefined
term that this administration refuses--it is like Jello. They
refuse to define it.
The Chairman. I think it is more like a sandwich that they
have said is built around one principle, which is: total
positive income means that someone like a hedge fund manager
cannot wipe out their millions with capital losses. In other
words, that is how they define it. But Senator Blackburn has
asked about this at a number of hearings. I think we all have a
right to have this in writing, and we are going to insist on
it, and then we will all share it at that time.
All right. Next up will be Senator Hassan.
Senator Hassan. Well, thanks Mr. Chair, and to you and the
ranking member for having this hearing. Thank you to our
witnesses for being here.
Mr. Pearl, this is a question for you. A large part of the
tax gap--that is the difference between what people or
businesses owe versus what is actually collected--comes from
major corporations and multimillionaires avoiding taxes by
underreporting their income, underpaying what they owe, or just
not filing tax returns at all.
Mr. Pearl, could you go over the recommendations you have
for reducing the underreporting of income so that we can ensure
that major corporations and the very wealthiest are paying
their fair share?
Mr. Pearl. Well, yes. We believe that the Internal Revenue
Service needs the funding to hire lawyers and experts who can
deal with these things. Most of what I have been talking about,
Senator, is not really people breaking the laws, but really the
fact that the laws that we now have allow the wealthiest among
us to pay for lower tax rates than their constituents who work
for a living.
Senator Hassan. Right. And so, just to follow up on that,
when the tax laws allow major corporations or the highest
earners in our economy to not pay taxes, what recommendations
do we have for changing those laws?
Mr. Pearl. Well, what we are suggesting--along the lines of
what the chairman proposed, and the President--is changing the
law so that economic income, whether it is income from wages or
income from your stocks going up in the stock market, is taxed
the same way for the highest earners.
We do not even mean people who make $400,000 a year. We
mean people who make millions of dollars a year. Those people
should pay taxes on the money they make that increases their
wealth, regardless of what form that income takes.
Senator Hassan. Thank you.
Ms. Huang, the IRS needs to continue to improve services
for taxpayers, such as making it easier for them to call the
IRS and quickly get answers to their questions. And I would
expect that every single Senator up here has a constituent
service team that spends a lot of time talking with taxpayers
who cannot get a hold of somebody at the IRS.
But the IRS struggles to do that, in part because of the
need to devote significant resources to stopping tax avoidance
by major corporations and the very wealthiest individuals. So
how does underreporting of income by the ultra-wealthy divert
resources away from improving taxpayer services at the IRS?
Ms. Huang. It absolutely does that. We should not be
focusing on the small amounts of money of many low- and
moderate-income people who are just making errors on their tax
returns. A person filling in a return for a Child Tax Credit,
for instance, faces a series of instructions that are as
complex as someone who has high income in filling in the
alternative minimum tax.
Senator Hassan. Well, thank you.
And then this is just really a question to the full panel.
We are here today talking about this tax gap, and you have all
made suggestions.
But I will start with Dr. Holtz-Eakin. We will just go down
the row. What is your top recommendation to help close the tax
gap? You have all hinted or said different things, but let us
just go down the line.
Dr. Holtz-Eakin. So just to be clear, the tax gap is
evasion. It is illegal, and so that is an enforcement issue and
comes down to having an effective audit strategy at the IRS and
the resources to implement it. Most of what we are talking
about today is avoidance, which is legal, and that means
changing the tax code to reduce those opportunities.
Senator Hassan. Right. Thank you.
Dr. McBride?
Dr. McBride. I would highly recommend radical
simplification of the tax code. As I mentioned, there are
examples around the world to look to with much simpler tax
systems, and they have a greater rate of voluntary compliance
and much lower administrative costs. And particularly, I am
thinking of the country of Estonia, and you can find more
information about that on our website.
Senator Hassan. All right; thank you.
Mr. Pearl?
Mr. Pearl. Yes; thank you. I would also say that most of
what we have been talking about is tax avoidance, which is
legal. But if you are concerned about compliance, well sure, if
you lower the tax rates to zero, you will get 100-percent
compliance. But I do not think that will actually solve the
real problem we are trying to solve, which is fairness in our
country and funding to fund the government.
Senator Hassan. Thank you.
And Ms. Huang?
Ms. Huang. There is absolutely a line between avoidance and
evasion. I think one of the things that is important to note is
that a complex series of tax breaks push people into that gray
area, and then sometimes over the line. So we both need to look
at resources for enforcement, but also the tax breaks to sort
of feed this planning activity.
Senator Hassan. All right. Thank you very much.
Thank you, Mr. Chair.
The Chairman. Let's see. I believe Senator Warner is next.
Senator Warner. Thank you, Mr. Chairman. I appreciate you
holding this hearing, and I know this is an issue that you and
a lot of our colleagues are passionate about, and I want to
work with you and others to get to the solution that works.
I also want to echo what I think a number of my colleagues
have said about IRS enforceability. The easiest way we can
start down this path is to make sure the IRS gets back to the
capabilities it had, for example, under President Bush, which
means it is going to need some of these resources.
You know, I have been thinking a lot about this, and I
think it is a hard thing to kind of come to a conclusion on. I
think we have to appreciate the comments from the panel. If we
are going to do this, it's got to be fair, it's got to be
simple, it's got to be comprehensive.
We've got to find a way to make sure that folks do not game
the system. As somebody who was lucky enough to be an
entrepreneur myself and then as a venture guy funding a lot of
entrepreneurs, I think we need to make sure we do not stamp out
that growth piece of our economy.
I appreciate, Mr. Chairman, that you've actually got the
buy, borrow, die platform up there, because that is where I
want to dig in, and I think Mr. Pearl actually made reference
to that. I want to focus on the borrow piece, because one of
the things I still struggle with is some of the proposals that
put a tax in place without a realization event, and I cannot
find other examples of that in other
nation-states.
But I do think the nature of our tax code is that you can
borrow against your assets, oftentimes liquid stock assets, and
some of the best billionaires around do that on a regular
basis. And then they ultimately die and they pass on those
assets without any realization of income. Yet they have used
the system to fund their lavish lifestyles.
I guess I will start with Ms. Huang and maybe go down the
panel, but this notion of--particularly if you are borrowing
for lifestyle as opposed to borrowing to make an additional
acquisition, I think is an area that has some difference.
And I do think there has been some recent testimony that
has indicated that there might be a lot more with the
appropriate use of borrowing as a realization event, with
assets of a certain size, that might obtain a lot more tax
revenue than previously thought. So, Ms. Huang--then we will go
down the list.
Ms. Huang. So, I think you are just putting your finger on
the fact that billionaires can spend their untaxed capital
gains income, and that is most obvious when they are borrowing
against it and they are purchasing things with it. It really
just sort of puts a finger on the point that this is income in
the real world. It is not just some theory that us lawyers and
economists have dreamed up, but they are real-world resources
that can be used, and it is just the tax system that is
currently ignoring that resource. And you are correct that
there are lots of options for addressing this.
Some of them include taxing those gains closer to when they
are made. Some of them focus on that sort of consumption out of
that wealth, and I think they deserve study. What is not sound
is just a system where that income can evaporate out of the tax
code altogether.
Senator Warner. Which is obviously the case, and we can all
list lots of people who use that tool.
Mr. Pearl?
Mr. Pearl. Yes, I agree with what Ms. Huang said.
Essentially, if I am able to borrow money against my brokerage
account, as long as the stocks that I own increase in value at
a higher rate than the interest on the account, I am still
becoming wealthier over time.
The broker is perfectly happy to see a debit balance
increase indefinitely for my entire life, and it is essentially
economically the same as a realization of that, except it is
not taxable. And yes, so I agree with you.
Senator Warner. Dr. McBride?
Dr. McBride. I would point out in these scenarios that are
being described here that we are talking about corporate stock,
I think, as the primary example, and that is because if you
look at the wealthiest individuals in the country by whatever
publication is doing that analysis, they do tend to be
entrepreneurs who have built a business that is subject to--you
got it--the corporate tax.
So I think that what is missing in the discussions is that
even if the individual who holds shares in these companies--and
we are talking about founders typically, who have a lot of
shares--if they do not realize income by selling the stock in
any given year, that does not mean they pay no tax, because
every year the company that they own is subject to corporate
tax, 21 percent on income.
Senator Warner. Yes, but the actual tax, as you know, Dr.
McBride, is functionally much, much lower than that. I probably
should have gone the opposite way on this with Dr. Holtz-Eakin.
I know my time is up, but please.
Dr. Holtz-Eakin. Well, I mean the key, as you mentioned, is
to maintain these incentives for growth. And so, we have had in
the code, full expensing of investments--capital investments,
investments in technologies and business models--and that is a
fantastic growth incentive that is very important to have.
It also changes the effective tax rate on the normal rate
of return to zero, which I think is fine. I am a zero-tax-on-
capital guy. If you allow them to borrow and make that
investment, the effective tax rate is negative. No. So given
the growth incentive, do not also allow them to do the interest
deductibility.
Get the effective tax rate down as low as possible, and get
rid of these avoidance opportunities.
Senator Warner. Thank you.
Thank you, Mr. Chairman.
The Chairman. Senator Carper is next.
Senator Carper. Welcome. I had a chance to talk to each of
you before the hearing started, and I missed a good part of it.
But I am here now and happy to see all of you today. Thank you
all for spending this time with us.
I remember as Treasurer--I was elected Treasurer when I was
29 years old. Nobody else wanted to run. We had the worst
credit rating in the country. We elected a Governor, a
Republican named Pete DuPont. He turned out to be a great
Governor and a good mentor for me.
And he--in spite of having large deficits--led an effort to
reduce our personal income tax; led our effort, and we did.
When I was Governor, I think for maybe my last 5 years as
Governor, we trended back, I think five times, 5 different
years.
So we ended up with instead of a 19-, almost 20-percent
marginal personal income tax rate, when he stepped down as
Governor, it was probably closer to 6 or 7, and we always
balanced our budget--always balanced our budget. And when I was
Governor, we had triple A credit ratings.
We still have triple A credit ratings. So the question is,
can you go out and collect taxes that are needed to fund
programs? Yes, we have shown you could do that in Delaware, and
we make sure that people pay their fair share of taxes.
I remember when I used to hold--and I know my colleagues
who served in the House with me, including the chairman, did--
but I used to hold a ton of town hall meetings. Once a year I
would do a meeting in each county, and we would invite the IRS
to come.
We would invite the State Division of Revenue to come. We
would actually provide services onsite on a Saturday to dozens,
scores of people who would bring their taxes and say, ``I need
some help in filling them out.'' My last year as Governor, when
the Delaware Quality Award was awarded, it was awarded to the
Delaware Division of Revenue--the Delaware Division of Revenue.
And they won because they provided great service--great
service. If people had an issue, they could call. They could
come to a town hall meeting. And they had offices in all three
counties--we only have three counties--where people could get
the help that they need. I remember having, in one of my town
hall meetings--we would actually do an exercise where we would
invite constituents to come and balance the budget--balance the
budget.
It could be, you know, entitlement spending, discretionary
spending. I remember this one time we were doing this exercise,
having a hard time balancing the budget with the group. I kind
of let them lead it, and I just shepherded a little bit.
But they could not balance the budget, and I said to them,
``You know, revenues are a piece of the pie.'' I said, ``It is
an option.'' And this one--I will never forget--this one lady
in the back of the room raised her hand, and she said, ``I do
not mind paying my fair share of taxes. I just want to make
sure other people are as well.'' I have never forgotten those
words--never forgotten those words.
And I have sat here on this committee for almost 20 years,
and I cannot tell you how many times we have had our IRS
Commissioner come before us and speak in terms of things that
they thought they needed support from us for: technology, for
people, the clarification of tax codes, and so forth.
But I think it has been a consistent message. But a big
part of it is that we need the IRS. We need not just great
leadership, and I think we have that with Danny Werfel. We need
the right resources--human, technology--in order to do the job.
And we need to be able to provide service, when people have
questions--to provide service. They call us and they get an
answer, and they get the straight answer.
We get a lot of calls in my offices in Delaware from people
who need help, and we help them. We help them. So, with that
having been said, I have a question or two here if I can find
them. So, bear with me for just a minute. Here we go; all
right. Thank you for your patience.
First question, and this is for Ms. Huang. How does funding
the IRS bolster the fiscal health of our Nation? I think I have
sort of set that up, but how would the proposed repeal of these
investments impact taxpayer compliance?
Ms. Huang. So the services that you were talking about are
actually one way people think about compliance and enforcement
as sometimes a scary thing, but sometimes it is as simple as
having the IRS be able to answer a question for someone who
wants to do their taxes well, and would make an error if they
could not get a straight answer to what they need to be doing.
So that is part of it. That is the reopening of the in-
person Taxpayer Assistance Centers across the country. The
other part is going after more pernicious forms of evasion and
avoidance. That requires highly skilled auditors who can pick
through the returns of the wealthiest filers, which are often
complex, and that all brings in far more per dollar spent than
is actually devoted to those people.
Senator Carper. All right; thank you.
Mr. Chairman, could I have another minute?
The Chairman. We are trying to get through----
Senator Carper. I will just stick around. I will just stick
around, if I can.
The Chairman. Oh, great; terrific.
Senator Carper. Thank you.
The Chairman. Senator Cassidy would be next.
Senator Cassidy. Thank you.
The Chairman. Depending on who else comes, the order would
be Senator Cassidy, Senator Casey, Senator Whitehouse.
Senator Cassidy?
Senator Cassidy. Okay; thank you all for being here. And I
have been puzzling about this for a long time. So George Soros,
George Soros, got a CARES Act check, meaning that he was
earning less than $150,000. Now, to his credit, he gave it
back. But the fact is that his income tax was such that he was
only making $150,000, and this is George Soros.
Now, there are other examples, but I picked him because he
is so well known. Would he be considered, Mr. McBride, among
the top .001 percent that year in terms of paying income tax,
or because his declared income was so low, he was actually not
considered part of that top 5 percent, 1 percent, .1 percent?
Dr. McBride. Well, I do not know his exact situation, of
course, but I could guess that we are talking 2020, perhaps
2021, both years in which the stock market would have been way
down----
Senator Cassidy. But my point is, if somebody borrows
against their assets and does not take salary----
Dr. McBride. Right.
Senator Cassidy [continuing]. And so their reported income
is low, are they considered among this top .001 percent even if
they are worth billions of dollars because they are reporting--
are we judging that percent by their wealth or by their
reported income that year?
Dr. McBride. Generally, by their reported income. Others
try to supplement that with other measures----
Senator Cassidy. I have limited time, so I just--I did not
know that.
So, Mr. Pearl, I have a friend of mine who is always
busting my chops on different things. He is a realtor, a real
estate developer, and he says because of section 1301--and I
understand the importance of incentivizing people to turn that
money over and the economic activity that it therefore
generates.
What he says is--one of the things he busts my chops on is,
he says that he has made a lot of money every year for several
decades, and he has not paid income tax for several decades.
So, when I read the statistics that the top 1 percent are
paying a disproportionate amount of the income tax, which I
accept, it seems to me that must be a heterogeneous group
though.
There are some who are really paying a lot, and some who
are making a lot of money and paying nothing. Is that a fair
assessment?
Mr. Pearl. Well, yes. Part of the problem is--I think you
are talking about like-kind exchanges.
Senator Cassidy. Yes.
Mr. Pearl. And yes, part of the issue is that some people--
if you are really rich, you do not need any taxable income,
either because you borrow against your assets for buy, borrow,
die schemes, or because you have like-kind exchanges and a few
other things that can reduce your taxable income.
Senator Cassidy. So, Ms. Huang, if I may, because you
seemed to be nodding your head kind of as I was talking.
Although some people who are billionaires are paying millions
of dollars of taxes, there are others who are millionaires,
like my friend, who is kind of like complaining that he is not
paying taxes.
I say, ``Well, you could give the taxes if you wanted to,''
but he says that is not the point. So within that, there are
those who, although making a lot of money--either because they
are borrowing or they are doing like-kind exchanges, et
cetera--they are paying nothing.
Ms. Huang. That is exactly right, yes. And the problem is
that when the statistics try to figure out who is in the top 1
percent, those people do not even show up in the top 1 percent
because the statistics are based on what shows up on tax
returns.
Senator Cassidy. Now to be clear, this is not their fault.
That is the fault of Congress.
Ms. Huang. Absolutely, absolutely.
Senator Cassidy. Congress has made these laws, and so we
have met the enemy, and he is us. I would like to say it was
the Democrats, but that is another issue. They would say to me,
you know, that's beside the point. [Laughter.]
So, Dr. Holtz-Eakin, good to see you, man. I could not
quite hear what you were saying to Senator Warner, but at the
end you said something along the lines that we should not allow
people to borrow money and then to----
Dr. Holtz-Eakin. Expense the investments they use that
borrowing to purchase.
Senator Cassidy. Say that one more time. I am a
gastroenterologist, not an economist.
Dr. Holtz-Eakin. And so, you have your gastroenterology
business, and you need to buy new equipment for it. So the tax
code, until recently, allowed you to fully deduct in the year
you buy that equipment, the cost of the equipment. That is
exactly the right thing to do, from my perspective.
It gives you full cost recovery for your investment--you
get it all back right away--and it provides excellent
investment incentives. Now that is essentially a zero effective
tax rate on the return to that investment, and I am fine with
that. If we then give you an extra deduction for the borrowing,
you change that zero to a negative number. We are subsidizing
that business. I see no reason to do that.
Senator Cassidy. And current law allows the deduction of
that borrowing?
Dr. Holtz-Eakin. Yes, yes.
Senator Cassidy. Now, reading your testimony, I was not
quite clear. Would you repeal capital gains tax and treat all
income as ordinary income? Because you said to go to zero on
capital gains. Does that mean that there is no taxation on the
individual from the sale of a stock, even if it has escalated
in value?
Dr. Holtz-Eakin. The easiest way to think about it is,
think of IRAs. Take your pick. You can do a traditional IRA,
give them the deduction up front but treat everything that
comes out and tax it at the same rate. That would tax interest,
dividends, capital gains, all at the same rate.
Or do a Roth IRA and do not allow a deduction, but do not
even attempt to go after the capital gains. Take your pick.
Both are good tax systems--very simple, good investment
incentives.
Senator Cassidy. You are implying that we are taking the
worst of both as opposed to one or the other, which would be
the best of one.
Dr. Holtz-Eakin. Let me stop implying and say, yes, we are
doing the worst.
Senator Cassidy. We are doing the worst. Okay. If you could
send that to me offline, I would appreciate that detail. Thank
you.
I have a lot more questions, but I am out of time. But I
really appreciate the testimony.
The Chairman. I thank my colleague and look forward to
working with him on these issues.
Senator Casey, you are next.
Senator Casey. Mr. Chairman, thanks for calling this
hearing. I want to thank our witnesses. I want to start with
kind of where we have been over the course of 40 years.
Due to the rigging of the tax code over roughly the last 40
years, our tax system over and over again intentionally favors
those with very large incomes and often very large lobbying
organizations, while the middle class continues to suffer from
very limited, if any, tax relief.
Just by way of example, between 2020 and 2022, just those
years, corporate profits rose 75 percent, five times--five
times--as fast as inflation. I released a report this week
called ``Greedflation,'' meaning major corporations taking
advantage of customers by jacking up prices and blaming it on
inflation, or using inflation as the cover to jack up prices.
The report shows that the average middle-class family in
Pennsylvania was forced to pay an extra 3,200 bucks in 2021,
and more than $3,500 in 2022, just because of this
greedflation. One corporate executive claimed that his company
``earned the right'' to raise prices. Another executive at a
different company bragged that their products are ``worth
paying a little more for,'' just seemingly oblivious to what
real people are paying at the grocery store and otherwise.
These same companies and their shareholders were given what
I would argue were obscene tax breaks in 2017 through that
bill, and so now they pay much less in taxes on their profits
than they squeeze out of American families.
So, Ms. Huang, what is the best way for Congress to ensure
that businesses' high profits are being appropriately taxed, so
that we could redirect or reinvest those dollars into the
middle class and put money back in the pockets of those
families?
Ms. Huang. So, I have heard my colleagues here say that
there is a problem with potential double taxation of both
corporate income and at the individual level. But if you look
at the data, the actual bigger problem is double non-taxation:
corporate profits not going taxed and then the gains also not
going taxed at the individual level.
And as you say, the research shows that a large and growing
share of those profits--at the very low-end, estimates are
about 60 percent of those profits are from windfall rents,
monopoly power, pure luck, those sorts of profits, profits that
are not sensitive to tax rates or to new investment.
So it is really important to make sure that that income at
both levels is subject to tax and subject to tax once.
Senator Casey. Let me just conclude with one more question.
Chairman Wyden recently discovered something troubling about
millionaires in this country. Not only do we have a problem
when wealthy taxpayers pay too little in taxes; sometimes they
do not even bother to file a tax return at all.
From 2017 to 2020, there were almost 1,000 Americans with
incomes over a million dollars who did not file their taxes at
all. They did not file anything. These taxpayers owed over $34
billion in tax penalties and interest as of May 2023. If we
collect those taxes, we could give $450 on average to every
child in America.
Mr. Pearl and Ms. Huang, could you talk about how we can
make sure that this small group of less than 1,000 millionaires
pays their fair share in taxes?
Mr. Pearl. Well, yes. We think that government, whether it
is the Department of the Treasury and the IRS or the Justice
Department, needs to have the resources to enforce the laws and
make sure that these 1,000 people out of the hundreds of
millions in our country obey the laws, just like all of your
constituents who have tax deducted from their paycheck every
week.
Senator Casey. Mr. Chairman, thanks very much.
The Chairman. Colleagues--and I will also say to those who
are following--Senator Casey is a very modest fellow, and what
he was talking about again was trying to ensure that there is
fair taxation and smart enforcement of the tax laws, because
there are a lot of important things that America needs to do to
get ahead.
Senator Casey has led the effort now for years on end to
try to build a savings ethic in this country for young people.
And I see all your heads nodding, and we've got the political
spectrum kind of down there. If I had my way, what we would
have in this country--and I think we have a chance to get
started on it.
I think we know that it is going to take a substantial
amount of money, but you know, if we cap some of these jumbo
IRAs beyond the vision of Bill Roth and collect the money from
the millionaires who are not even filing returns, we could get
started.
I would personally like to see poor kids and poor families,
when a child is born, go home with a little bit of a savings
account--the kind of thing Senator Casey's been working for--to
get them started. And it does not have to be some big
government program. It can be some of the approaches Senator
Casey is talking about.
So I want to thank the Senator for all his good work, and
they are all talking about whatever that retirement name was,
SECURE 2.0 and going after SECURE 3.0, SECURE 12.0 and all
that, and we may have good ideas for the future. Senator
Casey's idea to help those kids with a small savings account--I
want everybody to know, as long as I am chairman of this
committee, Senator Casey's idea is going to be at the top of
the list, and I thank my colleague.
Senator Whitehouse?
Senator Whitehouse. Thank you, Mr. Chairman. Thanks to
everybody for being here.
I just want to flag for this committee that we had a
hearing on this subject this week in the Senate Budget
Committee, where we looked at the tax gap and learned, first,
that the tax gap is known to undercount the actual tax gap,
because there are areas of omitted enforcement that it does not
even look at. So it is a way bigger number than we think it is.
The second thing that we developed in our testimony was that if
you look at the top 10 percent of filers, the amount that the
IRS obtains in revenue for a dollar spent in enforcement is
$12. So, it is a good deal more than we have been talking
about, looking across the board. And because President Biden
has promised to focus enforcement on entities and individuals
over $400,000 per year, we are starting to move closer to that
12 to 1 return on enforcement, compared to what we have been
talking about.
Interestingly, it gets even worse the higher you go up the
income level. When you get to the 0.1 percent of wealth, the
return on the enforcement dollar can go as high as $35--$35 in
revenue for every $1 in enforcement, which signals that there
is massive tax dodging and tax cheating going on at the 0.1
percent number. So, not only do Americans face a rigged tax
code, they face the double whammy of rigged tax enforcement,
even under that rigged tax code. So we have a lot of work to
do.
Two of the ideas I like, Mr. Pearl--billionaire Warren
Buffet famously highlighted the rigging of the tax code by
pointing out that he paid lower tax rates than his secretary.
My Pay Your Fair Share Act would codify what is called the
Buffet Rule, with a minimum 30-percent tax rate on income over
$1 million per year that phases into the $2 million, so there
is not an abrupt cliff. Can you say--how would this legislation
make our tax system fairer, and from your experience on the
investment side, would it cripple the private equity system?
Mr. Pearl. Well, yes. First, I was honored to stand with
the President, then-President Obama, when he made that speech
about the Buffet Rule. But yes, we think that it needs to be
fair. It is exactly the problem that Chairman Wyden was
outlining about buy, borrow, die, that results in Warren Buffet
paying a far lower tax rate than his assistant does----
Senator Whitehouse. Does it cripple the private equity
system?
Mr. Pearl. No. We do not have a shortage of people who are
willing to become private equity fund managers. There are tons
of people applying for those jobs. As I said in my testimony
earlier, I think if we are going to try to use the tax system
to incentivize people to join certain careers, I am sure that
you can find several careers that are more in need of people
than private equity fund managers are.
Senator Whitehouse. Thank you.
Ms. Huang, let me ask you a question about another piece of
legislation of mine, the Medicare and Social Security Fair
Share Act. You were kind enough to come to the Budget Committee
a little while ago and testify about that.
That bill has a provision to support Social Security and
Medicare by closing the so-called Gingrich-Edwards loophole
that lets wealthy individuals avoid Medicare taxes. Would you
mind walking the committee through how this loophole works and
through how much revenue-closing it might raise to support
Medicare?
Ms. Huang. Yes. So, the loophole is that some wealthy
filers can funnel their income through an S corporation, and if
they do so and they underpay themselves salaries and put more
of that return into business income, they can avoid facing any
of the Medicare taxes on payroll, on self-employment income,
and on investment income. So, they fall right into the gap, and
some of that----
Senator Whitehouse. And the money ends up in their pocket
either way? It's just a question of which way you route the
money that you control into your own pocket?
Ms. Huang. Absolutely. It's hundreds of billions of dollars
that are going through there, and some of that is--people even
overstep into evasion, speaking of fund owners. Some fund
owners right now are in disputes with the IRS, because the IRS
sees that they have gone over the line by trying to push so
much of their income into this hole.
Senator Whitehouse. Now the last thing I would mention, Mr.
Chairman, is that the other part of the hearing is on the
improvement in IRS performance as a result of funding of the
IRS, and that there has been massive improvement in how regular
taxpayers are treated.
We had a wonderful statement by Senator Romney saying,
``You know, if I am a regular taxpayer, I am going to call up,
and it is going to really matter to me to be able to get that
phone call answered in what is now a 3-minute wait time, and
that is really important for the service of regular
taxpayers.''
But he said, ``Once I became very wealthy, I was not
calling up that service line any longer. I have accountants and
lawyers who intermediate, and for that you really need to have
proper audit and enforcement.'' So, I want to commend Senator
Romney's statement to this committee. And with that, I yield
back.
The Chairman. I thank my colleague. It has been great to
work with you on all these issues, both here and at the Budget
Committee.
Senator Carper?
Senator Carper. Thanks, Mr. Chairman, for letting me have a
second round. Another follow-up, if I could. Ms. Huang, do you
believe that the role of noncompliant sole proprietors demands
more attention from the IRS, particularly when it comes to
wealthy taxpayers? And if so, do you have any recommendations
for how the IRS should address this?
Ms. Huang. Yes, it absolutely does. And in fact, it has
received so little attention because of the lack of resources
of the IRS to understand what is going on, that we do not have
a great idea of what is going on with high-income tax avoidance
using sole proprietorships.
But pass-throughs overall, we know are a really big source
of tax avoidance and evasion, and part of the reason is just
like with sole proprietorship. A lot of the income that flows
through them is really just on the honor system, and the IRS
does not have any way that they can check what the taxpayer
says in terms of the source or the amount of income. And you
know, the compliance rate on that income is less than 50
percent, compared to 99 percent for W-2 wage and salary income.
Senator Carper. All right. More broadly speaking, what
steps should Congress, what steps should this committee, and
the IRS for that matter, take to improve the tax compliance of
pass-through entities? Does the IRS need additional tools or
resources from Congress to support their work in identifying
noncompliant wealthy taxpayers?
Ms. Huang. I think the oversight role that this committee
has played in focusing the IRS's attention on partnerships and
pass-throughs is really important. But an additional tool that
lawmakers could give the IRS is, again, the ability to sort of
understand who owns what income when it flows through these
spider webs of different types of entities.
And that could include strengthening the bipartisan
Corporate Transparency Act, and allow the IRS to be able to
trace who actually owns what. That is a really basic question
that you need answered to have tax compliance.
Senator Carper. Thank you, ma'am. And I do not mean to pick
on you, but I do have another question, while I let these guys
catch their breath. Can you share with us how unequal audit
enforcement has historically contributed to wealth and racial
inequality?
Ms. Huang. Yes. Well, as audit rates on the wealthy filers
have plummeted, audits on low- and moderate-income filers have
increased as a share of all filers. And in addition to that, we
now know that, due to research that the IRS itself put forward,
Black filers are 2.9 to 4.7 times more likely to be audited by
the IRS, even at the same income level.
Part of that has come about because there has been an over-
focus on forms of noncompliance from refundable credits, even
though they contribute a much, much smaller part of the tax gap
than noncompliance by wealthy filers.
The Chairman. I am going to have to move on, Senator
Carper.
Senator Carper. Yes. Thanks for giving me the time, and
thank you all for being here today and for your good work.
The Chairman. Thank you for your good points.
Senator Cardin?
Senator Cardin. Well, Mr. Chairman, I came back, first to
thank you for holding this hearing. I apologize. I have been
busy on some Senate Foreign Relations business, but I just
really wanted to underscore the importance of the embarrassment
in our tax code on the rate of compliance for high-income
people, and the amount of resources that are put into auditing
lower-income taxpayers, who in many cases do not have the same
degree of help and services to allow them to understand our tax
code, which is rather complex.
We find that in so many different areas. I chaired the
Small Business Committee, and I found that small business
owners, in trying to comply with the requirements we have, do
not have the same resources as larger companies. This is a
systemic challenge we have in our society.
So my question is--we are giving the IRS a great deal of
resources. How can we help middle-income taxpayers, lower-
income taxpayers, with the type of information, outreach, and
services that can make it easier for them to comply with our
tax code, so that the resources of IRS can be really focused on
those who are not paying their fair share on higher income? Ms.
Huang, do you want to start? I see you are shaking your head
the right way, so I will start with you.
Ms. Huang. Well, you are absolutely right. Low- and
moderate-income filers do not have expensive tax advisors, and
they count on lawmakers to provide the IRS the resources so
that it can answer the phone in 3 minutes instead of 28
minutes, or to have Taxpayer Assistance Centers right there in
their community, where they can go and talk to a real person.
And they also count on the IRS--and this comes under the
compliance bucket--to put out clear guidance about what their
taxes mean. So that is really important.
Senator Cardin. Well, thank you.
Mr. Chairman, I would hope that we will put a concentration
on how we can help middle- and lower-income families get the
information they need, so that they can get the benefits they
are entitled to, because in many cases, they are losing out on
benefits that they are entitled to, and there is no one there
to audit their returns to say, ``You need more money. You
should have gotten more.''
It is always that you made a mistake, and therefore we are
going after you. And I think, with the resources that were
given to the IRS, as we go after the higher-income taxpayers
who are not paying their fair share, we need to devote
resources to modest-income families to make sure they are being
treated fairly in our tax code.
I thank the chairman.
The Chairman. I thank my colleague. We also ought to pass
the Cardin tax preparer bill, in order to beef up work that is
done in that area. So I look forward to working with my
colleague.
Senator Warren from Massachusetts.
Senator Warren. Thank you, Mr. Chairman.
So, in 2017, the Republicans in Congress passed one of the
biggest tax giveaways to millionaires and giant corporations in
recent memory. The Trump tax cut kicked working families to the
curb, while it added about $2 trillion to the national debt,
all so that Republicans could give a massive handout to their
wealthy pals and donors.
But the $2-trillion price tag on this does not actually
tell the full story. That is because some of the corporate tax
breaks had expiration dates, not because they actually wanted
those tax breaks to expire, but expiration dates because that
meant they could represent that the total costs of the
giveaways would look smaller than they really were.
Corporate lobbyists went along with this, because they knew
that when the tax breaks expired, Congress could be counted on
to renew them endlessly. Now, three of the biggest giveaways
are starting to expire, and the corporate lobbyists around here
are working overtime to get them extended.
Ms. Huang, corporate lobbyists claim that these three giant
giveaways--known as bonus depreciation, R&D expensing, and the
net interest deduction--were really important, because they
would spur American investment. So now we have some data on how
these corporate tax giveaways worked. Does the data show that
companies have used their tax breaks to make new investments?
Ms. Huang. So, the corporate tax cuts in 2017 were even
bigger than what companies asked for, and what we saw is
trillions going into buybacks and dividends. Economy-wide
investments and jobs did not grow any faster than they had
before the law, and careful economic analysis has failed to
find anything near what was promised.
And now as you are saying, there is talk about adding to
that retroactive business tax breaks, which would be just a
complete wasteful giveaway. You cannot change past investments
or wages by giving away tax cuts like that.
Senator Warren. Right. So take bonus depreciation as an
example here. Under normal tax rules, businesses are allowed to
deduct expenses from their income so they are not taxed for the
losses that they take. Because certain assets lose value over
time, like machines or buildings, businesses can typically
deduct the cost of that depreciation over the life of the
asset.
But bonus depreciation takes this logic and turns it upside
down. Instead of taking a chunk of the depreciation each year
that the asset has value--say a new set of delivery trucks--
bonus depreciation lets businesses deduct the entire cost of
those delivery trucks in the year that they buy them.
Ms. Huang, why do businesses benefit so much from bonus
depreciation?
Ms. Huang. So, like a lot of business tax breaks, a company
needs to actually be pretty big and highly profitable to take
full advantage of it. You hear a lot of rhetoric about small
and startup businesses, but they often cannot even access these
provisions, because they do not have enough profits to offset
them against.
And the research shows that the biggest companies that are
getting the bulk of the tax breaks are the least likely to
actually increase investment or wages.
Senator Warren. Okay. So the tax breaks are not used to
increase investment, and in fact these tax breaks, business tax
breaks, are going to the very richest corporations. And now,
like they did in 2017 and like they have done so many times
before, corporate lobbyists are asking for a temporary
extension of these tax breaks, to make them look cheaper than
they actually are. But they have every intention of pushing
Congress to extend these tax cuts again and again and again, so
their wealthy clients will never actually have to pay the bill.
Ms. Huang, if we look at the true cost of extending these
three corporation giveaways that are being championed by
lobbyists, and not made-up versions that are being peddled by
the corporate lobbyists, what would those figures look like?
Ms. Huang. Yes. The sticker price here is quite misleading,
because the true cost is much larger. The official cost of
temporary full expensing would be $3 billion through 2025. But
if you would make it permanent, it would be $325 billion.
Senator Warren. Yes. The difference between $3 billion
and--say that second number again.
Ms. Huang. Three hundred twenty-five.
Senator Warren. Three hundred twenty-five. So the nominal
cost of this, the representative cost of this, is about 1
percent of what you say it would really cost. You know, look. I
get it. Extending corporate tax breaks is really good for
massive corporations, but it is also really bad for the
American people.
We should not be rubber-stamping Trump tax cuts for giant
businesses. While Republicans play political games, Democrats
should be doing everything in our power to make sure that
millionaires, billionaires, and giant corporations are paying
their fair share.
Thank you, Mr. Chairman.
The Chairman. I thank my colleague, and I thank our
panelists. We have been at it for a couple of hours here, and I
would like to just wrap up this way.
You know, when I am home, people say, ``Are we going to
have one of these town hall meetings, Ron? Are we going to have
another one of these? We like them. We just kind of can come
and say our piece.'' And I have had like 1,065 of them. We have
36 counties, and all of them, again and again and again, 90
minutes, throw open the doors, and no subjects are off limits.
And the percentage of time devoted to taxes is high, and it
continues to get higher. It goes something like this. People
say, ``Ron, what is the deal with the tax deal, because it is
so hard to understand? And it sure looks like it just favors a
small number of people who can work the system.'' And I say,
``Well, let me offer you a couple of thoughts that I think at
least give you an idea of how I see it.''
So, when you ask about the tax deal, I always say there are
really two tax deals in America. One is for the people who are
the firefighters and the nurses, and they pay taxes with every
single paycheck. And that really colors everything they do. For
example, even if they are going to be audited, the government
already has a lot of their information, because they pay taxes
every paycheck.
Then there is another system, which is illustrated by the
sign up here, that if you are a billionaire--and Ms. Huang told
us how it is done--you bring in your accountants and you bring
in your lawyers, and you say, I do not want to pay any income
taxes this year. Make it possible for me to buy--and I gave
examples of that--and borrow, and then when you die, everybody
starts all over again.
And Bill Bradley was on the Finance Committee for a number
of years. I worked with him. I was a junior member of the
House. Doug Holtz-Eakin is smiling. He remembers Bill Bradley,
and he was another tall member of the Finance Committee, but he
had a better jump shot than I did. [Laughter.]
We always talked about, you know, what do you want in a tax
system? And he would say, ``Ron, we want a tax system that
gives everybody in America the chance to get ahead.'' And that
is what I want to close with, because to get a tax system that
gives everybody in America the chance to get ahead means it has
got to be built on the idea of being fair to everybody. And it
has to be a system that is going to give everyone a chance to
be successful, because that is what America is all about. That
is America at its best.
So, we appreciate the input that the four of you have given
us. I am putting the final details on our proposal that we have
been working on for some time, to lay out how we go about
fixing this problem of billionaires avoiding taxes through buy,
borrow, die, and giving everybody the chance to get ahead.
So, we will look forward to staying in touch with you. Our
doors will always be open to you four. We have worked with you
in the past.
It has been a very good hearing, a busy week for the
Finance Committee. Yesterday, we passed a major piece of health
legislation to rein in these PBM middlemen, passed it by the
narrow vote of 26 to nothing.
My wife asked me about it. I said, ``You cannot get 26
Senators to order a 7-Up right now without a big controversy.''
So the Finance Committee is serious about these policy issues,
and you saw it again today, where you did not see a lot of
shouting and hollering. You saw people who are serious about
dealing with making the tax system smarter, better, fairer, and
one in which we can all enjoy substantial success.
I want to thank our guests. And with that, the Finance
Committee is adjourned.
[Whereupon, at 11:58 a.m., the hearing was concluded.]
A P P E N D I X
Additional Material Submitted for the Record
----------
Prepared Statement of Hon. Mike Crapo,
a U.S. Senator From Idaho
Thank you, Mr. Chairman. I look forward to our discussion today on
the effect of the tax code on individuals and families as they work,
save, and invest.
The scope of today's hearing provides members the opportunity to
cover a broad range of topics, and we will no doubt hear a number of
concerns raised about how the code treats high-income taxpayers. We
should dispel the notion that there is any support for taxpayers who
evade their tax obligations; we all agree taxpayers should pay the tax
they legally owe.
For the gray area of taxpayers who aggressively structure their
affairs to reduce their tax liability, we should constantly assess how
the code can better target certain activity. But framing this issue
through the subjective lens of ``fairness'' often ignores the facts and
turns a blind eye to favored incentives.
Rather than focusing on rhetoric, we should examine the data and
how the code affects behaviors. That includes examining provisions that
primarily benefit a select group of the financially well-off--including
tax credits for those who can afford expensive electric vehicles,
costly energy-efficient home upgrades, and proposals to repeal the cap
or expand the highly regressive deduction for State and local taxes.
As for the data, these are the indisputable facts:
Most of the Federal tax burden is paid by high earners;
Federal tax collections have been near all-time highs;
The voluntary tax compliance rate is high and stable; and
Higher income taxes serve as disincentives to work, save,
and invest.
My Republican colleagues and I remain focused on safeguarding
taxpayers and their rights; reducing barriers to work, savings, and
investment; and promoting opportunity and wealth to improve the quality
of life for all Americans.
In 2017, Republicans lowered individual rates across the board,
with middle-
income taxpayers getting the largest proportional benefits. Republicans
also simplified filing for many, expanded the Child Tax Credit, and
limited regressive tax spending like the SALT deduction.
Critics charged that letting Americans keep more of their earnings
would stifle the economy, dry up Federal revenue, and favor the
wealthy. Instead, it created one of the strongest economies in our
Nation's history, including an unemployment rate that reached a
generational low; increased Federal tax collections to near all-time
highs; grew wages across the income spectrum; and expanded job
participation. All Americans benefited.
Notwithstanding claims that high earners pay the least taxes, the
reverse is actually true. According to the Biden Treasury Department,
in 2023 the top 1 percent of earners paid 42.2 percent of all Federal
income taxes--the highest--despite only earning 19 percent of all
income. In 2001, the top 1 percent of earners contributed 33.2 percent
of income tax revenue, 9 points lower. In other words, the country's
income tax burden is more progressive today than it was decades ago.
Expanding the aperture to examine the top 5 percent of taxpayers--
those with incomes above $200,000 a year--mirrors this dynamic. These
Americans pay 65.3 percent of all Federal income taxes while making
only 34 percent of all income.
Meanwhile, Federal tax collections reached an all-time high of $4.9
trillion in FY 2022--with individual income tax collections
contributing the most, growing 29 percent year over year. In fact,
individual income tax collections reached 10.5 percent of GDP in FY
2022, the highest level on record. All of this is after the impact of
Republican-led tax reform.
In arguing for tax code fairness, some have pointed to a recent tax
gap projection from the IRS, which shows an increase over the previous
estimate. This growth actually shows one of the many effects of
inflation.
Despite headlines to the contrary, the tax gap is proportionately
flat and historically average relative to the economy's size. According
to the Cato Institute's examination of the tax gap as a percentage of
GDP, for 2021, that ratio was 2.9 percent, squarely in line with the
20-year average. And the voluntary tax compliance rate--around 85
percent--remains substantially unchanged.
While we should work to find bipartisan measures to narrow the tax
gap, any such effort must not reduce economic growth.
I look forward to hearing the perspectives of today's witnesses on
how the individual tax system affects taxpayers from all income groups
and how increased taxes--in the midst of high and sustained inflation--
would impact our economy.
______
Prepared Statement of Douglas Holtz-Eakin, Ph.D.,
President, American Action Forum *
---------------------------------------------------------------------------
* The views expressed here are my own and not those of the American
Action Forum. I thank Gordon Gray, Angela Kuck, and Sarah Smith for
their assistance.
---------------------------------------------------------------------------
Chairman Wyden, Ranking Member Crapo, and members of the committee,
thank you for the privilege of appearing today to discuss issues
related to the tax code, high-income individuals, and tax planning
strategies.
I hope to make the following three main points:
The two most pressing policy problems are the poor pace of
economic growth and the unsustainable Federal budget outlook;
these interact as deficits are a headwind to growth, but faster
growth would improve the fiscal outlook.
Deficit reduction should be dominated by slowing the growth
of mandatory spending, while tax policy should be progrowth
with low taxes on saving, investment, and innovation.
Differential taxation of alternative forms of capital income
offers the greatest opportunities for tax avoidance and
evasion; a progrowth tax stance reduces risks of these
behaviors.
Let me discuss these in turn.
the twin challenges of economic growth and the federal fiscal outlook
The most pressing economic policy issues are interrelated: the need
for faster economic growth and a fiscal stance that reduces deficits
and controls the Federal debt. The record on growth is striking. From
1960 through 2000, the average pace of growth in real gross domestic
product (GDP) per capita was 2.4 percent. At this pace, GDP per
capita--a rough measure of the standard of living--would double every
29 years. Thus, in roughly one working career, growth would double the
standard of living, giving American families the opportunity to pursue
their economic dreams.
Since then, from 2001 to 2022 the average pace of growth has been a
full percentage point slower: 1.4 percent. At this pace the standard of
living will double only every 56 years. There is the palpable sense
that access to the American Dream is disappearing over the horizon.
The implications are enormous. Had the pace of growth been
maintained in the 21st century, real GDP (in 2017 dollars) would have
been $6.3 trillion higher in 2022, translating into additional real
income of nearly $19,000 per capita. There is no government transfer
program that can compete with the power of compound economic growth.
The budget consequences would be enormous as well. Assuming Federal
revenues are roughly 19 percent of GDP, a faster pace of growth would
mean that revenues would be $1.2 trillion higher than at present. At a
time when the Congressional Budget Office (CBO) projects $20 trillion
in Federal deficits over the next 10 years, having $12 trillion less in
deficits would make the job of controlling the Federal debt much more
manageable.
Federal fiscal policy is contributing to the slower pace of
economic growth. It is widely recognized that borrowing trillions of
dollars when the economy is at full employment competes with private-
sector demands for capital. Reduced access to capital diminishes
private-sector investment, thereby reducing growth in productivity and
the standard of living.
Note, however, that how Federal deficits will evolve is especially
antigrowth. The CBO baseline anticipates that the unified deficit will
rise from 5.8 percent of GDP in 2024 to 7.3 percent of GDP in 2033, a
1.5 percentage point rise. Social Security spending will rise by 0.7
percentage points (from 5.3 percent to 6.0 percent of GDP) and Medicare
spending will rise by 1.6 percentage points (from 3.7 percent of GDP to
5.3 percent of GDP). Thus, the combined growth of these two large
mandatory spending programs will exceed the increase in the deficit by
0.8 percentage points.
If resources are transferred from private-sector investment to
Federal subsidies to consumption, each dollar transferred reduces the
growth in productivity, real wages, and the standard of living. Notice
that this is true regardless of whether that transfer comes via taxes
or deficit finance, but deficit finance is more likely to come at the
expense of private investment. Past chronic federal deficits have
already been a headwind to growth; the evolution of deficits over the
next decade is an even greater threat to growth.
the role of tax policy
In the face of the rising debt and fiscal outlook, one might be
tempted to focus tax policy on raising revenue, especially from the
affluent. But many have observed that there is not enough potential
revenue in such an approach and a recent study by Brian Reidl
summarizes the evidence.\1\ He notes:
---------------------------------------------------------------------------
\1\ https://manhattan.institute/article/the-limits-of-taxing-the-
rich.
This report models an aggressive tax-the-rich agenda that
pushes tax rates for corporations and wealthy families toward
revenue-maximizing levels. It shows that such policies could
raise, at most, 2% of GDP--and likely far less, when accounting
for the macroeconomic losses that would result from layering so
many new taxes on top of one another. Consequently, a
sustainable economic and tax agenda would limit upper-income-
---------------------------------------------------------------------------
tax increases to 1% of GDP.
A focus on taxing the affluent to ``solve'' the budget challenge
will fail. A strategy more likely to succeed would be to focus tax
policy on growth, keeping taxes on the return to saving, investment,
and innovation as low and uniform as possible. As noted above, better
growth has beneficial impacts on the budget outlook. Moreover, focusing
deficit reduction on slowing the growth of mandatory spending programs
will have a beneficial impact on growth.
To the extent that raising revenue is necessary, it would be better
to focus on
consumption-based changes to the tax base. Indeed, a dramatic reform
would be to transition the tax code toward a personal consumption tax
as the foundation of a progrowth strategy.
the role of anti-avoidance and anti-evasion policies
People should pay their legally owed taxes and the Internal Revenue
Service (IRS) should be adequately staffed, funded, and mission-focused
to enforce a high level of compliance. Such efforts should be pursued
across the income distribution. I am troubled by the notion that recent
additional funding to the IRS should be exclusively focused on the tax
compliance of the affluent. The President's campaign promise was to not
raise taxes on those making under $400,000. He did not promise that
those individuals would be allowed to cheat on their taxes, and there
is ample evidence of a substantial middle-income tax gap that bears
scrutiny.
Tax avoidance, in contrast, is the legal pursuit of tax reduction
by taking advantage of features of the tax code. Stripped to the
basics, the heart of tax avoidance is to transform one type of income
(e.g., interest) to a less heavily taxed form of income (e.g., capital
gains). The tax code should be structured to keep the undesired
behavioral responses to a minimum by keeping tax rates as low as
possible and uniform across sources of income. The tax strategy for
growth pairs nicely with reducing the incentives for avoidance,
especially among the affluent who have concentration of capital income.
Thank you, and I look forward to your questions.
______
Questions Submitted for the Record to Douglas Holtz-Eakin, Ph.D.
Questions Submitted by Hon. Mike Crapo
Question. The Biden administration's 2024 budget proposed $4.8
trillion in new taxes targeted at high-income individuals and
businesses, making the case for raising taxes on Americans in order to
``solve'' our fiscal problems.
But you argue that ``[a] focus on taxing the affluent to `solve'
the budget challenge will fail.'' Not just that it is bad policy or
based upon flawed premises, but that it simply won't achieve what its
proponents intend.
Can you elaborate why taxing the affluent to resolve fiscal
challenges will fail?
Answer. A fiscal consolidation of $5 trillion (or larger) is
appropriate given the U.S. fiscal outlook. Deficit reduction that
averaged $500 billion per year would result an additional $1 trillion
in interest savings, for a combined reduction in debt relative to CBO's
baseline of about $6 trillion. Unfortunately, the deterioration in the
budget outlook is such that these savings would not reverse the
accumulation of additional debt and would still result in U.S. debt as
a share of GDP topping 100 percent of the economy within 10 years.
The Biden administration, however, has proposed no such plan.
Indeed, the Biden administration's budget proposed spending nearly half
of its proposed tax hikes, while allowing debt service costs to exceed
the cost of any Federal agency. Under the Biden budget, and again,
notwithstanding nearly $5 trillion in tax hikes, debt would continue to
grow. The scope and scale of the challenge is simply too large to rely
on taxing high-income individuals. A recent study \1\ by Brian Reidl
indicates that such opportunities are quite limited. Noting that ``an
aggressive tax-the-rich agenda'' could yield, at most, 2 percent of
GDP, well short of needed deficit reduction.
---------------------------------------------------------------------------
\1\ https://manhattan.institute/article/the-limits-of-taxing-the-
rich.
Question. Some would have you believe the Tax Cuts and Jobs Act
(TCJA) is exclusively a benefit for high-income taxpayers.
Unfortunately, this is an inaccurate assessment, and more akin to class
warfare than objective analysis. The truth is the various tax cuts
enacted by the TCJA resulted in a reduction of personal income tax
---------------------------------------------------------------------------
rates across all income brackets.
Could you describe how the TCJA improved incentives and economic
growth for all Americans, contributing to record low unemployment and
record high Federal tax collections?
Answer. The TCJA can generally be characterized as a major reform
to the individual, international, and business tax systems, paired with
significant individual tax relief. Prior to the enactment of the TCJA,
the U.S. business and international tax system placed U.S. employers at
a substantial disadvantage. The TCJA staunched the steady flight of
U.S.-headquartered firms and rendered the U.S. corporate income tax
somewhat more competitive. The tax literature is clear that these
changes would accrue benefits to American workers, indeed the only
serious debate is a matter how big the benefits are.
According to the distributional analysis of the TCJA by the Joint
Committee on Taxation, the majority of the tax relief delivered by the
TCJA in the years immediately following its enactment accrued to
taxpayers earning less than $200,000. Indeed, IRS data has since
generally borne out the fact that the TCJA delivered tax relief
substantially targeted at middle- and lower-income taxpayers.
Question. And how does the TCJA's tax relief across the board
contrast with the Biden administration's agenda to increase taxes on
the American people?
Answer. The TCJA reflected a growing, bipartisan consensus that the
U.S. tax system was outdated and an active drag on economic growth. The
U.S. corporate tax rate was the highest among major global economies.
The President's budget is instructive on the administration's economic
policy priorities--it would substantially increase the tax burden on
major U.S. employers and saddle future generations will poor economic
performance and unprecedented levels of debt.
______
Questions Submitted by Hon. Steve Daines
Question. One of the important provisions in the Tax Cuts and Jobs
Act (TCJA) was the section 199A deduction for small businesses. For
example, EY estimates \2\ that with 199A, the typical large pass-
through pays a similar effective rate as the typical public company.
Without 199A, their rate is significantly higher.
---------------------------------------------------------------------------
\2\ https://s-corp.org/2019/10/ey-on-tax-parity/.
Can you talk about the importance of that provision, especially how
it ensured small and family-owned businesses were competitive with
---------------------------------------------------------------------------
public companies and their new 21-percent rate?
Answer. Tax neutrality is a guiding principle in tax reform--that
tax policy should not distort the investment decisions of private
firms. Prior to the enactment of the TCJA, the U.S. corporation income
tax was the highest in the developed world. Theoretical and empirical
research reliably found that this tax posture was harmful to U.S.
economic performance. A signal achievement of the TCJA was the
modernization of U.S. business taxation, after which the steady flight
of firms from U.S. shores ceased.
Part and parcel to this modernization was the recognition that
taxation should be, to the extent practicable, neutral to a firm's
legal form of organization. This is more easily achieved in theory than
in practice, but, as affirmed by EY's analysis, TCJA came fairly close.
Section 199A was instrumental in this, and more closely harmonized
effective tax rates on the return to business investment than would
have been achieved through the TCJA's individual income tax changes.
Nevertheless, there remains scope for improving the design of this
provision as Congress revisits the TCJA in years to come.
Table ES-1. Effective and Marginal Tax Rates Under Pre- and Post-TCJA
Law
------------------------------------------------------------------------
Post-TCJA Post-TCJA
Pre-TCJA law (in law (in
law 2019) 2026)
------------------------------------------------------------------------
Effective tax rates
Large S corporation 41.2 33.8 41.2
C corporations:
Closely held, fully 43.1 31.2 30.8
taxable shareholders
Average C corporation 41.3 29.0 28.7
------------------------------------------------------------------------
Marginal effective tax rates
Large S corporations 23.1 16.3 26.2
C corporations 22.6 16.8 22.8
------------------------------------------------------------------------
Note: The effective tax rates are the average tax rate for hypothetical
business earnings received through an S corporation and a C
corporation. The marginal effective tax rates are for the additional
increment of income from a new investment. Figures are rounded.
Source: EY analysis.
Question. Another reason to support 199A is it helped small and
family-owned businesses avoid a tax hike under the TCJA. That is
because many of the corporate base broadening provisions included in
the TCJA, including the new cap on interest deductions, changes to the
tax treatment of R&E, and the elimination of the old manufacturing
deduction, would have increased taxes on pass-throughs, as did the cap
on SALT deductions and the new excess loss limitation rules. Absent
199A, taxes on many of these small and family-owned businesses would
have gone up.
Can you address how making 199A permanent would help to offset
these revenue raisers?
Answer. Harmonizing the taxation on the return to business
investment is critical to minimizing distortions in the investment
decisions of private firms. Such distortions lead to misallocation of
capital across the economy, ultimately harming long-term growth and
wages. Similarly, disparate tax treatment of similar economic activity
can encourage tax avoidance that unduly erodes the tax base. Section
199A is the TCJA's key instrument for minimizing tax distortions
depending on business form. This goal should animate Congress's efforts
to reform and render more stable the U.S. tax system as it faces the
expiration of 199A and other key elements of the TCJA.
Question. Most individual provisions in TCJA expire at the end of
2025, including section 199A. Many estimates, including a Brookings
paper authored by Robert Barro and Jason Furman,\3\ warn that
sunsetting TCJA provisions, including the 199A deduction, would reduce
economic output and hurt the labor market.
---------------------------------------------------------------------------
\3\ https://www.brookings.edu/wp-content/uploads/2018/03/
BarroFurman_Text.pdf.
What do you think would be the consequences for the competitiveness
of small businesses compared to large corporations if there is a
---------------------------------------------------------------------------
failure to extend section 199A?
Answer. Among the most progrowth features of the TCJA was making
the taxation on the return to business investment substantially more
competitive. Among least progrowth features of the TCJA is the
budgetary tradeoff that required rendering a significant share of the
U.S. tax code impermanent. Among the provisions set to expire is indeed
section 199A, which reflects a critical design feature of the TCJA that
narrowed certain distortions in the tax code. The expiration of this
and other portions of the tax code would introduce new distortions, in
particular significantly disparate tax treatment of different legal
forms of organization. This would uniquely penalize pass-through
entities, including many small and medium-sized firms. Research
commissioned by AAF, and performed by EY, found that making permanent
the key expiring individual and business provisions of the TCJA,
including 199A, would lead to a significant improvement in long-term
economic growth, investment, and real wages. Importantly, the magnitude
of these economic benefits materially depends on financing.
Specifically, financing these tax changes with spending reductions is
significantly more efficient than with future tax increases.
Table 1. Summary of the Major Macroeconomic Results for Featured
Parameters
(percent change)
------------------------------------------------------------------------
Provisions
Law as written permanent
------------------------------------------------------------------------
Long-run Results
Corporate productivity 2.5% 4.7%
Pass-through productivity -0.8% 3.1%
GDP per capita 0.9% 3.1%
10-year Results
Level of output after 10 years 0.4% 1.2%
Change in annual growth rate 0.04 p.p. 0.13 p.p.
Financing Assumptions, 2018-2027
Cost assuming JCT scoring and $1.2 trillion $1.7 trillion
our dynamic feedback
Annual lump sum cost per $900 $1,400
household
------------------------------------------------------------------------
______
Questions Submitted by Hon. Marsha Blackburn
Question. The importance of the 199A Qualified Business Income
deduction cannot be understated. It incentives entrepreneurship and
small business growth, which is the lifeblood of the U.S. economy and
accounts for nearly half of the Nation's private workforce. The
continuation of this credit, which was introduced as part of the Tax
Cuts and Jobs Act, is the most prominent issue that comes up when I
speak to small businesses in Tennessee. That is why I joined Senator
Daines and several of my colleagues in introducing the Main Street Tax
Certainty Act, which would make the tax deduction permanent and create
certainty for small businesses.
What has been the impact of the 199A Qualified Business Income
deduction on the growth and development of small business in the United
States?
Answer. U.S. economic performance subsequent to the enactment of
the TCJA was irreducibly strong, and subsequent research has found a
causal link between the TCJA and improved economic growth. The design
of the TCJA recognized the need for tax neutrality with respect to
business form, with section 199A as the principal instrument for that
policy goal. Allowing 199A to expire would reverse that policy design
choice, and disproportionately harm small business and lead to reduced
investment, productivity, and ultimately, workers' wages.
Question. What would be the impact on the small business community
if Congress does not extend this deduction?
Answer. A number of studies, including those published by Brookings
as well as AAF, have found that failure to extend key elements of the
TCJA, of which 199A is a significant part, would harm U.S. economic
performance. Congress will need to revisit the TCJA as it faces
substantial expiration in 2025, and should look for approaches that
maintain the principle of tax neutrality.
______
Questions Submitted by Hon. Todd Young
Question. During your live questioning, you briefly discussed how
the burden of the corporate tax falls to individuals. Specifically, you
noted the cost of corporate tax often falls to the ``shareholders or
the customers in higher prices or the workers in lower wages.''
Can you please elaborate on the impact of the tie between the
corporate tax rate and the economic burden for individuals?
Answer. Corporations are essentially a legal nexus of capital
through shareholders, labor through employees, and consumers through
their participation in the economy in which the corporation does
business. Corporate taxation will ultimately impose a burden on one or
all of those channels. This is a simplified narrative, but it
illustrates the nature of corporate taxation in a global economy:
Everyone but the corporation itself bears the burden, though not
equally.
The modern globalized economy is characterized by ever more mobile
capital. Increasingly, investment can flow to areas of lower taxation
with greater ease. Labor is not nearly so mobile. A worker who lives in
the low-tax jurisdiction will generally benefit as more capital flows
to firms while workers in high-tax jurisdictions will forgo higher
capital and associated productivity and resultant wage gains. There is
therefore the potential for labor to bear a high share of the corporate
tax burden, and a number of studies have found this burden to be quite
high.
Question. Some individuals, including a few of my colleagues, have
criticized certain Tax Cuts and Jobs Act (TCJA) provisions that
incentivize investment in research and development, among other items,
by saying they solely benefit big businesses. However, that narrative
fails to acknowledge that these provisions offer tax reductions for
workers and businesses across the board, including many small
businesses that are now concerned they will have to close their doors
if these incentives are not restored.
Can you please discuss the impact TCJA has had on small businesses
and their workforce?
Answer. U.S. economic performance materially improved in the wake
of the enactment of the TCJA, and there is growing evidence in the
research literature on positive contribution of the TCJA to this
performance. While the subsequent pandemic has somewhat distorted
recent economic history, directionally, TCJA plainly encouraged
economic growth. The improved incentives for business investment,
including those targeted at small and medium-sized firms, such as 199A
and section 179 expensing, are key elements of that improved set of
incentives. Reversing this progress would be to the clear detriment of
those same firms, as evidenced by research commissioned by AAF as well
as other analyses.
Additionally, it is important to note the wide-ranging positive
impacts these provisions have had on the economy, the availability of
high-paying jobs, and the ability for businesses to invest in new and
innovative products important to the long-term growth of the U.S.
Question. Can you please share some of the larger macroeconomic
impacts these business investments have provided to companies, both big
and small?
Answer. Among the most powerful, progrowth incentives introduced by
the TCJA was the 100-percent expensing of investment in equipment and
software. This tax provision appropriately treats up front investment
as an allowable expense, in contrast to complicated and inefficient
amortization schedules that simultaneously inhibited investment and
encouraged tax avoidance. A regrettable feature of the TCJA is the
expiration of this treatment of capital investment, and the
simultaneous erosion in the ability of firms to deduct the cost of
research and experimentation. In a modern, global economy, such
policies are antithetical to sound tax policy design. Making these and
other key design features of the TCJA permanent would forestall a
damaging tax increase while providing a more predictable and stable tax
code.
Question. In your written testimony, you highlighted concerns with
the current Federal budget outlook, noting that the ``unsustainable
Federal budget outlook'' combined with the ``poor pace of economic
growth'' act as a damper to growth, but that ``faster growth would
improve the fiscal outlook.'' You also recommended that ``tax policy
should be progrowth with low taxes on saving, investment, and
innovation.''
Given these concerns, how would you recommend Congress address the
sunset of the Tax Cuts and Jobs Act in 2025?
Answer. While the TCJA substantially improved the U.S. tax system,
it should not be viewed as the last word on U.S. policy. The scheduled
expiration of a substantially all of the individual tax provisions, as
well as some of the most pro-growth business tax reforms, should invite
an opportunity to revisit these tax policies, and the balance the
efficiency gains from these policies against the budgetary cost.
The solution is to neither let the TCJA expire nor extend it
permanently. The solution is to take the 2025 deadline as the
opportunity to continue the progrowth tax reforms begun in 2017. As a
general matter, tax reform is the process of keeping rates as low as
possible and the base as broad as feasible. Progrowth tax reform means
that the base should be as close to aggregate consumption as possible,
while the taxes on the return to saving, investment, and innovation
should be as low as possible. Finally, in the interest of efficiency,
the tax code should be as neutral as possible between debt- and equity-
financed investment; investments in human, physical, and technology
capital; and between activity in the corporate and noncorporate sector.
In practice, this means that there should be no contemplation of
raising the corporate rate as it is among the most successful parts of
the reform. In the decade prior to the TCJA, the United States lost
roughly 10 headquarters every year. Since then? None. Could there be
improvements in the corporate reforms? Of course, but the basic
structure works. Similarly, should there be a way to equalize the tax
treatments of corporate-source income and pass-through business income?
Question. In your testimony, you highlighted the pace of economic
growth and the fiscal outlook as top policy problems.
Where would you rank tax evasion on your list of policy priorities
and why?
Answer. The challenge of weak economic growth prospects combined
with high and growing Federal indebtedness poses a serious risk to the
prosperity and well-being of every American. Put simply, tax evasion
does not. One measure of tax evasion is the ``tax gap,'' which is an
estimate of how far short actual tax collections fall from an estimated
theoretical ideal. To be sure, there is merit in reducing this gap as
is practicable and duly enforcing related U.S. laws. But in general,
this gap is relatively stable over time, and is animated by a multitude
of factors, none of which invite easy remedy.
______
Prepared Statement of Chye-Ching Huang, Executive Director,
Tax Law Center, New York University School of Law
Chairman Wyden, Ranking Member Crapo, and distinguished members of
the committee, thank you for the opportunity to testify.\1\ I am the
executive director of the Tax Law Center at NYU Law, a public interest
initiative that seeks to improve the integrity of the tax system. The
Center is staffed by tax lawyers with expertise in tax administration,
private practice, and the tax legislative process, and our work draws
on extensive networks of public interest minded tax practitioners and
experts.
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\1\ This testimony draws heavily on my prior work, including:
Strengthening the Tax Base, Testimony Before the United States Senate
Committee on the Budget (September 27, 2023, https://
www.budget.senate.gov/imo/media/doc/huang_testimony_927.pdf); Funding
Our Nation's Priorities: Reforming the Tax Code's Advantageous
Treatment of the Wealthy, Testimony Before the House Subcommittee on
Select Revenue Matters (May 12, 2021, https://waysandmeans.
house.gov/wp-content/uploads/2021/05/Huang.Testimony.pdf).
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summary
The highest-income households get the bulk of their income from
their wealth. The Nation spends hundreds of billions of dollars each
year to maintain tax preferences that allow income from wealth to face
less tax than equivalent income from work.
Tax subsidies for income from wealth add to deficits by narrowing
and weakening the Federal tax base. Tax breaks like these are sometimes
called ``tax expenditures,'' or ``spending through the tax code''
because their impact on the budget and the economy is like a spending
program designed to subsidize a specific activity.
Tax subsidies for income from wealth are a poor investment. They
increase deficits, widen inequality, and spur complex tax avoidance and
evasion that locks up capital and talent that could be used for more
productive work and innovations. This is a misallocation of both public
and private resources. Tax evasion by the very wealthy can often
involve the proceeds of other criminal acts such as sanctions evasion
and corruption, which undermines the rule of law.
Federal resources can instead be directed towards investments that
better meet the Nation's most pressing challenges. That could include
investing in workers and families; supporting an innovative and dynamic
economy; meeting global challenges; and putting the Federal budget on a
stronger long-term Federal trajectory as the baby boomers retire.
the nation spends hundreds of billions each year
on tax breaks on income from wealth
Salary earners pay a top Federal tax rate of 40.8 percent on their
incomes, in the year they earn it, which is usually withheld in every
paycheck. The highest-income filers, however get the bulk of their
income not from salaries, but from wealth.\2\ Wealth includes financial
assets such as stocks and bonds, real estate, personal property such as
art, and ownership stakes in non-corporate businesses.\3\ About a third
of all U.S. wealth is held by the wealthiest 1 percent of
households.\4\ That wealth generates income, including capital gains
from when the assets grow in value, dividends, and business income from
ownership of ``pass-through'' businesses that does not face the
corporate tax rate, but is, in theory, taxed at owners' individual tax
rates.
---------------------------------------------------------------------------
\2\ Congressional Budget Office (CBO), The Distribution of
Household Income, 2019 (November 15, 2022, https://www.cbo.gov/
publication/58353#data). These data do not include unrealized capital
gains.
\3\ CBO, Trends in the Distribution of Family Wealth, 1989 to 2019
1 (September 27, 2022, https://www.cbo.gov/system/files/2022-09/57598-
family-wealth.pdf#page=7).
\4\ Joint Committee on Taxation (JCT), JCX-51-23, Present Law on
the Income Taxation of High Income and High Wealth Taxpayers 17
(November 7, 2023, https://www.jct.gov/publications/2023/jcx-51-23/);
see also id. at 2.
The Federal tax system gives income from wealth a series of
preferences that allow the very wealthy to effectively choose when--or
whether--to pay tax, and at what rate. Large amounts of income from
wealth can disappear from the Federal tax base and escape being taxed
across decades, lifetimes, and even generations. Federal tax breaks on
---------------------------------------------------------------------------
incomes from wealth include:
Lower rates. The Federal tax code allows income from wealth to face
a wide range of rates at a discount to what would be faced on salaries
of the same amount--depending on how that income is reported.\5\ Long-
term capital gains and dividends face a top rate of 23.8 percent, far
lower than the top rate of 40.8 percent that would be paid on the same
amount of salary. Such preferential rates cost the Federal Government
about $177 billion annually.\6\ The 2017 tax law's section 199A ``pass-
through deduction'' gives high-income filers a new 11.2 percentage
point discount on their top rate on salaries and wages, representing a
total tax expenditure of $42 billion in 2019, with over half of that
expenditure accruing to the top 1 percent of filers.\7\
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\5\ See Lily L. Batchelder and David Kamin, Taxing the Rich: Issues
and Options (February 1, 2020, https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=3452274).
\6\ The JCT projects that the reduced rate of tax on dividends and
long-term capital gains will cost $1.14 trillion from 2022 to 2026, or
an average of $227.9 billion each year. JCT, JCX-22-22, Estimates of
Federal Tax Expenditures for Fiscal Years 2022-2026, at 35 (December
22, 2022, https://www.jct.gov/publications/2022/jcx-22-22/). The surtax
on net investment income, estimated at--$254.2 between 2022 to 2026, or
an average of $50.8 billion each year--partially offsets the lower
rates. Id. at 6 n.16, 38.
\7\ See JCT, supra note 4, at 10; see also Chuck Marr, Brendan Duke
and Chye-Ching Huang, New Tax Law Is Fundamentally Flawed and Will
Require Basic Restructuring, Center on Budget and Policy Priorities
(CBPP) (August 14, 2018, https://www.cbpp.org/research/new-tax-law-is-
fundamentally-flawed-and-will-require-basic-restructuring).
Deferred tax. Capital gains, however, are usually invisible to the
tax system until they are ``realized,'' usually when the asset has
grown in value is sold. If a wealthy person holds stock that grows in
value from $100 million to $1 billion, they will not face tax on the
$900 million gain until they sell the stock. That allows the very
wealthiest filers to choose when to face capital gains income tax--even
though they can enjoy the benefit of the gain. The fact that this
income is ``real'' in any practical sense is perhaps most obvious when
filers borrow against the gain at low rates--and then, just as with any
other type of income, can choose to either consume or invest the
proceeds.\8\ At the same time as deferring taxes on gains, wealthy
filers will often rush to harvest losses. This is the main driver
behind estimates that the 400 highest-income households in the country
paid effective Federal income tax rates in the range of 8 to 10
percent.\9\ Precise estimates are difficult to make: the nature of this
preference means that the income does not show up on Federal income tax
returns.
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\8\ See, e.g., Rachel Louise Ensign and Richard Rubin, Buy, Borrow,
Die: How Rich Americans Live Off Their Paper Wealth, Wall Street
Journal (July 13, 2021, https://www.wsj.com/articles/buy-borrow-die-
how-rich-americans-live-off-their-paper-wealth-11625909583).
\9\ Danny Yagan, What Is the Average Federal Individual Income Tax
Rate on the Wealthiest Americans?, 39 Oxford Review of Economic Policy
438-50 (Autumn 2023, https://academic.oup.com/oxrep/article-abstract/
39/3/438/7245778?redirectedFrom=PDF). For an earlier version of this
paper based on data through 2018, see Greg Leiserson and Danny Yagan,
What is the Average Federal Individual Income Tax Rate on the
Wealthiest Americans?, White House (2021, https://www.whitehouse.gov/
cea/written-materials/2021/09/23/what-is-the-average-federal-
individual-income-tax-rate-on-the-wealthiest-americans/).
Evaporating income \10\ (stepped-up basis). If a wealthy person
holds assets that have gained in value until they die, then that
untaxed gain disappears from the income tax system entirely. Neither
they nor their heirs will ever pay income tax on the gain. This
provision is referred to as ``stepped up basis,'' or the ``angel of
death loophole.''\11\ It is a Federal tax subsidy for wealthy families
making intergenerational transfers because bequests are exempt from
capital gains taxes that would normally apply to the sale or transfer
of appreciated assets.\12\ JCT estimates that this exemption costs some
$60 billion annually.\13\ Over half of the value of the wealthiest
estates is made up of unrealized gain that has never faced tax.\14\ A
weakened estate tax means that much of that income will never face any
type of Federal tax.
---------------------------------------------------------------------------
\10\ See Jason S. Oh, Increasing Progressivity by Reforming the
Taxation of Capital Income, Testimony Before the Subcommittee on Select
Revenue Measures 2-3 (May 12, 2021, https://waysandmeans.house.gov/wp-
content/uploads/2021/05/Oh_Testimony.pdf#page=2).
\11\ Michael Kinsley, The ``Angel-of-Death'' Loophole, Washington
Post (June 25, 1987, https://www.washingtonpost.com/archive/opinions/
1987/06/25/the-angel-of-death-loophole/5a42296d-982b-4517-a13a-
c89ba270f52d/).
\12\ See Adam Looney, Funding Our Nation's Priorities: Reforming
the Tax Code's Advantageous Treatment of the Wealthy, Testimony Before
the Subcommittee on Select Revenue Measures (May 12, 2021, https://
docs.house.gov/meetings/WM/WM05/20210512/112604/HHRG-117-WM05-Wstate-
LooneyA-20210512.pdf).
\13\ JCT, supra note 6, at 37.
\14\ Chye-Ching Huang and Chloe Cho, Ten Facts You Should Know
About the Federal Estate Tax, CBPP (October 30, 2017, https://
www.cbpp.org/research/ten-facts-you-should-know-about-the-federal-
estate-tax).
a dizzying array of tax breaks, loopholes, and gaming
Lower rates, tax deferral, and the stepped-up basis are the most
obvious tax preferences for the wealthy. In turn, those tax breaks
support a dizzying array of additional methods that wealthy filers can
use to push yet more income out of the tax base.
Lawmakers have deliberately enacted further preferences that build
on or expand the rate, deferral, and step-up provisions. And tax
advisors have also created loopholes and complex avoidance schemes.
Using such methods, wealthy filers can not only seek the lowest
possible tax rate on income from their assets, but they can also try to
push their labor income into the code's preferences for ``capital''
income, to avoid top income and payroll rates.
Examples include:\15\
---------------------------------------------------------------------------
\15\ In the past, loss-making jojoba farms (before 1986 tax reform
equalized top rates on work and capital income), see Department of the
Treasury (Treasury), The Problem of Corporate Tax Shelters 42 (July
1999, https://home.treasury.gov/system/files/131/Report-Corporate-Tax-
Shelters-1999.pdf), and ``basket options'' (after gaps emerged again),
see Wyden Urges Treasury Action Against Basket Options, Tax Notes (June
16, 2015, https://www.taxnotes.com/research/federal/legislative-
documents/congressional-tax-correspondence/wyden-urges-treasury-action-
against-basket-options/fw89?highlight=basket+options+tax) were other
popular techniques, and more recently capital treatment for SPAC
founders was one feature of the SPAC craze. See Lee A. Sheppard, SPAC
Founders' Shares Are Compensation, Tax Notes (February 22, 2021,
https://www.taxnotes.com/tax-notes-federal/property-taxation/spac-
founders-shares-are-compensation/2021/02/22/
2zdyf?highlight=%22SPAC%20founders%22).
Carried Interest: Managers of private investment funds
(including hedge funds, venture capital funds, and private
equity funds) can be paid in both ``management fees'' taxed at
ordinary income rates and ``carried interest'' taxed at low
capital gains rates. Managers typically choose to receive as
much of their income as possible as carried interest.\16\
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\16\ The 2017 tax law made small modifications but left the tax
break largely intact. See Tax Policy Center (TPC), What is Carried
Interest, and How is It Taxed? (May 2020, https://
www.taxpolicycenter.org/briefing-book/what-carried-interest-and-how-it-
taxed).
Turning life insurance, investment funds, health savings
accounts, and retirement accounts into tax shelters. Some
investments, if made directly by a wealthy household, would
generate capital gains and dividends that would be taxed at
preferential rates. But planners have found ways to exploit
loopholes and deliberate preferences in the code to take that
income from wealth entirely out of the tax system by running it
---------------------------------------------------------------------------
through various vehicles recognized by the tax code.
For example, a loophole enables deferral and even complete
avoidance of tax on capital gains made through Exchange Traded
Funds (ETFs), including extreme forms of tax avoidance such as
``heartbeat trades,'' in which investment banks partner with
ETFs to cycle large stock portfolios into funds and then
quickly out of them using in-kind redemptions.\17\ Private
Placement Life Insurance (PPLI), a form of life insurance
offered privately and only to the wealthiest individuals,
enables investment in a wide range of assets and structures
(including hedge funds), with tax-deferred growth and tax-free
transfer to heirs.\18\ Health Savings Accounts (HSAs), instead
of improving health care, have become a favored vehicle for tax
sheltering, in part due to the ability for pretax contributions
to be invested and to accrue earnings free of tax.\19\
Retirement accounts, particularly Roth IRAs, have increasingly
become a vehicle into which the wealthy ``stuff'' undervalued
assets like founders' stock and never pay tax on their
incredible returns.\20\
---------------------------------------------------------------------------
\17\ Sam Potter, Katherine Greifeld and Elaine Chen, ETF Industry
Risks Losing Key Tax Edge as Democrat Whets Knife, Bloomberg (September
14, 2021, https://www.bloomberg.com/news/articles/2021-09-14/etf-
industry-risks-losing-key-tax-edge-as-democrat-whets-knife).
\18\ See Press Release, U.S. Senate Committee on Finance, Wyden
Launches Investigation Into Private Placement Life Insurance Schemes
(August 15, 2022, https://www.finance.senate.gov/chairmans-news/wyden-
launches-investigation-into-private-placement-life-insurance-schemes).
See also Lauren Loricchio, Sarah Paez, Kiarra M. Strocko and Chandra
Wallace, Offshore Life Insurance: Wrapped in Controversy Amid Senate
Probe, Tax Notes (August 31, 2023, https://www.taxnotes.com/featured-
news/offshore-life-insurance-wrapped-controversy-amid-senate-probe/
2023/08/30/7h7vq).
\19\ For discussion of existing tax sheltering using HSAs and House
proposals that would exacerbate these problems, see Gideon Lukens,
Expanding Health Savings Accounts Would Boost Tax Shelters, Not Access
to Care, CBPP (June 22, 2023, https://www.cbpp.org/research/health/
expanding-health-savings-accounts-would-boost-tax-shelters-not-access-
to-care).
\20\ See Justin Elliott, Patricia Callahan and James Bandler, Lord
of the Roths: How Tech Mogul Peter Thiel Turned a Retirement Account
for the Middle Class Into a $5 Billion Tax-Free Piggy Bank, ProPublica
(June 24, 2021, https://www.propublica.org/article/lord-of-the-roths-
how-tech-mogul-peter-thiel-turned-a-retirement-account-for-the-middle-
class-into-a-5-billion-dollar-tax-free-piggy-bank).
Tax avoidance using pass-through businesses, including
relabeling income from labor.\21\ An array of holes in the
taxation of pass-throughs allow high-income filers to pick
lower rates on their ``business'' income.\22\ The
``Gingrich-Edwards'' loophole is an example. Active owners of S
corporations, a type of pass-through, can underreport the share
of their income from those pass-throughs that is salary for
their labor services, overstate the share that is ``business
profits,'' and in doing so avoid both the 3.8-percent Medicare
payroll taxes on high salaries and the parallel 3.8-percent tax
on net investment income. The 2017 ``Tax Cuts and Jobs Act''
(TCJA) section 199A pass-through deduction supercharges the
incentive for filers to reclassify their income from services
as ``business'' income. Its ``guard rails'' to prevent this are
illogical and porous.\23\
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\21\ See Huang, Strengthening the Tax Base, supra note 1, at 1-2,
6, 11-12, 14-15.
\22\ See Treasury, Gaps between the Net Investment Income Tax Base
and the Employment Tax Base (April 14, 2016, https://home.treasury.gov/
system/files/131/NIIT-SECA-Coverage.pdf).
\23\ See Samantha Jacoby, Repealing Flawed ``Pass-Through''
Deduction Should Be Part of Recovery Legislation, CBPP (June 1, 2021,
https://www.cbpp.org/research/federal-tax/repealing-flawed-pass-
through-deduction-should-be-part-of-recovery-legislation).
Research suggests that about three quarters of ``business
profits'' the very wealthy receive through their pass-throughs
may in fact be compensation for their labor.\24\
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\24\ Matthew Smith, Danny Yagan, Owen Zidar and Eric Zwick,
Capitalists in the Twenty-First Century, 134 Quarterly Journal of
Economics 1675, 1675-76 (2019, http://ericzwick.com/capitalists/
capitalists.pdf).
The taxation of partnerships--a form of pass-through
controlling more than $40 trillion in assets and vastly
outnumbering public firms \25\--is another problem area that
currently combines complexity, inconsistency in the system, and
optionality.\26\
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\25\ For the size of total assets of all partnerships, see IRS, SOI
Tax Stats--Partnership Data by Size of Total Assets (All Partnerships)
(2020, https://www.irs.gov/statistics/soi-tax-stats-partnership-data-
by-size-of-total-assets). There were over 4 million partnerships in
2020, IRS, SOI Tax Stats--Partnership Statistics by Entity Type, Table
9a, compared with about 4,000 to 7,000 public companies. See also, IRS,
SOI Tax Stats--Corporation Data by Type of Return (https://www.irs.gov/
statistics/soi-tax-stats-corporation-data-by-type-of-return#_1120all).
\26\ See Chye-Ching Huang, Building Back Better: Raising Revenue to
Invest in Shared Prosperity, Testimony Before the Joint Economic
Committee 10 (October 6, 2021, https://www.jec.senate.gov/public/
_cache/files/b2b15aa5-ef93-4fdc-9557-2ddbd569502e/chye-ching-huang-
testimony.pdf); see also Press Release, U.S. Senate Committee on
Finance, Wyden Unveils Proposal To Close Loopholes Allowing Wealthy
Investors, Mega-Corporations To Use Partnerships To Avoid Paying Tax
(September 10, 2021, https://www.finance.senate.gov/chairmans-news/
wyden-unveils-proposal-to-close-loopholes-allowing-wealthy-investors-
mega-corporations-to-use-partnerships-to-avoid-paying-tax); Michael
Cooper et al., Business in the United States: Who Owns It, and How Much
Tax Do They Pay?, 30 Tax Policy and the Economy 91 (2016, https://
www.journals.uchicago.edu/doi/full/10.1086/685594#.).
One role of the estate tax is to provide a backstop ensuring that
some of the income that escapes the income tax base on its way to heirs
is subject to at least some Federal tax. More than half of the value of
estates with over $100 million in assets are made up of unrealized
capital gains that have never been taxed.\27\ But the estate tax has
been so weakened that only the largest 1 out of every 1,000 estates in
the country faces the tax, and those that do pay an effective rate of
16.5 percent because so much of the value of an estate is exempt.\28\
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\27\ See CBPP, The Federal Estate Tax (November 7, 2018, https://
www.law.nyu.edu/sites/default/files/
Broadening%20the%20US%20Federal%20Tax%20Base%20-%209.26.23.xlsx).
\28\ Id. See also Tax Law Center, Broadening the US Federal Tax
Base (September 27, 2023, https://www.law.nyu.edu/sites/default/files/
Broadening%20the%20US%20Federal%20Tax%20
Base%20-%209.26.23.xlsx).
Only the already wealthy can enjoy outright tax breaks on wealth;
they try to expand the coverage of these tax breaks and maneuver
through audits and disputes with the IRS to protect those advantages.
They have the resources to hire expert tax lawyers and accountants who
set up this tax planning and to enlarge and defend their tax breaks
through the courts. Such tools are not available to low- and
moderate-income workers, who are taxed at ordinary rates, pay taxes as
they earn their wages and salary, and overwhelmingly have no
professional representation when they are audited.\29\
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\29\ See Nina E. Olson, Hearing Before the House Committee on
Oversight and Government Reform (April 17, 2018, https://www.c-
span.org/video/?448991-1/tax-administration-irs-oversight).
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complexity and opacity conceal tax evasion
The focus of this hearing is the ways in which high-income filers
lawfully reduce their taxes, but it is important to know that tax
breaks in the law have costs that include unlawful tax evasion.
The top 1 percent (by income) of filers are responsible for some 28
percent of the tax gap of taxes owed but not paid each year that flows
from individual income underreporting--amounting to some $80 billion
annually, according to Internal Revenue Service (IRS) estimates.\30\
Other estimates suggest those figures are even higher.\31\ Some of this
tax gap is caused by high-income filers attempting to lawfully avoid
taxes but overstepping into unlawful evasion. Some of it flows from the
most egregious forms of tax evasion associated with the proceeds of
other crimes including sanctions, evasion, and corruption.
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\30\ Andrew Johns and Joel Slemrod, The Distribution of Income Tax
Noncompliance, 63 National Tax Journal (https://
www.journals.uchicago.edu/doi/abs/10.17310/ntj.2010.3.01); The
Distribution of Income Tax Noncompliance, 63 National Tax Journal; The
Distribution of Income Tax Noncompliance, 63 National Tax Journal 397,
406 (2010); Jason DeBacker et al., Tax Noncompliance and Measures of
Income Inequality, Tax Notes Federal 7-8 (February 16, 2020, https://
www.taxnotes.com/tax-notes-federal/compliance/tax-noncompliance-and-
measures-income-inequality/2020/02/17/2c3y5). The individual income tax
underreporting gap is estimated to have increased from about $348
billion annually between 2014 to 2016 to about $396 billion in 2021.
IRS, Tax Gap Projections for Tax Years 2020 & 2021 12 (October 12,
2023, https://www.irs.gov/pub/irs-pdf/p5869.pdf). See Huang, Funding
Our Nation's Priorities, supra note 1.
\31\ See John Guyton et al., Tax Evasion at the Top of the Income
Distribution 35 (National Bureau of Economic Research, Working Paper
No. 28542, 2021, https://www.nber.org/system/files/working_papers/
w28542/w28542.pdf#page=29). Estimates of the total tax gap and the
share attributable to the highest-income filers vary and are difficult
to make given limited sight lines of the IRS into some major categories
of noncompliance (including offshore income, digital assets, and income
held through complex layers of entities). See Daniel Reck et al.,
Washington Center for Equitable Growth, Tax Evasion at the Top of the
U.S. Income Distribution and How to Fight It (March 22, 2021, https://
equitablegrowth.org/tax-evasion-at-the-top-of-the-u-s-income-
distribution-and-how-to-fight-it); Tax Gap Projections for Tax Years
2020 & 2021, supra note 30, at 18-21.
Both scenarios can be difficult for the IRS to detect and untangle.
Wealthy households can have finances far more complex than most typical
salary earners. Some of that complexity arises from the slew of tax
breaks on income from wealth and the complicated structures developed
to take advantage of them.\32\ Webs of entities used by high-income
filers that own wealth and make income can also make it difficult for
the IRS to match income to owners who should pay tax on it. And, unlike
income from earnings reported on W-2s (which enjoy 99 percent
compliance rates), the IRS often holds little or no ``third-party''
independent information on income from wealth that they can use to
verify the source or amount of reported (or unreported) income.\33\
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\32\ Tax system complexity is thought to be a driver of the tax gap
generally. See CRS, Federal Tax Gap: Size, Contributing Factors, and
the Debate Over Reducing It 2 (October 30, 2022, https://
crsreports.congress.gov/product/pdf/IF/IF11887#page=2) (``Tax code
complexity also creates opportunities for taxpayers who can afford to
hire tax professionals to reduce their tax liability through
questionable interpretations of the code.'').
\33\ IRS, Federal Tax Compliance Research: Tax Gap Estimates for
Tax Years 2011-2013 20 (September 2019, https://www.irs.gov/pub/irs-
pdf/p1415.pdf).
The returns of wage and salary filers are far easier and cheaper to
audit than the complex returns of high-income filers. Before the recent
Inflation Reduction Act (IRA) passed, the IRS lost about 40 percent of
its auditors, including those experienced enough to review the most
complex returns of large businesses and high net worth individuals.\34\
Audit rates for the top 1 percent of filers fell by more than 70
percent, becoming a shrinking share of all audits.\35\
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\34\ See Chuck Marr et al., Rebuilding the IRS Would Reduce the Tax
Gap, Help Replenish Depleted Revenue Base (December 16, 2022, https://
www.cbpp.org/research/federal-tax/rebuilding-irs-would-reduce-tax-gap-
help-replenish-depleted-revenue-base).
\35\ Calculations use data from: IRS, IRS Data Book Table 17a:
Examination Coverage and Recommended Additional Tax After Examination,
by Type and Size of Return, Tax Years 2010-2018 (last updated October
22, 2020, https://www.irs.gov/statistics/soi-tax-stats-examination-
coverage-and-recommended-additional-tax-after-examination-by-type-and-
size-of-return-tax-years-2010-2018-irs-data-book-table-17a). The top 1
percent includes all filers with adjusted gross income of $500,000 and
above. Table 17a includes in-process and completed audits, so figures
may change as new audits are opened for recent tax years. The figure
cited above is for tax year 2015, the most recent year outside the
normal statute of limitations for tax returns filed on time.
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costly tax subsidies for income from wealth are a
poor way to invest in the nation's future
Targeted tax breaks for specific types of income like those for
wealth are sometimes called ``tax expenditures,''\36\ or ``spending
through the tax code,'' because their economic and budgetary impact is
like a spending program designed to subsidize a particular
activity.\37\ These preferences carve income out of the Federal tax
base.\38\ Just like other types of Federal spending, tax expenditures
are not inherently sound or unsound policy.\39\ But the largest tax
breaks on income from wealth have large costs, including the following:
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\36\ TPC, Briefing Book (Tax Expenditures): What Are Tax
Expenditures and How Are They Structured? (May 2020, https://
www.taxpolicycenter.org/briefing-book/what-are-tax-expenditures-and-
how-are-they-structured).
\37\ See Congressional Budget and Impoundment Control Act of 1974,
Pub. L. No. 93-344 Sec. 3(a)(3), 88 Stat. 297, 299 (1974).
\38\ See Treasury, Tax Expenditures (last visited September 24,
2023, https://home.treasury.
gov/policy-issues/tax-policy/tax-expenditures).
\39\ For example, the Child Tax Credit is a tax expenditure that is
a powerful tool for lifting families out of poverty. See CBPP, Policy
Basics: The Child Tax Credit (December 7, 2022, https://www.cbpp.org/
research/federal-tax/the-child-tax-credit).
Economic costs of tax avoidance and evasion. The tax avoidance,
sheltering, and gaming that these tax subsidies attract pulls capital
and talent away from more productive activities.\40\
---------------------------------------------------------------------------
\40\ This effect can be described as a reduction in ``allocative
efficiency.'' Empirical literature suggests that allocative efficiency
effects can be more substantial than supply-side impacts in the context
of individual income tax reform; see William Gale and Andrew A.
Samwick, Effects of Income Tax Changes on Economic Growth, Brookings
Institution (February 1, 2016, https://www.brookings.edu/research/
effects-of-income-tax-changes-on-economic-growth/).
Locking capital into relatively unproductive investments.
The ability to defer taxes on capital gains until they are
realized--or wipe them out if held until death--is a major tax
incentive for wealthy filers to hold onto old investments that
have increased in value. Without this ``lock in'' effect from
taxes, they might instead sell their appreciated assets and use
the returns to make other, more productive investments that
would deliver a higher pretax return for them and for the real
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economy.
Redirecting resources and talent into tax avoidance. Talent
and innovation go into industries devoted to creating and
implementing tax avoidance schemes--which are themselves
economically inefficient--rather than where that talent could
be more productive.\41\
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\41\ Len Burman, Capital Gains Tax Rates and Economic Growth (or
not), Forbes (March 15, 2012, https://www.forbes.com/sites/
leonardburman/2012/03/15/capital-gains-tax-rates-and-economic-growth-
or-not/?sh=65c8e411e2e0).
Competitively disadvantaging innovation and work. Relatedly,
innovators and entrepreneurs who wish to focus on productive
activity in the real economy can find themselves at a
disadvantage relative to those who use tax avoidance and
---------------------------------------------------------------------------
evasion to compete.
Increased inequality. About 90 percent of the benefit of lower
rates for capital gains and dividends accrues to the top 20 percent of
filers, with more than half going to the top 1 out of every thousand
filers, and stepped-up basis is similarly concentrated. These tax
benefits for existing wealth increase racial wealthiest disparities
that have been produced by historical and current barriers to wealth
building.\42\
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\42\ See Lily Batchelder and Greg Leiserson, Disparities in the
Benefits of Tax Expenditures by Race and Ethnicity, Treasury (January
20, 2023, https://home.treasury.gov/news/featured-stories/disparities-
in-the-benefits-of-tax-expenditures-by-race-and-ethnicity).
Failure to deliver promised benefits. Those seeking to maintain tax
breaks for income from wealth often argue--contrary to evidence--that
they deliver broad-based economic benefits. In fact, there is little
evidence that such tax breaks increase private savings rates--while the
amounts they add to national deficits and their other economic costs
are large and clear.\43\
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\43\ For reviews of the empirical literature addressing these
issues, see Congressional Research Service, Capital Gains Taxes: An
Overview of the Issues (May 24, 2022, https://sgp.fas.org/crs/misc/
R47113.pdf); Gale and Samwick, supra note 40; Chuck Marr and Chye-Ching
Huang, Raising Today's Low Capital Gains Tax Rates Could Promote
Economic Efficiency and Fairness, While Helping Reduce Deficits, CBPP
(September 9, 2012, https://www.cbpp.org/research/raising-todays-low-
capital-gains-tax-rates-could-promote-economic-efficiency-and-
fairness).
Fiscal costs_and opportunity costs. The combination of lower rates
for long-term capital gains and dividend income and stepped-up basis
adds over $200 billion to deficits annually.\44\ Taxes owed but not
paid by the top 1 percent (by income) of filers is an additional $77 to
143 billion of the annual individual income underreporting gap.\45\
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\44\ JCT, supra note 6 at 35.
\45\ Estimates suggest that roughly 28 percent to 36 percent of the
individual income underreporting gap is attributable to the highest-
income 1 percent of filers. Johns and Slemrod, supra note 30; DeBacker
et al., supra note 30; Guyton et al., supra note 31. The individual
income tax underreporting gap is estimated to have increased from about
$348 billion annually between 2014 to 2016 to about $396 billion in
2021. Internal Revenue Service, Tax Gap Projections for Tax Years 2020
& 2021, supra note 30 (https://www.irs.gov/pub/irs-pdf/p5869.pdf).
Devoting hundreds of billions in Federal resources annually to
support lower (and unpaid) taxes on income from wealth represents a
missed opportunity to make investments that could deliver better
returns for the Nation.
reallocating tax breaks on wealth to better investments
Major provisions of the tax law enacted by President Trump are set
to expire at the end of 2025. Some lawmakers are proposing to halt this
in full without offsetting the cost.\46\ That would increase
inequality, further lower revenues, and add to deficits, and would
represent a tripling-down on a policy mistake already made twice
before. Without the two rounds of tax cuts first enacted under
President Bush and President Trump, both of which gave a
disproportionate share of their benefit to the already wealthy,
revenues would be 3 percent higher as a share of GDP today and the
ratio of debt to GDP would be declining indefinitely.\47\
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\46\ See, e.g., TCJA Permanency Act, H.R. 976, 118th Cong. (2023).
\47\ Bobby Kogan, Tax Cuts Are Primarily Responsible for the
Increasing Debt Ratio, Center for American Progress (March 27, 2023,
https://www.americanprogress.org/article/tax-cuts-are-primarily-
responsible-for-the-increasing-debt-ratio/).
Instead, in 2025 lawmakers can take the opportunity to raise
revenues to meet our Nation's fiscal and economic challenges, including
by redirecting Federal resources away tax breaks for wealth towards
better investments.\48\
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\48\ Brian Deese and David Kamin, Principles for the 2025 Tax
Debate, Tax Notes (October 16, 2023, https://www.taxnotes.com/featured-
analysis/principles-2025-tax-debate/2023/10/13/7hdfd); Bobby Kogan, The
Rich Get Richer, Deficits Get Bigger: How Tax Cuts for the Wealthy and
Corporations Drive National Debt, Testimony Before the Senate Budget
Committee n.xxvi (May 17, 2023, https://www.budget.senate.gov/imo/
media/doc/Mr.%20Bobby%20Kogan%20-%20Testimony%20-
%20Senate%20Budget%20Committee1.pdf).
Federal revenues are currently about 18.4 percent of GDP, and CBO
projects this to fall through 2025, and to rise only modestly
thereafter. But a large part of that projected rise in revenues will
take place only if the parts of the 2017 tax law that are scheduled to
expire do in fact sunset. The U.S. raises less revenue at all levels of
government, relative to the size of its economy, than most other
developed countries.\49\
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\49\ TPC, How Do US Taxes Compare Internationally? (May 2020,
https://www.
taxpolicycenter.org/briefing-book/how-do-us-taxes-compare-
internationally).
The projected long-run growth in Federal spending stems primarily
from the retirement of the baby boomers and the related rise in health
care and retirement security costs.\50\ Higher revenues can help
address these costs while preventing cuts to programs and investments
that would both increase hardship and weaken the economy.\51\ Raising
revenues can also support the investments needed to raise health and
living standards for low- and moderate-income families; secure an
innovative, dynamic, and inclusive economy; and address global
challenges.
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\50\ CBO, The 2023 Long-Term Budget Outlook 6 (June 2023, https://
www.cbo.gov/system/files/2023-06/59014-LTBO.pdf).
\51\ See Paul Van de Water, Medicare Is Not ``Bankrupt,'' CBPP
(February 13, 2023, https://www.cbpp.org/research/health/medicare-is-
not-bankrupt).
Revenue options. There are many sound options for raising revenue.
For instance, in ``Broadening the U.S. Federal Tax Base,'' the Tax Law
Center has compiled several dozen options to strengthen the tax base,
which we have designed or analyzed. The options span individual,
transfer, corporate, and other Federal taxes. This work draws on the
deep tax practice, tax administration, and research expertise of our
staff, and our networks of public interest minded tax researchers and
market actors.\52\
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\52\ Many other compilations of potential base broadening options
include Treasury's ``Green Books,'' tax reform proposals, and CBO's
``Budget Options.'' Ours focuses on options that the Tax Law Center has
developed or analyzed recently in consultation with other experts, and
includes links to relevant Tax Law Center publications such as our
Priority Guidance Plan submissions and analyses of proposed
legislation.
To bring more income from wealth into the tax base in 2025,
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lawmakers can:
(1) Allow tax breaks for income from wealth to expire. Various
provisions of the TCJA expanded tax breaks for income from wealth,
increased complexity, encouraged tax avoidance, and delivered no
discernible economic benefit.\53\ They should be allowed to expire, and
include the following:
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\53\ The Tax Law Center and others have written about how the TCJA
should be addressed more broadly. See Deese and Kamin, supra note 48;
Huang, Funding Our Nation's Priorities, supra note 1; Chuck Marr, 2025
Tax Debate Begins, Offers Opportunity for Course Correction, CBPP
(March 7, 2023, https://www.cbpp.org/blog/2025-tax-debate-begins-
offers-opportunity-for-course-correction).
The section 199A ``pass through'' deduction. If kept in
place, it will cost $700 billion over 2026-2035.\54\ More than
half of its value goes to the top 1 percent (by income) of
filers, and a full quarter goes to the highest-income one out
of every 1,000 tax filers.\55\ Tax advisors have called section
199A a ``gaping hole'' in the code.\56\ It is, ``the very worst
kind of tax policy, picking winners and losers haphazardly in a
complex tax provision, and then generating significant
incentives for people to rearrange their businesses to try to
get on the right side of the line.''\57\ Research suggests that
the deduction failed to boost economic activity in the 2 years
following its enactment.\58\
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\54\ Chuck Marr and Samantha Jacoby, The Pass-Through Deduction is
Tilted Heavily to the Wealthy, Is Costly, and Should Expire as
Scheduled, CBPP (June 8, 2023, https://www.cbpp.org/research/federal-
tax/the-pass-through-deduction-is-tilted-heavily-to-the-wealthy-is-
costly-and).
\55\ TPC, Tax Benefit of the Deduction for Qualified Business
Income, Baseline: Current Law, Distribution of Federal Tax Changes by
Expanded Cash Income Percentile, 2022 (December 29, 2022, https://
www.taxpolicycenter.org/model-estimates/individual-income-tax-
expenditures-december-2022/t22-0262-tax-benefit-deduction).
\56\ Emily Horton, Tax Planner: Drive Wealthy Clients Through
``Gaping Hole'' in Tax Code, CBPP (May 31, 2018, https://www.cbpp.org/
blog/tax-planner-drive-wealthy-clients-through-gaping-hole-in-tax-
code).
\57\ Jacoby, supra note 23 (quoting David Kamin). Similarly, former
JCT Chief of Staff Edward Kleinbard called it ``Congress's worst idea
ever.'' Id.
\58\ Lucas Goodman et al., How Do Business Owners Respond to a Tax
Cut? Examining the 199A Deduction for Pass-Through Firms 1-4 (National
Bureau of Economic Research, Working Paper No. 28680, 2022, https://
www.nber.org/system/files/working_papers/w28680/w28680.
pdf).
The doubled exclusion from estate and gift taxes. The 2017
tax law doubled the amount that a wealthy couple can pass tax-
free to their heirs from $11 million to $22 million. Extending
this would cost $125 billion between 2026 and 2033.\59\ The
doubled exclusion potentially more than doubles the amount of
money wealthy individuals can pass on tax-free. This is because
the exemption can be used to make lifetime gifts of assets, and
those assets may appreciate over the donee's lifetime. Such
gifts can facilitate some of the most complex tax avoidance
techniques that push large fortunes out of the transfer tax
base.\60\
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\59\ CBO, Budgetary Outcomes Under Alternative Assumptions About
Spending and Revenue Table 1 (May 2023, https://www.cbo.gov/
publication/59169).
\60\ See, e.g., Jesse Drucker and Maureen Farrell, A Lavish Tax
Dodge for the Ultrawealthy Is Easily Multiplied, New York Times
(December 28, 2021, https://www.nytimes.com/2021/12/28/business/tax-
break-qualified-small-business-stock.html); Barbara Bryniarski, Helping
a Client Benefit from an Intentionally Defective Grantor Trust, Tax
Adviser (November 11, 2021, https://www.thetaxadviser.com/newsletters/
2021/nov/helping-client-benefit-intentionally-defective-grantor-
trust.html).
(2) Ensure the IRS has adequate resources and tools so that more
wealthy filers pay what they owe under the law. To rebuild and
transform taxpayer services and ensure that high-income filers and
large corporations pay more of the taxes they already owe, the IRA
provided the IRS an additional $80 billion to be spent through the end
of 2031. CBO estimated that this funding would raise a net $180.4
billion between 2022 and 2031 by simply collecting more tax revenue
that is already owed under the law.\61\ Along with improvements to
taxpayer services, the IRS has embarked on several initiatives to
improve high-income compliance, including creating a new unit
specifically to address large and complex pass-through entities and
tripling the size of its global high-wealth group.\62\ But by cutting
some $21.39 billion from this IRA funding, the debt limit deal, if
implemented, will add to deficits by a net of some $19 billion over the
next 10 years in increased tax noncompliance,\63\ and move forward a
cliff in IRS funding to FY 2030.\64\ Lawmakers can address this cliff
in 2025 and before then not worsen the damage from the debt ceiling
deal. Doing so will raise net revenue by continuing increased tax
compliance among wealthy filer and large businesses.\65\
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\61\ Phillip L. Swagel, Congressional Budget Office, Additional
Information About Increased Enforcement by the Internal Revenue Service
1 (August 25, 2022, https://www.cbo.gov/system/files/2022-08/58390-
IRS.pdf).
\62\ See IRS, IR-2023-166, IRS Announces Sweeping Effort to Restore
Fairness to Tax System with Inflation Reduction Act Funding; New
Compliance Efforts Focused on Increasing Scrutiny on High-Income,
Partnerships, Corporations and Promoters Abusing Tax Rules on the
Books, (September 8, 2023, https://www.irs.gov/newsroom/irs-announces-
sweeping-effort-to-restore-fairness-to-tax-system-with-inflation-
reduction-act-funding-new-compliance-efforts); IRS, IR-2023
-176, IRS to Establish Special Pass-Through Organization to Help with
High-Income Compliance Efforts; New Workgroup to Blend Current
Employees and New Hires to Focus on Complex Partnerships, Other Key
Areas (September 20, 2023, https://www.irs.gov/newsroom/irs-to-
establish-special-pass-through-organization-to-help-with-high-income-
compliance-efforts-new-workgroup-to-blend-current-employees-and-new-
hires-to-focus-on-complex-partnerships-other-key-areas); Wesley Elmore,
IRS Tripling Size of Its Global High-Wealth Group, Tax Notes (October
30, 2023, https://www.taxnotes.com/tax-notes-federal/tax-system-
administration/irs-tripling-size-its-global-high-wealth-group/2023/10/
30/7hhjt).
\63\ Thalia Spinrad and Chye-Ching Huang, Impact of House and
Senate IRS Funding Proposals, Tax Law Center (July 18, 2023, https://
medium.com/@taxlawcenter/impact-of-house-and-senate-irs-funding-
proposals-e8fea900d5e1).
\64\ Chye-Ching Huang, Thalia Spinrad, and Kathleen Bryant, Debt
Ceiling Deal's Cuts to IRS Funding Bring the IRS Funding Cliff Closer:
Appropriators Should Not Compound Harm, Tax Law Center (June 28, 2023,
https://www.law.nyu.edu/sites/default/files/Debt%20Ceiling%20
Deal%E2%80%99s%20Cuts%20to%20IRS%20Funding%20Bring%20the%20IRS%20Funding
%20
Cliff%20Closer-%20Appropriators%20Should%20Not%20Compound%20Harm.pdf).
Moreover, House bills have proposed to rescind all of the remaining IRA
funds and thus would, if enacted, move the funding cliff up to FY 2024.
Id.
\65\ Thalia Spinrad and Chye-Ching Huang, supra note 63.
Additionally, lawmakers can ensure that the IRS and other
regulators are able to better understand the opaque structures and
transactions that some wealthy filers use to conduct tax evasion, money
laundering, sanctions evasion, and other crimes. Options include the
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following:
Improving the bipartisan Corporate Transparency Act (CTA) to
identify tax evasion and other criminal activity using pass-
throughs. The Panama Papers highlighted the use of shell
companies to hide wealth from tax and law enforcement agencies.
Members of this committee helped lead a sound bipartisan step
to address this issue with the CTA, which establishes a
registry of the ultimate owners of certain entities that is
available to the IRS and other regulators. The registry covers
many corporations and LLCs but does not currently include most
general partnerships, trust arrangements, or other entities
with no State filing requirement. The most egregious tax
evasion linked with corruption, sanctions evasion and other
criminal activities is likely to flow towards the pass-throughs
and other entities left in the shadows, unless lawmakers act.
The Tax Law Center has proposed paths forward.\66\
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\66\ Sophia Yan, How Strengthening the Corporate Transparency Act
Can Help the IRS Follow the Money, Just Security (April 12, 2022,
https://www.justsecurity.org/81008/how-strengthening-the-corporate-
transparency-act-can-help-the-irs-follow-the-money/); Sophia Yan,
Budget Represents a Missed Opportunity to Promote Corporate
Transparency Act Reforms, Tax Law Center (April 19, 2023, https://
medium.com/@taxlawcenter/budget-represents-a-missed-opportunity-to-
promote-corporate-transparency-act-reforms-8be5d8bbf438); Tax Law
Center, Comment Letter on Beneficial Ownership Information Reporting
Requirements (February 7, 2022, https://www.regulations.gov/comment/
FINCEN-2021-0005-0403).
Extending broker reporting to high-value art and
antiquities. The opaque art and antiquities market facilitates
tax and sanctions evasion and money laundering.\67\ Currently,
brokers must provide information reporting to the IRS on the
gross proceeds of and gain or loss on dispositions of certain
assets, including stocks, securities, and digital assets, but
this requirement does not apply to art and antiquities.\68\ The
Tax Law Center proposes extending broker reporting to art and
antiquities to address their role in enabling tax evasion.
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\67\ See, e.g., Graham Bowley, As Money Launderers Buy Dalis, U.S.
Looks at Lifting the Veil on Art Sales, New York Times (June 19, 2021,
https://www.nytimes.com/2021/06/19/arts/design/money-laundering-art-
market.html); Permanent Subcommittee on Investigations, Committee on
Homeland Security and Governmental Affairs, The Art Industry and U.S.
Policies that Undermine Sanctions 35-37 (July 27, 2020, https://
www.hsgac.senate.gov/imo/media/doc/2020-07-
29%20PSI%20Staff%20Report%20-%20The%20Art%20Industry%20and%20U.S.%20
Policies%20that%20Undermine%20Sanctions.pdf#page=38).
\68\ The Secretary of Treasury has not exercised her authority
under section 6045(a) to require brokers to report the gross proceeds
of transactions involving art and antiquities.
Improving information reporting on digital assets. Digital
assets pose ``a significant detection problem by facilitating
illegal activity broadly including tax evasion.''\69\ In 2019,
the Financial Action Task Force (FATF) extended its anti-money
laundering and counter-terrorist financing measures to digital
assets.\70\ But the U.S. is not fully compliant.\71\
Congressional action, such as the bipartisan Digital Asset
Anti-Money Laundering Act, could help bring the U.S. into
compliance and address the significant money laundering and tax
evasions risks posed by digital assets by ensuring additional
information reporting.\72\
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\69\ Treasury, The American Families Plan Tax Compliance Agenda 20
(May 2021, https://home.treasury.gov/system/files/136/The-American-
Families-Plan-Tax-Compliance-Agenda.pdf#
page=21) (citing Omri Marian, Are Cryptocurrencies Super Tax Havens?,
112 Michigan Law Review First Impressions 38 (2013)); see also
Treasury, General Explanations of the Administration's Revenue
Proposals for Fiscal Year 2024 200 (March 2023, https://
home.treasury.gov/system/files/131/General-Explanations-
FY2024.pdf#page=207); David Lawder, U.S. IRS chief asks Congress for
authority to collect cryptocurrency transfer data, Reuters (June 8,
2021, https://www.reuters.com/business/us-irs-chief-says-needs-
congressional-authority-cryptocurrency-reporting-2021-06-08/).
\70\ FATF, Targeted Update on Implementation of the FATF Standards
on Virtual Assets and Virtual Asset Service Providers 2 (2023, https://
www.fatf-gafi.org/content/dam/fatf-gafi/guidance/June2023-Targeted-
Update-VA-VASP.pdf.coredownload.inline.pdf#page=4).
\71\ FATF, United States (last accessed November 7, 2023, https://
www.fatf-gafi.org/en/countries/detail/United-States.html).
\72\ Digital Asset Anti-Money Laundering Act of 2023, S. 2669,
118th Cong. (2023).
Finally, lawmakers should be ready to respond when taxpayers
exploit loopholes in the tax code or undermine provisions that aim to
curtail tax avoidance, including by securing interpretations of the
code in the courts that undermine legislative intent and tax
compliance.\73\
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\73\ Taxpayer challenges in the courts have put various bipartisan
regimes under pressure, including the reportable transactions regime
and the conservation easement deduction. See, e.g., Mann Construction
v. United States, No. 1:20-cv-11307 (6th Cir. March 3, 2022); CIC
Services LLC v. IRS, No. 3:17-cv-00110 (E.D. Tenn. March 21, 2021).
IRS, IR-2022-125, IRS wraps up 2022 ``Dirty Dozen'' scams list; agency
urges taxpayers to watch out for tax avoidance strategies (June 10,
2022, https://www.irs.gov/newsroom/irs-wraps-up-2022-dirty-dozen-scams-
list-agency-urges-taxpayers-to-watch-out-for-tax-avoidance-strategies).
Challenges to the economic substance doctrine are also pending.
(3) Ensure income from extraordinarily large fortunes faces at
least some tax and reduce preferences for income from wealth over work.
Lawmakers can address the fundamental issue that much capital gain and
dividend income does not face tax or face it at adequate rates. There
are many sound options for doing so. Former JCT Chief of Staff Harry L.
Gutman noted that in past decades, ``both Democratic and Republican
Treasury Departments have identified ``step-up'' as a problem and
proposed essentially identical solutions.''\74\ President Biden's
Billionaires Minimum Income Tax would raise $437 billion over 2024-
2033,\75\ and Chairman Wyden's Billionaires Income Tax would raise an
estimated $577 billion over 10 years.\76\
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\74\ Harry L. Gutman, Funding Our Nation's Priorities: Reforming
the Tax Code's Advantageous Treatment of the Wealthy, Testimony before
the Select Revenue Measures Subcommittee 3 (May 12, 2021, https://
docs.house.gov/meetings/WM/WM05/20210512/112604/HHRG-117-WM05-Wstate-
GutmanH-20210512.pdf#page=3).
\75\ Treasury, General Explanations of the Administration's Fiscal
Year 2024 Revenue Proposals 82, 214 (https://home.treasury.gov/system/
files/131/General-Explanations-FY2024.pdf#page=
89).
\76\ JCT estimate for 2022-2031. See Press Release, U.S. Senate
Committee on Finance, Wyden Statement on Billionaires Income Tax Score
(November 5, 2021, https://www.finance.senate.gov/chairmans-news/wyden-
statement-on-billionaires-income-tax-score).
Other proposals include: ending step-up basis, see Treasury, General
Explanations of the Administration's Fiscal Year 2023 Revenue Proposals
30, 34 (https://home.treasury.gov/system/files/131/General-
Explanations-FY2023.pdf); ``carryover basis,'' see Office of Senator
Mitt Romney, Romney, Bennet Offer Path to Bipartisan Compromise on
Refundable Credits, Business Tax Fixes (December 15, 2019, https://
www.romney.senate.gov/romney-bennet-offer-path-bipartisan-compromise-
refundable-credits-business-tax-fixes/); targeting consumption out of
unrealized gains; and inheritance taxation, see Lily L. Batchelder,
Leveling the Playing Field Between Inherited Income and Income from
Work through an Inheritance Tax, in Tackling the Tax Code: Efficient
and Equitable Ways to Raise Revenue 48-88 (Jay Shambaugh and Ryan Nunn
eds., 2020, https://www.
hamiltonproject.org/assets/files/Batchelder_LO_FINAL.pdf).
Lawmakers can also close down or cut back on some of the myriad of
other tax breaks and loopholes for income from wealth, such as by
closing the ``Gingrich-Edwards'' and related loopholes,\77\ ensuring
that partnership taxation is more rational, clear, and tied to economic
reality (including closing the ETF loophole);\78\ addressing PPLI,\79\
closing the carried interest loophole; \80\ and plugging numerous holes
in the transfer tax regime.\81\
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\77\ See Huang, Strengthening the Tax Base, supra note 1, at 14.
\78\ Id. at 14-17.
\79\ See Press Release, U.S. Senate Committee on Finance, Wyden
Launches Investigation Into Private Placement Life Insurance Schemes
(August 15, 2022, https://www.finance.senate.gov/chairmans-news/wyden-
launches-investigation-into-private-placement-life-insurance-schemes).
\80\ See Tax Law Center, Broadening the US Federal Tax Base
(September 27, 2023, https://www.law.nyu.edu/sites/default/files/
Broadening%20the%20US%20Federal%20Tax%20Base%20
-%209.26.23.xlsx).
\81\ For several options related to closing holes in the transfer
tax regime, see id.
______
Questions Submitted for the Record to Chye-Ching Huang
Questions Submitted by Hon. Catherine Cortez Masto
Question. Historically, we have seen a significant wealth gap
between White families and families of color. Many people of color are
also low-income workers and recent studies showed that Black Americans
were disproportionately targeted by IRS audits. I applaud the IRS for
working to address this issue, yet I am still concerned that we will
continue to see the racial wage gap and the overall tax gap widen.
In your testimony, you mention that ``tax benefits for existing
wealth increase racial wealth disparities that have been produced by
historical and current barriers to wealth building.''
Can you expand on how lack of action against ultra-wealthy tax
cheats disproportionally hurts communities of color?
Answer. Due to cuts to the IRS budget between 2010 and 2021, audit
rates on the top 1 percent fell so steeply that they are audited at
about the same rate as families claiming the Earned Income Tax Credit
(``EITC''), even though the top 1 percent of filers contribute far more
to the ``tax gap'' of taxes owed but not paid.\1\ Audits of EITC
recipients are easier and cheaper to accomplish than audits of wealthy
filers, so these rates fell far less steeply over the same period as a
result of budget cuts. Research has now also confirmed that the IRS's
audit algorithms have effectively been treating EITC errors as ``more
important'' than other types of tax non-compliance.\2\
---------------------------------------------------------------------------
\1\ Tax Law Center at NYU Law, Issue Brief on Rebalancing Reporting
on Sources of the Tax Gap (updated July 11, 2023, https://
www.law.nyu.edu/sites/default/files/Improper%20
Payments%20Refundables%20vs.%20Other%20Tax%20Gap%20Sources.pdf).
\2\ Tax Law Center at NYU Law, IRS Takes Important Step to Increase
Accuracy and Reduce Racial Disparities by Addressing Audits by Mail
(September 19, 2023, https://medium.com/@taxlawcenter/irs-takes-
important-step-to-increase-accuracy-and-reduce-racial-disparities-by-
addressing-audits-by-f74da8bbea7a); Kathleen Bryant and Chye-Ching
Huang, New Evidence on Racial Disparities in IRS Audit Selection Calls
for Immediate Action, Tax Law Center at NYU Law (March 2, 2023, https:/
/www.law.nyu.edu/sites/default/files/New%20Evidence%20on%20
Racial%20Disparities%20in%20IRS%20Audit%20Selection%20Calls%20for%20Imme
diate%20
Action_0.pdf).
Over-auditing of ETIC recipients for both of these reasons
compounds existing racial disparities and contributes to the over-
auditing of Black filers, in particular. Barriers to full economic
participation erected by past and present policy choices and
discrimination mean that people of color are disproportionately
represented among low-wage workers eligible for tax credits such as the
EITC and Child Tax Credit. According to data on audit rates before the
recent restoration of IRS funding, the most highly audited areas of the
country are rural southern counties that have predominantly Black
residents. Restoring and maintaining IRS resources in a way that
reduces the disparities in audit rates for wealthy filers compared to
---------------------------------------------------------------------------
EITC recipients is critical for addressing these racial disparities.
Furthermore, working families facing an audit overwhelmingly do not
have any professional help navigating that process and can end up
losing tax credits that they are eligible for just because they cannot
make it through the audit. The experience of being audited may also
scare them away from claiming tax credits they are in fact eligible for
in the future, research shows.\3\
---------------------------------------------------------------------------
\3\ John Guyton, Kara Leibel, Day Manoli, Ankur Patel, Mark Payne,
and Brenda Schafer, The Effects of EITC Correspondence Audits on Low-
Income Earners, IRS SOI Working Paper (December 2019, https://
www.irs.gov/pub/irs-soi/19rpeitccorresponenceaudit.pdf).
Question. How can Congress design and monitor Federal policies to
---------------------------------------------------------------------------
promote racial and gender equity?
Answer. First, the IRS and lawmakers can remove barriers preventing
underserved families and communities from accessing tax guidance and
reliable tax preparation services. Instead of subjecting filers who do
not have the resources or help to file accurately to unnecessary
audits, the IRS can focus on assisting filers to more easily understand
and comply with their tax obligations and claim tax credits that they
are eligible for. The tax system should not be subjecting filers who
are trying to file accurately to unnecessary audits when it could
instead provide them the information and support needed to file
accurate returns.
The IRS can do some of this by itself with restored funding and
better services--an excellent example is its important move to reopen
in-person taxpayer assistance centers.\4\ And the IRS has also already
taken commendable action to reduce reliance on correspondence audits
that research shows both feed racial disparities and increase
inaccuracy by denying credits to families who are eligible but cannot
make it through a burdensome audit process.\5\
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\4\ IRS, IR-2023-127, IRS Continues Reopening Closed Taxpayer
Assistance Centers; Begins Special Series of Community Assistance
Visits to Help Taxpayers in 8 States to Expand Service for People Who
Aren't Near Agency Offices (July 14, 2023, https://www.irs.gov/
newsroom/irs-continues-reopening-closed-taxpayer-assistance-centers-
begins-special-series-of-community-assistance-visits-to-help-taxpayers-
in-8-states-to-expand-service-for-people-who-arent-near-agency-
offices#::text=Help-
,IRS%20continues%20reopening%20closed%20Taxpayer%20Assistance%20
Centers%3B%20begins%20special%20series,aren't%20near%20agency%20offices)
\5\ Tax Law Center at NYU Law, IRS Takes Important Step to Increase
Accuracy and Reduce Racial Disparities by Addressing Audits by Mail,
supra note 2.
Congress can help by continuing to support the funding needed to
develop better taxpayer services and approaches to compliance,
including free and simplified filing tools.\6\ Congress can also
provide the IRS authority to require unenrolled paid tax preparers, who
lack a professional credential indicating their qualification and are a
large source of filing error, to meet basic standards of competence.\7\
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\6\ David Kamin and Mike Kaercher, Finally, Americans Could Soon
`Direct File' Taxes Online Without a Middleman, Tax Law Center at NYU
Law (June 15, 2023, https://medium.com/@taxlawcenter/finally-americans-
could-soon-direct-file-taxes-online-without-a-middleman-a74f11c6ec6b).
\7\ John Wancheck, IRS Needs Authority to Regulate Tax Return
Preparers, Center on Budget and Policy Priorities (May 5, 2021, https:/
/www.cbpp.org/blog/irs-needs-authority-to-regulate-tax-return-
preparers).
Second, the IRS can invest in research and transparency. The IRS
has not, to my knowledge, publicly committed to regularly reporting on
its progress eliminating audit disparities and should do so.
Additionally, the IRS has answered some, but not all, of the questions
experts have posed about the root causes of the racial disparities in
audit. This is also something the IRS should quickly address.\8\
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\8\ Kathleen Bryant, Unanswered Questions Remain on Causes of
Racial Disparities in Audit Selection and the IRS's Plans for Further
Evaluation, Tax Law Center at NYU Law (May 26, 2023, https://
medium.com/@taxlawcenter/unanswered-questions-remain-on-causes-of-
racial-disparities-in-audit-selection-and-the-irss-plans-1154e19fd09a).
It is notable that IRS data and research by Treasury Department
officials, in collaboration with external researchers, confirmed racial
disparities in audits that have been long suspected by independent
researchers.\9\ Lawmakers can ensure that the IRS uses some of its
restored funding to continue to invest in the types of research that
shone light on these disparities. The divisions of the IRS that perform
that research should also be enabled to continue to pursue it even when
it puts an uncomfortable spotlight on IRS practices that are not
working well or that are inequitable.
---------------------------------------------------------------------------
\9\ Hadi Elzayn, Evelyn Smith, Thomas Hertz, Arun Ramesh, Robin
Fisher, Daniel Ho, and Jacob Goldin, Measuring and Mitigating Racial
Disparities in Tax Audits, Stanford Institute for Economic and Policy
Research (January 30, 2023, https://dho.stanford.edu/wp-content/
uploads/IRS_Disparities.pdf).
The IRS Strategic Operating Plan acknowledges that research and
evaluation, including on racial disparities, is needed to ensure that
the restored funding is used most effectively and efficiently, and this
is a good start. Lawmakers can help hold the IRS accountable for
following through by ensuring that it makes concrete commitments of
resources and staff to research and evaluation on IRS services and
compliance efforts. This work is important, but is not likely to
generate ``quick wins,'' may lead to uncomfortable but necessary
criticism, and can be easily neglected in a major and complex
---------------------------------------------------------------------------
transformation project.
Third, the IRS can make sure it is hearing from all families
affected by the tax system. The IRS gets a lot of input from
sophisticated, high-income filers who are lobbying for certain
regulations, but low- and moderate-income filers do not have the same
level of access.\10\ In response, the IRS should make certain that the
stakeholder engagement practices it relies on to inform its work
enables it to get and consider input from all of the people affected by
the tax system, not just those with the most resources. For example,
the IRS can more actively work to guarantee that the Advisory
Committees that it relies on to hear from stakeholders are more
representative. There are a wide range of options for improvement in
this area, and it is also promising that the IRS and Treasury have
started to adopt some innovative approaches to broadening input.\11\
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\10\ See Shun-Yi Oei and Leigh Osofsky, Legislation and Comment:
The Making of the Sec. 199A Regulations, 69 Emory Law Journal 209
(2019, https://scholarlycommons.law.emory.edu/elj/vol69/iss2/1/); Clint
Wallace, Congressional Control of Tax Rulemaking, 71 Tax Law Review 179
(2017, https://scholarcommons.sc.edu/cgi/
viewcontent.cgi?article=2351&context=law_fac
pub).
\11\ Chye-Ching Huang, Modernizing Tax Regulatory Review, Yale
Journal on Regulation: Notice and Comment (June 29, 2023, https://
www.yalejreg.com/nc/modernizing-tax-regulatory-review-by-chye-ching-
huang/).
______
Question Submitted by Hon. Elizabeth Warren
Question. Congressional Republicans are working to extend and
revive three expiring business provisions from the 2017 Tax Cuts and
Jobs Act (TCJA)--100 percent bonus depreciation, R&E expensing, and the
net interest deduction--which help giant corporations cut their tax
rates to the bone. Just like they did in 2017, congressional
Republicans are pushing for a short-term extension to hide just how
expensive these provisions really are, despite having every intention
of extending them indefinitely.
According to your testimony, extending 100 percent bonus
depreciation for 3 years appears to only cost $3 billion over the next
decade, but permanently extending the provision would cost a staggering
$325 billion over the next decade.
How do the revenue projections differ between a short-term (e.g.,
3-year) extension and a permanent extension for all three provisions?
What accounting gimmicks have congressional Republicans used to make
corporate tax breaks appear drastically less expensive than they
actually are?
Answer. The TCJA prioritized making permanent large net cuts to
corporate taxes, including cutting the corporate tax rate from 35
percent to 21 percent and slashing the default rate on multinationals'
foreign profits even lower. To partially offset the large cost, the law
scaled back certain tax breaks for businesses starting in 2023,
including requiring businesses to deduct research and experimentation
(R&E) expenses more gradually over time and tightening limitations on
interest deductions. Furthermore, while the law initially allowed
businesses to fully expense their capital investments (``full bonus
depreciation''), it set this provision to gradually phase out.
Those three changes allowed proponents to claim $292 billion in
``savings'' in the last half of the budget window, enough to offset
about 40 percent of the cost of cutting the corporate tax rate in those
years. Corporate lobbyists now want policymakers to reverse those
offsets by reinstating the underlying tax breaks temporarily--but
without enacting a corresponding increase in the corporate tax rate or
otherwise reversing any of the law's large permanent tax cuts for
corporations.
Doing so would be a gimmick upon a gimmick upon a gimmick.
First, undoing ``offsets'' without also undoing the net tax cuts
that they purportedly paid for just richens the already large permanent
corporate tax cuts in the TCJA.
Second, doing so in small increments by ``temporarily'' enacting
corporate tax breaks masks the true permanent cost of these tax breaks,
which many businesses and lawmakers are seeking to ultimately make
permanent.
For example, loosening the limitation on net interest deductions
would cost roughly $19 billion over 10 years if enacted ``temporarily''
for 3 years,\12\ while the permanent provision would cost roughly $50
billion over 10 years.\13\
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\12\ Joint Committee on Taxation (JCT), JCX-29-23, Estimated
Revenue Effects of H.R. 3938, The ``Build It In America Act'' (June 9,
2023, https://www.jct.gov/publications/2023/jcx-29-
23/).
\13\ Committee for a Responsible Federal Budget, Tax Cut Extensions
Cost Over $3.3 Trillion (August 14, 2023, https://www.crfb.org/blogs/
tax-cut-extensions-cost-over-33-trillion#::text=
Extending%20the%20TCJA%20in%20full,6.8%20percent%20under%20current%20law
).
Third, and worse, full bonus depreciation and R&E expensing involve
shifts in the timing of when tax breaks are claimed, so the apparent
cost of these temporary cuts is even more unrepresentative of the true
cost of making these provisions permanent. Official estimates of a
temporary restoration of full bonus depreciation and R&E expensing tax
breaks show revenue losses for both provisions while the temporary tax
break is in effect, but then show revenue increases (above current law
levels) after the tax break is assumed to expire. Three-year temporary
full bonus depreciation is estimated to cost only $3 billion over 10
years,\14\ but the cost of permanent bonus depreciation is $325 billion
over 10 years.\15\ Three-year R&E expensing is estimated to cost $25
billion over 10 years,\16\ while the permanent provision costs more
than $150 billion over 10 years.\17\
---------------------------------------------------------------------------
\14\ JCT, supra note 12.
\15\ Congressional Budget Office (CBO), Budgetary Outcomes Under
Alternative Assumptions About Spending and Revenues (May, 2023, https:/
/www.cbo.gov/system/files/2023-05/59154-Budgetary-Outcomes.pdf).
\16\ JCT, supra note 12.
\17\ Committee for a Responsible Federal Budget, supra note 13.
Because businesses and some lawmakers see ``temporary''
reinstatement of these three provisions as a way to make the provisions
permanent, we should be looking at the permanent cost of provisions
like full bonus depreciation and R&E expensing over 10 years. That is
also why these provisions may be better addressed as part of a
---------------------------------------------------------------------------
discussion about permanent changes to the tax code in 2025.
______
Prepared Statement of William McBride, Ph.D., Vice President of Federal
Tax Policy and Stephen J. Entin Fellow in Economics, Tax Foundation
the size and distribution of the federal tax burden
Chairman Wyden, Ranking Member Crapo, and distinguished members of
the Senate Finance Committee, thank you for the opportunity to provide
testimony on the distribution of the Federal tax burden. I am William
McBride, vice president of Federal tax policy and Stephen J. Entin
fellow in economics at the Tax Foundation, where I focus on how we can
improve our Federal tax code.
Today, my testimony will focus on four points. First, I will
describe the current Federal tax system, showing that tax collections
in recent years are well above historical averages and the burden is
highly progressive. Second, I will describe how the tax code's
increasing complexity adds to this burden, raising compliance costs for
taxpayers and administrative costs for the Internal Revenue Service
(IRS). Third, I will describe the economic costs of the tax code's high
marginal income tax rates, which slow economic growth and reduce living
standards.
Finally, I will recommend ways to reform the Federal tax code to
reduce complexity and improve economic incentives, grow the economy,
benefit low- and
middle-income workers, and raise sufficient revenues at or above
current levels.
recent federal tax collections are above average and set to go higher
As a result of the economic recovery coming out of the pandemic and
surging inflation, Federal tax collections hit an all-time high of $4.9
trillion in Fiscal Year (FY) 2022, topping the prior year's record
collections by $850 billion.\1\ As a share of gross domestic product
(GDP), Federal tax collections in FY 2022 reached a multidecade high of
about 19.4 percent, up from 17.6 percent in the prior fiscal year and
near the last peak of 20.0 percent set during the dot-com bubble in FY
2000.\2\
---------------------------------------------------------------------------
\1\ William McBride, ``Inflation is Surging, So Are Federal Tax
Collections,'' Tax Foundation, Oct. 13, 2022, https://
taxfoundation.org/federal-tax-collections-inflation-surging/;
Congressional Budget Office, Budget and Economic Data, https://
www.cbo.gov/data/budget-economic-data.
\2\ Because the Bureau of Economic Analysis recently revised GDP up
considerably for several recent years including 2022, tax revenue as a
share of GDP has come down relative to earlier estimates.
Only 2 other years in U.S. history saw Federal tax collections as a
share of GDP exceed the FY 2022 level, both during World War II: in
1943, Federal tax collections reached 20.5 percent of GDP before
falling to 19.9 percent in 1944. FY 2022 tax collections exceeded the
---------------------------------------------------------------------------
post-war average of 17.2 percent of GDP by 2.2 percentage points.
In FY 2022, individual income tax collections contributed the most
to the surge in Federal tax collections, growing 29 percent to $2.6
trillion in FY 2022 from $2.0 trillion in FY 2021. Payroll taxes grew
13 percent to $1.5 trillion in FY 2022 from $1.3 trillion in FY 2021,
while corporate taxes grew 14 percent to $425 billion from $372
billion, and other revenues grew 13 percent to $356 billion from $316
billion.
Individual income tax collections reached 10.4 percent of GDP in FY
2022, the highest level on record. That level substantially exceeded
the prior record of 9.9 percent of GDP set in FY 2000 as well as the
World War II-era record of 9.2 percent of GDP set in FY 1944.\3\
---------------------------------------------------------------------------
\3\ Office of Management and Budget, Historical Tables, Table 2.3--
Receipts by Source as Percentages of GDP: 1934-2028, https://
www.whitehouse.gov/omb/budget/historical-tables/; a similar measure
from the Bureau of Economic Analysis (BEA) indicates Federal and State
individual income taxes as a share of personal income reached an all-
time high of 14.4 percent in calendar year 2022. See BEA, National
Income and Product Accounts, Table 2.1 Personal Income and Its
Disposition, https://www.bea.gov/itable/national-gdp-and-personal-
income.
The surge in individual income tax revenue is partly attributable
to growth in capital gains revenue due to booming stock and housing
markets in 2021, itself a function of inflationary fiscal and monetary
stimulus during the pandemic.\4\ The Congressional Budget Office (CBO)
estimates that capital gains realizations and revenue roughly doubled
during the pandemic years: realizations grew to $2.0 trillion in 2021
and $1.7 trillion in 2022 from $881 billion in 2019 while revenues grew
to $304 billion in FY 2021 and $378 billion in FY 2022 from $169
billion in FY 2019.\5\
---------------------------------------------------------------------------
\4\ William McBride, ``Inflation is Surging, So Are Federal Tax
Collections,'' Tax Foundation, Oct. 13, 2022, https://
taxfoundation.org/federal-tax-collections-inflation-surging/.
\5\ Congressional Budget Office, ``The Budget and Economic Outlook:
2023 to 2033,'' February 15, 2023, https://www.cbo.gov/publication/
58848; CBO, Budget and Economic Data, Revenue Projections, by Category,
https://www.cbo.gov/data/budget-economic-data#7.
As the inflationary boom of 2021 turned into a bust in 2022, and as
the Federal Reserve raised interest rates to fight the inflation,
Federal tax collections dropped about 9 percent to $4.4 trillion in FY
2023, or about 16.5 percent of GDP.\6\ The largest decline was for
individual income taxes, which fell $456 billion, or 17 percent, to
$2.2 trillion, apparently due in large part to a drop in revenue as the
stock and housing markets deflated. CBO's preliminary analysis also
points to ``higher-than-anticipated claims'' of the Employee Retention
Credit, a pandemic-era program that spawned a cottage industry until
the IRS recently halted new claims due to rampant fraud. Individual
income tax refunds were $129 billion higher this year than last, a 52-
percent increase. Another factor behind the decline, as noted by the
CBO, is that the IRS postponed the filing deadline for taxpayers
affected by natural disasters, including most taxpayers in California,
until October 16th or later.
---------------------------------------------------------------------------
\6\ Congressional Budget Office, ``Monthly Budget Review: September
2023,'' Oct. 10, 2023, https://www.cbo.gov/publication/59544; William
McBride, ``Federal Deficit Grew to $2 Trillion in FY 2023,'' Oct. 12,
2023, https://taxfoundation.org/blog/federal-budget-deficit-2023/.
In contrast, payroll taxes grew 9 percent to $1.6 trillion in FY
2023, reflecting growth in wages and jobs. Corporate income taxes were
roughly flat, falling $5 billion, or 1 percent, to $420 billion,
despite the introduction of the new minimum tax on corporate book
income and the stock buyback tax, both part of the Inflation Reduction
Act (IRA) enacted last year. Other receipts dropped $124 billion, or 35
percent, to $232 billion in FY 2023, primarily reflecting a near-
zeroing out of remittances from the Federal Reserve as higher interest
---------------------------------------------------------------------------
rates caused the central bank's interest expense to offset its income.
The extreme volatility in revenue collections over the last 2
years, marked by extraordinary capital gains in 2021 and most likely
heavy losses in 2022, reflects a Federal tax system that is heavily
reliant on high-income investors (where capital gains and losses are
concentrated), as we will see in more detail in the next section. It
also means that future tax collections will depend a great deal on
fluctuations in the economy, including the ups and downs of the stock
market. As one indicator, the S&P 500 rose about 27 percent in 2021,
dropped about 19 percent in 2022, and is up about 14 percent this year.
This, and other one-time factors mentioned above, suggests FY 2024
collections may be closer to FY 2022 levels than FY 2023 levels.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
.epsSimply averaging FY 2022 and FY 2023 together yields total
Federal tax collections of 17.9 percent of GDP, which is 0.7 percentage
points above the historical average since WWII. Individual income tax
collections average to 9.2 percent of GDP over the last 2 years, which
is about 1.4 percentage points above the historical average. In
addition, Federal tax collections exhibit an upward trend resulting
from many of the provisions of the Tax Cuts and Jobs Act (TCJA),
including the phaseout of bonus depreciation that is set to occur over
the next 5 years and the expiration of the individual income tax
provisions at the end of 2025, as well as the permanent features that
boost economic growth, especially the lower corporate tax rate.\7\ As
such, under a current law baseline, we expect Federal tax collections
over the next several years to trend upwards towards 18 percent of GDP
or higher, whereas full or partial extension of TCJA's expiring
provisions would reduce revenue to a range of about 17 to 18 percent of
GDP.\8\ Under current law, the CBO projects total collections of 18.0
percent of GDP and individual income tax collections of 9.5 percent of
GDP on average from FY 2024 to FY 2033.\9\
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\7\ Tax Foundation, ``Preliminary Details and Analysis of the Tax
Cuts and Jobs Act,'' Dec. 18, 2017, https://taxfoundation.org/research/
all/federal/final-tax-cuts-and-jobs-act-details-analysis/; William
McBride and Alex Durante, ``New Study Finds TCJA Strongly Boosted
Corporate Investment,'' Tax Foundation, Oct. 21, 2023, https://
taxfoundation.org/blog/tcja-corporate-tax-economic-effects/.
\8\ Our recent modeling of potential extensions of TCJA expiring
provisions indicates full extension of all provisions as they were in
2021, including individual, estate, and business provisions, would
reduce revenue to about 17 percent of GDP on average from FY 2024 to FY
2033 (dynamically scored, i.e., accounting for the policy's impacts on
economic growth) whereas extension of only the business provisions
would reduce revenue to about 17.7 percent of GDP.
\9\ CBO, ``An Update to the Budget Outlook: 2023 to 2033,'' May 12,
2023, https://www.cbo.
gov/publication/59096.
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most of the federal tax burden is paid by high earners
By any objective measure, the U.S. tax code is extremely
progressive and very redistributive. According to the latest IRS data
for 2020, the top 5 percent of taxpayers (about 7.9 million filers who
earn more than $220,521) paid in aggregate $1.1 trillion in income
taxes, amounting to 62.7 percent of all income taxes paid that
year.\10\ The top 1 percent of taxpayers (about 1.6 million filers who
earn more than $548,336) paid $723 billion in income taxes, or 42.3
percent of all income taxes paid--a larger share than the bottom 95
percent of taxpayers combined.
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\10\ Internal Revenue Service, Statistics of Income, ``Number of
Returns, Shares of AGI and Total Income Tax, AGI Floor on Percentiles
in Current and Constant Dollars, and Average Tax Rates,'' Table 1, and
``Number of Returns, Shares of AGI and Total Income Tax, and Average
Tax Rates,'' Table 2, https://www.irs.gov/statistics/soi-tax-stats-
individual-income-tax-rates-and-tax-shares; Erica York, ``Summary of
the Latest Federal Income Tax Data, 2023 Update,'' Tax Foundation, Jan.
26, 2023, https://taxfoundation.org/publications/latest-federal-income-
tax-data/.
The share of Federal income taxes paid by the top 1 percent is
higher than it has been in at least 20 years, according to IRS
data.\11\ In 2001, the top 1 percent's share of income taxes paid was
33.2 percent, then fluctuated with the business cycle and the ups and
downs of the housing and stock markets, before rising steadily to its
current high of 42.3 percent in 2020. The top 1 percent's share of
income taxes could well go higher in 2021 and 2022 due to growth of
capital gains revenue, which is paid primarily by high earners.
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\11\ Erica York, ``Summary of the Latest Federal Income Tax Data,
2023 Update,'' Tax Foundation, Jan. 26, 2023, https://
taxfoundation.org/publications/latest-federal-income-tax-data/.
High-income taxpayers also pay the highest tax rates, according to
the IRS. The average income tax rate in 2020 was 13.6 percent. The top
5 percent of taxpayers paid a 22.4-percent average rate while the top 1
percent of taxpayers paid a 26.0-percent average rate--more than eight
times higher than the 3.1-percent average rate paid by the bottom half
of taxpayers. The top 0.001 percent, or the richest 1,575 tax returns
filed in 2020, paid nearly $71 billion in income taxes and had an
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average tax rate of 23.7 percent.
The average tax rate for the top 0.001 percent is slightly lower
than that of the top 1 percent because a larger share of the top 0.001
percent's income is capital gains, which face a lower rate schedule.
One justification for the lower rate is that capital gains income is
earned in an environment where other taxes have already been applied.
In particular, shareholder taxes on capital gains and dividends
essentially apply on top of the corporate income tax of 21 percent.
That is, the same dollar of corporate income is first taxed by the
corporate income tax and then taxed again when distributed to
shareholders in the form of capital gains and dividends. Note that the
shares and average tax rates cited above do not reflect the additional
burden of the corporate income tax.\12\
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\12\ The IRS statistics on shares and average tax rates also do not
include the outlay portion of refundable tax credits, such as the
Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC), which
if included would reduce further the average tax rates paid by low-
income filers and increase the share of Federal income taxes paid by
high-income filers.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
.epsAnalysis from the CBO provides a more complete picture of the
distribution of the Federal tax burden. When accounting for individual
income taxes--including the outlay portion of refundable tax redits--
corporate income taxes, payroll taxes, estate taxes, and excise taxes,
CBO finds that the Federal tax system, as a whole, is progressive.\13\
The latest data indicates that households in the highest income
quintile paid about 69 percent of all Federal taxes in 2019, and the
top 1 percent of households paid about 25 percent of all Federal
taxes.\14\ In contrast, the bottom quintile of households paid about
0.1 percent of all Federal taxes.
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\13\ Congressional Budget Office, ``The Distribution of Household
Income 2019,'' Nov. 15, 2022, https://www.cbo.gov/system/files/2022-11/
58353-HouseholdIncome.pdf; Garrett Watson, ``CBO Analysis Finds Income
Growth and Progressive Tax Code in 2019,'' Tax Foundation, Jan. 10,
2023, https://taxfoundation.org/us-income-growth-progressive-tax-code/.
\14\ In CBO's analysis, the top 1 percent income group represents
about 1.2 million households. Income thresholds defining each income
group vary by household size. For example, a one-
person household in the top 1 percent of income earns more than
$447,200 in 2019 while a four-person household in the top 1 percent
earns more than $894,400.
Like the IRS data on Federal income taxes, the CBO analysis
indicates the share of all Federal taxes paid by high earners has grown
over time. For example, the share of Federal taxes paid by households
in the top 1 percent has approximately doubled to about 25 percent in
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2019 from roughly 12 percent in the early 1980s.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
.epsFurthermore, the CBO analysis indicates that average Federal
tax rates increase substantially with income. For example, the top
quintile of households paid an average Federal tax rate of 24.4 percent
in 2019 and the top 1 percent of households paid an average Federal tax
rate of 30.0 percent. In contrast, the bottom quintile paid an average
Federal tax rate of 0.5 percent, reflecting the fact that refundable
tax credits for this group almost entirely offset payroll taxes and
other Federal taxes.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
.epsThe CBO notes that within the top 1 percent's average Federal
tax rates are relatively flat at about 30 percent, as the effect of
lower capital gains tax rates are offset by higher average corporate
tax rates.\15\ For example, the top 0.01 percent of households paid an
average Federal tax rate of 30.2 percent in 2019.
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\15\ In CBO's analysis, 75 percent of corporate income taxes are
allocated to owners of capital in proportion to their income from
interest, dividends, rents, and adjusted capital gains, and 25 percent
to workers in proportion to their labor income.
Over time, the average Federal tax rate paid by the top 1 percent
has remained within a range of about 25 to 35 percent since 1979, and
as of 2019 is about in the middle of that range and close to the
average of 30.5 percent over the period 1979 to 2019. However, the
average Federal tax rate for the bottom quintile has declined
substantially, to nearly zero in 2019 due to the introduction and
expansion of refundable tax credits from a high of about 12 percent in
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1984.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
.epsData from the Joint Committee on Taxation (JCT) confirms that
average Federal tax rates consistently rise with income. When including
all Federal taxes, the bottom 50 percent of taxpayers face an average
Federal tax rate of 6.3 percent, compared to an average rate of 24.8
percent for the top 1 percent of taxpayers. The Federal income tax is
the most progressive of the Federal taxes, with corporate income taxes
and estate and gift taxes also adding to Federal progressivity. The
progressive tax sources more than offset payroll taxes and excise taxes
that apply higher average tax rates to lower income groups. The JCT
data also shows average Federal taxes rise within the top 1 percent,
from an average tax rate of 22.6 percent for those in the 99th to
99.5th percentiles of income to 32.9 percent for the top 0.01 percent
of earners, representing about 15,000 taxpayers in the United States.
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
.epstax code's complexity adds to the burden
By any measure, the Federal tax code is extremely complex. Totaling
more than 6,000 pages and about 4 million words (plus about 15,000
pages of associated tax law interpretations), no taxpayer can
reasonably be expected to fully comprehend it.\16\ The complexity
derives in part from the basic challenge of defining and taxing income,
an endeavor the country embarked on more than 100 years ago. Every
Congress and administration since has revised and added to an
accumulating pile of deductions, credits, and special provisions. By
official measures, there are now more than 200 such special provisions
known as ``tax expenditures,'' costing about $2 trillion annually. In
the last 3 years alone more than 100 tax expenditures have been created
or amended.\17\
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\16\ Demian Brady, ``Tax Complexity 2021: Compliance Burdens Ease
for Third Year Since Tax Reform,'' NTU, April 15, 2021, https://
www.ntu.org/foundation/detail/tax-complexity-2021-compliance-burdens-
ease-for-third-year-since-tax-reform.
\17\ The Joint Committee on Taxation, ``Estimates of Federal Tax
Expenditures for Fiscal Years 2022-2026,'' Dec. 22, 2022, https://
www.jct.gov/publications/2022/jcx-22-22/; Treasury Department, ``Tax
Expenditures,'' https://home.treasury.gov/policy-issues/tax-policy/tax-
expenditures.
While some tax expenditures are important structural elements of
the tax code, many are complicated and disproportionately benefit
specific industries or types of households.\18\ The CBO finds about
half of the total income tax benefits of expenditures go to high-income
households.\19\
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\18\ Alex Muresianu, ``JCT Tax Expenditure Report: Not All
Expenditures Are Created Equal,'' Tax Foundation, Feb. 13, 2023,
https://taxfoundation.org/largest-tax-expenditures-saving-investment-
tax/; Erica York and William McBride, ``Lawmakers Could Pay for
Reconciliation While Improving the Tax Code,'' Tax Foundation, Oct. 25,
2021, https://taxfoundation.org/pay-for-reconciliation-tax/.
\19\ Congressional Budget Office, ``Distribution of Major
Expenditures in 2019,'' October 2021, https://www.cbo.gov/system/files/
2021-10/57413-TaxExpenditures.pdf.
The Inflation Reduction Act (IRA), enacted last year, adds several
complicated provisions to the tax code, including a book minimum tax, a
stock buyback tax, and more than 20 different tax subsidies for green
energy. All of these require extensive regulatory guidance which
continues to roll out even as much of the law took effect at the
beginning of this year.\20\ Taxpayers too have highlighted several
remaining concerns and ambiguities in the law (e.g., reporting
requirements and applicable financial statements for the book minimum
tax, and domestic content rules for the green energy tax credits).\21\
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\20\ William McBride, Alex Muresianu, Erica York, and Michael
Hartt, ``Inflation Reduction Act One Year After Enactment,'' Tax
Foundation, Aug. 16, 2023, https://taxfoundation.org/research/all/
federal/inflation-reduction-act-taxes/; Internal Revenue Service,
``Latest Updates on the Inflation Reduction Act of 2022,'' https://
www.irs.gov/inflation-reduction-act-of-2022.
\21\ William McBride, Alex Muresianu, Erica York, and Michael
Hartt, ``Inflation Reduction Act One Year After Enactment,'' Tax
Foundation, Aug. 16, 2023, https://taxfoundation.org/research/all/
federal/inflation-reduction-act-taxes/.
The uncertainty in the law also translates into uncertainty about
the budgetary costs and distributional impacts. For example,
researchers now estimate the budgetary cost of the IRA's green energy
credits and subsidies will exceed $1 trillion over a decade, three
times the original cost estimated by the CBO and the JCT, with the
benefits accruing mainly to high earners.\22\
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\22\ Ibid; John Bistline, Neil Mehrotra, and Catherine Wolfram,
``Economic Implications of the Climate Provisions of the Inflation
Reduction Act,'' Brookings Papers on Economic Activity, March 2023,
https://www.brookings.edu/wp-content/uploads/2023/03/BPEA_Spring2023_
Bistline-et-al_unembargoedUpdated.pdf; Jason Furman, ``Comment on
`Economic Implications of the Climate Provisions of the Inflation
Reduction Act,' '' Mar. 30, 2023, https://www.brookings.
edu/wp-content/uploads/2023/02/2b_20230330-BPEA-climate-furman-
comment.pdf; Christine McDaniel, ``The Cost of Battery Production Tax
Credits Provided in the IRA,'' Forbes, Feb. 1, 2023, https://
www.forbes.com/sites/christinemcdaniel/2023/02/01/the-cost-of-battery-
production-tax-credits-provided-in-the-ira/?sh=362fc62279ef; Christine
McDaniel, ``The Costs of Wind Production Tax Credits Provided in the
IRA,'' Forbes, Mar. 8, 2023, https://www.forbes.com/sites/
christinemcdaniel/2023/03/08/the-costs-of-wind-production-tax-credits-
provided-in-the-ira/?sh=7cd6f4295ff7; Goldman Sachs, ``Carbonomics: The
Third American Energy Revolution,'' Mar. 22, 2023.
In the same month the IRA was enacted, Congress passed the CHIPS
and Science Act, which provides billions of dollars of targeted (and
complex) incentives and investment tax credits for semiconductor
manufacturing, along with a variety of eligibility and reporting
requirements.\23\
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\23\ Erica York, ``Careful What You Wish For: CHIPS Subsidies
Require `Excess Profits' Sharing,'' Tax Foundation, Mar. 2, 2023,
https://taxfoundation.org/biden-semiconductor-chips-act-subsidies/.
In 2022 (before the IRA or the CHIPS Act), Americans spent more
than 6.5 billion hours trying to comply with the tax code, according to
the latest estimates from the White House Office of Information and
Regulatory Affairs (OIRA).\24\ Based on wage and benefit estimates for
tax preparers and certified public accountants, we estimate the hourly
compliance costs of the tax code equates to about $313 billion each
year in lost productivity, or 1.4 percent of GDP.\25\ The compliance
burden for individual taxpayers is nearly $74 billion annually, while
the burden on corporate entities of complying with just their income
tax returns is more than $60 billion. Much of the remaining $179
billion of costs comes from complying with hundreds of other business
tax forms and regulations, such as those relating to depreciation and
amortization. Compliance with income tax returns for estates and trusts
costs $18 billion a year, approaching the amount of tax revenue raised
by the estate tax.
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\24\ White House Office of Information and Regulatory Affairs,
Information Collection Review, https://www.reginfo.gov/public/do/
PRAMain.
\25\ Scott Hodge, ``The Tax Compliance Costs of IRS Regulations,''
Tax Foundation, Aug. 23, 2022, https://taxfoundation.org/tax-
compliance-costs-irs-regulations/.
Our estimate of compliance costs does not include the cost of tax
planning, which is a significant industry on its own. Nor does it
include the cost of uncertainty in the law for taxpayers, which makes
planning for taxes as well as investment and other economic activities
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difficult and costly.
The majority of the compliance burden is from the complex taxing of
business income, which involves tracking and reporting multiple items
of income and expense to arrive at net taxable income and allowing
offsets from net income to account for past losses (in a typical year
roughly 40 percent of companies are in a loss position).\26\ In
addition, the U.S. tax code contains several business credits,
exclusions, and other special provisions that increase compliance
costs. Multinational corporations face a slew of complex provisions
that subject various types of foreign income and cross-border
transactions to tax, including subpart F, Global Intangible Low-Taxed
Income (GILTI), Foreign-Derived Intangible Income (FDII), and Base
Erosion and Anti-Abuse Tax (BEAT).\27\
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\26\ Arthur P. Hall, ``House Way & Means Committee Testimony:
Compliance Costs of Alternative Tax Systems II,'' Tax Foundation, March
1996, https://files.taxfoundation.org/legacy/docs/
8926e37c5827f958604933276fcb4864.pdf?_gl=1*1bocc81*_ga*MjkzNjU2MTcuMTY4M
Dg2Nj
cyOA..*_ga_FP7KWDV08V*MTY4M-TI5MzY4Ni40LjEuMTY4MTI5MzczNy45LjAuMA.
\27\ Kyle Pomerleau, ``A Hybrid Approach: The Treatment of Foreign
Profits under the Tax Cuts and Jobs Act,'' Tax Foundation, May 3, 2018,
https://taxfoundation.org/treatment-foreign-profits-tax-cuts-jobs-act/.
For individual filers, compliance costs generally increase
proportionally with income, such that most of the compliance burden is
borne by high earners.\28\ High-earning individuals typically have
multiple sources of income beyond wages, including capital gains,
dividends, rents, royalties, and pass-through business income from
partnerships and S corporations (income from these business forms is
subject to individual income tax rather than corporate income tax).
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\28\ Daniel Berger, Eric Toder, Victoria Bryant, John Guyton, and
Patrick Langetieg, ``Estimating the Effects of Tax Reform on Compliance
Burdens,'' Urban Institute, May 19, 2018, https://www.urban.org/
research/publication/estimating-effects-tax-reform-compliance-burdens.
Another aspect of the tax code's complexity is the administrative
costs and challenges for the IRS, an agency whose responsibilities have
grown well beyond simple revenue collection to include administration
of subsidies and benefits relating to children, health care, education,
housing, energy, the environment, economic stimulus, and more.\29\
Pursuant to its expanded role, in FY 2021 the IRS processed some 261
million returns and forms and received some 4.7 billion pieces of
information, detailing the composition and activities of nearly every
American household and business.\30\ In recent years, the IRS has found
itself literally buried in paperwork, resulting in processing delays,
millions of returns backlogged, and poor customer service.\31\ Last
year, for instance, the IRS answered only about 13 percent of the 173
million phone calls it received from taxpayers asking for help; those
who got through waited an average of 29 minutes.\32\
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\29\ Alex Muresianu and Garrett Watson, ``Chaotic IRS Filing Season
Shows the Perils of Running Social Policy Through the Tax Code,'' Tax
Foundation, Apr. 18, 2022, https://taxfoundation.org/irs-filing-season-
2022/.
\30\ Internal Revenue Service, Data Book 2021, May 2022, https://
www.irs.gov/statistics/soi-tax-stats-irs-data-book; Joseph Bishop-
Henchman, ``Transforming the Internal Revenue Service,'' Cato
Institute, Apr. 11, 2023, https://www.cato.org/policy-analysis/
transforming-internal-revenue-service/.
\31\ Internal Revenue Service National Taxpayer Advocate, ``2022
Annual Report to Congress,'' Jan. 11, 2023, https://
www.taxpayeradvocate.irs.gov/news/national-taxpayer-advocate-delivers-
2022-annual-report-to-congress/; Joseph Bishop-Henchman, ``Transforming
the Internal Revenue Service,'' Cato Institute, Apr. 11, 2023, https://
www.cato.org/policy-analysis/transforming-internal-revenue-service/.
\32\ Internal Revenue Service National Taxpayer Advocate, ``2022
Annual Report to Congress,'' Jan. 11, 2023, https://
www.taxpayeradvocate.irs.gov/news/national-taxpayer-advocate-delivers-
2022-annual-report-to-congress/.
IRS customer service improved considerably this filing season, due
partly to reduced demand as many complicated pandemic-era policies
expired, such as the 2021 expanded Child Tax Credit, as well as new
funding from the IRA and a shift in resources towards phone
service.\33\ For example, call volume dropped by more than half,
returning to ``normal'' levels seen pre-pandemic in which the IRS
received some 30 million to 40 million calls from taxpayers during the
filing season. The IRS answered about 34 percent of calls this filing
season and substantially reduced wait times. In addition, the IRS was
able to significantly reduce its backlog of returns.
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\33\ Erin Collins, ``Objectives Report to Congress, Fiscal Year
2024,'' National Taxpayer Advocate, June 2023, https://
www.taxpayeradvocate.irs.gov/reports/2024-objectives-report-to-
congress/; William McBride, Alex Muresianu, Erica York, and Michael
Hartt, ``Inflation Reduction Act One Year After Enactment,'' Tax
Foundation, Aug. 16, 2023, https://taxfoundation.org/research/all/
federal/inflation-reduction-act-taxes/.
However, other performance metrics worsened, including longer
processing delays for taxpayer correspondence and amended returns. As
well, the number of backlogged identity theft cases increased 46
percent to about 465,000 as of April, requiring about 15 months to
resolve on average.\34\ Making matters worse, some aspects of the tax
code became more complex, consuming more IRS resources and detracting
from other core duties. For instance, earlier this year, the IRS
requested an additional $3.9 billion in funding to further implement
the IRA's green energy tax credits.\35\ Clearly, there is room for
further improvement, as an overly complex tax code presents ongoing
administrative challenges at the IRS that are also problematic for
taxpayers.
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\34\ Erin Collins, ``Objectives Report to Congress, Fiscal Year
2024,'' National Taxpayer Advocate, June 2023, https://
www.taxpayeradvocate.irs.gov/reports/2024-objectives-report-to-
congress/.
\35\ Internal Revenue Service, ``Inflation Reduction Act Strategic
Operating Plan,'' Apr. 5, 2023, https://www.irs.gov/pub/irs-pdf/
p3744.pdf.
A report from the Government Accountability Office (GAO) sheds
light on the challenges faced by the IRS and taxpayers as a result of
the increasing complexity of the code.\36\ The report finds that the
average number of hours the IRS spends per audit has increased about 30
percent in recent years, to 6.5 hours in 2021 from 5.0 hours in 2010.
The increase is concentrated in high-income returns. Average hours per
audit increased 209 percent for incomes of $5 million and above, to
about 58 hours in 2021 from about 19 hours per return in 2010. Average
hours per audit increased 118 percent for incomes between $500,000 and
$5 million, to 34 hours from about 16, and 103 percent for incomes
between $200,000 and $500,000, from about 10 to 21 hours. In contrast,
audits for incomes below $200,000 took considerably less time--about 2
hours on average for incomes below $25,000, and 6 hours for incomes
between $25,000 and $200,000, and this remained stable over this
period.
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\36\ Government Accountability Office, ``Tax Compliance: Trends of
IRS Audit Rates and Results for Individual Taxpayers by Income,'' May
17, 2022, https://www.gao.gov/products/gao-22-104960.
The GAO report notes that IRS officials attribute the increase in
average audit hours to ``greater complexity of higher-income audits and
increased case transfers due to auditor attrition.'' The GAO report
mentions several legislative changes that have added to the IRS's
responsibilities in recent years, including the Patient Protection and
Affordable Care Act, the Foreign Account Tax Compliance Act, the TCJA,
as well as some 496 million stimulus payments totaling $837 billion as
part of the CARES Act and other pandemic relief packages. (Note the GAO
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report was published before enactment of the IRA or CHIPS Act.)
As a measure of the efficiency of audits, or the ``bang for the
buck,'' the GAO compared the recommended additional tax with hours
spent on audits. The GAO found that audits of the highest-income
returns--those with income of $5 million or more--resulted in the
highest amounts of recommended additional tax per audit hour ($4,880 in
2021), followed by audits of those claiming the EITC ($3,130) and those
reporting less than $25,000 of income ($2,120). In aggregate, the
majority of the total recommended additional tax came from audits of
taxpayers with income below $200,000. On average, roughly half of
recommended additional amounts are ultimately collected, however the
collection rate for EITC returns exceeds 70 percent since these audits
are typically done prior to issuing refunds.
Lastly, the GAO report documents that audit rates for individual
income tax returns have decreased for all income levels, dropping to
0.25 percent in 2019 from an average of 0.9 percent in 2010, which IRS
officials attribute mainly to reduced staffing as a result of reduced
funding. Audit rates decreased the most for high earners because,
according to IRS officials, these audits are generally more complex and
require more staff time to complete.
Simplifying the tax code would reduce IRS resources required to
more effectively administer it, including by reducing the time needed
to audit the currently complex returns of high earners. A simpler tax
code would also reduce taxpayer confusion so that there would be less
need for the IRS to produce volumes of guidance and respond to millions
of taxpayer calls for assistance. Less confusion on the part of
taxpayers would also boost compliance.\37\ As the IRS Taxpayer Advocate
explains: ``Simplifying the code and eliminating complexities in the
IRS's procedures would reduce taxpayer compliance burdens by making it
easier for taxpayers to understand their filing and payment
obligations, and it would also make it easier for the IRS to administer
the tax laws. Thus, simplification is essential to the integrity of the
U.S. tax system and will enhance voluntary compliance.''\38\
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\37\ Garrett Watson, ``Closing the Tax Gap and Improving the Tax
Code Are Complementary Goals,'' Tax Foundation, Nov. 21, 2019, https://
taxfoundation.org/closing-tax-gap-improving-tax-code/.
\38\ Erin Collins, ``Objectives Report to Congress, Fiscal Year
2024,'' National Taxpayer Advocate, June 2023, https://
www.taxpayeradvocate.irs.gov/reports/2024-objectives-report-to-
congress/.
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the economic cost of high marginal income tax rates
Decades of economic research amply demonstrates the steep cost of
high marginal income tax rates that arises from disincentives to work,
save, and invest.\39\ The economic harm of income taxes increases with
the square of the tax rate, meaning high income tax rates come with a
disproportionately large additional excess burden. This burden is over
and above the tax revenue collected, manifesting itself over the course
of several years as a drag on economic growth through less investment,
less innovation, fewer jobs, and lower wages.\40\
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\39\ N. Gregory Mankiw, Matthew Weinzierl, and Danny Yagan,
``Optimal Taxation in Theory and Practice,'' Journal of Economic
Perspectives 2009, volume 23(4), https://eml.berkeley.edu/yagan/
OptimalTaxation.pdf; William McBride, ``What Is the Evidence on Taxes
and Growth,'' Tax Foundation, Dec. 18, 2012, https://
www.taxfoundation.org/what-evidence-taxes-and-growth/; Alex Durante,
``Reviewing Recent Evidence of the Effect of Taxes on Economic
Growth,'' Tax Foundation, May 21, 2021, https://taxfoundation.org/
reviewing-recent-evidence-effect-taxes-economic-growth/; Timothy
Vermeer, ``The Impact of Individual Income Tax Changes on Economic
Growth,'' Tax Foundation, June 14, 2022, https://taxfoundation.org/
income-taxes-affect-economy/.
\40\ Robert Carroll, ``The Excess Burden of Taxes and the Economic
Cost of High Tax Rates,'' Tax Foundation, Aug. 2009, https://
files.taxfoundation.org/legacy/docs/sr170.pdf; Martin Feldstein, ``Tax
Avoidance and the Deadweight Loss of the Income Tax,'' The Review of
Economics and Statistics 81:4 (Nov. 1999): 674-680, https://
www.jstor.org/stable/2646716.
A study based on postwar tax reforms in the United States found
that reducing marginal tax rates on individual income for the top 1
percent of earners leads to increases in real GDP and declines in
unemployment, with a 1-percentage-point cut in the tax rate increasing
real GDP by 0.78 percent by the 3rd year after the tax change.\41\
Given the size of the U.S. economy today, that equates to about $204
billion in additional GDP for each 1-percentage-point cut in the
marginal tax rate on individual income earned by the top 1 percent. The
study shows the benefits of the resulting economic growth would be felt
throughout the economy.
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\41\ Karel Mertens and Jose Luis Montiel Olea, ``Marginal Tax Rates
and Income: New Time Series Evidence,'' The Quarterly Journal of
Economics 133:4 (Nov. 2018), https://academic.oup.com/qje/article-
abstract/133/4/1803/4880451?redirectedFrom=fulltext.
In looking at the experience of developed countries over the period
1971 to 2004, researchers at the Organisation of for Economic Co-
operation and Development (OECD) concluded that ``a reduction in the
top marginal [individual] tax rate is found to raise productivity in
industries with potentially high rates of enterprise creation. Thus,
reducing top marginal tax rates may help to enhance economy-wide
productivity in OECD countries with a large share of such
industries.''\42\
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\42\ Asa Johansson, Christopher Heady, Jens Arnold, Bert Brys,
Cyrille Schwellnus, and Laura Vartia, ``Taxation and Economic Growth.''
The CBO modeled three types of tax increases to fund a permanent
increase in government spending of 10 percent of GDP annually: a flat
labor tax, a flat income tax, and a progressive income tax. The CBO
found that a progressive income tax is the most economically damaging
of the three options, reducing GDP by 10 percent after 10 years, and
reducing lifetime consumption and hours worked, especially for younger
households.\43\
---------------------------------------------------------------------------
\43\ Congressional Budget Office, ``The Economics of Financing a
Large and Permanent Increase in Government Spending: Working Paper
2021-03,'' Mar. 22, 2021, https://www.cbo.gov/publication/57021; see
also Garrett Watson, ``Congressional Budget Office and Tax Foundation
Modeling Show That Some Tax Hikes Are More Damaging Than Others,'' Tax
Foundation, Mar. 26, 2021, https://www.taxfoundation.org/tax-hikes-are-
more-damaging-than-others-analysis/.
Corporate income taxes are generally more economically damaging
than individual income taxes, since they make investment opportunities
less profitable on an after-tax basis for corporations, reducing the
likelihood that marginal investments will be pursued. In most countries
including the U.S., business investment makes up the bulk of all
private sector investment; more uniquely in the U.S., about half of
business investment is done by corporations and the other half by pass-
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through businesses subject to individual income taxes.
An OECD study examining data from 63 countries concluded that
corporate income taxes are the most economically damaging way to raise
revenue, followed by individual income taxes, consumption taxes, and
property taxes.\44\ A study on taxes in the United Kingdom found that
taxes on consumption are less economically damaging than taxes on
corporate and individual income.\45\ A study of U.S. tax changes since
World War II found that a 1-percentage-point cut in the average
corporate tax rate raises real GDP per capita by 0.6 percent after 1
year, a somewhat larger impact than a similarly sized cut in individual
income taxes.\46\ Based on U.S. State taxes, a study found that a 1-
percentage-point cut in the corporate tax rate leads to a 0.2-percent
increase in employment and a 0.3-percent increase in wages.\47\
---------------------------------------------------------------------------
\44\ Asa Johansson, Christopher Heady, Jens Matthias Arnold, Bert
Brys, and Laura Vartia, ``Taxation and Economic Growth,'' Organisation
for Economic Co-Operation and Development Working Paper No. 620, July
3, 2008, https://www.oecd-ilibrary.org/economics/taxation-and-economic-
growth_241216205486.
\45\ Ahn D. M. Nguyen, Luisanna Onnis, and Raffaelle Rossi, ``The
Macroeconomic Effects of Income and Consumption Tax Changes,'' American
Economic Journal: Economic Policy 13:2 (May 2021), https://
www.aeaweb.org/articles?id=10.1257/pol.20170241&&from=f.
\46\ Karel Mertens and Morten O. Ravn, ``The Dynamic Effects of
Personal and Corporate Income Tax Changes in the Unites States,''
American Economic Review 103:4 (June 2013), https://www.aeaweb.org/
articles?id=10.1257/aer.103.4.1212.
\47\ Alexander Ljungqvist and Michael Smolyansky, ``To Cut or Not
to Cut? On the Impact of Corporate Taxes on Employment and Income,''
National Bureau of Economic Research Working Paper No. 20753 (October
2018), https://www.nber.org/system/files/working_papers/w20753/
w20753.pdf.
Furthermore, several studies demonstrate that the corporate tax is
borne in part by workers.\48\ For instance, a study of corporate taxes
in Germany found that workers bear about half of the tax burden in the
form of lower wages, with low-skilled, young, and female employees
disproportionately harmed.\49\
---------------------------------------------------------------------------
\48\ Stephen J. Entin, ``Labor Bears Much of the Cost of the
Corporate Tax,'' Tax Foundation, Oct. 24, 2017, https://
www.taxfoundation.org/labor-bears-corporate-tax/; and Alex Durante,
``Who Bears the Burden of Corporate Taxation? A Review of Recent
Evidence,'' June 10, 2021, https://www.taxfoundation.org/who-bears-
burden-corporate-tax/.
\49\ Clemens Fuest, Andreas Peichl, and Sebastian Siegloch, ``Do
Higher Corporate Taxes Reduce Wages? Micro Evidence from Germany,''
American Economic Review 108:2 (Feb. 2018): 393-418, https://
www.doi.org/10.1257/aer.20130570.
The corporate tax is also borne by owners of shares, including
retirees earning considerably less than $400,000. In the short run, the
JCT assumes owners of capital bear all of the corporate tax, yet that
includes more than 90 million tax filers earning less than $200,000. In
the long run, the JCT assumes workers bear a portion of the corporate
tax, such that the burden falls on more than 150 million tax filers
earning less than $200,000.\50\
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\50\ Joint Committee on Taxation, ``Revenue Estimates and
Distributional Analyses,'' Aug. 3, 2021, https://
www.finance.senate.gov/imo/media/doc/
jct_analysis_on_corporate_tax_increase.
pdf.
Another factor to consider regarding the corporate tax in
particular is competitiveness with respect to our major trading
partners, as corporate investment is highly mobile internationally and
will flow to lower-tax locations, all else equal. The corporate tax
rate reduction from the TCJA brought the U.S. closer to the average
among developed countries accounting for Federal and State level taxes,
though it remains slightly above average. The U.S. combined Federal-
State corporate tax rate in 2022 was 25.8 percent, compared to 21.2
percent in the average EU country and 23.6 percent in the average OECD
country.\51\
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\51\ Cristina Enache, ``Corporate Tax Rates around the World,
2022,'' Tax Foundation, Dec. 13, 2022, https://taxfoundation.org/
corporate-tax-rates-by-country-2022/.
Lastly, one of the most problematic and economically destructive
aspects of the U.S. tax code is the double taxation of corporate income
by the corporate income tax (and now also the book minimum tax) and
shareholder taxes on capital gains and dividends. Accounting for
Federal and State corporate and individual incomes taxes, the top
integrated tax rate on corporate income distributed as dividends is
about 47 percent in the U.S., compared to an OECD average of about 42
percent.\52\ Several OECD countries have integrated corporate and
individual tax codes to eliminate or reduce the negative effects of
double taxation of corporate income. In the U.S., after decades of
double taxing corporate income, a large share of business activity has
migrated to pass-through form, which has only one layer of income tax
as owners report pass-through profits on their individual income tax
returns.\53\
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\52\ OECD, Tax Database Table II.4. Overall Statutory Tax Rates on
Dividend Income, https://www.oecd.org/tax/tax-policy/tax-database/;
Elke Asen, ``Double Taxation of Corporate Income in the United States
and the OECD,'' Tax Foundation, Jan. 13, 2021, https://
taxfoundation.org/double-taxation-of-corporate-income/.
\53\ Scott Eastman, ``Corporate and Pass-through Business Income
and Returns Since 1980,'' Apr. 23, 2019, https://www.taxfoundation.org/
pass-through-business-income-since-1980/.
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recommendations for reform
For several years, the Tax Foundation has observed and analyzed tax
systems from around the world and evaluated them based on the
principles of sound tax policy.\54\ Most tax policy experts agree that
taxes should be simple, transparent, and stable over time so they are
easy to understand, comply with, and administer. Another element of
sound tax policy is neutrality: the tax code should generally treat
taxpayers equally with minimum preferences, which extends to equal
treatment of immediate versus delayed consumption via saving. A tax
code that embodies these principles naturally supports economic
flourishing, including plentiful jobs, growing wages, upward mobility,
innovation, progress, and higher standards of living.
---------------------------------------------------------------------------
\54\ TaxEDU, ``Principles of Sound Tax Policy,'' Tax Foundation,
https://taxfoundation.org/principles/.
In our annual ranking of the most competitive tax systems, we found
for the 10th year in a row that Estonia has the best tax code in the
OECD.\55\ This is in part because it has a fully integrated income tax
system that avoids double-taxing corporate income through taxes at both
the entity and shareholder levels. Instead of a complicated corporate
income tax and separate rules that apply to pass-through businesses,
all businesses are subject to a simple 20 percent tax on distributed
profits (including dividends and stock buybacks). At the individual
level, a simple flat tax of 20 percent applies to all individual income
except dividends, since they are already taxed by the distributed
profits tax. Capital gains are taxed as ordinary income at 20 percent.
Rather than a complicated estate tax like ours that taxes accumulated
savings at death, bequeathed assets are simply taxed as capital gains
when sold by the heir with deductible basis determined only by costs
incurred by the heir.\56\
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\55\ Alex Mengden, ``International Tax Competitiveness Index,
2023,'' Tax Foundation, Oct. 18, 2023, https://taxfoundation.org/
research/all/global/2023-international-tax-competitiveness-index/.
\56\ William McBride, ``Biden's New Tax Proposals are Complicated
and Rife with Double Taxation,'' Tax Foundation, Mar. 13, 2023, https:/
/taxfoundation.org/biden-tax-fairness/.
Simplicity and neutrality are the hallmarks of the Estonian income
tax system.\57\ Taxes are so simple in Estonia that they can typically
be filed in 5 minutes, and the cost of compliance for businesses is
among the lowest of any country.\58\ Estonia's tax system is also very
pro-growth, increasing small business entrepreneurship, investment,
labor productivity and thereby wages.\59\ Estonia's income tax system
does all of this while generating substantial revenue comparable to
other developed countries.\60\
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\57\ Estonia's simple approach to taxing business and individual
income has also been implemented in Latvia and Georgia. Daniel Bunn,
``Better than the Rest,'' Tax Foundation, Oct. 9, 2019, https://
taxfoundation.org/estonia-tax-system-latvia-tax-system/; Gia Jandieri,
``Tax Reform in Georgia 2004-2012,'' Tax Foundation, July 17, 2019,
https://taxfoundation.org/tax-reforms-in-georgia-2004-2012/.
\58\ Kyle Pomerleau, ``The Best Part of the Estonian Tax Code Is
Not 5 Minute Tax Filing,'' Tax Foundation, Jul. 21, 2015, https://
taxfoundation.org/best-part-estonian-tax-code-not-5-minute-tax-filing/;
William McBride, Garrett Watson, Erica York, ``Taxing Distributed
Profits Makes Business Taxation Simple and Efficient,'' Tax Foundation,
Mar. 1, 2023, https://taxfoundation.org/distributed-profits-tax-us-
businesses/.
\59\ Jaan Maaso, Jaanika Merikull, and Priit Vahter, ``Gross Profit
Taxation Versus Distributed Profit Taxation and Firm Performance:
Effects of Estonia's Corporate Income Tax Reform,'' The University of
Tartu Faculty of Economics and Business Administration Working Paper
No. 81-2011, March 23, 2011, https://ssrn.com/abstract=1793143 or
http://dx.doi.org/10.2139/ssrn.1793143; Jaan Masso and Jaanika
Merikull, ``Macroeconomic Effects of Zero Corporate Income Tax on
Retained Earnings,'' Baltic Journal of Economics, 11:2 (2011): 81-99,
https://www.tandfonline.com/doi/pdf/10.1080/1406099X.2011.10840502;
Aaro Hazak, ``Companies' Financial Decisions Under the Distributed
Profit Taxation Regime of Estonia,'' Emerging Markets Finance & Trade
45:4 (2009): 4-12, https://www.jstor.org/stable/27750676; Eduardo
Davila and Benjamin Hebert, ``Optimal Corporate Taxation under
Financial Frictions,'' NBER Working Paper No. 25520, Oct. 2021, https:/
/www.nber.org/papers/w25520.
\60\ Over the last 10 years, Estonia's central government tax
collections from income and profit amount to about 7.4 percent of GDP,
compared to 7.3 percent for the median OECD country and 8.4 percent
averaged across OECD countries. See OECD Tax Revenue Statistics,
https://stats.oecd.org/Index.aspx.
We recently analyzed the effect of a revenue-neutral reform of the
U.S. tax code along the lines of the Estonian income tax system,
keeping only certain features of the current code that benefit low-
income households (such as the EITC and Child Tax Credit) and support
saving (such as 401(k)s.\61\ By greatly simplifying the Federal tax
code, these reforms would substantially reduce compliance costs,
potentially saving U.S. taxpayers more than $100 billion annually,
comprised of more than $70 billion in reduced compliance costs for
businesses and more than $30 billion in reduced compliance costs for
individuals related to individual income and estate tax returns.
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\61\ William McBride, Huaqun Li, Garrett Watson, Alex Durante,
Erica York, and Alex Muresianu, ``Details and Analysis of a Tax Reform
Plan for Growth and Opportunity,'' Tax Foundation, Jun. 29, 2023,
https://taxfoundation.org/growth-opportunity-us-tax-reform-plan/.
In addition to compliance cost savings, our modeling of the
reform's impacts on the U.S. economy indicates it would increase GDP by
2.5 percent in the long run, grow the capital stock by 3.4 percent, add
1.3 million full-time equivalent jobs and raise wages by 1.4 percent.
By increasing GDP, we estimate the reform would reduce the debt burden
as measured by the debt-to-GDP ratio by 9.2 percentage points over the
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long run.
Distributionally, we find the reform would increase after-tax
income overall by 3.5 percent in the long run, accounting for improved
economic growth, with a larger boost of 4.3 percent for the bottom
quintile of earners and 4.7 percent for the second quintile.
More generally, the U.S. could learn from the experience of other
countries in the OECD, which rely more heavily on consumption taxes
than the U.S. does.\62\ Value-added taxes (VATs) are a major source of
revenue in virtually every developed country except the U.S., and as
the literature cited above indicates, VATs and other taxes on
consumption are among the least economically harmful ways to raise
revenue.\63\
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\62\ Daniel Bunn and Cecilia Perez Weigel, ``Sources of Government
Revenue in the OECD,'' Tax Foundation, Feb. 23, 2023, https://
taxfoundation.org/oecd-tax-revenue-by-country-2023/.
\63\ William McBride, ``What Is the Evidence on Taxes and Growth,''
Tax Foundation, Dec. 18, 2012, https://www.taxfoundation.org/what-
evidence-taxes-and-growth/.
OECD countries have also tended to abandon more complicated means
of taxing high earners such as wealth taxes due to their administrative
and economic challenges.\64\ Rather than high capital gains taxes, or
any attempt to tax unrealized capital gains, most OECD countries have
lower capital gains tax rates than the U.S., and tax capital income
overall at lower average tax rates.\65\
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\64\ Daniel Bunn, ``What the U.S. Can Learn from the Adoption (and
Repeal) of Wealth Taxes in the OECD,'' Tax Foundation, Jan. 18, 2022,
https://taxfoundation.org/wealth-taxes-in-the-oecd/.
\65\ Daniel Bunn and Elke Asen, ``Savings and Investment: The Tax
Treatment of Stock and Retirement Accounts in the OECD,'' Tax
Foundation, May 26, 2021, https://taxfoundation.org/savings-and-
investment-oecd/#Capital; Jacob Lundberg and Johannes Nathell, ``Taxing
Capital--An International Comparison,'' Tax Foundation, May 11, 2021,
https://taxfoundation.org/tax-burden-on-capital-income/.
Consumption taxes can be designed to progressively tax the
consumption of higher earners without the administrative complexity and
compliance costs of our current progressive income tax system. For
example, by splitting the VAT base in two, businesses would pay taxes
on their cash flow (sales less purchases and compensation paid), while
households would pay taxes on compensation received. Applying a
progressive rate schedule at the household level, with the top rate
matching the rate on business cash flow, is a relatively simple way to
achieve progressivity within a consumption tax.\66\ Under a more
standard value-added tax, the most efficient way to increase
progressivity would be to offer targeted relief to lower- and middle-
income households.\67\
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\66\ This design is known as the ``X Tax,'' developed by the late
economist David Bradford. See Robert Carroll and Alan D. Viard,
Progressive Consumption Taxation: The X Tax, (Washington, D.C.: The
Rowman & Littlefield Publishing Group, 2012).
\67\ See Rita de la Feria and Michael Walpole, ``The Impact of
Public Perceptions on General Consumption Taxes,'' British Tax Review
67:5 (Dec. 4, 2020), 637-669, https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=3723750 for a discussion on how other
approaches, such as exemptions or reduced rates can,
counterintuitively, increase regressivity by providing more benefits to
higher-income households.
We have recently modeled specific reforms that would shift the U.S.
tax system towards taxing consumption rather than income while
simplifying the tax code's various antipoverty programs, including an
option that combines a cash flow tax with a progressive household
compensation tax and per person credit. We find these reforms would
lead to higher economic output and higher after-tax income for lower-
income households while raising roughly the same amount of tax revenue
for the Federal Government.\68\
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\68\ Erica York, Garrett Watson, Alex Durante, and Huaqun Li, ``How
Taxing Consumption Would Improve Long-Term Opportunity and Well-Being
for Families and Children,'' Tax Foundation, Oct. 12, 2023, https://
taxfoundation.org/research/all/federal/us-consumption-tax-vs-income-
tax/.
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conclusion
We as a country have built a Federal tax system that is inherently
complex, costly, and controversial, one that is centered on taxing both
individual and business income at progressive tax rates and littered
with various preferences. To the extent it is comprehensible at all,
taxpayers do not perceive it as fair. The IRS has real challenges
administering such a complicated tax system, but boosting the IRS
budget will not fix the underlying problem that causes taxpayers to
call the IRS millions of times per year asking for help filling tax
forms that take them more than 6.5 billion hours to complete.
As top priority, lawmakers should simplify the tax code so that
taxpayers can understand the laws and the IRS can administer them with
minimum cost and frustration. As the IRS's National Taxpayer Advocate
states in their most recent report to Congress, ``Simplifying the code
is the most important step Congress can take to reduce taxpayer
compliance burdens. Simplification is essential to the integrity of the
U.S. tax system and will enhance voluntary compliance.''\69\ We have
outlined reforms that would reduce taxpayer compliance burdens by at
least $100 billion per year.
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\69\ Internal Revenue Service National Taxpayer Advocate, ``2022
Annual Report to Congress,'' Jan. 11, 2023, https://
www.taxpayeradvocate.irs.gov/news/national-taxpayer-advocate-delivers-
2022-annual-report-to-congress/.
Second, lawmakers should reduce the economic drag caused by the tax
code, particularly in the current environment of high interest rates
and still-too-high inflation reducing living standards and prosperity.
The tax code is one of the most effective levers available to lawmakers
to strengthen the economy, but it should not be done through
preferences that are targeted and complicated. Rather, lawmakers should
broadly improve incentives to work, save, and invest by lowering
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marginal tax rates on individual and corporate income.
We have shown that revenue-neutral tax reform can greatly improve
economic growth, increasing GDP by 2.5 percent in the long run, adding
1.3 million jobs, and raising wages by 1.4 percent such that after-tax
incomes for the bottom 40 percent of earners increase by more than 4
percent on average. Additionally, the experience of other countries
shows that taxing consumption as opposed to income raises substantial
revenue in a more economically efficient way. To address distributional
concerns, lawmakers can design consumption taxes to progressively tax
the consumption of higher earners without the administrative complexity
and compliance costs of our current progressive income tax system.
______
Questions Submitted for the Record to William McBride, Ph.D.
Questions Submitted by Hon. Mike Crapo
Question. Even as the administration has boasted it will make the
wealthy and businesses pay their ``fair share,'' the misnamed Inflation
Reduction Act provided hundreds of billions of dollars of tax subsidies
to Democrats' favored industries.
In your written testimony, you state that research shows that ``the
budgetary cost of the IRA's green energy credits and subsidies will
exceed $1 trillion over a decade, three times the original cost
estimated by the CBO and the JCT, with the benefits accruing mainly to
high earners.''
Can you discuss how the Inflation Reduction Act, which passed with
only Democrat votes, favors high-income earners in the tax code?
Answer. As noted in my written testimony, researchers now estimate
the budgetary cost of the Inflation Reduction Act's green energy
credits and subsidies will exceed $1 trillion over a decade, three
times the original cost estimated by the Congressional Budget Office
(CBO) and the Joint Committee on Taxation, with the benefits accruing
mainly to high earners.\1\
---------------------------------------------------------------------------
\1\ John Bistline, Neil Mehrotra, and Catherine Wolfram, ``Economic
Implications of the Climate Provisions of the Inflation Reduction
Act,'' Brookings Papers on Economic Activity, March 2023, https://
www.brookings.edu/wp-content/uploads/2023/03/BPEA_Spring2023_Bistline-
et-al_unembargoedUpdated.pdf; Jason Furman, ``Comment on `Economic
Implications of the Climate Provisions of the Inflation Reduction Act,'
'' Mar. 30, 2023, https://www.brookings.edu/wp-content/uploads/2023/02/
2b_20230330-BPEA-climate-furman-comment.pdf; Christine McDaniel, ``The
Cost of Battery Production Tax Credits Provided in the IRA,'' Forbes,
Feb. 1, 2023, https://www.forbes.com/sites/christinemcdaniel/2023/02/
01/the-cost-of-battery-production-tax-credits-provided-in-the-ira/
?sh=362fc62279ef; Christine McDaniel, ``The Costs of Wind Production
Tax Credits Provided in the IRA,'' Forbes, Mar. 8, 2023, https://
www.forbes.com/sites/christinemcdaniel/2023/03/08/the-costs-of-wind-
production-tax-credits-provided-in-the-ira
/?sh=7cd6f4295ff7; Goldman Sachs, ``Carbonomics: The Third American
Energy Revolution,'' Mar. 22, 2023.
Much of the cost results from about a dozen different investment
and production tax credits that subsidize certain companies engaged in
eligible activities, subsidies that largely benefit shareholders in the
short run and workers to a degree in the long run. For instance, the
Tax Policy Center (TPC) finds that in 2027, about 26 percent of the
benefits of the investment tax credits will accrue to individual filers
earning over $1 million, and more than 60 percent of the benefits will
accrue to filers earning over $200,000.\2\ TPC finds that about 9
percent of the benefits of the production tax credits will accrue to
individual filers earning over $1 million, and more than 65 percent of
the benefits will accrue to filers earning over $100,000.\3\
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\2\ Tax Policy Center, Table T23-0049, April 3, 2023, https://
www.taxpolicycenter.org/model-estimates/hr5376-inflation-reduction-act-
passed-senate-august-2022/t23-0049-energy-security.
\3\ Tax Policy Center, Table T23-0047, April 3, 2023, https://
www.taxpolicycenter.org/model-estimates/hr5376-inflation-reduction-act-
passed-senate-august-2022/t23-0047-energy-security.
The remainder of the cost is from various individual tax credits
for electric vehicles (EVs), solar panels, and other climate-oriented
luxury goods that appeal to high earners.\4\ According to TPC, about 5
percent of the benefits of the IRA green energy tax credits for
individuals accrue to filers earning more than $1 million and more than
50 percent accrues to filers earning over $200,000.\5\
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\4\ David Roberts, ``Clean Energy Tax Credits Mostly Go to the
Affluent. Is There a Better Way?,'' Nov. 24, 2015, https://www.vox.com/
2015/11/24/9792474/energy-tax-credits-inequitable.
\5\ Tax Policy Center, Table T23-0045, April 3, 2023, https://
www.taxpolicycenter.org/model-estimates/hr5376-inflation-reduction-act-
passed-senate-august-2022/t23-0045-energy-security.
The benefits of the EV credits are likely further skewed to high
earners as a result of regulatory guidance from the Biden
administration. While the IRA legislation limited the full EV credit of
$7,500 to filers earning below $300,000 and for cars with a sales price
below $55,000 (and SUVs and trucks below $80,000), regulatory guidance
has allowed consumers to avoid these limitations by leasing rather than
owning. As detailed in a New York Times article, the share of EV
consumers that lease rather than own has grown to 34 percent as of
March 2023, compared to 7 percent in September 2022, the month after
enacted.\6\
---------------------------------------------------------------------------
\6\ Lawrence Ulrich, ``Electric Vehicle Tax Credit Rules Create
`Chaos for Consumers,' '' The New York Times, Apr. 20, 2023, https://
www.nytimes.com/2023/04/20/business/electric-vehicle-tax-credits-
consumers.html.
Based on analysis by TPC and the updated revenue estimates for the
IRA's green energy tax credits, Jason Furman estimates that the credits
disproportionately benefit high earners. For instance, the top 1
percent of earners in 2027 receive a benefit of more than $11,000,
raising their after-tax income by 0.5 percent. In contrast, the bottom
quintile of earners receive a benefit of less than $100, raising their
after-tax income by 0.3 percent.\7\
---------------------------------------------------------------------------
\7\ John Bistline, Neil Mehrotra, and Catherine Wolfram, ``Economic
Implications of the Climate Provisions of the Inflation Reduction
Act,'' Brookings Papers on Economic Activity, March 2023, https://
www.brookings.edu/wp-content/uploads/2023/03/BPEA_Spring2023_Bistline-
et-al_unembargoedUpdated.pdf; Jason Furman, ``Comment on `Economic
Implications of the Climate Provisions of the Inflation Reduction Act,'
'' Mar. 30, 2023, https://www.brookings.edu/wp-content/uploads/2023/02/
2b_20230330-BPEA-climate-furman-comment.pdf.
Question. There is no shortage of research that demonstrates the
significant costs that high marginal income tax rates have on slowing
economic growth--which means less investment, fewer jobs, and lower
wages. As harmful as higher income tax rates are, some also want to tax
``wealth'' writ large--once as individual or corporate income, and
---------------------------------------------------------------------------
again as a capital gain or death tax.
How would higher marginal income tax rates, or even a wealth tax,
impact Americans' incentives to work, save, and invest?
How have wealth taxes held up in most European countries?
Answer. Because income is generated primarily by working, saving,
and investing, raising marginal income tax rates will increase the
penalty on those activities, naturally reducing the incentive to do
them. As described in my written testimony, this relationship has been
documented and measured over and over in dozens of empirical studies,
and it is generally well understood among economists that the effect is
substantial. This is why the CBO found that a progressive income tax,
with marginal income tax rates that rise with income, is substantially
more economically destructive than a flat income tax or a flat labor
tax.\8\
---------------------------------------------------------------------------
\8\ Congressional Budget Office, ``The Economics of Financing a
Large and Permanent Increase in Government Spending: Working Paper
2021-03,'' Mar. 22, 2021, https://www.cbo.gov/publication/57021.
Taxing unrealized capital gains or wealth would amount to an
additional penalty on saving and investment, and could particularly
harm incentives for entrepreneurs to start new companies and build them
into successful enterprises. It would give foreign savers, investors,
and entrepreneurs an advantage, so foreigners would finance and own a
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larger share of U.S. investment.
The mobility of capital is one reason OECD countries have tended to
abandon more complicated means of taxing high earners (e.g., wealth
taxes), as the administrative and economic challenges outweigh any
benefits in terms of tax revenue.\9\ Rather than high capital gains
taxes, or any attempt to tax unrealized capital gains, most OECD
countries have lower capital gains tax rates than the U.S. and tax
capital income overall at lower average tax rates.\10\
---------------------------------------------------------------------------
\9\ Daniel Bunn, ``What the U.S. Can Learn from the Adoption (and
Repeal) of Wealth Taxes in the OECD,'' Tax Foundation, Jan. 18, 2022,
https://taxfoundation.org/wealth-taxes-in-the-oecd/.
\10\ Daniel Bunn and Elke Asen, ``Savings and Investment: The Tax
Treatment of Stock and Retirement Accounts in the OECD,'' Tax
Foundation, May 26, 2021, https://taxfoundation.org/savings-and-
investment-oecd/#Capital; Jacob Lundberg and Johannes Nathell, ``Taxing
Capital--An International Comparison,'' Tax Foundation, May 11, 2021,
https://taxfoundation.org/tax-burden-on-capital-income/.
Questions Submitted by Hon. Marsha Blackburn
Question. I find it concerning that the IRS is selectively auditing
on factors unrelated to the accuracy of tax returns, particularly when
they're scrutinizing a tax base that has historically had no
significant issues with compliance. This July, GAO examined IRS audits
of large partnerships and found that the agency is starting from a weak
position. Between 2010 and 2018, four out of every five of those audits
resulted in no change, and of those that changed, the company overpaid
taxes and was owed money back by the IRS.
Has the Tax Foundation modeled the fiscal impacts of audit focus at
the IRS?
Is approaching audits in this way an effective use of IRS
resources?
Answer. No, we have not modeled the fiscal impacts of audit focus
at the IRS, nor do we have the capability currently to do so. Our model
works with economic aggregates and samples of individual tax return
information but does not contain any information on auditing. While we
do not model auditing practices, we do think sound tax policy
principles--including simplicity, transparency, and neutrality--apply
to auditing practices. These principles suggest that taxpayers and
administrators would be better served by an audit policy that sticks to
simple, understandable rules based on risk assessment, i.e., the risk
and likelihood of an audit identifying a substantial underpayment of
tax, where taxpayer income becomes a factor only to the extent it is
correlated with this risk.
Question. I'd like to ask about the costs to taxpayers to launch
the IRS-run, direct electronic filing (e-filing) tax return system. The
IRS report to Congress in May 2023 estimated that Direct File may cost
American taxpayers $2.5 billion over 10 years. However, TIGTA's report
issued in October asserted that the IRS could not provide any
documentation to support its cost estimates or how it determined there
would be at least 5 million users. As a result, TIGTA had no way to
identify the reasonableness of the IRS's cost estimates.
Has the Tax Foundation examined the potential costs to launch the
IRS's Direct File program?
If not, is Tax Foundation considering modeling the potential cost
of this program versus the cost to revitalize the existing Free File
program?
Answer. Yes, we have considered the potential costs of the IRS
launching a Direct File program and described our analysis in a July
blog post.\11\ While some countries, such as Estonia, have proven that
Direct File can work, it is important to understand the conditions
under which it can work. The main condition is the simplicity of the
tax code: Estonia's tax system is extraordinarily simple, with
relatively few special provisions, deductions, credits, et cetera.\12\
The U.S. tax code, on the other hand, is complex. It contains more than
200 tax expenditures, including deductions and tax credits for all
sorts of activities (e.g., home improvement, child care, medical and
educational expenses, et cetera). As such, there is no clear path for
the IRS to efficiently and accurately attain such diverse information
without intense involvement by the taxpayer. In other words, this is
putting the cart before the horse. Direct File should be pursued only
after lawmakers substantially simplify the tax code. As mentioned in
the prior answer, we do not have the capability to model Direct File,
nor do we intend to build out such a model in the near future.
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\11\ Taylor Cazy, ``The U.S. Tax Code Is Too Complex for Direct
eFile to Work,'' Tax Foundation, Jul. 11, 2023, https://
taxfoundation.org/blog/irs-efile-prefilled-tax-returns/.
\12\ William McBride, Huaqun Li, Garrett Watson, Alex Durante,
Erica York, and Alex Muresianu, ``Details and Analysis of a Tax Reform
Plan for Growth and Opportunity,'' Tax Foundation, Jun. 29, 2023,
https://taxfoundation.org/growth-opportunity-us-tax-reform-plan/.
______
Questions Submitted by Hon. Todd Young
Question. In your written testimony, you discussed the economic
cost of high marginal income tax rates, noting that ``high income tax
rates come with disproportionately large additional excess burden.''
This burden is furthered by the double taxation of corporate income,
which you noted as ``one of the most problematic and economically
destructive aspects of the U.S. tax code.''
Can you please discuss further the impacts this corporate tax
structure has on individuals?
Answer. The integral role corporations play in our economy and the
degree to which individuals are affected by corporate taxes are often
forgotten in discussions of corporate tax issues. A recent report by
McKinsey Global Institute finds, based on OECD data, that across major
OECD economies, the business sector contributed 72 percent of value
added (that is, GDP).\13\ In most countries, the business sector is
almost entirely in corporate form, whereas in the U.S., a substantial
portion is in pass-through form, only subject to one layer of tax when
owners report pass-through earnings on their individual tax returns.
Nonetheless, more than half of U.S. GDP is attributable to the
corporate sector.
---------------------------------------------------------------------------
\13\ McKinsey Global Institute, ``A new look at how corporations
impact the economy and households,'' May 31, 2021, https://
www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-
insights/a-new-look-at-how-corporations-impact-the-economy-and-
households.
One reason the pass-through sector is so large in the U.S. is the
fact that corporations are disadvantaged; they are subject to two
layers of tax: corporate income taxes at the entity level (Federal tax
rate of 21 percent plus now a minimum tax on book income and a stock
buyback tax) as well as shareholder-level taxes on dividends and
capital gains (top Federal tax rate of 23.8 percent). That such a large
and integral part of the U.S. economy is subject to substantial double
taxation makes it particularly problematic and destructive of U.S.
economic growth and productivity. The corporate income tax
substantially raises the cost of corporate investment, reducing the
amount of investment and the number of projects that are pursued. Less
investment means a smaller capital stock (fewer factories, equipment,
and tools for workers), which means less productive workers and
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commensurately less pay.
The buyback tax and shareholder taxes punish equity-financed
corporate investment, with capital gains and dividends taxes hitting
U.S. equity shareholders and disadvantaging U.S. savers, encouraging a
larger share of U.S. corporate investment to be financed and owned by
foreigners. As it stands, some 58 percent of U.S. households own
corporate shares directly or indirectly, such as through mutual funds
or retirement accounts, making these taxes a widespread burden on
American savers, including tens of millions earning less than
$200,000.\14\
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\14\ Hannah Mio, ``More Americans Than Ever Own Stocks,'' The Wall
Street Journal, Dec. 18, 2023, https://www.wsj.com/finance/stocks/
stocks-americans-own-most-ever-9f6fd963?st=mq1kiy
m32yeknyp; Joint Committee on Taxation, ``Revenue Estimates and
Distributional Analyses,'' Aug. 3, 2021, https://
www.finance.senate.gov/imo/media/doc/jct_analysis_on_corporate_tax_
increase.pdf.
Another large share of Americans depend on corporations for
employment, with slightly less than half of the private sector
workforce employed by traditional C corporations.\15\ This fact, and
the connection between corporate investment and wages, leads
researchers to allocate much of the corporate tax burden to workers in
the long run. Accounting for both the portion that falls on
shareholders and the remainder that falls on workers, the Joint
Committee on Taxation (JCT) assumes that in the long run, the corporate
tax burden falls on more than 150 million tax filers earning less than
$200,000.\16\
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\15\ Kyle Pomerleau, ``An Overview of Pass-Through Businesses in
the United States,'' Tax Foundation, Jan. 21, 2015, https://
taxfoundation.org/research/all/federal/overview-pass-through-
businesses-united-states/.
\16\ Joint Committee on Taxation, ``Revenue Estimates and
Distributional Analyses,'' Aug. 3, 2021, https://
www.finance.senate.gov/imo/media/doc/
jct_analysis_on_corporate_tax_increase.
pdf.
Question. One of the criticisms of the U.S. tax code often
highlighted by my Democrat colleagues is the idea that individuals are
---------------------------------------------------------------------------
able to ``buy, borrow, die,'' all while avoiding paying taxes.
Do you agree with this framing of the U.S. tax code? Why or why
not?
Answer. The ``buy, borrow, die'' story presented at the hearing
leaves out some important details and in particular fails to mention
the role of corporate taxes and estate taxes. As far as we know, the
highest net worth individuals in the U.S. (who purportedly rely on this
buy, borrow, die strategy) own a large share of their wealth in the
form of corporate shares, often founders' shares in companies they have
founded. Each year, these companies are subject to the Federal
corporate income tax of 21 percent, plus the new 15-percent minimum tax
on book income and the new 1-percent buyback tax. The company's market
value, and the owner's share of that market value, are reduced each
year by these taxes.
Furthermore, these taxes are collected even if the owner of the
shares receives no dividends and does not sell the shares during the
year, thus avoiding dividend and capital gains taxes (it is unclear how
common or economically significant this situation is).
While it is true that the owner of these shares can borrow against
the value of the corporate stock, it is costly to do so, particularly
now that interest rates for personal loans have increased to a range of
roughly 8 to 35 percent depending on circumstances.\17\ A portion of
the nominal interest rate represents taxes paid by lenders on their
interest income, e.g., corporate taxes on banks.
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\17\ Bank Rate, ``Best personal loan rates for December 2023,''
Dec. 18, 2023, https://www.
bankrate.com/loans/personal-loans/rates/.
Finally, estate taxes are a final layer of tax triggered by death.
The buy, borrow, die story is that step-up in basis for capital gains
allows capital gains taxes to be avoided at death, but the Federal
estate tax remains and currently applies at a top rate of 40 percent on
capital gains and all assets within an estate above a threshold of
about $13 million. Step-up in basis exists to avoid double taxing
---------------------------------------------------------------------------
estates.
Question. You have frequently discussed the positive economic
impacts the Tax Cuts and Jobs Act (TCJA) has had on the U.S. economy,
noting that ``[r]eal GDP grew at an annual rate of 2.6 percent from
2017 to 2019, compared to 2.3 percent over the 20 years prior to
TCJA'', among other measures that point to a strong post-TCJA
economy.\18\ One of the factors that contributed to this strong
economic growth were TCJA provisions that provided incentives for
businesses to invest in activities like research and development in
order to grow their business and, by extension, the economy.
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\18\ https://taxfoundation.org/research/all/federal/tax-cuts-and-
jobs-act-biden-tax-policies/
#::text=Real%20GDP%20grew%20at%20an,20%20years%20prior%20 to%20TCJA.
Can you please share some of the larger macroeconomic impacts the
business investments contained in TCJA have provided to companies, both
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big and small?
Answer. Lowering the corporate tax rate from the highest in the
OECD to roughly the middle of the pack improved our economy's
competitiveness and attractiveness as a place to locate major economic
activities, including U.S. multinational headquarters and R&D
operations. The lower corporate tax rate improved the long-run health
of the economy by substantially reducing the tax burden on corporate
investment, including for the more than 99 percent of C corporations
that have fewer than 500 employees.\19\ Bonus depreciation reduced the
economic harm of both the corporate tax and individual income taxes on
pass-through business income, boosting business investment incentives
broadly, albeit temporarily.
---------------------------------------------------------------------------
\19\ U.S. Census, ``County Business Patterns,'' https://
www.census.gov/programs-surveys/cbp.
html.
We found the TCJA's positive impacts on the economy would build
over time and by 2025 would result in a 3.0-percent increase in GDP, a
6.4-percent increase in the capital stock, and a 1.7-percent increase
in real wages. The improved economic growth would translate into larger
incomes for all income groups. For example, accounting for the growth
effects, we found the TCJA would substantially raise real after-tax
incomes for all quintiles of earners in 2025, by 3.9 percent for the
bottom quintile, 4.1 percent for the middle quintile, and 4.9 percent
for the top quintile.\20\
---------------------------------------------------------------------------
\20\ Huaqun Li and Kyle Pomerleau, ``The Distributional Impact of
the Tax Cuts and Jobs Act over the Next Decade,'' Tax Foundation, Jun.
28, 2018, https://taxfoundation.org/the-distributional-impact-of-the-
tax-cuts-and-jobs-act-over-the-next-decade/.
A recent study by economists associated with the National Bureau of
Economic Research and the Treasury Department finds the TCJA's
corporate reforms substantially raised U.S. capital investment and
boosted economic growth. Based on a large sample of 12,000 corporate
tax returns covering several years prior to the enactment of the TCJA
and 2 years after, the researchers found that, on average, firms
impacted by the policy changes increased domestic investment by about
20 percent in the subsequent 2 years relative to firms with no tax
change.\21\
---------------------------------------------------------------------------
\21\ William McBride and Alex Durante, ``New Study Finds TCJA
Strongly Boosted Corporate Investment,'' Tax Foundation, Oct. 31, 2023,
https://taxfoundation.org/blog/tcja-corporate-tax-economic-effects/.
______
Questions Submitted by Hon. John Thune
Question. In your testimony, you highlighted the progressive nature
of the tax code and made the point that the share of Federal income
taxes paid by the top 1 percent of taxpayers has increased over the
last several years. You specifically cited IRS tax data from the 2020
filing season illustrating that over 42 percent of all Federal income
taxes were paid by the top 1 percent of earners.
Can you outline how the share of Federal income taxes paid by the
highest earners has grown since enactment of the Tax Cuts and Jobs Act
and to what degree you anticipate that continuing to be the case should
the individual rates be extended beyond 2025?
Answer. As indicated by the IRS data, the share of Federal income
taxes paid by the top 1 percent of earners has trended up over the last
20 years, from 33.2 percent in 2001 to 42.3 percent in 2020 (the last
year of available data).\22\ The trend continued after the enactment of
TCJA: the share of Federal income taxes paid by the top 1 percent of
earners was 38.5 percent in 2017 and grew to 40.0 percent in 2018 (the
first year following enactment), the highest recorded share going back
to 1980. The top 1 percent share dropped in 2019 to 38.8 percent before
climbing to a new high of 42.3 percent in 2020.
---------------------------------------------------------------------------
\22\ Erica York, ``Summary of the Latest Federal Income Tax Data,
2023 Update,'' Tax Foundation, Jan. 26, 2023, https://
taxfoundation.org/data/all/federal/summary-latest-federal-income-tax-
data-2023-update/.
Two factors driving this trend are the growing share of income
reported by the top 1 percent of earners and policies that increase the
progressivity of the tax code, including higher top tax rates and more
generous tax credits for low earners (note that these figures do not
include the refundable portion of tax credits, which are counted as
outlays). The top 1 percent share of reported adjusted gross income
(AGI) grew from 17.4 percent in 2001 to 22.2 percent in 2020, with
little variation since the enactment of TCJA. AGI shares fluctuate with
the economy and the stock market, and as 2021 represented a rebounding
economy and a booming stock market, this points to a further increase
in the top 1 percent share of Federal income taxes for that year. As
well, certain pandemic-era policies in place during 2021, including the
expanded child tax credit, may further increase the share of Federal
---------------------------------------------------------------------------
taxes paid by the top 1 percent of earners.
The extension of TCJA's individual provisions beyond 2025 would
likely have little impact on the share of Federal income taxes paid by
high earners, since the rate reductions and other measures, including
the expanded standard deduction and Child Tax Credit, would provide a
broad set of tax cuts across the income scale.\23\
---------------------------------------------------------------------------
\23\ Erica York, Garrett Watson, Alex Durante, Huaqun Li, Peter Van
Ness, and William McBride, ``Details and Analysis of Making the 2017
Tax Reforms Permanent,'' Tax Foundation, Nov. 8, 2023, https://
taxfoundation.org/research/all/federal/making-2017-tax-reform-
permanent/.
Question. As you know, the Tax Cuts and Jobs Act capped the
deduction for State and local taxes at $10,000. And it is no secret
---------------------------------------------------------------------------
that the SALT deduction primarily benefits higher-income earners.
Could you walk through how any revisions of the tax code to either
increase the SALT deduction or repeal the cap all together would be a
highly regressive policy change and primarily benefit those in higher-
income brackets?
Answer. We have recently modeled several options for revising the
cap on SALT deductions, finding in general that any lifting of the cap
would primarily benefit high-income earners. For example, measured on a
conventional basis (static analysis excluding any macroeconomic
effects) in 2025, raising the cap to $15,000 for singles and $30,000
for joint filers would have no measurable impact on the bottom 60
percent of filers, but it would boost the after-tax income of the top
quintile by 0.4 percent. Fully eliminating the cap would have no
measurable impact on the bottom 40 percent of households, but it would
boost the after-tax income of the top quintile by 1.3 percent.\24\
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\24\ Garrett Watson, ``Policymakers Must Weigh the Revenue,
Distributional, and Economic Trade-Offs of SALT Deduction Cap Design
Options,'' Tax Foundation, Dec. 7, 2023, https://taxfoundation.org/
blog/salt-deduction-cap-design-options/.
______
Prepared Statement of Morris Pearl, Chair, Patriotic Millionaires
Chairman Wyden and Ranking Member Crapo, thank you for giving me
the opportunity to speak today. I had a long career on Wall Street and
currently serve as the chair of Patriotic Millionaires, but most
importantly for the purposes of this hearing, I am exactly the kind of
very wealthy individual that our tax code is designed to advantage.
The cost of those advantages is:
A permanent upper hand for the wealthy over working people;
Economic instability from an extreme concentration of wealth
and income at the top;
An eroding consumer base and tax base; and
Social instability as more and more people realize that
putting in a hard day's work is no longer a path to dignity and
a financially stable life.
The original sin of our tax code is the way we value money and
wealth over work and wages. Your constituents who work for a living
have taxes deducted from their paychecks every single week. I earn
money by just watching the numbers on my brokerage statement go up, and
I can decide to have that income become taxable if and when I feel like
it. We do not tax capital gains until the time of sale, which means for
people like me, taxes become essentially optional. We can take out low-
interest loans to fund living expenses; never realize the capital
gains, so never pay taxes on them; and when we die, thanks to the step
up in basis, we're able to pass that wealth on to the next generation
completely free of income tax, and the whole ``buy, borrow, die''
process starts again. People who are rich don't need any ``taxable''
income. The money made by investors should be subject to taxes just
like the money made by your constituents who work for a living. That is
the essence of the proposed legislation from Chairman Wyden and from
President Biden.
My own family benefited from the step-up basis rule in 2009,
inheriting shares of Berkshire Hathaway that had a gain of over 62,000
percent. We enjoyed millions of dollars of gains on which no one had
ever paid any income taxes, and on which no one ever will pay any
income taxes.
Even when I do choose to realize those gains and pay taxes, the
rate is far below the rate paid by people who earn that much from their
work. This is supposed to incentivize investment, which fundamentally
misunderstands what drives investors like me. My options are to invest
my money and get some growth, or stuff it under a mattress. And last
time I checked, mattresses don't have great returns. Perhaps even more
ridiculously, we give this same benefit to venture capital and private
equity fund managers who are managing other people's investments
through the carried interest loophole. If we believe we should be using
the tax code to incentivize people to enter certain professions, I
would put emergency-room nurses above fund managers.
Even the wealthy people who earn most of their income from work
don't experience a truly progressive tax code. Our top tax bracket for
a married couple filing jointly starts at a little under $700,000.
That's a lot of money every year, but let's not pretend they're in the
same income bracket as someone earning $7 million or $70 million. And
that couple earning $700,000 in compensation pays Social Security tax
on a substantial portion of their income. The burden of Social Security
tax for a couple making $7 million or $70 million is negligible (well
under 1 percent of income).
Many people, including some of you on this committee, have offered
serious solutions that would help reorient the way we tax the ultra-
wealthy. Your proposals to tax extreme wealth include Senator Warren's
Ultra-Millionaire Tax and the OLIGARCH Act introduced by Rep. Barbara
Lee and others in the House.
We also need taxes on unrealized gains of the ultra-rich, like
Chairman Wyden's proposal or President Biden's proposal.
To be clear, I am not against being rich. I lead an organization of
millionaires. We know that being rich is great, and we recommend that
everyone try it. But investors and business people do not want a nation
with a few rich people and lots of people just getting by. That is not
where we can invest and build businesses. Money doesn't trickle down,
it trickles up from every mortgage payment and phone bill payment you
make to investors like me who invest in mortgages and phone companies.
We need a nation filled with people who have enough money to spend on
this. That is what makes the economy work for everyone, including
investors. The tax code can, should, and must be used to reduce and
constrain inequality, and the status quo is doing the exact opposite.
Thank you, I will be happy to answer any questions you have.
______
Prepared Statement of Hon. Ron Wyden,
a U.S. Senator From Oregon
This Congress, the Senate Finance Committee has investigated a
number of tax schemes that the very wealthy--with the help of armies of
high-priced tax lawyers and accountants--use to pay virtually no
Federal tax for years on end.
Today, we'll examine one strategy--among others--called ``buy,
borrow, die.'' Just three little words on the chart behind me, that
have a huge impact. Here's how it works.
A corporate raider buys a business, and then borrows against its
growing, untaxed value to fund their extravagant lifestyle--everything
from superyachts to luxurious vacations, expensive art deals, you name
it. It goes up and up in value, all while not paying a dime in tax. And
when they die, their assets are passed to their kids--often entirely
tax-free--and the cycle continues.
Now let's contrast buy, borrow, die against the tax system mandated
for everyone else.
A nurse or a firefighter living in Philomath, OR is required to pay
taxes out of each paycheck. Working people don't get to play by the
same rules as billionaires. They don't get to call up an accountant
every time they don't feel like paying taxes.
Right now, the average billionaire wriggles their way into a measly
8-percent tax rate while a nurse or firefighter making $45,000 is
paying a 22 percent tax on their wages. How is that fair?
Americans overwhelmingly believe it's not. So it's time to look to
solutions that restore fairness to the tax code while still rewarding
success. After all, that's what our country is founded on: the idea
that everyone has a chance to get ahead.
Luckily, there's a solution that achieves both fairness and
economic growth. It's called mark to market. And here's the kicker:
there's already a version of it in the tax code. That means we have the
blueprint right in front of us to use as a model for mark-to-market
provisions for billionaires. Put simply: mark to market would require
billionaires to pay tax every year, just like everyone else.
Buy, borrow, die is the primary mechanism billionaires use to dodge
taxes. And if left unchecked, you're inviting more gaming into the
system. Ending buy, borrow, die is the best way to ensure billionaires
pay their fair share.
Tax laws don't apply to billionaires in the same way they do for
everybody else. They're optional, where everybody else's tax rules are
mandatory. It's time to close these loopholes and make sure those at
the very top are paying taxes on their income as it's earned, just like
everybody else.
My team on the Finance Committee and I are fighting tax injustices
from every angle. We've investigated crooked Swiss bankers hiding
Americans' income; $34 billion in unpaid taxes from millionaires; tax
dodging schemes between Leon Black and Jeffrey Epstein; and Supreme
Court Justice Clarence Thomas's wealthy buddy secretly forgiving a
massive, private loan.
Americans deserve a tax system that can be both fair and encourage
success. My hope is that effort could be bipartisan. The invention of
Roth IRAs--a Republican idea--has helped working Americans save for the
future and get ahead. But now, the ultra-wealthy are abusing them to
shield their vast fortunes from Federal tax. It's time to end this
exploitation of current tax laws and use the funds to give more
families a chance to get ahead by starting child savings accounts,
something my colleague, Senator Bob Casey, has been working on for
years.
I've laid out just a few of the endless ways the super-wealthy are
avoiding paying their fair share, but here's the real gut punch: it's
all perfectly legal. If that doesn't make your blood boil, I don't know
what will.
The decks are stacked against working families. Wealth continues to
build up in the hands of the fortunate few, leaving everyone else
behind. Over one-third of families in America don't have the cash on
hand to pay for a $400 emergency if they had to. Meanwhile, during the
pandemic when families were forced to make tough choices between paying
rent and buying groceries, billionaires increased their wealth by over
$1 trillion.
Bottom line: it's time to throw out business as usual here.
I'll close with this: there is growing support and demand for
solutions that restore fairness to the tax code and level the playing
field for working families. You can only have a successful economy if
you have a tax code that treats everyone fairly.
It's past time to close the gap between those at the top and
everyone else, and I look forward to working with my colleagues on the
Committee to make it happen.
______
Communications
----------
Center for Fiscal Equity
14448 Parkvale Road, Suite 6
Rockville, Maryland 20853
[email protected]
Statement of Michael G. Bindner, Principal Consultant
Chairman Wyden and Ranking Member Crapo, thank you for taking my
comments on this issue. While you have likely heard some of these
before, I offer them anew as a contrast to the testimony of the invited
witnesses.
How do the wealthy game the system? Let me count the ways:
Borrowing from accumulated shares at favorable terms for
additional acquisitions or to fund new enterprises and to fund lavish
personal spending.
Using Life Insurance so that heirs avoid taxation of
intergenerational wealth.
Using duty free zones to hide investment assets, such as art for
investment.
Using gifts, inheritance and donations to avoid capital gains
taxation.
The ability to offset financial losses to reduce the taxation of
wages and salaries.
Tax Cuts whenever a Republican is in the White House and
controls one or both chambers.
Leveraging these tax cuts into ownership of the national debt,
which is the leverage that allows capitalism to go off the rails into
speculation.
For the first four bullets, see our tax reform plan in the first
attachment for more detail.
The solution to the first two bullets is to enact a (credit) invoice
value-added tax, as well as an asset value-added tax. We propose that
subsidies to families be paid through an employer-paid subtraction VAT,
so that they may be distributed with wages or alternatively with other
government benefits under the Social Security Act, including
Unemployment Insurance.
The invoice VAT will hit every dollar spent, including when goods,
services and assets are purchased abroad and brought home. Duty Free
zone exemptions on paying such taxes must be abolished above $100.
Consumption taxes cannot be avoided by taking funds out of investments
or insurance policies, including that portion of the subtraction VAT
that is channeled to workers and their families.
The next to bullets are fixed by repealing capital gains taxes entirely
and replacing them with an asset value-added tax. There should only be
one rate for asset VAT, which should be set at the rate for long-term
capital gains. This would also be the rate for every short term
transaction. This would technically be a tax cut, which will force
Republicans to support it or be called out by Mr. Norquist.
At initial public offering, option exercise and the first sale after
inheritance, gift or donation, the sale would logically be marked to
market. If a family keeps the stock or company, there will be no tax
until someone else buys it.
The second tax cut would be to expand the ESOP tax exemption to all
sales of public stock, rather than just private stock. Maximizing
employee ownership will bring a new level of motivation and excellence
to the economy.
There is no hiding from a value-added tax taken at each transaction.
Any increased value added would be paid immediately rather than being
part of a portfolio which allows offsets from business losses to reduce
taxes on wages and salaries.
While requiring the taking of capital gains at death is emotionally
satisfying, it has no chance of passage, especially if this breaks up
family businesses. While we are in favor of breaking up such fortunes
as a general principle, it simply cannot be done until inherited firms
or shares in public companies are sold. Zero-rating ESOP sales fulfills
the promise of wealth redistribution to workers. Simply forcing the
sale of assets keeps them in the capitalist sector, doing nothing for
the working class.
Personal income tax filing on wage and dividend income for middle-
income households will be replaced with a subtraction value-added tax
surtax for income above the ceiling for FICA employee contributions,
which will be graduated from a 6.5% rate to a 26% rate for income over
$425,000. Again, without capital gains taxation, there is no way to
offset dividend and salary income. Using an employer collected surtax
with capital gains taxes exported to the asset VAT makes it possible to
end filing for all but the top 1% of households.
At $500,000, an individual surtax ranging between 6.5% and 26% would
fund net interest payments, debt reduction and paying down the Social
Security Trust Fund. For this reason, these payments will be made to
the Bureau of the Public Debt. The Asset VAT will be collected by the
SEC.
The subtraction VAT, any carbon added tax and the Invoice VAT, which
you can call a Fair Tax will be collected by the States (who will also
do any auditing on tax collection issues). It is an offer that
Republican members cannot refuse.
The 2017 personal income tax changes should not be made permanent or
extended, as has been proposed. This will reward savings and
speculation, rather than providing an incentive to invest in plant and
equipment. The latter responds to greater levels of consumption by
households funded by both the public and private sectors, including
Social Security recipients. For a more detailed treatment of why this
is the case, see the second attachment--which was drafted in 2017 in
opposition to the Trump-Ryan-Brady tax cuts. The third attachment
explains why any Fiscal Commission should use repeal of these tax cuts
as its baseline assumption.
The last attachment, which is an excerpt from my book, Settling (and
Squaring) Accounts: Who Owns the National Debt? Who Owes It? It shows
who really benefits from deficit spending. It is time for the
Republicans to wipe their crocodile tears on this issue.
Thank you for the opportunity to address the committee. Please contact
us for an in person briefing or to arrange for a public hearing.
Attachment One--Tax Reform, Center for Fiscal Equity, March 24, 2023
Synergy: The President's Budget for 2024 proposes a 25% minimum tax on
high incomes. Because most high income households make their money on
capital gains, rather than salaries, an asset value-added tax replacing
capital gains taxes (both long- and short-term) would be set to that
rate. The top rate for a subtraction VAT surtax on high incomes (wages,
dividends and interest paid) would be set to 25%, as would the top rate
for income surtaxes paid by very high income earners. Surtaxes
collected by businesses would begin for any individual payee receiving
$75,000 from any source at a 6.25% rate and top out at 25% at all such
income over $375,000. At $450,000, individuals would pay an additional
6.25% on the next $75,000 with brackets increasing until a top rate of
25% on income over $750,000. This structure assures that no one games
the system by changing how income is earned to lower their tax burden.
Individual payroll taxes. A floor of $20,000 would be instituted for
paying these taxes, with a ceiling of $75,000. This lower ceiling
reduces the amount of benefits received in retirement for higher-income
individuals. The logic of the $20,000 floor reflects full time work at
a $10 per hour minimum wage offered by the Republican caucus in
response to proposals for a $15 wage. The majority needs to take the
deal. Doing so in relation to a floor on contributions makes adopting
the minimum wage germane in the Senate for purposes of Reconciliation.
The rate would be set at 6.25%.
Employer payroll taxes. Unless taxes are diverted to a personal
retirement account holding voting and preferred stock in the employer,
the employer levy would be replaced by a goods and receipts tax of
6.25%. Every worker who meets a minimum hour threshold would be
credited for having paid into the system, regardless of wage level. All
employees would be credited on an equal dollar basis, rather than as a
match to their individual payroll tax. The tax rate would be adjusted
to assure adequacy of benefits for all program beneficiaries.
High-income Surtaxes. As above, taxes would be collected on all
individual income taxes from salaries, income and dividends, which
exclude business taxes filed separately, starting at $400,000 per year.
This tax will fund net interest on the debt (which will no longer be
rolled over into new borrowing), redemption of the Social Security
Trust Fund, strategic, sea and non-continental U.S. military
deployments, veterans' health benefits as the result of battlefield
injuries, including mental health and addiction and eventual debt
reduction.
Asset Value-Added Tax (A-VAT). A replacement for capital gains taxes
and the estate tax. It will apply to asset sales, exercised options,
inherited and gifted assets and the profits from short sales. Tax
payments for option exercises, IPOs, inherited, gifted and donated
assets will be marked to market, with prior tax payments for that asset
eliminated so that the seller gets no benefit from them. In this
perspective, it is the owner's increase in value that is taxed. As with
any sale of liquid or real assets, sales to a qualified broad-based
Employee Stock Ownership Plan will be tax free. These taxes will fund
the same spending items as high income and subtraction VAT surtaxes.
There will be no requirement to hold assets for a year to use this
rate. This also implies that this tax will be levied on all eligible
transactions.
The 3.8% ACA-SM tax will be repealed as a separate tax, with health-
care funding coming through a subtraction value-added tax levied on all
employment and other gross profit. The 25% rate is meant to be a
permanent compromise, as above. Any changes to this rate would be used
to adjust subtraction VAT surtax and high-
income surtax rates accordingly. This rate would be negotiated on a
world-wide basis to prevent venue seeking for stock trading.
Subtraction Value-Added Tax (S-VAT). Corporate income taxes and
collection of business and farm income taxes will be replaced by this
tax, which is an employer paid Net Business Receipts Tax. S-VAT is a
vehicle for tax benefits, including:
Health insurance or direct care, including veterans' health care
for non-
battlefield injuries and long-term care.
Employer-paid educational costs in lieu of taxes are provided as
either
employee-directed contributions to the public or private unionized
school of their choice or direct tuition payments for employee children
or for workers (including ESL and remedial skills). Wages will be paid
to students to meet opportunity costs.
Most importantly, a refundable child tax credit at median income
levels (with inflation adjustments) distributed with pay.
Subsistence-level benefits force the poor into servile labor. Wages and
benefits must be high enough to provide justice and human dignity. This
allows the ending of state administered subsidy programs and
discourages abortions, and as such enactment must be scored as a must
pass in voting rankings by pro-life organizations (and feminist
organizations as well). To assure child subsidies are distributed, S-
VAT will not be border-adjustable.
As above, S-VAT surtaxes are collected on all income distributed over
$75,000, with a beginning rate of 6.25%. replace income tax levies
collected on the first surtaxes in the same range. Some will use
corporations to avoid these taxes, but that corporation would then pay
all invoice and subtraction VAT payments (which would distribute tax
benefits). Distributions from such corporations will be considered
salary, not dividends.
Invoice Value-Added Tax (I-VAT). Border adjustable taxes will appear on
purchase invoices. The rate varies according to what is being financed.
If Medicare for All does not contain offsets for employers who fund
their own medical personnel or for personal retirement accounts, both
of which would otherwise be funded by an S-VAT, then they would be
funded by the I-VAT to take advantage of border adjustability.
I-VAT forces everyone, from the working poor to the beneficiaries of
inherited wealth, to pay taxes and share in the cost of government. As
part of enactment, gross wages will be reduced to take into account the
shift to S-VAT and I-VAT, however net income will be increased by the
same percentage as the I-VAT. Inherited assets will be taxed under A-
VAT when sold. Any inherited cash, or funds borrowed against the value
of shares, will face the I-VAT when sold or the A-VAT if invested.
I-VAT will fund domestic discretionary spending, equal dollar employer
OASI contributions, and non-nuclear, non-deployed military spending,
possibly on a regional basis. Regional I-VAT would both require a
constitutional amendment to change the requirement that all excises be
national and to discourage unnecessary spending, especially when
allocated for electoral reasons rather than program needs. The latter
could also be funded by the asset VAT (decreasing the rate by from
19.25% to 13%).
Carbon Added Tax (C-AT). A Carbon tax with receipt visibility, which
allows comparison shopping based on carbon content, even if it means a
more expensive item with lower carbon is purchased. C-AT would also
replace fuel taxes. It will fund transportation costs, including mass
transit, and research into alternative fuels. This tax would not be
border adjustable unless it is in other nations, however in this case
the imposition of this tax at the border will be noted, with the U.S.
tax applied to the overseas base.
Attachment Two--The Tax and Job Cuts Act
The Tax and Job Cuts Act (not a typo) was a classic piece of Austrian
Economics, where booms are encouraged and busts happen with no
bailouts. Strong companies and best workers keep jobs and the devil
take the hindmost. It is economic Darwinism at its most obvious, but
there is a safety valve. When tax cuts pass, Congress loses all fiscal
discipline, the Budget Control Act baseline discipline is (as it should
be) suspended and deficits grow. Bond purchasers pick up the slack
caused by the TCJA, which they will as long as we run trade deficits,
unless the President's economic naivete ruins that for us.
Modern economics has become infected with the idea that higher tax
rates and lower public spending hurt the economy. By definition, this
is not the case. The exact opposite is true. To refresh our memories of
what is in the U.S. Code and most basic economics textbooks, Gross
Domestic Product equals equal government purchases, consumption from
government employee, contractor, transfer recipient and second order
private-sector spending, which leads to private-sector investment, and
exports net of imports (which creates a source of funds for debt
finance).
Anything that is not part of GDP is considered ``savings'' or in
reality, is asset inflation. If you want to end poverty, give poor
people and retirees more money and the economy will grow. Increase
government expenditure (even bombers) and the economy will grow,
including for the now notorious upper middle class.
Lower tax rates also made money available to chase the same supply of
investment instruments, which bid up their price, and caused the
invention of a whole range of new products which would be built up and
sold by the emerging financial class, who would profit-take and watch
what they created go bust and start yet another modern recession,
especially the Great Recession just experienced. Only higher tax rates
or increased deficit spending control such asset inflation (and the
consumption cycles associated with them--which Marx thought was the
driver of the boom bust cycle--Marx had a failure of imagination).
A key part of our proposals is to increase income tax revenue from the
very wealthy through our income surtax. The higher the marginal tax
rate goes, the less likely shareholders and CEOs will go after worker
wages in the guise of productivity while pocketing the gains for
themselves. Since shareholders usually receive a normal profit through
dividends, it is the CEO class that gets rich off of workers unless tax
rates are high enough to dissuade them.
Attachment Three--The Proposed Fiscal Commission, October 19, 2023
Job one for any fiscal commission is to allow the Tax Cuts and Jobs Act
provisions to expire in 2025. No other baseline is appropriate. Without
such a requirement, the Center for Fiscal Equity must oppose any such
entity. Fiscal commissions are often an excuse to retain tax cuts that
are about to expire.
The 2017 personal income tax cuts reward savings and speculation,
rather than providing an incentive to invest in plant & equipment. The
latter responds to greater levels of consumption by households funded
by both the public and private sectors, including Social Security
recipients.
The reality of our fiscal policy is that income tax collected is 1.5%
of GDP too low. In other words, they need to be increased by 9%, or
more because of how long they have been inadequate. Because the ability
to borrow is based on the ability and willingness to tax incomes
adequately, AA+ is a gift from ratings agencies. Any other entity with
this revenue to debt ratio with an unwillingness to increase revenue
would be rated at junk bond levels.
Oddly, the downgrade is good for bond holders because interest rates
will go up. The vast majority of bonds held benefit high income
taxpayers. By my calculations, based on observations from the 2019
Survey on Consumer Finance, the top 10% of households own 54% of public
debt held by long term asset accounts (insurance policies, savings
bonds, retirement accounts) and bank deposits (and therefore assets
held by Federal Reserve Banks) and 77% of debt held by mutual fund
accounts and direct bond holdings. Applying the same share ratios to
the top 1% (which is supported by IRS AGI figures show holdings of 29%
of long term debt and Fed held assets and 59% of high yield assets. The
top 0.1% hold 45.6% of debt held by high yield assets.
Debt obligation is a function of income tax paid (FICA tax paid to
create assets held in trust by the government, not debt obligation).
The current factor is 19 dollars of debt owed for every dollar paid in
tax.
Ownership of Social Security assets is realized when households are in
the bottom quintiles who, at that time (because only 20% have income
beside Social Security), own almost all FICA trust fund assets. The
bottom quintiles hold more than their obligation.
The next three quintiles owe more than they own until we get to the top
0.1%. Because half of their income is earned through asset ownership
taxed at preferred rates and their high share of ownership of debt,
they break even. They own what they owe.
In other words, when interest rates go up due to downgrades, their
wealth expands in terms of debt owned compared to debt owed. This
should guide how the debt should be reduced responsibly.
The Office of Tax Policy and revenue committee staff will hammer out
the details as responsible actors. Again, no commission is necessary
for the kind of tax reform we need to grow out of our fiscal crisis.
Attachment Four--Debt Ownership as Class Warfare, March 20, 2023
Visibility into how the national debt, held by both the public and the
government at the household level, sheds light on why Social Security,
rather than payments for interest on the debt, are a concern of so many
sponsored advocacy institutions across the political spectrum.
Direct household attribution can be made by calculating direct bond
holdings, income provided by Social Security payments and secondary
financial instruments backed with debt assets for each income quintile.
Responsibility to repay the debt is attributed based on personal income
tax collection. Payroll taxes create an asset for the payer, so they
are not included in the calculation of who owes the debt. Using 2019
tax data and the national debt as of COB February 15th, 2022. the ratio
is $19 of debt owed for every dollar of income tax paid. Note well that
the adjusted gross income of the bottom 80% is just over that garnered
by the top 10%.
----------------------------------------------------------------------------------------------------------------
Federal Mutual
Reserve Long-Term Fund Social
Millions Income and Investment and Security
Percentiles of AGI Tax Debt Bank Debt Bond and
Returns Debt Assets Debt Medicare
Assets Assets Assets
----------------------------------------------------------------------------------------------------------------
Total with tax 104.01 11,210.1 1,581.4 30,040.3 6,806.6 3,276.5 6,419.1 3,186.5
----------------------------------------------------------------------------------------------------------------
Top .01% 0.02 659.0 163.2 3,100.2 820.6 378.8 2,519.8 0.0
----------------------------------------------------------------------------------------------------------------
.01% to 1% 7.26 1,427.9 185.6 3,526.6 1,736.9 844.4 1,652.5 10.2
----------------------------------------------------------------------------------------------------------------
1% to 10% 7.28 2,086.9 348.8 6,626.8 1,957.5 978.1 1,196.5 177.6
----------------------------------------------------------------------------------------------------------------
Top 10% 9.00 4,602.44 987.23 18,754.0 4,515.0 2,201.4 5,368.8 187.8
----------------------------------------------------------------------------------------------------------------
10% to 20% 13.08 1,788.34 200.3 3,805.1 921.5 644.9 583.2 463.7
----------------------------------------------------------------------------------------------------------------
Bottom 80% 81.92 4,829.22 393.6 7,476.6 1,370.1 430.3 467.2 2,534.9
----------------------------------------------------------------------------------------------------------------
The bottom 80% of taxpaying units hold few, if any, public debt assets
in the form of Treasury Bonds or Securities or in accounts holding such
assets and only take home one-third of adjusted gross income. Their
main national debt assets are held on their behalf by the government.
They are owed more debt than they owe through taxes. The next 10% (the
middle class), hold more in terms of long term investments and mutual
fund and bond assets. They hold a bit under a fifth of social insurance
assets.
The top 10% pay more than half of income taxes (the dividing line is
about 97.5%--and has been for a while). Asset shares within the top 10%
are estimated using the same breakdown as the entire population, that
is, the top 1% hold 54% of Federal Reserve and Long Term Investment
Assets and 77% of mutual funds and bonds as held by the top 10%. A
similar fraction is used to estimate holdings by the top 0.01%--which
is consistent with how much income they receive (note that I did not
say earn).
This illustration shows who benefits the most from having a national
debt, therefore who has the most to lose through default. The relative
shares of debt ownership, however, are current as reflected in the 2019
Federal Reserve Survey. The 2022 Survey has been released and
adjustments will be made accordingly.
______
Statement Submitted by Anand Desai
Thank you for monitoring the body of tax law and how it is actually
applying to look out for individuals and our country's financial well-
being.
Please consider whether the following issues along the lines of
your hearing are fair and appropriate:
1. Zeroed-out GRATs. Section 7520 of the Internal Revenue Code
provides for the Treasury and the IRS to prescribe interest rate based
valuation tables regarding interests in for instance trusts. This
seemingly innocuous simplification is widely used to transfer assets
net of an annuity-like return that would roughly exhaust them if they
were placed in stable, low-risk investments, but which leaves a lot
over if riskier investments like (for a simple example) a stock
portfolio does well. This is commonly repeated until the ups and downs
of the market wring out most of the value of a potentially vast fortune
to the next generation with allegedly little or no tax cost. See, e.g.,
``GRAT Strategy Comparison: How Do the Returns Stack Up?'', Valur
Library.\1\
---------------------------------------------------------------------------
\1\ https://learn.valur.io/grat-comparison/.
Treasury Regulation (26 CFR) 1.7520-3 contains an anti-abuse rule
prohibiting the use of a standard actuarial table for an annuity
measured by the life of someone who is terminally ill. Why shouldn't
the regulations prohibit taking the annuity formula to the zeroed-out
GRAT's unreasonable extreme more generally? The fact of a creditor's
interest not being worth its face value unless there is additional
capital involved to absorb normal ownership risk is obvious to anyone
---------------------------------------------------------------------------
saving for a down payment.
Whatever one thinks of the estate tax overall, it's hard to see
how accommodating that scheme furthers any individual, family,
business, or public-policy goal.
2. State and local tax deduction ``workarounds''. Administrative
guidance has been described as providing a ``workaround'' for the 2017
Tax Cuts and Jobs Act's limit on federal deductions for state and local
taxes. See ``Federal implications of pass-through entity tax
elections'', The Tax Adviser.\2\
---------------------------------------------------------------------------
\2\ https://www.thetaxadviser.com/issues/2022/nov/federal-
implications-passthrough-entity-tax-elections.html.
Whatever one thinks of the SALT deduction (I think it's a good
one, in the interest of federalism, as reflecting a sort of collective
charitable donation, and because foreign taxes even by our rivals are
generally creditable), extra-favorable treatment for taxpayers with
enough clout to ask for their income in the form of a business payment
seems unfair. Plus benefits for a substitute tax seem at odds with the
basic federal income tax judicial principle of substance over form and
principles from the foreign tax credit regime to ensure what the
federal system defers to are actually taxes, actually on income, and
---------------------------------------------------------------------------
actually on the person for whom claimed.
Moreover, generosity on a recently controversial ``revenue
raiser'' suggests concern about whether Congress (and particularly the
House's) role in tax rules is receiving proper weight and whether
Congress' internal rules about budget impact of legislation are working
as intended.
3. ``Carried interest'' in tax-favored retirement accounts.
Carried interest commonly refers to a manager's profit's interest in an
investment fund, which whose receipt is administratively deemed to not
be a taxable event under certain circumstances. See Rev. Proc. 93-27.
The GAO's October 2014 report to your Committee about ``Individual
Retirement Accounts''\3\ suggests that carried interest is being used
to stuff in returns that are disproportionate to invested capital (and
thus would seem to have true value far exceeding the contribution
limits Congress set to tax-favor only what might correspond to
reasonable retirement savings). Shouldn't this be investigated and
clearly addressed, at least as a valuation issue or with bright-line
rules?
---------------------------------------------------------------------------
\3\ https://www.gao.gov/assets/gao-15-16.pdf.
4. Section 7704, with significant exceptions, treats a publicly
traded partnership as a corporation. A corporation has an extra layer
of tax. But in recent decades many ``companies'' can elect not to be
taxed as ``corporations.'' See Treas. Reg. 301.7701-1 et seq. The
result seems to be to systematically increase taxes on those of us who
need to join with other investors through the stock markets to finance
our companies (or prefer to because they are a very efficient way to
allocate capital). Even if more-centralized taxation of business
entities with diversified ownership made sense originally, does it
still? Consider the recent ``centralized partnership audit regime'',
the Supreme Court's ``Wayfair'' case recognizing technological advances
in tax administration, and tax disadvantages (now perhaps less severe)
of having set up as a ``U.S. corporation.''\4\
---------------------------------------------------------------------------
\4\ See ``Nationalities of Convenience,'' Institutional Investor,
February 2002, https://www.institutionalinvestor.com/article/
2btgiowdmfyg7ialal98g/home/nationalities-of-convenience.
Former Intel Corp. tax chief Robert Perlman got himself into hot
water two years ago when he told the Senate Finance Committee: ``If I
had known at Intel's founding [in 1968] what I know today about the
international tax rules, I would have advised that the parent company
be established outside the U.S. Our tax code competitively
disadvantages multinationals simply because the parent is a U.S.
corporation.'' When Perlman suggested the company could have set up
shop in the Cayman Islands, New York's then-senator Daniel Patrick
Moynihan, a former ambassador to India and the United Nations,
upbraided the Intel executive, asking Perlman if he expected the
Marines to show up in the Caymans in case of trouble. Says an
unrepentant Perlman, ``I should have said `Ireland.' ''
______
National Women's Law Center
1350 I Street, NW, Suite 700
Washington, DC 20005
202-588-5180
https://nwlc.org/
Dear Chairman Wyden and Ranking Member Crapo, the National Women's Law
Center (``the Center'') commends the Committee for holding this
important hearing on the ways the tax code allows the very wealthy to
pay less than their fair share of taxes and submits this statement for
the record to highlight the ways this unfairness exacerbates gender and
racial inequity. Policy changes that would correct the weaknesses in
taxation of the wealthy identified by the witnesses at the hearing
would both address the gender and racial wealth gap and provide
significant revenue that could be invested to help women and families
thrive.
I. The gender and racial wealth gap measures inequity in
economic security for women and women of color,
driven by systemic discrimination
According to data collected in the 2019 Survey of Consumer Finances,
for every one dollar of wealth owned by a single white man, single
Black women and Latinas own approximately nine cents.\1\ Calculated at
the median, in 2019, single white men owned $92,300 in wealth, single
Black women owned $8,200, and single Latinas owned $7,900.\2\ Historic
and ongoing systemic discrimination drives these disparities. Women,
particularly women of color, continue to be underpaid for their
work.\3\ Women are also overrepresented in the low-paid workforce,
making up nearly two-thirds of those in the 40 lowest-paying jobs.\4\
Because of a lack of systemic investment in child care, paid family and
medical leave, and care for aging and disabled people, women also
disproportionately undertake unpaid caregiving responsibilities in the
home and predominate in the underpaid child care workforce.\5\ Women
therefore are less likely to have spare income to set aside in wealth
building opportunities such as 401(k) accounts,\6\ if they even work in
jobs that offer such benefits. Many other factors such as barriers to
homeownership,\7\ workplace harassment,\8\ discrimination in education
\9\ and more drive wealth disparities. Rather than working to
ameliorate such barriers, the tax code instead further entrenches and
compounds them.
---------------------------------------------------------------------------
\1\ Mariko Chang, Ana Hernandez Kent, and Heather McCulloch,
``Understanding the Gender Wealth Gap, and Why it Matters,'' in The
Future of Building Wealth: Brief Essays on the Best Ideas to Build
Wealth--For Everyone, ed. Ray Boshara and Ida Rademacher. (Aspen
Institute, 2021) 53-59, https://live-future-of-building-
wealth.pantheonsite.io/wp-content/uploads/2021/09/Sec1-Ch5-Chang-Kent-
McCulloch.pdf.
\2\ Id. at 57.
\3\ Brooke LePage and Jasmine Tucker, National Women's Law Center,
``A Window Into the Wage Gap: What's Behind It and How to Close It''
(January 2023), https://nwlc.org/wp-content/uploads/2023/01/2022-Wage-
Gap-Factsheet-1.10.23v2.pdf.
\4\ Jasmine Tucker and Julie Vogtman, National Women's Law Center,
``When Hard Work is Not Enough: Women in Low-Paid Jobs'' (April 2020),
https://nwlc.org/wp-content/uploads/2020/04/Women-in-Low-Paid-Jobs-
report_pp04-FINAL4.2.pdf.
\5\ Amy Royce and Amy Matsui, ``Unsupported: Underinvestment in the
Care Economy Drives Gender and Racial Wealth Gaps,'' Human Rights,
January 6, 2023, https://www.americanbar.
org/groups/crsj/publications/human_rights_magazine_home/wealth-
disparities-in-civil-rights/unsupported/; Josephine Kalipeni and Julie
Kashen, ``Building Our Care Infrastructure for Equity, Economic
Recovery and Beyond'' (September 2020), https://caringacross.org/
carepaper/; National Women's Law Center, ``Early Educators' Wage Growth
Lagged Behind Other Low-Paid Occupations, Jeopardizing the Supply of
Child Care as Relief Dollars Expire'' (July 2023), https://nwlc.org/wp-
content/uploads/2023/07/ChildCareDollarsFS.pdf.
\6\ Robert Paul Hartley, Ajay Chaudry, Melissa Boteach, Estelle
Mitchell, and Kathryn Menefee, National Women's Law Center, Center on
Poverty & Social Policy, ``A Lifetime's Worth of Benefits: The Effects
of Affordable, High-quality Child Care on Family Income, the Gender
Earnings Gap, and Women's Retirement Security'' (March 2021), https://
nwlc.org/wp-content/uploads/2021/04/A-Lifetimes-Worth-of-Benefits-
Compliant.pdf.
\7\ Sarah Javaid and Talia Grossman, ``Homeownership--A Pathway to
Wealth Building--Is Still Out of Reach for Many Women of Color''
(November 2023), https://nwlc.org/wp-content/uploads/2023/11/
2023_NWLC_Homeowner_Brief_Accessible.pdf.
\8\ National Women's Law Center, ``Comment on Proposed Enforcement
Guidance on Harassment in the Workplace Docket Number EEOC-2023-0005''
(November 2023), https://nwlc.org/wp-content/uploads/2023/11/NWLC-
Comment-on-EEOC-Proposed-Enforcement-Guidance-on-Workplace-
Harassment.pdf.
\9\ National Coalition on Women and Girls in Education, ``Title IX
at 50'' (June 2022), https://nwlc.org/wp-content/uploads/2022/06/NCWGE-
Title-IX-At-50-6.2.22-vF.pdf.
---------------------------------------------------------------------------
II. Specific aspects of the tax code lock in wealth
disparities, thereby exacerbating rather than
mitigating gender and racial inequities
The testimony at the hearing laid out ways the tax code preferences
income from wealth compared to income from work, allowing it to be
taxed at lower rates or to sometimes go untaxed altogether. Taken
together, these preferences for wealth mean those who are already
wealthy are positioned to maintain and grow their wealth, locking in
wealth disparities by gender and race. Further, specific preferences
disproportionately benefit men and white households.
For example, families of color and women are less likely to benefit
from tax preferences for capital gains. Taxation of capital gains at a
lower rate than wage income disproportionately benefits white
households, who are more likely to own investments. One analysis found
that while white households comprise 65% of all households, they own
almost 90% of corporate stock and private business.\10\ Moreover, women
are less likely to hold highly-paid jobs that offer investment-based
compensation \11\ and when surveyed, women have also reported being
less likely to invest in the stock market than men.\12\
---------------------------------------------------------------------------
\10\ Joe Hughes and Emma Sifre, Institution on Taxation and
Economic Policy, ``Investment Income and Racial Inequality'' (October
2021), https://itep.org/investment-income-and-racial-inequality/.
\11\ Alisha Haridasani Gupta, ``Surprise: Women and Minorities are
Underrepresented in Corporate Board Rooms,'' New York Times, October
12, 2021, https://www.nytimes.com/2021/06/07/us/women-minorities-
underrepresented-corporate-boardrooms.html.
\12\ Erin El Issa, ``Survey: Less Than Half of Women in U.S. Invest
in the Stock Market,'' Nerdwallet, September 1, 2021, https://
www.nerdwallet.com/article/investing/survey-less-than-half-of-women-in-
u-s-invest-in-the-stock-market.
When wealth is passed down to the next generation, these and other tax
preferences further compound largely to the benefit of white
households. As detailed in testimony, the step-up in basis wipes out
capital gains for tax purposes, and weaknesses in the estate tax do not
allow it to serve as an effective backstop. The number of estates
subject to the estate tax has plummeted to less than 2,000 per year, or
less than one-tenth of 1 percent of all estates (0.07%), due to
continuing increases in the exemption amount, most recently in the 2017
tax law.\13\ Well-known loopholes such as the use of trusts further
limit the reach of the estate tax.\14\ As economist Janelle Jones
notes, ``White families are twice as likely to receive an inheritance
as Black families, and that inheritance is nearly three times as
much.''\15\ Black families are also more likely to have to support
parents and older relatives rather than receiving financial support or
inheriting wealth from them.\16\ Thus, households of color are
generally locked out of tax preferences for inherited wealth.\17\
---------------------------------------------------------------------------
\13\ Tax Policy Center, ``Briefing Book: How many people pay the
estate tax?'' (May 2020), https://www.taxpolicycenter.org/briefing-
book/how-many-people-pay-estate-tax.
\14\ Bob Lord, Americans for Tax Fairness, ``Dynasty Trusts: Giant
Tax Loopholes that Supercharge Wealth Accumulation'' (February 2022),
https://americansfortaxfairness.org/wp-content/uploads/DT-PRINT-
2.2.pdf.
\15\ Janelle Jones, Economic Policy Institute, ``Receiving an
Inheritance Helps White Families More than Black Families,'' February
17, 2017, https://www.epi.org/publication/receiving-an-inheritance-
helps-white-families-more-than-black-families/.
\16\ Dorothy A. Brown, The Whiteness of Wealth (New York: Crown,
2021), 182-185.
\17\ Dorothy A. Brown, ``Congress is passing up a chance to close a
tax loophole--and the racial wealth gap,'' Washington Post, September
16, 2021, https://www.washingtonpost.com/outlook/2021/09/16/stepped-up-
basis-race/.
Testimony also highlighted the ways the very wealthy are able to fund
extravagant lifestyles while structuring their portfolios to avoid
taxation (known as ``buy, borrow, die''), making taxation at certain
levels of wealth essentially optional.\18\ Because wealth itself is
outside the tax system, which only reaches gains on wealth, these large
fortunes are considered outside the tax base.\19\ This generally inures
to the benefit of families that are wealthy and white. Because women
supporting families on their own and households of color are
underrepresented in higher income brackets, it is unsurprising that
they are underrepresented among the very wealthiest. One measure of the
gender and racial makeup of those at the very top can be seen in the
Forbes 400 list, which as of 2021 counted only two Black men and no
Black women.\20\ Even Black families in the top 10% by income have much
less wealth than white families at the same income level: median net
worth for white families at this income level is $1,789,300 while only
$343,160 for Black families.\21\
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\18\ Steve Wamhoff, Institution on Taxation and Economic Policy,
``Billionaires Should Pay Taxes on Their Income Every Year Like the
Rest of Us'' (September 2022), https://itep.org/billionaires-should-
pay-taxes-on-their-income-every-year-like-the-rest-of-us/.
\19\ Lily Batchelder and David Kamin, ``Taxing the Rich: Issues and
Options'' (September 11, 2019), https://papers.ssrn.com/sol3/
papers.cfm?abstract_id=3452274.
\20\ Nigel Roberts, ``Only Two Black People Made Forbes List of the
400 Richest Americans,'' BET, October 14, 2021, https://www.bet.com/
article/e8q6yp/only-two-black-people-on-forbes-richest-americans-list.
\21\ Kriston McIntosh, Emily Moss, Ryan Nunn, and Jay Shambaugh,
Brookings, ``Examining the Black-white Wealth Gap,'' (February 27,
2020), https://www.brookings.edu/blog/up-front/2020/02/27/examining-
the-black-white-wealth-gap/.
Wealthy and white families benefit not only from these, and multiple
other preferences in the tax code, but also from underfunded
enforcement. Deep cuts to the IRS budget have allowed audit rates to
fall dramatically, limiting enforcement on wealthy filers.\22\ This
underfunding subsidized people who do not follow the law, such as the
1.4 million wealthy people who did not file a tax return at all between
2017 and 2020.\23\ Wealthy people can avoid, or even evade, paying what
they owe when the IRS is overmatched by the tax lawyers and accountants
they employ.\24\ While audit rates at the top have plummeted, low-
income filers who claim the Earned Income Tax Credit are as likely to
be audited as families making up to a million dollars a year in
income.\25\ Women supporting families on their own and households of
color are underrepresented among high-income taxpayers who evade taxes,
but they are overrepresented in the lower-income brackets.\26\ It is no
surprise that those at the top have seen their wealth grow, depriving
the government and ordinary citizens of needed revenue and further
fueling wealth disparities.\27\
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\22\ Jeff Ernsthausen, ``IRS Strategic Plan Vows to Amp Up Audits
of the Rich,'' ProPublica, April 7, 2023, https://www.propublica.org/
article/irs-strategic-plan-wealth-tax-dodgers; U.S. Government
Accountability Office, ``Tax Compliance: Trends of IRS Audit Rates and
Results for Individual Taxpayers by Income'' (May 17, 2022), https://
www.gao.gov/products/gao-22-104960.
\23\ Senator Ron Wyden, Chairman, Senate Committee on Finance,
Letter to Commissioner Danny Werfel, Internal Revenue Service,
September 28, 2023, https://www.washingtonpost.
com/documents/df4c32e7-1c29-438d-8395-
180649f44f07.pdf?itid=lk_inline_manual_5.
\24\ Natasha Sarin, U.S. Department of the Treasury, ``The Case for
a Robust Attack on the Tax Gap'' (September 7, 2021), https://
home.treasury.gov/news/featured-stories/the-case-for-a-robust-attack-
on-the-tax-gap.
\25\ Paul Kiel and Jesse Eisinger, ``Who's More Likely to Be
Audited: A Person Making $20,000--or $400,000?,'' ProPublica, December
12, 2018, https://www.propublica.org/article/earned-income-tax-credit-
irs-audit-working-poor.
\26\ Married couples are over 4 times more likely than male-headed
households and nearly 1.8 times more likely than female-headed
households to have income in the top quintile. United States Census
Bureau, ``2021 Current Population Survey Household Income Table: HINC-
05, Percent Distribution of Households, by Selected Characteristics
Within Income Quintile and Top 5 Percent in 2020'' (2021), https://
www.census.gov/data/tables/2021/demo/cps/hinc-05.html. In 2019, white-
headed households were disproportionately in higher income quintiles
(while Black- and Latinx-headed households were disproportionately in
the lower income quintiles). Congressional Research Service, ``The U.S.
Income Distribution: Trends and Issues'' (updated January 13, 2021),
https://sgp.fas.org/crs/misc/R44705.pdf.
\27\ Oxfam International, ``Inequality and Poverty: The Hidden
Costs of Tax Dodging, https://www.oxfam.org/en/inequality-and-poverty-
hidden-costs-tax-dodging.
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III. Tax preferences for wealth deprive us of revenue for
needed investments in women and families, which
themselves would help women thrive, shrink the
wealth gap, and grow the economy
Correcting the tax preferences for wealth outlined above would yield
significant federal revenue, which could be used to invest in women and
families.\28\ Allowing the preferences for wealth to continue instead
drives increases in federal deficits, constraining the fiscal space for
investments. At the minimum, tax cuts passed in 2017 in the Tax Cuts
and Jobs Act that benefited the wealthiest households should not be
extended.\29\ These tax cuts have contributed significantly to the
federal revenue shortfall, growing the debt-to-GDP ratio of primary
concern to many lawmakers.\30\
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\28\ Amy Royce and Amy Matsui, National Women's Law Center,
``Taxing the Rich Will Make the Tax Code More Equitable and Support
Investments in Women and Families,'' (April 2023), https://nwlc.org/wp-
content/uploads/2023/03/UPDATED-APRIL-2023_nwlc_RevenueRaisers.
pdf.
\29\ William G. Gale, Brookings, ``A fixable mistake: The Tax Cuts
and Jobs Act'' (September 25, 2019), https://www.brookings.edu/
articles/a-fixable-mistake-the-tax-cuts-and-jobs-act/.
\30\ Bobby Kogan, Center for American Progress, ``Tax Cuts Are
Primarily Responsible for the Increasing Debt Ratio'' (March 27, 2023),
https://www.americanprogress.org/article/tax-cuts-are-primarily-
responsible-for-the-increasing-debt-ratio/.
Additional changes to the tax code are needed, however, to further
progressivity and support robust public investments that are long
overdue. For example, raising the capital gains rate to match the top
rate for labor income and closing the stepped-up basis loophole (the
primary driver of the ``buy, borrow, die'' strategy), is estimated to
raise $214 billion over 10 years.\31\ Similarly, Chairman Wyden's
proposed Billionaire's Income Tax, a tax on income from wealth as it is
earned (and used to buy real assets in the economy while not being
taxed) could yield $557 billion in federal revenue.\32\ An annual tax
on wealth itself is estimated to raise $1.9-$3.3 trillion over 10
years.\33\ Strengthening the estate tax could raise up to $430 billion
over 10 years,\34\ and even modest reforms, to return to 2009 levels,
are estimated to yield $189 billion.\35\
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\31\ ``General Explanations of the Administration's Fiscal Year
2024 Revenue Proposals'' (U.S. Department of the Treasury, March 2023),
https://home.treasury.gov/system/files/131/General-Explanations-
FY2024.pdf, p. 214.
\32\ U.S. Senate Committee on Finance, ``Wyden Statement on
Billionaires Income Tax Score,'' November 5, 2021, https://
www.finance.senate.gov/chairmans-news/wyden-statement-on-billionaires-
income-tax-score.
\33\ Batchelder and Kamin, ``Taxing the Rich: Issues and Options,''
p. 33.
\34\ ``Revenue estimate of the `For the 99.5 Percent Act,' ''
(Joint Committee on Taxation, March 24, 2021), https://
www.sanders.senate.gov/wp-content/uploads/For-the-99.5-Act-JCT-
Score.pdf.
\35\ ``Recent Changes in the Estate and Gift Tax Provisions''
(Congressional Research Service, October 19, 2021) https://sgp.fas.org/
crs/misc/R42959.pdf, p. 7.
Finally, fully funding IRS enforcement for wealthy filers would drive a
tremendous return on investment. Recent research found that every
dollar invested in high-
income audits translated to more than $12 in revenue,\36\ and it is
estimated that implementing the Inflation Reduction Act's $80 billion
in IRS funding would lead to at least $480 billion in additional taxes
collected over 10 years.\37\ This funding is already working: As of
October 2023, the Internal Revenue Service has collected $160 million
in back taxes in 2023 by enforcing against millionaires who haven't
paid what they owe.\38\ Recent rescissions to this funding should be
undone, and additional stable funding is needed.\39\
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\36\ Will Boning, Nathaniel Hendren, Ben Sprung-Keyser, and Ellen
Stuart, ``A Welfare Analysis of Tax Audits Across the Income
Distribution,'' Policy Impacts (June 14, 2023) https://
policyimpacts.org/research/67/a-welfare-analysis-of-tax-audits-across-
the-income-distribution.
\37\ Natasha Sarin and Mark J. Mazur, ``The Inflation Reduction
Act's Impact on Tax Compliance--and Fiscal Sustainability'' (May 21,
2023), https://papers.ssrn.com/sol3/papers.cfm?
abstract_id=4449161.
\38\ Internal Revenue Service, ``IRS launches new initiatives using
Inflation Reduction Act funding to ensure large corporations pay taxes
owed; continues to improve service and modernize technology with launch
of business tax account'' (October 20, 2023), https://www.irs.gov/
newsroom/irs-launches-new-initiatives-using-inflation-reduction-act-
funding-to-ensure-large-corporations-pay-taxes-owed-continues-to-
improve-service-and-modernize-technology-with-launch-of-business-tax-
account.
\39\ Chuck Marr, Samantha Jacoby, and Jabari Cook, Center on Budget
and Policy Priorities, ``Success of the IRS Rebuilding and Tax Gap
Reduction Effort Depends on Sufficient Funding Through Annual
Appropriations'' (December 7, 2022), https://www.cbpp.org/sites/
default/files/12-1-22tax.pdf; Kimberly A. Clausing and Natasha Sarin,
``The coming fiscal cliff: A blueprint for tax reform in 2025,'' The
Hamilton Project and Brookings (September 2023), https://
www.brookings.edu/wp-content/uploads/2023/09/
20230927_THP_SarinClausing_FullPaper_
Tax.pdf.
The revenue from more equitably taxing the wealthy and ensuring they
pay what they owe could be used for investments that support the health
and well-being of women and families, and enable women and people of
color to succeed in our economy. In addition to investments in the care
economy described above, additional revenues could support robust
public investments in policies such as the expanded Child Tax Credit,
which raised millions out of poverty in 2021, including 1 million Black
women, Latinas, and Asian women,\40\ other refundable tax credits for
women and families, and affordable and accessible housing. The path to
an economy that works for everyone includes raising revenue in a
progressive manner. It requires rejecting tax preferences for
billionaires and advancing policies that invest in women, families and
all of us.
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\40\ Sarah Hassmer, Amy Matsui, Kat Menefee, and Shengwei Sun, ``By
the Numbers: Data on Key Programs for the Well-Being of Women & Their
Families'' (May 2023), https://nwlc.org/resource/by-the-numbers-data-
on-key-programs-for-the-well-being-of-women-lgbtq-people-and-their-
families/.
The Center appreciates the opportunity to submit this written statement
for the record. Should you have any questions, please do not hesitate
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to contact Amy Royce, Senior Counsel, at [email protected].
______
Patriotic Millionaires
1629 K St., NW, Suite 300
Washington, DC 20006
https://patrioticmillionaires.org/
Statement of Bob Lord, Senior Advisor, Tax Policy
Chairman Wyden and Ranking Member Crapo, I'm submitting this statement
for the record in connection with the hearing held by the Senate
Finance Committee on ``Examining How the Tax Code Affects High-Income
Individuals and Tax Planning Strategies.''
I currently serve as Senior Advisor on tax policy for the Patriotic
Millionaires and as an Associate Fellow at the Institute for Policy
Studies. For the better part of the 4 decades between my graduation
from law school and joining the Patriotic Millionaires' staff last
year, I practiced tax law. In my practice I advised taxpayers in income
and estate tax planning and represented them in tax controversies. I
represented the taxpayers in Sacks v. Commissioner, 69 F.3d 982 (9th
Cir. 1995), a case involving a tax-advantaged transaction, which set
the standard in the Ninth Circuit for the determination of economic
substance.
From my career as a tax lawyer, and since then as an advocate for
fairer federal tax policy, I've come to believe our tax system is
fundamentally broken. The consequence of that broken system is an
extreme concentration of wealth that has resulted in a democracy-
threatening concentration of political power, together with social
instability. The problem is existential.
When I say our current tax system is broken, I'm referring to four
fundamental flaws, all of which work to the advantage of the ultra-
rich: First, our tax system lacks a reliable, working mechanism to
constrain the concentration of American wealth in the hands of the
ultra-rich. Second, our income tax law favors income from wealth over
income from work and further favors the income from work flowing to the
wealthy over income from work flowing to average Americans. Third, our
income tax law is riddled with loopholes, which not only facilitate
legal tax avoidance, but also give rise to abusive tax shelters.
Fourth, our system of tax enforcement is failing to address systematic
tax avoidance by the ultra-rich.
The Lack of a Reliable Working Mechanism to Constrain Wealth
Concentration. American wealth is more concentrated in the hands of the
ultra-wealthy than at any time since the Gilded Age. We see this play
out in the news on virtually a daily basis. For example, while enormous
media attention has been devoted over the past week to intense debate
over how a country of 330 million people might fund a $14.3 billion
foreign aid package, there are over 40 Americans who each have the
capacity to fund such an aid package entirely from their personal
fortunes.
The extreme concentration of wealth in America is the result of policy
failures in multiple areas; antitrust, labor, and intellectual property
law to name a few. But the role of tax policy is unique on this front.
Our tax system is the last line of defense--the firewall if you will--
against undue wealth concentration, and it is obvious why it hasn't
provided that defense: it lacks a reliable, working mechanism to do so.
Wealth concentration occurs when the rate at which the rich grow their
wealth is greater than the rate at which the country's total household
wealth grows. Absent taxation, that situation is bound to be the norm.
Besides the obvious advantage of being able to make lucrative
investments the rest of us lack the capital to make, the wealthy also
are not required to consume the bulk of their income on living
expenses.
Consequently, a well-functioning tax system should have a mechanism
that reliably reduces the after-tax rate at which the wealth of the
richest Americans grows to a rate no greater than the rate at which the
country's total household wealth grows. That mechanism would require
one or more of three bases for taxation: a tax on true economic income,
including unrealized gains, a tax on extreme wealth, or a tax on the
intergenerational transfer of extreme wealth.
Currently, our tax system contains one of those three mechanisms: a tax
on the intergenerational transfer of wealth, as embodied in our estate,
gift, and generation-skipping tax system. But through what has become
commonplace planning for the ultra-rich, that tax is entirely
avoidable, even by the nation's billionaires. Five or 6 years ago,
Chairman Wyden's office published a white paper outlining the various
strategies through which the ultra-rich are massively avoiding estate,
gift and generation-skipping taxation and bills have been introduced in
both chambers to address the systematic avoidance of wealth transfer
taxation, but to date, no meaningful action has been taken.
Unfortunately, we've waited too long. Even if our system of wealth
transfer taxation were reformed tomorrow, decades would pass before
America's dynastic wealth, much of which has been lodged in so-called
dynasty trusts, would be subject to meaningful levels of taxation. We
can't wait that long. Consequently, although the restoration of a
functional, robust wealth transfer tax system would be a welcome
development, constraining undue wealth concentration in America within
a reasonable timeframe will require us to implement one or both of the
other possible mechanisms for doing so: a tax on true economic income
or a tax on extreme wealth.
Members of this committee and other members of Congress have made
proposals to use each of those other reliable mechanisms to constrain
wealth concentration. Chairman Wyden has proposed a system of mark-to-
market taxation for the ultra-rich, which, together with the current
income tax system, would function to tax the economic income of the
ultra-rich. Senator Warren has proposed a wealth tax for the ultra-
rich, the Ultra Millionaire tax. Hopefully, one or both of those
proposals will receive serious consideration in the near future.
A Tax System That Favors Wealth Over Work (and Income from Work that
Flows to the Wealthy). As my Institute for Policy Studies colleague,
Sam Pizzigati, and I have written, our income tax code has increasingly
favored wealth over work.\1\ The most vivid example of this evolution
is the complete reversal of the respective treatment of income from
work and dividend income. Prior to 1981, income from work, ``earned
income'' under the tax code, was subject to a maximum federal tax rate
of 50 percent, while dividend income could be taxed at a rate as high
as 70 percent. Today, dividend income is subject to a maximum income
tax rate of 20 percent, while income from work can be taxed at a rate
as high as 37 percent.
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\1\ See, Lord, Bob, and Pizzigati, Sam, Trump Tax Plan Taunts the
Dignity of Labor (Dallas Morning News, November 8, 2017), https://
www.dallasnews.com/opinion/commentary/2017/11/08/trump-tax-plan-taunts-
the-dignity-of-labor/ (accessed Nov. 1, 2023); Lord, Bob, and
Pizzigati, Sam, A tax system that targets workers (Los Angeles Times,
June 20, 2013, https://www.latimes.com/opinion/la-xpm-2013-jun-20-la-
oe-pizzigati-tax-system-20130620-story.html (accessed Nov. 1, 2013)
The greatest preference of wealth over work in the tax law is of course
the treatment of long-term capital gains. Beyond the preferential
rates, capital gains are not taxed until the time of sale, which means
for the extremely wealthy, payment of tax becomes flexible. They can
take out low-interest loans that aren't available to the average
American to fund their living expenses, hold appreciated assets
indefinitely, and die with millions or even billions in assets that
have never been taxed. Upon their death, the unrealized gains in those
assets, often reflecting decades of appreciation, are zeroed out for
tax purposes. In the case of the wealthiest Americans, one hundred
billion dollars of gains could potentially escape income taxation on
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their deaths.
Beginning in 2018, an additional preference was added to the tax code:
the deduction under Code Section 199A for so-called pass-through
income; that is, income received through sole proprietorships,
partnerships, limited liability companies and Subchapter S
corporations. This new preference allows many wealthy Americans to
effectively pay no income tax on 20 percent of their income. As
ProPublica has reported, this has conferred enormous windfalls on many
of America's billionaires, including Michael Bloomberg and Dick and Liz
Uihlein.\2\ In some cases, wealthy Americans took enormous cuts in
their compensation paid through their businesses, causing a
commensurate increase in their pass-through income, along with a
deduction of 20 percent of that income.\3\
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\2\ See, Secret IRS Files Reveal How Much the Ultra-Wealthy Gained
by Shaping Trump's ``Big, Beautiful Tax Cut (ProPublica, August 11,
2021), https://www.propublica.org/article/secret-irs-files-reveal-how-
much-the-ultrawealthy-gained-by-shaping-trumps-big-beautiful-tax-cut
(accessed Nov. 1, 2023)
\3\ See, How the Trump Tax Law Created a Loophole That Lets Top
Executives Net Millions by Slashing Their Own Salaries (ProPublica,
August 19, 2021), https://www.propublica.org/article/how-the-trump-tax-
law-created-a-loophole-that-lets-top-executives-net-millions-by-
slashing-their-own-salaries (accessed Nov. 1, 2023)
Corporate income also is income from wealth. It is now taxed at a
maximum rate of 21 percent, the lowest maximum corporate tax rate since
1939. The effective rate of tax of many of America's largest
corporations, however, is well below ten percent and, in some cases,
---------------------------------------------------------------------------
zero.
Further, income from wealth, whether in the form of interest income,
rent, dividends, capital gains, or royalties, largely is exempt from
social security taxes. As the portion of wages subject to social
security tax has increased over the past 4 decades, the portion of
income from wealth that is subject to social security tax has remained
at the same level--zero.
Even the wealthy people who earn most of their income from work don't
experience a truly progressive tax code. Our top tax bracket for a
married couple filing jointly, 37 percent, starts at a little under
$700,000. That's a significant income, putting the household near the
top 1 percent of all American incomes. But it's a far cry from a $7
million or $70 million income, both of which are subject to the same
maximum rate of 37 percent. And that couple earning $700,000 in
compensation does pay social security tax on a substantial portion of
their income. Inversely, the burden of social security tax for a couple
making $70 million is negligible (well under one-tenth of 1 percent of
income). More significantly, when living expenses are taken into
account, the ability of a couple with $70 million in income to
accumulate wealth dwarfs that of the couple making $700,000. Under the
structure of income tax brackets like those that applied throughout the
3 decades preceding the Economic Recovery Tax Act of 1981, a couple
receiving $70 million of income would pay a substantially higher
maximum rate of income tax than one earning $700,000. Although many
factors impact the concentration of wealth in America, it is worth
noting that 1982, the year the Economic Recovery Tax Act of 1981 took
effect, is precisely when the concentration of wealth in America began
to skyrocket.
A System Rife with Legal and Abusive Tax Avoidance. Our income tax
system is riddled with loopholes. Some of them are obvious. One example
is how the rules for like-kind exchanges of real estate allow for the
systematic avoidance of gain from the sale of real estate as long as
the proceeds are reinvested. This enables the ``swap till you drop''
strategy employed by wealthy real estate investors. If they reinvest
the proceeds each time they sell real property, then, eventually, upon
their death, the unrecognized gains are excused from taxation. Another
example is how the rules governing the depreciation of real property
allow for deductions from income tax where no economic depreciation has
taken place. In the same vein, the rules allowing the amortization of
intangible assets for income tax purposes when those assets typically
are appreciating in value allow billionaire sports team owners to
shelter huge sums of income from taxation. Moreover, the deductions for
both amortization of intangible assets and depreciation of real
property are not subject to recapture upon death. That allows the
inheritor of a sports team or an office building to claim the same
amortization or depreciation deductions all over again. The list goes
on and on, and often these loopholes compound their effects over time.
The rules that favor income from wealth over income from work often
double as tax loopholes. Perhaps the most egregious example is the so-
called carried interest loophole, which allows investment managers to
pay tax at capital gains rates on the compensation they receive from
their investors and to defer payment of tax on that compensation until
the underlying assets are sold.
More generally, the line between income from wealth and income from
work is often blurry, which allows the capital gains preference and
other preferences to serve as loopholes. Take for example real estate
professionals. The gain from the sale of raw land is clearly capital
gain, while the sale of completed houses by homebuilders is clearly
ordinary income from the operation of a business. But those are the
endpoints of a vast continuum, which allows for structuring, sometimes
aggressive structuring, of real estate activities to maximize the
income that is taxed at capital gains rates. For example, the owner of
raw land might take the necessary steps to obtain a favorable change in
zoning, and then sell the property at a gain to a development entity in
which he has an ownership interest. The owner might take it a step
further and submit a plat map for approval before selling. Where along
the continuum the owner's gains become subject to tax at ordinary rates
is far from clear, and tax professionals take advantage of that lack of
clarity. Put another way, tax avoidance planners work in the gray
areas, and the preferences afforded to income from wealth give rise to
an infinite number of gray areas.
Where slight factual differences give rise to disproportionate tax
benefits, abusive tax shelters may arise. For example, the 17-
percentage-point difference between taxation at ordinary rates and
long-term capital gains rates can turn on a holding period of just one
additional day. By structuring transactions that create gains and
losses in nearly equal amounts, planners can develop strategies to
artificially offset short-term gains with losses on assets held for 365
days, while corresponding gains on assets held for 366 days are taxed
at capital gains rates. Whether such strategies will be respected for
tax purposes is rarely clear, but, as discussed below, there often is
little downside to taxpayers and their advisors in taking an aggressive
position, even when their interpretation of applicable authority is
likely incorrect.
Closing all the loopholes that are based on the long-term capital gains
rate and other preferences in the tax code would be difficult and the
solutions would be complex. Further, sophisticated tax planners
undoubtedly would develop new avoidance strategies using those
preferences. Those complex solutions would be unnecessary, however, if
Congress took the simple step of eliminating the preferences upon which
aggressive avoidance strategies are based. Put another way, if we
eliminate the preferences that confer an unfair advantage on the rich
and give rise to undesirable legal tax avoidance by the rich, much of
the illegal and borderline illegal avoidance will be eliminated as
well.
A Failure in Tax Enforcement Against the Rich. In three ways, the
system of tax enforcement in America favors the rich. First, the IRS
has been critically--and deliberately--underfunded. This precludes the
IRS from conducting audits of the rich with a thoroughness which will
deter aggressive tax avoidance and result in the collection of tax
underpayments. This underfunding has resulted in another sinister
effect: because the IRS only has the resources to conduct less labor-
intensive audits, the IRS now audits lower-income taxpayers at a higher
rate than rich taxpayers, whose accountants and tax attorneys
substantially prolong the audit process. The additional funding for
enforcement on the ultra-wealthy under the Inflation Reduction Act is
crucial to refocusing the IRS's enforcement efforts on the largest and
most pernicious component of the tax gap. It must be protected.
Second, our system for reporting tax information to the IRS doesn't
apply to the bulk of income that flows to the rich. For the vast
majority of Americans, the way the rich are taxed is far removed from
their own experience. Most people in this country make money from an
hourly or salaried job, have income and payroll taxes withheld from
each paycheck, get a W-2 at the end of the year showing the information
reported by their employer to the IRS, file their tax returns, and
either pay what they owe or receive a small refund. The rich, by
contrast, often have no information related to their tax liability
reported to the IRS. The reporting of receipts of their businesses and
the proceeds from sales of many assets are entirely voluntary, and not
subject to tax withholding. As a result, while wage earners see strong
deterrence for tax avoidance due to their income being reported to the
IRS, no analogous deterrent exists for rich business owners and
investors. Further, in one situation where considerable tax avoidance
takes place and where information reporting generally is required--
partnerships--the use of tiered structures, where the actual taxpayer
may be five or more levels of ownership removed from the entity that
produces income, has made the process of connecting reported
information to a taxpaying individual so difficult that the information
reporting is practically worthless.
Third, audits of the rich are not currently serving one of their core
purposes: deterring aggressive and abusive tax avoidance. Egregious tax
avoidance occurs because the risk of detection is minimal, and the
subsequent penalty for underpayment is negligible compared to the
financial reward of tax avoidance going undetected. In most cases,
detection on audit simply means the person being audited will pay the
tax they owe, plus a modest amount of interest. Penalties typically can
be avoided by showing that a taxpayer's reporting position, although
incorrect, was supported by substantial authority. That is extremely
difficult for average taxpayers. For rich taxpayers, however, who have
the assistance of high-powered tax professionals and who can afford
lengthy, sometimes concocted, written opinions supporting the
reasonableness of their tax reporting position at the time they file
their return, the IRS typically is willing to settle for the payment of
tax plus interest. The IRS simply does not have the resources to
litigate and risk losing many of these cases, including the substantive
tax issues involved, for the limited purpose of collecting penalties.
To remedy this situation, your committee should consider the expansion
of penalties, such as those assessable under Code Section 6707A, based
solely on the failure of the taxpayer to disclose their reporting
position to the IRS.
Section 6707A, however, as currently structured, substantially favors
ultra-rich taxpayers in its operation. The penalty under Section 6707A,
75 percent of the tax sought to be avoided through a listed
transaction, is a substantial deterrent in the case of an individual
seeking to avoid a modest amount of tax. But because the maximum
Section 6707A penalty for failing to disclose a listed translation is
$100,000, an ultra-rich taxpayer seeking to avoid, say, $10 million of
tax through a listed transaction, is not likely to be deterred, as the
penalty for non-disclosure is only 1 percent of the avoided tax.
Section 6707A should be amended to eliminate the ceilings on penalties
for both individuals and corporations.
Concluding Remarks. In closing, I note that I began my career as a tax
attorney in 1983, at the same time extreme wealth in America was
beginning to skyrocket. After spending 40 years working on tax matters
on a near-daily basis, I can attest that in a healthy and vibrant
society, tax law must function to limit economic inequality. All tax
policy proposals should be examined through that lens.
To address many of the matters I've outlined above, the Patriotic
Millionaires developed a comprehensive proposal, titled Crack the Code.
It includes both our recommendations on whether various provisions of
the 2017 Tax Cuts and Jobs Act scheduled to expire in 2025 or 2026
should be extended, and our proposals for constraining wealth
concentration, narrowing current tax loopholes, and minimizing tax
preferences that favor wealth over work. A copy of Crack the Code is
available electronically here: https://static1.squarespace.com/static/
643066008ad89d41f9a584c1/t/6439714b698938692be04a39/1681486160147/
Crack+The+Code.pdf.
Thank you.
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